by Humphrey Nash
On Proposed Rule:
Conditions for Use of Non-GAAP Financial Measures
File No. S7-43-02


The author of these comments is an actuary interested in improving accounting principles and practices for the general good. The author has proposed a prospective accounting model AFTF (see the Appendix for a summary) as an alternative or supplement to the current GAAP implementation of accounting principles. The author believes that the proposed model is superior to the current GAAP model and will eventually replace the current model. The comments below reflect this perspective.


  1. The proposal rules(s) refer to Non-GAAP financial measures. These are defined as financial measures which include items not in GAAP or which exclude or adjust GAAP items. Essentially this means that Non-GAAP measures are any measures that don't exactly match GAAP. This is a precise definition. Unfortunately GAAP is not that precisely defined in theory or practice. GAAP is constantly changing and evolving. Is it the intent that Non-GAAP measures be defined by today's GAAP or GAAP as it may evolve in the future? For example, GAAP today is predominantly retrospective (historic GAAP) but prospective measures are already well accepted and commonly used. The GAAP balance sheet is essentially prospective. Forward-looking information is shielded by "Safe Harbour" provisions. The AICPA publishes a detailed "Guide For Prospective Financial Information". The author has contributed to the development of a prospective accounting model. FASB may be moving toward a principles-based standard setting. This can accommodate both retrospective and prospective accounting.

    If FASB or the SEC adopts or promulgates standards for forward-looking financial measures and statements (Prospective GAAP) will these be included in the definition of GAAP financial measures? What if FASB and SEC standards differ (for political, timing, applicability or other reasons), what will GAAP be? I suggest that GAAP be defined as "those current or future standards promulgated by FASB not in conflict with SEC standards, rules or guidelines."

  2. The Sarbanes-Oxley Act seeks to enhance financial disclosure by criticizing pro-forma (non-GAAP) financial information. A number of companies are abandoning pro-forma statements in anticipation or in response to perceived deficiencies in those statements. Such statements cannot be entirely eliminated since they are required in some circumstances. The problem is not the pro-forma statement, which seeks to convey useful information, but the quality and comprehensibility of pro-forma statements. The lack of standards and accounting discipline are the culprits. We should not throw the baby out with the bath water. Pro-forma information must have some relevant purpose and obvious meaning. Pro-forma information must be standardized to provide comparability. That standardization must support an audit function.

    It is suggested that pro-forma information be based on quantitative monetary measures. If this financial information is shareholder value-based, it will have an obvious standard meaning and will convey decision-useful information to investors. How this can be done in a feasible and reliable manner is the subject of the author's proposals.

  3. The Sarbanes-Oxley Act seeks to eliminate manipulative or misleading non-GAAP financial measures. GAAP measures and financial reports may also be, and often are, misleading and manipulative. One part of the SEC proposal requires a reconciliation of pro-forma to GAAP. This will not necessarily eliminate the problem. It may compound the problem. For example, if pro-forma statements are forward looking or value-based, such a reconciliation may be impossible. On a practical level, the variability, volume and detail of GAAP pronouncements make such a reconciliation difficult. GAAP is not internally consistent and cannot be reconciled with itself. The problem of comparability will not be solved by such a reconciliation, any more than it is within GAAP.

    Reconciliation is more form than purpose or substance. Any accounts can be reconciled, but they cannot be made equivalent or consistent. The most a reconciliation can do to is highlight the differences, not always to the credit of GAAP. A more useful reconciliation would be to the cash accounts. They are generally unequivocal and balanced to the penny. The same applies to GAAP. If the pro-forma and GAAP statements are both reconciled to cash, is this sufficient?

    This raises the reverse question. Are statements of cash flows non-GAAP statements and do they require explicit reconciliation to GAAP?

  4. It may be useful to require that any non-GAAP information, not just accompanying detail, be posted on the company's website. This website should be registered with the SEC and any change of the website address should be immediately notifiable. The SEC should maintain a current registry of all website addresses. The website address should be provided with any released financial information. Since storage space is so inexpensive today, an SEC site for releases as well as periodic required filings would provide a convenient central repository. Hence when any release is made it must be released by upload to the SEC repository. It is recommended that indexing information be included (company name, release date, type of filing, defined importance rating, responsible party, etc.). It is also recommended that some common format be adopted such as PDF, plain text, MS Word of XBRL. Searchable text is preferred to scanned or image files.

