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Interpretation of Financial Statements #363624

Course Overview

Credit

Amount

CPA

CFP^®

7.5

CDFA^®

CIMA^®/CPWA^®/RMA^®

Course Author: Steven M. Bragg, CPA Field of Study (CPA): Finance Field of Study (CFP): Investment Planning Field of Study (CDFA): Investment Planning Field of Study (IWI/CIMA): Technical Investment Management

Course Description

Course publication/revision date: This course was updated on 2/15/2024.

Financial statements are designed to show the performance, financial condition, and cash flows of a business. The Interpretation of Financial Statements course reveals how to convert these statements into an open book that can be explored in depth, giving crucial insights to investors, lenders, and creditors. The course does so by describing the structure of the financial statements, noting a number of tools for extracting information from the statements, and providing a wealth of additional insights into the reasons for the presence of or changes in certain numbers within the statements. In short, this course contains the complete set of tools for breaking down and examining a set of financial statements.

Table of Contents

Chapter 1 - Overview of the Financial Statements1

The General Ledger	1
The Accrual Basis of Accounting	2
Costs versus Expenses	3
The Balance Sheet	4
The Income Statement	6
The Statement of Cash Flows	8
Interactions between the Financial Statements	10
Financial Statement Footnotes	11
Interpretation Tools	12
Ratio Analysis	13
Horizontal Analysis	14
Experience	15

Chapter 2 - Interpretation of Cash and Investments18

The Interpretation of Cash and Investments	18
Natural Cash Balance	19
Relevance of a Low Cash Figure	20
Restricted Cash	20
Events Triggering Changes in Cash	21
Sources of Cash	21
The Impact of Sales Growth on Cash	22
Sufficiency of the Cash and Investment Balance	23
The Liquidity of Investments	23
The Return on Investment	24
Analysis Conclusions	24

Chapter 3 - Interpretation of Receivables26

The Interpretation of Accounts Receivable	26
Inherent Profit Margin	27
Age of the Trade Receivables	28
Age of the Other Accounts Receivable	31
No Allowance for Doubtful Accounts	31
Reliability of the Allowance for Doubtful Accounts	31
No Allowance for Other Accounts Receivable	32
Amount of Bad Debts Recognized	32
Analysis Conclusions	32

Chapter 4 - Interpretation of Inventory35

The Interpretation of Inventory	35
Relative Importance of Inventory	36
Age of the Inventory	38
Reality of the Ending Balance	40
Type of Costing System Used	41
Ownership of the Inventory	41
Reliability of the Reserve for Obsolete Inventory	41
Amount of Obsolete Inventory and Inventory Adjustments Recognized	42
What is a Hidden Reserve?	42
Analysis Conclusions	43

Chapter 5 - Interpretation of Fixed Assets46

The Interpretation of Fixed Assets	46
Depreciation Method	49
Existence of Depreciation	52
Sufficiency of Depreciation	52
What is Being Capitalized	53
What is Being Derecognized	54
Proportion of Sales to Fixed Assets	54
Cash Flow Support of Fixed Assets	55
Proportion of Repairs to Fixed Assets	56
Analysis Conclusions	57

Chapter 6 - Interpretation of Other Assets60

The Interpretation of Prepaid Expenses	60
Nature of the Account Contents	61
The Increasing Account Balance	62
The Impact of Sales Growth on Prepaid Expenses	62
The Interpretation of Goodwill	62
Goodwill Impairment	63
Goodwill Amortization	64
Analysis Conclusions	64

Chapter 7 - Interpretation of Current Liabilities66

The Interpretation of Current Liabilities	66
Days Payables Outstanding	68
Changes in Payable Days	68
Sales Tax Payables Issues	69
Dividends Payable Issues	69
Wages Payable Issues	70
Income Taxes Payable Issues	70
Warranty Liability Issues	70
Unearned Revenues	70
Analysis Conclusions	71

