Budapest Post

Cum Deo pro Patria et Libertate
Budapest, Europe and world news

Accounting GAAP: Why digital companies struggle with reporting standards

Accounting GAAP: Why digital companies struggle with reporting standards

The legacy accounting system often misses the mark for many businesses. 

CFOs of digital companies face a dilemma every time they release their companies’ quarterly and annual reports — the metrics most informative of their companies’ health are in their pro forma reports and not in their income statement and other reports that follow traditional GAAP accounting standards.

But if they go into too much detail in their non-GAAP reports, they risk tipping off competitors to sensitive proprietary information.

“You don’t want too much non-GAAP data given to the public because it exposes the business’ inner workings,” Patrick Gildea, CFO of digital media company GumGum, told CFO Dive. GumGum is a private company, but Gildea previously led the finance operation of publicly traded Blackhawk Network. “It’s dangerous having competitors get access to that kind of data.”

And yet if CFOs were to rely solely on traditional GAAP reports, the true measure of how their companies are doing would be obscured.

“Financial reporting standards have fallen into disrepute as means of understanding current operating performance,” Michael Kwatinetz, managing partner with Azure Capital partners, said in a widely referenced blog post he wrote for CIO Network several years ago. Investors, he said, “rely on pro forma results instead of GAAP accounting, because they find pro forma statements provide more insight into the overall performance and health of a company.”


Widening gap


The gap between GAAP - Generally Accepted Accounting Principles - and non-GAAP metrics has been widening for decades, as dominance in the economy has shifted from the industrial companies GAAP was designed for and today’s digital companies.

At the core of the divide is how intangible assets - research and development, brand identity, social networks and staff expertise - that are so important to digital companies are treated by GAAP: as regular expenses rather than as investments that can be depreciated the way manufacturing companies can depreciate their plant and equipment.

As a result, the income statement, which is the traditional front line of a firm’s public reporting, poses valuation problems for a lot of companies. “The net income statement doesn’t include a lot of a company’s true value,” said Mary Barth, professor of accounting emerita at the Stanford Graduate School of Business. “So net income itself has become less relevant to shareholders,” Barth told CFO Dive.

A key example is GAAP's treatment of research and development as an expense. “It’s not recognized as an investment,” Barth said, “yet it's an investment that may have (significant) future value.”

Accounting for sales and marketing costs also poses a problem. According to John Bonney, CFO of digital software company Harness, those costs might be high when a young enterprise is growing its customer base, but then level off in later years after the base is established. That can lead to very high losses in early years and very high revenue in later years. Both exaggerate and distort the real financial status of the firm.

All too often, Barth said, digital companies will show rapid sales growth, have vast resources invested in R&D, and build a pipeline of future customers through an exponentially growing social network, yet show losses year after year. “It looks like they’re losing money when in fact they’re really just investing,” said Barth.

Accounting for this and other differences between the two types of measures has led to an awkward system in which companies are forced to come up with a slew of non-GAAP items that typically get tucked away in footnotes or discussion sections of a financial report.

These non-GAAP items include bookings and growth rates. It also includes dollar-based net expansion rates, which Bonney said is a great predictor of growth and profitability. “Almost every software company is disclosing it now,” Bonney said to CFO Dive.


System needs tweaking

The consequence of this tiered treatment is a lack of transparency that can harm retail investors, public investors, analysts, private investors, job seekers, the media, and other users of financial information, including the general public.

Even the company can be harmed if its GAAP numbers make it more difficult to attract top quality talent or tarnish a company’s reputation among customers and suppliers.

The problems are especially acute when the company is a recent IPO or simply young. “The younger the company, the less they look at GAAP measures and the more they look at other metrics,” said Bonney. In these cases, the income statement is increasingly disregarded or, at least, relegated to a lower status by investors.

And yet no one is suggesting the system should be thrown out completely. “GAAP is very useful as a baseline standard,” said Bonney. “It’s not perfect, but it’s evolved over time to address the new industries.” He cited ASC- 606, issued in 2014 by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), as helpful guidance for digital companies on revenue recognition issues.

“As bad as the GAAP system is, it’s still a very good foundation on which to build,” Barth said. “No one wants to throw it out and start with something new.”

There appears to be no immediate change on the horizon. Instead, the problem is being addressed in incremental steps, as standards-setting boards issue guidance, memo by memo, over time. The reason for the incremental pace isn’t clear, but, according to Barth, companies, analysts and other groups are simply slow to accept change.

“It takes standards setters a long time to win hearts and minds, because people are used to doing things one way and not so keen to change things,” she said.

But as more companies become digitized or otherwise migrate from the legacy business model, the GAAP accounting dilemma will likely worsen. More industries are starting to look like technology firms. Even manufacturing and financial services companies are increasingly technology-intensive.

“The new economy companies are definitely growing in number,” Barth said. “Technology is pervading a lot of industries now. So the problem needs to be addressed.”

