Professional Documents
Culture Documents
Joint Venture can be neither consolidated on each B.S. and would both use equity method.
Critical Acctg Policies: ones that requires significant and or subjective management
judgment. A first sign of a more aggressive policy is a new one or two sentence disclosure.
Revenue Recognition: Sell-in: recorded when shipped to distributor or dealer, more
aggressive. Sell-through: recorded upon sale to end customer.
Look at sales discount/return reserves over past several years as a quick analysis if company
is skimping on reserves to meet earnings.
Look at DSO trends over last 8 quarters. This is the most common item where less
conservative revenue recognition practices manifest themselves.
Look at other assets catch all account
Look at revenue/PP&E. Compare rate of change in rev to change in PPE. Costs may be placed
in PPE and lead to excessive cost capitalization.
This can permantly overstate OCF. Look if they ignore FCF because of higher CAPEX
expenses.
This excess depr will be added back to OCF and imperative to look at FCF and not
EBITDA.
Capitalized Interest will be depreciated slowly over time instead of interest expense. This
understate interest expense.
Ascertain the amortization period for capitalized costs and if its reasonable. ISIs view is that
start up costs and marketing/advertising costs that are capitalized is highly skeptical since
the benefit period over which the costs are expensed is highly variable and subjective.
Accounting Changes: A preferability letter from auditors is required to change from one
permissible standard to another permissible standard.
Deprecaition:: Units of production may understate economic depreciation for mature,
declining, or low capacity utilization industries.
If a companys accounting depreciation exceeds the assets real economic decline in value,
this represents and under-earning company. Usually with accelerated depr.
Depr and Amor can be included in cost of sales or SGA.
Relative Age of Assets = Gross PPE/Accd Depr
Avg Asset Depr Life= Gross PPE/Depr Expense
Avg Age of Assets= Accd Depr/Gross PPE
Remaining Depreciable Years= Gross PPE/Accd Depr
y by:
_ Failing to write-down inventory;
_ Overstate inventory quantity;
_ Add amounts to in
_ Overproduce inventory to absorb fixed overhead costs.
Converts
The accounting rule changes require interest expense to be recorded in earnings at a
companys higher nonconvertible debt interest rate as compared to the current practice of
recording interest expense at the lower cash (effective) interest rate. changed the
accounting for cash-settled convertible debt by requiring bifurcation accounting for
convertible bonds
Since a company issues a call option as part of a convertible bond on the issuance date, the
economic cost of issuing a convertible bond is unknown until the bond is
converted/repaid/redeemed. For enterprise value and other calculations, the convertible
bond should be treated as debt or equity. For a plain vanilla convertible bond, we suggest
including the shares in
the diluted share count if the current share price or the analysts target share price is
greater than the convertible bonds exercise (strike) price. On the other hand, if the
convertible bond is out-ofthe-money and unlikely to become in-the-money, we suggest
treating the entire amount of theconvertible debt as debt without including any shares in the
diluted share count.The companys share count may not include the analytically correct
number of
shares.
Debt
Is there a cross payment default provision? Under this provision, creditors of a material
amount of debt may elect to declare that a default has occurred under their debt
instruments and to accelerate the principal amounts due such creditors. Is there a cross
accelerated provision? This provision permits a default on a second debt to be declared only
if in addition to a default occurring under the first debt instrument, the indebtedness due
under the first debt instrument is actually accelerated. Is there a subjective acceleration
clause? This provision permits a debt maturity to be accelerated if certain events occur that
are not objectively determinable (or necessarily defined).
Goodwill
Since goodwill is not amortized as a periodic expense under GAAP, companies are
incentivized to allocate a large portion of the acquisition price to goodwill. If the acquisition
doesnt work out as planned, the company simply writes-off goodwill as a one-time
impairment charge to earnings. Since goodwill is the residual (or plug number) recorded
after the fair market value of net assets
are recorded, a high level of goodwill as a percentage of the total purchase price suggests
the company is attributing a large premium to synergy value. In other words, there is high
risk the company overpaid for the acquisition. In general, we consider goodwill representing
more than 70% of the purchase price to be high and believe it suggests substantial
overpayment for assets.
For example, did a company allocate a portion of the purchase
price to an indefinite life intangible asset brand that does not have longevity? Practically
speaking, we believe that few brands and other intangible assets have indefinite lives and
any large allocations thereto should be viewed skeptically.
value of goodwill will be less than its recorded value. We use this ratio as a screen for
goodwill impairments at the
aggregate company level since we dont have enough detail to calculate the goodwill
amounts at the reporting unit level. We reviewed goodwill impairment charges over recent
history (2000 present). Historically, the average goodwill-to-market capitalization ratio in
the quarter before a goodwill impairment occurs is 39% (median = 22%).