Wesley Bricker, deputy chief accountant with the Securities and Exchange Commission, is echoing concerns from other top SEC officials about the over-reliance on non-GAAP measures in financial reporting.
During a speech Thursday at Baruch’s College’s Financial Reporting Conference in New York, Bricker cited recent statements from SEC chair Mary Jo White and chief accountant James Schnurr and (see SEC Questions Widespread Use of Non-GAAP Measures). Keith Higgins, the director of the SEC’s Division of Corporation Finance, has also spoken out about the practice.
“The Commission’s original non-GAAP rules were adopted in 2003,” said Bricker. “Seven years later in 2010, the staff observed that while those rules had achieved substantial progress towards reducing the inappropriate use of non-GAAP measures, certain staff interpretive guidance had resulted in some unintended consequences. For example, certain measures that some argued would be useful were being effectively prohibited. In light of this, the staff guidance was revised in 2010 to avoid that result.”
Bricker noted that since those revisions took place, the SEC’s Division of Corporation Finance has continued to issue comments concerning non-GAAP measures and, in some cases, has objected to certain measures. The comments have focused on a company’s disclosure as to why their non-GAAP measures are useful; along with “apparent cherry picking adjustments within a non-GAAP measure” and adjustments to remove normal, cash operating expenses.
But the SEC is seeing more reason for concern of late with non-GAAP measures. “Recent examples of company practices related to non-GAAP measures have caused concern, including the use of individually-tailored accounting principles to calculate non-GAAP earnings; providing per share data for non-GAAP performance measures that look like liquidity measures; and non-GAAP tax expense,” said Bricker. “Recent examples of company practices related to operating metrics have also caused concern.”
Bricker cited how individually-tailored accounting principles could be used in the case of a hypothetical company that has a subscription-based business. “The company bills for the full subscription at the outset, but since it will deliver over time, it earns and recognizes GAAP revenue over that same period,” he said. “Now assume this company calculates non-GAAP revenue as though it had a different business. That is, it calculates what revenue it would have had, had it not sold a subscription, but rather had sold a product.”
The effect of the measure is that the company accelerates revenue recognition to the billing date and proceeds to calculate earnings based on this non-GAAP revenue, he noted. At that point, this company’s GAAP results are based on revenues recognized as the service is provided and the non-GAAP results are based on revenues that are merely billed to the customer.
“In this instance, the measure does not appear to help investors understand and analyze core operating results,” said Bricker. “Rather, it is a replacement of an important accounting principle with an alternate accounting model that does not match the company’s subscriptions business or earnings process, which is over time.”
Bricker explained how such measurements could be misleading. “Revenue adjustments do more than just adjust from GAAP: they change the very starting point from which other performance analyses flow,” he said.
He warned that the SEC staff will be monitoring how companies use such measures in light of the new revenue recognition standard. “As the staff monitors current practices and implementation of the new revenue standard, we will be looking to see if the reporting concepts within those standards are supplanted by any number of company-specific non-GAAP alternatives,” said Bricker. “For all of these reasons, if you present adjusted revenue, you will likely get a comment; moreover, you can expect the staff to look closely, and skeptically, at the explanation as to why the revenue adjustment is appropriate.”
Bricker stressed four points that have been made about non-GAAP measures in recent months. “First, preparers should consider how their disclosure controls and procedures apply to the disclosure of non-GAAP measures,” he said. “Second, despite the fact that GAAP measures sometimes gets forgotten once analysts and the press start commenting on a company’s results, investors should refer back to a company’s financial statements so that the non-GAAP measures are put into the proper context. Third, audit committees should be paying close attention to the non-GAAP measures a company presents, including the required related disclosures, and the processes it follows to consider both the appropriateness and reliability of the measures. I also would note that Chair White has mentioned the possibility of future rulemaking in this area.”
Bricker said the SEC may be issuing further rules in the future on non-GAAP measures. “In the meantime, the staff will be sharing its observations on non-GAAP measures in various forums,” he said. “Obviously, if necessary, the staff will consider potential recommendations to the Commission for rulemaking in this area, but I hope companies will seize this opportunity to review their practices and make any necessary changes.”
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