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In remarks Thursday during the 2016 Baruch College Financial Reporting Conference, SEC Deputy Chief Accountant Wesley Bricker and Mark Kronforst, Chief Accountant of the Division of Corporation Finance, provided stern warning against what the Commission views as the inappropriate use of non-GAAP financial reporting.
Shedding additional light on how the SEC “crackdown” will play out, Kronforst noted that while not public yet, comment letters on registrant filings will be issued in the next few weeks and preparers can expect a focus on the following areas:
- The use of individually-tailored accounting principles to calculate non-GAAP earnings
- Adjusted revenues
- Providing per-share data for non-GAAP performance measures that look like liquidity measures (e.g., cash flow per share or free cash flow per share)
- Non-GAAP tax expense (linking the impact of adjusting revenues to its effect on income taxes)
As an example of an “Individually-tailored accounting principle,” Bricker described a scenario where a company has a subscription-based business and bills for the full subscription at the outset — but since it delivers the service over time, it earns and recognizes GAAP revenue over time as the services are provided.
In this scenario, if the company were to calculate revenues had it sold a product instead of a subscription, this would result in an acceleration of revenue (i.e., revenue recognized on the billing date vs over time).
“In this instance, the measure does not appear to help investors understand and analyze core operating results. Rather, it is a replacement of an important accounting principle with an alternate accounting model that does not match the company’s subscriptions business or earnings process, which is over time,” stated Bricker.
This example speaks volumes when it comes to the approach the SEC will take to the adoption of upcoming major new standards including revenue recognition, leases and financial instruments. As Bricker stated, the SEC “will be looking to see if the reporting concepts within those standards are supplanted by any number of company-specific non-GAAP alternatives.”
In perhaps the most pointed statement of the day, Bricker noted “If you present adjusted revenue, you will likely get a comment.”
In highlighting further the SEC’s approach to non-GAAP tax expense, Kronforst noted his division will be looking to link the impact of adjusting revenues and earnings measures on a non-GAAP basis to their “hypothetical effect” on income taxes. For example, if adjusted-revenues or adjusted-earnings before tax were the hypothetical real GAAP measure, what would the impact have been from a tax perspective (e.g., would we have been able to utilize all of our tax deductions)?
For more information and a complete transcript of the SEC speech, including other key highlights on transition period activities and disclosures and PCAOB matters, please click here.
Update: On May 17, 2019 the SEC updated its guidance on the use of non-GAAP financial measures adding a number of new Compliance & Disclosure Interpretations (“C&DIs”) to its guidance. For more information click here.