DISCUSSION QUESIONS Q1!1" Or#ani$ations undertake %lannin# a&ti'ities t(at s(a%e t(ree ma)or a&ti'ities* finan&in#+ in'estin#+ and o%eratin#" Finan&in# is t(e means a &om%any uses to %ay for resour&es" In'estin# refers to t(e ,uyin# and sellin# of resour&es ne&essary to &arry out t(e or#ani$ation-s %lans" O%eratin# a&ti'ities are t(e a&tual &arryin# out of t(ese %lans" .lannin# is t(e #lue t(at &onne&ts t(ese a&ti'ities+ in&ludin# t(e or#ani$ation-s ideas+ #oals and strate#ies" Finan&ial a&&ountin# information %ro'ides 'alua,le in%ut into t(e %lannin# %ro&ess+ and+ su,se/uently+ re%orts on t(e results of %lans so t(at &orre&ti'e a&tion &an ,e taken+ if ne&essary" Q1!0" An or#ani$ation-s finan&in# a&ti'ities 1lia,ilities and e/uity 2 sour&es of funds3 %ay for in'estin# a&ti'ities 1assets 2 uses of funds3" An or#ani$ation-s assets &annot ,e more or less t(an its lia,ilities and e/uity &om,ined" (is means* assets 2 lia,ilities 4 e/uity" (is relation is &alled t(e a&&ountin# e/uation 1sometimes &alled t(e balance sheet equation3+ and it a%%lies to all or#ani$ations at all times" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-1 Q1!5" (e four main finan&ial statements are* in&ome statement+ ,alan&e s(eet+ statement of sto&k(olders- e/uity+ and statement of &as( flows" (e in&ome statement %ro'ides information a,out t(e &om%any-s re'enues+ e6%enses and %rofita,ility o'er a %eriod of time" (e ,alan&e s(eet lists t(e &om%any-s assets 1w(at it owns3+ lia,ilities 1w(at it owes3+ and sto&k(olders- e/uity 1t(e residual &laims of its owners3 as of a %oint in time" (e statement of sto&k(olders- e/uity re%orts on t(e &(an#es to ea&( sto&k(olders- e/uity a&&ount durin# t(e %eriod" (e statement of &as( flows identifies t(e sour&es 1inflows3 and uses 1outflows3 of &as(+ t(at is+ w(ere t(e &om%any #ot its &as( from and w(at it did wit( it" o#et(er+ t(e four statements %ro'ide a &om%lete %i&ture of t(e finan&ial &ondition of t(e &om%any" Q1!7" (e ,alan&e s(eet %ro'ides information t(at (el%s users understand a &om%any-s resour&es 1assets3 and &laims to t(ose resour&es 1lia,ilities and sto&k(olders- e/uity3 as of a #i'en point in time" Q1!8" (e in&ome statement &o'ers a period o time" An in&ome statement re%orts w(et(er t(e ,usiness (as earned a net in&ome 1also &alled %rofit or earnin#s3 or in&urred a net loss" Im%ortantly+ t(e in&ome statement lists t(e ty%es and amounts of re'enues and e6%enses makin# u% net in&ome or net loss" Q1!9" (e statement of &as( flows re%orts on t(e &as( inflows and outflows relatin# to a &om%any-s o%eratin#+ in'estin#+ and finan&in# a&ti'ities o'er a period o time" (e sum of t(ese t(ree a&ti'ities yields t(e net &(an#e in &as( for t(e %eriod" (is statement is a useful &om%lement to t(e in&ome statement+ w(i&( re%orts on re'enues and e6%enses+ ,ut w(i&( &on'eys relati'ely little information a,out &as( flows" Q1!:" ;etained earnin#s 1re%orted on t(e ,alan&e s(eet3 is in&reased ea&( %eriod ,y any net in&ome earned durin# t(e %eriod 1as re%orted in t(e in&ome statement3 and de&reased ea&( %eriod ,y t(e %ayment of di'idends 1as re%orted in t(e statement of &as( flows and t(e statement of sto&k(olders- e/uity3" ransa&tions refle&ted on t(e statement of &as( flows link t(e %re'ious %eriod-s ,alan&e s(eet to t(e &urrent %eriod-s ,alan&e s(eet" (e endin# &as( ,alan&e a%%ears on ,ot( t(e ,alan&e s(eet and t(e statement of &as( flows" Cambridge Business Publishers, 2013 1-2 !inancial Statement "nal#sis $ %aluation, 3rd &dition Q1!<" E6ternal users and t(eir uses of a&&ountin# information in&lude* 1a3 lenders for measurin# t(e risk and return of loans= 1,3 s(are(olders for assessin# t(e return and risk in a&/uirin# s(ares= and 1&3 analysts for assessin# in'estment %otential" Ot(er users are auditors+ &onsultants+ offi&ers+ dire&tors for o'erseein# mana#ement+ em%loyees for )ud#in# em%loyment o%%ortunities+ re#ulators+ unions+ su%%liers+ and a%%raisers" Q1!>" Fore&astin# is a met(od of formally e6%ressin# our e6%e&tations of a &om%any?s future %ayoffs" @(en fore&astin# &om%any %ayoffs+ we need to &onsider t(e effe&ts of t(eir ,usiness en'ironment on t(e &om%any?s a,ility to a&(ie'e t(ose future %ayoffs" Com%etiti'e for&es as well as o%%ortunities and t(reats will im%a&t w(at t(e &om%any &an %ay in t(e future" (is in turn affe&ts w(at %ayoffs are e6%e&ted" A ,etter understandin# of ,usiness en'ironment and a&&ountin# information leads to more a&&urate fore&asts of t(e future and more relia,le 'aluation estimates" Q1!1A" A .ro&ter B Cam,le-s inde%endent auditor is Deloitte B ou&(e DD." (e auditor e6%ressly states t(at Eour res%onsi,ility is to e6%ress an o%inion on t(ese finan&ial statements ,ased on our audits"F (e auditor also states t(at Et(ese finan&ial statements are t(e res%onsi,ility of t(e &om%any-s mana#ement"F (us+ t(e auditor does not assume res%onsi,ility for t(e finan&ial statements" Q1!11" G @(ile firms a&knowled#e t(e in&reasin# need for more &om%lete dis&losure of finan&ial and nonfinan&ial information+ t(ey (a'e resisted t(ese demands to %rote&t t(eir &om%etiti'e %osition" Cor%orate e6e&uti'es must wei#( t(e ,enefits t(ey re&ei'e from t(e finan&ial markets as a result of more trans%arent and re'ealin# finan&ial re%ortin# a#ainst t(e &osts of di'ul#in# %ro%rietary information to &om%etitors and ot(ers" Q1!10" G Cenerally A&&e%ted A&&ountin# .rin&i%les 1CAA.3 are t(e 'arious met(ods+ rules+ %ra&ti&es+ and ot(er %ro&edures t(at (a'e e'ol'ed o'er time in res%onse to t(e need to re#ulate t(e %re%aration of finan&ial statements" (ey are %rimarily set ,y t(e Finan&ial A&&ountin# Standards Goard 1FASG3+ a %ri'ate se&tor entity wit( re%resentati'es from &om%anies t(at issue finan&ial statements+ a&&ountin# firms t(at audit t(ose statements+ and users of finan&ial information" Ot(er ,odies t(at &ontri,ute to CAA. are t(e AIC.A+ t(e EIF+ and t(e SEC" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-3 Q1!15" G Cor%orate #o'ernan&e is t(e system of %oli&ies+ %ro&edures and me&(anisms t(at %rote&t t(e interests of stake(olders in t(e ,usiness" (ese stake(olders in&lude in'estors+ &reditors+ re#ulatory ,odies+ and em%loyees+ to name a few" Sound &or%orate #o'ernan&e in'ol'es t(e maintenan&e of an effe&ti'e internal auditin# fun&tion+ an inde%endent and effe&ti'e e6ternal auditin# fun&tion+ an informed and im%artial ,oard of dire&tors+ #o'ernmental o'ersi#(t 1su&( as from t(e SEC3+ and t(e o'ersi#(t of t(e &ourts" Q1!17" G (e auditor-s %rimary fun&tion is to e6%ress an o%inion as to w(et(er t(e finan&ial statements fairly %resent t(e finan&ial &ondition of t(e &om%any and are free from material misstatements" Auditors do not %re%are t(e finan&ial statements= t(ey only audit t(em and issue t(eir o%inion on t(em" (e auditors %ro'ide no #uarantees a,out t(e finan&ial statements or a,out t(e &om%any-s &ontinued %erforman&e" Q1!18" Finan&ial a&&ountin# information is fre/uently used in order to e'aluate mana#ement %erforman&e" (e return on e/uity 1;OE3 and return on assets 1;OA3 %ro'ide useful measures of finan&ial %erforman&e as t(ey &om,ine elements from ,ot( t(e in&ome statement and t(e ,alan&e s(eet" Finan&ial a&&ountin# information is also fre/uently used to monitor &om%lian&e wit( e6ternal &ontra&t terms" Ganks often set limits on su&( items as t(e amount of total lia,ilities in relation to