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44 Cards in this Set
- Front
- Back
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Current (short-term) Liabilities
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Obligations whose settlement requires use of current assets or the incurrence of another current liability within one year or the operating cycle, whichever is longer.
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Noncurrent (Long-Term) Liabilities
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Obligations not payable within one year or the operating cycle, whichever is longer.
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Operating Liabilities
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Obligations that arise from operating activities--examples are accounts payable, unearned revenue, advance payments, taxes payable, postretirement liabilities, and other accruals of operating expenses
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Financing Liabilities
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Obligations that arise from financing activities--examples are short- and long-term debt, bonds, notes, leases, and the current portion of long-term debt
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Important Features in Analyzing Liabilities
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1 - Terms of indebtedness (such as maturity, interest rate, payment pattern, and amount).
2 - Restrictions on deploying resources and pursuing business activities. 3 -Ability and !!! flexibility!!! in pursuing further financing. 4 - Obligations for working capital, debt to equity, and other financial figures. 5- Dilutive conversion features that liabilities are subject to. 6- Prohibitions on disbursements such as dividends. |
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Lease
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contractual agreement between a lessor (owner) and a lessee (user or renter) that gives the lessee the right to use an asset owned by the lessor for the lease term.
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MLP – minimum lease payments
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payments
of the lessee to the lessor according to the lease contract |
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Lease Accounting and Reporting / Capital Lease
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Lease Accounting For leases that transfer substantially all benefits and risks of ownership—accounted for as an asset acquisition and a liability incurrence by the lessee, and as a sale and financing transaction by the lessor
A lessee classifies and accounts for a lease as a capital lease if, at its inception, the lease meets any of four criteria: (i) lease transfers ownership of property to lessee by end of the lease term (ii) lease contains an option to purchase the property at a bargain price (iii) lease term is 75% or more of estimated economic life of the property (iv) present value of rentals and other minimum lease payments at beginning of lease term is 90% or more of the fair value of leased property |
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Lease Accounting and Reporting / Operating Lease
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Lease Accounting For leases other than capital leases—the lessee (lessor) accounts for the minimum lease payment as a rental expense (income)
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Lease Disclosure
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Lessee must disclose: (1) future MLPs separately for capital leases and operating leases — for each of five succeeding years and the total amount thereafter, and (2) rental expense for each period on income statement is reported
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Off-Balance-Sheet Financing
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when a lessee structures a lease so it is accounted for as an operating lease when the economic characteristics of the lease are more in line with a capital lease—neither the leased asset nor its corresponding liability are recorded on the balance sheet
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Impact of Operating Lease versus Capital Lease // Operating lease understates liabilities ->
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—> improves solvency ratios such as debt to equity
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Operating lease understates assets —>
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can improve return on investment ratios
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Operating lease delays expense recognition—>
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-> overstates income in early term of the lease and understates income later in lease term
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Operating lease understates current liabilities by ignoring current portion of lease principal payment —>
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- > inflates current ratio & other liquidity measures
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Operating lease includes interest with lease rental (an operating expense) ->
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- > understates both operating income and interest expense, inflates interest coverage ratios,understates operating cash flow, & overstates financing cash flow
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Postretirement Benefits / Pension benefits
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Employer-promises monetary benefits to employees after retirement, e.g., monthly stipend until death
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Other Postretirement Employee Benefits (OPEB)
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-- Employer-provided non-pension (usually nonmonetary) benefits after retirement, e.g., health care and life insurance
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Analyzing Postretirement Benefits
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Five-step procedure for analyzing postretirement benefits:
1) Determine and reconcile the reported and economic benefit cost and liability (or asset). 2) Make necessary adjustments to financial statements. 3) Evaluate actuarial assumptions (discount rate, expected return, growth rate) and their effects on financial statements. 4) Examine pension risk exposure (arises to the extent to which plan assets have a different risk profile than the pension obligation). 5) Consider the cash flow implications of postretirement benefit plans. |
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Contingencies
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-- potential losses and gains whose resolution depends on one or more future events.
