- 简体中文
- 繁体中文
- English
Evaluating the Earnings Quality of the Company
This report provides estimates of earnings persistence and predictability for over the last ten years (i.e. FY2011-2020). When measuring earnings persistence and predictability, the following formula is used:
If earning is persistent, the coefficient 
should be very high or close to 1. In other words, the earnings persistence relates to the time-series correlation of earnings. The more sustainable the earnings, the higher the persistence which increases the earnings quality.
Based on the output of the regression model in appendix 1, the earnings persistence of Domino and Collins, as well as the industry are shown in the following table:
Company | Coefficient on | p-value |
Domino | 0.419 | 0.301 |
Collins | -0.086 | 0.839 |
Industry | 0.588 | 0.000 |
Source: Author
For Domino, the coefficient = 0.419 indicates that earnings persistence for the firm is very low since it is closer to zero than 1. However, this beta value is greater than that for Collins = -0.086 which is negative but lower than the industry average = 0.588. Hence, Domino’s earnings are less persistent and less sustainable than the industry average.
Predictability is determined by the variance of the residuals. This value is the unexplained component of the dependent variable. Based on appendix 1, Domino’s variance of the residuals is 0.0004, which is less than that for Collins of 0.0012. In comparison, Domino’s earnings are more predictable than its competitor as it has a smaller variance.
In conclusion, Domino has less persistent earnings as its beta value is closer to zero than 1. Therefore, Domino’s earnings are less sustainable since they have low persistence, and hence lower earnings quality.
Providing More Evidence on Earnings Quality
Source: Author
The figure above shows the amount of earnings realized in cash from the fiscal year 2011 through 2020. The corresponding cash from operations appears increase steadily from $110,562,000 in 2011 to $848,526,000 in 2020 without any cost reductions. The net profit after tax is seen to increase from $12,797 in 2011 to $62,770,000 in 2016, slightly drops to $58,019,000, and then rises continuously to $103,898,000. Since these values are consistent or persistent, the company has high-quality earnings. Thus, this analysis does not support the initial conclusions about earnings quality predicted in previous section that the firm has low earnings persistence.
Describing the Key Accounting Policies of the Company and Its Competitor
The key accounting policies of Domino are:
1. PPE, leasehold improvements, and equipment under finance leases are estimated as cost less accumulated depreciation and impairment.
2. In calculating depreciation, the useful lives for plant and equipment are 1-10 years, and equipment under finance leases are 3-10 years. The method used is straight-line depreciation and is provided on PPE, excluding land.
3. Borrowing costs for acquiring qualifying assets are added to the costs of acquisition, construction or production of qualifying assets until when those assets are ready to be used or sale.
The key accounting policies of Collins Foods are:
1. All PPE is estimated as historical cost less depreciation.
2. Straight-line depreciation method is used. The useful lives for plant and equipment is 8 years and equipment under finance lease is 4 years.
3. Borrowing costs for acquiring qualifying assets are capitalized during the period of time required to complete and prepare those assets for their intended use or sale
Checking for Manipulated Earnings
This report examines whether the company may have manipulated earnings over the past five years. Two methods of earnings management are used to investigate this issue. Domino’s Pizza Enterprise has considered the cost of sales as immaterial and failed to include it in a separate section. Hence, its financial statements for the past five years have changed the gross profit method to only take into account the sales revenue. In doing so, its net income has improved on year-on-year basis. This particular item is material enough to be noted separately in a company’s financial report. Failing to include it in the financial statements violates the principle of materiality under the GAAP principles. In addition, the management recognizes revenues that are restricted to be used solely for advertising and promotional activities to benefit franchised stores. The two manipulations considered have enabled the firm to boost the overall profitability of its business.
Domino’s Pizza Enterprise has reported continued growth in its sales for over the past 5 years without taking into account its costs of goods sold. In particular, the company claims that the franchise revenues do not have a component of cost of sales and changes in these financial items have a disproportionate effect on the consolidated operating margin. The firm has also conducted a number of lease operations but has failed to include these transactions in its financial statements. As of December 30, 2018, the company made additional operating leases to serve suppliers, such as center tractors and retailers while establishing firm agreements for a new building constructed by the company’s landlord that was priced at approximately $39.1 million. However, the company has not made any attempt to justify these unexplained transactions that clearly boost the overall profit of its business.
Adjustments to the firm’s financial statements is necessary to reflect the true value of its general expenses as well as its liabilities. The amendments on revenue recognition will involve calculation of the cost of sales and subtraction of this value from the firm’s operating revenue to obtain a more accurate record of the annual gross profit during the 5-year period. In addition, the operating leases will be included in both the firm’s income statement and balance sheet. The lease depreciation will be determined using the straight-line method. (See calculations in the attached spreadsheet).
This report compares the quality of disclosures of Domino Pizza Enterprise with Collins Food. Domino communicate clearly about its business strategies, including its strengths, compliance to legal matters, and risk factors that could possibly affect its future developments and performance. However, it does not provide any footnotes to its consolidated financial statements, but it has indicated some notes which partially explain its financial items. In comparison, Collins Foods has a better quality disclosure than Domino as it provides footnotes to all its financial statements and its notes explain its accounting policies in detail, as well as expounds on its current performance.
