Chapter 4 — Non-GAAP Measures That May Be Misleading or Prohibited and Other Considerations Related to Common Non-GAAP Measures

4.3 What Is a Potentially Misleading Non-GAAP Measure?

An overriding theme of the SEC’s guidance on the use of or references to non-GAAP measures in public statements or disclosures is that they should not be misleading, whether such measures are used in a filing (e.g., Form 10-K) or elsewhere (e.g., press release). As described in Section 100 of the C&DIs, non-GAAP measures that could mislead investors include those that:

Exclude normal, recurring cash operating expenses necessary for business operations (see Section 4.3.1).
Are presented inconsistently between periods, such as by adjusting an item in the current reporting period, but not a similar item in the prior period, without appropriate disclosure about the change and an explanation of the reasons for it (see Section 3.6.3).
Exclude certain nonrecurring charges but do not exclude nonrecurring gains (e.g., “cherry picking” non-GAAP adjustments to achieve the most positive measure; see Section 3.6.2).
Are based on individually tailored accounting principles, including certain adjusted revenue measures (see Section 4.3.3).
Are mislabeled or not clearly labeled as non-GAAP measures or otherwise include adjustments that are not clearly or accurately labeled or described (see Section 4.3.4).

In addition to the examples discussed in the C&DIs, various other presentations could be considered potentially misleading, depending on the facts and circumstances.

In interactions with the SEC staff regarding non-GAAP measures viewed as misleading, some registrants have proposed supporting continued presentation of such measures by adding transparent disclosures related to the calculation of the measures or about the measures’ purpose and use. However, Question 100.06 of the C&DIs indicates that even detailed disclosures about a misleading measure would not prevent it from being misleading.

At the 2022 AICPA Conference, the SEC staff indicated that once a non-GAAP measure or adjustment is concluded to be misleading or otherwise inconsistent with non-GAAP rules, the staff expects the registrant to correct the presentation in the next filing or publicly available SEC document by removing the measure or adjustment. If comparable periods are presented, the non-GAAP measure or adjustment should be removed from all periods presented.

The SEC staff had primarily used the Division of Corporation Finance’s (the “Division’s”) comment letter process, various speeches, and the C&DIs to publicize its conclusions that certain measures are misleading and that it may object to their use. In addition, some enforcement actions have focused on misleading non-GAAP measures. For example, in 2002, the SEC brought an enforcement action against a registrant for disclosure of non-GAAP information in its earnings release, which stated that a “one-time” charge had been removed but failed to note that one-time gains had not been removed. In another enforcement action in 2009, a registrant’s non-GAAP measure professed to exclude certain nonrecurring items, but the measure actually removed various recurring operating expenses.

At the June 2016 International Corporate Governance Network Annual Conference, then SEC Chair Mary Jo White stated that the SEC staff would, if necessary, use its filing review process, enforcement, and further rulemaking “to achieve the optimal disclosures for investors and the markets.” After that speech, the SEC disclosed the results of two separate enforcement actions against registrants. In one, the SEC charged the registrant with knowingly overstating a non-GAAP measure in certain filings and press releases. In the other (which included a separate alleged violation unrelated to the non-GAAP issue), the SEC asserted that the registrant presented misleading non-GAAP measures by failing to disclose a change in a non-GAAP measure between periods and gave undue prominence to non-GAAP measures in press releases. See Section 3.3 for a discussion of a 2018 enforcement action against a registrant for its failure to give equal or greater prominence to comparable GAAP measures in certain press releases.

Changing Lanes

On December 13, 2022, the SEC staff released new and updated C&DIs on non-GAAP financial measures (see Appendix G). The staff has observed that the volume of non-GAAP disclosure comments has remained high over the past several years and that it continues to receive questions on this topic. The new and updated C&DIs help increase the transparency of the SEC staff’s process for evaluating certain non-GAAP measures as well as its criteria for considering such measures misleading.

At the 2022 AICPA Conference, Division Chief Accountant Lindsay McCord emphasized that the intent of the new and updated C&DIs is to communicate interpretive feedback that the SEC staff has provided to registrants in various speeches and the comment letter process. In addition, she noted that the updates to the C&DIs are not intended to change the SEC staff’s position on non-GAAP adjustments that it has not objected to in the past (e.g., adjustments for restructuring costs and stock-based compensation). However, Ms. McCord further acknowledged that conclusions about the application of the C&DIs to non-GAAP measures and adjustments will depend on a registrant’s individual facts and circumstances.

