Accounting & Financial Reporting

1. Accounting & Financial Reporting BUSG 503Michael Dimond

2. For next week… • Exercises E5-22, 23, 24, 27, 28, 31

3. E5-22

4. E5-23

5. E5-24

6. E5-27

7. E5-28

8. E5-31 a. Sales dropped at two segments: North American (1.9%) and Europe (2.7%). The other two segments had sales increases: Latin America (4.8%) and Asia (2%). b. On a consolidated basis, foreign currency exchange rates had a negligible impact on Kellogg’s sales (0.1%). Segment level analysis reveals a different story. In Europe and Latin America, sales were negatively affected by currency rate changes – Europe’s sales in U.S. dollars decreased by 2.8% and Latin American sales (again, in USD) dropped by a significant 8.9%. In contrast, sales in Asia, when converted to dollars, increased by 11.7%. From these effects, we can conclude that during 2010, the U.S. dollar strengthened with respect to the euro and Latin American currencies and weakened with respect to Asian currencies. c. Before the effects of foreign currency, North America experienced a small decline in profits, 1.7% which was moderated by a positive impact of foreign currency rate changes. Europe had 8.2% profit growth but the stronger dollar reduced the growth by 3.4 percentage points to 4.8%. Latin American profits were down slightly (-2.4%) but a significantly stronger dollar vis-à-vis Latin American currencies further reduced profits by 12.3 percentage points to an overall decline of 14.7%. Asian profits were down by a significant 29.5% but because of a weaker dollar, the net effect was only 14.3% decline. d. U.S. public companies are required to report their financial statements in $US. This means that all foreign currency transactions must by translated into $US. As the $US weakens, each foreign currency unit is worth more in dollar terms. Consequently, sales and expenses denominated in a foreign currency have a higher $US equivalent. Indeed, each income statement item is greater, thus increasing reported profits or losses. Companies with significant foreign-currency based transactions can experience large swings in reported numbers when currencies change dramatically. e. Kellogg uses derivatives such as foreign currency exchange contracts, options and currency swaps, to hedge its known foreign exchange exposure. Gains and losses resulting from hedging instruments offset the foreign exchange gains or losses on the underlying (hedged) items (assets, liabilities, revenues and expenses). Realized and unrealized gains and losses on these contracts are recognized in the same period as gains and losses on the hedged items.

9. Cisco Systems, Inc. Current Assets Note: Cisco’s Accounts Receivable are reported net of a $235 million allowance for uncollectible accounts.

10. Allowance for Uncollectible Accounts • The amount of expected uncollectible accounts is usually computed based on an aging analysis. • Each customer’s account balance is categorized by the number of days or months the underlying invoices have remained outstanding. • Based on prior experience or on other available statistics, bad debts percentages are applied to each of these categorized amounts, with larger percentages being applied to older accounts.

11. Aging Analysis Example • GAAP requires companies to disclose the amount of the allowance for uncollectible accounts, either on the face of the balance sheet or in the notes. • Companies are also required to disclose their accounting policies with respect to receivables.

12. Reporting Accounts Receivable Given our gross balance of $100,000 and estimated uncollectible accounts of $2,900, accounts receivable will be reported as follows:

13. Write-off of Uncollectible Accounts • The write-off of an uncollectible account does not affect income. The amount written-off is reflected as a reduction of the account receivable balance and the allowance for uncollectible accounts:

14. Income Shifting • By underestimating the provision, expense is reduced in the income statement, thus increasing current period income. • In one or more future periods, when write-offs occur for which the company should have provisioned earlier, it must then increase the provision to make up for the underestimated provision for the earlier period. • This reduces income in one or more subsequent periods. Income has, thus, been shifted (borrowed) from a future period into the current period.

15. Receivables Turnover & Days Sales in Receivables • The accounts receivables turnover (ART) rate is defined as • The accounts receivable turnover rate reveals how many times receivables have turned (been collected) during the period. • More turns indicate that receivables are being collected quickly. • A companion ratio is the Average Collection Period:

16. Computing COGS • FIFO, LIFO & Average Cost are three methods of computing inventory value

17. Inventory Turnover Rates

18. Long-Term Assets • Long-term assets mainly consist of property, plant, and equipment (PPE). • These assets often makeup the largest asset amounts. • Future expenses arising from these long-term assets often makeup the larger expense amounts—typically reflected in depreciation expense and asset write-downs.

19. For next week… • Exercises E6-22-30 & 36. We will go through these in class • Read Chapter 7 & preview the Mini Exercises