Underlying Profit

principles for reporting

of non-statutory profit

information

Published in 2009 by:

Australian Institute of Company Directors (AICD)Level 2, NAB House255 George StreetSydney NSW 2000Telephone: (+61 2) 8248 6600Facsimile: (+61 2) 8248 6633publications@companydirectors.com.auwww.companydirectors.com.au

Financial Services Institute of Australasia (FINSIA)Level 16, 1 Margaret StreetSydney NSW 2000Telephone Australia: 1300 FINSIA (1300 346 742) or (+61 2) 9275 7900Facsimile: (+61 2) 9275 7999Telephone New Zealand: (+64 9) 909 7534www.finsia.com

© Australian Institute of Company Directors (AICD)© Financial Services Institute of Australasia (FINSIA)

Printed by Ligare Pty LtdTypeset by Endnote Design, Collaroy, NSW

National Library of AustraliaCataloguing-in-Publication entry

Title: Underlying Profit: principles for reporting of non-statutory profitinformation/Australian Institute of Company Directors, Financial ServicesInstitute of Australasia.

ISBN 9781876604097

1. Corporate profits. 2. Financial statements. 3. Corporation.

338.516

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AICDThe Australian Institute of Company Directors (AICD) is a member institute fordirectors dedicated to having a positive influence on the economy andsociety by promoting professional directorship and good governance. AICDdelivers education, information and advocacy to enrich the capabilities ofdirectors, influence the corporate governance environment in Australia andpromote understanding of, and respect for, the role of directors. With officesin each state and more than 23,000 members, AICD represents a diverserange of corporations, from the top 200 publicly-listed companies to not-for-profits, public sector entities and smaller private family concerns.

FinsiaFinsia is the only professional association representing the entire spectrum ofthe Australasian financial services industry—including the wealthmanagement, banking and finance, and capital markets sectors. It connectsmore than 17,000 members—not only with each other, but with the latestthinking and information from across the industry and around the globe.Finsia's core purpose is to help its members succeed in their careers, and tosupport the growth and development of the financial services industry. This isachieved by providing members with relevant and high quality professionaldevelopment and networking programs, a comprehensive suite of careersupport services and a range of industry-leading information resources andpublications. Finsia's policy and advocacy initiatives ensure it plays a criticalrole in promoting industry growth both regionally and around the world.

DisclaimerThe material in this publication does not constitute legal, accounting or otherprofessional advice. While all reasonable care has been taken in itspreparation, neither AICD nor Finsia makes any express or impliedrepresentations or warranties as to the completeness, reliability or accuracyof any material in this publication. This publication should not be used orrelied upon as a substitute for professional advice or as a basis forformulating business decisions. To the extent permitted by law, AICD andFinsia exclude all liability for any loss or damage arising out of the use ofthe material in the publication. Any links to third-party websites are providedfor convenience only and do not represent endorsement, sponsorship orapproval of those third parties or any products and services offered.

CopyrightCopyright strictly reserved. No part of the material covered by copyrightshould be copied or reproduced in any form or by any means without thewritten permission of AICD and Finsia. AICD and Finsia endeavour tocontact copyright holders and request permission to reproduce all copyrightmaterial. There may be instances where AICD and Finsia have been unableto trace or contact copyright holders. If notified, AICD and Finsia will ensurefull acknowledgment of the use of copyright material.

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Contents

Acknowledgments 6

What this publication is about 7

Part A Background to this publication 10

Part B Principles for reporting underlying profit 15

Appendix 1 Potential adjustments to statutory profit 20

Appendix 2 Illustrative example 23

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Acknowledgments

AICD and Finsia would like to formally thank their respective honorarycommittees and task-force members for the considerable time and effortcontrbuted by them to make this publication possible. We also wish to thankthe many individuals and organisations who provided comment on thediscussion paper that led to this publication. This feedback was quitevaluable and much appreciated.

