View
215
Download
0
Tags:
Embed Size (px)
Citation preview
Special Industries:Banks, Utilities, Oil and Gas,
Transportation, Insurance,Real Estate Companies
COPYRIGHT ©2007 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license.
Chapter 12
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #2
Banks
• Regulation and structure– Federal charter
• Reports to Comptroller of the Currency
– State charter• Controlled by state banking departments• Sphere of operations controlled by state
– Federal reserve system members• Report to Federal Reserve and FDIC• Member banks maintain reserves at district reserve bank
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #3
Banks (cont’d)
• Balance Sheet – Assets
• Loans to customers are assets (receivables)• Assets are not subdivided into current and noncurrent• Typical assets
– Cash on hand or due from other banks, investment securities, loans, bank premises, and equipment
• Fixed-rate assets expose bank to risk if rates rise– The receivable itself decreases in value
• LDC (less-developed countries) loans more risky than domestic
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #4
Banks (cont’d)
• Balance Sheet– Assets
• Review for related-party loans• Allowance for loan loss account• Other real estate – property taken during foreclosure;
holding for probable resale
– Liabilities• Current: savings, time/demand deposits
– Reduction in this liability also indicates the loss of an inexpensive source of lendable funds
• Long-term: loan obligations, long-term debt
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #5
Banks (cont’d)
• Balance Sheet– Stockholders’ equity
• Typically low in relation to total assets (averages 6–7%)– Low stockholders’ equity indicates greater risk of failure
– High stockholders’ equity is less risky but more costly because of capital requirements
• Review for accumulated other comprehensive income/loss• Regulators view capital in relation to risk-adjusted assets
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #6
Banks (cont’d)
• Balance Sheet– Read notes and Management’s Discussion and
Analysis for indication of• Nonperforming assets: assets no longer producing income
or producing reduced income– Nonaccrual loans: payments are past due; interest no longer
being accrued– Renegotiated loans: modified as part of a restructured
agreement– Watch carefully; these may indicate potential future
difficulties
• Commitments and contingencies
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #7
Banks (cont’d)
• Income Statement– Interest
• Principal revenue is interest earned on loans and investment securities
• Principal expense is interest on deposits and other debt• Excess of interest revenue over interest expense is net
interest income (margin)• Interest rates
– Falling: reduces expense (interest paid on deposits)
– Increasing: increases expense
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #8
Banks (cont’d)
• Income Statement– Other income
• Fees, service charges, trading securities gain/loss, securities transactions
• Of increasing importance to banks
• Ratios– Many ‘traditional’ ratios do not work for banks– Workable ratios
• Return on assets• Return on equity• Most investment-related ratios
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #9
Banks (cont’d)
• Ratios– Earning Assets to Total Assets
• Earnings assets are loans, leases, investments securities, money market assets
– Exclude cash, nonearning deposits, fixed assets
• High result reflects how well the bank puts bank assets to work
– Interest Margin to Average Earning Assets• A key measure of bank profitability• Indicates management’s ability to control the spread
between interest income and interest expense
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #10
Banks (cont’d)
• Ratios– Loan Loss Coverage Ratio
• (Pretax income + provision for loan losses) ÷ net charge-offs
• Measures– Asset quality
– The level of protection of loans
– Equity Capital to Total Assets• Measures the extent of equity ownership in the bank
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #11
Banks (cont’d)
• Ratios– Deposits Times Capital
• Average deposits ÷ average stockholders’ equity• A type of debt-to-equity ratio• Concerns both depositors and stockholders• Indicators
– More capital implies greater margin of safety
– More deposits indicate investment potential
– Loans to Deposits• A type of asset to liability or debt coverage ratio
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #12
Regulated Utilities
• Regulation and structure– Subject to government regulation and rate
regulation– Accounting procedures prescribed by
• Federal Energy Regulatory Commission• Federal Communications Commission• State regulatory agencies
– Regulated utilities have added nonregulated businesses
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #13
Regulated Utilities (cont’d)
• Financial Statements– Balance sheet
• Plant, property, and equipment is listed first• Capitalization section includes sources of financing
– Long-term capital
– Long-term debt
• Current liabilities and deferred charges
– Income statement• Operating income• Other income• Interest charges
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #14
Regulated Utilities (cont’d)
• Financial Statements– Construction work in progress [balance sheet asset]
• Substantial construction work in progress should be viewed as more risky
• Rate base determination will not normally consider construction work in progress
• Disallowed costs provide no return
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #15
Regulated Utilities (cont’d)
• Financial Statements– Allowance for funds used during construction
[income statement]• Allowance for equity funds [other income]
– An assumed rate of return on equity funds
• Allowance for borrowed funds [interest charges]
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #16
Regulated Utilities (cont’d)
• Ratios– Few of the traditional ratios are appropriate for
regulated utilities
– Operating Ratio• Measures efficiency
• Operating expenses ÷ operating revenue
– Funded Debt to Operating Property• Operating (net) property is plant and equipment less
accumulated depreciation
• Include construction in progress
• Measures debt coverage
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #17
Regulated Utilities (cont’d)
• Ratios– Percent Earned on Operating Property
• Relates net earnings to the assets primarily intended to generate earnings
– Operating Revenue to Operating Property• A type of operating asset turnover ratio• Fixed plant is often much larger than revenue
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #18
Oil and Gas
• General background– Major impact on financial statements from method
of accounting for exploration and production– Specific required supplemental disclosures– Traditional ratios apply
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #19
Oil and Gas (cont’d)
