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financial statement analysis
Financial Statement Analysis 11th Edition K. R. Subramanyam - Solutions
Sales-type leases and direct financing leases are two common types of leases from a lessor’s perspective.Required:Compare and contrast a sales-type lease with a direct-financing lease on the following dimensions:a. Gross investment in the lease.b. Amortization of unearned interest income.c.
Capital leases and operating leases are two major classifications of leases.Required:a. Describe how a lessee accounts for a capital lease both at inception of the lease and during the first year of the lease. Assume the lease transfers ownership of the property to the lessee by the end of the
On January 1, Year 8, Von Company entered into two noncancellable leases of new machines for use in its manufacturing operations. The first lease does not contain a bargain purchase option and the lease term is equal to 80% of the estimated economic life of the machine. The second lease contains a
Refer to the financial statements of Campbell Soup Company in Appendix A.Required:a. Determine the net change in long-term debt during Year 11.b. Analyze and discuss the relative mix of debt financing for Campbell Soup. Do you think Campbell Soup has any solvency or liquidity problems? Do you think
Describe the provisions concerning leases involving real estate.
a. Identify the different classifications of leases by a lessor. Describe the criteria for classifying each lease type.b. Explain the accounting procedures for leases by a lessor
When a lease is considered a capital lease for both the lessor and the lessee, describe what amounts will be found on the balance sheets of both the lessor and the lessee related to the lease obligation and the leased asset.
When a lease is considered an operating lease for both the lessor and the lessee, describe what amounts will be found on the balance sheets of both the lessor and the lessee related to the lease obligation and the leased asset.
Discuss how the lessor reflects the benefits of leasing in the income statement under(a) an operating lease and(b) a capital lease.
What is the OPEB obligation and how is it determined?
Describe the “corridor method” for deferring and amortizing actuarial gains and losses and return on plan assets. What is the rationale for using this method?
Describe alternative measures for the pension obligation. Which measure is legally binding?
What determines a company’s cash flows related to pensions and OPEBs? Why are current cash outflows relating to pensions not a good predictor for future cash flows?
Define and describe pension risk exposure. What combination of factors precipitated the “pensions crisis” in the early 2000s? What are the three things that an analyst should check when evaluating pension risk?
What are the major actuarial assumptions underlying the postretirement benefits? Explain how a manager can manipulate these assumptions to window-dress the financial statements.
What considerations must be kept in mind when adjusting the financial statements (balance sheet and income statement) for postretirement benefits?
What are the primary categories of information disclosed in the postretirement benefit footnote?
What are other postretirement employee benefits (OPEBs)? What are the major differences between pensions and OPEBs?
How does current pension accounting (SFAS 158) articulate the net economic position (funded status) recognized in the balance sheet with the smoothed net periodic pension cost recognized in net income?
What does current pension accounting (SFAS 158) recognize in the balance sheet? How is it different from what was recognized earlier (under SFAS 87)?
The pension cost included in net income is the net periodic pension cost. How does it differ from the economic pension cost? What is the rationale for recognizing the smoothed net periodic pension cost instead of the economic pension cost in income?
What are the primary nonrecurring components of pension cost? Describe how current pension accounting defers and amortizes these nonrecurring components.
From a purely economic point of view define what constitutes the following: (a) pension obligation,(b) pension plan assets, (c) net economic position of the pension plan, and (d) economic pension cost.
Describe differences between defined benefit and defined contribution pension plans. How does the accounting differ across these two types of plans?
Many companies report “minority interests in subsidiary companies” between the long-term debt and equity sections of a consolidated balance sheet; others present them as part of shareholders’ equity.a. Describe minority interest.b. Indicate where on the consolidated balance sheet it best
Explain why the accounting for small stock dividends requires that market value, rather than par value, of the shares distributed be charged against retained earnings.
Explain the importance of disclosing the liquidation value of preferred stock, if different from par or stated value, for analysis purposes.
Identify features of preferred stock that make it similar to debt. Identify the features that make it more like common stock.
Identify objectives of the classifications and note disclosures associated with the equity section of the balance sheet. Explain the relevance of these disclosures to analysis of financial statements.
Distinguish between different kinds of deferred credits on the balance sheet. Discuss how to analyze these accounts.
Explain why analysis must be alert to the accounting for future loss reserves.
Identify and describe several categories of reserves, allowances, and provisions for expenses and losses.
Identify types of equity securities that are similar to debt.
Explain how off-balance-sheet financing items should be treated for financial analysis purposes.
Describe the criteria a company must meet before a transfer of receivables with recourse can be booked as a sale rather than as a loan.
Describe the required financial statement disclosures for financial instruments with off-balance-sheet risk of loss. How might these disclosures be used to assist financial analysis?
Define off-balance-sheet financing and provide three examples.
Explain when a commitment becomes a recorded liability.
Define a commitment and provide three examples of commitments for a company.
a. Explain a loss contingency. Provide examples.b. Explain the two conditions necessary before a company can record a loss contingency against income.
