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Analyzing Investing Activities. The Balance Sheet Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-2 “Old accountants never die;

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Presentation on theme: "Analyzing Investing Activities. The Balance Sheet Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-2 “Old accountants never die;"— Presentation transcript:

1 Analyzing Investing Activities

2 The Balance Sheet Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-2 “Old accountants never die; they just lose their balance” --Anonymous

3 Current (Short-term) Assets Noncurrent (Long- term) Assets Resources or claims to resources that are expected to be sold, collected, or used within one year or the operating cycle, whichever is longer. Resources or claims to resources that are expected to yield benefits that extend beyond one year or the operating cycle, whichever is longer. Classification Assets

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5 2-5 Common-Size Balance Sheet Expresses each item on the balance sheet as a percentage of total assets Reveals the composition of assets Form of vertical ratio analysis that allows comparison of firms Useful for evaluating trends within a firm and to make industry comparisons

6 TURKCELL $ 000Common Size Property, plant and equipment3,068,0212,652, %28.45% Intangible assets1,709,3111,897, %20.36% GSM and other telecommunication operating licenses ,058, %11.35% Computer software % Other intangible assets % Investments in equity accounted investees % Other investments % Due from Related parties % Other non-current assets % Trade receivables % Deferred tax assets % Total non-current assets5,357,0245,066, %54.36% Inventories % Other investments % Due from related parties % Trade receivables And accrued income % Other current assets % Cash and cash equivalents3,302,1633,095, %33.21% Total current assets4,437,5384,254, %45.64% Total assets9,794,5629,320, %

7 ARCELIK$ 000Common Size Donen varliklar: Nakit ve nakit benzerleri 1,317,166904, %14.08% Türev finansal araçlar 1,1854, %0.07% Ticari alacaklar 2,324,5782,233, %34.75% Stoklar 987,526906, %14.11% Diger dönen varliklar 117,984108, %1.70% Toplam donen varliklar 4,748,4394,157, %64.70% Duran varliklar: 0.00% Ticari alacaklar 12,4614, %0.07% Finansal yatirimlar 658,679395, %6.16% Özkaynak yöntemiyle degerlenen yatirimlar 136,604129, %2.01% Yatirim amaçli gayrimenkuller 5,4806, %0.10% Maddi duran varliklar 1,252,2451,244, %19.36% Maddi olmayan duran varliklar 461,417439, %6.85% Serefiye 7,1907, %0.12% Ertelenen vergi varliklar 39,24441, %0.65% Toplam duran varliklar 2,573,3202,268, %35.30% Toplam varliklar 7,321,7596,426, %

8 Current Assets Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-8 Operating cycle Time required to purchase or manufacture inventory, sell the product, and collect the cash Working capital Also called net working capital Current assets less current liabilities

9 Cash and Cash Equivalents  Short-term, highly liquid investments that are:  Readily convertible to a known cash amount.  Close to maturity date and not sensitive to interest rate changes  Companies risk a reduction in liquidity should the market value of short-term investments decline  Cash and cash equivalents are sometimes required to be maintained as compensating balances to support existing borrowing arrangements or as collateral for indebtedness.

10 Receivables  Receivables are amounts due from others that arise from the sale of goods or services, or the loaning of money  Accounts receivable refer to oral promises of indebtedness due from customers  Notes receivable refer to formal written promises of indebtedness due from others

11 Receivables are reported at their net realizable value — total amount of receivables less an allowance for uncollectible accounts Management estimates the allowance for uncollectibles based on experience, customer fortunes, economy and industry expectations, and collection policies Receivables are reported at their net realizable value — total amount of receivables less an allowance for uncollectible accounts Management estimates the allowance for uncollectibles based on experience, customer fortunes, economy and industry expectations, and collection policies Valuation of Receivables

