The regulatory furor over non-GAAP reporting may be diminishing, but the need for continued corporate vigilance on proper use of non-GAAP measures is not.

The Securities and Exchange Commission has been on a mission since early 2016 to clean up errant corporate uses of performance measures that fall outside the realm of U.S. Generally Accepted Accounting Standards. Companies are required to comply with GAAP in their financial reporting. While they are not prohibited from communicating with investors outside of financial statements in non-GAAP terms, they are required to comply with SEC rules governing non-GAAP measures to assure the communication is not misleading to investors.

A Deloitte analysis of SEC comment letters on 2016 financial statements shows the SEC committed plenty of focus to non-GAAP measures, with 43 percent of all reviews earning at least one remark on the company’s non-GAAP reporting. It was the most common area of comment, in fact, outranking even management discussion and analysis.

And there’s plenty of non-GAAP reporting out there to scrutinize. An analysis by Audit Analytics found nearly 90 percent of Standard & Poor’s 500 companies report at least one non-GAAP number to investors, with the majority of those measures making adjustments to income or earnings per share, metrics no doubt important to investors.

The SEC’s historic focus on non-GAAP is seen by some as like a pendulum, says Paula Hamric, a partner in BDO USA’s national SEC practice. Companies increase their use, the SEC responds with comments or perhaps enforcement actions, companies reign in their use, and then eventually companies begin to increase their non-GAAP reporting again.

While the SEC has indicated it is pleased with corporate response to the regulatory call for improvement, Hamric says, there’s an underlying desire on the part of many in the financial reporting supply chain to minimize resurgence of non-GAAP reporting problems this time around. “Everyone is considering what can be done to minimize the pendulum swing going forward,” she says.

“There’s a continuing desire for different flavors of information, driven to some extent by analysts,. Given the increasingly sophisticated tools analysts use to digest data, “that’s probably driving some of the demand for more and more information, including non-GAAP information.”
Kimber Bascom, Partner-in-Charge Accounting Standards Group, KPMG

Non-GAAP reporting will never go away, in part because companies are providing it in response to investor and analyst demand, says Kimber Bascom, partner-in-charge in the accounting standards group at KPMG. Especially as technology and the availability of data proliferate, the demand for non-GAAP reporting is not likely to diminish.

“There’s a continuing desire for different flavors of information, driven to some extent by analysts,” says Bascom. Given the increasingly sophisticated tools analysts use to digest data, “that’s probably driving some of the demand for more and more information, including non-GAAP information. A large component of the analyst community seems to have the perspective that there’s no such thing as too much information.”

Additionally, companies have always valued non-GAAP measures as a way to differentiate themselves in favorable ways, says Bascom. “That’s always going to be there,” he says.

Christine Davine, a partner at Deloitte & Touche, says she still gets plenty of questions and consultations on how companies can correctly use non-GAAP measures. Questions often arise due to changes in the business, so companies want to know how they can begin to use a new measure they haven’t historically or want to alter a measure they’ve used in the past.

According to Deloitte, disclosure controls and procedures over non-GAAP must address the following:

Compliance — Non-GAAP measures are presented in compliance with SEC rules, regulations, and guidance.
Consistency of preparation — Non-GAAP measures are presented consistently each period, and potential non-GAAP adjustments are evaluated on an appropriate, consistent basis each period.
Data quality — Non-GAAP measures are calculated on the basis of reliable inputs that are subject to appropriate controls.
Accuracy of calculation — Non-GAAP measures are calculated with arithmetic accuracy, and the non-GAAP measures in the disclosure agree with the measures calculated.
Transparency of disclosure — Descriptions of the non-GAAP measures, adjustments, and any other required disclosures are clear and not confusing.
Review — Non-GAAP disclosures are reviewed by appropriate levels of management to confirm the appropriateness and completeness of the non-GAAP measures and related disclosures.
Monitoring — The registrant’s monitoring function (e.g., internal audit, disclosure committee, or audit committee) appropriately reviews the DCPs related to non-GAAP disclosures. The audit committee is involved in the oversight of the preparation and use of non-GAAP measures.
Source: Deloitte


Business combinations often spur such questions, says Davine. “It may be the first major business combination in the lifecycle of a company, and so now they have depreciation and amortization that’s significant,” she says. “They want to know if they can take that out and adjust for it.”

The SEC recently updated its non-GAAP guidance, in fact, to address some narrow questions around business combinations.

Standard setters like the Financial Accounting Standards Board and the Public Company Accounting Oversight Board have tuned into the concerns about non-GAAP reporting, although it’s not yet clear whether those boards may develop new standards going forward with non-GAAP reporting problems in mind.

