AC330 Financial Accounting, Analysis and Valuation
Table of content
AC330 Financial Accounting, Analysis and Valuation 1
Consolidated Balanced Sheet ................................................................................................... 3
“Clean surplus” accounting ............................................................................................................. 3
“Dirty surplus” accounting .............................................................................................................. 3
Revaluation of non-current assets ................................................................................................... 3
Accounting for inventory ................................................................................................................. 3
Purchase (acquisition) accounting method ............................................................................. 5
Steps in consolidation ....................................................................................................................... 5
Analysis of S’s equity with NCI ....................................................................................................... 6
Consolidated retained profits in the consolidated balance sheet – alternative check ................ 7
Consolidated statement of changes in equity ................................................................................. 7
Sunder (1975) ............................................................................................................................ 8
Aim/purpose ...................................................................................................................................... 8
Background/theory ........................................................................................................................... 8
Key findings - relationship between accounting changes to LIFO and stock price changes ..... 8
Prakash and Sinha (2013) ........................................................................................................ 9
Relevant past paper .......................................................................................................................... 9
Purpose .............................................................................................................................................. 9
Assumptions/backgrounds ............................................................................................................... 9
Key findings ....................................................................................................................................... 9
Systematic "mismatch" in firms' revenue recognition practices .................................................................... 9
whether analysts fully incorporate information about ∆DRC in sales and earning forecasts .................... 10
Impacts on the market - abnormal returns ................................................................................................... 10
Lent Term Content .................................................................................................................. 11
Balance sheet - Profitability analysis ............................................................................................ 11
Reformulated Balance Sheet .......................................................................................................... 11
Reformulated income statement .................................................................................................... 11
Indicators frequently used by analysts ......................................................................................... 11
Reformated cash flow statement ................................................................................................... 12
,Ratio analysis .................................................................................................................................. 12
Operating ROA ............................................................................................................................................ 12
Cash flow analysis ........................................................................................................................... 12
Stock-and-flow equations ............................................................................................................... 12
Summary on standard practice for intangibles ........................................................................... 12
, Consolidated Balanced Sheet
“Clean surplus” accounting
Shareholders’ Equity + NI – dividends ± net capital contributions = Shareholders’ Equity
beg end
• Under clean surplus accounting the changes in the statement of financial position are entirely
reflected in the statement of total comprehensive income and the transactions with the owners
shown in the statement of changes in equity.
• This is an important element for the articulation of accounts and the interpretation of financial
statements. It also becomes a crucial element when using financial statements for company
valuation.
• The "clean surplus" is calculated by not including transactions with shareholders (such as
dividends, share repurchases or share offerings) when calculating returns; whereas standard
accounting for financial statements requires that the change in book value equal earnings minus
dividends (net of capital changes).
• The concept of a change in wealth being equal to net income is intuitive
• The relevance of clean surplus accounting is diminished by the observation that many of the ratios
used in Financial Analysis are based on net income, not comprehensive income.
• This may be justified – e.g. if land is revalued at irregular intervals and its value is somewhat
volatile, then the revaluation gains could distort financial ratios.
“Dirty surplus” accounting
CI = NI ± OCI
Shareholders’ Equity + NI ± OCI ± net capital contributions = Shareholders’ Equity
beg end
• This implies that losses on certain assets (e.g. certain financial instruments) might go straight to
equity, without being recorded in the statement of comprehensive income.
• You might regard this as a misrepresentation.
