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Monday, October 31, 2016

Strategic CSR - GAAP

The article in the url below reveals the extent to which large U.S. firms are now manipulating their quarterly results by presenting adjusted (i.e., non-GAAP) earnings in addition to their standard accounting results:
"Just 29 companies in the S&P 500 index—or 5.7% of the total—closed their books for 2015 exclusively using U.S. Generally Accepted Accounting Principles, or GAAP. That's a sharp decline from 25% in 2006, according to research firm Audit Analytics."
The reasons why firms do this do not seem to be in doubt:
"The purists are dwindling as companies struggle to increase their earnings in the wake of the 2008 financial crisis, analysts and accountants say. … The adjusted, or customized, figures many finance chiefs use to supplement their company's standard financial reports inflate income by an average of 44% at profitable companies, according to new research. … Adjustments can exclude the effects of such factors as currency swings, noncash charges like restructuring costs and one-time charges. That can help mask the impact of tepid global economic growth, which has left many businesses unable to raise prices and hindered sales growth."
As one accountant quoted in the article succinctly puts it:
"If everything is rosy and GAAP looks great, there is no need to include a non-GAAP metric."
The graphic accompanying the article demonstrates the speed with which firms have adopted this practice:
The interesting thing about this story, however, is not that this is happening so much as that investors are letting firms get away with it. In other words, although the information on the number of firms employing this practice is freely available, investors either do not know or do not care. Clearly, executives do not feel there is a penalty to be paid if they continue this practice. But, it seems reasonable to conclude that, the longer they are allowed to get away with it, the more they will push the boundaries of what is considered 'acceptable':
"U.S. companies are allowed to report non-GAAP metrics so long as they are labeled, justified and reconciled with comparable standard accounting figures, but there is little oversight of how these adjusted figures are calculated."
Ultimately, where is the line between presenting a more 'realistic' version of the firm's operations and outright lying about performance? Given the jump in use in recent years, this is something that is of concern to regulators:
"SEC Chairman Mary Jo White has warned against giving adjusted earnings more prominence than standard numbers, because it might mislead investors. In May, the agency issued new guidance on using and publicizing non-GAAP measures and signaled it may issue new rules to curtail the practice."
What might provide a bit more of an incentive for executives to curtail this practice is if SEC queries to specific firms about questionable practices are immediately made available to investors, rather than delayed as at present. Until there is some meaningful pushback from stakeholders, behavior is unlikely to change.
Take care
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Accounting Blurs Profit Picture
By Tatyana Shumsky and Theo Francis
June 28, 2016
The Wall Street Journal
Late Edition – Final