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Underlying Profit: principles for reporting of non-statutory profit information

What this publication is about

Purpose

Statutory financial reports prepared and audited in accordance with theCorporations Act are the primary financial accountability mechanism forAustralian companies.

1Reporting of additional, non-statutory financial

information can provide valuable information to shareholders and the widerinvestment community about the performance of a company, where it isdone appropriately and in accordance with the general duty of companiesand their officers not to provide information that is false or misleading.

This publication is intended to encourage companies to provide, in aresponsible and consistent manner, additional non-statutory informationabout underlying profit and to present this additional information incommunications to the investment community in a table that shows andexplains adjustments made to the statutory profit.

Meaning of underlying profit

In this publication, the term “underlying profit” means a company's statutoryprofit as adjusted in order to present a figure which reflects the directors'assessment of the result for the ongoing business activities of the company.

Meaning of statutory profit

In this publication, the term “statutory profit” means net profit after tax(NPAT), as derived from statutory financial statements compiled inaccordance with the Corporations Act 2001 and Australian AccountingStandards.

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1. For ease of expression, the term “company” has been used throughout this publication. Similarprinciples would apply to listed trusts and stapled securities.

2. NPAT has been chosen as the starting profit figure because it enables all potential adjustmentitems to be captured in a reconciliation table prepared under principle 3 of this publication. Inaddition, the definition of statutory profit in the Australian Accounting Standards does not includeearnings before interest and tax (EBIT) or earnings before interest, tax, depreciation andamortisation (EBITDA). If EBIT or EBITDA were used as the starting profit figure, certain significantone-off items (for example, a large one-off tax fine or an atypical financing cost ) would not bereflected in a reconciliation process. If a company selects a starting profit figure other than NPAT,it will be important for consistency and the integrity of the reconciliation process to maintain thatselection in future reconciliations. If the starting profit figure is subsequently changed, a furtherreconciliation will be needed to relate the new starting profit figure to the prior year's startingprofit figure.

This publication seeks specifically to encourage companies to:

1. Recognise that the different users of financial reports have differentinformation needs.

2. Adopt the term “underlying profit” in preference to “normalised profit”,“result excluding exceptional items”, “underlying result” or otherterminology used to express adjustments made to the statutory profitfigure.

3. When reporting underlying profit, present a table showing how thestatutory profit has been adjusted to arrive at the underlying profit.

4. Adopt a transparent and consistent approach to the reporting ofunderlying profit. Transparency includes reporting both positive andnegative adjustments to the statutory profit figure. In many instances, atransparent approach will also include a narrative to explain theadjustments.

5. Report on trends in the underlying profit across reporting periods.6. Clearly show both the statutory profit and the underlying profit and their

relationship in communications to shareholders and the wider investmentcommunity about the profit result, including annual andhalf-year reports, annual reviews, analysts' results briefings and othermanagement result commentaries.

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Underlying Profit: principles for reporting of non-statutory profit information

Structure

Part A of this publication provides information about the background to theinitiative by AICD and Finsia.

Part B sets out principles that AICD and Finsia believe companies shouldadopt when providing non-statutory information about underlying profit.

Appendix 1 lists some potential adjustments together with briefcommentary.

Appendix 2 provides an illustrative example of the preferred format forpresenting underlying profit information.

Scope

This publication does not cover the provision of future earnings guidance bycompanies. The principles stated here relate only to the presentation ofhistorical financial information. AICD and Finsia have attempted to couch theprinciples in this publication in a way that provides flexibility in the reportingof underlying profit, while encouraging reporting that is transparent andcomparable, with the aim of assisting shareholders, analysts and others.

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Part A

Background to this publication

Introduction

In April 2007, the Australian Institute of Company Directors (AICD) andthe Financial Services Institute of Australasia (Finsia) established aworking group to address the challenges posed by non-standard companyreporting of “underlying” or “normalised” profits. The working groupinvestigated whether there was scope for improving the quality andconsistency of presentation of a company's results. The project teamdecided to develop a framework to assist companies when reporting anunderlying profit.