The following changes related to misleading non-GAAP measures were made to the C&DIs:

C&DI Question 100.01 was updated to add interpretive guidance on what may be considered normal or recurring. The C&DI cautions issuers that a non-GAAP measure may be considered misleading if it excludes cash operating expenses that are normal and recurring in the operation of a registrant’s business.

At the 2022 AICPA Conference, Ms. McCord explained that the SEC staff evaluates whether an expense is “normal” by considering the nature and effect of the non-GAAP adjustment and how the expense is related to the registrant’s operations, revenue-generating activities, business strategy, industry, and regulatory environment. She also noted that the SEC staff evaluates whether an operating expense is considered “recurring” when it occurs repeatedly or occasionally, including at irregular intervals of reoccurrence. (See Section 4.3.1 for more information.)
C&DI Question 100.04 was updated to clarify that adjustments that represent the application of individually tailored accounting principles extend beyond the original example of adjustments that accelerate revenue recognition. The C&DI specifies that non-GAAP adjustments that change the GAAP recognition and measurement principles would be considered individually tailored and may cause the non-GAAP measure presentation to be misleading. The C&DI includes new examples that illustrate the application of individually tailored accounting principles and thus may be misleading. (See Section 4.3.3 for further discussion.)
C&DI Question 100.05 was added to highlight the SEC’s guidance that non-GAAP measures should be labeled as such and that adjustments should be clearly labeled and described in the disclosures. The C&DI also gives examples of misleading labels and descriptions for non-GAAP measures. (See Section 4.3.4 for further discussion.)
C&DI Question 100.06 was added to emphasize that no amount of disclosure can make a measure compliant with the non-GAAP rules if it has been determined to be misleading.

The C&DIs on misleading non-GAAP measures are presented below and discussed throughout this section.

C&DIs — Non-GAAP Financial Measures

Question 100.01

Question: Can certain adjustments, although not explicitly prohibited, result in a non-GAAP measure that is misleading?

Answer: Yes. Certain adjustments may violate Rule 100(b) of Regulation G because they cause the presentation of the non-GAAP measure to be misleading. Whether or not an adjustment results in a misleading non-GAAP measure depends on a company’s individual facts and circumstances.

Presenting a non-GAAP performance measure that excludes normal, recurring, cash operating expenses necessary to operate a registrant’s business is one example of a measure that could be misleading.

When evaluating what is a normal, operating expense, the staff considers the nature and effect of the non-GAAP adjustment and how it relates to the company’s operations, revenue generating activities, business strategy, industry and regulatory environment.

The staff would view an operating expense that occurs repeatedly or occasionally, including at irregular intervals, as recurring. [December 13, 2022]

Question 100.02

Question: Can a non-GAAP measure be misleading if it is presented inconsistently between periods?

Answer: Yes. For example, a non-GAAP measure that adjusts a particular charge or gain in the current period and for which other, similar charges or gains were not also adjusted in prior periods could violate Rule 100(b) of Regulation G unless the change between periods is disclosed and the reasons for it explained. In addition, depending on the significance of the change, it may be necessary to recast prior measures to conform to the current presentation and place the disclosure in the appropriate context. [May 17, 2016]

Question 100.03

Question: Can a non-GAAP measure be misleading if the measure excludes charges, but does not exclude any gains?

Answer: Yes. For example, a non-GAAP measure that is adjusted only for non-recurring charges when there were non-recurring gains that occurred during the same period could violate Rule 100(b) of Regulation G. [May 17, 2016]

Question 100.04

Question: Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?

Answer: Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:

changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;
presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse, presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and
changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis. [December 13, 2022]

Question 100.05

Question: Can a non-GAAP measure be misleading if it, and/or any adjustment made to the GAAP measure, is not appropriately labeled and clearly described?

