Financial Statements: Analysis, Reporting and Valuation

Acknowledgments
Disclaimer
Contents
Abbreviations
List of Tables
Part I Overview of Financial Statements and the Statement of Position
1 Overview of Financial Statements
	1.1 General
	1.2 The International Accounting Standard Board: IFRS
	1.3 European Financial Reporting Advisory Group (EFRAG)
	1.4 The United States: The FASB
	1.5 The United Kingdom: Financial Reporting Council (FRC)
	1.6 Japan: The Accounting Standard Board of Japan
	1.7 Australia: The Australian Accounting Standard Board
	1.8 New Zealand: The New Zealand Accounting Standards Board (NZASB)
	1.9 India: The Council of the Institute of Chartered Accountants of India (ICAI)
	1.10 China: Accounting Standard for Business Enterprises
	1.11 The Financial Statement Materials
		1.11.1 The Proxy Statement
		1.11.2 The Management Discussion & Analysis (MD&A)
	1.12 Interim Statements and Subsequent & Adjusting Events
		1.12.1 Interim Financial Statements
		1.12.2 Subsequent Events
		1.12.3 Adjusting Events
	1.13 Users of Financial Statements
	References
2 Short-Term Assets: Cash and Cash Equivalents
	2.1 General
	2.2 Cash and Cash Equivalents
		2.2.1 Bank Reconciliation
		2.2.2 Bank Overdraft
		2.2.3 Petty Cash
	2.3 Marketable Equity Securities and Fair Value Measurement
	2.4 Accounting for Financial Instruments
	2.5 Accounting for Derivatives
	2.6 Accounting for Hedging
	References
3 Short-Term Assets Inventories
	3.1 General
	3.2 Inventory Methods
		3.2.1 The Perpetual Inventory System
		3.2.2 The Periodic Inventory System
	3.3 Ownership Issues
	3.4 Valuation of Inventory
	3.5 The LIFO Reserve
	3.6 LIFO Liquidation
	3.7 Comprehensive Example
		3.7.1 Solutions:
	3.8 Restrictions on the Use of LIFO
	References
4 Account Receivables
	4.1 General
	4.2 Cash Discount on Sales
		4.2.1 The Gross Method
		4.2.2 The Net Method
	4.3 Bad Debts Concept
		4.3.1 Rebates
		4.3.2 Doubtful Accounts
		4.3.3 Accounting for Bad Debts
	4.4 Accounts Receivable Aging Method
	4.5 Assignment of Accounts Receivable
	4.6 Factoring of Accounts Receivable
		4.6.1 Recourse vs Non-Recourse Factoring
		4.6.2 Factoring V. Loan
		4.6.3 Factoring vs Assignment of Receivables
	4.7 Securitization of Receivables
		4.7.1 Sale Accounting Criteria
		4.7.2 Secured Borrowing
	4.8 Receivables—Troubled Debt Restructurings by Creditors
	4.9 Non-Trade Receivables
	References
5 Prepaid Expenses, Unearned Income, and Other Current Assets
	5.1 General
	5.2 Prepaid Expenses
	5.3 Unearned Income
	5.4 Other Current Assets
	References
6 Short-Term Liabilities & Working Capital
	6.1 General
	6.2 Accounts Payable
	6.3 Notes Payable
	6.4 Current Maturities of Long-Term Debt
	6.5 Other Current Liabilities
	6.6 Commercial Paper
	6.7 Working Capital
		6.7.1 Determinants of Working Capital
		6.7.2 Financing of Working Capital
		6.7.3 Computation of Working Capital: Example
7 Long-Term Assets: Plant, Property, and Equipment
	7.1 General
	7.2 Property, Plant, and Equipment
		7.2.1 Acquisition of Property, Plant, and Equipment
		7.2.2 Cost of Land
		7.2.3 Cost of Buildings
		7.2.4 Cost of Equipment
	7.3 Valuation of Property, Plant, and Equipment
	7.4 Amortization, Depreciation, and Depletion
		7.4.1 Straight-Line Method of Depreciation
		7.4.2 Declining Balance Method of Depreciation
		7.4.3 Double Declining Balance Depreciation Method
		7.4.4 Units of Production Method of Depreciation
		7.4.5 Sum of the Years’ Digits Method of Depreciation
	7.5 Disposition of Property, Plant, and Equipment
		7.5.1 Sale of Plant Assets
		7.5.2 Involuntary Conversion
		7.5.3 Miscellaneous Problems
	References
8 Long-Term Assets: Intangibles
