20110416-17上海交大CFAä&ce

20110416-17上海交大CFAä&ce

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Unformatted text preview: 金程教育2011年6月CFA一级强化班讲义 金程教育 Financial Statement And Analysis 讲师:练叔凡 日期:2011年4月16、17日 地点: ■ 上海 □北京 □深圳 □南京 上海金程国际金融专修学院 Topic Weightings in CFA Level I Content Session No. Weightings Study Session 1 Ethics & Professional Standards 15 Study Session 2-3 Quantitative Analysis 12 Study Session 4-6 Economics 10 Study Session 7-10 Financial Reporting and Analysis 20 Study Session 11 Corporate Finance 8 Study Session 12 Portfolio Management and Wealth Planning 5 Study Session 13-14 Equity Investment 10 Study Session 15-16 Fixed Income 12 Study Session 17 Derivatives 5 Study Session 18 Alternative Investments 3 2-157 100% Contribution Breeds Professionalism 100% Financial Reporting and Analysis SS7 R29: Financial Statement Analysis: An Introduction R30: Financial Reporting Mechanics R31: Financial Reporting Standards SS8 SS9 R32: Understanding the I/S R36: Inventories R33: Understanding the B/S R37: Long-Lived Assets R34: Understanding the C/F R38: Income Taxes R35: Financial Analysis Techniques R39: Non-current (Long-term) Liabilities SS10 R40: Financial Reporting Quality: Red Flags and Accounting Warning Signs R41: Accounting Shenanigans on the Cash Flow Statement R42: Financial Statement Analysis: Applications R43: International Standards Convergence 3-157 100% Contribution Breeds Professionalism 100% FSA Outlines Basic Concepts Income Statement: Revenue Recognition and EPS Balance Sheet: Measurement of Asset, Liabilities & Equity Cash Flow Statement: CFO, CFI, CFF; Free Cash Flow Ratio Analysis Inventories Long-term Assets: Capitalize or Expense, Depreciation, Impaiment Income Taxes Non-current Liabilities: Bond, Lease Financial Reporting Quality International Standards Convergence 4-157 100% Contribution Breeds Professionalism 100% Reading 29, 30, 31 Basic Concepts 5-157 100% Contribution Breeds Professionalism 100% SS7 Key Points Summary Major Financial Reporting SEC Filings MD&A Form S-1: 证券发行推荐书 Auditors Report Form 10-K: 年报 Balance Sheet DEF-14A: Proxy Statements代理人言论 (Comprehensive) Income Statement Form 10-Q: 季报 Statement of Stock Holders Equity Form 8-K: material events, including M&A Statement of Cash Flows Footnotes Elements of F.S. Asset, liabilities, owners’ equity, revenue (gains), expense (losses) Supplementary Info Qualitative characteristics of F.S. Constraints of F.S. Understandability Reliability vs. Time Relevance Cost vs. Benefit Reliability Statement vs. Intangible and Nonquantifiable Information Comparability 6-157 100% Contribution Breeds Professionalism 100% SS7 Key Points Summary (cont’) Financial Statement Analysis Framework Object and context Accounting equation A=L + Contributed Capital + R/EE A=L + Contributed Capital + R/EB + Revenue – Expense – DIV Gather data Process data Analyze and interpret data Effective financial reporting framework (Convergence) Conclusions or recommendations Transparency Update the analysis Comprehensiveness Accrual basis Unearned revenue Consistency Barriers to a coherent framework Prepaid expense Valuation Accrued revenue Standard-setting approach Accrued expense Measurement 7-157 100% Contribution Breeds Professionalism 100% Financial Statement Elements and Accounts Financial statement elements Assets, liabilities, owner’s equity, revenue, and expenses (and gain/loss under GAAP) Basic accounting equation Assets = Liabilities + Owners’ Equity Expanded accounting equation Owners’ Equity = Contributed Capital + Ending Retained Earning; and Ending Retained Earning = Beginning Retained Earning + Period’s Retained Earning; and Period’s Retained Earning = Net Income – Dividends = Revenue – Expense - Dividends Assets = Liabilities + Contributed Capital + Beginning Retained Earning + Revenue – Expense – Dividends Double-entry Accounting: Transaction is recorded in at least 2 accounts to keep accounting equation in balance 8-157 100% Contribution Breeds Professionalism 100% Key Financial Statements Income statement (I/S, P/L) Revenues - Expenses ± Gains/Losses = Net income For the year/XX months ended Dec, 31 Balance sheet (B/S): At the end of Assets = Liabilities + Owner’s Equity At Dec, 31 2010 Cash flow statement (CF) Cash Balance BGN + Operating Cash Flows + Investing Cash Flows + Financing Cash Flows = Cash Balance END Net Income ± Adjustment Items (Depreciation, Accounting Receivable, Accounting Payable …) = Operating Cash Flow For the year/XX months ended Dec, 31 Statement of Change in Owners’ Equity For the year/XX months ended Dec, 31 9-157 100% Contribution Breeds Professionalism 100% Relationship between Financial Statement Balance sheet and Income statement Assets = Liabilities + Contributed Capital + Beginning Retained Earning + Revenue – Expense – Dividends Balance sheet and Cash flow statement Cash and cash equivalent END - Cash and cash equivalent BGN = Operating cash flows + Investing cash flows + financing cash flows Income statement and Cash flow statement Net income ± Adjustments (AR, AP, prepaid Exp, accrued Exp, D&A, Inv, deferred tax) = Operating cash flow 10-157 100% Contribution Breeds Professionalism 100% Other Financial Information in Annual Report Financial statement notes (Footnotes) Providing information about accounting methods, assumptions, and estimates Providing additional information about business acquisitions or disposal, legal actions, employee benefit plans, significant customers, sales to related parties, and segments of the firm Are audited Supplementary schedules Operating income or sales by region or business segment Reserves for an oil and gas company Information about hedging activities and financial instruments Management’s Discussion and Analysis (MD&A) Providing an assessment of the financial performance and condition of a company from the perspective of its management Results from operations with a discussion of trends in sales and expense Capital resource and liquidity, with a discussion of trends in cash flow A general business overview based on known trends The effect of inflation 11-157 100% Contribution Breeds Professionalism 100% Other Financial Information Quarterly or semiannual reports The most updated information on the major financial statements and footnotes, not be audited. Securities and Exchange Commission (SEC) filings Form 8-K Acquisitions or disposals of major assets; changes in its management or corporate governance Form 10-K Annual financial statements Form 10-Q Quarterly financial statements Proxy statements Issued to shareholders when there are matters that require a shareholder vote Providing information about the board members, managements, compensation and the issuance of stock options 12-157 100% Contribution Breeds Professionalism 100% Audits Audit Audit is independent review of an entity’s financial statements by an independent accounting firm The audit process provides a basis for the independent auditor to express an audit opinion on the fairness of the financial statements that were audited Objective: Auditor provides reasonable assurance that the financial statements are fairly presented The standard auditor’s opinion Unqualified (clean) opinion: free from material errors, fraud, or illegal acts Qualified opinion Adverse opinion Internal control system Management is required to provide a report on the company internal control system under the Sarbanes-Oxley Act 13-157 100% Contribution Breeds Professionalism 100% Financial Statement Analysis Framework Phase Sources of info Output 1. State the objective and context • Nature • Needs & concern • Guidelines • Statement of purposes and objectives • A list of specific questions • Timetable & budgeted resources 2.Gather data • Financial, industry, economics data • Discussion & visit • Organized F/S • Financial data table • Complete questionnaires 3.Process the data • Data from previous phase • Adjusted F/S • Common - size statements • Ratios & forecasts 4.Analyze/interpret the data • Input data • Processed data • Analytical results 5.Report the conclusions or recommendations • Analytical results • Analytical reports • Recommendation 6.Update the analysis • Periodically repeating • Updated reports & recommendations 14-157 100% Contribution Breeds Professionalism 100% Accrual Base vs. Cash Base Cash base Advantages Intuitive Disadvantages Highly volatile, less predictive for CF and incomes Not desirable for firms with complex operations and financing strategies Difficult for analyzing balance sheets Accrual base Advantages Smoothed earning streams Enhanced predictability of future CF Provide incremental information related to firm’s profitability Disadvantages Can be confusing Left to managerial discretion 15-157 100% Contribution Breeds Professionalism 100% Revenue and Expense Accounting on Accrual Base Revenue and expense are not always recorded at the same time that cash received or paid Unearned revenue The firm receives cash before it provides a good or services to customers No revenue recognized; but a liability recognized Accrued revenue The firm provides goods or services before it receives cash payment Revenue recognition; and an asset recognized Prepaid expense The firm pays cash ahead of time for an anticipated expense No expense recognized; but an asset recognized Accrued expense The firm owes cash for expenses it has incurred Expense recognized; and a liability recognized 16-157 100% Contribution Breeds Professionalism 100% Standard-setting Bodies and Regulatory Authorities Standard – setting bodies (make the rules): Professional organizations of accountants and auditors that establish financial reporting standards Financial Accounting Standards Board (FASB) & Generally Accepted Accounting Principles (GAAP) in the U.S. International Accounting Standards Board (IASB) & International Financial Reporting Standards (IFRS) outside the U.S. Regulatory authorities (enforce the rules): Government agencies that have legal authority to enforce compliance with financial reporting standards. Barrier to develop one universally accepted set of financial reporting standard Different standard-setting bodies and regulatory authorities disagree on the best treatment of a particular items or issue Political pressure from business groups and others 17-157 100% Contribution Breeds Professionalism 100% IFRS Framework Qualitative characteristics Understandability: should be able to understand it Comparability: should be consistent among firms and across time periods Relevance: whether influences economic decisions (Materiality) Reliability: free from material error and bias, including faithful representation, substance over form, neutrality, prudence, completeness Required reporting elements Assets, Liabilities, Equity, Income (includes gains) and Expenses (includes losses) Base of measurement includes historical cost, current cost , realizable cost, present value, fair value Constraints Reliability vs. Time