INDEX

A Accounting standards
ABB Ltd., 574–576 changes in, 142–143
Abitibi-Consolidated Inc., 441–443, 457–458 effect of differences between, 341–344
Accounting related to capitalization of expenditures,
accrual basis, 725–728 421–425
cash basis, 725–728 Accounts, 28
clean-surplus, 712 common, 29
dirty-surplus, 712–713 doubtful, 134
distinguishing cash basis from accrual basis, Accounts payable, 42, 185
725–728 Accounts receivable, 28, 30, 44, 70
double-entry, 33 Accruals, 52–54, 735–743
equations, 8, 30–36, 62 accrued expenses, 54
basic, 8, 62 balance-sheet-based, 738
equity method of, 612–615 cash-flow-statement-based aggregate, 739
downstream sale, 620–621 prepaid expense, 54
upstream sale, 619–620 unbilled (or accrued) revenue, 53
inventory method of, 393–395 unearned (or deferred) revenue, 53
comparison of, 395 Accrued expenses (liabilities), 54, 185
placing discretion in context, 728–729 Accrued interest, 73
process, 36–52 Accrued wages, 47, 70, 71
accounting records, 36, 38–50 Accumulated depreciation, 30, 47, 73
accruals and valuation adjustments, Acquisition, 625
52–55 Activity ratios, 277, 278–284
financial statements, 50–52 calculation of, 278–280
illustration, 36–78 definitions of commonly used, 279
purchase method of, 433 interpretation of, 280–284
systems, 55–57, 725–733 fixed asset turnover, 283
debits and credits, 55, 57, 62–78 inventory turnover and DOH, 280–281
discretion in accounting systems, payables turnover and number of days of
725–733 payables, 282
flow of information in, 55 receivables turnover and DSO, 281
Accounting Changes and Error Corrections (FAS total asset turnover, 283
No. 154), 142 working capital turnover, 282–283
Accounting Policies, Changes in Accounting Administrative expenses (including employee
Estimates and Errors (IAS No. 8), 142 benefits), 337
Accounting profit, 470 Advertising expense, 43, 69

813

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 814 Index

Alcatel-Lucent (ALU), 396–402 accounting for acquisition of intangible,

consolidated balance sheets (2004–2006), 428–435
398–399 accounting for acquisition of tangible,
consolidated income statements 420–428
(2004–2006), 397 amortizing intangible with finite useful
selected notes to consolidated financial lives, 444
statements, 399–400 asset retirement obligations (AROs),
Allowance for bad debts, 29 444–449
Almanac of Business and Industrial Financial Ratios depreciating tangible, 435–443
(Troy), 203 impairment of, 456–461
Altria Group, Inc., 455, 670–671 disposal of, 449–455
American Eagle Outfitters, Inc., executive measurement bases of, 177–194
compensation disclosures of, 590 noncurrent, 30, 172
American Institute of Certified Public revaluation of, 461–463
Accountants (AICPA), 98 securitization of, 644
Accounting Standards Executive Committee tangible, 187, 420–428, 435–443, 456–458
(AcSEC), 98 temporary differences at initial recognition of,
Technical Practice Aid 5400.05, 141 484–485
Amortization, 134–138, 444 Auditor’s reports, 14–16
bond, accounting for, 512–515 Available-for-sale securities, 158, 327, 608
of excess purchase price, 616–618
AMR Corporation, 379–382 B
Analyst adjustments to reported financials, Backtesting, 369
371–385 Balance sheet, 8–10, 31, 50, 325, 326–336,
framework for, 371 561–562, 568, 699–700
related to goodwill, 376–378 classified, 171
related to inventory, 373–375 components and format of, 166–177
related to investments, 371 account format, 170
related to off-balance-sheet financing, assets, 168
378–385 current and noncurrent distinction,
related to property, plant, and equipment, 375 171–172
Annual Statement Studies (Risk Management equity, 169–170
Association), 203 IFRS and U.S. GAAP illustrations, 172–177
Antidilutive securities, 151–152 liabilities, 169, 172
AOL Time Warner, 525–526 report format, 170
Apple Computer, 206–207 elements, 325
cash flow analysis of comparables, 252 equity, 194–199
evaluation of liquidity ratio, 287 components of, 194–196
Asset retirement obligations (AROs), 444–449 statement of changes in shareholders’ equity,
Asset utilization ratios. See Activity ratios 196–199
Assets, 27–28, 29, 92, 166, 168, 192–194, 325 goodwill, 331–335, 776–777
current, 30, 171–172, 181–182 intangible assets other than goodwill, 335–336
determining the tax base of, 476–480 inventories, 329
intangible, 134, 187–192, 331, 420, investments, long-term, 330–331
428–435, 458 issues, 773–776, 781
goodwill, 190–192 goodwill, 776–777
identifiable, 187, 335 off-balance-sheet liabilities, 773–776
measuring, 189 marketable securities, 327–329
specifically identifiable, 188–189 measurement bases of assets and liabilities,
unidentifiable, 187, 331 177–194
long-lived, 134, 419–468. See also Long-lived current assets, 181–182
assets current liabilities, 184–187

