Financial Statement Analysis & Valuation, 6e

by Easton, McAnally, Sommers

| ISBN: 978-1-61853-360-9 | Copyright 2021

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Welcome to the Sixth Edition of Financial Statement Analysis & Valuation 


Our main goal in writing this book was to address the needs of todays instructors and students interested in financial analysis and valuation by providing the most contemporary, engaging, and user‑oriented textbook available. This book is the product of extensive market research including focus groups, market surveys, class tests, manuscript reviews, and interviews with faculty from across the country. We are grateful to students and faculty whose insights, suggestions and feedback greatly benefited this edition.


Target Audience 

Financial Statement Analysis & Valuation is intended for use in a financial statement analysis and/or valuation course in which profitability analysis and security valuation are emphasized. This book accommodates mini‑courses lasting only a few days as well as extended courses lasting a full semester.

Innovative Approach 

Financial Statement Analysis & Valuation is applications oriented and focuses on the most salient aspects of accounting, analysis, and valuation. It teaches students how to read, analyze, and interpret financial statement data to make informed business decisions. This textbook makes financial statement analysis and valuation engaging, relevant, and contemporary. To that end, it consistently incorporates real company data, both in the body of each module and throughout the assignment material.

Flexible Structure

The curricula, instructor preferences, and course lengths vary across colleges. Accordingly and to the extent possible, the 15 modules that make up Financial Statement Analysis & Valuation were designed independently of one another. This modular presentation enables each college and instructor to “customize the book to best fit their needs. Our introduction and discussion of financial statements constitute Modules 1 and 2. Module 3 presents the analysis of financial statements with an emphasis on analysis of operating profitability. Module 4 introduces credit risk analysis. Modules 5 through 10 offer an analysis of accounting numbers and disclosures. The aim of those modules is to help us better interpret financial statements and to adjust those statements as necessary to improve our financial statement analysis. Modules 11 through 15 describe forecasting, cost of capital estimation, and company valuation.

Flexibility for Courses of Varying Lengths

Many instructors have approached us to ask about suggested class structures based on courses of varying length. To that end, we provide the following table of possible course designs. For instructors desiring greater emphasis on accounting analysis, additional time can be spent on Modules 1 through 10. For instructors desiring greater emphasis on analysis and valuation, additional time can be spent on Modules 11 through 15.



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Innovative Pedagogy

Focus Companies for Each Module

Each modules content is explained through the reporting activities of real companies. To that end, each module incorporates a “focus company” for special emphasis and demonstration. The enhanced instructional value of focus companies comes from the way they engage students in real analysis and interpretation. Focus companies were selected based on the industries that business students typically enter upon graduation.

Focus Companies by Module


Real Company Data Throughout

Market research and reviewer feedback tell us that one of instructors' greatest frustrations with other financial statement analysis and valuation textbooks is their lack of real, contemporary company data. We have gone to great lengths to incorporate real company data throughout each module to reinforce important concepts and engage students. We engage nonaccounting students specializing in finance, marketing, management, real estate, operations, and so forth, with companies and scenarios that are relevant to them. For representative examples, SEE PAGES 3-17; 5-17; 6-22.

Analyst Adjustments

Analyst Adjustments are incorporated throughout most of the modules. These boxed elements explain and illustrate the types of adjustments analysts make to accounting information to make it more useful in their assessment of a firm. For representative examples, SEE PAGES 5-14; 6-28; 7-7.


Data Analytics and Data Visualization

New technologies are changing the landscape of accounting and financial reporting. Companies are increasingly using data analytics and visualization (charts, pictures, and graphs) to more effectively convey financial information. To familiarize students with data visualization, each module opens with a data dashboard and it uses real‑world data analytics and applications for student learning. Analytics and visualizations are reinforced with assignments in each module that present data graphically and require students to analyze and interpret the data visualizations. We provide students with online access to author‑created PowerBI dashboards where they can interact with the data and learn how to create their own data visualizations. These discussions and assignments are identified by the data analytics icon in the margin. SEE PAGES 1-35, 4-35, 5-56.


Business Insights & Analysis Insights

Updated Business Insight boxes throughout each module showcase real‑world business scenarios through the lens of financial statement analysis. For representative examples, SEE PAGES 2-11, 3-23, 5-10. Analysis Insight boxes, in select modules, highlight the importance of analysts’ professional judgment in financial analysis as well as with the reformulation of financial statements. For representative examples, SEE PAGES 3-33, 4-32, 13-5.

Research Insights

Academic research plays an important role in the way business is conducted, accounting and analysis are performed, and students are taught. It is important for students to recognize how modern research and modern business practice interact. Therefore, we periodically incorporate relevant research to help students understand the important relation between research and modern business. For representative examples, SEE PAGES 3-26, 5-37, 7-19.

Decision Orientation

One primary goal of a financial statement analysis and valuation course is to teach students the skills needed to apply their accounting knowledge to solving real business problems and making informed business decisions. With that goal in mind, Analysis Decision boxes in each module encourage students to apply the material presented to solving actual business scenarios.


Financial Statement Effects Template

As instructors, we recognize that the financial statement analysis and valuation course is not directed solely toward accounting majors. Financial Statement Analysis & Valuation embraces this reality. This book highlights financial reporting, analysis, valuation, interpretation, applications and decision making. We incorporate the following financial statement effects template to train students in understanding the economic ramifications of transactions and their impacts on financial statements. This analytical tool is a great resource for students in learning analysis and applying it to their future courses and careers. Each transaction is identified in the Transaction column. Then, the dollar amounts (positive or negative) of the financial statement effects are recorded in the appropriate balance sheet or income statement columns. The template also reflects the statement of cash flow effects (via the cash column) and the statement of stockholders equity effects (via the contributed capital and earned capital columns). The earned capital account is immediately updated to reflect any income or loss arising from each transaction (denoted by the arrow line from net income to earned capital). This template is instructive as it reveals the financial impacts of transactions, and it provides insights into the effects of accounting choices. For those desiring a more traditional analysis, journal entries and T‑accounts are shown in the margin.



Mid-Module and Module-End Reviews

Financial statement analysis and valuation can be challenging—especially for students lacking business experience or previous exposure to finance, management, and other business courses. To reinforce concepts presented in each module and to ensure student comprehension, we include multiple mid‑module and module‑end reviews that require students to recall and apply the financial statement analysis and valuation techniques and concepts described in each module. To aid students in developing their comparative analysis skills, most of those review problems center on a company or companies that compete with the focus company of that module. For representative examples, SEE PAGES 3-4, 8-14, 11-19.

