acct1511 2009s1week0607 Notes and Slides

Australian School of Business

School of Accounting

ACCT 1511

Accounting and Financial Management 1B

Session 1, 2009

Weeks 6 to 7

Introduction to Financial Statement Analysis

and

Accounting Policy Choice

Student Handout

Contents:

1.Learning Objectives

2.Tutorial Questions

3.Lecture Materials

4.Case Studies

Lecturer:

Leon Wong

Website: https://www.360docs.net/doc/c214774510.html,.au

Introduction and Learning Objectives

In this week’s lectures, we will learn to do financial statement analysis (“FSA”) to assess the performance and viability of a company. We will gain insights into the importance of accounting measurement issues and choice, when making decisions based on financial accounting.

We will appreciate that we are reliant on the information provided by the company, the quality of which is determined by accounting policy choice made by the management of the company.

At the end of these topic, you should be able to:

O1.Understand the purpose for which financial statement analysis is used and the framework within which it is conducted;

O2.Choose tools from the financial statement analysis toolbox;

O3.Calculate and interpret a variety of financial statement ratios including integrative ratio analysis;

O4.Link ratio analysis to pricing and valuation;

O5.Apply “Rules of Thumb” to interpret and understand a company’s financial statements, and look for “Red Flags” of potential concern;

O6.Appreciate the limitations of financial statement analysis;

O7.Appreciate the variety of areas in which accounting policy choice exist within the framework of Accounting Standards and Corporate Regulation; and

O8.Consider the effect of accounting policy choice and management incentives on the information disclosed in financial statements and the inferences from financial statement analysis

Required Readings for Financial Statement Analysis Trotman & Gibbins Chapter 15.1 – 15.5 (pp. 671-688) Trotman & Gibbins Appendix 1 (pp.756-783)

Spreadsheet template (download from My eLearning Vista)

Required Readings for Accounting Policy Choice ?Trotman & Gibbins Chapter 15.1 – 15.7 (pp. 616-637) ?Trotman & Gibbins Chapter 16

ACCOUNTING POLICY CHOICE WITH SPECIAL FOCUS ON THE LIMITATIONS OF FINANCIAL STATEMENT ANALYSIS WORKSHOP WEEK 7 (IN LECTURE)

JP MORGAN & CHASE (NYSE: JPM)

CITIGROUP INC (NYSE:C)

Wall Street: Greed is Good

https://www.360docs.net/doc/c214774510.html,/watch?v=5JZp215Bgyk

Market value of banks

https://www.360docs.net/doc/c214774510.html,/_nSTO-vZpSgc/SXoel6A1A-

I/AAAAAAAAFfM/KhBs_vgFVes/s1600-h/bank-circles.png

https://www.360docs.net/doc/c214774510.html,/q?s=jpm&

https://www.360docs.net/doc/c214774510.html,/jpmorganchase/index.cfm

https://www.360docs.net/doc/c214774510.html,/citigroup/fin/index.htm

Form 10-K

https://www.360docs.net/doc/c214774510.html,/Archives/edgar/data/19617/000095012309003840/y74757e10vk.ht m

https://www.360docs.net/doc/c214774510.html,/Archives/edgar/data/831001/000119312509041237/d10k.htm Opinions

https://www.360docs.net/doc/c214774510.html,/q/ao?s=jpm

https://www.360docs.net/doc/c214774510.html,/news.php?id=50332

https://www.360docs.net/doc/c214774510.html,/views/blogs/market-movers/2008/11/14/citis-achilles-heel-foreign-depositors

https://www.360docs.net/doc/c214774510.html,/apps/news?pid=20601087&sid=a6W90SKfZYZI&refer= home

