Upload
others
View
1
Download
0
Embed Size (px)
Citation preview
10-1
10- 1Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
10- 2Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Marshall,McManus,andViele11thEdition
AccountingWhattheNumbersMean
CHAPTER10: CorporateGovernance,Notestothe
FinancialStatements,andOtherDisclosures
10- 3Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CorporateGovernance
• Businessethics• Socialresponsibility• Equitabletreatmentofshareholders• Disclosuresandtransparency• Boardofdirectors’ responsibility
Learning Objective 10-1: D iscuss the significance of corporate governance.10- 4
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
The most powerful legislation to date has been the Sarbanes–Oxley Act (SOX) of 2002, which created the Public Company
Accounting Oversight Board (PCAOB) as the authoritative watchdog over the accounting and auditing profession.
TheSOXlegislationwasaimedprimarilytocurtailthemisbehaviorof
seniormanagementofcorporateentities:Chiefexecutiveofficers(CEOs)andchieffinancialofficers(CFOs)arerequiredunderSOXtoattest(infrontofanotary)tothecorrectnessoftheir
company’sfinancialstatements.
Theregistrantmustalsoreportinaseparatesectionofitsannual
10-Kreportany“ChangesinandDisagreementswithAccountantson
AccountingandFinancialDisclosure” asanaddedmeasureoftransparencyand
managementaccountability.
Learning Objective 10-1: D iscuss the significance of corporate governance.
CorporateGovernance
10- 5Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CorporateGovernance
In response to the financial crisis of 2007–2008, Congress passed the Wall Street Reform and Consumer Protection Act of 2010 (referred to as
the Dodd-Frank Act ). Although most of the act deals with financial regulation, several Dodd-Frank provisions impose new corporate governance rules not just on Wall Street banks but also on Main
Street public corporations.
Dodd-FrankActcontainsthe“sayonpay” mandaterequiringperiodicshareholderadvisoryvoteson
executivecompensationandgoldenparachuteprovisions.
Dodd-Frank provisionrequirescompaniestodisclosethereasonsthattheyhavechosentohaveeitherthe
samepersonorseparatepeopleserveastheCEOandchairmanoftheboard.
Learning Objective 10-1: D iscuss the significance of corporate governance.10- 6
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
1. Recording revenue too soon.•Recording revenue before completing any obligations under the contract.•Recording revenue far in excess of work completed on the contract.•Recording revenue before the buyer’s final acceptance of the product.•Recording revenue when the buyer’s payment remains uncertain or unnecessary.
2. Recording bogus revenue.•Recording revenue from transactions that lack economic substance.•Recording revenue from transactions that lack a reasonable arm’s-length process.•Recording revenue on receipts from non-revenue-producing transactions.•Recording revenue from appropriate transactions, but at inflated amounts.
3. Boosting income using one-time or unsustainable activities.•Boosting income using one-time events.•Boosting income through misleading classifications.
4. Shifting current expenses to a later period.•Improperly capitalizing normal operating expenses.•Amortizing costs too slowly.•Failing to write down assets with impaired value.•Failing to record expenses for uncollectible receivables and devalued investments.
RecentFinancialMisstatementsEarnings Manipulations Shenanigans (pg 1) :
Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years.
10-2
10- 7Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
5. Employing other techniques to hide expenses or losses.• Failing to record an expense from a current transaction.• Failing to record an expense for a necessary accrual or reversing a past expense.• Failing to record or reducing expenses by using aggressive accounting assumptions.• Reducing expenses by releasing bogus reserves from previous charges.
6. Shifting current income to a later period.• Creating reserves (often in conjunction with an acquisition) and releasing them into
income in a later period.• Improperly accounting for derivatives in order to smooth income.• Recording current-period sales in a later period.
7. Shifting future expenses to an earlier period.• Improperly writing off assets in the current period to avoid expenses in a future period.• Improperly recording charges to establish reserves used to reduce future expenses.
