Financial Statement Analysis: K.R. Subramanyam
Financial Statement Analysis: K.R. Subramanyam
Financial Statement Analysis: K.R. Subramanyam
Statement
Analysis
K.R. Subramanyam
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education.
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3
CHAPTER
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Overview of Chapter
Liabilities
Capital (Stockholders’ Equity)
Off balance sheet transactions
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Liabilities
Liabilities
Alternative Classification
Obligations
Obligationsthat
thatarise
arisefrom
fromoperating
operating
activities--examples
activities--examplesareareaccounts
accounts
Operating
Operating payable,
payable,unearned
unearnedrevenue,
revenue,advance
advance
Liabilities
Liabilities payments,
payments,taxes
taxespayable,
payable,
postretirement
postretirementliabilities,
liabilities,and
andother
other
accruals
accrualsofofoperating
operatingexpenses
expenses
Obligations
Obligationsthat
thatarise
arisefrom
fromfinancing
financing
activities--examples
activities--examplesare
areshort-
short-and
and
Financing
Financing long-term
long-termdebt,
debt,bonds,
bonds,notes,
notes,leases,
leases,
Liabilities and
andthe
thecurrent
currentportion
portionofoflong-term
long-term
Liabilities debt
debt
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Liabilities
Liabilities
Important Features in Analyzing Liabilities
• Terms of indebtedness (such as maturity, interest
rate, payment pattern, and amount).
• Restrictions on deploying resources and pursuing
business activities.
• Ability and flexibility in pursuing further financing.
• Obligations for working capital, debt to equity, and other
financial figures.
• Dilutive conversion features that liabilities are
subject to.
• Prohibitions on disbursements such as dividends.
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Liabilities
Liabilities
Classification
Current (short-term) Noncurrent (Long-Term)
Liabilities Liabilities
Liabilities
Capital (Stockholders’ Equity)
Off balance sheet transactions
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Shareholders’ Equity
Shareholders’ Equity
Basics of Equity Financing
Equity — refers to owner (shareholder)
financing; its usual characteristics include:
• Reflects claims of owners (shareholders) on
net assets
• Equity holders usually subordinate to
creditors
• Variation across equity holders on seniority
• Exposed to maximum risk and return
Shareholders’ Equity
Shareholders’ Equity
company performance
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Shareholders’ Equity
Components of Capital Stock
Contributed (or Paid-In) Capital — total financing received from
shareholders for capital shares; usually divided into two parts:
• Common (or Preferred) Stock — financing equal to par or
stated value;if stock is no-par, then equal to total financing
• Contributed (or Paid-In) Capital in Excess of Par or Stated
Value — financing in excess of any par or stated value
Shareholders’ Equity
Basics of Retained Earnings
Retained Earnings — earned capital of a company; reflects
accumulation of undistributed earnings or losses since inception;
retained earnings is the main source of dividend distributions
Cash and Stock Dividends
• Cash dividend — distribution of cash (or assets) to shareholders
• Stock dividend — distribution of capital stock to shareholders
Prior Period Adjustments — mainly error corrections of prior periods’
statements
Appropriations of Retained Earnings — reclassifications of retained
earnings for specific purposes
Restrictions (or Covenants) on Retained Earnings — constraints
or requirements on retention of retained earnings
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Shareholders’ Equity
Shareholders’ Equity
Reporting Capital Stock
Shareholders’ Equity
Shareholders’ Equity
Liabilities
Capital (Stockholders’ Equity)
Off balance sheet transactions
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Off-Balance-Sheet Financing
Illustration of SPE Transaction to Sell
Accounts Receivable
• A special purpose entity is formed by the sponsoring
company and is capitalized with equity investment,
some of which must be from independent third
parties.
• The SPE leverages this equity investment with
borrowings from the credit markets and purchases
earning assets from or for the sponsoring company.
• The cash flow from the earning assets is used to
repay the debt and provide a return to the equity
investors.
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Off-Balance-Sheet Financing
Off-Balance-Sheet Financing
Benefits of SPEs:
Off-Balance-Sheet Financing
Basics of Off-Balance-Sheet Financing
Off-Balance-Sheet Financing is the non-recording of financing obligations
Motivation
To keep debt off the balance sheet—part of ever-changing landscape, where as one
accounting requirement is brought in to better reflect obligations from a specific off-
balance-sheet financing transaction, new and innovative means are devised to take
its place
Transactions sometimes used as off-balance-sheet financing:
• Operating leases that are indistinguishable from capital leases
• Through-put agreements, where a company agrees to run
goods through a processing facility
• Take-or-pay arrangements, where a company guarantees to pay GAAP
for goods whether needed or not
• Certain joint ventures and limited partnerships
• Product financing arrangements, where a company sells and agrees to
either repurchase inventory or guarantee a selling price
• Sell receivables with recourse and record them as sales rather than liabilities
• Sell receivables as backing for debt sold to the public
• Outstanding loan commitments
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Off-Balance-Sheet Financing
Analysis of Off-Balance-Sheet Financing
Sources of useful information:
Notes and MD&A and SEC Filings
Companies disclose the following info about financial instruments with
off-balance-sheet risk of loss:
• Face, contract, or principal amount
• Terms of the instrument and info on its credit and market risk, cash
requirements, and accounting Loss incurred if a party to the
contract fails to perform
• Collateral or other security, if any, for the amount at risk
• Info about concentrations of credit risk from a counterparty or
groups of counterparties
Useful analyses:
• Scrutinize management communications and press releases
• Analyze notes about financing arrangements
• Recognize a bias to not disclose financing obligations
• Review SEC filings for details of financing arrangements
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Commitments
Contingencies
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Analyzing Commitments
Sources of useful information:
Notes and MD&A and SEC Filings
Useful analyses:
• Scrutinize management communications and press releases
• Analyze notes regarding commitments, including
Description of commitment and its degree of risk
Amount at risk and how treated in assessing risk exposure
Contractual conditions and timing
• Recognize a bias to not disclose commitments
• Review SEC filings for details of commitments
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Leases
Leasing Facts
Lease – contractual agreement between a
lessor (owner) and a lessee (user or renter) that
gives the lessee the right to use an asset
owned by the lessor for the lease term.
Leases
Lease Accounting and Reporting
(1) Capital Lease Accounting For leases that transfer substantially all benefits
and risks of ownership—accounted for as an asset acquisition and a liability
incurrence by the lessee, and as a sale and financing transaction by the lessor
A lessee classifies and accounts for a lease as a capital lease if,
at its inception, the lease meets any of four criteria:
(i) lease transfers ownership of property to lessee by end of the lease
term
(ii) lease contains an option to purchase the property at a bargain price
(iii) lease term is 75% or more of estimated economic life of the
property
(iv) present value of rentals and other minimum lease payments at
beginning of lease term is 90% or more of the fair value of leased property
(2) Operating Lease Accounting For leases other than capital leases—the lessee
(lessor) accounts for the minimum lease payment as a rental expense (income)