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Pro-forma income is the income that excludes certain costs of the company that may negatively affect the company’s image in terms of profitability. Pro-forma income statements do not comply with standardized GAAP (Generally Accepted Accounting Principles) in favor of presenting a more realistic picture to investors and creditors. Pro-forma income reports are usually conducted to prepare for such cases as mergers, acquisitions, new investments, or a change in a capital structure. Hogan et al. (2017) state that pro-forma earnings usually “exclude non-cash items such as asset impairments, amortization, or restructuring charges” (p. 12).
They explain that the report presents a more relevant situation regarding the business’ performance by excluding these items. Analysis of the listed items will establish whether they indeed distort the company’s profitability picture.
Impaired assets refer to assets with a decreased market value that does not reflect in the company’s balance sheet. All the assets need to be checked regularly for impairment, and their values need to be adjusted appropriately in the balance sheet. However, since the new value of an asset is lower than the previously documented value, the “loss” is recorded in the non-pro-forma income statements. It is not convenient for businesses to provide this picture to investors and creditors because it devalues the company’s potential to gain profit. Another item that is not mentioned in pro-forma reports is the costs of restructuring. Restructuring is not an act of a regular occurrence, and it only happens when the company is struggling with financial pressures such as debt. Pro-forma statements tend to exclude unusual expenses, and restructuring fits into the category of unique.
In conclusion, pro-forma earnings reports are more favorable for all parties involved because it improves the quality and timeliness of the financial information, and accurately interprets it for investors and creditors. However, there is always a risk for the company to abuse the pro-forma statements to disclose certain expenses that should be included in the financial reports. Therefore, some investors might want to be given the GAAP reports.
Reference
Hogan, B. R., Krishnamoorthy, G., & Maroney, J. J. (2017). Pro forma earnings presentation effects and investment decisions. Behavioral Research in Accounting, 29(2), 11-24. Web.
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