Let’s return to the IFRS 18 concept of management-defined performance measures.

You’ll recall that the new standard defines such a measure as ‘a subtotal of income and expenses that an entity uses in public communications outside financial statements; to communicate to users of financial statements management’s view of an aspect of the financial performance of the entity as a whole, excluding various defined items. As we addressed here, IFRIC recently received a request asking whether a performance measure that includes hypothetical income and expenses can meet the definition of a management-defined performance measure in IFRS 18; for this purpose it defined hypothetical income and expenses as income and expenses that an entity has not recognized and will never recognize in its statement of financial performance applying IFRS Accounting Standards. An example might be a measure of “net profit excluding the effects of a major crisis, such as a pandemic or a geopolitical conflict,” for which the entity estimates its income and expenses that it would have generated and incurred if that major crisis had not happened, perhaps removing some items of recognized income and expenses (which are not considered ‘hypotheticals’) but also adding estimated income and expenses (which are considered such).

The Committee tentatively concluded that a performance measure including such hypothetical income and expenses can be a subtotal of income and expenses and can faithfully represent what it purports to represent. In that case, if the measure meets all the relevant criteria in IFRS 18, then it’s a management-defined performance measure and the entity discloses the information for such measures required by the standard.

Many respondents agreed with the technical analysis while urging caution in one way or another. For example, this is from the UK’s Financial Reporting Council:

• Whilst the FRC does not object to all use of ‘hypothetical’ information in APMs, we have previously indicated that we expect entities not to present measures which attempt to depict what the entity’s financial performance would have been in the absence of a significant event (such as the Covid-19 crisis) which had, in fact, occurred. We think there is a risk that, although this is not the subject matter of the Agenda Decision, preparers might see it as opening the door to increased use of APMs containing hypothetical information, which could in turn include measures that the FRC considers problematic. We think it would be beneficial for the Agenda Decision to draw attention to the fact that ‘upstream’ decisions about what measures are appropriate to present outside the financial statements should take into account the legal and regulatory framework in the preparer’s jurisdiction.

From PwC International Limited:

• …depending on the label and description used in public communications outside of the financial statements…‘Net profit excluding the effects of a major crisis’ might not be sufficiently understandable, because without further description, it might be challenging to know what types of adjustments have or have not been made and how these adjustments were calculated.
• In those cases, an entity might be required to adjust the label or description in the financial statements to achieve faithful representation. The entity will need to provide an explanation to make a clear reconciliation between the label and description in the financial statements and those used in the public communications.

The Brazilian preparer, professor and standard-setter Patrick Matos thought that the kind of measure described above raises “serious concerns about relevance, faithful representation, neutrality, verifiability, auditability and comparability. It is, in my opinion, highly unlikely that management would be able to properly estimate what would be the economic outcomes for an entity if such events – such as a war, pandemic – had not happened.” He went on: “The Conceptual Framework requires financial information to faithfully represent economic phenomena. Faithful representation requires, to the extent possible, completeness, neutrality and freedom from error. In my opinion a counterfactual measure based on income or expenses that were not recognized and will never be recognized may fail to meet that threshold, particularly when the adjustment is not anchored in observable data, contractual rights or obligations, or IFRS-based measurements.”

Deloitte had similar thoughts, noting: “Paragraph 2.12 of the Conceptual Framework states that “[t]o be useful, financial information must not only represent relevant phenomena, but it must also faithfully represent the substance of the phenomena that it purports to represent.” It is unclear how an MPM based on a purely hypothetical phenomenon (for example, the non-occurrence of a crisis which did, in fact, occur) can be considered to faithfully represent substance.” I’m sympathetic to that line of thinking, and doubt that it’s really for the best to allow what Matos calls “counterfactual” measures into the financial statements. But I suppose the tentative agenda decision will become final, probably with some tweaks and clarifications, and he and I will just need to accept that we’re living if not in outright counterfactual times, largely in counter-rational ones…

The opinions expressed are solely those of the author.