In a provocative recent commentary about the growing use of non-GAAP reporting by public companies, Financial Accounting Standards Board (FASB) Chairman Russell Golden posits a contrarian notion: Could these companies actually be sending a signal about how to improve GAAP?
After all, there’s no mistaking the fact that non-GAAP reporting has dramatically increased. Golden cited a December 2015 report by Audit Analytics that said 88 percent of S&P 500 companies disclose non-GAAP metrics in earnings releases.
Further, the report revealed that non-GAAP adjustments increase net income 82 percent of the time, the average quarterly impact of non-GAAP income adjustments was an increase of $176 million, and acquisition and divestiture adjustments were the most common type of non-GAAP income items.
“While the number of non-GAAP measures garnered significant attention, the nature of some of the non-GAAP measures were particularly troubling,” Golden wrote. “Those measures lacked credibility because they ignored GAAP recognition and measurement principles altogether and inaccurately depicted the underlying transaction or event.”
The issue, naturally, is that investors may misunderstand company performance if “highly customized or tailored” non-GAAP numbers are used, he stated, adding that the US Securities and Exchange Commission is on this and has notified companies that it is monitoring how non-GAAP measures are used in communicating with investors.
Despite his concerns, Golden finds the non-GAAP issue “intriguing” – hence, his challenging question about companies’ signals. As it turns out, Golden’s notion has support.
He described a recent discussion with members of the Financial Accounting Standards Advisory Council, who said “investors rely on non-GAAP measures primarily because they are derived from GAAP information and affirmed our thinking about the potential standard-setting implications of non-GAAP reporting,” Golden wrote. “They encouraged us to continue to monitor the use of non-GAAP measures and observed that certain non-GAAP adjustments might help the FASB identify where improvements could be considered.”
One non-GAAP lesson to be learned involves identifying cases in which GAAP changes might reduce the need for non-GAAP reporting, Golden stated.
“Some non-GAAP reporting develops because investors request and help shape the information provided by companies,” he wrote. “Changing GAAP in these situations can help develop a standardized approach that is more consistent with common reporting practices that investors find useful. In other words, it would improve the credibility of financial reporting.”
He cited this example: The FASB is allowing debt-valuation adjustments for a company’s own credit risk to be recorded through other comprehensive income instead of net income. This eliminates the need for companies to make non-GAAP adjustments for such gains and losses, Golden wrote.
Going forward, Golden made clear that the FASB will monitor non-GAAP reporting processes for how they may affect standard setting. But that’s only to the extent that they “enhance the consistency and credibility of information reported in the markets,” he wrote.