Review of Financial Reporting & Analysis
• Rose Stubberfield
Our Approach Tonight
• We have only two hours.– Giddy up
• The emphasis is on review.• You should know this material, but not at the depth
you need to understand.• Assume you know how the financial statements
articulate.• Review the balance sheet, then the income
statement … you are on your own for cash flows.
Asset Definition
1. Probable future economic benefit
2. Obtained or controlled by the entity
3. As a result of past transactions
Current vs. Non-Current
- based on year or operating cycle, which ever is longer.
Cash and Cash Equivalents
• Cash, of course.• Equivalents include money market
instruments such as ST CDs, high quality commercial paper, Treasuries, money market funds that mature in three months or less.
Investments in Debt Securities
Three Categories
- Held to Maturity Requires ability and intent
- Available for Sale Cash Management
- Trading Intent to sell in the near term
Accounting for Debt Securities
Accounting & Valuation
- Held to Maturity Interest revenue, gain/loss on sale Reported on balance sheet at amortized cost
- Available for Sale Interest revenue, gain/loss on sale Fair value … with Unrealized Holding G/L to
Comprehensive Income (i.e., equity)
- Trading Interest Revenue, gain/loss on sale Fair value … with Unrealized Holding G/L to Current
Income (i.e., Income Statement, then Retained Earnings)
Investments in Equity Securities
Accounting is based on level of influence
- Minority, Passive (less than 20% ownership) Fair Value Method
- Minority, Active (20% - 50% ownership) Equity Method
- Majority, Active (more than 50% ownership) Consolidation Method
Accounting for Equity Securities
Accounting for Minority, Passive Investments
- Available for Sale Dividend Income, gain/loss on sale to Income
Statement Fair value … with Unrealized Holding G/L to
Comprehensive Income (i.e., equity)
- Trading Dividend Income, gain/loss on sale to Income
Statement Fair value … with Unrealized Holding G/L to Current
Income (i.e., Income Statement, then Retained Earnings)
Accounting for Equity Securities
Accounting for Minority, Active Investments
Record purchase at cost. Single line acquisitionIf purchase price exceeds proportionate share of investee’s book value, identify fair values of underlying assets & liabilities.
Recognize proportionate share of investee’s income as an increase in the Investment
Recognize proportionate share of investee’s dividends as reduction in Investment
Valuation
Fair Value MethodAnnual AdjustmentTrading – Unrealized Holding G/L in current incomeAvailable for Sale – Unrealized Holding G/L in
Comprehensive Income (i.e., equity)
Equity MethodAnnual AdjustmentProportional Share of Income = IncomeProportional Share of income less Dividends =
Investment Adjustment
Valuation
The Fair Value Option• Held-to-maturity• Available-for-sale• Equity method
Report unrealized gains and losses through the income statement (not though comprehensive income)
Brand-new and not many takers yet.
Consolidations
Basic Idea: The Parent company along with its Subsidiaries are a single economic unit.
Combine the financial results for Parent & all Subsidiaries, then– Eliminate Intercompany Payables– Eliminate Intercompany Sales– Eliminate double-counting of Investment– Eliminate double-counting of Income
Consolidations – non-controlling Interests
Non-controlling Interest - (aka Minority Interests)
Occurs when the Parent does not own 100% of the subsidiary. The percentage of ownership not controlled by the Parent.
For the Balance Sheet, Non-controlling Interests represent the percent of net assets (assets less liabilities of the subsidiary). Appears between Liabilities & Equities
For the Income Statement, Non-controlling Interest is the percentage of subsidiary income held by the minority shareholders.
Consolidating Foreign Subsidiaries
Companies often have international subsidiaries that must be consolidated with the Parent’s financial statements.
Typically, the subsidiaries accounts are maintained with local currency (and, sometimes, local GAAP). The amounts on the foreign subsidiaries financial statements must be translated in U.S. dollars.