Answer: Yes. Non-GAAP measures are not always consistent across, or comparable with, non-GAAP measures disclosed by other companies. Without an appropriate label and clear description, a non-GAAP measure and/or any adjustment made to arrive at that measure could be misleading to investors. The following examples would violate Rule 100(b) of Regulation G:

Failure to identify and describe a measure as non-GAAP.
Presenting a non-GAAP measure with a label that does not reflect the nature of the non-GAAP measure, such as:
- a contribution margin that is calculated as GAAP revenue less certain expenses, labeled “net revenue”;
- non-GAAP measure labeled the same as a GAAP line item or subtotal even though it is calculated differently than the similarly labeled GAAP measure, such as “Gross Profit” or “Sales”; and
- a non-GAAP measure labeled “pro forma” that is not calculated in a manner consistent with the pro forma requirements in Article 11 of Regulation S-X. [December 13, 2022]

Question 100.06

Question: Can a non-GAAP measure be misleading, and violate Rule 100(b) of Regulation G, even if it is accompanied by disclosure about the nature and effect of each adjustment made to the most directly comparable GAAP measure?

Answer: Yes. It is the staff’s view that a non-GAAP measure could mislead investors to such a degree that even extensive, detailed disclosure about the nature and effect of each adjustment would not prevent the non-GAAP measure from being materially misleading. [December 13, 2022]

Connecting the Dots

As a result of the ongoing uncertainty associated with the unprecedented nature of COVID-19 and the Russia-Ukraine war, companies may be faced with financial reporting and disclosure challenges that result in the recognition of infrequent or unusual gains, charges, or losses attributable to, or as a direct result of, the pandemic, the war, and related economic conditions. Registrants that are considering reflecting these items in their non-GAAP measures should be mindful of the various requirements and interpretations related to the use of non-GAAP measures. They should also consider CF Disclosure Guidance Topics 9 and 9A and the SEC’s May 3, 2022, sample letter to companies regarding disclosures about the financial impact of the Russia-Ukraine war and related supply-chain issues.

When evaluating whether an adjustment related to COVID-19 or to the impact of the Russia-Ukraine war is appropriate in a non-GAAP measure, a registrant should consider several factors, including (but not limited to) whether the adjustment is:

Directly related to COVID-19, the war, or the associated economic downturn.
Incremental to normal operations and nonrecurring (i.e., it is not expected to become the “new normal”).
Objectively quantifiable, as opposed to an estimate or hypothetical amount.
Appropriate under the existing C&DIs discussed above.

For example, it would not be appropriate to include routine costs in an adjustment for pandemic or war-related charges or to adjust for amounts that cannot be objectively quantified, such as estimated lost revenue. Similarly, it would not be acceptable to adjust for routine operating costs that were incurred before the pandemic or the war and continue to be incurred, such as routine employee compensation.

There may also be circumstances in which complete GAAP financial information is not available at the time of an earnings release because of ongoing consideration of matters related to the pandemic or the war. Registrants may choose to provide preliminary GAAP results that include either provisional amounts that are based on a reasonable estimate or a range of reasonably estimable GAAP results. Since earnings releases often include non-GAAP measures, registrants should consider CF Disclosure Guidance Topic 9 on the non-GAAP reconciliation requirements when complete GAAP information is not available.

For further discussion of the application of the SEC’s rules and guidance to non-GAAP adjustments attributed to COVID-19 as well as examples of certain of those adjustments, see Deloitte’s, July 1, 2020, Financial Reporting Alert.

4.3.1 Normal, Recurring Cash Operating Expenses

As noted in C&DI Question 100.01, a registrant should consider whether its non-GAAP performance measure removes costs necessary to generate revenues or normal, recurring cash charges. The SEC staff has, for example, commented when non-GAAP measures have:

Excluded certain sales and marketing expenses that were considered normal recurring cash operating expenditures.
Excluded expenses that a registrant has incurred over several successive quarters or years that appear to be necessary for operating its business.
Used a “price normalized cash margin” that included higher oil and commodity prices from earlier periods. See Section 4.16.
Inappropriately labeled an adjustment as nonrecurring, infrequent, or unusual when the charge or gain was reasonably likely to recur within two years or a similar charge or gain had occurred within the last two years. See Section 4.7.

