SEC Scrutinizes Profit Metrics --- Some companies are being questioned about adjustments that go beyond GAAP standard

"The Securities and Exchange Commission ( SEC) is expected to ask more companies to explain how they calculate performance measures that go beyond U.S. generally accepted accounting principles, a move to gauge whether these metrics could potentially mislead investors.

The U.S. securities regulator for years has monitored companies' use of so-called non-GAAP earnings measures in their financial statements, such as earnings before interest, taxes, depreciation and amortization, or Ebitda, and adjusted revenue. Such measures are commonly used and typically exclude abnormal, nonrecurring items.

The SEC in 2016 warned companies that non-GAAP measures that replace GAAP-based methods with individually tailored disclosure could violate its rules. These activities include moving the timing of recognition of an expense or revenue from one period to another and depreciating operating leases instead of recording rent expenses.

In December, the regulator expanded the guidance with more details on what constitutes a possible violation. For example, companies that change their accounting for revenue or expenses from an accrual basis under GAAP to a cash basis might mislead investors, as the latter is an unofficial accounting practice, the SEC said.

Companies rely increasingly on these measures, often to present an overly optimistic picture of profitability, accounting researchers said. Executives usually say that focusing on core operating earnings is the most accurate way to depict financial performance to investors, but their approach may vary.

Investors might assume that non-GAAP measures represent a company's earnings minus abnormal, nonrecurring items and then be fooled when the measures mean something different, said Nick Guest, an assistant professor of accounting at Cornell University. "That's what the SEC doesn't want and why they're not allowing each company to come up with their own definition of a non-GAAP measure," Mr. Guest said.

The SEC in a series of recent letters to businesses focused on companies' presentations of non-GAAP metrics that seem tailored to the specific firm. It has asked many of them to make changes for future filings so that investors can adequately assess the business. The agency's corporate-finance division regularly sends letters to public companies to inquire about their disclosures or accounting practices tied to filings such as quarterly or annual reports.

Ride-hailing firm Lyft Inc., mattress maker Sleep Number Corp., and media and education business Graham Holdings Co. were among the companies the SEC sent such letters to in exchanges the regulator made public in recent weeks.

SEC letters released in January and February showed a total of 20 companies were questioned about their compliance with Question 100.04, a section in its guidance focused on calculations of non-GAAP measures, according to MyLogIQ, a data provider. That is up from 11 companies in letters released in January and February 2022. SEC questions on the topic totaled 161 in 2022, down from 206 a year earlier and up from 124 two years earlier, MyLogIQ said.

That number will likely grow in the coming months due to the SEC's apparent focus and some companies' lack of awareness of the new guidance, accountants and academics said. The SEC typically makes correspondences public 20 business days after resolving matters, meaning inquiries following the December guidance could be released starting in early spring, said Olga Usvyatsky, a former vice president of research at research firm Ideagen Audit Analytics and a Ph.D. accounting student at Boston College.

The SEC has long expressed concerns about companies placing too much emphasis on their non-GAAP disclosures compared with GAAP disclosures. But its scrutiny on non-GAAP calculations could push companies to overhaul how they compute measures of financial performance. Changing how certain non-GAAP measures are calculated can be embarrassing and even costly for companies, accountants said. The SEC declined to comment.

In letters released recently, the SEC asked Lyft to explain how it considered agency rules in excluding insurance reserve costs, or funds allocated by a company for future insurance claims, in its adjusted Ebitda. The SEC also inquired about Sleep Number's use of a non-GAAP measure known as return on invested capital." [1]

1. Banking & Finance: SEC Scrutinizes Profit Metrics --- Some companies are being questioned about adjustments that go beyond GAAP standard
Maurer, Mark.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 01 Mar 2023: B.12.