Downturns are accounting crooks’ worst enemy

Downturns are accounting crooks’ worst enemy(economist.com)

98 points by lactobacillis 6 years ago | 36 comments

nknealk 6 years ago |

For those who have never read a 10K in their life, the SEC requires all companies who publish non-GAAP metrics to also (1) publish GAAP metrics more prominently than non-GAAP metrics and (2) publish a reconciliation on how they arrived at their non-GAAP measure from the published GAAP metrics.

Here’s a writeup of the SEC rules on non-GAAP metrics in earnings reports: https://www.protiviti.com/US-en/insights/sec-issues-guidance...

There’s a difference between what Enron did (ie. fraud) vs presenting alternative ways to measure business performance. If an investor thinks community adjusted EBITDA is a good metric to judge a business and then loses all their money, that’s on the investor. Even our most recent poster child of non-GAAP shenanigans publishes the GAAP numbers ahead of the non-GAAP measures (see eg. Page 111 which is the first mention of “adjusted EBITDA” presented below GAAP metrics vs page 21 on which the GAAP income statement is first published): https://www.sec.gov/Archives/edgar/data/1533523/000119312519...

Havoc 6 years ago |

Worth pointing out that this is largely a US only problem. Rest of the world uses IFRS which clamped down on that non-GAAP adjustment stuff pretty hard because well it’s not exactly a subtle gambit

CapriciousCptl 6 years ago | |

I think non-GAAP adjustments were mostly used in the article as a rough marker of "crookedness" that you can measure. Because by far, worldwide, the primary means of fraud involves revenue recognition and other accounting shenanigans (very much recommend the book by the same name) that both IFRS and GAAP are vulnerable to. It's just that's much harder to find that stuff out. But, when the SEC notices a problem with your revenue recognition policies affecting your revenue by a few percent, the SEC comes down on you hard. KHC was an example of that last year or maybe 2 years ago with the new rules in ASC606.

It was news to me that IFRS cracked down on non-GAAP adjustments, particularly because I follow some foreign filers in the US and haven't noticed much of a difference. But then again, I don't follow a lot of companies with the type of management that harps on EBITDA and adjusted EBITDA anyway. According to Charlie Munger, "I think you would understand any presentation using the word EBITDA, if every time you saw that word you just substituted the phrase, “bullshit earnings.”

Havoc 6 years ago | | |

Agreed regarding revenue being the bigger issue.

>It was news to me that IFRS cracked down on non-GAAP adjustments

It's mostly achieved by prohibiting adjustment for "extraordinary items". That stops 90% of this bullshit right there. I gather US GAAP has done the same but kept the concept of non-recurring items.

Whether presenting "Alternative Performance Measures" is allowed at all depends on the country specific regulator. Where they are it's generally in addition to the IFRS measures and if you look at ESMA (EU regulator) they require a reconciliation and various other stuff about fair presentation thereof:

https://www.esma.europa.eu/file/1689/download?token=VQsQ7JzC

clairity 6 years ago | | |

the conclusion that EBITDA == “bullshit earnings” is overblown, or a feint at worst.

EBITDA lets you look at the operational performance of a business in isolation. that is, before financial considerations, where lots of little levers like tax shifting & accelerated depreciation can cook the numbers too.

if you're skeptical about one number on an income statement, you might as well be skeptical of them all (and for most public businesses, you should be skeptical).

edit: should note that "adjusted" anything on a financial statement should tingle the spidey senses.

lotsofpulp 6 years ago | |

US governments at all levels love to use GAAP since it lets them use whatever assumptions they want to make up liability numbers for defined benefit pension and retiree healthcare benefits. In fact, the US itself forced non taxpayer funded employers to use strict standards when calculating defined benefit pension liabilities (PPA 2006), but exempted taxpayer funded pension plans from any rules.

This lets current politicians and current and near future recipients of defined benefit pensions to transfer the costs to future future taxpayers.

perl4ever 6 years ago | | |

It is true that governmental accounting standards are different from private sector ones. I believe the GASB promulgates the former; the FASB the latter.

So everybody uses "GAAP" but it's not the same standards nor "whatever assumptions they want". If they used anything else, it would still be "GAAP", too.

christophilus 6 years ago | |

Buffett makes non-GAAP adjustments available because GAAP misses important nuances. Also, in the US, security appreciation and depreciation is now reported as earnings (or something ridiculous like that), so it’s pretty important to be able to explain real earnings to your shareholders.

naveen99 6 years ago | |

Is there an official list of assumptions used in GAAP? According to the wikipedia, GAAP is just a bunch of very high level principles, such as be honest, consistent, give your best estimate of your finances... But it doesn't seem to prescribe any particular rules to use, just that you use them consistently. And then, what does that mean about non-GAAP ? Does non-GAAP basically allow you to be inconsistent and dishonest or use less than your best guess ?

Edit: I found a little more detail under revenue recognition page on wikipedia : https://en.wikipedia.org/wiki/Revenue_recognition

Havoc 6 years ago | | |

GAAP just means the local accounting standard. So US GAAP for the USA. UK GAAP mean FRS102 etc.

Non-GAAP essentially means the company decided it's extra special and the standard accounting doesn't capture it's uniqueness. Sometimes that's true but most of the time it's executive not liking what the GAAP number tells them.

A good example is WeWork's "Community Adjusted EBITDA".

perl4ever 6 years ago | | |

See: FASB, GASB

jmaa 6 years ago | |

Thanks. It is easy to forget how much reporting is specifically about the US, and that a lot of the rest of the world doesn't really have the same problems.

Tehdasi 6 years ago |

The Bezzle, which I think has been on a HN post before: https://klementoninvesting.substack.com/p/the-bezzle

thih9 6 years ago |

Sadly I can’t read it (mobile safari, private mode), I’m being asked to create an account.

Rexxar 6 years ago | |

On firefox you can just switch to reader mode and reload the page.

_Microft 6 years ago | | |

If Firefox does not offer reader mode by itself, prepend about:reader?url= to the url to force loading the page in reader mode by the way.

gandalfian 6 years ago | |

https://outline.com/FPGgpv

netsharc 6 years ago | | |

Is that the 2nd page? It doesn't start with the story about Madoff like in the original.

3xblah 6 years ago | |

Disable Javascript.

neonate 6 years ago |

https://archive.md/xEhMd

tick_tock_tick 6 years ago |

What a horrible article most investors understand Chinese companies lie about their number all the time. The non Chinese example is WeWork which was completely rejected by the market and failed to go public?

gandalfian 6 years ago | |

And Enron, Olympus, bt, WorldCom, Tesco, those people who bought dragon dictate and the African firm whose balance sheet was entirely supported by a large green gemstone. Just to name a few off the top of my head. Trying to work out a firm's true assets, liabilities and income is a genuine problem.

thesz 6 years ago | | |

By referring to large green gemstone, do you refer to The Hot Rock novel main plot goal? If so, it is unbelievably appropriate.

neximo64 6 years ago | | |

What’s this gemstone company?

surfmike 6 years ago | |

And was rejected before the current crises.

grey-area 6 years ago | | |

This downturn started last year.

IAmEveryone 6 years ago | |

Yes, the S&P500, that very Chinese index...

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