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 Index 815

financial instruments: financial assets and C

liabilities, 192–194 Capital markets regulation
intangible assets, 187–192 in Europe, 84
inventories, 182–184 in the United States, 85–87
prepaid expenses, 184 SEC filings, 85–87
tangible assets, 187 securities-related legislation, 85
property, plant, and equipment, 329–330 Capital One, 647–648
provisions (nonfinancial liabilities), 336 Capitalized interest costs, effect on coverage ratios
unclassified, 40–41 and cash flow, 426–428
uses and analysis of, 200–209 Capitalizing versus expensing
common-size analysis, 201–207 for ongoing purchases, impact of, 424
ratios, 207–209 financial statement impact of, 421–423
Bank debt, 44, 69 Carrying amount, 471
Barter, 126–127 Cash, 30, 43, 44, 65, 66, 67, 68, 69
BASF AG, 666–668 Cash conversion cycle (net operating cycle),
Becton, Dickinson and Company (BDX), 434 286–287
BHP Billiton (BHP), 358–359 Cash equivalents, 30
Blockbuster, 762 Cash flow, 3–4
BMW AG, 671–672 impact of pension and postretirement benefits,
Bonds payable, 506–519 586–589
accounting for bond issuance, 506–512 Cash flow ratios, 251–253
accounting for bond amortization, interest Cash flow statement, 10–12, 50–52, 215–258,
expense, and interest payments, 339–340
512–515 analysis, 243–253
current market rates and fair values, 519 cash flow ratios, 251–253
debt covenants, 516–517 common-size, 246–250
debt extinguishment, 515–516 evaluation of sources and uses of cash,
issued at a discount, 510–511 243–246
issued at face value, 507–509 free cash flow to the firm and to equity,
long-term debt, presentation and disclosure of, 250–251
517–519 components and format of, 217–228
zero-coupon, 511 classification of cash flows and noncash
Bottom line, 116 activities, 217–219
Bottom-up analysis, 368 direct and indirect cash flow formats for
Bright-line tests, 103 reporting operating cash flow, 221–228
Buffett, Warren, xxv summary of differences between IFRS and
Business activities, classification of, 26–27 U.S. GAAP frameworks, 219–220
Business combinations conversion of cash flows from the indirect to
and deferred taxes, 485 the direct method, 242–243
financial statement presentation subsequent to, direct format, 50, 221
636–638 statement prepared under IFRS, 222–224
with less than 100 percent acquisition, 633 indirect format, 50, 221
types of, 625 issues, 777–779
“Business Combinations: Applying the classification issues, 777
Acquisition Method: Joint Project of the omitted investing and financing activities,
IASB and FASB, 640 778–779
Business and geographic segments, real earnings management activity, 779
311–314 linkages with the income statement and
IAS 14 requirements, 311–313 balance sheet, 228–230
segment ratios, 313–314 steps in preparing, 230–241
definitions of, 313 financing activities: direct method, 237–238
evaluation of, 313–314 investing activities: direct method, 236–237

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 816 Index

Cash flow statement (Continued ) Completed contract method, 122–124

operating activities: direct method, 231–236 A Comprehensive Business Reporting Model:
overall statement of cash flows: direct Financial Reporting for Investors (CFA
method, 238 Centre position paper), 105–106
overall statement of cash flows: indirect Comprehensive income, 31, 157–159, 195
method, 239–241 Comprehensiveness, 102
Cash Flow Statements (IAS No. 7), 339 Consistency, 102
Cash ratio, 286 Constellation Energy Group Inc. (CEG),
Caterpillar Inc. (CAT), 406–411, 413, 562, 564, 446, 447
574–579, 587–589, 645 Contra account, 29–30
consolidated financial position (2004–2006), Contributed capital, 65
407–408 Corporate Finance: A Practical Approach, xxviii
consolidated results of operation Cost of goods sold (COGS), 44, 45, 70, 130, 761
(2004–2006), 406 Cost recovery method, 125–126
pension disclosures and selected supplemental Cost of sales, 337
information, 564–567 Credit, 55–56
selected notes to consolidated financial Credit analysis, 308–311, 364–367
statements, 408, 413 credit rating process, 309
CFA Centre for Financial Market Integrity, 105 research on ratios in, 310–311
CFA Institute selected credit ratios used by Standard &
evolving standards and the role of, 105–106 Poor’s, 310
history and origins of, xxv Credit risk, 308
Standards of Practice Handbook (SOPH), 22 assessing, 364–367
Charles River Associates, 118 peer comparison of ratios, 367
Chart of accounts, 28 quantifiable rating factors, Moody’s
Chevron Corporation, 704, 710–713 evaluation of, 365–366
Cisco Systems, 183–184 Current assets, 30, 171–172, 181–182
Clean-surplus accounting, 712 Current cost, 94, 177
CMS Energy Corp., 525–526 Current liabilities, 172, 184–187
CNH Global N.V., 558, 563, 565–567, 574–579 accounts payable, 185
Coca-Cola, Inc., 592, 593–594, 614–615, 658, accrued liabilities, 185
740–743 current portion of noncurrent borrowings, 185
accrual analysis, illustration of, 740–743 current tax payable, 185
annual report (2006), 614–615 notes payable, 185
excerpts from financial statements of unearned revenue, 185–187
(2004–2006), 593 Current ratio, 286
Commercial receivables, 30. See also Accounts
receivable D
Committee of European Securities Regulators DaimlerChrysler, 117
(CESR), 84 partial revenue recognition footnote for, 121
Common-size analysis, 270–275 Data-snooping bias, 369
and the balance sheet, 270 Debit, 55–56
cross-sectional, 272 Debt-to-assets ratio, 289
of the income statement, 271 Debt-to-capital ratio, 289
relationships among financial statements, Debt-to-equity ratio, 289
273–275 Deere & Co., 574–576
trend, 272 Defensive interval ratio, 286
Company disclosures, 106–108 Deferred revenue. See Unearned revenue
regarding the impact of recently issued Deferred tax assets, 471
accounting standards, 107–108 Deferred tax liabilities, 471
relating to critical and significant accounting Defined-benefit (DB) pension plans,
policies, 106–107 557–561

