Draft 2 Requirements

							Finance 3321(Moore) Draft 2 Requirements – Valuation Project



                       Draft 2 Requirements
                    Formal Accounting Analysis

      Structure of the Formal Accounting Analysis

      1.     Identify Key Accounting Policies (KAP)
              Key accounting policies must be directly linked to the Key
               Success Factors (KSF’s) identified and discussed in the first
               draft.
              These are NOT the “boilerplate” significant accounting
               policies listed in the supplementary disclosure of the 10-K.
              KAP’s regard disclosure related to those items you found to
               be significant either in terms of activities that drive (create)
               corporate value via the KSF’s identified in draft 1 or
               significant asset or liability items that materially affect the
               user’s view of the company.
                  o This means that depreciation methods and inventory
                      accounting methods are typically NOT considered
                      KAP’s for the purpose of this analysis.
                  o Significant asset and liability items can include (and
                      are not limited to) the extent, relative mix and use of
                      operating vs. capital leases; defined benefit plan
                      pension liabilities (and expenses) as they are based on
                      actuarial assumptions; commodity, interest-rate, and
                      currency derivative risk management exposure,
                      disclosure and assumptions; Off balance-sheet
                      collateralized debt obligations; etc.
                  o A very broad perspective is used when defining KAP’s
                      in that it looks at overall disclosure related to things
                      the valuation analyst finds important and not just the
                      underlying debits and credits.
                  o This section still involves and industry perspective, so
                      you must look at the 10-K’s of the company you are
                      valuing as well as the 10-K’s of the main competitors
                      in the industry
Finance 3321(Moore) Draft 2 Requirements – Valuation Project


      2.     Assess Degree of Potential Accounting Flexibility
              Again, this relates to the flexibility related to those items you
               identify as KAP’s.
              Be specific. Use institutional knowledge of GAAP and look at
               relative disclosures among firms in the industry.
      3.     Evaluate Actual Accounting Strategy
              Accounting strategy includes two basic dimensions:
                 o First, you need to assess whether your company is a
                    high disclosure company (levels of dis-aggregation,
                    segment reporting, extensive discussion and disclosure
                    within the financial report related to those items you
                    find important in assessing value) vs. low disclosure
                    (minimal reporting that satisfies GAAP).
                 o Second, you need to assess (within the confines of
                    accounting flexibility on the KAP’s whether the
                    company is conservative (leads to lower reported
                    earning) or aggressive (leads to higher reported
                    earnings) in its choice of accounting policies. Make
                    sure to do this on an absolute and relative basis.
      4.     Evaluate the Quality of Disclosure
              Qualitative Analysis
                    o This is essentially a matter of opinion (logical
                      argumentation) that is grounded in supportive facts
                      that lead to your conclusion. Main issue is overall
                      transparency and decision usefulness of the financial
                      reporting information. Ultimately, does the financial
                      information presented by the company provide
                      sufficient decision useful information that satisfies your
                      information needs (level of disclosure, discussion,
                      analysis,    dis-aggregation,    appropriate     segment
                      disclosure, etc. This analysis should be prepared on
                      both an absolute and relative basis.
              Quantitative Analysis
                    o Prepare a cross sectional and time series analysis
                      using the revenue manipulation and expense
                      manipulation diagnostic ratios. Analyze and report
                      your findings.
Finance 3321(Moore) Draft 2 Requirements – Valuation Project


      5.      Identify Potential “Red Flags”
            Previous Qualitative and Quantitative Factors.
            Asset Write-offs. 4th quarter adjustments.             Related Party
             transactions; Special purpose entities

   6. Undo Accounting Distortions
            Should you determine that significant balance sheet and
             income statement items are materially misstated (for the
             purpose of your analysis), then restate the financial statements
             based upon your analysis.
            Items that sometimes arise are overstated inventory (resulting
             from understated obsolescence rates), capitalizing operating
             leases (GAAP is not in violation, but off-balance sheet assets
             and liabilities are present that materially affect your
             assessments of resources and liabilities); capitalizing research
             and development, restating collateralized debt obligations and
             incorporating special purpose entities into the financials.

            You will only want to restate when the items materially alter your
             perception of the underlying company.