Accounting Seminar (Pro Team)

“Non-GAAP Metrics”

Disusun oleh:
Kevin Henrico (01031181621042)
Ardiko Tias Putra (01031281621093)

Kementerian Riset, Teknologi, dan Pendidikan Tinggi

Jurusan Akuntansi - Fakultas Ekonomi
Universitas Sriwijaya - Palembang
2019
 CHAPTER II

DISCUSSION

2.1. Non-GAAP vs GAAP

GAAP Non-GAAP
GAAP was developed by the Financial There are instances in which GAAP
Accounting and Standards Board (FASB) to reporting fails to accurately portray the
standardize financial reporting and provide operations of a business. Companies are
a uniform set of rules and formats to allowed to display their own accounting
facilitate analysis by investors and creditors. figures, as long as they are disclosed as non-
The GAAP created guidelines for item GAAP and provide a reconciliation between
recognition, measurement, presentation, and the adjusted and regular results. Non-GAAP
disclosure. Bringing uniformity and figures usually exclude irregular or noncash
objectivity to accounting improves the expenses, such as those related to
credibility and stability of corporate acquisitions, restructuring or one-time
financial reporting, factors that are deemed balance sheet adjustments. This smooths out
necessary for optimally functioning capital high earnings volatility that can result from
markets. Companies can be compared temporary conditions, providing a clearer
against one another, results can be verified picture of the ongoing business. Forward-
by reputable auditors, and investors can be looking statements are important because
assured that the reports are reflective of valuations are largely based on anticipated
fundamental well-being. These principles cash flows. However, non-GAAP figures are
were established and adapted largely to developed by the reporting company, so they
protect investors from misleading or may be subject to situations in which the
dubious reporting. incentives of shareholders and corporate
management are not aligned.

GAAP and non-GAAP results are both important in many cases, and studies by
academic and professional sources support this stance. Investors forced to choose a side as
the two diverge should consider the specific exclusions in adjusted figures, and personal
economic outlook is also important. Companies that consistently purchase smaller firms and
intend to sustain this acquisitive strategy often exclude certain acquisition-related costs that
remain a material ongoing expense to the business, but should not be overlooked.
 Studies have suggested that the exclusion of stock-based compensation from earnings
results materially reduces the predictive power of analyst forecasts, so non-GAAP figures
that merely adjust for equity compensation are less likely to provide actionable data.
However, non-GAAP results from responsible firms grant investors unparalleled insight into
the methodology employed by management teams as they analyze their own companies and
plan future operations.
Whenever non-GAAP metrics get attacked, a slew of contrarians leap to defend them
by pointing out that GAAP standards have many flaws. Traditional GAAP accounting, these
critics argue, do a poor job of reflecting economic realities and already contain enough
loopholes for executives to “manage” earnings.
GAAP standards contain numerous loopholes that executives can use to manipulate
earnings, which studies show they do with frequency and magnitude. Given these flaws, it’s
understandable that people would think non-GAAP metrics could better serve the interests of
investors who want to understand the true cash profitability of businesses (Bentley, 2018).

2.2. Non-GAAP Overview

Non-GAAP financial metrics are back in the news today thanks to a fresh report from
Audit Analytics, which finds that almost all large companies now report at least one such
metric in their financial statements, and that the number of non-GAAP metrics the average
filer reports has tripled in the last 20 years.
Audit Analytics looked at non-GAAP metrics reported by S&P 500 companies in
1996, 2006, and 2016. In that first year, only about 60 percent of companies used any non-
GAAP metrics at all, and the average company offered 2.35 non-GAAP metrics per filing.
Take a look at Figure 1, below, to see how that has changed over time.

Figure 1. Companies Related With Non-GAAP Presenting

Source : Audit Analytics (Christensen, et al, 2018)

By 2017, only 3 percent of the S&P 500 did not report any non-GAAP metrics. The
most common non-GAAP metrics related to income: 82 percent of all companies offered
some kind of adjusted income number — whether the company called it operating income or
some other adjustment ginned up to make income look better than what traditional GAAP
would allow.
Other common non-GAAP metrics pertained to earnings per share, EBITDA, cash
flow, and funds from operations (a common, and GAAP-approved). The rise of non-GAAP
reporting has long been a complaint among the financial reporting purists of the world. Those
complaints reached a crescendo in 2016 when the SEC published updated guidance on when
companies can use non-GAAP, and how to reconcile those numbers back to standard GAAP
so investors can follow the logic of a company’s non-GAAP thinking (Deloitte, 2019).

