Summary Business Accounting

Question:

Companies often voluntarily provide a pro forma earnings number when they announce annual or

quarterly earnings.

Required:

1. What is meant by the term pro forma earnings in this context?

2. How do pro forma earnings relate to the concept of earnings quality?



Answer:



Requirement 1

Companies often voluntarily provide a pro forma earnings number when they announce annual or

quarterly earnings calculated according to GAAP. These pro forma earnings numbers are management’s

view of permanent earnings. These pro forma earnings numbers are controversial as they represent

management’s biased view of permanent earnings and should be interpreted in that light.

Requirement 2

The term earnings quality refers to the ability of reported earnings (income) to predict a company’s

future earnings. Management believes that pro forma earnings are of much higher quality than reported

earnings because they are more indicative of future profitability.