RecentFinancialMisstatements
Earnings Manipulations Shenanigans (pg 2) :
Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years. 10- 8
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
1. Shifting financing cash inflows to the operating section.•Recording bogus cash flows from operations from a normal bank borrowing.•Boosting cash flows from operations by selling receivables before the collection date.•Inflating cash flows from operations by faking the sale of receivables.
2. Shifting normal operating cash outflows to the investing section.•Inflating cash flows from operations with boomerang transactions.•Improperly capitalizing normal operating costs.•Recording the purchase of inventory as an investing outflow.
3. Inflating operating cash flow using acquisitions or disposals.•Inheriting operating inflows in a normal business acquisition.•Acquiring contracts or customers rather than developing them internally.•Boosting cash flows from operations by creatively structuring the sale of a business.
4. Boosting operating cash flow using unsustainable activities.•Boosting cash flows from operations by paying vendors more slowly.•Boosting cash flows from operations by collecting from customers more quickly.•Boosting cash flows from operations by purchasing less inventory.•Boosting cash flows from operations with one-time benefits.
RecentFinancialMisstatementsCash Flow Shenanigans :
Learning Objective 10-2: Identify the types of financial reporting m isstatem ents that have occurred in recent years.
10- 9Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Because of the complexities related to financial reporting and because of the
number of alternative generally accepted accounting principles that can be used, explanatory notes are included as an
integral part of the financial statements.
NotestotheFinancialStatements
Learning Objective 10-3: Explain why the notes are an integral part of the financial statem ents.10- 10
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Summary of Significant Accounting Policies
Typical accounting policies that are disclosed in the notes to the financial statements include:1. Depreciation method used.2. Inventory valuation method used.3. Basis of consolidation of subsidiaries.4. Reconciliation of taxes paid to tax expense.5. The cost of employee benefit plans.6. Treatment of goodwill and intangible assets.7. Earnings per share information.8. Stock option and stock purchase plans.
NotestotheFinancialStatements
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10- 11Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherDisclosures
1. Accountingchanges.2. Businesscombinations.3. Contingenciesandcommitments.4. Eventssubsequenttothebalancesheetdate.5. Impactofinflation.6. Segmentinformation.
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.10- 12
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
DepreciationMethod
Disclosure of the depreciation method permits informed readers to make comparisons of
companies in the same industry.
Impactof
Income
Sum-of-the-Years’-Digits Method
Units-of-ProductionMethod
Straight-LineMethod
Declining BalanceMethod
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10-3
10- 13Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
InventoryValuation
The selection of an inventory valuation method influences the reported income and the inventory amount shown on the
balance sheet.
Impact on Income Statementand Balance Sheet
LIFOFIFO Weighted-Average
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.10- 14
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
BasisofConsolidation
The basis of consolidation disclosure requires that consolidated financial statements include data
from substantially all subsidiary companies.
ParentCompany
$
$
Subsidiary Company 1
$
$
Subsidiary Company 2
$
$
Subsidiary Company 3
$
$
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10- 15Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
IncomeTaxesA reconciliation of the statutory income tax rate with
the effective tax rate.The Internal
Revenue Code is the set of rules for
preparing tax returns.
financial statement income tax expense.
IRS income taxes payable.
GAAP is the set of rules for preparing
financial statements.
Usually. . . Results in . . . Results in . . .
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.10- 16
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
EmployeeBenefitsThe cost of employee pension plans included as an
expense in the income statement is disclosed.
Present value of benefits at present pay levels.
Present value of nonvestedbenefits at present pay
levels.
Present value of additional benefits related to projected
pay increases.
Accumulated Benefit Obligation
Projected Benefit Obligation
Vested Benefit Obligation
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10- 17Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
IntangiblesIncludingGoodwill
When the balance sheet contains intangible assets, including goodwill arising from business
acquisitions, the method of recognizing initial cost will be described. Any amortization or impairment
in value of the intangibles must be shown.
