Disclosures To Beat Earnings Benchmarks: GAAP Vs Non-GAAP Essay.

Quantas Airways Limited

Discuss about the Disclosures to Beat Earnings Benchmarks.

The Generally Accepted Accounting Principles had been developed by the Financial Accounting Standards Board for the purpose of standardizing the process of financial reporting by the providence of formats and rules and is essentially carried out for facilitating of the financial position of an organization by the creditors and investors. The utilization of the Generally Accepted Accounting Principles method of earning facilitates the reflection of the fair image of the business entity. Moreover, the annual reports of the different business entities that have been prepared on the basis of the GAAP can be reliably compared and analyzed.

The Non–GAAP earnings on the other hand, refers to the accounting regulation that has been utilized by the corporate entities for the purpose of displaying their own accounting figures. Such an accounting regulation is also legally supported as long as these accounting treatments have been disclosed as Non-GAAP in the annual report of the company and the providence of the reconciliation is carried out between the adjusted and regular results.

This particular study aims to focus on the difference between the GAAP and the Non-GAAP earnings. Moreover, the organizations that have been further selected for the better understanding of the research study are the Quantas Airways Limited and Star Entertainment Group Limited. These examples of the corporate entities have been utilized for the purpose of developing the particular research proposal that whether the accounting regulation of GAAP earnings are more useful in comparison to the Non-GAAP earnings.

The first company that has been selected for the purpose of the study is the Quantas Airways Limited that has been a domestic and international airline service provider. This airline service provider has been operating globally and is based out of Australia. The profitability graph of the selected company has gone through regular crests and troughs until the financial year of 2016.

The Star Entertainment Group Limited has been one of the largest entertainment and gaming groups on Australia. The Star Entertainment Group Limited has essentially been a corporate entity that has demerged from the parent entity in June 2011. The initial name of the corporate entity had been Echo Entertainment Group Limited. The demerger from the parent entity resulted in the occupying of the casinos business and from November 2015, the parent entity came to be known as Star Entertainment Group Limited. The Star Entertainment Group Limited has been listed under the top 100 listed corporate entities of Australia and operates under three major hotels and casinos of Australia namely Treasury Casino and Hotel in Brisbane, The Star Gold Coast on the Gold Coast and The Star, Sydney. The net profit that has been derived by the firm for the financial year of 2017 revolves around the figure of $264.4 million.

Star Entertainment Group Limited

The particular distinction between the corporate entities utilizing the particular mode of accounting regulations is that Quantas Airways does utilize the Non-GAAP methods while the corporate entity of Star Entertainment Group Limited utilizes the GAAP earning method. The particular rationale that has been provided by the executives of the particular airlines entity is that the utilization of the non-statutory metrics for the purpose of preparation of the financial statements have resulted in the resolving of the particular issues like the arrival at the adjusted underlying profit and is generally higher than the reported number that is arrived at, by utilizing GAAP. The management of the corporate entity further claims that the utilization of the Non-GAAP standards that is non-regulated and the non-audited standards have been more informative and reflective in nature (Baginski caes et al 2016).

On the other hand, the firm utilizing the traditional process of accounting that is the generally accepted accounting principles, have to go through a defined and detailed guideline of accounting standards for the purpose of preparing the financial statements. The reflection of the performance of the corporate entity is better reflected by the provision of the regulatory guidelines that has been established by the regulatory bodies in Australia. The Star Entertainment group has been utilizing the generally accepted accounting principles for the preparation of the financial statements. The management of the corporate entity has been of the opinion that the utilization of the accounting regulatory principles as prescribed by the regulatory bodies like the Australian Accounting Standards Board not only results in the preparation of the accounting statements that reflect a fair view of the financial position of the company but also help the firm to acquire the trust of the stakeholders thus increasing the number of potential shareholders of the firm. This can be further explained with the help of the fact that the preparation of the accounting statement on the basis of the prescribed accounting framework provides the stakeholders of the firm with the required level of trust and confidence in the financial position of the firm as they are aware of the particular guidelines that have been followed in regards to the preparation of the accounting statements (Baginski caes et al 2016).

The generally accepted accounting principles effectively reflect standards, regulations and rules that have been utilized by the standard setters for the purpose of governing the accounting practices and the preparation of the financial statements. The generally accepted accounting principles can be summarized as a set of accounting regulations that have been established for the purpose of financial reporting. These principles ensure the fundamental features of the books of accounts that are transparency, reliability and consistency. It can be further stated that GAAP imposes a certain degree of uniformity in the financial reporting. The utilization of the GAAP framework also ensures or facilitates the feature of comparability of the accounting statements (Bentley caes et al 2016).

