Questions 3.1 – 3.18 3.3 Questions 4.1 – 4.15 Questions 6.1 – 6.15 Questions 7.1 – 7.9 Questions 8.1 – 8.12 Questions 9.1 – 9.15 9.3 Questions 10.10 – 10.24 Case 10.3 Questions 11.1 – 11.10 11.3 11.4 Exercise 3.1 + Problem 3.1, 3.2, Problem 4.5 – 4.8 Problem 6.1, 6.5, 6.6, 6.7 Exercise 7.3 7.4 7.7 Problem 7.3 Exercise 8.1 8.2 8.5 8.6 Exercise 9.4 Problem 9.1 9.2 Exercise 10.1 Problem 10.3 10.4 11.17 11.19 Problem 11.1 11.2 3–1 Identify and describe the two major sources (as linked with business activities) of current liabilities (Xác định mô tả hai nguồn (liên kết với hoạt động kinh doanh) nợ ngắn hạn.) The two major source of liabilities, for both current and noncurrent liabilities, are operating and financing activities Current liabilities of an operating nature—such as accounts payable and operating expense accruals—represent claims on resources from operating activities Current liabilities such as notes payable, bonds, and the current maturities of long-term debt reflect claims on resources from financing activities 3–2 Identify the major disclosure requirements for financing-related current liabilities (Xác định yêu cầu công bố thông tin cho khoản nợ ngắn hạn liên quan tài chính.) The major disclosure requirements (in SEC FRR, Section 203) for financing-related current liabilities such as short-term debt are: a Footnote disclosure of compensating balance arrangements including those not reduced to writing b Balance sheet segregation of (1) legally restricted compensating balances and (2) unrestricted compensating balances relating to long-term borrowing arrangements if the compensating balance can be computed at a fixed amount at the balance sheet date c Disclosure of short-term bank and commercial paper borrowings: i Commercial paper borrowings separately stated in the balance sheet ii Average interest rate and terms separately stated for short-term bank and commercial paper borrowings at the balance sheet date iii Average interest rate, average outstanding borrowings, and maximum month-end outstanding borrowings for short-term bank debt and commercial paper combined for the period d Disclosure of amounts and terms of unused lines of credit for short-term borrowing arrangements (with amounts supporting commercial paper separately stated) and of unused commitments for long-term financing arrangements Note that the above disclosures are required for filings with the SEC but not necessarily for disclosures in published annual reports It should also be noted that SFAS states that certain short-term obligations should not necessarily be classified as current liabilities if the company intends to refinance them on a long-term basis and can demonstrate its ability to so 3–3 Describe the conditions necessary to demonstrate the ability of a company to refinance its short-term debt on a long-term basis (Mô tả điều kiện cần thiết để chứng minh khả công ty để tái tài trợ nợ ngắn hạn sở lâu dài.) The conditions required by SFAS that demonstrate the ability of the company to refinance it short-term debt on a long-term basis are: a The company has actually issued a long-term obligation or equity securities to replace the short-term obligation after the date of the company's balance sheet but before its release b The company has entered into an agreement with a bank or other source of capital that permits the company to refinance the short-term obligation when it becomes due Note that financing agreements that are cancelable for violation of a provision that can be evaluated differently by the parties to the agreement (such as ―a material adverse change‖ or ―failure to maintain satisfactory operations ‖) not meet the second condition Also, an operative violation of the agreement should not have occurred 3–4 Explain how bond discounts and premiums usually arise Describe how they are accounted for (Giải thích cách mà phần bù chiết khấu trái phiếu thường phát sinh Mô tả cách thức mà chúng hạch toán.) Since the interest rate that will prevail in the bond market at the time of issuance of bonds can never be predetermined, bonds usually are sold in excess of par (premium) or below par (discount) This premium or discount represents, in effect, an adjustment of the coupon rate to the effective interest rate The premium received is amortized over the life of the issue, thus reducing the coupon rate of interest to the effective interest rate incurred Conversely, the discount also is amortized, thus increasing the effective interest rate paid by the borrower 3–5 Both convertibility and warrants attached to debt aim at increasing the attractiveness of debt securities and lowering their interest cost Describe how the costs of these two features affect income and equity (Cả hai khả chuyển đổi bảo đảm gắn liền với nợ mục tiêu để tăng tính hấp dẫn chứng khoán nợ giảm chi phí lãi vay chúng Mô tả cách thức chi phí hai tính ảnh hưởng đến thu nhập vốn chủ sở hữu.) The accounting for convertibility and warrants impacts income and equity as follows: a The convertible feature is attractive to investors As a result, the debt will be issued at a slightly lower interest rate and the resulting interest expense is less (and conversely, equity is increased) Also, diluted earnings per share is reduced by the assumed conversion At conversion, a gain or loss on conversion may result when equity instruments are issued b Similarly, warrants attached to bonds allow the bonds to pay a lower interest rate As a result, interest expense is reduced (and conversely, equity is increased) Also, diluted earnings per share is affected because the warrants are assumed converted 3–6 Explain how the issuance of convertible debt and warrants can affect the valuation analysis conducted by current and potential stockholders (Giải thích việc phát hành nợ chuyển đổi bảo đảm ảnh hưởng đến việc phân tích định giá tiến hành cổ đông tiềm năng.) It is important to the analysis of convertible debt and stock warrants to evaluate the potential dilution of current and potential shareholders if the holders of these options choose to convert them to stock This potential dilution would represent a real wealth transfer for existing shareholders Currently, this potential dilution is given little formal recognition in financial statements 3–7 Describe the major disclosure requirements for long-term liabilities (Mô tả yêu cầu công bố nợ dài hạn.) SFAS 47 requires note disclosure of commitments under unconditional purchase obligations that provide financing to suppliers It also requires disclosure of future payments on long-term borrowings and redeemable stock Required disclosures include: For purchase obligations not recognized on purchaser's balance sheet: a Description and term of obligation b Total fixed and determinable obligation If determinable, also show these amounts for each of the next five years c Description of any variable obligation d Amounts purchased under obligation for each period covered by an income statement For purchase obligations recognized on purchaser's balance sheet, payments for each of the next five years For long-term borrowings and redeemable stock: a Maturities and sinking fund requirements for each of the next five years b Redemption requirements for each of the next five years 3–8 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 (Các hợp đồng nợ thường đặt hạn chế khả công ty để triển khai nguồn lực theo đuổi hoạt động kinh doanh Chúng thường gọi giao ước nợ.) a Identify where information about such restrictions is found (Xác định nơi thông tin hạn chế tìm thấy.) b 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 (Xác định biên an toàn áp dụng cho hợp đồng nợ mô tả cách biên độ an toàn ảnh hưởng đến đánh giá mức độ liên quan rủi ro công ty.) a Information about debt covenant restrictions are available in the details of the bond indentures of a company Moreover, key restrictions usually are identified and discussed in the financial statement notes b The margin of safety as it applies to debt contracts refers to the slack that the company has before it would violate any of the debt covenant restrictions and be in technical default For example, if the debt covenant mandates a maximum debt to assets ratio of 50% and the current debt to assets ratio is 40%, the company is said to have a margin of safety of 10% Technical default is costly to a company Thus, as the margin of safety decreases, the relative level of company risk increases 3–9 Explain how analysis of financial statements is used to evaluate a company’s liabilities, both existing and contingent (Giải thích cách phân tích báo cáo tài sử dụng để đánh giá công nợ công ty, có tiềm ẩn.) Analysis of the terms and conditions of recorded liabilities is an area deserving an analyst's careful attention Here, the analyst must examine critically the description