The Next Great Controversey: Pro Forma Earnings

SEC prepares to crack down on growing corporate use of non-GAAP financials.

The Enron fiasco has clearly raised the awareness of creative accounting maneuvers such as off-balance-sheet financing and special purpose entities (SPEs). But the growing corporate reliance on pro forma earnings may well be the next accounting issue to blossom into a full-fledged controversy.

In fact, just before the entire Enron scandal bubbled to the current frenzy, SEC commissioner Harvey Pitt seemed determined to get to the bottom of the pro forma problem. In October, just three months after taking office, Pitt ripped the growing practice of issuing pro forma results. At the time, he also called for a revamping of the financial reporting system. And as CFO.com reported last week, the SEC on Wednesday issued it’s first pro forma cease and desist order. The recipient? None other than Donald Trump, CEO of Trump Hotels & Casino Resorts.

But Chairman Pitt may have his hands full tackling the pro forma issue. In an exclusive CFO.com/KPMG survey released in November, 82 percent of 196 finance managers said their companies report some kind of non-GAAP (that is, pro forma) earnings in press releases.

And now comes further proof that pro forma results are real popular among the numeric keypad set. According to a recent survey conducted by the National Investor Relations Institute (NIRI), 133 of the 233 companies sampled, or 57 percent, reported pro forma information with prominence (or at least equal importance to GAAP measures if GAAP results were shown). Of the 133 companies reporting pro forma results, only four did not include GAAP earnings per share results.

What’s more, the bigger the company, the more likely they are to have used pro forma results. Among publicly traded corporations with a market capitalization exceeding $5 billion, more than 75 percent said they use this non-GAAP reporting method. Nearly 80 percent of the respondents at companies with market caps between $1.5 billion and $5 billion said they use pro forma results. Only around 50 percent of companies with a market value of less than $500 million said they use pro forma results.

Put another way, of the 90 companies surveyed with market caps greater than $1.5 billion, 78 percent reported the most recent quarterly results using pro forma measures; 22 percent did not.

If you measure by sales, the pattern is the same. The larger the turnover, the more likely a company issued pro forma measures. Of the 23 companies with sales exceeding $2 billion, 74 percent reported pro forma results. But, only 51 percent of the companies with sales less than $100 million reported pro forma measures.

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