Bài giảng Managerial Accounting - Chapter 12: Financial Statement Analysis

John Wiley & Sons, Inc.Prepared byKarleen Nordquist..The College of St. Benedict... and St. John’s University...with contributions byDr. Jessica J. Frazier.. and Philip Li...Eastern Kentucky University.Managerial Accounting Weygandt, Kieso, & KimmelChapter 12Financial Statement AnalysisAfter studying this chapter, you should be able to:1 Understand the concept of earning power and indicate how irregular items are presented.2 Discuss the need for comparative analysis and identify the tools of financial statement analysis.3 Explain and apply horizontal analysis.4 Explain and apply vertical analysis.5 Identify and compute ratios and describe their purpose and use in analyzing a firm’s liquidity, solvency, and profitability.6 Discuss the limitations of financial statement analysis.Chapter 12Financial Statement AnalysisPreview of Chapter 12Earning Power and Irregular ItemsDiscontinued OperationsExtraordinary ItemsChanges in Accounting PrincipleComprehensive IncomeComparative AnalysisHorizontal AnalysisVertical AnalysisFINANACIAL STATEMENT ANALYSISPreview of Chapter 12Ratio AnalysisLiquidity RatiosSolvency RatiosProfitability RatiosLimitations of Financial AnalysisEstimatesCostAlternative Accounting MethodsAtypical DataDiversificationFINANCIAL STATEMENT ANALYSISUnderstand the concept of earning power and indicate how irregular items are presented.Study Objective 1Earning Power and Irregular ItemsUltimately, the value of a company is a function of its future cash flows.When analysts use this year’s net income to estimate future cash flows, they must make sure this year’s net income does not include irregular revenues, expenses, gains, or losses.Net income adjusted for irregular items is referred to as earning power. Earning power is the most likely level of income to be obtained in the future (to the extent this year’s income is a good predictor of future income. Earning Power and Irregular ItemsAs an aid in the determination of earning power, irregular items are identified on the income statement. Three types of irregular items are reported:discontinued operations, extraordinary items, and changes in accounting principle.All of these items are reported net of income taxes. Discontinued OperationsDiscontinued operations refers to the disposal of a significant segment of a business, such as the elimination of a major class of customers or an entire activity.When the disposal of a significant segment occurs, the income statement should report both income from continuing operations and income (or loss) from discontinued operations.The income (loss) from discontinued operations consists of the income (loss) from operations and the gain (loss) on disposal of the segment.Discontinued OperationsTo illustrate, assume that Rozek Inc. has revenues of $2.5 million and expenses of $1.7 million from continuing operations in 1999. The company therefore has income before income taxes of $800,000.During 1999 the company discontinued and sold its unprofitable chemical division. The loss in 1999 from chemical operations (net of $60,000 taxes) was $140,000, and the loss on disposal of the chemical division (net of $30,000 taxes) was $70,000.Discontinued OperationsAssuming a 30% tax rate on income before taxes, the income statement presentation would be as follows:Income before income taxes $800,000Income tax expense 240,000Income from continuing operations 560,000Discontinued operations Loss from operations of chemical division, net of $60,000 income tax savings $140,000 Loss from disposal of chemical division, net of $30,000 income tax savings 70,000 210,000Net income $350,000Rozek Inc.Partial Income StatementFor the Year Ended December 31, 1999Illustration 12-1 Extraordinary ItemsExtraordinary items are events and transactions that meet two conditions: They are unusual in nature. They are infrequent in occurrence.Extraordinary items are reported net of taxes in a separate section of the income statement immediately below discontinued operations.If a transaction or event meets one, but not both, of the criteria for an extraordinary item, it should be reported as a separate line item in the upper portion of the income statement, usually in the “other revenues and gains” or “other expenses and losses” section at its gross amount.Classification of Extraordinary and Ordinary ItemsCondemnedExtraordinary ItemsOrdinary ItemsEffects of major casualties (acts of God), if rare in the area.Expropriation (takeover of property by a foreign government.Effects of a newly enacted law or regulation, such as a condemnation action.Effects of major casualties (acts of God), frequent in the area.Write-down of inventories or write-off of receivables.Losses attributable to labor strikes.Gains or losses form sales of PP&E.Illustration 12-2Extraordinary ItemsAssume that in 1999 a revolutionary foreign government expropriated