UAFRS: Uniform Adjusted Financial Reporting Standards

UAFRS: Uniform Adjusted Financial Reporting Standards


What is UAFRS?

UAFRS is an alternative set of standards for financial reporting aimed at creating more reliable reporting of corporate financial activity.

The term “uniform” suggests that all financial reporting rules should be made consistent for analysis of financial reports. This desired uniformity reflects that GAAP and IFRS financials are an antithesis to uniformity in financial statement reporting.

This specifically highlights the extensive research and documentation of the inconsistencies, misclassifications of categories and terminology, and lack of reliability of as-reported financial statements under GAAP and IFRS. (Generally Accepted Accounting Principles in the United States and International Financial Reporting Standards around the world.)

The term “adjusted” suggests that the process of achieving UAFRS is by adjusting the as-reported financial statements by disassembling and then re-building the financial statements with an entirely consistent set of accounting rules.

More detailed disclosure of financial activity by management may be desirable, however it is not necessary to achieve significant benefits from simply adjusting the as-reported GAAP and IFRS financial statements into UAFRS-based financial statements.

The Problem with As-Reported Financial Statements under GAAP and IFRS

Around the world, important elements of as-reported corporate financial statements have become unreliable. As-reported assets, investments, debts, earnings, equity accounts, and even revenue have become unreliable representations of the reality of the reported balances and activities. The problem stems from significant inconsistencies in the rules and application of those rules in financial statements as-reported today.

There is a growing awareness to the severity of these problems, but by only a small fraction of the total users of financial statements. Members of the governing accounting bodies of FASB and IASB have publicly called out many of the issues. The SEC has stated there is a growing “erosion in the quality of financial reporting.” Expert accounting practitioners have highlighted the many issues.

The case for UAFRS is becoming an obvious garbage-in, garbage-out situation. Performance metrics and derived valuation analysis built on as-reported financials are terribly distorted and in some cases useless.

Earnings can be reported to go up when in fact a firm’s performance has faltered. Price-to-earnings ratios show stocks to be expensive that are in actuality cheap. Margins, assets, capital expenditures, debts, and virtually all key financial performance indicators can be a far cry from an accurate representation of corporate activity.

Overwhelmingly, the CFO is not to blame. So who is?

Unfortunately, the CEO and CFO have received much of the blame for the erosion in financial statement quality. Financial shenanigans of many types are cited as the main issue. For some, there is a prevailing belief that the management team is responsible.

The problem is certainly getting worse, and yet it is not because of a few unscrupulous management teams. The global financial reporting problem rests squarely with the rule-making process of the governing accounting bodies over time.

The financial reporting authorities have established a set of standards that have been argued, debated, and then established over decades and decades. The result is a set of accounting rules with inconsistent policies that reflect a mixture of differing objectives for the financial statements.

The accounting rule-making discussions do not occur in a vacuum of accounting theory and practice. Instead, these rules have been established inside very influential and changing environments.

Among a long list of accounting-influencing environments, these include varying economic climates, changing political regimes, waxing and waning trends in globalization versus nationalism, and trends in the influence of various stakeholders such as equity, credit, or the general public.

How bad are the problems from inconsistent financial reporting rules?

The result is a set of financial reporting rules that certainly create grossly incomparable financial statement elements across country borders. However, that incomparability can be just as severe when comparing financial reports of even the closest industry peers in the same country.

Upon closer examination, and possibly most disturbing, is that even simple trend analysis of a single company’s performance from year to year can be materially unreliable.

It’s important to note that it’s not just the income statement and balance sheet that are so distorted. The controversy over the establishment of the statement of cash flows is well-documented, though often overlooked by most financial analysis. Several members of the FASB itself called out the problems of cash flow from operations, investing, and financing as mis-categorized, “misclassified,” and “likely to be misunderstood” by most users of the financial statements.

On that last comment, time has show the comments of those FASB members to have been prescient.

UAFRS Process in Practice

The viable solution is to disassemble the financial statements and then reassemble them using globally consistent standards that repair the problems cited above.

Research shows more than 130 adjustments are necessary to create uniformity in financial reporting standards. As-reported standards are inconsistent in either rule or application across GAAP and IFRS to such a degree that any one of these 130+ adjustments has been shown to create a material inconsistency in reported assets, earnings, or even revenue when conducting trend analysis or comparing peers.

Another important issue regarding the necessary adjustments is that to attain uniformity, automated and manual adjustments are necessary. Thankfully, many adjustments to the reporting standards can be done on an automated basis. In other words, for those adjustments, one can simply create a formulaic rule for creating uniformity.