Cost vs. Benefit Statement vs. Intangible and Non-quantifiable Information Assumption Accrual basis Going concern 18-157 100% Contribution Breeds Professionalism 100% IAS General Requirements Required financial statements Balance sheet Comprehensive income statement Cash flow statement Statement of change in owners’ equity Explanatory notes Principles for preparing financial statements Fair presentation Going concern basis Accrual basis Consistency Materiality Principles for presenting financial statements Aggregation No offsetting (assets against liabilities, income against expenses) Classified balance sheet Minimum information Comparative information 19-157 100% Contribution Breeds Professionalism 100% Coherent Financial Reporting Framework Characteristics of a coherent financial reporting framework Transparency: full disclose and fair presentation Comprehensiveness Consistency Barrier to creating a coherent financial reporting framework Valuation: different measurement bases for valuation involve a trade-off between relevance and reliability Standard setting IFRS: principles-based approach GAAP: traditionally rules-based approach, but moves to Objective-based approach Measurement Asset/liability approach: valuing elements at one point in time Revenue/expense approach: valuing changes between points in time 20-157 100% Contribution Breeds Professionalism 100% Information Flow in Accounting System Flow of information in an accounting system Journal entries and adjusting journal entries: sorted by date General ledger and T-account: all business transactions by account Trial balance and adjusted trial balance Financial statement from adjust trial balance 21-157 100% Contribution Breeds Professionalism 100% Reading 32 Income Statement 22-157 100% Contribution Breeds Professionalism 100% R32 Key Points Summary Format of income statement Operating vs. non operating Nonrecurring items before and below continuing operation Other comprehensive income (IFRS) Revenue recognition Long-term contracts (POC, CC and IFRS method replacing CC) Installment sales (instalment method, cost recovery method) Barter transaction (GAAP vs. IFRS) Gross vs. Net revenue reporting Basic EPS Denominator in case of stock dividends/split Diluted EPS Check, numerator and denominator in case of convertible bond, convertible preferred shares and options 23-157 100% Contribution Breeds Professionalism 100% Income Statement Format Typical Income Statement (GAAP) Revenue COGS Gross profit Operating Components R&D SG&A Operating income Investment income Interest Unusual or infrequent items Nonrecurring but still continuing items Income from continuing operations Income tax Net income from continuing operation Nonrecurring Items Discontinued operations Extraordinary items Effect of accounting changes Net income (IFRS: Other comprehensive income ) 24-157 100% Contribution Breeds Professionalism 100% Components of Income Statement Net revenue = Revenue- return – allowance Operating and non-operating components are reported separately Operating items: COGS; SG&A, R&D Non-operating items: Investment income, financing expense Unusual or infrequent items, but not both Gains/losses from disposal, impairment Included in continuing operation, before of tax Discontinued operations (将清算的业务) Reported separately, net of tax Extraordinary items Losses from an expropriation of assets (资产被没收), gains/losses from early retirement of debt, uninsured losses from natural disaster; after continuing operation, net of tax IFRS does not allow extraordinary items to be separated from operating results Effect of accounting changes 25-157 100% Contribution Breeds Professionalism 100% Retained Earning and Comprehensive Income Retained Earning (B/S) = Net income (I/S) – Dividends Other comprehensive income affect equity but not net income Including: foreign currency translation gains/losses unrealized gains/losses on available-for-sale security unrealized gains/losses on cash flow hedging derivatives minimum pension liability adjustment Accumulated other comprehensive income (B/S) = ∑Other comprehensive income Comprehensive income: net income + other comprehensive income 26-157 100% Contribution Breeds Professionalism 100% Revenue Recognition Principal: revenue is recognized when earned under accrual method Special revenue reorganization application Long-term contracts: certain cost → revenue = ?, net income=? Percentage-of-completion method (POC) Completed-contract method (CC) IFRS: if outcome can’t be measured, cost is recognized when incurred, if revenue < contract-cost, profit is recognized only at completion Installment sales: uncertain collection → revenue=?, cost=?, net income=? installment method: 分期同比例确认利润 cost recovery method: 先cover cost,再确认利润 27-157 100% Contribution Breeds Professionalism 100% Samples of Long-term Contracts Contract price: $1000, estimated total cost: $800 Year 20X5 20X6 20X7 Total Cost incurred $400 $300 $100 $800 Cost → Revenue = ?; net income=? Under percentage-of-completion method Y1: cost=400=50% of total cost → revenue=50%*total rev=500 net income=500-400=100 Y2: cost=300=37.5% of total cost → Rev=375, NI=75 Y3: cost=100=12.5% of total cost → Rev=125, NI=25 Under completed-contract method Y1: uncompleted → revenue, cost, net income=0 Y2: uncompleted → revenue, cost, net income=0 Y3: completed → revenue=1000, cost=800, net income=200 Percentage-of-completion: more aggressive, smoother earnings 28-157 100% Contribution Breeds Professionalism 100% Impact on financials Percentage-of-completion vs. Completed-contract During the period POC Completed Contract Greater Less Income Volatility Less Greater Cash flows Same Same Total assets Greater Less Same Same Greater Less Ratio of Liability to equity Less Greater Conservation Less More Net Income Liabilities Shareholder equity 29-157 100% Contribution Breeds Professionalism 100% Samples of Installment Total price of installment sales: $1000, cost: $800 Year 20X5 20X6 20X7 Total Collection $400 $400 $200 $1,000 Collection → Revenue=?, cost=?, net income=? Under installment method margin=(1000-800)/1000=20% Y1: revenue=collection=400, cost=400*(1-20%)=320, net income=400*20%=80 Y2: revenue=collection=200, cost=200*(1-20%)=160, net income=200*20%=80 Y3: revenue=collection=200, cost=200*(1-20%)=160, net income=200*20%=40 Total NI=80+80+40=200=total price*margin Under cost recovery method Y1: accumulated collection>cost? N → Rev=cost=collection=400, NI=0 Y2: accumulated collection>cost? N → Rev=cost=collection=400, NI=0 Y3: accumulated collection>cost? Y → Rev=collection=200, cost=0, NI=200 Installment method: more aggressive, smoother earnings 30-157 100% Contribution Breeds Professionalism 100% Impact on financials Installment method vs. cost recovery method During the period Installment Cost recovery Greater Less Income Volatility Less Greater Cash flows Same Same Total assets Greater Less Same Same Greater Less Ratio of Liability to equity Less Greater Conservation Less More Net Income Liabilities Shareholder equity 31-157 100% Contribution Breeds Professionalism 100% Revenue Recognition (cont’) Special revenue reorganization application Barter Transaction GAAP: recognized at fair value only if historically received cash IFRS: faire value based on similar non-barter transaction with unrelated parties Gross and net reporting of revenue example: $1000 ticket, $100 commission Gross reporting: Rev=1000 cost=900 Net reporting: Rev=100 cost=0 NI=100 NI=100 Gross reporting: primary obligor, risk taker, be able to choose supplier and establish the price (GAAP) 32-157 100% Contribution Breeds Professionalism 100% Expense Recognition Under accrual method, expense recognition is based on matching principle 费用与收入同期确认,如inventory→ COGS Period costs, e.g. administrative costs Cost of long-lived asset: depreciation, amortization expense Bad debt and warranty expense 33-157 100% Contribution Breeds Professionalism 100% EPS and Basic EPS EPS: Earning per share Basic EPS Simple capital structure, only preferred and common shares 现有普通股股东分收益 Numerator: Net income – Preferred dividends Denominator: Weighted average number of common share outstanding按月对 股份数加权平均 Share issue and repurchase Stock dividends: 股票股利,送股,10% means 100 share → 110 share Stock split: 拆股,2-for-1 means 100 shares → 200 shares 2-for-1 = 100% stock dividends 若送股、拆股,要从年初调起 basic EPS = 34-157 net income − preferred dividednds weighted average number of common shares outstanding 100% Contribution Breeds Professionalism 100% Samples of Basic EPS Net income: $100k; Cash preferred Div. paid: $10k; Cash common Div. paid: $30k Share BGN = 10k shares; 4k new shares issued on Apr 1; 10% stock dividend on Jul 1; 3k shares repurchased for the treasury Simple capital structure → Basic EPS Earning = 100k-10k=90k Outstanding shares: 年初:10k*110% =11k 12个 4月1号:4k*110% =4.4k 9个月 9月1号(不调):-3k 4个月 weighted average number of common share outstanding: [11k*12+4.4k*9+(-3k)*4]/12=13.3k Basic EPS = 90k/13.3k = $ 6.77 Preferred share: 1k, $100 par, 10% cash preferred Div. paid rate → Cash preferred Div. paid = 1k*100*10% = 10k 35-157 100% Contribution Breeds Professionalism 100% Diluted EPS Diluted EPS involves convertible debt, convertible preferred stock, stock options 现有及潜在普通股股东分收益 Numerator: 把分给潜在普通股股东的钱加回来(税后) Denominator: 增上潜在普通股股数 先判断是否摊薄 adjusted income available for common shares diluted EPS= weighted avg. common & potential common shares out ⎡convertible⎤ ⎡net income ⎤ ⎡convertible ⎤ ⎢ ⎥ (1 − t ) +⎢ + ⎢debt ⎢-preferred div.⎥ preferred div.⎥ ⎥ ⎣ ⎦⎣ ⎦ ⎢interest ⎥ ⎣ ⎦ = ⎡weighted ⎤ ⎡shares from ⎤ ⎡shares from ⎤ ⎡shares ⎤ ⎢average ⎥ + ⎢conversion of ⎥ + ⎢conversion of ⎥ + ⎢issuable from⎥ ⎢ ⎥⎢ ⎥⎢ ⎥⎢ ⎥ ⎢shares ⎥ ⎢conv. pfd. shares⎥ ⎢conv. debt ⎥ ⎢stock opt. ⎥ ⎣ ⎦⎣ ⎦⎣ ⎦⎣ ⎦ 36-157 100% Contribution Breeds Professionalism 100% Diluted EPS Summary Convertible debt 判断是否摊薄了EPS:税后利息/转换股数 < Basic EPS 对earning影响:把税后利息加回至普通股利润 Interest*(1-Tax%) 对share number影响:增加转换成的普通股数量 Convertible preferred stock 判断是否摊薄了EPS:优先股息/转换股数 < Basic EPS 对earning影响:把优先股息加回至普通股利润,与税率无关 对share number影响:增加转换成的普通股数量 Option or warrant 判断是否会摊薄EPS:执行价格 < 平均股价(average stock price) 对earning影响:无影响 对share number影响:增加普通股数量,数量=转换股数-执行总现金流入/平均股价 or 简便算法:(average price - exercise price)/ average *N 37-157 100% Contribution Breeds Professionalism 100% Samples of EPS with Convertible Debt Net income: $115.6k; Cash preferred Div. paid%: 10% Common share: 200k; preferred share: 1k, $100 par; Convertible debt: 600 $1k par, 7% coupon rate bonds, 1 bond is convertible to 100 common shares Tax rate = 40% Complex capital structure → Diluted EPS Basic EPS = (115.6k-10k)/200k = $0.53 Check: 税后利息600*1k*7%*(1-40%) = 25.2k; 转换股数 = 600*100=60k; 25.2k/60k = $0.42 < $0.53 → dilutive security Earning: 115.6k-10k+25.2k=$ 130.8k Shares: 200k+ 60k=260k Diluted EPS = 130.8k/260k = $0.50 38-157 100% Contribution Breeds Professionalism 100% Samples of EPS with Convertible Preferred Stock Net income: $115.6k; Cash preferred Div. paid%: 10% Common share: 200k Convertible preferred stock: 1k $100 par, 10% dividend rate preferred share, 1 share is convertible to 40 common shares Tax rate=40% Complex capital structure → Diluted EPS Basic EPS = (115.6k-10k)/200k = $0.53 Check: 优先股息1k*100*10% = $10k; 转换股数 = 1k*40=40k; 10/40 = $0.25 < $0.53 → dilutive security Earning: 115.6k-10k+10k=$115.6k Shares: 200k+ 40k=240k Diluted EPS = 115.6k/240k = $0.48 39-157 100% Contribution Breeds Professionalism 100% Samples of EPS with Option Net income: $115.6k; Cash preferred Div. paid%: 10% Common share: 200k; preferred share: 1k, $100 par; Option: 10k, 1 option allows its holder to buy 1 common share at $15; average stock price: $20 Complex capital structure → Diluted EPS Basic EPS = (115.6k-10k)/200k = $0.53 Check: exercise price $15<average price $20 → dilutive security Increase in common share = 10k - (15*10k/20) = 2.5k Diluted EPS = (115.6k-10k)/(200k+2.5k) = $0.52 40-157 100% Contribution Breeds Professionalism 100% Reading 33 Balance Sheet 41-157 100% Contribution Breeds Professionalism 100% R33 Key Points Summary Accounting treatment of marketable investment securities Held-to-mature security: amortized cost; realized gain in I/S Trading security: fair value; realized and unrealized gain in I/S Available for sales security: fair value; realized gain in I/S; unrealized gain in B/S Owner’s equity Outstanding shares = Issued shares - Treasury stock NI-dividends → retained earning Other comprehensive income → accumulated other comprehensive income 42-157 100% Contribution Breeds Professionalism 100% Components of Balance Sheet - Assets Assets provide probable future economic benefits controlled by an entity as s result of previous transaction Cash and equivalents Accounts receivable Inventory Prepaid expenses Investments (Trading securities) Property, plants, and equipment Investment (Held-to-maturity securities, Available-for-sale securities, Investment in affiliates) Intangible assets Deferred tax assets Pension assets 43-157 100% Contribution Breeds Professionalism 100% Marketable Investment Securities Marketable investment securities are classified as either: Held-to-maturity securities: debt securities acquired with the intent that they will be held to maturity Trading securities: debt and equity securities acquired with the intent to profit over the near term Available-for-sale securities: debt and equities that are not expected to be held to maturity or traded in the near term Held-to-Maturity Balance sheet – asset Trading Available-for-sale Amortized cost Fair value Fair value Unrealized gains/loss Balance sheet - equity NI → Retained earning NI → Retained earning →Accumulated OCI NI → Retained earning Income Statement 44-157 Interest Realized gains/loss Interest Dividends Realized gains/loss Unrealized gains/loss 100% Contribution Breeds Professionalism 100% Interest Dividends Realized gains/loss Components of Balance Sheet - Liability Liabilities are obligations owed by an entity from previous transaction that are expected to result in an outflow of economic benefits in the future Accounts payable Accrued expenses Unearned revenue Notes payable Bonds payable Capital (financial) lease obligations Pension liabilities Deferred tax liabilities Current assets/liabilities: be converted into cash/be satisfied within one year or one operating cycle, whichever is greater Current portion of long-term assets/debt Current assets – Current liabilities = Working capital 45-157 100% Contribution Breeds Professionalism 100% Components of Balance Sheet -Equity Owners’ equity is the residual interest in assets that remains after subtracting a firm’s liabilities Capital stock Additional paid-in capital (capital in excess of par) Treasury stock Noncontrolling interest in subsidiaries Retained earning Accumulated other comprehensive income 46-157 100% Contribution Breeds Professionalism 100% Components of Owners’ Equity Contributed capital (common and preferred stock) Preferred shareholders Common shareholders Authorized shares Issued shares Outstanding shares = Issued shares - Treasury stock Treasury stock (repurchased shares, reduces both assets and equity) No voting rights Does not receive dividends Retained earnings Accumulated other comprehensive income: from OCI (Under IFRS) Non-controlling interest (minority interest) 少数股东权益 47-157 100% Contribution Breeds Professionalism 100% Statement of Changes on Stockholders’ Equity Statement of changes on stockholders’ equity summaries all transactions that increase or decrease the equity accounts for a period Common Stock Beginning balance Net income Net unrealized loss on availablefor-sale securities Net unrealized loss on cash flow hedges Minimum pension liability Cumulative translation adjustment Comprehensive income Issuance of common stock Repurchase of common stock Dividends Ending balance 48-157 Retained Earnings 49,234 26,664 6,994 Accumulated Other Comprehensive Income -406 Total 75,492 6,994 -40 -40 -56 -56 -26 42 -26 42 6,914 1,282 -6,200 -2,360 75,128 1,282 -6,200 44,316 -2,360 31,298 100% Contribution Breeds Professionalism 100% 486 Reading 34 Cash Flow Statement 49-157 100% Contribution Breeds Professionalism 100% R34 Key Points Summary Classification of cash flow under GAAP and IFRS Interest / dividend paid/received under GAAP and IFRS CFO by direct method 5个对象 客户(收入),供应商(成本),员工(费用),债主(利息),政府(税) 资产增,现金出;负载增,现金入 CFO by indirect method 3个步骤 本期(应收应付调整)经营(投融资活动)现金(非现金活动)流 资产增,现金出;负载增,现金入 CFI 期初资产+购买流出-折旧-处置的账面净值=期末资产 处置流入-账面净值=损益 CFF 期初留存利润+本期净利润-股息=期末留存利润 FCFF and FCFE 50-157 100% Contribution Breeds Professionalism 100% Cash Flow Equation Cash flow equation Operating cash flow + Investing cash flow + Financing cash flow = Change in cash balance for period + Beginning cash balance = Ending cash balance 51-157 100% Contribution Breeds Professionalism 100% Cash Flow Classification - CFO Cash flows from operating activities (CFO): cash flows resulting from transaction that affect a firm’s net income Example of CFO under GAAP Inflows Outflows Cash collected from customers Cash paid to employees and suppliers Interest and dividends received Cash paid for other expenses Sale proceeds from trading securities Acquisition of trading securities Interest paid Taxes paid 52-157 100% Contribution Breeds Professionalism 100% Cash Flow Classification - CFI Cash flows from investing activities (CFI): cash flows resulting from the acquisition or disposal of long – term assets and certain investments Example of CFI under GAAP Inflows Outflows Sale proceeds from fixed assets Acquisition of fixed assets Sale proceeds from debt & equity investments Acquisition of debt & equity investments Principal received from loans made to others Loans made to others 53-157 100% Contribution Breeds Professionalism 100% Cash Flow Classification - CFF Cash flows from financing activities (CFF): cash flows resulting from transaction that affect a firm’s capital structure Example of CFF under GAAP Inflows Outflows Principal amounts of debt issued Principal paid on debt Proceeds from issuing stocks Payments to reacquire stock Dividends paid to shareholders 54-157 100% Contribution Breeds Professionalism 100% Cash Flow Classification – GAAP vs. IFRS IFRS allows more flexibility in the classification of cash flow. GAAP GAAP IFRS Interest received CFO CFO or CFI Interest paid CFO CFO or CFF Dividends received CFO CFO or CFI Dividends paid CFF CFO or CFF Income tax CFO CFO or CFI/CFF Bank overdrafts CFF Cash equivalents 55-157 100% Contribution Breeds Professionalism 100% Direct Method of Cash Flow Statement - CFO Direct Method 5个对象 Each item of the accrual-basis income statement is converted into cash receipts or payment. CFO calculation under direct method Cash collections from customers = net sales revenue - Cash paid to suppliers = -COGS - ΔA/R + Δunearned - Δinventory + ΔA/P - Cash paid for operating expenses = -operating expenses +ΔW/P + Δaccruals - Cash paid for interest = -interest expenses + ΔI/P - Cash paid for taxes = -income tax expenses + ΔT/P + ΔDTL - ΔDTA = Net income + NCC(D&A 折旧 摊销) ±Losses/gains from inv./fin. activities 投融资活动损益 = Difference between accrual base and cash base in op activities = Operating cash flow 56-157 100% Contribution Breeds Professionalism 100% 资产增→现金出 负债增→现金入 Indirect Method: Only for CFO Indirect Method 3个步骤:本期 经营 现金流 Net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions. Cash collections from customers = net sales revenue - Cash paid to suppliers = -COGS - ΔA/R + Δunearned - Δinventory + ΔA/P - Cash paid for operating expenses = -operating expenses + ΔW/P + Δaccruals - Cash paid for interest = -interest expenses + ΔI/P - Cash paid for taxes = -income tax expenses + ΔT/P + ΔDTL - ΔDTA = Net income + NCC(D&A 折旧 摊销) ±Losses/gains from inv./fin. activities 投融资活动损益 = Difference between accrual base and cash base in op activities = Operating cash flow 57-157 100% Contribution Breeds Professionalism 100% Indirect Method: Only for CFO (cont’) Net income → CFO: 3个步骤:本期 经营 现金流 Add back all Noncash changes(NCC) to net income: 调非现金活动 + Deprecation and Amortization Subtract(add) gains(losses) from investing and financing activities: 调非经营活 动 ±losses/ gains from assets disposal or investment Adjust changes to balance sheet operating accounts: difference between accrual base and cash base in operating actives: 调非本期活动 - Δ operating asset accounts, which implies use of cash + Δ operating liability accounts, which implies receipt of cash 资产增→现金出,负债增→现金入 58-157 100% Contribution Breeds Professionalism 100% Direct Method of Cash Flow Statement - CFI CFI calculation: 买资产流出,卖资产流入 Cash paid to purchase of fixed assets and identifiable intangible assets Net BVBGN + Purchasing - Δ Depreciation/amortization - Disposal Net BV= Net BVEND → Purchasing = Δ Net BV + Δ depreciation/amortization + disposal Net BV Cash paid to purchase unidentifiable intangible assets and investment securities Net BVBGN + Purchasing - Disposal Net BV= Net BVEND Proceeds received from sale of fixed assets and identifiable intangible assets Proceeds received – Disposal Net BV = Gain/(loss) → Proceeds received = Disposal Net BV ± Gain/(loss) Proceeds received from sale of unidentifiable intangible assets and investment securities Proceeds received – Sold BV = Gain/(loss) 59-157 100% Contribution Breeds Professionalism 100% Direct Method of Cash Flow Statement - CFF CFF calculation: 融资流入,还债、买股、发股息流出 All events that could have increased or decreased cash must be reconstructed Review long-term debt and stock Increases of debt and stock: financing cash flow in Decreases of debt and stock: financing cash flow out Dividend paid Retained earning BGN + Net Income – dividend declared = Retained earning END Dividend declared - Dividend paid = Δ dividend payables 60-157 100% Contribution Breeds Professionalism 100% Samples of Cash Flow Calculation Calculation CFO, CFI and CFF based following information: 31 Dec 09 31 Dec 10 Cash 2,300 