1. There are significant departures from clean surplus accounting. For examplea.Gains on marketable securities are reflected in stockholders' equity as "comprehensive income" ratherthan as income on the income statementb.Wide use of employee stock optionsc.Foreign currency translationsd.Some pension adjustment2. Determinants of residual income(e.g. ,book value and ROE) are not predictable.ViolationsViolationsofcleansurplussurplusaccounting1. Some events are not reported on the income statement.But do find their way to the equity section of thebalance sheet. In these cases, the book value of equity is correct, but net income is not.a.These omissions from net income can distort naive forecasts of net income and ROE.b.other timeshare, these positive and negative omissions can offset each other over time(e.g., foreigncurrency translations)c.c.The analyst must determine how these items will affect future forecast2. For example. Increase in fair value of some financial assets increase the value of equity through"comprehensive income", but these gains re not included on the income statement.a.the analyst can adjust this by adding the gain to NetIncome in calculating ROEb.The reverse would hold for decreases in fair value.c.c.No adjustment to invested capital is necessary b/c it already reflects the change in market value throughthe comprehensive income calculation.
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