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  1. 1. 1 Financial Statement Analysis Accounting 553: Winter 2006 Dr. Raymond N. Johnson, CPA Phone: 503.725.5354 Office: 461 SBA Fax: 503.725.5850 Office Hours: 3:00-5:00 Tuesday, after class and by appointment E-mail address: I am best reached through the mail feature in WebCT set up for Actg 553. Course Description: Sound financial information for making business decisions is obtained by an understanding of the accounting data from which the information is derived as well as by the application of tools of analysis. Students will gain an increased understanding of the properties and use of accounting numbers in the determination of financial position, results of operations, cash flows, and the financial disclosure process and its use in evaluating business performance. We will spend time looking at selected accounting disclosures in depth in order to “tease” out additional information that is useful in analysis. This is not a course in firm valuation. If you are interested in valuation models and techniques and have not already done so, you should take Finance 553: Financial Analysis and Business Valuation. The Stickney, Brown and Wahlen (hereafter SBW) textbook covers analysis in Chapters 1 through 9 and Valuation in Chapters 10 through 12. Our focus will be on Chapters 1-9. Prerequisites: Accounting 511, Finance 551 or 561. Traditionally, the accounting background of students enrolled in this class has varied widely. Students enrolled in the MSFA program have, at a minimum, completed a sequence in Intermediate Financial Accounting. The accounting background of some MBA students is limited to Accounting 551. Students whose financial accounting background is limited to Accounting 511 or the equivalent are likely to find it necessary to do additional background reading in order to gain full benefit from this course. Any recent Intermediate Accounting textbook (the library has several) will be a useful reference. We will spend some time discussing the accounting treatment of various items for the benefit of students who don’t have the accounting background or those for whom the accounting may be rusty. People with very strong accounting backgrounds will find portions of the course undemanding. There will be a tendency to raise more advanced issues and topics. On occasion, I may find it necessary to ask you to take your questions “off-line” to be discussed outside of class. People with prior background and experience in financial analysis are an extraordinary resource for classmates (and for me), and I will rely on you to share your knowledge. Required Course Materials: 1. Stickney, C., P. Brown, and J. Wahlen, Financial Reporting and Statement Analysis: A Strategic Perspective, Fifth Edition, (2004), Thomson Southwestern 2. Readings (some included in a reading packet available at Smart Copy or available through Electronic Reserve via the PSU Library Website (see directions below). Grading: Cases and Participation 50% Midterm 25% Term Project 25% 100% Readings:
  2. 2. 2 In addition to the textbook readings, there are two sources of supplemental readings for the course. The first source of supplemental readings is the Electronic Reserve (ER) list for the course, which will be accessible via the PSU library web site. The second source is the hardcopy (HC) packet available at Smart Copy. This packet includes selected readings from sources that could not be accessed via Electronic Reserve, as well as notes and overheads and some case materials. There are a few articles that appear in both the hardcopy packet and the electronic reserve list. In some cases, the electronic version does not include excerpts from financial statements and/or tables that appear in the hardcopy version. The hardcopy versions are easier to understand in these cases. Below are instructions for accessing the Electronic Reserve readings: 1) Go to 2) Click on Material on Reserve 3) Select my last name from the list of instructors and click GO 4) Select ACTG 553 5) Enter course page password (the course page password is my last name) 6) Click Accept 7) Select a document 8) Now you can view or print it Note: You need Adobe Acrobat Reader to open and view the articles. Recommended Problems: The syllabus lists a few problems selected from the back of the textbook chapters that illustrate key points. I will have a copy of the solutions to the recommended problems available for you to “borrow.” I strongly advise that you utilize this resource as part of your learning. Required Discussion Cases: There are case discussions due most class meetings. Much of the learning that takes place in this course occurs in the group discussion process. You learn as much from each other as you do from me. See discussion below about “Group formation” and “Course conduct and requirements” for an explanation of the role of cases. Many of the cases will be available on line through the WebCT site for the course. I will also make some cases available at Clean Copy. Exams: Attendance at exams is viewed as a very serious matter. Any absence not approved in advance of the examination will result in a failing grade on that exam. Approved absences will be rare. The midterm exam may be given as a take home depending on the pace at which the class moves. Academic Integrity: A requirement for passing this course is academic honesty and integrity. Failure to demonstrate honesty and integrity will result in a course grade of “F”. Term Project You will be asked to perform a comprehensive analysis of the business performance of a company of your choice over the last five years. You may evaluate the financial and business performance of the company that you work for if it is a public company. You may choose to evaluate the financial and business performance of a public company of your choosing. I will also provide a list of companies that you might choose from. Each student will evaluate a different company. However, you may not use a company that is part of the assigned cases. The comprehensive analysis should include an analysis and discussion of: 1. The industry’s economic characteristics. 2. The company’s strategies and objectives. 3. The quality of the financial statements. 4. The company’s profitability.