Chapter 8 - Interpretation of Debt73

The Interpretation of Debt	73
Financial Leverage	74
Debt-Equity Ratio	75
Interest Coverage Ratio	75
Relative Size of Debt	76
Seasonal Borrowings	76
Line of Credit Usage	76
Shifts from Long-term to Short-term Debt	77
Conversions from Payables to Debt	77
Conversions from Debt to Equity	77
Debt Forgiveness	78
Permanent Debt	78
Offshore Cash	78
Analysis Conclusions	79

Chapter 9 - Interpretation of Equity81

The Interpretation of Equity	81
The Book Value Concept	82
Tangible Book Value	83
Book Value per Share	84
Changes in Retained Earnings	84
Negative Retained Earnings	85
Appropriated Retained Earnings	85
Treasury Stock Usage	86
Number of Shares Authorized and Outstanding	86
Analysis Conclusions	87

Chapter 10 - Interpretation of Sales89

The Interpretation of Sales	89
The Trend of Sales	90
The Quality of Sales	90
The Reliability of Sales	91
The Timing of Revenue Recognition	91
Revenue at Gross or Net	92
Orders versus Sales	93
The Presence of Sales Discounts	94
The Trend of Sales Returns	95
Analysis Conclusions	95

Chapter 11 - Interpretation of the Cost of Sales and Gross Margin97

The Interpretation of the Cost of Sales and Gross Margin	97
Gross Margin Analysis	99
Contribution Margin Analysis	100
The Inventory Build Concept	101
Direct Materials Changes	102
Obsolete Inventory Changes	102
Scrap Changes	102
Direct Labor Changes	103
Factory Overhead Changes	103
Freight In Changes	103
Analysis Conclusions	104

Chapter 12 - Interpretation of Operating Expenses106

The Interpretation of Operating Expenses	106
Horizontal Analysis	108
Strategy Impact on Operating Expenses	109
Research and Development Costs	109
Payroll Tax Wage Cap Issues	110
Commission Fluctuations	110
Non-Cash Operating Expenses	110
Rent Subleases	110
Supplies Expense and the Capitalization Limit	111
The Fixed Nature of Compensation in Operating Expenses	111
The Public Company Impact on Operating Expenses	111
The Big Bath	112
Analysis Conclusions	112

Chapter 13 - Interpretation of Other Income, Taxes, and Profits114

The Interpretation of Other Income, Taxes, and Profits	114
Implications of Interest and Dividend Income	115
Implications of Gains/Losses on Asset Sales	115
Effects of Interest Expense	116
Implications of Taxable Income	116
Effective Tax Rate	116
Net Profit Ratio	117
Deflated Profit Growth	118
Core Earnings Ratio	119
Earnings per Share	120
Manipulation of Earnings per Share	121
Analysis Conclusions	122

Chapter 14 - Interpretation of Cash Flows124

The Statement of Cash Flows	124
Overview of the Statement of Cash Flows	124
The Direct Method	125
The Indirect Method	127
Examination of Cash Flows from Operating Activities	128
Examination of Cash Flows from Investing Activities	129
Examination of Cash Flows from Financing Activities	130
Cash Flow Return on Sales	131
Analysis Conclusions	132

Chapter 15 - Other Analysis Topics134

Financial Statement Audits, Reviews, and Compilations	134
Audit Opinions	135
Working Capital Analysis	135
Quick Ratio	136
Working Capital Productivity	137
Breakeven Point	138
Dividend Performance	141
Dividend Payout Ratio	141
Dividend Yield Ratio	142
Analysis Conclusions	143