of debt, its terms, conditions, and encumbrances with a desire to satisfy him/her as to the ability of the company to meet principal and interest payments Important analyses in the evaluation of liabilities are the examination of features such as:  Contractual terms of the debt agreement, including payment schedule  Restrictions on deployment of resources and freedom of action  Ability to engage in further financing  Requirements relating to maintenance of working capital, debt to equity ratio, etc  Dilutive conversion features to which the debt is subject  Prohibitions on disbursements such as dividends Moreover, we review the audit report since we expect auditors to require satisfactory recording and disclosure of all existing liabilities Auditor tests include the scrutiny of board of director meeting minutes, the reading of contracts and agreements, and inquiry of those who may have knowledge of company obligations and liabilities The analysis of contingencies (and commitments) also is aided by financial statement analysis However, the analysis of contingencies and commitments is more challenging because these liabilities typically not involve the recording of assets and/or costs Here, the analyst must rely on information provided in notes to the financial statements and in management commentary found in the text of the annual report and elsewhere Due to the uncertainties involved, the descriptions of commitments, and especially contingent liabilities, in the notes are often vague and indeterminate This means that the burden of assessing the possible impact of contingencies and the probabilities of their occurrence is passed to the analyst Yet, the analyst assumes that if a contingency (and/or commitment) is sufficiently serious, the auditor can qualify the audit report The analyst, while utilizing all information available, must nevertheless bring his/her own critical evaluation to bear on the assessment of all existing liabilities and contingencies to which the company may be subject This process must draw not only on available disclosures and reports, but also on an understanding of industry conditions and practices 3–10 a Describe the criteria for classifying leases by a lessee (Mô tả tiêu chí để phân loại hợp đồng thuê bên thuê.) b Prepare a summary of accounting for leases by a lessee (Chuẩn bị tóm tắt kế toán cho hợp đồng thuê bên thuê.) 10 a A lease is classified and accounted for as a capital lease if at the inception of the lease it meets one of four criteria: (1) the lease transfers ownership of the property to the lessee by the end of the lease term; (2) the lease contains an option to purchase the property at a bargain price; (3) the lease term is equal to 75 percent or more of the estimated economic life of the property; or (4) the present value of the rentals and other minimum lease payments, at the beginning of the lease term, equals 90 percent of the fair value of the leased property less any related investment tax credit retained by the lessor If the lease does not meet any of those criteria, it is to be classified and accounted for as an operating lease With regard to the last two of the above four criteria, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, neither the 75 percent of economic life criterion nor the 90 percent recovery criterion is to be applied for purposes of classifying the lease and as a consequence, such leases will be classified as operating leases b Summary of accounting for leases by lessees: The lessee records a capital lease as an asset and an obligation at an amount equal to the present value of minimum lease payments during the lease term, excluding executory costs (if determinable) such as insurance, maintenance, and taxes to be paid by the lessor together with any profit thereon However, the amount so determined should not exceed the fair value of the leased property at the inception of the lease If executory costs are not determinable from provisions of the lease, an estimate of the amount shall be made Amortization, in a manner consistent with the lessee's normal depreciation policy, is called for over the term of the lease except where the lease transfers title or contains a bargain purchase option; in the latter cases amortization should follow the estimated economic life In accounting for an operating lease the lessee will charge rentals to expenses as they become payable, except when rentals not become payable on a straight-line basis In the latter case they should be expensed on such a basis or on any other systematic or rational basis that reflects the time pattern of benefits serviced from the leased property 3–11.A a Identify the different classifications of leases by a lessor Describe the criteria for classifying each lease type (Xác định phân loại khác hợp đồng thuê bên cho thuê Mô tả tiêu chí để phân loại loại thuê.) b Explain the accounting procedures for leases by a lessor (Giải thích quy trình kế toán cho hợp đồng thuê bên cho thuê.) 11 a The major classifications of leases by lessors are: Sales-type leases Direct financing leases Operating leases The criteria for classifying each type are as follows: If a lease meets any one of the four criteria for capitalization (see question 10a above) plus two additional criteria (see below), it is to be classified and accounted for as either a sales-type lease (if manufacturer or dealer profit is involved) or a direct financing lease The additional criteria are (1) collectibility of the minimum lease payments is reasonable predictable, and (2) no important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease A lease not meeting these criteria is to be classified and accounted for as an operating lease b The accounting procedures for leases by lessors are: Sales-type leases The minimum lease payments plus the unguaranteed residual value accruing to the benefit of the lessor are recorded as the gross investment in the lease The difference between gross investment and the sum of the present value of its two components is recorded as unearned income The net investment equals gross investment less unearned income Unearned income is amortized to income over the lease term so as to produce a constant periodic rate of return on the net investment in the lease Contingent rentals are credited to income when they become receivable At the termination of the existing lease term of a lease being renewed, the net investment in the lease is adjusted to the fair value of the leased property to the lessor at that date, and the difference, if any, recognized as gain or loss The same procedure applies to direct financing leases (see below.) The present value of the minimum lease payments discounted at the interest rate implicit in the lease is recorded as the sales price The cost, or carrying amount, if different, of the leased property, and any initial direct costs (of negotiating and consummating the lease), less the present value of the unguaranteed residual value is charged against income in the same period The estimated residual value is periodically reviewed If it is determined to be excessive, the accounting for the transaction is revised using the changed estimate The resulting reduction in net investment is recognized as a loss in the period in which the estimate is changed No upward adjustment of the estimated residual value is made (A similar provision applies to direct financing leases.) Direct-financing leases The minimum lease payments (net of executory costs) plus the unguaranteed residual value plus the initial direct costs are recorded as the gross investment The difference between the gross investment and the cost, or carrying amount, if different, of the leased property, is recorded as unearned income Net investment equals gross investment less unearned income The unearned income is amortized to income over the lease term The initial direct costs are amortized in the same portion as the unearned income Contingent rentals are credited to income when they become receivable Operating leases The lessor will include property accounted for as an operating lease in the balance sheet and will depreciate it in accordance with his normal depreciation policy Rent should be taken into income over the lease term as it becomes receivable except that if it departs from a straight-line basis income should be recognized on such basis or on some other systematic or rational basis Initial costs are deferred and allocated over the lease term 3–12.A Describe the provisions concerning leases involving real estate (Mô tả quy định thuê liên quan đến bất động sản.) 12 Where land only is involved the lessee should account for it as a capital lease if either of the enumerated criteria (1) or (2) is met Land is not usually amortized In a case involving both land and building(s), if