Volume 24, No. 10: The Non-GAAP Earnings Epidemic, Part 2

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If accounting is the language of business, then the SEC provided the scaffolding for building the Tower of Babel when it issued Regulation G in 2003. That regulation legitimized the presentation of non-GAAP earnings by setting ground rules for their presentation and provided a safe harbor for companies as long as they stayed within the lines. Companies have responded eagerly to the regulation: non-GAAP earnings have proliferated like never before, both in terms of the dollars of adjustments made to reported income and the number of adjustments made to arrive at artisanal performance measures. The measures may be more anarchic than artisanal. While a company’s performance comparisons from one year to another might be improved by non-GAAP earnings, comparisons among companies become less relevant because of the different recipes used to concoct performance measures. There can be legitimate analytical reasons for adjusting earnings so logical comparisons can be made: maybe the removal of an impairment charge, for instance, or maybe a large legal settlement. All too frequently, however, the reason is that some adjustments represent non-cash expenses. The mongrel metric resulting from its removal is usually billed as being “cash earnings” – but it represents neither cash from operations nor earnings. Investors won’t stop using these metrics because companies won’t stop presenting them- or is it the other way around? They’re not likely to go away anytime soon – but if the FASB and the SEC improved basic income statement reporting, there might be less justification for presenting non-GAAP earnings. They might become less frequent, and less radically different, from reported earnings.

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