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 Index 817

calculation of obligation for an individual applying the simple measures of, 743–750
employee, 571–573 Earnings per share, 115, 144–152, 304–305
measuring periodic costs of, 560–561 basic, 8, 145–146
Defined-contribution (DC) pension plans, diluted, 8, 145, 146–152, 305
556–557 when a company has convertible debt
Dell, 206–207, 264–265 outstanding, 147–149
cash flow analysis of comparables, 252 when a company has convertible preferred
common-size cash flow statement, 249–250 stock outstanding, 147
evaluation of liquidity ratio, 287 when a company has stock options,
Deposits, 67 warrants, or their equivalents outstanding,
Depreciation, 13, 42, 117, 190, 330, 337–338, 149–151
375–376, 444 other issues with, 151–152
accelerated methods of, 136, 436 interpretation of, 304–305
diminishing (declining) balance method, simple versus complex capital structure,
136–137 144–145
double-declining balance, 137–138 Electronic Data Gathering, Analysis, and
accumulated, 30, 47, 73, 330, 375 Retrieval (EDGAR) system, 85
and amortization, 134–138 Electrolux AB, 705–708
differences in, 376 Emerging Issues Task Force (EITF), 98
estimates required for calculations, 439–440 Employee Benefits (IAS No. 19), 560, 561
expense, 47, 73, 337 Employee Compensation, postretirement and
methods, 435–439 share-based, 555–603
review of, 436–439 pensions and other postretirement benefits,
straight-line method of, 135, 375, 435–436 556–589
units-of-production methods, 436 evaluating disclosures of pension and other
Depletion, 444 postretirement benefits, 574–589
Derivative, 192 financial statement reporting of pension and
Deutsche Telekom AG, 646 other postretirement benefits of, 561–574
Diebold, Inc. (DBD), 757–760 measuring a defined-benefit pension plan’s
Diluted shares, 8 periodic costs, 560–561
Direct write-off method, 134 types of postretirement benefit plans and
Dirty-surplus accounting, 712–713 the implications for financial reports,
Disney 2004 annual report MD&A, 107 556–559
Dividend-related quantities, 305 share-based compensation, 589–594
dividend payout ratio, 305 other issues related to, 594
retention rate, 305 stock grants, 591
sustainable growth rate, 305 stock options, 591–594
Dividends, 238 Employee Retirement and Income Security Act
Double-entry accounting, 33 (ERISA), 586
Doubtful accounts, 134 Enron, 642
Dreamworks Animation SKG, 643 Equity, 93, 166, 169–170, 194–199, 325
DuPont analysis, 297–302 common shares (stock), 144
components of, 194–196
E ordinary shares, 144
Earnings recognition of current and deferred tax charged
expectations management, 730 directly to, 487–490
management activity, 728 shareholders’, 9, 28, 93, 158
manipulation of, 57–58 statement of changes in, 196–199
mean reversion in, 734–735 Equity analysis, 302–308
measures of the accrual component of, research on ratios in, 306–308
735–743 valuation ratios, 303–305
quality, 735–743 calculation of, 303–304

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 818 Index

Equity analysis (Continued ) contracts, 731–732

definition of selected, 303 mechanics, 25–78
dividend-related quantities, 305 accounting process, 36–52
interpretation of earnings per share, accounting systems, 55–57
304–305 accounts and financial statements, 27–36
Equity Asset Valuation, xxviii business activities, classification of, 26–27
Europe, capital markets regulation in, 84 quality, 723–787
European Securities Committee (ESC), 84 definitions, issues, and aggregate measures,
Expense recognition, 129–139, 761–773 733–750
general principles, 130–133 discretion in accounting systems, 725–733
issues in, 134–138, 761–773 framework for identifying low-quality
classification of ordinary expenses as financial reporting, 750–781
nonrecurring or nonoperating, 766–767 implications of fair value reporting, 782
deferring expenses, 763 warning signs, summary of, 779–781
depreciation and amortization, 134–138 standards, 79–112
doubtful accounts, 134 comparison of IFRS with alternative
understanding expenses, 761–763 reporting systems, 98–102
warranties, 134 convergence of global financial reporting
Expenses, 28, 29, 93, 129, 326, 726, 763 standards, 87–89
accrued, 54 effective financial reporting, 102–104
deferring, 763 International Financial Reporting Standards,
prepaid, 54, 184 13, 89–98
Exxon Mobil Corporation, 704, 710–712 International Organization of Securities
Commissions (IOSCO), 82–87
F monitoring developments in, 104–108
Fair value, 94, 177, 420 objective of financial reporting, 80–82
FASB Statement No. 95 (Statement of Cash standard-setting bodies and regulatory
Flows), 339 authorities, 82–83
Federal National Mortgage Association (Fannie Financial Services Authority (FSA), 82
Mae), 645–646 Financial statement analysis, 1–24, 259–321,
Fee revenue, 47, 71 349–388, 395–402
Finance costs, 338 applications, 349–388
Financial Accounting Standards Board (FASB), analyst adjustments to reported financials,
13, 82, 87, 88, 98, 103, 105, 120, 127, 371–385
221, 340 assessing credit risk, 364–367
Financial flexibility, 10 evaluating past financial performance,
Financial leverage, 288 351–356
ratio, 289–290 projecting future financial performance,
Financial notes and supplementary schedules, 356–364
13–14 screening for potential equity investments,
Financial position, 5 367–370
Financial reporting framework, 18–22, 262
effective, 102–104 analyze/interpret the processed data,
barriers to a single coherent framework, 21, 262
102–104 articulate the purpose and context of
framework, characteristics of an analysis, 19–20, 262
effective, 102 collect data, 20–21, 262
estimates in, 81 develop and communicate conclusions/
management, mechanisms disciplining, recommendations, 21–22, 262
732–733 follow up, 22, 262
manipulation incentives, 729–732 process data, 21, 262
capital markets, 729–731 implications of impairment charges in, 456–457

