Scrutiny over corporate use of non-GAAP accounting measures is still causing some heartburn for public companies, but the Securities and Exchange Commission is signaling it is encouraged by improvements in recent quarters.
At a conference on current financial reporting issues by Financial Executives International, SEC staff members indicated most companies have responded to SEC initiatives to bring non-GAAP accounting back inside the guardrails of what’s permitted for public companies. “We’ve seen a number of companies have made changes,” said Wes Bricker, interim chief accountant at the SEC. “We’ve seen changes in the prominence of GAAP and non-GAAP measures,” suggesting the SEC’s guidance has been effective.
Most companies communicate at least some information to investors that is not derived following Generally Accepted Accounting Principles because they believe it somehow explains something about the business that GAAP alone cannot convey. Non-GAAP information is not prohibited under securities laws or reporting rules, but the SEC has rules in place meant to assure companies don’t use non-GAAP information to mislead investors.
Alarmed by an increasing number of non-GAAP uses that strayed from the guidelines, the SEC began in late 2015 to call greater attention to non-GAAP reporting rules and updated its guidance to signal its attention to compliance. Mark Kronforst, chief accountant in the Division of Corporation Finance at the SEC, says the staff issued its latest guidance in May 2016, then intentionally gave companies a quarter or two to digest it and reflect it in their communication with investors before moving to comments to individual registrants.
“We thought most companies were just fine with respect to non-GAAP,” said Kronforst. “We did notice some troubling practices. We ended up objecting to a number of measures, but not a large number. The efforts most companies have made addressed the issue.”
The SEC will soon publish its comment letter exchanges with companies whose use of non-GAAP accounting led to objections, said Kronforst. “I think the vast majority are already resolved,” he said. “We found with companies where there were issues, they were resolved fairly quickly. Companies were motivated to get this behind them.” Still, there were a few that resisted, he said. “There are some, not a large number, of fairly contentious issues,” he said. “Those are taking a little longer.”
In terms of common issues companies have needed to address, they center on cherry-picking or misleading uses of non-GAAP, SEC staff members said. “Don’t back out normal cash you need to operate the business,” said Kronforst. That’s a concern for “serial restructurers,” he said, or companies that quarter after quarter announce restructuring charges. Companies also need to be careful not to back out non-recurring expenses, for example, without calling equal attention to non-recurring gains.
To assure companies don’t run afoul of non-GAAP provisions in the future, Bricker said companies would be wise to take what they’ve done to re-examine their non-GAAP accounting currently and bake it into their reporting processes going forward. “For all the investment and effort companies have put into their non-GAAP reporting, capture that within an appropriate, well-designed set of controls and procedures,” he said.