A discussion paper was issued in August 2008, and feedback solicitedfrom accountancy bodies, regulators, standard-setters, AICD and Finsiamembership, and other interested organisations. Comments received havebeen considered in formulating this publication. These principles andaccompanying appendices are intended as guidance only. It is recognisedthat circumstances will vary between companies and between industries.

Limitations of the statutory profit figure

The statutory profit figure is the foundation for reporting historical financialinformation, and is also used to analyse the absolute and relative financialperformance of a company. AICD and Finsia recognise the mandating ofInternational Financial Reporting Standards (IFRS) for listed companies.

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Equally, however, both organisations believe that companies should considerwhat supplementary information could be provided to assist shareholdersand the wider investment community in understanding the company'sfinancial position and performance.

Among the users of financial statements are analysts seeking to performvaluations of companies. Companies are usually valued on the basis ofexpected future profits and cash flows. Rather than using past statutory profitas the starting point for such valuations, analysts typically make adjustments toderive an underlying profit. This underlying profit is then projected into thefuture, using various assumptions (for example, rate of sales growth), and thentypically capitalised to determine a current company valuation. Alternatively,underlying profit is used as a basis for projecting cash flows, which arediscounted to arrive at a present valuation.

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Underlying Profit: principles for reporting of non-statutory profit information

3. When adopted in Australia, the International Financial Reporting Standards are currently knownas AIFRS.

While IFRS has established a standard method to report the financialposition and historical performance of companies, the accountingstandards are not intended to provide the information needed to value acompany.

For many Australian companies—and hence analysts of thesecompanies—a major impact of the introduction of IFRS has been theinclusion of asset revaluations (fair value adjustments) in the IncomeStatement.

The International Accounting Standards Board (IASB) and the USFinancial Accounting Standards Board (FASB) have acknowledged thisimpact in a discussion paper on financial statement presentation which waspublished in October 2008:

“Specifically, users are concerned that commingling gains or lossesfrom fair value remeasurements and other components ofcomprehensive income results in measures of financial performancethat are difficult to analyse.”

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The IASB-FASB discussion paper contains a proposal for a new reconciliationschedule, to appear in the notes to the statutory financial report, whichwould disaggregate income components of cash, accrual andremeasurement (for example, fair value changes). The IASB and FASBanticipate that the discussion paper will progress to an exposure draft forfurther comment in 2010, with a final standard not anticipated until 2011.

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The long lead time required to finalise and publish a new internationalstandard means that industry-led initiatives will continue to be important forthe near future.

Widespread use of additional income measures

In 2007, PricewaterhouseCoopers (PwC) published a survey of 2,800European financial statements, focusing on the additional income measuresthat companies include in the financial statements beyond those required byIFRS.

6The study found that the use and presentation of non-statutory

measures of income, such as underlying profit, is widespread.

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4. Preliminary Views on Financial Statement Presentation (18 October 2008), page 91http://www.iasb.org

5. Executive summary of the discussion paper http://www.iasb.org6. PricewaterhouseCoopers, Presentation of income under IFRS: flexibility and consistency explored

(2007). http://www.pwc.com

A 2007 Ernst & Young study7

examined financial reports and mediareleases of the top 20 Australian listed companies to determine, amongstother things:• whether there is a trend towards communicating different earnings from

those reported in statutory financial reports; and• if there is a trend, whether there is any consistency in approach.The study showed a trend towards reporting adjusted earnings to the marketand, while these results are reported in different ways, there is consistency inthe nature of adjustments being made. The study also revealed that two typesof adjustments are commonly made:

(1) for significant one-off transactions and events; and(2) for IFRS-related matters.

