Financial Reporting for Managers and Analysts Accounting 610

Transcription

1 Financial Reporting for Managers and Analysts Accounting 610 Fall 2011 Professor: Heather Wier Office: 3-30N Tel: Office Hours: M W 1:30 3:00 and by appointment Website: Class time and place: Section A1: T 14:00 16:50, Bus 4-13 Section X1: T 18:30 21:30, Bus 4-9 Required Material: Course Package for Acctg. 610: Financial Reporting for Managers and Analysts (sold through the Bookstore) Additional Material: The texts Intermediate Accounting, Volumes I and II, by Keiso, Weygandt, Warfield, Young, and Wiecek, Ninth Canadian Edition are on reserve in the Winspear Library for those of you who would like to do more in-depth reading about particular topics. Course Description and Learning Objectives: The primary objective of this course is to prepare managers and analysts to be better users of financial reporting. This involves: familiarity with the structure and content of annual reports; adequate technical knowledge to understand the individual line items in a firm s financial statements; the ability to interpret financial statement disclosures and understand their implications to investors; the ability to analyze an unstructured business situation, rank alternatives, and present and justify ideas in front of peers; an understanding the differential implications of cash flow and accrual accounting; knowledge of options available under the current reporting model; and understanding management motivation and its implications for valuation. The course will cover the most significant measures and disclosure issues that arise in the preparation and use of current public companies financial statements, including the following topics: revenue recognition, corporate income taxes, pensions, employee stock options; intercorporate investments, and cash flow analysis. Method of Instruction: Classes will be a combination of lecture and participative case analysis. 1

2 Grading: Grades for the course will be determined based in the following allocation: Midterm exam 35 Class contribution 30 Final exam % The new letter grade system translates as follows: Descriptor Letter Grade Point Value A+ 4.0 Excellent A 4.0 A- 3.7 Good B+ 3.3 B 3.0 Satisfactory B- 2.7 C+ 2.3 Failure C 2.0 Grade assignment will be based on the total points accumulated through the semester. Students acquiring 95% or more of the total points available will receive a grade of A+.. Students acquiring 90% - 94% of the total points available will receive a grade of A. Please note that depending on the overall performance of the class, a grade of A can be obtained with fewer than 90% of the total points. Students accumulating fewer than 50% of the total points available will not receive a grade above C. Students accumulating 50% or more of the total points available will not receive a grade below C+. Grades for students accumulating between 90% of the points and 50% of the points will be based on the overall performance of the class:. Accumulated Points Class Grade 95% or more Guaranteed A+ 90% through 94% Guaranteed A 50%-89% C+ through A, depending on class performance Less than 50% Lower than C+ (FAIL) 2

3 Midterm and Final Exams The midterm will be a case exam similar in focus to the cases discussed in class. The final exam will consist of multiple questions focusing on real-world financial reporting issues based on cases and / or excerpts from the financial statements of Canadian and U.S. companies. You may bring any materials you wish to both exams. Absence from an exam will result in a grade of zero (except for medical or compassionate reasons.) Class Contribution You should come to class having read all the assigned materials, ready to participate in the discussion of the assigned case and/or other materials. Thirty percent of your final grade is the result of your contribution to the class discussion. The grade I assign you will be a subjective assessment of the value of your input and will be based on the records I keep of each student's contribution after each class. For example, starting a discussion with a good review of the issues, or sharing meaningful analysis and interpretation of the issues will count more than a casual comment or being part of the general discussion. Your class contribution grade will only be used if it improves your grade; otherwise, the 30% will be allocated equally to the midterm and the final, giving these exams each a weight of 50%. Please note, however, that a grade of A+ will not be awarded without consideration of the class contribution grade. I would encourage you all to participate in class discussions, as this will improve not only your own learning, but also the general classroom dynamic. Academic Integrity The University of Alberta is committed to the highest standards of academic integrity and honesty. Students are expected to be familiar with these standards regarding academic honesty and to uphold the policies of the University in this respect. Students are particularly urged to familiarize themselves with the provisions of the Code of Student Behaviour (online at and avoid any behaviour which could potentially result in suspicions of cheating, plagiarism, misrepresentation of facts and/or participation in an offence. Academic dishonesty is a serious offence and can result in suspension or expulsion from the University. 3

