Chapter 7 Farsing Muament 461 Case 7-4 The Potential Darkside of Using Non-GAAP Metrics (a GVV case) King Bernard, of Blackswan Petfood, a large publicly traded manufacturer of organic gourmet dog and cat Le petting ready for the quarterly conference call with major investors and financial analysts in two days. The has been reviewing a draft of the quarterly financial statements for the fourth quarter ending September 30, and working with his financial team on how best to present the numbers in the conference call. During the cont quarter, the company had two material transactions which to him appear to unfairly distort the financial dation of the company in the GAAP numbers provided by Debbie Doberman, the Senior Manager in charge of nancial reporting. The first relates to a loss of $2 million due to a massive tsunami which wiped out their manufac ring facilities in Chihuahua, Mexico. This amount was included in Additional Income/Expense Items. The second sam relates to a loss of $1 million from the disposal of their Red Rooster product line of gourmet chicken feed that was discontinued. The income statement currently reads as follows: Blackswan Pet Food Income Statement September 30, 2018 (in 000's) Sales Cost of Goods Sold Gross Profit Selling and Administrative Depreciation and Amortization Non-Recurring Items Other Operating Items Operating Income Additional Income/Expense Items Earnings before Interest and Tax Interest Expense Earnings before Tax Income Tax Net Income before Discontinued $ 458,543 $1257,678) $ 200,865 $(123,738) $ (25,324) $ 125,000) $ (13,435 $ 13,368 $ 2,456) $ 10,912 $ 3.478) $ 7,434 $ 1.918 $ 5,516 Operations Discontinued Operations (net of tax $ $ Net Income (os) Earnings Doss) per share 7.500 (1.984) (0.20) Loyal Doge, the newest member of the vide the analysts with a number of GAAP to obtain the required 150 credits to sit fort a lot of companies are now using non-GA useful information to users of the financial repor the concept of Extraordinary Items was just bad acc umber of the CFO's financial team (and recent college graduate), suggests that they pro- er of GAAP and Non-GAAP metrics. He double majored in accounting and marketing sto sit for the CPA exam. He said he learned in his strategic marketing class that Shon-GAAP metrics to "better" explain their financial results and provide more cial reports. He also noted that the recent change to GAAP which eliminated just bad accounting and he believed that alone was reason enough to create 462 Chapter 7 Earnings Management some metrics of their own. King Bernard thought his idea made a lot of sense as he, too, was wondering why the costs related to the tsunami should be included in operating income. The group discussed providing the analysts with the following measures. Earnings before Interest, Tax, Depreciation and Amortization (EBITDA), Earnings before Discontinued Operations, Earnings before Extraordinary Items, Recurring Earnings which would exclude both the discontinued operation and extraordinary item. Whichever number(s) were to be presented would be net of tax, and an EPS number would be calculated as well. In addition, they discussed highlighting these new measures in the financials presented on their website. The group had a very animated discussion, and excitement continued to build as they realized that, through the use of these new metries, they could paint a much better picture of the operating results of the company. "Dilly, Dilly". Loyal Doge said expressively. He was excitedly talking about using multiple colors, large fonts, and the bolding of non-GAAP numbers in the quarterly financials when Debbie Doberman decided to speak up. Since it was 5 pm, the group decided to stop for the day and meet at 8 am the following morning at which time they would address Debbie's concerns. Assume you are in Debbie's place. You are a CPA, MBA, CFE. You have purposefully been silent up until now to first gather all the facts, hear everyone's opinion, and then provide guidance on what is and is not acceptable with respect to non-GAAP disclosures. Consider the following in developing a game plan for what to say when you address the group tomorrow. Questions 1. What are the main arguments that you will need to counter? That is, what are the reasons and rationalizations you will need to address? 2. What is at stake should you not convince King Bernard to follow the SEC guidelines on the use of non-GAAN metrics? Include both short and long-term potential consequences in your answer. 3. What levers do you have available? Include in your answer a discussion of the specific rules and guidelines for the use of non-GAAP metrics. 