Financial Statement Analysis and Quality of Earnings

Topics: Generally Accepted Accounting Principles, Income statement, Finance Pages: 2 (339 words) Published: May 26, 2012


TO:Beth Harlan, CEO
FROM:John Gomez, CFO
DATE:June 30, 2011
SUJECT:Financial Statement Analysis and Quality of Earnings

As per your request, the following information will help explain the bases for comparison in analyzing the company’s financial statements and the factors that affect the quality of our earnings.

The bases for comparison include intracompany basis, industry averages and intercompany basis. Intracompany basis refers to the method of comparing current year results to those of previous years. Only the financial information of our company is used for the analysis. This method allows us to analyze trends and changes in financial data.

Another basis is industry averages. This basis compares an item or financial relationships of our company with industry averages published by financial ratings organizations. In doing this analysis, we can compare our company’s financial performance with the norms of our industry.

Lastly, we refer to intercompany basis when we compare our financial data with the published financials of our competitors. In doing so, we can determine our competitive position.

Our investors and other parties are increasingly interested in the quality of earnings. Providing full and transparent information is critical to ensure high quality of earnings that minimizes confusion or misleading of those interested parties. There are three factors that lower the quality of earnings and these include the use of alternative accounting methods, pro forma income and improper recognition.

The use of alternative accounting methods, such as varied inventory accounting methods within the same industry, may create confusion for our users of financial statements because it makes it more difficult to compare a company with its competitors. In addition, the reporting of income using pro forma measurements, which excludes extraordinary items from income statements, may not paint a...
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