Making pro forma information more useful.

• Author: Arnold, Jerry L.
• Position: Corporate Reporting

The overnight collapse of Enron Corp. has served as a lightning rod for criticism of the current financial reporting system. Coupled with other high-profile failures and restatements of financial statements, it is critical that financial executives, regulators and the accounting profession work together to restore the public confidence in both audited financial statements and other reporting matters.

One area where such efforts are essential involves so-called "pro forma" results. Critics argue that the manner in which such data are presented is parallel to asserting that: "After backing Out the unusual runs scored by the Diamondbacks in the seventh game, the Yankees are the 2001 World Series champions."

The intent of this article is not to add to the continuing stream of those bashing pro forma measures. Instead, the focus is on observations and recommendations to create and report useful, understandable and transparent pro forma information to complement earnings included in GAAP-based financial statements. One premise here is that generally accepted accounting principles (GAAP) are relevant in presenting financial performance, but are not all-encompassing. Because investors primarily use historical financial data to predict future results, exclusion of unique, one-time items can be informative.

Thus, meaningful presentation of pro forma results should benefit investors. Even the Securities and Exchange Commission (SEC) cites the relevance of such measures, with adequate explanations and caveats. The problem is the way some entities attempt to direct analysts and investors away from actual performance to a biased, inflated perspective of operations. Much of the criticism of such measures is that they appear in press releases, which do not comport with the financial statements included in SEC filings. An overarching observation in this article is that the location of the pro forma measures is not relevant -- they could be in a press release, management discussion, etc.

A Dual Responsibility

For pro forma disclosures to be additive to the GAAP-based measures, management needs to apply a disciplined and consistent approach. Similarly, analysts and investors must recognize that the reflexive, broad-brush dismissal of "one-time items" is both naive and potentially dangerous. Consider the case of Bethlehem Steel Corp. As noted in a recent front-page article in The Wall Street Journal, the company's press release noted that over $1 billion in its deferred tax asset account was written off, with a reference to the notes to its quarterly financial statements. At least one analyst ignored this non-cash write-off as, effectively, irrelevant -- but the financial statement footnote proved prescient:

Our results to date and current outlook for the balance of 2001 are worse than we anticipated at the beginning of the year. We now expect to have both a financial accounting and tax loss for 2001. In the absence of specific favorable factors... application of FASB Statement No. 109 -- and its subsequent interpretations -- require a 100% valuation allowance....

Shortly thereafter, Bethlehem Steel filed for Chapter 11 protection. The message is clear: for pro forma measures to be useful, management must present them clearly as part of the complete disclosure package, and investors must use them in this...