Financial Statement AnalysisACC 380K.7

Professor Ross JenningsUniversity of Texas at Austin

Spring 2002

Course ContactsProfessor: Ross JenningsOffice: CBA 4M.228Office Hours: Tuesday 9:30 – 10:30 and 1:00 – 2:00 or by appointmentPhone: 471-5340E-mail: RJennings@mail.utexas.eduWeb Site: http://www.bus.utexas.edu/faculty/ross.jennings/

TA: Joon LeeOffice: CBA 4.352Office Hours: Thursday 12:00 – 2:00Phone: 232-6116E-mail: joon.lee@bus.utexas.edu

IntroductionThis course provides an overview of the use of financial accounting information in estimating the value of publicly-traded common stocks. This process consists of five steps: (a) analyzing the industry and economic environment in which the firm operates; (b) analyzing the accounting choices that the firm makes; (c) analyzing the recent financial performance and position of the firm, over time and in comparison to other firms; (d) forecasting the financial performance of the firm in the future; and (e) estimating the value of the firm.

We begin with the last step, in order to have a clear idea of where we are going by reviewing the dividend discount model and the residual income model as alternative valuation methods. The purpose of the rest of the course is to allow us to estimate firm value with more confidence by understanding the economic environment of the firm, the accounting choices the firm has made, the recent performance of the firm, and by forecasting complete financial statements which imposes a discipline on valuation estimates.

Next, we introduce financial ratios as a means to evaluate the financial performance and position of a firm. These ratios focus on the efficiency, leverage, liquidity, and profitability of the firm.

We then discuss the importance of the accounting choices that the firm makes and the limitations of current accounting rules to provide useful information in some economic situations. One challenge of teaching a course in Financial Statement Analysis is to strike a balance between time spent on how to use financial statement information versus time spent on how to read or interpret financial statement information. In this course we will review a set of financial accounting topics that are important to understanding the information presented in the financial statements. Those topics include the format of the

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income statement including identification of nonrecurring components of earnings and the effect of restructurings, as well as accounting for (a) receivables; (b) inventories; (c) fixed assets; (d) R&D and advertising; (e) goodwill; (f) leases; (g) stock-based compensation; (h) pensions and other post-retirement employee benefits (OPEB); (i) deferred tax assets and liabilities; and (j) contingencies. We will also discuss recent accounting rules related to presenting consolidated financial statements.

Next, we re-examine ratio analysis, paying particular attention to how ratios differ across industries, and to using industry averages as a benchmark for evaluating a firm’s position and performance. We also examine the economic environment in which the firm operates to determine its sources of value and the risks that it faces. This knowledge will allow us to evaluate financial information and project that information into the future with more confidence. In this part of the course we also discuss the requirement to include segment disclosures in the notes to the firm’s financial statements.

Finally, we use our previous analysis of the firm’s accounting, economic environment and recent performance to form a basis for forecasting complete financial statements into the future, and then use these forecasts as a basis for estimating the value of the firm.

Course MaterialsThe textbook for the course is Financial Reporting and Statement Analysis by Clyde P. Stickney and Paul R. Brown, fourth edition, published by Dryden.

Throughout the semester we will be using the annual reports of three competing chains of grocery stores, Albertson’s, Kroger, and Safeway. You may obtain a copy of their annual report either by logging onto their web site or by calling their investor relations department. Here are those internet addresses and telephone numbers:

Albertson’s http://www1.albertsons.com/corporate/ 208-395-6200Kroger http://www.kroger.com/aboutourcompany.htm 513-762-1220Safeway http://www.safeway.com/corp_home.asp 925-467-3790

I also recommend that you obtain two or three annual reports of other publicly-traded companies to use as resources throughout the class. An important part of this class is getting comfortable reading annual reports, and you will get more out of that part of the class if you have several different annual reports to refer to and compare as we discuss many of the topics in the course. Many companies now have their financial statements on-line at the company web site where they can be downloaded and printed out. Alternatively, you can send the company an e-mail message or short note asking for a hard copy of the most recent annual report and you will receive the published version with the glossy pictures.

Class Web SiteThere is a web site for the class located at http://www.bus.utexas.edu/faculty/ross.jennings/This site contains links to (a) the syllabus, (b) all assignments, (c) overhead slides for each class session, (d) specific company sites that will be useful during the semester, and (e) other sites with financial statement analysis resources.

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GroupsA substantial amount of work in this class will be done in groups. Your first group assignment is due at the second class session. Before that time you are expected to form a group that has no more than three persons in it. When you have formed the group, one of the members should send me an e-mail giving me the names and e-mail addresses of all of the members of the group. You may maintain the same group for all group assignments, or you may change groups whenever you wish. However, each time there is a change in group membership one of the members from each group that is affected should send me an e-mail with the names and e-mail addresses of the new members of the group.

AssignmentsWe will meet once each week for three hours. In general, during the first part of each class session we will discuss the assignment for that session. All of these assignments will be done in groups. During the second part of each class session we will have a lecture/discussion of the new topic that will be the basis for the next week’s assignment. Overhead slides for the lecture/discussion will be made available in advance. Each week you should do the following before coming to class: (a) complete the assigned readings for that day, (b) prepare the written assignment for that day (if any), and (c) briefly review the overheads that will be used in class that day. The better prepared you are, the more you will get out of each class and the more you will be able to contribute to your classmates.