To translate a foreign subsidiary’s financial statements into U.S. dollars, conversion is made with both Historical Exchange Rates (those which existed at the time a transaction occurred) and Current Exchange Rates (Exchange rates which exist as of the balance sheet date)
Consolidating Foreign Subsidiaries
The use of different exchange rates means the resulting financial statements will not balance.
To force the statements to balance, an account called “Translation Adjustment” is used.
Two approaches are used depending on the independence of the subsidiary from the Parent company.
- Self-contained: All-current method (local currency is functional)- Extension of US Parent: Monetary-Nonmonetary method (US dollar is functional currency)
Subsidiaries in countries with hyperinflation (100+%) use the U.S. dollar as the functional currency.
Accounts Receivable
Involves the application of two concepts – Definition of an Asset & Matching
Definition of an asset:- Probable future economic benefit- Obtained or controlled by the entity- As a result of past transactions
What is the cost of extending credit? - Bad debts.
Accounts Receivable
Acct Rec.
Beg. Bal.
End Bal.
Allowance for Bad Debts
Beg. Bal.
End Bal.
Sales
Collections
Write-Offs Write-Offs
Bad DebtExpense
Net Account Receivable
What I can Collect
What I expect to
Collect
Accounts Receivable Example
Year 1Sales $1,500,000
December 31, Year 1Accounts Receivable $175,000Allowance for Bad Debts (10,000)Accounts Receivable, net $165,000
Based on Analysis
Goes to the Balance Sheet
Accounts Receivable Example
December 31, Year 1Bad Debt Expense $10,000
Allowance for Bad Debts $10,000
This entry applies the two important concepts: - matching expenses with the related revenues - recording the asset at its net realizable value (NRV)
Accounts Receivable Example
Year 2Sales $5,000,000
Identified and wrote-off as uncollectible $21,500 of accounts receivable.
Allowance for Bad Debts $21,500Accounts Receivable
$21,500
Note, No impact of Net A/R
Accounts Receivable Example
Year 2
December 31, Year 2Accounts Receivable $330,000Allowance for Bad Debts (25,000)Accounts Receivable, net $305,000
Based on Analysis
Goes to the Balance Sheet
Accounts Receivable Example
December 31, Year 2Bad Debt Expense $36,500
Allowance for Bad Debts$36,500
Allowance for Bad Debts
10,000 Beg. Balance
25,000 End Balance
Write-Offs 21,500 36,500 Bad Debt Exp.
Inventory – Basic Approach
Beg. Inventory+ Purchases Cost of Goods Available for Sale
Sold
Cost of Goods Sold(Income Statement)
Not Sold
End. Inventory(Balance Sheet)
Inventory – Costing Methods
Beg. Inventory 300 units @ $10 per unitPurchase 100 units @ $12 per unitSale 200 units @ $30 per unitPurchase 600 units @ $14 per unitPurchase 200 units @ $15 per unitSale 600 units @ $30 per unitEnd Inventory 400 units
LIFO – Periodic Cost of Goods Sold $11,400 Ending Inventory $ 4,200
LIFO – Perpetual Cost of Goods Sold $10,800 Ending Inventory $ 4,800
Inventory – Costing Methods
Cost of Goods Sold
FIFO Periodic $ 9,800FIFO Perpetual
9,800
LIFO Periodic $11,400LIFO Perpetual
10,800
W/A Periodic $10,400W/A Perpetual
10,200
Ending Inventory
FIFO Periodic $ 5,800FIFO Perpetual
5,800
LIFO Periodic $ 4,200LIFO Perpetual
4,800
W/A Periodic $ 5,200W/A Perpetual
5,400
Inventory – Valuation (LCM)
• After determining FIFO/LIFO/W-A Ending Inventory, must compare to market valuation.
– Follows the definition of an asset
• Report on the balance sheet, the lower of cost or market. Write-downs of inventory from cost to market are included in cost of goods sold.
– Can establish a reserve account for obsolesce.
Inventory – LIFO Layers
As inventory levels increase, a LIFO layer is added.