A registrant should use judgment in determining what constitutes a normal, recurring cash operating expense. Since the release of the C&DIs, the SEC staff has issued comments related to expenses that may constitute normal, recurring cash operating expenses, such as restructuring costs, preopening costs, and rent adjustments. As part of the comment letter process, the SEC staff may request additional information about the nature and circumstances specific to an adjustment to help it determine the adjustment’s appropriateness. Costs that SEC comments have focused on have included the following:

Restructuring, transformation, realignment, and acquisition costs — If a registrant has recurring restructuring charges or frequent business acquisitions, the SEC staff may ask about the facts and circumstances supporting an adjustment for what may appear to be a normal cash operating cost. A registrant should therefore carefully consider which costs are being attributed to a restructuring or transformation activity. Depending on its specific circumstances, the registrant may be able to support its conclusion that such an adjustment is appropriate. However, the registrant may wish to consider whether enhancements to its disclosures about the nature and purpose of the adjustment or resulting non-GAAP measure would help clarify the intent of the measure or its use by management and investors. Similar considerations would apply to costs characterized as transformation or realignment costs.
Earnings before interest, taxes, depreciation, amortization, and rent (EBITDAR) and adjusted EBITDAR — The SEC has also asked certain registrants about their presentation of EBITDAR and adjusted EBITDAR because the deduction for rent could be viewed as eliminating a normal, recurring cash operating expense from a non-GAAP performance measure. Such non-GAAP measures are often presented as (1) a component of the ROIC metric or (2) individually, in certain industries (e.g., managed care facilities, airline, and gaming). In recent SEC comment correspondence, the staff has indicated that EBITDAR and adjusted EBITDAR should not be characterized as performance measures. However, in some circumstances, the staff may not object to disclosure of the measures if they are characterized as financial valuation measures. If EBITDAR and adjusted EBITDAR are disclosed as financial valuation measures, the purpose and use disclosures that accompany them should also indicate that the measures are used for valuation purposes (see Section 1.2.2), and they should still be reconciled to net income. Further, if EBITDAR is presented as a financial valuation measure, the SEC may object to such presentation for all comparative periods because it may indicate that the measure is also a performance measure. Accordingly, the SEC may request that the measure be presented only for the most recent period.
Preopening and start-up costs — Preopening costs are routinely incurred in certain industries, such as the restaurant and retail industries. Such costs are related to the opening of new company-operated store locations and may include legal fees, rent, training expenses, and travel and lodging costs for the preopening team before a store’s opening date. The SEC staff believes that preopening costs for new stores are generally considered a normal part of a stated growth strategy or of ongoing operations, since such costs are generally viewed as normal, recurring cash operating expenses; as a result, the SEC may challenge registrants that eliminate material preopening costs to arrive at a non-GAAP performance measure. Similarly, a registrant may incur start-up costs as part of a strategic initiative to expand an existing business line or offering. Such costs are also generally considered a normal part of a registrant’s growth plan and viewed as normal recurring cash operating expenses.

At the 2022 AICPA Conference, the SEC staff discussed an example from the retail industry in which retailers often open, close, and relocate stores in the normal course of business. The staff indicated that a retailer would not be able to reasonably argue that the expenses associated with opening a new store are unique because this would be considered part of (1) revenue generation and (2) the business strategy for the retailer’s growth. While new stores may not be opening at a high frequency (e.g., daily or monthly), such openings would still be considered part of normal operations and would most likely be occurring occasionally at irregular intervals. Therefore, the associated preopening expenses should not be excluded from the calculation of a non-GAAP measure. While the example given at the conference focused on the retail industry, the SEC staff has issued comments to registrants in other industries (e.g., restaurants, hospitality) that excluded preopening costs from non-GAAP measures.
Up-front and subsequent-development milestone expenses — In certain industries (e.g., life sciences), the parties to contractual arrangements often incur up-front and ongoing costs. For example, collaborative or licensing arrangements often involve an expense for the payment of an up-front licensing fee (in the form of cash, an equity investment, or both) and future expenses for subsequent payments based on the achievement of development milestones. Also, research and development arrangements accounted for as an asset acquisition may often involve an up-front expense for acquired in-process research and development (IPR&D) as of the acquisition date if such IPR&D has no alternative future use. Notwithstanding the fact that these two types of arrangements are different, registrants in the life sciences industry often include adjustments to eliminate the up-front and subsequent-development milestone expenses from their non-GAAP performance measures. In recent correspondence, the SEC staff has commented on the nature, purpose, and presentation of these adjustments. The staff indicated that when such arrangements are recurring or are a normal part of business activities or strategies, registrants should not include adjustments to eliminate these expenses.

