Accounting case

3/8/22, 12:42 PM Bogus numbers still cloud company accounts | Financial Times

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© Evgeny Ivanov/Dreamstime

Francine McKenna DECEMBER 7 2021

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The writer is editor of The Dig and adjunct professor in the MBA programme at

American University

Public companies all over the world are addicted to reporting alternative financial

performance metrics. Such numbers almost always tell a more positive story than the figures they are required to report.

This has helped to goose stock prices, divorcing market performance from financial reality and creating unreal values built for companies that report perpetual losses and

dubious listings

Opinion Markets Insight

Bogus numbers still cloud company accounts

FRANCINE MCKENNA

Adjusted figures spread, divorcing market performance from financial reality

3/8/22, 12:42 PM Bogus numbers still cloud company accounts | Financial Times

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dubious listings.

Companies say they use alternative metrics to create a more informative narrative and

to provide numbers that predict future performance better than standard accounting.

How do accounting standard-setters respond to the complaint that companies need

alternative numbers because standard accounting is not up to snuff?

The board that oversees the International Financial Reporting Standards for non-US

accounting has taken a direct approach, proposing to define “management

performance measures” and to require companies to disclose them in a single note. After an extended period of public comment, the International Accounting Standards

Board is weighing up those proposals.

For US accounts, the Financial Accounting Standards Board has no authority over

alternative metrics — that rests with the Securities and Exchange Commission. And it

seems the FASB has no interest in regulating metrics that do not fall into line with its rules known as Generally Accepted Accounting Principles. So it commissions more

studies to improve GAAP.

Auditors say they have no responsibility for alternative numbers in earnings releases

or company presentations that do not include their audited financial statements.

Auditors typically don’t check alternative numbers. But they are glad to help check alternative metrics if companies want to pay extra. Just give them a ring.

Researchers, however, provide evidence that companies create alternative numbers mostly to conceal losses, report positive earnings growth and meet or beat analysts’

expectations.

One recent study surveyed company practices between 2010 and 2016 finding that 11

per cent of adjustments equalled or exceeded 100 per cent of the absolute value of

GAAP net income. Positive adjustments outnumbered negative adjustments 3-1.

Share prices do not move as much any more when companies simply meet analyst estimates or make small earnings beats. That might explain why research from 2018

showed companies used alternative numbers to produce quarterly earnings per share

that would exceed analysts’ forecasts by 5 to 15 cents, rather than a penny or two.

The US Securities and Exchange Commission and the UK’s Financial Reporting

Council have both tried to address the issue. But alternative numbers have continued to proliferate.

3/8/22, 12:42 PM Bogus numbers still cloud company accounts | Financial Times

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In October 2021, the FRC published its review of alternative performance measures

based on a sample of 20 recent company annual reports. All presented adjusted numbers and some reported as many as 23 APMs. The most frequently used APMs are

adjusted earnings before interest, tax, depreciation and amortisation, adjusted profit before tax and adjusted operating profit.

In six cases, the adjustments changed losses into an adjusted profit. In 19 cases, the

alternative metrics were used to report higher profits, or lower adjusted losses, compared with real numbers.

Nearly all S&P 500 companies use non-GAAP numbers to change their financial story. In May 2016, the SEC issued new guidance to tighten slack that had developed since it

relaxed rules in 2010. SEC staff used a bully-pulpit approach and even slapped a few

wrists. However, the steady stream of SEC staff comments about inappropriate use of non-standard metrics became a trickle in 2017 under the Trump deregulatory agenda.

The Trump SEC did take civil action against a handful of companies. In one case, the security company ADT was fined $100,000 for a March 2018 earnings release that

used adjusted numbers in the headline and highlights section while citing the GAAP

numbers lower down. But US listed companies largely went back to their old tricks during the pandemic.

In May 2020, the Financial Times reported sightings of Ebitdac — earnings before interest, tax, depreciation, amortisation and coronavirus. A white paper published in

June 2020 found more than 40 companies had used similar Covid-free numbers.

I’d like to see more discipline in the market, a return to fundamentals. But all around

me investors tell me that’s too much of a drag. Trillions are traded based on unaudited

earnings press releases filled with never-to-be audited alternative numbers. Not enough investors want the genie back in the bottle.

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