4 Assignments Please note that when questions on the case material are supplied in the outline, these replace any questions provided on the face of the case. Lecture notes are posted to the course homepage under the Course Documents tab. Problem material is posted to the course homepage under the Assignments tab. Class 1 (Sept.13) Introduction READ: The Financial Reporting Environment (course homepage) READ: Annual report review: WestJet Airlines Ltd. (preliminary course package/course homepage). REQUIRED: Answer the questions provided in the preliminary course package. (We will complete this in class.) CASE: CAYMAN ISLAND DIVERS (preliminary course package). REQUIRED: We will complete the following in class: 1. Prepare a balance sheet for CID Ltd. at the end of the day on June 30, Prepare journal entries to record transactions 1 through Post your journal entries to T-accounts whose opening balances are obtained from step Prepare a statement of income and retained earnings and a balance sheet for CID s first year of operations. 5. Assume July 31 is the company s year-end. Prepare closing entries. Class 2 Income Statement and Cash Flow Statement (Sept. 20) Income Statement Components READ: Note on Statements of Income, Comprehensive Income, and Shareholders Equity (course homepage) READ: Informative or misleading? and Is less really better? (preliminary course package) CASE: MANAGEMENT EARNINGS DISCLOSURES AND PRO FORMA REPORTING (preliminary course package) REQUIRED: Answer the questions assigned in the case. READ: Note on the Statement of Cash Flows (course homepage) PROBLEMS: Cash flow questions 1-3 (course homepage) 4

5 Class 3 (Sept. 27) Cash Flow Statement, Revenue Recognition, and Current Monetary Items CASE: POLLY PECK INTERNATIONAL (course package) REQUIRED: Answer the questions assigned in the case. READ: READ: Note on Accounts Receivable (course homepage) Note on Revenue Recognition (course homepage) Class 4 Cash Flow Statement, Revenue Recognition, and Current Monetary Items (Oct. 4) CASE: POLICY MANAGEMENT (course package). This case was used as the 2005 midterm exam. REQUIRED: Answer the following questions: 1. Why did the financial reporting crisis occur? Why did the price drop so much? 2. (a) Consider the financial information for a typical $1 million, six-year software licensing agreement presented on page 3 of the case. Show the breakdown of revenues and direct expenses over the 6 years of the contract presented in accordance with the company s stated policy of revenue and expense recognition. Calculate the company s contribution (gross profit), and gross profit percentage (gross profit/sales) per year. (b) Repeat part (a) assuming that PMSC allocated 20% of the revenue on the contract to the initial license charge (ILC), and the remained to the monthly license charges. (c) Refer to the information on expected 1 st quarter earnings for 1993 in the quote from the Wall Street Journal at the beginning of the case. Why would a drop of only about 10% in revenue ($14M/$135M) cause a drop of close to 40% in income ($0.28/0.70)? Use your analysis from Parts (a) and (b) to describe how and why a decline in the number of customers signing ILCs annually would affect PMSC s growth trend. How did PMSC s business and accounting policy choice contribute to the financial reporting crisis? 3. Given management s responsibility for ensuring that investors understand the company s business model and its risks and rewards, what changes should Williams make to PMSC s financial reporting and disclosures? Begin by stating what you believe his decision criteria should be. Identify at least two good alternative courses Williams could pursue. Conclude as to your preferential choice and summarize your arguments. 4. What other group or groups were culpable in the misunderstanding and miscommunication of PMSC s business model? Explain. (Class 4 continued on following page) 5