©Copyright Patent
®Trademark
™Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10- 18Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
An explanation of the calculation of EPS may include the details of the computation of weighted-average number of common shares outstanding and the adjustments made to net income for preferred stock, stock options, and convertible securities.
EarningsPerShare
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.
10-4
10- 19Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
StockOptionandPurchasePlans
A stock option plan is designed to encourage management to meet company goals by
providing an incentive. The incentive may be measured by the difference between the
exercise price per share and the market price per share.
Stock purchase plans permit employees to purchase shares of the company’s stock at a slight discount from market value.
The plans are designed to help employees become owners of the company.
Learning Objective 10-4: D iscuss the kinds of significant accounting policies that are explained in the notes.10- 20
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
DetailsofFinancialAmountsMany financial statement amounts are
reported in the aggregate. Note disclosures permit companies to show more detail.
Property, plant, and equipment 1,257,500$ Less: Accumulated depreciation (498,000) 759,500
Balance Sheet Presentation
Property, plant, and equipment: Land 75,000$ Building 765,000 Equipment 315,500 Furniture and Fixtures 102,000 1,257,500$ Less: Accumulated depreciation (498,000) Net property plant and equipment 759,500$
Note Presentation
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.
10- 21Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherDisclosures
Mergers and acquisitions are accounted for using the
acquisition method. Under this method, net assets
are recorded at fair value on the date of acquisition.
Any amount paid in excess of fair value is the intangible
asset Goodwill.
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.10- 22
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherDisclosures
Typicalgain contingenciesinclude:n Possiblereceiptsofmoniesfromgiftsordonations.n Possiblerefundsfromthegovernmentintaxdisputes.n Pendingcourtcaseswithprobablefavorableoutcome.
Typical loss contingencies include:• Possible payments resulting from litigation.• Possible additional payments resulting from tax disputes.• Possible fines or penalties.
ContingenciesClaims or rights to receive or pay assets whose existence
is uncertain but which may become valid eventually.
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.
10- 23Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
SubsequentEvents
Company Year-End
12/31/xxxx 2/19 - Next Year
Financial Statements
Issued
SubsequentPeriod
Some significant events that occur in the subsequent period (next year) may be required to be included in the current year statements, while
other events may be disclosed in the notes.
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.10- 24
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ImpactofInflation
Reporting the effects of inflation is a controversial and complex area of accounting.
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.
Currently, the FASB encourages, but does not require, companies to provide supplementary information on the effects of changing prices
(inflation) in the notes to the financial statements.
If the economy experiences high rates of inflation in the future, efforts
to reflect the impact of inflation directly in the financial statements
are likely to be renewed.
10-5
10- 25Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
SegmentInformation
Most large corporations operate in several lines of business and operate in many
geographical areas.Segment information should include:1. Sales to unaffiliated customers,2. Operating profit,3. Capital expenditures,4. Depreciation expense,5. Identifiable assets.
Learning Objective 10-5: Describethenatureandcontentofvariousnotedisclosures.10- 26
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ReportingtotheSEC
Instead of an annual report, companies that are registered with the SEC file an annual
Form 10-K. The Form 10-K includes most of the information in the company’s annual
report and must also comply with additional SEC reporting requirements.
Learning Objective 10-6: Explain the role of the Securities and Exchange Com m ission and som e of its reporting requirem ents.
10- 27Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Management’sStatementofResponsibility
The company’s management bears ultimate responsibility for the financial statements and notes,
not the auditors who express an opinion on the fairness of the presentation of the financial
statements.
Learning Objective 10-7: Explain why a statem ent of m anagem ent’s responsibility is included with the notes.10- 28
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Acorporationisrequiredtoincludeasectioncalled“ManagementDiscussionandAnalysis”initsannualreport.Thissectiondescribesthe
firm’sactivitiesfortheyear,includingcommentsaboutitsfinancialconditionand
resultsofoperations.
Management Discussion and Analysis (MD&A)
Learning Objective 10-8: Describe the significance of m anagem ent’s discussion and analysis of the firm ’s financial condition and results of operations.