  3. 3. 3 5. The company’s cash flows. 6. The company’s operating cycle. 7. The company’s liquidity and solvency risk. The overall discussion should include an executive summary; the body of the paper should not exceed 10 pages, typed and double spaced; and you may add appendices. You should select the company during the first or second week, obtain its financial statements by the end of the second week, and perform your analysis as we work through other cases during the term. Group Formation: Preparation of the cases is part of the learning process. Consequently, I encourage you to work in teams on the cases. I will take an “inventory of accounting skills” in the class during the first evening, and based on this information I will assign individuals to teams of 3 to 4 people. Course Conduct and Requirements: Class meetings are intended to review and discuss the assigned materials for that date. It is expected that each student will arrive having completed the assigned readings and problems. The following is a description of the general format of the class. There may be variation in this depending on the amount of time it takes to cover a topic and the amount of discussion generated. When there is a case assigned related to a particular topic, it is expected that you will have read the case as well as the textbook material and articles prior to coming to class on the first day that the topic is assigned. The course format on the first day a topic is assigned will likely consist of lecture and discussion of the issues in the case. I will expect you each person to be able to discuss any issue or aspect of a case. I expect everyone to come to class prepared (and willing) to participate in the discussion. A portion of your grade is based on your ability to contribute to the case discussion. Following the discussion of the case, the next topic will be introduced. No late assignments will be accepted. Withdrawals and Audits: University regulations provide for specific dates when a student registered in this course may (1) withdraw at the student's discretion, (2) withdraw from this course only with the professor's and SBA approval, and (3) withdraw from a registered course are only by petition to the Deadline Appeals Board. Student should refer to the schedule of classes for these dates. Approved withdrawals from accounting courses will be granted only in instances of documented extraordinary circumstances. Approval will not be granted on the basis that the grade currently being earned is not deemed desirable. Students registering for a grade of Audit or who change their grade option to Audit must consult with me to determine the work necessary to earn an “Audit” designation. Office Hours and the Use of Voice Mail & E-mail: 1. The e-mail function in WebCT is a very effective way to reach me. 2. When you leave a voice mail message, please indicate likely or preferred times over he next day or two that you can be reached, or that a message can be left. I will do my best to return phone calls within 24 hours or on Monday if received over the weekend. The same is true of e-mail. 3. I do not answer the phone during office hours when I am meeting with a student. Please leave a message. Just because I do not answer my phone does not mean that I am not there during office hours. When I am done assisting the student in my office, I will return your call. 4. Occasionally, messages are lost. Please persist and let me know if you are having problems reaching me. Tentative Schedule of Assignments Warning: The attached course schedule is tentative and will likely be modified more than once during the term. Do not hesitate to offer me feedback on how the class can be more useful to you. I am counting on
  4. 4. 4 you to give me input on an ongoing basis. We will refine the course together. Notation: SBW = Stickney, Brown and Wahlen ER = Electronic Reserve Week 1 (January 10): Basics of Fundamental Analysis Textbook Reading: SBW Chapters 1, 2. Other Readings: None Chapter 1 is a framework for fundamental analysis and will be useful to those who are relatively new to the process of analysis. We will cover these steps in class. Much of what is covered in chapter 2 will be review. It is particularly important for those students without an extensive accounting background to review this chapter. I am indifferent to the authors proposed “analytical framework” discussed on pages 93-100. Some may find it useful, others may not. I don’t intend to use this particular method of illustration in class. Required Case: None Recommended Problems: SBW 3.4, 3.9 Week 2 (January 17): Profitability Analysis Textbook Readings: SBW Chapters 3 & 4 Other Readings: • Selling, Thomas and Clyde