Income measurement depends on estimates of future events
These estimates require:
?Use of judgment and probabilities ?Allocations of revenues and expenses across periods ?Prediction of the future usefulness of many assets ? Forecasts of future obligations
transactions and events are perceived ? Methods chosen that are most applicable to the
circumstances ? Relevant information is disclosed —favorable and
Analyzing Profitability
Measuring Income--Estimation Issues
Management discretion is part of income measurement
Estimates of skilled and experienced professionals ? Some consensus (less variability)
? Estimation Issues ? Accounting Methods ? Incentives for Disclosure ? Diversity across Users
Analyzing Profitability
Measuring Income--Estimation Issues
Hale Waihona Puke Analyzing Profitability
Focus of Profitability Analysis
Profitability analysis helps address questions such as: What is a company's relevant income measure? What is the quality of income? What income components are important for forecasting? How persistent are income and its components? What is a company's earning power?
? Profitability analysis is a key part of financial statement analysis
? All financial statements are pertinent to profitability analysis
? Emphasis of profitability analysis is on the income statement
income measurement
Social Influences
Political pressures
Academic research
Analyzing Profitability
Measuring Income--Accounting Methods
Methods reflect the outcome of numerous factors, including compromises Discretion is permitted to accommodate different business circumstances Methods geared toward “general -purpose” financial statements
unfavorable
Analyzing Profitability
Measuring Income--Incentives for Disclosure
Reality:
? Each of us possess opinions--we see the world from different
perspectives
? Managers bring strong views to the table ? Managers feel pressures of competition and society ? Directors expect results
Analyzing Profitability
Measuring Income--Accounting Methods
Professional experience
Regulatory agendas
Business happenings
Accounting standards governing
Analyzing Profitability
Measuring Income--Incentives for Disclosure
Ideally: ? Financial statements fairly present transactions and
events ? Accounting is neutral —not affecting how
Profitability Analysis
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Analyzing Profitability
Focus of Profitability Analysis
Analyzing Profitability
Measuring Income
Income is defined as revenues less expenses over a reporting period
This definition does not yield a unique amount because of: