Class 7 - Module5

• Below the line items
– Discontinued operations / Extraordinary items
• EPS Dilution • Foreign Currency Translation
Revenue Recognition
• Revenue recognition criteria – realized or realizable, and – earned • Realized or realizable means that the seller’s net assets (assets less liabilities) increase. • Earned means that the seller has performed its duties under the terms of the sales agreement.
How much cash Did they use in 2008 And 2007 for Restructuring?
Income Tax Expenses
• Companies maintain two sets of accounting records, one for preparing financial statements for external constituents, including current and prospective shareholders, and another for reporting to tax authorities. • Two sets of accounting records are necessary because the U.S. tax code is different from GAAP. • The difference between the two sets of records means that: – Tax expense may be recorded before it is due to the IRS (results in deferred tax liability) – Tax may be paid to the IRS before it is recorded as an expense(results in a deferred tax assets) – Differences are referred to as ―timing differences‖ – Some book income is never subject to tax, and some book expenses are never deductable for tax. – Such differences are referred to as ―permanent differences‖
Percentage-of-Completion
• The percentage-of-completion recognizes revenue by the proportion of costs incurred to date compared with total estimated costs. • The percentage-of-completion method of revenue recognition requires an estimate of total costs. • If total construction costs are underestimated, the percentageof-completion is overestimated (the denominator is too low) and revenue and gross profit to date are overstated. • This uncertainty adds additional risk to financial statement analysis.
Hewlett-Packard’s 2005 Restructuring Plan
• Of the $1.57 billion of expense recognized in 2005, $630 million was paid in that year, yielding an ending balance of approx. $1 billion. • In fiscal year 2006, H-P paid out an additional $747 million. • Is this a non-recurring item?
Cisco is much more complex:
Oracle’s Revenue Recognition Policy
• Microsoft reports $10.9 billion of unearned revenue in 2006. the company describes its recognition policy as follows:
Income Statement Analysis
Topics
• Revenue Recognition
– Earned vs. Unearned – Percent completion
• R&D Expense • Restructuring Costs • Income Taxes
– Deferred Taxes and Valerred Tax Liabilities and Assets
• Deferred tax liabilities increase when pretax book income is greater than tax return income. • Deferred tax assets increase when tax return income is greater than pretax book income.
Johnson Controls Revenue Recognition
Revenue Recognition Summary
• Analyst needs to understand the revenue recognition policy that the firm is using. • Read footnote 1 of the financial statements, which explains how the firm recognizes revenues • Assess the reasonableness and conservatism of the firm’s policies. • Compare the firm’s revenue recognition methods to other firms in the same industry. • Be aware that specialized industries may have specialized revenue recognition practices. Examples: software, TV broadcasting and motion pictures, mortgage lending, membership businesses. Analyst needs to be an expert in the practices of the industries she follows. • Be aware that revenue recognition problems account for over half of the restatements (and related stock impact) we observe.
Pfizer’s Revenue Recognition Policy
• Pfizer recognizes its revenues as follows: – Revenue Recognition—we record revenue from product sales when the goods are shipped and title passes to the customer. At the time of sale, we also record estimates for a variety of sales deductions, such as sales rebates, discounts and incentives, and product returns. – This is a very typical policy, problems are unlikely
Pfizer’s R&D Accounting Footnote
Restructuring Expenses
• Restructuring costs typically consists of two components: – Employee severance or relocation costs – Asset write-downs • Accounting standard: – A company is required to have a formal restructuring plan that is approved by its board of directors before any restructuring charges are accrued. – Also, a company must identify the relevant employees and notify them of its plan. • In each subsequent year, the company must disclose in its footnotes the original amount of the liability (accrual), how much of that liability is settled in the current period (such as employee payments), how much of the original liability has been reversed because of cost overestimation, any new accruals for unforeseen costs, and the current balance of the liability. • This creates more transparent financial statements, which presumably deters earnings management.