Fantasy Math Is
Helping Companies Spin Losses Into Profits
Major public companies are reporting
results that are not based on generally accepted accounting principles, or
GAAP. Credit Getty
Companies, if granted the leeway, will surely present their financial
results in the best possible light. And of course they will try to
persuade investors that the calculations they prefer, in which certain
costs are excluded, best represent the reality in their operations.
accentuating the positive, accounting-style.
surprising, though, is how willing regulators have been to allow the
proliferation of phony-baloney financial reports and how keenly investors have
embraced them. As a result, major public companies reporting results that are
not based on generally accepted accounting principles, or GAAP, has grown from a
modest problem into a mammoth one.
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According to a recent study in
The Analyst’s Accounting Observer,
90 percent of companies in the Standard & Poor’s 500-stock index
reported non-GAAP results last year, up from 72 percent in 2009.
still require corporations to report their financial results under accounting
rules. But companies often steer investors instead to massaged calculations that
produce a better outcome.
I know, I know —
eyes glaze over when the subject is accounting. But the gulf between reality and
make-believe in these companies’ operations is so wide that it raises critical
questions about whether investors truly understand the businesses they own.
companies that were in existence both last year and in 2009, the study showed,
non-GAAP net income was up 6.6 percent in 2015 compared with the previous year.
accepted accounting principles, net income at the same 380 companies in 2015
actually declined almost 11 percent from 2014.
fact: Thirty companies in the study generated losses under accounting rules in
2015 but magically produced profits when they did the math their own way. Most
were in the energy sector, which has been devastated by plummeting oil prices,
but health care companies and information technology businesses were also in
How can a
company turn losses into profits? By excluding some of its costs of doing
business. Among the more common expenses that companies remove from their
calculations are restructuring and acquisition costs, stock-based compensation
and write-downs of impaired assets.
abounds in today’s freewheeling accounting world. And the study found that
almost 10 percent of the companies in the S.&P. 500 that used made-up figures
took out expenses that fell into a category known as “other.” These include
expenses for a data breach (Home Depot), dividends on preferred stock (Frontier
Communications) and severance (H&R Block).
But these are
actual costs, notes Jack T. Ciesielski, publisher of The Analyst’s Accounting
Observer. “Selectively ignoring facts can lead to investor carelessness in
evaluating a company’s performance and lead to sloppy investment decisions,” he
wrote. More important, he added, when investors ignore costs related to
acquisitions or stock-based compensation, they are “giving managers a free pass
on their effectiveness in managing all shareholder resources.”
It puzzles some
accounting experts that the
Securities and Exchange Commission has not
been more aggressive about reining in this practice.
Lynn E. Turner
was the chief accountant of the S.E.C. during the late 1990s, a period when pro
forma figures really started to bloom. New rules were put in place to combat the
practice, he said in an interview, but the agency isn’t enforcing them.
For example, Mr.
Turner said, some companies appear to be violating the
requirement that they present their non-GAAP
numbers no more prominently in their filings than figures that follow accounting
“They just need
to go do an enforcement case,” Mr. Turner said of the S.E.C. “They are almost
creating a culture where it’s better to beg forgiveness than to ask for
permission, and that’s always really bad.”
As it happens,
the commission is in the midst of
reviewing its corporate disclosure
requirements and considering ways to improve its rules “for the benefit of both
companies and investors.”
This would seem
to be a great opportunity to tackle the problem of fake figures. But such work
does not appear to rank high on the S.E.C.’s agenda.
Kara M. Stein,
an S.E.C. commissioner, expressed concern about this in a public
statement on April 13. Among the questions
the S.E.C. was not asking, she said: “Should there be changes to our rules to
address abuses in the presentation of supplemental non-GAAP disclosure, which
may be misleading to investors?”
presidential election looming, Mr. Ciesielski said it was unlikely that any
meaningful rule changes on these types of disclosures would emerge anytime soon.
That means investors will remain in the dark when companies don’t disclose the
specifics on what they are deducting from their earnings or cash flow
restructuring costs, the most common expense excluded by companies from their
companies say, ‘This is a restructuring program that is going to take us four
years to complete, and here are the numbers,’” Mr. Ciesielski said in an
interview. “Restructuring programs cost cash. Why not face up to it and be real
about what you’re forecasting? If everybody did that consistently, that would be
a dose of reality.”
Mr. Turner, the
former S.E.C. chief accountant, agreed. What investors need, he said, is a
clearer picture of all items — both costs and revenues — that companies consider
unusual or nonrecurring in their operations. These details should appear in a
footnote to the financial statements, he said.
“We need to
require the disclosure of both the good and the bad,” Mr. Turner said. “If you
have a large nonrecurring revenue item, you need to disclose that as well as a
nonrecurring expense. Then you should require auditors to have some audit
liability for these items.”
Of course, some
of the fantasy figures highlighted by companies are worse than others. Excluding
the impairment of an asset, Mr. Ciesielski said, is “not the worst crime being
committed. But when you’re backing out litigation expenses that go on every
quarter, that’s a low-quality kind of adjustment, and those are pretty
The bottom line
for investors, according to Mr. Ciesielski and Mr. Turner, is to ignore the
allure of the make-believe. Real-world numbers may be less heartening, but they
are also less likely to generate those ugly surprises that can come from
accentuating the positive.
A version of this article appears in print on April 24, 2016, on page
BU1 of the New York edition with the headline: Fantasy Math Spins
Losses Into Profits.
© 2016 The
New York Times Company