Instructor: Robert Ricketts

ACCT 5301—Summer 2013

Syllabus

Instructor: Robert Ricketts

BA E367

806-834-3180

http://rricketts.ba.ttu.edu

Course Objectives:

The purpose of this course is to learn how common business transactions are measured and reported in financial statements, and how the process of measurement and reporting affects how business is conducted. Accounting measurement makes extensive use of estimates and judgment, with the result that some flexibility is available with respect to the reported figures. We will explore how the use of different measurement methods will affect the reported financial numbers, and how such methods potentially affect the business strategies and decisions. Ultimately, our goal is to develop the understanding necessary to recognize how different measurement methods will influence the data being used to make decisions, with the goal of being able to see through measurement differences to reach the best decision.

Course Grade:

Assignments will be provided after each weekend. The final grade will be based on the arithmetical mean of the score on these two assignments. Late submissions are strongly discouraged and will not be accepted without advance approval. Final grades will be assigned in December 2013.
Assignments Weekend 1

The following are a series of short-answer questions. Your answers must go beyond merely providing a numerical estimate—discussion of what the answer means from a business perspective is required. But the discussion should be relatively brief. Prepare a written document (in Word) summarizing your answers and analysis for each of the following questions. This will take some time. You will have to read large portions of the book, for example. You can email me with clarification questions if you wish (). Please submit your analysis by Friday, August 23rd. Be prepared to discuss your analysis in class. See you in August!

1. Evaluating Business Performance and Making Financial Decisions

Read Chapter 2 and work the Review Problem on page 63. You can check your own answers on pp. 75-76. Now open the 2012 Annual Report for Ford Motor Company (http://corporate.ford.com/doc/ar2012-2012%20Annual%20Report.pdf) and write short answers to the following questions.

a.  Begin with the company’s Income Statement on pages 64 and 65 of the annual report. How does Ford make money?

b.  Which of the company’s two divisions has the highest return on sales (or revenues in the case of Financial Services)? Would this comparison be sufficient to support a recommendation that the company focus its short-term growth efforts on the financial services activity?

c.  Now turn to the company's balance sheet (p. 66). By how much did the company's assets increase in 2012 relative to 2011? How about its total liabilities? What does this mean?

i. What portion of Ford's assets is effectively financed by debt? (Compute the debt:assets ratio).

ii. Looking at this question from a different perspective, for every dollar of equity, how many dollars of debt does Ford have? (Compute the debt:equity ratio).

iii. Now compute what is called the current ratio, which is defined as current assets ÷ current liabilities. Refer to the balance sheets we reviewed in class to answer this question (I worked through the footnotes to divide the company's assets and liabilities into current and long-term on the class handouts). What do you think this ratio measures? Where would you place this ratio on a scale from 1 (very comforting, nothing to be alarmed about) to 7 (sound the alarm, the company may not be able to pay its bills next year!). Explain (briefly).

d. Is Ford's inventory shrinking or growing? What about its accounts receivable? Ignore finance receivables (which should grow with sales and leasing activities), and focus on "Other Receivables," which likely consists of receivables from the company's distributor network. Does growth in inventory and receivables for a company like Ford seem like a good or bad trend? Explain.

e. Let's turn to the company's overall profitability. Compute Ford's return on assets and return on equity. In computing return on assets, use 27% as the company's effective tax rate (tax expense divided by income before taxes). For both ROA and ROE, use the average of the beginning of the year and year-end figures for total assets and total equity. (Think about why this is more appropriate than using end-of-year amounts).

i. How does Ford's ROA compare with its ROE? Who is capturing the greatest share of Ford's income--stockholders or creditors? Explain.

ii. Using the formula at the bottom of page 59 in your textbook, break Ford's return on equity into return on sales, asset turnover, and financial leverage. How much of the return on equity is attributable to leverage? Illustrate your answer by recomputing ROE holding the first two components constant, but reducing leverage by half. Similarly, consider how Ford's ROE will change if interest rates increase. (You do not need to repeat the 3-component analysis. Your answer will require you to recompute net income under the assumption that interest expense were higher--say double the actual amount for 2012--and divide the result by average shareholder's equity as you did in question i).

iii. Considering your answers to question c and e (ii) above, what does your analysis say about risk and return?

2. Cash vs. Net Income

Read Chapter 3 and work the Review Problem on page 101. Answer the following questions using the 2012 Annual Report for Ford Motor Company.

a. The Statement of Cash Flows reconciles the change in cash balances from the beginning to the end of the year. One step in this reconciliation is to reconcile net income from the Income Statement with the change in cash from operating activities.

i. Where do you find the detailed explanation of cash flow from operating activities in Ford's financial statements?

ii. How do the company's cash flows from operations compare to its reported net income? Is this a sign of strength or weakness?

iii. What are the two biggest reasons that operating cash flows exceed reported net income?

iv. Why does the company add depreciation back to net income in computing operating cash flows?

v. Why didn't the company have to pay all of its reported income tax in 2012?

b. See Note 1 for an explanation of the difference between operating cash flows in the consolidated statement and the figure in the detailed summary of operating cash flows provided in Note 27. It is likely that the adjustments in Note 1 were required by the company's external auditors (who are they?). Why do you imagine the company did not make this adjustment in footnote 27?

c. Compute the company's operating cash flow to current liabilities ratio (p. 92 in your text). For operating cash flow, use the operating cash flow figure from the consolidated cash flow statement and current liabilities from the summary balance sheet handed out in class.

d. Compute the company's discretionary cash flows (bottom of p. 93 in your textbook) using only the short-term portion of Debt payable from the balance sheet handed out in class. Do these two ratios raise any concerns in your mind? In answering this question, consider the information provided by management on page ii of the report (Highlights).

e. Does the fact that the company paid dividends in 2012 potentially provide any information regarding management's concerns with regard to the ratios you computed in questions c and d above?