the capitalization criteria applicable to land (see above) are met, the lease will retain the capital lease classification and the lessor will account for it as a single unit The lessee will have to capitalize the land and buildings separately, the allocation between the two being in proportion to their respective fair values at the inception of the lease If the capitalization criteria applicable to land are not met, and at the inception of the lease the fair value of the land is less than 25 percent of total fair value of the leased property both lessor and lessee shall consider the property as a single unit The estimated economic life of the building is to be attributed to the whole unit In this case if either of the enumerated criteria (3) or (4) is met the lessee should capitalize the land and building as a single unit and amortize it If the conditions above prevail but the fair value of land is 25 percent or more of the total fair value of the leased property, both the lessee and the lessor should consider the land and the building separately for purposes of applying capitalization criteria (3) and (4) If either of the criteria is met by the building element of the lease it should be accounted for as a capital lease by the lessee and amortized The land element of the lease is to be accounted for as an operating lease If the building element meets neither capitalization criteria, both land and buildings should be accounted for as a single operating lease Equipment which is part of a real estate lease should be considered separately and the minimum lease payments applicable to it should be estimated by whatever means are appropriate in the circumstances Leases of certain facilities such as airport, bus terminal, or port facilities from governmental units or authorities are to be classified as operating leases 3–13 Discuss the implications of lease accounting for the analysis of financial statements (Thảo luận tác động kế toán hợp đồng thuê để phân tích báo cáo tài chính.) 13 In the books of the lessee, the primary consideration regarding leases is the appropriate classification of operating leases When leases are classified as operating leases, the lease payment is recorded as rent expense However, lease assets and liabilities are kept off the balance sheet Because of this, many companies avail themselves of operating lease treatment even when the underlying economics justify capitalizing the leases If this is done, the asset and liabilities of a company are underreported and its debt-to-equity ratios are biased downward Often such leases are a form of ―off balance sheet‖ financing Therefore, an analyst must carefully examine the classification of operating leases and capitalize the leases when the underlying economic justify 3–14.A 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 (Khi hợp đồng thuê xem thuê hoạt động cho hai bên cho thuê bên thuê, mô tả số tiền tìm thấy bảng cân đối hai bên cho thuê bên thuê liên quan đến nghĩa vụ thuê tài sản cho thuê.) 14 For the lessor, when a lease is considered an operating lease, the leased asset remains on its books For the lessee, it will not report an asset or an obligation on its balance sheet 3–15.A 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 (Khi hợp đồng thuê coi hợp đồng thuê vốn cho hai bên cho thuê bên thuê, mô tả số tiền tìm thấy bảng cân đối hai bên cho thuê bên thuê liên quan đến nghĩa vụ thuê tài sản cho thuê.) 15 When a lease is considered a capital lease for both the lessor and the lessee, the lessor will report lease payments receivable on its balance sheet The lessee will report the leased asset and a lease obligation totaling the present value of future lease payments 3–16 Discuss how the lessee reflects the cost of leased equipment in the income statement for (a) assets leased under operating leases and (b) assets leased under capital leases (Thảo luận cách bên thuê phản ánh chi phí thiết bị cho thuê báo cáo thu nhập cho (a) Tài sản cho thuê theo hợp đồng thuê hoạt động (b) tài sản cho thuê theo hợp đồng thuê vốn.) 16 a Rent expense b Interest expense and depreciation expense 3–17.A Discuss how the lessor reflects the benefits of leasing in the income statement under (a) an operating lease and (b) a capital lease (Thảo luận cách bên cho thuê phản ánh lợi ích việc cho thuê báo cáo thu nhập theo (a) thuê hoạt động (b) hợp đồng thuê vốn.) 17 a Leasing revenue b Interest revenue (and possibly gain on sale in the initial year of the lease) 3–18 Companies use various financing methods to avoid reporting debt on the balance sheet Identify and describe some of these off-balance-sheet financing methods (Các công ty sử dụng phương pháp tài khác để tránh báo cáo nợ bảng cân đối Xác định mô tả số phương pháp tài ngoại bảng.) 18 Property, plant, and equipment can be financed by having an outside party acquire the facilities while the company agrees to enough business with the facility to provide funds sufficient to service the debt Examples of these kinds of arrangements are through-put agreements, in which the company agrees to run a specified amount of goods through a processing facility or "take or pay" arrangements in which the company guarantees to pay for a specified quantity of goods whether needed or not A variation of the above arrangements involves the creation of separate entities for ownership and the financing of the facilities (such as joint ventures or limited partnerships) which are not consolidated with the company's financial statements and are, thus, excluded from its liabilities Companies have attempted to finance inventory without reporting on their balance sheets the inventory or the related liability These are generally product financing arrangements in which an enterprise sells and agrees to repurchase inventory with the repurchase price equal to the original sales price plus carrying and financing costs or other similar transactions such as a guarantee of resale prices to third parties 4–1 Companies typically report compensating balances that are required under a loan agreement as unrestricted cash classified within current assets a For purposes of financial statement analysis, is this a useful classification? Explain b Describe how you would evaluate compensating balances a No When analyzing cash, the most liquid of current assets, the analyst is interested in the availability of cash in meeting the company's obligations A restriction under compensating balance arrangements does, at worst, remove these cash balances from immediate availability as means of payment Indeed, use of such balances can have repercussions for the company that can affect its future access to bank credit b The analyst should exclude cash restricted under compensating balance agreements from current assets SEC Accounting Series Release 148 requires that a company that has borrowed money from a bank segregate on its balance sheet any cash subject to withdrawal or usage restrictions under compensating balance agreements with the lending bank These requirements may, as is often the case in such situations, move companies and their banker to alter the form of their contractual agreements while retaining their substance The analyst must be ever alert to such attempts to distort analysis measurements by presentations whose form is not a true reflection of their substance One measure of a company’s vulnerability in this area is the ratio of restricted cash to total cash 4–2 a Explain the concept of a company’s operating cycle and its meaning (Giải thích khái niệm chu kỳ kinh doanh công ty ý nghĩa nó.) b Discuss the significance of the operating cycle to classification of current versus noncurrent items in a balance sheet Cite examples (Thảo luận ý nghĩa chu kỳ kinh doanh để phân loại khoản mục current với noncurrent bảng cân đối Cho ví dụ.) c Is the operating cycle concept useful in measuring the current debt-paying ability of a company and the liquidity of its working capital components? ( khái niệm chu kỳ kinh doanh có hữu ích việc đo lường khả chi trả ngắn hạn công ty tính khoản thành phần vốn lưu động hay không?) d Describe the impact of the operating cycle concept for classification of current assets in the following industries: (1) tobacco, (2) liquor, and (3) retailing (Mô tả tác động khái niệm chu kỳ kinh doanh để phân loại tài sản ngắn hạn ngành công nghiệp sau: (1) thuốc lá, (2) rượu, (3) bán lẻ.) a The operating cycle concept is important in the classification of assets and liabilities as either current or noncurrent The operating cycle encompasses the period of time from the commitment of cash for purchases until the collection of receivables resulting from the sale of goods or services The diagram near the beginning of Chapter illustrates this concept b If the normal collection interval of a receivables