Future-Oriented Financial
Information
FINANCIAL ACCOUNTING THEORY
GRACE BARTZ, DANIELLE COOK, MARTINE DENHERTOG, DAVID
D IM ATTEO, M ARK H ALEY, F ARIS I SMAILOVSKI, J ULIE P HILLIPS, &
DORIAN TEMLIN
Agenda
 Introduction
 Determining information about the future
 Assumptions
 Forecasting
 Time-period
 Presentation
 Disclosures
Introduction to Section 4250
 Addresses
 Measurement
 Presentation and disclosure
 Formats:
General purpose
 Special purpose

 Objective is to provide external users with
information that assists them in evaluating an
entity’s financial prospects
Introduction to Section 4250
Who might want to know future information about a
company?
Lenders
 Owners
 Investors
 Management
 Auditors
 Analysts
 Employees and Suppliers

Introduction to Section 4250
 Users of future information
 Lenders
See if borrowers will be generating sufficient cash flow to repay
loans
 Test borrowers knowledge of business


Owners and Security Markets
See if capital is generating sufficient rate of return
 Determine the course of investing action


Management

Benchmarks
Introduction to Section 4250
What could future financial prospect information be
used for?
Evaluate company’s ability to pay back loans
 To determine if meeting investors’ expectations
 Benchmark for management

Introduction to Section 4250
What type of information about the future of a
company would a user want to know?
Sales
 Net Income
 Cash Flow
 Debt to Equity

Determining Information About the Future
 Based on assumptions
 Forecasts
 Uses assumptions which reflect planned courses of action
 Projections
 Same assumptions as a forecast with one or more hypotheses
consistent with the purpose of the information
 Not necessarily the most probable in managements judgment
Importance of Future Information
 Company can communicate its expectations to the
market
 Management knows its business better than anyone
else

Management can use the information to sway investors
Assumptions
 Complete
 Affects reliability
 Reasonable
 Achievable
 Provide relevant information
 Adds value
 Consistent
 Interdependence
Consistent Assumptions
The assumptions need to be consistent with…?
Plans and strategies of the company
 Past performance
 Industry performance

Assumptions
 Complete
 Affects reliability
 Reasonable
 Achievable
 Provide relevant information
 Adds value
 Consistent
 Interdependence
Assumptions
Who should make the assumptions?

Management
Forecasts
 Generated from reasonable and supportable
assumptions by management
 Reflect most probable economic conditions and
planned courses of actions for the entity
 Supportable vs. reasonable
Supportable
How can assumptions made by management be
supportable?
Past performance of entity itself
 Performance of other entities with similar activities
 Feasibility studies
 Marketing studies
 Economic data
 Government and industry publications
 Other sources with objective corroboration of the assumptions
used

Supportable
 Extent of detailed information to support
assumptions
 Influenced by factors such as the significance of the
assumption, and availability and quality of
information
Forecast Methods
 Managements way of preparing financial
information from the reasonable and supportable
assumptions
 May use statistical, mathematical, or specialized
forecasting techniques
Forecast Methods
Once assumptions are determined, how do managers
come up with the forecasted numbers?
Forecast Methods
 Quantitative
 Percentage of sales
 Ratios
 Regression
 Trend line, time series, moving average, naïve method
 Qualitative/Subjective
 Management and executive opinions
 Delphi technique
 Consumer surveys
Forecast Methods
Forecasts can be prepared with extreme precision –
to the nearest cent – why is this accuracy
misleading to analysts?
If limited to only one forecast number, which would
you choose to see and why?
What if limited to only one financial statement?
Reasonability of Assumptions
 To be reasonable, must be consistent with the plans
of the entity.
How are assumptions considered consistent with the
plans of the entity?
Reflect expected effects of anticipated strategy
 Include effects of likely economic conditions

Reasonability of Assumptions
 Each assumption needs to be assessed as to its
reasonableness


Influenced by the significance of the assumption and the
quality of supporting information
As availability of information decreases, it becomes much
more difficult for management to make reasonable attempts
Reasonability of Assumptions
 A projection must also be based on reasonable
assumptions including one or more hypotheses
What would the criteria be for a hypothesis to be
considered reasonable?
Consistent with the purpose of the projection
 Plausible

Examination of Future Oriented Financial
Statements (AuG-6)
 An accountant’s objective is to form an opinion on
the underlying assumptions used but not to the
achievability of the forecast
 Crucial that the PA get a well-developed
understanding of the organization and its industry
Compilation of a Financial Forecast/Projection
(AuG-16)
 This pertains to subsequent earnings forecasts from
the prospectus
 The objective is to provide a service to those who
require assistance
 PA should question management’s approaches but
not form an opinion
Shortfalls of Forecasts
Shortfalls of Forecasts
How could actions and abuses of pro-formas be
prevented and stopped going forward?
Require more timely GAAP numbers
 Audit opinion on subsequent forecasts

