Implementing SOX Controls for Non-GAAP Measures Life Sciences Accounting & Reporting Congress PDF Free Download

Before we get started What was the estimated annual cost of public company s compliance with Regulation G? A $ 78 B $ 780 C $ 7,800 D $ 78,000 C $ 780,000 E None of the above Copyright 2017 Deloitte Development LLC. All rights reserved. 3

And the answer is A. $ 78 Junior Accountant We continue to estimate that public companies would have to comply with Regulation G six times a year. There are roughly 14,000 public companies. Using our estimates from the Paperwork Reduction Act section, we would expect that it would take a junior accountant roughly.5 hours to complete the required reconciliation and ensure there are no material misstatements. Accordingly, we have estimated that the total burden hours needed to comply with Regulation G would be 42,000 hours. Using cost data from the Securities Industry Association's Report on Management & Professional Earnings in the Securities Industry 2001 (SIA Report)70 and adding an additional 35% for costs associated with overhead, we find that, on average, a junior accountant would earn $26 an hour. We believe the salary of a junior accountant is appropriate for our estimates because, in most cases, we would expect the most directly comparable GAAP measure to be available. Therefore, we have estimated the total costs associated with complying with Regulation G to be $1,092,000. Source: March 28, 2003. Conditions for Use of Non-GAAP Financial Measures Securities and Exchange Commission 17 CFR PARTS 228, 229, 244 and 249 [Release No. 33-8176; 34-47226; FR-65; FILE NO. S7-43-02] RIN 3235-A169 Copyright 2017 Deloitte Development LLC. All rights reserved. 4

Today s snapshot. Understand the scope and impact of a non- GAAP measure Comprehend the views and comments from the SEC Connect the dots between learning and reality to discuss, brainstorm, and establish effective internal controls over non-gaap measures Describe/identify how your organization currently uses non-gaap measures and the controls or gaps around them Copyright 2017 Deloitte Development LLC. All rights reserved. 5

Identifying the population. Regulation G and Item 10(e) define a non-gaap financial measure the same way. That is, as a numerical measure of a registrant s historical or future financial performance, financial position or cash flows that: (i) Excludes amounts, or is subject to adjustments that have the effect of excluding amounts, that are included in the most directly comparable measure calculated and presented in accordance with GAAP in the statement of income, balance sheet or statement of cash flows (or equivalent statements) of the issuer; or (ii) Includes amounts, or is subject to adjustments that have the effect of including amounts, that are excluded from the most directly comparable measure so calculated and presented. Or said differently: If a registrant takes a commonly understood or defined GAAP amount and removes a component of that amount that is also presented in the financial statements, the resulting amount is generally considered a non-gaap measure. Copyright 2017 Deloitte Development LLC. All rights reserved. 7

Common non-gaap measures. Operating income that excludes one or more expense items Adjusted revenues, adjusted earnings, and adjusted earnings per share EBIT and EBITDA, and adjusted EBIT and EBITDA Net debt, which could be calculated as borrowings less cash and cash equivalent or borrowings less derivative assets used to hedge the borrowings Measures presented on a constant-currency basis, such as revenues and operating expenses Sales and sales increases/decreases Core earnings Free cash flow Funds from operations (FFO) Common non-gaap adjustments in these measures Acquisitions and divestitures Amortization and/or impairment of intangibles and adjustment of contingent consideration arising from prior business combinations Restructuring and litigation charges Copyright 2017 Deloitte Development LLC. All rights reserved. 8

Where are non-gaap measures generally presented? Registrants often provide non-gaap financial information in an earnings press release in a Form 8-K. Non-GAAP measures may also be released orally, telephonically, by webcast or broadcast, or by similar means, including earnings calls or investor presentations. Further, non-gaap disclosures may be included on a registrant s Web site or other electronic medium. Non-GAAP measures may also be included in a periodic filing (e.g., Form 10-K, 10-Q, or 20-F), registration statement (e.g., Form S-1, S-4, F-1, or 10), proxy statement, or other SEC filing. The sections of a filing in which a registrant would generally include such information are the Business, Selected Financial Data, and MD&A sections. Copyright 2017 Deloitte Development LLC. All rights reserved. 9

