Financial accounting IFRS 4 kieoso ch15 PPT

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Financial Accounting

IFRS 4th Edition

Chapter 15

Financial Analysis: The Big Picture

Weygandt ● Kimmel ● Kieso

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Chapter Outline

Learning Objectives

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Learning Objective 1

Apply Horizontal Analysis and Vertical Analysis to Financial

Statements

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Need for Comparative Analysis

data.

Basics of Financial Statement Analysis

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Basics of Financial Statement Analysis

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Horizontal analysis, also called trend

analysis, is a technique for evaluating a

series of financial statement data over a period of time.

retained earnings statement.

Horizontal Analysis

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Quality Department Store Condensed Statements of Financial Position

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• In the assets section, plant assets (net) increased €167,500, or 26.5%.

Changes suggest that the company expanded its asset base during 2020 and financed this

expansion primarily by retaining income rather than assuming additional long-term debt.

LO 1

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Quality Department Store Condensed Income Statements For the Years Ended December 31

Increase or (Decrease) during 2020

Total operating expenses 357,000 320,000 37,000 11.6%

Income from operations 459,000 377,000 82,000 21.8%

Other income and expense

Interest and dividends 9,000 11,000 (2,000) (18.2%)

Interest expense 36,000 40,500 (4,500) (11.1%)

Income before income taxes 432,000 347,500 84,500 24.3%

Income tax expense 168,200 139,000 29,200 21.0%

Net income € 263,800 € 208,500 € 55,300 26.5%

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Quality Department Store Retained Earnings Statements For the Years Ended December 31

Increase or (Decrease) during 2020

Retained Earnings Statement

In the horizontal analysis of the statement of financial position the ending retained earnings increased 38.6% As indicated earlier, the company

retained a significant portion of net income to finance additional plant facilities

LO 1

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Summary financial information for Rosepatch NV is as follows.

Compute the amount and percentage changes in 2020 using horizontal analysis, assuming 2019 is

the base year.

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DO IT! 1: Horizontal Analysis Solution

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Vertical analysis, also called common-size

analysis, is a technique that expresses each

financial statement item as a percent of a base amount.

statement.

Vertical Analysis

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• In the assets section, current assets decreased from 59.2% of total assets in 2019 to 55.6% in 2020.

through retention of earnings rather than through issuing additional debt.

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Quality Department Store Condensed Income Statements For the Years Ended December 31

Total operating expenses 357,000 17.0% 320,000 17.4%

Income from operations 459,000 21.9% 377,000 20.5%

Other income and expense

Interest and dividends 9,000 0.4% 11,000 0.6%

Interest expense 36,000 1.7% 40,500 2.2%

Income before income taxes 432,000 20.6% 347,500 18.9%

Income tax expense 168,200 8.0% 139,000 7.5%

Net income € 263,800 12.6% € 208,500 11.4%

Income Statement

Quality Department Store appears

to be a profitable business that

is becoming even more successful.

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Condensed Income Statements For the Year Ended December 31, 2020

(in thousands)

Selling and administrative expenses 357 17.0% 6,247,000 35.6%

Other income and expense (including income

Income Statement

Enables a comparison of companies of different sizes.

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Analyze a Company’s Performance Using Ratio Analysis

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Liquidity Ratios

•Measure short-term ability of the

company to pay its maturing

obligations and to meet unexpected

needs for cash

Profitability Ratios

•Measure the income or operating

success of a company for a given

period of time

Solvency Ratios

•Measure the ability of the company

to survive over a long period of time

Ratio Analysis

Ratio analysis expresses the relationship among selected items of financial statement data.

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Measure the short-term ability of the company to pay its maturing obligations and to meet

unexpected needs for cash

liquidity

turnover.

Liquidity Ratios

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Quality Department Store

Current Ratio

Current Ratio =

Current Assets Current Liabilities

The 2020 ratio of 2.96:1 means that for every euro of current liabilities, Quality has €2.96 of current assets

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Quality Department Store Statement of Financial Position (partial)

*Allowance for doubtful accounts is €10,000 at the end of each year

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Accounts Receivable Turnover =

Net Credit Sales Average Net Accounts Receivable

Measures the number of times, on average, the company collects receivables during the period

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€2,097,000 Accounts Receivable Turnover

€180,000 + €230,000 ÷ 2 = 10.2 times

A variant of the Accounts Receivable Turnover ratio is to convert it to an average collection period in terms of days

365 days ÷ 10.2 times = 35.78 daysReceivables are collected, on average, every 36 days

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€1,281,000 Inventory Turnover

€500,000 + €620,000 ÷ 2 = 2.3 times

A variant of the Inventory Turnover ratio is the Days in Inventory

365 days ÷ 2.3 times = every 159 daysInventory turnover ratios vary considerable among industries

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• Measure the income or operating success of a company for a given period of time

liquidity position, and the ability to grow.

shareholders’ equity, earnings per share, price-earnings, and payout ratio.