property held as an investment by Rozek Inc. Income before income taxes $800,000Income tax expense 240,000Income from continuing operations 560,000Discontinued operations Loss from operations of chemical division, net of $60,000 income tax savings $140,000 Loss from disposal of chemical division, net of $30,000 income tax savings 70,000 210,000Income before extraordinary item 350,000Extraordinary item Expropriation of investment, net of $21,000 income tax savings 49,000Net income $301,000Rozek Inc.Partial Income StatementFor the Year Ended December 31, 1999Illustration 12-3If the loss is $70,000 before applicable income taxes of $21,000, the income statement presentation will show a deduction of $49,000.Changes in Accounting PrincipleFor ease of comparison, financial statements are expected to be prepared on a basis consistent with that used for the preceding period. When a choice of principles is available, the principal initially chosen should be applied consistently from period to period. A change in accounting principle occurs when the principle used in the current year is different from the one used in the preceding year.Changes in Accounting PrincipleA change is permitted, when management can show that the new principle is preferable to the old principle, and the effects of the change are clearly disclosed in the income statement.Two examples are a change in depreciation methods (such as declining-balance to straight-line) and a change in inventory costing methods (such as FIFO to average cost).Sometimes a change in accounting principle is mandated by FASB.Changes in Accounting PrincipleA change in accounting principle affects reporting in two ways:The new principle should be used in reporting the results of operations of the current year.The cumulative effect of the change on all prior-year income statements should be disclosed net of applicable taxes in a special section immediately preceding Net Income.Changes in Accounting PrincipleAssume at the beginning of 1999, Rozek Inc. changes from the straight-line method to the declining-balance method for equipment purchased on January 1, 1996. The cumulative effect on prior-year income statements (statements for 1996-1998) is to increase depreciation expense and decrease income before income taxes by $24,000. If there is a 30% tax rate, the net-of-tax effect of the change is $16,800 ($24,000 x 70%). The income statement is presented on the next slide.Changes in Accounting PrincipleIncome before income taxes $800,000Income tax expense 240,000Income from continuing operations 560,000Discontinued operations Loss from operations of chemical division, net of $60,000 income tax savings $140,000 Loss from disposal of chemical division, net of $30,000 income tax savings 70,000 210,000Income before extraordinary item 350,000Extraordinary item Expropriation of investment, net of $21,000 income tax savings 49,000Cumulative effect of change in accounting principle Effect on prior years of change in depreciation method, net of $7,200 income tax savings 16,800Net income $284,200Rozek Inc.Partial Income StatementFor the Year Ended December 31, 1999Illustration 12-4Comprehensive IncomeAlthough most revenues, expenses, gains, and losses recognized during the period are included in net income, specific exceptions to this practice have developed.Certain items, such as unrealized gains and losses on available-for-sale securities, now bypass income and are reported directly in stockholders’ equity.(Unrealized gains and losses on available-for-sale securities are excluded from net income because disclosing them separately reduces the volatility of net income due to fluctuations in fair value, yet informs the financial statement user of the gain or loss that would be incurred if the securities were sold at fair value.) Comprehensive IncomeAnalysts have expressed concern that the number of items bypassing the income statement has increased significantly, which has reduced the usefulness of the income statement.To address this concern, the FASB now requires that, in addition to reporting net income, a company must also report comprehensive income.Comprehensive IncomeComprehensive income includes all changes in stockholders' equity during a period except those resulting from investments by stockholders and distributions to stockholders.A number of alternative formats for reporting comprehensive income are allowed. These formats are discussed in advanced accounting classes.Discuss the need for comparative analysis and identify the tools of financial statement analysis.Study Objective 2Comparative AnalysisEvery item reported in a financial statement has significance: Its inclusion indicates that the item exists at a given time and in a certain quantity.For example, if Iomega Corporation reports $243.8 million on its balance sheet as cash, it is known that Iomega did have cash and its quantity was $243.8 million. But whether