“Standard & Poor’s, responding to growing concerns about the worsening quality of corporate earnings reports, is expected to send out a letter Wednesday to top Wall Street executives suggesting a potentially significant change in so-called operating earnings,” writes Steve Liesman in today’s Wall Street Journal.

“The move by S&P, a unit of McGraw-Hill Cos., represents the latest twist in the growing controversy over ‘pro forma’ profitability measures, which are calculated by many companies across all industries ‘as if’ certain ordinary items — usually expenses — didn’t exist. Normally, companies label these nonstandard profit measures with terms like ‘pro forma earnings,’ ‘cash earnings’ or ‘operating earnings.’ S&P says it would like to create industry standards to eliminate confusion for analysts and investors, by creating a uniform definition for the term ‘operating earnings,’ which today has no generally accepted definition.”

“S&P in its letter says that it is reacting to an increasing number of complaints from the investment community that earnings reports are ‘becoming harder to understand, more difficult to compare across companies and less useful to analysts and investors.’ “

“S&P compiles the much-watched S&P 500-stock index, as well as the combined earnings of these companies. The earnings measure is one of several widely used by investors to determine the price-earnings ratio of the index, one way of gauging the relative overall value of the stocks in the index. If S&P should adopt these standards for the calculation of the index, it potentially could have a radical effect on perceptions of overall stock-market valuations.”

“S&P has no power to force anyone but its own analysts to change the way they present earnings, and it says its letter is just the opening salvo in what it expects to be a wide debate over how operating earnings should be defined.”

“In its letter, S&P suggests that several items that companies routinely exclude as part of operating earnings be included, because they “are normally part of a company’s operations.” These include restructuring charges, write-downs of assets from continuing operations, stock-option expenses and write-offs of research and development purchased from other companies.”

“S&P said its initial inclination is to exclude four broad categories of expenses from future operating-earnings calculations. Those are charges from write-downs of goodwill, the intangible asset created when one company pays a premium to buy another; charges from litigation settlements; gains and losses on asset sales; and ‘acquisition/merger related expenses,’ a term the letter does not define.”