Numerical Analysis of Potential Earnings Management \u2013 2008 to 2012<\/p>\n
The analysis of potential earnings management of the Six Flags includes a comprehensive ratio and trends analysis for the past five years. In this regard, ratios calculated include accounts receivable relative to sales, the allowance for doubtful accounts relative to accounts receivable, inventory relative to sales, the obsolescence reserve relative to inventory, age of inventory, days\u2019 payables outstanding, prepaid expenses relative to the related expense account, accrued expenses relative to the related expense account, and deferred revenue relative to revenue. <\/p>\n
The following table presents the final values of the ratios calculated for the past five financial years.<\/p>\n
Ratio 2012 2011 2010 2009 2008<\/p>\n
Accounts Receivable to Sales Ratio 0.029 0.019 0.022 0.019 0.157 <\/p>\n
Inventory to Sales Ratio 0.022 0.021 0.026 0.021 0.194 <\/p>\n
Obsolescence Reserve to Inventory Ratio 0.031 0.033 0.025 0.019 0.017 <\/p>\n
Age of Inventory 0.096 0.103 0.120 0.119 0.116 <\/p>\n
Days Payable Outstanding 38.104 40.433 64.157 46.948 42.675 <\/p>\n
Prepaid Expense for Spare Parts Inventory for Existing Rides and Attractions to Repair or Maintenance Expense 0.287 0.290 0.277 0.282 0.233 <\/p>\n
Accrued Interest to Interest Expense 0.050 0.016 0.026 0.604 0.232 <\/p>\n
Deferred Revenue to Revenue 0.052 0.039 0.028 0.019 0.137 <\/p>\n
(Six Flags)<\/p>\n
The accounts receivable to sales ratio indicate that around 98 percent of sales made by the company are on cash, which is understandable owing to the nature of the business. This ratio has been maintained throughout the period of five years. On the other hand, the company has maintained inventory levels at around two percent of the sales revenue throughout the period under consideration. However, with growth in sales revenues, growth in the percentage of inventory in relation to sales has also increased slightly, as can be noted in the year 2010 (Six Flags).<\/p>\n
The inventory turnover, as indicated by the age of inventory ratio for the company, is very low which implies that inventory is sold instantly. The days payable outstanding ratio, on the other hand, increased to two months from 2008 till 2010, but has since declined to 38 days by the end of year 2012. This also means that the cash conversion cycle for the company has improved over the period of three years. As far as the prepaid expenses for repair and maintenance for existing rides and attractions is concerned, the company has maintained around 28 to 30 percent prepayments in this regard. On the other hand, the accruals for interest have been determined to be fluctuating due to variations in the interest expenses incurred during the year. Similarly, the deferred revenues to total revenues ratio indicates that there is no constant proportion of total revenues maintained by the company with regard to other income, since earnings from other sources have fluctuated significantly throughout the period of five years (Six Flags).<\/p>\n
Note: The ratio, Allowance for doubtful debts to account receivables, has not been calculated since the company has not provided any details regarding its allowance for doubtful debts in the financial statements for five years.<\/p>\n
Trends noted in the revenues earned, net income and net cash from operating activities of the company are presented as follows:<\/p>\n
2012 2011 2010 2009 2008<\/p>\n
Revenue 5.64% 3.82% 6.90% -10.62% 5.20%<\/p>\n
Net Income -1630.17% -103.78% -361.35% 91.26% -53.07%<\/p>\n
Cash from Operations 35.17% 323.68% -16.55% -27.77% 1015.04%<\/p>\n
The revenues of Six Flags have been jolting since 2008 and there has been no consistency noted in the trends for revenue. The revenues have though shown improvement since 2010, as the company recovered from significant decline in 2009. As far as trends related to net income are concerned, there has been consistent decline noted in net income, apart from the year 2009. The main reason behind this decline is the increased operating costs and other expenses incurred by the company. Moreover, cash generated\/used by operating activities has also shown significant variations during the last five years. Although, there is a positive growth rate noted in 2012, but keeping in view past trends, it cannot be implied that the following year will also mark a positive growth in this regard (Six Flags; Rajasekaran). <\/p>\n
Earnings Management Incentives<\/p>\n
