Class Notes (807,463)
Canada (492,743)
Rotman Commerce (1,030)
RSM219H1 (86)

chapter 15

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University of Toronto St. George
Rotman Commerce
Alexander Edwards

Sustainable Income  Financial information is provided by general purpose financial statements, which are used to access the financial position and performance—cost, current, and future—of a company.  Investors, lenders, and other creditors often use profit reported on the income statement to help estimate future cash flows and, in particular, the timing and certainty.  Profit adjusted to it in regular Adams is known as sustainable income—the level of profit that is most likely to be of taint into which.  Sustainable income differs from actual profit by the amount of investment revenues, expenses, games, and losses that are included in profit.  To help determine sustainable income, even if irregular items are reported separately on the financial statement.  Two common types of irregular items: discontinued operation and changes in accounting policy. Discontinued Operations:  Discontinued operation refers to the disposal, work and availability for sale, of a component of an entity.  A component of an entity, for the purpose of discontinued operation, the presents a separate major line of business or major to geographical area of operations that has been disposed of or is held for sale. Statement of financial position:  Assets and liabilities of a discontinued operation that are held for sale are reported separately on the statement of financial position.  They are valued and reported at the lower of their carrying amount and fair value (less any anticipated costs of selling) as current or non-current assets or liabilities. * see illustration 14 – 1 in page 761* Income statements:  Discontinued operations are segregated from continuing operations and are reported separately on the income statement, because companies want readers of the financial statements to understand that discontinued operations are not likely to recur, they are shown near the bottom of the income statement immediately following the profit or loss from continuing operations.  Discontinued operations on the income statement can consist of two parts: 1. Profit or loss from the discontinued operations, net of any income tax expense or savings. 2. The gain or loss on the disposal of the components, and net of any income tax expense of saving.  If the component of an entity has not yet been disposed of and is being held for sale, only the first part will be reported on the income statement until the actual disposal of occurs * see illustration 14 – 2 in page 762* Change in accounting policy  Change in accounting policy: occurs when the accounting policy used in the current year is different from the one used in the preceding year.  When the principle used in the current year is different from the one used in the preceding year  Voluntary: Permitted, when new principle results in more reliable and relevant presentation  Mandatory: Required by standard setters  Cumulative effect of change to prior years is reported as adjustment to opening retained earnings  In statement of changes in equity (IFRS)  In statement of retained earnings (ASPE)  New policy used to report results of current year  Prior period statements restated  Effects of change detailed in notes *see illustration 14-3 in page 763* 1. Basis of Financial Statement Analysis 1.1 Analysing financial statements involves evaluating three characteristics of a company: its liquidity, its profitability, and its solvency. 1.1.1 A short-term creditor, such as s bank, is primarily interested in the ability of the borrower to pay obligations when they come due. 1.1.2 A long-term creditor, such as a bondholder looks to measures of profitability and solvency that indicate the firm’s ability to survive over a long period of time. 1.1.3 Shareholders are interested in the profitability and solvency of the enterprise. They assess the likelihood of dividends and the growth potential of the shares. 1.2 Comparison of financial information can be made on a number of different bases. 1.2.1 Intracompany basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. 1.2.2 Intercompany basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. 1.2.3 Industry averages basis compares an item or financial relationship of a company with industry averages published by Dun & Bradstreet, Statistics Canada, etc. 2. Comparative Analysis There are three basic tools of analysis: 2.1 Horizontal (trend) analysis. 2.2 Vertical (common size) analysis. 2.3 Ratio analysis. 3. Horizontal Analysis 3.1 Horizontal analysis (trend analysis) is a technique for evaluating a series of financial statement data over a period of time. Its purpose is to determine the increase or decrease that has taken place, expressed as either an amount or a percentage. 3.2 Although a horizontal analysis is relatively straightforward, complications can occur. If an item has no value in the base year or preceding year and a value in the next year, no percentage change can be calculated. If a negative amount appears in the base or preceding year and a positive amount exists the following year, or vice versa, no percentage change can be calculated. ANY COMPANY INC. Assumed Net Sales (in thousands) 2012 2011 2010 2009 2008 $ 6,051.0 $ 3,657.6 $ 8,989.2 $ 4,764.0 $ 3,376.8 179.2% 108.3% 266.2% 141.1% 100% ANY COMPANY INC. Assumed Net Sales (in thousands) 2012 2011 2010 2009 2008 $ 6,051.0 $ 3,657.6 $ 8,989.2 $ 4,764.0 $ 3,376.8 65.4% (59.3)% 88.7% 41.1% n/a 4. Vertical Analysis 4.1 Vertical analysis (common size analysis) is a technique that expresses each item within a financial statement as a percentage of a base amount. The base amount for asset items is total assets. The base amount for liability and shareholders’ equity items is total liabilities and shareholders’ equity. The base amount for income statement items is net sales. Vertical analysis is seldom performed on the statement of retained earnings or the cash flow statement. 4.2 Vertical analysis shows the relative size of each item on the balance sheet and income statement. It can also show the change in the percentage for individual items from one period to the next. Another benefit of vertical analysis is that it enables one to compare companies of different sizes. ANY COMPANY INC. Condensed Statement of Financial Position December 31 (in thousands) 2012 2011 Assets Amount Percent Amount Percent Current Assets $ 2,139.9 20.3% $ 2,271.7 25.1% Property, Plant, 8,062.7 76.3% 6,413.3 70.9% and Equipment Other Assets 363.1 3.4% 359.9 4.0% Total Assets $ 10,565.7 100% $ 9,044.9 100% 5. Ratio Analysis 5.1 Ratio analysis expresses the relationships between selected items of financial statement data. The relationship is expressed in terms of a percentage, a rate, or a simple proportion. 5.1.1 A period figure (e.g., income statement or cash flow statement) should be compared to an average, rather than an end of period, figure from the balance sheet. 5.2 Ratios can be classified as follows: 5.2.1 Liquidity ratios measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. 5.2.2 Profitability ratios measure the income or operating success of an enterprise for a given period of time. 5.2.3 Solvency ratios measure the ability of the enterprise to survive over a long period of time. 5.3 Liquidity Ratios 5.3.1 The working capital measures short-term debt paying ability. It is the difference between current asst and current liabilities. Higher result is desired. 5.3.2 The current ratio is a widely used measure of a company’s liquidity and short- term debt paying ability. It is calculated by dividing current assets by current liabilities. It does not take into account the co
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