Financial Reporting and Analysis

Lecture (3)
 Multi-Step Income
Statement and Ratio Analysis
Lecture 3
Process of Business Analysis
SWOT Analysis Business Environment and
Strategy Analysis
To what extent is the
Strategy Analysis company having a
Industry Analysis
competitive advantage

Forecasted earnings,
cashflows, ….etc
Financial Analysis
Profitability –
Accounting Liquidity – Risk Prospective
Analysis of Cash Flows
Analysis Solvency Analysis Analysis
Analysis
Valuation models
The quality of financial
Cost of capital Intrinsic value
reporting and to what extent
estimates
records reflect reality
MCQs
1. Which of the following accounts would not appear on a conventional balance sheet?
a) Accounts receivable
b) Accounts payable
c) Patents
d) Gain from sale of land
e) Common stock

2. Current assets typically include all but which of the following assets?
a) Cash restricted for the retirement of bonds
b) Unrestricted cash
c) Marketable securities
d) Receivables
e) Inventories

3. Inventories are the balance of goods on hand. In a manufacturing firm, they include all but which of the following?
a) Raw materials
b) Work in process
c) Finished goods
d) Supplies
e) Construction in process
4. Which of the following is not true relating to intangibles?
a) Research and development usually represents a significant intangible on the financial statements.
b) Goodwill arises from the acquisition of a business for a sum greater than the physical asset value.
c) Purchased goodwill is not amortized but is subject to annual impairment reviews.
d) The global treatment of goodwill varies significantly.
e) Intangibles are usually amortized over their useful lives or legal lives, whichever is shorter.
5. Which of the following is not a typical current liability?
a) Accounts payable
b) Wages payable
c) Interest payable
d) Pension liabilities
e) Taxes payable
6. Treasury stock is best classified as a
a) Current liability.
b) Current asset.
c) Reduction of stockholders’ equity.
d) Contra asset.
e) Contra liability.
7. For the issuing firm, redeemable preferred stock should be classified where for analysis purposes?
a) Marketable security
b) Long-term investment
c) Intangible
d) Liabilities
e) Shareholders’ equity
Question (1): Classify the following revenues and expenses as whether they are from continuing operation,
discontinued activities, extraordinary activities or other

a. Selling expense Continuing

b. Interest expense Continuing/other

c. Gain on the sale of marketable securities Other

d. Loss from flood Extraordinary

e. Income tax expense Continuing

f. Loss from prohibition of red dye Extraordinary

g. Loss from the write-down of inventory Continuing

Question (2): Prepare the multistep income statement
Income Statement
Sales $1,000,000
Less: Cost of Goods Sold
Beginning Inventory 650,000
+ Purchases 460,000
- Ending Inventory (440,000)
($670,000)

Gross Profit 330,000

Less: Operating Expenses
Selling Expenses 43,000
Administrative Expenses 62,000
($105,000)
Operating income (EBIT) $225,000
- Interest Expense (20,000)
Income before taxes (EBT) $205,000
- Tax Expense (100,000)
Net income From Continuing Activities $105,000
Loss from Extra ordinary items (30,000)
Net Income $75,000
Net income From Continuing Activities $105,000
EPS before extraordinary items = 105,000/100,000 = $1.05
Net EPS = 75,000/100,000 = $0.75
Problems with Balance sheet and Income Statement
• Many assets are valued at cost, so one cannot determine the market value or
replacement cost of many assets and should not assume that their balance sheet
amount approximates current valuation.
• Varying methods are used for asset valuation. For example, inventories may be
valued differently from firm to firm and, within a firm, from product to product.
Similar problems exist with long-term asset valuation and the related depreciation
alternatives.
• A different type of problem exists in that not all items of value to the firm are
included as assets. For example, such characteristics as good employees,
outstanding management, and a well-chosen location do not appear on the
balance sheet.
• In the same vein, liabilities related to contingencies also may not appear on the
balance sheet. These problems do not make statement analysis impossible, but
rather they merely require that qualitative judgment be applied to quantitative
data in order to assess the impact of these problem areas.
• The main problem of income statements is the some accounts are based on
estimates such as depreciation expense, bad debt expense.
Question (3): Classification of balance sheet accounts

Account Asset Liability Owners’

Current Non-Current Current Non-current Equity
a) Supplies x
b) Notes receivable x
c) Unearned subscription revenue x

d) Accounts payable x
e) Retained earnings x
f) Accounts receivable x
g) Preferred stock x
h) Prepaid rent x
i) Plant x
j) Capital x
k) Wages payable
l) Mortgage bonds payable x
m) Unearned interest x
n) Marketable securities x
x
o) Paid-in capital from sale of common stock
p) Land x
q) Inventories x
r) Taxes accrued x
s) Cash x
t) Long-term investment in stock x
u) Goodwill x
v) Marketable securities x
w) Copyrights x
Question (4): Income statement

a) Compute the net earnings remaining after removing nonrecurring items.

$146,000

b) Determine the earnings (loss) from the nonconsolidated subsidiary.

$20,000

c) Determine the total tax amount.

94,000 – 30,000 -50,000 + 25,000 = $39,000
Case (1): Balance sheet

1. The statement is entitled “Consolidated Balance Sheets.” What does it mean to have a consolidated balance sheet?
Existence of a parent and subsidiary companies
1. What is the gross amount of current receivables at October 2, 2010?

$5,454

1. Does there appear to be a significant increase in projects in progress?

Adequately yes

1. Are projects in progress and land depreciated?

No

1. What is the amount of total assets at October 2, 2010?

$69,206
1. What is the total current assets at October 2, 2010?

$12,225
1. What is the total inventory at October 2, 2010? Does the inventory method appear to
be conservative? Comment.
$1,442
1. How many common shares had been issued as of December 31, 2010? 2. How many shares were held in the treasury at
December 31, 2010? 3. How many shares were outstanding at December 31, 2010?
2.7 billion, 803.1 million 1896.9 million
1. Describe treasury stock and how it is reported.

Repurchase of stock , a reduction in capital

1. Describe non-controlling interests.

Minority interest
 End of Lecture (3)
• Covered Today
• Multi-step Income Statements
• Criticism of Balance sheet and Income statement
• Re-cap on Balance sheet