At FASB, Chairman Russ Golden says the manner in which companies adjust GAAP numbers to arrive at non-GAAP measures might serve as an indicator of where GAAP falls short in meeting investor information needs. “I often ask myself: Are these companies—deliberately or otherwise—sending us a signal about ways to improve GAAP?” he wrote.

Golden says non-GAAP reporting has already influenced some recent changes to GAAP. In one case, when GAAP required companies to reflect downgrades in their creditworthiness in a way that, counterintuitively, increased earnings, companies adjusted that out. FASB responded by requiring companies to channel that effect to equity rather than income.

Recent simplifications to hedge accounting might also address common causes for non-GAAP adjustments, Golden says. Where companies had difficulty qualifying for hedge accounting, they simply didn’t try and instead made non-GAAP adjustments to income to smooth over the resulting volatility. Now that more transactions may qualify for hedge accounting treatment, those adjustments presumably won’t be necessary.

SEC’s latest non-GAAP guidance, focused on business combinations

Question: Are financial measures included in forecasts provided to a financial advisor and used in connection with a business combination transaction non-GAAP financial measures?
Answer: No, if the conditions described below are met.
Item 10(e)(5) of Regulation S-K and Rule 101(a)(3) of Regulation G provide that a non-GAAP financial measure does not include financial measures required to be disclosed by GAAP, Commission rules, or a system of regulation of a government or governmental authority or self-regulatory organization that is applicable to the registrant. Accordingly, financial measures provided to a financial advisor would be excluded from the definition of non-GAAP financial measures, and therefore not subject to Item 10(e) of Regulation S-K and Regulation G, if and to the extent:
the financial measures are included in forecasts provided to the financial advisor for the purpose of rendering an opinion that is materially related to the business combination transaction; and
the forecasts are being disclosed in order to comply with Item 1015 of Regulation M-A or requirements under state or foreign law, including case law, regarding disclosure of the financial advisor’s analyses or substantive work. [Oct. 17, 2017]
Question 101.02
Question: Does the exemption from Regulation G and Item 10(e) of Regulation S-K for non-GAAP financial measures disclosed in communications relating to a business combination transaction extend to the same non-GAAP financial measures disclosed in registration statements, proxy statements and tender offer statements?
Answer: No. There is an exemption from Regulation G and Item 10(e) of Regulation S-K for non-GAAP financial measures disclosed in communications subject to Securities Act Rule 425 and Exchange Act Rules 14a-12 and 14d-2(b)(2); it is also intended to apply to communications subject to Exchange Act Rule 14d-9(a)(2). This exemption does not extend beyond such communications. Consequently, if the same non-GAAP financial measure that was included in a communication filed under one of those rules is also disclosed in a Securities Act registration statement, proxy statement, or tender offer statement, this exemption from Regulation G and Item 10(e) of Regulation S-K would not be available for that non-GAAP financial measure. [Oct. 17, 2017]
Source: SEC

FASB has recently also taken up a project of performance reporting more broadly, looking at how companies report various metrics and whether changes are warranted. That’s an effort that likely will be informed by the latest spate of non-GAAP reporting concerns.

The PCAOB is also looking at non-GAAP reporting, with a project on its research agenda to consider the auditor’s role with respect to information companies present outside the financial statements, including any non-GAAP measures.

In the meantime, accounting leaders are urging companies to continue their vigilance in complying with the SEC guidance on how non-GAAP measures may be used. It begins with sound disclosure controls and procedures, and it includes well-defined and documented policies around what’s included or excluded in any given non-GAAP measure.

It also requires active involvement from senior management and the audit committee, says Davine. “Those are the types of things companies are talking about today,” she says.

Companies would be wise to remain mindful of the biggest areas of concern raised by the SEC in the latest wave of non-GAAP enforcement, which focused heavily on prominence and reconciliation. SEC rules say companies cannot present a non-GAAP measure more prominently than its counterpart GAAP measure, and they must reconcile any non-GAAP measure to its GAAP counterpart.

Brad Davidson, a partner at Crowe Horwath, says companies would be wise to study what their industry peers report in the way of non-GAAP measures. To the extent they may be concerned about how the SEC will view a particular measure the company wants to use, preparers can explore the SEC’s comment letter repository and find plenty of insight. While the comment letters are a “lagging indicator,” they can give a sense of how the SEC staff has responded to specific non-GAAP reporting historically, says Davidson.

And if a company gets an SEC comment on a particular non-GAAP measure, companies should not view it as an immediate cause for panic, says Davidson. “If you get a comment letter, that happens,” he says. “It’s a matter of being responsive to what the SEC is asking for. It doesn’t necessarily mean when you get a comment letter that it’s the end of the world.”