Week 2 Discussion Post- article summaries

Beware Earnings Before the Bad Stuff Rapoport, Michael . Wall Street Journal , Eastern edition; New York, N.Y. [New York, N.Y]04 Aug 2016:

C.1.

ProQuest document link

ABSTRACT  

Companies that report significantly stronger earnings by using tailored figures like "adjusted net income" or

"adjusted operating income"are more likely to encounter some kinds of accounting problems than those that stick

to standard measures, according to research by consulting firm Audit Analytics.

FULL TEXT  

Regulators and investors are increasingly wary when companies overemphasize their own customized earnings

metrics. New research shows they may have a point.

Companies that report significantly stronger earnings by using tailored figures like "adjusted net income" or

"adjusted operating income"are more likely to encounter some kinds of accounting problems than those that stick

to standard measures, according to research by consulting firm Audit Analytics.

The rules allow companies to report such tailored figures, and the research, conducted for The Wall Street Journal,

doesn't necessarily mean such companies are less scrupulous in their bookkeeping. But it does suggest that

heavy use of metrics outside of generally accepted accounting principles -- sometimes referred to derisively as

"earnings before bad stuff" -- could be a warning sign.

"I would say an overprominent user of non-GAAP metrics would justify more attention and is a red flag," said Olga

Usvyatsky, Audit Analytics's vice president of research. Heavy use of non-GAAP metrics may indicate a company's

accounting is "more aggressive," she said.

The study focused on companies in the S&P 1500 index. It found that just 3.8% of those exclusively using standard

GAAP metrics had formal earnings restatements from 2011 to 2015. Among heavy users of non-GAAP measures --

those whose non-GAAP earnings were at least twice as high as their GAAP net income -- the rate was 6.5%.

Similarly, 7.5% of the GAAP-only group had material weaknesses in internal controls -- flaws in their procedures to

prevent financial errors and fraud -- versus 11% of the non-GAAP group.

Some of the numbers are small, and the use of non-GAAP metrics didn't specifically cause or relate directly to the

companies' accounting flaws. Audit Analytics cautioned more research is needed.

Still, the results suggest companies using non-GAAP metrics heavily "may be somewhat less rigorous in other

accounting areas" than companies using only GAAP, said Robert Pozen, a senior lecturer at the MIT Sloan School

of Management.

Two examples are Valeant Pharmaceuticals International Inc. and LendingClub Corp. Both companies have been

heavy users of pro forma metrics, and both have run into accounting and other problems that have hammered their

shares.

Valeant restated earnings earlier this year over revenue-booking issues and said it had material weaknesses

relating to its "tone at the top," or the commitment by a company's leadership to doing business ethically. Valeant

has used non-GAAP metrics for years, often benefiting significantly. In 2015, the company had a GAAP loss of

$291.7 million but an "adjusted" non-GAAP profit of $2.84 billion after stripping out amortization of intangible

assets, acquisition costs and other expenses.

Valeant spokeswoman Laurie Little said the company believes its non-GAAP measures "are useful to investors in

their assessment of our operating performance and the valuation of our company."

Online lender LendingClub forced its chief executive to resign in May after it found disclosure problems on some

loans, and it too cited a "tone at the top" material weakness. The company had a 2015 GAAP loss of $5 million but

non-GAAP net income of $56.8 million. LendingClub declined to comment.

Neither company was in the pool Audit Analytics examined.

Companies are allowed to use nonstandard metrics as long as they also provide GAAP numbers and show the

differences between the two. The tailored measures strip out unusual or noncash items to present what

companies say is a clearer picture of performance.

Even critics acknowledge the tailored metrics can sometimes be helpful -- showing a company's results in

constant currency is a legitimate adjustment, for instance, Mr. Pozen said.

But there is also a concern they are being abused, that companies are stripping out normal, ongoing costs to make

themselves look healthier.

A study in June by financial data-research firm Calcbench and corporate-compliance consultant Radical

Compliance showed non-GAAP metrics inflated 2015 earnings by $164.1 billion over GAAP at a group of 816 public

companies.

In May, the Securities and Exchange Commission issued new guidelines warning companies against placing too

much emphasis on non-GAAP metrics. The commission also has been taking issue with companies' non-GAAP

disclosures more frequentlyin comment letters critiquing the companies' SEC filings.

Credit: By Michael Rapoport

DETAILS

Subject: Audits; Accounting procedures; Earnings announcements

LINKS

Database copyright  2018 ProQuest LLC. All rights reserved. Terms and Conditions Contact ProQuest

Company / organization: Name: Valeant Pharmaceuticals International Inc; NAICS: 325412; Name: Lending

Club; NAICS: 518210, 522291

Publication title: Wall Street Journal, Eastern edition; New York, N.Y.

Pages: C.1

Publication year: 2016

Publication date: Aug 4, 2016

Publisher: Dow Jones &Company Inc

Place of publication: New York, N.Y.

Country of publication: United States, New York, N.Y.

Publication subject: Business And Economics--Banking And Finance

ISSN: 00999660

Source type: Newspapers

Language of publication: English

Document type: News

ProQuest document ID: 18 08586269

Document URL: http://ezproxy.ohiodominican.edu/login?url=https://search.proquest.com/docview/

1808586269?accountid=28333

Copyright: (c) 2016 Dow Jones &Company, Inc. Reproduced with permission of copyright owner.

Further reproduction or distribution is prohibited without permission.

Last updated: 2017-11-23

Database: The Wall Street Journal