QOE assignment
Quality-of-earnings (QOE) analysis attempts to evaluate whether the reported earnings of a company reflect its true economic earnings, and also evaluates the ability of reported earnings to predict future earnings. This problem asks you to evaluate factors related to QOE for a given company in relation to a comparator company. You must select and justify your choice of comparator company. You are provided with Word templates to organize your response (Exhibits 1-3). Add lines as needed to complete the forms.
Procedure:
1. Access the December 31, 2010 annual audited financial statements of ProMetic Life Sciences from www.sedar.com (posted April 5, 2011). Also access the MD&A that covers these financial statements (posted April 5, 2011).
2. Use your judgment to identify a comparator company for ProMetic Life Sciences Inc. Choose a public company, listed on the TSX, that files public information on sedar.com, and access its 2010 annual audited financial statements.
Note: Comparator companies might be identified in the financial press. Another possible source is through the sedar.com "Search database" tab. Use the "Industry groups" section. Carefully choose the industry grouping that is appropriate, and request financial statements only for the appropriate time frame in order to reduce the number of files selected. Companies that act as good comparators will share the following characteristics:
o They will be in the same general business.
o They will not be conglomerates or involved in many disparate business lines.
o They will not be in the development stage.
o They will be approximately the same size.
Length and complexity of the financial statements is another factor; some financial statements are very long and should be avoided. It will be a challenge to satisfy all these conditions; however, the first three are the most critical factors to consider.
Required
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a. Calculate the difference between cash flow from operations and net income for each company for 2009 and 2010. For example, if the net income (loss) was ($3) and cash flow from operations was $12, the difference would be $15.
b. Identify five different adjustments on the statement of cash flow (SCF) of ProMetic Life Sciences Inc. that have QOE implications, and explain their significance. You will have to refer to the financial statement notes, especially the accounting policy information, and/or the MD&A, to assess the nature of these items. Items chosen can be transactions or events (for example, the presence of business acquisitions) or accounting policies (for example, revenue recognition issues) but may not be ratios. High-quality answers will be detailed and specific.
These 2010 financial statements comply with Canadian GAAP because they were created before the 2011 IFRS deadline. Do not analyze the nature of differences between Canadian GAAP and IFRS in your solution.
c. Analyze your comparator company and explain and evaluate similar adjustments, if any exist. Complete the grid in Exhibit 2 of the solution template for each item.
d. Conclude with your assessment of the relative quality of earnings for ProMetic Life Sciences Inc. and its comparator company, based on your (limited) examination.
Refer to Exhibits 1 and 2 of "Earnings Quality: It's Time to Measure and Report" (Topic 1.8) and read the discussion in the topic for examples of sensitive areas.
Note: Content addressed may span all topics in FA2 and FA3. An example item is provided for you on the first section of the grid in Exhibit 2.
2. Supply the statement of cash flow (SCF) of your comparator company in Exhibit 3 of the solution. (You will lose marks if this is not provided.)
Procedure:
a. Open the financial statements of your comparator company and go to the SCF.
b. Right click and hold the button down; move the mouse to highlight the entire SCF content. Hold down the "CRTL" key and then hit the "C" key.
c. Return to your solution Word document and press "CRTL" and the "V" key. This will copy the material with no spacing, which is acceptable for this submission.
3. Comment on your choice of comparator company. First, evaluate and contrast the two companies. What justification do you have for the choice you made? Then, comment on the difficulties you experienced in identifying a comparator company. Provide one or two paragraphs explaining these points in Exhibit 1 of the solution template.
Exhibit 1: Solution template - Choice of Comparator Company
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QOE analysis company
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ProMetic Life Sciences Inc.,
December 31, 2010
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Comparator company
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Part 3: Comparator company choice commentary (5 marks)
(Add lines as needed to fit your one- or two-paragraph response in the right column)
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Exhibit 2: Solution template - QOE adjustments analysis
($ in millions)
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Example:
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QOE adjustment:
ProMetic
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ProMetic reports an adjustment of $(177) for a gain on capital asset disposal in 2010. There was no adjustment in 2009. Amortization "and writeoff" of capital assets was $299 in 2010, and $839 in 2009. In 2010, proceeds on the sale of capital assets of $255 were reported in the investing activities section. Note 9 on capital assets states that there was an impairment writeoff of $41 as a result of disposal. Note 2 indicates that such impairments were the excess of carrying value over fair value. Obsolescence and redundancy might be a risk because of sophisticated laboratory and computer equipment in this industry.
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Significance of adjustment
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The QOE models generally penalize gains and losses from asset sales, and impairments; assets are meant to be held for their useful lives, and estimates of useful life and residual values are meant to be accurate. Trends are a particular danger signal.
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Analysis of comparator company
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ABC (a fictitious company) reports a gain from sale of capital assets of $2,480 in 2010 and a loss of $1,322 in 2009. ABC appears to have a habit of selling capital assets, and reports larger gains and losses than ProMetic; these imply changes in plans and/or poor estimates of depreciation variables. Therefore, ABC would be viewed as having lower QOE.
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Part 1A
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Excess of cash flow from operations over net income for 2010 and 2009
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ProMetic
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2010:2009:
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Comparator company
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2010:2009:
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Parts 1B and 1C
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Item 1
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QOE adjustment:
ProMetic
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Significance of adjustment
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Analysis of comparator company
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Item 2
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QOE adjustment:
ProMetic
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Significance of adjustment
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Analysis of comparator company
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Item 3
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QOE adjustment:
ProMetic
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Significance of adjustment
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Analysis of comparator company
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Item 4
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QOE adjustment:
ProMetic
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Significance of adjustment
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Analysis of comparator company
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Item 5
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QOE adjustment:
ProMetic
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Significance of adjustment
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Analysis of comparator company
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Part 1D
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QOE conclusion
(Add lines as needed to fit your response, using full paragraphs, in the right column.)
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Exhibit 3: Solution template - SCF for comparator company