Performance Measurement for Equity Analysis and Valuation1

¹ This article draws on material from UBS Investment Bank, and Stephen Cooper. The views and opinions expressed in this article are those of the author and are not necessarily those of UBS. UBS accepts no liability over the content of the article. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments.

Abstract

This paper comments on the IASB/FASB project on financial statement presentation. It suggests that the basic approach of cohesiveness between statements is worthwhile and the split between operating, financing and investing is useful to investors. However it proposes different valuation and presentation approaches for different activities, and underlines the importance of earnings for forecasting comprehensive income. It suggests a conceptual approach to defining earnings and explores ways of avoiding recycling while identifying fair value changes for some assets and liabilities.

Notes

¹ This article draws on material from UBS Investment Bank, and Stephen Cooper. The views and opinions expressed in this article are those of the author and are not necessarily those of UBS. UBS accepts no liability over the content of the article. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments.

² See IASB or FASB web site for full details about the project and timing of publications. www.iasb.org

³ For example the impact of interest rate changes on a pension liability may be reported outside earnings in other comprehensive income whereas the same effect on any other long-term provision must be included as a gain or loss within earnings.

⁴ That is not quite true as the dividend income from such an investment would be reflected in earnings although this does not affect our overall message.

⁵ Presently only the market yield or expected return on investments held in a pension fund is recognised as a separate component of earnings, although for many companies this is a highly significant figure.

⁶ There are current value measures available that are still based upon cost including replacement cost and related measures such as current cost or deprival value. These have appeal in that they fit in with the transactions based approach already described but arguably give a more relevant measure of profit. The problem with replacement cost though is the difficulty of application assets and technology change; many assets are simply not replaced on a like for like basis. As discussed above, we would prefer to see replacement cost information, including narrative disclosures, to be provided in the notes to the accounts where this is needed to understand and forecast capital expenditure

⁷ Actually the value should be based on the forecast not historical operating result but the principle is the same.

⁸ This does give the same result although the calculation in this case is rather more involved. Forecast rather than historical earnings that must be capitalised, this will be lower due to the decline in the value of the contract and hence decline in market yield. Also the discount rate must take account of the different risks associated with operations and the contract value.

⁹ For an explanation of the problems of equity analysis under the new accounting approach to concessions see ‘IFRS concession accounting’, Valuation and Accounting Footnotes 31 January 2007.

¹⁰ We assume that it is the net of the defined benefit pension scheme assets and liabilities that is presented in financial statements. We believe that there is actually a good case for the full consolidation of pension funds with the separate presentation of assets and related income and liabilities and related expenses. This would more closely reflect the underlying economic impact of pensions.

¹¹ This is one of three approaches presently being considered by FASB in their liabilities and equity project.