10- 29Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Management Discussion and Analysis (MD&A)
1. Nature of operations.2. Economic outlook for the company.3. Important factors that may influence
profitability.4. Summary of operating results.
Learning Objective 10-8: Describe the significance of m anagem ent’s discussion and analysis of the firm ’s financial condition and results of operations. 10- 30
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
SummaryofFinancialData
Learning Objective 10-9: Identifywhatisincludedinthefive-year(orlonger)summaryoffinancialinformation.
Most corporate annual reports contain a 5-year or 10-year summary of key financial
data. This information often includes significant ratios and stock market prices
of the company’s common stock.
10-6
10- 31Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
IndependentAuditors’ Report
Introductory Paragraph – Describes the financial statements audited and states that management is responsible for the financial statements and that the auditors’ task is to express an opinion about the financial statements.
Scope Paragraph – Describes the nature and extent of the audit process. Auditors wish to obtain reasonable assurance that the financial statements are free from material misstatements.
Opinion Paragraph – Auditors express an opinion on the fairness of the financial presentation. Corporations wish to receive an unqualified report.
Internal Control Opinion Paragraph – Auditors make reference to the internal control effectiveness audit and the opinion issued by the auditors that accompanies the auditors’ report as required by the Public Company Accounting Oversight Board (PCAOB).
2
3
4
1
Learning Objective 10-10: D iscuss the m eaning and content of the independent auditors’ report.
Standard Format contains four paragraphs:
10- 32Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CompilationEngagement
For companies that are not registered with the SEC and do not have publicly traded securities,
accountants may provide a service by compilingfinancial statements.
A compilation is merely the presenting, in the form of financial statements, information that has been
prepared by management.
A compilation report does not provide any assurance from the auditors about the fairness of the financial
information.
Learning Objective 10-10: D iscuss the m eaning and content of the independent auditors’ report.
10- 33Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
EndofChapter10
10- 34Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
10- 35Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Marshall,McManus,andViele11thEdition
AccountingWhattheNumbersMean
CHAPTER11: FinancialStatementAnalysis
10- 36Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
FinancialStatementRatiosRatios are used to interpret the financial position and results of operations of an entity and may be
grouped in the following four categories:
1. Liquidity.
2. Activity.3. Profitability.
4. Debt, or financial leverage.
10-7
10- 37Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ConsiderationWhenUsingRatios
We should always look beyond the ratios.
Economic factors
Industry trends
Changes within the firm
Technological changes
Consumer tastes
10- 38Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ConsiderationWhenUsingRatios
Differencesinaccountingmethodsbetweencompaniessometimesmake
comparisonsdifficult.
We use the LIFO method to value inventory.
We use the FIFO method to value inventory.
Learning Objective 11-1: Explain how liquidity m easures can be influenced by the inventory cost flow assum ption used.
10- 39Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
LiquidityMeasuresThe liquidity measures of working
capital, current ratio, and acid-test ratio were discussed in Chapter 3.
Learning Objective 11-2: Explain how suppliers and creditors use a custom er’s paym ent practices to judge liquidity.10- 40
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
LiquidityMeasuresIs the firm paying its bills promptly?
Are all cash discounts taken?
What are the firm’s working
capital and liquidity ratios?
Creditors Suppliers
Learning Objective 11-2: Explain how suppliers and creditors use a custom er’s paym ent practices to judge liquidity.
10- 41Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
TurnoverRatios
41
Differencesininventorycostflowassumptionsanddepreciationmethodswillaffectcomparabilityof
turnoverratios.
We use the LIFO method to value inventory and an accelerated
depreciation method.
We report lower inventory and net book value of depreciable
assets.
We use the FIFO method to value inventory and the straight-line
depreciation method.
We have lower asset
turnover ratios
11-41
Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.10- 42
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ActivityMeasuresFocus primarily on relationships between
asset levels and sales. The general model for calculating turnover is:
Turnover = Sales ÷ Average assetsTurnover is often calculated for:
(1) Accounts receivable; (2) Inventories;
(3) Plant and equipment; (4) Total operating assets; and
(5) Total assets.Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.
