This edition of the GAAP Flash focuses on the scary, and potentially misleading, side of accounting: restatements, especially those related to revenue recognition under ASC 605 (SAB 104), and non-GAAP financial measures. Read more to learn about some pitfalls to consider, from an investor’s perspective!

Valeant Likely to Restate Results in Wake of Internal Review (February 23, 2016) – The Wall Street Journal (@wsj)

New evidence from an internal review at Valeant may cause the pharmaceutical company to restate of prior financial statements. The company now believes that approximately $58 million of revenue recorded in its 2014 fiscal year was booked inappropriately in accordance with ASC 605 and SAB 104, which equates to a reduction in earnings per share by 10 cents. Revenue generated by shipments to a distributor, Philidor, should not have been booked until sold to customers, due to Valeant’s investment in Philidor and consolidation of its results as part of Valeant’s reporting process.

This news comes on the heels of increased scrutiny over the pharmaceutical company’s accounting for acquisitions, including accusations of fraud related to its relationship with Philidor. The heart of the issue revolves around measurement period adjustments made to goodwill Valeant made after acquiring other companies. Accounting guidance allows these adjustments, but only up to one year after completion of the acquisition and assuming other conditions are met. Also, these adjustments typically impact the income statement in the period the adjustment is made; however, Valeant did not adjust its operating results, disclosing that the adjustment did not materially affect previously reported financial statements.

Both articles point to the intricacies and complexities surrounding appropriate accounting for revenue recognition and business combinations. What if a company doesn’t get it right? Valeant’s share price has tumbled 70% since August 2015!

Boeing Said to Face SEC Accounting Probe (February 11, 2016) – Accounting Today (@AccountingToday)

A whistleblower at Boeing brought an investigation from the U.S. Securities and Exchange Commission to determine whether the airplane manufacturer is properly accounting for costs and expected profits of two of its jetliners in accordance with ASC 605 and SAB 104. Currently, Boeing uses an acceptable method of accounting, called “program accounting”, to spread out average costs and anticipated profits over the duration of production for each “program”, typically one model of jet or airplane in the case of Boeing. This election relies on significant estimates that must be updated regularly and if earnings will not catch up to expenses, a loss should be recognized.

Now, speculation has grown that Boeing’s forecasts rely on unrealistic scenarios that are too optimistic. If so, Boeing could avoid recording losses that would hamper earnings and push down its value to investors! As new information emerges, especially the likelihood that future sales will not reach projections, the drum beat grows louder for Boeing to revise its stance on its accounting methodology.

Pesticide Company Charged with Accounting Fraud (February 19, 2016) – Accounting Today (@AccountingToday)

Accounting fraud is no joking matter, and Marrone Bio Innovations recently found that out when the SEC charged the pesticide company with accounting not consistent with ASC 605 / SAB 104 and inflating financial results. Namely, the former chief operating officer offered sales concessions for distributors to return unsold products, while booking full revenues for those sales. The COO also directed employees to falsify shipping documents and intentionally deliver products to book fraudulent sales.

What will happen to Marrone Bio? Well, for starters, its stock price took a beating, dropping more than 44 percent when this scandal came to light. Now, the company must also pay a $1.75 million penalty to settle the charges from the SEC.

Fuzzy-Math Accounting Chided by Buffet Gets Fresh SEC Scrutiny (March 1, 2016) – Bloomberg (@business)

A recent swell in the presentation and promotion of non-GAAP financial measures to investors is making the SEC wary. While reporting non-GAAP financial measures is permitted, some regulators believe these non-GAAP items make it more difficult for investors to understand and evaluate the financial condition of publicly traded companies. Non-GAAP financial measures must also be reconciled back to the corresponding GAAP results, but many times these reconciliations fall farther back in press releases or publicly issued statements, giving the non-GAAP measure more prominence and seemingly more importance, which is not in accordance with SEC rules.

Companies often find ways to make operating profits or cash flows look better than these results would look under U.S. GAAP. For instance, ConocoPhillips used crude oil prices from 2013 to boost profits in a non-GAAP financial measure by $755 million compared to GAAP. Twitter made a similar type of adjustment, stripping out stock compensation expense, to calculate non-GAAP profit of $276 million while GAAP results showed a loss of $521 million.

However, it is not just a handful of companies adjusting GAAP financial measures at an alarming rate. As this article by the Wall Street Journal shows, it is systemic throughout publicly listed entities. In 2015 non-GAAP figures show companies in the S&P 500 earned 0.4% more per share when compared to 2014. However, results under generally accepted accounting principles show earnings per share actually fell by 12.7% in 2015, compared to the prior year! These measures add a new level of opacity to true financial condition in an increasingly volatile market. Investors beware!

A Tesla Innovation Investors Can Do Without (February 11, 2016) – WSJ MoneyBeat (@WSJMoneyBeat)

Delving a little deeper into non-GAAP territory, Tesla recently unveiled a new cash flow metric – core operational cash flow. For investors who crave the innovation that Tesla offers, the new non-GAAP measure is a welcome sight, showing $179 million in positive cash flow for the fourth quarter. The news seemed to allay market fears about the amount of cash Tesla rapidly churns through regularly to keep production of current and new models on schedule.

However, a closer look shows that cash flows from operations, a GAAP financial measure, showed a $30 million cash outflow. Core operational cash flow, however, supplements this outflow with cash inflows of $209 million for cash received from vehicle sales to leasing partners. This presentation muddies the outlook of Tesla’s financial performance, especially in light of the cash expended for capital investments of $411 million.

In total, Tesla’s cash on hand balance fell below $1.2 billion at the end of 2015, or $0.2 billion lower than it was at the end of September. With approximately $1.5 billion capital expenditures planned in 2016, it seems difficult for Tesla to keep pace of their cash needs without finding additional financing, through debt or equity issuances. This may hurt current investors, causing more downward pressure on a share price that has already endured a steep decline in value.