GAAP earnings and Non-GAAP earnings

The particular figure that has been demonstrated above show the percentage in regards to the number of firms that utilize the Non-GAAP earnings method in the preparation of the financial statements. Furthermore, these are among the top 500 ASX listed firms. It can be observed that the percentage has declined in 2014.

However, it must be noted here that the particular feature of GAAP imposing a degree of uniformity over financial reporting has resulted in the negative effect over the corporations especially with substantial heterogeneity of economic and activities and the essential operations of business. This is because the earnings that are reported by these corporate entities in regards to the accounting system might fail to provide a reflection at the right time in regards to the underlying operating performance of the firm. Therefore, this has been the major reason behind the firms switching from GAAP to non-GAAP earnings mode (Bentley caes et al 2016).

The other reasons that can be cited behind the prevalence of the Non-GAAP earnings are that the firms, which are featured with low GAAP earnings, reflect less profit when utilizing the GAAP earnings method. Moreover, when the GAAP earnings are less relevant in regards to the value and where there has been a history of prior losses (Christensen caes et al., 2017).

However, this particular trend had been observed by the accounting regulatory bodies and the required amendments had been carried out by the regulatory bodies in Australia in order to increase the number of the firms adopting the generally accepted accounting principles or the particular standards that have been established by the Australian Accounting Standards Board in the reflection of the same. This can be further evidenced by the fact that particular reporting standards like the AASB 1018. Moreover, the particular announcement that the all publicly listed Australian companies will be mandatorily required to adopt the Australian standards equivalent to the International Financial Reporting Standards (Christensen caes et al., 2017).

The above graph depicts the firms providing proper disclosures for utilizing the Non-GAAP disclosure method. It must be noted here that the companies have been categorized on the basis of their industries.

In contrast to the GAAP reporting, the non-GAAP disclosures in the country of Australia have been largely unregulated in nature. A major reason behind this has been that the accounting standards and the Corporations Act do not necessarily restrict the presentation of the non-GAAP disclosures in the financial report of the organizations (Parrino 2016).

The feature of no restriction is a potential loophole that is utilized by firms for the purpose of preparing the financial report on the basis of Non-GAAP earning method. The regulators like the ASIC has mandated the adoption of the GAAP regulatory standards for the purpose of the preparation of the accounting statements.

Reasons for prevalence of Non-GAAP earnings

The above figure shows the mean and the median in regards to the GAAP and Non-GAAP earnings. Moreover, potential concerns were raised in regards to the Non-GAAP reporting when the particular scandal in relation to the corporate entities of Enron and WorldCom scandals came into the light. Therefore, it can be evidently concluded that the preparation of the financial statements on the basis of GAAP reporting is expected to be carried out by the financial entities (Parrino 2016).

It can also be stated that the importance of accounting disclosures that form an essential part of the GAAP regulations play a major role in helping the stakeholders and the third party investors to take the important economic decisions. This is because the accounting disclosures facilitate the true and fair view of the financial report of the corporate entity. This is not guaranteed by the non-GAAP earnings regulatory method.

This research study has been based upon secondary information that has been collected from different financial documents and academic journals. Therefore, the particular method that has been utilized for the purpose of conducting the required research in this particular study is that a number of academic journal articles have been referred to and other related financial or documents related to accounting have been considered. It must be noted here that the nature of the data that has been collected for this particular study is secondary in nature. This means that the information has not been derived from primary sources therefore, may suffer due to certain limitations. The particular limitations that this particular study is exposed to is that as information has not been collected from the primary sources the data is vulnerable to biasness, objectivity and error on the part of the researcher who has prepared the particular academic journal.

The method that has been applied to study the effect of the GAAP and Non GAAP earning announcement on the share price of the selected companies are the event study method. The statistical methodology and process are applied for performing event study analysis. The most common model that is used for the event study is the market model. In this method, the actual return of the baseline reference and the stock is compared to understand the effect of the event.  The event study aims to measure the effect on valuation because of corporate announcement. It is a process of measuring the response of the share price movement in case of a merger or earning announcement. The main assumption of this theory is that the market process the information in an efficient and unbiased manner. This helps in analyzing the effect of event in the share price of the company.

Mandatory requirement of adopting the Australian standards

The share price data of the selected company Qantas and Start Entertainment group have been collected from the Bloomberg. In the obtained data, the actual return and abnormal return are provided to verify the effect of GAAP and NON GAAP earning announcement on the share price of the company. The measurement of abnormal return is crucial for assessing the impact of an event. The abnormal event can be defined as the difference between expected return in the absence of the event and the actual realized return.

