Requirements for Reporting Non-GAAP Measures

Just as the name implies, non-GAAP measures are measures that are NOT in accordance with generally accepted accounting principles (GAAP). 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? This post introduces non-GAAP measures, including the various requirements for reporting them set out by the SEC.

Regardless of your personal view, companies disclose non-GAAP measures all the time (outside the financial statements, of course). However, if you disclose them, you better be sure you are following the SEC requirements because they are looking (as evidenced that they are the most cited issue in SEC comment letters)! If you want a deeper dive into non-GAAP measures, check out our eLearning course, where we cover the requirements using real-life examples.

The popularity of non-GAAP measures

Non-GAAP measures are numerical measures that exclude (or include) amounts that are otherwise included (or excluded) in the comparable measure calculated and presented in accordance with U.S. GAAP. The use of non-GAAP measures by companies has basically exploded. According to Audit Analytics:

• In 1996, 59% of S&P 500 companies used at least one non-GAAP measure
• In 2016, it increased to 76%
• And now, over 90% of S&P 500 companies use at least on non-GAAP measure!

Also, the average number of non-GAAP measures reported by a company has increased from 2.5 to 7.5 over the last 20 years.

Non-GAAP measures provide companies the flexibility to supplement their GAAP results with disclosures presented “through the eyes of management.” In other words, companies claim that non-GAAP measures help them to better tell their story to investors. Typically, companies use non-GAAP measures to eliminate things that they believe are not indicative of their ongoing operations; things like impairments or restructuring charges.

Non-GAAP measures: Reporting requirements

It’s important to be aware of the SEC rules and regulations that govern the reporting of non-GAAP measures. Both Regulation G and S-K Item 10(e) govern non-GAAP measures:

• Regulation G covers any public disclosure or release of material information, such as press releases, analyst presentations etc.
• Item 10(e) of Regulation 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

To find these regulations, go to the SEC’s website and under “Rules, Enforcement & Compliance” select “Statues and Regulations”.

Note that these regulations prohibit the disclosure of non-GAAP measures on the face of or in the footnotes to the financial statements.

Reporting requirements: Highlights

There are many requirements included within the SEC’s regulations relating to the reporting of non-GAAP measure, but we’ve highlighted a few of the main ones below:

• The non-GAAP measure taken together with the accompanying information cannot be misleading
• A reconciliation of the non-GAAP measure to the most directly comparable GAAP measure must be included
• The GAAP measure must be presented with equal or greater prominence than the non-GAAP measure
• Management must disclose why it believes the non-GAAP measure is useful to investors
• Non-GAAP measures must not use titles or descriptions that are the same as, or confusingly similar to, GAAP titles

Other guidance

The SEC publishes certain Compliance and Disclosure Interpretations (C&DIs) of the rules and regulations for non-GAAP measures, which have been updated throughout the years. The SEC’s most recent update provided additional guidance about expectations when using non-GAAP measures.

The purpose of the additional guidance was to promote changes in the use of the measures, particularly related to potentially misleading measures and undue prominence. 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.

It also clarified that individually tailored accounting principles (e.g., adjusting a non-GAAP measure to accelerate revenue recognition that would otherwise be recognized over time) are not allowed.

SEC comment letters on non-GAAP measures

If you think the use of non-GAAP measures by companies is popular, the comment letters issued by the SEC on non-GAAP measures is even more popular! Non-GAAP measures are consistently in the top 1-2 areas of issued comment letters to companies.

The most common comments relating to areas of non-GAAP measures include:

• Presentation (focusing on equal or greater prominence)
• The use of individually tailored accounting principles
• The disclosure of why management believes the non-gaap measure provides useful information to investors
• Reconciliation from the most comparable GAAP measure
• Appropriateness of adjustments made

Here is a specific comment received by a company from the SEC on its non-GAAP measures:

 You disclose non-GAAP measures without presenting the comparable GAAP measures with equal or greater prominence. Please ensure any discussion regarding non-GAAP measures is preceded by an equal or more prominent discussion of the comparable GAAP measure.”

Closing thoughts

Non-GAAP measures have become an important part of a company’s reporting process. It is critical for a company to evaluate the non-GAAP measures it presents and if the reporting requirements have been met. It’s also important for companies to make sure its disclosure controls and procedures (DCP) have properly addressed (and met) the requirements for presenting non-GAAP measures. If you have further questions about non-GAAP measures, be sure to check out our course SEC Reporting: Non-GAAP Financial Measures.

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Disclaimer
This post is for informational purposes only and should not be relied upon as official accounting guidance. While we’ve ensured accuracy as of the publishing date, standards evolve. Please consult a professional for specific advice.