SEC Chairman Jay Clayton and Chief Accountant Wes Bricker urged CPAs on Monday to deliver consistency in the non-GAAP information they report to investors.
"There has to be a similar consistency in the reporting of non-GAAP numbers and key performance indicators (KPIs) as we expect in GAAP numbers," Clayton said at the AICPA Conference on SEC and PCAOB Developments. "A point of investor frustration that we can be cognizant of is when non-GAAP numbers and KPIs move around in terms of how they are calculated."
The SEC has made non-GAAP measures a significant area of its focus in the past few years out of concern that companies were using non-GAAP data to mislead investors.
Investors can benefit from non-GAAP presentation when it provides information that leads them to a better understanding of the company. But non-GAAP reporting can become a problem if numbers are presented merely to present the company more favorably rather than more accurately.
In April, the SEC updated its Compliance and Disclosure Interpretations related to non-GAAP measures in an effort to educate companies on the SEC's requirements. Bricker said companies need to be thoughtful about developing tailored policies that reinforce the quality of non-GAAP reporting and the quality of their KPIs. He said a good balance of controls is needed to reinforce the integrity of the non-GAAP measures so that the information presented is complete, accurate, and consistent with how management understands the business.
"I consistently hear from investors that they don't want less information, but they certainly want quality to be built into that information," Bricker said.
Clayton acknowledged that there are times when perspectives evolve or mistakes happen, and changes in presentation become necessary. But he said the presentation needs to reflect how management actually operates and views the business, and Bricker said communication is important when presentations change.
"Company policies would do well to deal with situations where there's been a change in a presentation policy and how that would be communicated to investors, or a situation where a company identifies a mistake in a prior presentation, and how they'll correct that moving forward," Bricker said.
Mark Kronforst, a partner at EY and former chief accountant of the SEC's Division of Corporation Finance, said that the commission's recent focus on non-GAAP enforcement has improved compliance and disclosure. But he said non-GAAP measures always will be highly scrutinized by the SEC because investors are so interested in them.
Kronforst said a lot of companies now are struggling with the concept of an "individually tailored" accounting principle. An item that was added to the Compliance and Disclosure Interpretations in 2016 states that non-GAAP measures that substitute individually tailored revenue recognition and measurement methods for those of GAAP could violate SEC rules. Rules also may be violated by non-GAAP measures that use individually tailored recognition and measurement methods for financial statement line items other than revenue.
Kronforst said individually tailored accounting principles have not been clearly defined.
"I think exclusions that most companies may use are generally OK," he said. "When you start to recognize things differently or do partial exclusions or things like that where it's not as simple, that's where trouble can come. It's not quite defined yet. But I think it is still a fairly new concept. I know over the next couple of years … we'll have a much better idea of what an individually tailored accounting principle is and how to avoid one."
Cicely LaMothe, an associate director in the SEC's Division of Corporation Finance, said companies have to be careful not to make adjustments that are misleading to users of financial statements.
"When we talk about individually tailored accounting principle, these are the things that do go beyond the simple addition or subtraction of a particular line item in the financial statements," she said. "That's when you're starting to adjust that particular line item for timing differences, acceleration in measurement, differences that take it to a different level."
Human element remains important
Clayton and Bricker also addressed the integration of technology into financial reporting and auditing processes that has occurred in recent years. Bricker said technology enables good reporting and auditing but also can be an obstacle to advancement if it's not used and overseen properly.
He said that for innovation to be successful, the people who work with technology must understand what it is designed to do, its capabilities, its limitations, and the risks associated with it.
"In other words, having good professional judgment, good professional skepticism, good communication for all of those who are involved in the financial reporting process is critical," Bricker said. "So it's a balancing of an innovation-, technology-driven mindset, but also not missing the human element, the human intelligence element of financial reporting and auditing."
Clayton said the emergence of technology has not led to any decrease in the importance of human oversight of financial reporting and auditing processes.
"The systems around the world [are not] the same," he said. "The human analysis and view of that is essential. I defy someone to develop a technological system that synthesizes those differences and enables you to deal with them in one fell swoop."
Detailed Brexit disclosures encouraged
As U.K. Prime Minister Theresa May called off a vote on the country's plan for leaving the European Union, Clayton called on companies to provide detailed disclosures on Brexit's effects on their business.
He said some companies have provided granular details about how Brexit might affect their supply chain, investments, and other factors. Others have provided more general information about Brexit's impact on their business.
Clayton views the potential adverse effects of Brexit as poorly understood and underestimated. He said companies directly affected by Brexit are going "risk-off."
"When you go 'risk-off,' you hire fewer people, you invest less in plant, property, and equipment, and that can have a ripple effect," Clayton said.
Bricker said accountants have a key role in helping companies and their investors understand Brexit's potential effects because they understand business processes and how business is integrated across the globe.
"So finding your way to the table in those conversations, if you're not already there, is important so that the financial reporting indications, of which there are many, are brought to bear," he said.
— Ken Tysiac (Kenneth.Tysiac@aicpa-cima.com) is the JofA's editorial director.