	8.1 General
	8.2 The Goodwill
		8.2.1 Goodwill Impairment
	8.3 Computer Software
		8.3.1 Research and Development Costs of Computer Software
		8.3.2 Production Costs of Computer Software
		8.3.3 Purchased Computer Software
		8.3.4 Amortization of Capitalized Software Costs
		8.3.5 Presentation and Disclosure of Software Costs
		8.3.6 Software Purchased Before Technological Feasibility Established
		8.3.7 Disclosure of Risks and Uncertainties Related to Capitalized Software Costs
	References
9 Long-Term Liabilities: Leases
	9.1 General
	9.2 Lease
		9.2.1 Legal Definition of a Lease
		9.2.2 Advantages and Disadvantages of Leasing
	9.3 Types of Leases
		9.3.1 Finance Lease
		9.3.2 Operating Lease
	9.4 Sale-Leaseback
		9.4.1 Sale-Leaseback Advantages
		9.4.2 Accounting Analysis
	9.5 Short-Term Lease
	9.6 Lease Disclosure
		9.6.1 In the Balance Sheet
		9.6.2 In the Statement of Cash Flows
	References
10 Long-Term Liabilities: Pension & Postretirement Liabilities
	10.1 General
	10.2 Types of Pension Plans
		10.2.1 Defined Contribution Plan
		10.2.2 Defined Benefit Plan
	10.3 Net Pension Asset/Liability
	10.4 Projected Benefit Obligations
	10.5 Plan Assets
	10.6 Reporting Pensions Plans on Financial Statements
		10.6.1 In the Statement of Income
		10.6.2 In the Balance Sheet
	10.7 Funded Status
	10.8 Postretirement Benefits Other Than Pensions
	References
11 Shareholders’ Equity
	11.1 General
	11.2 Common Stock
		11.2.1 Par Value of Common Stock
		11.2.2 Stated Value of a Common Stock
		11.2.3 Authorized Capital
		11.2.4 Issued Capital
		11.2.5 Outstanding Capital
	11.3 Issuance of Shares of Stock
		11.3.1 Issuance of Par Value Stock
		11.3.2 Issuance of no Par Stock
	11.4 Issuance of Shares for Non-Cash Items
	11.5 Lump Sum Stock Issuance
	11.6 Treasury Stock—Cost Method
	11.7 Treasury Stock—Par Value Method
	11.8 Stock Dividends
		11.8.1 Small Stock Dividend
		11.8.2 Large Stock Dividend
	11.9 Employee Stock Options
		11.9.1 Legal Understanding
		11.9.2 Statement of Financial Accounting Standard No. 123
		11.9.3 Illustration
		11.9.4 Stock Splits
		11.9.5 Retained Earnings
	References
Part II The Statement of Income
12 Analysis of the Statement of Income
	12.1 General
	12.2 The Single-Step Income Statement
	12.3 Multiple-Step Income Statement
		12.3.1 Analysis of the Multiple-Step Components
		12.3.2 Format and Example
	12.4 Holding Equity
	12.5 Income from Discontinued Operations
	References
13 Other Comprehensive Income
	13.1 General
	13.2 Presentation of the OCI
	13.3 Accumulated OCI
		13.3.1 Foreign Currency Accounting
		13.3.2 Discontinued Operations
	13.4 Reclassification Out of Accumulated Other Comprehensive Income
		13.4.1 Presentation on the Face of the statement—in Net Income
		13.4.2 Presentation as a Separate Disclosure in the Notes
	13.5 Earnings Per Share
		13.5.1 The Computation of the Simple EPS
		13.5.2 The Computation of the Diluted EPS
			13.5.2.1 Dilution through the Issuance of Stock Options
	References
14 The Sub-Statement of Retained Earnings
	14.1 General
	14.2 Steps in Preparing the Statement of Retained Earnings
	14.3 Retained Earnings Formula:
	14.4 Changes in Retained Earnings
		14.4.1 Accounting Changes and Retained Earnings
		14.4.2 Accounting Errors and Retained Earnings
	References
15 The Computation of the Taxable Income
	15.1 General
	15.2 Differed Taxes & Assets
		15.2.1 Temporary Differences for Revenue and Expenses
		15.2.2 Permanent Differences
	15.3 Net Operating Losses
	15.4 Undistributed Profits of Foreign Subsidiaries
	15.5 APB 23 and Indefinitely Reinvested Earnings
	15.6 ASC 740: Accounting for Uncertainty in Income Taxes (Formerly FIN 48)
