LOS E requires us to:
explain appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company
Financial statements of different companies are subject to estimates and assumptions made by the management. This restricts the comparability of different statements. Therefore, in order to facilitate better comparison, we need to make certain adjustments to the financial statements. Some of them are:
a. Investments. The investments should be separately classified as ‘available for sale’ and ‘trading’ investments. The income from the ‘available for sale’ investments is shown under ‘other comprehensive income. Whereas, the income from ‘trading’ investments enters the income statement directly.
b. Inventory. Inventories may be measured using the FIFO and LIFO methods. All necessary adjustments as discussed in the chapter on inventories should be made to facilitate comparison.
c. Long-Lived Assets. There are different methods and estimates used to present the long-lived assets in the financial statements. Before making any conclusions regarding the performance of long-lived assets it is necessary to make adjustments to them.
d. Goodwill. There may be different types of companies, the ones that grow internally and the ones that grow through mergers and acquisitions. So in comparing these different types of companies, instead of comparing goodwill, it is better to compare the tangible book values.
e. Off-Balance Sheet Financing. Debt ratios should include the liabilities for both capital and operating lease. For an operating lease, the present value is not reflected in the financial statements, though the five-year payment schedule is. In order to make a meaningful comparison, one needs to look into the details of leases carefully.