Interpretation of Financial Statements

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1 Interpretation of Financial Statements Steven M. Bragg

2 Chapter 1 Overview of the Financial Statements... 1 Learning Objectives... 1 Introduction... 1 The General Ledger... 1 The Accrual Basis of Accounting... 2 Costs versus Expenses... 3 The Balance Sheet... 3 The Income Statement... 6 The Statement of Cash Flows... 8 Interactions between the Financial Statements Financial Statement Footnotes Interpretation Tools Ratio Analysis Horizontal Analysis Experience Summary Review Questions Review Answers Chapter 2 Interpretation of Cash and Investments Learning Objectives Introduction The Interpretation of Cash and Investments Natural Cash Balance Relevance of a Low Cash Figure Restricted Cash Events Triggering Changes in Cash Sources of Cash The Impact of Sales Growth on Cash Sufficiency of the Cash and Investment Balance The Liquidity of Investments The Return on Investment Analysis Conclusions Review Questions Review Answers Chapter 3 Interpretation of Receivables Learning Objectives Introduction The Interpretation of Accounts Receivable Inherent Profit Margin Age of the Trade Receivables Age of the Other Accounts Receivable No Allowance for Doubtful Accounts Reliability of the Allowance for Doubtful Accounts No Allowance for Other Accounts Receivable Amount of Bad Debts Recognized Analysis Conclusions Review Questions Review Answers Chapter 4 Interpretation of Inventory Learning Objectives Introduction... 35

3 The Interpretation of Inventory Relative Importance of Inventory Age of the Inventory Reality of the Ending Balance Type of Costing System Used Ownership of the Inventory Reliability of the Reserve for Obsolete Inventory Amount of Obsolete Inventory and Inventory Adjustments Recognized Analysis Conclusions Review Questions Review Answers Chapter 5 Interpretation of Fixed Assets Learning Objectives Introduction The Interpretation of Fixed Assets Depreciation Method Existence of Depreciation Sufficiency of Depreciation What is Being Capitalized What is Being Derecognized Proportion of Sales to Fixed Assets Cash Flow Support of Fixed Assets Proportion of Repairs to Fixed Assets Analysis Conclusions Review Questions Review Answers Chapter 6 Interpretation of Other Assets Learning Objectives Introduction The Interpretation of Prepaid Expenses Nature of the Account Contents The Increasing Account Balance The Impact of Sales Growth on Prepaid Expenses The Interpretation of Goodwill Goodwill Impairment Goodwill Amortization Analysis Conclusions Review Questions Review Answers Chapter 7 Interpretation of Current Liabilities Learning Objectives Introduction The Interpretation of Current Liabilities Days Payables Outstanding Changes in Payable Days Sales Tax Payables Issues Dividends Payable Issues Wages Payable Issues Income Taxes Payable Issues Warranty Liability Issues Unearned Revenues Analysis Conclusions Review Questions Review Answers ii

4 Chapter 8 Interpretation of Debt Learning Objectives Introduction The Interpretation of Debt Financial Leverage Debt-Equity Ratio Interest Coverage Ratio Relative Size of Debt Seasonal Borrowings Line of Credit Usage Shifts from Long-term to Short-term Debt Conversions from Payables to Debt Conversions from Debt to Equity Debt Forgiveness Permanent Debt Offshore Cash Analysis Conclusions Review Questions Review Answers Chapter 9 Interpretation of Equity Learning Objectives Introduction The Interpretation of Equity The Book Value Concept Tangible Book Value Book Value per Share Changes in Retained Earnings Negative Retained Earnings Appropriated Retained Earnings Treasury Stock Usage Number of Shares Authorized and Outstanding Analysis Conclusions Review Questions Review Answers Chapter 10 Interpretation of Sales Learning Objectives Introduction The Interpretation of Sales The Trend of Sales The Quality of Sales The Reliability of Sales The Timing of Revenue Recognition Revenue at Gross or Net Orders versus Sales The Presence of Sales Discounts The Trend of Sales Returns Analysis Conclusions Review Questions Review Answers Chapter 11 Interpretation of the Cost of Sales and Gross Margin Learning Objectives Introduction The Interpretation of the Cost of Sales and Gross Margin Gross Margin Analysis iii

5 Contribution Margin Analysis The Inventory Build Concept Direct Materials Changes Obsolete Inventory Changes Scrap Changes Direct Labor Changes Factory Overhead Changes Freight In Changes Analysis Conclusions Review Questions Review Answers Chapter 12 Interpretation of Operating Expenses Learning Objectives Introduction The Interpretation of Operating Expenses Horizontal Analysis Strategy Impact on Operating Expenses Research and Development Costs Payroll Tax Wage Cap Issues Commission Fluctuations Non-Cash Operating Expenses Rent Subleases Supplies Expense and the Capitalization Limit The Fixed Nature of Compensation in Operating Expenses The Public Company Impact on Operating Expenses Analysis Conclusions Review Questions Review Answers Chapter 13 Interpretation of Other Income, Taxes, and Profits Learning Objectives Introduction The Interpretation of Other Income, Taxes, and Profits Implications of Interest and Dividend Income Implications of Gains/Losses on Asset Sales Effects of Interest Expense Implications of Taxable Income Effective Tax Rate Net Profit Margin Deflated Profit Growth Core Earnings Ratio Earnings per Share Manipulation of Earnings per Share Analysis Conclusions Review Questions Review Answers Chapter 14 Interpretation of Cash Flows Learning Objectives Introduction The Interpretation of the Statement of Cash Flows Overview of the Statement of Cash Flows The Direct Method The Indirect Method Examination of Cash Flows from Operating Activities Examination of Cash Flows from Investing Activities iv

6 Examination of Cash Flows from Financing Activities Cash Flow Return on Sales Analysis Conclusions Review Questions Review Answers Chapter 15 Other Analysis Topics Learning Objectives Introduction Financial Statement Audits, Reviews, and Compilations Audit Opinions Working Capital Analysis Quick Ratio Working Capital Productivity Breakeven and the Margin of Safety Dividend Performance Dividend Payout Ratio Dividend Yield Ratio Analysis Conclusions Review Questions Review Answers Chapter 16 Additional Public Company Information Learning Objectives Introduction The Form 10-K Item 1. Business Item 1A. Risk Factors Item 1B. Unresolved Staff Comments Item 2. Properties Item 3. Legal Proceedings Item 4. Mine Safety Disclosures Item 5. Market for Company Stock Item 6. Selected Financial Data Item 7. Management s Discussion and Analysis of Financial Condition and Results of Operation (MD&A) Item 7A. Quantitative and Qualitative Disclosures about Market Risk Item 8. Financial Statements and Supplementary Data Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Item 9A. Controls and Procedures Item 10. Directors, Executive Officers and Corporate Governance Item 11. Executive Compensation Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Item 13. Certain Relationships and Related Transactions, and Director Independence Item 14. Principal Accountant Fees and Services Analysis Conclusions Review Questions Review Answers Glossary Index v

Accounting for Managers

Accounting for Managers 2 nd Edition Steven M. Bragg Chapter 1 The Need for Accounting Information... 1 Learning Objectives... 1 Introduction... 1 The Accountancy Concept... 1 Financial and Managerial