An investigation of corporate financial statements from an investment standpoint

63 Pages·03.12 MB·English

by  Clark, J. C.

AH INVESTIGATION OF CORPORATE FINANCIAL
STATEMENTS FROM AN INVESTMENT STANDPOINT
A T hesis
P resented to
th e F aculty of th e School of Commerce
and B usiness A dm inistration
•Hie U n iv ersity o f Southern C a lifo rn ia
In P a rtia l F u lfillm en t
of th e R equirem ents fo r th e Degree
M aster of B usiness A dm inistration
hy
J* Cass in Claris:
February 1942
UMI Number: EP43159
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This thesis, written by
............................J.fc..£ASjSIH..CLASK.....................................
I
under the direction of h.Ajsi Faculty Committee,
($•1 c
and approved by all its members, has been
presented to and accepted by the Council on
Graduate Study and Research in partial fulfill­
ment of the requirements for the degree of
MASTER OF BUSINESS ADMINISTRATION
Dean
Secretary
Faculty Committee
Chairman
TABLE OF CONTENTS
CHAPTER PAGE
I . INTRODUCTION AND STATEMENT OF PURPOSE . . . . 1
Purpose of th e in q u iry . . . . . . . . . . 2
Statem ent of th e purpose .................................... 2
C o n tro llin g f a c t o r s . . . . . 2
Method o f procedure and o rg an izatio n . . . 6
The procedure . . . . . . . . . . . . . . 6
The o rg an izatio n . . ..................... . . . . . 7
Review o f lite ra tu re . . . . . . . . . . 7
I I . THE INCOME STATEMENT.......................... 10
S ales . . . . . . . . . . . . . . ..................... 10
Cost o f sa le s and e x p e n s e s ..................................... 11
D epreciation ............................................... . . . . . 15
O ther deductions . . . . . . . . . . . . . 18
Summary . . . . . . . . . ..................................... . 21
H I . SURPLUS ADJUSTMENTS .......................... 22
IV. THE BALANCE SHEET.................................................................... 26
Cash . . . . . . . . . . . . . . . . . . . 26
i
M arketable s e c u ritie s . . . . . . . . . . . 27
R eeeivables . . . . . . . . . . . _29
In v en to ries . . . . . . . . . . . ..................... 30
P ro p erty account ........................................ 33
C urrent lia b ilitie s and debts. . . . . . . 36
Sum m ary................................... 37
i i i
CHAPTER PAGE
Y. CONCLUSION . . .............................. 39
A d d itio n al in q u irie s .................... 45
BIBLIOGRAPHY . . . . . .......................... . . . . . . . . . . . 46
APPENDIX 49
LIST OF TABLES
TABLE PAGE
I . Tobacco Com panies* S ales of C ig are tte s and Net
E arnings p er Share fo r P ast Ten Y ears . . . . 49
I I . S elected Item s from C hrysler C orporation*s
F in an cial Statem ents fo r Y ears 1929 and 1940. 50
I I I . W estern Union Company*s E arning Statem ent
Showing D epreciation Reported to Stockholders
and G overnm ent...................... . . . . ; ......................... 51
IT . P ennsylvania-D ixie Cement Company’s E arnings
Statem ent Showing D epreciation B eported to
S tockholders and Government . . . . . . . . 52
Y. Sw ift & Company’s Treatm ent of **Reserve fo r
Inventory P rice D ecline" . . . . ........................... 55
VI. In te rn a tio n a l H arvester Company’s Income
Statem ent In d ic a tin g Number of Reserve
E n trie s . . . . . . . . . . . . . . . . . . . 54
V II. Comparison of S urplus A djustm ents of Union
C arbide & Carbon Company and A llied
Chemical & Dye Company ......................... 55
V III. A llied Chemical & Dye Company’s Treatm ent of
M arketable S e c u ritie s . . . . . . . . . . . . 56
2X. O il Companies’ Fixed A ssets and Underground
R eserves ........................................................... . . . . . . 57
CHAPTER I
mTRomrcTicN and statement of purpose
I t can be f a ir ly said th a t by fa r th e m ajo rity of
in v esto rs today have a t b est only a bare knowledge of
fin a n c ia l rudim ents and investm ent p rin c ip le s. To some
degree th is can be traced to th e fa c t th a t over th e p a st h a lf
century ow nership o f e n te rp rise s has passed from th e sm all
community of in te re s ts to a w idespread d iv e rs ific a tio n o f
p a rt ow ners. T ogether w ith th is tre n d has gone th e r e lin ­
quishm ent o f the in v e s to r's p erso n al acquaintanceship w ith
a ll th e e n te rp ris e 's problem s, re s u ltin g in the in s titu tio n
of absentee management.
To th e layman of th is p ast e ra , a su b sta n tia l knowl­
edge of th e in tric a c ie s of investm ent was not n e c e ssa rily
p re re q u isite to h is su ccess. Knowing f i r s t hand most of th e
fa c to rs th a t created w ealth and p ro fits , he needed only to
apply common sense in order to achieve a good re s u lt.
At the p resen t tim e, however, th e layman is perhaps
one part-ow ner out of a to ta l o f h a lf a m illio n ; in a ll
p ro b a b ility he has never seen th e in sid e of th e p la n t nor
in q u ired from whom m a te ria ls are purchased or to whom prod­