Statement of comprehensive income
(either combined with income statement or separate)
Profit for the year (from the I/S)
Other comprehensive income (OCI):
- Revaluation gains
- Exchange differences (overseas subsidiaries)
Total comprehensive income
OCI includes
• Gains on property revaluation (revaluation reserve)
• Exchange differences (translating foreign operations)
• Gains/losses on cash flow hedges
• Actuarial gains/losses (pension plans)
• Income tax relating to these items
Net capital contributions include:
• New share issues
• Repurchases of shares
• Payments of dividends
Revaluation of non-current assets
Gain (loss) on disposal of revalued asset = Sale proceeds – Carrying amount (based on last valuation)
Accounting for inventory
Cost of sales = opening Inventory + purchases - closing inventory
Inventory needs to be measured at cost
• adjusted back from markup price - Normal selling price / (1+markup%)
Adjustments from
Opening inventory 1
Table of content
AC330 Financial Accounting, Analysis and Valuation 1
Consolidated Balanced Sheet ................................................................................................... 3
“Clean surplus” accounting ............................................................................................................. 3
“Dirty surplus” accounting .............................................................................................................. 3
Revaluation of non-current assets ................................................................................................... 3
Accounting for inventory ................................................................................................................. 3
Purchase (acquisition) accounting method ............................................................................. 5
Steps in consolidation ....................................................................................................................... 5
Analysis of S’s equity with NCI ....................................................................................................... 6
Consolidated retained profits in the consolidated balance sheet – alternative check ................ 7
Consolidated statement of changes in equity ................................................................................. 7
Sunder (1975) ............................................................................................................................ 8
Aim/purpose ...................................................................................................................................... 8
Background/theory ........................................................................................................................... 8
Key findings - relationship between accounting changes to LIFO and stock price changes ..... 8
Prakash and Sinha (2013) ........................................................................................................ 9
Relevant past paper .......................................................................................................................... 9
Purpose .............................................................................................................................................. 9
Assumptions/backgrounds ............................................................................................................... 9
Key findings ....................................................................................................................................... 9
Systematic "mismatch" in firms' revenue recognition practices .................................................................... 9
whether analysts fully incorporate information about ∆DRC in sales and earning forecasts .................... 10
Impacts on the market - abnormal returns ................................................................................................... 10
Lent Term Content .................................................................................................................. 11
Balance sheet - Profitability analysis ............................................................................................ 11
Reformulated Balance Sheet .......................................................................................................... 11
Reformulated income statement .................................................................................................... 11
Indicators frequently used by analysts ......................................................................................... 11
Reformated cash flow statement ................................................................................................... 12
,Ratio analysis .................................................................................................................................. 12
Operating ROA ............................................................................................................................................ 12
Cash flow analysis ........................................................................................................................... 12
Stock-and-flow equations ............................................................................................................... 12
Summary on standard practice for intangibles ........................................................................... 12
, Consolidated Balanced Sheet
“Clean surplus” accounting
Shareholders’ Equity + NI – dividends ± net capital contributions = Shareholders’ Equity
beg end
• Under clean surplus accounting the changes in the statement of financial position are entirely
reflected in the statement of total comprehensive income and the transactions with the owners
shown in the statement of changes in equity.
• This is an important element for the articulation of accounts and the interpretation of financial
statements. It also becomes a crucial element when using financial statements for company
valuation.
• The "clean surplus" is calculated by not including transactions with shareholders (such as
dividends, share repurchases or share offerings) when calculating returns; whereas standard
accounting for financial statements requires that the change in book value equal earnings minus
dividends (net of capital changes).
• The concept of a change in wealth being equal to net income is intuitive
• The relevance of clean surplus accounting is diminished by the observation that many of the ratios
used in Financial Analysis are based on net income, not comprehensive income.
• This may be justified – e.g. if land is revalued at irregular intervals and its value is somewhat
volatile, then the revaluation gains could distort financial ratios.
“Dirty surplus” accounting
CI = NI ± OCI
Shareholders’ Equity + NI ± OCI ± net capital contributions = Shareholders’ Equity
beg end
• This implies that losses on certain assets (e.g. certain financial instruments) might go straight to
equity, without being recorded in the statement of comprehensive income.
• You might regard this as a misrepresentation.
Statement of comprehensive income
(either combined with income statement or separate)
Profit for the year (from the I/S)
Other comprehensive income (OCI):
- Revaluation gains
- Exchange differences (overseas subsidiaries)
Total comprehensive income
OCI includes
• Gains on property revaluation (revaluation reserve)
• Exchange differences (translating foreign operations)
• Gains/losses on cash flow hedges
• Actuarial gains/losses (pension plans)
• Income tax relating to these items
Net capital contributions include:
• New share issues
• Repurchases of shares
• Payments of dividends
Revaluation of non-current assets
Gain (loss) on disposal of revalued asset = Sale proceeds – Carrying amount (based on last valuation)
Accounting for inventory
Cost of sales = opening Inventory + purchases - closing inventory
Inventory needs to be measured at cost
• adjusted back from markup price - Normal selling price / (1+markup%)
Adjustments from
Opening inventory 1
