Financial reporting: the alphabet soup

Posted by Mark Fuchs, Chief Accountant

Warning: Financial reporting minutiae below. Proceed with caution.

We're going to provide a bit more information with our October 20 earnings announcement. In this and future announcements, we're going to include a so-called pro-forma, or non-GAAP, diluted earnings per share (EPS) number as a supplement to our GAAP EPS number.

In the past, we've only provided GAAP EPS. But because Wall Street analysts typically estimate and describe our results with non-GAAP EPS numbers, that resulted in some confusing apples-to-oranges analyses of our results. (By the way, we review non-GAAP results when we analyze our own performance.) By providing both, we hope it will be easier to understand our results.

Now, if you’ve got your green eyeshade handy, read on. What follows is in accountant-speak.

Earnings per share is calculated by dividing profit (net income) by the number of outstanding shares. That's GAAP. To compute our non-GAAP EPS, we’ll add back to our net income things such as charges for stock-based compensation. (Before adding back stock-based compensation – or other certain charges – we’ll factor in related taxes. What does that mean? When we add back a charge, we subtract the tax benefit related to it that we would get under GAAP accounting. In other words, in the non-GAAP calculation we don't want to include the GAAP tax benefit.) After tax-affecting the charges and then adding them back to net income, we'll take that sum, divide it by outstanding shares and come up with our non-GAAP EPS number.

To illustrate all of this with a fictitious example, let's assume these imaginary data points:

• GAAP net income - $300 million
• Stock-based compensation charge - $100 million (note that other charges in addition to stock-based compensation may be excluded from the computation and presentation of our non-GAAP results as appropriate in the future)
• Tax affect of stock based compensation charge - $35 million
• Shares outstanding for Google - 600 million

To get our GAAP EPS, we would simply divide $300 million GAAP net income by the 600 million shares outstanding and arrive at a GAAP EPS of $0.50.

$300,000,000 / 600,000,000 = $0.50

Now, to get the non-GAAP EPS, we would:

1. Subtract the $35 million tax affect from the $100 million stock-based compensation charge to arrive at $65 million
2. Add that $65 million to the $300 million GAAP net income for a new, non-GAAP net income of $365 million
3. Divide $365 million by 600 million shares outstanding and get a non-GAAP EPS of $0.61.

($300,000,000 + ($100,000,000 - $35,000,000)) / 600,000,000 = $0.61

As if this weren't complicated enough, we should note that most, if not all, analysts have historically computed our non-GAAP earnings by adding stock-based compensation to net income without tax-affecting the charge. As a result, when we provide our non-GAAP EPS number, we may be adding back less to compute our non-GAAP earnings than will most of the analysts.

Using the same set of imaginary numbers, analysts might, for example:

1. Add the full $100 million stock-based compensation charge to the GAAP net income of $300 million and arrive at their non-GAAP net income of $400 million
2. Divide that by outstanding shares and arrive at non-GAAP EPS (for the fictitious example, $0.67 per share)

($300,000,000 + $100,000,000) / 600,000,000 = $0.67

Congratulations to those of you who were able to make it this far. We're sorry for the density, but this is dense stuff and we've got to be comprehensive in our explanation of it.