Do Earnings Reports Need Auditing? Some Practitioners Say Yes

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By Denise Lugo

Earning releases may need auditors’ review, some accountants and auditors said at recent financial reporting discussions.

“I happen to think that a majority of the investment decisions are being made off of earnings releases, not off of 10-Qs,” FASB member Lawrence Smith said at a June 1 meeting of the board’s advisory committee for smaller public companies.

Smith suggested that the four legs of the financial reporting stool—the Securities and Exchange Commission, Financial Accounting Standard Board, Accounting Standards Board and Public Company Accounting Oversight Board—should work together to see if more audit oversight could be directed to earnings releases. “And if the earnings release is what’s pushing the markets and investment decisions, then why isn’t the process just moved back to the earnings release.”

“One of the important measures within an earnings release is often non-GAAP measures, which would be measures of financial performance that are different than what’s necessarily in financial statement,” PwC’s U.S. chief auditor Len Combs told Bloomberg BNA. “I do believe there is a bit of a demand for auditors providing more assurance over non-GAAP measures.”

One idea, said Smith, would be to require numbers that are included in earnings releases to be subject to the internal control system that’s being reviewed on an ongoing basis by an auditor, or have some type of review report.

However, auditors at PCAOB’s standing advisory group meeting expressed concerns that subjecting earnings releases to some type of review process would slow down the timing of financial information and other information being released to analysts and investors.

Combs also sees that potential drawback. “Because if the auditors have some further form of responsibility for that, we would probably need to complete additional procedures that would take more time, and there could be a delay in the filing of the earnings release—and that for analysts and investors would be a negative,” he said.

Big Issue of Time

It’s the issue of time that’s at the crux of the topic, practitioners said.

“The typical analyst, like for a brokerage firm, has so many companies to follow, there’s no way they can possibly go through all the filings that a company puts out, even the quarterly filings,” Herb Greenberg, partner at independent research firm Pacific Square Research, told Bloomberg BNA June 2. “There’s no way these guys that are covering 20 or 30 stocks can do that. It’s just too many, so they have to pick and choose.”

Companies differ in how they approach issuing their reports. Amazon released both its earnings report and 10-Q on April 27. Yahoo, however, issued its first quarter earnings on April 18 but waited over three weeks to file its 10-Q. Twitter waited about a week—the release was done on April 26 and the 10-Q came out on May 2.

Where the process gets interesting is when there’s a big gap between the earnings release and the 10-Q, Michelle Leder, editor and founder of Footnoted, told Bloomberg BNA. Footnoted looks at the things companies bury in their routine SEC filings.

“In a lot of ways, I like to think of it as ‘look at the shiny object—the earnings release—and don’t pay as close attention to the Q,’” said Leder. “Of course you can also make an argument that by releasing earnings and the Q on the same day, it’s a distraction since everyone will pay attention to the earnings,” she said.

Analysts: 10-Qs a Compliance Exercise

The issue might be one of perception. 10-Qs get more scrutiny by investors during the initial investment in a company, but analysts typically don’t pay too much attention to them during quarterly earnings updates. That is because they are viewed as compliance requirements, some on FASB’s Small Business Advisory Committee said.

10-Qs are a step below the annual 10-K reports and include legal disclosures that companies sometimes would rather not draw too much attention, the SBAC’s discussions indicated.

The 10-Qs might also contain other kinds of nuanced items, such as deferred tax assets and valuation allowances—types of information that aren’t in an earnings release but that are pertinent to a company’s financial health. Trends related to that information take time and scrutiny to dig out.

Analysts therefore prefer the quick-hit revenue trends and margin expansion they can easily get from earnings releases. “An earnings release is more the investment community demanding a quick turnaround of what’s gone on within the most recent quarter,” William Waller, portfolio manager/managing member of M3Funds, LLC and M3F, said during the discussions.

“We want to know what’s going on now, we don’t want to wait 40 or 45 days and have that lag that it takes to put together everything that goes into a 10-Q,” Waller said.

Earnings Releases Often Rely on Non-GAAP

Alternative financial numbers—“non-GAAP” measures—aren’t included in generally accepted accounting principles (GAAP) financial statements and aren’t audited. They are generally provided in earnings releases or management discussion and analysis (MD&A). Companies like using them because they generally paint a better financial picture of earnings than GAAP, the numbers in financial statements companies must file with the SEC.

It’s an area that has come under heightened scrutiny by securities regulators in recent years. The SEC has said the use of alternative reporting measures is excessive, and the gap has widened between those figures and those in GAAP financial statements. The issue therefore can be a source of confusion to stock investors, the agency said.

To contact the reporter on this story: Denise Lugo in New York at dlugo@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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