CH. 3 ANALYZING FINANCING ACTIVITIES

1. CH. 3ANALYZING FINANCING ACTIVITIES

2. Preview • Financing liabilities: all forms of credit financing. • Operating liabilities: obligations that arise from operations. • Liabilities are commonly reported as either current or noncurrent.

3. Analyzing Liabilities • We need assurance that companies account for them (includes disclosure of their amounts and due dates). • Many companies attempt to reduce the amount of liabilities reported on their financial statements. • Certain liabilities are more apt to be misclassified or inadequately described.

4. Leases • Capital lease & Operating Lease • Off-balance-sheet financing: neither the leased asset nor its corresponding liability are recorded on the balance sheet when a lease is accounted for as an operating lease even though many of the benefits and risks of ownership are transferred to the lessee.

5. Leases • Over lease term, total expense of operating and capital lease is identical. But, capital lease lease reports more expense in the earlier years and less expense in later years.

6. Analyzing Leases • Impact of operating leases: • Understate liabilities => inflate solvency ratios • Understate assets => inflate ROI • Delay recognition of expenses • Understate current liabilities => inflate current ratio and other liquidity measures • Understate operating income and interest expense => inflate interest coverage ratios

7. Postretirement Benefits • Costs of providing postretirement benefits be recognized when the employee is in active service, rather than when the benefits are actually paid. • Defined benefit plans & Defined contribution plans.

8. Analyzing Postretirement Benefits • Reconciling economic and reported numbers • Adjusting the income statement and balance sheet • Evaluate actuarial assumptions

9. Contingencies and Commitments • Contingent liabilities: potential claims on a company’s resources. • Commitments: potential claims against a company’s resources due to future performance under contract.

10. Off-Balance-Sheet Financing • Operating leases • Special Purpose Entities (SPEs)

11. Shareholders’ Equity • Capital stock: • Explanation of changes in the number of capital shares • Evaluation of the options held by others that when exercised cause the number of shares outstanding to increase and thus dilute ownership • Retained Earnings • Restrictions imposed on distributions of retained earnings

12. Analyzing Contingent Liabilities • Management estimates • Analyze note disclosures for all loss (and gain) contingencies. • Reserve for future losses => big bath