The Non-GAAP Roadmap for Audit Committees

Here's a welcome development: Securities regulators have acknowledged recent improvements in how companies are presenting financial measures that do not conform to U.S. Generally Accepted Accounting Principles (GAAP).

That good news, however, doesn’t foretell an end to the long-running issue of non-GAAP measures. Those same regulators have also signaled that they expect continued improvements.

So what's the way forward on non-GAAP measures? That question was at the heart of a series of 2017 roundtables hosted by the Center for Audit Quality (CAQ) on the presentation and use of non-GAAP measures. The events brought together audit committee members, management, investors, securities lawyers, and public company auditors.

As captured in a new report from the Center for Audit Quality (CAQ), one overarching takeaway from these discussions was that the audit committee can play a key role when it comes to non-GAAP measures. To help audit committees with that role, the report offers a "roadmap" with three central components: (1) identify key discussion topics, (2) understand the role of the external auditor regarding non-GAAP measures, (3) and adopt leading practices.

1. Identify Key Discussion Topics

For non-GAAP measures to be useful, they must present a balanced representation of the company’s performance. Discussions between management and the audit committee could result in the audit committee having confidence that the non-GAAP measures achieve that balance.

For the audit committee, many ingredients should go into these discussions, including the following.

• 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.

2. Understand the External Auditor’s Role in Non-GAAP

External auditors may be able to serve as a resource for audit committees on non-GAAP measures, although the starting point must be having clarity around the auditor's role in this area.

In a nutshell, that role is the following: The external auditor’s opinions on the company’s financial statements and, when required, the effectiveness of the company’s internal control over financial reporting (ICFR) do not cover non-GAAP measures. Professional auditing standards indicate that the auditor should read non-GAAP measures presented in documents containing the financial statements (such as annual and quarterly reports) and consider whether non-GAAP measures or the manner of their presentation is materially inconsistent with information appearing in the financial statements or a material misstatement of fact.

Though external auditors do not audit non-GAAP measures as part of the financial statement or ICFR audits, audit committees and management may consider leveraging the external auditors as a resource when evaluating non-GAAP measures. Separate from the financial statement and ICFR audits, external auditors may be engaged to perform certain procedures related to non-GAAP measures. Although the procedures the external auditor can perform for non-GAAP measures are limited, they could include testing certain 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. External auditors may be able to address audit committees’ concerns related to non- GAAP measures and to increase the trust and confidence in those measures.

 Here are three points that audit committees may consider discussing with their auditors on non-GAAP measures.

• 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.

3. Adopt Leading Practices

Finally, if they're not doing so already, audit committees should take note of leading practices that support the presentation of high quality non-GAAP measures.

• Disclosure controls: Establishing disclosure controls specific to non-GAAP measures could enable companies to mitigate risks and support sound decision making about their reporting. The disclosure controls should be documented and robust enough to facilitate testing of the controls.
• Non-GAAP policies: Management representatives shared that they have established policies that provide a set of guidelines to follow when preparing and presenting non-GAAP measures. These policies can help in making decisions on the treatment of new transactions or events within non-GAAP measures that the company presents. Also, having policies in place can help promote consistency in the measures that are presented and the way they are calculated.
• Audit committee disclosure: Few, if any, companies publicly disclose their non-GAAP policies. However, given the current regulatory environment and the fact that non-GAAP measures are important to investors and are central to their decision making, there could be benefits to an audit committee voluntarily disclosing that the company has non-GAAP policies (but not necessarily the relevant details of those policies). Such disclosure could demonstrate 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.

For more on the roadmap and the CAQ's roundtables, read the full report, which is available at the CAQ website. And don't miss the report's companion video, which provides additional context and real-life examples of how audit committees are thinking about non-GAAP measures.

A securities lawyer, Cindy Fornelli has served as the Executive Director of the Center for Audit Quality since its establishment in 2007.