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Module 1Introduction to the Course

“Overall, a central focus of financial analysis is evaluating a company’s ability to earn a return on its capital that is at least equal to the cost of that capital, to profitably grow its operations, and to generate enough cash to meet obligations and pursue opportunities” CFA Study Guide

So the financial statements are not as straight forward as we have made them seem. We will be going into some of the more esoteric1 areas to gain insight into the company’s financial condition and future.

The Plan

Introduction to the oversight/regulatory agencies

SEC

FASB

Financial Statements- General Considerations

Disclosures

The Role of Footnotes

Summary of Significant Accounting Policies

Subsequent Events

Noteworthy Events and Transactions

A big complicated review problem

One area of Managerial we have to cover

The Balance Sheet

Investments

Revenue Recognition

Review of Present Values

1 Intended for or likely to be understood by only a small number of people with a specialized knowledge or interest, or an enlightened inner circle.

The writing in this manual is very esoteric; I’d need a degree in engineering just to understand it!

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Fixed Income

Bonds

Suzie- Debbie Problem

Valuation

Ratio Analysis - Hermi Revisited

But First, A Review Problem

The MFE Group, doing business as MFE, Inc., had the following balances at the end of 2019:

Cash $100,000Accounts Receivable 82,000Allowance for Doubtful Accounts (2,000)Inventory (80 Boobobs @ 600 each) 48,000Prepaid Insurance 3,000Equipment 150,000Accumulated Depreciation (51,760)Security Deposit 5,000Accounts Payable 30,000Wages Payable 7,000Taxes Payable 14,000Rent Payable 6,000 Bond Payable 100,000Discount on Bond Payable 11,093Preferred Stock 10,000Common Stock (2,000 shares) 2,000Paid In Capital 18,000Retained Earnings 158,333

Not taking things personally is a superpower.

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During 2020, the following transactions occurredPaid beginning accounts payable and received $78,000 accounts receivable.Purchased 600 Boobobs at $650 each: paid 90% this year and the rest next year.Sold 550 Boobobs for $1,300 each. Customers paid 80% this year and the rest in 2021.Paid cash wages of $40,000 and owed $5,000 at the end of the year.Paid last year’s taxes.The rent is $3,000 per month and during 2020, MFE paid the landlord $45,000.On September 1, MFE sold a piece of equipment for $4,000. The equipment had been purchased on January 1, 2016 for $10,600 with an estimated salvage value of $1,000. It had been originally estimated that it would last 8 years. Paid $10,000 in advertising during the year and owed $2,000 in advertising at end of year.On October 1, 2020, MFE, Inc. paid cash of $10,000 and issued 100 shares of common stock in

exchange for a piece of land worth $20,000.On Dec 1, MFE purchased a new truck. The cost was $40,000. They put $4,000 down and will pay the rest in 60 equal monthly, which include interest at 4.6%. The first payment will be made January 1, 2021.On December 31, 2020, MFE paid the annual interest payment on the Bond Payable of $6,000. The bond was issued on December 31st of 2017 to yield 7%. The bond is convertible into 500 shares of common stock.

During the year- the company wrote off $2,500. One customer, who was written off, came back and paid $400. -one customer returned one Boobob. The Boobob was one which had cost us $600.-one customer told us one Boobob arrived damaged. MFE gave her a $200 credit, which more than satisfied her.-the company paid $2,000 in dividends on the common stock.

-paid $400 for the preferred dividend. The preferred stock is convertible into 100 shares of common stock.-

Other Information-The prepaid insurance is for a three-year policy taken out on June 30, 2019. -The new truck purchased is expected to last for 6 years and then be worth $4,000.-The company estimates that 2.5% of accounts receivable will ultimately not be collected.-The beginning equipment originally cost $150,000, had a $12,000 salvage value and was expected to last eight years from the date of its purchase.

The tax rate is 30% and she paid ½ of 2020 taxes in 2020. She will pay the rest in 2021.MFE uses the FIFO inventory system. For Depreciation, the company using monthly depreciation during the year of purchase and the year of sale of fixed assets.

Prepare Journal Entries, The Ledger (T-Accounts), and a trial balance at December 31, 2020.

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Oversight of Financial Statements

When analyzing financial statements

How sure can we be?

The SEC

https://www.investopedia.com/terms/s/sec.asp

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.

As more and more first-time investors turn to the markets to help secure their futures, pay for homes, and send children to college, our investor protection mission is more compelling than ever.

As our nation's securities exchanges mature into global for-profit competitors, there is even greater need for sound market regulation.

And the common interest of all Americans in a growing economy that produces jobs, improves our standard of living, and protects the value of our savings means that all of the SEC's actions must be taken with an eye toward promoting the capital formation that is necessary to sustain economic growth.