sto&k(olders- e/uity or t(e amount of di'idends t(at a &om%any may %ay" Audited finan&ial statements %ro'ide information t(at &an ,e used to monitor &om%lian&e wit( t(ese limits 1often &alled co'enants3" ;e#ulators and ta6in# aut(orities also utili$e finan&ial information to monitor items of interest" Q1!19" Mana#ers are 'itally &on&erned a,out dis&losin# %ro%rietary information t(at mi#(t ,enefit t(e &om%any-s &om%etitors" Of most &on&ern+ is t(e E&ostF of losin# some &om%etiti'e ad'anta#e" (ere (as traditionally ,een tension ,etween &om%anies and t(e finan&ial %rofessionals 1es%e&ially in'estment analysts3 w(o %ress firms for more and more finan&ial and nonfinan&ial information" Cambridge Business Publishers, 2013 1-( !inancial Statement "nal#sis $ %aluation, 3rd &dition Q1!1:" Net in&ome is an im%ortant measure of finan&ial %erforman&e" It indi&ates t(at t(e market 'alues t(e &om%any-s %rodu&ts or ser'i&es+ t(at is+ it is willin# to %ay a %ri&e for t(e %rodu&ts or ser'i&es enou#( to &o'er t(e &osts to ,rin# t(em to market and to %ro'ide t(e &om%any-s in'estors wit( a %rofit" Net in&ome does not tell t(e w(ole story+ (owe'er" A &om%any &an always in&rease its net in&ome wit( additional in'estment in somet(in# as sim%le as a ,ank sa'in#s a&&ount" A more meanin#ful measure of finan&ial %erforman&e &omes from measurin# t(e le'el of net in&ome relati'e to t(e in'estment made" One in'estment measure is t(e ,alan&e of sto&k(olders- e/uity+ and t(e &om%arison of net in&ome to a'era#e sto&k(olders- e/uity 1;OE3 is a fundamental measure of finan&ial %erforman&e" Q1!1<" Gorrowed money must ,e re%aid+ ,ot( t(e %rin&i%al amount ,orrowed+ as well as interest on t(e ,orrowed funds" (ese %ayments (a'e &ontra&tual due dates" If %ayments are not %rom%t+ &reditors (a'e %owerful le#al remedies+ in&ludin# for&in# t(e &om%any into ,ankru%t&y" Conse/uently+ w(en &om%arin# two &om%anies wit( t(e same return on e/uity+ t(e one usin# less de,t would #enerally ,e 'iewed as a safer 1less risky3 in'estment" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-) MINI EHE;CISES M1!1> 11A minutes3 1I millions3 Assets 2 Dia,ilities 4 E/uity I5<+8>> I5A+<55 I:+:99 Dell re&ei'es more of its finan&in# from nonowners 1I5A+<55 million3 t(an from owners 1I:+:99 million3" Its owner finan&in# &om%rises 0A"1J of its total finan&in# 1I:+:99 millionK I5<+8>> million3" (us+ nonowners finan&e :>">J of Dell-s total assets" M1!0A 11A minutes3 1I millions3 Assets 2 Dia,ilities 4 E/uity I1:+<7> I1A+88: I:+0>0 Gest Guy re&ei'es more of its finan&in# from nonowners 1I1A+88: million3 t(an from owners 1I:+0>0 million3" Its owner finan&in# &om%rises 7A">J of its total finan&in# 1I:+0>0 millionK I1:+<7> million3" Cambridge Business Publishers, 2013 1-* !inancial Statement "nal#sis $ %aluation, 3rd &dition M1!01 118 minutes3 1I millions3 Assets 2 Dia,ilities 4 E/uity Lewlett!.a&kard I107+8A5 I<5+:00 1a3 I7A+:<1 Ceneral Mills I1<+9:7 1,3 I10+A90 I9+910 ar#et 1&3 I75+:A8 I0<+01< I18+7<: (e %er&ent of owner finan&in# for ea&( &om%any follows* Lewlett!.a&kard""""""""""""""""""""" 50"<J 1I7A+:<1 million K I107+8A5 million3 Ceneral Mills""""""""""""""""""""""""""" 58"7J 1I9+910 million K I1<+9:7 million3 ar#et""""""""""""""""""""""""""""""""""""""" 58"7J 1I18+7<: million K I75+:A8 million3 Ceneral Mills and ar#et are more owner finan&ed+ w(ile Lewlett!.a&kard is more nonowner finan&ed+ ,ut all are finan&ed wit( rou#(ly t(e same le'el of de,t and e/uity" All t(ree en)oy relati'ely sta,le &as( flows and &an+ t(erefore+ utili$e a #reater %ro%ortion of de,t 's" e/uity" As t(e un&ertainty of &as( flows in&reases+ &om%anies #enerally su,stitute e/uity for de,t in order to redu&e t(e ma#nitude of &ontra&tual %ayment o,li#ations" M1!00 A 118 minutes3 In its O&to,er 0A1A annual re%ort+ Star,u&ks re%orts t(e followin# fi#ures 1in I millions3* Assets 2 Dia,ilities 4 E/uity I 9+5<8"> 2 I 0+:A5"9 4 I 5+9<0"5 As s(own+ t(e a&&ountin# e/uation (olds for Star,u&ks" Also+ we &an see t(at Star,u&ks- nonowner finan&in# is 70"5J 1I0+:A5"9 K I9+5<8">3 of its total finan&in#" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-+ M1!05 A 10A minutes3 Du.ont Statement of ;ein'ested Earnin#s For Mear Ended De&em,er 51+ 0A1A Ge#innin# rein'ested earnin#s+ De&em,er 51+ 0AA>"""""""""""""""""""""" I 1A+:1A Net in&ome for 0A1A""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 5+A51 Common sto&k di'idends"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11+8AA3 .referred sto&k di'idends""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11A3 reasury sto&k retirementN"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 10A13 Endin# rein'ested earnin#s+ De&em,er 51+ 0A1A"""""""""""""""""""""""""""" I 10+A5A N reasury Sto&k re%resents t(e &om%any-s re%ur&(ase of Common Sto&k" (e effe&t is to de&rease sto&k(olders- e/uity+ w(i&( is t(e o%%osite effe&t from t(e issuan&e of sto&k" Durin# 0A1A+ Du.ont retired reasury Sto&k and will not reissue t(ese s(ares a#ain" (is transa&tion redu&ed t(e &om%any-s retained earnin#s ,ut did not affe&t net in&ome for t(e year" M1!07 10A minutes3 a" GS and SCF d" GS and SE #" SCF and SE ," IS e" SCF (" SCF and SE &" GS f" GS and SE i" IS+ SE+ and SCF Cambridge Business Publishers, 2013 1-, !inancial Statement "nal#sis $ %aluation, 3rd &dition M1!08 11A minutes3 (ere are many stake(olders im%a&ted ,y t(is ,usiness de&ision+ in&ludin# t(e followin# 1alon# wit( a des&ri%tion of (ow3* Mou as a Mana#erOyour re%utation+ self!esteem+ and %otentially your li'eli(ood &ould ,e ne#ati'ely im%a&ted" Creditors and Gond(oldersO&redit de&isions ,ased on ina&&urate information &ould o&&ur" S(are(oldersO,uyin# or sellin# s(ares ,ased on ina&&urate information &ould o&&ur" Mana#ement and ot(er Em%loyees of your &om%anyOre%er&ussions of your de&ision e6tend to all ot(er em%loyees" Also+ a de&ision to re&ord t(ese re'enues su##ests an en'ironment &ondonin# dis(onesty" Indeed+ your de&isions &an affe&t many more %arties t(an you mi#(t initially reali$e" (e s(ort!term ,enefit of meetin# @all Street-s e6%e&tations &ould (a'e serious lon#!term ramifi&ations" M1!09 G 11A minutes3 Internal &ontrols are desi#ned for t(e followin# %ur%oses* Monitorin# an or#ani$ation-s a&ti'ities to %romote effi&ien&y and to %re'ent wron#ful use of its resour&es Ensurin# t(e 'alidity and &redi,ility of e6ternal a&&ountin# re%orts .romotin# effe&ti'e o%erations Ensurin# relia,le internal re%ortin# Con#ress (as a s%e&ial interest in internal &ontrols and re%orts a,out t(em" S%e&ifi&ally+ t(e a,sen&e or failure of internal &ontrols &an ad'ersely affe&t t(e effe&ti'eness of domesti& and #lo,al finan&ial markets" Enron %ro'ided Con#ress wit( a &ase in %oint" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-- EHE;CISES E1!0: 118 minutes3 a" ar#et (as a %ro%rietary &redit &ard 1t(e ar#et Card3" Customers- un%aid &redit &ard ,alan&es at t(e end of t(e re%ortin# %eriod are similar to a&&ounts re&ei'a,le" ," ar#et-s in'entories &onsist of t(e %rodu&t lines it &arries* &lot(in#+ ele&troni&s+ (ome furnis(in#s+ food %rodu&ts+ and so fort("
