While performing financial analysis, an analyst will make several adjustments to the financial statements of a company in order to make them comparable with other companies. The adjustments are required due to the different accounting choices made by the firms and also due to the differences in accounting standards.
Some of these adjustments are listed below:
- Two firms may be using different inventory accounting methods. The firm using LIFO method will report lower income and lower inventory compared to a firm using FIFO method.
- Firms may classify investments in securities available-for-sale, held-for-trading or held-to-maturity. Any unrealized gains/losses on held-for-trading securities are reported in income statement while for other securities it is not. Also, for held-for-trading and available-for-sale securities, the unrealized gain/loss is reflected in the balance sheet while for held-to-maturity securities, it is not.
- For investment securities, the treatment of unrealized gain/loss is different under IFRS/US GAAP. Under IFRS, if the unrealized gain/loss on available-for-sale securities is due to exchange rate fluctuation, then it is recorded in income statement. There is no such requirement in US GAAP.
- The two firms may follow different depreciation methods. One may be using a straight-line method, while the other may be using accelerated depreciation method. They may also have different estimates of useful life of similar assets. An analyst should adjust the financial statement for these differences.
Similarly there are many differences that an analyst must consider and make appropriate adjustments while comparing financial statements.