If companies must continue issuing quarterly earnings guidance, they should at least consider following a standard template to improve transparency and comparability, say two corporate think tanks that have gone through the trouble of drafting a template.
The CFA Institute Centre for Financial Market Integrity and the Business Roundtable Institute for Corporate Ethics have jointly published a report calling on companies to improve the quality and clarity of their quarterly earnings announcements by following a standard template. The two groups have openly criticized the practice of issuing earnings guidance, saying it feeds a focus on short-term results.
“There’s a misperception in the marketplace that that means getting rid of quarterly communication,” says Kurt Schacht, managing director for the CFA Centre. “That’s not the case. Users of financial information rely heavily on quarterly reporting. We’re looking for better quality information consistent with Regulation G.”
Schacht
Regulation G was issued by the Securities and Exchange Commission in connection with Sarbanes-Oxley to require companies to reconcile any figures they want to highlight that do not conform to Generally Accepted Accounting Principles with the related GAAP measure. “It was designed to get at the problem of the proliferation of pro forma earnings announcements without any reference to GAAP earnings,” Schacht says.
The concern now, Schacht continues, is that investors often see press releases without seeing the full, formal financial statements. “More times than not, you don’t see the long-term valuation measures,” he says
The earnings release template recommended by the CFA Institute and Business Roundtable groups would include a GAAP income statement that begins with the revenue line and proceeds to a net income figure. It would also position GAAP reconciliation tables adjacent to non-GAAP measures, and include a consolidated balance sheet and statements of cash flows.
Schacht said roughly 60 percent of large-cap companies and one-third of midcap companies report quarterly earnings according to a format like the one CFA Institute and Business Roundtable are recommending. “If all companies were to provide the GAAP reconciliation at the end of the press release so everyone would know where the real number is, that would be an improvement more in line with what Reg G was after,” he says.
Dean Krehmeyer, executive director of the Business Roundtable Institute for Corporate Ethics, calls the template a tool companies can use to enhance transparency and consistency of quarterly reporting. “The expectation is that this will also lead to fostering a longer-term mindset,” he said in a statement. “Companies can provide more robust and qualitative information about the overall financial health of the firm and its strategy for creating long-term value.”
Gordon McCoun, senior managing director of investor relations at the communications consulting division of FTI Consulting, says the template is sound for reporting financial results, but the earnings announcement should also include commentary on the business performance and execution of strategy.
“The best reconciliation will provide a backward view of what the numbers were, but will not convey intelligence into what drove the business during the recent period or where the company is going and how it will get there,” McCoun says. “Investors need to understand the present but are investing in the future.”
If companies were to abandon earnings guidance as CFA Institute and Business Roundtable advocate, “that kind of descriptive information is all the more important,” he adds.
McCoun says while it’s useful for a company to develop a format that is consistent over time and consistent with peer companies, “it is a stretch to force every company to comply with the same format because one needs room to allow for differences across industries.”
FASB To Revisit Guidance On Renewal Intangible Assets
The Financial Accounting Standards Board has decided to try again to straighten out an apparent conflict in the accounting rules regarding how to amortize renewable intangible assets.
The Board has added a project to its agenda to provide guidance on how to determine the useful life and amortize renewable intangible assets as described in Financial Accounting Standard No. 142, Goodwill and Other Intangible Assets.
It won’t be the first time the Board has debated the issue, however. Last summer, FASB voted to abandon a similar project after issuing a first draft of its proposed guidance in FASB Staff Position (FSP) FAS 142-d, Amortization and Impairment of Acquired Renewable Intangible Assets. After reviewing comment letters, which generally objected to FASB’s approach for a variety of reasons, the Board was deadlocked on how to proceed, so it abandoned the guidance with no final decision.
Stuart Moss, a partner at Deloitte & Touche and a former practice fellow at FASB who worked on the abandoned guidance, says the Board must reconcile a “perceived inconsistency in the accounting literature” between how the fair value of a renewable intangible asset is initially determined and the useful life it is assigned. Such assets might include licensing agreements, servicing rights, trademark or software use, and other contractual provisions, to name a few.
According to FAS 142, the useful life of such assets determines how they are amortized or depreciated, so companies must do some analysis to determine the useful life. FAS 142 says such an analysis should account for any legal, regulatory, or contractual provisions that enable the asset to be renewed or extended beyond its existing contractual life, so long as it can be renewed without significant cost or significant change in terms and conditions.
At the same time, Financial Accounting Standard No. 141, Business Combinations, addresses how to allocate a purchase price to various assets, including renewable intangible assets—but it offers what some say is conflicting direction in how to determine the useful life of such assets.
Moss says the differences in interpretation have led to differences in practice. He gives the example of television network affiliation agreements. While such agreements may have a defined life contractually, they often can be renewed by renegotiating the terms. Accounting experts often debate whether that means the useful life should be limited to the contractual period, he says.
Moss
“A company that operates a television station might believe that based on its history, there’s no reason it can’t renew the agreement, so it amortizes the asset in a manner that is consistent with the initial fair value determination,” he says, meaning it would take into account future renewal periods. “Others might believe that since the agreement is subject to renegotiation, you have to amortize it over the contractual period only. You can see how that would create a big difference in the reported periodic expense.”
FASB’s plan in 2006 was to create a new category of renewable intangible assets, but comments largely criticized the idea saying it only added to the problem of accounting complexity. FASB’s decision to drop the project “hasn’t solved the practice issue,” Moss says, adding that although the Board was unable to reach a majority decision the first time around to address the practice issue, “it does not mean they can’t come to an agreement now.”
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