4,200 A/R 1,000 3,000 Inventories 1,000 2,000 Fixed assets 4,000 5,000 Asset 8,300 Loans A/P Accruals T/P I/P Div/P Capital R/E 14,200 L&E 31 Dec 09 31 Dec 10 3,000 2,000 1,500 4,000 100 300 100 200 500 100 200 2,500 5,000 1,000 2,000 8,300 14,200 *: The $1,000 gain is from disposal of land, whose book value is $500 61-157 100% Contribution Breeds Professionalism 100% Sales COGS Expense Depreciation Gain* Op. income Interest Income tax Net income FY 10 10,000 -7,000 -500 -1,000 1,000 2,500 -500 -600 1,400 Samples of Cash Flow Calculation (cont’) CFO by direct method 资 产 增 ↓ 现 金 出 负 债 增 ↓ 现 金 入 Cash collection Sales - Δ A/R 10,000 -2,000 8,000 Cash paid to suppliers - COGS -7,000 - Δ Inventory -1,000 +Δ A/P 2,500 -5,500 Cash expense - Expense -500 +Δ Accrual 200 -300 Cash interest - Interest expense -500 +Δ I/P 500 0 Cash income tax - Income tax expense -600 +Δ T/P 100 -500 CFO 1,700 62-157 CFO by indirect method Net income 1,400 Adjustment Depreciation 1,000 Gain from disposal -1,000 Change in B/S Op. account - Δ A/R -2,000 - Δ Inventory -1,000 +Δ A/P 2,500 +Δ Accrual 200 +Δ I/P 500 +Δ T/P 100 CFO 1,700 100% Contribution Breeds Professionalism 100% Samples of Cash Flow Calculation (cont’) CFI Fix asset movement 4,000 BV BGN +Purchase ? - Depreciation -1,000 - Disposal -500 BV END 5,000 → Purchase = 2,500(-) Disposal Proceeds from disposal - BV of FA sold -500 Gain/loss 1,000 → Proceeds = 1,500 - Cash used in investment +Cash received from disposal CFI -1,000 63-157 ? -2,500 1,500 100% Contribution Breeds Professionalism 100% Samples of Cash Flow Calculation (cont’) CFF New borrowings Δ Loans -1,000 Proceeds from stock issuance Δ Capital 2,500 Dividend paid - Dividend declared -400 +Δ D/P 100 -300 CFF 1,200 Dividend declared 1,000 Retained earning BGN +Net income 1,400 - Dividend declares ? Retained earning END 2,000 → Dividend declared = -400 64-157 100% Contribution Breeds Professionalism 100% Noncash Investing and Financing Activities Noncash investing and financing activities are not reported in the cash flow statement since they do not result in inflows or outflows of cash A firm acquires real estate with financing provided by the seller An exchange of debt for equity Noncash transaction must be disclosed in either a footnote or supplemental schedule to the cash flow statement 65-157 100% Contribution Breeds Professionalism 100% Free Cash Flow Free cash flow attempts to measure the cash available for discretionary purposes Free cash flow to the firm (FCFF): available to all investors, both equity owners and debt holders FCFF = CFO + [ Int * (1 - tax rate) ] – FCInv (under GAAP) FCInv: Fixed capital investment FCFF = NI + NCC + [ Int * (1 - tax rate) ] – FCInv – WCInv WCInv: Working capital investment Free cash flow to equity (FCFE): available for distribution to common shareholders. FCFE = FCFF - [ Int * (1 - tax rate) ] + Net borrowing (– Net debt repayment) = CFO – FCInv + Net borrowing (– Net debt repayment) 66-157 100% Contribution Breeds Professionalism 100% Reading 35, 42 Financial Analysis 67-157 100% Contribution Breeds Professionalism 100% R35 Key Points Summary Common size Balance sheet Income statement Liquidity Short-term solvency Current ratio Quick ratio Cash ratio Long-term solvency Debt/Asset Profitability Activity: operation efficiency Margin Receivables turnover → Average receivables collection period Gross margin Operation margin Payables turnover → Average payment period Net margin Return Inventories turnover → Average inventory processing period ROA ROE DuPont system Cash conversion cycle Valuation ratio: Debt/Equity Sustainable growth rate Financial leverage Interest coverage 68-157 100% Contribution Breeds Professionalism 100% Common-size Statement and Analysis Common-size statement normalized balance sheets and income statements allow the analyst to more easily compare performance across firms and for a single firm over time. Common-sized B/S ratios Item in balance sheet account / total assets Common-sized I/S ratios Item in income statement account / revenues Common-sized C/F ratios item in the cash flow statement inflow account / total inflow item in the cash flow statement outflow account / total outflow item in the cash flow statement flow account / revenues 69-157 100% Contribution Breeds Professionalism 100% Common Ratios - Liquidity Ratios Current ratio = current assets / current liabilities Quick ratio = (cash + marketable securities + receivable) / current liabilities = (current asset – inventories) / current liabilities Cash ratio = [cash + marketable securities] / current liabilities Defensive interval = (cash + marketable securities + receivables) / average daily expenditures 70-157 100% Contribution Breeds Professionalism 100% Common Ratios - Solvency Ratios Debt: long-term debt + interest-bearing short-term debt Debt-to-equity ratio = total debt / equity Debt-to-capital = total debt / (total debt + total shareholders’ equity) Debt-to-assets = total debt / total assets Financial leverage = average total assets / average total equity Interest coverage = operating profit / interest expense = EBIT / I Fixed charge coverage = (EBIT + lease payments) / (interest expense + lease payments) 71-157 100% Contribution Breeds Professionalism 100% Common Ratios - Profitability Ratios Gross profit margin = gross profits / revenue Operating profit margin = operating profit (EBIT) / revenue Pretax margin = EBT / revenue Net profit margin = net income / revenue Return on assets (ROA) = net income / average total assets Operating return on assets = operating income (EBIT) / average total assets Return on total capital = EBIT / average total capital Return on equity = Net income / average total equity Return on common equity = (Net income- pre. Div) / average total common equity 72-157 100% Contribution Breeds Professionalism 100% Common Ratios - Activity Ratios Receivables turnover = sales / average receivables Inventory turnover = COGS / average inventory Payables turnover = purchase / average accounts payable Average receivables collection period = 365 / receivables turnover Average inventory processing period = 365 / inventory turnover Average payment period = 365 / payables turnover Cash conversion cycle = collection period + inventory period - payment period Total asset turnover = revenue / average total assets Fixed asset turnover = revenue / average net fixed assets Working capital turnover = revenue / average working capital 73-157 100% Contribution Breeds Professionalism 100% Common Ratios - DuPont Systems of Analysis Original DuPont approach net income revenue assets ROE = × × revenue assets equity = net profit margin * asset turnover * leverage ratio = ROA * leverage ratio Extended DuPont approach net income EBT EBIT revenue assets ROE = × × × × EBT EBIT revenue assets equity = tax burden * interest burden * EBIT margin * asset turnover * financial leverage 74-157 100% Contribution Breeds Professionalism 100% Equity Analysis - Valuation Ratios Price-to-earning (P/E) ratio Price-to-cash flow Price-to-book value EPS, Cash flow/EBIT/EBITDA/Dividend per share Sustainable growth rate g = RR × ROE RR = 1 - dividend payout ratio ROE = net income / equity Assumption: without additional external equity issues while holding leverage (equity to debt) constant 75-157 100% Contribution Breeds Professionalism 100% Equity Analysis - Ratios in Certain Industries Business risk Coefficient variation revenue = δ of sales / average revenue CV operating income = δ of operating income / average operating income CV net income = δ of net income / average net income Net income per employee and sales per employee are used in the analysis and valuation of service and consulting companies Growth in same-store sales is used in the restaurant and retail industries Sales per square foot is used in the retail industry 76-157 100% Contribution Breeds Professionalism 100% Credit Analysis EBIT interest coverage = EBIT / gross interest EBITDA interest coverage = EBITDA / gross interest Fund from operation to total debt = Net income adjusted for noncash items / total debt CFO to total debt = CFO / total debt Total debt to EBITDA = Total debt / EBITDA Total debt to total debt plus equity = Total debt / (total debt + equity) 77-157 100% Contribution Breeds Professionalism 100% Limitations of Ratio Analysis Not useful when viewed in isolation Financial ratios are only valid when compared to those of other firms or to the company’s historical performance. Difference in accounting treatment among companies Ratio analysis relies on accounting data, which is subject to earning management through choice of accounting alternatives. Multiple business lines Many firms have multiple lines of business, making it difficult to identify the appropriate industry to use in comparing firms. Inconsistency of different ratios It’s often necessary to consider more than one set of ratios to develop a comprehensive profile of the firm. Difficulty in determining the right value for comparison purpose A range of appropriate values for the ratio has to be considered. 78-157 100% Contribution Breeds Professionalism 100% Reading 36 Inventories 79-157 100% Contribution Breeds Professionalism 100% R36 Key Points Summary Inventory accounting and its basic equation Inventory → COGS Inventory END = Inventory BGN + Purchases – COGS FIFO, LIFO and WAC The items first/last purchased are regarded as COGS; ending inventory is the most recent/earliest items Impact of price increase/decrease on COGS and ending inventory Periodic and perpetual inventory system For LIFO and WAC methods, COGS and inventory value might differ under periodic and perpetual system Inventory valuation method Inventory IFRS: Min[cost, net realizable value (NRV)], where NRV=selling price- selling cost GAAP: Min[cost, market ] where market = replacement cost, if replacement cost is between [NRV, NRV-normal profit margin] No write-up allowed under GAAP 80-157 100% Contribution Breeds Professionalism 100% Relationship between Inventory and COGS The measurement of inventory is the key point to measure the COGS. When inventories are sold, costs of inventories are regarded as COGS Inventory END = Inventory BGN + Purchases – COGS Purchases is same under different cost flow method Product costs: the costs capitalized in the inventories account on the balance sheet and include: Purchase cost less trade discounts and rebates Conversion costs including labor and overhead Other costs necessary to bring the inventory to its present location and condition Period costs: the costs expensed in the period incurred and include: Abnormal waste of materials, labor, or overhead Storage costs (unless required as part of production) Administrative overhead Selling costs 81-157 100% Contribution Breeds Professionalism 100% Cost Flow Method - Specific Identification Each unit of inventories is specifically identified and valued. The cost of goods sold is determined by the specific cost of each item to be sold. Appropriate for items which are not interchangeable, like jewelry or outside projects 82-157 100% Contribution Breeds Professionalism 100% Cost Flow Method - FIFO, LIFO, Weighted Average Cost FIFO: First-in, First-out The items first purchased are first to be sold and these costs are regarded as COGS Ending inventory is the cost of the most recent items purchased. LIFO: Last-in, First-out, only under GAAP The items last purchased are the first to be sold and these costs are regarded as COGS. Ending inventory is the cost of the earliest items purchased. Weighted average cost Cost per unit is calculated by dividing the cost of goods available by total units available. This average cost is used to determine both cost of goods sold and ending inventory. 