In this second article of the series, we will review the SEC rules regarding non-GAAP measures and discuss considerations that management should make when determining whether to include them.
The Pillars of Using Non-GAAP Measures
The use of non-GAAP measures is permitted in some cases (as long as the use abides by specific rules) and prohibited in other situations. The chart below details when non-GAAP measures are and are not allowed, as well as the requirements for using them.
|Prohibitions Against Non-GAAP Measures
||Requirements for the Use of Non-GAAP Measures
|When taken together with any accompanying information, non-GAAP measures cannot contain untrue statements of material fact, omit material facts, or be misleading.
||Non-GAAP measures must be accompanied by, and reconciled to, the corresponding GAAP measures in a manner that is consistent with their use as either performance measures or liquidity measures, and those GAAP measures must be presented with equal or greater prominence.
|Non-GAAP measures cannot be presented on the face of the financial statements or of Article 11 pro forma financial information.
||Non-GAAP measures are required to be presented with each adjustment (in the reconciliation to GAAP) clearly labeled and separately quantified.
|Organizations cannot apply titles or descriptions to non-GAAP measures that are the same as or similar to those of GAAP measures.
||Non-GAAP measures have to be presented in proximity to the GAAP measure with an appropriate balance of discussion.
|Non-GAAP measures cannot present segment-level profit information on a consolidated basis that creates a non-GAAP financial measure in contrast to the applicable SEC disclosure rules.
||When presenting non-GAAP measures, companies must add disclosures that fully explain:
1. why the measures are useful to investors, and
2. any additional ways management uses the measures, if material.
A better understanding of the rules for and against the use of non-GAAP measures allows management to determine if the use is appropriate in a particular circumstance. Management should also ask the following questions:
- Why is the non-GAAP measure being used, and how it provides investors with useful information?
- Do the non-GAAP measures have greater prominence than the GAAP measures, as prohibited by SEC rules?
- Are the explanations of how the non-GAAP measures are used — and why they are useful for your investors — accurate, complete, and drafted without boilerplate?
- Are there appropriate controls over the calculation of non-GAAP measures?
Given the SEC’s increased focus, management and the company’s audit committee should make sure they understand applicable SEC rules and that their non-GAAP measures comply with those requirements.
It is important for entities to have a meaningful, disciplined process in place when developing non-GAAP measures and to be transparent when disclosing such measures.
CRI Can Help You Mind the Gap Between Financial Accounting Standards
CRI’s professionals are proficient regarding the SEC’s rule and regulations over non-GAAP measures. Contact us for assistance with providing more transparent disclosure about how you bridge the divide of GAAP and non-GAAP measures for your organization’s financial needs.