1. Financial Statement Analysis (Fin 6465)
Fall 2012 – Module 2
Instructor: Michael Ryngaert
Office: 321 Stuzin Hall
Phone: Office: 392-9765
e-mail: michael.ryngaert@warrington.ufl.edu
Office Hours: M, W 10:00-11:30 and by appointment
Course Materials:
1. Financial Reporting & Analysis, Revsine, Collins and Johnson, Mittelstadt, 5th
edition, 2012, Publisher: McGraw Hill Irwin.
The book provides a good framework for statement analysis by explaining in a
fair amount of detail the key aspects of a financial statement and providing a
reasonable analysis of accounting choices and how the choices affect reported
numbers. The book is fairly up to date in terms of accounting rules. You can view
this book as a primary reference for the course and maybe future endeavors.
2. Course Packet: Target Copy: This contains a small number of additional readings and a
case concerning WorldCom.
3. In class handouts and/or class site postings
There will be numerous in class handouts and e-learning postings. There are many
excellent articles in the financial press that discuss various accounting issues. If a good
one comes up I might post it. Notes are available on e-learning and are handed out in
class. I will have additional handouts that will be available in class and posted on the
class site. Class handouts are not ALWAYS listed on the syllabus, but are of value and
you should be aware of them and I will remind you of them via e-learning.
In addition: I suggest that you may want to have a book available for reviewing certain
valuation-oriented topics. The best such book from the Fin 6427 class is
Valuation: Measuring and Managing the Value of Companies, Tim Koller, and
Marc Goedhart, and David Wessels, John Wiley, 5th edition, 2010.
This book also discusses many of the issues we discuss in the class – how to deal with
items like stock options, operating leases, pensions, restructuring costs, income tax
disclosures, etc…

2. Course Overview:
The course is designed to make the student comfortable with the key aspects of financial
statements and the financial reporting environment. There are four main themes:
1. Solidifying basic accounting skills and the interrelationship among different
financial statements (balance sheet, cash flow statement, income statement)
2. Helping to detect possible downturns in firm performance given financial statement
disclosures and incentives of individuals in the financial reporting environment.
3. Understanding how information in financial statements can be used to enhance
valuation models (better forecasting, better multiples, why multiples might differ)
4. Accurately measuring financial performance in terms of profitability ratios and
coverage ratios given different accounting assumptions and different levels of
certain activities (option compensation, pension usage, operating leases) across
companies.
5. Examination of some the more current controversies that involve financial
disclosure such as treatment of taxes on foreign income, pro-forma earnings
reporting, and fair value rules for firm assets and liabilities.
Grading:
1. 4 Case and/or Problem set Write-ups (Group) applying class concepts: 60%
2. Final Exam: 40% (Monday, December 10 at your usual class time – HGS150)
3. Class participation is a “tie-breaker”
Course grades and GPA: A = 4.0, A- = 3.7, B+ = 3.3, B = 3 , B- = 2.7. C+ = 2.3. C = 2.0,
C- = 1.7, D+ = 1.3. D = 1.0, D- = 0.7 and E = 0.
Assignment grading policy: Cases and problem sets are to be done in groups of 4 or 5.
You can form your own groups. You should give me your group pairings by the end of this
week. There will be 4 written assignments and you will always have one week
notification of an assignment. Late assignments are not accepted. I will also adjust
group case and problem set grades based on peer evaluations! Only two assignments
are listed
Class Participation: For those that attend regularly and make insightful comments, if
they are on the border areas between two grades, they will get a bump up.
Make-up exams: No make-up exams will be given for the final except in case of
documented illness or family tragedy. Requests for early exams are discouraged
unless there are truly extraordinary reasons.
Students with Disabilities
Students requesting testing accommodations must first register with the Dean of Students
Office. The Dean of Students Office will provide documentation to the student who must
then provide this documentation to the instructor when requesting accommodations.