83-157 100% Contribution Breeds Professionalism 100% Samples of FIFO, LIFO, Weighted Average Cost Use the inventory data to calculate COGS and ending inventory balance under difference costing methods. Inventory data Quantities Price Jan. 1 Beginning inventory 100 units $12 Jan. 6 Purchase 100 units $14 Jan.12 Sold 110 units Jan. 15 Purchase 110units $15 Jan. 24 Sold 90 units Jan.31 Ending inventory 110 units COGS and inventory END Sold:110 + 90=200 units; Ending inventory: 110 units FIFO: COGS = $12*100 +$14*100 = $2600; Inventory END = $15*110 = $1650 LIFO: COGS = $15*110+$14*90= $2910; Inventory END = $12*100+$14*10= $1340 Weighted average cost: unit cost = ($12*100+$14*100+$15*110)/(100+100+110) = $13.71 COGS =$13.71*200=$2742; Inventory END =110*$13.71= $1508 84-157 100% Contribution Breeds Professionalism 100% Periodic vs. Perpetual Inventory System (new content) Periodic inventory system Inventory value and COGS are determined at the end the accounting period. Periodic inventory system records inventory purchase or sale in "Purchases" account. The previous sample is calculated under periodic inventory system monthly. Perpetual inventory system Perpetual inventory system updates inventory accounts after each purchase or sale. COGS is accumulated as costs are transferred from Inventory to COGS as sales are made. For LIFO and weighted-average cost methods, COGS and inventory value might differ under periodic and perpetual system. 85-157 100% Contribution Breeds Professionalism 100% Samples of Perpetual Inventory System Use previous example data and calculate COGS and ending inventory balance in perpetual inventory system. Inventory data Quantities Price Jan. 1 Beginning inventory 100 units $12 Jan. 6 Purchase 100 units $14 Jan.12 Sold 110 units Jan. 15 Purchase 110units $15 Jan. 24 Sold 90 units Jan.31 Ending inventory 110 units FIFO under perpetual inventory system Inventory data Quantities Price COGS Ending Jan. 1 Inventory BGN 100 units $12 $1200 Jan. 6 Purchase 100 units $14 $12*100+$14*100=$2600 Jan.12 Sold 110 units $12*100+$14*10=$1340 $2600-$1340=$1260 Jan. 15 Purchase 110 units $15 $1260+$15*110=$2910 Jan. 24 Sold 90 units $14*90=$1260 $2910-$1260=$1650 Jan.31 Inventory END 110 units $1650 COGS = $1340+$1260=$2600; Inventory END = $1650 86-157 100% Contribution Breeds Professionalism 100% Samples of Perpetual Inventory System (cont’) LIFO under perpetual inventory system Inventory data Quantities Price COGS Ending Jan. 1 Inventory BGN 100 units $12 $1200 Jan. 6 Purchase 100 units $14 $12*100+$14*100=$2600 Jan.12 Sold 110 units $14*100+$12*10=$1520 $2600-$1520=$1080 Jan. 15 Purchase 110 units $15 $1080+$15*110=$2730 Jan. 24 Sold 90 units $15*90=$1350 $2730-$1350=$1380 Jan.31 Inventory END 110 units $1380 COGS = $1520+$1350=$2870; Inventory END = $1380 87-157 100% Contribution Breeds Professionalism 100% Samples of Perpetual Inventory System (cont’) Weighted average cost under perpetual inventory system Inventory data Quantities Price COGS Ending unit cost Jan.1 Inventory BGN 100 units $12 $12 Jan.6 Purchase 100 units $14 ($12*100+$14*100)/200=$13 Jan.12 Sold 110 units $13*110=$1430 $13 Jan.15 Purchase 110 units $15 ($13*90+$15*110)/200=$14.1 Jan.24 Sold 90 units $14.1*90=$1269 $14.1 Jan.31 Inventory END 110 units COGS = $1520+$1350=$ 2699; Inventory END = $14.1*110=$1551 Summary Inventory System COGS Inventory END FIFO LIFO WAC FIFO LIFO WAC Periodic system 2600 2910 2742 1650 1340 1508 Perpetual system 2600 2870 2699 1650 1380 1551 For LIFO and weighted-average cost methods, COGS and inventory value might differ under periodic and perpetual system. 88-157 100% Contribution Breeds Professionalism 100% Impact on Financial Statement and Ratios Impact of LIFO and FIFO on Financial statement and ratios, assuming rising prices and stable or increase in quantities of inventories I/S B/S CF Ratios LIFO Higher COGS Lower EBIT Lower taxes Lower net income Lower inventory balances Lower working capital Higher CFO(↓ taxes paid ) Lower net and gross margins Lower current ratio Higher D/A and D/E Higher inventory turnover FIFO Lower COGS Higher EBIT Higher taxes Higher net income Higher inventory balances Higher working capital Lower CFO(↑ taxes paid ) Higher net and gross margins Higher current ratio Lower D/A and D/E Lower inventory turnover Impact of weighted average cost is between LIFO and FIFO 89-157 100% Contribution Breeds Professionalism 100% Measurement of Inventory at Lower Cost and NRV IFRS: Inventories shall be measured at the lower of cost and net realizable value (NRV) NRV = sales price - selling cost Inventory can be written up but only limited to the loss recognized previously GAAP: Inventories shall be measured at the lower of cost and market Market is usually equal to replacement cost but if replacement cost > NRV, market =NRV or if replacement cost < NRV – normal profit margin, market = NRV – normal profit margin No write-up allowed under U.S.GAAP 90-157 100% Contribution Breeds Professionalism 100% Samples of Inventory Write-down Original cost $210 Estimated selling price $225 Estimated selling cost $22 Net realizable value $203 Replacement cost $197 Normal profit margin $12 Carrying value under IFRS and GAAP? IFRS Min [cost, Net realizable value]=Min [cost, selling price - selling cost]=Min [210, 225-22]=203 Carrying value=$203; loss=$7 GAAP Replacement cost(197) v.s. [NRV, NRV-profit margin]=[203,191] 197属于区间内,可用 Min [cost, replacement cost]=[210, 197]=197 Carrying value=$197; loss=$13 If replacement cost=$204 or $190? 91-157 100% Contribution Breeds Professionalism 100% Reading 37 Long-lived Assets 92-157 100% Contribution Breeds Professionalism 100% R37 Key Points Summary Impact of capitalization and expensing Capitalized interest Interest expense decreases, net income increases in the construction period Depreciation is greater and net income is less in subsequent asset using period Deprecation of fixed assets SL vs. DDB; unit of production; component deprecation Estimate of useful life, average age and remaining useful life Acquisition and amortization of intangible Assets Goodwill: purchase price - fair value of the identifiable assets; not amortized R&D and software development cost under GAAP and IFRS Impairment Impairment IFRS: Recoverable amount = max[ fair value – selling cost, value in use (present value)] GAAP: 2 steps; undiscounted CF used in test and discounted Revalution Revalution 93-157 100% Contribution Breeds Professionalism 100% Capitalizing vs. Expensing An expenditure that is expect to provide a future economic benefit over multiple accounting periods is capitalized; if the economic benefit is unlikely or uncertain, the expenditure is expensed in the period incurred. Capitalizing At the year Asset Cash↓ Assets↑ Expensing At the year Liability Equity Asset Cash ↓ During subsequent years Asset Assets↓ 94-157 Liability Equity R/E↓ (D or A) 100% Contribution Breeds Professionalism 100% Liability Equity R/E↓ (Expense) Impact of Capitalizing vs. Expensing on Financial Statement Capitalizing Expensing Total assets Higher Lower Shareholders’ equity Higher Lower Income volatility Lower Higher Net income (ROA, ROE) at first year Higher Lower Net income (ROA, ROE) at subsequent years Lower Higher Total cash flow Same Same Cash flow from operating Higher Lower Cash flow from investing Lower Higher Debt ratio, debt-to-equity Lower Higher Interest coverage at first year Higher Lower Interest coverage at subsequent years Lower Higher 95-157 100% Contribution Breeds Professionalism 100% Capitalized Interest When a firm constructs an asset for its own use or resale, the interest that accrues during the construction period must be capitalized as a part of the asset’s cost If interest is capitalized Interest expense decreases, net income increases in the construction period Depreciation is greater and net income is less in subsequent asset using period Items Impacts Construction period Using period 96-157 Interest expense No interest expense Income statement impacts Net Income Interest coverage ratio No Higher Higher Depreciation expense Lower 100% Contribution Breeds Professionalism 100% CFO Understate Lower CFI Overstate Deprecation Methods – SL and DDB Straight-line Depreciation Method DDB (a kind of accelerated depreciation method) Recognize an equal amount of depreciation expense each period Recognize more depreciation expense in the early years of the asset’s useful life and less depreciation expense in the later years of its life . SL depreciation in every year = DDB depreciation in year X = original cost - salvage cost depreciabl e life 97-157 2 depreciabl e life in years × book value at the beginning of year X 100% Contribution Breeds Professionalism 100% Samples of SL and DDB Depreciation Original cost = $12,000; depreciable life = 5 years; salvage value = $2,000 Depreciation expense and ending carrying value by SL method Depreciation expense in every = ($12k-$2k)/5=$2k Carrying book value in 5 years are $10k, $8k, $6k, $4k, $2k Depreciation expense and ending carrying value by DDB method 2/Depreciable life in years = 2/5 = 0.4 双倍折旧率是常数 Year Book Value BGN 1 12,000 I/S Depreciation Expense 12,000*0.4=4,800 Book Value END 12,000-4,800=7,200 2 7,200 7,200*0.4=2,880 7,200-2,880=4,320 3 4,320 4,320*0.4=1,728 4,320-1,728=2,592 4 2,592 5 2,000 98-157 1)2592*0.4=1,036.8 2)2592-2000=592 (correct) 1)2592-1036.8 =1555.2<2000 (not applicable) 2)2,592-592=2,000 (correct) 0 100% Contribution Breeds Professionalism 100% 2,000 Impact of Different Depreciation Methods Depreciation impact on financials in early years Straight line Accelerated (DDB) Depreciation expense Lower Higher Net income Higher Lower Assets Higher Lower Equity Higher Lower ROA Higher Lower ROE Higher Lower Total asset turnover ratios (rev/asset) Lower Higher Same Same Cash flow – Tax (假设税法规定的折旧方法一致) 99-157 100% Contribution Breeds Professionalism 100% SL Depreciation Analysis Estimated total useful life = Average age + Remaining useful life Estimated total useful life = Average age = h istorical cost - SV annual depreciation expense accumulate d depreciati on depreciati on expense Remaining useful life = Net PP & E - SV