Six steps in accounting analysis of BMW company

the data of 2019 report: https://www.bmwgroup.com/en/investor-relations/financial-reports.html

1. identify accounting measures (to capture firm performance in managing key factors)

Analyst needs to identify :

a. accounting measures the firm uses to measure its critical factors and risks b. the policies that determine how the measures are implemented

c. the key estimates embedded in these policies

Product quality/defect <=>warranty expenses & reserves

Innovation <=> R&D expenditure

Credit risk <=> loan loss expenses & reserves

2. evaluate accounting flexibility

All firms have some flexibility and offer potential for managing reported numbers

depreciation policy

restructuring charges

goodwill impairment

provisions

3. assess accounting/reporting strategy

When managers have accounting flexibility

Can use it either to communicate the firm's true economic situation or hide

true performance.

Ask: are there strong incentives to use accounting discretion for earnings

management?

Close to violating accounting-based debt covenants?

Difficulty meeting earnings forecasts?

Difficulty meeting accounting-based bonus targets? Takeover target?

Union negotiations?

4. evaluate quality of disclosure identify red flags

Disclosure quality is an important dimension of a firm's accounting quality Does the firm provide adequate supplementary disclosures to assess its business strategy and its

economic consequences?

Do the notes to the accounts adequately explain the key accounting policies and assumptions and their logic?

Obfuscation strategy in case of bad news?

5. Identify and assess potential red flags

Unexplained changes in accounting when performance is poor

Unexplained transactions that boost profits

Abnormal increases in receivables relative to sales

Abnormal increases in inventory relative to sales

Increasing gap between accounting-based profit and cash flows

Increasing gap between accounting and tax profit

Use of financing mechanisms

Unexpected large asset write-offs (goodwill/loan-other receivables)

Large fourth quarter adjustments

Qualified audit opinions or change in auditors Poor internal governance systems Related-party transactions

6. Undo accounting distortions(if necessary )

If accounting analysis suggests that reported numbers are misleading an analyst should attempt to restate the reported numbers

Focus on the Notes as a starting point Common adjustments include:

Adjustments for one time charges such as asset impairments and restructuring costs

Capitalisation of R&D if deemed necessary

Adjustment of depreciation policy, bad debt provisions in line with industry norms