Measuring the Unconventional
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How do you measure a company’s performance?

Financial statements provide a crucial starting point that follows GAAP and IFRS
standards.
 General Accepted Accounting Principles and International Financial
Reporting Standards)

But many companies include other performance measures in their reporting to
stakeholders.
 These performances measures are not required to be included in
financial reporting.
This additional information can help tell a more complete story of a company’s past
performance, current condition, and future prospects.
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For example, Netflix’s 2020 annual report included the number of streaming paid
memberships it had across the globe at year end from 2016 (89.1 million) through
2020 (203.7 million). (See the bar graph for Netflix’s year‐over‐year increase in
streaming paid memberships since 2016; the increase in 2020 [of over 35 million
subscribers] can largely be attributed to the COVID‐19 pandemic, which forced
people to stay at home.)
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
Grocery companies such as Sobeys and Loblaw include the number, size, and type of
their stores.

A theatre might report on the demographics of its subscribers, which is relevant to its
marketing strategy and future growth potential.
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In fact, 70% of TSX 60 members included these kinds of:
Non‐GAAP metrics in their regulatory filings, according to a 2018 report by
Veritas Investment Research.

These metrics are NON-GAAP so they do not have to necessarily follow a
certain set of rules as would be otherwise required.
But since these metrics are self‐selected and self‐defined:
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It can be harder for outside stakeholders to assess the information to make relevant
decisions.
 Because these metrics do not follow any required rules. Definitions can be
manipulated in their advantage or only good information can be presented.
There is a natural incentive for management to choose metrics that show their companies
in the best light:

Some investors and regulators have criticized a tendency to include non‐GAAP
financial performance measures that are misleading.

Because they do not want the perception of a company to be skewed by these
metrics that do not follow a certain set of rules.
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To address these concerns, the Accounting Standards Board (AcSB) developed a
Framework for Reporting Performance Measures in 2018
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“to encourage conversations and actions to improve the quality of information when
entities choose to report performance measures outside financial statements.”

Basically, information that is not required to be reported by the rules.
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AcSB chair Linda Mezon commented:
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“I don’t think there is anything inherently evil in these companies wanting to tell their
story,”
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but she stressed the need for the same kind of quality control and oversight that is applied
to GAAP numbers to be applied to these other metrics.
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The framework provides a set of principles to guide entities in providing this high‐quality
information.

This set of principles will let you choose what information is relevant and
appropriate to show outside investors.
Preview of Chapter 2
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Users of financial statements need relevant and reliable information.

Extra information might skew in a bad way the perception of the company and
deceive the investor.
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This includes not only financial information (such as revenues and net income):

But also non‐financial information (for instance, barrels of oil produced, number of
new customer subscriptions, or information about climate change).

None-Gaap info
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Some of this information is presented within:
1. The financial statements, and
2. Some is presented outside of the statements (for example, in the annual report or in
separate reports).

This none-Gaap information could be presented with the quarterly financial results
or in other presentations, meetings, or reports.
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To help ensure that the information provided is useful, various frameworks have been
developed.
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“Principles”
For financial statements, accountants use:
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Conceptual frameworks for financial accounting and reporting.
These are developed by the IASB and AcSB.

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Financials are all about GAAP and nothing else. Therefore, decisions are
made with a framework provided by these authority accounting entities since
they are based on rather specific rules.
For other information, regulators and others issue:
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Guidance, adoption of which may be mandatory or voluntary.

Since this is extra information outside of GAAP. we use the word “guidance”
instead of “rules” when reporting this information.

This guidance might be voluntary or mandatory hence “no specific set of
rules to follow mindset”
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As noted in the opening story, the Canadian Accounting Standards Board has issued a:
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Non‐mandatory Framework for Reporting Performance Measures (including non‐
GAAP measures, other financial measures, and non‐financial/operational measures).
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In Chapter 1, we also noted that various presentation and disclosure frameworks have
been developed for reporting on sustainability:
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The goal of all of these frameworks is to continue to improve the quality of information
provided.
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The goal of a framework is to give a set of principles needed in order to properly
label a financial transaction GAAP or NONE-GAAP.

Not every financial transaction will be able to be classed with the CPA BOOK.
Sometimes is not a straight-forward decision, and the CPA needs to use his
judgement (supported by these frameworks.
This chapter will focus on the conceptual frameworks for financial accounting and
reporting.
2.1 Conceptual Framework
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A conceptual framework is like a constitution: it is a:

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“Coherent system of interrelated objectives and fundamentals that can lead to
consistent standards and that prescribes the nature, function, and limits of financial
accounting and financial statements.”
Many observers believe that:

The real contribution of standard‐setting bodies, and even their continued existence,
depends on the quality and usefulness of the conceptual framework.