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 Index 819

of inventories, 395–402 objective of, 89–90

illustration, 396–402 preparation, challenges in, 326
inventory ratios, 396 presentation requirements, 96–98
major financial statements and other qualitative characteristics of, 91
information sources, 5–18 required, 95
supplementary information, 6–16 restraints on, 92
scope of, 2–5 statement of changes in owners’ equity, 12
techniques, 259–321 summary of IFRS required disclosures in the
business and geographic segments, 311–314 notes to, 98
common-size analysis, 270–275 using in security analysis, 57–57
computations and analysis, distinguishing Financing activities, 11, 27, 218
between, 261–264 direct method for determining cash flows from,
credit analysis, 308–311 237–238
equity analysis, 302–308 dividends, 238
graphs, 275–276 long-term debt and common stock, 237
model building and forecasting, 314 First Bancshares, 125
process, objectives of, 261 First in, first out (FIFO) method, 132, 133,
ratios, 265–269, 276–302 182, 341–342, 374–375, 393–395, 414,
regression analysis, 276 679–680
Financial statement elements and accounts, Fixed-charge coverage ratio, 290
27–30 Fixed costs, 288
Financial statements, consolidated, 632–636 Fixed Income Analysis, xxviii
business combination with less than 100 Ford Motor Credit, 762
percent acquisition, 633 Forecasting
consolidation process, 632 basic example of, 361–362
minority (noncontrolling) interests: balance consistency of forecasts, 363–364
sheet, 633–635 issues in, 359–360
Financial statements, major, 6–16, 50–52, Foreign currency financial statements, translation
57–58, 326 of, 671–713
auditor’s reports, 14–16 analytical issues, 688–699
balance sheet, 8–10, 50 conceptual issues, 672–676
cash flow statement, 10–12, 50–52 illustration of (excluding hyperinflationary
constraints on, 92 economies), 684–687
elements of, 27–30, 92–94 translation methods, 676–684, 703–713
assets, 92 current rate method, 676
equity, 93 disclosures related to, 704–713
expenses, 93 functional currency, 678–680
general requirements for, 94–98 highly inflationary economies, 681–684
income, 93 monetary/nonmonetary method, 676
liabilities, 93 temporal method, 676
measurement of, 94 translation of retained earnings, 680–681
recognition of, 94 using both at the same time, 703–713
underlying assumptions in financial when a foreign subsidiary operates in a
statements, 93 hyperinflationary economy, 699–703
financial notes and supplementary schedules, Foreign currency transactions, 658–671
13–14 analytical issues, 663–666
fundamental principles underlying the disclosures related to gains and losses, 666–671
preparation of, 96 exposure to foreign exchange risk, 659–663
income statement, 6–8, 50 accounting for, with intervening balance
Management’s Discussion and Analysis sheet date, 661–663
(MD&A), 14 accounting for, with settlement before
minimum required line items in, 97 balance sheet date, 660–661

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 820 Index

Foreign Currency Translation (SFAS No. 52), 660, H

672, 676, 678, 680, 682, 683–684, 700, Handbook of International Auditing, Assurance,
704, 705 and Ethics Pronouncements (International
Framework for the Preparation and Presentation of Federation of Accountants), 14
Financial Statements (IASB), 80–81, 119, Heineken NV, 666, 668–670
129–130, 324 Held-to-maturity securities, 327, 608
Held-for-trading securities, 327, 608
G Hewitt Associates, analysis of off-balance-sheet
Gains, 116, 119, 141–142 disclosures, 179–181
Gateway, 206–207, 264 Hewlett-Packard Co., 206–207
cash flow analysis of comparables, 252 cash flow analysis of comparables, 252
evaluation of liquidity ratio, 287 evaluation of liquidity ratio, 287
General Electric (GE), 745–747 Historical cost, 94, 177
General Electric Capital, 511 Hurricanes Katrina and Rita (2005), 141
General ledger, 56
Generally accepted accounting principles I
(U.S. GAAP) i2 Technologies, revenue recognition of, 129
analyst adjustments to revaluations in IFRS/ IAS 14 requirements, 311–313
U.S. GAAP comparisons, 343–344 IAS No. 1 (Presentation of Financial Statements),
authoritative guidance, 99 94, 117, 140
comparison of IFRS and, 496–499 IAS No. 7 (Cash Flow Statements), 339
convergence with IASB framework IAS No. 8 (Accounting Policies, Changes in
summary of differences between IFRS and Accounting Estimates and Errors), 142
U.S. GAAP frameworks, 100, 219–220 IAS No. 12, 470
effect of, versus IFRS on ROE comparisons, IAS No. 16 (Property, Plant, and Equipment), 135
354–355 IAS No. 19 (Employee Benefits), 560, 561
illustrations of cash flow statements prepared IAS No. 21, 678, 679, 682, 700, 704, 705
under, 224, 226–228 IAS No. 38 (Intangible Assets), 138
role of the SEC in, 99 If-converted method, 147–148, 152
GlaxoSmithKline, 636–638 IFRS No. 3, 624
Global Industrial Classification System (GICS), 203 IFRS No. 5 (Non-Current Assets Held for Sale and
Going concern, 93, 96 Discontinued Operations), 140
Goodwill, 30, 138, 190–192, 331–335, Impairment, 331, 420, 618
615–618, 638 implications of charges in financial statement
analyst adjustments related to, 376–378 analysis, 456–457
impairment of, 191–192, 459–460, 638–639 of intangible assets with a finite life, 458
calculating, 459–460 of long-lived assets
testing, 332–334 held for sale, 460
ratio comparisons for, 377–378 reversals of, 460–461
Google, 86 Income, 93, 119, 326
Graham, Benjamin, xxv comprehensive, 31
Graphs, use of as analytical tool, 275–276 Income statement, 6–8, 31, 50, 113–164, 326,
Gross profit margin, 117, 156, 292 336–339, 700
Group Danone, 115–118, 142, 143, 145 administrative expenses (including employee
consolidated financial statements and benefits), 337
statements of cash flows (2004–2005), analysis of, 152–156
244–246 common-size, 152–154
consolidated statements of income ratios, 154–156
(2002–2004), 115 basic equation underlying the, 6, 31
Grouping by function, 117 components and format of, 114–118
Grouping by nature, 117 comprehensive income, 157–159
Growth investors, 369 cost of sales, 337