10-8
10- 43Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
AccountsReceivableTurnoverSales
Average accounts receivable
Accounts receivableturnover
=
Matrix, Inc.Amounts at year end in thousands
Cash 30,000$ Accounts receivable, net Beginning of year 17,000 End of year 20,000 Inventory Beginning of year 10,000 End of year 12,000 Total current assets 65,000 Total current liabilities 42,000 Sales 500,000 Cost of goods sold 140,000
We will use these amounts to
calculate our ratios!
Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.10- 44
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
AccountsReceivableTurnover
A measure of how many times a company converts its receivables
into cash each year.
= 27.0 times$500,000
($17,000 + $20,000) ÷ 2
Accounts receivableturnover
=
Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.
10- 45Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
InventoryTurnoverCost of goods soldAverage inventory
Inventoryturnover
=
A measure of the numberof times merchandise inventory
is sold and replaced during the year.
= 12.7 times$140,000
($10,000 + $12,000) ÷ 2Inventoryturnover
=
Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.10- 46
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
PlantandEquipmentTurnover
SalesAverage plant and equipment
Plant and equipmentturnover
=
Property and equipment, net (January 1) 300,000$ Property and equipment, net (December 31) 346,390$
Matrix, Inc. (in thousands)
Plant and equipment = $500,000
turnover ($300,000 + $346,390) ÷ 2 = 1.55 times
Learning Objective 11-3: D iscuss the influence of alternative inventory cost flow assum ptions and depreciation m ethods on turnover ratios.
10- 47Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherActivityMeasures
Days’ in accounts receivable
= Accounts receivableAnnual sales ÷ 365 days
Number of Days’ Sales in Accounts Receivable
A measure of how many days it takes, on average, to collect an account receivable.
= 14.6 days= $20,000 $500,000 ÷ 365
Days’ in accounts receivable
Learning Objective 11-4: D iscuss how the num ber of days’ sales in both accounts receivable and inventory are used to evaluate the effectiveness of the m anagem ent of receivables and inventory. 10- 48
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherActivityMeasures
Number of Days’ Sales in Inventory
Days’ in inventory
= InventoryCost of goods sold ÷ 365 days
= 31.28 days= $12,000 $140,000 ÷ 365
Days’ in inventory
A measure, on average, of the number of timesinventory is sold and replaced.
Learning Objective 11-4: D iscuss how the num ber of days’ sales in both accounts receivable and inventory are used to evaluate the effectiveness of the m anagem ent of receivables and inventory.
10-9
10- 49Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
ProfitabilityMeasuresIn Chapter 3, two significant profitability measures were presented: (1) Return on Investment (ROI);
and (2) Return on Equity (ROE).
Operating income 86,100$ Other expenses (interest) (7,300) Other Income 700 Income before taxes 79,500 Provision for income taxes (23,850) Net income 55,650$
Matrix, Inc. 12/31 (in thousands)
Both ROI and ROE should be based on operating income
rather than net income.
Learning Objective 11-5: D iscuss the significance of the price/earnings ratio in the evaluation of the m arket price of a com pany’s com m on stock. 10- 50
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Price/EarningsRatio
Price/earningsratio
Market price per shareDiluted earnings per share
=
Closing market price of stock 21.50$ Diluted earnings per share 1.97
Matrix, Inc. 12/31
A measure often used by investors as a general guideline in gauging stock values.
Price-earningsratio
$21.50$1.97
= = 10.91 times
Learning Objective 11-5: D iscuss the significance of the price/earnings ratio in the evaluation of the m arket price of a com pany’s com m on stock.
10- 51Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
DividendYieldDividend
yieldDividends per share Market price per share=
Closing market price of stock 21.50$ Annual cash dividend 0.84
Matrix, Inc. 12/31
Identifies the return, in terms of cash dividends, on the current market price of the stock.
