Financial Reporting and Statement Analysis A Strategic Approach

by Stickney, Clyde P.; Brown, Paul; Wahlen, James M.

• ISBN13: 9780324186383
• ISBN10: 032418638X
• Edition: 5th
• Format: Hardcover
• Copyright: 2003-07-18
• Publisher: South-Western College Pub

Summary

The premise of the text is that students learn financial statement analysis most effectively by performing the analysis on actual companies. Students learn to integrate concepts from economics, business strategy, accounting, and other business disciplines. The text is designed for courses on financial statement analysis and financial reporting found in accounting, finance, and economics departments.

Table of Contents

Chapter 1 Overview of Financial Reporting and Financial Statement Analysis	1	(70)
Overview of Financial Statement Analysis	2	(2)
Step 1: Identify the Industry Economic Characteristics	4	(7)
Tools for Studying Industry Economics	6	(5)
Value Chain Analysis	6	(2)
Porter's Five Forces Classification	8	(2)
Economic Attributes Framework	10	(1)
Step 2: Identify the Company Strategy	11	(3)
Framework for Strategy Analysis	11	(2)
Application of Strategy Framework to PepsiCo's Beverage Segment	13	(1)
Step 3: Assess the Quality of the Financial Statements	14	(18)
Balance Sheet-Measuring Financial Position	15	(6)
Income Statement-Measuring Operating Performance	21	(6)
Statement of Cash Flows	27	(4)
Summary of Financial Statements and Notes	31	(1)
Step 4: Analyze Profitability and Risk	32	(4)
Tools of Profitability and Risk Analysis	32	(4)
Step 5: Value the Firm	36	(35)
Role of Financial Statement Analysis in an Efficient Capital Market	37	(1)
Sources of Financial Statement Information	38	(1)
Summary	39	(1)
Problems and Cases	40	(20)
Case 1.1 Nike: Somewhere between a Swoosh and a Slam Dunk	60	(11)
Chapter 2 Asset and Liability Valuation and Income Measurement	71	(40)
Asset and Liability Valuation	72	(7)
Historical Value: Acquisition Cost	72	(1)
Historical Value: Adjusted Acquisition Cost	73	(1)
Historical Value: Present Value of Cash Flows Using Historical Interest Rates	74	(2)
Current Values: Current Replacement Cost	76	(1)
Current Values: Net Realizable Value	76	(1)
Current Values: Present Value of Cash Flows Using Current Interest Rates	77	(1)
GAAP Valuations	78	(1)
Income Recognition	79	(5)
Treatment 1: Value Changes Recognized on the Balance Sheet and Income Statement When Realized	79	(2)
Treatment 2: Value Changes Recognized on the Balance Sheet When They Occur but Recognized in Net Income When Realized	81	(1)
Treatment 3: Value Changes Recognized on the Balance Sheet and the Income Statement When They Occur	82	(2)
Summary of Asset and Liability Valuation and Income Recognition	84	(1)
Accounting for Income Taxes	84	(9)
Overview of Income Tax Accounting	85	(4)
Measuring Income Tax Expense: A Bit More to the Story	89	(3)
Reporting Income Taxes in the Financial Statements	92	(1)
Framework for Analyzing the Effects of Transactions on the Financial Statements	93	(6)
Overview of Analytical Framework	95	(4)
Summary of Analytical Framework	99	(1)
Summary	99	(1)
Problems and Cases	100	(11)
Chapter 3 Income Flows versus Cash Flows: Key Relationships in the Dynamics of a Business	111	(65)
Income Flows, Cash Flows, and Life Cycle Relations	113	(14)
Net Income and Cash Flow from Operations	113	(4)
Relation between Cash Flows from Operating, Investing, and Financing Activities	117	(2)
Illustrations of Cash Flow Relations	119	(8)
Preparing the Statement of Cash Flows	127	(9)
Algebraic Formulation	128	(1)
Classifying Changes in Balance Sheet Accounts	128	(7)
Illustration of the Preparation Procedure	135	(1)
Summary	136	(2)
Problems and Cases	138	(16)
Case 3.1 W.T. Grant Co.	154	(22)
Chapter 4 Profitability Analysis	176	(86)
Profitability Analysis	178	(1)
Rate of Return on Assets	178	(28)
Disaggregating ROA	181	(1)
Economic and Strategic Factors in the Interpretation of ROA	182	(10)
