As we mentioned in this post, on December 13, 2022, the SEC updated several non-GAAP Compliance and Disclosure Interpretations.  One of the updates relates to a frequent comment area, the use of “tailored accounting principles.”  This can be a complex issue:

Question 100.04

Question: Can a non-GAAP measure violate Rule 100(b) of Regulation G if the recognition and measurement principles used to calculate the measure are inconsistent with GAAP?

Answer: Yes. By definition, a non-GAAP measure excludes or includes amounts from the most directly comparable GAAP measure. However, non-GAAP adjustments that have the effect of changing the recognition and measurement principles required to be applied in accordance with GAAP would be considered individually tailored and may cause the presentation of a non-GAAP measure to be misleading. Examples the staff may consider to be misleading include, but are not limited to:

• changing the pattern of recognition, such as including an adjustment in a non-GAAP performance measure to accelerate revenue recognized ratably over time in accordance with GAAP as though revenue was earned when customers were billed;

• presenting a non-GAAP measure of revenue that deducts transaction costs as if the company acted as an agent in the transaction, when gross presentation as a principal is required by GAAP, or the inverse, presenting a measure of revenue on a gross basis when net presentation is required by GAAP; and

• changing the basis of accounting for revenue or expenses in a non-GAAP performance measure from an accrual basis in accordance with GAAP to a cash basis. [December 13, 2022]

As an example, consider this disclosure in an S-4 by Bowlero Corp. that reconciles from net income to adjusted EBITDA.  In particular, look at the adjustment to rent expense.

In its description of the “Contra rent expense” adjustment, the company said:

Represents Net income (Loss) before Interest, Income Taxes, Depreciation and Amortization, …… with Contra Rent Expense accounting for Rent on a cash basis (Cash Rent Expense).

This generated the following SEC comment:

1. 22. We note the adjustment Contra Rent Expense which you state is accounting for rent on a cash basis. Please further clarify for us in further detail how this adjustment is calculated. Additionally, please tell us how this adjustment complies with Question 100.04 of the Staff’s Compliance and Disclosure Interpretations on Non-GAAP Financial Measures.

After an initial response and this follow-up comment, the company removed the “Contra rent expense adjustment” from adjusted EBITDA:

5. We note your response to our prior comment number 22. You state that “Contra rent expense is an adjustment to report rent expense on a cash basis.” By making this adjustment you are substituting an individually tailored recognition and measurement method to record rent expense instead of GAAP rent expense which is prohibited by Question 100.04 of the Staff’s Compliance and Disclosure Interpretations on Non- GAAP Financial Measures. Accordingly, please revise to remove this adjustment.

As always, your thoughts and comments are welcome!