Accounting Problems in Analyzing Financial Statements
Basic Balance Sheet Accounts
Assets: Cash Receivables Inventory Current Assets Incorrect Allowance for Sales Returns: W.T. Grant Bankruptcy Inadequate Bad Debt Allowance Recording the shipment of inventory as a sale when it is effectively on consignment. O.M. Scott
Gross Fixed Assets Accumulated Depreciation Net Fixed Assets
Goodwill Other Assets Total Assets
Basic Balance Sheet Accounts
Assets: Cash Receivables Inventory Current Assets Inventories really are not there. Either “never bought” or “sold but sale not recorded”. Phar-Mor Overstatement of ending inventory, overstates prior year’s net income and understates next year’s net income. The opposite is true for understating ending inventory.
Gross Fixed Assets Accumulated Depreciation Net Fixed Assets
Goodwill Other Assets Total Assets
Use of LIFO, understates true inventory value in periods of rising prices. To adjust, one should add the “LIFO reserve” shown in footnotes.
Basic Balance Sheet Accounts
Assets: Cash Receivables Inventory Current Assets
Gross Fixed Assets Accumulated Depreciation Net Fixed Assets
Goodwill Other Assets Total Assets
Totally dependant on the accounting procedures used for yearly depreciation expense.
Basic Balance Sheet Accounts
Assets: Cash Receivables Inventory Current Assets Goodwill is difference between Fair Market Value Paid and Book Value of Assets Acquired. Stock for stock transactions generally do not require the recognition of GW. Goodwill can be amortized over 5 - 40 years. The firm decides. Goodwill amortization is not a tax deductible expense.
Gross Fixed Assets Accumulated Depreciation Net Fixed Assets
Goodwill Other Assets Total Assets
Basic Balance Sheet Accounts
Assets: Cash Receivables Inventory Current Assets Gross Fixed Assets Accumulated Depreciation Net Fixed Assets Goodwill Other Assets Total Assets Some lease agreements must be capitalized and show as both an asset & liability of the firm. These are referred to as “Capitalized Leases”. Other lease agreements are not shown on the balance sheet. These are known as Operating Leases”.
However, the present value of required cash payments of Operating Leases can exceed the asset value of Capitalized Leases.
Basic Balance Sheet Accounts
Sometimes a firm will recognize a cash receipt (or receivable) as revenue when it should actually be reported as unearned income, a liability. Cendent Payables Accruals Current Portion of LTD Current Liabilities Long-term Debt Employee Benefit Obligations Deferred Taxes Long-Term Liabilities Common Stock Paid in Surplus Retained Profits Treasury Shares Total Equity Total Liabilities and Equity
Basic Income Statement Accounts
+Revenues Sometimes a firm will recognize a cash receipt (or receivable) as revenue when it should actually be reported as unearned income, a liability. Cendent
Many firms will rush shipments at the end of a year in order to “book” the shipment as revenue in the current year. This is done to meet security analysts expectations of EPS growth. Firm’s manage reported revenue.
Basic Income Statement Accounts
-Cost of goods sold Dependant on accurate inventory counts.
If the firm uses FIFO accounting, you might wish to estimate this uses LIFO procedures to better reflect the “Economic Profits” of the firm.
This can be difficult to due with precision. But it can be important if prices are rising significantly in the industry.
Basic Income Statement Accounts
-Cash Operating Expenses
No significant problems in general. But watch out for the “big bath” syndrome in years of very good or bad income.
Basic Income Statement Accounts
-Depreciation
Totally dependant on method chosen for depreciating asset. Might have little relationship with economic depreciation of assets.
Basic Income Statement Accounts
No significant problems in general.
But watch out for the “big bath” syndrome in years of very good or bad income.
-Extraordinary items (watch for the “big bath”)
Also watch for unnecessary “Restructuring” Charges