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 Index 821

earnings per share, 144–152 controlling interest investments, 624–642

simple versus complex capital structure, consolidated financial statements, 632–636
144–145 contingent consideration, 640
elements, 326 contingent liabilities, 640
expense recognition, 129–139 date of acquisition, 630
general principles, 130–133 financial statement presentation subsequent
implications for financial analysis, 139 to business combination, 636–638
issues in, 134–138 goodwill, 638
finance costs, 338 goodwill impairment, 638–639
nonrecurring items and nonoperating items, in-process research and development, 640
139–144, 339 pooling of interests, 624–626
changes in accounting standards, 142–143 post-acquisition, 630–632
discontinued operations, 140 proposed joint project of the IASB and
extraordinary items, 140–141 FASB, 640–642
nonoperating items: investing and financing purchase method, 626–629
activities, 143–144 purchase price less than fair value (bargain
unusual or infrequent items, 141–142 purchase), 640
revenue recognition, 118–129 joint ventures, 622–624
for construction contracts, 337 minority active investments, 612–622
general principles, 119–121, 336–337 amortization of excess purchase price,
implications for financial analysis, 128–129 616–618
in special cases, 121–128 disclosure, 621
Income tax expense, 338–339 equity method of accounting, 612–615
Income taxes, 469–504 impairment, 618
accounting profit and taxable income, investment costs that exceed the book value
differences between, 470–476, 481–485 of the investee, 615–616
current tax assets and liabilities, 471–472 issues for analysts, 621–622
deferred tax assets and liabilities, 472–476 transactions with associates, 618–621
deductible temporary differences, 485 minority passive investments, 606, 607,
taxable temporary differences, 481–485 608–612
assets and liabilities, determining the tax base accounting for, 610–611
of, 476–480 available-for-sale investments, 608
changes in income tax rate, 479–480 designated fair value, 609–612
current and deferred tax, recognition and held-to-maturity investments, 608
measurement of, 486–490 held-for-trading securities, 608
charged directly to equity, recognition of, variable interest and special purpose entities,
487–490 642–648
valuation allowance, recognition of, 487 consolidated versus nonconsolidated
IFRS and U.S. GAAP, comparison of, 496–499 securitization transactions, 646–648
presentation and disclosure, 490–496 qualifying special purpose entities,
tax losses and credits, unused, 486 645–646
Industry-specific ratios, 306 securitization of assets, 644
Installment method, 125–126 SPE for a leased asset, illustration of, 643
Installment sales, 125–126 Interest
Intangible assets, 134, 138, 331, 187–192, 420, accrued, 73
428–435, 458. See also Assets, intangible expense, 47, 73
Intangible Assets (IAS No. 38), 138 bond, accounting for, 512–515
Integrated financial ratio analysis, 295–302 income, 47
DuPont analysis, 297–301 market rate of, 507
overall picture, 295 payable, 47
Intercorporate investments, 605–655 stated rate of payments, 507
basic categories, 606–607 Interest coverage ratio, 290

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 822 Index

International Accounting Standards Board marketable securities, 327–329

(IASB), 13, 80, 82, 83, 87, 88, 103, 105, property, plant, and equipment, 329–330
119–120, 340 provisions (nonfinancial liabilities), 336
International Accounting Standards Committee cash flow statement, 339–340
(IASC), 83, 330 IFRS Framework, 325–326
International Auditing and Assurance Standards challenges in financial statement
Board, 14 preparation, 326
International Federation of Accountants, 14 key aspects of, 325–326
International Financial Reporting Standards income statement, 336–339
(IFRS) administrative expenses (including employee
analyst adjustments to revaluations in IFRS/ benefits), 337
U.S. GAAP comparisons, 343–344 cost of sales, 337
comparison with alternative reporting systems, depreciation expenses, 337–338
98–102 finance costs, 338
implications of other reporting systems, nonrecurring items, 339
99, 101 revenue recognition for construction
reconciliation of financials prepared contracts, 337
according to different standards, 101 revenue recognition, general, 336–337
summary of differences between IFRS and standard setters’ agenda for convergence,
U.S. GAAP frameworks, 100, 219–220 340–341
U.S. GAAP, 98–99 Inventories, 30, 42, 44, 45, 70, 182–184, 329,
comparison of U.S. GAAP and, 496–499 389–418
effect of, versus U.S. GAAP on ROE accounting methods, 393–395
comparisons, 354–355 comparison of, 395
international adoption status of (2006), 88 analyst adjustments related to, 373–375
International Financial Reporting Standards costing and accounting methods, 129–139,
(IFRS) Framework, 89–98, 178, 325–326 390–395
financial statements determination of inventory cost, 391–392
constraints on, 92 declines in inventory value, 392–393
elements of, 92–94 financial analysis of, 395–402
objective of, 89–90 illustration, 396–402
qualitative characteristics of, 91 inventory ratios, 396
restraints on, 92 LIFO accounting method under U.S. GAAP,
key aspects of, 325–326 403–413
International Organization of Securities inventory financial note disclosures, 413
Commissions (IOSCO), 82–87 liquidations, 411–412
capital markets regulation reserve, 405–411
in Europe, 84 method choice, effects of, 413–415
in the United States, 85–87 financial statement effects of using LIFO,
International Paper Company, 367, 441–443 414
International Standards on Auditing, 84 method changes, 414–415
No. 200, 14 Investing activities, 11, 26–27, 217–218
International standards convergence, 323–347 net cash flow from, example, 218
accounting standards, effect of differences direct method for determining cash flows from,
between, 341–344 236–237
balance sheet, 326–336 Investment Advisers, Ltd. (IAL), 36–78
goodwill, 331–335 Investments, 47, 66, 72
income tax expense, 338–339 analyst adjustments related to, 371
intangible assets other than goodwill, intercorporate. See Intercorporate
335–336 investments
inventories, 329 long-term, 330–331
long-term investments, 330–331 in subsidiaries, branches, and associates, 485