depreciati on expense accumulate d depreciati on Relative age = net PP & E - SV 100-157 100% Contribution Breeds Professionalism 100% Deprecation Methods – UOP and Component Depreciation Units-of-production method is based on usage rather than time UOP depreciation expense = original cost - salavge cost × output units in the period life in output units IFRS requires firms to depreciate the components of an asset separately, thereby requiring useful life estimates for each component 101-157 100% Contribution Breeds Professionalism 100% Samples of Component Depreciation Global Airlines purchased a new airplane with cost of $50mn. The estimated life is 30years and salvage value is $5mn. Global Airlines expects to replace interior of the airplane after 15 years, and the component cost is $3mn. Calculate depreciation expense in Year 1 using SL method under component depreciation. Component depreciation expense Total aircraft cost = interior cost + aircraft component → Aircraft component = 50-3=$47mn Aircraft depreciation expense = (47-5)/30=$1.4mn Interior depreciation expense = 3/15=$0.2mn Total depreciation expense in Year 1 = 1.4+0.2=$1.6mn 102-157 100% Contribution Breeds Professionalism 100% Intangible Assets Intangible assets created internally R&D cost Under U.S.GAAP, R&D must be expensed in the period incurred IFRS requires expensing research costs, but capitalizing development costs that meeting certain criteria Software development costs Under U.S. GAAP, cost of software developing for sale is expensed as incurred until the product’s technological feasibility has been established, after which cost is capitalized; cost of software developing for its own use is capitalized Under IFRS, cost is capitalized Intangible assets purchased Recorded on the B/S at cost Intangible assets obtained in a business combination Goodwill = purchase price - fair value of the identifiable assets, is capitalized as unidentifiable intangible asset 103-157 100% Contribution Breeds Professionalism 100% Samples of Goodwill A paid $600mn for all outstanding stocks of B At the acquisition date, assets and liabilities of B (mn): Current assets PP&E Goodwill Liabilities Equity Book value $80 $760 $30 $400 $470 Fair value same $880 same same same Acquisition → Goodwill Purchase price: $600mn Fair value of identifiable net assets: $80+$880-$400=$560 Goodwill: $600 - $560 = $40 104-157 100% Contribution Breeds Professionalism 100% Amortization of Intangible Assets Only intangible assets with finite lives are amortized, SL or other method are permitted Patents, trademarks, copyright purchased externally, franchise agreement Trademarks, copy right or franchise that can be renewed at minimal cost is considered to have an indefinite life Capitalized on the B/S and amortized over useful life Intangible assets with indefinite lives are not amortized, but are tested for impairment Goodwill is unidentifiable intangible asset Capitalized on the B/S but not amortized 105-157 100% Contribution Breeds Professionalism 100% Impairment of PP&E and Intangible Assets IFRS and GAAP require firms to write down impaired assets by recognized a loss in I/S Under IFRS, impairment loss = carrying value - recoverable amount Recoverable amount = max[ fair value – selling cost, value in use (present value)] Impairment loss can be reversed Under GAAP, 2 steps, recoverability test and loss measurement are required an asset is consider impaired if its carrying value > future undiscounted cash flow If impaired, the asset is write down to its fair value or discounted cash flow Impairment loss recoveries are not permitted Impairment impact on financial statements Asset PP&E or intangible asset ↓ 106-157 Liability Equity R/E↓ (Impairment loss) On I/S: continuing operations, before the tax 100% Contribution Breeds Professionalism 100% Impairment of Long-lived Assets Held for Sales If a firm classifies a long-live asset as held for sale, the asset is no longer depreciated or amortized, but is tested for impairment and write down to net realizable value (fair value – selling cost) Impairment loss of assets held for sale can be reversed under both IFRS and GAAP, but the reversal is limited to original impairment loss 107-157 100% Contribution Breeds Professionalism 100% Impact of Impairment Impact of impairment on financial statement Impairment Effects Cash flow No effect Assets Decrease Deferred taxes liability Decrease Stockholder’s equity Decrease Current net income, ROA,ROE Decrease Future net income, ROA,ROE Increase Depreciation expense Decrease Future asset turnover ratios Increase Debt/equity ratio Increase 108-157 100% Contribution Breeds Professionalism 100% Revaluation of Assets Under U.S.GAAP, upward revaluation of assets is generally prohibited (except for long lived assets held for sale), but permitted under IFRS Under GAAP, most long-lived assets are reported at deprecated cost Under IFRS, revaluation model permits long-lived assets to be reported at fair value Loss or gains below historical cost is record in I/S, changes above historical cost is reported in B/S equity account called revaluation surplus 不超过历史成本的减值或恢复记录在I/S中,高 于历史成本的升值或减值记录在权益中 Upward revaluation of assets will increase assets and equity, decrease leverage ratios (D/E) increase comprehensive income in the period the revaluation occurs in subsequent periods, Higher depreciation expense and lower profitability Lower ROA and ROE 109-157 100% Contribution Breeds Professionalism 100% Reading 38 Income Taxes 110-157 100% Contribution Breeds Professionalism 100% R38 Key Points Summary Taxable income != Pretax income Temporary difference Tax payable != income tax expense Permanent difference Tax Base != carrying value DTL/DTA = difference * Tax% Tax% change Income tax expense=taxes payable + △DTL - △ DTA Valuation allowance Effective tax rate 111-157 100% Contribution Breeds Professionalism 100% Income Taxes Terminology Tax Return Terminology Taxable income: 应税所得 Taxes payable: 应交税金 on B/S Income tax paid: 实际缴纳税金 on Cash Flow Statement Tax loss carryforward: 税前亏损结转,产生DTA Tax base: (资产或负债的)税基 Financial Reporting Terminology Accounting profit: (会计)税前利润 on I/S Income tax expense: 所得税费用 on I/S Permanent difference: 永久性差异 Temporary difference: 暂时性差异 Carrying value: (资产或负债)账面价值 Deferred tax liabilities (DTL): 递延所得税负债 Deferred tax assets (DTA) : 递延所得税资产 Valuation allowance: (DTA)备抵 112-157 100% Contribution Breeds Professionalism 100% Permanent Difference vs. Temporary Difference Permanent difference is difference between taxable income and pretax income that will not reverse, e.g., municipal bond interest, penalty Permanent difference will cause the firm’s effective tax rate to differ from statutory tax rate Effective tax rate = income tax expense / pretax income != statutory tax% Temporary difference is difference between carrying value and tax base that will result in taxable amounts or deductible amounts in the future 由税法和会计对所得税的不同处理引起 If temporary difference is expected to reverse, a DTA or DTL is created Depreciable expense R&D cost Account receivable doubtful debt Customer advance Warranty liability 113-157 100% Contribution Breeds Professionalism 100% DTL and DTA from I/S Approach DTL: income tax expense > tax payable 会计早确认收入(税法晚确认);或会计晚确认费用(税法早确认) Accounting profit > taxable income 本期确所得税但不缴,未来再缴,是负债DTL △DTL = (Accounting profit - Taxable income) * Tax rate Cases: different depreciation method, R&D cost DTA: income tax expense < tax payable 会计晚确认收入(税法早确认);或会计早确认费用(税法晚确认) 存在可抵税亏损 (tax loss carryforwards) Accounting profit < taxable income 本期缴了未来的税,未来少缴,是资产DTA △DTA = (taxable income - Accounting profit) * Tax rate Cases: AR doubtful debt; warranty expense, post-employment benefits, tax loss carryforwards 114-157 100% Contribution Breeds Professionalism 100% Samples of DTL and DTA from I/S Approach An equipment with original cost of $800k, no salvage value; life time = 4 years; income tax rate = 10%; DTL BGN= 0 Y1 Y2 Y3 Y4 Sale-COGS 1000 1000 1000 1000 Accounting Depreciation (SL) 200 200 200 200 Accounting profit 800 800 800 800 Income tax expense = Accounting profit * Tax% 80 80 80 80 Tax Depreciation (DDB) 400 200 100 100 Taxable income 600 800 900 900 Taxes payable = Taxable income * Tax% 60 80 90 90 △DTL = Income tax expense - Taxes payable 20 0 -10 -10 DTL 20 20 10 0 END 115-157 100% Contribution Breeds Professionalism 100% DTL and DTA from B/S Approach Tax base of asset: 未来可税前抵扣量,从税务角度看资产价值 资产tax base > carrying value 未来多抵税,少缴税,确认资产DTA DTA= (Tax base – Carrying value)*Tax% 资产tax base < carrying value 未来少抵税,多缴税,确认负债DTL DTL = (Carrying value – Tax base)*Tax% Examples Depreciation: 会计折旧慢,税法折旧快,carrying value > tax base → DTL R&D: 会计当期费用化,税法确认资产,carrying value< tax base → DTA A/R: A/R本期计税,未来收款时不收税,即未来税前抵扣的量 出现坏账准备,会计当期确认资产减值,税法不确认,A/R税基是原值 carrying value<tax base → DTA Municipal bond interest: 不纳税,permanent difference 记:从税法操作上确认资产税基 会计资产高,补负债(DTL);资产低,补资产(DTA) 116-157 100% Contribution Breeds Professionalism 100% DTL and DTA from B/S Approach (cont’) Tax base of liability: 负债-未来可税前抵扣量(或不征税的量),税务 角度看负债价值 负债tax base > carrying value → 未来可税前抵扣量 < 0 未来少抵税,多缴税,确认资产DTL DTL= (Tax base – Carrying value)*Tax% 资产tax base < carrying value → 未来可税前抵扣量 > 0 未来多 抵税,少缴税,确认资产DTA资产tax base < carrying value DTA = (Carrying value – Tax base)*Tax% Examples Customer advance: 会计确认负债;税法不确认负债,税基为0,未来收款时不征 税,carrying value > tax base → DTA Warranty liability: 会计确认负债;税法不确认,税基为0,carrying value > tax base → DTA Note payable, interest paid: 会计税法均确认负债,无差异 Officers’ life insurance: 不可抵税,permanent difference 记:从税法操作上确认负债税基;会计负债高,补资产(DTA) 117-157 100% Contribution Breeds Professionalism 100% Samples of DTL and DTA from I/S Approach An equipment with original cost of $800k, no salvage value; life time = 4 years; income tax rate = 10%; DTL BGN= 0 Y1 Y2 Y3 Y4 800 600 400 200 Accounting Depreciation (SL) 200 200 200 200 Carrying value 600 400 200 0 Tax Depreciation (DDB) 400 200 100 100 Tax base 400 200 100 0 20 20 10 0 20 0 -10 -10 Asset DTL 资 产 高 , 补 负 债 DTL BGN END = (Carrying value – Tax base)*Tax% △DTL 118-157 100% Contribution Breeds Professionalism 100% Income Tax Expense Calculation Income tax expense = Taxes payable + △DTL - △ DTA 从B/S approach 算所得税费用 Income tax expense: 会计上确认的本期所得税 taxes payable: 税法上实际要交的所得税 △DTL: 本期少交,未来补交,即本期负债增加额 △DTA: 本期多交,未来少交,即期资产增加额 会计上应交的 = 实际交的 + 少交的 – 多交的 △DTL = Income tax expense - Taxes payable 从I/S approach算递延税负债变化 △DTL: 本期应交,但实际未交的额 △DTA = Taxes payable - Income tax expense 从I/S approach算递延税资产变化 △DTA: 本期多交,未来可少交的额 119-157 100% Contribution Breeds Professionalism 100% Tax Rate Change Income tax expense=taxes payable + △DTL - △ DTA 税率变动 →△DTL/DTA变动 → income tax expense变动 DTL/DTA= Difference between carrying value and tax base*tax% → △DTL/DTA = Difference between carrying value and tax base* △ tax% Old DTL(DTA) = Difference between carrying value and tax base * old tax% →Difference between carrying value and tax base = Old DTL(DTA) /old tax% New DTL(DTA) = Difference between carrying