Narrative reporting and non-GAAP measures: Audit committee questions

Narrative reporting

and non-gaap

measures

Audit Committee Questions

Audit Committee Institute part of

KPMG Board Leadership Centre

The integrity of the financial statements and the systems generating the information r eported

in the financial statements receives a lot of attention from management, internal audit and

external audit. The same is not always true for non-GAAP measures and various narrative

reporting disclosures provided to investors and other stakeholders.

Assurance

asymmetry

Pressure to

meet analyst

consensus

Understanding

investor needs

Transparency

and

comparability

Tone,

balance and

consistency

Audit committee oversight essentials …

It is essential for the audit committee to consider and

assess the assurance asymmetry between the financial

statements and any other information provided to

investors and stakeholders – such as non-GAAP

measures and narrative reporting pieces included in

management’s commentary sections, earnings

releases, analyst presentations, etc.

It is not always feasible or appropriate for the audit

committee to review all information companies provide

to investors, but management should have processes in

place to ensure the relevance and probity of all such

financial information. The audit committee has an

important role to play in ensuring such processes are fit

for purpose and working as intended.

The audit committee should seek to ensure that

management considers the materiality of all information

reported and assesses whether the assurance received

over such information is appropriate in the

circumstances. It is a reasonable assumption t hat if

information is of value to investors then it should be

reported to them and, conversely, if a company reports

information then it is on the basis that it believes that

the information is of value to investors. In either case,

there should be an expectation that such information is

accurately reported and that it is not otherwise

misleading.

Audit committees also have a role to play in ensuring

that the tone of all the reported information is

appropriate and that corporate reports, viewed in their

entirety, are fair, balanced and understandable.

The factors an audit committee should consider when

carrying out its oversight role in terms of narrative

reporting and non-GAAP measures are, in many

respects, very similar to those considered in the context

of the financial statements. However, audit committees

might specifically seek to assess:

• What information requires disclosure?

• The appropriate use of key performance indicators

(particularly non-financial key performance indicators)

and non-GAAP measures.

• The level of assurance needed for each type of

disclosure or reporting.

• The tone, balance and consistency of reporting.

Key questions for audit committees to consider:

What information requires

disclosure?

- Has management carried out appropriate consultation

and investigation to fully understand regulatory,

investors’ and other stakeholders’ needs?

- Is there a process in place to apply relevant materiality

thresholds to determine whether certain information

should or should not be disclosed in the annual report?

- Has the company’s narrative reporting sections and its

use of key performance indicators been properly

compared to those of its peers and best practice pro-

forma reporting to ensure that no significant gaps and/or

irrelevant disclosures are present in any financial

information?

Key performance indicators and

non-GAAP measures

- Do all key performance indicators have meaningful

names and is their context properly explained?

- Are any key performance indicators and non GAAP

measures clearly defined and reconciled to the most

relevant GAAP amount?

- Are any adjustments to key performance indicators and

non-GAAP measures clearly explained, together with

the reasons why they are being made?

- Are comparatives presented, disclosing key

performance indicators and non-GAAP measures

consistently over time?

What level of assurance is

needed?

- Has management assessed the materiality of all

information reported to investors taking into account

the information most valued by investors and regulatory

requirements?

- Is the level of assurance commensurate on

management’s assessment of materiality?

- Are effective processes and internal controls in place

ensuring that information disclosed is complete,

accurate and consistent?

- Are effective communication channels and processes in

place by which relevant, timely and accurate

information is brought to the attention of those

responsible for preparing financial reporting

disclosures?

- Is the extent of assurance provided by the internal

and/or the external auditor on the narrative sections of

the annual report appropriate in the circumstances?

Tone, balance and

consistency

- Is the language used precise and does it explain

complex issues clearly? Is jargon and boiler plate

avoided?

- Is appropriate weight given to the “bad news” as well

as the “good news”?

- Is an appropriate level of aggregation applied and tables

of reconciliations supported by, and consistent with,

the accompanying narrative?

- Are important messages, policies and transactions

highlighted and supported with relevant context and

not obscured by immaterial detail?

- Are cross-references used effectively and is repetition

avoided?

- Are the narrative sections consistent with the (basic)

financial statements reported?

- Are all significant matters appropriately disclosed and

explained so that there are no hidden surprises?

- Are significant changes from the prior period, whether

matters of policy or presentation, properly explained?

- Does the information reported enable readers to

properly understand the company’s performance,

strategy and risk appetite?

- Are principal risks that the board is concerned about

properly disclosed and explained?

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