Adjusted long term expense

What Is Adjusted Long-Term Expense?

Adjusted long-term expense refers to a company's expense figures that have been modified from their reported values, typically to provide a clearer view of recurring operational performance. It falls under the broader category of financial accounting, specifically related to the analysis of a company's financial statements. These adjustments often remove non-recurring, unusual, or non-cash items that might otherwise obscure the underlying profitability or cash flow generation of the business. Analysts and investors frequently use adjusted long-term expense metrics to assess a company's sustainable earnings and facilitate comparisons across different reporting periods or among industry peers.

The concept of adjusted long-term expense is rooted in the attempt to present a more "normalized" picture of a company's financial health, beyond what is strictly mandated by standard accounting principles. While Generally Accepted Accounting Principles (GAAP) provide a consistent framework for financial reporting, companies may present adjusted figures as non-GAAP measures to offer additional insights. Understanding these adjustments is crucial for a comprehensive analysis of an income statement.

History and Origin

The practice of presenting adjusted or "pro forma" financial results, including adjusted long-term expenses, evolved as companies sought to highlight their operational performance by excluding items considered anomalous or distorting to core business activities. This trend gained significant momentum during periods of rapid corporate restructuring, mergers and acquisitions, and the rise of the dot-com era in the late 1990s and early 2000s. Companies often used these adjustments to emphasize what they considered their "true" earning power, separate from the impact of one-time events or specific accounting treatments like large depreciation charges or amortization of goodwill.

However, the proliferation and sometimes aggressive nature of non-GAAP adjustments led to increased scrutiny from regulators and investors. The U.S. Securities and Exchange Commission (SEC) has historically issued guidance and taken enforcement actions to ensure that these non-GAAP measures, including adjusted long-term expenses, are not misleading and are reconciled to their GAAP equivalents. The SEC's Financial Reporting Manual provides extensive guidance on the proper disclosure and use of such measures⁵. This regulatory oversight aims to balance a company's desire to communicate its performance clearly with the need for transparency and consistency in financial reporting.

Key Takeaways

• Adjusted long-term expense modifies reported expense figures to exclude non-recurring or non-cash items, aiming for a clearer view of core operational costs.
• These adjustments are often presented as non-GAAP measures and are intended to help investors assess sustainable profitability.
• Common adjustments include removing one-time restructuring costs, litigation settlements, or large non-cash charges like asset write-downs.
• Analysts use adjusted long-term expenses for better comparability of financial performance across different periods and companies.
• Regulatory bodies like the SEC provide guidance to ensure that adjusted expense reporting is transparent and not misleading.

Formula and Calculation

An "Adjusted Long-Term Expense" is not derived from a single universal formula but rather by taking a GAAP expense figure and applying specific additions or subtractions for items a company deems non-recurring, non-operational, or non-cash. The precise calculation depends on the nature of the adjustments.

A general representation of this adjustment process could be:

[
\text{Adjusted Long-Term Expense} = \text{Reported GAAP Expense} \pm \text{Adjustments}
]

Where:

• Reported GAAP Expense: The total expense line item as presented on the financial statements (e.g., total operating expenses, cost of goods sold, or specific long-term expenses like selling, general, and administrative expenses). This is the figure determined in accordance with accounting standards set by bodies such as the Financial Accounting Standards Board (FASB).
• Adjustments: These can be additions (if a non-recurring gain reduced expenses) or subtractions (if a non-recurring charge increased expenses). Common adjustments for long-term expenses might include:
  • Restructuring charges (e.g., severance pay, facility closure costs)
  • Impairment charges (e.g., goodwill impairment, asset write-downs)
  • Non-cash stock-based compensation
  • Unusual litigation expenses or settlements
  • Merger and acquisition-related costs (e.g., integration costs, transaction fees)
  • Amortization of acquired intangibles (though this is often excluded from certain adjusted profit metrics like EBITDA, not always specifically "adjusted long-term expense").

Each company's adjustments vary, and detailed explanations of these non-GAAP adjustments are typically found in the footnotes to their financial statements or in their earnings press releases.

