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Prep ch2
 

Prep ch2

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    Prep ch2 Prep ch2 Presentation Transcript

    • Understanding Financial Reports and the Income Statement Chapter 2 UWYO COB ACCT2000
    • Learning Objectives
      • Financial statements, reports, and filings
      • Income statements
      • Quality of earnings
    • Required components of financial statements (US GAAP)
      • A complete set of financial statements shows:
      • Financial position at the end of the period
      • Earnings for the period
      • Comprehensive income
      • Cash flows
      • Investments by and distributions to owners
    • Reports and filings
      • Annual report to shareholders
        • Management analysis and discussion
        • Financial highlights and summary
        • Auditor report
        • Financial statements and footnotes
      • Schedule 14A Proxy solicitation materials
        • Ownership of Securities (insider, institution, block holder)
        • Board composition and ownership (insiders and outsiders)
        • Executive Compensation
        • Audit committee, compensation committee, etc
      • SEC filings
        • Form 10K Annual report (audited)
        • Form 10Q Quarterly report (not audited)
        • Form 8K Current report (special relevant events, not audited)
    • Auditor’s Report
      • Unqualified opinion
        • Statements fairly present the the company’s position or results
      • Qualified opinion
        • Everything is fine except for…
      • Adverse opinion
        • Statements do not fairly present the the company’s position or results
      • Disclaimer of opinion
        • Auditor is unable to state an opinion
      • Proxy Statement Table of Contents (edited) 
      • •   Voting Procedures
      • •   Proposals 1—8
      • •   Ownership of Securities
      • •   Executive Compensation
      • •   Report of Compensation Committee on Executive Compensation
      • •   Report of Audit and Legal Committee
      • •   Performance Graph
      • •   Other Matters
      • APPENDIX
      • •   Management's Discussion and Analysis of Financial Condition and Results of Operations
      • •   Financial Highlights
      • •   Financial Statements and Notes
      • Form 10K includes
      • Annual report
      • Items included by reference to another report
        • Financial statements included in Proxy statement
      • Discussion of the nature of business operations
        • Geographic locations
        • Stock trading information
        • Auditor information
        • Information on management
      • Other information
    • Income statement: a single-step example
    • Income statement: a multi-step example
    • Sales revenue
      • Proceeds from customers in exchange for the delivery of goods or services for the use of assets
      • Generally recognized when earned and realized or realizable
        • When goods/services are exchanged for cash or claims to cash
        • Substantially accomplished what must be done
        • Service revenue is recognized with reference to the percentage of completion
      • Management may recognize revenue prematurely
      • See P2-1, P2-2, & P2-5
    • Net sales
      • Net sales = Sales revenue - Returns and allowances
        • Returns: customer returns goods for a refund
        • Allowance: customer retains goods but receive a partial refund if unhappy with quality of merchandise
    • Cost of Sales
      • Direct cost of purchasing or producing the goods or services to be delivered to customers
        • Retail: purchase cost (Cost of good sold)
        • Manufacturing: material, labor and overhead (Cost of good sold)
        • Service: labor and supplies (Cost of services provided)
      • Management has considerable discretion in recognizing these costs
    • Gross Profit & Gross Margin
      • Gross profit = Net sales – Cost of sales
      • Gross margin = Gross profit ÷ Sales
      • Motorola
        • Margin = (30,004-21,445) ÷30,004 = 28.6%
      • Nokia
        • Margin = (31,191-19,787) ÷31,191 = 36.6%
    • Other operating expenses
      • Selling, General and Administrative Expenses (SG&A)
        • Salaries
        • Pension costs
        • Marketing costs
        • Research & development costs
        • Insurance
        • Rent
        • Depreciation
        • Other
      • Restructuring and Other Charges
    • Research and Development
      • Searching for new knowledge and translating this knowledge into a plan or design for a new process or product
      • Should be assets but are expensed immediately on the income statement
      • Positively associated with market value
      • Management may cut R&D to boost short-term earnings. This will hurt a firm’s future profitability.
      • See P2-4 Advertising & P2-6 R&D
    • Depreciation
      • Allocation of the cost of assets that are expected to provide benefits over more than one accounting period
      • Can be a component of Cost of sales or SG&A
      • Methods and their effect on earnings
        • Straight-line depreciation: equal amount of expense for each period (aggressive)
        • Accelerated depreciation: greater expense in early years of assets life (conservative)
      • It’s a matter of allocating a fixed amount of expense across periods.
      • See P2-7 & P2-12
    • Restructuring and Other Charges
      • Appears when a business reorganizes
      • Includes charges associated with asset write downs and employee separations
      • Generally a one-time charge
      • Management tends to take excessive restructuring charges to boost future earnings
    • Operating income
      • Results of primary operations, independent of investment, financing and tax expenses
      Operating income (S G & A) (Restructuring and Other Charges) Gross profit (Cost of sales) Sales
    • Income statement, continued
      • Nonoperating income
        • interest income/expense
        • dividend income
        • gains/losses on asset sales
      Income after taxes (Provision for income taxes) Income before taxes Nonoperating income Operating income
    • Income statement - Special items
      • Minority share of income
        • Subsidiaries’ income that belongs to others
      • Discontinued operations
        • Disposition of a large component of business
      • Extraordinary items
        • Unusual and infrequent
      • Cumulative effect of change in accounting principles
      • Management may shift net income across the line
      • See P2-8, P2-9, & P2-10
    • Comprehensive income
      • All income statement items
      • Other comprehensive income
        • Change in the value of some securities held for investment
        • Gains/losses on foreign currency translation
    • Quality of income
      • Management has discretion in reporting income
        • Accounting methods (depreciation, inventory valuation, revenue recognition)
        • Assumptions (retirement benefits)
        • Estimations (sales returns, bad debts)
      • The tradeoff
        • Pros: allow management to provide more relevant information
        • Cons: enable management to manipulate earnings
    • Summary
      • Financial statements
      • Reports and filings
      • Income statements
      • Quality of earnings
    • Problems and Cases
      • Revenue recognition
        • P2-1, P2-2, & P2-5 (D)
      • Operating Expenses
        • Advertising P2-4, R&D P2-6, & Depreciation P2-7 (D)
      • Special Items
        • Minority Interest P2-8 (C) , Discontinued operations P2-9 (D) , & Extraordinary items P2-10 (C)
      • Basic Calculations (CFA exam)
        • EPS P2-11 (A) & Depreciation P2-12 (C)
    • Problems and Cases
      • Case 2-1
        • The importance of footnotes (things behind the reported numbers)
        • Understate expenses (e.g. depreciation expenses)
        • Shift income across lines (e.g. move non-operating income to operating income)
        • Don’t be fooled by numbers!