Pro Forma Adjustments to Gaap Earnings : An Analysis of Specific Adjustments, Materiality and Sec Action

The Securities and Exchange Commission (SEC) issued Regulation G (implementing Section 401 (b) of the Sarbanes-Oxley Act of 2002) in 2003 subsequent to its warning in December 2001 about reporting misleading non-GAAP or pro forma results. This research provides a longitudinal analysis of the earnings releases of a sample of companies reporting pro forma results from 1999 through 2004, especially in the context of recent SEC action. The research examines (1) the specific items included in pro forma adjustments and their frequency, (2) the extent of materiality or magnitude of the adjustments compared to GAAP, and (3) the stated rationale for the adjustments. The research also specifically addresses the impact of the SEC's recent guidance and the extent to which Regulation G has modified pro forma reporting behavior. Our findings indicate pro forma adjustments have continued to be systematically biased in recent years to show significantly higher earnings compared to GAAP earnings and that the magnitude of such differences is highly material. While SEC action, particularly Regulation G, appears to have greatly reduced the number of companies disclosing non-GAAP financial measures and has improved transparency, a significant number of companies continue to make adjustments that are likely of concern to the SEC