Analyzing the Profit Margin for ROA	192	(6)
Analyzing Total Assets Turnover	198	(4)
Supplementing ROAR in Profitability Analysis	202	(4)
Rate of Return on Common Shareholders' Equity	206	(5)
Earnings per Common Share	211	(3)
Calculating EPS	211	(3)
Criticisms of EPS	214	(1)
Interpreting Financial Statement Ratios	214	(2)
Comparisons with Corresponding Ratios of Earlier Periods	214	(1)
Comparisons with Corresponding Ratios of Other Firms	215	(1)
Summary	216	(1)
Problems and Cases	217	(27)
Case 4.1 Profitability and Risk Analysis of Wal-Mart Stores	244	(8)
Case 4.2 Specialty Apparel Retailing: The Gap and Limited Brands	252	(10)
Chapter 5 Risk Analysis	262	(80)
Framework for Risk Analysis	263	(2)
Analyzing Short-term Liquidity Risk	265	(6)
Analyzing Long-term Solvency Risk	271	(4)
Analyzing Credit Risk	275	(6)
Analyzing Bankruptcy Risk	281	(15)
The Bankruptcy Process	281	(1)
Models of Bankruptcy Prediction	282	(11)
Synthesis of Bankruptcy Prediction Research	293	(3)
Market Equity Beta Risk	296	(2)
Financial Reporting Manipulation Risk	298	(6)
Motivations for Earnings Manipulation	299	(1)
Empirical Research on Earnings Manipulation	299	(2)
Application of Beneish's Model to Sunbeam Corporation	301	(3)
Summary of Income Manipulation Risk	304	(1)
Summary	304	(1)
Problems and Cases	305	(8)
Case 5.1 Massachusetts Stove Company-Bank Lending Decision	313	(7)
Case 5.2 Fly-By-Night International Group: Can this Company Be Saved?	320	(11)
Case 5.3 Millennial Technologies: Apocalypse Now	331	(11)
Chapter 6 Quality of Accounting Information and Adjustments to Reported Financial Statement Data	342	(86)
Accounting Quality	343	(6)
High Quality Reflects Economic Information Content	344	(2)
High Quality Signals Earnings Persistence Over Time	346	(3)
Discontinued Operations	349	(4)
Extraordinary Items	353	(2)
Changes in Accounting Principles	355	(5)
Items of Other Comprehensive Income	360	(2)
Impairment Losses on Long-lived Assets	362	(3)
Restructuring and Other Charges	365	(6)
Changes in Estimates	371	(3)
Gains and Losses from Peripheral Activities	374	(2)
Restated Financial Statement Data	376	(1)
Account Classification Differences	377	(4)
Financial Reporting Worldwide	381	(2)
Earnings Management	383	(2)
Summary	385	(1)
Problems and Cases	386	(20)
Case 6.1 International Paper: A Recurring Dilemma	406	(6)
Case 6.2 Tanaguchi Corporation-Part A	412	(1)
Appendix 6.1 (Case 6.2) Unconsolidated Financial Statements for Tanaguchi Corporation	413	(6)
Appendix 6.2 (Case 6.2) Comparison of U.S. and Japanese GAAP	419	(6)
Case 6.3 Tanaguchi Corporation-Part B	425	(3)
Chapter 7 Revenue Recognition and Related Expenses	428	(91)
Income Recognition	429	(19)
Criteria for Revenue Recognition	430	(3)
Criteria for Expense Recognition	433	(1)
Application of Revenue and Expense Recognition Criteria	434	(5)
Income Recognition for Long-term Contractors	439	(5)
Revenue Recognition when Cash Collectibility Is Uncertain	444	(4)
Inventory Cost-flow Assumption	448	(11)
FIFO	449	(1)
LIFO	449	(3)
Weighted Average	452	(1)
Conversion from LIFO to FIFO	452	(4)
Stock Price Reaction to Changes in Inventory Cost-flow Assumption	456	(1)
Persistent Earnings and the Cost-flow Assumption	457	(2)
Accounting for Fixed Assets	459	(7)
Fixed Asset Valuation	459	(1)
Depreciable Life	460	(2)
Depreciation Method	462	(2)
Impairment of Fixed Assets	464	(1)
Persistent Earnings and Fixed Asset Reporting	464	(2)
Accounting for Intangible Assets	466	(9)
Accounting for Research And Development Costs	468	(2)
Accounting for Software Development Costs	470	(2)
Accounting for Goodwill	472	(1)
Persistent Earnings and Intangible Asset Reporting	473	(1)
Valuing Intangibles-Is It Possible?	474	(1)
Summary	475	(1)
Appendix 7.1 Accounting for the Effects of Changing Prices	476	(6)
Problems and Cases	482	(12)
Case 7.1 Arizona Land Development Company	494	(9)
Case 7.2 Chiron Corporation-An R&D Puzzle	503	(4)