  5. It is noteworthy that "If the GAAP financial measure is not accessible on a forward-looking basis, the registrant must disclose that fact, explain why it is not accessible on a forward-looking basis and provide any reconciling information that is available without an unreasonable effort." This is a major and welcome shift in emphasis. The burden is on GAAP to reconcile to forward-looking measures and to explain the absence of the GAAP measure rather than the presence of the non-GAAP measure. This seems to be an acknowledgment of the incompleteness of GAAP measures, a point made in the draft proposal Accounting For The Future (AFTF) by the author.

  6. The exemption for foreign private issuers should be provided if "the securities of the issuer are only listed or quoted on a securities exchange or inter-dealer quotation system outside of the the United States;" The bolded word only has been inserted.

  7. Since cash flows generally balance to the penny and have a relatively unequivocal definition both GAAP and non-GAAP should be reconciled to cash flows, to the extent possible. For example, a forward looking accounting model, such as AFTF, based on cash flows, would reconcile to current period cash flows only.

  8. It is futile to require reconciliation to both GAAP income statements and GAAP balance sheets since they don't reconcile with each other. The GAAP income statement is essentially retrospective and the GAAP balance sheet is essentially prospective. The past does not equal the future. They only balance because of forced and arbitrary balancing items. This deficiency is made clear if we compare and contrast with AFTF where the unified "Statement of Values" serves simultaneously as the income statement and balance sheet.

  9. Prospective measures from the prior period should be reconciled with GAAP (or cash flows) of the current period. If the actual differs from the expected some reconciliation and/or explanation should be provided. Hence a partial exemption is provided; it is not necessary or desirable to provide a complete reconciliation since this is precisely what the prospective measure accomplishes.

  10. "Should we limit the definition of non-GAAP financial measures to historical financial measure?" See the prior answer. If FASB settles on a big tent approach to accounting,, setting standards for goals and concepts rather that detailed rules, then GAAP can encompass both historic GAAP and prospective GAAP Surprisingly, both historic GAAP and prospective GAAP, as exemplified by AFTF, satisfy most accounting concepts and basic accounting principles. With big tent GAAP, forward looking measures are no longer non-GAAP measures. This would bring discipline to forward-looking measures and avoid the need for reconciliations.

  11. The definition of non-GAAP seems tight enough. The problem is defining GAAP. See Comment 1.

  12. The type of disclosure (oral versus non-oral) should not be the exclusion criterion. The line should be drawn at public versus non-public disclosure, with the understanding that non-public disclosure may be prohibited. The principle is that any information which might reasonable affect investment decisions should be disclosed publicly and should be treated similarly, i.e., subject to Regulation G and posted on the website. There should be no crack.

  13. All public financial reports should be audited. If they are worth publishing they are worth auditing. If both GAAP and non-GAAP are audited properly they should be naturally reconciled. A published reconciliation may then be redundant.

  14. The purpose of the non-GAAP financial measure must be stated, but it may contrast starkly with GAAP for which no purpose is stated. AFTF has a clear purpose, namely to support decisions at all levels (investor decisions and operational, tactical, and strategic management decisions) with measures of shareholder value or value added.

  15. I see no reason that website and commission filing should differ. Reconciliations and comparative GAAP figures (to the extent available) should be relegated to appendices. They are not central accounting elements and will tend to obscure if given prominence. The statement of purpose and the item labels should provide enough central information.

  16. It is not the formality of filing that matters. It is the breadth and depth of the public effect that should prompt disclosure. A good portion of the benefit from such disclosures may accrue to management and to accounting. Comparisons, explanations, reconciliations will spotlight accounting problems and reveal solutions.

  17. Ultimately all accounting must reconcile to cash, otherwise the accounting itself has created or destroyed wealth. Perhaps any financial presentation which does not reconcile to cash should be prohibited.

