Skip to main content

Even in cases where tax avoidance or deferral isn’t a main reason for making the investment – in which case the OIFP rules should not apply – the taxman may choose to apply the rule anyway.seb_ra/Getty Images/iStockphoto

BCE and the case of recurring charges

It makes sense that a company might want to exclude a one-time expense from the earnings it reports to shareholders. But what happens if it has one "one-time" expense after another?

One company that does is BCE Inc., which has made strategic acquisitions a key part of its business model. BCE has adjusted for "severance, acquisition and other costs" each year for the past five years, Veritas says. (In 2015, BCE added $446-million back to its $2.73-billion in net earnings, on its way to $8.55-billion in "adjusted EBITDA.") The company says it excludes the expenses and uses adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) and adjusted EBITDA margin so it can evaluate the "ongoing profitability" of its businesses. "The implication is that it is non-recurring," Veritas says. "If a company does a single acquisition, the costs can be reasonably argued to be non-recurring in nature. However, we would argue that a company whose primary strategy is growth-by-acquisition should not exclude transaction-related costs as these are simply a cost of doing business."

BCE spokesman Jean Charles Robillard says "like other Canadian corporations and our major competitors, we use non-GAAP measures to ensure our business performance and comparability of our financial results is accurately reflected. These kinds of measures help investors and financial analysts better understand the value of the company and how we're performing.

"Bell has made a number of acquisitions in recent years," he says, adding that acquisitions are often a matter of "utilizations of excess free cash flow" – and including the associated costs of acquisitions in its earnings "would lead to unusual short-term results and impact comparability with normal-course business operations."

Kinross and asset-impairment charges

Asset-impairment charges may be the king of non-cash expenses. When a company has an asset on the books that has suffered a permanent decline in value and cannot generate the cash flows to support its stated value, the company must write it down. The amount is charged directly to earnings, which can result in a multibillion-dollar loss under GAAP. Since there's no cash used at the time of the writedown, however, companies often exclude the charge from their preferred quarterly numbers.

"When a company takes an asset-impairment charge, management is in essence telling investors that (relative to the value of the asset on their books today) they could not sell it to a third party for at least that much nor will the present value of the cash flows the asset is expected to generate recover the value of the asset," Veritas says.

While nearly all the resource companies in Canada have taken writedowns in recent years, Kinross Gold Corp. is notable. Kinross's 2010 purchase of Red Back Mining Inc. has now resulted in $7.5-billion (U.S.) in writedowns, a number greater than its $5.6-billion market capitalization on the New York Stock Exchange.

Kinross spokesman Louie Diaz says that while the company presents both GAAP/IFRS and non-GAAP financial results in its quarterly news releases in equal prominence, it presents "adjusted net earnings" because it "allows shareholders and analysts to better evaluate the underlying performance of the company." Kinross has excluded asset impairments "as they do not accurately reflect the current underlying performance of the asset, and are not necessarily indicative of future operating results. Asset impairments are, as the Veritas report notes, 'inherently backwards looking,' and therefore do not impact future cash flows."

Agnico-Eagle Mines and stock option expenses

For more than a decade, accountants, regulators, investors and companies argued about whether the expense of stock options should appear in an income statement; those who wanted to see the number deducted from profit won in 2005. Today, however, companies that use stock-based compensation subtract those costs to arrive at their preferred numbers.

"The standard rationale is that the expense is 'non-cash' and therefore should be excluded," Veritas says. "In our view, stock options are a form of compensation for employees that must be accounted."

Agnico Eagle Mines Ltd. had $24.6-million in 2015 net income under International Financial Reporting Standards (IFRS), but added back $19.5-million in stock options expenses, along with other items, to get to $93-million in "adjusted net income." Over the three years from 2013 to 2015, Agnico Eagle had nearly $66-million in stock options expense.

Ammar Al-Joundi, Agnico-Eagle's president, says the company always lists its IFRS-calculated net income number first in its press release. However, "we break out a number of items that we have been told by analysts that they want to see broken out … they could go into the financials and dig it up, but they want that up front, so we put it in the first paragraph."

The issue with stock option expense, Mr. Al-Joundi says, is that "the actual potential cost of stock options varies very much from the theoretical value upon the day they're issued, which is what drives the accounting." But, he says, "to me, start with the number that's consistent for everybody under the IFRS rules, identify all the different elements, and as long as it's transparent and clear, people can make an assessment as to whether they want to incorporate different pieces."

Pembina Pipeline and a shifting definition of EBITDA

EBITDA is a non-GAAP measure; it takes net income and adds back interest, taxes, depreciation and amortization to arrive at its "earnings" figure. That definition is generally understood, but not prescribed by accounting rules, so some firms have found they can tweak the definition to their liking.

An example: Pembina Pipeline Corp. defined EBITDA in its 2015 annual report as "results from operating activities plus share of profit (loss) from equity accounted investees (before tax, depreciation and amortization) plus depreciation and amortization (included in operations and general and administrative expense) and unrealized gains or losses on commodity-related derivative financial instruments."

Says Veritas: "One conclusion is that investors should not assume they know what management means when they discuss EBITDA in presentations or disclosure, and should always confirm the definition of EBITDA that each company is using as part of standard due diligence."

Pembina spokesman Jason Fydirchuk says that, starting in 2016, Pembina moved to an "adjusted EBITDA" metric "and is no longer referencing the discussed 'EBITDA' measurement. … Considering our updated reporting metrics, we believe Pembina is no longer a relevant example."

Veritas analyst Taso Georgopoulos says the company used EBITDA and adjusted EBITDA in the first quarter and finalized its metric in the second quarter. "I think this makes this case even more interesting, as you can clearly see a progression and change in the disclosure over a short period of time for a single company. "

Mr. Fydirchuk, asked to speak to the company's evolution in disclosure, said "we review our disclosure metrics quarterly to ensure we're in line with industry best practices."

Magna International and the emphasis on non-GAAP

One of the core rules about the presentation of non-GAAP metrics – a regulation in the United States and guidance in Canada – is that GAAP measures must have equal or greater prominence to the non-GAAP measures. The idea is to keep companies from emphasizing an earnings measure that doesn't conform with accounting rules, at the expense of one that does.

Magna International Inc.'s preferred earnings measure, its disclosures suggest, is "adjusted EBIT," a metric that removes interest and taxes, but not depreciation and amortization, from net income, and then makes additional tweaks. Adjusted EBIT appears in the table in Magna's 2015 earnings release before the GAAP net income. In the annual report, the company provides discussion of its adjusted EBIT figure with less attention to net income, which seems to give adjusted EBIT more prominence than net income.

Companies also must look at its non-GAAP metric and identify the GAAP measure that's most directly comparable to it. They must then provide a reconciliation between the two figures – and alert investors to the reconciliation the first time the non-GAAP measure is used. Magna didn't make that reference on its first use of adjusted EBIT, Veritas says, and didn't provide the reconciliation until the "notes" section of its annual report, as opposed to including it in the more-prominent Management Discussion and Analysis section.

Magna spokeswoman Tracy Fuerst said the company is unable to comment for this story.