Profitability Ratios

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Profit Margin

Profit Margin =

Net Income Net Sales

Measures the percentage of each dollar of sales that results in net income

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Asset Turnover

Net Sales Average Assets

Measures how efficiently a company uses its assets to generate sales

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Return on Assets

Net Income Average Assets

An overall measure of profitability

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Return on Ordinary Shareholders’ Equity

Return on Ordinary Shareholders’ Equity =

Net Income − Preference Dividends Average Ordinary Shareholders’ Equity

Shows how many euros of net income the company earned for each euro invested by the owners

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Earnings per Share (EPS)

Earnings per Share =

Net Income − Preference Dividends Weighted-Average Ordinary Shares Outstanding

A measure of the net income earned on each ordinary share

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Price-Earnings Ratio

Price-Earnings Ratio = Market Price per Share

Earnings per Share

Reflects investors’ assessments of a company’s future earnings

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Solvency ratios measure the ability of a company to survive over a long period of time.

are two ratios that provide information about debt-paying ability.

Solvency Ratios

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Debt to Assets Ratio

Total Assets

Measures the percentage of the total assets that creditors provide

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Times Interest Earned

Times Interest Earned =

Net Income + Interest Expense + Income Tax Expense

Interest Expense

Provides an indication of the company’s ability to meet interest payments as they come due

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The condensed financial statements of John Cully Group, for the years ended June 30, 2020 and 2019 are presented below.

John Cully Group Income Statements For the Year Ended June 30

(in thousands)

Sales revenue €6,336.3 €5,790.4

Costs and expenses

Cost of goods sold 1,617.4 1,476.3

Selling and administrative expenses 4,007.6 3,679.0

Interest expense 13.9 27.1

Total costs and expenses 5,638.9 5,182.4

Income before income taxes 697.4 608.0

Income tax expense 291.3 232.6

Net income €406.1 €375.4

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John Cully Group Statements of Financial Position

June 30

(in thousands)

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John Cully Group Statements of Financial Position

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Compute the following ratios for 2020 and 2019.

a Current ratio

b Inventory turnover (Inventory on 6/30/18 was €599.0).

c Profit margin.

d Return on assets (Assets on 6/30/18 were €3,349.9.)

e Return on ordinary shareholders’ equity (Equity on 6/30/18 was €1,795.9.)

f Debt to assets ratio.

g Times interest earned.

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Apply the concept of sustainable income

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Sustainable income is the most likely level of income to be obtained by a company in the future.

income from continuing operations.

Sustainable Income

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Discontinued operations refers to the disposal of a significant component of a business.

Report the income (loss) from discontinued operations in two parts:

Discontinued Operations

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During 2020 Acro Energy Ltd has income before income taxes of NT$800,000 During 2020, Acro discontinued and sold its unprofitable chemical division The loss in 2020 from chemical operations (net of NT$60,000 taxes) was NT$140,000 The loss on disposal of the chemical division (net of NT$30,000 taxes) was NT$70,000 Assuming a 30% tax rate on income.

LO 3

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Acro Energy Ltd.

Statement of Comprehensive Income (partial) For the Year Ended December 31, 2020

Discontinued operations

Loss from operations of chemical division, net of NT$60,000 income tax savings

NT$140,000Loss from disposal of chemical division, net of NT$30,000 income tax savings

70,000 210,000

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• Occurs when the principle used in the current year is different from the one used in the preceding year.

average-cost).

Change in Accounting Principle

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• Comprehensive income is the sum of net income and other comprehensive income items.

they are part of Other comprehensive income.

• Reduces the volatility of net income due to fluctuations in fair value.

• Informs financial statement users of the gain of loss that would be incurred if the securities were sold at fair value

Comprehensive Income

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Pace AG Statement of Comprehensive Income For the Year Ended December 31, 2020

Discontinued operations

Loss from operation of plastics division, net of income tax savings €18,000 (€60,000 × 30%) €42,000

Gain on disposal of plastics division, net of €15,000 income taxes (€50,000 × 30%) 35,000 7,000

Other comprehensive income

Statement of Comprehensive Income

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In its proposed 2020 statement of comprehensive income, AIR plc reports income before income taxes

£400,000, loss on operation of discontinued flower division £50,000, and loss on disposal of discontinued

flower division £90,000 The income tax rate is 30% Prepare a correct statement of comprehensive income,

beginning with “Income before income taxes.”

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AIR plc Statement of Comprehensive Income (partial) For the Year Ended December 31, 2020

Income before income taxes

₤ 400,000 Income tax expense (₤400,000 × 30%)

120,000 Income from continuing operations

280,000 Discontinued operations

Loss from operation of flower division, net of ₤15,000 tax savings

₤35,000 Loss on disposal of flower division, net of ₤27,000 tax savings

63,000 98,000 Net income

₤182,000

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• The basic accounting for discontinued operations is the same under GAAP and IFRS.

• The accounting for changes in accounting principles and changes in accounting estimates are the same for both GAAP and IFRS

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• The issues related to quality of earnings are the same under both GAAP and IFRS It is hoped that by adopting a more principles-based approach, as found in IFRS, many of the earnings quality issues will disappear.

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Looking to the Future

The FASB and the IASB are working on a project that would rework the structure of financial statements One part of this project addresses the issue of how to classify various items in the income statement A main goal of this new approach is to provide information that better represents how businesses are run In addition, the approach draws attention away from one number—net income

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