financial statement analysis chapter 10 ppp

8/9/2019 financial statement analysis chapter 10 ppp

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Cambridge Business Publishers, 2013

FINANCIAL STATEMENT

ANALYSIS & VALUATIONThird Edition

Peter D. Mary Lea Gregory A. Xiao-Jun

Easton McAnally Sommers Zhang


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Module 10:Module 10:

Of-Balance-SheetOf-Balance-SheetFinancingFinancing


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Of-Balance SheetOf-Balance Sheet

FinancingFinancing

Of-balance sheetOf-balance sheetfnancing means thatfnancing means thateither assets or liabilities, or both, are noteither assets or liabilities, or both, are not

reported on the ace o the balance sheet.reported on the ace o the balance sheet.

Managers generall belie!e that "eepingManagers generall belie!e that "eeping

such assets and liabilities o# the balancesuch assets and liabilities o# the balancesheet impro!es mar"et perception o theirsheet impro!es mar"et perception o their

operating perormance and fnancialoperating perormance and fnancial

condition.condition.

$mpirical e!idence suggests that analsts$mpirical e!idence suggests that analsts

ad%ust balance sheets to include assetsad%ust balance sheets to include assets

and liabilities that managers e&clude.and liabilities that managers e&clude.


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LeasingLeasing

' lease is a contract bet(een the o(ner' lease is a contract bet(een the o(nero an asset )the lessor* and the parto an asset )the lessor* and the partdesiring to use that asset )the lessee*.desiring to use that asset )the lessee*.

+enerall, leases pro!ide or the+enerall, leases pro!ide or the

ollo(ing termsollo(ing terms1.1. -he lessor allo(s the lessee the unrestricted-he lessor allo(s the lessee the unrestricted

right to use the asset during the lease term.right to use the asset during the lease term.

2.2. -he lessee agrees to ma"e periodic paments-he lessee agrees to ma"e periodic pamentsto the lessor and to maintain the asset.to the lessor and to maintain the asset.

3.3. -itle to the asset remains (ith the lessor,-itle to the asset remains (ith the lessor,(ho usuall reta"es possession o the asset(ho usuall reta"es possession o the assetat the conclusion o the lease.at the conclusion o the lease.


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Capital vs. OperatingCapital vs. Operating

LeasesLeases

+''P identifes or t(o di#erent+''P identifes or t(o di#erent

approaches in the reporting o leasesapproaches in the reporting o leases

b the lesseeb the lessee

Capital lease ethodCapital lease ethod--both theboth the

lease asset and the lease liabilit arelease asset and the lease liabilit are

reported on the balance sheet.reported on the balance sheet.

Operating lease ethodOperating lease ethod-- neitherneitherthe lease asset nor the lease liabilitthe lease asset nor the lease liabilit

is on the balance sheet.is on the balance sheet.


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Capital vs. OperatingCapital vs. Operating

LeasesLeases


7/32Cambridge Business Publishers, 2013

Operating LeasesOperating Leases

Conseuences or the lesseeConseuences or the lessee

1.1. -he lease asset is not reported on the balance sheet / net-he lease asset is not reported on the balance sheet / netoperating asset turno!er )'-* is higher.operating asset turno!er )'-* is higher.

2.2. -he lease liabilit is not reported on the balance sheet /-he lease liabilit is not reported on the balance sheet /fnancial le!erage is impro!ed.fnancial le!erage is impro!ed.

3.3. ithout analtical ad%ustments )see later section onithout analtical ad%ustments )see later section on

capitaliation o operating leases*, the portion o 4$capitaliation o operating leases*, the portion o 4$deri!ed rom operating acti!ities )4'* appears higher,deri!ed rom operating acti!ities )4'* appears higher,(hich impro!es the percei!ed ualit o the compan5s(hich impro!es the percei!ed ualit o the compan5s4$.4$.

6.6. 7uring the earl ears o the lease term, rent e&pense7uring the earl ears o the lease term, rent e&pense

reported or an operating lease is less than thereported or an operating lease is less than thedepreciation and interest e&pense reported or a capitaldepreciation and interest e&pense reported or a capitallease. -his means that net income is higher in those earllease. -his means that net income is higher in those earl

ears (ith an operating lease. 8urther, i the compan isears (ith an operating lease. 8urther, i the compan isgro(ing and continuall adding operating lease assets, thegro(ing and continuall adding operating lease assets, thele!el o profts (ill continue to remain higher during thele!el o profts (ill continue to remain higher during the

gro(th period.gro(th period.