is longer than a year (such as with longer term installment receivables), then their inclusion as current assets is proper provided the operating cycle is equal to or greater than the obligation due date for the receivables Similarly, if inventories, by business need or custom, have to be kept on average for more than 12 months, then this normal inventory holding period becomes part of the operating cycle and such inventories are included among current assets c The limitations of the current ratio (which is computed from items defined as working capital) as a measure of shortterm liquidity are discussed in Chapter 11 Still, if we accept the proposition that it is useful to measure the current resources available to pay current obligations, then it is difficult to see how extension of "current" from the customary 12 months to periods of 36 months or longer can serve a useful purpose The operating cycle concept may help companies show the kind of positive current position that they otherwise might not be able to show, but this concept is of doubtful value or validity from the point of view of a financial analyst that must assess a company’s shortterm liquidity d (1) Tobacco Industry The tobacco leaf must go through an aging, curing, and drying process extending over several years This tobacco inventory (green leaves), that may not be used in the production of a salable product for many years, is classified as current under the operating cycle concept This would occur even if longterm loans (classified among noncurrent liabilities) were taken out to finance the carrying of this inventory (2) Liquor Industry The liquor industry has an operating cycle extending beyond the customary 12 months In this case, the holding of liquor inventory for aging purposes over many years provides sufficient justification for inclusion of such inventories among current assets (3) Retailing Industry In retailing, the sale of "large ticket" items on the installment plan can extend the operating cycle to, for example, 36 months or longer As such, these installment receivables are reported among current assets 4–3 a Identify the main concerns in analysis of accounts receivable (Xác định mối quan tâm phân tích khoản phải thu.) b Describe information, other than that usually available in financial statements, that we should collect to assess the risk of noncollectibility of receivables a The two most important questions facing the financial analyst with respect to receivables are: (1) Is the receivable genuine, due, and enforceable? and (2) Has the probability of collection been properly assessed? While the unqualified opinion of an independent auditor lends some assurance with regard to these questions, the financial analyst must recognize the possibility of an error of judgment as well as the lack of complete independence b Description of the receivables in the notes to financial statements usually not contain sufficient clues to allow a reliable judgment as to whether a receivable is genuine, due, and enforceable Consequently, knowledge of SFAS 95 requires that the statement of cash flows classify cash receipts and cash payments by operating, financing and investing activities Operating activities encompass all the earningrelated activities of the enterprise They encompass, in addition to all the income and expense items found on the income statement, all the net inflows and outflows of cash that operations impose on the enterprise Such operations include activities such as the extension of credit to customers, investment in inventories, and obtaining credit from suppliers This means operating activities relate to all items in the statement of income (with minor exceptions) as well as to balance sheet items that relate to operations mostly working capital accounts such as accounts receivable, inventories, prepayments, accounts payable, and accruals SFAS 95 also specifies that operating activities include all transactions and events that are not of an investing or financing nature Financing activities include obtaining resources from owners and providing them with a return of or a return on (dividends) their investment They also include obtaining resources from creditors and repaying the amounts borrowed or otherwise settling the obligations Investing activities include acquiring and selling or otherwise disposing of both securities that are not cash equivalents and productive assets that are expected to generate revenues over the longterm They also include lending money and collecting on such loans 7–4 Explain the three categories of adjustments in converting net income to cash flows from operations (Giải thích ba loại điều chỉnh việc chuyển đổi thu nhập ròng sang dòng tiền từ hoạt động.) We can distinguish among three categories of adjustments that convert accrual basis net income to cash from operations: (i) Expenses, losses, revenues, and gains that not use or generate cash such as those involving noncash accounts (except those in ii), (ii) Net changes in noncash accounts (mostly in the operating working capital group) that relate to operations— these modify the accrualbased revenue and expense items included in income, (iii) Gains and losses (such as on sales of assets) that are transferred to other sections of the SCF so as to show the entire cash proceeds of the sale 7–5 Describe the two methods of reporting cash flow from operations Mô tả hai phương pháp báo cáo dòng tiền từ hoạt động The two methods of reporting cash flow from operations are: Indirect Method: Under this method net income is adjusted for noncash items required to convert it to CFO The advantage of this method is that it is a reconciliation that discloses the differences between net income and CFO Some analysts estimate future cash flows by first estimating future income levels and then adjusting these for leads and lags between income and CFO (that is, noncash adjustments) Direct (or InflowOutflow) Method: This method lists the gross cash receipts and disbursements related to operations Most respondents to the Exposure Draft that preceded SFAS 95 preferred this method because this presentation discloses the total amount of cash that flows into the enterprise and out of the enterprise due to operations This gives analysts a better measure of the size of cash inflows and outflows over which management has some degree of discretion As the risks that lenders are exposed to relate more to fluctuations in CFO than to fluctuations in net income, information on the amounts of operating cash receipts and payments is important in assessing the nature of those fluctuations 7–6 Contrast the purpose of the income statement with that of cash flow from operations The function of the income statement is to measure the profitability of the enterprise for a given period This is done by matching expenses and losses with the revenues and gains earned While no other statement measures profitability as well as the income statement, it does not show the timing of cash flows and the effect of operations on liquidity and solvency The latter is reported on by the SCF Cash from operations (CFO) reflects a broader concept of operations relative to net income It encompasses all earningrelated activities of the enterprise CFO is concerned not only with expenses and revenues but also with the cash demands of these activities, such as investments in customer receivables and in inventories as well as the financing provided by suppliers of goods and services CFO focuses on the liquidity aspect of operations and is not a measure of profitability because it does not include important costs such as the use of longlived assets in operations or important revenues such as the equity in the earnings of nonconsolidated subsidiaries or affiliates 7–7 Discuss the importance to analysis of the statement of cash flows Identify factors entering into the interpretation of cash flows from operations The SCF sheds light on (i) the effects of earning activities on cash resources, (ii) what assets are acquired, and (iii) how assets are financed It also can highlight more clearly the distinction between net income and cash provided by operations The ability of an enterprise to generate cash from operations on a consistent basis is an important indicator of financial health No business can survive over the long run without generating cash from its operations However, the interpretation of CFO figures and trends must be made with care and with a full understanding of all surrounding circumstances Prosperous as well as failing entities can find themselves unable to generate cash from operations at any given time, but for different reasons The entity caught in the "prosperity squeeze" of having to invest its cash in receivables and inventories to meet everincreasing customer