Potential reasons to use non-gaap Measures. Management believes that non-gaap measures present a clearer picture of normal operations. Management compensation and incentive plans may be based on non-gaap measures. Debt covenants or other requirements may be based on non-gaap measures. Investors, analysts, and others may find non-gaap information useful for a variety of reasons; for example, the information may provide meaningful insight into items affecting a company s performance and comparability of results. Certain non-gaap measures, such as EBITDA, may be used for assessing business valuations in analyses of either earnings multiples or comparable transactions. And while the intent is good Copyright 2017 Deloitte Development LLC. All rights reserved. 10

the result is curious. 88% Approximately 88% of S&P 500 component companies use non- GAAP measures 1 Non-GAAP performance measures were greater than the nearest GAAP equivalent for about 82% of the S&P 500 companies that reported a non-gaap adjusted net income metric 1 67% In 2015, 67% of the companies in the Dow Jones Industrial Average reported non-gaap earnings per share and, on average, the difference between GAAP and non-gaap earnings per share was approximately 30%, representing a significance increase from approximately 12% in 2014 2 40% A study of seven large US drug companies demonstrated that for the 13 quarters ended March 31, 2016, non-gaap net income was 40 percent higher than net income reported in accordance with US GAAP 3 Sources: 1 Audit Analytics, Trends in Non-GAAP Disclosures (December 2015). 2 Did DJIA Companies Report Higher Non- Copyright 2017 Deloitte Development LLC. All rights reserved. GAAP EPS in FY 2015? FactSet Insight (March 11, 2016). 3 Tatyana Shumsky, Non-GAAP Accounting Lifts Adjusted 11 Earnings by 38% in Pharmaceuticals Credit Suisse, Wall Street Journal (July 15, 2016)

Evolution of non-gaap measure rules and regulations. SEC issues Regulation G and S-K Item 10(e) SEC increases focus on non-gaap measures as measures increase in use and prominence 2001 2010 2016 SEC issues cautionary advice to registrants 2003 2015 Compliance & Disclosure Interpretations (C&DIs) issued by SEC New and updated C&DIs issued by SEC Copyright 2017 Deloitte Development LLC. All rights reserved. 13

Increasing attention. Non-GAAP comments have increased as a % of total SEC comments Call for registrants to self-correct Concerns about the increased use and prominence Dramatic increase in press coverage and increasing SEC focus Issuance of updated C&DIs Larger differences between such measures and amounts reported under GAAP Potential for such measures to be misleading Copyright 2017 Deloitte Development LLC. All rights reserved. 14

The rules. SEC Rule Regulation G Item 10(e) of Regulation S-K Overview of the requirements Non-GAAP financial measures must not be misleading. The most directly comparable GAAP measure must be presented. A quantitative reconciliation of the non-gaap financial measure to the most comparable GAAP measure must be presented for: a historical non-gaap measure and forward-looking information (to the extent available without unreasonable effort) Expands upon Regulation G requirements to also include: Present most directly comparable GAAP measure with greater or equal prominence of that of the non-gaap measure Disclosure indicating why the registrant believes that the non- GAAP measure is useful to investors Disclosure of the additional purposes, if any, for which the registrant uses the non-gaap measure Copyright 2017 Deloitte Development LLC. All rights reserved. 15

Updated C&DI. More prominent presentation of non-gaap measures (C&DI 102.10) Full non-gaap income statement Omitting comparable GAAP measures from press release headlines Bolder or larger font Non-GAAP measure that precedes a comparable GAAP measure Equally prominent description for a GAAP measure (e.g., record performance ) Disclosures related to forward-looking non-gaap measures Same discussion and prominence for GAAP measures Tabular disclosure/reconciliation that starts with a non-gaap measure Copyright 2017 Deloitte Development LLC. All rights reserved. 16

Updated C&DI (cont d). Misleading measures (C&DI 100.01 100.04) Financial measures using individually tailored accounting principles (C&DI 100.4) Using a registrants' own set of accounting principles to determine a non- GAAP measure Staff may not object to a measure that adjusts to reflect the adoption of the new revenue recognition accounting standard Prohibition on presenting liquidity measures on a per share basis (C&DI 102.05) Designated performance measures that are really liquidity measures Non-GAAP tax expense (C&DI 102.11) Tax adjustments commensurate with the non-gaap measure of profitability Clear explanation of how the adjustment was determined Copyright 2017 Deloitte Development LLC. All rights reserved. 17

