American companies and accounting professionals enjoy a certain level of freedom when preparing financial statements; by using accounting measures that deviate from generally accepted accounting principles, they can customize reports to suit their unique circumstances. In early 2016, the Securities and Exchange Commission expressed concern over these non-GAAP measures and announced plans to investigate them further. If the SEC enacts further regulation, companies that persist with the adjusted measures may face legal issues.
As of April 2016, the SEC advises companies to use GAAP measures, which are prepared by the Financial Accounting Standards Board and the Governmental Accounting Standards Board of the Financial Accounting Foundation. The measures are designed to provide a consistent reporting standard that enables investors and government bodies to evaluate a company effectively.
GAAP measures are not infallible, however, and they do not always communicate a company's unique situation. To address this issue, the SEC permits companies to use non-GAAP measures to help explain how the business is performing. These nontraditional measures adjust GAAP standards to take into account unique factors, including unusual changes to the business. The SEC permits the use of non-GAAP measures, as long as companies also provide the closest GAAP measure. In addition, the GAAP equivalent must not be presented with less prominence.
While non-GAAP measures can be a useful tool, the SEC has stated concerns about illegal misuse. Under a non-GAAP formula, companies often remove costs and gains they deem out of the ordinary, largely to present a more realistic picture of core operations. Unfortunately, in an effort to appear more profitable and high performing, companies may choose to remove unusual costs while keeping unusual gains. In the process, they artificially inflate profits, thereby misleading shareholders and potential investors.
At a conference in March 2016, SEC Chairman Mary Jo White stated her concern about these adjusted earnings, noting they "tell a better story" than the nonadjusted earnings. As a result, investors may proceed with undue confidence. White mentioned the possibility of using regulation to prevent companies from painting their prospects in an overly positive light. The non-GAAP figures can also vary between companies and industries, making it difficult for investors to obtain a clear understanding.
As of April 2016, the SEC has not announced how it will target problematic non-GAAP measures. Some experts suggest the SEC will impose GAAP regulations on all company disclosures, including websites, press releases and marketing materials; these new rules would be particularly important for accountants who work in investor relations. Because the average investor may be more likely to get information from a website or media outlet rather than a dense financial statement, this type of regulation could curb illegal behavior.
For accounting professionals, 2016 promises to be a year of change in financial reporting. By staying up-to-date on regulations related to non-GAAP measures, companies and financial professionals can avoid legal issues that might sabotage company performance.
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