value and tax base * new tax% = Old DTL(DTA) / old Tax% * new Tax % 120-157 100% Contribution Breeds Professionalism 100% Samples of Tax Rate Change A firm owns an equipment with a carrying value of $200k and a tax base of $160k at year end. The tax rate is 40%. The firm also recognized $10k bad debt loss, which has not yet been deducted on tax return. Calculated the DTL and DTA, and effect on income tax expense if tax rate change to 30%. Depreciation Asset (equipment) carrying value $200k > tax base $160k, 资产高,补负债DTL DTL = (carrying value – tax base) * tax%= (200k-160k)*40%=$16k Bad debt Asset (A/R) carrying value 原值-$10k < tax base 原值, 负债高,补资产DTA DTA = (carrying value – tax base) * tax%= 10k*40%=$4k Change of tax rate △DTL = difference between carrying value and tax base* △tax%=40k*(-10%)= $-4k △DTA = difference between carrying value and tax base* △tax%=10k*(-10%)= $-1k Or: New DTL = Old DTL/old Tax% * new Tax% = 16k/40%*30%=$12k △DTL = 12k-16k=$-4k New DTA = Old DTA/old Tax% * new Tax% = 4/40%*30%=$3k △DTA = 3k-4k=$-1k Income tax expense = Taxes payable + △DTL - △ DTA → 所得税费用减少$3k 121-157 100% Contribution Breeds Professionalism 100% DTL in Equity and Valuation Allowance Deferred Tax liabilities Deferred tax liabilities that are never expected to reverse, should be treated as equity Deferred tax liabilities that are expected to reverse, should be treated as liabilities Valuation allowance of DTA A contra account (offset) against deferred tax assets Based on the likelihood that there assets will not be realized Impact: reduce income from continuing operating 122-157 100% Contribution Breeds Professionalism 100% Effective Tax Rate Reported effective tax rate = income tax expense (F/S)/ pretax income (F/S) Effective tax rate = tax payable (tax return)/ pretax income (F/S) or = tax paid (tax return)/ pretax income (F/S) The low effective tax rate indicates possible earning manipulation 123-157 100% Contribution Breeds Professionalism 100% Difference Between IFRS and GAAP Key provisions of and differences between income tax accounting under IFRS and U.S.GAAP Similar in most respects Exception: revaluation of fixed assets and intangible assets: GAAP prohibits upward revaluations, but they are permitted under IFRS and result in deferred tax assets that are recognized in equity 124-157 100% Contribution Breeds Professionalism 100% Reading 39 Non-current Liabilities 125-157 100% Contribution Breeds Professionalism 100% R39 Key Points Summary Premium vs. discount Coupon rate>(<) market rate (effective rate) → issue at a premium(discount) Basic accounting treatment Inception: assets and liabilities increased by proceeds received; CFF Payment: Interest expense (I/S) = Liabilities BGN * effective rate Assets (B/S) decreased by coupon interest paid; CFO Liabilities (B/S) decreased by difference of coupon interest and interest expense Overvalued/undervalued of CFO, CFF Issuance costs under GAAP and IFRS (undepreciated issuance asset when redeem under GAAP) Covenant Motivations of leasing Classification criteria for lessee and lesser 4 basic criteria:租期结束资产转移, 最低购买权, 租长(75%), 租金高(90%) 2 additional criteria for lessor: 自己不倒闭,别人能给钱 126-157 100% Contribution Breeds Professionalism 100% R39 Key Points Summary (cont’) Accounting treatment of financing lease for lessee A =L +E +Rev -Exp Inception: +PV(MLP) +PV(MLP) Payment: -Payment -Principals -Deprecation -Interest -Dep. Exp PV(MLP) = PV of minimum lease payment Interest = Liability BGN * lease rate; CFO Principals = Payment – Interest; CFF Accounting treatment of financing lease for lessor A =L +E +Rev Inception: -Asset + L/R if sales-type: Payment: +Payment-Principals -Exp +profit +PV(MLP) +Interest Interest = L/R BGN * lease rate; CFO Principals = Payment – Interest; CFI Pension assets, liabilities and pension fund status 127-157 100% Contribution Breeds Professionalism 100% -Asset Bond Terminology Face value, maturity value, par value 面值 Coupon rate 票面利率(固定,用于计算每期支付的利息) Coupon payment 每期利息 =面值*票面利率 Effective rate of interest, market rate 使债券未来现金流现值等于 债权发行价格的折现率,即发行时的市场利率,与票面利率是两 个概念 Balance sheet liabilities of bond, book value, carrying value 债券 账面价值,在资产负债表上表现为债券未来现金流按实际利率 (发行时市场利率)折现的现值 Interest expense 利息费用(财务费用),等于债券期初账面价值 ( Balance sheet liabilities )*实际利率,与每期利息是两个概念 128-157 100% Contribution Breeds Professionalism 100% Difference between Bond Face Value and BV coupon rate != market rate A bond with Par value $1k; coupon rate 10%, market rate at issuance 8%, 3 years maturity, issued in Jan 1st Y1 Bond coupon = 1k*10%=$100 Bond cash flow: $100 in end of Y1, $100 in end of Y2, $1100 in end of Y3 BV (market value) at issue = 100/(1+8%) + 100/(1+8%)2 + 1100/(1+8%)3=$1051.54 > face value $1000 票面利率高于市场利率,所以溢价发行 (issued at a premium) A bond with Par value $1k; coupon rate 10%, market rate at issuance 12%, 3 years maturity, issued in Jan 1st Y1 Bond coupon = 1k*10%=$100 Bond cash flow: $100 in end of Y1, $100 in end of Y2, $1100 in end of Y3 BV (market value) at issue = 100/(1+12%) + 100/(1+12%)2 + 1100/(1+12%)3=$951.96 < face value $1000 票面利率高于市场利率,所以折价发行 (issued at a discount) coupon rate = market rate 按面值发行 (issued at par) 129-157 100% Contribution Breeds Professionalism 100% Accounting Treatment of Bond Interest expense on I/S: BV BGN * effective rate Cash on B/S: record proceeds, coupon and principal payments R/E on B/S: effected by interest expense from I/S Bond BV END = BV BGN – (coupon-interest expense) 配平B/S,摊销溢价 Year BV BGN Interest expense Coupon =BV BGN*effective rate BV END =BV BGN + interest expense -coupon Y1 1051.54 84.12 100 1035.66向面值靠近 Y2 1035.66 82.85 100 1018.51 Y3 1018.51 81.48 B/S Bond 100 1000 债券到期,回到面值 I/S Cash Y0: +1051.54 Y1: -100 Y2: - 100 Y3: -100-1000 R/E 现金支付票面利率和本金 130-157 Y0: + 1000+ 51.54 Y1: - 15.78 Y2: - 17.51 Y3: - 18.61- 1000 Y1: -84.12 Y2: -82.85 Y3: -81.48 100% Contribution Breeds Professionalism 100% Interest expense Y1: 84.12 Y2: 82.85 Y3: 81.48 Change of Bond BV Year BV BGN Interest expense Coupon =BV BGN*effective rate BV END =BV BGN + interest expense -coupon Y1 1051.54 84.12 100 1035.66 Y2 1035.66 82.85 100 1018.51 Y3 1018.51 81.48 100 1000 BV 溢价发行后,随着BV靠近Par,越来越小,利息费用减少,溢价摊销越来越快 Premium Par Discount 折价发行后,随着BV靠近Par,越来越大,利息费用增加,溢价摊销越来越快 To maturity 131-157 100% Contribution Breeds Professionalism 100% Issuance Costs of Bond and Fair Value Reporting Option Issuance costs Under GAAP: capitalized as an asset and amortized over the term of the bond Under IFRS: reduce the initial bond liability which will increase the effective interest rate Fair value reporting If yield (current market interest rate) changes, fair value of issued bond changes IFRS and GAAP give firms irrevocable option to report debt at fair value replacing book value The gain (yield increases and fair value of bond decreases) or loss (yield decreases and fair value of bond increases) result from bond market value are reported in I/S 132-157 100% Contribution Breeds Professionalism 100% Cash Flow Impact of Issuing a Bond Under GAAP Impact on Cash Flow Statement CFF CFO Issuance of debt Increased by cash received (PV of the bond) No effect Periodic interest payments No effect Decreased by interest paid (coupon*par value) Payment at maturity Decreased by face value No effect Economic view of interest payment CFF CFO Premium bonds Overstated Understated Discount bonds Understated Overstated 133-157 100% Contribution Breeds Professionalism 100% I/S Impact of Issuing a Bond Impact on I/S Par bonds Premium bonds Discount bonds Market rate=coupon rate Market rate<coupon rate Cash paid=coupon rate*face value Interest expense=cash paid-amortization of premium Market rate>coupon rate Interest expense=cash paid+ amortization of discount Interest expense is constant Interest increases over time 134-157 Interest decreases over time 100% Contribution Breeds Professionalism 100% B/S Impact of Issuing a Bond Impact on B/S Par bonds Carried at face value Premium bonds Discount bonds Carried at face value less discount (PV) The liability decreases as the premium is amortized to interest expense 135-157 Carried at face value plus premium (PV) The liability increases as the discount is amortized to interest expense 100% Contribution Breeds Professionalism 100% Derecognition and Covenants Redeem 赎回价格和账面价值的差立刻确认为G/L Under GAAP: 因发行费用确认的资产的账面价值减记至0 Debt covenants Affirmative covenants: the borrower promises to do certain things Negative covenants: the borrower promises to refrain from certain activities Technical default: violates a covenant 136-157 100% Contribution Breeds Professionalism 100% Disclosures relating to financing liabilities Disclose in footnotes: The nature of liabilities Maturity dates Stated and effective interest rates Call provisions and conversion privileges Restrictions imposed by creditors Assets pledged as security The amount of debt maturing in each of the next five year 137-157 100% Contribution Breeds Professionalism 100% Leasing Motivations Motivations for leasing rather than purchasing assets Less costly financing Reduced risk of obsolescence Less restrictive provisions Off-balance-sheet financing Tax reporting advantage 138-157 100% Contribution Breeds Professionalism 100% Leasing Classification and Criteria from View of Lessee A lease is a contractual arrangement where by the lessor , the owner of the asset , allows the lessee to use the asset for a specified period of time (lease term) in return for periodic lease payment Two types of leases and respective criteria Finance lease: from the perspective of lessee, if one or more of below criteria is met: The title to the leased asset is transferred to the lessee at the end of the lease period. 租期结束资产转移 A bargain purchase option exists.最低购买权 The lease period is at least 75% of the asset’s economic life. 租期长 The present value of the lease payments is equal to or greater than 90% of the fair value of the leased asset. 