SEC comment letter trends - recent areas of focus. Prominence: When a registrant presents its non-gaap financial measures more prominently than its GAAP measures (e.g., the registrant presents them before, or places greater emphasis on them than its GAAP measures, or presents a full non-gaap Income Statement) Sample comment: We note that in your executive summary you focus on key non-gaap financial measures and not GAAP financial measures which may be inconsistent with the updated Compliance and Disclosure Interpretations issued on May 17, 2016 (specifically Question 102.10). We also note issues related to prominence within your earnings release.... Please review this guidance when preparing your next earnings release. Copyright 2017 Deloitte Development LLC. All rights reserved. 18

SEC comment letter trends - recent areas of focus (cont.). Purpose and use: Includes comments on whether the disclosures demonstrate the purpose of the measures (i.e., their usefulness to investors and how management uses them). Sample comment: Please revise to disclose the reasons why you believe your presentation of each of the non-gaap financial measures provides useful information to investors regarding your financial condition and results of operations. The justification for the use of the non-gaap financial measure must be substantive. Merely indicating that you provide such non-gaap financial measures to give investors additional data to evaluate your operations is not sufficient support for disclosure of the non-gaap financial measures. Please also revise to expand your disclosure of the additional purposes for which management uses each of the non-gaap financial measures. Please refer to Item 10(e) of Regulation S-K. Copyright 2017 Deloitte Development LLC. All rights reserved. 19

SEC comment letter trends - recent areas of focus (cont.). Impact of income taxes: comments on the calculation of the tax impact of non-gaap adjustments and the related disclosures. Sample comment: Please expand your disclosures to explain how you calculated the tax effect for the adjustments to net (loss) income attributable to... and per diluted share in accordance with the guidance in Question 102.11 of the Non-GAAP Financial Measures Compliance & Disclosure Interpretations. Copyright 2017 Deloitte Development LLC. All rights reserved. 20

SEC comment letter trends - recent areas of focus (cont.). Nature of adjustments: Comments on the nature of reconciling adjustments and the related disclosures. Sample comment: 1. We note that your non-gaap measures exclude purchased intangible amortization, restructuring costs, asset impairments, acquisition-related costs, and income tax items and that you describe these items as infrequent or unusual although you have reported similar items for multiple fiscal years. Please note that Item 10(e)(1)(i)(A) of Regulation S-K prohibits you from adjusting a non-gaap performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur within two years or there was a similar charge or gain within the prior two years. In addition, your non-gaap measures appear to exclude certain normal, recurring, cash operating expenses which is inconsistent with the updated Compliance and Disclosure Interpretations issued on May 17, 2016. Please review this guidance when preparing your next earnings release. 2. Given that your ongoing acquisition of businesses is a critical strategy you employ to achieve and maintain growth in your business, please tell us why you remove the impact of acquisition-related expenses and the amortization of intangible assets you acquire, as well as the impact of other fair value adjustments recorded under acquisition accounting in presenting your non-gaap financial measures Copyright 2017 Deloitte Development LLC. All rights reserved. 21

Haven t we already been down this road? ICFR v. DCPs Need to set the stage by clarifying whether controls over non-gaap measures are related to disclosure controls and procedures (DCPs), to internal control over financial reporting (ICFR), or to both. ICFR, which is defined in both SEC and PCAOB rules, focuses on controls related to the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. DCPs, on the other hand, are more broadly defined and pertain to all information required to be disclosed by the company. Copyright 2017 Deloitte Development LLC. All rights reserved. 24

Non-GAAP controls from a *COSO perspective. The consideration of non-gaap measures and how they may be viewed through the COSO lens, both the reporting objective (related to external financial reporting) and the compliance objective (related to compliance with laws and regulations) come into play. Copyright 2017 Deloitte Development LLC. All rights reserved. *Committee of Sponsoring Organizations (COSO) 25 Internal Control Integrated Framework

