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CRASH COURSE IN
ACCOUNTING
AND FINANCIAL
STATEMENT ANALYSIS,
SECOND EDITION

MATAN FELDMAN
ARKADY LIBMAN
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This book is printed on acid-free paper. ∞

Copyright © 2007 by Wall Street Prep. All rights reserved.
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Library of Congress Cataloging-in-Publication Data:
Feldman, Matan, 1978-
Crash course in accounting and financial statement analysis / Matan Feldman, Arkady Libman. — 2nd ed.
p. cm.
Includes bibliographical references.
ISBN-13: 978-0-470-04701-9 (pbk.)
ISBN-10: 0-470-04701-1 (pbk.)
1. Accounting. 2. Financial statements. I. Libman, Arkady, 1978- II. Title.
HF5636.F45 2007
657—dc22
2006015443
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
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Contents

About the Authors viii

Preface x
Chapter 1 Introduction to Accounting 1
What Is Accounting? 1
Why Is Accounting Important? 2
Making Corporate Decisions 2
Making Investment Decisions 2
Accounting Facilitates Corporate and Investment Decisions 2
Who Uses Accounting? 2
U.S. Accounting Regulations 2
Generally Accepted Accounting Principles 2
Overview of the Securities and Exchange Commission 3
Overview of the Financial Accounting Standards Board 4
International Accounting Regulations 4
Convergence of U.S. GAAP and IFRS 6
Summary 6
Chapter 2 Basic Accounting Principles 11
Assumptions 11
Assumption 1: Accounting Entity 12
Assumption 2: Going Concern 13
Assumption 3: Measurement and Units of Measure 13
Assumption 4: Periodicity 14
Wrap-up: Assumptions 15
Principles 18
Principle 1: Historical Cost 18
Principles 2 and 3: Accrual Basis 18
Principle 4: Full Disclosure 21
Wrap-up: Principles 21
Constraints 24
Constraint 1: Estimates and Judgments 24
Constraint 2: Materiality 24
Constraint 3: Consistency 24
Constraint 4: Conservatism 24
Summary 27
iii
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iv Contents
Chapter 3 Financial Reporting 29
Financial Reporting Overview 29
Finding Financial Reports 30
Form 10-K (Annual Filing) 30
Why Is the 10-K Important? 30
Form 10-Q (Quarterly Filing) 30
Other Important Filings 31
Form 8-K 31
Form S-1 31
Form 14A 31
Form 20-F 31
Summary 32
Chapter 4 Reading the Annual Report 35
Introduction 35
Letter to Stockholders 36
Financial Highlights 38
Management’s Discussion and Analysis 38
Financial Statements 40
Income Statement 40
Balance Sheet 41
Cash Flow Statement 41
Notes to Consolidated Statements 41
Report of Management’s Responsibilities 43
Certification of Financial Statements 46
Risk Factors 48
Legal Proceedings 48
Report of Independent Auditors 49
Directors and Officers 52
Summary 54
Chapter 5 Income Statement 55
What is the Income Statement? 55
Why Is It Important? 57
Revenues 57
Not All Income Is Revenue 58
Bad Debt Expense 61
What Is Bad Debt Expense? 61
Revenue Recognition: To Recognize and When? 61
Revenue Recognition: Long-Term Projects 62
Expense Recognition and Accrual Basis of Accounting 65
Basic Principles Revisited: Accrual Basis of Accounting
and Matching Principle 65
Putting It All Together: The Accrual Basis of Accounting 65
Why Use Accrual Accounting? 65
Accrual versus Cash Accounting: What’s the Difference? 66
Revenue Manipulation 67
Cost of Goods Sold 70
COGS Do Not Include Administrative Costs 70
Gross Profit 73
Selling, General and Administrative 75
Research and Development 77
Stock Options Expense 77
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Index 277

Estimates and judgments constraint, 24 Income tax expense, 99

Extraordinary items. See Non-recurring Intangible assets
Items amortization of, 180-181
and goodwill, 184-185
FASB. See Financial Accounting Standards categories of, 185
Board defined, 179-180
Financial Accounting Standards Board, 4-5 Interest expense, 97-98
Financial ratio analysis, 259-265 Interest income, 99
Fixed assets. See Property, Plant, and International accounting regulations. See
Equipment International Financial Reporting
Form 8-K, 31 Standards
Form 10-K, 30 International Accounting Standards Board, 5
annual report versus, 30 Inventories
form 10-Q versus, 31 and the cash flow statement, 236-238
Form 10-Q, 30-31 COGS and, 157-160
form 10-K versus, 31 defined, 157
Form 14A, 31 valuation of, 161-163
Form 20-F, 31 writing down, 164
Form S-1, 31 Investments, 177-179
Full disclosure principle, 21 Consolidation method of accounting for, 179
Cost method of accounting for, 177-178
GAAP. See Generally Accepted Accounting Equity method of accounting for, 177-178
Principles
Generally Accepted Accounting Principles, 2-3 Leases
convergence with IFRS, 6 capital, 194
Going concern, 13 operating, 194-195
Goodwill treatment of, 272
amortization of, 96 Liabilities, 190-211
annual impairment tests of, 182-183 defined, 134, 190-191
real-world case studies in, 184 summary, 209
representation on balance sheet, 182 Liquidity ratios
Gross profit, 73-74 current cash debt coverage ratio, 261
current ratio, 260
Historical cost principle, 18 quick (acid) test, 260

IFRS. See International Financial Reporting

Marketable securities, 153
Standards
Materiality constraint, 24
Income statement, 55-128
Measurement assumption, 13-14
defined, 55
Minority interest
components of, 56
on the balance sheet, 205-208
exercise, 125-127
on the income statement, 102-103
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278 Index
Net income, 104
Non-recurring items
accounting changes, 114-115
defined, 110
discontinued operations, 112-113
extraordinary items, 113-114
summary of, 116-117
unusual or infrequent items, 110-112
Other assets, 186
Other current assets, 167
and the cash flow statement, 240-241
Other current liabilities, 192
and the cash flow statement, 241
Other non-operating income, 99
Pensions
defined, 198
defined benefit plan, 202-204
defined contribution plan, 198-201
Percentage of completion method, 62
Periodicity assumption, 14
PP&E. See Property, Plant, and Equipment
Preferred stock, 215
Profitability ratios
gross profit margin, 261
payout ratio, 262
price to earnings ratio, 262
profit margin, 261
return on assets, 262
return on equity, 262
Property, plant and equipment
capitalizing of, 175
defined, 168
depreciation and, 168-170
exercise, 171-174
impairment of, 175-176
reconciliation of, 170
retirement and disposal, 176-177
R&D. See Research and Development
Research and development, 77
Retained earnings, 144-145, 217-218
Revenues, 57-69
defined, 57-58
manipulation of, 67
recognition of (see accrual basis of
accounting principle)
unearned, 192
Securities and Exchange Commission, 3-4
Selling, general and administrative 75-76
SG&A. See Selling, General and
Administrative
Shareholders’ equity, 212-222
defined, 134, 212-213
exercise, 220-221
summary, 219
Shares outstanding
defined, 104
exercise, 106-107
representation on the income statement,
104-105
weighted average basic, 104
weighted average diluted, 104
Stock options expense
advanced discussion of, 267-269
defined, 77
financial analysis implications of, 78-79
Treasury stock, 104, 216
Units of measure assumption. See
Measurement Assumption
Unusual or infrequent items. See Non-recur-
ring Items
Working capital, 233-241