Type (1) adjustments are made to indicate what a stable earnings base forthe company should be. Type (2) adjustments are also made for this purpose,and for additional reasons that indicate dissatisfaction with how IFRS reflectsthe company's business in that certain “fair value” adjustments (not reflectedin cash) are included in IFRS financial reports incorporating unrealisedprofits/losses. The AICD/Finsia project team suggests that the increase inreporting of adjustments demonstrates that users of financial statements arenot receiving, or are perceived to be not receiving, all the information theyneed.

Demand for underlying profit disclosure and desire for greaterconsistencyIn November 2006, Finsia conducted a survey of equity analysts

8on the

quality of financial reporting. Respondents were generally positive about thequality of financial reporting in Australia, but noted that the “normalising” ofearnings was one area that could benefit from greater consistency. Whenasked whether a “separate and consistent disclosure of a normalised profitwould be useful”, 82 per cent

9agreed “to some extent” or “to a great

extent”.

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Underlying Profit: principles for reporting of non-statutory profit information

7. Ernst & Young, Reported earnings - Trends, analysis and predictions (May 2007).8. A media release, “Finsia's Equity Analysts Survey reveals “Normalised” Profit and Segmental

Reporting as key concerns,” dated 11 December 2006, and summary of the survey results canbe found at http://www.finsia.com

9. 41 per cent of respondents agreed “to a great extent” and, equally, 41 per cent agreed “to someextent”. Fewer than 18 per cent of respondents agreed “a little”. See Company Reporting: theEquity Analyst Perspective, available at http://www.finsia.com

The importance of the underlying profit figure to the investmentcommunity does not diminish the importance of companies preparingfinancial statements according to the law and applicable accountingstandards. Furthermore, this guidance is not based on a view that financialreporting under IFRS is incorrect or misleading. Rather, in recognition thatusers of financial reports have a variety of information needs, theseprinciples are intended to lead to a presentation of additional explanatoryinformation not otherwise readily available.

Other voluntary reporting guidance

Simultaneous with the widespread use of additional profit measures, therehas been a growth in other voluntary reporting guidance. In July 2005,AICD in conjunction with PwC issued the Shareholder Friendly Report (SFR).This provided a practical example of how Australian companies can presentfinancial information in a relevant and understandable way to retailshareholders. In March 2007, as an adjunct to the SFR, AICD published aseries of principles for good communication with shareholders. Like the SFR,these are targeted largely at communications with retail shareholders.

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In May 2008, Ernst & Young and the Group of 100 publishedguidelines for preparation of annual reviews (non-statutory reports):Reporting to shareholders: a good practice guide.

11This publication includes

guidelines about the reporting of underlying profit in the “performancehighlights” section of an annual review.

The Institute of Chartered Accountants in Australia (ICAA) released inOctober 2008 a paper on Broad Based Business Reporting, which isdesigned to communicate operational and financial results as well asenvironmental and social issues affecting a business.

12The paper was

prepared by the ICAA's Broad Based Business Reporting advisory panel,which consists of representatives from KPMG, PricewaterhouseCoopers,governance research company Regnan, and the Australasian InvestorRelations Association.

Such initiatives are also occurring overseas. For example, the Genericoannual report has been prepared as part of the improved reporting initiativeknown as the Report Leadership Initiative. This is a “multi-stakeholder groupthat aims to challenge established thinking on corporate reporting.” Thecontributors to the initiative are the Chartered Institute of Management

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10. AICD Principles of Good Communications with Shareholders:http://www.companydirectors.com.au

11. http://www.group100.com.au12. Leadership: Broad Based Business Reporting - the complete reporting tool (October 2008):

http://www.charteredaccountants.com.au

Accountants (CIMA), PwC LLP, Radley Yeldar and Tomkins plc. The initiativewas launched in the United Kingdom during November 2006. Includedwithin the Generico Annual Report are examples of non-statutory measuresof profit.

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Regulatory concerns about additional profit information instatutory reports, prompting need for industry leadership

In July 2005, the Australian Securities and Investments Commission (ASIC)released a draft guide on disclosing pro forma financial information.

