ACNT 2375 – 40 Pt Case Step 1: 15 pts Read the article and prepare a paper that provides: (1) A summary of the article: Use your own words. Do not use quotations from the article – use your words for...

ACNT 2375 – 40 Pt Case

Step 1: 15 pts

Read the article and prepare a paper that provides:

(1)    A summary of the article:  Use your own words.  Do not use quotations from the article – use your words for this summary.10 pts

(2)    Your meaningful comments on this issue. 5 pts (Clearly label your comments.  Be professional).  Avoid general statements such as ‘They just want to cheat. I fully agree.”) 5 pts

Step 2: 25 pts

From the article, select 3 items that were excluded in determining Non-GAAP EPS (items are discussed in the body of the article and in Table 1 of the article.  For each of these 3 items, find the GAAP.  DO NOT use the glossary or section 50 for this step.  For example, if you choose ‘Noncash interest expense on convertible debentures’. Find the GAAP (using the Codification) to locate current GAAP for this issue.

If there is pending GAAP, discuss this pending GAAP (including when it becomes effective).

The purpose of step 3 is to locate the current GAAP for the selected issues.  It is fine to cut and paste from the Codification.  Be sure to use the Printer Friendly feature at the bottom of the page.  This provides the full citation and proper formatting.  18 pts

For each of the 3 items, Include a

1. comment
   that shows how the exclusion of this issue would affect EPS (4 pts)
   


2. 
   discussion of how you located the GAAP in the ASC (3 pts)
   

