© 2005 by Robert F. Halsey, all rights reserved ACC7500 Financial Reporting and Statement Analysis Prof. Bob Halsey 302 Luksic Hall

© 2005 by Robert F. Halsey, all rights reserved

ACC7500 Financial Reporting

and Statement Analysis

Prof. Bob Halsey302 Luksic Hall


Introduction Course focus on footnotes

Most of the action is here Review ACC7000/FIBD notes if you haven’t already

Syllabus/Schedule/Resources Text: Wild, Subramanyam and Halsey (WSH), FSA, 8th ed. Blackboard (http://blackboard.babson.edu/ ) Bring mini-cases to class Outside help: Wednesday afternoons or by appt., email,

phone. I’m a nice guy and I’m here to help

Questions are ok … really! Please, let’s share our ideas, but keep focused and not

too many tangents


Course content Financial statements

Overview Cash Flow Accruals Core earnings Projections Foreign Currency

Translation Deferred Taxes

Earnings Management Valuation

DCF Residual Income ROE Disaggregation

review

Off Balance Sheet Leasing VIEs Derivatives Pensions

Investments Passive Equity method Consolidations

Equity transactions Equity carve outs Convertibles Stock Options


Grace’s Dress Company

Transaction Analysis


Initial capital contribution of $1,000 into the business; borrow $500 to be repaid $100 per period @ 2% per period. Purchase 10 dresses $500 on account and fixtures, furniture and equipment for $500 in cash (depreciate over 5 periods):

amount Sales Cost of goods Sold Gross profit Wage expense Depreciation expense Interest expense Net profit ASSETS Amount LIABILITIES amount

Cash Accounts payable Accounts Receivable Wages payable Inventories Note Payable Furn, Fix & Equip EQUITY Accumulated Depreciation Contributed Capital Furn, Fix & Equip (net) Earned Capital Total Assets Total Liabilities and Equity


Sell 5 dresses for $600 on account that cost $250; employees earn wages of $100 to be paid next month; record depreciation expense, pay interest on note, repay principal, and pay off account payable:

amount Sales Cost of goods Sold Gross profit Wage expense Depreciation expense Interest expense Net profit

ASSETS Amount LIABILITIES amount Cash Accounts payable Accounts Receivable Wages payable Inventories Note Payable Furn, Fix & Equip EQUITY Accumulated Depreciation Contributed Capital Furn, Fix & Equip (net) Earned Capital Total Assets Total Liabilities and Equity


DuPont Mini-case

Review of Financial Statements


Transitory Items Sales- Cost of Goods Sold (COGS) Gross Margin (GM)- General, Sales and Admin. Costs (SGA)- Interest- Taxes

Earnings From Continuing Operations± Discontinued Operations (net of tax)

± Extraordinary Items (net of tax)± Changes in accounting Principles (net of tax) Net Earnings- Dividends Change in Retained Earnings


Transitory Items

Items below the line (e.g., Cont. Ops.) Discontinued operations Extraordinary items (will reduce in the future) Changes in accounting principles

Transitory items above the line Gains (losses) on asset sales / debt repurchase

(no longer an extraordinary item) Restructuring expenses (write-downs and

accruals)


Frequency of Extraordinary Items

0%

2%

4%

6%

8%

10%

12%

14%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Pro

po

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om

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Re

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rtin

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Pos count % Neg count % Total

Magnitude of Extraordinary Items

0.0%

1.0%

2.0%

3.0%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Year

Me

dia

n a

bs

olu

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as

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Median pos % Median neg % Total


Frequency of Special Items

0%

10%

20%

30%

40%

50%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Year

Pro

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Magnitude of Special Items

0%

1%

2%

3%

4%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Year

Med

ian

ab

solu

te

valu

e as

a p

erce

nt

of

sale

s



Discontinued Operations

Separately identifiable business segment being disposed Disclosure – segregate operating results from continuing

operations: Income (loss) from operations from BOY to

measurement date (net of tax) Gain (loss) on disposal (net of tax)

Operating income from measurement date to disposal date

Gain (loss) from disposal Recognize losses, defer gains

Adjust income statement retroactively for comparative years

May also segregate assets & cash flows


Effect of Disc Ops on Inc. Stmt.