4.3.2 Other Reconciling Adjustments

At the 2016 AICPA Conference and other venues, the SEC staff noted a few observations regarding other adjustments registrants have made to their non-GAAP measures:

Stock-based compensation — The staff has not focused on adjustments for stock-based compensation. Further, it generally would not object to the exclusion of any shortfall or windfall (tax impacts) in its non-GAAP measures as a result of the new stock compensation guidance in ASU 2016-09.
Derivatives — The SEC staff may continue to ask questions about the appropriateness of adjustments related to derivatives.

4.3.3 Individually Tailored Accounting Principles

C&DI Question 100.04 notes that a registrant is prohibited from presenting a non-GAAP performance measure that is a substitute for a GAAP accounting recognition and measurement method and provides a few examples of “non-GAAP adjustments that . . . would be considered individually tailored” and therefore misleading. While these examples are mainly related to revenue recognition, the C&DI applies to any individually tailored accounting that creates a non-GAAP measure, including an individually tailored expense or other tailored measures. At the 2018 AICPA Conference, the staff indicated that adjustments that change the accounting policy or the method of recognition of an accounting measure may be misleading and may therefore not be permitted. The staff acknowledged that entities often face challenges in identifying individually tailored accounting principles and provided examples of questions to which affirmative responses may be indicators of adjustments that could result in tailored accounting:

Questions	Examples
Does the adjustment shift the measure from an accrual basis of accounting to a cash or modified basis of accounting?	Presenting cash receipts or billings as a proxy for revenue for a subscription-based business that recognized revenue over time
Does the adjustment include transactions that are also reportable in another company’s financial statements?	Presenting adjustments to consolidate financial results for an entity that is accounted for under the equity method Presenting revenue, gross, as the principal in a transaction when the company is required to report revenue, net, as an agent
Does the adjustment reflect part, but not all, of an accounting concept?	Adjusting a performance measure for the cash portion of income tax expense but not the noncash portion
Does the adjustment render the measure inconsistent with the underlying economics or ignore certain aspects of the economics?	Adjusting revenues for sales-type or direct financing leases to account for them as if they were operating leases, thus ignoring the economics of the lease agreements

The following are some additional examples of revenue and cost adjustments that may be considered individually tailored:

Adjusted revenue — One example in the C&DI refers to a prohibited non-GAAP performance measure that reflects revenue recognized ratably over time under GAAP on an accelerated basis as if the registrant earned revenue when it billed its customers. The measure is prohibited because it is an individually tailored accounting principle and does not reflect the registrant’s required GAAP measurement method. However, as outlined at the 2020 AICPA Conference, the SEC may not object in certain circumstances when a registrant presents the amount of revenue billed to a customer — that is, “billings” or “bookings” (with appropriate characterization) as an operational metric — because such measures are not considered non-GAAP measures. At the 2020 AICPA Conference, the SEC staff also cautioned registrants about the presentation of a non-GAAP measure labeled “net revenue” in which certain costs of sales are subtracted from GAAP revenue. The staff indicated that the labeling of such measures could be misleading if the measures refer to revenue or sales and emphasized that it is likely to ask questions if a registrant identifies something as revenue that is not, in fact, revenue. The staff further explained that it may be acceptable to refer to such measures as “Adjusted Gross Profit” or “Contribution Margin” but reminded registrants that the GAAP measure that is most comparable to an adjusted gross profit or contribution margin is generally a “fully loaded” GAAP gross margin.

