Accounting and financial statement analysis 2 - Bocconi bachelor (any course), Appunti di Analisi Di Bilancio E Principi Contabili

Scarica Accounting and financial statement analysis 2 - Bocconi bachelor (any course) e più Appunti in PDF di Analisi Di Bilancio E Principi Contabili solo su Docsity! Accounting and financial statement analysis module 2 Why does a corporation exist? Which are the benefits of it? Which are the benefits of SE? - Limited liability, you create a separation between the founder and his compbany —> if company goes bad creditors cannot attack the founder. - Access to capital, firstly you need capital to grow, secondly companies listed in stock exchange have the benefit of being transferrable between investors —> exchange ownership. Benefits of stock ownership: • Financial rights = bonds, borrowings and so on, they are entitled to receive capital at the end and interests. Here we have to macro categories: - Dividends - Residual claim that is what is owned by the shareholder • Control rights = taking decisions on the corporations (by having the right to vote, being part of the board and selecting members of the board) SE on the BS has: contributed capital (common stock) and earned capital generated by the company’s profit-making activities. Shareholders equity categorization; equity and benefits. - Common stock (additional paid in capital) —> ownership of this will bring financial and control benefits - Preferred stock (additional paid in capital) —> ownership of this will bring priority in financial benefits (so payment of dividends or payment of any residual claim) - Retained earnings First two points are the contributed capital, third point is earned capital. Authorized n of shares = max n of shares of stock a corporation can issue as specified in its charter. • Issued shares = total shares sold to investors • Outstanding are currently owned by investors (currently trading) • Treasures are those bought back by the corporation • Unissued shares = shares that have never been sold Common stock transaction First step: issuance of equity (IPO = initial public offering, first time a corporation issues equity) or (SEO = season equity offer, other outstanding equity have been made). Then we have dividends payment and repurchase of shares, all this is part of the distribution in the journal entry.. 1 issuance is important the difference between the market value (currently trading) and the par value (… ). Compensation - to make sure managers will act in the owners best interest they could be offered some rewards for meeting the goals or stocks: stock awards = grant shares of stock to employees that vest on future dates or stock options = I give the employee the option to buy a share in the future at this price, both provide incentives for employee to take actions that increase the company’s stock price —> align their interests to the shareholders ones. [1] Repurchase of stock, (outstanding shares = treasury shares) there are many reasons why a company would do that: first for compensation, rather than issuing new stock I buy back treasury stock from the market and use that for 1 di 17 compensation, then they would do that for taxes and financial reasons since it would be better for me to have shares rather than cash, another reason would be under valuation because by buying my shares from the market I am telling people that the price is not high enough, my company is undervalued and lastly if I buy shares from the market, the quantity will be reduced —> the price will increase. - Treasury stock is not an asset, is a contra equity account (XSE) - Treasury stock is reported as negative account - Treasury stock is non-profitable investments - Treasury stock has no dividends or voting rights [2] Dividends is the way to return value to shareholders. a. declaration date, when the board of director approves the dividend —> L+ SE- b. date of record, no journal entry is made here, is just created a list of stockholders who will receive the money c. date of payment, $- L- To do so we need to meet two conditions, first the company needs to have enough RE and the second is that the company should have enough cash to pay. Another important point is the ex-dividend date, in general 2 days before the record and is the date limit when you can buy share and be recompensed for it There is another type of dividend which is the stock dividend represents the distribution of additional distribution if shares given by irrationality of investors, the only change that could happen is a small difference un shares (for example from owning the 50% you will own the 50.5%), the main point is to bring the attention of the analysis’s and put a small pressure on market prices. There is just some journal entry we should take care of. [3] Stock dividends are considered small if < 20-25% (record at current market value), while large when stock dividends > 20-25% (record at par value of stock). [4] Stock splits are not dividends, here a company gives stockholders a specified number of additional shares for each share that they currently hold, so also here the number of shares increases; no journal entry just disclosed in the notes, no economic substance. Preferred stock offers dividend preference over common stock. Is less risky because of priority payments of dividends and assets before common stock; it