Determine the amount of the expense on the income statement

Assignment Help Financial Accounting

Reference no: EM131323008

FINANCIAL ACOUNTING ASSIGNMENT

Companies:

1- Oula fuel marketing co
2- Kuwait resort company

https://www.boursakuwait.com.kw/Stock/Financials.aspx?Stk=651&S=INC

1. Revenue Recognition

Revenue is the largest item on the income statement and we must assess it on a quantitative and qualitative basis.

• _Use horizontal analysis to identify any time trends

• _Compare the horizontal analyses of the companies.

• _Consider the current economic environment and the company`s competitive landscape. Given that they operate in the same industry, you may expect similar revenue trends.

• _Read the management's discussion and analysis (MD&A) section of the annual reports to learn how the companies' senior managers explain revenue levels and changes.

2. R&D Activities

Do the companies engage in substantial R&D activities?

• _Determine the amount of the expense on the income statement. You may need to look in the footnotes or the MD&A for this information. Is the common-sized amount changing over time? What pattern is detected?

• _Read the footnotes and assess the company's R&D pipeline. What are the major outcomes or innovations during the year?

3. Restructuring Activities

Have the companies restructured operations in the past three years?

• _Determine the amount of the expense on the income statement-we might need to look in the footnotes or the MD&A for this information.

• _Are other close competitors also restructuring during this time period?

• _Read the footnotes and assess the company's restructuring plans. How many years will it take to fully execute the plan? What additional expenditures are required?

• _Find the restructuring liability on the balance sheet (again the notes will help). Does the liability seem reasonable over time?

• _Are there significant reversals of prior accruals? This might indicate income shifting

Do the companies engage in substantial R&D activities?

4. Tax Disclosures and Strategies

Examine the income tax expense and deferred tax assets and liabilities.

• _Determine the amount of tax expense on the income statement and distinguish between current and deferred portions.

• _•Read the footnotes and assess the company's effective tax rate. Is it a consistent rate? If not, do the fluctuations seem reasonable?

• _Do the deferred tax assets and liabilities seem appropriate given the company's industry?

5. Accounting Quality

Evaluating accounting quality is more of an art than a science. The point is to form an overall opinion about the reliability of the numbers in the financial statements.

• _Consider the list in the section titled "Assessing and Remediating Accounting Quality" and use it to assess the quality of the companies' reported numbers.

• _Use an online investment Website to find key ratios for close competitors. Compare to our companies.

• _Were there any one-time items or unusual changes in any expenses that might have caused the company to just meet or beat the forecast? This could indicate earnings management.

6. Accounts Receivable

The following provides some guidance for analyzing a company's accounts receivable.

• _Are sales primarily on credit or is a typical sale transacted in cash? Consider the industry and the companies' business model.

• _What is the relative size of accounts receivable? How has this changed over the recent three-year period?

• _How large is the allowance for doubtful accounts? Determine the balance relative to gross accounts receivable.

• _What did the company record for bad debt expense? Compute the common size amount.

• _Compute accounts receivable turnover and days sales outstanding for all three years reported on the income statement. One will need to obtain additional balance sheet information to be able to compute average balances for the denominator. Consider the current economic environment and the companies' competitive landscape. Would one expect collection to have slowed down or sped up during the year?

• _Does the company have any large customers that increase the company's credit risk?

• _For each point of analysis, compare across companies and over time. The goal is to determine whether each company's accounts receivable (levels and changes) seems appropriate and to gauge the quality of the receivables.

7. Inventory

The following provides some guidance for analysis of a company's inventory.

• _What is inventory for the company? Does the company manufacture inventory? What proportion of total inventory is raw materials? Work in process? Finished goods?

• _Compare the two companies' inventory costing methods.

• _What is the relative size of inventory? How has this changed over the recent three-year period?

• _Compute inventory turnover and average inventory days for all three years reported on the income statement.

• _Compute gross margin in percentage terms. Consider the current economic environment and the companies' competitive landscape. Can we explain any changes in gross profit levels? Have costs for raw materials and labor increased during the year? Have sales volumes softened? What has happened to unit prices? Read the MD&A to determine senior management's take.

• _Does the company face any inventory related risk? What has been done to mitigate this risk? Read the MD&A.

For each point of analysis, compare across companies and over time.

8. Plant Assets

The following provides some guidance to the companies' long-term (fixed) assets.

