Monday, November 14, 2016 Print E-Mail Show Judy McLevey is Assistant Director at The Conference Board. This post is based on a Conference Board publication. Another quarterly earnings cycle is just about to start with companies putting the final touches on their Q3 2016 earnings releases, analyst presentations and the messages they will share with investors. There is intense pressure on companies to meet quarterly analyst estimates and there is also extra attention from the Securities & Exchange Commission (SEC) on how companies report and present their financial information. U.S. public companies are required by the SEC to provide financial statements prepared in accordance with U.S Generally Accepted Accounting Principles (GAAP) and this information is audited annually by external auditors to ensure accurate and consistent reporting. However, it is a valid, common practice for public companies to publish non-GAAP or pro-forma financial adjustments to exclude unusual and/or one-time items such as restructuring charges, the sale of a business, extraordinary legal costs, layoffs, etc. Companies doing an IPO will use pro-forma financials to reflect the use of proceeds being used to write-down debt and reduce interest expense, to reflect investor payouts as a result of changes in ownership, for M&A, etc. Non-GAAP data is not audited, but the idea is to give investors and analysts a consistent picture of the business excluding out of the ordinary and/or unusual income or expense so financial results can be tracked and compared over time to determine earnings success (or lack thereof). The potential over-emphasis and/or over-use of non-GAAP measures has gotten the attention of the SEC. In May, the SEC published updated Compliance & Disclosure Interpretations (CD&I’s) related to the use of Non-GAAP Financial Measures. The updated CDIs called out concerns with certain potentially misleading adjustments companies may be taking, the reconciliations between GAAP and non-GAAP measures, inconsistent reporting between periods, adjustments made for normal, recurring expenses, not adjusting for unusual or non-recurring gains as non-GAAP, the equal or greater prominence of GAAP versus non-GAAP data in financial statements and press releases, etc. In order to focus more attention on this, the SEC also sent comment letters to companies requesting information about their use of non-GAAP measures and there have been several recent enforcement actions as well.
During White’s speech, she urged audit committees to ensure they are carefully overseeing the use of non-GAAP measures and reporting. New York Stock Exchange (NYSE) rules also place responsibility for probing the use of non-GAAP measures on the Audit Committee. NYSE rules 303A.07 Audit Committee Additional Requirements (b) (iii) (H) General Commentary to Section 303A.07(b), says “… the audit committee must review:
The non-GAAP measures issue has also concerned a group of top executives and institutional investors. In July, this group of business leaders including JPMorgan’s Jamie Dimon, Berkshire Hathaway’s Warren Buffett, and BlackRock’s Larry Fink published a set of Commonsense Corporate Governance Principles (discussed on the Forum here). Principle number IV, which relates solely to public company reporting, emphasized the need for transparent financial results and clear communication around the company’s goals and long-term strategy. The use of non-GAAP measures was highlighted as follows:
Responsibility for a company’s financial statements and disclosures falls on management, but audit committees, in particular, and the full board need to seriously consider non-GAAP measures. Reports indicate that the SEC saw some signs of improvement in Q2 2016 earnings releases, especially with GAAP measures getting equal or greater prominence to non-GAAP measures. However, the SEC will use the comment letter process to drive further changes to which non-GAAP measures are acceptable or not and how companies disclose these measures and why they differ from GAAP. In the meantime:
It will be interesting to see if further changes are made to Q3 2016 earnings. In the meantime, audit committees get busy! Do companies have to report GAAP?For one thing, unlike public companies, private companies aren't required to publicly disclose their financial results, have their financial statements audited, or even follow generally accepted accounting principles (GAAP).
Which of the financial statements are required by the GAAP?The following three major financial statements are required under GAAP: The income statement. The balance sheet. The cash flow statement.
Does GAAP apply to all companies?The use of GAAP is not mandatory for all businesses, but SEC requires publicly traded and regulated companies to follow GAAP for the purpose of financial reporting.
What entity requires that members prepare financial statements in accordance with GAAP?In the United States, the Financial Accounting Standards Board (FASB) issues Generally Accepted Accounting Principles (GAAP). GAAP is required for all publicly traded companies in the U.S.; it is also routinely implemented by non-publicly traded companies as well.
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