Investors See Record Gaps in Pro Forma vs. GAAP Earnings

Preliminary statistical data show the difference between operating (pro forma) earnings and net income under generally accepted accounting principles (GAAP) reached an all-time high in 2001. These statistics cover the largest U.S. public companies, collectively known as the Standard & Poor’s 500 (S&P-500).

The Securities and Exchange Commission (SEC) and accounting firms have been cautioning companies about the risks of disclosing pro forma earnings and the need to reconcile these earnings to net income under GAAP. But, until the Enron collapse, many had challenged, “What’s the big deal? Aren't there always accounting-related earnings surprises in a recessionary economy?”

Record-Breaking Gaps

A timely analysis by TheStreet.Com shows why investors should be concerned:

  • First Call=100%. Current estimates show S&P 500 companies earned about $410 billion in 2001 using the definition of earnings popularized by Thomson Financial/First Call, Wall Street’s unofficial arbiter on how company results are quantified.
  • S&P=88%. Standard & Poor’s has taken issue with the way earnings are reported by First Call. Preliminary estimates of earnings under S&P’s methodology are about 88% of First Call’s.
  • GAAP=58%. On a GAAP basis, the same companies earned about $240 billion, or 58% of the earnings reported by First Call.
  • Prior recessions. Today's gaps are not characteristic of prior recessions. In 1991, at the bottom of the last economic recession, GAAP earnings were 82% of First Call earnings. In 1982 in the midst of the most severe recession since the Great Depression, GAAP earnings were basically in line with First Call results.
  • A Moral Hazard

    TheStreet.Com goes so far as to suggest that pro forma earnings may be a “moral hazard.” At one time, operating or pro forma earnings were a way to adjust for factors beyond management’s control. Now, they are a way of clouding over management’s mistakes. “Securities regulators are out for blood in this game,” sums TheStreet.Com, “and they have $170 billion to play with.”

    -Rosemary Schlank

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