Another example in the C&DI refers to a prohibited non-GAAP measure of revenue in which transaction costs are deducted to arrive at a net revenue amount when the registrant is the principal in the transaction, as required by GAAP. This measure is prohibited because the accounting method is tailored to present revenue as if the registrant were an agent in the transaction. The example also states that the inverse of this situation would also be prohibited — that is, if the registrant is an agent in the transaction and the non-GAAP measure of revenue is presented on a gross basis when net presentation is required by GAAP.
Sales incentives — Registrants should not exclude from their presentation the effects of any sales incentives, discounts, or rebates that are recorded as a reduction to revenue as adjustments to revenue or earnings measures because such a presentation may be an individually tailored method of revenue recognition and measurement. Similarly, depending on the terms in a warrant and other related agreements, a registrant may be required under U.S. GAAP to offset the expense associated with warrants issued as sales incentives as a reduction of revenue over the related performance period. The SEC staff has noted that registrants should also generally not exclude from their presentation the effects of the fair value of warrants issued as sales incentives as adjustments to revenue or earnings measures because this presentation may be an individually tailored method of revenue recognition and measurement.
Adjustments affecting capital structure — In certain circumstances, a registrant may wish to adjust a non-GAAP measure in a manner that provides an alternative presentation of the entity’s capital structure. For example, a registrant may wish to present an adjustment in which:
- Two different classes of stock that have different rights and economics are combined into one class of stock for the presentation of an adjusted earnings per share measure, when GAAP requires earnings per share presentation using the two-class method.
- Operating lease expenses are replaced with estimated depreciation expense in an effort to adjust for differences in capital structure between a registrant and its competitors.10
The SEC staff has commented that each of these examples may constitute an individually tailored accounting method. However, the SEC might not object to the presentation discussed in the second example if (1) a registrant believes that the adjustment will help investors with comparability related to the registrant’s transition from the existing lease requirements to ASC 842 (because such adjustments effectively bring the effect of operating leases onto the balance sheet in a manner consistent with the principles of ASC 842) and (2) the measure is clearly labeled “Adjusted.” After the adoption of ASC 842, it would be expected that a registrant may no longer need to present an adjustment for off-balance-sheet leases.
LIFO-to-FIFO adjustments — In certain situations, it may not be misleading for a registrant to present a measure that substitutes one acceptable measure under GAAP for another such measure. For example, if a registrant reports its inventory by using the LIFO method of accounting, it may make an adjustment to show the impact of reporting inventory on a FIFO basis if such an adjustment otherwise complies with the non-GAAP measure rules. This may not be considered individually tailored accounting and therefore may be permitted because both presentations are acceptable under GAAP.
Presentation of EBITDA measures after the adoption of IFRS 16 — Because of differences between the guidance in ASC 842 and IFRS 16, EBITDA measures presented by a domestic registrant after the adoption of ASC 842 may not be comparable to similar measures presented by an IFRS filer. For example, ASC 842 requires the reduction of the right-of-use asset for an operating lease to be recorded as rent expense in the income statement. Under IFRS 16, however, such a reduction must be presented in a manner similar to that of a financing lease, which would result in depreciation expense for the right-of-use asset. At the March 20, 2019, CAQ SEC Regulations Committee joint meeting with the SEC staff, the SEC staff explained that it would view “a measure presented by an IFRS registrant that adjusts EBITDA to deduct interest and depreciation solely related to leases as an individually tailored accounting principle.” For more information about the differences between ASC 842 and IFRS 16, see Deloitte’s Roadmap Leases.
Segment measures — Under ASC 280, a registrant may present segment measures on a basis that is consistent with the manner in which the registrant is managed but different from the GAAP basis of presentation in its consolidated financial statements (e.g., a material charge for restructuring or impairment that is related to a specific segment may not be included in management’s measure of the segment’s operating profit or loss). Such segment measures are not non-GAAP financial measures under the Rules as long as they are presented on a separate segment basis, although the SEC staff would consider their presentation or discussion on a consolidated basis, if disclosed outside of the footnotes to the financial statements, to be a non-GAAP financial measure.

In addition, the SEC staff has objected to entity-wide disclosures in which revenue information is presented in a manner that is inconsistent with GAAP. For example, a company may have presented revenue exclusive of discounts, returns, allowances, and other concessions that it must, under GAAP, recognize as a deduction from revenue. Since ASC 280 requires companies to align entity-wide disclosures with the corresponding amounts in the GAAP financial statements, excluding certain adjustments from revenue may be considered an individually tailored accounting principle and may not be appropriate.

