CH. 3ANALYZING FINANCING ACTIVITIES

Preview Financing liabilities: all forms of credit

financing. Operating liabilities: obligations that arise

from operations. Liabilities are commonly reported as either

current or noncurrent.

Analyzing Liabilities We need assurance that companies account

for them (includes disclosure of their amounts and due dates).

Many companies attempt to reduce the amount of liabilities reported on their financial statements.

Certain liabilities are more apt to be misclassified or inadequately described.

Leases Capital lease & Operating Lease Off-balance-sheet financing: neither the

leased asset nor its corresponding liability are recorded on the balance sheet when a lease is accounted for as an operating lease even though many of the benefits and risks of ownership are transferred to the lessee.

Leases Over lease term, total expense of operating

and capital lease is identical. But, capital lease lease reports more expense in the earlier years and less expense in later years.

Analyzing Leases Impact of operating leases:

Understate liabilities => inflate solvency ratios

Understate assets => inflate ROI Delay recognition of expenses Understate current liabilities => inflate

current ratio and other liquidity measures Understate operating income and interest

expense => inflate interest coverage ratios

Postretirement Benefits Costs of providing postretirement benefits

be recognized when the employee is in active service, rather than when the benefits are actually paid.

Defined benefit plans & Defined contribution plans.

Analyzing Postretirement Benefits Reconciling economic and reported

numbers Adjusting the income statement and

balance sheet Evaluate actuarial assumptions

Contingencies and Commitments Contingent liabilities: potential claims on a

company’s resources. Commitments: potential claims against a

company’s resources due to future performance under contract.

Off-Balance-Sheet Financing Operating leases Special Purpose Entities (SPEs)

Shareholders’ Equity Capital stock:

Explanation of changes in the number of capital shares

Evaluation of the options held by others that when exercised cause the number of shares outstanding to increase and thus dilute ownership

Retained Earnings Restrictions imposed on distributions of retained

earnings

Analyzing Contingent Liabilities Management estimates Analyze note disclosures for all loss (and

gain) contingencies. Reserve for future losses => big bath