Financial Accounting – Selim Hasagasioglu

Solution to Management Science Series #197: Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date

Financial accounting as a forensic tool: Selling Receivables, aka pure factoring, Before the Collection Date

Company A sold its receivables to a competitor and was paid in cash. You do not know whether the sale was made on nonrecourse basis or not. How would you label this transaction, financing or operating?

Company B sold its receivables to a bank and agreed to assume the risk of collection while also being granted a loan against the receivables sold. How would you label this transaction, financing or operating?

Company C, a manufacturer of trucks, sold its receivables to a bank on a nonrecourse basis. Nonetheless, if the bank were not able to collect the receivables, Company C should sell trucks in equivalent value to the bank and even repurchase the trucks if the bank were not able to sell them. How would you label this transaction, financing and operating?

As I’ve always been doing, in this article, I will solve this question and demystify the tricky accounts receivable account and what you need to look for lest you not get tricked by financial shenanigans related to receivables.

Solution to Management Science Series #196: Financial accounting as a forensic tool: This time, investigating restructuring projects

Financial accounting as a forensic tool: This time, investigating restructuring projects

Many analysts and investors have a hard time, grasping the reasons behind why companies, especially those that are publicly traded, announce bigger layoff plans than is financially warranted.

Laying off employees is almost always one of the first acts companies undertake in their restructuring efforts. Nonetheless, these restructuring projects may be utilized to smooth earnings. Do you know how? Try to solve the following example:

Assume that the automaker Alliance planned to lay off 200 people and published the developments accordingly. The company offers $60,000 severance package for each person who is going to be laid off.

In fact, laying off only 100 people would have sufficed; however, the company chose to announce a bigger number, i.e. 200 people, and stated the relevant accounts as if it had laid off 200 people.

Why would it do so? How will this restructuring charge affect current period’s operating profit?

How would the operating profit change if the company were to restate the relevant accounts and release the related reserve accounts to reflect the real number associated with these layoffs, i.e. 100 people rather than initially stated 200 people, in the following quarters?

Solution to Management Science Series #192: Accounting for Investments in Other Companies and Financial Forensics 🕵️

A publicly traded company, Museum Enterprises (ME) has had rough years lately not living up to the expectations of financial markets and equity investors, missing all of its target earnings.

ME, which stores and sells art collectibles, believes that organic growth is not viable given the current market conditions.

So, at the end of the last fiscal year, it purchased 65% of equity in Castle Entertainment. At the end of this fiscal year, Castle recorded $500M in revenues and incurred total expenses amounting to $230M.

-How will this investment affect ME’s revenues and operating income? Give a quantitatively concrete answer.

-How will this investment help ME’s income before income taxes? Give a quantitatively concrete answer.

-Assume that ME has 40 million shares of stock issued and outstanding and the corporate tax rate for ME is 21%. How will ME’s investment in Castle affect its EPS this year; calculate it!

Financial Accounting is a forensic tool! This time, the focus is accounting for receivables! Detecting frauds ranging from channel stuffing and bill and hold to roundtripping

Ability to use financial accounting at expert level gives the user a forensic tool.
Accounting frauds and schemes will become easier to detect, solve, and track when one masters it.
Innumerable scandals in the business world have been related to accounting frauds and they are still happening (why it is so is a long debate)
For example, think of a retailer having a hard time to hit its fourth quarter sales target. The trend shows that it will not hit the target by quarter end. However, by a sleight of hand, it magically hit the revenue target.
Where would you look at first? Which accounts and ratios would lead you to the detection of these inflated revenue numbers?
While answering all of these questions, I will also provide you with some recent examples of accounting scandals and how you could have detected them in the first place. I will also present you with some additional resources concerning the topic.

Deciphering financial ratios that could lead to bad management and investment decisions

Test your finance and accounting skills! 💹
This time through a story!
⬇️

You are a buy-side equity analyst.

You are poring over financial statements of different companies.

You are looking for a company that has showed strong growth potential in the last 5 years although you are aware that past-performance may not always be a good indicator for future performance.

After weeks of hard work, you think you found one: Ace Chemicals.

Its net revenues have been growing so have its net earnings.

Then, you remembered what your fellow classmate, who is also working as a buy-side equity analyst at a competitor firm and with whom you discuss financial markets superficially, had said about this company a few weeks ago: “I went to their factory. The place was falling apart…”

So, “How was that possible?”, you asked yourself.