Can result in very old costs embedded in inventory.
100 units at $10 per unit
40 units at $13 per unit
20 units at $17 per unit
15 units at $20 per unit
Inventory – LIFO Liquidations
Assume current costs are now $25 per unit.
Delay purchases to “dip” into the LIFO layers …
Instead of CGS at $25 per unit, now it is $20, then $17, then $13 and eventually, $10 per unit
100 units at $10 per unit
40 units at $13 per unit
20 units at $17 per unit
15 units at $20 per unit
Inventory – LIFO Liquidations
LIFO Liquidations come at a very high cost –taxes!!
LIFO Conformity rule states that if you use LIFO accounting for your tax return, you use it for your financial statements as well.
It costs real money to dip into your LIFO Layers.
Inventory – Comparability
1. BIF + P – CGSF = EIF2. BIL + P – CGSL = EIL3. P = CGSL + EIL – BIL
Substitute 3 into 14. BIF + (CGSL + EIL – BIL) – CGSF = EIF
Rearrange …CGSF = CGSL - [(EIF - EIL) – (BIF - BIL)]
CGSF = CGSL – (LIFO ReserveE – LIFO ReserveB)CGSF = CGSL – Change in LIFO Reserve
Inventory – Comparability
LIFO FIFO
CGS Higher Lower
Income before taxes Lower Higher
Income taxes Lower Higher
Net Income Lower Higher
Cash Flow Higher Lower
Inventory Balance Lower Higher
Assume rising inventory costs and stable orIncreasing inventory levels.
Inventory - Summary
Inventory
Beg. Bal.
End. Bal.
Purchases
Cost of Goods Sold
Obsolescence
Long-Lived Assets – Major Issues
Multi-period assets whose costs are matched to the revenues they help generate.• Smooths the impact on income
Impairment IssuesBased on the definition of an assetGreat opportunities to shift expenses from one
period to another.
Costs Expense
(Asset)Capitalize Allocate
Long-lived Assets
Long-lived Asset Acc. Depreciation
Beg. Bal.
End Bal.
AcquisitionsDisposals
Impairments
Beg. Bal.
End Bal.
Depreciation Expense
Disposals
Impairments
Long-lived Assets – Acquisitions
Acquisition Cost – All the costs necessary to ready the asset for its intended use.
Specialized machinery for a manufacturer.Invoice priceTaxesDelivery chargesSpeeding ticket during deliveryInstallation costs (including repouring floor)Repair work for damage during installationSetup costs (labor and materials)
Long-lived Assets– Depreciation
Depreciation – Allocating the cost of the asset over the period of benefit.
Accounting depreciation ≠ Economic Depreciation
Depreciable amount = Acquisition Cost less Residual Value
Cost - $1,000,000Residual Value - $250,000
Depreciable Amount - $750,000The amount to be expensed over the estimated useful life
of the asset.
Long-lived Assets– Depreciation Methods
Straight-Line: Simple and most pervasive.
Other methods: Sum-of-the-years digits Units of production Declining balance MACRS (tax return only)
Depreciation Expense Book Value
Long-lived Assets– Betterments vs. Repairs
Betterment – Costs incurred after the asset has been placed in service. A betterment extends the asset’s useful life, increases the asset’s productive capacity, or increases the asset’s productive efficiency. Capitalize costs incurred.
Repairs – No increase in economic benefit or increased service potential. Expense costs as incurred.
Long-lived Assets– Disposals & Exchanges
Disposal – Compare the asset’s book value to the value received from the sale. The difference is either a gain or loss.
Exchange – One productive asset (e.g., inventory) for another asset (e.g., equipment).
General rule: The new asset is recorded as the Fair market value (FMV) of the asset exchanged.
Exceptions for exchanges of similar assets or where FMV is not ascertainable.
Long-lived Assets– Change in market Value
Revaluation – Not with U.S. GAAP. However, IFRS and other countries allow revaluation up to market value.
