Description and Analysis in the Credit Write-up
Q: Why are you not utilizing tax returns as well as financial statements?
A: First, business income tax returns are not prepared according to GAAP but, rather, according to Congressional legislation, which reflects political input frequently in violation of GAAP guidance.
Second, financial statements prepared according to GAAP best represent the financial results and financial position of a company. Therefore, it is these statements that we need to use to properly conduct ratio and cash flow analysis.
Third, we could use business income tax returns but only after we had converted the quasi-income statement on the first page of Form 1120S – Schedule 1120S as we call it – to an accrual income statement, which is a very tedious task.
Finally, keep in mind that the primary objective of the accountant preparing business income tax returns is to drive the taxable income to the lowest dollar amount possible. As a result, unadjusted business income tax returns frequently present a more negative picture of a company's financial results – in addition to violating many GAAP guidelines.
Course overview: Description and Analysis in the Credit Write-up