Risk & Compliance

Non-GAAP Rules Are Needed to Keep Companies Honest

While non-GAAP metrics are often useful, too many companies use them to present a misleading picture of performance, a senior auditor says.
Jennifer BiundoMay 18, 2017

Companies present non-GAAP financial measures for various reasons. At times, the intent is to overshadow an entity’s results of operations, especially if it doesn’t meet market expectations or isn’t yet profitable.

Indeed, non-GAAP financial measures often present a rosier picture of an entity than is justified by what’s actually occurring. As auditors, we do not believe the SEC’s rules are too strict. They are meant to curb public companies’ appetite for exactly that sort of presentation.

The regulations vary based on where the non-GAAP items are presented. Overall, companies must:

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  • Provide a reconciliation of the non-GAAP measure to the GAAP measure.
  • Disclose why investors would find the non-GAAP measure useful.
  • Provide the management purposes of the non-GAAP measure.
  • Present the GAAP measure with equal or greater prominence than that given the non-GAAP measure.

Companies have flexibility on which, if any, non-GAAP measures to present in earnings releases or within a filing. A recent report on the use of non-GAAP measures by more than 800 public companies indicates that non-GAAP net income was cumulatively $164.1 billion higher than GAAP net income, with the most common reasons for adjustments being acquisition costs, stock-based compensation, and restructuring costs.

Additionally, non-GAAP measures can vary from one company to another and can change quarter to quarter.

For instance, prior to their fourth-quarter 2016 and first-quarter 2017 earnings releases, respectively, Facebook and Alphabet excluded stock-based compensation from their non-GAAP net income because they believed the costs were subjective and not comparable year over year.

But in subsequent earnings releases, both companies made the decision that while stock-based compensation is not a cash expense and the assumptions used in the valuation methodologies can vary across companies, it is a typical compensation method for how they reward their employees and should not be considered a non-GAAP measure.

Non-GAAP measures can be used to exclude one-time expenses that would cause the financial statements to not be directly comparable to the company’s historical financial statements. But what are we to make of companies that include the same “one-time” expense as a non-GAAP measure year over year, which is not uncommon?

During 2015, HP Inc. announced that it was would separating into two publicly traded companies and presented $1 billion of restructuring charges. While this was considered to be a one-time expense, HP has been reporting restructuring charges every year since 2008. Should that really be a non-GAAP expense?

Non-GAAP financial measures can be relevant and important to help an entity present critical operating and other measures of its business. But if not presented properly and consistently, they can create ambiguities that can disrupt the true picture of an entity’s financial health.

Jennifer Biundo is a senior audit partner with accounting and consulting firm Mazars USA.