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Lecture 4

BUS 202 Lecture 4: Out+04+202+2017+Completed

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Department
Business
Course
BUS 202
Professor
Joseph D' Adamo
Semester
Spring

Description
University of Rhode Island BUS 202 Managerial Accounting 2016 -2017 Joseph M. D’Adamo Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 1 of 36 I. Description and Purpose of Financial Statement Analysis A. Description o Financial Statement Analysis involves Comparisons among Financial Statement Data that are Plausibly-Related o Typical Comparisons: ▪ Current Period Data vs. Prior-Period Data for the firm ▪ Current Period Data vs. Current Period Data for the firm ▪ Current Period Data of the firm vs. Current Period Data of Major Competitor and/or its Industry o Common Components of Financial Statement Analysis: ▪ Overview Analyses ▪ Profitability, Performance and Shareholder Returns Analyses ▪ Liquidity and Liquid Asset Management Analyses ▪ Solvency, Financial Flexibility and Financial Leverage Analyses B. Purposes 1. Increase management’s understanding of the firm’s past and present as a basis for effective decision-making about its future 2. Help investors and creditors monitor their interests in the firm and improve their abilities to make better predictions about their future returns and related-risks 3. Provide information to the external auditor to identify and assess the risks that the firm’s GAAP financial statements may be materially-misstated Analytics or Analytical Procedures Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 2 of 36 II. Financial Statement Analysis: Initial Steps A. Read the Statements and Related-Information 1. GAAP Financial Statement Components a. Comprehensive Income Statement Part 1: Net Earnings (Loss) and its Components • Measures and reports the results of operations for a period of time in terms of earnings (profits) using accrual basis • Reports earnings in total and on a per share of common basis • IS data used primarily to perform: o Profitability and Performance Analyses o Analysis of Shareholder Returns o Liquid Asset Management Analysis Part2: Other Comprehensive Income (Loss) And its Components • Changes in the values of assets and liabilities not recognized in net earnings o Certain Pension Adjustments o Unrealized Gains (Losses) on Available-for-Sale Securities o Foreign Currency Translation Adjustments o Effective Portion of Cash Flow Hedges • Comprehensive Earnings (Loss) o Measures and reports changes in equity from non-owner transactions during a period of time o EXCLUDES Investments by owners and Distributions to owners • Computation ± Net Earnings (Loss) ± Other Comprehensive Earnings (Loss) = Comprehensive Earnings (Loss) Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 3 of 36 b. Statement of Equity  Reports changes in equity from all transactions during a period of time • Calculation of Retained Earnings balance Beginning R/E ± Net Earnings (Loss) − Dividends = Ending R/E • Calculation of Accumulated Other Comprehensive Income balance Beginning AOCI ± Other Comprehensive Earnings (Loss) = Ending AOCI c. Balance Sheet  Statement of Financial Position • Measures and reports the financial position (A =L + E) as of a specific point in time • B/S data used primarily to perform: o Performance Analysis o Liquidity and Liquid Asset Management Analyses o Solvency, Financial Flexibility and Financial Leverage Analyses d. Statement of Cash Flows • Provides basis for assessing the sources and uses of cash resources to predict the amounts, timing and risks of the firm’s future cash flows and their effects on the future cash flows to investors and creditors e. Explanatory Footnotes  Integral part of the other statements Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 4 of 36 2. Management’s Reports and Analysis  Annual Report to SEC (Form 10-K) a. GAAP Financial Statements prepared by management b. Management Discussion and Analysis (MD&A) • Management analyzes and reviews the company’s past performance, cash flows, and financial position • Discusses risk factors that may affect the company’s future performance, cash flows, and financial position c. Management Report on Internal Control over Financial Reporting (ICFR) • ICFR = Policies and procedures that provide reasonable assurance of the accuracy of financial statements • Report indicates whether or not management believes it maintains an effective system of “checks and balances” to increase the reliability of its financial reports (GAAP F/S) o Affects the level of the confidence that investors, creditors, analysts, and the financial markets have in management’s competence and integrity relative to financial reporting Effective ICFR  increases confidence Ineffective ICFR  decreases confidence Item 8. Financial Statements and Supplementary Data. MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING Management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)). Mattel’s management, including Bryan G. Stockton, its principal executive officer, and Kevin M. Farr, its principal financial officer, evaluated the effectiveness of Mattel’s internal control over financial reporting using the framework in Internal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that Mattel’s internal control over financial reporting was effective as of December 31, 2015. The effectiveness of the Company’s internal control over financial reporting as of December 31, 2015 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein. Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 5 of 36 3. External Auditor’s Reports a. Auditors provide an attest function b. Auditor’s Report on the Company’s Financial Statements • Opinion on the accuracy of the F/S • States whether or not the F/S comply with GAAP in all material respects • NOT a report on the Company’s performance, its creditworthiness, its investment potential, its fair value, etc. • Unmodified Opinion = Best opinion possible = No exceptions • Qualified Opinion = Exception c. Auditor’s Report on Internal Control over Financial Reporting • Opinion on the effectiveness of ICFR • Supports or refutes management’s assessment of ICFR • Adds to credibility of management’s report and its systems Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 6 of 36 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Mattel, Inc. In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of Mattel, Inc. and its subsidiaries at December 31, 2015 and December 31, 2014, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 8. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company’s internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions. A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Los Angeles, California February 25, 2016 Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 7 of 36 B. Earnings Management/Income Smoothing (NOT ALLOWED BUT) Attempts to smooth earnings through improper timing of recordings and/or through the use of unrealistic accounting methods and estimates 1. Taking a “big bath” ▪ If you are going to report a loss, make it as big as possible. ▪ Overly-conservative estimates of potential losses and asset write-off’s 2. Creating and using “cookie jar” reserves ▪ Overly-conservative estimates of potential losses and asset write-off’s to reduce higher-than-expected earnings ▪ Reverse overly-conservative estimates to increase lower-than-expected earnings 3. “Cooking the books” ▪ Fraudulent Financial Reporting ▪ Punishable as a criminal offense and subject to civil action Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 8 of 36 C. Perform Overview Analyses of the Income Statement and Balance Sheet 1. Horizontal Analysis = Trend Analysis a. Change in Current Amounts from Base Period b. Change in Current Amounts from Prior Period (Current Year – Prior Year) = Amount of Change Amount of Change ÷ Prior Year = Percent Change 2. Vertical Analysis = Common-Size Financial Statements a. Compute each line of Income Statement as a % of Net Sales b. Compute each line of Balance Sheet as a % of Total Assets 3. Interpreting Results = Looking for unexpected or unusual results Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 9 of 36 III. Profitability, Performance and Shareholder Returns Analyses A. Profitability Analysis 1. Objectives a. Increase understanding of business operations b. Evaluate management’s operating performance c. Assess ability to effectively use resources d. Assess ability to generate cash flows that affects: 1) Likelihood of future financing needs 2) Ability to meet obligations and pay dividends 2. Earnings (Profits) • Accrual-accounting measurement of Accomplishments vs. Efforts • Used to report results of operations in the Income Statement • Difference between Revenues Earned and Expenses Incurred • Additional Net Assets produced by operations during the period that are either retained in the business or converted to cash and distributed to shareholders as dividends Revenue: Selling Price of Goods/Services Provided to Customers Expenses: Cost of Assets and Services Used or Consumed Revenues must be sufficient to recover costs incurred including investments in long-term assets AND provide a sufficient profit to justify risks taken Profits: Value-Added Premium included in Selling Prices Profits measure the additional value placed on the goods/services of a company by its customers. Profits compensate a company for its expertise, convenience, satisfaction and enjoyment, quality, perception of value, added services, and risks taken to provide goods and services. Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 10 of 36 Consider Mattel’s profitability in 2015 as compared to 2014: Increase (Decrease) 2015 2014 Amount Percent Net Earnings $369,416 $498,874 ($129,458) -26.0% Supporting Calculation: Current Year – Previous Year = Change Amount ÷ Previous Year = % Change $369,416 − $498,874 = ($129,458) ÷ $498,874 = -26.0% Interpretations/Conclusions: Yes X 1) Was Mattel profitable in fiscal year 2015? No X SUPPORT: Positive Net Earnings More X 2) Was Mattel more profitable or less profitable in fiscal year 2015 as compared to fiscal year 2014? Less X SUPPORT: Less Profitable b/c Net Earnings  4. Profitability Relationships Sales Volume Efficiency X Margins = Profitability Amount of Net Sales from % of Profit in $ of Net Sales $ Amount of Profit Earned meeting Demand Created Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 11 of 36 a. Sales Volume Efficiency • Significant factor in generating profits • Function of overall market demand, competition, firm’s pricing strategies • Ability to maximize sales volume generated from assets employed produces superior returns from profits b. Margins = % of Profit in each Dollar of Sales 1) Margins are produced by: • Markups included in Selling Prices • Controlling Costs 2) Price Sensitive Products = Price Elastic • Small changes in prices  Large increases (decreases) in demand (volume) 3) Margins Resulting from Markups in Selling Prices (SP) ASSUMES DEMAND PRICE ELASITIC %  Demand > %  SP Margins Volume Profitability Larger Markups  Margins and  SP  SP tend to  Demand  Profitability Smaller Markups  Margins and  SP  SP tend to  Demand  Profitability %  Demand > %  SP LEGEND:  = INCREASE  = DECREASE This analysis assumes that the changes in selling prices are NOT accompanied by any changes in the value placed by customers on the related goods or services. A company will be able to increase its selling prices and its margins WITHOUT reducing demand and therefore increase profits under certain conditions such as: • Changes in the marketplace resulting in decreased competition • Increases in the perceived value of its goods or services by its customers  Higher Margins do not necessarily result in Higher Overall Profits Higher margins due to larger profit %’s added into selling prices may reduce demand/volume and thereby reduce total profits  Lower Margins do not necessarily result in Lower Overall Profits Lower margins due to lower profit %’s added into selling prices may increase demand/volume and thereby increase total profits Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 12 of 36 4) Margins from Controlling Costs a) Higher Costs  Constrain management b) Effects of Lower Costs  Provide competitive advantage Margins Volume Profitability Lower Costs Not  Margins and NO  SP NO  SP  NO  Demand  Profitability Passed on to Customers Lower Costs  SP and NO  Margins  SP tend to  Demand  Profitability Passed on to Customers LEGEND: NO  = NO CHANGE This analysis assumes that the lower costs are achieved WITHOUT reducing the quality of the product and level of customer service and product support provided. Conclusions: Higher margins due to lower costs incurred should result in higher overall profits as long as reduced costs do not affect the quality of products and related-services expected by customers. B. Performance: Margin Measurements %’s of Net Sales FORMULA 1. Gross Margin Gross Margin = Gross Profit ÷ Net Sales (Gross Profit Percentage or Ratio) • Measures the average percentage of each sales dollar that is profit after considering ONLY the cost of the products; it is a measurement of the markup in each dollar of sales 2. Operating Margin Operating Margin = Operating Profit ÷ Net Sales (Operating Profit Percentage or Ratio) • Measures the average percentage of each sales dollar that is operating profit • The difference between the gross margin and the operating margin is the average percentage of each sales dollar eaten up by the operating expenses Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 13 of 36 3. Net Margin Net Margin = Net Earnings ÷ Net Sales (Net Profit Percentage or Return on Net Sales) • Measures the average percentage of each sales dollar that is overall profit • Affected by ability to differentiate products and charge more AND/OR ability to manage costs as a percentage of revenue  Ability to convert sales into overall profits Consider the effects of Mattel’s sales volume and margins on its profitability in 2015 as compared to 2014: Increase (Decrease) 2015 2014 Amount Percent Net Sales Revenues Volume $5,702,613 $6,023,819 ($321,206) -5.3% Gross Margin % Markup 49.21% 49.82% -0.61% -1.2% Operating Margin % Core Business Profit 9.49% 10.85% -1.36% -12.5% Net Margin % % Overall Profit from NS 6.48% 8.28% -1.80% -21.7% Interpretations/Conclusions: 1) Did the change in Mattel’s sales volume in fiscal year 2015 as compared to fiscal yearive X 2014 have a positive or negative effect on its profitability? Negative X SUPPORT: Sales Volume  Higher X 2) Did Mattel sell its products at prices with an average percentage markup that was higher or lower in fiscal year 2015 as compared to fiscal year 2014? Lower X SUPPORT: Gross Margin  3) Was Mattel more or less efficient in managing its primary, core business operationsre X in fiscal year 2015 as compared to fiscal year 2014 in terms of the percentage profit generated from net sales? Less X SUPPORT: Operating Margin  Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 14 of 36 4) Was Mattel more or less efficient in managing its business in fiscal year 2015 as More X compared to fiscal year 2014 in terms of the percentage of overall profit generated from net sales? Less X SUPPORT: Net Margin  C. Performance: Efficiency Measurements FORMULA 1. Fixed Asset Turnover Fixed Asset Turnover= Net Sales ÷ Average Fixed Assets • Measures the average number of times the plant assets were converted into sales during the period • Ability to turn plant assets into sales = relative efficiency in using fixed assets to create sales • G.R.  