MBA 6101 Financial Accounting
Prof. Larry Louie
Key Concepts and Techniques
These are the key concepts and techniques for this course.
Chapter 1: Introduction
Key Concepts
Three primary business activities
Operating – revenues, expenses and operating assets/liabilities
Investing – long term operating assets vs. nonoperating assets
Financing – creditor vs. equity
Communications from management to shareholders
Letters to shareholders
Management Discussion and Analysis
Auditor report – covers financial statements and notes only
Regulatory filings and proxy statements (e.g. SEC 10-K, 8-Q)
Accounting Equation
Assets = Liabilities + Shareholders’ Equity
4 Basic Financial Statements and their relationships (see Exh 1.7)
Balance Sheet (as of a specific date, permanent)
Income Statement (for a period, temporary/gets reset)
Statement of Equity (for a period, temporary/gets reset)
Statement of Cash Flows (for a period, temporary/gets reset)
Be familiar with accounts that are commonly found in those statements (e.g. cash,
accounts receivable, accounts payable, common stock, dividends, revenues, cost of
good sold, rent expense, etc.)
Market Efficiency - Weak, Semi-strong, Strong form
Competitive Analysis – Porter’s Five Forces
Oversight of Financial Accounting
SEC
GAAP (FASB)
Board of Directors (and its Audit Committee)
Sarbanes – Oxley Act
Accounting and Analytical Techniques
ROA = Return on Assets = Net Income/Average Assets
ROA = Net Income/Sales x Sales/Average Assets
(or Profit Margin x Asset turnover)
Chapter 2: Introducting Financial Statements and Transactional Analysis
Key Concepts:
Components of balance sheet – current and noncurrent assets, current and
noncurrent liabilities, and shareholders equity (and typical accounts)
Working capital
Operating cycle
Components of the Income Statement – sales, cost of goods sold, etc.
Components of the Stateement of Stockholders’ Equity – common stock,
retained earnings, etc.
Components of the Statement of Cash flows – cash flow from operating,
investing and financing activities
Articulation of financial statements – linkage beween the 4 statements.
Recording transactions (using the template approach, we will not use the T
account approach in this course), adjustitng entries and generating financial reports
SEC filings – 10K, 8K
Other information sources – analyst reports, credit services (e.g. Standard and
Poor’s, Moody’s and Fitch’s), data services (e.g. Thompson)
Accounting and Analytical Techniques
Steps to record transactions (e.g. ACME accounting exercise)
1. Journal Entry (debits and credits to accounts)
Post to ledge
Chapter 3: Accounting Adjustments and Constructing Financial Statements
Key Concepts:
Financial Statemetn Effects Template
Typical transactions and how to record them using the template
 Capital investment
 Asset acquisition
 Revenue and expens recognition
 Capital distributions
Typical Accounting Adjustments
 Prepaid expenses
 Unearned revenues
 Accrued expenses
 Accrued revenues
Trial balance
Financial statement preparation
 Income statement
 Balance sheet
 Statement of Stockhlolders; Equity
 Statement of Cash Flow (only use indirect method)
 Closing process
Accounting and Analytical Techniques
Steps to record transactions
1. Templatel Entries
2. Post to ledger (or to a T Account)
3. Create a Trial Balance
4. Generate Financial Statements
Chapter 4: Financial Statement Analysis
Key Concepts
Use perspectives – manager, investors, and creditor
Distinguishing between operating and non-operating assets and liabilities
Profitability analysis
Disaggregation
Core versus Transitory; Operating versus Nonoperating
Financial Leverage – pros and cons of using leverage
Rating Agencies – Standard and Poors, Moody’s
Liquidity Analysis
Solvency Analysis
Limitations of accounting information
Horizontal Analysis (common sizing)
Accounting and Analytical Techniques
ROE Disaggregation – know how to find data, generate the ratio, and interpret
the results (you will not need to know Nonoperating return components
o ROE
o RNOA
o FLEV
o Spread
o NOPAT
o NOA
o NFO
o NFR
o NFE
Gross Profit Margin
Turnover- Accounts Receivable Turnover
Average Collection Period
Inventory Turnover
Average Inventory Days Outstanding
Long Term Operating Asset Turnover
Accounts Payable Turnover
Average Payable Days Outstanding
Net Operating Working Capital Turnover
Average Cash Cycle
Liquidity Ratios
Current and Quick Ratio
Solvency Ratios
Debt to Equity Ratio
Long Term Debt to Equity
Flow Ratios
Times Interest Earned
Operating Cash Flow to Liabilities
Chapter 5: Operating Income
Key Concepts
Operating Components
Revenue Recognition
GAAP and SEC guidelines
Know “challenges”
Percentage of Completion
Employee Stock Options – accounting treatment
Foreign Currency Translation – in other comprehensive income
Research and Development
Income Taxes
Deferred income taxes
Transitory Income Components
Discontinued Operations – definition, operating losses and gain/loss on
disposition
Extraordinary Items – unusual and infrequent
Change in Accounting Principle – show cumulative effect, disclose, and prepare
proforma statements showing effect of change if applied to all reported periods
Change in Accounting Estimate (e.g. life on depreciation) – apply prospectively
only, no cumulative effect
Unusual Items
Gains and Losses on Asset Sales = proceeds – net book value
Restructuring Costs – creation of reserves
CISCO example
Workforce reduction
Consolidation of facilities
Impairment of goodwill
Write down of inventory
Goodwill Write-down
Earnings Per Share (basic and diluted)
Accounting and Analytical Techniques
Percentage of Completion
Gain or Loss on Sale
Basic EPS
Diluted EPS
Chapter 6: Operating Assets
Key Concepts
Accounts Receivable
How it is created and issues from a financial analysis standpoint (collectibility,
speed of collection)
Typical terms – 2/10 n/30
Allowance for uncollectible accounts
Analysis of receivables
Risk of income shifting
Analyze A/R collection period and turnover
Inventory
Inventory for Merchandising vs. Manufacturing company
