Dispelling EBITDAC rumors
- July 27, 2020
- Posted by: Hood & Strong
- Category: FASB
Stakeholders have long been concerned about financial metrics that don’t comply with U.S. Generally Accepted Accounting Principles (GAAP). But a new non-GAAP figure — earnings before interest, taxes, depreciation, amortization, and coronavirus (EBITDAC) — has resurrected the debate over whether companies should be allowed to use these unaudited metrics. Here are some of the pros and cons of using non-GAAP metrics, as well as why EBITDAC isn’t expected to become a widespread financial reporting trend in 2020.
GAAP vs. non-GAAP
U.S. GAAP is a set of rules and procedures, created by the Financial Accounting Standards Board (FASB), that accountants typically follow to record business transactions. These guidelines provide the foundation for consistent, fair, honest and accurate financial reporting. Private companies generally aren’t required to follow GAAP, but many do. Public companies don’t have a choice; they’re required to follow GAAP.
In recent years, the use of non-GAAP measures — such as earnings before interest, taxes, depreciation and amortization (EBITDA) — has grown. These figures can provide added insight when they’re used to supplement GAAP performance measures. In fact, some public companies claim that non-GAAP measures provide a better reflection of how they manage their business than traditional GAAP metrics do. And investors may find them useful in getting management’s perspective on the company’s operations.
However, these metrics aren’t calculated consistently or audited. Moreover, when companies use non-GAAP figures during quarterly earnings calls and in press releases to present a better financial picture to investors, it may lead to a temporary boost in stock prices.
“We are concerned that corporations are selectively reporting one-time and recurring items as non-GAAP financial measures that may make ‘core’ operations look more favorable and not disclosing one-time adjustments that would make ‘core’ operations look worse,” explained Tony Sondhi, a member of the FASB’s Emerging Issues Task Force (EITF).
Now stakeholders are expressing concerns about the potential use of EBITDAC in 2020 financial reporting. The EBITDAC phenomenon seems to have started with a German applied measuring technology company, Schenck Process LLC. It reportedly added back 5.4 million euros to its earnings, the amount the company would have made if not for business disruptions caused by the COVID-19 pandemic.
If companies use EBITDAC to include speculative earnings, stakeholders fear that it will take non-GAAP metric to the next level of sketchiness. The crisis is affecting companies in multiple ways, making it different than other unusual or nonrecurring items.
For example, COVID-19 might have impacted lost sales because of reduced customer traffic. Companies may have also experienced disruptions on supply chain or have had more expenses to try to protect their workers. EBITDAC would potentially be misleading because it’s based on speculative estimates and projections that may be subject to manipulation.
Though a few European and Australian companies have been reporting EBITDAC, the metric isn’t expected to become popular in the United States. One analyst quipped that there are more EBITDAC coffee mugs for sale than there are such adjusted numbers in quarterly earnings releases.
There’s one notable exception: Companies that report impairment losses for acquired goodwill and other intangibles may decide to adjust 2020 EBITDA figures for the nonrecurring impairment loss incurred during the pandemic. However, such adjustments would reflect just one component of the COVID-19 loss, not the full impact.
The Securities and Exchange Commission (SEC) has regulations that govern the use of non-GAAP metrics by public companies. In late March, SEC staff warned companies against using adjusted metrics just to inflate their numbers during a pandemic. Moreover, Matthew Jacques, chief accountant of the SEC’s Division of Enforcement, warned companies not to take advantage of COVID-19 and present misleading numbers.
“We expect companies will be using more non-GAAP metrics during this time to compensate for some of the weaknesses potentially [in] how they are doing their financial reporting overall,” said Jacques during a May 12 forum. “GAAP is always the foundation; we much prefer if they reconcile back to that. But we are going to be on the lookout for people abusing those non-GAAP metrics representing in a way that is not transparent to investors.”