七InvestmentToolsFinancialStatementAnalysisBasicCon.docx

七InvestmentToolsFinancialStatementAnalysisBasicCon.docx

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七InvestmentToolsFinancialStatementAnalysisBasicCon

七InvestmentTools:

FinancialStatementAnalysis:

BasicConcepts

1.A:

PreliminaryReadingMeasuringBusinessIncome

a:

Explainwhyfinancialstatementsarepreparedattheendoftheregularaccountingperiod,whyaccountsmustbeadjustedattheendofeachperiod,andwhytheaccrualbasisofaccountingproducesmoreusefulincomestatements&balancesheetsthanthecashbasis.

Toberelevant,informationmustbereliable.Thismeansinformationmustbe

consistentandcomparableovertimeandbeprovidedonatimelybasis.Accordingtotherelevancyprinciple,afirmneedstoidentifyitsactivitiesinatimelyfashionwithinaspecificperiod,suchasaquarteroryear.

Normalaccountingprocedureistorecordduringtheaccountingperiodthoseeconomiceventsthatoccurredastheresultofexternaltransactions.Attheendoftheperiodafteralltheexternaltransactionshavebeenrecorded,severaloftheaccountsintheledgerneedtobeupdatedbeforetheirbalancescanbepostedtothefinancialstatements.

Theadjustingprocessisconsistentwithtwoimportantaccountingprinciples:

1.Therevenuerecognitionprinciple,whichrequiresthatrevenuebereportedintheincomestatementonlywhenitisearned,notbeforeandnotafter.

2.Thematchingprinciplereportsexpensesontheincomestatementinthesameaccountingperiodastherevenuesthatwereearnedasaresultoftheexpenses.

Accrualbasisaccountingassignsrevenuestotheaccountingperiodinwhichtheyareearnedandmatchesexpenseswiththerevenuesgeneratedbythoseexpenses.Theobjectiveoftheaccrualbasisistoreporttheeconomiceffectsofrevenuesandexpenseswhentheyareearnedorincurred,notwhencashisreceivedorpaid.

Cashbasisaccountingrecognizesrevenueswhencashisreceivedandexpenseswhencashispaid.Underthecashbasisnetincomefortheperiodisthedifferencebetweenrevenuesreceivedincashandexpensespaidwithcash.

Accrualaccountinggenerallyprovidesabetterindicationofperformancethaninformationbasedonthereceiptanddisbursementofcash.Accrualaccountingincreasesthecomparabilityofincomestatementsandbalancesheetsfromoneperiodtoanotherperiod.Theaccrualbasisreflectstheunderstandingthattheeconomiceffectofrevenuegenerallyoccurswhenitisearnedandnotwhencashisreceived.Therevenuerecognitionprincipleisthebasisformakingadjustingentriesthatpertaintounearnedandaccruedrevenues.Adjustingentriesarenecessarytobettermatchrevenuesandexpensesthatoccurredduringtheaccountingperiod.Adjustingentriesareusedtorecordtheeffectsofinternaleconomicevents.

1.B:

PreliminaryReadingFinancialReportingandAnalysis

a:

Defineeachassetandliabilitycategoryonthebalancesheetandprepareaclassifiedbalancesheet.

Assetscategoryonthebalancesheet

Currentassetsareassetswhichwillbesold,collected,orconsumedwithinoneyearorthefirm’soperatingcycle,whicheverislonger.Theoperatingcycleistheaveragetimebetweenpayingforinventoryortheemployeeswhoperformservicesandreceivingcashpaymentbackfromthefirm’scustomers.

1.Cashiscurrencyordemanddeposits.

2.Short-terminvestmentsaredebtorequityinvestmentsforwhichareadymarketexistsandmanagementintendstosellwithinoneyearoroperatingcycle.

3.Accountsreceivableareamountsowedtothefirmbyitscustomersforgoodsandservicesdelivered.

4.Notesreceivableareamountsowed,usuallybycustomers,whichwillnotbecollectedwithinthetypicalcollectionperiod.

5.Inventoryrepresentsproductsthatwillbesoldinthenormalcourseofbusiness.

6.Prepaidexpenses（e.g.,rent）areservicespaidforbutnotyetused.

Investmentsareland,debtsecurities,orequitysecuritieswhichmanagementdoesnotintendtosellwithintheyear.

1.Property,plant,andequipment:

Landistherealestateuponwhichthefirm’sbuildingssit.

2.Intangibleassetsareeconomicresourceslackingtangibleexistencesuchaspatents,copyrights,trademarks,andgoodwill.

Liabilitycategoriesonthebalancesheet

Liabilitiesareresponsibilities（amountsowed）whichmustbemetinthefuture,usuallybythepaymentofcash.Currentliabilitiesarethoseliabilitiesthatwillbepaidwithinoneyearoroperatingcycle.

1.Accountspayablearetheamountsowedtosuppliersforgoodsorservicesreceivedbutnotyetpaidfor.

2.Wages,rent,etc.payablesaretheamountsowedtoemployees,landlord,etc.forservicesusedbutnotyetpaidfor.

3.Notespayablearetheamountsowedcreditorsusuallywithexplicitinterestexpense.

4.Dividendspayableareowedtoownersfordividendsdeclaredbutnotyetpaid.