!elta"s!elta"s

FootnoteFootnote

!isclosu!isclosures o#res o#

LesseesLessees

C i li i O iC i li i O i



Capitali$ing OperatingCapitali$ing Operating

LeasesLeases

#or %nal&sis 'urposes#or %nal&sis 'urposes1.1. 7etermine the discount rate.7etermine the discount rate.

2.2. Compute the present !alue oCompute the present !alue o

uture operating lease paments.uture operating lease paments.

3.3. 'd%ust the fnancials to include the'd%ust the fnancials to include the

present !alue o the lease assetpresent !alue o the lease asset

and lease liabilit.and lease liabilit.



!elta"s (plicit !iscount!elta"s (plicit !iscount

)ate)ate



ap a $a on o e a sap a $a on o e a sOperating Leases on theOperating Leases on the

Balance SheetBalance Sheet



%d*ustents to the%d*ustents to the

(ncoe Stateent(ncoe Stateent

4emo!e rent e&pense rom operating4emo!e rent e&pense rom operating

e&pense.e&pense.

'dd depreciation e&pense rom the'dd depreciation e&pense rom the

lease assets to operating e&pense andlease assets to operating e&pense andadd interest e&pense rom the leaseadd interest e&pense rom the lease

obligation as a nonoperating e&pense.obligation as a nonoperating e&pense.



Capitali$ation o# !elta"sCapitali$ation o# !elta"s

Operating LeasesOperating Leases



'ensions'ensions

+enerall t(o tpes o plans+enerall t(o tpes o plans

!e+ned contribution plan.!e+ned contribution plan.-his plan has-his plan has

the compan ma"e periodic contributions tothe compan ma"e periodic contributions to

an emploee5s account, and man plansan emploee5s account, and man plansreuire an emploee matching contribution.reuire an emploee matching contribution.

!e+ned bene+t plan.!e+ned bene+t plan.-his plan has the-his plan has the

compan ma"e periodic paments to ancompan ma"e periodic paments to an

emploee ater retirement.emploee ater retirement.


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%ccounting #or%ccounting #or

!e+ned Contribution 'lans!e+ned Contribution 'lans

8rom an accounting standpoint,8rom an accounting standpoint,

defned contribution plans o#er nodefned contribution plans o#er no

particular problems.particular problems. -he contribution is recorded as an-he contribution is recorded as an

e&pense in the income statemente&pense in the income statement

(hen paid or accrued.(hen paid or accrued.


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o ccoun ng ssueso ccoun ng ssues)elated to !e+ned Bene+t)elated to !e+ned Bene+t

'lans'lans1.1. -he appropriate balance sheet presentation o-he appropriate balance sheet presentation othe pension in!estments and obligation.the pension in!estments and obligation. -he pension standard allo(s companies to report the-he pension standard allo(s companies to report the

netnetpension liabilit on their balance sheet.pension liabilit on their balance sheet. 9nderunded plans are reported on the balance9nderunded plans are reported on the balance

sheet as a long/term liabilit.sheet as a long/term liabilit. !erunded plans are reported as a long/term asset.!erunded plans are reported as a long/term asset.

2.2. -he treatment o :uctuations in pension-he treatment o :uctuations in pensionin!estments and obligations in the incomein!estments and obligations in the incomestatement.statement.

-he 8';B allo(s companies to report pension-he 8';B allo(s companies to report pensionincome based onincome based on expectedexpectedlong/term returns onlong/term returns onpension in!estments )rather than actual in!estmentpension in!estments )rather than actual in!estmentreturns*, and to deer the recognition o unrealiedreturns*, and to deer the recognition o unrealiedgains and losses on both pension in!estments andgains and losses on both pension in!estments and

pension obligations.pension obligations.


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'lan %ssets and 'BO'lan %ssets and 'BO

CoputationsCoputations


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Balance Sheet 'resentationBalance Sheet 'resentation


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'BO Coponents'BO Coponents

Service costService cost< the increase in the< the increase in thepension obligation due to emploeespension obligation due to emploees(or"ing another ear or the(or"ing another ear or the

emploer.emploer. (nterest cost(nterest cost< the increase in the< the increase in the

pension obligation due to the accrualpension obligation due to the accrualo an additional ear o interest.o an additional ear o interest.

