IPOs and Non-GAAP Measures for Financial Reporting
February 24, 2015
By Marc Fogarty, CPA, CFE
Eighteen percent of U.S. IPOs last year showed profits using their own accounting methods (as disclosed under the Non-GAAP Measures heading in their IPO filings); but reported losses when they had used traditional standardized (GAAP) accounting rules. The concern is that using differing accounting measures could confuse or mislead investors. While the companies using non-GAAP measures believe they are providing better transparency, the SEC is asking some to revise their regulatory filings.
An example of how traditional and non-traditional accounting methods differ can be exemplified by how expense items are reported. A company using a nonstandard accounting measure might remove expense items such as acquisitions and executive bonuses, which would not be excluded if standard accounting methods were used. Some companies have defended this by saying that a one-time expense should not be factored into possible future earnings. Their theory is that if a company has a "one-time" high-ticket expense, it would be more misleading to investors if they include it, since it would not be included as an expense against future earnings. In other words, using non-GAAP reporting measures might be an opportunity to highlight certain facts and downplay others to investors, which could make the company heading into an IPO appear more attractive on paper.
The danger is that companies tend to have several yearly “one-time” events. For example, this year a company could have a one-time severance cost, and next year they shut down a plant. In the third year, they have a costly hurricane event. These are all considered "one-time" events; but if they are excluded from the company's expense reporting, then the public's understanding of the company's true profitability may be distorted.
To avoid issues with regulatory filing, a company including earnings using non-GAAP measures should also prominently disclose their earnings under GAAP (aside from what is already reported in the core financial statements). Additionally, there should always be consistency in the way non-GAAP measures are used, both before and after an IPO.