typically doesn’t have voting rights (pro for who issues the stock and has a fixed dividends rate). - Current dividend preference requires a to pay dividends before … - Cumulative dividends: also when they are declassed and not paid they are not lost, but cumulated [5] 1st - compute dollar amount of preferred dividend , dividends in arrives = unpaid dividends cumulated over time. Common stock has characteristic comparable to characteristics to debt, you will issue common stock if you don’t want to give away control rights. Appendix A - reporting and interpreting investments in other companies A company may invest in securities of another company in other to: Engage in acquisition, be flexible (like apple) 2 di 17 • Receivables/inventory (are both operating assets) a cash collection (of acc. receivables) materializes through a decrease in account receivables —> negative sign decreasing amount of operating asset you are generating cash while by increasing the amount of operating asset you are absorbing cash • Increase in current operating liabilities generates cash (positive signs) and vcvs A common rule is to avoid firms with rising net income but falling cash flow from operations. In the long run, operations are the only source of cash and investors will not invest in a company if they do not believe that cash generated from operations will be available to pay them dividends or expand the company and creditors will not lend money if they do not believe that cash generated from operations will be available to pay back the loan. Reporting and interpreting cash from investing activities: Investment = asset, but not ST operating asset Before we need to make an analysis of the accounts related to property, plant and equipment. Then tangible and intangible assets and investments in the securities of other companies. Reporting and interpreting cash from financing activities: Changes in financing liabilities, then changes in common stock + add paid in capital) minus dividends. The long-term growth of a company is normally financed from three sources: 1. Internally generated funds (cash from operating activities) 2. Issuance of stock 3. Money borrowed on a long-term basis The statement of cash flows shows how management has elected to fund its growth. This information is used by analysts who wish to evaluate the capital structure and growth potential of a business. Supplement CF info: 2 additional required cash flow disclosure that are usually listed at the bottom of the statement or in the notes • Non-cash investing and financing activities, such as the purchase of a building with a mortgage given by the former owner. • Cash paid for interest and cash paid for income taxes (for companies that use the indirect method) INCOME TAXES - Lecture 9 Income taxes are a sub-category of taxes, which are of many different kinds. There are a number of sub accounts for journal entries, like > down payments, income tax expense, income tax payable, etc. Computation of the income tax expense, which is the same of the computation of the income tax liability. THE TIMELINE OF TAXATION Taxation is a progressive cost for the corporation (> income, > tax). The timeline is related to one big item, that is the down payment (also known as prepayment or advanced payment). 5 di 17 The company liable for tax, and the amount will be related to its ability to generate income and there is also a risk associated with this contribution to the government, a cash related risk: it's a huge cash transfer to do once a year, and the firm might not be able to make it > the Government could face issues and because of this risk, the Government requires corporations to scatter down payments over a number of times during the fiscal year. - How many down payments is a company required to make? It’s country specific: we'll rely on the Italian case, where the down payments are two. - How much will have to be paid for each down payment? a proportion of the previous year income tax expense > it's an estimation At the end of the year the company will be able to account for profits before taxation, then the tax liability created will be offset by the down payments made during the fiscal period. The pre payments will likely not match perfectly the amount of the tax liability: • The down payments might be larger than the actual income tax • The company can potentially claim for a refund for the difference • The company can bring the difference and use it for the next year down payment • The company can use the difference to pay other kinds of taxes (like VAT) • The down payments might be smaller than the actual income tax JOURNAL ENTRIES DOWN PAYMENT Generally happen twice in Italy: at the end of June (40% of the previous year tax liability) and at the end of November (60% of the previous year tax liability) +Advanced tax payment (+A) - Bank account (-A) > same as cash, but Italian regulations want a bank transfer END OF YEAR - tax liability + Income tax expense (+ EXP, - SE) + Income tax payable (+L) - Income tax payable (-L) - Advance tax payment (-A) - OFFSETTING THE OUTSTANDING BALANCE When the down payments are less than the tax liability, the difference will have to be settled with a bank transfer within June 30th of the following year. - Income tax payable (-L) - Bank account (-A) EX 1 (from Exercise set 2) Tax expense of the previous year was 