Reading 27 Evaluating Financial Reporting Quality

Hello, Could somebody explain to me what the following means: “If a Co excludes different items from its computation of pro forma earnings across quarters, this is a good indication that the company is opportunistically using its discretion to classify items as recurring or non-recurring” CFAI books Volume 2 Financial Reporting and Analysis Page 391 Warning signs. Basically I do not understand how one would identify misclassification when in the first place the items are excluded or does this Statement infer that we are comparing the figures to others? Thanks!

key word here is pro forma, because its a non GAAP or IFRS disclosure, they have the opportunity to classify operating profit as they wish. if it was an official 10k submission for example, requirements for disclosure would be harder to play with. in this example, you have to analyze both what they took out and what they left in the Op. Profits What you would need to understand is that: - you need to get info from the Footnotes, MD&A - look at the trend in operating profit and understand what is driving it. - Understand what items they took out and use judgement to put them back in if needed

Guille_GE basically got it in one, but yes: The key point is that ‘pro forma’ can meet whatever the company wants it to mean. With specific regard to the sentence you quoted, the implication is that how the company defines pro forma can change from year to year at the whim of the company. This can make year-on-year comparisons almost meaningless unless you have a good handle on what items the company is classifying as ‘recurring’ and ‘non-recurring’. If a specific item is constantly being classified as ‘nonrecurring’ but it’s showing up every year…perhaps it should be a recurring item. Recurring items should show up every year if they are recurring. If new, different items show up each year as ‘recurring’ under pro forma income, the analyst has to judge whether such items are truly ‘recurring’.

Thanks - That was very helpful. Good luck with you revisions but you both seem to be very far ahead…