3. Revenue Recognition

Read Chapter 5.

a.  Review the discussion in Note 2 (p. 76 of the annual report) regarding Ford’s revenue recognition policies.

i. When does Ford record revenue from automobile sales? Who are its primary customers? If the company ships vehicles to its dealer/distributor network in faster than the network can sell the vehicles into the retail market, what might we expect to see in the financial statements? (What is the ratio of “Other Receivables” to Sales in 2011 and 2012?)

b. Read the information provided on page 35 of the annual report regarding credit losses.

i. What is the LTR% illustrated in the left-hand chart in this discussion? Is the company’s reserve for credit losses as a percentage of its outstanding receivables higher or lower than its LTR%? Does this relationship suggest that the company’s accounting methods for estimating bad debt expenses is conservative or aggressive?

ii. On the company’s 2010 and 2011 income statements, it reports negative expenses for bad debt losses of $216 million and $33 million respectively. Does this make sense? What do these negative numbers mean?

4. Inventory Valuation

Chapter 6 of your text discusses a variety of approaches allowable for the measurement of inventory and cost of goods sold. What effect does the use of LIFO, rather than FIFO for inventory valuation have on the company’s net income on the income statement? (See the discussion at pages 203 and 204 of your text).

5. Leases

Leasing automobiles is a significant component of Ford’s business. Read pages 310-316 in your text and Note 8 in Ford’s 2012 annual report.

a.  Is Ford the lessee or lessor in the lease transactions described in its financial statements? Are its leases capital leases or operating leases? What portion of its total assets is attributable to its automobile leases? By how much did that increase from 2011 to 2012?

b.  If the leases were structured as capital leases, what would be the effect on Ford’s balance sheet? (i.e., would assets go up or down? Would its reported liabilities change?)

6. Comprehensive Income

Read pages 385-387 in your text. As we discussed in class, most assets and liabilities on the balance sheet are recorded at their historical cost, rather than their market values. In some cases, such as with securities held for resale, historical cost is misleading because the asset is held for resale and companies might continue to hold it rather than selling it and realizing the loss if selling it would require them to record a loss in their financial statements. For assets such as these, GAAP requires that a company write the asset down to its fair value, but the associated loss does not have to be reported on the Income Statement. Instead, it is recorded in an account called “other comprehensive income” which is reported in the equity section of the balance sheet, alongside retained earnings. Another economic cost that flows through other comprehensive income but not the income statement is the company’s liability for unfunded pension obligations.

a.  Ford’s consolidated statement of comprehensive income is reported at the bottom of page 64 of the annual report, as an addendum to its consolidated income statement. By how much did Ford’s unfunded pension obligations increase in 2012? Is the unfunded pension obligation a “real” cost? Explain.

b.  Taking other comprehensive income into account, what was Ford’s net comprehensive income for 2012? Substituting this figure for net income in calculating Ford’s profitability ratios, how does your evaluation of Ford’s profitability change?

c.  We talked in class about how Ford has turned a $16 billion deficit in Retained Earnings into a $16 billion surplus in the past four years. Taking Accumulated Comprehensive Income into account, has the company erased its accumulated earnings deficit?

7. Overall Evaluation of Ford and Comparison with General Motors.

Ford’s turnaround since 2008 has been very impressive. The company was financially insolvent in 2008, and in only four years it has transformed itself into a profitable, solvent company with a global portfolio of popular, well-regarded automobiles. The following are just a sample of stories in the financial press regarding Ford’s prospects:

·  http://www.fool.com/investing/general/2010/09/18/fords-turnaround-continues-to-impress.aspx

·  http://money.cnn.com/2010/07/23/news/companies/ford_earnings/index.htm

·  http://seekingalpha.com/article/1347301-fords-turnaround-story-continues

·  http://www.thestreet.com/story/11989596/1/cramer-quick-take-ford-is-the-best.html

Using many of the metrics you calculated in questions 1-6, do a comparative analysis of Ford vs. GM (GM’s 2012 annual report is here: http://www.gm.com/content/dam/gmcom/COMPANY/Investors/Stockholder_Information/PDFs/2012_GM_Annual_Report.pdf

Frame your comparison around a single table summarizing profitability, risk and other metrics for the two companies, followed by a discussion of your evaluation of the relative strengths of the two companies. This does not have to be particularly lengthy, but it needs to have substance. Which company do you think is the better buy at this point in time?