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Contingent liabilities --
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contingencies with potential claims on resources
-- to record a contingent liability (and loss) two conditions must be met: (i) probable i.e. an asset will be impaired or a liability incurred, and (ii) the amount of loss is reasonably estimable; -- to disclose a contingent liability (and loss) there must be at least a reasonable possibility of incurrence |
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Contingent assets
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contingencies with potential additions to resources
- a contingent asset (and gain) is not recorded until the contingency is resolved --a contingent asset (and gain) can be disclosed if probability of realization is very high |
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Analyzing Contingencies
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Sources of useful information:
Notes, MD&A, and Deferred Tax Disclosures Useful analyses: • Scrutinize management estimates • Analyze notes regarding contingencies, including Description of contingency and its degree of risk Amount at risk and how treated in assessing risk exposure Charges, if any, against income • Recognize a bias to not record or underestimate contingent liabilities • Beware of big baths — loss reserves are contingencies • Review SEC filings for details of loss reserves • Analyze deferred tax notes for undisclosed provisions for future losses Note: Loss reserves do not alter risk exposure, have no cash flow consequences, and do not provide insurance |
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Commitments
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-- potential claims against a company’s resources due to future performance under contract
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Analyzing Commitments
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Sources of useful information:
Notes and MD&A and SEC Filings Useful analyses: •Scrutinize management communications and press releases •Analyze notes regarding commitments, including Description of commitment and its degree of risk Amount at risk and how treated in assessing risk exposure Contractual conditions and timing • Recognize a bias to not disclose commitments •Review SEC filings for details of commitments |
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Off-Balance-Sheet Financing
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is the non-recording of financing obligations
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Motivation
To keep debt off the balance sheet |
part of ever-changing landscape, where as one accounting requirement is brought in to better reflect obligations from a specific off-balance-sheet financing transaction, new and innovative means are devised to take its place
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Transactions sometimes used as off-balance-sheet financing:
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Operating leases that are indistinguishable from capital leases • Through-put agreements, where a company agrees to run goods through a processing facility • Take-or-pay arrangements, where a company guarantees to pay for goods whether needed or not • Certain joint ventures and limited partnerships • Product financing arrangements, where a company sells and agrees to either repurchase inventory or guarantee a selling price • Sell receivables with recourse and record them as sales rather than liabilities • Sell receivables as backing for debt sold to the public • Outstanding loan commitments |
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Analysis of Off-Balance-Sheet Financing //
Companies disclose the following info about financial instruments with off-balance-sheet risk of loss: |
• Face, contract, or principal amount
• Terms of the instrument and info on its credit and market risk, cash requirements, and accounting Loss incurred if a party to the contract fails to perform • Collateral or other security, if any, for the amount at risk • Info about concentrations of credit risk from a counterparty or groups of counterparties Sources of useful information: Notes and MD&A and SEC Filings |
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Analysis of Off-Balance-Sheet Financing // Useful analyses:
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• Scrutinize management communications and press releases
• Analyze notes about financing arrangements • Recognize a bias to not disclose financing obligations • Review SEC filings for details of financing arrangements |
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Benefits of SPEs:
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SPEs may provide a lower-cost financing alternative than borrowing from the credit markets directly.
Under present GAAP, so long as the SPE is properly structured, the SPE is accounted for as a separate entity, unconsolidated with the sponsoring company. |
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Basics of Equity Financing // Equity
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— refers to owner (shareholder) financing; its usual characteristics include:
• Reflects claims of owners (shareholders) on net assets • Equity holders usually subordinate to creditors • Variation across equity holders on seniority • Exposed to maximum risk and return |
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Equity Analysis
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— involves analyzing equity characteristics, including:
• Classifying and distinguishing different equity sources • Examining rights for equity classes and priorities in liquidation • Evaluating legal restrictions for equity distribution • Reviewing restrictions on retained earnings distribution • Assessing terms and provisions of potential equity issuance |
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Equity Classes
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— two basic components:
• Capital Stock • Retained Earnings |
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Sources of increases in capital stock outstanding:
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- Issuances of stock
- Conversion of debentures and preferred stock - Issuances pursuant to stock dividends and splits - Issuances of stock in acquisitions and mergers - Issuances pursuant to stock options and warrants exercised |
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Sources of decreases in capital stock outstanding:
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Purchases and retirements of stock
Stock buybacks Reverse stock splits |
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Components of Capital Stock
// Contributed (or Paid-In) Capital |
— total financing received from shareholders for capital shares; usually divided into two parts:
• Common (or Preferred) Stock — financing equal to par or stated value;if stock is no-par, then equal to total financing • Contributed (or Paid-In) Capital in Excess of Par or Stated Value — financing in excess of any par or stated valu |
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Components of Capital Stock
// Treasury Stock (or buybacks) |
- shares of a company’s stock
reacquired after having been previously issued and fully paid for. Reduces both assets and shareholders’ equity contra-equity account (negative equity). typically recorded at cost |
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Classification of Capital Stock
// Preferred Stock — |
- stock with features not possessed by common stock; typical preferred stock features include:
Dividend distribution preferences Liquidation priorities Convertibility (redemption) into common stock Call provisions Non-voting rights |
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Classification of Capital Stock
// Common Stock |
— stock with ownership interest and bearing ultimate risks and rewards (residual interests) of company performance
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Retained Earnings
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— earned capital of a company; reflects accumulation of undistributed earnings or losses since inception; retained earnings is the main source of dividend distributions
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Basics of Retained Earnings
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Cash and Stock Dividends
• Cash dividend — distribution of cash (or assets) to shareholders • Stock dividend — distribution of capital stock to shareholders Prior Period Adjustments — mainly error corrections of prior periods’ statements Appropriations of Retained Earnings — reclassifications of retained earnings for specific purposes Restrictions (or Covenants) on Retained Earnings — constraints or requirements on retention of retained earnings |
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Shareholders’ Equity
// Spin-off |
, the distribution of subsidiary stock to shareholders as a dividend; assets (investment in subsidiary) are reduced as is retained earnings
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Shareholders’ Equity
// Split-off, |
the exchange of subsidiary stock owned by the company for shares in the company owned by the shareholders; assets (investment in subsidiary) are reduced and the stock received from the shareholders is treated as treasury stock.
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