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Felix I. Lessambo Financial Statements Analysis, Reporting and Valuation Second Edition Financial Statements Felix I. Lessambo Financial Statements Analysis, Reporting and Valuation Second Edition Felix I. Lessambo Fordham University New York, NY, USA ISBN 978-3-031-15662-5 ISBN 978-3-031-15663-2 (eBook) https://doi.org/10.1007/978-3-031-15663-2 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2018, 2022 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval,electronicadaptation,computersoftware,orbysimilarordissimilarmethodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such namesareexemptfromtherelevantprotectivelawsandregulationsandthereforefreefor general use. Thepublisher,theauthors,andtheeditorsaresafetoassumethattheadviceandinforma- tion in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respecttothematerialcontainedhereinorforanyerrorsoromissionsthatmayhavebeen made.Thepublisherremainsneutralwithregardtojurisdictionalclaimsinpublishedmaps and institutional affiliations. This Palgrave Macmillan imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Acknowledgments Writing a book is always a challenge. Nevertheless, writing a book on “Financial Statements: Analysis, Reporting and Valuation” geared to M.B.A. students, a more daring intellectual exercise for two-fold reasons: (i)becauseofthehardchoiceoftopicstocover,and(ii)financialanalysis is part science and part art. I would like to express my gratitude to those who motivated me all along the project, knowing my dedication to the subject, and thought I am more than able to complete this project: Dr. Gordon Marsha, Dr. Linda Sama, Dr. Lester Reid, Dr. Lavern Wright, Jordan Romine, Yanick Gil, and Jerry Izouele. Several good friends provided me with needed guidance and materials tocompletethisbook,whileotherstookfromtheirbusiesttimetoreview andcombthemanuscripts:ReverendPastorRolandDaloandYanickGil. v Disclaimer While the author has made every effort to ensure that the information in this book is correct at the time of publication, he does not assume and herebydisclaimsanyliabilitytoanyPartyforanyloss,damage,ordisrup- tioncausedbyerrorsoromissions,whethersucherrorsoromissionsresult from negligence, accident, or any other cause. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold on the understandingthatthepublisherisnotengagedinrenderingprofessional services. If professional advice or other expert assistance is needed, the services of a competent professional should be sought. vii Contents Part I Overview of Financial Statements and the Statement of Position 1 Overview of Financial Statements 3 1.1 General 3 1.2 The International Accounting Standard Board: IFRS 4 1.3 European Financial Reporting Advisory Group (EFRAG) 4 1.4 The United States: The FASB 5 1.5 The United Kingdom: Financial Reporting Council (FRC) 9 1.6 Japan: The Accounting Standard Board of Japan 12 1.7 Australia: The Australian Accounting Standard Board 13 1.8 New Zealand: The New Zealand Accounting Standards Board (NZASB) 16 1.9 India: The Council of the Institute of Chartered Accountants of India (ICAI) 16 1.10 China: Accounting Standard for Business Enterprises 17 1.11 The Financial Statement Materials 18 1.11.1 The Proxy Statement 18 ix x CONTENTS 1.11.2 The Management Discussion & Analysis (MD&A) 19 1.12 Interim Statements and Subsequent & Adjusting Events 19 1.12.1 Interim Financial Statements 19 1.12.2 Subsequent Events 19 1.12.3 Adjusting Events 20 1.13 Users of Financial Statements 22 References 24 2 Short-Term Assets: Cash and Cash Equivalents 25 2.1 General 25 2.2 Cash and Cash Equivalents 27 2.2.1 Bank Reconciliation 28 2.2.2 Bank Overdraft 30 2.2.3 Petty Cash 32 2.3 Marketable Equity Securities and Fair Value Measurement 33 2.4 Accounting for Financial Instruments 35 2.5 Accounting for Derivatives 39 2.6 Accounting for Hedging 41 References 43 3 Short-Term Assets Inventories 45 3.1 General 45 3.2 Inventory Methods 46 3.2.1 The Perpetual Inventory System 46 3.2.2 The Periodic Inventory System 48 3.3 Ownership Issues 51 3.4 Valuation of Inventory 51 3.5 The LIFO Reserve 52 3.6 LIFO Liquidation 53 3.7 Comprehensive Example 54 3.7.1 Solutions 54 3.8 Restrictions on the Use of LIFO 57 References 57 4 Account Receivables 59 4.1 General 59 4.2 Cash Discount on Sales 60 CONTENTS xi 4.2.1 The Gross Method 60 4.2.2 The Net Method 61 4.3 Bad Debts Concept 62 4.3.1 Rebates 63 4.3.2 Doubtful Accounts 63 4.3.3 Accounting for Bad Debts 63 4.4 Accounts Receivable Aging Method 64 4.5 Assignment of Accounts Receivable 66 4.6 Factoring of Accounts Receivable 67 4.6.1 Recourse vs Non-Recourse Factoring 68 4.6.2 Factoring V. Loan 68 4.6.3 Factoring vs Assignment of Receivables 70 4.7 Securitization of Receivables 70 4.7.1 Sale Accounting Criteria 71 4.7.2 Secured Borrowing 73 4.8 Receivables—Troubled Debt Restructurings by Creditors 74 4.9 Non-Trade Receivables 75 References 76 5 Prepaid Expenses, Unearned Income, and Other Current Assets 77 5.1 General 77 5.2 Prepaid Expenses 77 5.3 Unearned Income 80 5.4 Other Current Assets 81 References 82 6 Short-Term Liabilities & Working Capital 83 6.1 General 83 6.2 Accounts Payable 83 6.3 Notes Payable 84 6.4 Current Maturities of Long-Term Debt 85 6.5 Other Current Liabilities 85 6.6 Commercial Paper 86 6.7 Working Capital 87 6.7.1 Determinants of Working Capital 87 6.7.2 Financing of Working Capital 88 6.7.3 Computation of Working Capital: Example 88 xii CONTENTS 7 Long-Term Assets: Plant, Property, and Equipment 89 7.1 General 89 7.2 Property, Plant, and Equipment 90 7.2.1 Acquisition of Property, Plant, and Equipment 90 7.2.2 Cost of Land 91 7.2.3 Cost of Buildings 92 7.2.4 Cost of Equipment 93 7.3 Valuation of Property, Plant, and Equipment 94 7.4 Amortization, Depreciation, and Depletion 94 7.4.1 Straight-Line Method of Depreciation 95 7.4.2 Declining Balance Method of Depreciation 96 7.4.3 Double Declining Balance Depreciation Method 97 7.4.4 Units of Production Method of Depreciation 99 7.4.5 Sum of the Years’ Digits Method of Depreciation 100 7.5 Disposition of Property, Plant, and Equipment 101 7.5.1 Sale of Plant Assets 102 7.5.2 Involuntary Conversion 102 7.5.3 Miscellaneous Problems 103 References 103 8 Long-Term Assets: Intangibles 105 8.1 General 105 8.2 The Goodwill 106 8.2.1 Goodwill Impairment 107 8.3 Computer Software 111 8.3.1 Research and Development Costs of Computer Software 112 8.3.2 Production Costs of Computer Software 112 8.3.3 Purchased Computer Software 112 8.3.4 Amortization of Capitalized Software Costs 113 8.3.5 Presentation and Disclosure of Software Costs 114