Experiential Learning

Students retain information longer if they can apply the lessons learned from the module content. To meet this need for experiential learning, we conclude each module with a hands‑on analysis project. A series of questions guides students’ inquiry and helps students synthesize the material in the module and integrate material across modules. For representative examples, SEE PAGES 1-48, 3-57, 11-51.

Excellent, Class-Tested Assignment Materials

Excellent assignment material is a must‑have component of any successful textbook (and class). We went to great lengths to create the best assignments possible from contemporary financial statements. In keeping with the rest of the book, we used real company data extensively. We also ensured that assignments reflect our belief that students should be trained in analyzing accounting information to make business decisions, as opposed to working on mechanical tasks. Assignments encourage students to analyze accounting information, interpret it, and apply the knowledge gained to a business decision or in a valuation context. There are six categories of assignments: Questions, Mini Exercises, Exercises, Problems, IFRS Applications, and Analysis Discussion Points.

Sixth Edition Changes

Based on classroom use and reviewer feedback, a number of substantive changes have been made in the new edition to further enhance the students’ experiences.

  • Digital delivery enhanced To serve the expanding delivery modes of higher education, we updated and expanded our in‑module Reviews and Guided Example videos for all modules (each Learning Objective has a Review/Guided Example, as well as a corresponding eLecture). In addition, all objective assignments are available in MBC.
  • Data visualizations and analytics Companies are increasingly using data visualizations (charts, pictures, and graphs) to more effectively convey financial information. To support student learning, each module opens with a data dashboard and includes end‑of‑module assignments that present data graphically and require students to analyze and interpret the data visualizations. We provide students with online access (via MBC) to author‑created PowerBI dashboards where they can interact with the data and learn how to create their own data visualizations.
  • Content reflects new standards This edition covers new standards on Revenue Recognition, Leases, and Marketable Securities. It also includes in‑depth discussion of the Tax Cuts and Jobs Act and how new tax law impacts financial analysis.
  • Redundancies have been reduced In response to adopter feedback, we have eliminated redundant discussions spanning Modules 3, 4, and 7 related to credit ratings and liquidity/ solvency ratios.
  • Revenue, operating expenses, and receivables We expanded the discussion of revenue recognition following the new standard and included an illustration and analysis of Microsoft’s revenue recognition. We also discuss sales returns and allowances and the effects of foreign currency exchange rates. Our operating expenses discussion introduces the effects of the Tax Cuts and Jobs Act, with a deeper discussion in Module 10.
  • Inventories Our discussion of cash conversion cycle includes an illustration of management actions undertaken by Home Depot to streamline its supply chain to reduce days inventory outstanding.
  • Bond rating A new section in Module 7 discusses Credit Analysis, including how bond ratings are determined. We provide an example of S&P Globals ratings for Verizon, following its purchase of Vodafones interest in Verizon Wireless. We also simplify our discussion of bond pricing.
  • Share-based compensation Module 8 includes an expanded discussion of share‑based compensation and Teslas use of convertible debt.
  • Investments We include a deeper discussion of the determination of fair value, including an expanded discussion of Level 3 inputs to value securities with limited markets and the accounting for those securities. Module 6 includes a new, expanded discussion of the new goodwill impairment standard.
  • Derivatives We markedly revised our discussion of derivatives to simplify the exposition while maintaining the analysis coverage.
  • Equity carve-outs The discussion of equity carve‑outs is simplified and we provide examples of the accounting for sell‑offs, IPOs, spin‑offs, and split‑offs. We also discuss the deconsolidation of a subsidiary.
  • Leasing Module 10 reflects the new lease standard including the analysis of right‑of‑use assets and differences between operating and financial leases. We discuss retrospective and prospective adoption, using Microsoft and Delta Airlines.
  • Pension disclosures We markedly revised our discussion of pension accounting with a detailed illustration of the pension footnote disclosures. We include a section on fair valuation of pension obligations and the accounting for plan settlements.
  • Taxes We provide an in‑depth, completely revised, discussion of income tax expense, including the effects of the Tax Cuts and Jobs Act and the analysis implications during the transition period.
  • Updated assignments We updated all data and financial statements throughout the book to reflect each companys latest available financial statement filings and disclosures. Assignments include current financial statement excerpts and reflect new standards for Revenue Recognition, Leases, and Marketable Securities and the Tax Cuts and Jobs Act.




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Expand/Collapse All
About the Authors (pg. iii)
Preface (pg. v)
Brief Contents (pg. xv)
Contents (pg. xvi)
Module 1 Framework for Analysis and Valuation (pg. 1-1)
Step 1 Business Environment and Accounting (pg. 1-5)
Review 1-1 (pg. 1-6)
Financial Statements: Demand and Supply (pg. 1-6)
Demand for Information (pg. 1-6)
Supply of Information (pg. 1-9)
International Accounting Standards (pg. 1-10)
Review 1-2 (pg. 1-11)
Review of Financial Statements (pg. 1-12)
Balance Sheet (pg. 1-12)
Income Statement (pg. 1-15)
Statement of Stockholders’ Equity (pg. 1-17)
Statement of Cash Flows (pg. 1-18)
Information Beyond Financial Statements (pg. 1-19)
Review 1-3 (pg. 1-19)
Analyzing the Business Environment (pg. 1-20)
Analyzing the Value-Chain (pg. 1-20)
Five-Forces Analysis of Business Environment (pg. 1-20)
SWOT Analysis of Business Environment (pg. 1-21)
Analyzing Competitive Advantage (pg. 1-22)
Review 1-4 (pg. 1-23)
Step 2 Adjusting and Analyzing Financial Data (pg. 1-24)
Managerial Choices in Financial Reporting (pg. 1-24)
Analysis of Return on Assets (pg. 1-25)
Components of Return on Assets (pg. 1-25)
Analysis of Return on Equity (pg. 1-26)
Review 1-5 (pg. 1-27)
Step 3 Forecasting Financial Numbers (pg. 1-27)
Review 1-6 (pg. 1-28)
Step 4 Business Valuation (pg. 1-29)
Valuation Models (pg. 1-29)
Are Financial Data Relevant? (pg. 1-29)
Financial Statement Analysis in an Efficient Capital Market (pg. 1-30)
Analyzing Global Reports (pg. 1-31)
Review 1-7 (pg. 1-32)
Appendix 1A: Financial Statement Data and Analytics (pg. 1-32)
SEC Filings (pg. 1-32)
Data Analytics (pg. 1-35)
Guidance Answer (pg. 1-36)
Questions (pg. 1-36)
Mini Exercises (pg. 1-37)
Exercises (pg. 1-39)
Problems (pg. 1-41)
IFRS Applications (pg. 1-47)
Analysis Decision Points (pg. 1-48)
Ongoing Analysis Project (pg. 1-48)
Solutions to Reviews (pg. 1-49)
Module 2 Review of Business Activities and Financial Statements (pg. 2-1)
Interpreting A Balance Sheet (pg. 2-3)
Assets (pg. 2-3)
Liabilities and Equity (pg. 2-5)
Review 2-1 (pg. 2-12)
Interpreting An Income Statement (pg. 2-12)
Recognizing Revenues and Expenses (pg. 2-13)
Reporting of Transitory Items (pg. 2-14)
Analyzing the Income Statement (pg. 2-16)
Review 2-2 (pg. 2-16)
Interpreting A Statement of Stockholders’ Equity (pg. 2-17)
Review 2-3 (pg. 2-18)
Interpreting A Statement of Cash Flows (pg. 2-18)
Statement Format and Data Sources (pg. 2-18)
Review 2-4 (pg. 2-19)
Articulation of Financial Statements (pg. 2-19)
Retained Earnings Reconciliation (pg. 2-20)
Financial Statement Linkages (pg. 2-20)
Review 2-5 (pg. 2-21)
Analyzing Transactions and Adjustments (pg. 2-22)
Four-Step Accounting Cycle (pg. 2-22)
Financial Statement Effects Template (pg. 2-22)
Accounting Cycle Step 1-Analyze Transactions and Prepare Entries (pg. 2-24)
Applying the Financial Statement Effects Template (pg. 2-24)
Applying the Journal Entry and T-Account (pg. 2-24)
Review 2-6 (pg. 2-26)
Accounting Cycle Step 2-Prepare Accounting Adjustments (pg. 2-27)
Prepaid (Deferred) Expenses (pg. 2-28)
Unearned (Deferred) Revenues (pg. 2-28)
Accrued Expenses (pg. 2-29)
Accrued Revenues (pg. 2-29)
Accounting Adjustments for Apple (pg. 2-30)
Review 2-7 (pg. 2-31)
Accounting Cycle Step 3-Prepare Financial Statements (pg. 2-31)
Review 2-8 (pg. 2-31)
Accounting Cycle Step 4-Close the Books (pg. 2-32)
Review 2-9 (pg. 2-32)
Additional Information Sources (pg. 2-32)
Form 10-K (pg. 2-32)
Form 20-F and Form 40-F (pg. 2-34)
Form 8-K (pg. 2-35)
Analyst Reports (pg. 2-35)
Credit Services (pg. 2-36)
Data Services (pg. 2-36)
Review 2-10 (pg. 2-36)
Analyzing Global Reports (pg. 2-36)
Guidance Answers (pg. 2-37)
Questions (pg. 2-37)
Mini Exercises (pg. 2-38)
Exercises (pg. 2-40)
Problems (pg. 2-46)
IFRS Application (pg. 2-51)
Analysis Discussion Points (pg. 2-52)
Ongoing Analysis Project (pg. 2-53)
Solutions to Reviews (pg. 2-53)
Module 3 Profitability Analysis and Interpretation (pg. 3-1)
Return on Equity (ROE) (pg. 3-3)
Review 3-1 (pg. 3-4)
ROE Disaggregation: DuPont Analysis (pg. 3-4)
Return on Assets (pg. 3-4)
Financial Leverage (FL) (pg. 3-5)
Review 3-2 (pg. 3-6)
Return on Assets and Its Disaggregation (pg. 3-6)
Analysis of Profitability and Productivity (pg. 3-7)
Analysis of Profitability (pg. 3-8)
Analysis of Productivity (pg. 3-9)
Analysis of Financial Leverage (pg. 3-12)
Review 3-3 (pg. 3-14)
Balance Sheet Analysis with an Operating Focus (pg. 3-15)
Return on Net Operating Assets (RNOA) (pg. 3-15)
Net Operating Assets (NOA) (pg. 3-16)
Net Nonoperating Obligations (NNO) (pg. 3-17)
Income Statement Analysis with an Operating Focus (pg. 3-19)
Review 3-4 (pg. 3-19)
Operating Line Items on the Income Statement (pg. 3-20)
Nonoperating Line Items on the Income Statement (pg. 3-20)
Net Nonoperating Expense (NNE) (pg. 3-23)
Review 3-5 (pg. 3-23)
Return on Net Operating Assets (RNOA) (pg. 3-24)
RNOA Disaggregation into Margin and Turnover (pg. 3-26)
Review 3-6 (pg. 3-26)
Net Operating Profit Margin (pg. 3-27)
Net Operating Asset Turnover (pg. 3-27)
Trade-Off between Margin and Turnover (pg. 3-28)
Review 3-7 (pg. 3-30)
Analyzing Global Reports (pg. 3-30)
Appendix 3A: Operating versus Nonoperating Classification (pg. 3-31)
Appendix 3B: Nonoperating Return Component of ROE (pg. 3-32)
Nonoperating Return (pg. 3-32)
Nonoperating Return- With Substantial Net Nonoperating Assets: Amazon (pg. 3-34)
Nonoperating Return- With Noncontrolling Interest: AT&T (pg. 3-35)
Review 3-8 (pg. 3-36)
Appendix 3C: Vertical and Horizontal Analysis (pg. 3-36)
Limitations of Ratio Analysis (pg. 3-37)
Review 3-9 (pg. 3-39)
Guidance Answer (pg. 3-40)
Questions (pg. 3-40)
Mini Exercises (pg. 3-40)
Exercises (pg. 3-44)
Problems (pg. 3-49)
IFRS Application (pg. 3-56)
Analysis Discussion Points (pg. 3-56)
Ongoing Analysis Project (pg. 3-57)
Solutions to Reviews (pg. 3-58)
Module 4 Credit Risk Analysis and Interpretation (pg. 4-1)
Market for Credit (pg. 4-3)
Demand for Credit (pg. 4-3)
Supply of Credit (pg. 4-4)
Review 4-1 (pg. 4-7)
Credit Risk Analysis Process (pg. 4-8)
Information for Credit Risk Analysis (pg. 4-8)
Chance of Default (pg. 4-9)
Loss Given Default (pg. 4-11)
Review 4-2 (pg. 4-13)
Measuring Credit Risk (pg. 4-13)
Adjusting Financial Information (pg. 4-14)
Profitability Analysis (pg. 4-15)
Coverage Analysis (pg. 4-17)
Liquidity Analysis (pg. 4-20)
Solvency Analysis (pg. 4-21)
Review 4-3 (pg. 4-24)
Credit Ratings (pg. 4-25)
Importance of Credit Ratings (pg. 4-27)
How Credit Ratings Are Determined (pg. 4-28)
Review 4-4 (pg. 4-33)
Predicting Bankruptcy Risk (pg. 4-33)
Altman Z-Score (pg. 4-33)
Application of Z-Score (pg. 4-34)
Bankruptcy Prediction Errors (pg. 4-34)
Review 4-5 (pg. 4-35)
Guidance Answers (pg. 4-35)
Questions (pg. 4-35)
Mini Exercises (pg. 4-36)
Exercises (pg. 4-38)
Problems (pg. 4-41)
IFRS Applications (pg. 4-46)
Analysis Discussion Point (pg. 4-49)
Ongoing Analysis Project (pg. 4-49)
Solutions to Reviews (pg. 4-50)
Module 5 Revenue Recognition and Operating Income (pg. 5-1)
Analyzing Revenue (pg. 5-3)
Revenue Recognition Rules (pg. 5-4)
Complications of Revenue Recognition (pg. 5-6)
Performance Obligations Satisfied Over Time (pg. 5-7)
Review 5-1 (pg. 5-11)
Analyzing Sales Allowances (pg. 5-12)
Accounting for Sales Allowances (pg. 5-12)
Reporting Sales Allowances (pg. 5-13)
Analysis of Sales Allowances (pg. 5-13)
Review 5-2 (pg. 5-15)
Analyzing Unearned (Deferred) Revenue (pg. 5-16)
Review 5-3 (pg. 5-17)
Foreign Currency Effects on Revenue, Expenses, and Cash Flow (pg. 5-18)
Foreign Currency and Cash Flows (pg. 5-18)
Foreign Currency and Income (pg. 5-19)
Foreign Currency and Future Results (pg. 5-19)
Review 5-4 (pg. 5-20)
Analyzing Accounts Receivable (pg. 5-21)
Aging Analysis of Receivables (pg. 5-21)
Accounting for Accounts Receivable (pg. 5-22)
Analysis of Accounts Receivable-Magnitude (pg. 5-23)
Analysis of Accounts Receivable-Quality (pg. 5-25)
Review 5-5 (pg. 5-27)
Analyzing Expenses and Losses (pg. 5-27)
Analyze Deductions from Income (pg. 5-27)
Analyze Research and Development Expense (pg. 5-28)
Provision (Benefit) for Taxes on Income (pg. 5-31)
Analyze Discontinued Operations (pg. 5-31)
Review 5-6 (pg. 5-33)
Pro Forma Income Reporting (pg. 5-34)
Regulation G Reconciliation (pg. 5-35)
SEC Warnings about Pro Forma Numbers (pg. 5-35)
Disclosures and Market Assessments (pg. 5-36)
Review 5-7 (pg. 5-38)
Analyzing Global Reports (pg. 5-39)
Guidance Answer (pg. 5-39)
Questions (pg. 5-39)
Mini Exercises (pg. 5-40)
Exercises (pg. 5-45)
Problems (pg. 5-52)
IFRS Applications (pg. 5-58)
Analysis Discussion Points (pg. 5-59)
Ongoing Analysis Project (pg. 5-59)
Solutions to Reviews (pg. 5-60)
Module 6 Inventories, Accounts Payable, and Long-Term Assets (pg. 6-1)
Analyzing Inventory-Costing Methods (pg. 6-3)
First-In, First-Out (FIFO) (pg. 6-5)
Last-In, First-Out (LIFO) (pg. 6-5)
Average Cost (AC) (pg. 6-5)
Financial Statement Effects of Inventory Costing (pg. 6-7)
Review 6-1 (pg. 6-8)
Analyzing Inventory-Reporting (pg. 6-9)
Lower of Cost or Market (LCM) (pg. 6-9)
LIFO Reserve Adjustments to Financial Statements (pg. 6-10)
LIFO Liquidations (pg. 6-11)
Review 6-2 (pg. 6-13)
Analyzing Inventory-Tools (pg. 6-14)
Gross Profit Analysis (pg. 6-14)
Days Inventory Outstanding and Inventory Turnover (pg. 6-15)
Days Payable Outstanding (pg. 6-17)
Cash Conversion Cycle (pg. 6-18)
Review 6-3 (pg. 6-19)
Analyzing PPE Assets-Capitalization and Depreciation (pg. 6-20)
Plant and Equipment (pg. 6-20)
Research and Development Facilities and Equipment (pg. 6-22)
Review 6-4 (pg. 6-22)
Analyzing PPE Assets-Sales, Impairments, and Restructuring (pg. 6-23)
Asset Sales (pg. 6-23)
Asset Impairments (pg. 6-24)
Restructuring Costs (pg. 6-25)
Review 6-5 (pg. 6-30)
Analyzing PPE Assets-Tools (pg. 6-31)
PPE Turnover (pg. 6-31)
PPE Useful Life (pg. 6-32)
PPE Percent Used Up (pg. 6-33)
Review 6-6 (pg. 6-33)
Analyzing Global Reports (pg. 6-33)
Guidance Answers (pg. 6-34)
Questions (pg. 6-35)
Mini Exercises (pg. 6-36)
Exercises (pg. 6-38)
Problems (pg. 6-45)
IFRS Applications (pg. 6-48)
Analysis Discussion Points (pg. 6-49)
Ongoing Analysis Project (pg. 6-50)