	15.7 Financial Statement Reporting
		15.7.1 Statement Reporting
		15.7.2 Presentation
		15.7.3 Disclosure
	References
Part III The Statement of Cash Flows & Financial Ratios
16 Analysis of the Statements of Cash Flows
	16.1 General
	16.2 Classification of Cash Flows
		16.2.1 Cash Flows from Operating Activities
		16.2.2 Cash Flows from Investing Activities
		16.2.3 Cash Flows from Financing Activities
	16.3 Content and Form of the Statement of Cash Flows
		16.3.1 Reporting Cash Flows from Operating Activities
		16.3.2 Quick Analysis of the Operating Cash Flows
	16.4 Examples
		16.4.1 Example of Operating Cash Flows
		16.4.2 Example with Investing Cash Flows
		16.4.3 Example with Financing Cash Flow Activities
	16.5 Noncash Investing and Financing Activities
	References
17 Financial Ratios Analysis
	17.1 General
	17.2 Liquidity Measurement Ratios
	17.3 Solvency Ratios
	17.4 Profitability Indicator Ratios
	17.5 Efficiency Ratios
	17.6 Debt Ratios
	17.7 Operating Performance Ratios
	17.8 Cash Flow Indicator Ratios
	17.9 Investment Valuation Ratios
	17.10 Strategic Financial Ratios
	17.11 Bankruptcy Ratios
		17.11.1 Working Capital/Total Assets
		17.11.2 Retained Earnings/Total Assets
		17.11.3 Earnings Before Interest and Taxes/Total Assets
		17.11.4 Market Value of Equity/Book Value of Total Debt
		17.11.5 Sales/Total Assets
	17.12 Limitations
	References
Part IV Pro-Forma Financial Statements
18 Forecasting Financial Statements’ Analysis
	18.1 General
	18.2 The Forecasted Statement of Income
		18.2.1 Sales Forecasting
		18.2.2 Production & COGS Forecasting
		18.2.3 Expenses’ Forecasting
	18.3 The Forecasted Statement of Position
		18.3.1 Making Assumptions
	18.4 The Forecasted Statements of Cash Flows
		18.4.1 Forecasting Operating Cash Flows
		18.4.2 Forecasting Financing Cash Flow
		18.4.3 Forecasting Investing Cash Flow
	References
Part V Consolidated Financial Statements
19 Foreign Currency Accounting
	19.1 General
	19.2 Determination of the Functional Currency of the Foreign Entity
		19.2.1 Factors to Be Considered
		19.2.2 Changing the Functional Currency
	19.3 Translation Methods
		19.3.1 Current/Noncurrent Method
		19.3.2 Monetary/Nonmonetary Method
		19.3.3 Temporal Method
		19.3.4 Current Rate Method
	19.4 Re-Measurement into the Functional Currency
		19.4.1 The Foreign Entity Does not Book or Record in Functional Currency
		19.4.2 Highly Inflationary Economies—US GAAP
	19.5 Hedging Balance Sheet & Forecasted Exposure
	References
20 Consolidated Financial Statements
	20.1 Overview
	20.2 Purpose of Consolidation
	20.3 Consolidation Methods
	20.4 Consolidation Theories
		20.4.1 Parent Company Theory
		20.4.2 Contemporary/Entity Theory
		20.4.3 Traditional /Hybrid Theory
	20.5 The Consolidation Process
	20.6 Pushdown Accounting
	References
21 Segment and Intermediary Financial Statements
	21.1 General
	21.2 Segment Statements
		21.2.1 Reportable Segments
		21.2.2 Identification of Additional Segment
		21.2.3 Disclosure Requirements
		21.2.4 Measurement
			21.2.4.1 Reconciliations
			21.2.4.2 Interim Report
			21.2.4.3 Restatement of Previously Reported Information
		21.2.5 Entity-Wide Information
			21.2.5.1 Information About Products and Services
			21.2.5.2 Information About Geographic Areas
			21.2.5.3 Information About Major Customers
		21.2.6 Goodwill Considerations
	21.3 Intermediary Statements
	References
22 IFRS and GAAP
	22.1 General
	22.2 Principles Based vs. Rules Based
	22.3 Selected International Accounting Standards
		22.3.1 IAS 1—Presentation of Financial Statement
			22.3.1.1 Complete Set of Financial Statements
			22.3.1.2 Core Principles