An example would be in the reporting of cost of goods sold wherein all companies would be set to a LIFO, last-in first-out method, to remove the distortion of some firms reporting on a FIFO first-in first out basis.

For firms where cost of goods sold is a significant portion of expenses, or the firm does not turn over inventory frequently, clearly varying LIFO and FIFO methods can create inconsistencies in assets and earnings. The fix is easy and automatable.

Manual Versus Automated Adjustments

Unfortunately, several of the necessary adjustments are manual in nature and require specific analysis to arrive at the proper adjustment to achieve uniformity. In other words, one cannot simply “add-back” or “subtract-out” a financial statement item to create an apples-to-apples comparison of company activity.

An example comes from mergers and acquisitions accounting, which even in “low” M&A environments can create massive inconsistencies in financial reporting.

Most of the world’s governing accounting bodies have disallowed the pooling of interests method of accounting for acquisitions. Under the governing “purchase method” rules, significant material distortions arise in assets, earnings, liabilities, reported cash flows, and even revenue. The problem is that the date of the acquisition drives the income statement and cash flow statement, while the balance sheet is unaffected. At the end of the year, the parent company reports an acquisition fully on the balance sheet, with goodwill.

However, the impact on the income statement and the cash flow statement is wholly dependent on the acquisition date. An acquisition early in the parent company’s fiscal year will show much of the target firm’s revenue, earnings, and cash flow. An acquisition at the end of the year will show almost none of it.

The mismatch between the balance sheet and the inconsistent income and cash flow statements is obvious. The fix requires an analyst to manually examine the data, and while systematic in nature, create a manual “fix.”

Unfortunately, many of the required adjustments to repair material inconsistencies require good old-fashioned elbow grease by a seasoned financial analyst. The quality of financial reporting is sufficiently inconsistent such that an automated “spreadsheet” will not repair many of the material distortions.

UAFRS Results

Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Thereby, business performance, equity valuation analysis, and credit analysis under UAFRS-reported numbers begin to provide significant improvement over any analysis driven by as-reported numbers.

A growing base of research is now showing the proof behind UAFRS-based analysis.
UAFRS-based credit analytics appear to consistently provide an early signal on the credit worthiness and riskiness of corporate debts.

In a plethora of case examples and larger studies, UAFRS-based equity analysis is showing an ability to better classify firms as “cheap” versus “expensive,” or as low quality versus high quality vis a vis analysis such as economic profit.

Even simple business performance analyses seem to benefit from the fewer distortions, analyses such as the DuPont method for analyzing margins and turns as the drivers of return on assets.

Some of the most compelling evidence has been in aggregate analysis, when looking at entire stock markets of USA, China, Germany, Singapore, and others. There is a clear relationship between market valuations and UAFRS earnings that does not at all exist between valuations and as-reported earnings.

I hope this site will become a resource for better understanding and applying UAFRS for financial statement analysts of every background and purpose.

Thank you,

Joel Litman

UAFRS-Related Articles and Publications

SeekingAlpha: Adjusted Metrics Reveal Danaher’s True Post-Acquisition Value

SeekingAlpha: Economic Suicide In China: With a UAFRS focus

Harvest: The Dark Side of M&A in the Financials

Harvest: R&D Is An Investment, Not An Expense – How capitalizing R&D impacts understanding corporate profitability (GILD, FB, BA, DHR)

Harvest: UAFRS – How As-Reported PP&E is Distorting Financial Ratios

Valens Research Newsletter: How UAFRS Highlights GAAP and IFRS Distortions, Weekly

6,000+ companies in UAFRS: UAFRS-based Performance and Valuation Database

Selection of Programs Addressing UAFRS Around the World

NYSSA (“CFA New York”): NYSSA Panel on Financial Reporting of Mergers & Acquisitions

CFA United Kingdom: Webinar on GAAP and IFRS: The Dark Side of Financial Reporting

CFA Germany at Bloomberg: The Dark Side of Financial Statement Analysis (Frankfurt)

CFA Singapore: Strategic Valuation: Addressing Serious Distortions in GAAP and IFRS

CFA Society Emirates: Cross-Capital Investing Seminar Program in Dubai

HKSFA (“CFA Hong Kong”): The Dark Side of Financial Statements – May 2017

Kellogg Alumni: The Dark Side and Bright Side of USA & China Markets Through UAFRS

Hult International Business School: Global Strategic Valuation with UAFRS Financials, London June 2017