12 TURKCELL Allowance for doubtful receivables During the current year, the Group has changed its accounting estimates regarding the determination of allowance for doubtful receivables. Formerly, the allowance for doubtful receivables was based on management’s evaluation of the volume of the receivables outstanding, historical collection trends and general economic conditions. With the new accounting estimate, the Group maintains an allowance for doubtful receivables for estimated losses resulting from the inability of the Group’s subscribers and customers to make required payments. The Group bases the allowance on the likelihood of recoverability of trade and other receivables based on the aging of the balances, historical collection trends and general economic conditions. The allowance is periodically reviewed. The allowance charged to expenses is determined in respect of receivable balances, calculated as a specified percentage of the outstanding balance in each aging group, with the percentage of the allowance increasing as the aging of the receivable becomes longer. This change is accounted as a change in accounting estimates in accordance with IAS 8 “Accounting Policies, Changes in Accounting Estimates and Errors”. Based on the evaluation performed, the change in the estimates regarding the determination of allowance for doubtful receivables caused the following impact on bad debt provision expense: Bad debt expense for the year ended 31 December 2010 Previous accounting estimate127,921 Current accounting estimate 126,257 Impact 1,664 Due to the impracticability, the Group has not disclosed the effect of the change for the future periods.

13 Arcelik

14 Assessment of earnings quality is often affected by an analysis of receivables and their collectibility Analysis must be alert to changes in the allowance—computed relative to sales, receivables, or industry and market conditions. Two special analysis questions: (1) Collection Risk Review allowance for uncollectibles in light of industry conditions Apply special tools for analyzing collectibility: Determining competitors’ receivables as a percent of sales—vis-à-vis the company under analysis Examining customer concentration—risk increases when receivables are concentrated in one or a few customers Investigating the age pattern of receivables—overdue and for how long Determining portion of receivables that is a renewal of prior receivables Analyzing adequacy of allowances for discounts, returns, and other credits (2) Authenticity of Receivables Review credit policy for changes Review return policies for changes Review any contingencies on receivables Assessment of earnings quality is often affected by an analysis of receivables and their collectibility Analysis must be alert to changes in the allowance—computed relative to sales, receivables, or industry and market conditions. Two special analysis questions: (1) Collection Risk Review allowance for uncollectibles in light of industry conditions Apply special tools for analyzing collectibility: Determining competitors’ receivables as a percent of sales—vis-à-vis the company under analysis Examining customer concentration—risk increases when receivables are concentrated in one or a few customers Investigating the age pattern of receivables—overdue and for how long Determining portion of receivables that is a renewal of prior receivables Analyzing adequacy of allowances for discounts, returns, and other credits (2) Authenticity of Receivables Review credit policy for changes Review return policies for changes Review any contingencies on receivables Analyzing Receivables

15 Receivables are Carried at Amortized Cost (C) 2007 Prentice Hall, Inc.2-15  When sales are made on credit, the interest imputed in the transaction is not recognized as sales revenue but as INTEREST INCOME  By using the Effective Interest Method

16 Illustration (C) 2007 Prentice Hall, Inc.2-16  The sales price of TL was charged to customer for a sales on credit (n/90) on 1 November. If the same goods were sold at cash, the price would have been TL  The effective interest rate for the transaction is:

17 (C) 2007 Prentice Hall, Inc.2-17 Present Value of 52,000 at the end of the year – 30 days remain to payment day

18 Securitization (or factoring) is when a company sells all or a portion of its receivables to a third party Receivables can be sold with or without recourse to a buyer (recourse refers to guarantee of collectibility) Sale of receivables with recourse does not effectively transfer risk of ownership Securitization (or factoring) is when a company sells all or a portion of its receivables to a third party Receivables can be sold with or without recourse to a buyer (recourse refers to guarantee of collectibility) Sale of receivables with recourse does not effectively transfer risk of ownership Securitization of Receivables For securitizations with any type of recourse, the seller must record both an asset and a compensating liability for the amount factored For securitizations without any recourse, the seller removes the receivables from the balance sheet

19 Inventories-Definitions  Inventories are goods held for sale, or goods acquired (or in process of being readied) for sale, as part of a company’s normal operations  Expensing treats inventory costs like period costs— costs are reported in the period when incurred  Capitalizing treats inventory costs like product costs— costs are capitalized as an asset and subsequently charged against future period(s) revenues benefiting  from their sale