14In the

accompanying press release, ASIC stated that it had concerns with practicesused by some listed entities in releasing financial reports containingalternative financial statements that are not in accordance with accountingstandards.

AICD and Finsia strongly endorse industry-driven standards foradditional reporting such as underlying profit, provided the additional non-statutory information is effectively distinguished from statutory information,and it is clear whether the additional information has been audited. Somecompanies seek to achieve this differentiation by including the underlyingprofit figure in the annual directors' report or a separate “managementcommentary” section of the annual report, rather than in the auditedfinancial report.

Conclusion

AICD and Finsia believe that the market is assisted if a company can providean underlying profit figure and explanation that reflects the directors'assessment of the company's result for ongoing operations.

Part B of this publication sets out principles that Finsia and AICD believecompanies should adopt when providing non-statutory information aboutunderlying profit. A list of some potential adjustments together with briefcommentary is given in Appendix 1. An illustrative example of the preferredtabular format is provided in Appendix 2.

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Underlying Profit: principles for reporting of non-statutory profit information

13. Report Leadership Initiative: http://www.reportleadership.com14. Draft ASIC Guide: Disclosing pro forma financial information (July 2005) can be found at

http://www.asic.gov.au. As at January 2009, the guide was published in draft form only.

Part B

Principles for reporting underlying profit

Principle 1—report on the underlying profit, where relevant, inaddition to the statutory profit

As noted in Part A of this publication, there are limitations to theinformation provided by the statutory profit figure and other statutoryfinancial disclosures. AICD and Finsia believe that the market is assisted bythe additional reporting of an underlying profit figure that reflects thedirectors' assessment of the result for the ongoing business activities of thecompany.

A company that reports on its underlying profit should do so in a waythat:• clearly differentiates underlying profit from statutory profit without giving

undue prominence to the underlying profit figure (see also principles 3and 4)

• is transparent (see also principles 4 and 5)• is consistent (see also principle 6).

Principle 2—use the term “underlying profit”

Consistent use by companies of a single terminology to describe underlyingprofit promotes greater certainty for the investment community. AICD andFinsia support use of the term “underlying profit” in preference to otherterminology to describe an adjusted profit figure.

To date, companies have used a variety of terms including:• profit before exceptional items

• result excluding exceptional items

• result before non-recurring items

• result before significant items

• result before special items

• result before specific items

• normalised result

• underlying result

• current operating result

• underlying earnings.

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According to the 2007 PwC survey of 2,800 European financialstatements,

15“result excluding exceptional items” is the most commonly used

term in the United Kingdom, although the number of companies using“underlying profit” increased significantly from 2004 to 2005 following theintroduction of IFRS. French companies tended to use “result before non-recurring items”.

The 2007 Ernst and Young study16

noted that Australian companies havevariously described their adjusted earnings figure as “underlying profit”,“normalised profit”, “cash profit”, “underlying EBIT” or “underlying EBITDA.”

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AICD and Finsia recognise that terms such as “normalised” or“adjusted” have been widely used both in Australia and overseas. However,the term “underlying profit” has the following advantages:• it is neutral about future expectations (in contrast to “sustainable

earnings”, which arguably has a predictive element)• expressions such as “normalised profit” carry with them connotations in

some people's minds, for example, regarding “smoothing” of profit oradjustments based on management's judgments, rather than accordingto a standard or accepted procedure

• it does not seek to undermine the IFRS process by reintroducing orchanging accounting terminology.

Principle 3—reconcile the underlying profit figure to the statutoryprofit figure and present the adjustments in tabular form, withany accompanying explanation that may be necessary

The underlying profit calculation should be presented in a table andreconciled to the statutory profit figure.

18The reconciliation should show each

adjustment, both gross and net of tax, and include an explanatory noteabout the adjustment if needed to make the tabular information meaningful(such as the reason for making the adjustment and how it has beenquantified).