$0.84$21.50= = 3.91%
Dividendyield
Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock. 10- 52
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
DividendPayoutRatio
Dividendpayout ratio
Annual dividend per share Earnings per share
=
A gauge of the portion of current earnings being paid out in dividends. Investors seeking current income
would like this ratio to be high.
Dividendpayout ratio = = 42.6%$0.84
$1.97
Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock.
10- 53Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
PreferredDividendCoveragePreferred dividend
coverage ratioNet income
Annual preferred dividend=
Preferred shares outstanding 4,000 Par value per share 100$ Total par value 400,000$ Dividend rate 6%Annual preferred dividend 24,000$
Matrix, Inc. - 12/31
Preferred dividend coverage ratio
= $55,650$24,000 = 2.3 times
A measure of the margin of safety for preferred shareholders.
Learning Objective 11-6: D iscuss how dividend yield and the dividend payout ratio are used by investors to evaluate a com pany’s com m on stock. 10- 54
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
DebtRatioTotal liabilities
Total liabilities + stockholders’ equityDebt ratio =
Measures the percent of assets being provided by creditors.
Debt ratio = = 32.33%$112,000$346,390
Matrix, Inc.Information at 12/31 in thousands
Total stockholders' equity $234,390Total liabilities $112,000
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.
10-10
10- 55Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
FinancialLeverageFinancial leverage involves acquiring assets
with funds at a fixed rate of interest.
Return onInvestment in
assets>
Fixed rate of return on borrowed
funds
Positive financial leverage
=
Return on investment in
assets<
Fixed rate of return on borrowed
funds
Negative financial leverage
=
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.10- 56
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
Debt/EquityRatio
Debt/equity ratio =
Total liabilitiesTotal stockholders’ equity
Debt/equity ratio = = 47.8%
$112,000$234,390
Measures the relative proportion of contribution from owners and creditors.
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.
10- 57Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
FinancialLeverage
Financial leverage (frequently called just leverage ) refers to the use of debt (and, in the broadest context of the term,
preferred stock) to finance the assets of the entity. Leverage adds risk to the operation of the firm because if
the firm does not generate enough cash to pay principal and interest payments, creditors may force the firm into bankruptcy. However, because the cost of debt (i.e., interest) is a fixed charge regardless of the amount of
earnings, leverage also magnifies the return to the owners (ROE) relative to the return on assets (ROI).
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.10- 58
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
WithoutFinancialLeverage
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.
10- 59Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
WithFinancialLeverage
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.
Increase from 12 to 16.4%
10- 60Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
TimesInterestEarnedCruisers, Inc.’s, income statement for fiscal 2017, is shown below. The
calculation of times interest earned is:
Learning Objective 11-7: Explain what financial leverage is and why it is significant to m anagem ent, creditors, and owners.
10-11
10- 61Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherAnalyticalTechniquesBook Value Per Share of Common Stock
A measure of the amount that would be distributed to stockholders of each share of common stock if all assets were sold at their balance sheet carrying
amounts and if all creditors were paid off.
= $6.70Book value per share
$234,39035,000
=
Book value per share
Common stockholders’ equityNumber of common shares outstanding
=
Learning Objective 11-8: Explain what book value per share of com m on stock is, describe how it is calculated, and discuss why it is not a very m eaningful am ount for m ost com panies 10- 62
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CommonSizeFinancialStatementsLet’s take a look at the information from the comparative
income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.
Dodson Industries, Inc.Comparative Income Statements
For the Years Ended December 31Common-Size Percentages
2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600 Net income 17,500$ 22,400$
Net sales is usually the base and is expressed as 100%.
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years.
