Non-GAAP revenue driving comments from SEC’s Division of Corporation Finance
In remarks at a conference on May 5, SEC Deputy Chief Accountant Wes Bricker warned that presenting revenue on a basis other than Generally Accepted Accounting Principles − i.e., non-GAAP revenue − is likely to trigger a comment lettter from the SEC's Division of Corporation Finance. Although the SEC has permitted companies to provide non-GAAP information if such information is deemed by the company to be useful to investors and not misleading, the SEC has been particularly troubled by instances of "individually tailored" non-GAAP information that seems geared toward misleading investors.
An example provided by Bricker was a company that generated revenue from selling subscriptions and provided supplementary non-GAAP information on its revenue "as if" it had been for product sales (earned at point of sale and billing) vs. earned over the period during which the company fulfilled its contractual obligation to the customer.
"In this instance, the measure does not appear to help investors understand and analyze core operating results," Bricker said. "Rather, it is a replacement of an important accounting principle with an alternate accounting model that does not match the company's subscriptions business or earnings process, which is over time."
Bricker emphasized the reason behind the concern with non-GAAP revenue measures. "Revenue adjustments do more than just adjust from GAAP; they change the very starting point from which other performance analyses flow."
Referencing the new revenue recognition standard issued by the Financial Accounting Standards Board, Revenue from Contracts with Customers (Topic 606 in FASB's Accounting Standards Codification), Bricker said, "As the staff monitors current practices and implementation of the new revenue standard, we will be looking to see if the reporting concepts within those standards are supplanted by any number of company-specific non-GAAP alternatives.
"For all of these reasons, if you present adjusted revenue, you will likely get a comment," said Bricker, referring to the comment letters generated by the SEC's Division of Corporation of Finance if they have questions about annual (10-K), quarterly (10-Q) or other filings. "Moreover, you can expect the staff to look closely, and skeptically, at the explanation as to why the revenue adjustment is appropriate."
Future rulemaking possible
Noting that concerns about non-GAAP reporting had been voiced by SEC Chair Mary Jo White, Chief Accountant James Schnurr and Division of Corporation Finance Director Keith Higgins, Bricker summed up the SEC's core message on this subject as follows:
- First, preparers should consider how their disclosure controls and procedures apply to the disclosure of non-GAAP measures.
- Second, despite the fact that GAAP measures sometimes are forgotten once analysts and the press start commenting on a company’s results, investors should refer back to a company's financial statements so that the non-GAAP measures are put into the proper context.
- Third, audit committees should be paying close attention to the non-GAAP measures a company presents, including the required related disclosures, and the processes it follows to consider both the appropriateness and reliability of the measures.
"I also would note that Chair White has mentioned the possibility of future rulemaking in this area," said Bricker, referencing remarks of White at the U.S. Chamber of Commerce's Capital Markets Summit.
"If necessary," Bricker said, "the staff will consider potential recommendations to the Commission for rulemaking in this area, but I hope companies will seize this opportunity to review their practices and make any necessary changes."
Transition to new rev rec standard
With FASB's new standard on revenue recognition almost upon us in terms of its effective date, Bricker pointed out a number of issues that investors should focus on. As such, these points would be significant to preparers as well.
In attempting to understand how revenue recognition is changing, investors might want to consider some of the important building blocks of the model, such as the role and definition of a contract with a customer; identifying the portions of a contract that are important in the context of the standard (called performance obligations); understanding distinctions between transfers of control at a point in time or over a period of time; and the delineation between contract assets and accounts receivable. Investors will be better positioned to understand the reporting under the new guidance with a familiarity of these core reporting concepts.
- Does the company have an implementation plan for adopting the new standards? If so, how will the audit committee monitor the company’s progress of that implementation plan?
- What changes will be made to the company’s accounting policies due to adoption of the new standards, and what is the potential impact of those changes on financial results and trends?
- How will the standards affect the company’s corporate policies and practices, such as sales commissions, compensation plans, and contracting approaches?
- What are the income tax accounting implications of adopting the new standards?
"While this list is clearly not all-inclusive," said Bricker, "it underscores for management the importance of full and transparent communication with investors."
He also reminded preparers of the obligation to provide "SAB 74" disclosures of the estimated impact of accounting standard that have been issued but not yet adopted. "Investors should expect the level of disclosures to increase as companies make further progress in their implementation plans for adopting the new standards and, when necessary, engage with company management to understand these disclosures," added Bricker.
Other topics touched on by Bricker included FASB's upcoming final standard on credit loss impairment and a generally upbeat update on progress being made on various standard-setting issues by the PCAOB.
For details, see the full text of Bricker's remarks.