Frequency of Discontinued Operations

0%2%4%6%8%

10%12%14%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Year

Pro

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s r

ep

ort

ing


Magnitude of Discontinued Operations

0%

1%

2%

3%

4%

5%

85 86 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Year

Me

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HP mini-case

1. Briefly describe the accounting for assets and income of discontinued operations. That is, how are sales, expenses, profits and net assets reported in the financial statements?

2. What were the sales and net profits for the discontinued operations in 1999?

3. Prepare a summary balance sheet of the discontinued operations as of 7/31/99.

4. How are the assets, liabilities and equity of the discontinued operations reflected in HP’s balance sheet?

5. How do discontinued operations affect analysis of the financial condition of the company? That is, within the framework of the DuPont analysis, how does the accounting for discontinued operations affect net profit margin, turnover and financial leverage?

6. What adjustments might you wish to make to HP’s reported financial results in your analysis of the company?





HP Mini-case #5

Reported w/o DONPM (NI/Sales) 3491/42370 8.20% (3491-387)/42370 7.30%TAT (Sales/TA) 42370/35297 1.2 42370/(35297-3533) 1.3LEV (TA/TE) 35297/18295 1.9 (35297-3533)/(18295-3533) 2.2

ROE 19% 21%


Asset Measurement mini-case

Intangible Assets


ACC7500 asset measurement mini-case

The use of historical costing is justified on the basis of objectivity and verifiability, which arguably lessen potential bias in financial statements by reducing the degree of subjectivity in the amounts reported. This focus on objectivity often means that information which would otherwise be relevant to financial statement users might be omitted since it is usually more subjective in nature. The book value of stockholder’s equity is reported in conformity with GAAP and often is different from the market value of the company, which is equal to the market price of the firm’s shares multiplied by the numbers of common shares outstanding.

Remembering that the characteristic of an asset is the expectation that it will produce future benefits (net cash inflows), identify three “assets” which might be omitted from the balance sheet and, thereby, contribute to the difference between the market value and the book value of the company (i.e., think of “assets” which investors might view as important for the determination of firm value, but which are excluded from the balance sheet because their measurement is too subjective):


Sarbanes-Oxley

Management more accountable - Sarbanes-Oxley assertions: I have reviewed the report F/S not materially misleading F/S fairly represent the financial condition of Co. Internal controls are sufficient


EY Resigns Over Selectrica Internal Control Deficiencies1. Accounts receivable and services revenue incorrectly included a

general reserve position in the allowance for doubtful accounts as of December 31, 2004, and incorrectly recorded a receivable as uncollectible as of March 31, 2005, for which payment was subsequently received after March 31 but prior to the completion of the quarterly close process.

2. Cash equivalents as well as short-term and long-term investments were not classified in the accordance with generally accepted accounting principles during the treasury process for Selectica's India subsidiary.

3. Selectica failed to reverse deferred revenue when all criteria for revenue recognition had occurred.

4. The company failed to record the expenses related to the benefits extended when employees were fired.

5. Deficiencies in its financial statement close process included insufficient controls over the monitoring of the terms of employment agreements and bonus programs and determining the related appropriate accounting treatment.

6. The company also cited insufficient controls over the monitoring of accrued liabilities recorded upon the sale of the company's E-insurance business to Accenture in December 2003. The company said it had incorrectly not reversed the accrual when the related obligation expired on December 31, 2004. An adjustment as of that date to decrease accrued liabilities and decrease G&A expense was recorded prior to the issuance of the December 31, 2004, financial statements.


Who sets accounting standards? SEC created by 1933,1935 acts of Congress to

regulate securities industry and to establish reporting requirements

SEC has delegated standard setting to private industry: FASB

But, Public Company Accounting Oversight Board (PCAOB) controls FASB’s funds. SEC oversees PCAOB

Bottom line: accounting standard setting is very much a political process. Compromises limit the effectiveness of accounting standards.

Documents

© 2005 by Robert F. Halsey, all rights reserved ACC7500 Financial Reporting and Statement Analysis Prof. Bob Halsey 302 Luksic Hall