6 Class 4, continued Cash Flow Statement, Revenue Recognition, and Current Monetary Items READ: Note on Inventory (course homepage) CASE: DANIEL DOBBINS DISTILLERY (course package) REQUIRED: Answer the following questions. 1. In your opinion, what costs should be included in Dobbins inventory? You need not quantify your answer. 2. Why did the company incur a net loss in 1988? Compare the 1988 and 1987 income statements, and identify the main items that contributed to the reduced profitability in Prepare a cash flow statement for Daniel Dobbins for Advise Daniel Dobbins about the financing of his expansion plans. Class 5 Capital Assets (Oct 11) Tangible Capital Assets READ: Note on Tangible Capital Assets (course homepage) CASE: HOTYE UNITED ELECTRONIC SERVICES (course package). This case was used as the 2004 midterm exam. REQUIRED: Answer the questions assigned in the case. Intangible Assets READ: Note on Intangible Assets (course homepage) CASE: CASE: MICROSOFT S FINANCIAL REPORTING STRATEGY (course package). REQUIRED: Answer the following questions: 1. Microsoft s market value in June of 1999 was $460 billion while the book value of its equity at this time was $28 billion. What are the factors that are likely to explain the difference between its book and market values of equity? 2. Consider Microsoft s software development costs policy. Under US GAAP, all research and development costs must be expensed. The only exception to this rule is SFAS No. 86, Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed. The rules here are very similar to those governing the accounting treatment for research and development costs in Canada, where certain costs can be capitalized. Details of SFAS No. 86 are provided in the case. What effect did Microsoft s accounting treatment of software development costs have on the company s 1997, 1998, and 1999 income statements? To answer, recalculate income before tax (ignore any potential tax effects) to assume that, beginning in 1995, Microsoft capitalized the appropriate software development costs in accordance with SFAS No. 86. Assume that 60% of Microsoft s research and development expenses were software development costs incurred after technological feasibility was established, and that the average product life was two years. What justification do you think the company could provide for its existing policy? (Class 5 continued on following page) 6

7 Class 5, continued Capital Assets 3. Your case explains Microsoft s revenue recognition policy. If we undo the revenue deferrals, we increase beforetax income by year as follows: Increase in before-tax income ,470 1,351 Describe Microsoft s revenue recognition policy. What justification do you think the company could provide for its existing (subsequent to 1996) policy? 4. Now consider both accounting policies choices together. Quantify the effect of these choices on income for Begin with income before taxes as reported in Exhibit 2, and adjust for the capitalization of software costs per your calculations in question 2, and the change in revenue recognition policy that I have quantified in question 3 to calculate revised income before tax figures. Is the effect of Microsoft s accounting policy choices material? 5. Analyze Microsoft s financial reporting strategy. What strategic business reasons do you think the company had for making the choices it did? Class 6 (Oct. 18) MIDTERM Class 7 Intercorporate Investments (Oct. 25) READ: Impairment (course homepage) READ: Note on Investments in Equity Securities (course homepage) REQUIRED: Southwestern Foods (course homepage, at back of note described above) 7

8 Class 8 Intercorporate Investments/Financial Liabilities (Nov. 1) CASE: ACCOUNTING FOR ACQUISITIONS AT JDS UNIPHASE (course package) REQUIRED: 1. How will the acquisition of SDL impact the JDSU s balance sheet? 2. The staggering losses announced in July 2001 relate primarily to the write-downs of goodwill. JDSU determined the amount of the goodwill write-down based on the fall in its own stock price. What do you think of this procedure? How much is JDSU saving in future goodwill amortization on an annual basis? Also consider why JDSU is taking the writedowns now. What is the effect of taking the write-downs sooner rather than later? Is there a potential downside? 3. Did JSDU go wrong with respect to the SDL acquisition? Did management abuse the equity capital of JDSU? Did management fail to act in the best interest of shareholders? Should management be held accountable? 4. In the Motley Fool article (see Exhibit 1), Bill Mann writes, one thing that counts against JDS Uniphase is the opportunity cost of having had a highly valued currency (its stock) that might have, at least partially, been converted into cash through a secondary offering. Comment. READ: Note on Financial Liabilities (course homepage) PROBLEMS: Bond questions 1 and 2 (course homepage) Class 9 Leases (Nov. 8) READ: Note on Leases (course homepage) PROBLEMS: Lease questions 1 and 2 (course homepage) CASE: AIR CANADA: BOND RATINGS AND OFF-BALANCE SHEET OPERATING LEASES (course package) REQUIRED: Answer the following questions: 1. How should operating leases be treated in the assessment of the quality of a firm s bonds? Why? 2. Following the constructive capitalization technique outlines in Exhibit 8, quantify the effect that the capitalization of aircraft operating leases and other property operating leases would have on the following ratios for the 2000 and 2001 financial statements. Use the 8.25% reflected in the note 15 calculations as the discount rate and the gross interest paid disclosed in Exhibit 5. Ignore the present value of uncommitted purchase options: a. Interest coverage (use EBITDAR as the numerator) b. Total debt/(total debt plus the book value of equity) 3. Has Air Canada s creditworthiness, improved, remained stable, or deteriorated from 2000 to 2001? (Class 9 continued on following page) 8

