1. Consider the costs/harms and benefits of disclosing non-GAAP financial numbers. What value, if any, do you see in the use of non-GAAP metrics?

2. What responsibilities do auditors currently have related to the use of non-GAAP measures by their attest clients? What responsibilities do you think they should have? Be specific.

3. Do you believe that GE is attempting to manage earnings by disclosing five different non-GAAP measures? Explain.

4. If you were a financial analyst looking at GE’s metrics in Exhibit 1, what questions would you ask and why?

According to an October 16, 2017, article by Richard Clough of Bloomberg News,1 General Electric reported earnings per share of $.28, $.13, $.19 and $.15 for the quarter ending September 30, 2017, on an earnings call. Yes, you read that correctly, GE reported four different earnings per share figures for the same quarter. The numbers represent profit that includes or excludes certain items, such as pension costs and discontinued operations. For example, GE referred to one of these measures as ‘industrial operating plus verticals earnings per share’ rather than simply ‘adjusted,’ ‘core,’ or ‘non-GAAP earnings per share’ as is common place at most companies.2 GE is not alone in the use of both GAAP and non-GAAP metrics they include in their financial reporting. However, according to Bloomberg, GE is only one of 21 S&P 500 companies to use more than one earnings per share figure.
Fast forward to the fourth quarter of 2017 and the fiscal year 2017, and we see a different picture in the MD&A. These results are presented in Exhibit 1 below. Notice there are five measures of GAAP and five non-GAAP metrics. The numbers have declined from the third quarter in large part due to insurance adjustments. Beyond that, the descriptions do not seem to match up. To say this is confusing would be an understatement.
Back in July 2017, the SEC sent a comment letter to GE3 in regard to their improper use of non-GAAP metrics and inconsistencies in their description and application of them. Per Tomi Kilgore’s October 27, 2017 Market Watch article the SEC letter identified “16 items in its 10-K filing were listed as being potentially misleading to investors, with half the items mentioning the reporting of numbers that were inconsistent with Generally Accepted Accounting Principles (GAAP)."
GE’s response letter to the SEC seems to confuse matters even more. For example, the SEC asked: “We note your discussion regarding the $0.5 billion increase in industrial earnings. Explain to us how you determined industrial earnings and whether it is a non-GAAP measure. Tell us how the measure differs from industrial profit, the GAAP measure presented [in your report].” GE’s response was: “With regard to how industrial earnings and industrial profits differ, industrial earnings is an after-tax measure that reflects an adjustment for earnings/losses attributable to noncontrolling interests, while industrial profit is a pre-tax measure.”
This is the second time the SEC has called out GE for their use of non-GAAP metrics, as they sent them a series of letters on this topic during 2016 as well. However, GE is not being singled out as the only company who perhaps stretches the limit of their usage. In both 2016 and 2017, the SEC sent more comment letters regarding the use of non-GAAP measures than on any other topic (with 429 letters to 223 registrants in 2016 or 16.75 percent and 656 letters to 311 registrants in 2017 or 28.34 percent of all SEC comment letters sent).5 The growing use of non-GAAP metrics is also of concern to the PCAOB, who are actively researching their use and questioning whether the current standards should require auditors to perform specific testing of non-GAAP metrics contained in public filings and even those used on earnings calls and other types of releases.
Per Bloomberg, the use of non-GAAP metrics has increased from just 58 percent of publicly traded companies to virtually all of them in just 20 years. However, Bloomberg suggests that the use of this many metrics by GE has made their financials more confusing, resulting in investors shying away from GE and negatively impacting their market price per share. The Bloomberg article quotes an executive from Westwood Holdings who has been decreasing the size of a major stake in GE as saying, “GE somewhere along the line lost the benefit of the doubt that the non-GAAP adjusted EPS number was a good reflection of what they were earning.” A look at GE’s stock performance in relation to the overall market showing a steady decline supports this contention with their stock currently trading at close to its lowest level since the 2009 market crash. As of February 16, 2018, GE was trading at around $15 dollars per share, which was 50 percent of what it was trading at the same date in 2017, while the rest of the market was up over 18 percent during that same period.