&" ar#et-s ..E assets &onsist of land+ ,uildin#s+ store im%ro'ements su&( as li#(tin#+ floorin#+ LVAC+ store s(el'in#+ s(o%%in# &arria#es+ and &as( re#isters" d" Alt(ou#( ar#et sells some of its mer&(andise 'ia its @e,site+ t(e ma)ority of its sales a&ti'ity is &ondu&ted in its retail lo&ations" (ese stores re%resent a su,stantial and ne&essary &a%ital in'estment for its ,usiness model" E1!0< 10A minutes3 1I millions3 a" Usin# t(e a&&ountin# e/uation* Assets 1I95+1<93 2 Dia,ilities 1I15+:893 4 E/uity 1P3 .hus/ I7>+75A 2 E/uity Li#(!te&( &om%anies must &ontend wit( a su,stantial amount of risk relatin# to &(an#in# te&(nolo#y" Future &as( flows are+ t(erefore+ not as &ertain and &annot su%%ort (i#( le'els of de,t" (us+ t(e &om%any uses e/uity finan&in#= :<"0J in t(e &ase of Intel" Cambridge Business Publishers, 2013 1-10 !inancial Statement "nal#sis $ %aluation, 3rd &dition E1!0< 1&on&luded3 ," Usin# t(e a&&ountin# e/uation at t(e beginning of t(e year* Assets 1I9+87>3 2 Dia,ilities 1P3 4 E/uity 1I1+8793 .hus/ Beginning Dia,ilities 2 I8+AA5 Usin# t(e a&&ountin# e/uation at t(e end of t(e year* Assets 1I9+87> 4 I773 2 Dia,ilities 1I8+AA5 ! I973 4 E/uity 1P3 .hus/ &nding E/uity 2 I1+987 "lternati'e approach to sol'ing part 0b1/ Assets1I773 2 Dia,ilities1I!973 4 E/uity1P3 w(ere EF refers to E&(an#e in"F .hus/ &nding E/uity 2 I77 ! I!97 2 I1A< and Endin# e/uity 2 I1+879 4 I1A< 2 I1+987 &" ;etained Earnin#s is t(e ,alan&e s(eet a&&ount t(at %ro'ides t(e link ,etween t(e ,alan&e s(eet and t(e in&ome statement" Ea&( a&&ountin# %eriod+ ;etained Earnin#s is u%dated ,y t(e net in&ome 1loss3 re%orted for t(at %eriod 1and is redu&ed ,y any di'idends t(at are %aid to s(are(olders3" (e ,alan&e s(eet and t(e in&ome statement are+ t(erefore+ linked ,y t(is ,alan&e s(eet a&&ount" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-11 E1!0> 118 minutes3 E6ternal &onstituents use a&&ountin# information from finan&ial statements to answer /uestions su&( as t(e followin#* 1" S(are(olders 1in'estors3+ ask /uestions su&( as* a" Are t(e &om%any-s resour&es ade/uate to &arry out strate#i& %lansP ," Are t(e &om%any-s de,ts a%%ro%riate in amount #i'en t(e &om%any-s e6istin# assets and %lans for #rowt(P &" @(at is t(e &urrent le'el of in&ome 1and w(at are its &om%onents3P d" Is t(e &urrent sto&k %ri&e indi&ati'e of t(e &om%any-s %rofita,ility and le'el of de,tP 0" Creditors+ ask /uestions su&( as* a" Does t(e ,usiness (a'e t(e a,ility to re%ay its de,ts as t(ey &ome dueP ," Can t(e ,usiness take on additional de,tP &" Are &urrent assets suffi&ient to &o'er &urrent lia,ilitiesP 5" Em%loyees+ ask /uestions su&( as* a" Is t(e ,usiness finan&ially sta,leP ," Can t(e ,usiness afford to %ay (i#(er salariesP &" @(at are #rowt( %ros%e&ts for t(e or#ani$ationP d" @ill t(e &om%any ,e a,le to %ay my %ension w(en I retireP E1!5A 11A minutes3 Com%utation of di'idends Ge#innin# retained earnin#s+ 0A1A""""""""""""""""""""""""""""""""""""""""""""""""" I 15+18: 4 Net in&ome"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+0A5 Q Cas( di'idends""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1P3 2 Endin# retained earnin#s+ 0A1A"""""""""""""""""""""""""""""""""""""""""""""""""""""" I 17+50> (us+ di'idends were I1+A51 million for 0A1A" (e &om%any %aid out di'idends e/ual to 79"<J of 0A1A net in&ome 1I1+A51 K I0+0A53" Cambridge Business Publishers, 2013 1-12 !inancial Statement "nal#sis $ %aluation, 3rd &dition E1!51 10A minutes3 a" Col#ate!.almoli'e was %rofita,le durin# 0A1A as witnessed ,y its %ositi'e net %rofit mar#in of 17J" Lowe'er+ t(e %rofit mar#in is lower t(an in 0AA>" ," Col#ate!.almoli'e-s %rodu&ti'ity measure 1asset turno'er3 de&reased sli#(tly from 1"8 in 0AA> to 1"7 in 0A1A" (is indi&ates t(at o%eratin# assets are #eneratin# a sli#(tly lower le'el of sales t(an in t(e %rior year" (is is a ne#ati'e de'elo%ment"
&" ;OA 2 .rofit mar#in asset turno'er" 0A1A ;OA 2 17J 1"7 2 1>"9J" 0AA> ;OA 2 18J 1"8 2 00"8J" (e de&rease in ;OA durin# 0A1A results from a de&rease in ,ot( %rofita,ility and %rodu&ti'ity" E1!50 118 minutes3 ;eturn on assets 1;OA3 2 Net in&ome K A'era#e assets 2 I915 K 1I9+8:> 4 I:+7903K0R 2 <":J Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-13 E1!55 10A minutes3 a" Creditors are an im%ortant #rou% of e6ternal stake(olders" (ey are %rimarily interested in t(e a,ility of t(e &om%any to #enerate suffi&ient &as( flow in order to re%ay t(e amounts owed" Sto&k(olders are anot(er si#nifi&ant stake(older in t(e &om%any" (ey are %rimarily interested in t(e &om%any-s a,ility to effe&ti'ely raise &a%ital and to in'est t(at &a%ital in %ro)e&ts wit( a rate of return in e6&ess of t(e &ost of t(e &a%ital raised+ t(at is+ to in&rease t(e 'alue of t(e firm" ;e#ulators su&( as t(e SEC and t(e ta6 aut(orities+ in&ludin# t(e I;S and state and lo&al ta6 offi&ials+ are im%ortant &onstituents t(at are interested in knowin# w(et(er t(e &om%any is &om%lyin# wit( all a%%li&a,le laws and re#ulations" ," Cenerally A&&e%ted A&&ountin# .rin&i%les 1CAA.3 are t(e 'arious met(ods+ rules+ %ra&ti&es+ and ot(er %ro&edures t(at (a'e e'ol'ed o'er time in res%onse to t(e need to re#ulate t(e %re%aration of finan&ial statements" (ey are %rimarily set ,y t(e Finan&ial A&&ountin# Standards Goard 1FASG3+ a %ri'ate se&tor entity wit( re%resentati'es from &om%anies t(at issue finan&ial statements+ a&&ountin# firms t(at audit t(ose statements+ and users of finan&ial information" Ot(er ,odies t(at &ontri,ute to CAA. are t(e AIC.A+ t(e EIF+ and t(e SEC" &" Finan&ial information %ro'ides users wit( information t(at is useful in assessin# t(e finan&ial %erforman&e of &om%anies and+ t(erefore+ in settin# sto&k and ,ond %ri&es" o t(e e6tent t(at t(ese %ri&es are a&&urate+ t(e &osts of t(e funds t(at &om%anies raise will a&&urately refle&t t(eir relati'e effi&ien&y and risk of o%erations" Com%anies t(at &an utili$e &a%ital more effe&ti'ely will ,e a,le to o,tain t(at &a%ital at a reasona,le &ost and so&iety-s finan&ial resour&es will ,e effe&ti'ely allo&ated" d" First+ t(e %re%aration of finan&ial statements in'ol'es an understandin# of &om%le6 a&&ountin# rules and si#nifi&ant assum%tions and &onsidera,le estimation" Se&ond+ CAA. allows for differin# a&&ountin# treatments for t(e same transa&tion" And t(ird+ auditors are at a relati'e information disad'anta#e 'is!S!'is &om%any a&&ountants" As t(e &a%ital markets %la&e in&reasin# %ressures on &om%anies to %erform+ a&&ountants are often %la&ed in a diffi&ult et(i&al %osition to use t(e fle6i,ility #i'en to t(em under CAA. in order to ,ias t(e finan&ial results or to use t(eir inside information to t(eir ad'anta#e" Cambridge Business Publishers, 2013 1-1( !inancial Statement "nal#sis $ %aluation, 3rd &dition E1!57 10A minutes3 a" ;OE 2 Net in&ome K A'era#e sto&k(olders- e/uity 2 I>78"9 million K T1I5+A89"> million 4 I5+9<0"5 million3K0R 2 0<"1J ," (e re%ur&(ase of &ommon sto&k redu&es t(e denominator 1a'era#e sto&k(olders- e/uity3" (e outflow of &as( for t(e re%ur&(ase+ (owe'er+ redu&es net in&ome ,y t(e return on t(e &as( t(at is for#one" Cenerally+ t(e redu&tion in t(e denominator is #reater t(an t(at for t(e numerator+ and &onse/uently ;OE in&reases" (at is one of t(e reasons &ited for s(are re%ur&(ases" &" Com%anies usually re%ur&(ase t(eir own sto&k w(en t(ey feel t(at it is under'alued ,y t(e market" (e re%ur&(ase is a way to send a si#nal to t(e market to t(at effe&t" Com%any mana#ement is+ in essen&e+ ,a&kin# u% its assertions t(at t(e sto&k is under'alued wit( a tan#i,le in'estment of t(e &om%any-s funds" Com%anies also re%ur&(ase t(eir own sto&k to (a'e s(ares a'aila,le to #i'e to e6e&uti'es and ot(er em%loyees as &om%ensation" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-1) .;OGDEMS .1!58 17A minutes3 a" 0A11 ;OE 2 I15+5<1 K T1I98+0<8 4 I:A+79<3K0R 2 1>":J 0A1A ;OE 2 I17+5:A K T1I:A+79< 4 I9<+8703K0R 2 0A":J @al!Mart-s ;OE de&reased from 0A1A to 0A11+ and is sli#(tly ,elow t(e median ;OE of 0AJ for ot(er &om%anies in t(e Dow Uones a'era#e" ," 0A11 ;OA 2 I15+5<1 K T1I195+70> 4 I1:A+7A:3K0R 2 <"AJ 0A1A ;OA 2 I17+5:A K T1I1:A+7A: 4 I1<A+9953K0R 2 <"0J @al!Mart-s ;OA de&reased from 0A1A to 0A11 ,ut is a,o'e t(e median for ot(er Dow Uones &om%anies" &" @al!Mart does not sell %rodu&ts wit( a (i#( le'el of te&(nolo#y and s%e&iali$ation+ and it+ t(erefore+ is not %rote&ted ,y %atents or ot(er le#al ,arriers to entry" It does+ (owe'er+ (a'e &onsidera,le market %ower o'er su%%liers as a result of its &onsidera,le si$e+ w(i&( may result in %rodu&t &ost sa'in#s" @al!Mart is also a,le to use its &onsidera,le ad'ertisin# ,ud#et to its ad'anta#e"