Solutions to Reviews (pg. 6-50)
Module 7 Liability Recognition and Nonowner Financing (pg. 7-1)
Analyzing Accrued Liabilities (pg. 7-3)
Accrued Liabilities Defined (pg. 7-3)
Accruals for Contractual Liabilities-Wages Payable Example (pg. 7-4)
Accruals for Contractual Liabilities-Deferred Revenue Example (pg. 7-5)
Accruals for Contingent Liabilities Defined (pg. 7-5)
Accruals for Contingent Liabilities-Warranties Example (pg. 7-5)
Review 7-1 (pg. 7-8)
Analyzing Short-Term Debt (pg. 7-9)
Reporting for Short-Term Debt (pg. 7-9)
Current Maturities of Long-Term Debt (pg. 7-10)
Analyzing Long-Term Debt-Pricing (pg. 7-10)
Pricing of Bonds Issued at Par (pg. 7-11)
Pricing of Bonds Issued at a Discount (pg. 7-12)
Pricing of Bonds Issued at a Premium (pg. 7-12)
Effective Cost of Debt (pg. 7-13)
Review 7-3 (pg. 7-14)
Analyzing Long-Term Debt-Reporting (pg. 7-15)
Balance Sheet Reporting (pg. 7-15)
Income Statement Reporting (pg. 7-16)
Financial Statement Effects of Bond Repurchase (pg. 7-16)
Fair Value Disclosures (pg. 7-17)
Review 7-4 (pg. 7-18)
Analyzing Credit Quality (pg. 7-18)
Credit Analysis (pg. 7-18)
Credit Ratings (pg. 7-19)
Why Credit Ratings Matter (pg. 7-20)
Review 7-5 (pg. 7-23)
Analyzing Global Reports (pg. 7-23)
Appendix 7A: Time Value of Money (pg. 7-24)
Present Value Concepts (pg. 7-24)
Future Value Concepts (pg. 7-29)
Appendix 7B: Amortization of Debt (pg. 7-30)
Amortization of Discount (pg. 7-30)
Amortization of Premium (pg. 7-31)
Guidance Answer (pg. 7-31)
Questions (pg. 7-32)
Mini Exercises (pg. 7-32)
Exercises (pg. 7-35)
Problems (pg. 7-40)
IFRS Applications (pg. 7-45)
Analysis Discussion Points (pg. 7-46)
Ongoing Analysis Project (pg. 7-46)
Solutions to Reviews (pg. 7-47)
Module 8 Equity Recognition and Owner Financing (pg. 8-1)
Analyzing Stockholders’ Equity and Classes of Stock (pg. 8-3)
Stockholders’ Equity Accounts (pg. 8-3)
Statement of Stockholders’ Equity (pg. 8-6)
Preferred Stock (pg. 8-7)
Common Stock (pg. 8-8)
Review 8-1 (pg. 8-9)
Analyzing Stock Transactions (pg. 8-10)
Stock Issuance (pg. 8-10)
Stock Repurchase (Treasury Stock) (pg. 8-11)
Review 8-2 (pg. 8-14)
Analyzing Stock-Based Compensation (pg. 8-14)
Characteristics of Stock-Based Compensation Plans (pg. 8-15)
Analysis of Stock-Based Compensation Plans (pg. 8-15)
Accounting for Stock-Based Compensation (pg. 8-16)
Footnote Disclosures for Stock-Based Compensation (pg. 8-17)
Review 8-3 (pg. 8-18)
Analyzing Dividends and Stock Splits (pg. 8-19)
Cash Dividend Disclosures (pg. 8-19)
Dividend Payout and Yield (pg. 8-19)
Cash Dividends Financial Effects (pg. 8-20)
Stock Split (pg. 8-20)
Review 8-4 (pg. 8-21)
Analyzing Accumulated Other Comprehensive Income (AOCI) (pg. 8-21)
AOCI Components (pg. 8-21)
AOCI Disclosures and Interpretation (pg. 8-22)
Review 8-5 (pg. 8-24)
Analyzing Convertible Securities (pg. 8-24)
Review 8-6 (pg. 8-25)
Analyzing Earnings per Share (EPS) (pg. 8-26)
Review 8-7 (pg. 8-27)
Analyzing Global Reports (pg. 8-28)
Appendix 8A: Stock-Based Compensation: Reporting and Analyzing (pg. 8-29)
Employee Stock Purchase Plans (ESPP) (pg. 8-29)
Stock Awards (pg. 8-29)
Stock Options (pg. 8-29)
Stock Appreciation Rights (SAR) (pg. 8-30)
Summary of Share-Based Compensation (pg. 8-30)
Analysis Implications (pg. 8-31)
Guidance Answer (pg. 8-32)
Questions (pg. 8-32)
Mini Exercises (pg. 8-33)
Exercises (pg. 8-36)
Problems (pg. 8-42)
IFRS Applications (pg. 8-51)
Ongoing Analysis Project (pg. 8-53)
Solutions to Reviews (pg. 8-53)
Module 9 Intercorporate Investments (pg. 9-1)
Analyzing Intercorporate Investments (pg. 9-3)
Passive Investments in Equity Securities (pg. 9-4)
Investments in Debt Securities (pg. 9-8)
Analyzing Equity Investments with Significant Influence (pg. 9-12)
Investments with Significant Influence (pg. 9-12)
Equity Method Accounting and ROE Effects (pg. 9-14)
Review 9-2 (pg. 9-19)
Analyzing Equity Investments with Control (pg. 9-19)
Investments with Control (pg. 9-19)
Review 9-3 (pg. 9-30)
Analyzing Global Reports (pg. 9-31)
Appendix 9A: Analyzing Derivatives (pg. 9-32)
Analysis of Derivatives (pg. 9-34)
Review 9-4 (pg. 9-34)
Appendix 9B: Analyzing Equity Carve-Outs (pg. 9-35)
Analysis of Equity Carve-Outs (pg. 9-39)
Guidance Answer (pg. 9-40)
Questions (pg. 9-40)
Mini Exercises (pg. 9-40)
Exercises (pg. 9-44)
Problems (pg. 9-54)
IFRS Applications (pg. 9-57)
Analysis Discussion Point (pg. 9-58)
Ongoing Analysis Project (pg. 9-59)
Solutions to Reviews (pg. 9-60)
Module 10 Analyzing Leases, Pensions, and Taxes (pg. 10-1)
Analyzing Leases (pg. 10-3)
New Lease Reporting Standard (pg. 10-3)
Lessee Reporting Example-Microsoft Corporation (pg. 10-4)
Lease Accounting (pg. 10-6)
Summary of Lease Accounting and Reporting (pg. 10-10)
Analysis Issues Relating to Leases (pg. 10-11)
Review 10-1 (pg. 10-12)
Analyzing Pensions (pg. 10-13)
Defined Benefit Pension Plans on the Balance Sheet (pg. 10-13)
Analysis Issue-Sufficiency of Plan Assets to Pay Pension Obligations (pg. 10-15)
Defined Benefit Pension Plans on the Income Statement (pg. 10-16)
Pension Expense Smoothing (pg. 10-17)
Fair Value Accounting for Pensions (pg. 10-21)
