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Understanding Profitability Analysis and its Interrelationship with Analytical Issues

This study unit delves into profitability analysis, exploring how various analytical issues affect reported profitability. We investigate the limitations of financial ratios and the importance of comparability, considering income recognition, accounting policies, and quality of revenues. Additionally, we look at the impact of foreign exchange fluctuations and off-balance-sheet financing, including the implications of unconsolidated subsidiaries and operating leases. Key differences between US GAAP and IFRS are discussed, along with essential concepts of fair value accounting.

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Understanding Profitability Analysis and its Interrelationship with Analytical Issues

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  1. Study Unit 3 Profitability Analysis & Analytical Issues 2/2 part

  2. Introduction Previous parts covered: Ethics and Ratios Review LOS page 91/92 as an intro How Profitability Analysis and Analytical Issues are inter-related?  restatement / adjustment Limitations of ratios = comparability issues Are the financials always a good base? What about items/risks off the books?

  3. 3.6 Factors affecting reported profitability • Income • How are we recognizing revenue and expenses? • What are the Accounting policies/rules in place? • Revenues • Sources of revenues? Quality of Revenues?  Returns • A/R and Inventories • Relationship A/R and Revenues (collectability, Cash Flows) • Revenues and Inventory (WIP, MOH, DL, Destruction…) • COGS • Gross Margin distortion = Price increase? COGS? G2N? • Expenses • Variables, Marketing, Operations, Commercial, Fixed… G&A

  4. 3.7 Effects of Foreign Exchange Fluctuations • Reporting currency / functional currency / local • Translation = exchange rate exposure • Accounting for Gains and Losses  OCI • Remeasurement and translation • Temporal vs. All-current Method

  5. 3.8 Off-Balancing-Sheet Financing Objective and impact on financials Unconsolidated subsidiaries SPEs Operating / Capital Leases Factoring A/R = collection costs

  6. 3.9 US GAAP / IFRS • Cover major differences • Understand overall context and objectives • Revenue/Expense recognition • R&D costs • FIFO / LIFO (no LIFO in IRFS) • Leases • Impairment of Assets • Extraordinary Items

  7. 3.10 Fair Value Accounting Historical cost/current cost/market value Net realizable value/NPV(discounted CF) Fair value

  8. ESSAY TIPS • Time Management • Quant/Qual content • No spreadsheet = easy calculations • Don’t get “caught up” on the order of ? • Demonstrate ability to become a CMA • High sense of Integrity / Ethics • Facts / Formulate opinion / recommendation • No right / wrong solution = up for debate (depends)

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