Cambridge Business Publishers, 2013 1-1* !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!59 15A minutes3 a" Ceneral Mills+ In&" In&ome Statement 1I millions3 For Mear Ended May 0>+ 0A11 ;e'enue""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I17+<<A"0 Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" <+>09": Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 8+>85"8 otal e6%enses""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 7+188"0 Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 1+:><"5 Ceneral Mills+ In&" Galan&e S(eet 1I millions3 May 0>+ 0A11 Cas(""""""""""""""""""""""""""""""""""" I 91>"9 otal lia,ilities""""""""""""""""""""""""" I10+A90"5 Non&as( assets""""""""""""""""" 1<+A87"> Sto&k(olders- e/uity"""""""""""""" 9+910"0 otal assets"""""""""""""""""""""""" I1<+9:7"8 otal lia,ilities and e/uity"""""" I1<+9:7"8 Ceneral Mills+ In&" Statement of Cas( Flows 1I millions3 For Mear Ended May 0>+ 0A11 Cas( from o%eratin# a&ti'ities I 1+809"< Cas( from in'estin# a&ti'ities 1:18"13 Cas( from finan&in# a&ti'ities 1<98 "53 Net &(an#e in &as( 185"93 Cas(+ ,e#innin# year 9:5 "0 Cas(+ endin# year I 91> "9 ," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a %ositi'e si#n of mana#ement-s &ommitment to future ,usiness su&&ess" A ne#ati'e amount for &as( from finan&in# a&ti'ities refle&ts t(e redu&tion of lon#!term de,t+ w(i&( is often a %ositi'e si#n of t(e &om%any-s a,ility to retire de,t o,li#ations" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-1+ .1!59 1&on&luded3 &" .rofit mar#in 2 I1+:><"5 K I17+<<A"0 2 10"A>J urno'er of total assets 2 I17+<<A"0 K I1<+9:7"8 2 A"<A ;eturn on assets 2 I1+:><"5 K I1<+9:7"8 2 >"9J 110"A>J V A"<A3 ;eturn on e/uity 2 I1+:><"5 K I9+910"0 2 0:"0J .1!5: 15A minutes3 a" A,er&rom,ie B Fit&( In&ome Statement 1I millions3 For Mear Ended Uanuary 0>+ 0A11 ;e'enue"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I5+79> Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1+08: Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+010 E6%enses"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 0+A90 Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 18A A,er&rom,ie B Fit&( Galan&e S(eet 1I millions3 Uanuary 0>+ 0A11 Cas(""""""""""""""""""""""""""""""""""" I <09 otal lia,ilities"""""""""""""""""""""""""""I 1+A8: Non&as( assets"""""""""""""""" 0+100 Sto&k(olders- e/uity"""""""""""""""" 1+<>1 otal assets""""""""""""""""""""""" I0+>7< otal lia,ilities and e/uity""""""" I0+>7< Cambridge Business Publishers, 2013 1-1, !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!5: 1&on&luded3 A,er&rom,ie B Fit&( Statement of Cas( Flows 1I millions3 For Mear Ended Uanuary 0>+ 0A11 Cas( from o%eratin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" I 5>0 Cas( from in'estin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 1>53 Cas( from finan&in# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 11753 Net &(an#e in &as("""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 189 Cas(+ ,e#innin# year"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 9:A Cas(+ endin# year""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I <09 ," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a %ositi'e si#n of mana#ement &ommitment to future ,usiness su&&ess" A ne#ati'e amount for &as( from finan&in# a&ti'ities refle&ts t(e redu&tion of lon#!term de,t+ w(i&( is often a %ositi'e si#n of t(e &om%any-s a,ility to retire de,t o,li#ations" &" .rofit mar#in 2 I18A K I5+79> 2 7"50J Asset turno'er 2 I5+79> K I0+>7< 2 1"1< ;eturn on assets2 I18A K I0+>7< 2 8"A>J 17"50J V 1"1<3 ;eturn on e/uity 2 I18A K I1+<>1 2 :">5J Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-1- .1!5< 15A minutes3 a" Cis&o Systems+ In&" In&ome Statement 1I millions3 For Mear Ended Uuly 51+ 0A1A Sales""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I7A+A7A Cost of #oods sold"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 17+5>: Cross %rofit"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 08+975 E6%enses"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 1:+<:9 Net in&ome""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I :+:9: Cis&o Systems+ In&" Galan&e S(eet 1I millions3 Uuly 51+ 0A1A Cas("""""""""""""""""""""""""""""""""" I 7+8<1 otal lia,ilities""""""""""""""""""""""""""""""I59+<78 Non&as( assets""""""""""""""" :9+87> Sto&k(olders- e/uity"""""""""""""""""""" 77+0<8 otal assets"""""""""""""""""""""" I<1+15A otal lia,ilities and e/uity"""""""""""I<1+15A Cis&o Systems+ In&" Statement of Cas( Flows 1I millions3 For Mear Ended Uuly 51+ 0A1A Cas( from o%eratin# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" I1A+1:5 Cas( used in in'estin# a&ti'ities""""""""""""""""""""""""""""""""""""""""" 111+>513 Cas( from finan&in# a&ti'ities""""""""""""""""""""""""""""""""""""""""""""" 901 Net &(an#e in &as("""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 11+15:3 Cas(+ ,e#innin# year"""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" 8+:1< Cas(+ endin# year""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""""" I 7+8<1 ," A ne#ati'e amount for &as( from in'estin# a&ti'ities refle&ts furt(er in'estment ,y t(e &om%any in its lon#!term assets+ w(i&( is #enerally a %ositi'e si#n of mana#ement &ommitment to future ,usiness su&&ess" Cambridge Business Publishers, 2013 1-20 !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!5< 1&on&luded3 &" .rofit mar#in 2 I:+:9: K I7A+A7A 2 1>"7J urno'er of total assets 2 I7A+A7A K I<1+15A 2 A"7> ;eturn on assets2 I:+:9: K I<1+15A 2 >"8:J 11>"7J V A"7>3 ;eturn on e/uity 2 I:+:9: K I77+0<8 2 1:"8J .1!5> 118 minutes3 Cro&ker Cor%oration Statement of Sto&k(olders- E/uity For Mear Ended De&em,er 51+ 0A11 Contri,uted Ca%ital ;etained Earnin#s Sto&k(olders- E/uity De&em,er 51+ 0A1A"""""""""""""""""""""""""""""" I :A+AAA I 5A+AAA I1AA+AAA Issuan&e of &ommon sto&k"""""""""""""""" 5A+AAA 5A+AAA Net in&ome""""""""""""""""""""""""""""""""""""""""""" 8A+AAA 8A+AAA Cas( di'idends"""""""""""""""""""""""""""""""""""" WWWWWWW 108+AAA3 108+AAA3 De&em,er 51+ 0A11""""""""""""""""""""""""""""""" I1AA+AAA I 88+AAA I188+AAA Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-21 .1!7A 118 minutes3 Ca%+ In&" Statement of Sto&k(olders- E/uity For Mear Ended Uanuary 0>+ 0A11 Common Sto&k and A.IC reasury Sto&k ;etained Earnin#s A&&um" Ot( Com%" In& Sto&k(olders- E/uity Uanuary 5A+ 0A1A""""""""""""""""""""""""""""""""""""""""""""" I0+>>A I1>+A9>3 I1A+<18 I188 I7+<>1 Sale of sto&k""""""""""""""""""""""""""""""""""""""""""""""""""" 7 7 .ur&(ase of sto&k"""""""""""""""""""""""""""""""""""""""""" 11+:>:3 11+:>:3 Net in&ome"""""""""""""""""""""""""""""""""""""""""""""""""""""" 1+0A7 1+0A7 Ot(er &om%" in&ome""""""""""""""""""""""""""""""""""""""" 5A 5A Cas( di'idends""""""""""""""""""""""""""""""""""""""""""""""" 10803 10803 Uanuary 0>+ 0A11""""""""""""""""""""""""""""""""""""""""""""" I0+>>7 I11A+<993 I11+:9: I1<8 I7+A<A .1!71 15A minutes3 1I millions3 a" ;OA ;OE 0AA> 1A"1J I1+<<7KT1I1>+0A>4I1<+A<>3K0R 5:">J I1+<<7KT1I8+9>A4I7+0913K0R 0A1A >"7J I1+<75KT1I1>+<974I1>+0A>3K0R 51"AJ I1+<75KT1I9+0A04I8+9>A3K0R Cambridge Business Publishers, 2013 1-22 !