Footnote Disclosure-Key Assumptions (pg. 10-23)
Analysis Implications (pg. 10-23)
Other Post-Employment Benefits (OPEB) (pg. 10-25)
Review 10-2 (pg. 10-26)
Analyzing Income Taxes (pg. 10-27)
Timing Differences Create Deferred Tax Assets and Liabilities (pg. 10-27)
Disclosures for Income Taxes (pg. 10-31)
Analysis of Income Tax Disclosures (pg. 10-32)
Expanded Explanation of Deferred Taxes (pg. 10-33)
Review 10-3 (pg. 10-37)
Analyzing Global Reports (pg. 10-38)
Appendix 10A: Lease Accounting Example- Finance and Operating Leases (pg. 10-39)
Questions (pg. 10-40)
Mini Exercises (pg. 10-40)
Exercises (pg. 10-45)
Problems (pg. 10-54)
IFRS Applications (pg. 10-64)
Ongoing Analysis Project (pg. 10-65)
Solutions to Reviews (pg. 10-66)
Module 11 Financial Statement Forecasting (pg. 11-1)
Forecasting Process (pg. 11-3)
Company Guidance (pg. 11-6)
Review 11-1 (pg. 11-7)
Forecasting the Income Statement (pg. 11-9)
Review 11-2 (pg. 11-12)
Forecasting the Balance Sheet (pg. 11-13)
Review 11-3 (pg. 11-17)
Building Forecasts from the Bottom Up (pg. 11-17)
Segment Data (pg. 11-17)
Review 11-4 (pg. 11-19)
Appendix 11A: Forecasting the Statement of Cash Flows (pg. 11-19)
Review 11-5 (pg. 11-21)
Appendix 11B: Multiyear Forecasting with Target Cash and New Debt Financing (pg. 11-21)
Review 11-6 (pg. 11-23)
Appendix 11C: Parsimonious Method for Forecasting NOPAT and NOA (pg. 11-23)
Multiyear Forecasting with Parsimonious Method (pg. 11-23)
Review 11-7 (pg. 11-24)
Appendix 11D: Morgan Stanley’s Forecast Report on Procter & Gamble (pg. 11-24)
Questions (pg. 11-32)
Mini Exercises (pg. 11-32)
Exercises (pg. 11-38)
Problems (pg. 11-45)
Ongoing Analysis Project (pg. 11-51)
Solutions to Reviews (pg. 11-52)
Module 12 Cost of Capital and Valuation Basics (pg. 12-1)
Basics of Valuation (pg. 12-3)
Payoffs from Equity and Debt Instruments (pg. 12-4)
Steps in Stock Valuation (pg. 12-4)
Intrinsic Value (pg. 12-5)
Review of Time Value of Money (pg. 12-6)
Valuation of a Debt Instrument (pg. 12-9)
Valuation of an Equity Instrument (pg. 12-9)
Estimating Cost of Capital (pg. 12-10)
Diversifiable and Non-Diversifiable Risk (pg. 12-11)
Review 12-1 (pg. 12-11)
Cost of Equity Capital Using the Capital Asset Pricing Model (pg. 12-12)
Cost of Equity Capital Using a Multi-Factor Model (pg. 12-13)
Review 12-2 (pg. 12-14)
Cost of Debt Capital (pg. 12-14)
Review 12-3 (pg. 12-16)
Weighted Average Cost of Capital (pg. 12-16)
Review 12-4 (pg. 12-18)
Dividend Discount Model (pg. 12-18)
Recursive Process of Valuation (pg. 12-18)
Framework of the Dividend Discount Model (pg. 12-19)
Dividend Discount Model with Constant Perpetuity (pg. 12-19)
Review 12-5 (pg. 12-20)
Dividend Discount Model with Increasing Perpetuity (pg. 12-20)
Issues in Applying the Dividend Discount Model (pg. 12-21)
Review 12-6 (pg. 12-23)
Appendix 12A: Estimating Cost of Equity Capital (pg. 12-23)
Guidance Answer (pg. 12-28)
Questions (pg. 12-29)
Mini Exercises (pg. 12-29)
Exercises (pg. 12-30)
Problems (pg. 12-31)
Analysis Discussion Points (pg. 12-34)
Ongoing Analysis Project (pg. 12-36)
Solutions to Reviews (pg. 12-37)
Module 13 Cash-Flow-Based Valuation (pg. 13-1)
Equity Valuation Models (pg. 13-3)
Dividend Discount Model (pg. 13-3)
Discounted Cash Flow Model (pg. 13-4)
Residual Operating Income Model (pg. 13-4)
Model Equivalency (pg. 13-4)
Valuation Model Inputs (pg. 13-4)
Review 13-1 (pg. 13-6)
Discounted Cash Flow (DCF) Model (pg. 13-6)
DCF Model Structure (pg. 13-6)
Steps in Applying the DCF Model (pg. 13-7)
Illustrating the DCF Model (pg. 13-8)
Extending the DCF Model (pg. 13-9)
Analyzing Global Reports (pg. 13-15)
Review 13-2 (pg. 13-15)
Appendix 13A: Financial Statements for Procter & Gamble (pg. 13-16)
Appendix 13B: Derivation of Free Cash Flow Formula (pg. 13-18)
Appendix 13C: Deutsche Bank Valuation of Procter & Gamble (pg. 13-18)
Guidance Answer (pg. 13-29)
Questions (pg. 13-29)
Mini Exercises (pg. 13-29)
Exercises (pg. 13-30)
Problems (pg. 13-33)
Analysis Discussion Point (pg. 13-37)
Ongoing Analysis Project (pg. 13-37)
Solutions to Reviews (pg. 13-38)
Module 14 Operating-Income-Based Valuation (pg. 14-1)
Equity Valuation Models (pg. 14-3)
Dividend Discount Model (pg. 14-3)
Discounted Cash Flow Model (pg. 14-4)
Residual Operating Income Model (pg. 14-4)
Model Equivalency (pg. 14-4)
Valuation Model Inputs (pg. 14-5)
Review 14-1 (pg. 14-6)
Residual Operating Income (ROPI) Model (pg. 14-6)
ROPI Model Structure (pg. 14-6)
Steps in Applying the ROPI Model (pg. 14-7)
Illustrating the ROPI Model (pg. 14-8)
Extending the ROPI Model (pg. 14-10)
Review 14-2 (pg. 14-11)
Steady State in Valuation (pg. 14-11)
Multi-Year Forecast Precision (pg. 14-12)
Achieving Steady State (pg. 14-12)
Forecasting Steady State-An Illustration (pg. 14-13)
Review 14-3 (pg. 14-15)
Managerial Insights from the ROPI Model (pg. 14-15)
Management Focus on Improved Efficiency (pg. 14-15)
Management Focus on Improved Profitability (pg. 14-16)
Assessment of Valuation Models (pg. 14-16)
Analyzing Global Reports (pg. 14-17)
Review 14-4 (pg. 14-18)