80k, and during that year 61k of down payments were paid. Journal entries: 30th June of the current year First, we have to settle any outstanding balance of 80k - 61k = 19k Then, we have to start with the new down payments. In June we have 40% of the previous year tax liability, so 40% of 80k = 32k - Income tax payable (-L) - 19k 6 di 17 - Bank account (-A) -19k + Advanced tax payment (+A) +32k - Bank Account (-A) -32k 30th November of the current year In June we have 60% of the previous year tax liability, so 60% of 80k = 48k + Advanced tax payment (+A) +48k - Bank Account (-A) -48k The sum of the two advanced tax payment must be equal to the previous year tax liability (48k + 32k = 80k) Assume that in the current year, the tax expense is 96k. Prepare: • The journal entry of 31 December of the current vear We have two journal entries: we report and account for the tax expense, then account for the payable with the down payments + + Income tax expense (+EXP, -SE) +96k + Income tax payable (+L) +96k - Advanced tax payment (-A) -80k - Income tax payable (-L) -80k Will a cash balance be due in the following year? Why? How much? Yes, because we have a difference of 96k - 80k = 16k. The down payments were of an amount inferior to the tax liability, so not able to cover the tax expense entirely. The amount of the prepayment is the combination of prepayment 1 and 2 —> 57 + 38 = 95k which is smaller than 111k —> liability just reduced for a total amount of 95k. Then 111 - 95 = 65. Taxable income (revenues minus expenses recognized by tax law) != income before taxes (revenues minus expenses included in the IS according to GAAP), taxable income is the amount to which the tax rate is applied in order to compute the income tax expense to be recorded in the financial statement —> when calculating income taxes one must calculate first taxable income. But we don’t have to use two different accounting systems for GAAP and tax purposes! Because we start from an IS measure (profit before taxation) and we make some adjustments. Fiscal variations could be: 7 di 17 A company sells water bottles the 2 directors by for their personal use jewelry with the company’s credit card this will bring a decrease in $ that should be reported as an expense in the IS. These revenues (of operating activities) will be taken into consideration for taxes, same for COGS, but the jewelry are not going to be seen as deductible costs bc not pertinent to the business activity —> adjustment needed in the computation of taxable income: You add back all non deductible costs You subtract back all non taxable revenues —> achieve the same result that would have occurred if we had ‘cancelled’ all the costs compulsory disclosure, sometimes company do EBITDA discolsure or they don’t, is a simply metric. To properly analyze the info reported in the FS its necessary to develop appropriate comparisons, two general methods are: - Across time: info for a single company compared over time - Across companies: info for more companies compared ad a point in time or across rtime (typically key competitors or industry average) Comparison can be developed through 2 approaches: • Horizontal: line by line comparison of the accounts with those of the previous year, and over n of years provides trend of changes, declines. • Vertical: structural changes in the accounts, increased profitability through more efficient production or greater dependance on borrowing and component percentage expression of each item on FS as a percentage of a single base amount. Component percentages, the single base amount is: net sales (for IS) or total assets (for BS) Ratios Is an analytical tool that measures the proportional relationship between two FS accounts. a. Profitability ratios - measure of the overall success of the company b. Efficiency ratios c. Liquidity ratios - enough $ to meet financial obligations d. Solvency ratios e. Market ratios - a. Profitability ratios a. Return on equity (ROE) = NI / average total SE measures the income earned on the shareholders investment in the business, its ability to earn profits for its shareholders, influenced by financing decisions. Is higher ROE always a good sign? Higher ROE can be determined also by a higher risk in investments maybe. To find what’s a good value of the ROE we have to study the. Market so in years for example first years of a century have a different level of risk so different levels of inflation and other factors must be considered. b. Return on asset (ROA) = NI / average tot. asset how much a firm earned for each dollar invested in asset, measures profitability and effectiveness indep. From financial strategy, higher ROA higher performance c. Earnings per share ration (EPS) = NI / weighted average n of common shares outstanding amount of earnings attributable to a single share of outstanding common stock, the only ratio required by GAAP d. Quality of income ratio = CF from op activity / NI (portion of NI that turned into cash so the ability to generate cash), expected to be > 100%, when < problems! Net sales - COGS = Gross profit —> Gross profit margin = gross profit/net sales rev —> ability of a company to charge a premium on its goods 10 di 17 —> net profit margin = net income / net sales rev —> measures how much of every sales dollar generated during the period is profit Efficiency and effectiveness Here