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Thursday, November 1, 2007
Figure it out

The aim is to render Headline Earnings more consistent across companies

One of the main uses of headline earnings in South Africa is in the calculation of a consistent price-earnings ratio (P/E). Since 1995 the JSE has used headline earnings to create its P/E database. The South African Institute of Chartered Accountants (SAICA), in consultation with the headline earnings sub-committee of the United Kingdom Society of Investment Professionals, has revised the formula, at the request of the JSE, to align it with the changes in International Financial Reporting Standards (IFRS).
Sue Ludolph, SAICA’s project director for accounting, says the revised headline earnings formula must be calculated by all listed companies for their financial periods (interim or annual) ending on or after 31st August 2007.
The original headline earnings concept was based on the principle of excluding from earnings those items of a capital nature, in order to reflect the operating/trading performance of the entity. Subsequently, however, several developments in the financial world have blurred the distinction between capital and operating/trading performance, among them:
The focus of most IFRSs is on recognition of assets and liabilities (more of a balance sheet approach);
Financial statements increasingly incorporating more fair value measures; and
Increased use and complexity of derivative instruments and the consequential accounting treatments.
A SAICA research project in the first half of 2006 and subsequent interviews with various user groups, including fund managers, analysts and financial institutions, highlighted a need for a more clearly defined reference number for reporting and comparative purposes, other than the earnings per share figure (in terms of IAS 33 – Earnings per Share).
In future headline earnings is to be calculated by starting with the basic earnings figure produced per IFRS and then excluding all re-measurements as identified in a joint JSE/SAICA 8/2007 circular, that normally relate to the platform or capital of the entity.
Ludolph says that the focus on re-measurements – whether realised or unrealised – as opposed to all capital items, provides a more consistent mechanism for determining headline earnings in the IFRS context. The exclusion of most re-measurements – other than those stemming, for example, from operating/trading – parallels in most cases the original headline earnings distinction between capital and operating/trading.
“Another reason for reconsidering the calculation of headline earnings was to ensure consistency of treatment by all companies of the same or similar items. The only way to achieve this consistency was to create detailed rules for all items that were separately disclosable in terms of IFRS.”
John Burke, head of listings at the JSE, says, “Headline earnings is not a departure from IFRS, but just a way of dividing the IFRS-reported profit between re-measurements that are more closely aligned to the operating/trading activities of the entity and the platform used to create those results.”   He says this provides ongoing justification for the original principle and validates the continued use of the currently published historic headline earnings data without interruption.
  While it is believed that there will be consistency of treatments for most items, the calculation of headline earnings following the revised circular may not be identical to the results obtained from applying the previous formula.
  Specific departures from the old formula for companies have been identified as follows:
Not all gains or losses on the closure, sale or termination of a business will automatically be excluded from headline earnings;
A new approach is required for the recognition of a deferred tax asset of the acquiree, following a business combination;
Additional adjustments for any linked unit (where a share and debenture trade as a linked unit) which are a common feature of the property sector; and
A new specific banking industry rule for re-measurements relating to private equity activities (associates or joint ventures) regarded as operating/trading activities.
Unlike its predecessor, Circular 8/2007 also sets out a standard format for the headline earnings reconciliation to ensure maximum benefit to users in terms of the detailed disclosure.
Mr Burke says the JSE will capture the revised headline earnings numbers for all financial periods ending on or after 31st August 2007 for the P/E database.

Copyright © Insurance Times and Investments® Vol:20.10 1st November, 2007
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