Impairments – Decline in market value of an asset. There are different kinds of tests for different kinds of long-lived assets.
Long-lived Assets– Acquired Intangibles
Acquired Business
Identifiable IntangiblesTangible Assets Other Balance Sheet
Marketing related Contract relatedTechnology relatedCustomer related
• Trademarks• Trade names• Marketing materials• Style guide (unique
color, shape or package design)
• Mastheads• Domain names
• Distributor relationships
• Retailer relationships• Order or production
backlog• Contractual and non-
contractual customer relationships
• Trade secrets, such as secret formulas, processes or recipes
• Patented and un-patented technology
• Computer software• Databases
• Supply contracts• Advertising,
management & service contracts
• Licensing & royalty agreements
• Lease agreements• Construction permits• Franchise agreements• Non-compete
agreements
Goodwill
Goodwill arises when the purchase price paid for another business exceeds the fair market value of the acquired net assets of that business.
$10 million
$5 million
$3 million
$1 million - Goodwill
- Excess net asset FMV over BV
- Net asset book value
Considerationtransferred
Allocation
$1 million - Identifiable Intangibles
Long-lived Assets– Intangibles Amortization
Depends on the type of intangible asset it is.
•Limited Life intangible assets– Amortize straight-line over estimated economic life.
•Indefinitive Life intangible assets– Assets that the firm intends to maintain for an
unknown period of time.– No amortization.
•Goodwill– No amortization.
Long-lived Assets– Impairments
Property, Plant & Equipment and Limited Life Intangible Assets (Category 1)
Two Step Impairment Test:Step one: Compare future estimated undiscounted cash flows to book value. If cash flows are less than book value, the asset is impaired.Step two: Write the asset down to either fair market value (FMV) or discounted future cash flows & recognize the impairment loss.
Long-lived Assets– Impairments
Indefinite-Life Intangible Assets (other than Goodwill) (Category 2)
One Step Impairment Test:Step one: Write the asset down to either fair market value (FMV) or discounted future cash flows if below book value.
Long-lived Assets– Impairments
Goodwill (Category 3)
Two Step Impairment Test:Step one: Compare the fair value of the reporting unit to its book value including goodwill If fair value is below book value, then go to step two.Step two: Determine the implied fair value of goodwill by comparing the fair value of the reporting to the fair value of net identifiable assets. Write goodwill down if needed.
Long-lived Assets– Impairments
The FASB added a new Step Zero for Intangibles and Goodwill.
– Step zero is an optional, qualitative assessment.
– If determined that it is more likely than not (i.e., a greater than 50% likelihood) that the fair value of a reporting unit exceeds its carrying value, then no further work required.
Liabilities – Major Issues
Fixed PaymentDates & Amts.
Fixed Payment Amts, Est. Dates
Est. Date& Amount
Advances& UnexecutedAgreements
MutuallyExecutedContracts
ContingentObligations
Note PayableInterest Pay.Bonds Pay.
Accounts Pay.Taxes Pay.
WarrantiesPayable
Rental FeesSubscriptionsInsurance
PurchaseEmploymentCommitments
Pending LawsuitsOff BS Instruments
Recognized as Accounting Liabilities
Generally Not Recognized as Accounting Liability
Liabilities – Basic Definition
1. Probable future economic sacrifice,
2. The obligation belongs to the firm, and
3. Is the result of past transactions.
Parallels the definition of an asset.
Liabilities – Current
• Accounts payable• Wages, salaries, and other payroll items• Short-term notes and Interest payable• Warranties – Matching concept.
• Estimate the warranty liability at the time of sale and record the expense.
• Reduce the liability based on actual costs incurred.
Bonds– Early retirement
Example:
The $100,000 bond is two years from maturing. Originally issued at a market rate of 8%, now trades in the market at 12%.
