The Center for Audit Quality (CAQ) released a new report on how auditors can contribute to the reliability and comparability of non-GAAP financial measures and key performance indicators (KPIs). The report includes questions audit committee members can ask to fulfill their oversight responsibilities as they discuss non-GAAP financial measures and KPIs with management and auditors, and questions for investors as they use these measures in their analysis.
“The CAQ report is a useful contribution on the important and complex topic of how companies use non-GAAP reporting to supplement audited financial statements in their communications with shareholders and the role auditors could and can play,” said Wes Bricker, PwC’s vice chair and assurance leader for the United States and Mexico and former chief accountant at the Securities and Exchange Commission (SEC). “The location of non-GAAP reporting results in a difference in whether the auditor typically does work on the measures, which is important for boards, investors, and stakeholders to understand about the auditor’s role.”
“Non-GAAP measures are an important supplement in the ecosystem of communications between companies and shareholders and other stakeholders.”
Wes Bricker, Vice Chair and Assurance Leader for the United States and Mexico, PwC
Investors continue to request information outside of traditional financial statements to evaluate companies’ performance, long-term value, and overall health. At least one non-GAAP financial measure was used by 94 percent of all S&P 500 companies in their earnings releases, according to data provided by Audit Analytics and calculated by the CAQ, as a way to tell their story and supplement their GAAP results. KPIs are already used by many companies in their ESG reporting, and auditors play important roles by providing an outside expert view.
“Investors are really seeking information outside of traditional financial statements as a result of COVID-19 to understand the impact of the pandemic on financial performance, and non-GAAP measures and KPIs are one way for companies to communicate these impacts,” said Dennis McGowan, the CAQ’s senior director of professional practice. He notes some companies have new types of COVID-specific adjustments, while others have the same types of adjustments as in the past, like impairment, but the amounts may be larger.
“Non-GAAP measures are an important supplement in the ecosystem of communications between companies and shareholders and other stakeholders, and they have an important role in the way companies describe their performance and liquidity,” Bricker said. “In times like these impacted by COVID, uncertainty, and geopolitics, understanding management’s view of a company’s performance is an important supplement to the standardized view provided in the financial statements.”
Bricker’s view is that non-GAAP measures help tell the story of how a company’s baseline performance might need to be adjusted to understand how isolated significant events affect financial results, like impairment of assets or additional measures companies are taking because of the pandemic. “Non-GAAP measures help investors to understand the special items impacting financial performance, but they also bridge the historical financial statements to the future and help investors understand the business from a go forward perspective as they make decisions about the future,” he said.
Despite the importance of these metrics, auditors have limited responsibility for and do not provide assurance on non-GAAP measures and KPIs. “It’s important to remind people external auditors have no responsibility for non-GAAP measures and KPI in documents that do not contain audited financial statements,” McGowan said. “When they are included in documents that contain audited financial statements, auditors most only ‘read and consider’ the information, which is not the same as an audit.” In reading and considering the information, the auditor is looking at whether the information itself or how it is presented is materially inconsistent with the audited financial statements, or whether it contains a material misstatement of fact. If the information is included in company earnings releases or analyst or investor presentations on company websites, the auditors typically do not perform any procedures and provide no assurance.
The CAQ report notes auditors could be engaged to perform additional procedures on non-GAAP financial measures or KPIs. These could include attestation services on the calculation and consistency of all or certain metrics, a compliance examination of whether the company followed the relevant SEC rules, and internal control testing on the company’s preparation and disclosure of the measures. “The CAQ is not suggesting auditors do more without discussing with audit committees if it’s the right thing to do,” said McGowan. “Based on our conversations, audit teams would be open to doing more if asked and should discuss with audit committees what might make sense.”
“Now is a good time for auditors to have these conversations with audit committees because of the increase in COVID-19 non-GAAP adjustments,” said Mike Santay, audit partner at Grant Thornton. They are seeing some new categories of adjustments but also a resurgence in existing categories like impairment and nonrecurring and unusual costs. “Although we don’t have professional standards responsibility for most non-GAAP information provided outside of filings on Form 10-K and 10-Q, we are seeing audit partners talking to management and audit committees about this information.”
Santay suggests now is a good time for companies and their auditors to discuss and sort out auditor involvement in non-GAAP reporting and how investors view it. “As a starting point, there is agreement that auditor involvement with information outside the financial statements can enhance the comparability and reliability of the information, but at what cost?” Santay said. “There also needs to be agreement about the dollar cost of doing more work, along with the issue of auditor involvement slowing the speed of getting information to the market, and this conversation is ongoing.”
It is Santay’s view that the CAQ report’s conclusion that auditor involvement can enhance the reliability of non-GAAP measures and KPIs is worth further discussion. “This has been a running discussion for a while, but this is a good opportunity to take another run at the topic and continue the dialogue about how auditors and practitioners can enhance this information,” he said. “The CAQ’s report jumpstarts the cost/benefit conversation again and provides important reminders for audit committees about the potential expectation gap and about the benefit of having auditors perform procedures.” He expects this to be a continued area of focus for the SEC and Public Company Accounting Oversight Board and believes the report will be used to engage again with regulators and investors about changes in auditor involvement.
Bricker and PwC also support this important dialogue about the way auditors can add to the confidence and quality of this information. He believes it is worth discussing the role of the auditor in helping to narrow the existing expectation gap and to provide this confidence to companies, audit committees, and investors.
“The auditor’s role, and the degree of investor protection provided by auditors, depends on the location of the information,” he said. “Investors are asking for this information and using it, but they may not have assurance from auditors. There is an important policy question here that is a theme in the CAQ report—that auditors can be hired to do more than the regulatory minimum, but companies and their boards need to do that.”