In May 2016 the SEC updated guidance on the use of non-GAAP financial measures in its revised Compliance & Disclosure Interpretations. The updates add clarity to what the SEC considers misleading non-GAAP measures. These updates, along with recent speeches expressing concern by SEC Chair Mary Jo White and various SEC staff members, have made it clear that non-GAAP financial measures are coming under increased scrutiny at the SEC.
With the increased scrutiny, should these non-GAAP financial measures be tagged in XBRL? Today non-GAAP financial measures generally are not tagged. The reason is that the current SEC tagging requirement for periodic reporting covers only the primary financial statements and the notes to the financial statements. The non-GAAP measures are almost always reported outside the primary financial statements and notes, so the non-GAAP measures have evaded the tagging requirement.
But if future Regulation S-K rules requires tagging of information such as a company’s earnings release or the management discussion and analysis section of Form 10-K or 10-Q (which may not be that far away based on questions asked in the Regulation S-K Concept Release and the resulting public comments), then non-GAAP measures will become part of the structured data that allows software to efficiently consume the information.
What’s the benefit of tagging non-GAAP measures? For some non-GAAP financial measures, such as EBITDA, all of the components are GAAP items. So it’s likely each individual component (net income, interest, taxes, depreciation and amortization) has already been tagged as part of the current tagging requirement. This means that today an analyst using XBRL can already obtain EBITDA using XBRL tagged data. In effect, the non-GAAP measure is already tagged.
But consider when a non-GAAP measure has components that aren’t GAAP items, or the components haven’t been disclosed in the financial statements. In this case the tagging of the non-GAAP item may be very valuable to the analyst, or the SEC, since it allows efficient automated analysis of the measure and each of its components, including how the components relate to other tagged items in the financial statements. Even if the non-GAAP disclosure or several of its components are unique items which require unique tags (i.e. extension tags) the tagging would increase transparency since each item would be easily identifiable, include a definition and show the explicit calculation relationship.
The benefits of tagging would even extend to the reporting company. If the company is trying to show the components of a non-GAAP measure, including the required reconciliation to a GAAP item, the company will have an extremely transparent and standardized way to do that. With XBRL tagging, the company that wants to clearly explain its non-GAAP financial measures will find it easy to do so. The company that is trying to be misleading with its non-GAAP financial measures will encounter difficulties being transparent.
I believe non-GAAP financial measures are extremely useful for a company to provide relevant information and deeper insight. Tagging the information in a structured data format will enhance the transparency that’s needed for these disclosures. It will bring an efficient way for both the SEC and analysts to more deeply understand the measures, and at the same time allow reporting companies to add clarity to non-GAAP financial disclosures that are currently under increased SEC scrutiny.