Asset quality and asset values

https://www.360docs.net/doc/c214774510.html,/information/products/category/indices/abx.html

https://www.360docs.net/doc/c214774510.html,/downloads/ONE/512749581x0x264147/6118e99c-cf83-4e3e-b38a-ca14fd98bdbf/4Q08-Analyst-Presentation-FINAL.pdf

https://www.360docs.net/doc/c214774510.html,/blog/2009/01/16/51258/the-fine-print/

https://www.360docs.net/doc/c214774510.html,/apps/news?pid=20601087&sid=agfrKseJ94jc&refer=hom e

https://www.360docs.net/doc/c214774510.html,/news/story/citigroup-reports-1348-billion-

level/story.aspx?guid={C06333CB-C985-4B41-A7B2-1699184BBA4E}

Off-balance sheet risk

https://www.360docs.net/doc/c214774510.html,/article/80357-absurd-accounting-rules-and-5-trillion-off-bank-balance-sheets

https://www.360docs.net/doc/c214774510.html,/apps/news?pid=20601039&sid=akv_p6LBNIdw&refer=h ome

https://www.360docs.net/doc/c214774510.html,/apps/news?pid=20601103&sid=aFTh5VXP9m0U&refer =news

JPM 10-K p.69

The derivative exposure

https://www.360docs.net/doc/c214774510.html,/apps/news?pid=20601109&sid=a96UdT6uCOcA&refer= home

https://www.360docs.net/doc/c214774510.html,/statistics/derstats.htm

https://www.360docs.net/doc/c214774510.html,/ftp/release/2009-34a.pdf

https://www.360docs.net/doc/c214774510.html,/s/mcclatchy/20090309/pl_mcclatchy/3184724/print

Don’t worry be happy, it’s not your money anyway

https://www.360docs.net/doc/c214774510.html,/watch?v=PE9ZXh0Fuwk

Tutorial Questions for Week 7 (27 April 2009) FINANCIAL STATEMENT ANALYSIS

Preparation Questions:

Trotman & Gibbins Financial Statement Analysis Case Study

Use the spreadsheet template provided on myelearnings

Vista with information on Coles and Woolworths:

(a) Calculate the ratios for Coles Myer 2004.

(b) Analyse the ratios for

(i) trend analysis;

(ii) profitability ratios,

(iii) liquidity;

(iv) financial structure ratios;

(v) activity ratios;

(vi) dupont analysis;

discussing for each ratio, whether Coles Myer is

performing better than Woolworths.

(c) Provide a (i) stock recommendation for Coles; and

(ii) stock price target for Coles.

Homework Questions:

(1) Final exam, Semester 1, 2007, Question 2.

(2) Final exam, Semester 1, 2008, Question 3.

See following pages for exam questions.

Tutorial Questions for Week 8(4 May 2009) ACCOUNTING POLICY CHOICE

Preparation Questions

Trotman & Gibbins ?Problem 16.1

?Problem 16.2

?Problem 16.8

?Case 16D

Homework Questions

(1) Final exam, Semester 1, 2007, Question 3.

(2) Final exam, Semester 1, 2008, Question 4.

See following pages for exam questions.

FINAL EXAM, SEMESTER 1, 2007

QUESTION 2 (15 MARKS): FINANCIAL STATEMENT ANALYSIS

You have recently graduated from UNSW with a BCom degree (with a double major in Accounting and Finance) and have been hired by McDonald Bank, one of the most prestigious investment banks in Asia-Pacific region, to work as an equity investment analyst. Your first project is to help with the process of reviewing and analysing the financial results of Coles Ltd for the financial year ended on 30 July 2006.

You have been provided with the company’s concise financial statements (see pages 5 and 6) and nearly-completed worksheet on its key financial information (see page 7). You have also been provided with the relevant corresponding financial information about the company’s major competitor, Woolworths Ltd.

Note: Use the following formulae for ratio calculations if required.

