Companies often voluntarily provide non-GAAP earnings when they announce annual or quarterly earnings. These numbers are controversial

Question:

Companies often voluntarily provide non-GAAP earnings when they announce annual or quarterly earnings. These numbers are controversial as they represent management’s view of permanent earnings. The Sarbanes-Oxley Act (SOX), issued in 2002, requires that if non-GAAP earnings are included in any periodic or other report filed with the SEC or in any public disclosure or press release, the company also must provide a reconciliation with earnings determined according to GAAP. Presented below is the reconciliation of GAAP net income to non-GAAP net income for Cisco Systems, Inc.

Disclosure note: For its internal budgeting process, Cisco’s management uses financial statements that do not include, when applicable, share-based compensation expense, amortization of acquisition-related intangible assets, acquisition-related/divestiture costs, significant asset impairments and restructurings, significant litigation settlements, and other contingencies, gains and losses on equity investments, the income tax effects of the foregoin and significant tax matters. Cisco’s management also uses the foregoing non-GAAP measures, in addition to the corresponding GAAP measures, in reviewing the financial results of Cisco.

Required:
1. Which is typically higher--GAAP net income or non-GAAP net income? Is that true for Cisco?
2. Which line item provides the biggest upward adjustment to GAAP net income in calculating non-GAAP net income?
3. What is a justification management provides for its calculation of non-GAAP net income?
4. A concern with non-GAAP reporting is that managers are excluding normal operating expenses for the purpose of reporting higher performance, which could mislead investors and creditors. For which line item is this most likely the concern?

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