20 Use of Inventory Methods in Practice Inventory Costing Method

21 Costs of Goods Sold Ending Inventory Oldest Costs Recent Costs First-In, First-Out (FIFO) Cost Flow of Inventories

22 Costs of Goods Sold Ending Inventory Recent Costs Oldest Costs Last-In, First-Out (LIFO) Cost Flow of Inventories

23 Average Cost When a unit is sold, the average cost of each unit in inventory is assigned to cost of goods sold. Cost of Goods Available for Sale Units available on the date of sale ÷

24 Inventory Accounting Methods (C) 2007 Prentice Hall, Inc.2-24  Inventory valuation may significantly affect BOTH the balance sheet and the income statement and thus the financial ratios based on these statements  Disclosure of inventory cost flow assumption found in notes  Inventory reported on balance sheet at LOWER OF COST OR MARKET (net realizable value)  Checked for impairment annually  Companies may use more than one method for inventories

25 Inventory on January 1, Year $500$ 20,000 Inventories purchased during the year $600 36,000 Cost of Goods available for sale 100 units$ 56,000 Note: 30 units are sold in Year 2 for $800 each for total Revenue of $24,000 Inventory on January 1, Year $500$ 20,000 Inventories purchased during the year $600 36,000 Cost of Goods available for sale 100 units$ 56,000 Note: 30 units are sold in Year 2 for $800 each for total Revenue of $24,000 Illustration of Costing Methods

26 Beginning NetCost ofEnding Inventory+Purchases=Goods Sold+Inventory FIFO$20,000+$36,000=$15,000+$41,000 LIFO$20,000+$36,000=$18,000+$38,000 Average$20,000+$36,000=$16,800+$39,200 Assume sales of $35,000 for the period—then gross profit under each method is: Sales– Cost of Goods Sold =Gross Profit FIFO$24, ,000 =$9,000 LIFO$24, ,000 =$6,000 Average$24, ,800 =$7,200 Beginning NetCost ofEnding Inventory+Purchases=Goods Sold+Inventory FIFO$20,000+$36,000=$15,000+$41,000 LIFO$20,000+$36,000=$18,000+$38,000 Average$20,000+$36,000=$16,800+$39,200 Assume sales of $35,000 for the period—then gross profit under each method is: Sales– Cost of Goods Sold =Gross Profit FIFO$24, ,000 =$9,000 LIFO$24, ,000 =$6,000 Average$24, ,800 =$7,200 Illustration of Costing Methods

27 Economic Profit vs. Holding Gain  In periods of rising prices, FIFO produces higher gross profits than LIFO because lower cost inventories are matched against sales revenues at current market prices. This is sometimes referred to as FIFO’s phantom profits.  The FIFO gross profit is actually a sum of two components: an economic profit and a holding gain:  Economic profit = 30 units x ($800 - $600) = $6,000  Holding gain = 30 units x ($600 - $500) = $3,000

28 Prepaid expenses are advance payments for services or goods not yet received that extend beyond the current accounting period— examples are advance payments for rent, insurance, utilities, and property taxes Prepaid Expenses Two analysis issues: (1)For reasons of expediency, noncurrent prepaids sometimes are included among prepaid expenses classified as current-- when their magnitude is large, they warrant scrutiny (2) Any substantial changes in prepaid expenses warrant scrutiny Two analysis issues: (1)For reasons of expediency, noncurrent prepaids sometimes are included among prepaid expenses classified as current-- when their magnitude is large, they warrant scrutiny (2) Any substantial changes in prepaid expenses warrant scrutiny Analysis of Prepaids Other current assets

29 Chapter 9Mugan-Akman Accounting for Debt and Equity Investments Debt Valuation Method Short term Long term (trading securities) Fair Value (Market Value) Held for resale* Held to maturity Fair market value Amortized Cost Stocks Valuation Method Short term (trading securities) Long term Ownership percentage 0 –20% of the investee shares* 20-50% of the investee shares Greater than 50% of the investee shares Fair Value (Market Value) Equity MethodConsolidation * usually classified as available for sale investments

