GAAP GAP

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GAAP GAP

turteltaub-adam-200x200-150x150By Adam Turteltaub
adam.turteltaub@corporatecompliance.org

My parents have a vacation home, and near it is a restaurant, now closed, sadly, that offered great family-style dining accompanied by hot scones with honey butter.  These scones were amazing.  Even after a dinner of steak and all the fixings, everyone agreed the scones and honey butter were the best part of the meal.

When my cousin Ben came to visit for the first time, we took him to the restaurant and eagerly awaited his verdict on these delicious treats.  He put some honey butter on his scone, took a bite, and then said, “So if we call them hot scones with honey butter we’re allowed to eat donuts with our dinner?”

We all looked at each other, at our scones, at Ben again and realized he was right.  We basically were eating hockey puck-shaped donuts and adding our own glazing.  And, when we told friends what Ben had said, they all realized that they had been fooled, too.

Calling one thing something else is a bit of a sin in the world of donuts and scones, but it’s a small deception, and not a mal-intended one I’m sure.

But in the world of business finance and accounting, such gamesmanship is discouraged, at least officially.  The Generally Accepted Accounting Principles (GAAP) are there to help investors, lenders and others get a clear picture of the finances of an organization.  They are there to make sure an expense is treated as an expense and not, say, an investment.

The problem, as the Wall Street Journal recently reported, is that the GAAP rules are turning out to be far less generally accepted than we might believe.  Just 25 companies in the S&P 500 closed their books last year exclusively using the GAAP standards.  That’s down from about 125 in 2006.

Defenders of supplemental non-GAAP reporting state that it’s designed to give a clearer picture of what’s going on.  In some industries, non-GAAP measures fill in blanks that GAAP misses.  In other cases they tend to better reflect, defenders argue, the impact of currency swings and one-time events.

But, critics point out that that they can also give a distorted picture.  Their argument is supported by research conducted by Calcbench Inc., a financial data provider, which found that adjusted or customized figures inflate income by 44% on average in profitable companies.

So, why should we in compliance care?  We’re not going to change the accounting practices, although the Wall Street Journal reports the SEC might.  The Journal reported:  “In May, the agency issued new guidance on using and publicizing non-GAAP measures and signaled it may issue new rules to curtail the practice.”

I think we should care because at least some employees likely notice that the company is making its own rules.  In saying, “well, that accounting principle really apply to us because this special thing happened” a message may be communicated that rules aren’t really rules.  That if you can find a reason to do something different, that’s okay.  That if there’s a case to be made that this is an exceptional situation it’s okay to say so and do something that deviates from the standard.

That can be dangerous.  When an organization deviates from the GAAP rules it is supposed to disclose it, and it appears that most, if not all, do.

But to the individual investor walking down the street, or to the employee walking the factory floor, it may well be surprising to learn about.  And it may erode trust, especially by employees, that when the company says that they should follow the rules, it really means it.

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1 COMMENT

  1. Adam, your assessment is on the spot. The problem is that the companies that do “creative accounting” usually have highly paid attorneys and large accounting firms on-call who will agree with the company’s assessment that they are following GAAP, or that their circumstance is outside of GAAP rules, and therefore open to interpretation. Usually this is to the company’s interpretive advantage and explained in such a confusing way that investors may think this is an acceptable method. After all, it helps the bottom line.

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