Non-GAAP measures - The role of the audit committee

• What is the purpose of the non-GAAP measure?
• Which competitors and peer companies use non-GAAP measures and how do they compare to those used by the company?
• What questions or feedback has management received from investors or analysts on a specific non-GAAP measure(s)?

• What procedures are in place to ensure the calculations are accurate and consistent with those of prior periods?
• Is the process covered by management’s internal control over financial reporting or other disclosure controls? If not, why not?
• Has the company considered having internal audit perform a review of the internal controls over the derivation of non-GAAP measures to determine whether the controls are effective?

• What is the company’s policy on what will give rise to a non-GAAP adjustment? How is materiality considered in this policy?
• What are the areas of judgment?
• How do non-GAAP measures impact management compensation?
• How does management’s disclosure committee focus on non-GAAP measures and consider their appropriateness?

• Are GAAP measures presented with equal or greater prominence?
• Is the disclosure descriptive and transparent or “boilerplate”?
• Has the company received an SEC comment letter focused on any non-GAAP matters?

• Can the measures potentially be considered misleading?
• Are prohibited measures excluded?
• Are adjustments to arrive at a non-GAAP measure labeled as non-recurring, infrequent, or unusual expected to recur in the next two years?

• Is additional disclosure necessary to ensure the metric is not materially misleading, including further information on any estimates or assumptions underlying the metric or its calculation?
• Are the reasons for any changes in the methodology of material KPIs appropriately disclosed?
• What disclosure controls and procedures are in place to ensure the completeness and accuracy of KPIs?

More companies now use non-GAAP measures, and the majority of the time, their non-GAAP results are better than those reported under GAAP. The last time the SEC updated its interpretive guidance by releasing additional Compliance & Disclosure Interpretations (C&DIs) was in May 2018. Since those C&DIs were released, the SEC has reiterated their views on non-GAAP.

The disclosure requirements vary based on the applicable regulation. Regardless of the source, all of the governing regulations share an overarching principle that non-GAAP information cannot be misleading. Companies may also be subject to express prohibitions depending on which regulation governs a particular non-GAAP disclosure.

The use of GAAP provides uniformity in how companies report their financial performance. But most S&P 500 companies choose to report non-GAAP metrics in addition to GAAP measures. If done appropriately, non-GAAP measures can provide insights into a company’s business, past performance, and its potential prospects.