5.Currentportionoflong-termdebtisthatportionoflong-termdebtthatwillbepaidwithintheyear.Long-termliabilitiesaretheamountsowedcreditorsthatwillnotbepaidwithinoneyear.

Stockholders’equityistheowners'investmentandthetotalearningsretainedfromthebeginningofthebusiness.Contributedcapital（paid-in-capital）istheamountofthestockholders'investmentinthefirm’sequitysecurities.Commonstockistheportionofstockholders'investmentvaluedatpar.Otherpaid-in-capitalistheexcessoftheshareholders’investmentoverthestock’sparvalue.Retainedearningsisthetotalnetincomelesstheamountdistributedtotheownersasdividendsfromthebeginningofbusiness.

Aclassifiedbalancesheet

Abalancesheetcanbepresentedinmanydifferentways.Aclassifiedbalancesheetisoneinwhichtheaccountsareorderedinsomelogicalmanner,suchasbyliquidityormaturity.Inatypicalclassifiedbalancesheet:

1.Assetsarelistedinorderofliquidity,frommostliquidtoleastliquid.

2.Liabilitiesarelistedinorderofwhentheybecomedue.

3.Equityisgenerallypresentedwithcontributedorpaid-incapitalfirstandretainedearningslast.

b:

Defineeachcomponentofamultistepincomestatementandprepareamultistepincomestatement.

Amulti-stepincomestatementisastatementthatprovidessubtotalsalongthewaytoprovidingnetincome.Thebasicstructureoftheincomestatementis:

saleslesscostofgoodssoldequalsgrossmargin（grossprofit）lessoperatingexpensesequalsIncomefromoperations（operatingincome）addorsubtractotherrevenuesandexpensesequalsincomebeforeincometaxeslessincometaxesequalsnetincome.

∙Grosssalesorrevenuesarethetotalsales（cashandcredit）duringanaccountingperiod.Netsalesornetrevenuesarethegrossamountlessreturns,allowances,anddiscounts.

∙Costofgoodssoldisthecostofsalesforthegoodssoldduringtheperiod;thatis,thecostofthemerchandise（paidfororthecosttomanufacture）.

∙Operatingexpensesarethecostsofoperatingabusinessotherthanthecostofgoodssold.Examplesincludesellingexpensesandadministrativeexpenses.

∙Otherrevenuesandexpensesarenon-operatingitems.Examplesincludeinterestexpenseandinterestincome.

∙Incometaxesaretheprovisionforincometaxesforreportingpurposes.

1.C:

PreliminaryReadingShort-TermLiquidAssets

a:

Describehowtochoosetheappropriateaccountingmethodforinvestmentsecuritiesandexplainhowfair（market）valuegainsandlossesonsuchinvestmentsarereported.

Short-terminvestments（marketablesecurities）areinvestmentsintendedtobeheldonlyuntilcashisneededfortheoperationsofthebusiness.Itisintendedthattheseinvestmentsaretobeheldforlessthanoneyear.Short-terminvestmentsareinitiallyrecordedatcost（cashpriceplusanyacquisitioncostssuchasbrokeragefees）.

Ifmanagementintendstoholdshort-terminvestmentsindebtsecuritiestomaturity,thentheyarereportedattheiroriginalcost.Thesearecalledinvestmentsinsecuritiesheldtomaturity.Ifmanagementclassifiesashort-terminvestmentasatradinginvestment（tradinginvestmentsarealwaysconsideredtobecurrentassets）,thentheinvestmentisreportedonthebalancesheetatitsfairmarketvalue.Anyunrealizedholdinggainsorlossesduetotheappreciationordepreciationoftheinvestmentmustbelistedasagainorlossontheincomestatement.

b:

Describehowtoaccountfortransactionswithcreditcustomers,includingaccountingforbaddebtsundertheallowancemethodandthedirectwrite-offmethod.

LetSSScorporationhave$10,000ofcreditsalesand$2,000ofcashcollectionsinitsaccountsreceivableduringtheyear:

AccountsReceivable

$10,000

SalesRevenue

$10,000

Cash

$2,000

AccountsReceivable

$2,000

Nowassumeitisyearend.Itisestimatedthatofthe$8,000balanceinaccountsreceivable,$1,000willultimatelyturnouttobeuncollectable.

BadDebtsExpense

$1,000

AllowanceforDoubtfulAccounts

$1,000

Thebaddebtsexpensedecreasesnetincomeunderthematchingconcept.Andtheallowancefordoubtfulaccountsdecreasestheaccountsreceivableonthebalancesheettoitsnetrealizablevalue.

BalanceSheet:

AccountsReceivable

$8,000

lessAllowanceforDoubtfulAccounts

（1,000）

Netrealizablevalue

$7,000

Tocontinuetheexample,inthefollowingyear,itislearnedthatcustomerZZZ,whoowedthefirm$100hasdeclaredChapter7bankruptcy.ZZZ'saccountreceivablewillbewritten-offbyreducingtheallowanceandtheparticularaccountsreceivable.

Allowancefordoubtfulaccounts

$100

AccountsReceivable

$100

Thedirectwrite-offmethodisusedforincometaxcalculationsandbyfirmswithimmaterialbaddebts.Herethefirmdoesnotuseanallowanceaccount（accountsreceivableonthebalancesheetistheamountowedbycustomers）.Itrecognizesbaddebtsexpenseonlywhenaparticularaccountisw