Reforming pro forma

Entrepreneur, May, 2003 by Jennifer Pellet

Last year, the SEC warned investors to view company-issued pro forma financial reports with skepticism. This year, the agency is cracking down on companies that use them. Pro forma reporting was originally intended to enable companies to issue financial releases that exclude "one-time expenses" from earnings to enable investors to better compare quarter-to-quarter or year-to-year performance.

"The bias was to remove things that made the earnings look lower, and it got out of control," explains Peter H. Knutson, associate professor emeritus of accounting at the University of Pennsylvania's Wharton School, who says some companies used pro forma figures to mislead investors.

To bring pro forma reporting back under control, the SEC recently prohibited companies from making misleading statements and omissions in pro forma reports. It also ruled that companies must clearly delineate what transactions have been excluded or included, detailing how pro forma statements differ from Generally Accepted Accounting Principles (GAAP).

While critics charge that corporate lobbying efforts have been effective in softening some of the recent SEC regulatory reform efforts, the regulations on pro forma reporting are clear and enforceable. However, says Knutson, because companies have to adhere to GAAP in preparing financials anyway, the ruling will pose no hardship to ethical firms. "All they're doing is flipping a light switch in a dark room," he says. "It's a matter of revealing what they've al ready done."