  18. The initial effect of the legislative activity culminating in Sarbanes-Oxley Act seems to be fear and decreased use of non-GAAP measures. It will become clear that it is not non-GAAP measures which are at fault. It will, over time, become clear that it is historic GAAP that lacks relevance and that this lack of relevance is a far greater danger to the capital markets than the recent abuses that the Act seeks to address. Comparisons, explanations, reconciliations required by Regulation G will spotlight accounting problems and reveal solutions. This will accelerate the use of non-GAAP measures or, even better, accelerate the evolution of GAAP.

  19. The limited exception for foreign private investors is appropriate and realistic. I doubt that greater application is feasible or even our business. Less application would not protect the U.S. investing public.

  20. Non-GAAP measures are more common for foreign issuers. I don't believe they will be discouraged by disclosures. In fact, they may view the disclosure process as permitting or even encouraging use non-GAAP measures.

  21. GAAP generally fails to account for value but is forced to do so for business combinations. Hence GAAP has embarrassing discontinuities. These especially need to be highlighted through disclosures. Such discontinuities are softened or eliminated when an anticipatory or value-based accounting model is used.

  22. To protect companies from frivolous or harassing actions and from statutory complexities, the Commission should be the enforcement mechanism, especially since it has the explicit power to act. However, a responsive private complaint acceptance system should be established at the Commission.

  23. Regulation G will help meet the goals of the Act mainly by gradually revealing the deficiencies of historic GAAP and, perhaps, by encouraging the evolution of a broader principles-based GAAP model. Regulation G does not seem especially burdensome. In the authors opinion, AFTF is a far better way to satisfy the intent of the ACT and the intent of accounting, but it is more burdensome.

  24. Per share data can be valuable to the investor. Such data may include earnings per share, dividends per share, net worth per share, price per share. In the case of AFTF, value per share is furnished which provides a useful comparison to price per share. To prohibit such monetary non-GAAP measures may be a disservice. If anything, it is GAAP earnings per share that should be prohibited, since such earnings do not relate well to value or price.

  25. Unless GAAP evolves to encompass more than current cost-based implementation, it may be prevent desirable progress to insist on equal or greater prominence to GAAP measures. It is hoped that value-based measures would replace current GAAP measures or, equivalently that a principles based GAAP be adopted to include prospective measures. This may create the problem of conflicting GAAP measures. Until the time a better accounting model is fully developed, understood and implemented, this requirement is reasonable. If GAAP evolves to a principles-based set of accounting standards, this requirement may always be reasonable and desirable.

  26. "Are there additional disclosures that should be required in filings?" AFTF provides value-based forward-looking measures designed to provide decision-useful information. Although AFTF vastly simplifies accounting and provides the disciplines that the Sarbanes-oxley Act seeks to promote, it is not a suitable component of Regulation G or Item 10 of Regulation S-K. The concern is that these regulations not close to door to future accounting progress,

  27. Should non-GAAP measures be continued from prior period? Although consistency and comparability are desirable accounting characteristics, continuity of bad or inappropriate measures should not be enforced. Relevant measures that provide universal consistency and comparability, when available, should be universally enforced. AFTF suggests such measures.

  28. Form 8-K filings should be required for all releases with no exception. However this should be automated as suggested in point 4 above. It may be more important to file widely and rapidly disseminated information for monitoring and enforcement purposes.

  29. "Public Disclosure" should be defined as the release of any significant information to any individual or group not bound by insider trading restrictions. "Significant" should mean any information which would reasonably be expected to affect investment decisions.

  30. Item 1.04 should also apply to estimates, but it may be better to apply it generally rather than to this or that special case. For example, it could apply to any new formation whether retrospective (past results) or prospective (expectations).

  31. If the announcement and the filing are automated and simultaneous then the regulations would not significantly deter. It may encourage if filing affords a degree of protection. To expedite filing, an electronic submission form and automated transmission should be developed and provided by the SEC. Item 1.04 should require simultaneous website filing due to the increased importance of this medium.

  32. The application of Item 1.04 only to completed periods might encourage more timely disclosures. If Item 1.04 applies to all disclosures that encouragement will be diminished somewhat depending on the filing difficulty.

  33. It seems that the burden (hours of work) of compliance is underestimated. However, even if it takes several times as long, that burden seems acceptable.

Appendix A

Prospective Accounting (AFTF)

By Humphrey Nash

Surprisingly, prospective accounting can be made both relevant and reliable, so that it becomes suitable for financial reporting as well as management decisions. This is new.

