2013/9/23 1 4-1 4 CHAPTER Analyzing Investing Activities 4-2 Current (Short-term) Assets Noncurrent (Long- term) Assets Resources or claims to resources that are expected to be sold, collected, or used within one year or the operating cycle, whichever is longer. Resources or claims to resources that are expected to yield benefits that extend beyond one year or the operating cycle, whichever is longer. Current Asset Introduction Classification 4-3 Cash Currency, coins and amounts on deposit in bank accounts, checking accounts, and some savings accounts. Current Asset Introduction Cash, Cash Equivalents and Liquidity 2013/9/23 2 4-4 Cash Equivalents Short-term, highly liquid investments that are: Readily convertible to a known cash amount. Close to maturity date and not sensitive to interest rate changes. Current Asset Introduction Cash, Cash Equivalents and Liquidity 4-5 Companies risk a reduction in liquidity should the market value of short-term investments decline. Cash and cash equivalents are sometimes required to be maintained as compensating balances to support existing borrowing arrangements or as collateral for indebtedness. Current Asset Introduction Analysis of Cash and Cash Equivalents 4-6 Receivables Receivables are amounts due from others that arise from the sale of goods or services, or the loaning of money Accounts receivableAccounts receivable refer to oral promises of indebtedness due from customers Notes receivableNotes receivable refer to formal written promises of indebtedness due from others Current Asset Introduction Receivables 2013/9/23 3 4-7 Receivables are reported at their net realizable value total amount of receivables less an allowance for uncollectible accounts Management estimates the allowance for uncollectibles based on experience, customer fortunes, economy and industry expectations, and collection policies Current Asset Introduction Valuation of Receivables 4-8 Assessment of earnings quality is often affected by an analysis of receivables and their collectibility Analysis must be alert to changes in the allowancecomputed relative to sales, receivables, or industry and market conditions. Two special analysis questions: (1) Collection Risk(1) Collection Risk Review allowance for uncollectibles in light of industry conditions Apply special tools for analyzing collectibility: Determining competitors receivables as a percent of salesvis-vis the company under analysis Examining customer concentrationrisk increases when receivables are concentrated in one or a few customers Investigating the age pattern of receivablesoverdue and for how long Determining portion of receivables that is a renewal of prior receivables Analyzing adequacy of allowances for discounts, returns, and other credits (2) Authenticity of Receivables(2) Authenticity of Receivables Review credit policy for changes Review return policies for changes Review any contingencies on receivables Current Asset Introduction Analyzing Receivables 4-9 Securitization (or factoring) is when a company sells all or a portion of its receivables to a third party Receivables can be sold with or without recourse to a buyer (recourse refers to guarantee of collectibility) Sale of receivables with recourse does not effectively transfer risk of ownership Current Asset Introduction Securitization of Receivables For securitizations with any type of recourse, the seller must record both an asset and a compensating liability for the amount factored For securitizations without any recourse, the seller removes the receivables from the balance sheet 2013/9/23 4 4-10 Prepaid expenses are advance payments for services or goods not yet received that extend beyond the current accounting period examples are advance payments for rent, insurance, utilities, and property taxes Current Asset Introduction Prepaid Expenses Two analysis issues: (1) For reasons of expediency, noncurrent prepaids sometimes are included among prepaid expenses classified as current- when their magnitude is large, they warrant scrutiny (2) Any substantial changes in prepaid expenses warrant scrutiny Analysis of Prepaids 4-11 Inventories Definitions InventoriesInventories are goods held for sale, or goods acquired (or in process of being readied) for sale, as part of a companys normal operations ExpensingExpensing treats inventory costs like period costscosts are reported in the period when incurred CapitalizingCapitalizing treats inventory costs like product costscosts are capitalized as an asset and subsequently charged against future period(s) revenues benefiting from their sale 4-12 FIFO 46%Other 4%Weighted Average 20%LIFO 30%Use of Inventory Methods in Practice Inventories Inventory Costing Method 2013/9/23 5 4-13 Costs of Goods Sold Ending Inventory Oldest Costs Recent Costs Inventories First-In, First-Out (FIFO) 4-14 Costs of Goods Sold End