4. If you cannot convince the King to follow the guidelines for using non-GAAP metrics, what is your next step 5. If the earnings call goes forward and the non-GAAP measures are prominently highlighted as Loyal Dose gests, what are your options then? Chapter 7 Farsing Muament 461 Case 7-4 The Potential Darkside of Using Non-GAAP Metrics (a GVV case) King Bernard, of Blackswan Petfood, a large publicly traded manufacturer of organic gourmet dog and cat Le petting ready for the quarterly conference call with major investors and financial analysts in two days. The has been reviewing a draft of the quarterly financial statements for the fourth quarter ending September 30, and working with his financial team on how best to present the numbers in the conference call. During the cont quarter, the company had two material transactions which to him appear to unfairly distort the financial dation of the company in the GAAP numbers provided by Debbie Doberman, the Senior Manager in charge of nancial reporting. The first relates to a loss of $2 million due to a massive tsunami which wiped out their manufac ring facilities in Chihuahua, Mexico. This amount was included in Additional Income/Expense Items. The second sam relates to a loss of $1 million from the disposal of their Red Rooster product line of gourmet chicken feed that was discontinued. The income statement currently reads as follows: Blackswan Pet Food Income Statement September 30, 2018 (in 000's) Sales Cost of Goods Sold Gross Profit Selling and Administrative Depreciation and Amortization Non-Recurring Items Other Operating Items Operating Income Additional Income/Expense Items Earnings before Interest and Tax Interest Expense Earnings before Tax Income Tax Net Income before Discontinued $ 458,543 $1257,678) $ 200,865 $(123,738) $ (25,324) $ 125,000) $ (13,435 $ 13,368 $ 2,456) $ 10,912 $ 3.478) $ 7,434 $ 1.918 $ 5,516 Operations Discontinued Operations (net of tax $ $ Net Income (os) Earnings Doss) per share 7.500 (1.984) (0.20) Loyal Doge, the newest member of the vide the analysts with a number of GAAP to obtain the required 150 credits to sit fort a lot of companies are now using non-GA useful information to users of the financial repor the concept of Extraordinary Items was just bad acc umber of the CFO's financial team (and recent college graduate), suggests that they pro- er of GAAP and Non-GAAP metrics. He double majored in accounting and marketing sto sit for the CPA exam. He said he learned in his strategic marketing class that Shon-GAAP metrics to "better" explain their financial results and provide more cial reports. He also noted that the recent change to GAAP which eliminated just bad accounting and he believed that alone was reason enough to create 462 Chapter 7 Earnings Management some metrics of their own. King Bernard thought his idea made a lot of sense as he, too, was wondering why the costs related to the tsunami should be included in operating income. The group discussed providing the analysts with the following measures. Earnings before Interest, Tax, Depreciation and Amortization (EBITDA), Earnings before Discontinued Operations, Earnings before Extraordinary Items, Recurring Earnings which would exclude both the discontinued operation and extraordinary item. Whichever number(s) were to be presented would be net of tax, and an EPS number would be calculated as well. In addition, they discussed highlighting these new measures in the financials presented on their website. The group had a very animated discussion, and excitement continued to build as they realized that, through the use of these new metries, they could paint a much better picture of the operating results of the company. "Dilly, Dilly". Loyal Doge said expressively. He was excitedly talking about using multiple colors, large fonts, and the bolding of non-GAAP numbers in the quarterly financials when Debbie Doberman decided to speak up. Since it was 5 pm, the group decided to stop for the day and meet at 8 am the following morning at which time they would address Debbie's concerns. Assume you are in Debbie's place. You are a CPA, MBA, CFE. You have purposefully been silent up until now to first gather all the facts, hear everyone's opinion, and then provide guidance on what is and is not acceptable with respect to non-GAAP disclosures. Consider the following in developing a game plan for what to say when you address the group tomorrow. Questions 1. What are the main arguments that you will need to counter? That is, what are the reasons and rationalizations you will need to address? 2. What is at stake should you not convince King Bernard to follow the SEC guidelines on the use of non-GAAN metrics? Include both short and long-term potential consequences in your answer. 3. What levers do you have available? Include in your answer a discussion of the specific rules and guidelines for the use of non-GAAP metrics. 4. If you cannot convince the King to follow the guidelines for using non-GAAP metrics, what is your next step 5. If the earnings call goes forward and the non-GAAP measures are prominently highlighted as Loyal Dose gests, what are your options then