Financial Reporting &Analysis Using Financial Accounting Information 11th Editi on Charles H. Gibson The University of Toledo, Emeritus Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States Financial Reporting & Analysis, © 2009, 2007 South-Western, a part of Cengage Learning Eleventh Edition ALL RIGHTS RESERVED. No part of this work covered by the copyright herein Charles H. Gibson may be reproduced, transmitted, stored or used in any form or by any means VP/Editorial Director: Jack W.
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Printed in the United States of America 1 2 3 4 5 6 7 12 11 10 09 08 About the Author Charles Gibson is a certified public accountant who practiced with a Big Four accounting firm for four years and has had more than 30 years of teaching experience. His teaching experi- ence encompasses a variety of accounting courses, including financial, managerial, tax, cost, and financial analysis. Professor Gibson has taught seminars on financial analysis to financial executives, bank commercial loan officers, lawyers, and others. He has also taught financial reporting seminars for CPAs and review courses for both CPAs and CMAs.
He has authored several problems used on the CMA exam. Charles Gibson has written more than 60 articles in such journals as the Journal of Accoun- tancy, Accounting Horizons, Journal of Commercial Bank Lending, CPA Journal, Ohio CPA, Management Accounting, Risk Management, Taxation for Accountants, Advanced Management Journal, Taxation for Lawyers, California Management Review, and Journal of Small Business Management. He is a co-author of the Financial Executives Research Foundation Study entitled, “Discounting in Financial Accounting and Reporting. Gibson co-authored Cases in Financial Reporting (PWS-KENT Publishing Company).
He has also co-authored two continuing education courses consisting of books and cassette tapes, published by the American Institute of Certified Public Accountants. These courses are entitled “Funds Flow Evaluation” and “Profitability and the Quality of Earnings.” Professor Gibson is a member of the American Accounting Association, American Institute of Certified Public Accountants, Ohio Society of Certified Public Accountants, and Financial Executives Institute. In the past, he has been particularly active in the American Accounting Association and the Ohio Society of Certified Public Accountants. Gibson received the 1989 Outstanding Ohio Accounting Educator Award jointly pre- sented by The Ohio Society of Certified Public Accountants and the Ohio Regional American Accounting Association.
In 1993, he received the College of Business Research Award at The University of Toledo. Gibson was honored as an “Accomplished Graduate” of the College of Business at Bowling Green State University. In 1999, he was honored by The Gamma Epsilon Chapter of Beta Alpha Psi of The University of Toledo. Dedication This book is dedicated to my wife Patricia and daughters Ann Elizabeth and Laura.
Special Dedication To professors and students who have provided comments on this edition and prior editions. Their comments have contributed to the quality of this book. Brief Contents Preface xii Chapter 1 Introduction to Financial Reporting 1 Chapter 2 Introduction to Financial Statements and Other Financial Reporting Topics 45 Chapter 3 Balance Sheet 93 Chapter 4 Income Statement 145 Chapter 5 Basics of Analysis 177 Chapter 6 Liquidity of Short-Term Assets; Related Debt-Paying Ability 201 Chapter 7 Long-Term Debt-Paying Ability 253 Chapter 8 Profitability 297 Chapter 9 For the Investor 335 Chapter 10 Statement of Cash Flows 365 Summary Analysis Nike, Inc. (Includes 2007 Financial Statements on Form 10-K) 407 Chapter 11 Expanded Analysis 447 Chapter 12 Special Industries: Banks, Utilities, Oil and Gas, Transportation, Insurance, Real Estate Companies 501 Chapter 13 Personal Financial Statements and Accounting for Governments and Not-for-Profit Organizations 543 Glossary 569 Bibliography 589 Index 598 Contents Preface xii Chapter 1 Introduction to Financial Reporting 1 Development of Generally Accepted Accounting Principles (GAAP) in the United States 1 American Institute of Certified Public Accountants (AICPA) • Financial Accounting Standards Board (FASB) • Operating Procedure for Statements of Financial Accounting Standards (SFASs) • FASB Conceptual Framework Additional Input—American Institute of Certified Public Accountants (AICPA) 7 Emerging Issues Task Force (EITF) 8 A New Reality 8 FASB Accounting Standards CodificationTM (Codification) 10 Traditional Assumptions of the Accounting Model 10 Business Entity • Going Concern or Continuity • Time Period • Monetary Unit • Historical Cost • Conservatism • Realization • Matching • Consistency • Full Disclosure • Materiality • Industry Practices • Transaction Approach • Cash Basis • Accrual Basis Using the Internet 19 Companies’ Internet Web Sites • Helpful Web Sites Summary 21 To the Net 21 Questions 21 Problems 24 Cases Case 1-1 Standards Overload? 29 • Case 1-2 Standard Setting: “A Political Aspect” 29 • Case 1-3 Standard Setting: “By the Way of the United States Congress” 32 • Case 1-4 Flying High 33 • Case 1-5 Hawaii Centered 35 • Case 1-6 Going Concern? 