Case 7.3 Corporãcion Industrial Sanluis: Coping With Changing Prices	507	(4)
Case 7.4 America Online: Past Reporting Vindicated?	511	(8)
Chapter 8 Liability Recognition and Related Expenses	519	(123)
Principles of Liability Recognition	520	(1)
Principles of Liability Valuation	521	(1)
Application of Criteria for Liability Recognition	522	(4)
Controversial Issues in Liability Recognition	526	(8)
Issuance of Hybrid Securities	526	(1)
Off-Balance-Sheet Financing Arrangements	527	(7)
Leases	534	(12)
Operating Lease Method	535	(1)
Capital Lease Method	536	(2)
Choosing the Accounting Method	538	(2)
Effects on Lessor	540	(3)
Lease Accounting for Tax Purposes	543	(1)
Converting Operating Leases to Capital Leases	543	(3)
Impact of Accounting for Operating Leases as Capital Leases	546	(1)
Derivative Instruments	546	(18)
Nature and Use of Derivative Instruments	548	(1)
Accounting for Derivatives	549	(3)
Illustrations of Accounting for Derivatives	552	(9)
Summary of Examples	561	(1)
Disclosures Related to Derivative Instruments	561	(2)
Accounting Quality Issues and Derivatives	563	(1)
Retirement Benefits	564	(15)
Pensions	564	(12)
Analysts' Treatment of Pensions	576	(1)
Impact of Actuarial Assumptions	577	(1)
Signals about Earnings Persistence	578	(1)
Postretirement Benefits Other than Pensions	579	(1)
Income Taxes	580	(14)
Review of Income Tax Accounting	580	(3)
Required Income Tax Disclosures	583	(7)
Assessing a Firm's Tax Position	590	(1)
Analyzing PepsiCo's Income Tax Disclosures	591	(3)
Summary of Income Taxes	594	(1)
Understanding Reserves in the Financial Statements	594	(4)
Nature of a Reserve Account	596	(1)
Use of Reserve Accounts	596	(2)
Summary of Reserves	598	(1)
Summary	598	(1)
Problems and Cases	599	(29)
Case 8.1 American Airlines and United Airlines: A Pension for Debt	628	(9)
Case 8.2 CIFRA: Remodeling the Financial Statements	637	(5)
Chapter 9 Intercorporate Entities	642	(96)
Corporate Acquisitions	643	(9)
Overview of the Purchase and Pooling-of-Interests Methods	644	(1)
Illustration of the Purchase Method	645	(5)
Corporate Acquisitions and Income Taxes	650	(1)
Corporate Disclosures on Acquisitions	651	(1)
Investments in Securities	652	(21)
Accounting for Investments	652	(1)
Percentage of Voting Stock	653	(1)
Minority, Passive Investments	654	(5)
Minority, Active Investments	659	(2)
Majority, Active Investments	661	(9)
Primary Beneficiary of a Variable Interest Entity	670	(2)
Income Tax Consequences of Investments in Securities	672	(1)
Foreign Currency Translation	673	(12)
Functional Currency Concept	674	(1)
Translation Methodology-Foreign Currency Is Functional Currency	674	(5)
Translation Methodology-U.S. Dollar Is Functional Currency	679	(1)
Implications of Functional Currency Determination for Analysis	680	(4)
Foreign Currency Translation and Income Taxes	684	(1)
Accounting for Stock-based Compensation	685	(4)
Summary	689	(1)
Problems and Cases	689	(23)
Case 9.1 Fisher Corporation	712	(15)
Case 9.2 Clark Equipment Company: Analyzing a Joint Problem	727	(7)
Case 9.3 Loucks Corporation: Obtaining Security in Translation	734	(4)
Chapter 10 Forecasting Pro Forma Financial Statements	738	(69)
Overview	739	(1)
Introduction to Forecasting	739	(2)
Preparing Pro Forma Financial Statements	741	(6)
General Forecasting Principles	742	(1)
Six-Step Forecasting Game Plan	743	(2)
Practical Tips for Implementing the Six-Step Game Plan	745	(1)
Using FSAP to Prepare Pro Forma Financial Statements	746	(1)
Step 1: Project Sales and Other Revenues	747	(5)
Projecting Sales	747	(4)
Projecting Other Revenues	751	(1)
Step 2: Project Operating Expenses	752	(2)
Step 3: Project the Assets on the Balance Sheet	754	(9)
Step 4: Project Liabilities and Shareholders' Equity	763	(7)
Step 5: Project Interest Expense, Interest Income, Income Tax Expense, and the Change in Retained Earnings	770	(5)
Closing the Loop: Solving for Co-Determined Variables	774	(1)