3. Topic 1: An Overview of the Financial Reporting Environment
We explore the rationale for financial reporting, the basic principles underlying the rules
that govern it, and the incentives of those making the rules and reporting under the rules.
In particular, we try to get at the issues of why reporting rules are often seemingly not
representative of the economic reality they attempt to portray. We also address the motives
of management to truthfully depict the creditworthiness and profitability for their
companies. To the extent there are accounting deceptions, one generally needs to establish
who has a motive to commit them. To put it another way, there are certain contexts in
which management is more likely to commit fraud (or “aggressively” manage earnings).
We will also discuss what recent measures have been implemented to increase investor
confidence in the validity of corporate disclosures.
Readings: 10-K Checklist from UBS
Accounting Fraud at Worldcom (read for second class day brief discussion)
Chapter 1 (pages 1-31) and Chapter 1 summary pp. 37-38
Chapter 7 (pages 375-403 and 407) – Role of information in financial contracts
Topic 2: Review of Valuation “Models” (P/E , Enterprise Values, Market to book
value, DCF valuation)
Analysts use a number of valuation models such as P/E ratios, enterprise multiples, and
DCF valuation. These models are meant to rank stock attractiveness or in some cases put
specific values on firms. We briefly review these models so that we can think about how
differences in reporting, evidence of earnings manipulation, and the presence of special
items detected in a financial statement might influence our ability to forecast future cash
flows and might impact valuation multiples. Additionally, we will later see that pensions,
operating leases, and options also influence how we go about applying these valuation
models. This section is a brief basic valuation refresher with the idea of reminding you
what to keep your eye on in subsequent topics.
Chapter 6: 313-336, 351-357 = A general discussion about valuation pertaining to equities
351-357 reviewing using historical data to forecast future (topics covered
elsewhere like Measuring and Managing Value and Financial Modeling I)

4. Topic 3: Income, cash flows, and accruals
In spite of problems with reported profits, earnings are still a better indicator of firm value
than short term cash flow measures. Accrual accounting better measures profitability than
cash accounting. That said, discrepancies between cash flows and profits can be a warning
sign of future earnings disappointment. We explain why this is so and how one might
profit from this fact. This section is also a useful review of basic accounting and the
interplay of the cash flow statement, balance sheet, and income statement.
Readings: Packet: Income, Accruals, Cash Flows & their interpretation
Forensic Investing by Strum
Chapters 2: 57-69 and 84-88 on comprehensive income
Chapter 4: 193-220 – Review of balance sheet and Cash flow statement
Chapter 17: Optional if you have trouble understanding cash flow statement
First Assignment will entail exercises from the first 3 topics
Topic 4: Red Flags in accounting numbers and earnings quality
This topic discusses traditional diagnostic checks for whether earnings are sustainable. We
discuss how to gain insights on whether certain “red flags” are really a problem or have
more innocent explanations.
Readings: Chapter 8 (pp. 425-435)
Packet: Two articles on Hansen ‘earnings management”
Related Case (2nd) Assignment: Most likely Friedman Jewelers (handout)
Topic 5: Special Items affecting reported income and pro-forma accounting
We discuss the phenomenon of “pro-forma” earnings and “unusual items” reported in
income statements that cloud the question of true profitability and earnings sustainability.
The analytical goal is how to interpret and use these items and other items frequently
ignored such as discontinued operations, extraordinary items, and changes in accounting
principles
Readings: Chapter 2: 69-80 – Special and Unusual Items
Chapter 10: 564-572 – Intangible amortization & Asset impairments
Packet: Management Earnings Disclosure and Pro-Forma Reporting
General Electric smoothing article by Smith, Lipin & Naj
Stocks to Write-off by Lowenstein
IBM accounting flap by Lowenstein