35 • Case 1-7 Economics and Accounting: The Uncongenial Twins 38 • Case 1-8 I Often Paint Fakes 39 • Case 1-9 Oversight 39 • Case 1-10 Regulation of Smaller Public Companies 43 • Web Case: Thomson One, Business School Edition 44 Chapter 2 Introduction to Financial Statements and Other Financial Reporting Topics 45 Forms of Business Entities 45 The Financial Statements 46 Balance Sheet (Statement of Financial Position) • Statement of Stockholders’ Equity (Reconciliation of Stockholders’ Equity Accounts) • Income Statement (Statement of Earnings) • Statement of Cash Flows (Statement of Inflows and Outflows of Cash) • Notes The Accounting Cycle 49 Recording Transactions • Recording Adjusting Entries • Preparing the Financial Statements • Treadway Commission vi Contents Auditor’s Opinion 52 Auditor’s Report on the Firm’s Internal Controls • Report of Management on Internal Control over Financial Reporting Management’s Responsibility for Financial Statements 56 The SEC’s Integrated Disclosure System 56 Proxy 59 Summary Annual Report 60 The Efficient Market Hypothesis 60 Ethics 61 SEC Requirements—Code of Ethics Harmonization of International Accounting Standards 63 Consolidated Statements 66 Accounting for Business Combinations 66 Summary 67 To the Net 67 Questions 68 Problems 70 Cases Case 2-1 The CEO Retires 75 • Case 2-2 The Dangerous Morality of Managing Earnings 78 • Case 2-3 Firm Commitment? 82 • Case 2-4 Rules or Feel? 83 • Case 2-5 Materiality: In Practice 83 • Case 2-6 Management’s Responsibility 84 • Case 2-7 Safe Harbor 85 • Case 2-8 Enforcement 86 • Case 2-9 Watch–Dollars–Auditing Standards—GAAP 87 • Case 2-10 Multiple Country Enforcement 90 • Case 2-11 Notify the SEC 91 • Web Case: Thomson One, Business School Edition 91 Chapter 3 Balance Sheet 93 Basic Elements of the Balance Sheet 93 Assets • Liabilities • Stockholders’ Equity • Quasi-Reorganization • Accumulated Other Comprehensive Income • Equity-Oriented Deferred Compensation • Employee Stock Ownership Plans (ESOPs) • Treasury Stock • Stockholders’ Equity in Unincorporated Firms Statement of Stockholders’ Equity 122 Problems in Balance Sheet Presentation 123 Summary 124 To the Net 124 Questions 125 Problems 127 Cases Case 3-1 It’s a Trip 133 • Case 3-2 Up, Up, and Away 135 • Case 3-3 Line of Health 139 • Case 3-4 Buy Now 140 • Case 3-5 Our Principal Asset is Our People 140 • Case 3-6 Brands Are Dead? 141 • Case 3-7 Advertising—Asset? 141 • Case 3-8 IFRS Model Balance Sheet 141 • Case 3-9 Canadian GAAP vs.
GAAP 142 • Web Case: Thomson One, Business School Edition 142 Chapter 4 Income Statement 145 Basic Elements of the Income Statement 145 Net Sales (Revenues) • Cost of Goods Sold (Cost of Sales) • Other Operating Revenue • Operating Expenses • Other Income or Expense Special Income Statement Items 148 (A) Unusual or Infrequent Item Disclosed Separately • (B) Equity in Earnings of Nonconsolidated Subsidiaries • Income Taxes Related to Operations Contents vii • (C) Discontinued Operations • (D) Extraordinary Items • (E) Cumulative Effect of Change in Accounting Principle • (F) Minority Share of Earnings Earnings per Share 155 Retained Earnings 155 Dividends and Stock Splits 155 Legality of Distributions to Stockholders 158 Comprehensive Income 159 Summary 161 To the Net 161 Questions 162 Problems 163 Cases Case 4-1 Home Building Blues 171 • Case 4-2 Entertainment Provider 172 • Case 4-3 Apparel Extraordinary 173 • Case 4-4 The Big Order 173 • Case 4-5 Celtics 174 • Case 4-6 Polymer Products 175 • Case 4-7 Multiple Income 175 • Web Case: Thomson One, Business School Edition 176 Chapter 5 Basics of Analysis 177 Ratio Analysis 177 Common-Size Analysis (Vertical and Horizontal) 178 Year-to-Year Change Analysis 178 Financial Statement Variation by Type of Industry 179 Review of Descriptive Information 181 Comparisons 183 Trend Analysis • Standard Industrial Classification (SIC) Manual • North American Industry Classification System (NAICS) • Industry Averages and Comparison with Competitors • Caution in Using Industry Averages Relative Size of Firm 190 Other Library Sources 190 Ward’s Business Directory • Standard & Poor’s Stock Reports • Standard & Poor’s Register of Corporations, Directors, and Executives • Standard & Poor’s Analyst’s Handbook • Standard & Poor’s Standard Corporation Descriptions (Corporation Records) • America’s Corporate Families:® The Billion Dollar Directory® • D&B® Million Dollar Directory® • Directory of Corporate AffiliationsTM • Thomas Register of American Manufacturers • Mergent Industrial Manual and News Reports • Security Owner’s Stock Guide • Standard & Poor’s Statistical Service • Mergent Dividend Record Standard & Poor’s Annual Dividend Record • D&B Reference Book of Corporate Managements • Compact Disclosure • Lexis-Nexis The Users of Financial Statements 193 Summary 193 To the Net 194 Questions 195 Problems 196 Case Web Case: Thomson One, Business School Edition 199 Chapter 6 Liquidity of Short-Term Assets; Related Debt-Paying Ability 201 Current Assets, Current Liabilities, and the Operating Cycle 201 Cash • Marketable Securities • Receivables • Inventories • Prepayments • Other Current Assets • Current Liabilities viii Contents Current Assets Compared with Current Liabilities 220 Working Capital • Current Ratio • Acid-Test Ratio (Quick Ratio) • Cash Ratio Other Liquidity Considerations 224 Sales to Working Capital (Working Capital Turnover) • Liquidity Considerations Not on the Face of the Statements Summary 226 To the Net 226 Questions 227 Problems 230 Cases Case 6-1 Steel Man 241 • Case 6-2 Rising Prices, a Time to Switch Off LIFO?