30 Chapter 9Mugan-Akman Investor Corporation Minority, Active Investments (typically between 20% and 50% ownership) Minority, Active Investments (typically between 20% and 50% ownership) Majority, Active Investments (greater than 50% ownership) Majority, Active Investments (greater than 50% ownership) Minority, Passive Investments (less than 20% ownership) Minority, Passive Investments (less than 20% ownership) held as current assets, marketable Securities Trading sec held as current assets, marketable Securities Trading sec held as long-term Investments- Available for sale held as long-term Investments- Available for sale acquired in Purchase- consolidation acquired in Purchase- consolidation The accounting for investments depends on the purpose of the investment and the percentage of voting stock held. Types of Investments-Stocks Equity method of accounting Equity method of accounting

31 Chapter 9Mugan-Akman Classification of Financial Instruments  Financial assets at fair value through profit or loss: has two subcategories:  Trading securities: Marketable securities – both equity and debt securities – that are held for short-term profit purposes; and  Derivatives: financial instruments that do not have a value by themselves but derive their value from the underlying security or asset such as shares, foreign exchange, commodities etc.- except for cash flow hedges that are accounted for similar to trading securities;  Held to Maturity: Debt securities for which a firm has both the positive intent and ability to hold to maturity  Available for Sale Securities: Neither trading securities nor securities held to maturity- usually classified as long term investments.

32 Chapter 9Mugan-Akman Short-Term Investments-Trading Securities  usually consist of :  marketable equity securities (stocks of other companies)  savings accounts (time deposits)  investment funds  precious metals like gold  government bonds  treasury bills  asset securitized bonds  private bonds  Characterized by frequent and active buying and selling with the object of generating profit  Typically only financial institutions hold trading securities  Since trading securities are acquired for short-term profit, unrealized gains or losses that result from adjustments to market value pass through the income statement and increase or reduce net income before there is a sale of the securities.

33 Chapter 9Mugan-Akman Accounting for Marketable Equity Securities  record them at the acquisition cost that includes the price of the security plus any brokerage commissions and applicable taxes, and other costs incurred  record dividend revenue when dividends declared and later when cash is received  adjust to fair market value at the end of the accounting period-adjusting entry

34 Adjusting Entries-Trading Securities Chapter 9Mugan-Akman  at the end of an accounting period, cost/carrying value of the portfolio of marketable equity securities is compared with the fair value (market value)  carrying value = fair value at the latest reporting date  if the fair value of the securities is greater than the cost -unrealized holding gain  if the fair value is less than the cost - unrealized holding loss  any unrealized gains or losses on trading securities are charged to revenues  securities are reported at the fair value in the statement of financial position

35 Chapter 9Mugan-Akman Accounting for Marketable Debt Securities  same as the accounting for marketable equity securities – both are trading securities  carrying value of these securities will be compared to the market or fair value at the reporting dates  carrying value = the market value or fair value at the latest reporting date  unrealized holding gains or losses will be reflected in the income statement

36 Available for Sale Securities Chapter 9Mugan-Akman  neither as trading securities or held to maturity securities  held by non-financial companies usually  both equity and debt securities  non-derivative financial assets that are initially designated by the management as available for sale (AFS)  typically tied to a specific cash need  usually classified as long-term assets  measured at fair value in the statement of financial position  unlike trading securities; any unrealized holding gains or losses - shown under the owners’ equity section with the name “Unrealized Holding Gains or Losses”  realized gain or loss when these securities are sold  interest or dividend revenues received from AFS securities are reflected in the income statement

37 Comparison - trading and available for sale securities Chapter 9Mugan-Akman  both are recorded at acquisition cost  both are written up or down to market with adjusting entries at the reporting date.  both give rise to an unrealized holding gain or loss account upon adjustment.  unrealized holding gain or loss for trading securities is charged to revenues – when sold, realized gain or loss is determined by taking the difference between the carrying value and proceeds from the sale  unrealized holding gain or loss for available for sale securities remains on the statement of financial position until such assets are sold-when sold, this account must then be closed and the realized gain or loss is computed by comparing the historical cost and proceeds from the sale