A new approach to valuation is proposed which combines and coordinates capital market information with management information. This approach, called the "dual validation", is one of the disciplines that makes prospective accounting simultaneously relevant and reliable. The "dual validation" is described in the draft proposal Accounting For The Future and in the paper Disciplining Prospective Accounting, both by the editor. It will also be fully described in later issues of Future Accounting News.

In addition to the "dual validation", other disciplines are proposed to enhance reliability. These take the form of disclosures and checks and balances. The checks and balances arise from a natural division of labor and responsibilities. This division is also a key ingredient in making prospective accounting feasible.

The traditional accounting income statement and balance sheet would be replaced by a unified statement of values showing consecutive valuations and the value added. The value added is defined as the current valuation less the prior valuation (adjusted for interest). The interest rate used is the historic cost of capital that emerges from the dual validation.

The unified statement of values automatically coordinates the progress of the company with the status of the company, unlike traditional accounting where the income statement and balance sheet are uncoordinated. Among other things, this coordination makes it possible for shareholder equity to be shareholder value.

Using a shareholder cost of capital as a discount rate means that values correspond directly with decisions; a positive valuation implies a positive decision. This make prospective accounting automatically decision-useful. In fact, with prospective accounting we don't value traditional accounting tangibles at all. Instead we value decisions.

At the broadest level, the company valuation provides a decision criterion for stock purchase.

At the line of business level, the valuation provides information as to whether the LOB is covering the cost of capital. A positive LOB valuation suggests continuation or expansion; a negative valuation suggests dropping or changing the LOB. The LOB or division level of aggregation would be the normal financial reporting level of presentation.

At the micro level, a prospective valuation provides decision criteria, for example, for pricing an individual product or for capital budgeting decisions.

This multilevel decision framework of prospective accounting will improve management and capital market efficiency. It will also improve the efficiency of accounting functions within an enterprise. It does this by unifying all accounting and decisions measures. For example, management must explicitly quantify its plans in order to evaluate and decide, but this same process is used for financial reporting, i.e., to determine value and value added.

A prospective accounting model will enhance the role and opportunities for accountants.

First, accounting will become more relevant so that the accountant will be adding more value and be more valued.

Second, accounting will be improved and simplified within a clearer purpose and vision; detailed practice prescriptions or proscriptions will give way to the general principle.

Third, accounting unification creates an opportunity for the accountant to assume a broader role within a company.

Fourth, that role involves the accountant in the decision process. This is good for the accountant and good for the decision process.

Prospective accounting has a clear, relevant purpose. It can be made reliable and feasible with the technologies and structures proposed.

The full text of the draft proposal Accounting for the Future and many other closely related essays can be found at:

Accounting Problems Addressed by AFTF

  1. Low level and continuing decline of relevance of GAAP accounting

  2. Decline in the efficiency of U.S. capital markets

  3. Decline in the efficiency of management decisions

  4. Incompleteness of short-term accounting measures

  5. Lack of decision utility of a retrospective accounting model

  6. Lack of management accountability

  7. Complexity and inconsistencies within the current GAAP accounting model

  8. Lack of discipline and abuses within accounting

  9. Inefficiency of multiple accounting and financial measurement systems

  10. Decline of the accounting profession.

Appendix B

Recent Corporate Failures

By Humphrey Nash

Global Crossing, Enron, Adelphi, Worldcom, now infamous names, represent massive corporate failures. Many employees, investors, creditors have been damaged. Who is to blame?

The most obvious blame belongs to the CEO's who have the overall authority and responsibility for management and financial reporting. They cannot claim to be doing their jobs and to be ignorant of accounting fraud, at least not in the same sentence. The CEO may not produce bad accounting numbers but he must not pressure, encourage, tolerate or be ignorant of those who do. The highly paid CEO's job includes the responsibility to oversee accounting functions. Executive bonus compensation tied to reported earnings may need to be abandoned or curtailed to reduce temptations.

Accounting functions are the direct responsibility of the corporate accountants. Corporate accountants understand the corporation and accounting and their duty to produce relevant and accurate financial reports. Accountants must not be influenced by personal greed or by the pressure to produce the desired result. If the public is misled or not properly informed, the corporate Certified Public Accountant is to blame.