2.3. Why Do Registrants Use Non-GAAP Measures?

Many registrants assert that non-GAAP measures are meaningful and provide
valuable insight into the information management considers important in running the
business (Deloitte, 2019). Registrants may believe that GAAP numbers do not provide a full
picture of their business or their results of operations and liquidity unless they are
supplemented with non-GAAP measures that they believe are useful. While the SEC staff
allows registrants to use non-GAAP measures “to tell their story,” registrants must apply the
appropriate SEC guidance and provide disclosures. Reasons why registrants may use non-
GAAP measures include the following:
A. Management compensation and incentive plans may be based on non-GAAP
measures.
B. Debt covenants or other requirements may be based on non-GAAP measures.
C. Investors, analysts, and others may find non-GAAP information useful for a variety of
reasons; for example, the information may provide meaningful insight into items
affecting a company’s performance and comparability of results to others in the
industry.
D. Forecast and budgets used by management may be based on non-GAAP measures.
E. Certain non-GAAP measures, such as EBITDA, may be used for assessing business
valuations in analyses of either earnings multiples or comparable transactions.

A registrant should provide transparent disclosure that clearly demonstrates (1) the
usefulness of the non-GAAP measure to investors and (2) the additional purposes for which
management uses such measure (e.g., for incentive and compensation arrangements, to
manage its business, to allocate resources, or as a debt covenant).
2.4. Common Non-GAAP Measures
The following are examples of common non-GAAP financial measures:
A. Operating income that excludes one or more expense items.
B. Adjusted revenues, adjusted earnings, and adjusted earnings per share.
C. EBIT and EBITDA, and adjusted EBIT and EBITDA.
D. Core earnings.
E. Free cash flow.
F. Funds From Operations.
G. Net debt, which could be calculated as borrowings less cash and cash equivalent or
borrowings less derivative assets used to hedge the borrowings.
H. Measures presented on a constant-currency basis, such as revenues and operating
expenses.
I. System-wide sales.

2.5. SEC Guidance on Non-GAAP Measures

The SEC’s written guidance on non-GAAP financial measures has been in existence
for many years. During this time, the SEC staff has periodically issued new and updated
guidance on the use and disclosure of such measures or informally communicated its views in
speeches and comments at various forums. The graphic below illustrates key events in the
evolution of the SEC’s guidance on these measures and is followed by a discussion of each
event.
Figure 2. History of SEC Guidance of Non-GAAP

Source : Audit Analytics (Christensen, et al, 2018)

In October 2017 and April 2018, the SEC staff updated and added certain C&DIs on
non-GAAP financial measures associated with business combinations that addressed whether
financial measures in forecasts provided to financial advisers, boards of directors, or bidders
and used in connection with a business combination transaction constitute non-GAAP
measures. These updates included new and revised C&DIs that addressed whether financial
measures in forecasts provided to financial advisers, boards of directors, or bidders and used
in connection with a business combination transaction constitute non-GAAP measures.
The disclosure committee reviews the non-GAAP measures disclosed in the draft
earnings release for compliance with Regulation G and other SEC guidance and ensures the
following:
A. The non-GAAP measure is neither misleading nor prohibited.
B. The non-GAAP measure is presented with and reconciled to the most directly
comparable GAAP measure and with no greater prominence than the GAAP measure.
C. The non-GAAP measure is appropriately defined and described and is clearly labeled
as non-GAAP.
D. The non-GAAP measure is balanced (i.e., it adjusts not only for nonrecurring
expenses but also for nonrecurring gains).
E. There is transparent and company-specific disclosure of the substantive reason(s) why
management believes that the measure is useful for investors and, if material, the
purpose for which management uses the measure.
F. The non-GAAP measure is not presented on the face of the GAAP financial
statements or in the accompanying notes or on the face of any pro forma financial
statements required to be disclosed.
G. The titles or descriptions of non-GAAP financial measures are not the same as, or
confusingly similar to, titles or descriptions used for GAAP financial measures.
H. The measure is consistently prepared from period to period in accordance with the
defined policy and is comparable to that of the company’s peers.

2.6. Purpose of Non-GAAP

Consider the abstract question that non-GAAP raises. Should companies deviate from
GAAP to provide investors a more complete picture of operations? Or should companies
deviate from operations to give investors a more standard picture of financial performance?
Which choice serves investors better?
Current SEC rules split the difference, by allowing companies to report non-GAAP
metrics only if they also explain why those metrics are useful, and reconcile those non-GAAP
measures back to the closest one allowed in GAAP.
 Audit Analytics also found several companies reporting multiple non-GAAP metrics
for cash flow. CenturyLink, for example, reported net cash provided by operating activities (a
GAAP-approved metric) of $2.6 billion in 2017. It also reported “free cash flow” of $1.68
billion, “cash provided by operating activities before after-tax discretionary pension
contribution” of $2.94 billion, and “free cash flow before after-tax discretionary pension
contribution” of $2 billion.
Non-GAAP financial information can be useful for FMC reporting entities, investors
and others, as it can provide additional insight into an FMC reporting entity’s financial
performance, financial condition and/or cash flow (FMA, 2012).

