What are your thoughts on non-GAAP measures? Are you on the side that thinks they are helpful in painting an accurate picture of how a company is operating? Or do you think they are used to manipulate investors and mask underperforming results? Well, regardless of your personal views on non-GAAP measures, they are being used now more than ever and have been a consistent focus of the SEC for many years! And the SEC’s focus on the use of non-GAAP measures is not going anywhere, especially this year, with the public company adoption of ASC 606, Revenue from Contracts with Customers and the new tax reform changes. So, we are here today to provide an update on current views regarding the use of non-GAAP measures and to remind you of the specific non-GAAP measurement rules.
The popularity of non-GAAP measurements
According to FactSet, more than 90% of S&P 500 companies disclose at least one non-GAAP measurement in their financial statements, which is up from 60% in 2013. And as of June 1, 2018, 78% of S&P 500 companies reported earnings above consensus estimates, but 88% of those results were “adjusted.” Additionally, a recent study noted that from 2009-2014, companies have nearly doubled the amount of one-time costs that have been excluded in order to report non-GAAP metrics. I can go on and on about the increased use of non-GAAP measurements, but the important thing to know is that the SEC has been (and still is) taking notice.
Non-GAAP measures were the number one topic of SEC comment letters for the year ended July 31, 2017 but since then, there have been improvements in the number of comments. However, because of investor interest in non-GAAP measures, the SEC will continue to monitor the related disclosures and use of non-GAAP measurements, especially considering the public company adoption of ASC 606 and the new tax reform laws. In May 2018, the SEC’s chief accountant, Wesley Bricker, gave a speech at Baruch College’s financial reporting conference, warning against the misuse of non-GAAP financial measures and stressing the importance of having disclosure controls and procedures in place over how any changes in non-GAAP measurements are reported.
Some of the early SEC comments on the adoption of ASC 606 relate to information presented outside the financial statements (e.g., press releases) on the disaggregation of revenue, so it is important for companies to be aware of how that information is being presented. Yum! Brands and Mattel are two examples that have also recently made headlines regarding their non-GAAP disclosures. Yum! disclosed that their adoption of ASC 606 negatively impacted their core operating growth (which is a non-GAAP metric) and Mattel excluded the impact of the Toys “R” Us bankruptcy procedures from their first quarter earnings (but will this impact only last one quarter?). Additionally, Kyle Moffatt, chief accountant in the SEC’s Division of Corporation Finance, stated there have been many inquiries on what can be done to adjust results for the impact of the new tax laws on a non-GAAP basis and reiterated that companies can’t apply the lower tax rate of 21% to prior year non-GAAP pro-forma financial statements for comparability purposes. There can be a significant amount of judgment when disclosing non-GAAP disclosures, but companies can easily interpret the regulations in a variety of ways.
Non-GAAP measurement reminders
As a reminder, a non-GAAP measurement represents a numerical measure that excludes (includes) amounts that are otherwise included (excluded) in the comparable measure calculated and presented under GAAP (e.g. US GAAP, IFRS). Both Regulation G and S-K Item 10(e) govern non-GAAP measurements: Regulation G covers any public disclosure or release of material information, such as press releases, analyst presentations etc.; and Item 10(e) of S-K covers filings under the Exchange Acts of 1933 and 1934, such as 10-K, 10-Q, 8-K, registration statements and proxy statements. Additionally, in April 2018, the SEC updated their Compliance & Disclosure Interpretations (C&DIs) of Non-GAAP Financial Measures, to provide additional guidance about expectations when using non-GAAP measures. The SEC’s intent was not to eliminate the use of non-GAAP financial measures, but rather to promote changes in the use of the measures, particularly related to potentially misleading measures and undue prominence. As a reminder, companies should continue to consider whether undue prominence is being given to non-GAAP measures, whether reported non-GAAP measures are misleading to users, whether non-GAAP measures are clearly labeled as such, and whether sufficient disclosures related to the purpose of non-GAAP measure have been provided, among other things. Check out this post where we’ve summarized the rules for reporting non-GAAP measures.
The importance of audit committees
As Wesley Bricker also discussed in his speech, recent attention has also focused on a company’s audit committee and the oversight role they can play when companies are disclosing non-GAAP measures to investors. The audit committee’s position to challenge the integrity of the disclosures and to ask questions to understand compliance with regulations and internal policies is extremely important in establishing a strong reporting culture and to help establish consistency. The CAQ recently published a roadmap for audit committees on non-GAAP measures to help increase involvement. The roadmap includes a variety of suggestions for audit committees to increase their review and discusses leading practices to implement. With the continued increase in the use of non-GAAP measures, the scrutiny of disclosures, and the variety of interpretations, it is extremely important for audit committees to be involved in order to help improve the transparency and integrity of the measures being used.
This post is published to spread the love of GAAP and provided for informational purposes only. Although we are CPAs and have made every effort to ensure the factual accuracy of the post as of the date it was published, we are not responsible for your ultimate compliance with accounting or auditing standards and you agree not to hold us responsible for such. In addition, we take no responsibility for updating old posts, but may do so from time to time.