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 Index 823

J current, 172, 184–185

JetBlue Airways corporation (JBLU), 778–779 determining the tax base of, 476–480
Johnson & Johnson (JNJ), 358–359 long-term. See Long-term liabilities
Joint ventures, 607, 622–624 measurement bases of, 177–194
interests in, 485 noncurrent, 172
Journal entries, 56 nonfinancial (provisions), 336
Jupitermedia (JUPM), 451–454 temporary differences at initial recognition of,
484–485
Liquidity, 3
K ratios, 154–156, 277, 284–287
Kahn Distribution Limited (KDL), 131–133 calculation of, 285–286
Kolenda Technology Group, 124 cash conversion cycle (net operating cycle),
Koninklijke KPN, 462, 462 286–287
Kraft Foods, 115–118, 140, 142, 143, 145, 154, cash ratio, 286
156, 455 current ratio, 286
consolidated statements of earnings defensive interval ratio, 286
(2002–2004), 116 definitions of commonly used, 285
gross profit margin (2002–2004), 156 evaluation of, 287
interpretation of, 286–287
L quick ratio, 286
Last in, first out (LIFO) method, 132–133, 182, Long-lived assets, 134, 419–468
341–342, 374–375, 393–395, 403–413, accounting for acquisition of intangible,
679–680 428–435
adjustment for a company using, 372–373 acquired in a business combination,
effects on financial statements and ratios, 433–435
341–342 developed internally, 429
financial statement effects of using, 414 purchased in situations other than business
illustration, 403–405 combinations, 428–429
inventory financial note disclosures, 413 accounting for acquisition of tangible,
liquidations, 411–412 420–428
illustration, 412 accounting standards related to
layer, 133 capitalization of expenditures, 421–425
reserve, 405–411 capitalization of interest costs, 426–428
illustration, 409–411 costs incurred at acquisition, 425
under U.S. GAAP, 403–413 amortizing intangible with finite useful
Leases, 527–553 lives, 444
advantages of leasing, 527 estimates required for calculations, 444
finance (or capital) leases versus operating asset retirement obligations (AROs), 444–449
leases, 527–544 reporting, 445–446
accounting and reporting by the lessee, depreciating tangible, 435–443
528–537 depreciation methods, 435–439
accounting and reporting by the lessor, estimates required for calculations, 439–440
538–544 using fixed asset disclosures to compare
off-balance-sheet financing, other types of, companies’ average age of depreciable
545–549 assets, 440–443
sale of receivables, 547–549 disposal of, 449–455
take-or-pay and throughput, 545–547 calculation of gain or loss on sale of,
Lenovo Group Limited, 280, 281–282 449–450
Liabilities, 28, 29, 93, 166, 169, 192–194, financial statement reporting the sale of,
325, 640 451–454
accrued, 185 other than by a sale, 454–455
contingent, 640 impairment of, 456–461

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 824 Index

Long-lived assets (Continued ) Microstrategy, 756

assets held for sale, 460 Minority interest, 174
goodwill and other intangibles with Model building and forecasting, 314
indefinite lives, 459–460 Modified Accelerated Cost Recovery System
intangible assets with a finite life, 458 (MACRS), 439
reversals of, 460–461 Monte Carlo simulation, 363
tangible assets held for use, 456–458 Moody’s Investors Service, 365–366, 367
revaluation of, 461–463 Motorola, 263–264, 359–360
Long-term contracts, 121–124 effect of U.S. GAAP versus IFRS on ROE
Long-term investments, 330–331 comparisons, 354–355
Long-term liabilities, 505–526, 549–553 historical performance of, 351–354
bonds payable, 506–519 revenue recognition policy for, 128–129
accounting for bond issuance, 506–512 MTR Gaming Group, 426–428
accounting for bond amortization, interest Multinational operations, 657–721
expense, and interest payments, 512–515 foreign currency transactions, 658–671
current market rates and fair values, 519 analytical issues, 663–666
debt covenants, 516–517 exposure to foreign exchange risk, 659–663
debt extinguishment, 515–516 disclosures related to gains and losses,
issued at a discount, 510–511 666–671
issued at face value, 507–509 translation of foreign currency financial
long-term debt, presentation and disclosure statements, 671–713
of, 517–519 analytical issues, 688–699
zero-coupon, 511 conceptual issues, 672–676
debt with equity features, 519–526 disclosures related to translation methods,
convertible debt, 519–522 704–713
debt with warrants, 522–524 illustration of translation methods
financial instruments with characteristics of (excluding hyperinflationary economies),
both debt and equity, 524–526 684–687
Look-ahead bias, 369 translation methods, 676–684
Losses, 116, 141–142 using both translation methods at the same
Louisiana-Pacific, 367 time, 703–713
when a foreign subsidiary operates in a
M hyperinflationary economy, 699–703
Management’s Discussion and Analysis (MD&A),
14, 57, 106, 356, 705 N
Managing Investment Portfolios: A Dynamic Process Nestlé SA, 658
(Maginn and Tuttle), xxviii Net asset balance sheet exposure, 675–676
Mark-to-market inventory accounting, 192, 392 Net liability balance sheet exposure, 675–676
Market-oriented investors, 369 Net asset value, 169
Marketable securities, 327–329 Net book value, 137, 507
accounting for, 328 Net income (loss), 31, 115
categories of, 328 Net operating assets (NOA), 738–739
Matching principle, 130 Net profit margin, 154, 293
Materiality, 91 Net realizable value (NRV), 182
Matsushita Electric Industrial Co., Ltd., 769–773 Net revenue, 114–115
Micron Technology, Inc. NetFlix, 762
consolidated balance sheets, 491–492 New Era Network Associates, 123
consolidated statements of operations, 491 New products or types of transactions, 104
income taxes note to the consolidated financial Nokia, 263–264, 354–356
statements, 492–494 effect of U.S. GAAP versus IFRS on ROE
Microsoft Corporation, 429–430, 777 comparisons, 354–355
balance sheets (2006–2007), 752–753 Noncurrent assets, 30, 172