			22.3.1.3 Financial Statements: Structure and Content
		22.3.2 IAS 2—Inventories
		22.3.3 IAS 5—Non-Current Assets Held for Sale and Discontinued Operations
		22.3.4 IAS 7—Statements of Cash Flows
			22.3.4.1 Statements of Cash Flows: Presentation
			22.3.4.2 Reporting Cash Flow from Operating Activities
			22.3.4.3 Foreign Currency Cash Flows
		22.3.5 IAS16—Leases
			22.3.5.1 Sale and Leaseback Transactions
			22.3.5.2 A Sale and Leaseback Results in Finance Lease
			22.3.5.3 A Sale and Leaseback Results in Operating Lease
		22.3.6 IAS 24—Related Disclosures
			22.3.6.1 Disclosures
			22.3.6.2 Exemption to Disclosures Rules: Government-Related Entities
		22.3.7 IAS 27—Consolidated Financial Statements
			22.3.7.1 Presentation of Consolidated Financial Statements
			22.3.7.2 Scope of Consolidated Financial Statements
			22.3.7.3 Consolidation Procedures
			22.3.7.4 Loss of Control
			22.3.7.5 Accounting for Investments in Subsidiaries, Jointly Controlled Entities and Associates in Separate Financial Statements
			22.3.7.6 Disclosure
		22.3.8 IAS 32—Financial Instrument—Presentation
		22.3.9 IAS 33—Earnings Per Shares
		22.3.10 IAS 34—Interim Financial Reporting
	References
Part VI Case Study
23 Apple and Microsoft
	23.1 Industry Analysis
	23.2 Apple
		23.2.1 Overview
		23.2.2 Competition
		23.2.3 Business Strategy
		23.2.4 Financial Statements
			23.2.4.1 The Consolidated Balance Sheet
			23.2.4.2 The Consolidated Statement of Income
			23.2.4.3 Consolidated Statement of Comprehensive Income
			23.2.4.4 Consolidated Statement of Shareholders Equity
			23.2.4.5 Consolidated Statement of Cash Flows
	23.3 Microsoft
		23.3.1 Overview
		23.3.2 Competition
		23.3.3 Business Strategy
		23.3.4 Financial Statements
			23.3.4.1 Consolidated Balance Sheet
			23.3.4.2 Consolidated Statement of Income
			23.3.4.3 Comprehensive Statement of Income
			23.3.4.4 Consolidated Statement of Shareholders Equity
			23.3.4.5 Consolidated Statement of Cash Flows
	23.4 Financial Analysis
		23.4.1 Industry Analysis—Porter Five Forces
		23.4.2 Common-Size Balance Sheet Analysis
		23.4.3 Common-Size Income Statement Analysis
		23.4.4 Comparative Financial Statements Analysis
		23.4.5 Financial Ratio Analysis
		23.4.6 Comparative Financial Ratio Analysis
	References
Part VII Non-GAAP Reporting & Earnings Management
24 Non-GAAP Reporting
	24.1 General
	24.2 Non-GAAP Metrics’ Concerns
	24.3 Perceived Advantages and Fears
		24.3.1 Advantages of Non-GAAP Metrics
		24.3.2 Perceived Disadvantages
	24.4 Illustration of Non-GAAP Reporting
	24.5 Identification of Risk-Accounts’ Tools
	24.6 The Disaggregation of the Statement of Income
	24.7 Improving the Intermediary Measurements of Profits
	24.8 Concluding Remarks
	References
25 Earnings Management Through Excessive Reserves and Provisions
	25.1 General
	25.2 Creation of Reserves
	25.3 Accounting for Provision
		25.3.1 Creation of a Provision
		25.3.2 Use of a Provision
		25.3.3 Reversal of a Provision
	25.4 Earnings Management Cases in the United States
		25.4.1 Cookie Jar Reserves
		25.4.2 Use of Hidden Reserves
		25.4.3 Undisclosed Changes in Accounting Methods
	25.5 Detecting Earnings Manipulations
	References
Part VIII Valuation
26 Valuation Accounting
	26.1 General
	26.2 Importance of Asset Valuation
	26.3 Valuation Principles
		26.3.1 Historical Cost Method of Valuation
		26.3.2 Current Cost Method of Valuation
		26.3.3 Realizable Value
		26.3.4 Present Value
	26.4 Valuation Methods
		26.4.1 Method 1: Comparable Analysis (“Comps”)
		26.4.2 Method 2: Precedent Transactions
		26.4.3 Method 3: DCF Analysis
		26.4.4 Book Value
		26.4.5 Liquidation Value
Glossary of the Terms
Index