United States: CAQ Issues New Roadmap For Audit Committees On Non-GAAP Measures

Last Updated: April 3 2018
Article by Cydney Posner

The Center for Audit Quality has issued a new guide for audit committees related to non-GAAP financial measures. Based on information gained from a series of roundtables held in 2017, Non-GAAP Measures: A Roadmap for Audit Committees identifies common themes and key considerations for audit committees, including leading practices to help assess whether a company's non-GAAP measures present "high-quality non-GAAP measures." And what exactly is a "high-quality non-GAAP measure"? According to the CAQ, a non-GAAP measure is high-quality if it provides a "balanced representation of the company's performance."

When presented appropriately, the roadmap concludes, non-GAAP measures can provide useful information, but that means that they must be "transparent, calculated consistently, and comparable to measures disclosed by other companies." The CAQ hopes that "enhancing audit committee oversight and involvement will lead to more transparency and consistency and that it will promote a greater understanding of all stakeholders' roles relative to non-GAAP measures."

The roundtables that provided the source material for the roadmap comprised approximately 20 to 25 participants each, including audit committee members, management, investors, securities lawyers and public company auditors, and each focused on specific industries.

While the non-GAAP measures used differed from industry to industry, the challenges were consistent across industries. In particular, the biggest challenge for investors was the lack of consistency among companies, which made comparisons tricky, even within the same industry. Also, apparently, the media are not always clear in their reporting on whether results are GAAP or non-GAAP. For management, the biggest challenges were determining what to include in or exclude from a measure and ensuring transparency regarding measures. The challenges identified for audit committees were understanding the reason for the measure, the roles and responsibilities of those involved and how the measure compares to peers. To the extent that non-GAAP measures may be used in determining incentive compensation, audit committee oversight becomes even more critical.

SideBar

In 2016, the CAQ released another tool, Questions on Non-GAAP Measures: A Tool for Audit Committees, that should still be of help to audit committees in addressing non-GAAP measures. Rather than provide a checklist, with this tool, the CAQ provides sample questions that audit committees should consider asking of management and external auditors regarding transparency, consistency and comparability of non-GAAP measures. The tool is designed to assist audit committees evaluate whether management is complying with the SEC rules and guidance regarding non-GAAP measures—particularly in light of the scrutiny by regulators of potentially abusive or misleading use of these measures — and whether non-GAAP measures are actually assisting analysts and investors in understanding the performance of the business. (See this PubCo post.)

The CAQ characterized the audit committee's oversight role as an important one that positions the committee to "act as a bridge between management and investors," assessing management's rationale and the adequacy of the related disclosure, as well as whether "the measures present a fair and balanced view of the company's performance." The roadmap reported that there was a "consensus among participants that audit committees can promote rigor related to non-GAAP measures by having a dialogue with company management as well as internal and external auditors."

Identify key discussion topics

The roadmap identified the following as useful topics for discussions with management and others:

  • "Putting itself in the investors' shoes when evaluating if the presented non-GAAP measures and related disclosures align with the company's overall strategy and performance.
  •  Engaging with investors directly or through investor relations to ensure that the presented non-GAAP measures aid investors' understanding of the company's performance.
  •  Asking management whether it has an internal policy that provides guidelines for determining how non-GAAP measures are generated, calculated, and presented, including the rationale for the measures and adjustments that it presents and excludes. If there is no policy, encourage management to create one.
  •  Discussing with management how the company makes changes to non-GAAP measures it presents, and the rationale for why it would or would not make changes.
  •  Seeking the perspective of counsel on non-GAAP measures.
  •  Asking the company to compare or benchmark its non-GAAP measures to those of its peers.
  •  Finding out what disclosure controls and procedures are in place as they relate to the information that is presented and disclosed.
  •  Asking the external auditors what their responsibilities are for non-GAAP measures, and whether that responsibility is different depending on where non-GAAP measures are presented.
  •  Asking the external auditors for perspectives on how non-GAAP measures that the company presents generally compare with those of other companies.
  •  Discussing with the external auditors what their views are on the company's non-GAAP measures, including whether the measures are consistent with the auditors' understanding and knowledge of the company's performance."

