Standard & Poor's stepped into a standard-setting vacuum on May 14, 2002 and introduced a new set of definitions for measures of corporate earnings commonly used by the financial community. The newly-defined measure of core earnings will soon take on added importance, as the firm plans to incorporate this measure into its COMPUSTAT database for the U.S. and in its U.S. equity indices, including the S&P 500.
In addition to core earnings, Standard & Poor's considered "as reported" earnings, operating earnings and pro forma earnings. Highlights of definitions from the firm's white paper are as follows:
- As reported earnings include all charges except those related to discontinued operations, the impact of cumulative accounting changes, and extraordinary items as defined by generally accepted accounting principles.
- Operating earnings start with as reported earnings and exclude charges seen as corporate or one-time expenses. The paper says this measure is popular in corporate reports and seems to have been borrowed from management accountability reporting that is designed to measure business unit performance excluding corporate-level costs.
- Pro forma earnings originally meant a special analysis of a major change, such as a merger, where adjustments were made for an "as if" review. However, in recent times, the specific items included in "as if" reviews have not been clearly defined, leading to confusion and abuses.
- Core earnings include all the revenues and costs associated with a company's ongoing operations. These earnings include employee stock option grant expenses, restructuring charges from ongoing operations, write-downs of depreciable or amortizable operating assets, pension costs, and purchased research and development expenses. They exclude goodwill impairment charges, gains or losses from asset sales, pension gains, unrealized gains or losses from hedging activities, expenses related to mergers or acquisitions, and litigation or insurance settlements and proceeds.
In a fact sheet of frequently asked questions, Standard & Poor's answered the question: Why use core earnings to recalculate a company's operating earnings? Aren't current accounting practices sufficient? Its answer: In the last few years, the reliability of earnings reports has dramatically decreased. As Standard & Poor's business is based on providing investors with reliable information, analysis and advice, it believes it is time for the investment community at large to take corrective action. . . . Earnings reports must be understandable, consistent and transparent.
Read the white paper and fact sheet.