Key Ratio Formulae:

Return on Equity (ROE) = Net Profit After Tax / Shareholders’ Equity

Return on Assets (ROA) = Earnings before Interest & Tax (EBIT) / Total Assets Profit Margin = Net Profit After Tax / Sales Revenue

Gross Margin = Gross Profit / Sales Revenue

Asset Turnover = Sales Revenue / Total Assets

Inventory Turnover = COGS / Average Inventory

Days Inventory on Hand = 365 / Inventory Turnover

Debtors (receivables) Turnover = Credit Sales / Average Trade Debtors

Days in Debtors = 365 / Debtors turnover

Creditors Turnover = Purchases (or COGS) / Average Accounts Payable

Days in Creditors = 365 / Creditors Turnover

Cash Flow Cycle = Days in Inventory + Days in Receivables – Days in Creditors Current Ratio = Current Assets / Current Liabilities

Quick Ratio = (Current Assets – Inventories) / Current Liabilities

Interest Coverage = EBIT / Interest Expense (net)

Debt to Equity Ratio = Total Liabilities / Total Equity

Debt to Assets = Total Liabilities / Total Assets

Leverage = Total Assets / Shareholders’ Equity

QUESTION 2 CONTINUES ON PAGE 7

QUESTION 2 CONTINUED:

Required:

(a)Using the information from Coles’ 2006 concise financial statements, calculate

the missing 2006 figures in the worksheet below on key financial information.

State your answers in the boxes provided. Note that ratio formulae are

provided on page 4 (6 marks).

Coles Woolworths

200620052006 2005

Income Statement

Revenue from sale of goods 34,212.033,018.0 37,849.7 31,481.2

1,302.1 EBIT 1,027.2

1,722.2

Profit from continuing operations 536.4686.1 1,014.6 817.2

Profit for the year 1,163.6637.9 816.2

[see Note 2 of Income Statement]

Balance Sheet

Total Current Assets 3,881.34,259.6 3,064.5

Total Assets 9,135.39,223.8 13,346.4 8,775.2

Total Current Liabilities 3,962.83,962.9 3,780.7

Total Equity 3,598.03,415.0 4,027.8 2,002.2

Basic EPS (cents) 63.251.890.89 79.19

As at the financial year-end date

Closing share price $14.61$10.20$19.93 $16.67

Price Earnings (PE) Ratio 23.1219.6921.93 21.05

Trend analysis

12.70%

Sales growth 2.33%20.23%

Profit growth (from continuing

operations) 11.29%24.16%

11.78%

Liquidity Ratios

Current Ratio 1.070.81

Financial Structure Ratios

Leverage 2.70 3.31

4.38

8.67

Interest Coverage 18.61 6.90

(b)Comment on the “Sales growth” of Coles Ltd from 2005 to 2006 compared to the

sales growth of Woolworths Ltd over the same period (1 mark).

DO NOT WRITE BEYOND THIS LINE

(c)Comment on the “Profit growth (from continuing operations)” with reference to

the changes in the “Profit for the year” from 2005 to 2006 for Coles Ltd (2 marks).

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(d)What do you think of the decision by the Coles’ management to report $1,163.6m

as the “Profit for the year” in the Income Statement? Explain your answer by referring to the footnote 2 of the Income Statement on page 5 (2 marks).

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(e) With references to a rule of thumb, discuss the change in the Current Ratios of

Coles Ltd over the last 2 years, and whether it gives rise to any cause for concern

(2 marks).

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(f)The management wishes to make a presentation to analysts in order to inform

them of the company’s 2006 financial results. In the presentation, the management is expected to provide guidance that Coles Ltd’s Basic EPS would be

90 cents for the year 2007. Assuming that the PE Ratio stays constant as at the

financial year-end of 2006, what do you expect the share price to be at the end of the year 2007? (2 marks).

FINAL EXAM, SEMESTER 1, 2007

QUESTION 3 (20 MARKS): ACCOUNTING POLICY CHOICE,

CORPORATE GOVERNANCE AND PROFESSIONAL ETHICS

Part A (10 marks):

ET FoneHome Ltd (“ETF” or “The Company”) is a mobile phone company listed on

the Australian Stock Exchange (ASX). The Company is considering issuing new

shares to finance the acquisition of mobile telephone spectrum licenses. The

management prepared the following Income Statement for the period ending 31st

December 2007, to be submitted to the Board of Directors for its approval:

