1. Reasons for Over-Reporting Earnings
• To meet analysts’ earnings expectations
• To meet debt covenants.
• Need additional debt or equity financing
• To obtain higher remuneration & commission based on
performance.
Study Session 10, Reading 33

2. • To obtain trade relief.
• Negotiate lower payments for a prior business transaction.
• Negotiate concessions from unions, creditors, vendors, employees
etc.
• To save on income taxes.
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3. • The use of some of the accounting method choices
• Taking advantage of loopholes in accounting standards to structure
a transaction in a desired way
• Using inappropriate and unrealistic estimates and assumptions
• Stretching accounting principles in a way to achieve desired results.
• Engaging in fraudulent financial reporting.
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4. • If pressure or incentive to report fraudulent financial statements
such as meeting debt covenants or analysts’ expectation exist.
• If the opportunity to commit fraud due to a lack of proper internal
control systems in existence.
• If individuals can rationalize their behaviour themselves.
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5. • Aggressive revenue recognition techniques - this can be detected by
the study of revenue recognition policies.
• Earnings are positive and growing, while operating cash flow is
negative or declining - analysts should checked whether the cash flow
earning index is consistently below 1 or continuously declining.
• Excess use of operating leases to show better financial ratios -
Financial statements should be adjusted
Study Session 10, Reading 33

6. • Stretching out payables means slowing the rate of payments to
vendors.
• Stretching out payables is an indication that a company is struggling
to generate cash.
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7. • refers to involving a third party financial institution to pay the
vendor in the current accounting period, and paying off the financial
institution in the next accounting period.
• used to show higher operating cash flows in the current period.
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8. • packaging the receivables, particularly longer-term receivables with
having higher credit quality, and transferring them to a financial
institution or variable interest entity (VIE).
• used to show an increase in cash flow from operations
Study Session 10, Reading 34

9. • Used to reduce taxes payables, increase paid-up capital, and is
added by some companies to net income and in the operating cash
flows.
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10. • If the tax benefit of stock options is added to income in the cash
flow statement, it results in an increase in operating cash flows.
• In a period of rising stock price because of an increase in the
exercise of stock options, operating cash outflows will increase.
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11. Parameters Used For Evaluation of Past Performance
• Profitability, liquidity, solvency and efficiency over the period of
analysis.
• Comparison
• Analysis of the business model and strategy
• Study the aspects of performance
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12. Projecting future financial performance can be undertaken in two
ways:
1) Projection of near term financial performance that can be used
as an input to market based valuation
2) Complex projections that forecast multiple-period performance.
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13. • Projections made by the company about its future financial
performance.
• Previous financial statements of the company.
• Structure and outlook of the industry.
• Macroeconomic forecasts.
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14. • Credit analysis is the evaluation of the risk of loss due to a default in
the payment of principal and interest by the borrower.
• Credit analysis focusses on cash flows instead of accrual-income
returns.
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15. • Scale and diversification
• Operational efficiency
• Tolerance for leverage
• Margin stability.
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16. • Market data and financial ratios are used by investors when
screening for potential equity investments.
• Screening is the application of a set of criteria that shortlists
potential investment candidates from the available investment
universe.
• Back testing is a process by which analysts evaluate how a portfolio
based on a particular screen would have performed in the past.
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17. • Top-down analysis
• Bottom-up analysis
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18. Adjustments made by analysts are generally related to
• Investments
• Inventory
• Property, plant and equipment
• Goodwill, and off-balance sheet financing
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