AI Disclaimer: An advanced artificial intelligence (AI) system generated the content of this page on its own. This innovative technology conducts extensive research from a variety of reliable sources, performs rigorous fact-checking and verification, cleans up and balances biased or manipulated content, and presents a minimal factual summary that is just enough yet essential for you to function as an informed and educated citizen. Please keep in mind, however, that this system is an evolving technology, and as a result, the article may contain accidental inaccuracies or errors. We urge you to help us improve our site by reporting any inaccuracies you find using the "Contact Us" link at the bottom of this page. Your helpful feedback helps us improve our system and deliver more precise content. When you find an article of interest here, please look for the full and extensive coverage of this topic in traditional news sources, as they are written by professional journalists that we try to support, not replace. We appreciate your understanding and assistance.
Newsletter

Related Articles

0:00
0:00
Close
Vatican hosts first Catholic LGBTQ pilgrimage
Apple Unveils iPhone 17 Series, iPhone Air, Apple Watch 11 and More at 'Awe Dropping' Event
France joins Eurozone’s ‘periphery’ as turmoil deepens, say investors
France Faces New Political Crisis, again, as Prime Minister Bayrou Pushed Out
Nayib Bukele Points Out Belgian Hypocrisy as Brussels Considers Sending Army into the Streets
France, at an Impasse, Heads Toward Another Government Collapse
The Country That Got Too Rich? Public Spending Dominates Norway Election
EU Proposes Phasing Out Russian Oil and Gas by End of 2027 to End Energy Dependence
More Than 150,000 Followers for a Fictional Character: The New Influencers Are AI Creations
EU Prepares for War
Trump Threatens Retaliatory Tariffs After EU Imposes €2.95 Billion Fine on Google
Tesla Board Proposes Unprecedented One-Trillion-Dollar Performance Package for Elon Musk
Gold Could Reach Nearly $5,000 if Fed Independence Is Undermined, Goldman Sachs Warns
Uruguay, Colombia and Paraguay Secure Places at 2026 World Cup
Trump Administration Advances Plans to Rebrand Pentagon as Department of War Instead of the Fake Term Department of Defense
Big Tech Executives Laud Trump at White House Dinner, Unveil Massive U.S. Investments
Tether Expands into Gold Sector with Profit-Driven Diversification
‘Looks Like a Wig’: Online Users Express Concern Over Kate Middleton
Florida’s Vaccine Revolution: DeSantis Declares War on Mandates
Trump’s New War – and the ‘Drug Tyrant’ Fearing Invasion: ‘1,200 Missiles Aimed at Us’
"The Situation Has Never Been This Bad": The Fall of PepsiCo
At the Parade in China: Laser Weapons, 'Eagle Strike,' and a Missile Capable of 'Striking Anywhere in the World'
The Fashion Designer Who Became an Italian Symbol: Giorgio Armani Has Died at 91
Putin Celebrates ‘Unprecedentedly High’ Ties with China as Gazprom Seals Power of Siberia-2 Deal
China Unveils New Weapons in Grand Military Parade as Xi Hosts Putin and Kim
Rapper Cardi B Cleared of Liability in Los Angeles Civil Assault Trial
Google Avoids Break-Up in U.S. Antitrust Case as Stocks Rise
Couple celebrates 80th wedding anniversary at assisted living facility in Lancaster
Information Warfare in the Age of AI: How Language Models Become Targets and Tools
The White House on LinkedIn Has Changed Their Profile Picture to Donald Trump
"Insulted the Prophet Muhammad": Woman Burned Alive by Angry Mob in Niger State, Nigeria
Trump Responds to Death Rumors – Announces 'Missile City'
Druzhba Pipeline Incident Sparks Geopolitical Tensions
Cost of Opposition Leader Péter Magyar's Economic Plan Revealed
Germany in Turmoil: Ukrainian Teenage Girl Pushed to Death by Illegal Iraqi Migrant
United Krack down on human rights: Graham Linehan Arrested at Heathrow Over Three X Posts, Hospitalised, Released on Bail with Posting Ban
Asian and Middle Eastern Investors Avoid US Markets
Ray Dalio Warns of US Shift to Autocracy
Eurozone Inflation Rises to 2.1% in August
Russia and China Sign New Gas Pipeline Deal
Von der Leyen's Plane Hit by Suspected Russian GPS Interference in an Incident Believed to Be Caused by Russia or by Pro-Peace or by Anti-Corruption European Activists
China's Robotics Industry Fuels Export Surge
Suntory Chairman Resigns After Police Probe
Gold Price Hits New All-Time Record
UK Fintechs Explore Buying US Banks
Greece Suspends 5% of Schools as Birth Rate Drops
Apollo to Launch $5 Billion Sports Investment Vehicle
Bolsonaro Trial Nears Close Amid US-Brazil Tension
European Banks Push for Lower Cross-Border Barriers
Poland's Offshore Wind Sector Attracts Investors
×