The world of investing is fascinating and complex, and it can be very fruitful. But unlike the banking world, where deposits are guaranteed by the federal government, stocks, bonds and other securities can lose value. There are no guarantees. That's why investing is not a spectator sport. By far the best way for investors to protect the money they put into the securities markets is to do research and ask questions.

The laws and rules that govern the securities industry in the United States derive from a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security. Only through the steady flow of timely, comprehensive, and accurate information can people make sound investment decisions.

The result of this information flow is a far more active, efficient, and transparent capital market that facilitates the capital formation so important to our nation's economy. To insure that this objective is always being met, the SEC continually works with all major market participants, including especially the investors in our securities markets, to listen to their concerns and to learn from their experience.

The SEC oversees the key participants in the securities world, including securities exchanges, securities brokers and dealers, investment advisors, and mutual funds. Here the SEC is concerned primarily with promoting the disclosure of important market-related information, maintaining fair dealing, and protecting against fraud.

Crucial to the SEC's effectiveness in each of these areas is its enforcement authority. Each year the SEC brings hundreds of civil enforcement actions against individuals and companies for violation of the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them.https://www.sec.gov/Article/whatwedo.html

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Other Countries Equivalents, but not necessarily of the same level of oversight (my plane ride)

England- Financial Services Authority

China- China Securities Regulation

Ghana – Securities Exchange Commission – Ghana

India – Securities Exchange Board –

Nicaragua

South Africa – Financial Sector Conduct Authority

Who is covered?

….the SEC enforces the statutory requirement that public companies and other regulated companies submit quarterly and annual reports, as well as other periodic reports. In addition to annual financial reports, company executives must provide a narrative account, called the "management discussion and analysis" (MD&A), that outlines the previous year of operations and explains how the company fared in that time period. MD&A will usually also touch on the upcoming year, outlining future goals and approaches to new projects. In an attempt to level the playing field for all investors, the SEC maintains an online database called EDGAR (the Electronic Data Gathering, Analysis, and Retrieval system) online from which investors can access this and other information filed with the agency. https://en.wikipedia.org/wiki/U.S._Securities_and_Exchange_Commission

Not all offerings of securities must be registered with the Commission. Some exemptions from the registration requirement include:

private offerings to a limited number of persons or institutions; offerings of limited size; intrastate offerings; and securities of municipal, state, and federal governments.

AuditsBy ALICIA TUOVILA Updated Jul 14, 2019

What Is an Auditor's Opinion?An auditor's opinion is a certification that accompanies financial statements. It is based on an audit of the procedures and records used to produce the statements and delivers an opinion as to whether material misstatements exist in the financial statements. An auditor's opinion may also be called an accountant's opinion.

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Understanding Auditor's OpinionsAn auditor's opinion is presented in an auditor’s report. The audit report begins with an introductory section outlining the responsibility of management and the responsibility of the audit firm. The second section identifies the financial statements on which the auditor's opinion is given. A third section outlines the auditor’s opinion on the financial statements. Although it is not found in all audit reports, a fourth section may be presented as a further explanation regarding a qualified opinion or an adverse opinion.

For audits of companies in the United States, the opinion may be an unqualified opinion in accordance with generally accepted accounting principles (GAAP), a qualified opinion, or an adverse opinion. The audit is performed by an accountant who is independent of the company being audited.

KEY TAKEAWAYS

An auditor's opinion is made based on an audit of the procedures and records used to produce financial records or statements.

There are four different types of auditor's opinions. An auditor's opinion is presented in an auditor's report, which includes an

introductory section, a section that identifies financial statements in question, another section that outlines the auditor’s opinion on of those financial statements, and an optional fourth section that may augment information or provide additional relevant information.

Unqualified Opinion AuditAn unqualified opinion is also known as a clean opinion. The auditor reports an unqualified opinion if the financial statements are presumed to be free from material misstatements. In addition, an unqualified opinion is given over the internal controls of an entity if management has claimed responsibility for its establishment and maintenance, and the auditor has performed fieldwork to test its effectiveness.

Qualified AuditA qualified opinion is given when a company’s financial records have not followed GAAP in all financial transactions. Although the wording of qualified opinion is very similar to an unqualified opinion, the auditor provides an additional paragraph including deviations from GAAP in the financial statements and points out why the auditor report is not unqualified. A qualified opinion may be given due to either a limitation in the scope of the audit or an accounting method that did not follow GAAP. However, the deviation from GAAP is not pervasive and does not misstate the financial position of the company as a whole.

Adverse OpinionThe most unfavorable opinion a business may receive is an adverse opinion. An adverse opinion indicates financial records are not in accordance with GAAP and are grossly misstated. An adverse opinion may be an indicator of fraud, and public entities that receive an adverse opinion are forced to correct their financial statements and have the financial statements re-audited. Investors, lenders, and other financial institutions do not typically accept financial statements with adverse opinions as part of their debt covenants.

