(a) Toobasco is in the retail industry. In the reporting of financial information, the directors have disclosed several alternative performance measures (APMs), other than those defined or specified under IFRS Standards. The directors have disclosed the following APMs:
(i)‘Operating profit before extraordinary items’ is often used as the headline measure of the Group’s performance, and is based on operating profit before the impact of extraordinary items. Extraordinary items relate to certain costs or incomes which are excluded by virtue of their size and are deemed to be non-recurring. Toobasco has included restructuring costs and impairment losses in extraordinary items. Both items had appeared at similar amounts in the financial statements of the two previous years and were likely to occur in future years.
(ii) ‘Operating free cash flow’ is calculated as cash generated from operations less purchase of property, plant and equipment, purchase of own shares, and the purchase of intangible assets. The directors have described this figure as representing the residual cash flow in the business but have given no detail of its calculation. They have emphasised its importance to the success of the business. They have also shown free cash flow per share in bold next to earnings per share in order to emphasise the entity’s ability to turn its earnings into cash.
(iii) ‘EBITDAR’ is defined as earnings before interest, tax, depreciation, amortisation and rent. EBITDAR uses operating profit as the underlying earnings. In an earnings release, just prior to the financial year end, the directors disclosed that EBITDAR had improved by $180 million because of cost savings associated with the acquisition of an entity six months earlier. The directors discussed EBITDAR at length describing it as ‘record performance’ but did not disclose any comparable information under IFRS Standards and there was no reconciliation to any measure under IFRS Standards. In previous years, rent had been deducted from the earnings figure to arrive at this APM.
(iv) The directors have not taken any tax effects into account in calculating the remaining APMs.
Required:
Advise the directors whether the above APMs would achieve fair presentation in the financial statements. (10 marks)
(b) Daveed is a car retailer who leases vehicles to customers under operating leases and often sells the cars to third parties when the lease ends.
Net cash generated from operating activities for the year ended 31 August 20X8 for the Daveed Group is as follows:
(a) (i) APMs are not defined by IFRS Standards and therefore may not be directly comparable with other companies’ APMs, including those in the group’s industry. Where the same category of material items recurs each year and in similar amounts (in this example, restructuring costs and impairment losses), the entity should consider whether such amounts should be included as part of underlying profit.
Under IFRS Standards, items cannot be presented as ‘extraordinary items’ in the financial statements or in the notes. Thus it may be confusing to users of the APMs to see this term used. It is not appropriate to state that a charge or gain is non-recurring unless it meets the criteria. Items such as restructuring costs or impairment losses should not be labelled as non-recurring where it is misleading. However, the entity can make an adjustment for a charge or gain which they believe is appropriate, but they cannot describe such adjustments inaccurately.
(ii) The deduction of capital expenditures, purchase of own shares and the purchase of intangible assets from the IAS 7 measure of cash flows from operating activities is acceptable as free cash flow does not have a uniform definition. As a result, a clear description and reconciliation showing how this measure is calculated should be disclosed. Entities should also avoid misleading inferences about its usefulness. Free cash flow does not normally represent the residual cash flow available as many entities have mandatory debt service requirements which are not normally deducted from the measure. It would also be misleading to show free cash flow per share in bold alongside earnings per share as they are not comparable.
(iii) When an entity presents an APM, it should present the most directly comparable measure which has been calculated in accordance with IFRS Standards with equal or greater prominence. The level of prominence would depend on the facts and circumstances. In this case, the entity has omitted comparable information from an earnings release which includes APMs such as EBITDAR. Additionally, the entity has emphasised the APM measure by describing it as ‘record performance’ without an equally prominent description of the measure calculated in accordance with IFRS Standards. Further, the entity has provided a discussion of the APM measure without a similar discussion and analysis of the same information presented from an IFRS Standard perspective.
The entity has presented EBITDAR as a performance measure; such measures should be reconciled to profit for the year as presented in the statement of comprehensive income. Operating profit would not be considered the best starting point as EBITDAR makes adjustments for items which are not included in operating profit such as interest and tax.
The entity has changed the way it calculates the APM because it has treated rent differently. However, if an entity chooses to change an APM, the change and the reason for the change should be explained and any comparatives restated. A change would be appropriate only in exceptional circumstances where the new APM better achieves the same objectives, perhaps if there has been a change in the strategy. The revised APM should be reliable and more relevant.
(iv) The entity should provide income tax effects on its APMs depending on the nature of the measures. The entity should include current and deferred income tax expense commensurate with the APM and the APM should not be presented net of tax as income taxes should be shown as a separate adjustment and explained.
(b) (i) Adjustment of net cash generated from operating activities for errors in the statement
(iii) Purchase and sale of cars
Daveed’s presentation of cash flows from the sale of cars as being from investing activities is incorrect as cash flows from the sale of cars should have been presented as cash flows from operating activities ($30 million). IAS 16 Property, Plant and Equipment (PPE) states that an entity which normally sells items of PPE which are held for rental to others should transfer such assets to inventories at their carrying amount when they cease to be rented and become held for sale. Subsequent proceeds from the sale of such assets should be recognised as revenue in accordance with IFRS 15 Revenue from Contracts with Customers and thus shown as cash flows from operating activities.
Purchase of associate