demand will often find that its profitability will facilitate financing by equity as well as by debt That same profitability should ultimately turn CFO into a positive figure The unsuccessful firm, on the other hand, will find its cash drained by slowdowns in receivable and inventory turnovers, by operating losses, or by a combination of these factors These conditions usually contain the seeds of further losses and cash drains and also can lead to difficulties in obtaining trade credit In such cases, a lack of CFO has different implications The unsuccessful or financially pressed firm can increase its CFO by reducing accounts receivable and inventories, but usually this is done at the expense of services to customers that can further depress future profitability Even if the unsuccessful firm manages to borrow, the costs of borrowing only magnify the ultimate drains of its cash Thus, profitability is a key consideration, and while it does not insure CFO in the short run, it is essential to a healthy financial condition in the long run Changes in operating working capital items must be similarly interpreted in light of attending circumstances An increase in receivables can mean expanding consumer demand for enterprise products or it can mean an inability to collect amounts due in a timely fashion Similarly, an increase in inventories (and particularly of the raw material component) can imply preparations for an increase in production in response to consumer demand It also can imply (particularly if the finished goods component of inventories is increasing) an inability to sell due to, say, when anticipated demand did not materialize 7–8 Describe the computation of free cash flow What is its relevance to financial analysis? A valuable analytical derivative of the SCF is "free cash flow." As with any other analytical measure, analysts must pay careful attention to components of this computation Here, as in the case of any cash flow measures, ulterior motives may sometimes affect the validity of the computation One of the analytically most useful computations of free cash flow is: Cash from Operations (CFO) - Capital expenditures required to maintain productive capacity used in generating income - Dividends (on preferred stock and maintenance of desired payout on common stock) = Free Cash Flow (FCF) Positive FCF implies that this is the amount available for company purposes after provisions for financing outlays and expenditures to maintain productive capacity at current levels Internal growth and financial flexibility depend on an adequate amount of FCF Note that the amount of capital expenditures needed to maintain productive capacity at current levels is generally not disclosed by companies It is included in total capital expenditures, which also can include outlays for expansion of productive capacity Breaking down capital expenditures between these two components is difficult The FASB considered this issue, but in SFAS 95 it decided not to require classification of investment expenditures into maintenance and expansion categories 7–9 List insights that the statement of cash flows can provide to our analysis For financial statement analysis, the SCF provides clues to important matters such as: • • • • • • • • Feasibility of financing capital expenditures and possible sources of such financing Sources of cash to finance an expansion in the business Dependence of the firm on external sources of financing (such as debt or equity) Future dividend policies Ability to meet future debt service requirements Financial flexibility, that is, the firm's ability to generate sufficient cash so as to respond to unanticipated needs and opportunities Insight into the financial habits of management and indications of future policies Signals regarding the quality of earnings 8–1 How is return on invested capital used as an internal management tool? (Làm mà lợi nhuận vốn đầu tư sử dụng công cụ quản lý nội bộ?) The return that is achieved in any one period on the invested capital of a company consists of the returns (and losses) realized by its various segments and divisions In turn, these returns are made up of the results achieved by individual product lines and projects A wellmanaged company exercises rigorous control over the returns achieved by each of its profit centers, and it rewards the managers on the basis of such results Specifically, when evaluating new investments in assets or projects, management will compute the estimated returns it expects to achieve and use these estimates as a basis for its decision to invest or not 8–2 Why is return on invested capital one of the most relevant measures of company performance? How we use this measure in our analysis of financial statements? (Tại lợi nhuận vốn đầu tư biện pháp phù hợp hiệu suất công ty? Làm để sử dụng phép đo phân tích báo cáo tài chính?) Profit generation is the first and foremost purpose of a company The effectiveness of operating performance determines the ability of the company to survive financially, to attract suppliers of funds, and to reward them adequately Return on invested capital is the prime measure of company performance The analyst uses it as an indicator of managerial effectiveness, and/or a measure of the company's ability to earn a satisfactory return on investment 8–3 Why is interest, expense ignored when computing return on net operating assets (RNOA)? Tại chi phí lãi suất bỏ qua tính toán lợi nhuận tài sản hoạt động ròng (RNOA)? If the investment base is defined as comprising net operating assets, then net operating profit (e.g., before interest) after tax (NOPAT) is the relevant income figure to use The exclusion of interest from income deductions is due to its being regarded as a payment for the use of money from the suppliers of debt capital (in the same way that dividends are regarded as a payment to suppliers of equity capital) NOPAT is the appropriate amount to measure against net operating assets as both are considered to be operating 8–4 Discuss the motivation for excluding “nonproductive” assets from invested capital when computing return What circumstances justify excluding intangible assets from invested capital? First, the motivation for excluding nonproductive assets from invested capital is based on the idea that management is not responsible for earning a return on non-operating invested capital Second, the exclusion of intangible assets from the investment base is often due to skepticism regarding their value or their contribution to the earning power of the company Under GAAP, intangibles are carried at cost However, if their cost exceeds their future utility, they are written down (or there will be an uncertainty exception regarding their carrying value in the auditor's opinion) The exclusion of intangible assets from the asset base must be based on more substantial evidence than a mere lack of understanding of what these assets represent or an unsupported suspicion regarding their value This implies that intangible assets should generally not be excluded from invested capital 8–5 Why must income used in computing return on invested capital be adjusted to reflect the capital base (denominator) used in the computation? The basic formula for computing the return on investment is net income divided by total invested capital Whenever we modify the definition of the investment base by, say, omitting certain items (liabilities, idle assets, intangibles, etc.) we must also adjust the corresponding income figure to make it consistent with the modified asset base 8–6 What is the relation between return on net operating assets and sales? Consider both NOPAT sales and sales to net operating assets in your response The relation of net income to sales is a measure of operating performance (profit margin) The relation of sales to total assets is a measure of asset utilization or turnover—a means of determining how effectively (in terms of sales generation) the assets are utilized Both of these measures, profit margin as well as asset utilization, determine the return realized on a given investment base Sales are an important factor in both of these performance measures 8–7 Company A acquires Company B because the latter has a NOPAT margin exceeding the industry norm After acquisition, a shareholder complains that the acquisition lowered return on net operating assets Discuss possible reasons for this occurrence Profit margin, although important, is only one aspect of the return on invested capital The other is asset turnover Consequently, while Company B's profit margin is high, its asset turnover may have been sufficiently depressed so as to drag down the overall return on invested capital, leading to the shareholder's complaint 8–8 Company X’s NOPAT margin is 2% of sales Company Y has a net operating asset turnover of 12 Both companies’ RNOA are 6% and are considered unsatisfactory by industry norms What is the net operating asset turnover of Company X? What is the NOPAT margin for Company Y? What strategic actions you recommend to the managements of the respective companies? The asset turnover of Company X is The profit margin of Company Y is 0.5% Since both companies are in the same industry, it is clear that Company X must concentrate on improving its asset turnover On the other hand, Company Y must concentrate on improving its profit margin More specific strategies depend on the product and industry 8–9 What is the purpose of measuring asset turnover for different asset categories? The sales to total assets (asset turnover) component of the return on invested capital measure reflects the overall rate of asset utilization It does not reflect the rate of utilization of individual asset categories that enter into the overall asset turnover To better evaluate the reasons for the level of asset turnover or the reasons for changes in that level, it is helpful to compute the rate of individual asset turnovers that make up the overall turnover rate 8–10 What factors (limitations) enter into our evaluation of return on net operating assets? 