Shortfalls of Forecasts
 CEO’s who are “overconfident” are more likely to
issues forecasts that are overly optimistic
 Companies are protected by the Safe Harbour Rule,
which ultimately allows for optimistic outlooks.
What is your opinion on the Safe Harbour Rule?
Time Period in Earnings Forecasts
 Time period covered by future financial statements
shouldn’t go beyond the period where information
can be reasonably estimated

It may not be shorter than ‘the period of long-term
undertakings for which an entity has set expenditure limits’
Time Period in Earnings Forecasts
 Factors influencing reasonableness:
 Need of users
 Ability to make appropriate assumptions
 Nature of industry
 Operating cycle of entity
What are some reasons management would not be
able to reasonably estimate information?
Economic volatility
 Uncertain future of the organization

Time Period in Earnings Forecasts
 Future financial statements should be prepared in
accordance with accounting policies and
presentation format used in presenting historical
financial statements

ie. If preparing statements on a quarterly basis, pro forma
statements should be estimated on a quarterly basis
Time Period in Earnings Forecasts
 Forecasts are not normally prepared for periods
beyond the following fiscal year


To be practical should be updated and revised for new
information as it becomes known
Comparison to actual should be evaluated
Time Period in Earnings Forecasts
 Projections may be prepared for periods beyond the
following fiscal year if there is a reasonable base for
making estimates

Many entities use 3, 5, or 10 year projections in order to make
longer-term decisions
 The degree of uncertainty normally increases with
the length of the future period covered
Presentation
 General purpose statements presented in the format
of historical financial statements
 Must use historical policies except…

In the case of special purpose financial statements

Use whatever framework the two parties agree on
Special Purpose Financial Statements
 Special purpose financial statements are a set of
financial statements that are prepared using a
special purpose framework to cater to the special
needs of specific users of financial statements
 Not prepared in accordance with the general
reporting framework
 Not made for public – limited use



Internal users
Those charged with governance
Limited external users
Special Purpose Financial Statements
Can you give examples of industries or companies
that would use special purpose financial
statements?
Banks
 Governments
 Financials for tax authorities (statements completed in accordance
with tax regulatory framework)

Presentation
 If presentation using historical statements is not
possible -> note and accounting policy disclosure…

To the extent of adding understanding
Presentation
 Exact dollar value
 Presented as a range
 Takes into account inherent imprecision with forecasting
 Care to ensure that range is not too broad that the values are
no longer meaningful
Presentation
When would a range be more useful?
Farming operations – weather unpredictable
 Bidding in an acquisition (min and max willing to pay)
 New market/market does not exist when a new product is
introduced into the market

When would an exact dollar value be useful?
Analyst
 Investors who use mathematical models

Presentation in an IPO Setting
 As part of the prospectus
 Five periods of audited income statements
 Two most recent balance sheets
 Is an earnings forecast required in an IPO prospectus?
 No: standard says that its optional but not required
 If included must be audited and include audit statement
 Why might a company want to include an earnings forecast?
 Higher earnings = positive reaction from public
 Assurance – not hiding information from public
 Providing more information to investors
 Why would a company decline to include an earnings forecast?
 Cant complete one with accuracy (volatile industries)
 Forecasted earnings may deter users
 information sharing -> competitors
Disclosure
 Effective date of assumptions
 Date that information was approved: subsequent events may
impact usefulness of this information
 Extent of inclusion of actual financial results and its
period
 Varying nature of actual results

Entities are faced with limitations and uncertainties in regards
to future conditions and actions
Disclosure
Once a company discloses that actual results may
vary significantly (or materially) from the forecast,
is the forecast still useful ?
Disclosure
 Plans to update future-oriented financial
information subsequent to issue

Must disclose if the entity accepts no responsibility to update
the information
Disclosure of Assumptions
 Use assumptions based on planned course of action
 Will this planned course of action likely occur?
 Significant assumptions underlying future-oriented
financial information should be disclosed

What is significant?
 Incorporate a sensitivity analysis
Other Disclosures
 If future-oriented statements include a change in
account policy must disclose


Describe change
Nature of effect
 Special purpose financial information
 Disclose purpose & who it is meant for
 Purpose/Limitation of usefulness of projection
Delta Air Lines/ComAir
 ComAir is a wholly owned subsidiary of D.A.L.
 09/14/2005 – D.A.L. files for cpt. 11 bankruptcy
 Forces ComAir into bankruptcy
 Chapter 11 Bankruptcy
 Allows for reorganization of company with a judges approval

Value of business is greater if a going concern


Business “engine” can be restarted to generate cash to repay creditors
More economically efficient to:


Cancel some debts
Give ownership of reorganized company to creditors whose debts
cancelled
 How do you prove this will work?
Other Disclosures
General Disclosure:
Passenger Revenue Projections:
Aircraft Fuel Cost Projections:
SportsGoodStop - Case
KPMG Study
 1% of the firms reviewed hit their forecast exactly
 22% came within five percent either way
 On average forecasts were out by 13%
Thank you
Questions?