Qantas Group
Date	Change in GAAP Earning	Change in NON GAAP Earning	T Test
30-06-10	-4.50%	-98.20%	0.72
31-12-10	372.80%	124.10%	0.40
30-06-11	-95.90%	42.20%	2.14
31-12-11	365.40%	-86.50%	-0.68
30-06-12	-784%	-41.80%	-1.70
31-12-12	-138.20%	629.20%	-0.87
30-06-13	-196.80%	-150.40%	-1.21
31-12-13	97.50%	133.80%	0.45
30-06-14	1001.90%	43.20%	3.20
31-12-14	-107.60%	-159.10%	0.69
30-06-15	53.30%	113.70%	-1.09
31-12-15	79.70%	15.50%	2.64
30-06-16	-49.70%	-17.10%	-1.35
31-12-16	55%	3.50%	-0.51

The table and the figure above indicates the relationship between the announcement and the movement in the return of the share price from the expected return. It can be clearly seen from T test that the market reacts more to the results of the GAAP earning than the NON GAAP earnings. Therefore, in case of Qantas share price reacts to the GAAP earnings more than the NON GAAP earnings.

Star entertainment Group
Date	Change in GAAP Earning	Change in NON GAAP Earning	T Test
31-12-11	-9.10%	-11.40%	8.76
30-06-12	-140%	-63.70%	1.07
31-12-12	-338.90%	201.30%	3.19
30-06-13	-75.00%	-31.40%	0.37
31-12-13	146.10%	-21.80%	4.17
30-06-14	29.70%	141.40%	-2.92
31-12-14	56.90%	-2.30%	3.34
30-06-15	-34.70%	-17.00%	2.27
31-12-15	22.80%	23.50%	-0.19
30-06-16	125.90%	-29.40%	0.05
31-12-16	9%	11.30%	0.03
30-06-17	-13.50%	0.40%	-0.15
31-12-17	-72.30%	15.80%	-0.17

The table above provides the data related to the star entertainment group. The figure above shows the relationship between the earning announcement and the share price movement. The figure above clearly shows that in case of star entertainment group the share price is more effected with the NON GAAP earning announcement.

Conclusion

The particular conclusion that can be derived from the information that has been derived from the preceding paragraphs is that though non-GAAP reporting looks lucrative and is favored by the executives , the prevalence of GAAP reporting is accepted and honored by the majority of the corporate entities in Australia.  However, the analysis above shows that investor in case of Qantas Group is more reactive to the GAAP earning announcement where as in case of SGR the investors reacts more to NON GAAP earning announcements.

References

Baginski, S., Demers, E., Wang, C., Yu, J., Jiang, D., Kumar, A. and Law, K.K., 2016. Using adverse-selection cost as a proxy for information asymmetry, we find evidence that non-GAAP earnings numbers issued by management (pro forma earnings) and analysts (street earnings) improve price discovery. First, information asymmetry before an earnings announcement is positively associated with the probability of a non-GAAP earnings number at the forthcoming earnings announcement. Second,... Review of Accounting Studies, 21(1), pp.198-250.

Bentley, J.W., Christensen, T.E., Gee, K.H. and Whipple, B.C., 2016. Disentangling managers’ and analysts’ non-GAAP reporting incentives.

Bhattacharya, N., Christensen, T., Liao, Q. and Ouyang, B., 2015. Can Short Sellers Constrain Opportunistic Non-GAAP Earnings Reporting?.

Black, E.L., Christensen, T.E., Kiosse, P.V. and Steffen, T.D., 2017. Has the Regulation of Non-GAAP Disclosures Influenced Managers’ Use of Aggressive Earnings Exclusions?. Journal of Accounting, Auditing & Finance, 32(2), pp.209-240.

Black, E.L., Christensen, T.E., Taylor Joo, T. and Schmardebeck, R., 2017. The Relation Between Earnings Management and Non?GAAP Reporting. Contemporary Accounting Research, 34(2), pp.750-782.

Christensen, T., Pei, H., Pierce, S. and Tan, L., 2017. Non-GAAP reporting following debt covenant violations.

Guest, N.M., Kothari, S.P. and Pozen, R., 2017. High Non-GAAP Earnings Predict Abnormally High CEO Pay.

Isidro, H. and Marques, A., 2015. The role of institutional and economic factors in the strategic use of non-GAAP disclosures to beat earnings benchmarks. European Accounting Review, 24(1), pp.95-128.

Parrino, R.J., 2016. New compliance guidance by SEC staff signals increased scrutiny of non-GAAP financial measures. Journal of Investment Compliance, 17(4), pp.23-33.

Twardus, I. and Bhattacharjee, S., 2018. Effect of Non-Gaap Emphasis and Voluntary Disclosures on Nonprofessional Investor Decision Making in the Equity Crowdfunding Environment