pro forma earnings Income not necessarily calculated in accordance with generally accepted accounting principles. For example, a company might report pro forma earnings that exclude depreciation expense and nonrecurring expenses such as restructuring costs. In general, pro forma earnings are reported in an effort to put a more positive spin on a company's operations. Case Study Unlike net income reported in audited financial statements according to generally accepted accounting principles, pro forma earnings are calculated in any number of ways because there is no generally accepted definition for this measure of earnings. Companies may inflate pro forma earnings by omitting certain expenses, such as stock compensation, interest payments, and amortization of intangible assets. The result is a hodgepodge of earnings calculations that are not consistent from company to company or, for the same company, from year to year. In early 2001 Amazon.com released quarterly pro forma results that omitted writedowns of impaired assets, interest expense, and losses on equity investments. The latter item had been a particularly important source of income for many Internet and technology-based companies when the stock market was booming rather than swooning. According to Amazon.com officials, the firm's quarterly U.S. pro forma operating loss narrowed to $16 million while its overall pro forma operating loss amounted to $60 million. At the same time the company reported that the net loss calculated according to generally accepted accounting principles was $545 million. Critics contended that companies were emphasizing whichever measure of earnings produced the most favorable result. The controversy over reported earnings caused a group of financial executives to begin work on developing a standard for pro forma earnings. The group was at work at the time the Amazon.com results were released. In late 2001 the Securities and Exchange Commission issued a warning that companies issuing misleading pro forma earnings could face civil fraud suits. On January 16, 2002, the SEC instituted its first enforcement action addressing the abuse of pro forma earnings when it initiated proceedings against Trump Hotels & Casino Resorts, Inc., for making misleading statements in the firm's third-quarter 1999 earnings release. The SEC found that the release cited pro forma figures to tout the firm's purportedly positive results of operations while failing to disclose that the results were primarily attributable to an unusual one-time gain rather than to operations. The SEC also found that the company, through its chief executive officer, chief financial officer, and treasurer, violated the antifraud provisions of the Securities Exchange Act by knowingly or recklessly issuing a materially misleading press release. |