Chapter 16 - Additional Public Company Information145

The Form 10-K	145
Item 1. Business	148
Item 1A. Risk Factors	151
Item 1B. Unresolved Staff Comments	153
Item 1C. Cybersecurity	153
Item 2. Properties	153
Item 3. Legal Proceedings	154
Item 4. Mine Safety Disclosures	155
Item 5. Market for Company Stock	156
Item 6. Selected Financial Data	159
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation	159
Item 7A. Quantitative and Qualitative Disclosures about Market Risk	162
Item 8. Financial Statements and Supplementary Data	164
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	164
Item 9A. Controls and Procedures	165
Item 10. Directors, Executive Officers and Corporate Governance	167
Item 11. Executive Compensation	168
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	176
Item 13. Certain Relationships and Related Transactions, and Director Independence	177
Item 14. Principal Accountant Fees and Services	178
Analysis Conclusions	179

Answers to Chapter Questions182

Glossary194

Index197

Course Details

Author: Steven M. Bragg, CPA

Steven Bragg, CPA, has been the chief financial officer or controller of four companies, as well as a consulting manager at Ernst & Young. He received a master’s degree in finance from Bentley College, an MBA from Babson College, and a Bachelor’s degree in Economics from the University of Maine. He has been a two-time president of the Colorado Mountain Club, and is an avid alpine skier, mountain biker, and certified master diver. Mr. Bragg resides in Centennial, Colorado. He has written more than 300 books and courses, including New Controller Guidebook, GAAP Guidebook, and Payroll Management.

Publication/Revision Date: 2/15/2024

Course Exam Questions (online): 55 (multiple-choice)

Program Delivery Method: Self-Study (NASBA QAS Self-Study)

Available Formats of Course Text: PDF or PDF plus printed copy sent in the mail

Course Level, Prerequisites, and Advance Preparation Requirements

License	Course Level	Prerequisites	Advance Preparation Requirements
CPA	Overview	None	None
CFP^®	Advanced	Familiarity with Financial Statements	None
CDFA^®	Intermediate	Familiarity with Financial Statements	None
CIMA^®/CPWA^®/RMA^®	Overview	None	None

Sponsor ID Numbers

National Registry of CPE Sponsors ID: 107615

CFP Board Sponsor ID: 1008 — Course ID: 257133

Registered with the Institute for Divorce Financial Analysts

IWI CE Sponsor ID: 222740 — Course ID: 24BCNHF009

State CPA Board Sponsor ID Numbers (where applicable)

Florida Division of Certified Public Accounting: 0004761

Hawaii Board of Public Accountancy: 14003

New York State Board for Public Accountancy: 002146

Ohio Accountancy Board: CPE .51 PSR

Pennsylvania State Board of Accountancy: PX178025

Texas State Board of Public Accountancy: 009349

Learning Objectives

As a result of studying the course material, you should be able to meet the objectives listed below:

Recognize the accrual basis of accounting concept and how it functions, as well as the accounting equation concept.
Specify the business situations indicated by different cash levels and cash designations.
Cite the uses of the contribution margin and days sales outstanding measurements, as well as the situations in which they can be misleading.
Specify the industry situations in which an investment in inventory is considered to be more or less critical, as well as the reasons for different inventory turnover levels.
Cite the calculations used for the different depreciation methods, and the effects on profitability of the various depreciation rules.
State the contents of the prepaid expenses line item, as well as the situations that can change this balance. Also note the circumstances under which goodwill is considered to be impaired.
Identify the business conditions that can alter the balances in the current liabilities line items.
Identify the circumstances causing a change in debt classification, as well as the situations in which the debt level can be considered minor.
Specify the effects of debt-to-equity conversions on measurements, as well as the contents of the book value and tangible book value measurements.
Recognize the situations causing reliable sales, as well as the types of investors attracted to rapid sales growth.
Identify the contents of the cost of goods sold, and the methods used to improve the gross margin percentage.
Define the contents of operating expenses, and the business situations that can cause these line items to change.
Recognize the situations in which net operating losses may be generated, and the techniques used to improve the net profit margin and earnings per share.
Specify the contents of the different classifications within the statement of cash flows.
Identify the types of audit examinations, the uses to which the margin of safety can be put, and the contents of the dividend analysis formulas.
Specify the required contents of the different sections of the Form 10-K.

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