This is an MIT Sloan Management Review article. For decades, companies have used custom metrics that don't conform to generally accepted accounting principles (GAAP) or international financial reporting standards (IFRS) as supplements to their official financial statements. Some common non-GAAP measures include adjusted earnings before interest, taxes, depreciation, and amortization (known as adjusted EBITDA), free cash flow, funds from operations, adjusted revenues, adjusted earnings, adjusted earnings per share, and net debt. However, as the authors point out, it's not unusual for these alternative measures to lead to problems. Since companies devise their own methods of calculation, it's difficult to compare the metrics from company to company -or, in many cases, from year to year within the same company. According to the authors, alternative measures, once used fairly sparingly and shared mostly with a small group of professional investors, have become more ubiquitous and further and further disconnected from reality. In 2013, McKinsey & Co. found that all of the 25 largest U.S.-based nonfinancial companies reported some form of non-GAAP earnings. Press releases and earnings-call summaries often present non-GAAP measures that are increasingly detached from their GAAP-based equivalents. In addition to creating potential problems for investors, the authors argue, alternative metrics can harm companies themselves by obscuring their financial health, overstating their growth prospects beyond what standard GAAP measures would support, and rewarding executives beyond what is justified. Board members, top executives, compliance officers, and corporate strategists need to make sure that whatever alternative measures companies use improve transparency and reduce bias in financial reports. Although no standard is perfect, the authors note that GAAP and IFRS standards provide a foundation for consistent measurement of corporate performance over time and across businesses.

In October 2016, Apple Inc. announced the financial results for its fiscal year 2016. CEO Tim Cook commented on a very successful fiscal year 2016 and focused on all the positive financial results. However, Apple's 2016 annual report was also telling another story. Apple's total revenue had decreased 9% and iPhone revenue decreased 13% compared to the fourth quarter of fiscal year 2015. Apple also faced some criticism from consumers regarding the iPhone 6 and IPhone 6 Plus Upgrade Program. A September 2016 survey reported that an increasing number of customers decided to subscribe to the iPhone Upgrade Program. In spite of this, the company was very supply constrained on the iPhone 7 and 7 Plus and financial analysts were still eager to receive more information on the impact of the iPhone Upgrade Program on Apple's financials.

On September 9, 2015, Apple Inc. announced the "iPhone Upgrade Program," a new way to purchase iPhone models 6s and 6s Plus in Apple's retail stores throughout the U.S. Next to the strategic implications of the Upgrade Program, financial analysts tried to understand the accounting implications, especially the recognition of revenue, which the Upgrade Program could have on Apple's financials. Analysts' reactions to the disclosure were mixed. Was Apple's accounting system "right" for the iPhone Upgrade Program introduced in 2015?

In a perfect world, investors, board members, and executives would have full confidence in companies' financial statements. They could rely on the numbers to make intelligent estimates of the magnitude, timing, and uncertainty of future cash flows and to judge whether the resulting estimate of value was fairly represented in the current stock price. And they could make wise decisions about whether to invest in or acquire a company, thus promoting the efficient allocation of capital. Unfortunately, that's not what happens in the real world, for several reasons. First, financial statements necessarily depend on estimates and judgment calls that can be widely off the mark, even when made in good faith. Second, standard financial metrics intended to enable comparisons from one company to another often fall short, giving rise to unofficial measures that have their own problems. Finally, executives routinely face strong incentives to manipulate financial statements. In recent years, we've seen the implosion of Enron, the passage of the Sarbanes-Oxley Act, the 2008 financial crisis, the adoption of the Dodd-Frank regulations, and the launch of a global initiative to reconcile U.S. and international accounting regimes. Meanwhile, the growing importance of online platforms has dramatically changed the competitive environment for all businesses. In this article, the authors examine the impact of those developments and consider new techniques to combat the gaming of performance numbers.