u c ts are so ld ; in sh o rt, he is now dependent upon some
stra n g e r to advise him of the a ff a irs of h is company.
Xt is p ra c tic a lly a tru ism th a t th e more minds a se t
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of fa c ts must pass through from its in cep tio n to th e fin a l
re s u lt, th e more apt i t is to be d is to rte d . Much the same
process tak es p lace betw een the a c tu a l re s u lts of th e oper­
a tio n s of a company and the fin a l conception o f the re s u lts
in th e mind of th e investor* The fa c ts have passed through -
th e minds of th e management and acco u n tan ts, and may even
have been m odified through in te rfe re n c e from Governm ental
agencies, before th ey reach the in v e sto r.
I . PURPOSE OF THE INQUIRY
Statem ent of th e purpose. The o b ject of th is in q u iry
was to consider and c ritic iz e a few of the p e rtin e n t con­
fu sin g and m isleading statem en ts, as w ell as some of the
short-com ings o f corporate re p o rts presen ted to stockholders
as th e ir prim ary source of fin a n c ia l in fo rm atio n . A lso,
th e re was the d e sire to p resen t a c tu a l exam ples in a su f­
fic ie n tly v iv id manner to in sp ire the stu d en t o f investm ent
problem s and th e in v esto r to analyze c a re fu lly and v e rify
a l l th e statem ents of supposed fa c t th a t come to th e ir
a tte n tio n .
C o n tro llin g fa c to rs . Inasmuch as accounting d eals
w ith th e c o lle c tio n , a sso rtin g , and reco rd in g o f fig u res
p e rta in in g e ith e r to th e o p eratio n s or s ta tic condition of
an e n te rp rise , th o se who read fin a n c ia l re p o rts are very
s
lik e ly to attach .-to them th e same degree o f f in a lity and
p re c isio n th a t th ey would a tta c h to m athem atics. For p u r­
poses o f v e rific a tio n as to accuracy o f a d d itio n and sub­
tra c tio n , th is assum ption is p e rfe c tly c o rre c t; fo r purposes
of proper in te rp re ta tio n of th e fig u re s, or of a sc e rta in ­
ing, fo r exam ple, w hether a c e rta in item should be c a p ita l­
ized fo r fu tu re am o rtizatio n or charged as a cu rren t ex­
pense, th e assum ption th a t re p o rts are acceptable re g a rd le ss
of the m eaning behind them sim ply because they are a rith m e t­
ic a lly c o rre c t, can lead one fa r a fie ld from th e r e a litie s
of a s itu a tio n . A ccounting in one sense is an exact science,
su b ject to m athem atical p re c isio n , but in another sense i t
is a re la tiv e scien ce, c o n sistin g la rg e ly o f statem ents o f
opinion which are su b ject to in te rp re ta tio n s and in d iv id u a l
judgm ents *
In a p p reciatin g th e d if f ic u ltie s under which fin an ­
c ia l statem ents are prepared, i t must be kept in mind th a t
accountants are the em ployees of th e management of corpora­
tio n s , and in both broad and sp e c ific ways are su b ject to
th e ir d e sire s. In p rep arin g th e ir re p o rts, accountants may
be forced to compromise between th e d e sire s o f th e manage­
ment and th e ir own self-im posed stan d ard s, so th a t w hile a
statem ent may not be in s tr ic t accordance w ith th e ir stan d ­
ard of p ra c tic e , i t may, n e v e rth e le ss, rep resen t th e b est
p o ssib le method of se ttin g fo rth a l l th e d ata, when th e
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re s tric tio n s surrounding th e case are considered.
As an illu s tr a tio n , many larg e co rp o ratio n s had un­
broken earning and dividend records fo r tw o, th re e , and more
decades p rio r to 1932, but in th a t y ear p ro fita b le opera­
tio n s were most d if f ic u lt to m ain tain . Would i t not be
q u ite n a tu ra l fo r the management to w ish to keep the record
of p ro fits unbroken i f a t a l l p o ssib le w ithout tak in g too
g reat lib e r tie s w ith the accounting p o licy ? From an exam­
in a tio n of sev eral hundred re p o rts, th is assum ption appears
to be p e rfe c tly tru e , and th e su sp icio n is stro n g th a t many
com panies, both a t th a t p a rtic u la r tim e as w ell as subse­
quently, have taken too many lib e r tie s in th e ir fin a n c ia l
statem ents subm itted to sto ck h o ld ers. F o rtu n ately , th e
standards of accounting p ra c tic e have advanced so ra p id ly
In th e p ast th ree decades through th e profession*^ own e f­
fo rts , and through Industry*s e ffo rts tow ard u n ifo rm ity ,
th a t in the not to o d is ta n t fu tu re most of th ese abuses may
have disappeared.
There is a v a st d ifferen ce in th e q u a n tity of in ­
form ation divulged by any re p re se n ta tiv e group of corpora­
tio n s . To a larg e degree th ese varying q u a n titie s of in ­
form ation, as w ell as d ifferen c e s in accounting p o licy , may
be a ttrib u te d to v a ria tio n s in th e requirem ents o f dissim ­
ila r in d u s trie s . However, even w ith a sin g le In d u stry th e
re p o rts of one company may d iffe r from those o f another