Higher turnover preferred (Current + Prior) ÷ 2 = Ave. B/S Value Turnovers  # of times (x) = frequency 2. Total Asset Turnover Total Asset Turnover = Net Sales ÷ Average Total Assets • Measures the average number of times the assets were converted into sales during the period • Ability to turn all of its assets into sales = relative efficiency in using all assets to create sales • G.R.  Higher turnover preferred 3. Return on Assets (ROA) Return on Assets = Net Earnings ÷ Average Total Assets • Measures the efficiency in using assets to generate profits • % earnings on average investments in assets during the period • Returns are always presented as %’s • G.R.  Higher return preferred Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 15 of 36 4. DuPont Method of Analysis of Return on Assets (ROA) Sales Volume Efficiency X Margins = Profitability Total Asset Turnover X Net Margin = Return on Assets Net Sales Net Earnings Average Total Assets X Net Sales = Return on Assets Efficiency in using assets to Efficiency in generating profits generate sales from sales Consider the effects of Mattel’s performance in terms of its efficiency in using its assets to generate sales and profits in 2015 as compared to 2014: Increase (Decrease) 2015 2014 Amount Percent Fixed Asset Turnover 7.71x 8.62x (0.91)x -10.6% Total Asset Turnover 0.86x 0.92x (0.06)x -6.5% Return on Assets 5.57% 7.58% -2.01% -26.5% Total Asset Net Profit Return on Turnover Margin Assets Return on Assets FY 2015 0.86 6.48% 5.57% Return on Assets FY 2014 0.92 8.28% 7.62% ▪ Mattel generated fewer sales from assets in 2015 vs. 2014 ▪ Mattel produced a lower % profit from its sales in 2015 vs. 2014 ▪ The higher net margin offset the lower total asset turnover resulting in increase in ROA Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 16 of 36 Interpretations/Conclusions: 1) Did Mattel use its plant assets more of less efficiently to produce sales in fiscal yearX 2015 as compared to fiscal year 2014? Less X SUPPORT: Fixed Asset Turnover  2) Did Mattel use its total assets more of less efficiently to produce sales in fiscal yearX 2015 as compared to fiscal year 2014? Less X SUPPORT: Total Asset Turnover  More X 3) Did Mattel use its total assets more of less efficiently to produce profits in fiscal year 2015 as compared to fiscal year 2014? Less X SUPPORT: Return on Assets  Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 17 of 36 D. Analysis of Shareholder Returns A company provides returns to its shareholders by: • Increasing the value of the company’s stock • Distributing profits to shareholders as dividends 1. Objectives of Analysis a. Evaluate management’s performance  change in shareholder wealth b. Assess ability to effectively use invested capital c. Assess dividend potential d. Develop measurements used in stock valuation models e. Assess market confidence in ability to produce future returns 2. Earnings per Share EPS = (Net Earnings– Preferred Dividends*) Weighted-Average Common Shares Outstanding * Preferred dividends only if preferred stock issued Basic EPS = Likely Diluted EPS = Pessimistic • Presents net profits on a per common share basis in the income statement • Measurement of the dividend potential of the company’s common stock • Represents the estimated amount profit earned on behalf of each share of common stock during the period • Only financial ratio required to be presented in the GAAP financial statements  Analysts do not calculate 3. Cash Dividends per Share (DPS) • Cash distributions of profits to common shareholders for each share owned ▪ Reported at the bottom of the income statement, in the statement of equity, OR in the financial summaries  Analysts do not calculate Course Outline #4: Financial Statement Analysis and Performance Evaluation Page 18 of 36 4. Dividend Payout Ratio Payout Ratio = Dividends per share ÷ Basic EPS • Measures % of current profits distributed to common shareholders as cash dividends • 1- Payout Ratio = Earnings Retention Ratio 5. Dividend Yield Dividend Yield = Dividends per share ÷ MP per share • Measures % of return dividend provides on current market price of stock • Current Dividend Yield = uses most recent dividend • Leading Dividend Yield = uses expected dividend 6. Market Price per Share = Fair Value per Share • Selling price of each share of stock on a stock exchange = the value of each share of stock • Firm attempts to positively influence price  cannot control • It is NOT reported in the financial statements • May be found in the financial summaries; usually can be obtained from company web site or stock listing such as Yahoo Finance or the WSJ 7. Pric
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