5. Topic 6: S&P 500 Index Earnings and Market valuation (optional)
This is a time permitting topic. There are multiple definitions of earnings and different
analysts will come on a television show and within hours give you different price to
earnings multiples on the S&P 500 as part of an analysis of whether markets are fairly
valued. We will discuss why this is and what thins look like today.
Class Handout (Posting): Macro-Insights on Earnings and Valuation
Topic 7: Understanding Income Tax Disclosures
A clear understanding of the taxes that companies are paying and what they likely will be
paying in the future can be quite important in valuing companies and determining earnings
quality (sustainability). We will try to shed some light on this topic by focusing on a few
different companies and their tax disclosures such as Google and Apple. Deferred taxes
and effective tax rates will get the bulk of the attention.
Chapter 15: 749-778
Class Handouts on specific firm tax disclosures
Topic 8: Profitability Ratios
We will analyze one firm in depth with respect to a profitability analysis of a company of
my choosing. One frustrating aspect of using data services to generate items like ROE,
ROA and ROIC (ROOIC) is that they all estimate the numbers differently. We will get
into some of the subtleties of profitability analysis in this section. This material relates to
issues such as performance evaluation that you may have discussed in Measuring and
Managing Value with Chris James. In the process of discussing this material we will also
spend some additional time on the tax footnote. Figuring out the marginal tax rates,
effective tax rates, and statutory tax rates is an important part of assessing profitability and
also forecasting future profits. I will have an extensive spreadsheet for this exercise.
Subsequent topics also deal with how to better measure profitability and performance given
accounting for leases, pensions, R&D, etc…
Readings: Chapter 5 (263-273)
Reference (not required): Mckinsey book, Chapter 25

6. Topic 9: Operating Leases and Options
Operating leases are the right to use equipment for some period of time, but not so long a
period that you are considered the owner (as in a capitalized lease). In the next few years,
all operating leases may be capitalized. We show how one can capitalize a lease and that
alters the balance sheet and income statement of the firm and how that impacts ROOIC,
debt ratios, interest coverage ratios, and enterprise multiple ratios. A second footnote item
in this section is options granted to employees. We discuss how they are accounted for and
what the implications might be for taxes, DCF valuations, and multiple valuations.
Readings: Leases Chapter 12: 693-712 more importantly: 730-734
Options: Chapter 15: 905-924; Chapter 17: 1051-1053
Possible handout on tax features of options (but likely optional on details)
Topic 10: Pensions and Health Care Liabilities
Many large unionized firms (UPS, GM, Ford, Lockheed Martin to name a few) have large
pension obligations and health care liabilities. We discuss how to get a better handle on
financial risk resulting from Pensions, how to incorporate them into financial statements in
a more “sensible” way distinguishing between operating and financing costs associated
with these liabilities. This can alter ROOIC, enterprise multiples, and DCF valuations in a
meaningful way.
Readings: Chapter 14: 821-861
Topic 11: Selected Asset Issues – Capitalization of start-up costs, PP&E issues
Firm financial statements sometimes give misleading profits and returns on capital due to
immediate expensing of start-up costs like R&D. We show how that can be approximately
fixed. Also, we can sometimes get some analytic insights from a firm’s depreciation
disclosures and see how age of assets might influence profitability ratios.
Chapter 10: 551-563, 574-583
Chapter 17: 1048-1049

7. Topic 12: Do book values matter - Fair Value Accounting for Financial Assets and
Liabilities
In many cases the book value of firm’s equity is relatively meaningless in deterring value.
For financial firms this is less true since most of their assets are financial. Fair value
accounting impacts the valuation of these assets. There has been much to do about how
fair value accounting exacerbated the financial crisis. This topic will discuss the basics of
fair value accounting and how important it has been in terms of distorting (or not) financial
firms reported earnings and capital adequacy. One thing is clear; there is a lot of
subjectivity in the analysis of fair value once we stray from valuing actively traded
securities.
Readings: text: Fair Value Accounting: 325-325, 403-406 and 626-630
Packet: Notes on Fair Value Accounting
Testimony of Kevin J. Bailey
Is It Fair to Blame Fair Value Accounting for the Financial Crisis?
Wall Street Says -2 + -2 = 4