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!71 1&on&luded3 .rofit Mar#in 1.M3 Asset urno'er 1A3 0AA> >">J 1I1+<<7KI1>+1183 1"A0 I1>+118KT1I1>+0A>4I1<+A<>3K0R 0A1A >"5J 1I1+<75KI1>+:793 1"A1 I1>+:79KT1I1>+<974I1>+0A>3K0R Xim,erly!Clark-s ;OA and ;OE ,ot( de&lined from 0AA> to 0A1A" (e de&line in ;OA is a result of a de&line in %rofit mar#in 1from >">J to >"5J3 as well as a sli#(t de&line in asset turno'er 1from 1"A0 to 1"A13" (e %rofit mar#in de&line was t(e more si#nifi&ant &ause" ," (e re%ur&(ase of &ommon sto&k redu&es ,ot( t(e numerator 1net in&ome3 and denominator 1sto&k(olders- e/uity3 of t(e return on e/uity &al&ulation" ;e%ur&(ases redu&e net in&ome ,y t(e for#one %rofit on t(e &as( t(at is used to ,uy t(e sto&k on t(e o%en market" Xim,erly! Clark-s re%ur&(ase of &ommon sto&k redu&ed sto&k(olders- e/uity ,y I7": ,illion+ t(us de&reasin# t(e denominator ,y t(at amount" Cenerally+ t(e denominator effe&t dominates* its redu&tion is #reater t(an t(e redu&tion of t(e numerator" (erefore+ it is reasona,le to %redi&t t(at t(e re%ur&(ase would in&rease ;OE" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-23 .1!70 15A minutes3 ;OA ;OE 0A1A :"0J I771KT1I9+8:>4I8+9913K0R 51":J I771KT1I1+8:04I1+01A3K0R 0A11 <":J I915KT1I:+7904I9+8:>3K0R 57"1J I915KT1I0+A014I1+8:03K0R .rofit Mar#in 1.M3 Asset urno'er 1A3 0A1A 8"1J 1I771KI<+90:3 1"71 I<+90:KT1I9+8:>4I8+9913K0R 0A11 9"5J 1I915KI>+:AA3 1"5< I>+:AAKT1I:+7904I9+8:>3K0R Got( ;OA and ;OE in&reased from 0A1A to 0A11" (e in&rease in ;OA is dri'en %rimarily ,y t(e in&rease in %rofit mar#in 1from 8"1J to 9"5J3 as asset turno'er de&lined sli#(tly durin# t(e year 1from 1"71 to 1"5<3" Cambridge Business Publishers, 2013 1-2( !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!75 10A minutes3 a" ;eturn on e/uity is net in&ome di'ided ,y a'era#e total sto&k(olders- e/uity" Nokia-s ;OE* Y1+<8A K T1Y19+051 4 Y17+:7>3K0R 2 11">J" ," @e know t(at sales minus e6%enses e/uals net in&ome" Usin# Nokia-s num,ers we o,tain* Y70+779 ! E6%enses 2 Y1+<8A E6%enses 2 Y7A+8>9" &" Com%anies re%ur&(ase t(eir own sto&k for a num,er of reasons" First+ mana#ers may ,elie'e t(at t(e &om%any-s sto&k is under'alued ,y t(e market" (e re%ur&(ase is a way to si#nal t(e market to t(at effe&t" Essentially+ &om%any mana#ement is ,a&kin# u% its assertions t(at t(e sto&k is under'alued wit( a tan#i,le in'estment of t(e &om%any-s funds" Se&ond+ firms often use treasury s(ares to (onor e6e&uti'e and ot(er em%loyees- sto&k o%tion e6er&ises" (ird+ sto&k ,uy,a&ks return &as( to in'estors w(o may %refer &a%ital #ains 1from a ,uy,a&k3 to ordinary di'idends+ for ta6 reasons" .1!77 10A minutes3 a" ;OA 2 Net in&ome K A'era#e assets UH 0A11 ;OA 2 I1+575 K T1I:+>:0 4 I:+7973 K 0R 2 1:"7J ANF 0A11 ;OA 2 I18A K T1I0+>7< 4 I0+<003 K0R 2 8"0J ," UH ANF .rofit Mar#in I1+575KI01+>70 2 9"1J I18AKI5+79> 2 7"5J Asset urno'er I01+>70KT1I:+>:04I:+7973K0R 2 0"<7 I5+79>KT1I0+>7<4 I0+<003K0 2 1"0A ;OA 9"1J V 0"<7 2 1:"5JN 7"5J V 1"0A 2 8"0J N ;oundin# differen&e Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-2) .1!77 1&on&luded3 &" UH is out%erformin# ANF in 0A11" ANF-s re%utation as a (i#(!end retailer would lead us to e6%e&t (i#(er %rofit mar#ins" Gut+ t(is is not t(e &ase as UH-s %rofit mar#in is o'er 7AJ (i#(er t(an ANF-s" UH-s real &om%etiti'e ad'anta#e+ (owe'er+ is in its asset turno'er of nearly 56+ nearly 0"76 (i#(er t(an ANF-s 1"0A" In 0A11+ UH is out%erformin# ANF on ,ot( dimensions+ resultin# in a ;OA of 1:"7J+ o'er 56 (i#(er t(an ANF-s ;OA of 8"0J" .1!78 15A minutes3 a" 0A1A 0AA> ;OA I7+>79"5KT1I51+>:8"04I5A+007">3K0R 2 18">J I7+881"AKT1I5A+007">4I0<"791"83K0R 2 18"8J .rofit Mar#in I7+>79"5KI07+A:7"9 2 0A"8J I7+881"AKI00+:77": 2 0A"AJ Asset urno'er I07+A:7"9KT1I51+>:8"04I5A+007">3K0R 2 A":: I00+:77":KT1I5A+007">4I0<+791"83K0R 2 A":< ," M&Donald-s ;OA in&reased from 0AA> to 0A1A+ due to an in&rease in %rofita,ility 1from 0A to 0A"8J3 as its asset turno'er de&reased sli#(tly 1from A":< to A"::3 durin# t(is %eriod" Cambridge Business Publishers, 2013 1-2* !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!79 15A minutes3 a" .rofit Mar#in Asset urno'er ;OA 0AA< I5+79AKI08+09> 2 15":J I08+09>KT1I08+:>54I07+9>73K0R 2 1"AA 15":J 1"AA 2 15":J 0AA> I5+1>5KI05+105 2 15"<J I05+105KT1I0:+08A4I08+:>53K0R 2 A"<: 15"<J A"<: 2 10"AJ 0A1A I7+A<8KI09+990 2 18"5J I09+990KT1I5A+1894I0:+08A3K0R 2 A">5 18"5J A">5 2 17"0J 5M-s ;OA di%%ed durin# t(e re&ession of 0AA<!0AA>+ ,ut re,ounded in 0A1A" ," (e %rimary dri'er of t(e ;OA di% in 0AA> was a de&rease in asset turno'er" (at year+ %rofit mar#in stayed a,out t(e same* 15":J to 15"<J" (is flu&tuation in asset turno'er is attri,uta,le to t(e 0AA<KA> re&ession" (en+ in 0A1A as t(e e&onomy im%ro'ed ,ot( turno'er and %rofit mar#in stren#t(ened" Alt(ou#( some assets are more 'aria,le in nature 1i"e"+ re&ei'a,les and in'entories3+ 5M is &a%ital intensi'e and &annot redu&ed its lon#!term assets in t(e s(ort run" As a result+ asset turno'er de&lines as sales de&line durin# a re&ession and in&reases as sales im%ro'e durin# t(e re&o'ery" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-2+ .1!7: A 108 minutes3 a" (e auditors address t(eir re%ort to t(e &om%any-s ,oard of dire&tors and t(e s(are(olders of A%%le In&" (is is an im%ortant %oint" Auditors work for t(e ,enefit of t(e s(are(olders and re%ort dire&tly to t(e ,oard of dire&tors+ t(e ele&ted re%resentati'es of t(e s(are(olders w(ose )o, it is to %rote&t s(are(older interests" It would not ,e a%%ro%riate for t(e e6ternal auditors to re%ort dire&tly to mana#ement ,e&ause t(e auditors are e6aminin# mana#ement-s a&ti'ities as des&ri,ed in t(e &om%any-s finan&ial statements" ;e%ortin# to t(e ,oard %reser'es t(e auditor-s inde%enden&e" ," (e audit %ro&ess &onsists of two &om%onents" First t(e auditors assess t(e &om%any-s system of internal &ontrols to ensure t(e information in t(e finan&ial statements was #at(ered+ re&orded+ a##re#ated in a&&ordan&e wit( CAA." (is in'ol'es an assessment of t(e &om%any-s a&&ountin# %oli&ies to#et(er wit( t(e assum%tions used and estimates made in t(e %re%aration of t(e finan&ial statements" Se&ond+ t(e auditors e6amine+ on a test ,asis+ e'iden&e su%%ortin# t(e amounts and dis&losures in t(e statements" (e key word is test" Auditors do not e6amine ea&( transa&tion" (ey take a sam%le from t(e transa&tions" If t(at sam%le does not un&o'er any irre#ularities+ t(ey #o no furt(er" If it does+ t(ey e6%and t(e sam%le until t(ey are &onfident t(at t(e amounts %resented in t(e statements fairly %resent t(e &om%any-s %erforman&e and &ondition in a&&ordan&e wit( CAA." &" (e nature of t(e inde%endent auditors- o%inion is t(at t(e finan&ial statements E%resent fairly+ in all material res%e&ts+ t(e finan&ial &ondition of t(e &om%any"F Ge&ause t(is is standard audit!re%ort lan#ua#e+ any de'iations s(ould raise a fla#" E.resent fairlyF does not mean a,solute assuran&e t(at t(e finan&ials are error!free" It means t(at a reasona,le %erson would &on&lude t(at t(e finan&ial statements reasona,ly des&ri,e t(e finan&ial &ondition of t(e &om%any" d" X.MC also rendered an o%inion on t(e &om%any-s system of internal &ontrols" Internal &ontrols are desi#ned to insure t(e inte#rity of t(e finan&ial re%ortin# system and t(e %reser'ation of t(e &om%any-s assets" A well!fun&tionin# internal &ontrol system is a &riti&al &om%onent of t(e &om%any-s o'erall &or%orate #o'ernan&e system" Cambridge Business Publishers, 2013 1-2, !inancial Statement "nal#sis $ %aluation, 3rd &dition .1!7< 10A minutes3 a" Ste'e Uo,s made assertions t(at t(e Sar,anes!O6ley A&t re/uires all CEOs and CFOs to make" In %arti&ular+ Uo,s &ertified t(at* Le (as read t(e finan&ial re%orts" (e finan&ial re%orts do not &ontain any si#nifi&ant 1material3 misstatement or omit to state a si#nifi&ant fa&t t(at s(ould (a'e ,een in&luded" (e finan&ial re%orts are+ t(erefore+ &om%lete" (e finan&ial re%orts fairly %resent t(e finan&ial &ondition of t(e &om%any" (e &om%any maintains a system of internal &ontrols and t(ose &ontrols are fun&tionin# &orre&tly" ," Con#ress %assed t(e Sar,anes!O6ley A&t followin# a s%ate of &or%orate a&&ountin# s&andals in t(e early 0AAAs" (e im%etus for t(e le#islation was t(e ,elief t(at some CEOs and CFOs no lon#er assumed res%onsi,ility for t(e finan&ial re%ortin# of t(eir &om%anies" Gy re/uirin# t(ese (i#(!rankin# e6e&uti'es to %ersonally &ertify to t(e items referen&ed in %art a a,o'e+ Con#ress wanted to en&oura#e &loser s&rutiny of t(e finan&ial re%ortin# %ro&ess at t(e (i#(est le'els of t(e &om%any" &" (e Sar,anes!O6ley A&t %res&ri,es si#nifi&ant %enalties for falsely &ertifyin# to t(e &om%leteness and &orre&tness of t(e finan&ial re%orts" CEOs and CFOs fa&e fines of u% to I8 million and %rison terms of u% to 0A years" Additionally+ s(ould t(e &om%any later restate its finan&ial statements as a result of wron#ful false re%ortin#+ t(e CEOs and CFOs may ,e re/uired to forfeit any %rofits earned as a result of t(at re%ortin#" (is forfeiture (as ,een la,eled Edis#or#ementF in t(e finan&ial %ress" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-2- .1!7> 15A minutes3 Followin# is t(e statement of Cor%orate Co'ernan&e from CE-s @e,site* 1" ;ole of Goard and Mana#ement CE-s ,usiness is &ondu&ted ,y its em%loyees+ mana#ers and offi&ers+ under t(e dire&tion of t(e &(ief e6e&uti'e offi&er 1CEO3 and t(e o'ersi#(t of t(e ,oard+ to en(an&e t(e lon#!term 'alue of t(e Com%any for its s(areowners" (e ,oard of dire&tors is ele&ted ,y t(e s(areowners to o'ersee mana#ement and to assure t(at t(e lon#!term interests of t(e s(areowners are ,ein# ser'ed" Got( t(e ,oard of dire&tors and mana#ement re&o#ni$e t(at t(e lon#!term interests of s(areowners are ad'an&ed ,y res%onsi,ly addressin# t(e &on&erns of ot(er stake(olders and interested %arties in&ludin# em%loyees+ re&ruits+ &ustomers+ su%%liers+ CE &ommunities+ #o'ernment offi&ials and t(e %u,li& at lar#e" 0" Fun&tions of Goard (e ,oard of dire&tors (as ei#(t s&(eduled meetin#s a year at w(i&( it re'iews and dis&usses t(e %erforman&e of t(e Com%any+ its %lans and %ros%e&ts+ as well as immediate issues fa&in# t(e Com%any" Dire&tors are e6%e&ted to attend all s&(eduled ,oard and &ommittee meetin#s" In addition to its #eneral o'ersi#(t of mana#ement+ t(e ,oard also %erforms a num,er of s%e&ifi& fun&tions+ in&ludin#* a" sele&tin#+ e'aluatin# and &om%ensatin# t(e CEO and o'erseein# CEO su&&ession %lannin#= ," %ro'idin# &ounsel and o'ersi#(t on t(e sele&tion+ e'aluation+ de'elo%ment and &om%ensation of senior mana#ement= &" re'iewin#+ monitorin# and+ w(ere a%%ro%riate+ a%%ro'in# fundamental finan&ial and ,usiness strate#ies and ma)or &or%orate a&tions= d" assessin# ma)or risks fa&in# t(e Com%any O and re'iewin# o%tions for t(eir miti#ation= and e" ensurin# %ro&esses are in %la&e for maintainin# t(e inte#rity of t(e Com%any ! t(e inte#rity of t(e finan&ial statements+ t(e inte#rity of &om%lian&e wit( law and et(i&s+ t(e inte#rity of relations(i%s wit( &ustomers and su%%liers+ and t(e inte#rity of relations(i%s wit( ot(er stake(olders" 5" Qualifi&ations Dire&tors s(ould %ossess t(e (i#(est %ersonal and %rofessional et(i&s+ inte#rity and 'alues+ and ,e &ommitted to re%resentin# t(e lon#!term interests of t(e s(areowners" (ey must also (a'e an in/uisiti'e and o,)e&ti'e %ers%e&ti'e+ %ra&ti&al wisdom and mature )ud#ment" @e endea'or to (a'e a ,oard re%resentin# di'erse e6%erien&e at %oli&y!makin# le'els in ,usiness+ #o'ernment+ edu&ation and te&(nolo#y+ and in areas t(at are rele'ant to t(e Com%any-s #lo,al a&ti'ities" Dire&tors must ,e willin# to de'ote suffi&ient time to &arryin# out t(eir duties and res%onsi,ilities effe&ti'ely+ and s(ould ,e &ommitted to ser'e on t(e ,oard for an e6tended %eriod of time" Dire&tors s(ould offer t(eir resi#nation in t(e e'ent of any si#nifi&ant &(an#e in t(eir %ersonal &ir&umstan&es+ in&ludin# a &(an#e in t(eir %rin&i%al )o, res%onsi,ilities" Dire&tors w(o also ser'e as CEOs of %u,li&ly!traded &om%anies or in e/ui'alent %ositions s(ould not ser'e on more t(an two ,oards of %u,li& &om%anies in addition to t(e CE ,oard+ and ot(er dire&tors s(ould not ser'e on more t(an four ot(er ,oards Cambridge Business Publishers, 2013 1-30 !inancial Statement "nal#sis $ %aluation, 3rd &dition of %u,li& &om%anies in addition to t(e CE ,oard" Current %ositions in e6&ess of t(ese limits may ,e maintained unless t(e ,oard determines t(at doin# so would im%air t(e dire&tor-s ser'i&e on t(e CE ,oard" (e ,oard does not ,elie'e t(at ar,itrary term limits on dire&tors- ser'i&e are a%%ro%riate+ nor does it ,elie'e t(at dire&tors s(ould e6%e&t to ,e renominated annually until t(ey rea&( t(e mandatory retirement a#e" (e ,oard self!e'aluation %ro&ess des&ri,ed ,elow will ,e an im%ortant determinant for ,oard tenure" Dire&tors will not ,e nominated for ele&tion to t(e ,oard after t(eir :5rd ,irt(day+ alt(ou#( t(e full ,oard may nominate &andidates o'er :5 in s%e&ial &ir&umstan&es" 7" Inde%enden&e of Dire&tors A ma)ority of t(e dire&tors will ,e inde%endent dire&tors+ as inde%enden&e is determined ,y t(e ,oard+ ,ased on t(e #uidelines set fort( ,elow" All future non!em%loyee dire&tors will ,e inde%endent" CE seeks to (a'e a minimum of ten inde%endent dire&tors at all times+ as inde%enden&e is determined ,y t(e ,oard ,ased on t(e #uidelines set fort( ,elow+ and it is t(e ,oard-s #oal t(at at least two!t(irds of t(e dire&tors will ,e inde%endent" Dire&tors w(o do not satisfy CE-s inde%enden&e #uidelines also make 'alua,le &ontri,utions to t(e ,oard and to t(e Com%any ,y reason of t(eir e6%erien&e and wisdom" For a dire&tor to ,e &onsidered inde%endent+ t(e ,oard must determine t(at t(e dire&tor does not (a'e any dire&t or indire&t material relations(i% wit( CE" (e ,oard (as esta,lis(ed #uidelines to assist it in determinin# dire&tor inde%enden&e+ w(i&( &onform to or are more e6a&tin# t(an