Step 6: Projecting the Statement of Cash Flows	775	(3)
Shortcut Approaches to Forecasting	778	(4)
Analyzing Pro Forma Financial Statements	782	(2)
Sensitivity Analysis and Reactions to Announcements	784	(1)
Summary	785	(1)
Problems and Cases	786	(11)
Case 10.1 Massachusetts Stove Company: Analyzing Strategic Options	797	(10)
Chapter 11 Valuation: Cash-flow-based Approaches	807	(72)
Introduction and Overview	808	(1)
Rationale for Cash-flow-based Valuation	809	(2)
Overview of Cash-flow-based Valuation	811	(1)
Measuring Periodic Free Cash Flows	811	(12)
Continuing Value of Future Free Cash Flows	823	(4)
Discount Rates	827	(10)
Cash-flow-based Valuation Equations	837	(3)
Illustrations of Cash-flow-based Valuation	840	(1)
Valuation of a Single Project	840	(14)
Valuation of PepsiCo	842	(1)
Valuation of PepsiCo Using Free Cash Flows to All Debt and Equity Capital Stakeholders	843	(5)
Valuation of PepsiCo Using Free Cash Flows to Common Equity Shareholders	848	(6)
Evaluation of Present Value of Cash Flows Valuation Method	854	(1)
Summary	854	(1)
Problems and Cases	854	(9)
Cases	863	(1)
Case 11.1 Holmes Corporation: LBO Valuation	863	(16)
Chapter 12 Valuation: Earnings-based Approaches	879	(33)
Introduction and Overview	880	(1)
Rationale for Earnings-based Valuation	881	(3)
Earnings-based Valuation: Practical Advantages and Common Concerns	884	(2)
Theoretical and Conceptual Foundations for Residual Income Valuation	886	(4)
Residual Income Model with Finite Horizon Earnings Forecasts and Continuing Value Computation	890	(2)
Valuation of PepsiCo Using the Residual Income Model	892	(6)
Discount Rates for Residual Income	893	(1)
PepsiCo's Book Value of Equity and Residual Income	893	(2)
Discounting PepsiCo's Residual Income to Present Value	895	(1)
Necessary Adjustments to Compute Common Equity Share Value	896	(1)
Sensitivity Analysis and Investment Decision-Making	896	(2)
Residual Income Model Implementation Issues	898	(4)
Dividends Valuation Model	902	(4)
Application of the Dividends Valuation Model to PepsiCo	904	(2)
Causes of Differences in Residual Income, Dividends, and Free Cash Flow Value Estimates	906	(1)
Summary Comments on Valuation	907	(1)
Problems and Cases	908	(3)
Cases	911	(1)
Chapter 13 Valuation: Market-based Approaches	912	(50)
Introduction and Overview	913	(2)
Market Multiples of Accounting Numbers	915	(1)
Market-to-Book and Value-to-Book Ratios	916	(9)
A Theoretical Model of the Value-to-Book Ratio	916	(5)
Reasons Why VB Ratios and MB Ratios May Differ from One	921	(1)
Empirical Data on MB Ratios	922	(1)
Empirical Research Results on the Predictive Power of MB Ratios	922	(3)
Application of the Value-to-Book Model to PepsiCo	925	(4)
Price-Earnings and Value-Earnings Ratios	929	(14)
A Theoretical Model for the Value-Earnings Ratio	929	(1)
Price-Earnings Ratios	930	(12)
Summary of VE And PE Ratios	942	(1)
Using Market Multiples of Comparable Firms	943	(1)
Price Differentials	944	(4)
Computing PDIFF for PepsiCo	945	(3)
Reverse Engineering	948	(2)
Reverse Engineering PepsiCo's Stock Price	948	(2)
The Relevance of Academic Research for the Work of the Security Analyst	950	(5)
Level of Aggregation Issue	951	(1)
Theory Development and Practice Feed Each Other	951	(1)
Has the Theory of Capital Market Efficiency Gotten in the Way?	952	(1)
Striking Evidence on the Degree of Market Efficiency and Inefficiency with Respect to Earnings	953	(2)
Summary	955	(1)
Problems	956	(5)
Cases	961	(1)
Appendix A Statements and Notes for PepsiCo, Inc. and Subsidiaries	962	(43)
Appendix B Management's Discussion and Analysis of Results of Operations and Financial Condition for PepsiCo, Inc. and Subsidiaries	1005	(24)
Appendix C Output of Analysis Spreadsheet in Financial Statement Analysis Package (FSAP) for PepsiCo, Inc. and Subsidiaries	1029	(8)
Appendix D Output of Forecasts and Valuations Spreadsheets in Financial Statement Analysis Package (FSAP) for PepsiCo	1037	(32)
Index	1069