Companies use various financing methods to avoid reporting debt on the balance sheet. Identify and describe some of these off-balance-sheet financing methods.
a. Describe the criteria for classifying leases by a lessee.b. Prepare a summary of accounting for leases by a lessee.
Companies often issue convertible debt or debt with attached warrants.a. What is convertible debt?b. What is debt issued with warrant? How does it differ from convertible debt?c. Why do companies issue convertible debt?d. How do we account for convertible debt?e. What are the analysis implications
Define margin of safety as it applies to debt contracts and describe how the margin of safety can impact assessment of the relative level of company risk.
Debt contracts usually place restrictions on the ability of a company to deploy resources and to pursue business activities. These are often referred to as debt covenants.a. Identify where information about such restrictions is found.b. Describe how covenants serve as an early warning mechanism for
What do we mean by secured debt? What consideration should an analyst keep in mind when analyzing secured debt?
What do we mean by seniority of debt? What consideration should an analyst keep in mind when analyzing debt seniority?
What are the various forms of protections that lenders incorporate into their debt contracts?
Describe the usefulness and the problems with reporting long-term debt at (1) face value, (2) amortized cost, and (3) fair values.
Describe the major disclosure requirements for long-term debt.
How do we account for short-term debt? What is the logic for this approach?
Describe how fair value accounting for long-term debt works. How does it differ from the current accounting using amortized cost?
Explain how bond discounts and premiums usually arise. Describe how they are accounted for in the balance sheet and income statement.
What are the major forms of financing liabilities? Which are long term and which are short term?
Explain the difference between operating and financing liabilities.
Explain major forms of financing and their characteristics.
Answer the following questions using the annual report of Colgate in Colgate Appendix A to this book.a. Who is responsible for the preparation and integrity of Colgate’s financial statements and notes? Where is this responsibility stated in the annual report?b. In which note does Colgate report
The following is an excerpt from a quarterly earnings announcement by American Express:American Express Reports Record Quarterly Net Income of $648 Million QUARTER ENDED SEPTEMBER 30 Percentage($ millions except per share amounts) 20X9 20X8 Inc./(Dec.)Net income $ 648 $ 574 13.0%Net revenues $
Consider the following: While accrual accounting information is imperfect, ignoring it and making cash flows the basis of all analysis and business decisions is like throwing the baby out with the bath water.Required:a. Do you agree or disagree with this statement? Explain.b. How does accrual
A finance textbook likens accrual accounting information to “nail soup.” The recipe for nail soup includes the usual soup ingredients such as broth and noodles, but it also includes nails. This means with each spoonful of nail soup, one gets nails with broth and noodles. Accordingly, to eat the
Emerson Electric is engaged in design, manufacture, and Emerson Electric sale of a broad range of electrical, electromechanical, and electronic products and systems. The following shows Emerson’s net income and net income before extraordinary items for the past 20 years (in millions):Required:a.
The following information is extracted from the annual report of Lands’End (in millions, except per share data):Fiscal year Year 9 Year 8 Year 7 Year 6 Year 5 Year 4 Net income $31.2 $64.2 $ 51.0 $30.6 $36.1 $43.7 Cash from (used by) operations 74.3 (26.9) 121.8 41.4 34.5 22.4 Net cash flow 0.03
The FASB in SFAS No. 123, “Accounting for Stock-Based Options,” encourages (but does not require) companies to recognize compensation expense based on the fair value of stock options awarded to their employees and managers. Early drafts of this proposal required the recognition of the fair
According to an article in The Wall Street Journal, a European filmmaking studio, Polygram, is considering funding movie production by selling securities. These securities will yield returns to investors based on the actual cash flows of the movies that are financed from the sale of these
In a discussion of corporate income, a user of financial statements makes the following allegation:“One of the real problems with income is that you never really know what it is. The only way you can find out is to liquidate a company and reduce everything to cash. Then you can subtract what went
Equity valuations in today’s market are arguably too high. Many analysts assert that price-toearnings ratios are so high as to constitute an irrational valuation “bubble” that is bound to burst and drag valuations down. Skeptics are especially wary of the valuations for high-tech and Internet
Consider the following claim from a business observer:An accountant’s job is to conceal, not to reveal. An accountant is not asked to give outsiders an accurate picture of what’s going on in a company. He is asked to transform the figures on a company’s operations in such a way that it will
A standard setter recently made a private remark that conservatism was a “barbaric relic” that violated the “neutrality” requirement of accounting information and that financial statements would be far more informative without conservatism.Required:a. What is conservatism? What are the
Consider the following excerpt from the Financial Analysts Journal:Strictly speaking, the objectives of financial reporting are the objectives of society and not of accountants and auditors, as such. Similarly, society has objective law and medicine—namely, justice and health for the
An FASB member expressed the following view:Are we going to set accounting standards in the private sector or not? . . . Part of the answer depends on how the business community views accounting standards. Are they rules of conduct, designed to restrain unsocial behavior and arbitrate conflicts of
An editor of the Financial Analysts Journal reviewed an earlier edition of this book and made this assertion:Broadly speaking, accounting numbers are of two types: those that can be measured and those that have to be estimated. Investors who feel that accounting values are more real than market