P. Stickney, “The Effects of Business Environment and Strategy on a Firm’s Rate of Return on Assets,” Financial Analysts’ Journal, January-February, 1989, pg. 97-106. (ER) • Peers, M. and R. Sidel, “Days May be Numbered for Ebitda Numbers,” The Wall Street Journal, July 5, 2002, pg. C1. (ER) The focus of discussion will be on analyzing the profitability of a company. Students will be asked to evaluate the profitability of the Adolph Coors Company for the three years ended December 30, 2001. We will also discuss how to evaluate the profitability of various divisions or geographic regions and a company’s sustainable growth rate. In addition, we will discuss how to determine the length of an entity’s operating cycle and how to evaluate the statement of cash flows. Chapter 3 discusses the Statement of Cash Flows and its relationship to the income statement. Everyone may find pages 111-127 informative. Students who need a review of the basics of the Statement of Cash Flows should be sure to read pages 127-136. Required Discussion Case: Adolph Coors Brewing, 2001 (A) (Available on WebCt) Recommended Problems: SBW 4.2, 4.3, 4.6, 4.11, Week 3 (January 24): Risk Analysis Models, Quality of Earnings, Introduction to Nonrecurring Items Textbook Reading: SBW Chapter 5 Other Readings: • Giacomino, D. and D. Mielke, “Cash Flows: Another Approach to Ratio Analysis,” Journal of Accountancy, March, 993, pg. 55-58. (ER) • Greenberg, Herb, “Eight ‘Warnings’ You Want to See,” Fortune, June 26, 2000, pg. 304. (ER) This week’s class will continue to focus on analyzing business performance with financial statements. Key topics will include understanding the statement of cash flows, understanding an entity’s operating cycle, and assessing liquidity and solvency risk. We will continue the discussion of risk in the context of the Adolph Coors Company. We will also do a brief in-class exercise in the context of Timberline Software. Required Discussion Case: Adolph Coors Brewing, 2001 (B) (Available on WebCt) Recommended Problems: SBW 5.3 Week 4 (January 31): Putting it all Together. Textbook Readings: SBW Chapters 1 though 5
  5. 5. 5 This week will focus in the complete reading and analysis of a company’s financial performance in the context of analyzing the performance of the Winnebago Corporation. Required Discussion Case: • Comprehensive Analysis of the Winnebago Corporation (Available on WebCT) Recommended Problems: SBW 5.3, 6.3 and 6.5 Week 5 (February 7): Quality of Accounting Information, Nonrecurring Items and Pro Forma Earnings Textbook Readings: SBW Chapter 6 Other Readings: Quality of Earnings • Krantz, Matt, “Avoiding the next Enron,” USA Today, February 1, 2002, pg. 3B. (ER) • Fairfield, P. and J. Scott Whisenant, “Using Fundamental Analysis to Assess Earnings Quality: Evidence from the Center for Financial Research and Analysis,” Journal of Accounting, Auditing and Finance, Fall, 2001, pg. 273-295. (ER – not required, only for the deranged) Nonrecurring Items • Weil, J. and S. Liesman, “Missed Signals: Stock Gurus Write Off Most Big Write-Offs, But they Shouldn’t – ‘Special’ or ‘Unusual’ Charges Often Hold Vital clues to Companies Prospects,” The Wall Street Journal, December 31, 2001, pg. A1. (ER) • Tergesen, Anne, “A Closer Look at All Those Write-Offs,” Business Week, October 13, 2003, pg. 130-132. (ER) Pro Forma Earnings • “NASDAQ 100 Companies Report Combined Losses of $82 billion to the SEC While Reporting Combined Profits of $19 billion to Shareholders,”, LLC, 2002. (HC) • Byrnes, Nanette and Mara Derhovanesian, “Earnings: A Cleaner Look,” Business Week, May 27, 2002, pg. 34-37. (ER) • Henry, David, “Ouch! Real Numbers,” Business Week, March 24, 2003, pg. 72-73. (ER) • Weinberg, Ari, “The SEC’s G-Day,”, March 28,2003. (ER) This week will have two aspects to our class discussion. The first will focus on a discussion of the take home midterm. The second will focuses on an in depth discussion of quality of earnings and nonrecurring items. TAKE HOME MIDTERM DUE Required Discussion Case: • None Recommended Problems: SBW 6.3 and 6.5 (same as last week)
