SEC Clamping Down on "Individually Tailored" Disclosures
Over some time, the SEC has been waging a battle with certain registrants over what is termed “individually tailored” accounting. These are disclosures of non-GAAP financial information that may be misleading. For example, in 2016, the SEC was critical of Tesla for adding back certain costs to revenue calculated under generally accepted accounting principles in its presentation of certain financial metrics.
The SEC has been concerned that companies may be using non-GAAP data to mislead investors. At an AICPA conference, SEC Chairman, Jay Clayton, stated, “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.”
Recently the SEC provided more clarity regarding what constitutes “individually tailored” accounting. Questions that should be considered include:
- Does the adjustment shift GAAP from an accrual basis of accounting to a cash or modified basis of accounting? (Example: using cash receipts or billings as a proxy for GAAP revenue)
- Does the adjustment add in transactions that are also reportable in the company’s financial statements?
- Does the adjustment reflect parts, but not all, of an accounting concept? (Example: adjusting income tax effects for cash paid but not for other components of income tax expense)
- Does the adjustment render the measure inconsistent with the economics of a transaction or an agreement? (Example: a lessor presenting income from sales-type or financing leases as if they were operating leases)
The SEC does not have a problem if non-GAAP data are presented that provide the user with a better understanding of the company. The problem arises when disclosures present the company in a more favorable light rather than more accurately.