ACNT 2375 – 40 Pt Case Step 1: 15 pts Read the article and prepare a paper that provides: (1) A summary of the article: Use your own words. Do not use quotations from the article – use your words for this summary.10 pts (2) Your meaningful comments on this issue. 5 pts (Clearly label your comments. Be professional). Avoid general statements such as ‘They just want to cheat. I fully agree.”) 5 pts Step 2: 25 pts From the article, select 3 items that were excluded in determining Non-GAAP EPS (items are discussed in the body of the article and in Table 1 of the article. For each of these 3 items, find the GAAP. DO NOT use the glossary or section 50 for this step. For example, if you choose ‘Noncash interest expense on convertible debentures’. Find the GAAP (using the Codification) to locate current GAAP for this issue. If there is pending GAAP, discuss this pending GAAP (including when it becomes effective). The purpose of step 3 is to locate the current GAAP for the selected issues. It is fine to cut and paste from the Codification. Be sure to use the Printer Friendly feature at the bottom of the page. This provides the full citation and proper formatting. 18 pts For each of the 3 items, Include a 1. comment that shows how the exclusion of this issue would affect EPS (4 pts) 2. discussion of how you located the GAAP in the ASC (3 pts) 3ethics.qxd The constant pressure to reportfavorable earnings performance motivates many companies to re- port income numbers that exclude unusual events that almost always seem to be costly and depress earn- ings. For many years, the use of fi- nancial performance measures other than Generally Accepted Ac- counting Principles (GAAP) has been an important subject to in- vestors and the Securities & Ex- change Commission (SEC). In 1973, the SEC issued Account- ing Series Release (ASR) No. 142, “Conditions for Use of Non-GAAP Financial Measures,” warning of possible investor confusion from the use of financial measures out- side of GAAP. This release states: “If accounting net income computed in conformity with [GAAP] is not an accurate reflection of economic performance for a company or an industry, it is not an appropriate so- lution to have each company inde- pendently decide what the best measure of its performance should be and present that figure to its shareholders as Truth.” One of the objectives of the Sarbanes-Oxley Act of 2002 (SOX) was to “eliminate the manipulative or misleading use of non-GAAP fi- nancial measures and, at the same time, enhance the comparability associated with the use of that in- formation.” Consequently, the SEC issued Regulation G, “Conditions for Use of Non-GAAP Financial Measures,” in January 2003. It re- quires companies using a non- GAAP measure to disclose that the measure isn’t misleading and to provide a reconciliation between their measure and the most di- rectly comparable GAAP measure. The GAAP presentation must have equal or greater prominence. Man- agement must disclose the reasons why the non-GAAP measure pro- vides useful information to in- vestors and offer a statement of additional purposes for which the non-GAAP measure is used. Only GAAP financial information can be presented directly on the face of a company’s financial statements, possibly to highlight the fact that the independent audit opinion doesn’t cover such information. Adjusting Earnings Aside from excluding unusual events for reporting to the public, another prominent use of non- GAAP earnings performance has been to determine executive com- pensation. Since the passage of the Revenue Reconciliation Act of 1993, executive salaries amounting to more than $1 million aren’t tax deductible, but bonus payments of any amount are deductible if they result from achieving established performance goals. A February 26, 2014, article in The Wall Street Journal, “Some Companies Alter the Bonus Playbook,” notes that more U.S. companies are using nonstandard accounting measures to compute bonus payments. For example, Exelon Corpora- tion used non-GAAP earnings to pump up executive bonuses signif- icantly. Its 2012 audited earnings per share (EPS), based on GAAP, were $1.42. To arrive at the pub- licly reported, adjusted non-GAAP operating EPS of $2.85, manage- ment made 10 separate adjust- ments that amounted to a net in- crease of $1.43 per share, a little more than 100%. Adjustments that increased non-GAAP EPS in- cluded plant retirements and di- vestitures ($0.29), merger and in- tegration costs ($0.31), State of Maryland commitments related to merger ($0.28), amortization of commodity contract intangibles ($0.93), and Federal Energy Regu- Curtis C. Verschoor, CMA, CPA, Editor ETHICS Is Non-GAAP Reporting Unethical?The use of non-GAAP financialmeasures is widespread and sometimes misleading. It can result in higher reported current earnings, forecasts of improved future results, and larger execu- tive compensation. 14 S T R AT E G IC F I N A N C E I Apr i l 2 014 latory Commission (FERC) settle- ment ($0.21). These adjustments increased EPS by $2.02. The adjustments that decreased Exelon’s non-GAAP EPS included mark-to-market impact of eco- nomic hedging activities ($0.38), unrealized gains related to nuclear decommissioning trust funds ($0.07), and reassessment of state deferred income taxes ($0.14). The total decrease amounted to $0.59. But the EPS used for bonus pur- poses was $2.91. In other words, Exelon added $0.06 arbitrarily. Perhaps the most outrageous use of a misleading non-GAAP earnings measure to improve prof- its was when Groupon, Inc. re- ported earnings in its initial public offering (IPO) in 2011. It invented a unique measure called “adjusted consolidated segment operating income (CSOI).” The biggest dif- ference from GAAP earnings was online marketing expenses. The rationale for omitting such seem- ingly normal and recurring ex- penses wasn’t clear in the registra- tion statement, despite the SEC’s rule requiring disclosure of the reason non-GAAP information is more informative to investors. A sample of online earnings press releases from 2013 shows the variety of ways that large and rec- ognizable public companies are describing the costs and expenses they have excluded from their GAAP earnings to arrive at im- proved non-GAAP performance (see Table 1). Some highlights in- clude Callaway Golf Company, which not only excluded charges related to cost-reduction initia- tives as well as gains and sales re- lated to sales of certain brands or products transitioned to a third- party model, but it also presented sales on a constant currency basis and calculated taxes at an assumed rate. Electronic Arts excluded acquisition-related expenses, amortization of debt discount, certain nonrecurring litigation ex- penses, change in deferred net rev- enue (e.g., packaged goods, digital content), loss (gain) on strategic investments, restructuring charges, stock-based compensation, and income tax adjustments. And Gannett Company excluded spe- cial items consisting of workforce restructuring charges, transforma- tion costs, pension settlement charges, a noncash impairment charge, a currency-related loss rec- ognized in other nonoperating items, and certain credits to its in- come tax provision. Gannett says it believes that such expenses and credits aren’t indicative of normal ongoing op- erations and thus reasons that their inclusion in results makes it more difficult to compare results between periods and with peer group companies. On the con- trary, there is likely to be less com- parability than if everyone used only GAAP, which is well known and understood, because compa- nies in Gannett’s peer group are likely to calculate their own non- GAAP measures in their own way. A Broken System Several conclusions seem obvious about the relevance and usability of the current financial reporting system. Even considering the im- precise nature of current account- ing standards, it’s too easy for companies to turn poor GAAP earnings into great non-GAAP earnings by simply designing their own performance measures that can readily be adjusted to unethi- cally report successful accomplish- ment of the goals created using those same measures. Conse- quently, non-GAAP earnings re- porting should be strictly limited and permitted only in extraordi- nary circumstances—that is, in cases where current GAAP doesn’t clearly reflect economic reality. Companies should have to demonstrate a real necessity and communicate meaningful, unique reasons why they believe using a non-GAAP measure is mandatory to avoid misleading investors and others, not just to portray better short-term profits, earn bigger bonuses, and cash in on stock options. The widespread use of non- GAAP performance measures seems to provide conclusive evi- dence that the current financial re- porting system is broken. Neither the SEC’s December 2013 “Report on Review of Disclosure Require- ments in Regulation S-K” nor the February 25, 2014, Financial Ac- counting Standards Board (FASB) news release, “Post Implementa- ETHICS 16 S T R AT E G IC F I N A N C E I Apr i l 2 014 For guidance in applying the IMA Statement of Ethical Professional Practice to your ethical dilemma, contact the IMA Ethics Helpline at (800) 245-1383 in the U.S. or Canada. In other countries, dial the AT&T USA Direct Access Number from www.usa.att.com/ traveler/index.jsp, then the above number. tion Review Concludes Fair Value Accounting Standard Meets Its Objectives,” addresses the need for basic reporting reform. The Public Company Account- ing Oversight Board (PCAOB) should reconsider Release No. 2012-004, which states, “The audi- tor’s responsibility with respect to information in a document does not extend beyond the financial information identified in his re- port, and the auditor has no oblig- ation to perform any procedures to corroborate other information contained in a document.” Perhaps the responsibility should extend further. Companies spend hun- dreds of millions of dollars each year to prepare GAAP-based fi- nancial statements and to have them audited. These large expen- ditures don’t seem to be worth it if more and more investors and oth- ers rely on less reliable non-GAAP disclosures instead, Tell us if you have any com- ments on this issue. SF Curtis C. Verschoor, CMA, CPA, is the Emeritus Ledger & Quill Re- search Professor, School of Accoun- tancy and MIS, and an honorary Senior Wicklander Research Fellow in the Institute for Business and Professional Ethics, both at DePaul University, Chicago. He is also a Research Scholar in the Center for Business Ethics at Bentley Univer - sity, Waltham, Mass. He was selected by Trust Across America-Trust Around the World as one of the Top Thought Leaders in Trustwor- thy Business–2014. John Wiley & Sons has published his latest book, Audit Committee Essentials. His e-mail address is [email protected] Apr i l 2 014 I S T R AT E G IC F I N A N C E 17 Table 1. Arriving at Non-GAAP EPS Company Items Excluded Analog Devices Items of a nonrecurring or noncash nature