that represents an increase over prior years, or whether it is adequate for the company’s needs cannot be determined from that amount alone.The amount must be compared with other financial data to perceive its significance. Comparative AnalysisThree types of comparisons increase the decision usefulness of financial information:Intracompany basis: Comparisons within a company are often useful to detect changes in financial relationships and significant trends. Industry averages: Comparisons with industry averages provide information about a company’s relative position with the industry.Intercompany basis: Comparisons with other companies provide insight into a company’s competitive position.Comparative AnalysisThree basic tools are used in financial statement analysis to highlight the significance of financial statement data:Horizontal analysisVertical analysisRatio analysisExplain and apply horizontal analysis.Study Objective 3Horizontal AnalysisHorizontal analysis (also known as trend analysis) is a technique for evaluating a series of financial statement data over a period of time.The purpose of horizontal analysis is to determine whether an increase or decrease has taken place.The increase or decrease can be expressed as either an amount, or a percentage of a base-year amount. Horizontal AnalysisTo illustrate horizontal analysis, the most recent net sales figures (in millions) of Kellogg Company are shown below: 1997 1996 1995 1994 1993 $6,830.1 $6,676.6 $7,003.7 $6,562.0 $6,295.4If 1993 is assumed to be the base year, percentage increases/decreases from this base-period amount can be computed using the formula shown below.Change since base periodCurrent-year amount – Base-year amountBase-year amount=Illustration 12-5For example, net sales for Kellogg increased by almost 8.5% [($6,830.1 - $6,295.4)/$6,295.4] from 1993 to 1997. Net sales horizontal analysis for all 5 years is shown on the next slide. 1997 1996 1995 1994 1993 $6,830.1 $6,676.6 $7,003.7 $6,562.0 $6,295.4 108.5% 106.1% 111.3% 104.2% 100%Kellogg CompanyNet Sales (in millions)Base Period 1993Illustration 12-6 Horizontal AnalysisTo further illustrate horizontal analysis, Kellogg’s 2-year condensed balance sheets and income statements for 1996 and 1997 with dollar and percentage changes are shown on the following two slides.Kellogg Company, Inc.Condensed Balance Sheets (in millions)December 31 Increase/Decrease during 1997Assets 1997 1996 Amount PercentCurrent assets $1,467.7 $1,528.6 $ (60.9) (4.0)%Plant assets (net) 2,773.3 2,932.9 (159.6) (5.4) Other assets 636.6 588.5 48.1 8.2 Total assets $4,877.6 $5,050.0 $ (172.4) (3.4) Liabilities and Stockholders’ EquityCurrent liabilities $1,657.3 $2,199.0 $ (541.7) (24.6) Long-term liabilities 2,222.8 1,568.6 654.2 41.7 Total liabilities 3,880.1 3,767.6 112.5 3.0 Stockholders’ Equity Common stock 196.3 201.8 (5.5) (2.7) Retained earnings and other 958.5 3,984.0 (3,025.5) (76.0) Treasury stock (cost) (157.3) (2,903.4) 2,746.1 (94.6) Total stockholders’ equity 997.5 1,282.4 (284.9) (22.2) Total liabilities and stockholders’ equity $4,877.6 $5,050.0 $ (172.4) (3.4)%Illustration 12-7Kellogg Company, Inc.Condensed Income Statements (in millions)December 31 Increase/Decrease during 1997 1997 1996 Amount PercentNet sales $6,830.1 $6,676.6 $153.5 2.3%Cost of goods sold 3,270.1 3,122.9 147.2 4.7 Gross profit 3,560.0 3,553.7 6.3 0.2 Selling & administrative expense 2,366.8 2,458.7 (91.9) (3.7) Nonrecurring charges 184.1 136.1 48.0 35.3 Income from operations 1,009.1 958.9 50.2 5.2 Interest expense 108.3 65.6 42.7 65.1 Other income(expense), net 3.7 (33.4) (37.1) — Income before income taxes and cumulative effect of accounting change 904.5 859.9 44.6 5.2 Income taxes 340.5 328.9 11.6 3.5 Income before cumulative effect of accounting change 564.0 531.0 33.0 6.2 Cumulative effect of accounting change (net) (18.0) — (18.0) — Net income $ 546.0 $ 531.0 $ 15.0 2.8%Illustration 12-8Horizontal Analysis: Balance SheetThe comparative balance sheets show that a number of changes occurred in Kellogg’s financial position from 1996 to 1997. In the assets section, current assets decreased $60.9 million, or 4.0% ($60.9  $1,528.6), plant assets (net) decreased $159.6, or 5.4%, and other assets increased 8.2%.In the liabilities section, current liabilities decreased $541.7, or 24.6%, while long-term liabilities increased $654.2, or 41.7%. In the stockholders’ equity section, retained earnings decreased $3,025.5, or 75.9%. The decrease in retained earnings and treasury stock is due to a retirement of a significant number of shares of treasury stock.Horizontal Analysis: Income StatementHorizontal analysis of the income statements shows these changes:Net sales increased $153.5, or 2.3% ($153.5  $6.676.6).Cost of goods sold increased $147.2, or 4.7%.Selling and administrative expenses decreased $91.9, or 3.7%.Overall, gross profit increased $6.2 million, or less than 