Interpreting the Adjusted Long-Term Expense

Interpreting adjusted long-term expense involves understanding why a company has made particular modifications to its reported GAAP figures. The primary goal of presenting adjusted long-term expense is often to highlight the recurring profitability and operational efficiency of the business, setting aside what management considers to be non-representative events.

When evaluating this metric, analysts look for consistency in the types of adjustments made over time. For example, if a company consistently reports significant "restructuring charges" year after year that are excluded from its adjusted long-term expense, it may signal an ongoing operational challenge rather than a true one-time event. Conversely, a legitimate, one-off event—like a large legal settlement—may warrant exclusion to help evaluate the core operating expenses of the business.

Users should compare the adjusted long-term expense against the corresponding GAAP figures to understand the magnitude and nature of the adjustments. This comparison helps determine if the adjustments provide genuinely useful insights or if they potentially obscure underlying issues. A significant divergence between GAAP and adjusted figures for multiple periods might indicate aggressive accounting or a business model prone to frequent non-recurring events.

Hypothetical Example

Consider "Tech Innovations Inc." (TII), a software company that recently acquired a smaller competitor. In its latest quarterly report, TII reports total expenses of $50 million. However, management also provides an "adjusted long-term expense" figure.

Here's a breakdown:

• Reported GAAP Expenses: $50,000,000
• Adjustments identified by TII management:
  • Acquisition-related integration costs: TII spent $3,000,000 on one-time costs to integrate the newly acquired company, including system migrations and employee training. Management considers these non-recurring.
  • Severance packages: Due to a strategic realignment post-acquisition, TII paid $1,500,000 in one-time severance to redundant staff. This is also deemed non-recurring.
  • Non-cash stock-based compensation: TII had $2,000,000 in stock options that vested during the quarter. While a legitimate expense under GAAP, it's a non-cash item that some analysts adjust to gauge cash profitability.

To calculate the adjusted long-term expense:

By presenting an adjusted long-term expense of $43.5 million, TII's management aims to show that its ongoing, core operational costs, excluding the temporary impact of the acquisition and non-cash compensation, are lower than the GAAP reported $50 million. This allows investors to better gauge the company's baseline profitability without the noise of one-time events.

Practical Applications

Adjusted long-term expenses are commonly used in several practical financial applications, particularly within financial analysis and corporate reporting. Companies often present these adjusted figures in their earnings releases and investor presentations to provide supplemental views of their performance beyond strict GAAP requirements. For instance, a company might highlight its adjusted expenses to demonstrate improved cost control in its core business, excluding specific non-operating expenses that are not expected to recur.

Analysts and investors frequently use these adjusted metrics when performing valuation analyses, such as calculating enterprise value multiples like EV/EBITDA. Metrics like Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) themselves are a form of adjusted earnings, often used to normalize results by excluding certain non-cash items and financing structures. Companies like Thomson Reuters regularly report adjusted EBITDA and other adjusted figures to offer a clearer picture of their operational performance, as seen in their financial results announcements.

F⁴urthermore, internal management teams often rely on adjusted expense figures for budgeting, forecasting, and performance evaluations. By stripping out volatile or extraordinary items, they can better assess underlying trends and make more informed strategic decisions related to capital expenditures and operational efficiency. The Federal Reserve also publishes its audited financial statements, which show various income and expense items, highlighting the importance of clear financial reporting even for central banks.

#³# Limitations and Criticisms

While adjusted long-term expenses can offer valuable insights, they come with significant limitations and criticisms. The primary concern is that these adjustments are "non-GAAP" and are determined by company management, which introduces subjectivity. There is no standardized definition for what constitutes an "adjusted" expense, allowing companies considerable discretion in deciding which items to exclude. This flexibility can lead to a lack of comparability between companies, even within the same industry, as each might have its own set of "adjustments."

Critics argue that companies may use these adjustments to paint an overly optimistic picture of their financial health by consistently excluding costs that, while perhaps non-recurring in a strict sense, are part of the ongoing business cycle (e.g., frequent restructuring charges). This practice can obscure genuine operational issues or systemic problems. The SEC has a strong focus on ensuring that non-GAAP measures do not mislead investors, emphasizing that companies must clearly reconcile these adjusted figures to their GAAP counterparts and explain the nature of the adjustments. Th²e SEC's guidance cautions against the misleading allocation of fees and expenses.

