Curt Verschoor on Ethics

CHAPTER 2STUDIES OF ETHICAL AND UNETHICAL CULTURE

Is Non-GAAP Reporting Unethical?

The constant pressure to report favorable earnings performance motivates many companies to report income numbers that exclude unusual events that almost always seem to be costly and depress earnings. For many years, the use of financial performance measures other than Generally Accepted Accounting Principles (GAAP) has been an important subject to investors and the Securities & Exchange Commission (SEC).

In 1973, the SEC issued Accounting Series Release (ASR) No. 142, “Conditions for Use of Non-GAAP Financial Measures,” warning of possible investor confusion from the use of financial measures outside of GAAP. This release states: “If accounting net income computed in conformity with [GAAP] is not an accurate reflection of economic performance for a company or an industry, it is not an appropriate solution to have each company independently decide what the best measure of its performance should be and present that figure to its shareholders as Truth.”

One of the objectives of the Sarbanes-Oxley Act of 2002 (SOX) was to “eliminate the manipulative or misleading use of non-GAAP financial measures and, at the same time, enhance the comparability associated with the use of that information.” Consequently, the SEC issued Regulation G, “Conditions for Use of Non-GAAP Financial Measures,” in January 2003. It requires companies using a non-GAAP measure to disclose that the measure isn’t misleading and ...