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 Index 825

Noncurrent liabilities, 172 pension expense, 568–569

Non-Current Assets Held for Sale and Discontinued measuring a defined-benefit pension plan’s
Operations (IFRS No. 5), 140 periodic costs, 560–561
Nonoperating items, 143–144 types of postretirement benefit plans and
Norwalk Agreement, 87 the implications for financial reports,
Notes payable, 185 556–559
NOVA Chemicals Corporation, 767–769 Percentage-of-completion method, 122–124
Novartis, 609–610 Period costs, 130–131
Pfizer Inc., 450–451
O Prepaid expenses, 54, 184
Off-balance-sheet financing, 545–549 Prepaid rent, 47, 67, 72
analyst adjustments related to, 378–385 Present value, 94, 177
liabilities, 773–776 Presentation of Financial Statements (IAS No. 1),
Office of the Comptroller of the Currency, 82 94, 117, 140
Operating activities, 11, 26, 27, 217 Pretax margin, 156, 292–293
direct method for determining cash flows from, Price-to-earnings ratio (P/E), 4
231–236 Prime Retailers (PR), 103–104
cash paid to employees, 234 Profit and loss (P&L) statement, 6. See also
cash paid for income taxes, 236 Income statement
cash paid for interest, 235 Profit versus cash flow, 3
cash paid for other operating expenses, Profit margin, 154
234–235 Profitability ratios, 277, 291–294
cash paid to suppliers, 233–234 calculation of, 291
cash received from customers, 231–232 definitions of commonly used, 292
Operating efficiency ratios. See Activity ratios evaluation of, 294
Operating income (profit), 8, 117 gross profit margin, 292
Operating leverage, 288 interpretation of, 292–293
Operating profit margin, 156, 292 net profit margin, 293
Owners’ equity, 8, 28, 29, 166. See also operating profit margin, 292
Shareholders’ equity return on assets, 293
statement of, 52 return on total capital, 293
statement of changes in, 12 Projecting future financial performance, 356–364
market-based valuation, input to, 357–360
P issues in forecasting, 359–360
Partners’ capital, 9, 28. See also Owners’ equity using historical operating profit margins to
Past financial performance, evaluating, 351–356 forecast operating profit, 358–359
Payroll expense, 47 projecting multiple-period performance,
Pensions and other postretirement benefits, 360–364
556–589 Property, plant, and equipment, 28, 30, 329–330,
evaluating disclosures of pension and other 420, 440–443, 615, 727
postretirement benefits, 574–589 analyst adjustments related to, 375
assumptions, 574–579 Property, Plant, and Equipment (IAS No. 16), 135
cash flow information, 586–589 Proportionate consolidation, 622
underlying economic expense (or income), Provisions (nonfinancial liabilities), 336
579, 582–586 Public Company Accounting Oversight Board
underlying economic liability (or asset), (PCAOB), 14
579–581 Purchase method of accounting, 433, 626–629
financial statement reporting of pension and Purchasing power loss/gain, 700
other postretirement benefits of, 561–574
assumptions and actuarial gains and losses, Q
impact of, 569–574 Quantitative Investment Analysis, xxviii
balance sheet, 561–568 Quick ratio, 286

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 826 Index

R implications for financial analysis, 128–129

Ratio analysis, 58, 154–156, 206–207, 265–269, issues, 751–761
276–302, 377–378 misstatement, 751–755
common ratios used in financial analysis, as source of accounting discretion, 729
276–302 in special cases, 121–128
activity ratios, 277, 278–284 barter, 126–127
interpretation and context, 277–278 gross versus net reporting, 127–128
liquidity ratios, 277 installment sales, 125–126
profitability ratios, 277 long-term contracts, 121–124
solvency ratios, 277 Roche Group, 172–174, 208–209, 222–224, 229
valuation ratios, 277
comparisons for goodwill, 377–378 S
sources of ratios, 269 S&P 500
universe of ratios, 266–268 common-size balance sheet statistics for
value, purpose, and limitations of, 268–269 (2005), 204–205
Ratios, industry- and task-specific, 306, 307 common-size income statements statistics for
Realizable (settlement) value, 94 (2005), 155
Regulation FD, 87 SABMiller plc., 585–586
Regulation, industry-specific, 82 Sales, 115
Regression analysis, 276 Sales returns and allowances, 30
Rent expense, 47, 72 Salvage value, 37
Reporting of Comprehensive Income (SFAS No. SAP AG, 186–187
130), 195–196 Sarbanes-Oxley Act of 2002, 14, 15, 85, 98, 545
Research and development (R&D), 429–435 Scenario analysis, 314
in-process, 640 Screening for potential equity investments,
Residual claim, 31 367–370
Restructuring charges, 141 ratio-based, 370
Retail method, 183 Security analysis, using financial statements in,
Retention rate, 305 57–58
Retrospective application, 142 accounts and entries, use of judgment in, 57
Return on assets (ROA) ratio, 267–268, 293 misrepresentations, 58
Return on equity (ROE), 268 Securities Act of 1933, 85
decomposition of, 297–302 Securities Exchange Act of 1934, 85
five-way, 301–302 Securities and Exchange Commission (SEC), 82,
Return on sales, 154 107, 120, 356, 545, 574
Return on total capital, 293 filings, 85–87
Revaluation, 461–463 annual report, 86
Revenue, 28, 29, 44, 45, 70, 114–115, 726 Form 11-K, 87
accelerating, 755–760 Form 144, 87
problems, range of, 755 Form 8-K, 87
warning signs, 755–757 Form 20-F, 645, 646
classification of nonrecurring or nonoperating Forms 3, 4, and 5, 87
as operating, 760–761 Forms 10-K, 20-F, and 40-F, 86, 647
problems, range of, 760 Forms 10-Q and 6-K, 86–87
warning signs, 761 other filings, 87
gross versus net reporting of, 127–128 proxy statement/form DEF-14A, 86
unbilled (or accrued), 53–54 initial registration statement, 86
unearned (or deferred), 53, 185–187, 751 report on off-balance-sheet financing
analysis of, 186–187 (2005), 379
Revenue recognition, 118–129, 729 Selling, general and administrative (SG&A), 761
for construction contracts, 337 Sennett Designs, 3
general principles, 119–121, 336–337 Sensitivity analysis, 314

