(Moore) Draft 2 Requirements – Valuation Project Updated Feb. 2017
Draft 2 Requirements
Formal Accounting Analysis
Structure of the Formal Accounting Analysis
1. Write an introduction that transitions from Industry and Strategy analysis (Draft 1) to an analysis of absolute and relative levels of disclosure (10-k; investor relations; etc.).
a. Main issue is whether or not firms provide decision useful information that you, the outside analysts, can use to judge the success of the firm (achieving desired outcomes identified in draft 1).
b. How transparent is the financial disclosure within the industry and for the firm you are valuing?
c. Are there significant items on the financial reports that potentially distort your view of the financial performance of the firm (Type 2 Key accounting policies)?
2. Discuss Key Accounting Policies (Type 1 and Type 2). What are they and why should I (you) care? Type 1 Key accounting policies must be directly linked to the Key Success Factors (KSF’s) identified and discussed in the first draft.
a. These are NOT the “boilerplate” significant accounting policies listed in the supplementary disclosure of the 10-K.
b. KAP’s regard disclosure related to those items you found to be significant either in terms of activities that drive (create) corporate value via the KSF’s identified in draft 1 or significant asset or liability items that materially affect the user’s view of the company.
c. This means that depreciation methods and inventory accounting methods are typically NOT considered KAP’s for the purpose of this analysis.
3. Assess the degree to which material potentially distortive items exist in the financial report. (Discuss Type 2 Key Accounting Policies).
a. Significant asset and liability items can include (and are not limited to) the extent, relative mix and use of operating vs. capital leases; defined benefit plan pension liabilities (and expenses) as they are based on actuarial assumptions; commodity, interest-rate, and currency derivative risk management exposure, disclosure and assumptions; Off balance-sheet collateralized debt obligations; etc.
b. In this section, you must provide preliminary analysis as to whether material and significant distortive items exist for the firm your group is valuing. The criteria for restatement must be examined for each of the past 5 years. These criteria immediately follow.
i. Goodwill > 30% of Net Fixed Assets
ii. Goodwill Impairment eliminates > 30% Operating Income
iii. R&D expense reduces operating income by more than 20%
iv. Capitalized Operating Leases would increase non-current liabilities by more than 20%
· If the boundaries above are exceeded, then you must prepare restated financial statements in good form for the entire 5 or 6 previous years. In this section of the draft, just state whether boundaries are violated. Provide a summary table presenting evidence of whether a violation exists or not. You will restate the financials later in this draft.
4. Evaluate Actual Accounting Strategy
· Accounting strategy includes two basic dimensions:
o First, you need to assess whether your company is a high disclosure company (levels of dis-aggregation, segment reporting, extensive discussion and disclosure within the financial report related to those items you find important in assessing value) vs. low disclosure (minimal reporting that satisfies GAAP).
o Second, you need to assess (within the confines of accounting flexibility on the KAP’s whether the company is conservative (leads to lower reported earning) or aggressive (leads to higher reported earnings) in its choice of accounting policies. Make sure to do this on an absolute and relative basis.
5. Evaluate the Quality of Disclosure
· Qualitative Analysis
o This is essentially a matter of opinion (logical argumentation) that is grounded in supportive facts that lead to your conclusion. Main issue is overall transparency and decision usefulness of the financial reporting information. Ultimately, does the financial information presented by the company provide sufficient decision useful information that satisfies your information needs (level of disclosure, discussion, analysis, dis-aggregation, appropriate segment disclosure, etc. This analysis should be prepared on both an absolute and relative basis.
Item 6. Undo Accounting Distortions
· Should you determine that significant balance sheet and income statement items are materially misstated (for the purpose of your analysis), then restate the financial statements based upon your analysis.
· Items for restatement consideration:
i. R&D
ii. Goodwill
iii. Operating Leases
· Defined benefit plans can’t be restated but assumptions should be analyzed for reasonableness.
· If you restate the financial, you MUST provide commentary as to how this affects your view of the firm.