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Accounting Analysis. Identifying accounting distortions caused by estimation error, bad GAAP, or management manipulation From a valuation perspective, Correcting the distortion = Forecasting the distortion’s reversal But you have to know the distortion exists!.
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Accounting Analysis • Identifying accounting distortions • caused by estimation error, bad GAAP, or management manipulation • From a valuation perspective, • Correcting the distortion = Forecasting the distortion’s reversal • But you have to know the distortion exists!
the RI model and accounting distortions • suppose firm has 100 in SE, but you believe that 8 of their assets are worthless. • you forecast 12 of NI next year, but only 4 in NI the year after when they will write off the worthless assets. • now suppose that you restate accounting so that SE = 92.
the RI model may be immune to accounting manipulationbut are you? 1997 1998 1999 2000 2001 2002 2003 … beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF
Salton, Inc. • Who are they? • makers of the George Foreman Grill (1/3 of sales) and other small appliances. • What is their strategy? • manufacture in Asia • sell to K-Mart, Wal-Mart etc. • Can they sustain a competitive advantage? http://www.esalton.com/store/application
load Salton into eVal • close any open eVal files • browse to CD, “Salton” folder • open file “Salton Benchmark Valuation” • with students we simply pass them a raw data file to import under the “Input Historical Data” step on the User’s Guide.
The Deal with George Foreman • the old deal with George: 60% of gross profit • approximately $64 million in 1999 • the new deal with George: $122 million pmt , amortized over 15 years (after 8.1 amortization 113.9 as of yr end) • How will the deal change the financial statements going forward? • Is this an accounting distortion? • correcting the balance sheet today versus forecasting the correction in the future? http://www.biggeorge.com/familyman/familyman.htm
accounting distortions Suppose Foreman Trademark has a 3 year life. Adjusted amounts based on amortization over 3 years = 40.5M/yr or 32.4M more than As Reported
removing the 113.9M asset • benchmark price is $1417.84 (with 9/30/2000 valuation date). • move $113,900K from Intangibles to Other Assets • method 1: write off in year 1 • put -8.5% for Other Income in 2001, 0 thereafter • set Other Assets/Sales = 0% in 2001 and beyond • results in value = $1571.55 • note that debt/asset ratios are 19.9 and 38.1 • method 2: remove asset in year 0 • set Other Asset = $0 in 2000 • lower Retained Earnings by $113,900K in 2000 • note the debt/asset ratios (19.9 current and 38.1 LT) • reset debt/asset ratios to 19.9 and 38.1 each year • results in value = $1571.57. • So value is the same in either case, BUT WHY DOES VALUE INCREASE?
Salton Redux • what was the point again? • accounting distortions influence on valuation • when we correct doesn’t matter • the asset writeoff in year 0 or year 1 • but don’t let a distorted past influence your forecasted future • margins were artificially improved by the long amortization period • what does it mean to say the asset is “worthless”? • extreme valuation caused by • naïve extrapolation of past sales growth • overstatement of profitability
