The chief accountant of the SEC has described pro forma earnings as “earnings before the bad stuff.” In their study, “The Predicitive Value of Expenses Excluded from Pro Forma Earnings,” Professors Doyle, Lundholm, and Soliman prove there is some truth to that claim.
Companies issue pro forma earnings reports because they feel US GAAP rules penalize them for “unusual and nonrecurring transactions.” In some cases, they have a point. Unusual events that are unlikely to effect future cash flows can distort a company’s bottom line and investors’ perceptions thereof. However, as the authors show, too many corporations are using pro forma earnings reports to excite investors with rosy projections that don’t match reality. These pro forma reports are often trumpeted in press releases, while any mention of the bad stuff is buried at the end, such as AT&T’s 2001 fourth quarter release. Worse yet, the evidence shows that the gap between GAAP and Pro Forma is widening, as demonstrated by Bradshaw and Sloan.
As a student studying accounting for the first time, I find this disturbing. So far, the more I learn about accounting, the more I learn about ways corporations can cheat. I’m glad to know about these methods, legal, borderline, and otherwise, but a part of me wants to return to the days where ‘ignorance is bliss.’
