Chapter 6
Additional Aspects of
Financial Reporting
and Financial Analysis
Intermediate Accounting 11th edition
Nikolai Bazley Jones
An electronic presentation
By Norman Sunderman
and Kenneth Buchanan
Angelo State University
COPYRIGHT © 2010 South-Western/Cengage Learning
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XBRL (eXtensible Business Reporting Language)
 XBRL is an Internet language for business
reporting that will make it easier for users to
extract and analyze information contained in
annual reports, press releases, and other
communications by directing that information
into the many analytical tools they use.
 Currently, the SEC allows voluntary filing of
supplemental financial information using
XBRL.
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XBRL - eXtensible Business Reporting Language
 An open standard free of license fees
 Offers cost savings, greater efficiency, and
improved accuracy and reliability to all those
involved in supplying or using financial data
 Should enhance the transparency of financial
reporting
 Being developed by an international non-profit
consortium
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Market Efficiency
Evidence from research on an efficient markets
hypothesis tends to show:
The prices of securities
traded in the capital
markets fully reflect all
publicly available
information.
These prices are
adjusted almost
immediately based on
new information and in
an unbiased manner.
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Auditor’s Report (Opinion)
1. That the company
maintained effective
internal control over its
financial reporting
2. That the company’s
financial statements
present fairly the financial
position of the company
and the results of its
operations and cash flows
in conformity with GAAP
An auditor’s standard
report includes two
opinions...
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Responsibilities of Management
Management is responsible for internal control and for
preparing and presenting the financial statements.
This means that the
company …
Continued
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Internal Control
1. Has a reliable accounting system
2. Maintains records in reasonable detail
3. Has a process for providing reliable financial
statements prepared according to GAAP
4. Has adequate procedures for preventing or
detecting significant unauthorized acquisition,
use, or disposal of its assets
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Auditor’s Report (Opinion)
The first (introductory)
paragraph lists the financial
statements that were audited,
indicates that internal control
was audited, declares that
management is responsible for
the financial statements and
related internal control, and
asserts that the auditor is
responsible for expressing an
opinion on them.
An audit report
consists of five
paragraphs.
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Auditor’s Report (Opinion)
The second (scope)
paragraph describes what
the auditor has done.
The third (definition)
paragraph identifies
internal control over
financial reporting,
including policies and
procedures.
The fourth (inherent
limitations) paragraph
discusses the possibility
that internal control
may not prevent or
detect misstatements of
the financial
statements.
The fifth (opinion)
paragraph gives the
auditor’s opinions.
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Auditor’s Report (Opinion)
1. An unqualified opinion is not a “clean bill of
health.”
2. An unqualified opinion provides no assurance
of the future success of the company.
3. An audit report does not provide an assurance
that fraud has not been committed by a
member, or members, of the company unless
such fraud would cause a material
misstatement in the financial statements.
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Disaggregation of Financial Information
 Although investors and creditors know the
importance of consolidated statements in
evaluating overall company performance, the
disaggregation of total financial data also can
be important in their financial analysis.
 A company improves the financial analysis
information on risk and return by presenting
disaggregated information on its operating
segments.
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Audit Committee and
Management’s Report
 The SEC requires all publicly held
companies to have an audit committee,
which is a group that has oversight over
the financial reporting process of a
company.
 Most audit committee members usually
are “outside directors” (not officers or
employees of the company).
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Audit Committee and
Management’s Report
 The audit committee acts as the liaison
between the auditor and management.
 The preparation and presentation of a
company’s financial statements are the
responsibility of its management.
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Segment Reporting
A company’s financial statements might be
disaggregated in a number of ways, such as by
products and services, geography, legal entity,
or type of customer.
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Segment Reporting
An operating segment is a component of a
company:
1. That engages in business activities to earn
revenues and incur expenses
2. Whose operating results are regularly reviewed
by the company’s chief operating officer to
make decisions about allocating resources to
the segment and assessing its performance
3. For which financial information is available
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Segment Reporting
An operating segment is significant and is a
reportable segment if it satisfies at least one of
the following tests:
1. Revenue Test. Its reported
revenues are 10% or more of
the combined revenues of all
the company’s reported
operating segments.
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Segment Reporting
An operating segment is significant and is a
reportable segment if it satisfies at least one of
the following tests:
2. Profit Test. The absolute
amount of its profit (loss) is
10% or more of the
combined reported profits of
all operating segments that
did not report a loss.
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Segment Reporting
An operating segment is significant and is a
reportable segment if it satisfies at least one of
the following tests:
3. Asset Test. Its segment
assets are 10% or more of
the combined assets of all
operating segments.
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Interim Financial Statements
Interim financial statements are
required of all publicly held companies
on a quarterly basis.
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Interim Income Taxes
To present fairly the results of
operations, at the end of each interim
period a company must make its best
estimate of the effective income tax
rate to be applicable for the entire
year.