The compensation of executives comprise of base salary, annual incentives, long term incentives and perquisites and benefits. Base salary is determined by negotiation, whereas annual incentives are based on attainment of strategic objectives, which relate to EBITDA, net debt level, satisfaction of guests and maintaining safe and secure environment. The annual incentives are paid as bonuses which represent a certain percentage of basic salaries. In addition, long term incentives, which include stock options or restricted stock units, are determined by evaluating the contribution of executives in increasing the value of company\u2019s stocks. Other perquisites and benefits include health and welfare related payments to executives. Keeping in view the determination of compensation for executives, there are incentives to manage earnings, as noted for annual incentives and long term incentives (Six Flags).<\/p>\n
As far as the violation of debt covenants on the part of the company, there are no such instances notified in the Form 10K of the company (Six Flags).<\/p>\n
On the other hand, considering the earnings reported by Six Flags, the company has performed well above the expectations and forecasts of analysts. In fact, the company performed over and above expectations continuously in the year 2012 (Hoffman).<\/p>\n
Discussion related to Tax Accounts<\/p>\n
The effective tax rate for the company during the past three years has been calculated as follows, by considering the net income before tax and total tax expense for the year:<\/p>\n
2012 2011 2010<\/p>\n
Net Income Before Tax 211,612.00 3,879.00 748,421.00<\/p>\n
Income Tax Expense 74,064.00 1,358.00 261,947.00<\/p>\n
Effective Tax Return 35.00 % 35.01 % 35.00 %<\/p>\n
It can be observed from the above calculations, that the net income of the company has been taxed at the same rate during the last three financial years (Six Flags).<\/p>\n
The forecasting of effective tax rate for Six Flags can be considered as complex process, since it is difficult to make projections regarding the profit making ability of the company in the years to come. Although, management has shown optimism by making use of the federal net operating loss carry forward, the reality, however, cannot be assumed with so much surety, as the company has been suffering significant losses in the recent past (Six Flags). <\/p>\n
Apart from this, the company has disclosed a valuation allowance in relation to deferred tax assets owing to the uncertainty regarding the utilization of deferred tax assets in the future. The allowance is adequate because the company has based it on the taxable income in the jurisdiction of its operations (Six Flags). <\/p>\n
Stock Compensation<\/p>\n
The assumptions used to calculate the fair value of stock option grants are based on the Black-Scholes option pricing valuation model. In this regard following assumptions have been made:<\/p>\n
S. No. Assumptions<\/p>\n
1 The rate used as risk-free rate is the \u201cyield on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term assumption at the time of grant.\u201d (Six Flags F-30) <\/p>\n
2 The volatility expected has been based on the common stock volatilities expected by companies of similar business for the same period (Six Flags F-30).<\/p>\n
3 The dividend expected has been based on the expectations for the term (Six Flags F-30).<\/p>\n
4 The fair value of stock has been expensed out using a straight line method over a period of vested term (Six Flags F-30). <\/p>\n
Since the company has considered market trends and yield on U.S. Treasury zero-coupon issues, the assumptions therefore seem to be appropriate and do not indicate management of stock options expense downwards.<\/p>\n
The options overhang for Six Flags has been calculated as follows:<\/p>\n
\u00a0 Shares<\/p>\n
Granted Stock Options and Restricted Stocks 1,467,000<\/p>\n
Remaining Stocks 347,000<\/p>\n
Total 1,814,000<\/p>\n
Outstanding Shares 53,818,762<\/p>\n
Overhang 3.4%<\/p>\n
(Six Flags)<\/p>\n
The percentage of stock options and restricted stocks and remaining options in relation to outstanding shares does not imply that the existing overhang requires high levels of growth for ensuring returns to the investors.<\/p>\n
Works Cited<\/p>\n
Hoffman, Derek. Six Flags Entertainment Earnings: What Investors Should Watch. 20 July 2013. 23 February 2014. <http:\/\/wallstcheatsheet.com\/stocks\/six-flags-entertainment-earnings-what-investors-should-watch-2.html\/>.<\/p>\n
Rajasekaran, V. Financial Accounting. New Delhi: Dorling Kindersley Private Limited, 2011.<\/p>\n
Six Flags. Form 10K. SEC Filing. Grand Prairie: Six Flags, 2012.<\/p>\n
\u2014. Form 10K. SEC Filing. Grand Prairie: Six Flags, 2011.<\/p>\n
\u2014. Form 10K. SEC Filing. Grand Prairie: Six Flags, 2010.<\/p>\n
\u2014. Form 10K. SEC Filings. Grand Prairie: Six Flags, 2009.<\/p>\n
\u2014. Form 10K. SEC Filing. Grand Prairie: Six Flag, 2008.<\/p>\n
\u2014. Form 10K. SEC Filing. Grand Prairie: Six Flags, 2007.<\/p>\n
\u2014. SCHEDULE 14A. Proxy Statement. Grand Prairie: Six Flags, 2012.<\/p>\n","protected":false},"excerpt":{"rendered":"
Numerical Analysis of Potential Earnings Management \u2013 2008 to 2012 The analysis of potential earnings management of the Six Flags<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-43529","post","type-post","status-publish","format-standard","hentry"],"yoast_head":"\n