Appendix 2 provides an illustrative example of the preferred format.

Selecting and itemising adjustmentsThe adjustments made to the statutory profit figure will depend on a rangeof factors, such as the size of the business, the industry sector and thenature of its operations. For example, although a mark to market revaluation

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Underlying Profit: principles for reporting of non-statutory profit information

15. PricewaterhouseCoopers, Presentation of income under IFRS: flexibility and consistency explored (2007)http://www.pwc.com

16. Ernst & Young, Reported earnings - Trends, analysis and predictions (May 2007)17. EBIT—Earnings before interest and tax; EBITDA—Earnings before interest, taxes, depreciation

and amortisation.18. Refer to page 7 for the definition of “statutory profit” in this publication.

for a manufacturing company may be adjusted in calculating underlyingprofit, this may not be appropriate for a financial institution.

Appendix 1 lists some potential adjustments to the statutory profit figurethat may be relevant for a company from time to time. This list is notexhaustive and other adjustments may also be appropriate in specific cases.Similarly, inclusion of an item in Appendix 1 does not mean such an itemshould always be an adjustment.

Adjustments made to arrive at the underlying profit should be separatelyitemised if they are “significant”. The tax associated with each adjustmentshould also be clearly identified.

What is “significant” will vary between companies, but as a guide, anitem may be considered significant if it impacts the statutory net profit aftertax figure by more than five per cent.

One-off/non-recurring gains or losses will usually be significant andadjustments for these should be individually itemised. Smaller items that arenot individually significant may be aggregated for adjustment purposes, butshould still be disclosed and explained.

In preparing the table, companies should be aware of the needs ofshareholders, analysts and others. The objective is to provide a transparent,logical and justifiable reconciliation between the statutory profit figure and theunderlying profit.

19At the same time, the reconciliation may assist analysts

and others who may wish to carry out valuations.

Principle 4—present the underlying profit and accompanyingexplanation in the directors' report or other managementdiscussion and analysis of the profit result

The underlying profit reconciliation table and accompanying explanationsshould be:(a) clearly differentiated from the statutory financial report, for example, by

its location; and(b) made available in communications to shareholders and the wider

investment community about the profit result (including annual andhalf-year reports, annual reviews, analysts' results briefings and othermanagement result commentaries).

One way of differentiating the underlying profit figure from the statutoryfinancial report is to include information about the underlying profit in thedirectors' report or in a separate “management discussion and analysis”section of the annual report.

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19. The situation can also arise where either the statutory profit or the underlying profit (or both) is infact a loss. The principles contained in this publication should still be applied in order to calculateand report the underlying loss.

The extent to which the underlying profit reconciliation has been auditedor reviewed should also be clearly disclosed. The concept of underlyingprofit is complementary to the reporting structure under IFRS, and does notreplace IFRS financial statements. Other than through the reconciliation table,unaudited underlying profit information should not be incorporated within, orassociated in any other way with, the IFRS-based financial statements.

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Principle 5—include both positive and negative adjustments tothe statutory profit figure

Transparency requires that companies include adjustments whether they havea positive or negative impact on the underlying profit figure.

The disclosure of underlying profit should not be seen as anopportunity to “window dress” the financial result. There is some historyof companies “cherry picking” the items they wish to emphasise.Ultimately, this approach reduces the long-term confidence of theinvestment community in the individual company and in the market generally.

“Contra” effects should also be disclosed. For example, if assetwrite-downs occur, the resulting reduction in depreciation charges shouldalso be disclosed in a footnote to the reconciliation table.

Principle 6—maintain consistent adjustments to the statutoryprofit figure between reporting periods

The types of adjustments used to arrive at an underlying profit figureshould be consistent between reporting periods.

