Not Minding the GAAP
U.S. GAAP and international standards like IFRS are far from perfect representations of a company’s financial performance, as they require estimates that may or may not reflect the economic reality of a business at any given point in time. While sometimes useful, “adjusted” figures are prone to even more significant biases — these adjustments essentially go in just one direction, of course. One mark of a good management team is making conservative accounting assumptions and presenting non-biased results with an eye towards long-term sustainability rather than just hitting quarterly targets.
Just 29 companies in the S&P 500 index — or 5.7% of the total — closed their books for 2015 exclusively using U.S. Generally Accepted Accounting Principles, or GAAP. That’s a sharp decline from 25% in 2006, according to research firm Audit Analytics. The purists are dwindling as companies struggle to increase their earnings in the wake of the 2008 financial crisis, analysts and accountants say, and regulators are taking notice. The adjusted, or customized, figures many finance chiefs use to supplement their company’s standard financial reports inflate income by an average of 44% at profitable companies, according to new research by financial-data provider Calcbench Inc. Adjustments can exclude the effects of such factors as currency swings, noncash charges like restructuring costs and one-time charges… “As the economy slows or grows companies are incentivized to provide more or less [customized] metrics,” said Angela Newell, partner at accounting firm BDO USA LLP. “If everything is rosy and GAAP looks great, there is no need to include a non-GAAP metric,” she added.
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The common practice of tweaking financial figures has contributed to the ballooning disparity between earnings calculated using standard and non-GAAP accounting, according to Calcbench’s analysis of the 816 U.S. public companies disclosing adjusted financial results in their most recent fiscal years…
For profitable companies, common adjustments yielded a $94 billion improvement on top of the combined $214 billion in GAAP net income they reported for the year, according to additional analysis by Calcbench and The Wall Street Journal. Unprofitable companies got a bigger boost than profitable ones, the joint analysis showed. Among 328 companies reporting net losses for the year, the adjustments improved non-GAAP results by a combined $65 billion, or about 70% of their aggregate net losses of $93.5 billion. Adjustments varied widely by sector, Calcbench’s study found. Financial firms made the biggest adjustments, at $40 billion, more than two-thirds of which related to acquisitions. Tech firms made the most adjustments, about 1,500 among 196 companies totaling $34 billion, 61% of which related to stock-based compensation.