SEC May Start Curtailing Pro Formas

For years, companies have used pro forma statements as a means of better comparing previously reported financial statements with current statements where circumstances have changed significantly, as in a merger or acquisition.

But recently, companies have been using pro forma statements to reflect what they believe to be the "true" financial health and well being of the company, taking into consideration various assets that may not appear on traditional accounting books, such as brand loyalty, market share, patents and other intellectual property.

It is through this pro forma reporting process that Cisco Systems recently reported a 1st quarter profit of $230 million to its investors through a press release at quarter end. Weeks later, the company filed the "official results" with the Securities and Exchange Commission, as required by law. The result? Under traditional accounting rules, Cisco reported an actual net loss of $2.7 billion.

Should a $3 billion swing in earnings for the same period be tolerated?

The increasing use of pro forma statements to show current quarter earnings several weeks before the "official" accounting reports to the general public have the SEC concerned.

"People are using the pro forma earnings to present a tilted, biased picture to investors that I don't believe necessarily reflects the reality of what's going on with the business," said Lynn Turner, the SEC's chief accountant.

The SEC is currently investigating a couple of companies for what they believe is bordering on fraudulent reporting of corporate earnings, and may end up making an example of some. For now they are holding off on a larger crackdown, but if the practice isn't curtailed to their liking, new rules may follow.

A possible solution to the dilemma comes from Jack Ciesielski, publisher of the watchdog Analyst's Accounting Observer newsletter.

He proposed the SEC require companies to release their legally mandated financial filings on the same day they report earnings to the public, eliminating the typical window of 25 to 30 days between the two. This would not only guarantee that investors have both sets of numbers at the same time, it would virtually force companies to explain the differences between the two earnings statements in detail.

Changes to the current system are not far away...

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