If, for example, a company makes an adjustment for foreign exchangeimpacts in the current year, it should disclose similar adjustments in followingyears (even if the adjustment is insignificant in those future years). However,to avoid the situation where insignificant adjustments are reported inperpetuity, with a resulting, ever-increasing list of adjustments, it would beacceptable to cease separately disclosing the item if it is “insignificant” forthe second consecutive year and has been disclosed for the prior yeardespite being “insignificant”.

Through the consistent application of these principles in compiling theunderlying profit over several years, a company will present financialinformation about prior and subsequent years that is more indicative ofunderlying performance and its trend.

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Underlying Profit: principles for reporting of non-statutory profit information

20. ASIC has indicated that underlying profit adjustments should not be made on the face of statutoryfinancial statements. Draft ASIC Guide: Disclosing pro forma financial information (July 2005)can be found at http://www.asic.gov.au. As at January 2009, the guide was published in draftform only.

Principle 7—disclose whether these principles have been reliedon in reporting an underlying profit figure

These principles are the result of a market-driven initiative designed toimprove the reporting of non-statutory profit information. AICD and Finsiaare not seeking to mandate the reporting of underlying profit, but where anunderlying profit figure is reported, AICD and Finsia consider that thecompany should state whether these principles have been applied inreporting that underlying profit.

A statement, in conjunction with the underlying profit table, that theAICD/Finsia principles have been followed allows the investment communityto differentiate those companies that have adopted these principles fromthose that have developed their own. The statement will also convey to themarket that the company's underlying profit figure may be comparable withthose of other companies.

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An example statement appears below the reconciliation table inAppendix 2.

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21. Users of underlying profit reports will need to make their own assessments of each company'sinterpretation of these principles. See the disclaimer information elsewhere in this publication.

Appendix 1

Potential adjustments to statutory profitThe particular adjustments to be included when compiling an underlyingprofit table will vary from company to company. Shareholders, analysts andothers in the investment community will also arrive at different conclusionsregarding the significance of one adjusted item over another.

The decision by directors as to which adjustments are appropriate is inherentlysubjective, and will vary from company to company and industry to industry.However, by applying the principles in this publication, companies should beable to assist the investment community in making an informed decision aboutthe relevance of each adjustment made to arrive at the underlying profit figure.The tabular presentation and explanation of these adjustments should be clearand comparable between reporting periods.

Listed below are some items that are likely to be appropriate fortreatment as an adjustment. This list is not exhaustive, but is intended toprovide a guide to the nature of adjustments that could be included in thereconciliation table to derive the underlying profit. Other adjustments mayalso be appropriate in specific cases. Similarly, inclusion of an item in thislist does not mean that the item should always be an adjustment. Theseexample adjustments should be read in conjunction with the examplereconciliation table in Appendix 2. To enable users to fully understand theeffect of each adjustment, the tax effect of each adjustment should be shown.

Comparative figures should also be presented: see principle 6.While there may be disagreement with the inclusion of some of the

items discussed below, by including these in the reconciliation table,including the taxation effect, the market is able to select which items are ofinterest, and may elect to disregard other items.

Significant transactions or events—While “significant” is a subjectiveterm, it is suggested that any transaction that on its own, or in combinationwith a number of similar transactions, may be considered significant if itimpacts the statutory net profit after tax figure by more than five per cent.(Refer to the discussion under principle 3). These items should be identifiedand adjusted for where they are not expected to be repeated consistentlyover a number of years. Transactions giving rise to adjustments wouldinclude divestments of operating businesses or assets. Another example is thecost of a failed takeover attempt. The financial effects of significant eventssuch as floods, fire and related unexpected events should similarly be noted.Where significant events are covered by insurance, the net amount shouldbe included.

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Underlying Profit: principles for reporting of non-statutory profit information

One-off provisions—Provisions that are clearly one-off and not expectedto recur can impact current year profits. Provisions may include expectedcosts for redundancies or restructuring, but are not limited to these cases.