Group Work – There are eleven “Assignments” for the semester and a Final Project, all of which are available at the class web site, and all of which will be done in groups. Each group must do the following

- All of Assignment numbers 5, 10, and 11, and the Final Project- Five of Assignment numbers 1, 2, 3, 4, 6, 7, and 9- Present to the class their solution for one of the Assignments

Individual Work – There will be two in-class exams that will be done individually. In addition, individual class participation will count toward your grade.

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GradesGrades for the course will be based on a combination of group work (which will count for 50 percent of your grade) and individual work (which will count for 50 percent of your grade). Grades for the course will be determined on the basis of the following assignments and weights.

Grading Summary

Points PercentFive “Optional” Written Assignments in Groups 125 12.5%

Three “Required” Written Assignments in Groups 150 15.0%

One Assignment Presentation by Group 25 2.5%

Two Exams Done Individually 400 40.0%

Final Project Report by Group 200 20.0%

Class Participation 100 10.0%

Total 1,000 100.0%

Honor CodeCollaboration is strongly encouraged outside of class, but within limits that are described at the end of each assignment. Please read these limitations carefully and adhere to them. Violations will be considered to be violations of the Honor Code.

DisabilitiesThe University has requested that I include the following information in this syllabus:

The University of Texas at Austin provides upon request appropriate academic accommodations for qualified students with disabilities. For more information, contact the Office of the Dean of Students at 471-6259, 471-4641 TTY.

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Financial Statement AnalysisCourse Schedule

Professor Ross JenningsUniversity of Texas at Austin

Spring 2002

Session Date Topic/Assignment

1 3-18 Introduction

In-Class: Overview of course, schedule and grading policyA trial valuation of a firm with limited information

2 3-20 Valuation – Part I

Assignment: Assignment #1 – Dividend Discount Model(“optional,” write-up but no memo, done by group)Read Chapters 1 and 2 in Stickney and Brown

In-Class: Introduction to valuation, using the dividend discount model and the residual income model, and introduction to the concept of a “steady state”

3 3-25 Ratio Analysis

Assignment: Assignment #2 – Residual Income Model(“optional,” write-up but no memo, done by group)Assignment #3 – Steady State (“optional,” write-up but no memo, done by group)Read Chapter 3 in Stickney and Brown

In-Class: Ratio analysis

4 3-27 Accounting Topics – Part I

Assignment: Assignment #4 – Ratios (“optional,” write-up but no memo, done by group)Read Chapter 4 in Stickney and Brown

In-Class: Various accounting topics: the income statement, special items, extraordinary items, discontinued operations, restructurings and deferred taxes.

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Session Date Topic/Assignment

5 4-1 Accounting Topics – Part II

Assignment: Assignment #5 – Income Statement(“required,” write memo, done by group)Read Chapter 5 in Stickney and Brown

In-Class: Various accounting topics: receivables, inventory, plant and equipment, goodwill, advertising and research & development.

6 4-3 Accounting Topics – Part III

Assignment: Assignment #6 – Assets(“optional,” write-up but no memo, done by group)Read Chapter 6 in Stickney and Brown

In-Class: Various accounting topics: leases, stock-based compensation, pensions and other post-retirement employee benefits (OPEB), and contingencies.

7 4-8 Accounting Topics – Part IV

Assignment: Assignment #7 – Liabilities(“optional,” write-up but no memo, done by group) Read Chapter 7 in Stickney and Brown

In-Class: Selected accounting topics: consolidations, and international accounting standards.

8 4-10 Midterm

9 4-15 Industry Analysis

Assignment: Assignment #8 – Industry Analysis (no write-up, class discussion only)Read Chapter 8 in Stickney and Brown

In-Class: Industry analysis, ratio analysis and segment disclosures

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Session Date Topic/Assignment

10 4-17 Forecasting

Assignment: Assignment #9 – Ratio analysis(“optional,” write-up but no memo, done by group)Read Chapter 10 in Stickney and Brown

In-Class: Step-by-step introduction to forecasting

11 4-22 Valuation – Part II

Assignment: Assignment #10 – Forecasting (“required,” write memo, done by group)Scan Chapters 11 and 12 in Stickney and Brown

In-Class: Using forecasted financial statements to value firms and estimating the cost of capital

12 4-24 Valuation – Part III

Assignment: Assignment #11 – Valuation(“required,” write-up but no memo, done by group)

In-Class: Complete the discussion of valuation

13 4-29 Wrap-up

Assignment: No assignment

In-Class:

14 5-1 Exam

Assignment: No assignment

In-Class: Exam

Final project is due Wednesday May 8, 2002

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Presentation Sign-Up Sheet

Presentation Date Assignment 1 March 20 1

2 March 25 2

3 March 25 3

4 March 27 4

5 April 1 5

6 April 1 5

7 April 3 6

8 April 8 7

9 April 8 7

10 April 17 9

11 April 22 10

12 April 24 11

When you have formed your group, you should send me an e-mail message that includes the following information:

- Names of the members of your group (no more than three)

- Presentation number, date and Assignment number for the assignment that your groupwill present to the class (first come, first served)

Before the midterm on April 8, you should send me an e-mail message that includes the name of the company your group is going to analyze for your final project and a brief summary of the method you used to pick the company.

If you decide to change the members of your group, you should send me an e-mail message that includes the names of the people leaving the group and the names of the people who are joining the group.