Journal Entry
Bonds Payable $103,630Cash $ 96,535Gain on early retirement 7,095
Reported in the Income Statement
Contingent Liabilities
When is a liability a liability? If there is uncertainty regarding the outcome of an event (e.g., litigation, possible assessments, expropriation of assets).
Disclosure or Recognize?
Two Criteria for Accruing a Liability:- “Probable”- “Reasonably estimated”
Liabilities – Capital Leases Requirements
Must meet one of the four criteria:1. The lease transfers the ownership to the lessee at the
end of the lease term.
2. The lease contains an option to purchase substantially less than the expected fair market value at the end of the lease term.
3. The lease term is equal to 75% or more of the estimated remaining economic life.
4. At the beginning of the lease term, the present value of the minimum lease payments equals or exceeds 90% of the fair market value of the leased asset
Liabilities – Operating Leases
No entry at lease inception - executory contract
Lease Payment Journal EntryRent Expense $ xx
Cash $ xx
No asset nor liability recognized on the balance sheet.
Footnote disclosures are substantial including description and payment schedule.
Liabilities – Capital Leases
At Lease Inception
Leased Asset $ xxLease Liability $ xx
Present value of Minimum Lease
Payments
Second GP
Amortize the leased asset over the life of the lease. Amortization Expense $ xx
Leased Asset $ xx
Lease payments follow Long-Debt GP Interest Expense $ xx Lease Liability $ xx
Cash $ x
Difference
Leases
Managerial considerations
– On Balance sheet or off?• Are investors really fooled?
– Cash flows• Operating leases – Operating cash flows• Capital leases – Investing cash flows• Performance metrics
Pensions – Defined Contribution Plans
Defined Contribution Plans are the dominate pension vehicle.
•Transfers ownership of risks to employees
•Easy accounting:Pension Expense $ XX
Cash $ XX
Pensions – Defined Benefit Plans
Rose in popularity following WWII.
•Employer bear risks of funds market returns
•Conceptual Underpinnings– Matching concept– Record expenses in period of benefit– Record liability
•Management Incentives– Management prefers not to report a liability Cost of Credit Share price impact
Pensions – Defined Benefit Plans
Three Concepts
Vested benefits- Legal issue with respect to employee right. If
they leave the firm prior to achieving retirement conditions (e.g., age, years of service).
Accumulated Benefit Obligation (ABO)- Vest & non-vested benefits- Non-vested benefits are estimated- “Actuarial” net present value of benefits earned to
date at today’s pay levels.
Pensions – Defined Benefit Plans
Three Concepts
Projected Benefit Obligation (PBO)- PBO equals …
“Actuarial” net present value of benefits earned to date projected at future pay rates
- The real liability conceptually• Best estimate of future payments
Pensions – Defined Benefit Plans
Three Elements of Pension Accounting
Record liability for deferred cash flows- Increase for interest recognized over time- Decrease for cash payments
Record asset for invested funds- Recognize earnings on invested funds- Increase cash contributions to fund- Decrease for payments made to retirees
Record expense for “service cost”- NPV of incremental benefit earned for current year services
Pensions – Defined Benefit Plans
Violations of FASB Conceptual Framework
Off-set Revenues and ExpensesAnnual pension expense = Net of …
Interest expense Service Cost expense Investment Returns
Off-set Asset & LiabilitiesNet Pension asset or Liability on Balance SheetThe Plan is said to be either “over-funded” or “under-funded”
Pensions – Components of Pension Exp.
1. Service Cost – Increase in PBO because employees have worked another year.
2. Interest Cost – The PBO is the discounted present value of expected benefits to be paid to employees. As the payment date gets closer, interest cost must be recognized (2nd general principle of long-term debt)
3. Expected Return on Plan Assets – The off-sets pension costs and makes pension expense smaller. The expected return is used rather than the actual return to avoid the effects of the stock market’s volatility.
