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Pro Forma Earnings Disclosures Must be Regulated. Discuss

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´╗┐FLORIDA ATLANTIC UNIVERSITY PRO FORMA EARNINGS DISCLOSURES MUST BE REGULATED A PAPER SUBMITTED TO DR. TERRANCE R. SKANTZ ACG 6135 SUMMER 2002 BY STUDENT'S NAME FT. LAUDERDALE, FL JULY 16, 2002 Instructor?s notes: 1. Here are comments that I made about this paper after I finished grading: "Introduction motivates the paper, reveals the writer's familiarity with the topic and places issue in larger context. Writer references academic research and understands the point of that research." T. Skantz 2. There are some formatting changes because I scanned the document. I tried to fix everything. Please ignore any incorrect formatting. ________________ CONTENTS INTRODUCTION 1 EVOLUTION OF PRO FORMA AND GAAP FINANCIAL STATEMENTS 2 PRO FORMA EARNINGS DISCLOSURES ARE BIASED, MISLEADING AND INCONSISTENT 4 COMPANIES USE PRO FORMA DISCLOSURES TO MANAGE MARKET PERCEPTIONS OF EARNINGS 7 PRO FORMA PRESENTATIONS MUST BE RECONCILED TO GAAP 10 CONCLUSION 12 REFERENCE LIST 14 ii ________________ INTRODUCTION The financial reporting practices of publicly held companies have come under the microscope of the general investing public in recent years. The public demise of Enron Corporation has emphasized the critical need, to the benefit of investors and creditors, for the issuance of financial statements that are easy to understand, consistent and comprehensible. Over the past decade, management of public companies has, without the guidance of the Securities and Exchange Commission (SEC) or the Financial Accounting Standards Board (FASB), developed a new financial reporting format referred to as pro forma financial statements. Pro forma financial statements and earnings disclosures have evolved into subjective interpretations of generally accepted accounting principles (GAAP) by public companies. These interpretations are suited to the particular needs of public companies to present financial results in a manner to improve the performance of stock prices. Pro forma presentations have become the primary presentation of the results of operations, with results under GAAP being relegated to the back portion of company press releases. ...read more.


The trend towards more pro forma financial reporting started innocently and in accordance with GAAP, with many firms reporting and thoroughly explaining extraordinary items and the pro forma impact of acquisitions and divestitures in income statements and supplementary footnotes. Over the past decade, firms have become more aggressive determining which financial statement items to include in pro forma financial statements. Many chief executives and chief financial officers have complained that GAAP financial statements do not adequately present the "core" operating results, future growth prospects, and future cash flow potential of their firms. The SEC has also admitted that GAAP-based earnings (which are based upon historical cost) do not adequately measure key value drivers of today's listed firms. Top management of publicly listed companies is paid to maximize company share value-for the benefit of 7 ________________ shareholders, investors, creditors, and themselves. Without the restriction of outside regulation, firms have developed the concept of proforma earnings press releases and financial disclosures to manage earnings perceptions in a marketplace. Analysts have developed consensus forecasts of firm earnings, with pro forma disclosure components, to produce what is commonly called "Street Earnings" as the primary measure of firm quarterly performances compared to forecasts. Analysts also utilize pro forma earnings information to determine if firm nonrecurring expenses and write-offs are permanent in nature or transitory (Ali, Mein, and Rosenfield 1992). Scholarly research performed on alternative measures of pro forma earnings on stock prices has expanded in recent years, defending the information content, predictive ability, and relevance of pro forma earnings disclosures. These studies have compared a variety of earnings measures over time, including pro forma or "Street" earnings, GAAP earnings, and earnings before extraordinary items and discontinued operations (EBED). One study "suggests that users of financial information can obtain higher quality of earnings measures using pro-forma operating income released by managers than they can by perusing less timely [GAAP] I O-Q and I O-K filings with the SEC" (Brown and Sivakumar 2001, 3). ...read more.


Bradshaw, M. and R. Sloan. 2002. GAAP versus the Street: An empirical assessment of two alternative definitions of earnings. Journal of Accounting Research 40, no. 1: 41-66. Brown, L. and K. Sivakumar. 2001. Comparing the quality of three earnings measures. Working paper, Georgia State University. Bryant, L., S. Henning, and W. Shaw. 2002. Alternative earnings measures, key performance indicators, and firm value in the IT professional services sector. Working paper, Ohio State University and Southern Methodist University. Collins, D., E. Maydew, and 1. Weiss. 1997. Changes in the value relevance of earnings and book values over the past forty years. Journal of Accounting and Economics 24: 39-67. Doyle, J., R. Lundholm, and M. Soliman. 2002. The predictive value of expenses excluded from C pro forma' earnings. Working paper, University of Michigan business school. Eccles, R., R. Herz, M. Keegan, and D. Philipps. 200 1. A value reporting revolution: Moving beyond the earnings game. John Wiley & Sons, Inc., New York, NY. Elliot, J. and W. Shaw. 1998. Write-offs as accounting procedures to manage perceptions. Journal of Accounting Research 26 (Supplement): 91-119. NIRI Executive Alert. 200 1. FEI and NIRI issue earnings press release guidance; Encourage inclusion of GAAP financial results, (accessed June 26, 2002), http://www.nifi.org/publications/alerts/ea042601.cfm Francis, J. and K. Schipper. 1999. Have financial statements lost their relevance? Journal of Accounting Research 37, no. 2: 319-352. Henry, D. 200 1. The numbers game. Business Week May 14: 100-114. 14 ________________ Kinney, M. and R. Trezevant. 1997. The use of special items to manage earnings and perceptions. Journal of Financial Statement Analysis 3 (Fall): 45-53. Lougee, B. and C. Marquardt. 2002. Earnings quality and strategic disclosure: An empirical examination of 'pro forma' earnings, (accessed July 11, 2002), http://papers.ssm.com/abstract=298363 Schrand, C. and B. Walther. 2000. Strategic benchmarks in earnings announcements: The selective disclosure of prior-period earnings components. The Accounting Review 75, no. 2, 151-177. Security and Exchange Commission 2001. Release Nos. 33-8039, 34-45124, FR-59, December 4, 200 1, (accessed June 15, 2002), http://www. SEC.gov/news/ ress/2001-144.txt Turner, L. 2000. Remarks to the 39th annual corporate counsel institute presented by Northwestern University Law School on October 12. 15 ...read more.

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