Reporting and Disclosures Using Non-GAAP Financial Measures

By Rashty, Josef; O'Shaughnessy, John | The CPA Journal, March 2014 | Go to article overview

Reporting and Disclosures Using Non-GAAP Financial Measures


Rashty, Josef, O'Shaughnessy, John, The CPA Journal


Public companies provide information to investors and other market participants in many different ways, including SEC filings (e.g., annual and quarterly reports), company websites, earnings releases, investor calls, and analyst presentations. Such companies frequently use non-GAAP financial measures to communicate such important information to the public. As a result, there is a large volume of nonGAAP financial information circulating outside the SEC filing system, even though fie SEC does not discourage companies from disclosing important non-GAAP information in their SEC filings-particularly when nondisclosure could lead to an inconsistency in how a company portrays its business in its SEC filings versus communications outside the SEC filing system.

Generally, a non-GAAP financial measure is a measure of historical or future financial performance, financial position, or cash flow that excludes items included in the most directly comparable GAAP measure or that includes items excluded from the most directly comparable GAAP measure. Commonly used financial nonGAAP measures include earnings before interest and taxes (EBIT); earnings before interest, taxes, depreciation, and amortization (EBITDA); free cash flow; and earnings per share (EPS) that exclude stock compensation or certain other charges.

The authors reviewed 25 companies that had initial public offerings (IPO) in 2011, filed their first Forms 10-K in 2012, and disclosed non-GAAP financial measures. This discussion focuses on the non-GAAP reporting practices of those companies and how they provided transparency and disclosures in their non-GAAP presentations. CPAs should keep in mind some of the best practices for non-GAAP reporting-based upon the SEC's Regulation G, "Conditions for Use of Non-GAAP Financial Measures"-examined in the following sections.

SEC Guidance for Non-GAAP Reporting

The SEC regulates the disclosure of nonGAAP financial measures under Regulation G and Regulation S-K, designed to protect investors from being misled by non-GAAP disclosures.

Regulation G. As directed by the Sarbanes-Oxley Act of 2002 (SOX), the SEC adopted new rules and amendments to address public company disclosures of certain financial information that is calculated and presented on the basis of methodologies other than GAAP. One such rule was Regulation G, effective March 28, 2003. Regulation G applies whenever a company publicly discloses material information that includes a non-GAAP financial measure. It requires the company to include a presentation of the most directly comparable GAAP financial measure and a reconciliation of it to the non-GAAP financial measure.

Regulation S-K. Item 10(e) of Regulation S-K, on the other hand, only regulates non-GAAP financial measures included in SEC filings. Under Item 10(e)(l)(i), the following information should accompany a company's disclosure of non-GAAP financial measures:

* A presentation of GAAP measures, with equal or greater prominence as non-GAAP financial measures

* A reconciliation of non-GAAP measures to GAAP presentations (by schedule or another clearly understood method)

* A statement disclosing the reasons why management believes that presentation of the non-GAAP financial measure provides useful information to investors

* To the extent it is material, a statement disclosing the additional purposes for nonGAAP measure disclosures, if any.

In addition, Item 10(e) prohibits the following when disclosing non-GAAP financial measures:

* Excluding charges that require cash settlement from non-GAAP liquidity measures, other than EBIT and EBITDA pre- sentations-for example, free cash flow should not be used in a manner that could imply that the non-GAAP measure represents the residual cash flow available for discretionary expenditures by the company, because the company may have mandatory debt service requirements or other nondiscretionary expenditures that are not deducted from the free cash flow measure

* Eliminating or smoothing items identified as nonrecurring, infrequent, or unusual when the nature of the charge or gain is reasonably likely to recur within two years or a similar charge or gain has occurred within the two prior years

* Presenting non-GAAP financial measures on the face of GAAP financial statements or in the accompanying notes

* Presenting non-GAAP financial measures on the lace of any pro forma financial information required by Article 11 of Regulation S-X, which requires pro forma presentation in certain circumstances (e. …

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