Appendix 14A: P&G Financial Statements (pg. 14-18)
Guidance Answer (pg. 14-20)
Questions (pg. 14-21)
Mini Exercises (pg. 14-21)
Exercises (pg. 14-23)
Problems (pg. 14-26)
Analysis Discussion Point (pg. 14-30)
Ongoing Analysis Project (pg. 14-31)
Solutions to Reviews (pg. 14-32)
Module 15 Market-Based Valuation (pg. 15-1)
Valuation Model Using Market Multiples (pg. 15-3)
Application of the Model Using Market Multiples (pg. 15-4)
Valuation Using Balance Sheet Multiples (pg. 15-5)
Valuation Using a Net Operating Asset (NOA) Multiple (pg. 15-6)
Valuation Using a Book Value (BV) Multiple (pg. 15-6)
Review 15-1 (pg. 15-8)
Valuation Using Income Statement Multiples (pg. 15-8)
Valuation Using a Net Operating Profit After Tax (NOPAT) Multiple (pg. 15-9)
Valuation Using a Net Income (NI) Multiple (pg. 15-10)
Valuation Using Industry-Based Multiples (pg. 15-11)
Combining Estimates from Differing Multiples (pg. 15-11)
Review 15-2 (pg. 15-12)
Selecting Comparables for Market Multiples (pg. 15-12)
Deriving Price-to-Book from Residual Operating Income Model (pg. 15-13)
PB Ratios in Relation to Profitability, Growth, and Risk (pg. 15-13)
Deriving Price-to-Earnings from Residual Operating Income Model (pg. 15-16)
PE Ratios in Relation to Profitability, Growth, and Risk (pg. 15-17)
Review 15-3 (pg. 15-18)
Interpreting and Reverse Engineering Market Multiples (pg. 15-19)
Interpreting and Reverse Engineering the PB Ratio (pg. 15-19)
Interpreting and Reverse Engineering the PE Ratio (pg. 15-21)
Perspective on Valuation Multiples and Fundamental Analysis (pg. 15-21)
Review 15-4 (pg. 15-22)
Guidance Answer (pg. 15-23)
Questions (pg. 15-23)
Mini Exercises (pg. 15-24)
Exercises (pg. 15-26)
Problems (pg. 15-30)
Analysis Discussion Points (pg. 15-34)
Ongoing Analysis Project (pg. 15-37)
Solutions to Reviews (pg. 15-37)
Appendix A Compound Interest Tables (pg. A-1)
Appendix B Computing and Analyzing Cash Flows (pg. B-1)
Framework for Statement of Cash Flows (pg. B-3)
Relation Among Financial Statements (pg. B-3)
Statement of Cash Flows Structure (pg. B-4)
Operating Activities Preview (pg. B-7)
Investing Activities Preview (pg. B-8)
Financing Activities Preview (pg. B-8)
Review B-1 (pg. B-9)
Cash Flow from Operating Activities (pg. B-9)
Steps to Compute Net Cash Flow from Operating Activities (pg. B-10)
Java House Case Illustration (pg. B-12)
Review B-2 (pg. B-15)
Computing Cash Flows from Investing Activities (pg. B-16)
Analyze Remaining Noncash Assets (pg. B-16)
Java House Case Illustration (pg. B-16)
Review B-3 (pg. B-18)
Cash Flows from Financing Activities (pg. B-18)
Analyze Remaining Liabilities and Equity (pg. B-18)
Java House Case Illustration (pg. B-18)
Review B-4 (pg. B-19)
Computing Cash Flows from Balance Sheet Accounts (pg. B-19)
Supplemental Disclosures for Indirect Method (pg. B-20)
Review B-5 (pg. B-21)
Analysis of Cash Flow Information (pg. B-21)
Cash Flow Components (pg. B-21)
Cash Flow Patterns (pg. B-23)
Usefulness of the Statement of Cash Flows (pg. B-25)
Review B-6 (pg. B-27)
Ratio Analyses of Cash Flows (pg. B-27)
Free Cash Flow (pg. B-28)
Review B-7 (pg. B-29)
Appendix BB: Direct Method Reporting for Statement of Cash Flows (pg. B-29)
Cash Flows from Operating Activities (pg. B-29)
Converting Revenues and Expenses to Cash Flows (pg. B-29)
Java House Case Illustration (pg. B-30)
Convert Sales to Cash Received from Customers (pg. B-30)
Convert Cost of Goods Sold to Cash Paid for Merchandise Purchased (pg. B-30)
Convert Wages Expense to Cash Paid to Employees (pg. B-31)
Convert Insurance Expense to Cash Paid for Insurance (pg. B-31)
Eliminate Depreciation Expense and Other Noncash Operating Expenses (pg. B-31)
Convert Income Tax Expense to Cash Paid for Income Taxes (pg. B-31)
Omit Gains and Losses Related to Investing and Financing Activities (pg. B-31)
Cash Flows from Investing and Financing (pg. B-32)
Supplemental Disclosures (pg. B-32)
Review B-8 (pg. B-32)
Guidance Answer (pg. B-32)
Questions (pg. B-33)
Mini Exercises (pg. B-34)
Exercises (pg. B-37)
Problems (pg. B-42)
IFRS Application (pg. B-55)
Solutions to Reviews (pg. B-56)
Appendix C Comprehensive Case (pg. C-1)
Reviewing Financial Statements (pg. C-3)
Business Environment for Financial Reporting (pg. C-3)
Income Statement Reporting and Analysis (pg. C-4)
Balance Sheet Reporting and Analysis (pg. C-9)
Statement of Cash Flows Reporting and Analysis (pg. C-22)
Independent Audit Opinion (pg. C-23)
Assessing Profitability and Creditworthiness (pg. C-24)
ROE Disaggregation-DuPont Analysis (pg. C-24)
ROE Disaggregation-Operating Focus (pg. C-26)
Disaggregation of RNOA-Margin and Turnover (pg. C-26)
Credit Analysis (pg. C-27)
Summarizing Profitability and Creditworthiness (pg. C-28)
Forecasting Financial Statements (pg. C-28)
Valuing Equity Securities (pg. C-31)
Discounted Cash Flow Valuation (pg. C-32)
Residual Operating Income Valuation (pg. C-33)
Assessment of the Valuation Estimate (pg. C-34)
Summary Observations (pg. C-34)
Appendix D Chart of Accounts (with Acronyms) (pg. D-1)
Glossary (pg. G-1)
Index (pg. I-1)
Peter D. Easton