Bene+ts paid to eplo&eesBene+ts paid to eplo&ees< the< thecompan5s obligation is reduced ascompan5s obligation is reduced asbenefts are paid to emploees.benefts are paid to emploees.


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'ension /pense'ension /pense


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!elta"s Funded Status!elta"s Funded Status


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!elta"s 'ension /pense!elta"s 'ension /pense


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Cash Flo (plicationsCash Flo (plications

ne application o the pension ootnoteis to assess the li"elihood that thecompan (ill be reuired to increase itscash contributions to the pension plan.


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'ro+t (plications'ro+t (plications


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o 'ensions Con#oundo 'ensions Con#ound

(ncoe %nal&sis(ncoe %nal&sis


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lobal %ccountinglobal %ccounting

LeasesLeases--

=84; lease standards currentl allo(=84; lease standards currentl allo(or operating leases, but the standards are suchor operating leases, but the standards are such

that it is !er di#icult or a lease agreement tothat it is !er di#icult or a lease agreement to

uali as an operating lease.uali as an operating lease.

'ensions'ensions-- 9.;. +''P permits deerral o9.;. +''P permits deerral oactuarial gains and losses and then amortiesactuarial gains and losses and then amorties

them to net income o!er time. =84; companiesthem to net income o!er time. =84; companies

can recognie all actuarial gains and losses incan recognie all actuarial gains and losses in

comprehensi!e income in the ear the occur.comprehensi!e income in the ear the occur.

Special 'urpose ntitiesSpecial 'urpose ntities-- 9nder 9.;. +''P,9nder 9.;. +''P,the primar benefciar is reuired to consolidatethe primar benefciar is reuired to consolidate

the ;P$. =84; ocuses on the general concept othe ;P$. =84; ocuses on the general concept o

>control? to determine i the ;P$ is consolidated.>control? to determine i the ;P$ is consolidated.


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Special 'urpose ntitiesSpecial 'urpose ntities

2S's3: %sset Securiti$ation2S's3: %sset Securiti$ation

' sponsoring compan orms a subsidiar that' sponsoring compan orms a subsidiar thatis capitalied entirel (ith euit@ this createsis capitalied entirel (ith euit@ this createsaa bankruptcy remote transactionbankruptcy remote transaction, (hich, (hichreduces the li"elihood o ban"ruptc orreduces the li"elihood o ban"ruptc or

subseuent in!estors*.subseuent in!estors*. -he subsidiar purchases assets rom the-he subsidiar purchases assets rom the

sponsoring compan and sells them to asponsoring compan and sells them to asecuritiation )o#/balance/sheet* trust )thesecuritiation )o#/balance/sheet* trust )the

;P$*, (hich purchases the assets using;P$*, (hich purchases the assets usingborro(ed unds.borro(ed unds. Cash :o(s rom the acuired assets are usedCash :o(s rom the acuired assets are used

b the ;P$ to repa its debt.b the ;P$ to repa its debt.


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Special 'urpose ntitiesSpecial 'urpose ntities

2S's3: Ford Motor Credit2S's3: Ford Motor Credit


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Ford"s %sset Securiti$ationFord"s %sset Securiti$ation

) ti l # S') ti l # S'


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)ationale #or S')ationale #or S'

FinancingFinancing

Loer cost o# capital.Loer cost o# capital. ;P$s canpro!ide lo(er cost fnancing or acompan.

Li4uidit&.Li4uidit&. ;ecuritiation o assetspro!ides a consistent cash :o( source.


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Consolidation o# S'sConsolidation o# S's

+enerall, an entit that+enerall, an entit that lac"s independence rom the sponsoringlac"s independence rom the sponsoring

compancompan lac"s su#icient capital to conduct itslac"s su#icient capital to conduct its

operations apart rom the sponsoringoperations apart rom the sponsoring

compancompanmust be consolidated (ith (hate!er entitmust be consolidated (ith (hate!er entitbears the greatest ris" o loss and standsbears the greatest ris" o loss and standsto reap the greatest re(ards rom itsto reap the greatest re(ards rom its

acti!ities.acti!ities.

-he e#ect o consolidation o ;P$s is to-he e#ect o consolidation o ;P$s is to

report both the assets and liabilities on thereport both the assets and liabilities on the

consolidated balance sheet.consolidated balance sheet.


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financial statement analysis chapter 10 ppp

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