Fair value adjustments—The unrealised profit/loss arising from the markto market impact of revaluing assets (such as derivatives, financialinstruments, property or agricultural assets) at reporting date to fair value isnot reflected in any movement of cash and may be included as anadjustment. It is recognised that including a fair value adjustment may becontentious in some situations, and therefore particular caution should beexercised. For example, a share trading company would not adjust for fairvalue changes to financial instruments, because the value of financialinstruments would generally be an integral part of the operating result.

Impairment losses—Impairment testing of assets may result in a largewrite-down to recoverable amounts that may be of a non-recurring nature.

Income tax settlements—Where a company has received a significanttax refund or paid a tax penalty that does not relate to the current yearoperating profit, this would typically be an appropriate item to include in thereconciliation.

Defined benefit pension plans—While not common in Australia,several companies have needed to “top up” defined benefit plans. Wherethis is the case, this may be an appropriate item to include as an adjustment.

Revaluation of long-term liabilities—Some companies havelong-term, non-operating related legal obligations. Where the revaluation ofthe long-term obligation is included in the reported profit, this should beitemised. This discussion does not relate to long-term liabilities that exist oraccrue in the normal course of a company's operations (for example, landrehabilitation for mining companies).

Items for which an adjustment should not be made

AICD and Finsia are of the view that some companies are adjusting theirstatutory profit for items that should not be adjusted for. These items include:• Employee share schemes—and related entries, which are a legitimate

and real impost on the business from the perspective of shareholders.• Amortisation and depreciation—which, in the normal course, should not

be included in the reconciliation table, but should be noted clearlyelsewhere in a management discussion and analysis of the profit result.

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Where there has been a change to depreciation because of asignificant event, this change could be disclosed as an adjustment in thereconciliation table.

The following items may also need to be considered by some companies:• Property sales or other items that could be classified either as “one off”

or “ongoing” items. The company should determine whether these itemsare actually one off in nature given the context of the company andtherefore be excluded from underlying profit.

• For a mining company, land rehabilitation is typically a normal expenseincurred by the company.

• For a chemical or residential development company, removal ofchemicals from land is expected to be a normal part of the business.

• Asset sales by a property company whose business model includesregular asset sales would typically not give rise to an adjustment.

• Impairment of loans for a financial company would be included as anormal part of doing business, but in some cases extraordinary loanlosses may be adjusted.

• Hedging profits and losses would be considered normal items for acompany that has a hedging policy that relates to its underlyingbusiness.

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Underlying Profit: principles for reporting of non-statutory profit information

Appendix 2

Illustrative example

The following example is illustrative only and demonstrates the preferredtabular format. The particular adjustments to be included when compiling anunderlying profit table will vary from company to company. Shareholders,analysts and others in the investment community will also arrive at differentconclusions regarding the significance of one adjusted item over another.

UNDERLYING PROFIT RECONCILATION TABLE (Unaudited)200Y 200X(current (prioryear) year)

Gross Tax Net Gross Tax NetStatutory Profit 100 98(NPAT) ($M)Impairment—tile plant 0 0 0 15 –5 10(note 1)Tax provision writeback –5 –5 0 0 0Significant item—flood 0 0 0 5 –2 3damageCost of failed takeover 10 –3 7 0 0 0attemptCosts associated with 7 –3 4 4 –1 3inquiry (note 2)Redundancies (note 3) 20 –7 13 0 0 0Currency hedges (fair –12 4 –8 –15 5 –10value adjustment)Profit on sale of business –15 2 –13 0 0 0Subtotal 10 –12 –2 9 –3 6Underlying Profit ($M) 98 104

This table has been prepared in accordance with the AICD/Finsiaprinciples for reporting underlying profit.

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Explanatory Notes (further information is provided in themanagement discussion of the profit result).

1. Impairment—tile plant: one-off due to change in technology2. Costs associated with inquiry: participation in a government inquiry into

the possible environmental impact of a proposed new plant3. Redundancies: due to one-off business restructure.

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Underlying Profit: principles for reporting of non-statutory profit information