European Firms Are Embracing Practice of Pro Forma Accounting
LONDON -- At a time when U.S. regulators are increasingly warning against the use of pro forma accounting, some of Europe's biggest companies are enthusiastically exploring its possibilities.
Finnish mobile-phone company Nokia Corp., for example, was able to highlight third-quarter pretax profit of nearly 1.1 billion euros ($984.3 million) on a pro forma basis when it issued results in October. But actual pretax profit, based on International Accounting Standards, was 281 million euros.
The use of pro forma results became a trademark of many U.S. Internet companies in the late 1990s; in short, these are results presented "as if" certain items -- usually expenses or losses, running the gamut from restructuring charges to asset write-downs -- didn't exist. But analysts and accountants are worried by the fact that big, respected European companies are now embracing the practice. "Companies like Nokia ... are inflating their results," maintains Per Lindberg, an analyst at Dresdner Kleinwort Wasserstein.
Nokia Surprises Market Watchers With Revised Earnings Outlook (Dec. 11, 2001)
SEC Warns Against Improper Use of 'Pro Forma' Financial Results (Dec. 5)
A spokeswoman for Nokia disagrees, saying "there shouldn't be any confusion" between the pro forma and IAS results; the pro forma results are clearly marked and run parallel to the audited results in the tabulated results. "We very clearly tell what the difference is" between the pro forma numbers and the audited results, she says. Moreover, the release of pro forma figures comes on the back of investor demand for clearer insight into the company's operations. "We have received a lot of good feedback" from investors about how results are presented, she says.
Pro forma reporting can play a role -- and indeed is sometimes mandatory -- when investors are looking at accounts involving acquisitions or mergers. But widespread criticism of other sorts of pro forma results by U.S. companies in their earnings news releases led to an alert from the Securities and Exchange Commission last month that this could "mislead investors if it obscures generally accepted accounting principles." SEC Chairman Harvey Pitt has said the agency is eyeing enforcement action.
In the United Kingdom, the Financial Services Authority makes a long list of items companies must have in investor releases, but doesn't force companies to give this information more prominence than other data prepared to different standards. A spokeswoman for the FSA says there are no plans at present for an overhaul. In Germany, awareness of the issue is only just emerging. The German accounting standards board has yet to debate the issue although it is monitoring it.
Meanwhile, more and more European companies are engaging in the practice. A study of pro forma accounting in the U.K. by Company Reporting Ltd., an Edinburgh, Scotland, independent financial research company, showed that not only is the practice growing, but the bigger the company, the more likely it was to produce pro forma accounts. A sample of about 400 large and midsize companies showed that from 1999 to 2001 the proportion producing pro forma accounts increased to 9% from 6%. But among major companies, the proportion was even higher: Of the most-recent 78 blue-chip companies to be analyzed, 22 of them, or 28%, produced pro forma figures, according to Company Reporting.
In Germany the practice, although rare on the main board, has been adopted with enthusiasm by companies listing on the Neuer Markt. One study in a professional journal found no difficulty in rounding up 40 such companies.
John Mackey, a partner of Ernst & Young France, believes more European companies will use pro forma figures. He says that as accounting standards become more rigorous and standardized across Europe, companies will have less and less room to maneuver in their official figures. At that point they will be looking for new ways to give "more positive information" to investors, especially as a U.S-style investor culture takes root in Europe beyond the U.K.
He says the key problem is when management put the accent on pro forma numbers prepared on a subjective basis, with unpleasant items disregarded on the grounds that they are deemed nonrecurring, which he says is a particularly difficult term to define.
Not all uses of pro forma accounting are particularly egregious, analysts say. Company Reporting's survey of the U.K. showed that more than half of the pro forma accounts were due to major purchases or disposals, the least-controversial use of pro forma figures. In fact, some European markets such as France require pro forma figures to be produced in such circumstances. Mr. Mackey says, for instance, that without pro forma reports, investors could never have understood the first years of European Aeronautic Defence & Space Co. NV, a company that pooled assets from France, Germany and Spain in 2000 to create Europe's biggest military and aerospace group. |