• _Are fixed assets significant for the companies? What proportion of total assets is held as fixed assets (PPE)? What exactly are the companies' fixed assets? That is, what is their nature?

• _Compare the two companies' depreciation policies. Do they differ markedly?

• _What is the relative size of fixed assets? How has this changed over the three-year period?

• _Did the company increase fixed assets during the year? Was the increase for outright asset purchases or did the company acquire assets via a merger or acquisition?

• _Compute PPE turnover for all three years reported on the income statement.

• _Compute the average age of assets and percentage used up.

• _Are any assets impaired? Is the impairment charge significant? Is the impairment specific to the company or is the industry experiencing a downturn?

For each point of analysis, compare across companies and over time.

9. Operating Liabilities

Operating liabilities arise from ordinary operations and provide a less expensive source of financing. The following questions help direct our analysis.

• _Are operating liabilities large for the companies? Compare common-sized amounts. What proportion of total liabilities are operating?

• _What are the companies' main operating liabilities?

• _Compute accounts payable turnover and compare it over time and between the two companies.

• _Are there substantial contingencies? What gives rise to these? Read the footnote and determine whether the company has recorded a liability on its balance sheet for these contingencies.

10. Non-operating Liabilities

Examine the debt footnote and consider the following questions.

• _What proportion of total liabilities are non-operating? What is the common-sized debt and how does that compare to published industry averages?

• _What types of debt does the company have? Is it publicly traded? Are there bank loans? Other types of debt?

• _When does the debt mature? Determine if there is a large proportion due in the next year or two. If so, can the company refinance given its current level of debt?

• _What is the average interest rate on debt? Compare it to the coupon rates reported.

• _Read the footnote and the MD&A to see if there are any debt covenants and whether the company is in compliance.

• _If the company has publicly traded debt, determine its current price. Sharp drops in bond prices could indicate a deterioration in the company's credit quality.

11. Capital and Operating Leases

Read the debt and lease footnotes to determine whether the company uses leases.

• _Does the company use leases? What types of assets are leased?
• _What proportion of leases are capital (finance) versus operating?
• _Are leases a substantial component of overall financing?
• _Quantify the effect that capitalizing the operating leases would have on the following financial items and ratios for each company: return on equity (ROE), net operating profit after tax (NOPAT), net operating assets (NOA), and measures of financial leverage, liquidity, and solvency.

12. Credit Ratings

Find the companies' credit ratings at two or three ratings agencies' Websites.

• _What are the credit ratings and how do they compare across the agencies? Are the two companies similarly rated?
• _Have the ratings changed during the year? If so, why?
• _Are the companies on a credit watch or a downgrade list?
• _If possible, find a credit report online and read it to gain a better understanding of the companies' creditworthiness.
• _Calculate the ratios in Exhibit 7.6 for your firms. Compare the ratios to those for firms with similar credit ratings. Do the credit ratings for the firms seem reasonable?

13. Contributed Capital

Use the balance sheet and the statement of stockholders' equity to determine how the company has structured its equity.

• _What proportion of assets are financed with equity?
• _What classes of equity does the company have? What transactions occurred during the year?
• _Does the company have treasury stock? Read the MD&A and the footnotes to determine the main reason for holding treasury stock.

Assess the treasury stock transactions during the year. How much was spent and/or received? What did the company do with the proceeds? Compare the average price paid for treasury shares to the current stock price.

• _Does the company use share-based compensation? What types of plans are used? What was the magnitude of the compensation? What is the magnitude of the outstanding (unvested) options and/or shares? To assess this, consider their common size and their effect on diluted earnings per share. Compare the level of treasury shares to outstanding (unvested) options and / or shares.

• _Compute the market capitalization of the firms and compare to the book value of equity. Find an online source for the average market-to-book ratio for the industry and see where the firms fit. Follow up on anything unusual.

14. Earned Capital

Recall that the least costly form of financing is internal - that is, plowing earned profits (and cash) into new investments is a low-cost means to grow the company and return even more to stockholders.

• _How profitable were the companies? Compare return on equity for the three-year period and determine causes for major differences over time and between companies.

• _Review accumulated other comprehensive income and determine the main components of that account. How did AOCI change during the year?

• _Did the companies pay cash dividends? Compute the dividend payout and the dividend yield for all three years and compare them.

• _Did the company have any stock splits or pay stock dividends?

Reference no: EM131323008

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