Similarly, when reviewing a registrant’s determination of the segment measure of profit or loss within the financial statements, the SEC staff has objected to the application of a recognition or measurement principle to income or expense line items for a company’s segments that differs from the accounting principle it used for recognition and measurement in its GAAP financial statements (see additional discussion of tailored accounting principles in Section 2.5).
Adjusted allowance for loan loss disclosures — Banking industry registrants use certain non-GAAP financial measures that may adjust the allowance for loan losses. The SEC has objected to measures that remove the impact of purchase accounting (“fair value”) adjustments for acquired loans from the GAAP measure and therefore may be considered individually tailored accounting measures, which are prohibited under Rule 100(b) of Regulation G and C&DI Question 100.04. Such measures would include those that:
- Present an “adjusted allowance for loan losses to total loans” which adds the remaining discount on purchased loans to both the numerator and denominator.
- Reduce interest income by the amount of accretion income on purchased loans to compute the related loan yield or net interest margin.
Pro rata consolidation — The calculation and presentation of non-GAAP measures that use the pro rata consolidation method, which is common in the real estate, health care, and energy industries, may be inconsistent with the interpretive guidance related to individually tailored accounting principles11 as well as with C&DI 102.10 regarding prominence (see also Section 3.3). In this type of presentation, a registrant may want to combine some or all of the information in its GAAP statement of operations line item with information related to its pro rata share of unconsolidated investees or affiliates to arrive at a non-GAAP pro rata statement of operations.

Example 4-1

Registrant A uses a columnar presentation for its statement of operations. In the first column, it presents its GAAP consolidated results. In the second column, it presents its pro rata portion of the results of its unconsolidated investees. The third column reflects A’s non-GAAP pro rata statement of operations. The following is a condensed excerpt of A’s presentation for illustrative purposes (not all individual revenue and expense line items have been included, and numerical values have been omitted):

	GAAP Consolidated Statement of Operations A	Pro Rata Portion of Unconsolidated Investees B	Non-GAAP Pro Rata Statement of Operations A+B
Revenues
Expenses

The SEC generally objects to this type of presentation because it is regarded as an individually tailored accounting principle. Registrant A has not met the criteria to consolidate the affiliates under GAAP. Further, it fails to comply with the SEC’s “prominence” guidance because the registrant has presented a non-GAAP income statement on a pro rata consolidated basis. Therefore, such presentation contradicts two C&DI Questions: 100.04 and 102.10 (see Section 3.3.1). However, since it may be useful for an investor to understand the effect of investees’ proportional ownership, A may provide the relevant pieces of detailed financial information it used in calculating this measure (which, by itself, would not be considered a non-GAAP measure), but the registrant should not “do the math.” That is, instead of presenting the third column in the example above, which provides information about the non-GAAP pro rata statement of operations, A may provide selected information that is consistent with the non-GAAP rules.

While the SEC often comments on individually tailored revenue recognition principles in non-GAAP measures, it has recently increased the frequency of its comments about individually tailored measures related to topics other than revenue. After a registrant responds in writing to an SEC comment, the SEC staff may request a phone call with the registrant to discuss its presentation of non-GAAP measures that use individually tailored accounting principles or certain of the registrant’s other non-GAAP presentations. As a result of these discussions, the registrant may make prospective changes to modify certain adjustments or eliminate measures that were the subject of the comment.

4.3.4 Labeling Non-GAAP Measures and Reconciling Items

As described in C&DI Question 100.05, a non-GAAP measure or an adjustment to that measure may be misleading if it is not appropriately labeled and clearly described. As a result, the SEC staff continues to focus on whether registrants have (1) clearly labeled and described non-GAAP measures and adjustments, (2) used appropriate conventional accounting terminology, and (3) provided context for their presentation of non-GAAP measures.

At the 2021 AICPA Conference, the SEC staff observed that titles of non-GAAP measures or non-GAAP adjustments often do not match their description. Referring to this practice as “mislabeling,” the staff stated that the title of a non-GAAP measure or adjustment should align with its nature. The staff indicated that mislabeling may include describing a contribution margin or non-GAAP gross margin as “net revenue” or referring to an earnings measure that excludes material costs of revenue or other expenses directly tied to business operations as “core earnings.”

Certain registrants have used the label “core” to describe their non-GAAP measures or have disclosed that some or all of their non-GAAP adjustments are not part of their “core operating performance.” Registrants should clearly explain what constitutes core operating performance and indicate why this measure is useful to an investor. In addition, their disclosures should give context about why certain amounts, such as restructuring costs, amortization of intangibles, or transaction and integration costs, would not be considered an integral or “core” part of their operations.