we break down ROA and ROE to analyze it better and implement the business strategy, this is the DuPont model. The financial leverage reflects how much a company uses its liabilities to leverage up its return to stockholders b. Efficiency ratios (measures the ability of a company to generate revenues in relation to total assets and manage efficiently its payable, inventories and receivables • How many times a year a company pays suppliers (we don’t want to p • Finished goods inventory should be kept as low as possible since inventory is money absorbed • Accounts receivables is like financing another company by providing them a loan so you want to keep receivables as low as possible • Accounts payable is a loan that you are obtaining from a supplier so you want this amount to be as high as possible a. Receivable turnover ratio = Net credit sales / average net receivables how well the company uses its asset to generate revenue, the higher the more efficient b. Fixed asset turnover ratio = net sales rev / average net fixed asset how well the company uses its fixed assets (property, plant, equipment) to generate revenues, the higher the more efficient c. Receivable turnover ratio = net credit sales /average net receivables how many times in a year the company collects its accounts receivable, the higher the faster) —> a. DSO is the average days to collect receivables = 365 / receivables turnover indicates the average time it takes receivables to convert in cash, the higher the greater time needed ( better low) d. Inventory turnover ratio = COGS / average inv measures the operating efficiency, how many times average inventory was produced and sold during the period, the higher the more quickly inventory moves —> a. DIO average days to sell 365/inv turnover average days it takes the company to sell its inventory e. Ter. Payable turnover ratio = COGS / average accounts payable how many times in a year the company pays suppliers, higher in time —> a. DPO average number of days payable are outstanding: 365/ acc payable turnover, average time it takes payables to be paid in cash Inventory low —> high COGS/average inv—> potential sales loss due to lack of readily available products Receivables low —> high net credit sales/average net receivables —> customers may be lost due to stringent credit policy 11 di 17 Payables high —> low COGS/average accounts payables —> implicit interest rates on payables may be higher than the interest rated financial liabilities c. Liquidity ratios focus on CA and CL, usually analyzed across years or in comparison with other companies a. Current ratio = CA / CL measures to what extent a company’s total CA cover its total CL , if <1 problem! Should be between 1 and 2. b. Quick ratio = marketable securities / CL c. Cash ratio = cash and cash equivalents / CL its a test of liquidity, relates cash n hand to total CL recorded in the statement d. Solvency ratios important for banks and external analysts because represents the balance between liabilities and SE so good proxy to see if company Abel to ask for another debt a. Times interest earned ratio = (NI + int exp + income tax exp) / int exp relation between interest obligation and profit available to pay so margin of protection for creditors b. Cash coverage ratio = CF from op activity / interest paid number of time the cash flow from operations cover the interest payment to lenders c. Debt-to-equity ratio (D/E) = tot. L / tot. SE companies debt as proportion to SE, high means company relies heavily on debt financing relative to equity financing e. Market ratios they include market prices a. Price-earning ratio (PE) = market price per share / EPS it tells you how much as investor I’m willing to pay for one unit of earnings, this has to be close to 15 so an investor is willing to pay 15 dollars for 1 dollar of earning b. Dividends yield ratio = dividends per share / market price per share what’s the dividend return Accounting for business combination If a company has extra money it should expand horizontally (expanding in business in the same area) or vertically (integrating parts of their production process, so expanding in the supply chain). Orange juice producing, expand horizontally by producing apple juice too while vertically by growing my own oranges, open a shop. There is a distinction between internally and externally and business combination focuses on the latter by buying other firms for example so by merger and acquisition, the a company achieves control of another company through shareholders’ rights. Company B has a shareholder that owns 100% of the shares, when company A buys the shares from the shareholder we have a merger, acquisition so now company B is incorporated in company A Merger - company B doesn’t exist anymore legally, accounting process will happen once Acquisition - company B continues to exist as a separate entity just owned by another, here the 12 di 17 • non depreciable assets, the surpluses may, together with the assets to which they relate to, be subjected to impairment testing [PPE = property plant and equipment, here we have all the adjustments (depreciation and amortization), in the case of this exercise we just have the depreciation —> PPE = opposite to depreciation in the journal entries.] Consolidation adjustments Is the elimination of intra company transactions, so all those happening