t(e inde%enden&e re/uirements in t(e New Mork Sto&k E6&(an#e listin# re/uirements 1NMSE rules3" In addition to a%%lyin# t(ese #uidelines+ t(e ,oard will &onsider all rele'ant fa&ts and &ir&umstan&es in makin# an inde%enden&e determination" (e ,oard will make and %u,li&ly dis&lose its inde%enden&e determination for ea&( dire&tor w(en t(e dire&tor is first ele&ted to t(e ,oard and annually t(ereafter for all nominees for ele&tion as dire&tors" If t(e ,oard determines t(at a dire&tor w(o satisfies t(e NMSE rules is inde%endent e'en t(ou#( (e or s(e does not satisfy all of CE-s inde%enden&e #uidelines+ t(is determination will ,e dis&losed and e6%lained in t(e ne6t %ro6y statement" In a&&ordan&e wit( NMSE rules+ inde%enden&e determinations under t(e #uidelines in se&tion 1a3 ,elow will ,e ,ased u%on a dire&tor-s relations(i%s wit( CE durin# t(e 59 mont(s %re&edin# t(e determination" Similarly+ inde%enden&e determinations under t(e #uidelines in se&tion 1,3 ,elow will ,e ,ased u%on t(e e6tent of &ommer&ial relations(i%s durin# t(e t(ree &om%leted fis&al years %re&edin# t(e determination" a" (e &ornerstone of CE-s #o'ernan&e stru&ture is its relian&e on an inde%endent and /ualified Goard of Dire&tors" Inde%enden&e means t(at insiders are not in'ol'ed in o'ersi#(t of t(e &om%any-s mana#ers" (is (el%s a'oid %otential &onfli&ts of interest" ELi#(ly /ualifiedF dire&tors ensure t(at t(ose res%onsi,le for o'ersi#(t (a'e t(e knowled#e to %erform t(eir duties and t(e &on'i&tion to ask %ro,in# /uestions" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-31 .1!7> 1&on&luded3 ," Co'ernan&e stru&tures ser'e s(are(olders 1and indire&tly+ %u,li& interest3" (e s(are(olders of CE (o%e to ensure t(at t(e &om%any-s %oli&ies are ad(ered to and t(at t(e interests of s(are(olders are #i'en %aramount &onsideration in t(e mana#ement of t(e ,usiness" Cambridge Business Publishers, 2013 1-32 !inancial Statement "nal#sis $ %aluation, 3rd &dition IF;S A..DICAIONS I1!8A 10A minutes3 1&urren&y in millions3 Assets 2 Dia,ilities 4 E/uity OMV Crou% Y 01+718 Y 11+5<A 1a3 Y 1A+A58 Eri&sson SEX 09>+<A> 1,3 SEX 10<+:<0 SEX 171+A0: GAE Systems 1&3 Z08+7A: Z0A+9<A Z7+:0: (e %er&ent of owner finan&in# for ea&( &om%any follows* 1all &urren&y in millions3 OMV Crou%""""""""""""""""""""""""""""" 79">J 1Y 1A+A58 K Y 01+7183 Eri&sson"""""""""""""""""""""""""""""""""" 80"5J 1SEX 171+A0: K SEX 09>+<A>3 GAE Systems"""""""""""""""""""""""""" 1<"9J 1Z7+:0: K Z08+7A:3 Got( Eri&sson and OMV Crou% (a'e a,out (alf of t(eir finan&in# from owners" GAE Systems is more nonowner!finan&ed" Li#(!te&( &om%anies+ su&( as Eri&sson+ fa&e more un&ertain &as( flows t(an do &a%ital intensi'e &om%anies su&( as GAE Systems" Ge&ause nonowner finan&in# is riskier+ &om%anies like Eri&sson 1t(at fa&e #reater un&ertainty3 tend to utili$e more e/uity in t(eir &a%ital stru&ture" OMV #rou% is a mature &as(!#eneratin# &om%any and+ as su&(+ (as re%aid its de,t+ w(i&( is now relati'ely t(e same le'el as t(e &om%any-s e/uity" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-33 I1!81 108 minutes3 a" 0AA< ;OE 2 I7+007 K T1I19+A9A 4 I17+>183K0R 2 0:"5J 0AA> ;OE 2 I:+7>A K T1I0A+<014I19+A9A3K0R 2 7A"9J Astra[ene&a-s ;OE (as in&reased from 0AA< to 0AA>+ and is well a,o'e t(e median ;OE of 1:J for &om%anies in t(e Dow Uones a'era#e" (e &om%any is e6&eedin#ly %rofita,le in 0AA>" ," 0AA< ;OA 2 I 7+007 K T1I79+>8A4I7:+><<3K0R 2 <">J 0AA> ;OA 2 I:+7>A K T1I87+>0A 4 I79+>8A3K0R 2 17":J Astra[ene&a-s ;OA in&reased from 0AA< to 0AA> and it too is well a,o'e t(e median for Dow Uones &om%anies 1on a'era#e3 for ,ot( years" On t(is dimension+ t(e &om%any is 'ery %rofita,le" &" Astra[ene&a sells %rodu&ts t(at (a'e a (i#( le'el of te&(nolo#y and s%e&iali$ation" Some or t(e &om%any-s &om%ounds are %atented" Com%anies t(at are a,le to a&(ie'e a &om%etiti'e ad'anta#e wit( uni/ue %rodu&ts and ser'i&es ty%i&ally en)oy a,o'e!le'el %rofita,ility and returns on e/uity" Furt(er+ to t(e e6tent t(at t(e &om%any is a,le to de'elo% &ustomer!s%e&ifi& %rodu&ts and ser'i&es+ &om%etiti'e t(reats lessen and+ t(us+ furt(er in&rease its %rofita,ility" Cambridge Business Publishers, 2013 1-3( !inancial Statement "nal#sis $ %aluation, 3rd &dition I1!80 108 minutes3 a" 0AA< ;OA 2 Z0+15A K T1Z5A+197 4 Z07+<A:3K0R 2 :":8J 0AA> ;OA 2 Z0+199 K T1Z79+A85 4 Z5A+1973K0R 2 8"9<J ," 0AA< .rofit Mar#in 2 Z0+15A K Z7:+0>< 2 7"8AJ 0AA> .rofit Mar#in 2 Z0+199 K Z87+50: 2 7"AAJ 0AA< Asset urno'er 2 Z7:+0>< K T1Z5A+197 4 Z07+<A:3K0R 2 1":0 0AA> Asset urno'er 2 Z87+50: K T1Z79+A85 4 Z5A+1973K0R 2 1"75 &" O'er t(is %eriod+ es&o-s ;OA de&reased from :":8J to 8"9<J" (is de&rease is due to two fa&tors* i3 %rofita,ility de&reased from 7"8AJ to 7"AAJ and ii3 asset turno'er de&reased from 1": to 1"7" @e would &on&lude t(at t(e &om%any is less %rofita,le on e'ery sale and (as redu&ed asset effi&ien&y durin# 0AA> &om%ared to 0AA<" (is &orres%onds to a %eriod of #eneral weakenin# in t(e #lo,al e&onomy" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-3) DISCUSSION .OINS D1!85 15A minutes3 Finan&in# &an &ome from a num,er of sour&es+ in&ludin# o%eratin# &reditors+ ,orrowed funds+ and t(e sale of sto&k" Ea&( (as its stren#t(s and weaknesses" 1" O%eratin# &reditors Q o%eratin# &reditors are mer&(andise and ser'i&e su%%liers+ in&ludin# em%loyees" Cenerally+ t(ese lia,ilities are non! interest ,earin#" As a result+ &om%anies ty%i&ally use t(is sour&e of &redit to t(e fullest e6tent %ossi,le+ often stret&(in# %ayment times" Lowe'er+ a,use of o%eratin# &reditors (as a si#nifi&ant downside" (e &om%any may ,e una,le to su%%ly its o%eratin# needs and t(e dama#e to em%loyee morale mi#(t (a'e si#nifi&ant re%er&ussions" O%eratin# &redit must+ t(erefore+ ,e used wit( &are"
0" Gorrowed funds Q ,orrowed money ty%i&ally &arries an interest rate" Ge&ause interest e6%ense is dedu&ti,le for ta6 %ur%oses+ ,orrowed funds redu&e in&ome ta6 e6%ense" (e ta6es sa'ed are &alled t(e Eta6 s(ield"F (e dedu&ti,ility of interest redu&es t(e effe&ti'e &ost of ,orrowin#" (e downside of de,t is t(at t(e &om%any must make %rin&i%al and interest %ayments as s&(eduled" Failure to make %ayments on time &an result in se'ere &onse/uen&es Q &reditors (a'e si#nifi&ant le#al remedies+ in&ludin# for&in# t(e &om%any into ,ankru%t&y and re/uirin# its li/uidation" (e lower &ost of de,t must ,e ,alan&ed a#ainst t(e fi6ed %ayment o,li#ations"
