APMs have a twofold use; directors monitor the financial and economic performance through APMs, and reporting entities heavily rely on APMs to communicate results to their financial statement users. APMs should normally be consistent with the performance indicators used by directors. However, regulatory restrictions or confidentiality issues may prevent directors from disclosing all of the types of performance indicators used. Furthermore, complexity in calculation or use of non-financial information could also prevent directors from publicly disclosing certain types of APMs.
A structured way to organize an entity’s APM process may involve the following four steps:
- Identify the relevant APMs for users that are also eligible for external communication
- Design and implement a process to monitor that the applicable regulatory guidelines are applied for the APMs selected
- Monitoring that APMs are based on reliable and traceable information
- Ensure that their placement is capable of meeting their communication objectives
Because the steps above are entirely part of the internal procedures, an entity should also set up monitoring activities within its internal control system in order to ensure the absence of weaknesses throughout the process and the compliance with applicable enforcement decisions and regulations. In the following section, some relevant considerations regarding the first three steps are summarised. The placing of APMs has been thoroughly addressed in the previous chapters, and will therefore not be elaborated on below.
Identification of the APMs
Identifying APMs is a complex exercise where directors have to consider a myriad of facts and circumstances.
At first glance, directors need to identify what their communication needs are. A suggested method could be to use a twofold approach:
• Bottom-up approach: APMs should normally be consistent with internal performance measures used by management, which are based on the specific circumstances of an entity (e.g., its value chain, success factors, served the market, type of clients). If a performance measure provides relevant information, it should be selected as a possible candidate for inclusion in financial communication as an APM where GAAP measures do not convey the same information. The bottom-up approach is normally not sufficient on its own to identify a performance measure as an APM for external communication.
• Top-down approach: in assessing whether all candidates for APMs identified are sufficient and useful to users, an entity should interact with its analysts and investors and should be aware of any industry-specific practices. This could be achieved by review (perhaps via a survey) of what competitors are doing in the market, or benchmarking of peers or competitors.
This twofold approach has the merit of identifying what is useful internally and externally. However, it still does not answer the question as to the appropriateness of using an APM in financial communication.
APMs still need to be assessed in terms of consistency and compliance with the guidelines issued by the regulators.
Entities may prepare a fit-gap analysis in terms of consistency with the regulated framework and best practices. In particular, the gap analysis should consider the applicable guidelines in order to ensure that the identified APMs:
- May be disclosed
- Comply with existing requirements
- Would not be better placed in other areas of the financial report (e.g., segment note in the financial statements)
Finally, the issuer should define an action plan to align all identified gaps. Only after having passed these “gates” should directors use a performance measure as an APM.
Design and implement process for APM disclosure
As part of its action plan, an issuer should design and implement the process to produce, on a timely basis, its identified APMs. Such a process is usually included in the financial statement closing process, which should be updated to include the following:
• Policies and procedures: internal policies must clearly identify the definition of APMs and the methodology to be used to calculate them. Also, policies should define the items to which selected APMs should be reconciled. The issuer should clearly identify those individuals in charge of the process and define specific tasks in the closing process, along with a timetable for their preparation.
• Reporting system: APM calculation and reconciliation must be supported by a proper reporting system, e.g., the system implemented for GAAP financial reporting purposes. Extensive use of spreadsheets and unstructured reporting systems typically prevent straightforward reconciliation, more frequently lead to mistakes, and make auditing the APMs, if applicable, more difficult, delaying the entire disclosure process. Data should be stored in a reporting system that allows the calculation to be reperformed and/or backtracked from the APM indicators to source data.
• Internal control over financial reporting: since the APMs are part of the financial information, the internal control system must be updated; regulators are already suggesting that entities evaluate whether their disclosure controls and procedures are robust enough to ensure the APMs are prepared consistently over periods, the measures are accurately calculated and transparent, and that the measures are adequately reviewed and monitored.