Financial Statement Analysis I:
Chapter 2
©NACM
General Chapter Notes
A. Debtor’s Decisions, An Example: Legal Form of the Debtor
1. What Legal Form Means
2. The Six Typical Forms: Sole Proprietorship,
General Partnership, Limited Partnership, LLC,
Subchapter S Corp., Chapter C Corp.
B. Forms with Personal Liability for Business Debts:
Sole Proprietorship, General Partnership
C. Forms with Limited Liability: LLC, Subchapter S and
Chapter C Corporations, Limited Partnerships
D. Relevance of Business Balance Sheet for Sole Prop., Part.
E. Limited Liability and Guarantees of Account
F. Legal Form and Taxes on Business Income
Slide 2-1
General Chapter Notes (continued)
G. Liquidity and the Ordering of the Balance Sheet
H. Public Reporting Accounting and Tax Accounting
I. Going Concern Value, Market Value, Book Value, and
Liquidation Values for Assets
J. Assets Outside of the Balance Sheet
K. Information on the Priority and Security Position
of Liabilities
L. Liquidity and the Operating Cycle (see next slide)
Slide 2-2
Cash Flows of the Firm
Slide 2-3
Notes for Particular Parts of Chapter 2
A. Consolidation
B. Fiscal Year-end Dates
C. Introduction to Trend Analysis
D. Common Size Statements
Slide 2-4
Notes for Particular Parts of Chapter 2
(continued)
E. Marketable Securities and Why Firms Hold Them
F. Accounts Receivable
G. Inventory
1. The importance of inventory investment
2. Why firms hold finished goods inventory
3. LIFO, FIFO, and actual inventory practice
4. Inventory accounting and price levels
H. Taxes, Inventory Accounting, and Cash Flow
I. PP&E, Depreciation, Amortization, and Market Value
J. Other Assets
Slide 2-5
Notes for Particular Parts of Chapter 2
(continued)
K.
L.
M.
N.
O.
P.
Accounts Payable
Current Maturities of Long-Term Debt
Accrued Liabilities
Deferred Income Taxes and Depreciation
Long-Term Debt
Capital Leases, Operating Leases, Owned Assets,
and the Balance Sheet
Q. Preferred Stock
R. The Three Common Equity Accounts
1. The three accounts defined
2. Where retained earnings go
3. Book equity versus market value
4. Relevance of equity value for trade creditors
Slide 2-6
Problem 2.11
Public Accounting Tax Accounting
Revenue
$800,000
$800,000
Other Expenses
$350,000
$350,000
Depreciation
$130,000
$200,000
Earnings Before Taxes
$320,000
$250,000
Tax Bill (34% of EBT)
$108,800
$85,000
Increase in Deferred Taxes
$23,800
Slide 2-7
Problem 2.14a
Inventory in order of purchase:
Units
600 x
1,000 x
900 x
700 x
3,200
Beginning inventory
First purchase during the year
Second purchase during the year
Third purchase during the year
Total
x Cost
$10 =
11 =
12 =
14 =
= Total
$ 6,000
11,000
10,800
9,800
$37,600
Sales for the year = 1,900 units
Ending inventory = 3,200−1,900 = 1,300 units
Total for new inventory purchases: $37,600−$6,000 = $31,600
Slide 2-8
COGS and Inventory Balance using Weighted
Average Cost per Unit:
Weighted average cost = $37,600/3,200 = $11.75 per unit
COGS = $11.75 x 1,900 units = $22,325
Ending inventory balance = $11.75 x 1,300 units = $15,275
Slide 2-9
COGS and Inventory Balance using FIFO:
COGS calculation:
600@$10 = $6,000 entire beginning inventory
1,000@$11 = $11,000 entire first purchase
300@$12 = $ 3,600 partial from second purchase
Total COGS $20,600
Remaining at $12 per unit from second purchase: 900-300 = 600 units
Ending Inventory:
600@$12 = $ 7,200 remaining from second purchase
700@$14 = $ 9,800 entire third purchase
Total
$17,000
Slide 2-10
COGS and Inventory Balance using LIFO:
COGS calculation:
700@$14 = $ 9,800 entire third purchase
900@$12 = $10,800 entire second purchase
300@$11 = $ 3,300 partial from first purchase
Total COGS $23,900
Remaining at $11 from first purchase: 1,000−300 = 700 units
Ending Inventory:
600@$10 = $ 6,000 entire beginning inventory
700@$11 = $ 7,700 remaining from first purchase
Total
$13,700
Slide 2-11
Problem 2-11 parts b, c, and d
Contrast of three inventory accounting methods
Method
Weighted Average
FIFO
LIFO
COGS
$22,325
$20,600
$23,900
Ending Inventory
$15,275
$17,000
$13,700
Actual cash outflow for purchasing inventory: $31,600 (does not
depend on accounting method chosen)
Reduction in taxes from using LIFO over FIFO:
$23,900−$20,600 = $3,300; $3,300*0.34 = $1,122 a cash flow savings
Slide 2-12
Problem 2.18
Dean Corporation
Year
2008
Beginning Retained Earnings
Net Income
End Ret. Earns., no Dividends
Act. Ending Ret. Earnings
Cash Dividends
$700
$890 $1,045
$250
$225
$40
$950 $1,115 $1,085
$890 $1,045 $1,010
$60
$70
$75
Slide 2-13
2009
2010
Problem 2.19
Balance Sheet at December 31, 20XX
Assets
Current Assets
Cash
Accounts receivable
Inventory
Prepaid expenses
Total Current Assets
Property, plant and equipment
34,000
Less accumulated depreciation
(10,500)
Net property, plant and equipment
Land held for sale (an Other Asset)
Total Assets
Slide 2-14
$1,500
6,200
12,400
700
$20,800
$23,500
$9,200
$53,500
Problem 2.19 (continued)
Liabilities and stockholders' equity
Current liabilities
Accounts payable
Notes payable
Accrued interest payable
Current portion of long-term debt
Total current liabilities
Deferred taxes payable
Bonds payable
Total liabilities
Slide 2-15
$4,300
8,700
1,400
1,700
$16,100
1,600
14,500
$32,200
Problem 2.19 (continued)
Stockholders' equity
Common stock
Additional paid-in capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
$2,500
7,000
11,800
21,300
$53,500
Calculation of Retained Earnings: $53,500−$32,200−$2,500−$7,000 =
$11,800
Current Ratio = Total Current Assets/ Total Current Liabilities
= $20,800/$16,100 = 1.29
Slide 2-16