Financial reporting has been likened to cartography:Required:a. Explain why neutrality is such an important quality of financial statements.b. Identify examples of the lack of neutrality in accounting reports more completely it represents the complex phenomena that are being mapped. We do not judge
Financial statement users often liken accounting standard setting to a political process. One user made the following assertion: “My view is that the setting of accounting standards is as much a product of political action as of flawless logic or empirical findings. Why? Because the setting of
In the past decade, several large “money center” banks recorded huge additions to their loan loss reserve. For example, Citicorp recorded a one-time addition to its loan loss reserve totaling about $3 billion. These additions to loan loss reserves led to large net losses for these banks. While
A former chairman of the SEC refers to hidden reserves on the balance sheet as “cookie-jar”reserves. These reserves are built up in periods when earnings are strong and drawn down to bolster earnings in periods when earnings are weak.Required:Reserves for (1) bad debts and (2) inventory, along
Accrual accounting requires estimates of future outcomes. For example, the reserve for bad debts is a forecast of the amount of current receivables that will ultimately prove uncollectible.Required:Identify and explain three reasons why accounting information might deviate from the underlying
Analysts produce forecasts of accounting earnings along with other forward-looking information.This information has strengths and weaknesses versus financial statement information.Required:a. Discuss whether you believe analysts’ forecasts are more relevant for business decision making than
a. Identify at least two reasons why an accrual accounting income statement is more useful for analyzing business performance than a cash flow based income statement.b. Describe what would be reported on the asset side of a cash flow based balance sheet versus the asset side of an accrual
Financial statements are inexorably moving to a model where all assets and liabilities will be measured on the basis of fair value rather than historical cost.Required:a. Discuss the conceptual differences between historical cost and fair value.b. Discuss the merits and demerits of the two
Financial statements are a major source of information about a company. Forecasts, reports, and recommendations from analysts are popular alternative sources of information.Required:a. Discuss the strengths of financial statement information for business decision makers.b. Discuss the strengths of
There are various motivations for managers to make voluntary disclosures. Identify whether you believe managers are likely to release the following information in the form of voluntary disclosure (examine each case independently):a. A company plans to sell an underperforming division for a
Managers are responsible for ensuring fair and accurate financial reporting. Managers also have inside information that can aid their estimates of future outcomes. Yet managers face incentives to strategically report information in their best interests.Required:Assume a manager of a publicly traded
The SEC requires various statutory reports from companies with publicly traded securities.Required:Identify which SEC report is the best place to find the following information.a. Management’s discussion of the financial results for the fiscal year.b. Terms of the CEO’s compensation and the
The SEC requires companies to submit statutory financial reports on both a quarterly and an annual basis. The quarterly report is called the 10-Q.Required:What are two factors about quarterly financial reports that can be misleading if the analyst does not consider them when performing analysis of
Some financial statement users criticize the timeliness of annual financial statements.Required:a. Explain why summary information in the income statement is not new information when the annual report is issued.b. Describe the types of information in the income statement that are new information to
Announcements of good news or bad news earnings for the recently completed fiscal quarter usually create fairly small abnormal stock price changes on the day of the announcement.Required:a. Discuss how stock price changes over the preceding days or weeks help explain this phenomenon.b. Discuss the
Some financial statement users maintain that despite its intrinsic intellectual appeal, uniformity in accounting seems unworkable in a complex modern society that relies, at least in part, on economic market forces.Required:a. Discuss at least three disadvantages of national or international
What factors and incentives motivate companies (management) to engage in earnings management?What are the implications of these incentives for financial statement analysis?
Identify and explain three types of earnings management that can reduce earnings quality.
Explain how earnings management affects earnings quality. How is earnings management distinguished from fraudulent reporting?
What is the effect of external factors on earnings quality?
How does a balance sheet analysis provide a check on the validity and quality of earnings?
What is the relation between the reported value of assets and reported earnings? What is the relation between the reported values of liabilities, including provisions, and reported earnings?
What are discretionary expenses? What is the importance of discretionary expenses for analysis of earnings quality?
What is meant by earnings quality? Why do users assess earnings quality? What major factors determine earnings quality?
Would you be willing to pay more or less for a stock, on average, when the accounting information provided to you about the firm is unaudited? Explain.
Explain how accounting concepts and standards, and the financial statements based on them, are subject to the pervasive influence of individual judgments and incentives.
Describe the role that accrual accounting information and cash flow information play in your own models of company valuation.
Explain what is meant by the term earnings management and what incentives managers have to engage in earnings management.
What are popular earnings management strategies? Explain.
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