Inventory Cost Flows
Costing methods (FIFO, LIFO, Average Cost)
Impact of FIFO/LIFO/Av Cost on financial statements and taxes
Lower of cost or market
Note disclosure (including LIFO liquidations)
Analysis of inventories
Property Plant and Equipment
Capitalized costs
Depreciation (straight line, declining balance)
Asset sales, estimates, impairment
Analysis of PP&E
Accounting and Analytical Techniques
Accounting Process for receivables
Sales are made on credit
Create an allowance for bad debt
Cash is received from a customer
Write-off a bad debt from a customer
Aging of Accounts receivable and adjustment of allowance account
Analysis of receivables
Accounts receivable turnover
Average Collection Period (or Days Sales Outstanding)
Accounting Process for inventory
Purchase inventory on credit
Pay vendor for inventory
Sell products
Analysis of Inventories and Cost of Good Sold
Gross Profit Margin
Inventory Turnover
Average Inventory Days Outstanding
Accounting Process for PP&E
Purchase fixed asset
Depreciate using SL or DB basis
Sell asset = proceeds – net book value
Impairments
Analysis of PP&E
PPE turnover
Percent used up
Chapter 7: Intercorporate Invdstments
Key Concepts
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Passive investments (market method)
o Within passive equities– available for sale (B/S at market, hit OCI
with market value changes) versus trading securities (B/S at
market, hit I/S with market value changes, shown as gains and
losses).
o Within passive debt – additional classification as held to maturity
(do not record market value changes in B/S or I/S)
Significant influence (equity method)
o Investment at cost
o Prorata share of income of investment
o Dividends shown as reduction in investment accounts
Control (consolidation and purchase method)
o Include 100% on line items of bal sheet and income statement,
reflect minority interest as one line item
o Eliminate intercompany transactions and receivables/payables
o Goodwill accounting
 Purchase method only
 Goodwill subject to annual impairment tests
Disclosure requirements (balance sheet and notes)
Derivatives – investments which derive value from other securities,
investments or indices
o Speculative versus hedging
Accounting and Analytical Techniques
 Accounting for
o Passive
o Equity
o Consolidation
 Impact of Goodwill impairment on balance sheet and income statement
Chapter 8: Nonowner Financing
Key Concepts
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Current Liabilities
o Accounts Payable
o Accrued Liabilities
o Product warranty
o Short Term Debt
Long Term Liabilities
o Bond
 Coupon or stated rate
 Market rate (yield)
 Face amount
 Term
 Issued at discount versus premium
 Amortization of premium or discount
o Bond Repurchases
o Debt Ratings and agencies
Accounting and Analytical Techniques
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Accounting for bonds
o Issuance
o Amortization
o Retirement
Effect of reserves and estimated liabilities on balance sheet and income
statements (e.g. warranties)
Chapter 9: Owner Financing
Key Concepts
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Contributed Capital
o Preferred Stock
 Cumulative, convertible, liquidation preference, participating,
par and $ or % dividends
o Common Stock
 Par value or stated value
o Paid in Capital in Excess of Par
o Convertible securities – debt or equity
Earned Capital
o Net Income
o Dividends (cash and stock)
o Other Comprehensive Income
 Foreign currency translation
 Derivatives
 Securities
 Pension Plans
Major corporate restructurings
o Sell Offs – sell part of co to outside entity
o Spin Offs – separate legal entities (e.g. Limited Too)
o Split Offs - parent exchanges its shares of the subsidiary for
shares to itself, end result is two separate publicly traded entities
(A&F)
Accounting and Analytical Techniques
 Accounting for stock transactions (preferred or common)
o Issuance
o Dividends
o Repurchase (treasury)
o Splits
Chapter 10: Off Balance Sheet Financing
Key Concepts
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Leases – operating leases vs. capital leases
Pension plans – watch for unfunded liabilities
o Defined contribution vs. defined benefit
Variable Interest Entities (formerly Special Purpose Entities) – watch
for consolidation or non-consolidation
Accounting and Analytical Techniques
 Convert operating leases to capital leases
 Compute funded vs. unfunded liability for pension
Chapter 11: Adjusting and Forecasting Financial Statements
Key Concepts:
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Core vs. transitory items
Operating vs. nonoperating items
Watch for underreported expenses (e.g. reserves)
Common adjustments
Accounting and Analytical Techniques
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Simple forecasting methods based on historical analysis, judgments
regarding the future, and key financial relationships and trends. (P&G
example)
Chapter 12: Valuation of Equity Securities
Key Concepts:
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Discounted cash flow model
o FCCF = NOPAT – increase in NOA
o Forecast for horizon period
o Estimate terminal value based on growth formula
o Subtract net financial obligations to get equity value
o Determine NPV and stock value per share
Residual Operating Income (ROPI) Model – you do not need to know this:
o Value = NOA + PV of Expected ROPI
o Less commonly used
Comparables – as an initial or reasonableness check
o Price Earnings
o Market to Book Value
o Sales multiple
Accounting and Analytical Techniques
 DCF method – know how to estimate value
 Comparables calculations
Key Concepts
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Bridge between balance sheets, income statements and retained
earnings
Information from a cash perspective (vs. accrual perspective)
Separates activities in Operating, Investing, and Financing activities
Accounting and Analytical Techniques
o You will not be responsible for the construction of a SCF, since we did
not go over this chapter in class.