Corporate annual reports risk misleading investors

Media release

1 July 2011

Underlying profit measures in corporate annual reports risk misleading investors

Financial reporting survey shows companies are trying to provide "numbers that make some sense" to investors but may fall short

The use of underlying profit measures in corporate annual reports risks misleading investors, according to a Deloitte report.

The second annual Deloitte Financial Reporting Survey shows it is common practice for large companies to use underlying profit measures in annual reports, as a device to reflect directors' views of company performance. But 25% of measures are not clearly reconciled to statutory profit, therefore running the risk of confusing investors.

The annual survey of 100 listed and other large companies with publicly available information showed 87 referred to alternative profit measures in addition to statutory profit in their 2010 annual reports.

Deloitte partner Denise Hodgkins says the practice has attracted considerable comment in the media in the past year, with many writers expressing concerns that investors were finding annual reports increasingly complicated to understand.

In total, 214 varieties of alternative profit measures were used by the companies, including earnings before interest, tax, depreciation and amortisation (EBITDA), operating profit and underlying earnings.

"The survey shows that companies are certainly trying to provide investors with numbers that make some sense and give an indication of the company's sustainable earnings, while at the same time complying with the more complex reporting standards," Ms Hodgkins says.

"However, it's not clear that the objective of providing user-friendly information is being adequately met when so many variations of measuring profit are being used, and there are variations in how these figures are conveyed and their prominence."

Ms Hodgkins says the Deloitte survey shows that when underlying profit measurements were used in an annual report, 92% of cases showed an improved result either by increasing a profit figure, turning a loss into a profit, or reducing a loss.

As such, directors should carefully consider the purpose of the measure being provided and ensure that this is explained with a clear reconciliation back to statutory profit.

"The critical factor is the extent to which the reports clearly and appropriately explain the use of alternative measures and how these relate to statutory profit in order to ensure that investors are not misled."

Directors also need to closely monitor the position of regulators, in light of the Financial Markets Authority recently taking over from the Securities Commission, and also bear in mind that the practice has come under close scrutiny in Australia.

To see the annual Deloitte Financial Reporting Survey series, go to www.deloitte.com/nz/financialreportingsurvey.

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