Peter D. Easton

Peter D. Easton is an expert in accounting and valuation and holds the Notre Dame Alumni Chair in Accountancy in the Mendoza College of Business.

Professor Easton’s expertise is widely recognized by the academic research community and by the legal community. Professor Easton frequently serves as a consultant on accounting and valuation issues in federal and state courts.

Professor Easton holds undergraduate degrees from the University of Adelaide and the University of South Australia. He holds a graduate degree from the University of New England and a PhD in Business Administration (majoring in accounting and finance) from the University of California, Berkeley.

Professor Easton’s research on corporate valuation has been published in the Journal of Accounting and Economics, Journal of Accounting Research, The Accounting Review, Contemporary Accounting Research, Review of Accounting Studies, and Journal of Business Finance and Accounting.

Professor Easton has served as an associate editor for 11 leading accounting journals and he is currently an associate editor for the Journal of Accounting Research, Journal of Business Finance and Accounting, and Journal of Accounting, Auditing, and Finance. He is an editor of the Review of Accounting Studies.

Professor Easton has held appointments at the University of Chicago, the University of California at Berkeley, Ohio State University, Macquarie University, the Australian Graduate School of Management, the University of Melbourne, Tilburg University, National University of Singapore, Seoul National University, and Nyenrode University. He is the recipient of numerous awards for excellence in teaching and in research. Professor Easton regularly teaches accounting analysis and security valuation to MBAs. In addition, Professor Easton has taught managerial accounting at the graduate level.


Mary Lea McAnally

Mary Lea McAnally

Mary Lea McAnally is the Philip Ljundahl Professor of Accounting at the Mays Business School at Texas A&M. She obtained her Ph.D. from Stanford University and B. Comm. from the University of Alberta.

She worked as a Chartered Accountant (in Canada) and is a Certified Internal Auditor. Prior to arriving at Texas A&M in 2002, Professor McAnally held positions at University of Texas at Austin, Canadian National Railways, and Dunwoody and Company.

Her research interests include accounting and disclosure in regulated environments, executive compensation, and accounting for risk. She has published articles in the leading academic journals including Journal of Accounting and Economics, Journal of Accounting Research, The Accounting Review, Review of Accounting Studies, and Contemporary Accounting Research. Professor McAnally received the Mays Business School Research Achievement Award in 2005. She was Associate Editor at Accounting Horizons, served on the editorial board of Contemporary Accounting Research, and was Guest Editor for the MBA-teaching volume of Issues in Accounting Education. She is active in the American Accounting Association and its FARS section.

At Texas A&M, Professor McAnally teaches financial reporting, analysis, and valuation in the full-time, Professional, and Executive MBA programs. Through the Mays Center for Executive Development, she works with corporate clients. She has also taught at University of Alberta, University of Calgary, IMADEC (in Austria) and at the Indian School of Business at the Hyderabad and Mohali campuses. She has received numerous faculty-determined and student-initiated teaching awards at the MBA and executive levels. Those awards include the Beazley Award, the Trammell Foundation Award, the MBA Teaching Award (multiple times), the MBA Association Distinguished Faculty Award (three times), the Award for Outstanding and Memorable Faculty Member, and the Distinguished Achievement Award.


Gregory A. Sommers

Gregory A. Sommers

Gregory A. Sommers is Director of the Master of Science in Accounting program and Professor of Practice in Accounting in the Edwin L. Cox School of Business at Southern Methodist University.

He holds an undergraduate degree in accounting from Fresno Pacific University and a PhD in Accounting and Management Information Systems from The Ohio State University. Professor Sommers is a Certified Public Accountant who practiced in and continues to be licensed in California.

Professor Sommers’ research focuses on market-based empirical studies of the relations between currently available accounting data, expectations of future accounting data, expected cost of capital and valuation. His research has been published in Journal of Accounting Research and Journal of Business, Finance, and Accounting. Professor Sommers serves on the editorial board of Review of Accounting Studies.

Professor Sommers teaches financial accounting, including international accounting, in the undergraduate and graduate programs as well as in executive education at Southern Methodist University. He has taught financial statement analysis and valuation for over ten years at the graduate level and his teaching materials were previously utilized as resources for another textbook in this area. Professor Sommers’ teaching has earned him numerous awards including Outstanding MBA Teaching as well as recognition from student organizations.

Professor Sommers is an active member of the American Accounting Association and its Financial Accounting and Reporting Section. He has served as chairman of the Trueblood Seminar for Professors sponsored by Deloitte. Professor Sommers is recognized as an expert in the areas of financial reporting, financial analysis, estimation of cost of capital, and business valuation.


Student
Errata
Last Updated: Sep 16 2020

Corrections to identified errors in the text.

Appendix C
Last Updated: Jul 13 2020

Appendix C:  Comprehensive Case / Harley-Davidson

Excel Templates - Students
Last Updated: Sep 16 2020

Excel templates for use with Module Reviews.

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