38 Long term assets Long-term assets—resources that are used to generate revenues (or reduce costs) in the long run Tangible fixed assets such as property, plant, and equipment Deferred charges such as research and development (R&D) expenditures, and natural resources Intangible assets such as patents, trademarks, copyrights, and goodwill Financial assets such as available for sale; equity method investments

39 Allocation of initial costs to respective periods Allocation —process of periodically expensing a deferred cost (asset) to one or more future expected benefit periods; determined by benefit period, salvage value, and allocation method Terminology Depreciation for tangible fixed assets Amortization for intangible assets Depletion for natural resources Allocation —process of periodically expensing a deferred cost (asset) to one or more future expected benefit periods; determined by benefit period, salvage value, and allocation method Terminology Depreciation for tangible fixed assets Amortization for intangible assets Depletion for natural resources

40 Acquisition cost Acquisition cost excludes financing charges (except in self constructed assets) and cash discounts All expenditures needed to prepare the asset for its intended use Purchase price Acquisition cost of PPE

41 Property, Plant, and Equipment (PP&E) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-41 Land refers to property used in business, not investment property. Leasehold investments are additions or improvements made to leased structures. Construction in progress are the costs of constructing new buildings that are not yet complete. Equipment represents the original cost of the machinery and equipment used in business operations.

42 Property, Plant, and Equipment (PP&E ) Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-42 Proportion of fixed assets in a company’s asset structure is determined by nature of the business. Fixed assets are most prominent at the manufacturing level.

43 Depreciation is the process of allocating the cost of a plant asset to expense in the accounting periods benefiting from its use. Cost Allocation Acquisition Cost (Unused) Stat of Fin Position (Used) Income Statement Expense Depreciation Book value = original cost/revalued amount - accumulated depreciation to date – impairment losses

44 Factors in Computing Depreciation The calculation of depreciation requires three amounts for each asset:  Cost.  Salvage Value.  Useful Life.  Depreciation Method

45 Cost - Salvage Value Useful life in periods Depreciation Expense per Year = Straight-Line Method Depreciation Rate = 1/ useful life in periods If useful life is 5 years, straight line rate is = 1/5 = 20% Straight-Line Method gives the same amount of depreciation expense every year

46 Step 1: Step 2: Double-declining- balance rate = 2 × Straight-line depreciation rate Step 3: Depreciation expense = Double-declining- balance rate × Beginning period book value Ignores salvage value Straight-line depreciation rate = 100 % Useful life Double-Declining-Balance Method

47 Depreciation Per Unit = Cost - Salvage Value Total Units of Production Step 1: Step 2: Depreciation Expense = Depreciation Per Unit × Units Produced in Period Activity (Units-of-Production) Method

48 Depreciation Methods-comparison Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-48 Straight-line method allocates an equal amount of expense to each year of the depreciation period. Accelerated method apportions larger amounts of expense to earlier years of the asset’s depreciable life – in Turkey most common one is double declining. Units-of-production method bases depreciation expense on actual use. Companies can use different methods for different asset classes. number of companies % SL% ACC ,5320,47 Economic consequences of firms’ depreciation method choice: Evidence from capital investments ☆ Scott B. Jackson a, Xiaotao (Kelvin) Liu b, Mark Cecchini a

49 SIC code description% SL% ACC SIC code description% SL% ACC Metal mining Transportation equipment Oil and gas extraction Measuring, analyzing, and controlling instruments Building construction general contractors Miscellaneous manufacturing industries Food and kindred products Wholesale trade durable goods Textile mill products Wholesale trade non-durable goods Apparel and other finished products made from fabrics General merchandise stores Furniture and fixtures Food stores Paper and allied products Apparel and accessory stores Printing, publishing, and allied industries Home furniture, furnishings, and equipment stores Chemicals and allied products Eating and drinking places Petroleum refining and related industries Miscellaneous retail Rubber and miscellaneous plastics products Business services Stone, clay, glass, and concrete products Motion pictures Primary metal industries Amusement and recreation services Fabricated metal products Health services Industrial and commercial machinery and equipment Engineering, accounting, management, and related services Electronic and other electrical equipment and components Other SIC codes Economic consequences of firms’ depreciation method choice: Evidence from capital investments ☆ Scott B. Jackson a, Xiaotao (Kelvin) Liu b, Mark Cecchini a

