Factors to be considered in Time Series Analysis

The factors to be considered in time series analysis are:

1. Structural changes.

2. Accounting policy changes.

3. Accounting classification changes.

4. Adjustment for abnormal items.

Structural Changes

Structural changes in the series may be caused by changes within the firm or by external factors.  For example,

• Change in accounting policies, accounting techniques, and government regulation.

• Change in competition, either from other products or from new firms.

• Developments in technology that substantially change cost-volume-profit relationships.

• Acquisitions or divestments - that is, the entity being measured has changed composition due to mergers or divestments.

For example, a company may have changed its depreciation policy from straight line to written down value. In this case, the effect of change has to be ironed-out to make comparison possible. Similar will be the case when accounting year is changed from usual 12 months to another period, say 15 months; then, 15 months period is to be divided so as to make it a period of 12 months. Otherwise, data for two years cannot be compared.

One or many of the above circumstances are likely to have occurred in any reasonable time span. The analyst has to determine the causes for the structural changes based on the time series analysis. The options available in time series analysis when structural changes occur include the following:

• Ignore the implications on the implicit justification that the effects are trivial.

• Split the series of readings into segments that are comparable.

• Make the necessary adjustments to produce a homogeneous series.

• Allow for the structural change in the model.

Accounting Policy Changes

These changes could be voluntary or mandated by a regulatory body. The option available for an analyst in time series analysis when Accounting method changes occur include the following:

1. Do not make any adjustment on the assumption that the change is immaterial.

2. Retain all observation in the time series but make adjustments so that a consistent set of accounting rules is used over the time series.

3. Examine only those observations in the time series that are derived from the same set of accounting methods.  

For example, a company may have changed its depreciation policy from straight line to written down value or its inventory valuation from LIFO to FIFO.

Accounting Classification Issues

The accounting classification adopted by an analyst may be different from that adopted by the firm; this is so because firms have a considerable flexibility over the timing of many events and in the classification used to represent those events in the financial statements. An analyst may wish to adopt different pattern of timing or classification of events than is represented in the financial statements.

Adjustment for Abnormal Items

Abnormal Items: An accounting term describing events that arise in the normal course of a company's business but which have been unusually large during the reporting period.

The option available to an analyst in time series analysis for Adjustment for abnormal items include the following:

• Do nothing with the reported loss, in the belief that it represents a phenomenon that may recur on an ongoing basis in subsequent period. For example, large losses which appear to be an ongoing phenomenon in case of airlines, steel, and motor vehicle industries.

• To adjust the reported loss, in the belief that it represents a phenomenon that may not recur in subsequent  period or it is expected to  recur in subsequent  period  and  it is material to take into account. For example, a fire accident or strike in a factory.

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