ET FoneHome Ltd

Income Statement

For the period ending 31st December 2007

$m $m

2007 2006

Sales revenue 678.2 330.9

(908.6) Expenses

305.7

Earnings Before Interest, Tax, Depreciation & Amortisation (EBITDA) (230.4) 25.2

Depreciation & amortisation (35.3) (12.3)

Net interest (expense)/ revenue 3.3 (1.6)

Net profit/ (loss) before income tax (262.4) 11.3

Income tax expense (30%) (3.4)

Net profit/ (loss) after income tax (262.4) 7.9

After reviewing the draft 2007 Income Statement, the Chief Executive Officer (CEO)

is concerned that, by reporting a loss for 2007, it may cause the Company’s share

price to drop and make it difficult to raise further funds from a share issue. The CEO

therefore asks the Chief Financial Officer (CFO) for suggestions regarding the

figures. The CFO suggests that the $450 million spent on marketing costs on 1st

January 2007 and currently treated as an expense, should be capitalised and amortised

over 3 years instead.

Required:

(a)Re-calculate and prepare a new 2007 Income Statement to reflect the proposed

change in the accounting policy for marketing costs. Use 1-decimal point in every step of the calculations as well as for the answer (4 marks).

New Old

20072007 2006 Sales revenue 678.2 330.9 Expenses (908.6) 305.7 EBITDA (230.4) 25.2 Depreciation & amortisation (35.3) (12.3) Net interest (expense)/ revenue 3.3 (1.6) Net profit/ (loss) before income tax(262.4) 11.3 Income tax expense (30%) (3.4) Net profit/ (loss) after income tax (262.4) 7.9

(b)According to the AASB Framework, what is the appropriate treatment for

marketing costs in 2007? Apply the relevant definition and recognition criteria in your answer (3 marks).

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(c)Discuss the cash flow implications (directional and size effects, if any) of the

proposed accounting policy change for 2007 and 2008 (3 marks).

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FINAL EXAM SEMESTER 1, 2008

QUESTION 3 (12 MARKS): FINANCIAL STATEMENT ANALYSIS

The following data and chart relate to two companies: Citygroup Inc (C) and JP Morgan Chase & Co (JPM). The third chart shows a stock price performance comparison between the two companies.

QUESTION 3 (CONT.): FINANCIAL STATEMENT ANALYSIS

Summary data:

US$ Citigroup (C)JP Morgan (JPM) Fiscal Year Ends 31 Dec 200731 Dec 2007 Price as at 17 April 2008 24.0345.12 Market Cap 125.11B153.25B Trailing P/E 33.5110.3 Forward P/E (fye 31-Dec-09) 7.3510.62 PEG Ratio (5 yr expected) 2.07 1.77 Price/Sales 1.9 2.37 Price/Book 1.03 1.23 Profit Margin 5.63%23.82% Return on Assets 0.18% 1.06% Return on Equity 3.10%12.86% Income Statement

Revenue: 159.23B116.35B Net Income Available to shareholders: 3.58B15.37B Diluted EPS: 0.72 4.38 Balance Sheet

Total Asset 2,187.63B1,562.15B Total Liability 2,074.03B1,438.93B Shareholders Equity 113.6B123.22B Cash Flow Statement

Operating Cash Flow -71.43B-110.56B Investing Cash Flow -62.38B-73.12B Financing Cash Flow 144.49B182.99B QUESTION 3 (CONT.): FINANCIAL STATEMENT ANALYSIS

You are an equity investment analyst reviewing the information provided in the charts and the summary data provided in the previous pages.

Required:

(a) Choose one of the above two companies, Citigroup (C) or JP Morgan (JPM). What would be your stock recommendation with respect to your choice relative to the other, and what would be your price target? (2 marks)

Stock recommendation:

Price target:

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(b) Using financial statement analysis, valuation analysis and a visual inspection of the price charts, give FIVE (5) reasons in support of the above stock recommendation. You may calculate other ratios to support your recommendation. (2 marks for each reason):

1.

2.

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QUESTION 3 (CONT.): FINANCIAL STATEMENT ANALYSIS 3.

4.

5.

DO NOT WRITE OUTSIDE THE BOX PROVIDED