1%, and net income increased 2.8%. The increase in net income can be primarily attributed to the decrease in selling and administrative expenses.Horizontal Analysis: ComplicationsThe measurement of changes from period to period in percentages is relatively straightforward and quite useful. However, complications can arise in performing the computations. If an item has no value in a base year or preceding year, no percentage change can be computed.Also, if a negative amount appears in the base or preceding period, and a positive amount exists the following year, or vice versa, no percentage change can be computed.For example, no percentage change could be calculated for the cumulative effect in Kellogg’s income statement.Describe and apply vertical analysis.Study Objective 4Vertical AnalysisVertical analysis is a technique for evaluating financial statement data that expresses each item in a financial statement as a percent of a base amount.Total assets is always the base amount in vertical analysis of a balance sheet.Net sales is always the base amount in vertical analysis of an income statement.Vertical AnalysisVertical analysis shows the relative size of each category on the financial statements.To further illustrate vertical analysis, Kellogg’s 2-year condensed balance sheets and income statements for 1996 and 1997 with vertical analysis percentages are shown on the following two slides.Kellogg Company, Inc.Condensed Balance Sheets (in millions)December 31 1997 1996 Assets Amount Percent Amount PercentCurrent assets $1,467.7 30.1% $1,528.6 30.3%Plant assets (net) 2,773.3 56.9 2,932.9 58.0 Other assets 636.6 13.0 588.5 11.7 Total assets $4,877.6 100.0% $5,050.0 100.0%Liabilities and Stockholders’ EquityCurrent liabilities $1,657.3 34.0% $2,199.0 43.5%Long-term liabilities 2,222.8 45.6 1,568.6 31.3 Total liabilities 3,880.1 79.6 3,767.6 74.6 Stockholders’ Equity Common stock 196.3 4.0 201.8 4.0 Retained earnings and other 958.5 19.6 3,984.0 78.9 Treasury stock (cost) (157.3) (3.2) (2,903.4) (57.5) Total stockholders’ equity 997.5 20.4 1,282.4 25.4 Total liabilities and stockholders’ equity $4,877.6 100.0% $5,050.0 100.0%Illustration 12-9Kellogg Company, Inc.Condensed Income Statements (in millions)December 31 1997 1996  Amount Percent Amount PercentNet sales $6,830.1 100.0% $6,676.6 100.0%Cost of goods sold 3,270.1 47.9 3,122.9 46.8 Gross profit 3,560.0 52.1 3,553.7 53.2 Selling & administrative expense 2,366.8 34.6 2,458.7 36.8 Nonrecurring charges 184.1 2.7 136.1 2.0 Income from operations 1,009.1 14.8 958.9 14.4 Interest expense 108.3 1.6 65.6 1.0 Other income(expense), net 3.7 .1 (33.4) (.5) Income before income taxes and cumulative effect of accounting change 904.5 13.3 859.9 12.9 Income taxes 340.5 5.0 328.9 4.9 Income before cumulative effect of accounting change 564.0 8.3 531.0 8.0 Cumulative effect of accounting change (net) (18.0) (.3) — — Net income $ 546.0 8.0% $ 531.0 8.0%Illustration 12-10Vertical Analysis: Balance SheetNote the following changes in Kellogg’s financial position.Current assets decreased slightly from 30.3% to 30.1% of total assets from 1996 to 1997. Plant assets (net) decreased from 58.0% to 56.9% of total assets. Current liabilities went down from 43.5% to 34.0%, while long-term liabilities went up from 31.1% to 45.6% of total liabilities and stockholders’ equity.Significantly, during the same year, stockholders’ equity decreased from 25.4% to 20.4%. Thus, the company shifted toward a heavier reliance on debt financing, both by using more long-term debt and by reducing the amount of outstanding equity.Vertical Analysis: Income StatementVertical analysis of the income statements reveals:Cost of goods sold as a percentage of net sales increased 1.1% (from 46.8% to 47.9%) while selling and administrative expenses decreased 2.2% (from 36.8% to 34.6%). Even with these changes, net income as a percent of net sales remained the same, yet net income actually increased $15 million.Vertical AnalysisAs shown from the preceding example, vertical analysis shows the relative size of each category on the financial statements.Vertical analysis also enables the comparison of companies of different sizes. This benefit of vertical analysis is evident from its alternative name: common-size analysis.As an example, see the following vertical analysis comparing Kellogg’s income statement with that of General Mills, Inc., one of Kellogg’s competitors.Condensed Income StatementsFor the Year Ended December 31, 1997(in millions) Kellogg Company General Mills, Inc.  Amount Percent Amount PercentNet sales $6,830.1 100.0% $5,609.3 100.0%Cost of goods sold 3,270.1 47.9 2,328.4 41.5 Gross profit 3,560.0 52.1 3,280.9 58.5 Selling & administrative expense 2,366.8 34.6 2,422.0 43.2 Nonrecurring charges 184.1 2.7 48.4 .9 Income from operations 1,009.1 14.8 810.5 14.4 Interest expense 108.3 1.6 100.5 1.8 Other income(expense), net 3.7 .1 (6.3) (.1) Income b