Dialogue with Frank Marinara
“I wanted to meet today about assigning you a corporate accounting project. It is necessary to understand the client’s accounting and strategy before we can consider recommendations.
Choice Hotels’ accounting is audited by Ernst & Young LLP. This same firm audits their internal controls. As a result of the Sarbanes-Oxley Act of 2002 (SOX), Choice Hotels must rely on a different firm for accounting advice, and it will likely use one of the other big four accounting firms.
I am handing down this assignment from our managing director, Elisa Izuki, who heads the accounting projects group in Maryland Creative Solutions, LLC (MCS). She has asked for a complete review and ratio analysis of the most recent 10-K annual financial statements for Choice Hotels International, Inc.
“Speaking of financial statements,” Frank adds, “the most common financial statements are the income statement, balance sheet, and statement of cash flows. While you are at it, you should know a bit about accounting conventions and standards in the United States.”
Your goal is to develop an understanding of the business of Choice Hotels using the 2018 annual report that the company files with the Securities and Exchange Commission (10-K). I recommend you analyze the 10-K financial reports using accounting and finance ratios after you read key parts of the Document.
Ratio analysis is especially difficult because Choice Hotels is one of the largest hotel franchisors in the world. The company does not sell any products and has no inventory, and because of this, some traditional analyses does not apply.
Also, the company has had and continues to have an aggressive Treasury stock repurchase program, and this has caused negative equity on the balance sheet. Many companies have had stock repurchase programs in recent history. Choice Hotels has been among the most aggressive in Treasury stock repurchase programs. The negative equity means that we cannot use ratios like Return on Equity and Debt to Equity. Fortunately, there are other ratios we can use.
Choice Hotels’ management recently completed a large acquisition. You need to understand what was acquired.
The first part of the 10-K Document has useful information that describes the business, the risk factors, and Management’s Discussion and Analysis of Financial Condition and Results of Operations. This information is beneficial to your analysis.
Analysts use the Notes to Consolidated Financial Statements in the 10-K Document to evaluate the riskiness of the debt. The notes also state that Choice Hotels has an investment grade credit rating. However, the interest rates seem high compared to our other clients. Both Standard & Poor’s and Moody’s rate Choice Hotels’ debt as the lowest investment grade BBB- and Baa3 with a stable outlook.
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