4. Prior Year Service Cost – Adjustments to PBO for additional benefits granted to employees … “sweeteners.”
5. Amortization of Excessive Plan Gains & Losses – Due to changes in Fund earnings experience or PBO assumptions.
Accounting for Dividends
Stock DividendSmall (less than 20 – 25% of outstanding stock)
Retained Earnings $ FMVCommon Stock $ ParAdditional Paid-In Capital
Difference
Large (more than 20 – 25% of outstanding stock)
Retained Earnings $ ParCommon Stock $ Par
Accounting for Dividends
Stock Split
Just like a stock dividend, increases the number of shares outstanding … without impacting Retained Earnings.
No entry is record. Par value and shares outstanding are adjusted to reflect the split.
PhilDrakeCo has 1,000,000 shares of $10 par common stock.Following a 2 for 1 stock split, there are 2,000,000 shares outstanding with a par value of $5.
Treasury Stock
Purchase 10,000 shares of PhilDrakeCo at $11 per share.
Treasury Stock $ 110,000Cash $ 110,000
Reissue Above Cost - $15 per share
Cash $ 150,000Treasury Stock $ 110,000Paid-In Capital – TS 40,000
Reissue Below Cost - $5 per shareCash $ 50,000Paid-In Capital – TS 60,000
Treasury Stock $ 110,000
Contra-Equity
Convertible Securities
Convertible securities (debt and preferred stock) is the underlying security with an option to convert the security into common stock. Terms of conversion are typically fixed (i.e., 50 shares common stock for each $1,000 bond).
For debt, the conversion feature reduces the interest rate due to the investor … lowers cost of borrowing.
When the security is converted, no gain or loss is recognized. Thus, the conversion is done at the convertible security’s book value.
Revenue Recognition
The Securities and Exchange Commission (SEC) has issued authoritative statements in Staff Accounting Bulletin (SAB) 104.
Revenue, generally, is realized or realizable and earned when all of the following criteria are meet:
1. There is persuasive evidence that an arrangement exists,
2. Delivery has occurred or services have been rendered*,
3. The seller’s price to the buyer is fixed or determinable, and
4. Collectability is reasonable assured.
* Risk of loss is transfer or no future performance required
Research & Development
• Companies engage in R&D with the expectation of producing profitable future goods and services. However, there is the risk that these expenditures will have no value for the firm.
• The resulting assets typically have values unrelated to the R&D costs.
• Expensed as incurred. Lacks the probable future economic benefit criteria of an asset.
• Creditors generally do not lend on R&D projects.
Restructuring Activities
Most firms experience some type of restructuring. It is a natural evolution of business.
Restructuring can include employee layoffs, lease terminations, asset write-downs, moving locations, closing operations and other reorganizations.
Following the commitment to a formal plan of restructuring, recognize a liability & expense.
Restructuring Activities
Provides management with a tool for earnings management. The Big Bath Theory.
As the restructuring unfolds, the liability & expense are updated for the new information.
This creates an incentive to front-load expenses.
Strangely, restructuring costs imposed by a merger as expensed as incurred. No liability is established due to past abuses.
Accounting for Income Taxes
GAAPFASB, SEC
Tax lawCongress
Book Income
Taxable Income
≠
Timing differences
Permanentdifferences
A timing difference results when a revenue (gain) or expense (loss) enters book income in one period but affects taxable income in a different (earlier or later) period.
The basics
A permanent difference results when a revenue (gain) or expense (loss) enters book income but never recognized in taxable income or vise versa.
Temporary Differences
EventBook
IncomeTax
IncomeDef. Tax
AssetDef. Tax Liability
Installment Sales Revenue Today Income Later
Product Warranties Expense Today Deduction Later
Bad Debt Expense Expense Today Deduction Later
Rent Rec’d in Advance Revenue Later Income Today
Depreciation Expense Straight-Line Accelerated
Prepaid Expenses Expense Later Deduction Today
Deferred Tax Liability when Future Taxable Income > Future Book Income
Deferred Tax Asset when Future Taxable Income < Future Book Income
XXXX
XX
Permanent Differences
• Permanent differences will not reverse in the future. Thus, book and tax will never equalize.
