Diversity In Performance Reporting. Empirical Evidence From The London Stock Exchange Concerning The Classification Of Interest Components Within The Income Statement

Abstract

This study is motivated by the concerns of researchers, practitioners, and regulators regarding the drawbacks of non-statutory earnings subtotals. We investigate whether the flexibility in classifying subtotals within the income statement provided to managers under IFRS serves its intended purpose of facilitating the needs of investors. Responding to criticism, the IASB is currently deliberating on explicitly defining an EBIT subtotal. However, such an endeavour requires a clarification of how various interest components should be classified. In light of the IASB’s deliberations, we also investigate a European capital market’s treatment of two typically diffuse interest components - interest on defined benefit obligations and finance leases - by assessing their abilities to predict stock price and stock return. Using a sample of 391 non-financial firms on the London Stock Exchange, we document diversity among European firms in classification of the two interest components. Results show that the diversity in reporting practices does not result in more relevant disaggregation of earnings, suggesting flexibility do not facilitate the needs of investors. Furthermore, an explicitly defined EBIT subtotal might prove more relevant when industry-specific factors are taken into account. Moreover, this paper does not provide inferences as to how an EBIT subtotal may or may not be defined, however the results shed some light on how investors classify two typically diffuse interest components as opposed to how European firms classify them. This paper also contributes to the work of standard setters by providing an indication of which type of EBIT subtotal could be more beneficial to European capital markets.