Accounting has been on my mind a lot these last few days. A colleague recently asked me to review his pitch deck for a prospective attorney client. We ended up spending time in discussing a slide about pension accounting. I suggested that he move the focus away from accounting-driven balance sheet risk and instead discuss the economic implications of an underfunded plan. Let's leave aside for now that we could have a lengthy and complex discussion about how to properly measure a shortfall - whether for a defined benefit plan or a defined contribution plan. Instead, I would like to reiterate that economic numbers are seldom the same as accounting numbers.
Let me repeat.
Economic numbers are not necessarily the same as accounting numbers. That's not to say that one is bad and the other is good. So much depends on the objective at hand. If I am a risk manager and need to plan for adequate cash on hand, a historical accounting number is not sufficient. Furthermore, accounting numbers can be based on a set of rules or driven by a collection of principles. I will likewise leave a discussion of the merits of Generally Accepted Accounting Principles ("GAAP"), non-GAAP reporting, international accounting standards and hybrid approaches for another day. Until then, interested readers can check out "Principles vs Objectives-Based Accounting Systems," excerpted from "2012 Current Developments Update: Accounting & Financial Reporting" by Steven C. Fustolo, In a similar vein, if you would like to get a snippet of the concept that actuarial numbers are not necessarily the same as economic numbers, you can read "Will the Real Pension Deficit Please Stand Up?" by Susan Mangiero (June 22, 2006). While written before the Pension Protection Act of 2006 was signed into law by President George W. Bush on August 17, 2006, the notion about actuarial representations versus economic reality remains valid today. Complicating things is that actuarial numbers themselves can vary by virtue of inputs and model selection but I digress.
The important message is that one needs to understand how numbers are assembled, what they represent and, just as critical for proper decision-making, what they do not include. Moreover, it is essential to understand that accounting numbers can vary across countries, across sectors such as private versus public and over time.
Consider a November 11, 2013 statement from Fitch Ratings, Ltd. that predicts a likely jump in reported defined benefit plan provisions for 2013 as the result of a revised standard known as International Accounting Standard ("IAS") 19 on Employee Benefits. Authors of "German Corporates Most Affected by Pension Accounting" - John Boulton, Alex Griffiths and Cynthia Chan - write that "as there would be no change to the economics of a company's pension obligation, the new rules should not change our analysis or ratings." However, if an investor is comparing financial statements for a German company with a non-German competitor that utilizes a different way to create year-end and quarterly data, it will be necessary to make adjustments. Otherwise, the financial statement user is unable to make an evaluation on an apples-to-apples basis. In addition, it is important that the accounting numbers be converted to metrics that allow the investor to evaluate required cash flow, anticipated impact on debt service and other types of economic risks that are associated with the sponsor's offering of a benefit plan(s).
Another recent example of allowable story-telling about benefits that merits further analysis comes courtesy of Gretchen Morgenson. In "Earnings, but Without the Bad Stuff" (November 9, 2013), this New York Times muckraker describes the use of Regulation G by Twitter to present a second set of operating results "through the eyes of management" by lopping off $79 million stock-based compensation expense for Q1 through Q3 2013. She cites Jack T. Ciesielski, publisher of The Analyst's Accounting Observer, as saying that 'When they back out stock-based compensation they're basically saying that management is working for free...And we know that's not the case." Click to download the final amendment to the Twitter prospectus and visit the section entitled "Reconciliation of Net Loss to Adjusted EBITDA." You will see that, for the first nine months of 2013, a net loss of roughly $133.852 million is the top line. Then $79.170 million is added back, along with $77.670 million for depreciation and amortization expense. Another $6.203 million is added back for interest and other expense. Adding back $1.494 million as a provision for income taxes results in an Adjusted EBITDA of $30.685 million.
For all of the investors that include pension funds, endowments, foundations and family offices with allocations to organizations that are large shareholders of the now public 140-character communications company, they may want to ask about how different numbers were parsed. According to the Washington Post (November 6, 2013), Twitter's major shareholders include Benchmark Capital, JPMorgan and Rizvi Traverse.