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Disclaimer of OpinionIn the event that the auditor is unable to complete the audit report due to absence of financial records or insufficient cooperation from management, the auditor issues a disclaimer of opinion. This is an indication that no opinion over the financial statements was able to be determined. A disclaimer of opinion is not an opinion itself.

The Financial Statements

Role of the auditor

Who must get audited

Types of Opinions

1. Unqualified Also called a clean opinion

2. Qualified3. Adverse4. Disclaimer

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Qualified-Departure from GAAP “except for…”-Scope Limitation

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We will be assuming fair and complete disclosures in the financial statements

Rules of Accounting

Guided by Principals vs Rules

https://www.youtube.com/watch?v=7wMWcRpCqz8

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PCOB, Public Company Accounting Reform and Investor Act of 2002Sarbanes Oxley, or simply SOX

Requires management report on internal controls and auditors evaluate it. Page 63 of Home Depot annual report.

The Role of Footnotes

1. Allow additional information and clarification to items in the Income Statement, Balance Sheet and Cash Flow Statement

2. Present required disclosures, accounting methodologies and subsequent events.

3. May reveal issues with a company’s financial health

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Think about Pensions, long-term debt, subsequent events

GAAP vs Non-GAAP

The Securities and Exchange Commission requires that any company that reports non-GAAP earnings also present the most directly comparable GAAP financial measure. For example, a company reporting EBITDA would also have to provide a step-by-step reconciliation with net earnings (the most comparable GAAP measure). https://finance.zacks.com/gaap-vs-nongaap-earnings-10887.html

GAAP and IFRS

Start MFE Group

Add Sales Returns and Allowances

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Sales $100,000

Less

Net

Questions1. Providing information about the performance and financial position of companies so that

users can make economic decisions best describes the role of:A. AuditingB. Financial reportingC. Financial Statement analysis

2. Which of the following best describes the role of financial statement analysis:A. To provide information about a company’s performanceB. To provide information about a company’s changes in financial positionC. To form expectations about a company’s future performance and financial

position

3. The role of financial statement analysis is best described as:A. Providing information useful for making investment decisionsB. Evaluating a company for the purpose of making economic decisions.C. Using financial reports prepared by analysts to make economic decisions

4. A company’s financial position would best be evaluated using:A. The balance sheetB. The income statementC. The cash flow statement

5. A company’s financial position would best be evaluated using:A. The balance sheetB. The income statementC. The cash flow statement

6. The financial statement that presents a shareholder’s residual claim on assets is: A. The balance sheet

B. The income statement C. The cash flow statement

7. A company’s profitability over a period of time is best evaluated using:

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A. The balance sheet B. The income statement C. The cash flow statement

8. The income statement is best used to evaluate a company’s

A. financial position B. sources of cash flow C. financial results for business activities

9. Accounting policies, methods, and estimates used in preparing financial statements are most likely found in the:

A. Auditor’s report.B. Management commentaryC. Notes to the financial statements

10. Information about management and director compensation are least likely to be found in:A. Auditor’s reportB. Proxy statementC. Notes to the financial statements

11. Information about a company’s objectives, strategies, and significant risks are most likely to be found in the:

A. Auditor’s reportB. Management commentaryC. Notes to the financial statements

12. Which of the following best describes why the notes that accompany the financial statement are required?

A. Permit flexibility in statement preparationB. Standardize financial reporting across companiesC. Provide information necessary to understand financial statements

13. What type of audit opinion is preferred when analyzing financial statements?

A. QualifiedB. AdverseC. Unqualified

14. An auditor determines that a company’s financial statements are prepared in accordance with applicable accounting standards except with respect to inventory reporting. This exception is most like to result in an audit opinion that is:

A. Adverse B. Qualified C. Unqualified

15. An independent audited report is most likely to provide:

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A. Absolute assurance about the accuracy of the financial statementsB. Reasonable assurance the financial statements are fairly presented C. A qualified opinion with respect to the transparency of the financial statements

16. Interim financial reports release by a company are most likely to be:

A. MonthlyB. UnauditedC. Unqualified

17. Which of the following sources of information used by analysts is found outside a company’s annual report?

A. Auditor’s reportB. Peer company analysisC. Management discussion and analysis

18. Ratios are an input into which step in the financial statement analysis framework?

A. Process dataB. Collect input dataC. Analyze/interpret the processed date

19. Which phase in the financial statement analysis framework is most likely to involve producing updated reports and recommendations?

A. Follow-up B. Analyze/interpret the processed data C. Develop and communicate conclusions and recommendations.

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Homework Module 1

Read Readings 1, 2, & 3

Watch https://www.youtube.com/watch?v=7wMWcRpCqz8

½ to 1 page on where you are right now. Where are you living, what fears, troubles you are having etc. anything you want to share.