Financial Statement Analysis I: Chapter 2

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General Chapter NotesA. Debtor’s Decisions, An Example: Legal Form of the Debtor

1. What Legal Form Means

2. The Six Typical Forms: Sole Proprietorship,

General Partnership, Limited Partnership, LLC,

Subchapter S Corp., Chapter C Corp.

B. Forms with Personal Liability for Business Debts:

Sole Proprietorship, General Partnership

C. Forms with Limited Liability: LLC, Subchapter S and

Chapter C Corporations, Limited Partnerships

D. Relevance of Business Balance Sheet for Sole Prop., Part.

E. Limited Liability and Guarantees of Account

F. Legal Form and Taxes on Business Income

Slide 2-1

General Chapter Notes (continued)

G. Liquidity and the Ordering of the Balance Sheet

H. Public Reporting Accounting and Tax Accounting

I. Going Concern Value, Market Value, Book Value, and Liquidation Values for Assets

J. Assets Outside of the Balance Sheet

K. Information on the Priority and Security Position of Liabilities

L. Liquidity and the Operating Cycle (see next slide)

Slide 2-2

Cash Flows of the Firm

Slide 2-3

Notes for Particular Parts of Chapter 2

A. Consolidation

B. Fiscal Year-end Dates

C. Introduction to Trend Analysis

D. Common Size Statements

Slide 2-4

Notes for Particular Parts of Chapter 2 (continued)

E. Marketable Securities and Why Firms Hold Them

F. Accounts Receivable

G. Inventory

1. The importance of inventory investment

2. Why firms hold finished goods inventory

3. LIFO, FIFO, and actual inventory practice

4. Inventory accounting and price levels

H. Taxes, Inventory Accounting, and Cash Flow

I. PP&E, Depreciation, Amortization, and Market Value

J. Other Assets

Slide 2-5

Notes for Particular Parts of Chapter 2 (continued)

K. Accounts Payable

L. Current Maturities of Long-Term Debt

M. Accrued Liabilities

N. Deferred Income Taxes and Depreciation

O. Long-Term Debt

P. Capital Leases, Operating Leases, Owned Assets,

and the Balance Sheet

Q. Preferred Stock

R. The Three Common Equity Accounts

1. The three accounts defined

2. Where retained earnings go

3. Book equity versus market value

4. Relevance of equity value for trade creditors

Slide 2-6

Problem 2.11

Public Accounting Tax Accounting

Revenue $800,000 $800,000

Other Expenses $350,000 $350,000

Depreciation $130,000 $200,000

Earnings Before Taxes $320,000 $250,000

Tax Bill (34% of EBT) $108,800 $85,000

Increase in Deferred Taxes $23,800

Slide 2-7

Problem 2.14a

Inventory in order of purchase:

Units x Cost = Total

Beginning inventory 600 x $10 = $ 6,000

First purchase during the year 1,000 x 11 = 11,000

Second purchase during the year 900 x 12 = 10,800

Third purchase during the year 700 x 14 = 9,800

Total 3,200 $37,600

Sales for the year = 1,900 units

Ending inventory = 3,200−1,900 = 1,300 units

Total for new inventory purchases: $37,600−$6,000 = $31,600

Slide 2-8

COGS and Inventory Balance using Weighted Average Cost per Unit:

Weighted average cost = $37,600/3,200 = $11.75 per unit

COGS = $11.75 x 1,900 units = $22,325

Ending inventory balance = $11.75 x 1,300 units = $15,275

Slide 2-9

COGS and Inventory Balance using FIFO:

COGS calculation:

600@$10 = $6,000 entire beginning inventory

1,000@$11 = $11,000 entire first purchase

300@$12 = $ 3,600 partial from second purchase

Total COGS $20,600

Remaining at $12 per unit from second purchase: 900-300 = 600 units

Ending Inventory:

600@$12 = $ 7,200 remaining from second purchase

700@$14 = $ 9,800 entire third purchase

Total $17,000

Slide 2-10

COGS and Inventory Balance using LIFO:

COGS calculation:

700@$14 = $ 9,800 entire third purchase

900@$12 = $10,800 entire second purchase

300@$11 = $ 3,300 partial from first purchase

Total COGS $23,900

Remaining at $11 from first purchase: 1,000−300 = 700 units

Ending Inventory:

600@$10 = $ 6,000 entire beginning inventory

700@$11 = $ 7,700 remaining from first purchase

Total $13,700

Slide 2-11

Problem 2-11 parts b, c, and dContrast of three inventory accounting methods

Method COGS Ending Inventory

Weighted Average $22,325 $15,275

FIFO $20,600 $17,000

LIFO $23,900 $13,700

Actual cash outflow for purchasing inventory: $31,600 (does not

depend on accounting method chosen)

Reduction in taxes from using LIFO over FIFO:

$23,900−$20,600 = $3,300; $3,300*0.34 = $1,122 a cash flow savings

Slide 2-12

Problem 2.18

Dean Corporation

Year 2008 2009 2010

Beginning Retained Earnings $700 $890 $1,045Net Income $250 $225 $40End Ret. Earns., no Dividends $950 $1,115 $1,085Act. Ending Ret. Earnings $890 $1,045 $1,010Cash Dividends $60 $70 $75

Slide 2-13

Problem 2.19Balance Sheet at December 31, 20XX

Assets

Current Assets

Cash $1,500

Accounts receivable 6,200

Inventory 12,400

Prepaid expenses 700

Total Current Assets $20,800

Property, plant and equipment 34,000

Less accumulated depreciation (10,500)

Net property, plant and equipment $23,500

Land held for sale (an Other Asset) $9,200

Total Assets $53,500

Slide 2-14

Problem 2.19 (continued)

Liabilities and stockholders' equity

Current liabilities

Accounts payable $4,300

Notes payable 8,700

Accrued interest payable 1,400

Current portion of long-term debt 1,700

Total current liabilities $16,100

Deferred taxes payable 1,600

Bonds payable 14,500

Total liabilities $32,200

Slide 2-15

Problem 2.19 (continued)

Stockholders' equity

Common stock $2,500

Additional paid-in capital 7,000

Retained earnings 11,800

Total stockholders' equity 21,300

Total liabilities and stockholders' equity $53,500

Calculation of Retained Earnings: $53,500−$32,200−$2,500−$7,000 =

$11,800

Current Ratio = Total Current Assets/ Total Current Liabilities

= $20,800/$16,100 = 1.29

Slide 2-16