This document discusses analyzing various types of liabilities reported on company financial statements. It covers financing liabilities, operating liabilities, leases, postretirement benefits, contingencies, commitments, off-balance sheet financing, and shareholders' equity. Specifically, it discusses how companies may attempt to reduce or misclassify liabilities, the differences between capital and operating leases, issues with accounting for postretirement benefits, and analyzing contingencies, commitments, and off-balance sheet financing activities.

1. CH. 3
ANALYZING FINANCING
ACTIVITIES

2. Preview
 Financing liabilities: all forms of credit
financing.
 Operating liabilities: obligations that arise
from operations.
 Liabilities are commonly reported as either
current or noncurrent.

3. Analyzing Liabilities
 We need assurance that companies account
for them (includes disclosure of their
amounts and due dates).
 Many companies attempt to reduce the
amount of liabilities reported on their
financial statements.
 Certain liabilities are more apt to be
misclassified or inadequately described.

4. Leases
 Capital lease & Operating Lease
 Off-balance-sheet financing: neither the
leased asset nor its corresponding liability
are recorded on the balance sheet when a
lease is accounted for as an operating lease
even though many of the benefits and risks
of ownership are transferred to the lessee.

5. Leases
 Over lease term, total expense of operating
and capital lease is identical. But, capital
lease lease reports more expense in the
earlier years and less expense in later years.

6. Analyzing Leases
 Impact of operating leases:
 Understate liabilities => inflate solvency
ratios
 Understate assets => inflate ROI
 Delay recognition of expenses
 Understate current liabilities => inflate
current ratio and other liquidity measures
 Understate operating income and interest
expense => inflate interest coverage ratios

7. Postretirement Benefits
 Costs of providing postretirement benefits
be recognized when the employee is in
active service, rather than when the
benefits are actually paid.
 Defined benefit plans & Defined
contribution plans.

8. Analyzing Postretirement
Benefits
 Reconciling economic and reported
numbers
 Adjusting the income statement and
balance sheet
 Evaluate actuarial assumptions

9. Contingencies and Commitments
 Contingent liabilities: potential claims on a
company’s resources.
 Commitments: potential claims against a
company’s resources due to future
performance under contract.

10. Off-Balance-Sheet Financing
 Operating leases
 Special Purpose Entities (SPEs)

11. Shareholders’ Equity
 Capital stock:
 Explanation of changes in the number of capital
shares
 Evaluation of the options held by others that when
exercised cause the number of shares outstanding to
increase and thus dilute ownership
 Retained Earnings
 Restrictions imposed on distributions of retained
earnings

12. Analyzing Contingent Liabilities
 Management estimates
 Analyze note disclosures for all loss (and
gain) contingencies.
 Reserve for future losses => big bath