A similar blame accrues to the external auditors who review the accounting and opine on the financial reports. The auditing company's responsibility is to insure that corporate accounting follows the rules. External auditors must investigate and discover. There is no excuse for overlooking abuses 10 digits long. They must form independent, unbiased, and meaningful opinions. Clearly the external auditing function has failed, most visibly with Arthur Anderson.

Financial analysts "diligently" evaluate companies and claim to see beyond the deficiencies or biases of corporate reports. They make "professional" recommendations which they profess represents the interests of the readers of their reports or analyses. They claim to be unbiased and independent. Financial analysts have failed in their stated mission. In some cases they have actively contributed to corporate failures. They must accept blame for their obvious failures and move forward. Financial analysts can have a very valuable financial role, but clearly not their current role.

The discipline and enforcement arm of the AICPA has accomplished nothing and through inaction has encouraged creative accounting and other misdeeds. Self-regulation and self-discipline is preferred, but only if it has teeth and will.

Regulators have failed their charters. The SEC has ultimate authority: over financial reporting for publicly traded companies, to regulate capital markets, and to protect the investor. If the system is not working, it must be fixed. It has not been fixed. FASB establishes the accounting rules. In many cases of failure, the rules have been followed, but the principle violated or nonexistent. In most cases the rules are detailed, complex, and difficult to interpret, apply, or enforce. FASB has made extraordinary efforts to defend and extend the life of an antiquated accounting model, but it needs to initiate fundamental change.

Congress must share the blame for not appreciating the importance of sound accounting and for not adequately supporting the regulators and their independence. For the moment, congressmen seem to understand their past mistakes, but they still accept campaign contributions.

Shareholders must shoulder some of the blame. Exuberance and greed have propelled prices to unreasonable and unsustainable levels. Management was often forced to live up to irrational capital market expectations. If expectations are not met through actual results, they can, with a little help from friends, be achieved with reported results. This keeps everyone happy ... for a while.

Employees must assume some of the blame. If they do their jobs, are not overpaid and add real value to the company, the company will generally succeed. Most are good apples. Many employees have seen their savings and retirement funds evaporate. Most of these were, at least, exuberant and did not diversify their investments. Management and employee benefits advisors within the company also abrogated their fiduciary responsibilities in not advising or requiring adequate diversification.

Boards of directors and their audit committees have generally been yes-people not true overseers. Involvement, courage, independence, stewardship, and public duty have not been hallmarks of boards.

Bond rating organizations have improved somewhat, but they are often a day late and a dollar short, despite the fact that many failures were years in the making. Perhaps they are partially shielded from responsibility and blame because bondholders have first claim. Rating organizations can be a force for financial responsibility.

Banks, investment bankers, and speculators play a major role. The often accumulate large sums of money through their machinations. Where does that money come from?

It's tragic that that stupidity, greed, dishonesty, self-interest, fraud and incompetence are so epidemic.

Wait a minute!

There seem to be more blamees than blame. Can blame be diluted out of existence? If everyone is to blame, is anyone to blame? Have we missed something?

The Real Failure

When a problem is widespread and pervasive that problem is systemic.

The common denominator in the above failures is the current accounting system. The above failures are fundamental accounting failures. The current accounting system needs to be updated. There must be a single set of books not GAAP/pro-forma/management accounting/acquisition accounting/SEC filings/regulatory accounting/tax accounting/performance measures/scorecards/financial analysts valuations. Within GAAP alone there are a myriad of accounting treatments and fixes. Accounting needs to be made comprehensive yet simple, relevant yet feasible, flexible yet disciplined, forward looking yet auditable. It must be consistent at all levels and across all industries. It must be guided by clear principles not complex and unstable rules. It must process data and provide high level decision-useful information.

Is it possible to update the accounting model to satisfy the foregoing goals? Yes.

The model that does this seemingly impossible task is Accounting For The Future (AFTF). AFTF is the embodiment of existing technologies and existing trends and existing developments within accounting. Please refer to my other essays or the draft proposal Accounting For The Future for details. In brief, AFTF is a disciplined value-based accounting system employing the Present Value of Expected Cash Flows (PVECF).