  6. 6. 6 Week 6 (February 14): Revenue Recognition, Asset Disclosures Textbook Reading: SBW Chapter 7 Other Reading: • Brown, Ken, “Creative Accounting: How to Buff a Company,” The Wall Street Journal, February 21, 2002, pg. C1. (ER) • Condon, Bernard, “Gaps in GAAP,” Forbes, January 25, 1999, pg. 76-80. (ER) • Tergesen, Anne, “How Much is the Goodwill Worth?” Business Week, September 16, 2002, pg. 83-84. (ER) • Harris, Roy and Jennifer Caplan, “The Perils of Impairment,” CFO Magazine, January 1, 2002. (ER) Week 6 again focuses on two topics of discussion. Though the Warnaco case we will complete or discussion of earning quality and one-time transactions. We will then move on to discuss various accounting issues related to the valuation of assets. We have already discussed accounting for inventories in the context of LIFO and FIFO. We will continue this discussion in the context of mark to market accounting and the valuation of assets at their fair value. Required Case: Warnaco Group, Inc. (A). Recommended Problems: SBW 7.4 and 7.6 Week 7 (February 21): Off- Balance Sheet Financing, Leases, Taxes Textbook Reading: SBW Chapter 2 (pages 84-93 review) and Chapter 8 (pages 519-546, 580-594) Other Reading: Financing: • Lubove, Seth and Elizabeth MacDonald, “Debt? Who Me?” Forbes, February 18, 2002, pg. 56-57. (ER) • Henry, David, “Who Else is Hiding Debt?” Business Week, January 28, 2002, pg. 36-37. (ER) • Glater, J., “Top Debt Rating Agencies Take a Look at Accounting,” The New York Times, January 11,2003, Page 1. (ER) Week 7 will again focus on two topics. Our discussion will begin with a discussion of the Foster’s Group and how accounting in Australia may differ from that of a U.S. company. This may provide an interesting comparison with the Adolph Coors Company. Then we will move our discussion to the trend of using special purpose entities and off balance sheet financing. Many companies use special purpose entities. It is important to understand how they are accounted for and how they affect the evaluation of liquidity and solvency risks. Required Discussion Case: The Foster’s Group (Available on WebCT) Recommended Problems: 8.6, 8.7 and 8.16 Week 8 (February 28): Pensions, Post-retirement benefits and Stock Based Compensation Textbook Reading: SBW Chapter 8 (pages 564-580) and Chapter 9 (pages 685-689) Other Reading: Pensions: • Henry, David, “The New Pinch from Pensions,” Business Week, August 5, 2002, pg. 44-46. (ER) • MacDonald, Elizabeth, “Pension Pangs,” Forbes, June 9, 2003, pg. 140-141. (ER) Options: • Byrnes, T. “Stock-Option Accounting Hides in the Shadows of the Financials,” The Wall Street Journal, March 21, 2002, (ER) • Borrus, Amy and Paula Dwyer, “To Expense or Not to Expense,” Business Week, July 29, 2002, pg. 44-47. (ER) • Hamm, S. with A. Borrus and M. McNamee,” Will Expensing Cost the U.S. Jobs?” Business Week, December 22, 2003, pg. 40-41. (ER) Week 8 will begin with a discussion of Enron, its financial reporting, and the signals that were apparent prior to the company’s filing for bankruptcy. The discussion will then move to other elements of liquidity and solvency risk --- specifically we will discuss pensions, post-retirement benefits, and accounting for stock based compensation. This topic is particularly relevant for industries like the airlines industry, heavy equipment and automotive industries, as well as the compensation plans provided in the information and technology industries.
  7. 7. 7 Required Discussion Case: Enron (Available on WebCT) Recommended Problems: 8.14 and 9.15 Week 9 (March 7): Analysis of Complex Financial Statements Textbook Reading: SBW Chapters 1 though 8 Recently all the major credit rating agencies downgraded General Motors credit to junk bond status. General Motors is a complex global organization with complex financial statements. The discussion for week 9 will focus on dissecting General Motors financial statement to learn about the strength of the entity’s business operations and underlying liquidity and solvency risks of the company. Required Case: Required Discussion Case: General Motors (Available on WebCT) Recommended Problems: None Week 10 (March 14): Corporate Governance Textbook Reading: None Other Reading: • Wallison, Peter, “Debating Sarbanes-Oxley: Give Use Disclosure, Not Audits,” The Wall Street Journal, June 2, 2003, pg. A. 16. (ER) • Schroder, Michael, “Corporate Reform: The First Year: Cleaner Living, No Easy Riches; Critics Say Sarbanes- Oxley Law Hobbles Stocks, Chills Risk Taking, But Upshot is Far Less Dramatic,” The Wall Street Journal, July 22, 2003, pg. C1. (ER) • Montgomery, C. and R. Kaufman, “The Board’s Missing Link,” Harvard Business Review, March 2003, pg. 86-93. (ER) • Max Bazerman, George Loewenstein and Don Moore, “Why Good Accountants Do Bad Audits,” Harvard Business Review, November 2002, pp 97 – 102. (ER) The final week will focus on the issue of earnings restatements, the quality of audits, and the reliability of financial reporting. The class discussion will focus on the underlying causes of the Sarbanes-Oxley Act of 2002 and whether the change in laws has made a significant difference in reliable financial reporting. Required Case: Restating Revenues and Earnings at INVESTools, Inc. (A) Recommended Problems: None Finals Week: March 21 TERM PROJECT DUE