SEC to Examine Use of Non-GAAP Metrics

In 2010, securities regulators eased rules regarding the use of non-GAAP metrics in financial reporting. Companies are now allowed to use their own metrics to report financial results, as long as those metrics are clearly labeled as non-GAAP metrics and reported alongside standard GAAP financial statements.The Securities and Exchange Commission, however, isn’t so sure that the new rules are being followed in every case. To investigate the use of non-GAAP metrics, the regulatory agency recently established a new Financial Reporting and Audit Task Force. The unit’s chairman said at a recent conference for the American Institute of Certified Public Accountants that the task force is particularly interested in mislabeling, or instances in which non-GAAP metrics have been presented with GAAP terms. The agency is questioning whether these uses of non-GAAP metrics may confuse investors, especially in the leadup to an IPO.Non-GAAP metrics such as customer churn rate or average revenue per user have become more commonly used, especially by companies in the tech world. While many non-GAAP metrics can provide useful insight into a business’s operations, many others could easily cloud the perception of a company’s actual financial results.

For example, in the third quarter of 2013, Tesla reported a non-GAAP revenue to be up nine percent over the previous year and non-GAAP net income of $15.9 million. However, those numbers include the unusual practice of adding in all the future fees paid over the life of a lease rather than just the fees that had already been paid. Under traditional GAAP metrics, Tesla’s revenue only increased six percent and the company actually had a $38.5 million loss.LinkedIn also reported a big non-GAAP profit in the third quarter, with net income of $46.8 million, an 86 percent increase over the previous year. That figure, however, was calculated by stripping out stock-based compensation and amortization of acquired assets. Under GAAP principles, the social media company actually had a $3.4 million loss.Other companies, like Barrick Gold, Frontier Communications and Salesforce.com, have all used non-GAAP metrics to report earnings. In the months leading up to its IPO, Twitter touted something called “adjusted EBITDA” to report a 2012 profit of $21.4 million. However, its actual EBITDA for the year under GAAP principles was a loss of $69.3 million. Similarly, in the months leading up to its IPO, Groupon used a metric called “adjusted consolidated segment operating income” to report profits when it had, in fact, been losing money.Two accounting professors from Boise State University and the University of Colorado said at a recent Institute of Management Accountants conference that, when used properly, non-GAAP metrics can provide investors with a clear view of a business’s operations. However, the non-GAAP metrics should be clearly labeled and defined. Any ambiguity that may cause an investor to view the metrics as actual financial results could be inappropriate and may land the company in the bullseye of the SEC.