In remarks today before the 2016 Baruch College Financial Reporting Conference, SEC Deputy Chief Accountant Wesley Bricker discussed one of the SEC’s topics du jour, non-GAAP reporting. Recently, the SEC and staff (Chair White, Chief Accountant James Schnurr, Corp Fin Director Keith Higgins) have been barnstorming the country, wagging their collective fingers about abuses of non-GAAP measures. White has also hinted at the possibility of future rulemaking (see this PubCo post), and the head of the SEC’s Financial Reporting and Audit Task Force has previously indicated that the SEC was looking at the use of these non-GAAP measures “with an eye toward possible enforcement cases.” (See this PubCo post.) Now Bricker has taken the baton, reiterating and extending those admonitions about practices the staff considers to be dodgy.
Bricker observes that, since Corp Fin’s 2010 non-GAAP guidance, the staff has issued a number of comments objecting to the use of, or disclosures regarding, non-GAAP measures, in particular, companies’ disclosures as to why their non-GAAP measures are useful, apparent cherry-picking of adjustments within a non-GAAP measure and adjustments to remove normal, cash operating expenses. More recently, Corp Fin has expressed concern regarding company practices such as “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.”
In his remarks, Bricker takes particular aim at individually tailored accounting principles. To illustrate the problem, Bricker provides the following example:
“[C]onsider a 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. 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. 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 his analysis of the issue, Bricker concludes that the non-GAAP “measure does not appear to help investors understand and analyze core operating results. 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. Revenue adjustments do more than just adjust from GAAP: they change the very starting point from which other performance analyses flow.” Bricker cautions that, in the course of monitoring implementation of the new revenue recognition standard (which is also discussed extensively in his remarks), the staff “will be looking to see if the reporting concepts within those standards are supplanted by any number of company-specific non-GAAP alternatives. 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.” [Emphasis added.]
In closing on this topic, Bricker reinforces four points that have been made about non-GAAP measures in recent months:
- Companies should consider the application of disclosure controls and procedures to non-GAAP measures.
- Investors should be sure to consider non-GAAP measures in the context of the GAAP information in the financial statements (and, presumably, companies should facilitate that possibility).
- Audit committees should pay close attention to the company’s non-GAAP measures, the related disclosures and the processes the company follows “to consider both the appropriateness and reliability of the measures.”
- To stave off (perhaps) the potential SEC rulemaking to which White has alluded (as well as the possibility of becoming the target of Enforcement), companies should heed these staff warnings (and those to come in the future) and “seize this opportunity to review their practices and make any necessary changes.”