This is an MIT Sloan Management Review article. Just as sports teams have increasingly relied on rigorous quantitative analyses, so have many businesses. In particular, a growing number of service organizations have been investigating the use of a sophisticated linear programming technique called DEA, or data envelopment analysis. (In this article, the authors use the term "balanced benchmarking"to denote DEA.) The technique enables companies to benchmark and locate best practices that are not visible through other commonly used management methodologies. Today, balanced benchmarking can be used by anyone with Microsoft Excel, but it was not always so easy. When it was first introduced in the 1980s, balanced benchmarking was an academic tool for measuring and managing relative efficiency of peer organizations. Balanced benchmarking simultaneously considers the multiple resources used to generate multiple services, along with the quality of the services provided. It also provides managers with a sophisticated mechanism to assess the performance of different service providers -comparing, for example, the London and Tokyo offices of a global advertising agency -by going well beyond crude metrics and ratios such as profitability and account billings per employee. A company can identify its least efficient offices or business units, and it can assess the magnitude of the inefficiency and investigate potential paths for improvement. Moreover, executives can study the top-performing units, identify the best practices and transfer that valuable knowledge throughout the organization. Lastly, balanced benchmarking enables companies to test their assumptions, particularly before implementing initiatives that might inadvertently be counterproductive.

Who would want to join the audit committee of a board of directors? Wouldn't that just mean slogging through the minutiae of Sarbanes-Oxley compliance? Not anymore. Audit teams have pretty much mastered SOX compliance; they're now turning their attention to the meaty problems of increasing business value. To do that, say Northeastern University professor Sherman, Korn/Ferry's Carey, and Sprint CFO Brust, audit teams need a broader range of expertise. Four areas in particular cry out for new blood. Someone, the authors argue, needs to decipher financial guesstimates. GM reported a $3 billion loss in the second quarter of 2006, which it adjusted to a $1 billion profit. Why was that? Things might have gone differently last winter if the company's audit committee had explored the assumptions that GM's managers had used to come up with those kinds of disparate figures. Second, someone needs to keep an eye on M&A performance. Managers today have unprecedented discretion in determining estimates of an acquisition's fair market value, but such calculations clearly warrant greater scrutiny, since fully half of all mergers and acquisitions consistently fail to live up to expectations. Third, someone has to objectively analyze the myriad new risks facing businesses today. Imagine how altered the current economic climate might be if audit committees at Merrill Lynch or Lehman Brothers had recommended limiting their investments in mortgage-backed securities. Last, someone has to make sense of the difference between accounting standards used in Europe and those used in the United States and understand how those standards cloud companies' abilities to reward executives and accurately assess their own performance relative to rivals'.

In the current economic climate, there is tremendous pressure--and personal incentive for managers--to report sales growth and meet investors' revenue expectations. As a result, more companies have issued misleading financial reports, according to the SEC, especially involving game playing around earnings. But it's shareholders who suffer from aggressive accounting strategies; they don't get a true sense of the financial health of the company, and when problems come to light, the shares they're holding can plummet in value. How can investors and their representatives on corporate boards spot trouble before it blows up in their faces? According to the authors, they should keep their eyes peeled for common abuses in six areas: revenue measurement and recognition, provisions and reserves for uncertain future costs, asset valuation, derivatives, related party transactions, and information used for benchmarking performance. This article examines the hazards of each accounting minefield, using examples like Metallgesellschaft, Xerox, MicroStrategy, and Lernout & Hauspie. It also provides a set of questions to ask to determine where a company's accounting practices might be overly aggressive. These questions are the first line of defense against creative accounting. The authors argue that members of corporate boards need to be financially literate.

Many executives have attempted to simplify the reporting procedures of fund accounting by using business practices. However, nonprofit enterprises have financial structures and objectives different from those of business. Managers of nonprofit institutions need greater familiarity with the requirements of nonprofit financial structures and accounting practices. A review of the components of fund accounting and an illustrative case help clarify the principles.