Further, clear, transparent labeling is important for all items in the reconciliation. For example, a registrant should not use a reconciling item labeled “other” that includes numerous significant items without clearly disclosing the nature of such items along with the amount of each adjustment. In addition, if a registrant uses a reconciling item labeled “transaction costs” or “acquisition costs,” such amounts should be representative of costs related to the transaction (e.g., legal, valuation, or due diligence costs) as opposed to costs incurred after the transaction (e.g., implementation, transition, or severance costs).

As non-GAAP adjustments evolve over time, it is important to consider clearly labeling and describing these adjustments. Many registrants disclose the non-GAAP measure “adjusted EBITDA”; however, the actual adjustments included in such a measure may differ greatly among individual registrants. The SEC staff has observed that such variability and the number of adjustments in a registrant’s calculation of non-GAAP measures may create complexity in investment analyses and that clearly labeled adjustments and sufficiently detailed descriptions may facilitate comparison with other registrants’ similar measures.

Regulation S-K, Item 10(e), includes a prohibition indicating that when labeling a non-GAAP financial measure, a registrant must not use titles or descriptions that are the same as, or are confusingly similar to, titles or descriptions used for GAAP financial measures or amounts presented in accordance with Regulation S-X.

For example, a registrant should not:

Use GAAP titles such as “gross margin” or “operating income” for amounts presented that exclude costs that the registrant would generally include in these totals under GAAP or Regulation S-X, Article 5. If the registrant does exclude such costs, the label associated with them should clearly indicate that the amounts are adjusted. For example, a registrant may exclude restructuring charges from its non-GAAP “operating earnings” measure in MD&A. If so, the registrant could label the measure as “adjusted operating earnings” or “non-GAAP operating earnings” to avoid confusion with the GAAP measure as reflected in the income statement.
Label a measure “pro forma” if the measure was not calculated in a manner consistent with the concepts in Regulation S-X, Article 11, or in ASC 805.
Refer to a non-GAAP measure as “operating income” or “operating earnings,” which is a common practice in the insurance industry (although it may occur in other industries as well). If such measures are not calculated as they would be under GAAP, registrants should instead label them as “adjusted” or “non-GAAP” operating earnings or income. See Section 4.9 for a discussion of measures that exclude depreciation and amortization.

The SEC staff has also indicated that in adjusting non-GAAP measures, registrants sometimes use conventional accounting terms or other measures differently from the way they are commonly understood by investors. Citing an example of such use in the oil and gas industry, the staff noted that derivative gains and losses may be labeled in a way that suggests that the adjustments are calculated under GAAP even when they exclude net unrealized gains and losses. The SEC staff has reminded registrants to stay true to the meaning of accounting terminology as defined in GAAP. Further, a non-GAAP measure should not be identified as EBITDA if it excludes any amounts other than interest, taxes, depreciation, and amortization (e.g., impairment charges).

In addition, if registrants include non-GAAP adjustments related to the effects of the war between Russia and Ukraine, they should clearly label and describe them and should not use titles or descriptions that are vague or confusingly similar to those used for GAAP financial measures. For example, instead of describing an adjustment as “effects of the war,” a registrant should specify what the adjustment includes. Moreover, registrants should disclose why they believe that the non-GAAP measure provides useful information to investors and, if applicable, a statement describing how management uses such a measure. See Deloitte’s March 10, 2022 (updated May 7, 2022), Financial Reporting Alert for more information about non-GAAP measures that include adjustments associated with the impact of the Russia-Ukraine War.

Footnotes

ROIC measures are sometimes adjusted in this manner. Registrants often estimate the depreciation expense included in the non-GAAP measure by multiplying operating lease expense by a factor (e.g., rent expense multiplied by a factor of 6) to arrive at an estimated asset base to use in calculating the depreciation adjustment.

The SEC’s position related to measures that use pro rata consolidation was clarified at the National Association of Real Estate Investment Trusts (NAREIT) Senior Financial Officer Workshop on September 27, 2016, at which “a Division staff member communicated this position.” An October 18, 2016, NAREIT alert, Further Guidance on Pro-Rata Reporting of Non-GAAP Financial Measures and Metrics, explains the staff’s position on pro rata consolidation and discusses certain other alternative presentations that may not violate the non-GAAP measure rules.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This SEC Reporting Interpretations manual provides comprehensive guidance; however, the manual does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.