5" Sale of sto&k Q &om%anies &an sell 'arious &lasses of sto&k to in'estors" Some &lasses of sto&k (a'e mandatory di'idend %ayments" On ot(er &lasses of sto&k+ di'idends are not a le#al re/uirement until de&lared ,y t(e ,oard of dire&tors" Conse/uently+ unlike de,t %ayments+ some di'idends &an ,e &urtailed in ,usiness downturns" (e downside of sto&k issuan&e is its &ost" Ge&ause e/uity is t(e most e6%ensi'e sour&e of &a%ital+ &om%anies use it s%arin#ly" Cambridge Business Publishers, 2013 1-3* !inancial Statement "nal#sis $ %aluation, 3rd &dition D1!87 15A minutes3 Ea&( of t(e t(ree %rimary finan&ial statements %ro'ides a different %ers%e&ti'e on t(e &om%any-s finan&ial %erforman&e and &ondition" 1" In&ome statement" (e in&ome statement %ro'ides information on t(e &om%any-s sales+ e6%enses+ and net in&ome or loss" .rofita,ility indi&ates t(at t(e &om%any-s #oods or ser'i&es are 'alued ,y t(e market+ t(at is+ &ustomers are willin# to %ay a %ri&e t(at is suffi&ient to &o'er t(e &osts of %ro'idin# t(ose #oods andKor ser'i&es to#et(er wit( an ade/uate return on in'ested &a%ital" Furt(er+ t(e in&ome statement is %re%ared on an a&&rual ,asis+ w(ere re'enues are re&o#ni$ed w(en EearnedF and e6%enses w(en Ein&urred"F A&&ountants do not wait for &as( to ,e re&ei'ed or %aid to re&ord re'enues and e6%enses" Conse/uently+ mana#ement is a,le to &ommuni&ate some of its %ri'ate information a,out e6%e&ted &as( inflows or outflows t(rou#( its re&ordin# of re'enues and e6%enses" .resuma,ly t(is information is 'alua,le to finan&ial statement readers ,e&ause t(e in&ome statement %ro'ides information a,out t(e e&onomi& %rofit of t(e &om%any" 0" Galan&e s(eet" (e ,alan&e s(eet re%orts t(e resour&es a'aila,le to t(e &om%any and (ow t(e &om%any o,tained t(ose resour&es 1t(e sour&es3" (e ,alan&e s(eet also re'eals asset &ate#ories 1%ro'idin# insi#(t into mana#ement-s in'estment %(iloso%(y3 and t(e manner in w(i&( mana#ement (as finan&ed its o%erations 1t(e relati'e use of de,t 'ersus e/uity3" Effi&ient mana#ement of t(e ,alan&e s(eet is &riti&al to finan&ial %erforman&e and &areful analysis of t(e ,alan&e s(eet &an %ro'ide &lues into t(e effe&ti'eness of t(e &om%any-s mana#ement team and t(e 'ia,ility of t(e &om%any wit(in t(e &onte6t of its industry" 5" Statement of &as( flows" Cas( is im%ortant to a &om%any-s &ontinued o%erations" De,ts must ,e %aid in &as( and em%loyees ty%i&ally only a&&e%t &as( in %ayment of t(eir ser'i&es" Com%anies must #enerate %ositi'e &as( flow o'er t(e lon# run in order to sur'i'e" (e in&ome statement+ %re%ared on an a&&rual ,asis+ does not dire&tly %ro'ide information a,out &as( flows" Gut t(e statement of &as( flows does+ and+ for t(at reason+ it is a &riti&al finan&ial statement" (e statement of &as( flows tells us t(e sour&es of &as( and (ow &as( (as ,een used" In %arti&ular+ t(e statement re%orts o%eratin#+ in'estin# and finan&in# &as( flows" From t(e statement we &an infer w(et(er t(e &om%any-s sour&es of &as( are lon#!term or transitory" (is is im%ortant to fore&astin# future &as( flows" In addition+ t(e uses of &as( %ro'ide insi#(t into mana#ement-s in'estment %(iloso%(y+ w(i&( &an ,e a Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-3+ 'alua,le in%ut into our e'aluation of mana#ement and 'aluation of t(e &om%any" Cambridge Business Publishers, 2013 1-3, !inancial Statement "nal#sis $ %aluation, 3rd &dition D1!88 15A minutes3 .ransparenc# is t(e de#ree to w(i&( t(e finan&ial statements a&&urately and &om%letely %ortray t(e finan&ial &ondition of t(e &om%any and t(e results of its o%eratin# a&ti'ities" rans%arent finan&ial statements are timely and %ro'ide all t(e information re/uired to effe&ti'ely e'aluate t(e finan&ial %erforman&e of t(e &om%any" A&&ura&y+ timeliness+ and &om%leteness are im%ortant to finan&ial statement readers w(o seek finan&ial information t(at is rele'ant and relia,le" rans%aren&y ,e&ame a &entral issue in finan&ial re%ortin# followin# t(e a&&ountin# s&andals of t(e early 0AAAs+ w(en analysts ,elie'ed too many finan&ial statements la&ked trans%aren&y" Galan&in# &om%anies- desire to issue trans%arent finan&ial statements is t(eir need to %rote&t %ro%rietary information" Markets are 'ery &om%etiti'e+ and t(e information dis&losed to in'estors and &reditors is also dis&losed to t(e &om%any-s &om%etitors" Most &riti&al is information relatin# to t(e &om%any-s strate#i& dire&tion" E'en (istori&al information+ (owe'er+ %ro'ides insi#(t into t(e relati'e %rofita,ility of t(e &om%any-s o%eratin# units t(at &an ,e effe&ti'ely utili$ed ,y future &om%etitors" (ere (as traditionally ,een tension ,etween &om%anies and t(e finan&ial %rofessionals 1es%e&ially in'estment analysts3 w(o %ress firms for more and more finan&ial and nonfinan&ial information" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-3- D1!89 15A minutes3 A&&ountin# measures ot(er t(an net in&ome (a'e ,e&ome &ommon%la&e in &or%orate %ress releases" Gy t(eir use+ &om%anies seek to redefine t(e ,en&(mark t(e market uses to e'aluate t(e &om%anies- %erforman&e" (ese non!CAA. in&ome metri&s often &reate a lower ,ar t(at &om%anies &an more easily rea&(" Gy toutin# non!CAA. %erforman&e measures+ &om%anies (o%e to im%ro'e t(e market-s assessment of %erforman&e" (e SEC will not a&&e%t non!CAA. finan&ial statements for /uarterly and annual finan&ial re%ortin#" In fa&t+ auditors must &ite CAA. e6&e%tions in t(eir audit o%inion+ w(i&( &reates a si#nifi&ant red fla#" Com%anies are allowed to use non!CAA. measures in %ress releases+ %ro'ided t(at t(ey also re&on&ile t(e non!CAA. num,ers to CAA. num,ers in t(e same %ress release" It is a &riminal offense to issue false or misleadin# finan&ial statements for t(e %ur%ose of influen&in# se&urity %ri&es" Also+ most &om%anies (a'e de'elo%ed and %u,lis(ed to em%loyees+ &odes of &ondu&t t(at %ro(i,it t(e falsifi&ation of finan&ial re%ortin# for t(e %ur%ose of )o, retention+ %romotion+ or &om%ensation" Offi&ially+ senior mana#ement ,elie'es t(at false finan&ial re%orts %ose si#nifi&ant et(i&al issues t(at must ,e &learly &ommuni&ated to all em%loyees" Nonet(eless+ we &ontinue to witness &or%orate e6e&uti'es doin# a E%er% walkF on national V as t(ey are es&orted to )ail ,y federal aut(orities" Condonin# e6&e%tions to finan&ial re%ortin# im%li&itly &ondones t(eft in all of its forms+ and t(e &or%orate &ulture /ui&kly deteriorates" .ro%er &or%orate #o'ernan&e re/uires t(e &ommuni&ation of &lear #uidelines a,out w(at information may ,e &ommuni&ated in %ress releases and (ow internal %erforman&e measures are to ,e &onstru&ted" (ese must ,e enfor&ed to t(e letter" Guffett is ri#(tly &on&erned wit( t(e use of non!CAA. measures of %erforman&e" On&e t(e door is o%ened to im%ro%er re%ortin#+ it ,e&omes in&reasin#ly diffi&ult to &onsistently measure %erforman&e" Cambridge Business Publishers, 2013 1-(0 !inancial Statement "nal#sis $ %aluation, 3rd &dition D1!8: G 15A minutes3 (e SEC (as 'oi&ed its &on&ern o'er t(e %er&ei'ed la&k of inde%enden&e of auditors+ and Con#ress (as %assed le#islation to define t(e a&ti'ities t(at auditors may and may not %erform for t(eir &lients" (e issue of inde%enden&e first arose w(en auditors fa&ed no &ontrols" In res%onse to de&linin# audit fees+ %u,li& a&&ountin# firms sou#(t to ,olster t(eir in&ome wit( mana#ement &onsultin# en#a#ements+ su&( as software de'elo%ment+ MBA assistan&e+ internal audit outsour&in#+ su%%ly &(ain mana#ement+ and a (ost of ot(er ser'i&es" As mana#ement &onsultin# re'enues and %rofits #rew dis%ro%ortionately &om%ared to traditional audit re'enues and %rofit+ t(e SEC ,e&ame &on&erned t(at auditors mi#(t ,e unduly influen&ed to issue ,iased audit re%orts rat(er t(an risk losin# lu&rati'e mana#ement &onsultin# fees from t(e same &lient" In res%onse+ t(e SEC &om%elled %u,li& a&&ountin# firms to di'est t(eir mana#ement &onsultin# su,sidiaries" Furt(er+ firms were limited as t(e ty%es of non!audit en#a#ements t(ey &ould %erform for &lients" Auditors are an im%ortant &om%onent of t(e &or%orate #o'ernan&e system+ and t(eir effe&ti'eness is lessened if t(eir inde%enden&e is &om%romised" (e ,oard of dire&tors 1s%e&ifi&ally+ t(e audit &ommittee3 must &ontinually e'aluate t(e inde%enden&e of t(e &om%any-s auditors" Cambridge Business Publishers, 2013 Solutions Manual, Module 1 1-(1