10 The evaluation of return on invested capital involves many factors The inclusion/exclusion of extraordinary gains and losses, the use/nonuse of trends, the effect of acquisitions accounted for as poolings and their chance of recurrence, the effect of discontinued operations, and the possibility of averaging net income are just a few of many such factors Moreover, the analyst must take into account the effects of price-level changes on return calculations It also is important that the analyst bear in mind that return on invested capital is most commonly based on book values from financial statements rather than on market values And finally, many assets either not appear in the financial statements or are significantly understated Examples of such assets are intangibles such as patents, trademarks, research and development activities, advertising and training, and intellectual capital 8–11 How is the equity growth rate computed? What does it measure? The equity growth rate is calculated as follows: [Net income – Preferred dividends – Common dividend payout] / Average common equity This is the growth rate due to the retention of earnings and assumes a constant dividend payout over time It indicates the possibilities of earnings growth without resort to external financing The resulting increase in equity can be expected to earn the rate of return that the company earns on its assets and, thus, further contribute to growth in earnings 11 8–12 a How return on net operating assets and return on common equity differ? b What are the components of return on common shareholders’ equity? What the components measure? 12 a The return on net operating assets and the return on common stockholders' equity differ by the capital investment base (and its corresponding effects on net income) RNOA reflects the return on the net operating assets of the company whereas ROCE reflects the perspective of common shareholders b ROCE can be disaggregated into the following components to facilitate analysis: ROCE = RNOA + Leverage x Spread RNOA measures the return on net operating assets, a measure of operating performance The second component (Leverage x Spread) measures the effects of financial leverage ROCE is increased by adding financial leverage so long as RNOA>weighted average cost of capital That is, if the firm can earn a return on operating assets that is greater than the cost of the capital used to finance the purchase of those assets, then shareholders are better off adding debt to increase operating assets 9–1 What are some of the uses for prospective analysis? Prospective analysis is central to security valuation All valuation models rely on forecasts of earnings or cash flows that are, then, discounted back to the present to arrive at the estimated value of the security Prospective analysis is also useful to examine the viability of companies’ strategic plans, that is, whether they will be able to generate sufficient cash flows from operations to finance expected growth or whether they will be required to seek external financing In addition, prospective analysis is useful to examine whether announcing strategies will yield the benefits expected by management Finally, prospective analysis can be used by creditors to assess companies’ ability to meet debt service requirements 9–2 What steps must usually take place before the forecasting process can begin? Prior to the forecasting process, financial statements can be recast to better portray economic reality Adjustments might include elimination of transitory items or reallocating them to past or future years, capitalizing (expensing) items that have been expensed (capitalized) by management, capitalizing operating leases and other forms of off-balance sheet financing, and so forth 9–3 In addition to recent trends, what other items of information might be brought to bear in the projection of sales? In addition to trend analysis, analysts frequently incorporate external (nonfinancial) information into the prospective process Some examples are the expected level of macroeconomic activity, the degree to which the competitive landscape is changing, any strategic initiatives that have been announced by management, and so forth 9–4 What is the forecast horizon? The forecast horizon is the period for which specific estimates are made It is usually 5-7 years Forecasts beyond the forecast horizon are of dubious value since estimates are uncertain 9–5 What assumption is usually made about sales growth at the end of the forecast horizon? Since all valuation models are infinite horizon models, analysts frequently assume a steady state into perpetuity after the forecast horizon A common assumption is that the company will grow at the long-run rate of inflation, that is, remaining constant in real terms 9–6 Describe the steps in forecasting the income statement The projection process begins with an expected growth in sales Gross profit and operating expenses are, then, estimated as a percentage of forecasted sales using historical ratios and external information Depreciation expense is usually estimated as a percentage of beginning gross depreciable assets under the assumption that depreciation policies will remain constant Interest expense is usually estimated at an average borrowing rate applied to the beginning balance of interest bearing liabilities Projections of expected interest rates are used for variable rate indebtedness and new borrowings Finally, tax expense is estimated using the effective tax rate on pre-tax income 9–7 Describe the two-step process of forecasting the balance sheet In the first step, balance sheet items are projected using forecasted income sales (COGS) and relevant turnover ratios Long-term assets are projected using forecasted capital expenditures Long-term liabilities are projected from current maturities of longterm debt disclosed in the debt footnote, and paid-in-capital is assumed to be constant in this stage Retained earnings are projected adding (subtracting) projected profits (losses) and subtracting projected dividends Once total liabilities and equities are forecasted, total assets is set equal to this amount and forecasted cash is computed as the plug figure In the second step, long-term liabilities and equities are adjusted to yield the desired level of cash The analyst must be careful to maintain the historical leverage ratio and adjust liabilities and equities proportionately 9–8 What are value drivers? The residual income model expresses stock price as the book value of stockholders’ equity plus the present value of expected residual income (RI) Residual income can be expressed in ratio form as, RI = (ROEt – k) * BVt-1 Where ROE=NIt/BVt-1 This form highlights the fact that stock price is only impacted so long as ROE ≠ k In equilibrium, competitive forces will tend to drive rates of return (ROE) to cost (k) so that abnormal profits are competed away The estimation of stock price, then, amounts to the projection of the reversion of ROE to its long-run value for a particular company and industry ROE is a value driver since it impacts our valuation of the stock price Its components (asset turnover and profit margin) are also value drivers 9–9 Describe the typical trend of value drivers over time We can make two observations regarding the reversion of ROE: a ROEs tend to revert to a long-run equilibrium This reflects the forces of competition Furthermore, the reversion rate for the least profitable firms is greater than that for the most profitable firms And finally, reversion rates for the most extreme levels of ROE are greater than those for firms at more moderate levels of ROE b The reversion is incomplete That is, there remains a difference of about 12% between the highest and lowest ROE firms even after ten years This may be the result of two factors: differences in risk that are reflected in differences in their costs of capital (k); or, greater (lesser) degrees of conservatism in accounting policies The reversion of ROA and NPM are similar While some reversion of TAT is evident, it is much less than that of the other value drivers 9–10A Why are short-term cash forecasts important for the analysis of financial statements? 