Between mid-September and mid-October of 2016, the Securities and Exchange Commi
ID: 2530501 • Letter: B
Question
Between mid-September and mid-October of 2016, the Securities and Exchange Commission (SEC) put Tesla Inc. under fire after the latter added back certain costs to revenue using non-GAAP earnings. While the use of non-GAAP earnings is allowed to some extent, Tesla violated the US GAAP. In four separate comment letters sent from the SEC to Tesla, the regulatory body inquired about “….a statement disclosing the reason why you believe that the presentation of a non-GAAP financial measure provides useful information to investors...not how your management uses the information”. Briefly summarize the response from Tesla to the SEC and whether it makes sense to you. Please support your answer.
Explanation / Answer
The Securities and Exchange Commission (’SEC’) seems to have a notion that Tesla might have been cooking its books to look like it has more cash for which the SEC sought the company for measurements of its earnings report. The company utilized an accounting trick which logs in revenue even before it is certain that the company might be even receiving such revenue. The SEC sought the company to make changes to its debateable measure of revenue i.e. its non-GAAP figures which are often presented alongside GAAP figures in company earning reports, and exploited to make profits look better.
Actually the company began providing guarantees on those cars which are leased from its banking partners. The company promised that when the lease expired after 3 years the bank had the option of selling the vehicle back to Tesla at determined price. It also promised that should the user of car decide to sell the car elsewhere and receives less than the company’s promised price than the company would cover the shortfall. The company apprehends that the value of the electric car is not going to fall below that pre-determined price over the course of three years. But the same is risky for investors as in case rates for a used cars drops, the company would be suffering the loss.
Hence under GAAP rules, the company would have had to classify the selling price of the car as a liability on sale. The company would recognize the revenue from sale in fixed increments over the period of lease.
The company’s non-GAAP figures ignored the possibility that the used cars could be sold for less than it determined, even after three years which is not a correct presentation as the Non GAAP revenues are highly inflated based on an assumption having not much chances of materializing.
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