50 Capitalization Capitalization —process of deferring a cost that is incurred in the current period and whose benefits are expected to extend to one or more future periods For a cost to be capitalized, it must meet each of the following criteria: It must arise from a past transaction or event It must yield identifiable and reasonably probable future benefits It must allow owner (restrictive) control over future benefits Capitalization —process of deferring a cost that is incurred in the current period and whose benefits are expected to extend to one or more future periods For a cost to be capitalized, it must meet each of the following criteria: It must arise from a past transaction or event It must yield identifiable and reasonably probable future benefits It must allow owner (restrictive) control over future benefits

51 Valuation of PPE (C) 2007 Prentice Hall, Inc Option: Property, plant & equipment are valued at cost less accumulated depreciation and allowance for impairment 2. Option: Property, plant & equipment are valued at revalued amount less accumulated depreciation and allowance for impairment  Impairment—process of writing down asset value when its expected (undiscounted) cash flows are less than its carrying (book) value  Two distortions arise from impairment:  Conservative biases distort long-lived asset valuation because assets are written down but not written up  Large transitory effects from recognizing asset impairments distort net income.

52 Valuation Analysis  Valuation emphasizes objectivity of historical cost, the conservatism principle, and accounting for the money invested Limitations of historical costs:  Balance sheets may not reflect market values after initial acquisition  Not especially relevant in assessing replacement values- either entry or exit values  Not comparable across companies—even if two land pieces side by side– may be purchased at different times  Not particularly useful in measuring opportunity costs  Collection of expenditures reflecting different purchasing power

53 Total cost, including exploration and development, is charged to depletion expense over periods benefited. Extracted from the natural environment and reported at cost less accumulated depletion. Examples: oil, coal, gold Natural resources (wasting assets)—rights to extract or consume natural resources Natural Resources

54 Depletion is calculated using the units-of-production method. Unit depletion rate is calculated as follows: Total Units of Capacity Cost – Salvage Value Depletion of Natural Resources

55 Total depletion cost for a period is: Unit Depletion Rate Number of Units Extracted in Period × Total depletion cost If not Inventory If sold Cost of goods sold

56 Assess reasonableness of depreciable base, useful life, and allocation method Review any revisions of useful lives Evaluate adequacy of depreciation—ratio of depreciation to total assets or to other size-related factors Analyze plant asset age—measures include Average total life span= Gross plant and equipment assets / Current year depreciation expense. Average age = Accumulated depreciation / Current year depreciation expense. Average remaining life = Net plant and equipment assets / Current year depreciation expense. Average total life span = Average age + Average remaining life (these measures also reflect on profit margins and financing requirements) Analyzing Depreciation and Depletion

57 Noncurrent assets without physical substance. Useful life is often difficult to determine. Usually acquired for operational use. Intangible Assets Often provide exclusive rights or privileges. Intangible Assets

58 Accounting for Intangible Assets  Patents  Copyrights  Leaseholds  Leasehold Improvements  Goodwill- only recognized in company acquisitions – not amortized  Trademarks and Trade Names Record at cost, including purchase price, legal fees, and filing fees.

59 Analyzing Intangibles and Goodwill  Search for unrecorded intangibles and goodwill— often misvalued and most likely exist off-balance- sheet  Examine for unusually good earnings as evidence of goodwill  Review amortization periods— any likely bias is in the direction of less amortization and can call for adjustments  Recognize goodwill has a limited useful life-- whatever the advantages of location, market dominance, competitive stance, sales skill, or product acceptance, they are affected by changes in business

60 Other Assets Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall 2-60 Can include many other noncurrent items: Property held for sale Start-up costs in connection with a new business Cash surrender value of life insurance policies Long-term advance payments Long-term investments


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