AFTF informs. All those blamed for recent accounting failures would have been protected by being informed. All those suffering financial damage would have been protected.

Global Crossing, Enron, Worldcom, et al.

It may be of some current interest to briefly consider how AFTF would have applied to above companies.

First, we note that AFTF is value-based and decision-relevant. Clearly, the GAAP financial reporting model, as it was applied, was not based on value and did not properly inform. But this is more than a problem of improper application. Current GAAP make no attempt to value and is marginally decision-relevant. There is a fundamental lack of principle. AFTF, on the other hand, has a bright beacon to guide: capital market value. AFTF is decision-useful. In fact, decisions are AFTF accounting elements.

Second, many accounting fiascoes are the result of accounting allocations, the near arbitrary shifting of revenues, to produce the desired current GAAP earnings. With AFTF there is no shifting of cash flows; none is needed; none is possible.

Third, AFTF is based on cash flows and only on cash flows. These may be past cash flows (used for model validation), current cash flows (used to compare actual-to-expected), and future expected cash flows based on a validated model. The measure of these cash flows (PVECF) is scaled to the capital market and represents shareholder value. This value is defined uniformly and is decision-useful at all levels within the corporation and across all industries. Cash flows are defined unequivocally and are measured to the penny within the books of account or within published expected cash flows. Users of accounting information increasingly recognize the advantages of cash flow over reported earnings. For example, the Price/Cash Flow ratio is often used instead of the P/E ratio. The best ratio measure is Price/PVECF. It compares price to value providing a easy decision criterion, is normalized at 1.00, making comparisons between companies or across industries meaningful, and takes into account a shareholder cost of capital for the entity.

The problem with Worldcom, Enron, etc., was that earnings substituted for cash flows and that earnings exceeded cash flows, past, present and future. Any accounting system must ultimately reconcile to cash flows, otherwise money is manufactured. There was no such balancing of the books at Worldcom or Enron. The most natural solution to this balancing requirement is to base accounting directly on cash flows. This is foolproof.

Enron would not have failed so dramatically with AFTF in place. For one thing, the share price would not have outstripped share value. Growth would have been controlled and pressure to manage earnings would have been non-existent (see the draft proposal for reasons). Cash flow measures could not have been exaggerated. Capital markets would have been informed and would have better restrained and guided management.

AFTF reports Actual to Expected (A/E) cash flow ratios. These would have revealed the true situation at an early stage.

The AFTF cash flow models used to project cash flows would have to fit (validate to) the past. This anchors the expected future to the actual past, restraining exaggerated projections. The measure (PVECF) of expected cash flows depends on the discount rate. For AFTF, this is the historic cost of capital arising from the dual validation. The dual validation eliminates the motive and opportunity for financial finagling.

The historic cost of capital represents the expected shareholder yield; it is a prominent feature of AFTF financial reporting. It readily reveals any misalignment of value and price.

The Larger Problem

Recent accounting failures are dramatic and have caused hardship to many people, while others profited. Should we be overly concerned about who wins and who loses? Are we, in essence, dealing with gambling outcomes in a zero-sum game? Why not clone Las Vegas and close Wall Street?

It is clear that the capital market is not a zero-sum game. Capital markets exist to efficiently allocate scarce capital resource to productive enterprises, enterprises that create or add value and enhance total capital resources. Our economy and standard of living depend on efficient capital markets. We have the most efficient and most trusted capital markets in the world, but that efficiency and trust is dependent upon relevant and reliable accounting information.

Enron, Worldcom and other recent corporate failures have damaged the capital markets far beyond their own huge losses. A continuation of such failures could depress capital investment enough to produce a major economic recession. The greatest risk is that capital market efficiency is gradually eroded by bad or irrelevant accounting creating a pervasive and sustained decline in financial and economic activity. Such erosion is insidious and, indeed, may be well under way as the economy shifts and accounting stagnates. AFTF has the potential, not only to maintain capital market efficiency, but to substantially improve it. AFTF is anticipatory and accounts for the long term; this will tend to stabilize the markets and further improve capital market efficiency. AFTF can also improve company efficiency since it provides forward-looking decision-useful management information.


Recent corporate failures are human failures and accounting system failures. As a by-product of its relevance, AFTF would have prevented or reduced those failures.

July 4, 2002