Evaluating the Earnings Quality of the Company
This report provides estimates of earnings persistence and predictability for over the last ten years (i.e. FY2011-2020). When measuring earnings persistence and predictability, the following formula is used:
If earning is persistent, the coefficient should be very high or close to 1. In other words, the earnings persistence relates to the time-series correlation of earnings. The more sustainable the earnings, the higher the persistence which increases the earnings quality.
Based on the output of the regression model in appendix 1, the earnings persistence of Domino and Collins, as well as the industry are shown in the following table:
Company | Coefficient on | p-value |
Domino | 0.419 | 0.301 |
Collins | -0.086 | 0.839 |
Industry | 0.588 | 0.000 |
Source: Author
For Domino, the coefficient = 0.419 indicates that earnings persistence for the firm is very low since it is closer to zero than 1. However, this beta value is greater than that for Collins = -0.086 which is negative but lower than the industry average = 0.588. Hence, Domino’s earnings are less persistent and less sustainable than the industry average.
Predictability is determined by the variance of the residuals. This value is the unexplained component of the dependent variable. Based on appendix 1, Domino’s variance of the residuals is 0.0004, which is less than that for Collins of 0.0012. In comparison, Domino’s earnings are more predictable than its competitor as it has a smaller variance.
In conclusion, Domino has less persistent earnings as its beta value is closer to zero than 1. Therefore, Domino’s earnings are less sustainable since they have low persistence, and hence lower earnings quality.
Providing More Evidence on Earnings Quality
Source: Author
The figure above shows the amount of earnings realized in cash from the fiscal year 2011 through 2020. The corresponding cash from operations appears increase steadily from $110,562,000 in 2011 to $848,526,000 in 2020 without any cost reductions. The net profit after tax is seen to increase from $12,797 in 2011 to $62,770,000 in 2016, slightly drops to $58,019,000, and then rises continuously to $103,898,000. Since these values are consistent or persistent, the company has high-quality earnings. Thus, this analysis does not support the initial conclusions about earnings quality predicted in previous section that the firm has low earnings persistence.
Describing the Key Accounting Policies of the Company and Its Competitor
The key accounting policies of Domino are:
1. PPE, leasehold improvements, and equipment under finance leases are estimated as cost less accumulated depreciation and impairment.
2. In calculating depreciation, the useful lives for plant and equipment are 1-10 years, and equipment under finance leases are 3-10 years. The method used is straight-line depreciation and is provided on PPE, excluding land.
3. Borrowing costs for acquiring qualifying assets are added to the costs of acquisition, construction or production of qualifying assets until when those assets are ready to be used or sale.
The key accounting policies of Collins Foods are:
1. All PPE is estimated as historical cost less depreciation.
2. Straight-line depreciation method is used. The useful lives for plant and equipment is 8 years and equipment under finance lease is 4 years.
3. Borrowing costs for acquiring qualifying assets are capitalized during the period of time required to complete and prepare those assets for their intended use or sale
Checking for Manipulated Earnings
This report examines whether the company may have manipulated earnings over the past five years. Two methods of earnings management are used to investigate this issue. Domino’s Pizza Enterprise has considered the cost of sales as immaterial and failed to include it in a separate section. Hence, its financial statements for the past five years have changed the gross profit method to only take into account the sales revenue. In doing so, its net income has improved on year-on-year basis. This particular item is material enough to be noted separately in a company’s financial report. Failing to include it in the financial statements violates the principle of materiality under the GAAP principles. In addition, the management recognizes revenues that are restricted to be used solely for advertising and promotional activities to benefit franchised stores. The two manipulations considered have enabled the firm to boost the overall profitability of its business.
Domino’s Pizza Enterprise has reported continued growth in its sales for over the past 5 years without taking into account its costs of goods sold. In particular, the company claims that the franchise revenues do not have a component of cost of sales and changes in these financial items have a disproportionate effect on the consolidated operating margin. The firm has also conducted a number of lease operations but has failed to include these transactions in its financial statements. As of December 30, 2018, the company made additional operating leases to serve suppliers, such as center tractors and retailers while establishing firm agreements for a new building constructed by the company’s landlord that was priced at approximately $39.1 million. However, the company has not made any attempt to justify these unexplained transactions that clearly boost the overall profit of its business.
Adjustments to the firm’s financial statements is necessary to reflect the true value of its general expenses as well as its liabilities. The amendments on revenue recognition will involve calculation of the cost of sales and subtraction of this value from the firm’s operating revenue to obtain a more accurate record of the annual gross profit during the 5-year period. In addition, the operating leases will be included in both the firm’s income statement and balance sheet. The lease depreciation will be determined using the straight-line method. (See calculations in the attached spreadsheet).
This report compares the quality of disclosures of Domino Pizza Enterprise with Collins Food. Domino communicate clearly about its business strategies, including its strengths, compliance to legal matters, and risk factors that could possibly affect its future developments and performance. However, it does not provide any footnotes to its consolidated financial statements, but it has indicated some notes which partially explain its financial items. In comparison, Collins Foods has a better quality disclosure than Domino as it provides footnotes to all its financial statements and its notes explain its accounting policies in detail, as well as expounds on its current performance.