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Preparation and Disclosure of Summarized Interim Financial Data
When publicly held companies report
interim summaries of financial
information, the following data must be
reported at a minimum.
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Preparation and Disclosure of Summarized Interim Financial Data
Sales or gross revenues,
income taxes,
extraordinary items (net
of tax), and net income
Earnings per share for
each period presented
Seasonal revenues, costs,
and expenses
Significant changes
in estimates of
income taxes
Results of
discontinued
operations and
material unusual or
infrequent items
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Preparation and Disclosure of Summarized Interim Financial Data
Contingent items
Changes in accounting
principles or estimates
Significant changes in
financial position (cash
flows)
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SEC Reports
Form 10-K is the most common
SEC annual report form and is
required to be filed with the SEC
within 60 days of a company’s fiscal
year-end.
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SEC Reports
Form 10-Q is used to report a
company’s quarterly financial
information to the SEC and is required
to be filed within 40 days of the end of
the company’s first three fiscal
quarters.
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IFRS vs. U.S. GAAP
 IFRS and GAAP require segment reporting.
 IFRS require a company to disclose each
segment’s liabilities if that information is
regularly provided to the chief operating
decision maker. U.S. GAAP has no such
requirement.
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IFRS vs. U.S. GAAP
 For interim reporting, IFRS differ from U.S.
GAAP in that they do no allow:
– The allocation of expenses between interim
periods
– The deferral of manufacturing variances that are
expected to be offset in a later interim period
– The deferral of a temporary market decline in
inventory that is expected to be recovered in a
later interim period.
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Appendix: Horizontal Analysis
In horizontal analysis,
changes in a company’s operating
results and financial position over
time are shown in percentages as
well as in dollars.
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Appendix: Vertical Analysis (Income Statement)
In vertical analysis, the monetary
relationships between items on the
financial statements are shown in
percentages as well as in dollars.
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Appendix: Ratio Analysis
Stockholder Profitability Ratios
Earnings per share is probably the
most frequently cited ratio in a financial
analysis.
Net Income – Preferred Dividends
Average Common Shares Outstanding
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Appendix: Ratio Analysis
Stockholder Profitability Ratios
Price/earnings is used by actual and potential
stockholders to evaluate the attractiveness of
an investment in the stock of a company.
Market Price per Common Share
Earnings per Share
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Appendix: Ratio Analysis
Stockholder Profitability Ratios
Dividend yield provides the stockholders their
individual rates of return based on the actual
dividends received as compared with the
ending market price of the stock.
Dividends per Common Share
Market Price per Common Share
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Appendix: Ratio Analysis
Company Profitability Ratios
Profit margin is used to evaluate a
company’s efficiency in controlling
costs and expenses in relation to sales.
Net Income
Net Sales
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Appendix: Ratio Analysis
Company Profitability Ratios
Return on total assets indicates how
efficiently a company uses its economic
resources.
Net Income + Interest Expense (net of
tax)
Average Total Assets
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Appendix: Ratio Analysis
Company Profitability Ratios
Return on stockholders’ equity shows the
residual return on the owners’ equity.
Net Income
Average Stockholders’ Equity
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Appendix: Ratio Analysis
Liquidity Ratios
The current ratio is used to evaluate a
company’s short-run liquidity.
Current Assets
Current Liabilities
1.
2.
3.
4.
5.
Cash
Short-term investments
Accounts receivable
Inventory
Prepaid expenses/supplies
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Appendix: Ratio Analysis
Liquidity Ratios
The acid-test ratio is a more severe test of
a company’s short-term debt-paying
abilities.
Quick Assets
Current Liabilities
1. Cash
2. Short-term investments
3. Accounts receivable
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Appendix: Ratio Analysis
Activity Ratios
Inventory turnover indicates the number of
times the inventory is “turned over” or sold
during an accounting period.
Cost of Goods Sold
Average Inventory
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Appendix: Ratio Analysis
Activity Ratios
Receivables turnover indicates how
many times receivables are “turned
over” or collected each period.
Net Credit Sales
Average Net Receivables
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Appendix: Ratio Analysis
Activity Ratios
The payables turnover ratio measures
the number of times accounts payable
turn over during the year.
Cost of Goods Sold
Average Accounts Payable
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Appendix: Ratio Analysis
Activity Ratios
The days in operating cycle estimates
the total number of days from cash to
cash.
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Appendix: Ratio Analysis
Stability Ratios
The debt ratio indicates the
percentage of total assets contributed
by creditors.
Total Liabilities
Total Assets
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Appendix: Ratio Analysis
Stability Ratios
Times interest earned is used to evaluate
the ability of a company to cover its interest
obligations through its annual earnings.
Pretax Operating Income
Interest Expense
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Appendix: Ratio Analysis
Stability Ratios
Book value per common share
shows the net assets per share of stock.
Common Stockholders’ Equity
Outstanding Common Shares
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Appendix: Ratio Analysis
Cash Flow Ratios
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Chapter 6
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