Question

Discuss the following regarding non-GAAP financial measures used in publicly held companies’ reports filed with the SEC. Don’t just give a short answer but have a discussion on each question:

1. Discuss what the SEC allows and what it does not allow in reporting non-GAAP financial measures used in reports filed with the SEC?

Answer 1

A non-GAAP financial measure is one that:

- excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP.
- includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable GAAP.

Whenever a registrant required to file reports under Section 13(a) or 15(d) of the Exchange Act (other than a registered investment company) discloses or releases publicly any material information that includes a non-GAAP financial measure, the provisions of regulation G of the SEC apply.

The SEC requires the following:
That the entity make a presentation of the most directly comparable GAAP measure & prepare a reconciliation of the differences between the non-GAAP measure disclosed or released with the most directly comparable GAAP measure. With regard to forward-looking information, a quantitative reconciliation is only required to the extent available without unreasonable efforts. If all of the information necessary is not available without unreasonable efforts, the registrant must identify the information that is unavailable and disclose probable significance.
This regulation is put into place by the SEC to ensure that users of financial statements are clearly able to comprehend the impact of Non-GAAP measures on the books.

For example, if investors can easily see the difference in profit of a company due to use of non GAAP measures vs. GAAP, then they can make a more informed decision on whether or not to invest in that company.

The SEC does not allow the following:
The registrant (or person acting on the registrant’s behalf) is prohibited from making public a non-GAAP financial measure that, taken together with any information accompanying it, contains an untrue statement of material fact or omits to state a material fact necessary in order to make the presentation of the non-GAAP financial measure, in light of the circumstances under which it is presented, not misleading.

This is done in order to prevent entities from using non GAAP practices to mislead others or intentionally manipulate the financial statements for their own benefits. For example presenting adjusted financial results excluding research and development asset acquisition expense can result in a greater profit, but if such expense is part of normal business operations then it should be included in the adjusted financial results which will lead to a lower profit.