within the group are to be canceled when preparing consolidated accounts. A. Elimination of intracompany receivables and payables and revenue and expenses B. Elimination of intracompany profit and losses (included in the values of inventories and in long lived asset C. Elimination of intercompany dividends The consolidated financial statement provides the representation of the economic and financial situation of the group as a single entity: a company with many divisions/internal functions (set up by different companies that are included in consolidation area). Transactions between group companies = transactions between divisions/functions within a company. These are not transaction with "third parties”—> shouldn’t be recognized in the general accounting system. The consolidated financial statement should represent only those operations that group companies have made with third parties outside the group. Those values, which arise from intra-group transactions, must be eliminated A. Revenues, expenses , receivables and payables These items are ‘irrelevant’ for the consolidated financial statement —> should remove intra group revenues and expenses intra group receivables and payables —> these operations do not give rise to deferred tax assets or liabilities. Reconciliation of intra group transactions The procedure for removal of intra-group transactions is based on the assumption that there is equivalence between accounts of each company. Procedure: 1. Identify values of credit/debt or costs/revenues from intra group transactions 2. Check there is mutual equivalence between groups (if not reconcile the values) 3. Delete the mutual accounts B. Elimination of intracompany profits and losses The group result should be that generated by the group with any third party and not the one that individual companies have achieved working together —> intra-group profits and losses must be removed. Achieved by: - Adjusting the carrying value of asset value of assets "subject" of the intra-group transaction that are still in the balance sheet of the acquiring company; the value of these goods must be "brought back" to that they would have if they wouldn’t have been transferred from one to another group company 15 di 17 Expenses, receivables and payables A owns 80% of B. B gave A 4000 loan (to be paid in installments of 500$), the financial expenses = interests are 120$ and the 1st payment is done. A: payables 3500 (4000 - 500) Int. expenses 120$ B: receivables 3500$ (4000-500) In revenues 120$ - Adjusting the income items related to those goods that are "generated" by the intra- group transaction. The economic result of companies involved in the transaction, in fact, has changed as a result of intra-group transaction: this change must be eliminated. 1. Calculate the total intercomoany profit / loss 2. Multiply it by the % of goods that are still in the warehouse of acquiring company at year end 3. Reduce/increase the closing balance of inventory by the amount of intercompany profit/loss When writing down inventories there is a rule ‘lower of cost or market’ rule which requires an asset be reported in the FS at whichever is Lowe (its historical cost or its market value). If the market value < cost —> you will write down the market value. It is possible that two companies belonging to the same group set up a commercial transaction which gives rise to an intragroup loss —> intragroup loss must be fully eliminated. If this loss is due to a LT reduction in the asset’s value, the intragroup loss must not be eliminated, as it reflects the loss on value of the asset 1. Identify accounting effect being careful to gains/losses and sld assets and their depreciations 2. Identify values affected by these losses/… 3. Correct then the book value must be compared with its value in use Company A —> transaction 1 —> company B —> transaction 2 —> third party We have to record Transaction 1 for A Transaction 1 for B Transaction 2 for B —> in consolidated we assume no transaction 1 and transaction 2 for A&B group What we have (60% inventory still on hand) Sales +R +SE +360 A COGS +E -SE 210 A Inventory +A 360 B What we should have (60% inventory still on hand) Sales +R +SE +360 A&B COGS +E -SE 210 A&B Inventory +A 360 B&B Intra-group dividends: B has 60% of A and 40% of non controlling dividends (NCD), in the journal entries there is an increase in dividends of R in A and a decrease of retained earnings in B —> after we have to make the opposite to counterbalance so make the dividends of A go down and the Retained earnings of B go up (in both cases is 2000*60%) —> 16 di 17 Computation of NC Net Income In the consolidation we consolidate: • 100% asset • 100% liability • Equity must be separated in • Parent shareholder • Minority shareholder Stockholders equity is made of at least common stock, retained earnings (of the precedent accounting periods) and the profit / losses of the year. NCI net income = (PrSub +/- adj.) * %NCI Ex. Minorities own 10%, the profit of the subsidiary is 900 and adjustments are 150 —> NCI NI = (900-150)*10% The adjustments that shall be taken into consideration are: - Adjustments generated by depreciation / amortization of the surpluses - Adjustment generated by upstream transactions (= all transactions where the seller /provider is the subsidiary and the buyer /beneficiary is the parent) 17 di 17