An Analysis of Kodak’s Quality Financial Reporting

Published January 10, 2014 by Mayrbear's Lair

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Quality financial reporting (QFR) helps paint a clear picture of a company’s financial condition. Miller (2002) explains that QFR is more of an attitude than a set of practices that involves firms developing relationships with capital market participants to help communicate their needs effectively (Miller, 2002). The focus of this post is to ascertain whether the financial statements of the Kodak Corporation’s 2007 Annual Report revealed a high level of quality financial reporting. To determine this, the statements should reveal: (a) their cash flow potential, (b) how effective they were at raising capital, and (c) whether it painted the real economic picture of the firm or if the data was fabricated to make it appear in better financial health than it was. My research will also determine whether the report provided sufficient explanations about their accounting choices, estimates and judgments, and whether they were relevant, verifiable, consistent, and presented the data fairly with neutrality, all of which are critical criteria for high quality financial reporting. The following components were used as a checklist to help determine the quality of data: (a) the earnings reported for sales, (b) the cost of goods sold, (c) the non-operating revenue and expenses, (d) the operating expenses, and (e) other commitments and contingencies. The findings of this post will deduce that Kodak’s 2007 Annual Report revealed a high level of quality reporting that was effective in representing the economic truth of their financial condition.

kodak pic

Evidence of Kodak’s QFR

Quality financial reporting helps capital market participants understand a company’s financial condition from the data and ratios that the statements contain which reveal cash flow and profitability outcomes. Bahnson and Miller (2002) explained it more effectively stating that QFR can divulge how companies create opportunities to receive and perpetuate cash flows (Bahnson & Miller, 2002). My research work began with an examination of Kodak’s sales and costs of goods sold figures to search for inconsistencies and trends. Next, I took a look at the inventory valuation methods and determined it was based on fair market value. In addition, there were no clues that would indicate premature revenue recognition. In the meantime, Kodak’s income statement (see Exhibit A) showed a steady decline in net sales figures from 2005 to 2007. A comparison of the accounts receivables and inventories ratios from the Common Size Balance sheet (see Exhibit B) corroborated the decline and confirmed a large ratio of debt to revenue. The common size income statement (see Exhibit C), also revealed a consistency in debt ratios that showed declining patterns in the relationships among sales, accounts receivable, and inventory. The notes offered adequate explanations for their accounting choices and disclosed the declining figures resulted from their restructuring strategy. In other words, to investors, debt implies risk, but Kodak’s report offered relevant details that were verifiable to explain the reasons for these debt ratios. Furthermore, the declining numbers did not raise red flags indicating the possibility of premature revenue recognition. This level of clarification provided a fuller picture that helped explain the low profit and high debt figures to alleviate uncertainty.

Kodak’s report also provided details about their revenue recognition policies explaining how their revenue was derived as well as how they calculated deferred income. In addition, the report included details about reductions to revenue policies and the methods used to measure revenue derived from consumer incentive programs. The statement also provided explanations with neutrality about estimates and judgments that were made based on the firm’s past experiences and historical records. This helped leave little room for unanswered questions about how Kodak’s inventory was valued as well as how it was collected and recognized.

Quality financial reporting can also help skilled analysts identify whether a company is manipulating the figures to show higher profits. For instance, Kodak’s common size income statement (Exhibit C) revealed that the gross profit margin showed a slight increase each year but reported zero operating profits. This means the firm was able to increase sales but not enough to control the substantial growth of operating expenses which was most likely due to their restructuring process. The data also confirmed their ability to raise funds showing a $238 million impairment charge from the sale of their Chinese facility and that selling the Health Group Company was also expected to generate future cost savings.

kodak-logo

What the Report Revealed about Kodak’s Future

High quality financial statements disclose the real economics of the company’s transactions and also reveal how well the company managed their assets to forecast their future. Turner (2000) asserts without QFR analysts lack reliable data to forecast future earnings (Turner, 2000). For example, Kodak’s ratios revealed that cash flow margins continued to decrease which made it difficult for them to service debt, pay dividends, and invest in further capital assets. However, the notes revealed their confidence of strength in future earnings and cash flow potential because of their ownership patents. This data revealed their potential to generate continuous revenue from licensing.

Other clues about Kodak’s future can be determined from explanations that revealed the firm’s other long-term commitments which include rental expenses of real property that showed a decreasing trend beginning with $149 million in 2005, dipping to $130 in 2007 that continued to drop in 2008 to $99 and thereafter. Furthermore, the report disclosed other contingencies stating the company and its subsidiaries were involved in a variety of litigation cases that could have an adverse effect on their future finances. Finally, the consumer price index (CPI) is also considered to help analysts forecast Kodak’s future earnings. For example, statement ratios along with CPI figures that measure the rate of inflation are significant components that are factored in to help strategists forecast future potential earnings. For instance, a 6% rate of inflation occurred during the 2006-2007 accounting period which was measured at 201.6 in 2006 and jumped to 207.3 in 2007. Strategists use these figures to help predict Kodak’s future growth potential based on past performances and factoring in a 6% CPI increase level into their formulas, which was calculated at 215.3 in 2008.

kodak_printdock3

Conclusion

Incomplete information on a company’s financial statements can create uncertainty for capital market participants. Fraser and Ormiston (2010) remind us that high quality financial statements provide sufficient data that help business owners make more effective decisions (Fraser & Ormiston, 2010). My research work determined that Kodak’s financial statements provided sufficient explanations that: (a) disclosed their cash flow potential from relevant accounting data of past performance to help forecast future behavior; (b) used reliable information that reflected the real economics of activities reported; (c) included verifiable and measurable data developed free of bias towards a predicted result; and (d) provided valuable ratio data for comparison to reveal how effective they were at raising capital. Based on these principles, the findings of this study concluded that Kodak’s 2007 Annual Report met criteria that were consistent with quality reporting that revealed the true nature of their financial condition during that period.

Exhibit A

kodak income statement Exhibit A

(Kodak, 2008)

Exhibit B

Assignment 5 Exhibit B - Common Bal

(Kodak, 2008)

Exhibit C

Assignment 5 Exhibit C - Common Income

(Kodak, 2008)

References

(2008). Kodak. Washington: Securities and Exchange Commission.

Bahnson, P., & Miller, P. (2002). Quality financial reporting. New York, NY: McGraw-Hill.

Fraser, L., & Ormiston, A. (2010). Understanding financial statements. Pearson Education.

Miller, P. (2002, April). Quality Financial Reporting. Retrieved November 25, 2013, from Journal of Accountancy: http://www.journalofaccountancy.com/Issues/2002/Apr/QualityFinancialReporting.htm

Turner, L. (2000, March 23). Speech by SEC staff: Charting a course for high quality financial reporting. Retrieved November 27, 2013, from US Securities and Exchange Commisssion: http://www.sec.gov/news/speech/spch356.htm

4 comments on “An Analysis of Kodak’s Quality Financial Reporting

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