租金高 Operating lease: if none of above criteria is met, the lease is classified as an operating lease Operating leases are referred to as off-balance-sheet financing activities 139-157 100% Contribution Breeds Professionalism 100% Account Treatment of Finance Lease for Lessee Lessee verifies whether the finance lease criteria is met At the inception of the lease Recognize an asset and a liability at min[PV of minimum lease payment, fair value of the leased asset] 按租金现值和资产公允价值低者,同时 确认资产和负债 折现率(租赁利率)为租赁合同约定利率和承租人借款利率低者 Over the term of lease Depreciates the lease asset 租赁资产折旧,资产减少,经营费用增加 Pay lease payment, which repays liability and incurs interest expense 支 付租金(资产减少),租金分为偿还负债本金和支付利息费用两部 分(负债减少,财务费用增加) GAAP: 偿还负债本金为融资活动,支付利息是经营活动,不同CF 利息费用 =负债BVBGN*租赁利率 偿还本金 = 本期租金 –利息费用 负债BV END = 负债BVBGN – 本期偿还本金 140-157 100% Contribution Breeds Professionalism 100% Impact of Finance Lease on Lessee’s Financial Statement Finance Lease Operating Lease B/S Inception No effect Leased asset = Lease liability = PV of MLP •MLP = Future lease payment over lease term •Discount rate = Min [lessee’s borrowing costs, implicit interest rate] i.e. of MLP = FV of the leased assets B/S Payment Leased asset: Depreciation over lease term Lease liability (current liability + long-term liability): Decrease by principle repayment E/R: Decrease by depreciation and interest expense E/R: Decrease by lease payment (COGS, etc. ) I/S Payment Interest expense Depreciation Lease payment CF Payment CFF: Principal repayment CFO: Interest expense CFO: Lease payment 141-157 100% Contribution Breeds Professionalism 100% Samples of Lessee Treatment of Finance Lease A firm leases a machine for 4 years with annual payment of $10k. At the end of lease, the machine is returned to the lessor, who will sell it for its scrap value. The implicit interest rate is 6%. The firm applies SL deprecation for the machine. Classification The asset is being leased for longer of 75% of its useful life, so it’s finance lease Initial BV of the asset and lease liability N=4; I/Y=6%; PMT=-10k; FV=0; CPT → PV=34,651 Asset BGN = $34.651, BV BGN of lease liability = $34,651 Annual treatment Yea Interest expense Expense BV END BV BGN Payment Asset END r BV BGN*Int.% Int. exp + Dep. BV BGN - (payment-Int. exp ) 0 34,651 34,651 1 34,651 2,079 10k 26,730 25,988 10,742 2 26,730 1,604 10k 18,334 17,326 10,267 3 18,334 1,100 10k 9,434 8,663 9,763 4 9,434 566 10k 0 0 9,229 利息费用逐年减少 142-157 100% Contribution Breeds Professionalism 100% 总费用先高后低 Impact of Finance Lease on Lessee’s Financial Ratios Financial Statement Assets Liabilities Net income (in early years) CFO CFF Total cash flow EBIT Current Ratio Working Capital Assets Turnover Return on Assets (in early years) Return on Equity (in early years) Debt on Equity 143-157 Capital lease Higher Higher Lower Higher Lower Same Higher Dep.<Payment Lower current liability Lower current liability Lower Lower Lower Higher 100% Contribution Breeds Professionalism 100% Operating lease Lower Lower Higher Lower Higher Same Lower Higher Higher Higher Higher Higher Lower Required disclosures General description of the leasing arrangement The lessee must disclose the lease payments that are due in each of the next 5 years and lease payments due after 5 years can be aggregated Amount of lease revenue and expense reported in the I/S for each period presented Amounts receivable and unearned revenues from lease arrangements Restrictions imposed by lease agreements 144-157 100% Contribution Breeds Professionalism 100% Leasing Classification Criteria from View of Lessor Finance lease criteria for lessor One of basic criteria same as lessee The title to the leased asset is transferred to the lessee at the end of the lease period. A bargain purchase option exists.最低购买权 The lease period is at least 75% of the asset’s economic life. 租期长 The present value of the lease payments is equal to or greater than 90% of the fair value of the leased asset. 租金高 2 additional criteria for lessor The collectability of lease payment is predictable. Substantially completed performance 2 type of finance lease under GAAP Direct financing lease: PV of payment = asset BV 相当于出租人向承租人贷款用以 购买资产,额度等于资产价格,出租人出租时无销售盈利 Sales-type: PV of payment > asset BV 出租人通常是资产制造商,出租人向承租 人贷款用于购买出租人生产的资产,价格小于贷款额,出租人产生销售盈利 Operating lease criteria for lessor Neither of 4 basic criteria is met Or any of 2 additional criteria isn’t met 145-157 100% Contribution Breeds Professionalism 100% Leasing Classification Criteria Summary Lessee Lessor Finance lease 146-157 • Neither of 4 basic criteria is met Operating lease • Any of 4 basic criteria is met • Any of 2 additional conditions is not satisfied Operating lease Operating lease • Any of 4 basic criteria is met • Both 2 additional conditions are satisfied Capital lease • If manufacturer, sales-type lease • If for financing, direct-finance lease 100% Contribution Breeds Professionalism 100% Impact of Lease on Lessor’s Financial Statement Sales-type Lease Direct financing Lease Operating Lease I/S Inception Sales = PV of MLP COGS = BV of assets Profit = Sales – COGS No sales or COGS is recognized B/S Inception Lease receivable (LR) = PV(MLP) Lease receivable (LR) No effect = PV(MLP) = BV of assets I/S Payment Interest revenue = LR BGN * implicit interest rate Interest revenue = LR BGN * implicit interest rate Revenue or gain B/S Payment LR END =LR BGN - (payment – Interest expense) NLR END =NLR BGN - (payment – Interest expense) No effect CF Inception CFI outflow 贷款 CFO inflow 销售收入 No effect No effect CF Payment CFI inflow 本金收回 CFO inflow 利息收入 CFI inflow 本金收回 CFO inflow 利息收入 CFO inflow 经营收入 147-157 100% Contribution Breeds Professionalism 100% No sales or COGS is recognized Pension Plan A pension is a form of deferred compensation earned over time through employee service Defined contribution plan: a retirement plan in which the firm contributes a sum each period to the employee’s retirement account 当期付给员工,不参与 投资,不形成负债 Defined benefit plan: the firm promises to make periodic payments to employees after retirement 当期出钱并投资,员工退休后按时发退休金,是企业的负债 The PV of future obligation is named defined benefit obligation (DBO) For Defined benefit plan, pension expense includes: Service cost Interest cost Expected return on plan assets Actuarial gains and losses Prior service cost Difference between DBO and pension assets is funded status Pension asset > DBO: overfunded Pension asset < DBO: under funded 148-157 100% Contribution Breeds Professionalism 100% Leverage and Coverage Ratios Leverage ratios Debt-to-assets = total debt / total assets Debt-to-capital = total debt / (total debt + total shareholders’ equity) Debt-to-equity ratio = total debt / equity Financial leverage = average total assets / average total equity Coverage ratios Interest coverage = operating profit / interest expense = EBIT / I Fixed charge coverage = (EBIT + lease payments) / (interest expense + lease payments) 149-157 100% Contribution Breeds Professionalism 100% Reading 40, 41, 43 Financial Reporting Quality & International Standards Convergence 150-157 100% Contribution Breeds Professionalism 100% SS10 Key Points Summary Motivations and actions to manage B/S and I/S Coupon rate>(<) market rate (effective rate) → issue at a premium(discount) Fraud Triangle: Incentive/Pressure, Attitudes/Rationalization, Opportunity Common accounting warning sign and methods of detecting Manipulate cash flows to inflate sustainable CFO International Standards Convergence Investment in 50-50 joint venture under GAAP and IFRS Other differences 151-157 100% Contribution Breeds Professionalism 100% Motivations and Activities Motivations to overstate/understate earnings To meet earning expect; to remain in compliance with lending covenants; to receive higher incentive compensation To obtain trade relief in the form of quotas or protective tariffs; to negotiate favorable terms from creditors; to negotiate favorable labor union contracts Motivations to manage the balance sheet Overstate assets or understate liabilities to appear more solvent (D/E ratio) Understate assets or overstate liabilities to enhance its performance ratios (ROA, ROE, Asset turnover ratio) Activities that result in low quality earnings Selecting acceptable accounting principles that misrepresent the economics of a transaction (using inappropriate depreciation method to enhance NI) Structuring transactions to achieve a desired outcome Using aggressive or unrealistic estimates and assumptions (lengthening the lives or increasing the residual value) Exploiting the intent of an accounting principle Leverage ratios 152-157 100% Contribution Breeds Professionalism 100% Fraud Triangle Three conditions that are usually present when fraud occurs Incentive/Pressure Opportunity 153-157 Attitudes/Rationalization 100% Contribution Breeds Professionalism 100% Financial Reporting Quality Common accounting warning sign and methods of detecting Aggressive revenue recognition Different grow rates of CFO and earnings Abnormal sales grow as compared to the economy, industry, or peers Abnormal inventory grow as compared to sales grow Boosting revenue with nonoperating income and nonrecurring gains Delaying expense recognition Abnormal use of operating leases by lessees Hiding expenses by classifying them as extraordinary or nonrecurring LIFO liquidations Abnormal gross margin and operating margin as compared to industry peers Extending the useful lives of LT assets Aggressive pension assumptions Year-end surprises Equity method investments and off-balance-sheet special purpose entities Other off-balance-sheet financing arrangements including debt guarantees 154-157 100% Contribution Breeds Professionalism 100% Manipulation of Cash flows Management may manipulate cash flows to inflate sustainable CFO Misclassification Classifying CFF as CFO and vice versa Timing of cash flows Stretching accounting payable delay payment to suppliers → CFO↑ Financing accounts payable manage timing of CFO Securitizing accounts receivable sale A/R → CFO↑ Tax benefit from stock options option exercise →tax↓ → CFF↑ Repurchasing stock to offset dilution repurchase to offset dilution → CFF ↓ Employee stock options are part of compensation, the outflow of CFF should be reclassified as CFO for analysis purpose. 155-157 100% Contribution Breeds Professionalism 100% Inter-corporate Investments Accounting treatment for different levels of an investor’s percentage ownership in an investee and related extent of control Extent of Control Percent Ownership No significant influence < 20% Significant influence Control Joint control 156-157 20 - 50% Accounting Treatment Market Equity accounting > 50% Consolidation Shared IFRS: proportionate consolidation or equity accounting GAAP: equity accounting 100% Contribution Breeds Professionalism 100% Differences between GAAP & IFRS Under IFRS, inventory is reported on B/S at lower of cost or net realizable value, and subsequent recovery after a write down is recognized, unlike US GAAP. Under IFRS, value of PP&E can be revalued upward which is not permitted under USGAAP. Under IFRS, identifiable intangible assets can be revalued upward which is not permitted under USGAAP. Under IFRS, revenue recognition based on costs incurred is allowed when the firm can’t reliably estimate the outcome of the project while under USGAAP revenue is only recognized at completion LIFO is prohibited under IFRS. IFRS requires depreciation method reflects pattern of consumption and that the amount is allocated on a systematic basis over an asset’s useful life. IFRS doesn’t allow extraordinary items in IS Under IFRS, interest & dividends received may be classified as either CFO or CFI and dividends paid may be classified as either CFO or CFF. 157-157 100% Contribution Breeds Professionalism 100% ...
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This note was uploaded on 11/02/2011 for the course FINANCE 612 taught by Professor Liyang during the Spring '11 term at Covenant School of Nursing.

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