E explain appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company.

Question 1

Investments in Securities

Answer 1

If differences are significant, then ‘disclose to adjust N.I. and assets of one firm to what they would have been had their classifications been the same.’

The classification of a firms investment securities (Held-for-trading, held-to-maturity, available-for-sale) affects how changes in their values are recorded and significantly affect reported earnings and assets

Held-for-trading securities : Unrealized G’s and L’s record in Inc statement. Unrealized G’s and L’s reflected in BS asset values

Available-for-sale: Unrealized G’s and L’s reflected in BS asset values

Held-to-maturity:

IFRS v. GAAP diff: Under IFRS, unrealized gains and losses on available-for-sale debt securities that result from exchange rate fluctuations are recorded on the income statement.

Question 2

Inventory Accounting Differences ( aka adjust LIFO reserves)

Answer 2

Adjusting for inventory accounting differences. Watch for firms which use the LIFO reserve aka lifo reserved is used to adjust LIFO cost of goods and inventory to their FIFO equivalents.

LIFO reserve is an addition to CA, because LIFO is a COGS cost method, and includes inventory, which is an asset

Appr. adjustment to make the firms income statement comparable is to subtract new years LIFO reserve from OLD, then interpret the change in GP, Op. Profit. NI compared to LIFO reporting.

Question 3

Differences in Depreciation Methods and Estimates

Answer 3

1. Obtain qualitative information (Disclosures related to depreciation are not specific enough)

Adjust any ‘aggressive reporting’ which uses higher estimates of useful asset lives or asset salvage values to report lower annual depreciation expense and higher NI relative to ‘conservative’ firms which use lower estimates of useful lives or salvage values

Aggro firms thus increase BS and NAV’s and reported NI. So adjust NI and fixed asset carrying values

Upward revaluation of fixed asset values : IFRS allowed : increases assets and equity. If reval reverses a previous downward reval then the inc. in value is reported on the income statement

Compute and compare average ages and useful lives of assets within an industry to reveal differences in firms future capital spending needs.

To estimate the # of years worth of depreciation a firm has recognized: divide accum. depr. from BS by depr. exp. from IS which is aka AVERAGE AGE of the firms assets.

Est. Average useful life of a firms assets (Gross PPE . Depr exp)

Average remaining useful life: (Net property, plant, and equipment / depreciation expense)

Question 4

Off-Balance-Sheet Financing

Answer 4

To estimate the PV of operating lease liabilities: Use the ratio of the PV of capital lease obligations to the sum of these future payments

or

Make some assumption about the timing of operating lease payments beyond five years and calculate a discount rate to use when calculating the present value of operating lease payments

Question 5

Goodwill (Aquisition Growth)

Answer 5

Acquired units [as goodwill] (Tangible + Intangible) belong on the balance sheet

Tangible: Fair Value

Intangible: Acquisition Cost

Adjustments made to goodwill to improve comparability in such a case: 1. Subtract from assets when calculating financial ratios
2. Reverse and IS exp. from the impairment of goodwill in current period (this increases reported NI)

Calculating price to book value of equity per share Remove goodwill from assets and recalculate a lower adjusted book value, resulting in a price to adjusted book value ratio that is greater.

Question 6

Other Intangible Assets

Answer 6

..