• Successful-Efforts versus Full-Costing Methods– Successful-efforts
• Theory: unsuccessful efforts are costs of the current period
• Capitalize costs of successful efforts• Immediately expense costs of unsuccessful efforts • More conservative approach yielding lower net income
due to immediate expensing of unsuccessful efforts
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #20
Oil and Gas (cont’d)
• Successful-Efforts versus Full-Costing Methods– Full-costing
• Theory: all costs are part of eventually finding successful wells
• Capitalize all costs of exploration• Items capitalized are subject to depletion
– In total, the same amount is expensed under either method, but the timing of expense recognition varies dramatically
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #21
Oil and Gas (cont’d)
• Successful-Efforts versus Full-Costing Methods– Practical application
• Smaller companies choose full-costing method• Larger balance sheet due to full capitalization• Short-run higher profit (expense is periodic depletion, not full
cost)• Presents more favorable picture to creditors and investors• Larger companies use variation of successful-efforts method• Smaller balance sheet with only successful efforts capitalized• Short-run lower profit due to immediate expensing of
unsuccessful efforts
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #22
Oil and Gas (cont’d)
• Required supplementary disclosure: SFAS 69– Proved oil and gas reserve quantities– Results of operations for oil- and gas-producing
activities– Costs incurred in oil and gas property acquisition,
exploration, and development activities– Capitalized costs relating to oil- and gas-producing
activities– A standardized measure of discounted future net cash
flows relating to proved oil and gas reserve quantities
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #23
Transportation
• Regulation and oversight– Civil Aeronautics Board
• Commercial aviation• Uniform system of accounts and reporting
– Interstate Commerce Commission• Interstate railroads• Interstate motor carriers• Uniform system of accounts and reporting
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #24
Transportation (cont’d)
• Financial Statements– Balance sheet
• Similar to manufacturing and retailing reporting• Plant, property, and equipment makes up large portion of
assets
– Income statement• Similar to utility reporting• Revenues and expenses grouped by natural objectives and
functional activities• Reports operating income (operating revenues minus operating
expenses)• Presented in single-step fashion
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #25
Transportation (cont’d)
• Ratios– Sources of comparable data
• Interstate Commerce Commission’s Annual Report on transport statistics
• American Trucking Association’s Financial Analysis of the Motor Carrier Industry
– Operating Ratio• Operating expenses ÷ operating revenue
• External forces will impact the ratio
– Long-Term Debt to Operating Property• Operating property: long-term property and equipment
• Measures the sources of funds with which property has been obtained
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #26
Transportation (cont’d)
• Ratios– Operating Revenue to Operating Property
• Measures turnover of operating assets• Operating objective is to generate as many dollars in
revenue per dollar of property
– Per-Mile, Per-Person, and Per-Ton Passenger Load Factors
• Not required but often presented in the financial statement notes or highlights
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #27
Insurance
• Types of service– Identified contract service (mortality or loss)– Investment management service
• Types of insurance organizations– Stock companies: organized to return a profit to stockholders– Mutual companies: incorporated without private ownership
interest– Fraternal benefit societies: similar to a mutual insurance
company– Assessment companies: organized group with a similar
interest
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #28
Insurance (cont’d)
• Primary regulation is at the state level• Accounting
– Uniform SAP (statutory accounting practices) reporting under auspices of the National Association of Insurance Commissioners
• Balance sheet is emphasized; focus is on solvency• Ratio analysis conducted by the NAIC
– GAAP exists for public (SEC) filings
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #29
Insurance (cont’d)
• Sources of comparative data– Best’s Insurance Reports
• Separate ratings for life-health and property-casualty companies
• Ratings range from A+ (Superior) to C– (Fair); also a “Not Assigned” category
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #30
Insurance (cont’d)
• Balance Sheet Under GAAP– Investments
• High liquidity, typically bonds• Review spread between cost or amortized cost and fair value• Review stockholders’ equity for unrealized gains and losses
on investments
– Assets Other than Investments• Operating (plant) assets• Policy acquisition costs are deferred and matched to
premium-earning period for GAAP; expensed for SAP• Goodwill and other intangibles
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #31
Insurance (cont’d)
• Balance Sheet Under GAAP– Liabilities
• Loss reserves: commitments reported at present value• Policy and contract claims: claims accrued net of
recoverable portion
– Stockholders’ equity• Resembles other industry stockholders’ equity• Review for unrealized gains and losses on investments
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #32
Insurance (cont’d)
• Income Statement Under GAAP– Duration of contract governs revenue
• Short-duration: revenue recognized over period of the contract in proportion to protection provided
• Long-duration: revenue recognized when premium is due– Low-risk contracts are “investment contracts” and accounted
for as liabilities
– Realized gains/losses from investments
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #33
Insurance (cont’d)
• Ratios– Industry-specific based on SAP reporting to states– Ratios based on GAAP data
• Profitability• Investor-related
– Confusion surrounding insurance industry reporting• Two accounting standards: SAP and GAAP• Insurance stock typically carries discount to the average
market price
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #34
Insurance (cont’d)
• Federal oversight and enforcement– Limited by McCarran-Ferguson Act of 1945– SEC has jurisdiction only over publicly-traded
companies– Nationwide review of insurance practices by FBI
Copyright 2007 by Thomson South-Western, a part of The Thomson Corporation. All rights reserved.Chapter 12, Slide #35
Real Estate Companies
• Construct and operate income-producing real properties
• Contend that conventional accounting misleads investors
• Real estate companies supplement historical cost information with current value– Current value is based on future income potential