2.7. Evaluating Non-GAAP To Improve GAAP

As we think about identifying new ways in which to improve GAAP, it is important to
see how companies today use non-GAAP reporting to communicate their performance to
shareholders. Non-GAAP depicts measures of performance that are alternatives to GAAP.
These measures (common ones include adjusted EBITDA, operating earnings, and free cash
flow) are based upon information contained in GAAP financial statements. It’s a direct path
from the GAAP calculation to the non-GAAP calculation. Such numbers are generally
derived directly from GAAP results and thus are easy to reconcile. Non-GAAP performance
measures also include measures that ignore GAAP recognition and measurement principles
altogether. In these cases, companies are developing customized or tailored measures of
performance to highlight their preferred methods of assessing business growth (Ana, 2017).
Another example is our current project on hedge accounting. Today, many preparers
do not attempt to qualify for hedge accounting because the accounting guidance on
derivatives is complex. Some of those preparers account for certain derivatives without
applying hedge accounting and then simply use non-GAAP measures to adjust away the
accompanying volatility in their GAAP results. Making hedge accounting easier may
encourage more companies to apply that guidance and potentially reduce the need for
companies to report non-GAAP measures. If non-GAAP measures developed by
management are inconsistent, misleading, and noncomparable then they don’t enhance
consistency and credibility in financial reporting and won’t be acted on by the FASB.

2.8. Application of Non-GAAP Benefits

Vmware, Inc. is a publicly traded software virtualization company listed on the NYSE
under stock ticker VMW. Dell Technologies is a majority share holder. VMware provides
cloud computing and platform virtualization software and services. To provide investors and
others with additional information regarding VMware’s results, we have disclosed in this
press release the following non-GAAP financial measures: non-GAAP operating income,
non-GAAP net income, non-GAAP operating margin and trailing twelve-month free cash
flows. Vmware has provided a reconciliation of each non-GAAP financial measure used in
this earnings release to the most directly comparable GAAP financial measure. These non-
GAAP financial measures differ from GAAP in that they exclude stock-based compensation,
employer payroll tax on employee stock transactions, amortization of intangible assets,
acquisition related items, and the net effect of the amortization and capitalization of software
development costs, each as discussed below.
VMware’s management uses these non-GAAP financial measures to understand and
compare operating results across accounting periods, for internal budgeting and forecasting
purposes, for short- and longterm operating plans, to calculate bonus payments and to
evaluate VMware’s financial performance, the performance of its individual functional
groups and the ability of operations to generate cash. Management believes these non-GAAP
financial measures reflect VMware’s ongoing business in a manner that allows for
meaningful period-to-period comparisons and analysis of trends in VMware’s business, as
they exclude expenses that are not reflective of ongoing operating results. Management also
believes that these non-GAAP financial measures provide useful information to investors and
others in understanding and evaluating VMware’s operating results and future prospects in
the same manner as management and in comparing financial results across accounting
periods and to those of peer companies. Additionally, management believes information
regarding free cash flows provides investors and others with an important perspective on the
cash available to make strategic acquisitions and investments, to repurchase shares, to fund
ongoing operations and to fund other capital expenditures.

CHAPTER III

CONCLUSION
 The rise of non-GAAP reporting has long been a complaint among the financial
reporting purists of the world. Non-GAAP measures are meaningful and provide valuable
insight into the information management considers important in running the business.
Registrants may believe that GAAP numbers do not provide a full picture of their business or
their results of operations and liquidity unless they are supplemented with non-GAAP
measures that they believe are useful.

REFERENCES
Ana, Marques. 2017. "Non-GAAP earnings: international overview and suggestions for
future research", Meditari Accountancy Research, Vol. 25 Issue: 3, pp.318-335,
https://doi.org/10.1108/MEDAR-04-2017-0140.
Bentley, J., T. Christensen, K. Gee, and B. Whipple. 2018. Disentangling managers’ and
analysts’ non-GAAP reporting. Journal of Accounting Research, In Press.
Christensen, Theodore E. and Gomez, Enrique and Ma, Matthew and Pan, Jing. 2018.
Analysts’ Role in Shaping Non-GAAP Reporting: Evidence from a Natural
Experiment. SMU Cox School of Business Research Paper No. 18-32. Available at
SSRN: https://ssrn.com/abstract=3242271 or http://dx.doi.org/10.2139/ssrn.3242271.
Deloitte. 2019. A Roadmap to Non-GAAP Financial Measures.
FMA. 2012. Disclosing Non-GAAP Financial Information.