So the framework needs to produce consistent positive legitimate results.
Rationale for a Conceptual Framework
Why is a conceptual framework necessary?
1. First, to be useful, standard setting should build on an established body of concepts and
objectives.

Having a soundly developed conceptual framework as their starting point, standard
setters are then able to issue additional useful and consistent standards over time.
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The result is a coherent set of standards and rules, because they have all been built
upon the same foundation.

It is important that such a framework increase financial statement users’
understanding of and confidence in financial reporting, and that it enhance the
comparability of different companies’ financial statements.

Just like the law, this “constitution” is the base of standards setters because their
standards need to follow the principles in that “constitution”. This yields positive
consistent and legimate results in all financial statements.
2. Second, by referring to an existing framework of basic theory,
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It should be possible to solve new and emerging practical problems more quickly.
It is difficult, if not impossible, for standard setters to quickly state the proper accounting
treatment for highly complex situations.

Think of crypto and taxes. The CRA needs a framework in order to quickly
classify this asset or if it even needs to be taxed. The framework could start with
“any economic advantage needs to be taxed unless otherwise specified” for
example.

Things are moving fast and unproper reporting might be exploited by companies
and deceive the investor. Sometimes even the accountants might not know.
Practicing accountants, however, must solve such problems on a day‐to‐day basis.

By using good judgement, and with the help of a universally accepted conceptual
framework, it is hoped that accountants will be able to decide against certain
alternatives quickly and to focus instead on a logical and acceptable treatment.

This framework helps standard setters but also accounting so they make the
right decisions and can be held liable since there is a framework that needs to
be followed when classifying financial transactions.
Development of the Conceptual Framework
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Over the years, many organizations, committees, and interested individuals developed
and published their own conceptual frameworks:

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Realizing there was a need for a generally accepted framework, in 1976 the Financial
Accounting Standards Board (FASB) issued:
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A three‐part discussion memorandum entitled “Conceptual Framework for Financial
Accounting and Reporting: Elements of Financial Statements and Their
Measurement.”
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It stated the major issues that would need to be addressed in establishing a conceptual
framework for setting accounting standards and resolving financial reporting
controversies.
Based on this memorandum, a conceptual framework was developed.
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But no single framework had been universally accepted and relied on in practice.
The AcSB and IASB followed the FASB’s example and issued their own respective
frameworks.
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Different frameworks.
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A new framework was issued by the IASB in March 2018 (effective January 1, 2020).
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The conceptual frameworks developed by the AcSB and IASB:
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Are not considered to be accounting standards;
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Therefore, they do not override any of the ASPE or IFRS standards that specifically
deal with accounting for transactions and events.
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CONCEPTUAL FRAMEWORKS ARE NOT ACCOUNTING STANDARDS.
YOU NEED TO FOLLOW ACCOUNTING STANDARDS.
Also, inconsistencies may exist between:
1. The newer conceptual frameworks and
2. The older accounting standards (in both ASPE and IFRS)
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Because the older standards may have been created using an older conceptual
framework (or none at all).
Illustration 2.1 shows an overview of a conceptual framework.
1. At the first level, the objectives identify:

Accounting’s goals and purposes: these are the conceptual framework’s building
blocks.
2. At the second level are:

The qualitative characteristics that make accounting information useful and the
elements of financial statements (assets, liabilities, equity, revenues, expenses,
gains, and losses).
3. At the third and final level are the foundational principles used in establishing and
applying accounting standards.
Information Asymmetry Revisited
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As discussed in Chapter 1, investors and creditors need information in order to make
sound resource allocation decisions.
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However, information in the capital marketplace is not always evenly accessible or
available to investors and creditors.
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Stock markets and regulators go to great lengths to ensure information symmetry for all
capital market participants so that no one is at a disadvantage.
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Despite these efforts, various stakeholders often do not have the same information. This
can be a problem as stakeholders may make suboptimal decisions because they lack good
or complete information.
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Financial statements play a large part in helping to ensure that investors, creditors, and
others have access to information they need to make decisions.
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However, because of adverse selection and/or moral hazard (see Chapter 1), problems
may arise.
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The moral hazard issue is worse where:
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Certain stakeholders such as accountants and owner‐managers have expert knowledge
that the rest of the capital marketplace does not.

They may use this expertise to act in their own self‐interest, to the detriment of other
capital marketplace participants such as investors.
A well‐written conceptual framework based on sound principles may help:
1. Address these information asymmetry concerns.
2. In addition, as noted later in this chapter, strong control and governance systems
and environments are critical.

