A PDF of the below Comment Letter can be downloaded here »
Mr. Jackson M. Day
Technical Director
Financial Accounting Standards Board
801 Main Avenue, PO Box 5116 |Norwalk, CT 06856-5116
Re: File Reference No. 2024-ITC100
Dear Mr. Day,
This letter is submitted by Financial Executives International’s (FEI) Committee on Corporate Reporting (CCR) in response to the Financial Accounting Standards Board’s (FASB or Board) Invitation to Comment (ITC) on Financial Key Performance Indicators (KPIs) for Business Entities.
FEI is a leading international organization comprised of members who hold positions as Chief Financial Officers, Chief Accounting Officers, Controllers, Treasurers, and Tax Executives at companies in every major industry. CCR is FEI’s technical committee of approximately 50 Chief Accounting Officers and Corporate Controllers from Fortune 100 and other large public companies, representing more than $16 trillion in market capitalization. CCR reviews and responds to pronouncements, proposed rules and regulations, pending legislation, and other documents issued by domestic and international regulators and organizations such as the U.S. SEC, PCAOB, FASB, and IASB.
This letter represents the views of CCR and not necessarily the views of FEI or its members individually.
Summary of KPIs Presented by CCR Companies
The majority of CCR companies and their peers present Financial KPIs outside of the financial statements, primarily in either press releases furnished via Form 8-K, within the Management’s Discussion and Analysis (MD&A) section of periodic SEC filings, or both. Some CCR companies also present Financial KPIs within investor presentations, proxy statements, or on their investor relations websites. The most commonly presented Financial KPIs amongst CCR companies are adjusted earnings per share (EPS) and free cash flow (FCF) or adjusted FCF.
Consistent with the FASB’s discussion in the ITC, most CCR companies believe many of the Financial KPIs presented by their peers are not directly comparable to their own. Based on an assessment of peer company disclosures, CCR companies have observed that even similar Financial KPIs presented by peers are not directly comparable due to entity-specific adjustments that reflect how management views the business and how incentive compensation targets are measured. Furthermore, even when there are similarities in the calculation of Financial KPIs, each company applies its own policies when identifying and calculating specific adjustments, as further described below.
Summary of CCR Views on Potential Financial KPI Project
We commend the FASB for gathering stakeholder feedback on Financial KPIs, which are critical for companies to effectively communicate business performance to investors. While CCR generally does not believe the FASB should prioritize a project on Financial KPIs, we recognize the value in gathering broader stakeholder input. We believe the FASB’s Agenda Consultation efforts (including the related ITC) will clarify whether stakeholders broadly believe the FASB should prioritize a project on Financial KPIs over other standard-setting initiatives. If the FASB were to pursue a project on Financial KPIs, CCR believes:
- The Board should not require disclosure of Financial KPIs that a company has not previously disclosed outside the financial statements;
- The scope of the project should be sufficiently narrow (e.g., focusing on FCF and EBITDA); and
- The Board should not engage in the determination of non-recurring adjustments.
Further Rationale for CCR’s Views
First, we believe a project to standardize and require disclosure of Financial KPIs may be inconsistent with the objective of disclosing these metrics. Companies disclose Financial KPIs to communicate business performance to investors consistent with the way management views the business and measures performance. As a result, entity-specific calculations and adjustments are critical for providing meaningful insights to investors. Requiring companies to disclose standardized Financial KPIs that are not used by management could confuse investors and provide information that is not relevant to their analysis. Further, most investors already understand entity-specific Financial KPIs disclosed today and often make their own unique adjustments in their analyses. Therefore, we expect companies and investors will continue to tailor their computations for management reporting and investor analysis, even if the FASB develops standardized Financial KPI definitions. Finally, there are certain metrics for which introducing new Financial KPI reporting requirements could add complexity to financial reporting processes and increase compliance costs to gather the necessary data to calculate and audit a standardized metric that management ultimately does not use. Based on these considerations, we believe the Board should not require disclosure of Financial KPIs that a company has not previously disclosed outside the financial statements, if the FASB pursues a project on Financial KPIs.
Second, we believe the FASB would encounter significant challenges if it were to move forward with a project to define Financial KPIs. Specifically, we are concerned about how the Board would apply its Conceptual Framework to determine the optimal definitions of specific Financial KPIs that are meaningful, relevant, and operable for all stakeholders. As noted above, companies and investors already have their own diverse definitions of Financial KPIs, and the FASB would likely hear conflicting viewpoints when developing a standardized definition of a specific Financial KPI. For example, consider FCF and EBITDA:
- FCF: While CCR companies generally find FCF to be the most comparable Financial KPI disclosed today (outside of the financial services industry), we believe the FASB would still encounter significant challenges if it attempted to develop a standardized definition of FCF. CCR observed that one company may define FCF as net cash from operating activities less capital spending, plus sales of property, plant and equipment (PP&E), while a similar company may define FCF as operating cash flow less capital spending. These differences reflect each management team’s unique perspective on business performance –– with one company’s management emphasizing net capital spending over gross capital spending.
- EBITDA: The ITC indicates 33% of SEC filers report EBITDA or adjusted EBITDA. However, we believe developing a standardized definition of EBITDA would be even more complex than FCF based on the current diversity in calculations of EBITDA. For example, we have observed that EBITDA may be computed using either a (1) “top-down approach,” where operating income is adjusted for depreciation and amortization or (2) “bottoms-up approach,” where net income is adjusted for interest, taxes, depreciation and amortization. Additionally, certain preparers and investors apply differing levels of precision when calculating interest, depreciation, and amortization. For example, certain calculations only include interest on debt, while some calculations also include other interest, such as interest related to pensions and postretirement benefits.
Given these complexities, we believe the scope of any project would need to be sufficiently narrow to allow the Board to focus on working with stakeholders to carefully develop a standardized definition of each Financial KPI.
Third, we believe it would be significantly more challenging for the Board to develop standardized adjustments for nonrecurring items. For example, companies adjusting for nonrecurring costs, such as restructuring programs or acquisitions, may have different policies for what constitutes nonrecurring based on the nature of their business and historical activity (e.g., the length of time that those costs qualify as nonrecurring). Similarly, companies may apply different quantitative thresholds when calculating adjustments as a governance technique. For example, some companies apply a dollar threshold when determining whether divestiture gains or losses can be adjusted to ensure the divestitures represent unusual or nonrecurring activities. As a result, we do not believe the Board should engage in the determination of non-recurring adjustments if it were to pursue a potential project.
Furthermore, we believe there is sufficient SEC guidance – including Regulation G, Item 10(e) of Regulation S-K, and other guidance – to assist investors in understanding Financial KPIs and to ensure companies do not disclose misleading Financial KPIs. For example, the SEC issued guidance on KPIs and metrics in MD&A in February of 2020, acknowledging that companies disclose metrics that vary significantly from company to company and industry to industry. That SEC guidance indicates the Staff expects companies to disclose (1) a clear definition of the metric and how it is calculated, (2) a statement indicating the reasons why the metric provides useful information to investors, and (3) a statement indicating how management uses the metric in managing or monitoring performance of the business. The guidance also encourages companies to disclose information about significant estimates or assumptions used in the calculation of the metric and any significant changes in calculation methodology.
Conclusion
We appreciate the Board’s effort to obtain input from stakeholders as it considers a potential project on Financial KPIs for business entities. We thank the Board for its consideration of our views and welcome further discussion with the Board or staff at your convenience.
Sincerely,
Alice L. Jolla
Chair, Committee on Corporate Reporting
Financial Executives International