10- 63Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CommonSizeFinancialStatements
Dodson Industries, Inc.Comparative Income Statements
For the Years Ended December 31Common-Size Percentages
2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 Operating expenses 128,600 126,000 Net operating income 31,400 39,000 Interest expense 6,400 7,000 Net income before taxes 25,000 32,000 Less income taxes (30%) 7,500 9,600 Net income 17,500$ 22,400$
2015 Cost ÷ 2015 Sales × 100% ( $315,000 ÷ $480,000 ) × 100% = 65.6%
2016 Cost ÷ 2016 Sales × 100% ( $360,000 ÷ $520,000 ) × 100% = 69.2%
Let’ s take a look at the information from the comparative income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years. 10- 64
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
CommonSizeFinancialStatementsLet’s take a look at the information from the comparative
income statements of Dodson Industries, Inc. for 2016 and 2015. We will prepare a common-size income statement.
Dodson Industries, Inc.Comparative Income Statements
For the Years Ended December 31Common-Size Percentages
2016 2015 2016 2015Net sales 520,000$ 480,000$ 100.0 100.0 Cost of goods sold 360,000 315,000 69.2 65.6 Gross margin 160,000 165,000 30.8 34.4 Operating expenses 128,600 126,000 24.8 26.3 Net operating income 31,400 39,000 6.0 8.1 Interest expense 6,400 7,000 1.2 1.5 Net income before taxes 25,000 32,000 4.7 6.6 Less income taxes (30%) 7,500 9,600 1.4 2.0 Net income 17,500$ 22,400$ 3.4 4.7
We would perform the same calculations for the balance sheet and would set total assets equal to 100%.
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years.
10- 65Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
HorizontalAnalysisLet’s take a look at some selected information from
Dodson Industries, Inc. for 2012 through 2016. We will prepare a horizontal analysis.
The base year is 2012, so its amounts will equal 100%.The base year values will be the denominator in all
calculations.
YearItem 2016 2015 2014 2013 2012
Sales 400,000$ 355,000$ 320,000$ 290,000$ 275,000$ Cost of goods sold 285,000 250,000 225,000 198,000 190,000 Gross margin 115,000 105,000 95,000 92,000 85,000
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years. 10- 66
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
HorizontalAnalysis
YearItem 2016 2015 2014 2013 2012
Sales 105% 100%Cost of goods sold 104% 100%Gross margin 108% 100%
2013 Amount ÷ 2012 Amount × 100%( $290,000 ÷ $275,000 ) × 100% = 105%( $198,000 ÷ $190,000 ) × 100% = 104%( $ 92,000 ÷ $ 85,000 ) × 100% = 108%
Let’s take a look at some selected information from Dodson Industries, Inc. for 2012 through 2016.
We will prepare a horizontal analysis.
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years.
10-12
10- 67Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
HorizontalAnalysisLet’s take a look at some selected information from
Dodson Industries, Inc. for 2012 through 2016. We will prepare a horizontal analysis.
From this analysis, we see that cost of goods sold is increasing faster than sales, which is slowing the
increase in gross margin.
YearItem 2016 2015 2014 2013 2012
Sales 145% 129% 116% 105% 100%Cost of goods sold 150% 132% 118% 104% 100%Gross margin 135% 124% 112% 108% 100%
Learning Objective 11-9: D iscuss how com m on size financial statem ents can be used to evaluate a firm ’s financial position and results of operations over a num ber of years. 10- 68
Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
OtherOperatingStatisticsPhysical measures of activity, rather than the financial measures included in the financial statements, are frequently useful. For
example, reporting sales in units provides a perspective that may be hidden by price changes when only sales dollars are reported.
Learning Objective 11-10: Generalize about how operating statistics using physical, or nonfinancial, data can be used to help m anagem ent evaluate the results of the firm ’s activities.
Many analysts combine physical and financial measures to develop
useful statistics to show trends or make
comparisons between firms.
There is no “cookbook” of quantitative measures for management to follow; the
challenge is to understand the firm’s objectives and
procedures, and then to develop measurement and reporting techniques to help people
accomplish their goals.
10- 69Copyright © 2017 M cGraw-Hill Education. A ll rights reserved. No reproduction or distribution w ithout the prior written consent o f M cGraw-Hill Education.
EndofChapter11