Another limitation is that adjusted expenses, by excluding certain costs, may not reflect the full economic reality of running a business. For instance, consistently excluding stock-based compensation from adjusted expenses, while a non-cash item, represents a real cost of attracting and retaining talent and dilutes shareholder value. Investors must therefore exercise caution and thoroughly review the reconciliation of adjusted figures to the GAAP numbers presented on the balance sheet and income statement to fully understand the impact of these exclusions.

Adjusted Long-Term Expense vs. Operating Expense

The key difference between adjusted long-term expense and operating expense lies in their scope and the presence of discretionary adjustments.

Operating Expense:

• Definition: Operating expenses are the costs incurred by a business through its normal operations. These include selling, general, and administrative (SG&A) expenses, research and development (R&D) costs, and cost of goods sold (COGS). They are recurring and essential for generating revenue.
• Basis: Operating expenses are reported directly on the income statement according to GAAP. The expense recognition principle dictates that these expenses should be matched with the revenues they help generate in the same accounting period.
• ¹ Purpose: They reflect the ongoing cost structure of a business's primary activities.

Adjusted Long-Term Expense:

• Definition: Adjusted long-term expense is a modified version of operating or other long-term expenses, where specific items deemed non-recurring, extraordinary, or non-cash by management are excluded.
• Basis: This is a non-GAAP measure. The adjustments are at the discretion of the company, though typically explained and reconciled to GAAP figures.
• Purpose: To provide a clearer, "normalized" view of a company's core operational profitability by removing "noise" from unusual events or non-cash charges.

The confusion often arises because companies might consider certain long-term operating expenses, such as depreciation or amortization of intangible assets, as items to be "adjusted out" to arrive at metrics like EBITDA, which aims to show profitability before these long-term non-cash charges. However, operating expenses are the starting point for many of these adjustments. While all operating expenses contribute to the GAAP reported expense, only a subset, or specific non-recurring components within them, might be removed to arrive at an adjusted long-term expense figure.

FAQs

What types of items are typically adjusted out of long-term expenses?

Common items adjusted out of long-term expenses include one-time restructuring charges, impairment losses on assets, legal settlement expenses, costs related to mergers and acquisitions, and non-cash items such as stock-based compensation or the amortization of acquired intangibles. The goal is to separate these specific items from the regular, recurring costs of operations.

Why do companies report adjusted long-term expenses if GAAP requires specific reporting?

Companies report adjusted long-term expenses to offer investors and analysts a supplemental view of their performance. While GAAP provides a standardized framework, management believes that excluding certain volatile, non-recurring, or non-cash items can provide a clearer picture of the underlying profitability and sustainable operational efficiency of the core business. This allows for better period-to-period comparisons.

Are adjusted long-term expenses audited?

While the underlying GAAP financial statements from which adjusted expenses are derived are audited, the specific non-GAAP adjustments themselves are generally not subject to the same level of independent audit scrutiny. Auditors will verify that the reconciliation from GAAP to non-GAAP figures is accurate and that the disclosures meet regulatory requirements. However, the qualitative judgment on what constitutes an "adjusted" item remains management's prerogative.

How can I find a company's adjusted long-term expense?

Companies typically disclose adjusted long-term expenses (or related non-GAAP measures like adjusted EBITDA or adjusted operating income) in their earnings press releases, investor presentations, and regulatory filings (such as 10-K or 10-Q reports). These disclosures will usually include a detailed reconciliation of the adjusted figures back to the most directly comparable GAAP measure on the income statement.

Is it always better to use adjusted figures for analysis?

No, it is not always better. While adjusted figures can provide useful insights into a company's core operational performance, relying solely on them can be misleading. It is crucial to analyze both the GAAP reported figures and the adjusted figures, understand the nature of the adjustments, and consider whether these adjustments genuinely reflect non-recurring events or if they consistently mask underlying business realities. A balanced approach using both sets of data is recommended for comprehensive financial reporting.