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 Index 827

SFAS No. 52 (Foreign Currency Translation), 660, Statement of owners’ equity, 52

672, 676, 678, 680, 682, 683–684, 700, Statements of financial accounting standards, 13
704, 705 Statement of retained earnings, 32–33, 52
SFAS No. 130 (Reporting of Comprehensive Statutory consolidation, 625
Income), 195–196 Statutory merger, 625
SFAS No. 109, 470 Stelle Technology, 123–124
SFAS No. 140, 645 Stock appreciation rights (SARs), 594
SFAS No. 141, 624, 641 Stockholders’ equity, 28. See also Owners’ equity
SFAS No. 158, 562, 586 Straight-line method of depreciation, 135, 375
SFAS No. 159, 613 Survivorship bias, 369
Shareholders’ equity, 9, 28, 93, 158, 166. See also Sustainable growth rate, 305
Owners’ equity Syngenta, 101–102, 108
statement of changes in, 196–199 impact of recently issued accounting
Sheppard, C. Stewart, xxvi standards, 108
Siemens AG, 744–747 reconciliation of GAAP income, 101
Simulation, 314
Software development costs, 430–433 T
Solvency, 3, 288 T-accounts, 56, 62–78
ratios, 154–156, 277, 288–291 Tangible assets, 187, 420–428, 435–443,
calculation of, 288–289 456–458. See also Assets, tangible
debt-to-assets ratio, 289 Tax base, 471
debt-to-capital ratio, 289 Tax expense, 471
debt-to-equity ratio, 289 Tax loss carry forward, 471
definition of commonly used, 289 Taxable income, 470–476
evaluation of, 290–291 Tech Data Corporation, 224, 226
financial leverage ratio, 289–290 Telefónica Group, 224, 225–226
fixed-charge coverage ratio, 290 Temporary differences, 472–473, 481–485
interest coverage ratio, 290 deductible, 482
interpretation of, 289–291 examples of, 482–484
Sony Corporation, 172, 174–177, 197–199 at initial recognition of assets and liabilities,
South Central Missouri Title Company, 125 484–485
Special purpose entities (SPEs), 642–648, 781 taxable, 481–482
qualifying, 645–646 treatment of, 482
Specific identification method, 132 Tesco, 30
Standard cost, 183 Thomson Corporation, 764
Standards Advisory Council, 83 TomTom, 358–359
“Standards for Educational and Psychological Top-down analysis, 368
Testing,” xxvi Total invested capital, 356
Standards of Practice Handbook (SOPH) (CFA Toyota Motor Corp., 645
Institute), 22 Trade accounts receivable, 28
Statement of cash flows. See Cash flow statement Trade receivables, 28, 30, 182
Statement of Cash Flows (FASB Statement Trading securities, 157
No. 95), 339 Transparency, 102
Statement of changes in owners’ equity, 12 Treasury stock method, 149–150
Statement of changes in shareholders’ equity, Trial balance, 56
196–199
Statement of financial condition, 8, 166. See also U
Balance sheet Unbilled (or accrued) revenue, 53
Statement of financial position, 8, 31, 166. See Unclassified balance sheet, 40–41
also Balance sheet Unearned revenue (or fees), 42, 47, 53, 68, 71,
Statement of operations, 6, 32. See also Income 119, 185–187
statement analysis of, 186–187

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 828 Index

United Microelectronics Corp. (UMC), 283–284 Wal-Mart (WMT)

United States Cellular Corporation (USM), 434 cash flow statements (2004–2005),
Uniting of interests, 625 227–228
Unrealized gains, 47 consolidated balance sheets (2004–2005),
UPM-Kymmene Corporation (UPM), 441–443 9–10
consolidated statements of cash flows
V (2003–2005), 11–12
Valuation, 102–103 consolidated statements of income
adjustments, 54–55 (2003–2005), 7, 8
allowance, 471 independent audit report (2005), 15, 16
recognition of, 487 off-balance-sheet debt, 774–776
ratios, 277, 303–305 report to shareholders on corporate governance
calculation of, 303–304 and internal control (2005), 16,
definition of selected, 303 17–18
dividend-related quantities, 305 Warranties, 134
interpretation of earnings per share, 304–305 Waste Management, Inc. (WMI), 447–449
Value investors, 369 Weighted average cost (WAC) method, 132,
Variable costs, 288 133, 182
Variable interest entities (VIEs), 642–648 Wheeling-Pittsburgh Corporation,
Variable interests, 625 545–547
Vicon Industries, 141 Working capital, 282–283
Vodafone Group, PLC, 191–192 WorldCom, 57–58
Volvo Group, 607, 621
Y
W Yahoo! Inc., 705, 709–710
Wages
accrued, 47, 70, 71 Z
expense, 70, 71 Z-score, 310–311

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