“The company has been growing, at least based on the metrics that I think are important.

I also looked at the ratio, according to which the company was in a good position regarding its investments in physical assets”
—
Yes, it is possible and in reality, this company is not growing.

It escaped your notice as you did not look at the most important metric revealing a company’s operational performance clearly.

What is it?

What was the ratio tricking you into believing that the company was investing in physical assets (and in fact, it was not)?

Solution to Management Science Series #175: Accounting for PP&E: Investigating Apple 🧮

1. What was the original cost of Property Plant and Equipment disposed of in 2020? Assume that all purchases in 2020 were made in cash (neither equity nor debt financing). Assess the feasibility of this assumption.

2. What was the Accumulated Depreciation on the Property Plant and Equipment sold in 2020?

3. Are Apple’s Property, Plant, and Equipment more or less than half way through their useful lives on average? How did you know? Assume there is no salvage value on PP&E Apple currently holds.

Note: Solution of this question (and those of all the questions asked so far) is shared on my website.

Detecting Fraudulent Practices in Financial Statements: Close Look at Inventory Fraud and Solution to the question asked

There are many different types of frauds in financial accounting.

Many times, even the most trained eyes cannot detect frauds on financial statements.

The most basic one is inventory fraud.

Solving the following example will lead you to evidence.⬇️

“Amazing” company overstated its ending inventory by $20MM for the year.

What are the effects of this deliberate act on following accounts given a corporate income tax of 25%?

-Current and next year’s net income?
-Current and next year’s retained earnings?
-Next year’s inventory?
-Current and next year’s cash flows from operations?

Solution to Management Science Series #169: How to account for the bonds: NVIDIA 🧮

Refer to the NVidia’s 10-K for the fiscal year ended January 31, 2021. Find the information related to the bonds issued by the company.
Answer the following questions related to the bonds defined as “2.85% Notes Due 2030”

a. Were these notes initially recorded at par, at a discount, or at a premium?

b. What was the effective market rate at the time the notes were issued? Assume that it was not given. So, you are expected to calculate it! (Since current NBV of the bond is equal to the bond principal (probably because of the rounding), first calculate the NBV that should have been reported without the rounding, by using the effective interest rate given. Then, calculate the effective market rate from there!)

c. What will be the exact carrying value (net book value) of the notes at the end of 2025 (or January 31st, 2026)?

d. Assume further that as of December 31, 2025, the prevailing market rate for interest obligations similar to NVidia’s Notes due 2030 will be 7%. What would be the carrying value (net book value) of the notes at the end of 2025?

e. Now assume further that NVidia would redeem these notes from their holder at market value at the end of 2025. Which of the company’s financial statements would be affected, in what direction, and by how much? (Ignore taxes).

f. Assume that as of December 31, 2025, the prevailing market rate for interest obligations similar to NVidia’s Notes due 2030 will be 2%. What would be the carrying value (net book value) of the Notes at the end of 2025? If the company were to decide to retire these bonds, which accounts would be affected?

How to account for the changes in depreciation estimates 🧮

Assume that Sega purchased an arcade cabin production machinery for $80,000,000 with an estimated useful life of 15 years and estimated residual value of $5,000,000. Shortly after the start of Year 6, Sega changed the initial estimated life to 10 years and lowered the estimated residual value to $7,500,000.

What will be the depreciation expense that needs to be recorded by Sega from Year 6 onwards?

Solution to ‘Understanding Inventory Valuation for Automakers, a real-world example: Medium From the courses I have been teaching 📖

Understanding Inventory Valuation for Automakers, a real-world example: Medium
From the courses I have been teaching 📖

The following note was contained in a recent Ford Motor Company annual report:

Inventory Valuation–Automotive.

Inventories are stated at the lower of cost or market. The cost of most US inventories is determined by the last-in, first-out (“LIFO”) method. The cost of the remaining inventories is determined substantially by the first-in, first-out (“FIFO”) method.

If FIFO were the only method of inventory accounting used by the company, inventories would have been $1,235 million higher than reported this year and $1,246 million higher than reported last year.

1. Determine the ending inventory that would have been reported in the current year if Ford had used only FIFO.
2. The cost of goods sold reported by Ford for the current year was $74,315 million. Determine the cost of goods sold that would have been reported if Ford had used only FIFO for both years.
3. If the company had always used FIFO, what would have been the effects on taxes and retained earnings? Assume 30% marginal tax rate.