10 Short-term cash forecasts are key to assessments of short-term liquidity An asset is called "liquid" because it will or can be converted into cash within the current period The analysis of short-term cash forecasts will reveal whether an entity will be able to repay short-term loans as planned This also means such analysis is extremely important for a potential short-term credit grantor Shortterm cash forecasts often are relatively realistic and accurate because of the shortness of the time span covered 9–11A What limitations are associated with short-term cash forecasting? 11 A cash forecast, to be most meaningful, must be for a relatively short-term period of time There are many unpredictable variables involved in the preparation of a reliable forecast for a highly liquid asset such as cash Over a long period of time (that is, beyond the time span of one year), the difference in the degree of liquidity among items in the current assets group is usually insignificant What is more important for long time spans are the projections of net income and other sources and uses of funds The focus should be shifted to working capital (and other accrual measures), and away from cash flows, for longer forecast horizons of, say, thirty months—where the time required to convert current assets into cash is insignificant 9–12A Describe the relation between inflows of cash and outflows of cash 12 Cash inflows and outflows are highly interrelated These two flows are crucial to a company’s ―circulation system." A deficiency in any part of the system can affect the entire system For example, a reduction or cessation of sales affects the vital conversion of finished goods into receivables or cash, which in turn leads to a drop in the cash reservoir If the system is not strengthened by "transfusion" (such as additional investment by owners or creditors), production must be curtailed or discontinued Lack of cash inflows also will reduce other expenses such as advertising, promotion, and marketing expenses, which will further adversely affect sales This can yield a vicious cycle leading to business failure 9–13A It is often asserted: From an operational point of view, management focuses on cash rather than working capital Do you agree with this statement? Why or why not? 13 Most would agree with this assertion Cash is the most liquid asset and when management urgently needs to purchase assets or incur expenses, a cash exchange is the quickest and easiest means to execute a transaction Moreover, unless management has a credit line established with a reliable outsider (such as a revolving account at a bank), lack of cash can mean a permanent loss of profitable opportunities 9–14A Describe the primary difference between “funds flow” analysis and ratio analysis Which analysis technique is preferred and why? 14 Ratio analysis is a static measurement tool Ratios measure relations among financial statement items as of a given moment and time In contrast, funds flow analysis is a dynamic measure covering a period of time A dynamic model of funds flow analysis uses the present only as a starting point and utilizes the best available estimates of future plans and conditions to forecast the future availability and disposition of cash or working capital Analyzing funds flow also encompasses the projected operations of a company Since one of the fundamental assumptions of accounting is the going-concern concept, some assert that the dynamic model is more realistic and is superior to static representations However, care should be taken in placing too much reliance on funds flow analysis as it is primarily based on estimates, and not on realized observations 9–15A What is the usual first step in preparing cash forecasts, and what considerations are required in this step? 15 Except for transactions involving the raising of money from external sources (such as through loans or additional investments) and the investments of money in long-term assets, almost all internally generated cash flows relate to and depend on sales Accordingly, the usual first step in preparing a cash forecast is to estimate sales for the period under consideration The reliability of any cash forecast depends on the accuracy of this forecast of sales In arriving at the sales forecast, the analyst should consider: (1) past trends of sales volume, (2) market share, (3) industry and general economic conditions, (4) productive and financial capacity, and (5) competitive factors, among other variables 10–10 What is the current ratio? What does the current ratio measure? What are reasons for using the current ratio for analysis? 10 The current ratio is the ratio of current assets to current liabilities It is a static measure of resources available at a given point in time to meet current obligations The reasons for its widespread use include: • It measures the degree to which current assets cover current liabilities • It measures the margin of safety available to allow for possible shrinkage in the value of current assets • It measures the margin of safety available to meet the uncertainties and the random shocks to which the flows of funds in a company are subject 10–11 Since cash generally does not yield a return, why does a company hold cash? 11 Cash inflows and cash outflows are not perfectly predictable For example, in the case of a business downturn, sales can decline more rapidly than outlays for purchases and expenses The amount of cash held is in the nature of a precautionary reserve, which is intended to take care of shortterm surprises in cash inflows and outflows 10–12 Is there a relation between level of inventories and sales? Are inventories a function of sales? If there is a relation between inventories and sales, is it proportional? 12 There is a relation between inventories and sales Specifically, as sales increase (decrease), the inventory level typically increases (decreases) However, inventories are a direct function of sales only in rare cases Methods of inventory management exist, and experience suggests that inventory increments vary not in proportion to demand (sales) but rather with measure approximating the square root of demand 10–13 What are management’s objectives in determining a company’s investment in inventories and receivables? 13 Management’s major objectives in determining the amounts invested in receivables and inventories include the promotion of sales, improved profitability, and the efficient utilization of assets 10–14 What are the limitations of the current ratio as a measure of liquidity? 14 The current ratio is a static measure The value of the current ratio as a measure of liquidity is limited for the following reasons: • Future liquidity depends on prospective cash flows and the current ratio alone does not indicate what these future cash flows will be • There is no direct or established relationship between balances of working capital items and the pattern which future cash flows are likely to assume • Managerial policies directed at optimizing the levels of receivables and inventories are oriented primarily toward the efficient and profitable utilization of assets and only secondarily at liquidity considerations 10–15 What is the appropriate use of the current ratio as a measure of liquidity? 15 The limitations to which the current ratio is subject should be recognized and its use should be restricted to the type of analytical task it is capable of serving Specifically, the current ratio can help assess the adequacy of current assets to discharge current liabilities This implies that any excess (called working capital) is a liquid surplus available to meet imbalances in the flow of funds, shrinkage in value, and other contingencies 10–16 What are cash-based ratios of liquidity? What they measure? 