As we discussed in a recent blog post, non-GAAP measures can provide useful context around required disclosures for analysts and other users of financial statements, especially regarding management’s perspective on the business. While observers appear to be increasingly worried about the proliferating use of non-GAAP measures, a useful debate on non-GAAP measures would probably focus on the nature of their presentation within various disclosures rather than whether or not they should be outlawed altogether. Indeed, existing regulations primarily stipulate that: 1
- A non-GAAP measure should be accompanied by i) the most directly comparable GAAP measure, and ii) a reconciliation between the two measures.
- The GAAP measure should be presented more prominently that the non-GAAP variant.
Updated guidance from the SEC in mid-May 2016 clarifies its interpretation of rules and regulations on the use of non-GAAP financial measures. According to the latest updates, a non-GAAP performance measure can be misleading and violate regulations if:
- The measure excludes normal, recurring, cash operating expenses necessary to operate the business.
- Adjustments underlying the measure change from one period to the next. For significant changes, preparers may be required to recast prior presentations to eliminate any inconsistency with the current disclosure.
- The measure excludes charges, but does not exclude any gains.
- The measure presents individually tailored revenue figures in contravention of GAAP revenue recognition and measurement rules. GAAP-alternate measures for other income statement items could also trigger violations of regulations.
- The measure erroneously identifies and eliminates non-recurring, infrequent or unusual items. In general, a charge may not be identified as non-recurring if it is reasonably likely to recur within two years or if there was a similar charge or gain within the prior two years. Nevertheless, preparers are not precluded from presenting measures that adjust for these charges.
While the latest SEC updates state that non-GAAP per share performance measures may be meaningful from an operating perspective, liquidity measures that measure cash generated should not be presented on a per share basis. In a nod to their widespread use, prior guidance had carved out EBIT and EBITDA from the prohibition on measures that exclude cash-settled charges or liabilities. The latest updates also clarify that EBIT and EBITDA should be reconciled to net income and not operating income.
Back in March, SEC chair Mary Jo White had indicated that the regulator (subscription required) was keeping tabs on the use of non-GAAP measures, and whether some practices would need to be curtailed using (additional?) regulation. With the latest updates providing commentary around existing rules, it remains to be seen if the SEC can jawbone preparers to act in a manner that alleviates its concerns regarding non-GAAP measures.
- Non-GAAP Measures: Here to Stay?
- Equity-Based Compensation: Are Non-GAAP Earnings Misleading?
- Non-GAAP Measures are Gaining Popularity in IPOs
1 See for example, Regulation G: Final Rule: Conditions for Use of Non-GAAP Financial Measures.