Reporting and compliance. In its assessment of the design of effective internal control over non-gaap measures, a company may consider its objectives in terms of reporting and compliance and, on the basis of those objectives, take into account the five components of internal control and the 17 principles within the components. Control environment Risk assessment Control activities Information and communication Monitoring activities 1. Demonstrates commitment to integrity and ethical values 2. Exercises oversight responsibilities 3. Establishes structure, authority, and responsibility 4. Demonstrates commitment to competence 6. Specifies suitable objectives 7. Identifies and analyzes risk 8. Assesses fraud risk 9. Identifies and analyzes significant change 10. Selects and develops control activities 11. Selects and develops general controls over technology 12. Deploys through policies and procedures 13. Uses relevant, quality information 14. Communicates internally 15. Communicates externally 16. Conducts ongoing and/or separate evaluations 17. Evaluates and communicates deficiencies 5. Enforces accountability Copyright 2017 Deloitte Development LLC. All rights reserved. 26

Disclosure committee considerations. Registrants may find it helpful to use a disclosure committee to assist the CEO, CFO, and audit committee in preparing and overseeing disclosures, including those related to non-gaap measures Disclosure committees are typically management committees, although some companies prefer that the disclosure committee function as a subcommittee of the board and audit committee. Disclosure committees can set parameters for and determine the appropriateness of disclosures related to non-gaap measures. The disclosure committee could review draft earnings releases to provide input and oversight by using the seven considerations outlined above. As part of its review, the disclosure committee can provide effective governance and play an integral role in the accuracy, completeness, timeliness, and fairness of a company s disclosures. Copyright 2017 Deloitte Development LLC. All rights reserved. 27

DCPs over non-gaap measures. Design DCPs to ensure that procedures cover: Compliance Consistency Data quality Accuracy Transparent disclosure Review Monitoring Non-GAAP measures presented in compliance with rules, regulations and guidance Adjustments evaluated and presented in an appropriate and consistent manner each period Calculated based on reliable inputs Calculation is arithmetically accurate Descriptions of adjustments and required disclosures are clear and not confusing Reviewed by the appropriate levels of management Internal audit, disclosure committee or audit committee reviews the controls or is involved in the oversight Establishing a written policy that (1) clearly describes the nature of allowable adjustments to GAAP measures, (2) defines the non-gaap measure(s) to be used under the policy, and (3) explains how potential changes in the inputs, calculation, or adjustments will be evaluated and approved may help management identify its DCPs. Copyright 2017 Deloitte Development LLC. All rights reserved. 28

Questions to ask When considering non-gaap measures. Is the measure misleading or prohibited? Is the measure presented with the most directly comparable GAAP measure and with no greater prominence than the GAAP measure? Is the measure appropriately defined and described, and clearly labeled as non- GAAP? Does the reconciliation between the GAAP and non-gaap measure clearly label and describe the nature of each adjustment, and is each adjustment appropriate? Is there transparent and company-specific disclosure of the reason(s) why the measure is useful for investors and the purpose for which management uses the measure? Is the measure balanced (i.e., it adjusts not only for nonrecurring expenses but also for nonrecurring gains) and consistently prepared? Does the measure appropriately focus on material adjustments and not include immaterial adjustments that would not seem to be a focus of management? Do the disclosure controls and procedures address non-gaap measures? Is the audit committee involved in the oversight of the preparation and use of non-gaap measures? Copyright 2017 Deloitte Development LLC. All rights reserved. 29

A resource for you. Detailed non-gaap measure publication combining SEC guidance with interpretations and examples: Background of non-gaap measures Presentation and disclosure considerations Prohibited measures Disclosure controls and procedures Appendixes also includes: Questions to ask when disclosing non-gaap measures Recent remarks from recent SEC officials Example SEC comments Copyright 2017 Deloitte Development LLC. All rights reserved. 33

Let s stay in touch. Steve Curry Partner, Deloitte & Touche LLP Joseph Sutter Manager, Deloitte & Touche LLP 1.617.437.2549 stecurry@deloitte.com 1.571.429.1446 jsutter@deloitte.com Copyright 2017 Deloitte Development LLC. All rights reserved. 34

This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation. As used in this document, Deloitte means Deloitte & Touche LLP, a subsidiary of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2017 Deloitte Development LLC. All rights reserved. 36 USC 220506

Implementing SOX Controls for Non-GAAP Measures Life Sciences Accounting & Reporting Congress 2017