With a framework, the accountants will be able to properly discern information
and not omit information needed to reduce moral hazard or information
asymmetry.
Objective of Financial Reporting
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According to the conceptual framework, the objective of financial reporting is:
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Financial information is useful in making decisions about how to:
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Allocate resources (including assessing management stewardship).
For example, a bank may need information in order to decide whether to lend a company
money or call a loan.
Similarly, an investor may need information about a company’s profitability in order to
decide whether to invest in it or divest.
Management stewardship is:
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To communicate information that is useful to investors, creditors, and other users.
How well management is using entity resources to create and sustain value.
Consequently, companies should provide information about their:
1. Financial position,
2. Changes in financial position, and
3. Performance.
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They should also show:
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How efficiently and effectively management and the board of directors have
discharged their responsibilities to use the entity’s resources wisely.
Companies provide this information to users of financial statements through:
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General‐purpose financial statements.
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These are basic financial statements that give information that meets the needs of key
users.
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The statements are intended to provide the most useful information possible in a manner
whereby benefits exceed costs to the different kinds of users.
2.2 Qualitative Characteristics of Useful Information
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Choosing:
1. An acceptable accounting method,
2. The amount and types of information to be disclosed, and
3. The format in which information should be presented
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Involves determining which alternative gives the most useful information for
decision‐making purposes (decision usefulness).
The conceptual framework’s second level has identified:

The qualitative characteristics of accounting information that distinguish information
that is better (more useful) for making decisions from information that is inferior (less
useful).
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These characteristics are explained next.
Fundamental Qualitative Characteristics
1. Relevance and
2. Representational faithfulness (sometimes called faithful representation) are:

Fundamental qualities that make accounting information useful for decision‐making.
Above all else, these two characteristics must be present.
Relevance
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To be relevant, accounting information must:
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Be capable of making a difference in a decision.
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If a piece of information has no impact on a decision, it is irrelevant to that decision.
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Care should be taken to ensure that relevant information is included in financial
reporting.
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Relevant information helps users make predictions about the final outcome of past,
present, and future events; that is,
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It has predictive value.
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For example, separating income from continuing operations from that of operations that
have been discontinued may help users predict future income.
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Relevant information also helps users:
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Confirm or correct their previous expectations;
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It has feedback/confirmatory value.
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For instance, providing information about rental income and the value of the rinvestment
in rental properties might help users assess how well management is managing the
investment in rental properties.
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When discussing relevance, we often hear about the notion of materiality.
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Materiality refers to:
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How important a piece of information is.
Information is generally thought to be material if it:
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Would make a difference to the decision‐maker.
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For instance, a major product defect would be of interest to a potential investor.
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Material information that is relevant should be included in the financial statements.
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When determining whether something is material or not, the amount in question is:

Often compared with the entity’s amounts of other revenues and expenses, assets and
liabilities, or net income.
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It is hard to give firm guidelines to decide when an item is or is not material because
materiality depends on both a relative amount and relative importance.
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The IASB has issued a Practice Statement, Making Materiality Judgements, which
provides:
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A four‐step approach to deciding how to assess whether something is material.
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The Practice Statement is not mandatory but is intended to be helpful in ensuring that
all material items are presented and disclosed properly in the financial statements.
The four steps are as follows:
1. Identify any information that might make a difference to primary users of the financial
statements when they are making investing and lending decisions. Consider any
requirements noted in specific IFRS that are applicable (for example, IFRS 15). Then
look at additional items that you think a user might need to know.
2. Assess whether the information is material (including doing a quantitative and qualitative
assessment).
3. Make sure the information is organized in the financial statements in a way that is clear
and concise so that the user may make an informed decision.
4. Review the complete set of financial statements in the end to ensure that all material
information has been included and presented appropriately for all items.
Representational Faithfulness
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Accounting information is representationally faithful to the extent that:
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It faithfully reflects or represents the underlying economic substance of an event or
transaction, not just its legal form.
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Although the legal form may be the starting point in terms of understanding the nature of
a transaction:
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Companies sometimes structure transactions a certain way from a legal perspective in
order to:
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Manage risk, protect the company from lawsuits, or minimize income taxes.
Thus, the legal form of the transaction may be:
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It is often necessary to look behind the legal form.
Quite complex and may differ from the economic substance or intent.
Where this happens, the conceptual framework requires:

That the financial statements reflect the economics of the transaction
notwithstanding the legal structure.
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We will refer back to this notion of economic substance over legal form throughout the
text as we begin to look at more complex transactions.
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This notion of representing economic reality is sometimes called:

Transparency.
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If financial statement users read the financial statements, can they see what lies beneath
the numbers?
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This is critical since the statements are meant to tell a story about the business. Is this
a risky business? Is it a mature business? Is it capital‐intensive?
How do we ensure that this information is appropriately presented?

Information that is representationally faithful is complete, neutral, and free
from error.
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In addition, highly uncertain estimates affect representational faithfulness.
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For instance, where the only information about an amount (such as the estimated
potential loss on a lawsuit) is highly uncertain,:
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Perhaps additional disclosure may be necessary to explain this.
We will return to the issue of measurement later in this chapter and again throughout
the text.