• Common permanent differences:– Fines and Penalties– Meals and Entertainment– Political Contributions– Officers Life Insurance– Tax-exempt Interest
• Permanent differences are ignored for financial accounting purposes.
Accounting for Taxes – Mechanics
Income tax expense is the “plug” after determining the tax liability and changes in deferred taxes.
1.Record the tax liability2.Record the changes in the deferred tax accounts3.Plug “Income tax expense.”
Unusual occurrence – Income tax expense when there is a net loss.
Deferred Tax Assets
Deferred tax assets must pass the definition on an asset … “probable future economic benefit”
If there is uncertainty realizing the deferred tax asset (e.g., history of operating losses/profits, unsettled
circumstances, presence of existing contracts or backlog), then a valuation allowance (contra asset) must be establish.
The criteria for the valuation allowance is needed is whether the it is “more likely than not” that the tax benefits will be realized.
Net Operating Losses
The U.S. income Tax code allows firms reporting operating losses to offset those losses against past or future tax payments.
Valuation Allowance
When a valuation allowance is recognized, there is a corresponding increase in the income tax expense.
If it subsequently determined that the deferred tax benefit will be realized, then the entry that established the valuation allowance is reversed. This results in a decrease in income tax expense and an increase in net income. Some analysts call this cookie jar accounting.
Also reveals information about the long-term prospects of a firm’s profitability. General Motors established a $38.6 billion valuation allowance in the 3rd quarter, 2007.
Effective v. Marginal Tax Rates
• Effective Tax Rate (ETR)– Income tax expense divided by pretax book income.– Provides information as to a firm’s tax management.
• Marginal Tax Rate– Income tax for the next dollar of taxable income.– For the U.S. companies, use a marginal federal rate of
35% plus estimated 5% state and local tax rate.
• In conducting incremental analysis and after-tax effects (e.g., interest costs), use the marginal tax rate.
Foreign Currency Transactions
Amerco, a U.S. company, sells goods to a German customer at a price of 1 million Euros (€) when the spot exchange rate is $1.50 per Euro.
If payment were received at the date of sale, Amerco would convert 1 million Euros into $1,500,000.
Instead, Amerco allows the German customer 30 days to pay. At the end of 30 days, the euro had depreciated to $1.45 per Euro and Amerco can convert the 1 million euros into $1,450,000.
How should Amerco account for the $50,000 decrease in value?
Foreign Currency Transactions
Two-transaction perspective:- The export sale- The decision to extend credit
Date of SaleAccounts Receivable $1,500,000
Sales $1,500,000
Date of CollectionForeign Exchange Loss $ 50,000
Accounts Receivable $ 50,000
Cash $1,450,000Accounts Receivable $1,450,000
Goes to Income Stmt
Below the line components
Discontinued Operations & Extraordinary Items- Reported net of tax - Separate EPS calculations
Proctor & Gamble
Earnings Per Share
Very powerful … highly cited, moves markets, motivates people, affects M&As.
The most important single financial number.
Simple Capital Structure – No potential common stock (e.g., NO convertible bonds, convertible preferred stock, stock warrants, stock options)
Earnings Per Share
Complex Capital Structure:Dual Structure- Basic EPS, Diluted EPSFor Diluted EPS calculation include only dilutive securities, exclude antidilutive securities.
Impact of Conversions & Options
The “if converted” method:
• Assumes that all convertible bonds are exchanged for stock at the beginning of the reporting period.
• But conversion is unlikely if the stock price ($75) is substantially below the conversion price ($100).
• The resulting diluted EPS figure overstates likely dilution in this case and thus understates EPS.
The “treasury stock” method:
• Assumes that proceeds received on exercise of the options ($100 per share) are used to buy back shares at the average market price.
• If the average market price is below the exercise price, the options are not dilutive for EPS purposes.
• The resulting diluted EPS figure understates likely dilution and overstates diluted EPS.