9 4. Why do airlines focus on EBITDAR instead of the more standard EBITDA? Evaluate the use of EBITDAR as the numerator of the interest coverage ratio. 5. In addition to your analysis in questions 2 through 4, suggest some qualitative factors Barbara should consider in her assessment of the investment quality of Air Canada s bonds. 6. In summary, how will the assessments you have formed in this case influence your assessment of the risk/return trade-offs Barbara faces as she considers investing in the Air Canada bonds? Class 10 Dilutive Securities (Nov. 15) READ: Notes on Dilutive Securities: Convertible Bonds and Compensatory Stock Option Plans (course homepage) PROBLEMS: Dilutive securities and earnings per share question 1 (course homepage) CASE: CORNING, INC.: ZERO COUPON CONVERTIBLE DEBENTURES DUE NOVEMBER 8, 2015 (course package) REQUIRED: Answer the questions assigned in the case. Class 11 Dilutive Securities and Earnings per Share (Nov. 22) READ: Note on Earnings per Share (course homepage) PROBLEMS: EPS question 2 (course homepage) CASE: TARGET TECHNOLOGIES REQUIRED: Answer the following questions: 1. Select and justify the assumptions that Target should use to determine the options value of their most recent (September 2004) option grant. 2. Outline the financial reporting effects for the recognition of the September 2004 option grant for the 2004 and future financial statements. 3. Next, select the most aggressive assumptions you feel you could justify (i.e., the assumptions that would minimize reported option expense). Calculate the new option value, and compare the financial reporting effects to those you just calculated in part 2 above using your best estimate of the assumptions for inputs to the Black-Scholes model. (Class 11 continued on the following page) 9

10 4. Assume a Black-Scholes value of $6 per options granted and a current stock price of $12 at September 1, 2005 when Target granted 3,818,540 options to employees. Assume Target considered an equally-valued grant of restricted shares. Also assume the following prices for Target s stock on December 31, 2004, 2005, and 2006, 5. and September 1, 2007 respectively: $12, $15, and $18, and $18. Calculate the expense Target would report for employee stock incentive plans for the years ended December 31, 2004, 2005, 2006, and 2007, assuming: 1. The company granted 3,818,540 options to employees on September 1, (amortize over 4 years) 2. The company granted RSUs of equivalent value to be settled in shares. (amortize over 3 years) 3. The company granted RSUs of equivalent value to be settled in cash. (amortize over 3 years) 5. Assess the company s existing long-term incentive plans, and make recommendations for changes, if necessary. Your assessment should be based in accounting and tax implications as well as on the company s goals for compensation and the perspectives of institutional shareholders. Class 12 Corporate Income taxes/employee Future Benefits (Nov. 29) READ: Note on Accounting for Income Taxes, pp The remaining questions are for your information only. (course homepage) PROBLEMS: Corporate income tax questions 1-2. The remaining problems are for your information only. (course homepage) READ: Note on Employee Future Benefits (course homepage) PROBLEMS: Pension questions 1 and 2 (course homepage) Class 13 (Dec. 6) READ: CASE: Employee Future Benefits Erasing Pension Losses, Ivey Business Journal, September/October 2011 (see link on course homepage) TBA (to be distributed) FINAL EXAMINATIONS: A1: 2 pm 5 pm, December 20 th. If you are enrolled in section A1, and would like to write your final examination with Section X1 on December 13 th you may do so, but please inform me by in advance. X1: 6:30 pm 9:30 pm, December 13th 10