Many analyst reports have been published over the past several months that discuss the advantages and disadvantages of this increased focus on EPS for measuring operating performance. Most advocates of this approach still would look to funds from operations (FFO) or some other metric for valuation purposes. Many of these advocates believe that additional focus on EPS will support the industry's efforts to attract a broader spectrum of investors by aligning the industry's performance reporting with universal reporting practices.

But What Is EPS?
There are many different views as to the most appropriate earnings metric to be used in calculating EPS. Some believe that EPS should be calculated using "bottom-line" GAAP net income. Others believe that the better measure is income before the three non-recurring items defined by GAAP—extraordinary items, results of discontinued operations and cumulative effects of accounting changes. Still others believe that EPS should be based on income before all unusual items—the three GAAP defined items and any other items that are deemed to be unusual or non-recurring. This latter definition may represent what most industries call adjusted net income (ANI).

As consensus emerges as to the most appropriate measure on which to base EPS, a number of fundamental distinctions should be considered. These include the distinctions between reported and adjusted net income, GAAP and non-GAAP measures, earnings and basis of valuation, and reporting and analysis.

Reported and Adjusted Net Income
Bottom-line GAAP net income is often referred to as "reported net income." This metric includes all income and expense items and all gains and losses whether they are considered recurring or non-recurring.

In comparison, ANI excludes certain amounts included in reported net income. The exclusion of items from ANI is not controlled by GAAP, but all items of revenue, expense, gains and losses included in ANI are measured by GAAP. Items are excluded at the discretion of the reporting company and/or analysts. Many believe that ANI should represent income from normal, ongoing operations. ANI generally represents the estimated and actual earnings tracked by services such as First Call and is a metric used by most companies and analysts across corporate America.

GAAP and Non-GAAP Measures
Virtually all adjustments made to calculate ANI and the items that remain in ANI are based on GAAP measurements. For example, if a gain on the sale of an asset is excluded from ANI, the amount excluded is the gain measured by GAAP. If amortization of an intangible is adjusted out of reported net income, the amount of amortization is based on GAAP.

This principle sounds very obvious, but some may advocate adjusting certain items included in ANI to amounts that do not conform to GAAP. For example:

• If gains on sales of assets are included in ANI, the amount of the gain might be adjusted for accumulated depreciation resulting in a gain inconsistent with GAAP. Some refer to this measurement as the "economic gain."
• The rental income included in ANI might be adjusted to a non-GAAP, cash basis—often called the straight-line rent adjustment.
• Depreciation included in ANI might be calculated using methods not allowed under GAAP.

Earnings and Basis of Valuation
ANI represents a supplemental accrual based earnings measure. Other measures, such as adjusted FFO and cash (or funds) available for distribution, represent cash or near cash measures. What may be getting lost in current debates is that companies in most industries report EPS to provide a metric to compare with analysts' expectations—not necessarily to provide a basis of valuation. Generally, further analysis is undertaken in order to develop a basis of valuation.

Reporting and Analysis
The current debates over the most appropriate basis for calculating EPS may have more to do with analysis than with what a company reports as its earnings. As with earnings and cash flow, two distinct measures may be required to satisfy the need for both a comprehensive earnings measure and a metric that measures only the ongoing profitability of a company.

As industry participants consider the most appropriate definition of EPS, it may be useful to distinguish between the earnings measure and related disclosures that companies report versus metrics that might be used for different analytical purposes and valuation—including indicators of ongoing profitability. More specifically, some believe that EPS should include all revenues, expenses, gains and losses, and that related disclosures would allow users to adjust EPS to fit the purpose of any specific analysis. Others suggest that EPS should include only the results of "core operations." One question to consider is whether "core operations" can be defined for all companies—even companies in the same industry.

Some may suggest that "core operations" could be defined by each company—that a common definition may not be necessary. This would be similar to the current practice of companies reporting pro forma earnings which are not controlled by any universal standards. Before taking this course, consideration should be given to the most recent negative reactions to this practice from the Securities and Exchange Commission and the Financial Accounting Standards Board.

Maintaining Distinctions
This article simply suggests that, as participants consider the various bases for calculating EPS, they carefully consider the distinctions discussed above. Acting in accordance with these distinctions would enhance the transparency and credibility of the industry's reporting, and further align it with universal reporting practices.