16 Cash-based ratios of liquidity typically refer to the ratio of cash (including cash equivalents) to total current assets or to total current liabilities The choice of deflator depends on the purposes of analysis (i) The higher the ratio of cash to total current assets the more liquid the current asset group is This means that this portion of the total current assets is subject only to a minimal danger of loss in value in case of liquidation and that there is practically no waiting period for conversion of these assets into usable cash (ii) The ratio of cash to total current liabilities measures how much cash and cash equivalents are available to immediately pay current obligations This is a severe test that ignores the revolving nature of current liabilities It supplements the cash ratio to total current assets in that it measures cash availability from a somewhat different point of view 10–17 How can we measure “quality” of current assets? 17 An important measure of the quality of current assets such as receivables and inventories is their turnover The faster the turnover—collections in case of receivables and sales in case of inventories—the smaller the likelihood of loss on ultimate realization of these assets 10–18 What does accounts receivable turnover measure? 18 The average accounts receivable turnover measures in effect the speed of their collection during the period The higher the turnover figure, the faster the collections are, on average 10–19 What is the days’ sales in receivables? What does it measure? 19 The collection period (or days' sales in accounts receivable) measures the number of days' sales uncollected It can be compared to a company's credit terms to evaluate the quality of its collection activities 10–20 Assume a company’s days’ sales in receivables is 60 days in comparison to 40 days for the prior period Identify at least three possible reasons for this change 20 Either one or all of the following are possible reasons for an increase in the collection period: • A relatively poorer collection job • Difficulty in obtaining prompt payment for various reasons from customers in spite of diligent collection efforts • Customers in financial difficulty, which in turn may imply a poor job by the credit department • Change of credit policies or sales terms in a desire to increase sales • Excessive delinquency of one or a few substantial customers 10–21 What are the repercussions to a company of (a) overinvestment and (b) underinvestment in inventories? 21 (a) If the inventory level is inadequate, the sales volume may decline to below the level of sales otherwise attainable A loss of potential customers can also occur (b) Excessive inventories, however, expose the company to expenses such as storage costs, insurance, and taxes as well as to risks of loss of value through obsolescence and physical deterioration Excessive inventories also tie up funds that can be used more profitably elsewhere 10–22 What problems are expected in an analysis of a company using the LIFO inventory method when costs are increasing? What effects price changes have on the (a) inventory turnover ratio and (b) current ratio? 22 The LIFO method of inventory valuation in times of increasing costs can render both the inventory turnover ratio as well as the current ratio practically meaningless However, there is information regarding the LIFO reserve that is reported in financial statements Use of the LIFO reserve enables the analyst to adjust an unrealistically low LIFO inventory value to a more meaningful inventory amount Still, in intercompany comparative analysis, even if two companies use LIFO cost methods for their inventory valuations, the ratios based on such inventory figures may not be comparable because their respective LIFO inventory pools (bases) may have been acquired in years of significantly different price levels 10–23 Why is the composition of current liabilities relevant to our analysis of the quality of the current ratio? 23 The composition of current liabilities is important because not all current liabilities represent equally urgent and forceful calls for payment Some claims, such as for taxes and wages, must be paid promptly regardless of current financial difficulties Others, such as trade bills and loans, usually not represent equally urgent calls for payment 10–24 A seemingly successful company can have a poor current ratio Identify possible reasons for this result 24 Changes in the current ratio over time not automatically imply changes in liquidity or operating results In a prosperous year, growing liabilities for taxes can result in a lowering of the current ratio Moreover, in times of business expansion, working capital requirements can increase with a resulting contraction of the current ratio— so-called "prosperity squeeze." Conversely, during a business contraction, current liabilities may be paid off while there is a concurrent (involuntary) accumulation of inventories and uncollected receivables causing the ratio to rise Finally, advances in inventory practices (such as just-in-time) can lower the current ratio [...]... year, then X=5), and Y equals the "sumofyears'digits" (that is, for a 5-year asset, Y= 5+4 + 3+2 +1 =15) b Straight line is easily understood and provides level depreciation and earnings effects The sumoftheyears'digits gives heavier weight to earlier years and causes higher depreciation and lower earnings in the early years and lower depreciation and higher earnings toward the end of the asset's life (2)... difference between “funds flow” analysis and ratio analysis Which analysis technique is preferred and why? 14 Ratio analysis is a static measurement tool Ratios measure relations among financial statement items as of a given moment and time In contrast, funds flow analysis is a dynamic measure covering a period of time A dynamic model of funds flow analysis uses the present only as a starting point and utilizes... consumer demand for enterprise products or it can mean an inability to collect amounts due in a timely fashion Similarly, an increase in inventories (and particularly of the raw material component) can imply preparations for an increase in production in response to consumer demand It also can imply (particularly if the finished goods component of inventories is increasing) an inability to sell due to, say,... flow What is its relevance to financial analysis? 8 A valuable analytical derivative of the SCF is "free cash flow." As with any other analytical measure, analysts must pay careful attention to components of this computation Here, as in the case of any cash flow measures, ulterior motives may sometimes affect the validity of the computation One of the analytically most useful computations of free cash... nature of the underlying event or transaction should possess a high degree of abnormality and be of a type clearly unrelated to, or only incidentally related to, the ordinary and typical activities of the entity, taking into account the environment in which the entity operates b Infrequency of occurrence of the underlying event or transaction should be of a type that would not reasonably be expected to... Average Age + Average Remaining Life The above ratios are helpful in assessing a company's depreciation policies and assumptions over time The ratios can be computed on a historical cost basis as well as on a current cost basis 4–15 Analysts must be alert to what aspects of goodwill in their analysis of financial statements? 15 One of the more common solutions applied by analysts to the analysis of goodwill... factors Moreover, the analyst must take into account the effects of price-level changes on return calculations It also is important that the analyst bear in mind that return on invested capital is most commonly based on book values from financial statements rather than on market values And finally, many assets either do not appear in the financial statements or are significantly understated Examples... important for the analysis of financial statements? 10 Short-term cash forecasts are key to assessments of short-term liquidity An asset is called "liquid" because it will or can be converted into cash within the current period The analysis of short-term cash forecasts will reveal whether an entity will be able to repay short-term loans as planned This also means such analysis is extremely important for... regarding an entity's depreciation policies to critical analysis and scrutiny The company can choose among several acceptable but vastly different depreciation methods The reasons a particular choice(s) is made by the company and the effect on reported depreciation expense and accumulated depreciation should be assessed 4–13 Analysts cannot unequivocally accept the depreciation amount One must try to estimate... LCM (Xác định các luận cứ chống lại việc sử dụng của LCM.) 9 a Cost, defined generally as the price paid or consideration given to acquire an asset, is the primary basis in accounting for inventories As applied to inventories, cost generally means the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location These applicable