Understand the external auditor's role regarding non-GAAP measures

Although non-GAAP measures are not audited and are outside the external auditor's opinion, under professional auditing standards, when they are presented in certain documents containing the financial statements, the auditor is still supposed to read them and consider whether they are presented in a way that is "materially inconsistent with information appearing in the financial statements or a material misstatement of fact." As a result, the roadmap recommends that the committee leverage the auditors as a resource to provide the committee with perspective on the measures, including potentially even engaging them to perform non-audit procedures such as testing "controls related to the preparation and disclosure of non-GAAP measures in accordance with the company's policies, and reporting results to the audit committee."

SideBar

A working group of the PCAOB's Investor Advisory Group, commenting on the use of non-GAAP measures, has indicated that GAAP and non-GAAP measures can together provide a more comprehensive perspective on the business. Nevertheless, it was important that non-GAAP measures be verified: are they actually tied to the company's books and records? Do they really reflect how the company is run? How are they tied to the process for setting risk appetite? Are they used consistently at the company and across the industry? How are they used by outsiders? The group even recommended that non-GAAP measures should be audited. (See this PubCo post.)

Adopt leading practices

The following leading practices were identified at various roundtables and considered to promote the presentation of high-quality non-GAAP measures:

  •  Disclosure controls: Participants favored subjecting non-GAAP measures to robust disclosure controls to help mitigate risks, support sound decision-making about reporting and drive more consistency and transparency. The disclosure controls should be documented and tested.

SideBar

As discussed in this article in CFO.com, establishment of controls and procedures for non-GAAP measures is especially important because they are—by definition—not standard, and controls and procedures can help companies ensure appropriate disclosure and regulatory compliance. According to the article, these controls should focus on seven key areas:

  • Measures comply with SEC rules and guidance
  • Non-GAAP adjustments are consistent across periods, appropriate and not cherry-picked (e.g., adjusted not only for nonrecurring expenses, but also for nonrecurring gains) or otherwise misleading
  • Data used for inputs in non-GAAP measures are reliable and subject to appropriate controls
  • Calculations of non-GAAP measures are accurate and tie to the same measures as disclosed
  • Descriptions of non-GAAP measures, adjustments and other required disclosures are transparent and unambiguous
  • Non-GAAP measures and related disclosures are reviewed by management for appropriateness and completeness
  • Disclosure controls for non-GAAP measures are monitored by management with oversight from the audit committee

The author recommends that companies craft a written non-GAAP policy that "(1) clearly describes the nature of allowable adjustments to GAAP measures, (2) defines the non-GAAP measure(s) to be used under the policy, and (3) explains how potential changes in the inputs, calculations, and adjustments will be evaluated and approved. For example, a policy might describe qualitatively the types of adjustments that are non-recurring and unusual, and are thus within the defined policy. It might also outline specific quantitative thresholds for which income and/or expense items would be evaluated to determine whether they should be included in non-GAAP adjustments." (See this PubCo post.)

  •  Non-GAAP policies: Policies that provide a set of guidelines for preparing and presenting non-GAAP measures can promote consistency and help guide decisions on issues related to non-GAAP measures and the treatment of new transactions or events in the context of the company's non-GAAP measures.
  •  Audit committee disclosure: While the roadmap acknowledged that few, if any, companies disclose the substance of their non-GAAP policies, there was apparently a split of opinion on whether it would be good practice to disclose that the company even has a non-GAAP policy. The roadmap suggests that disclosure might have the benefit of demonstrating "to investors the importance of this information to the audit committee and that policies are in place to support the metrics being consistent, transparent, and comparable."

SideBar

At the 2017 PLI Securities Regulation Institute, panelists noted that the pendulum seemed to have swung back from the intense scrutiny of the past few years—at least in part because of conformance by companies to SEC staff criticism and guidance (see this PubCo post). However, although there is less focus now on non-GAAP measures, the staff continues to look at consistency and the quality of disclosure if changes are made. Panelists advised to have internal controls and policies behind non-GAAP measures. To the extent there are changes to a non-GAAP policy, audit committees should play a role. (See this PubCo post.)

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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