Appunti di Accounting finance and control

Accounting, finance & control

Contents

INTRODUCTION & RECOVERY ................................................................................................................. 2

Balance Sheet (BS) .............................................................................................................................. 3

Income Statement (IS) ........................................................................................................................ 8

Cash Flow Statement (CFS) ................................................................................................................. 9

FINANCIAL STATEMENT CONSOLIDATION ............................................................................................ 10

Consolidation Process ....................................................................................................................... 10

FINANCIAL ANALYSIS ............................................................................................................................. 14

1. Understanding the context ........................................................................................................... 14

2. First analysis of financial performances ........................................................................................ 15

3. Common size analysis ................................................................................................................... 16

4. Analysis with indicators ................................................................................................................ 16

5. Benchmarking ............................................................................................................................... 22

FINANCE ................................................................................................................................................ 24

Value Measurement ......................................................................................................................... 24

Net Cash Flows (NCF) .................................................................................................................... 24

Cost of Capital (k) .......................................................................................................................... 25

Terminal Value (TV) ....................................................................................................................... 27

Relative Evaluation........................................................................................................................ 27

BUDGETING ........................................................................................................................................... 30

Non-financial indicators ........................................................................................................................ 37

REPORTING ........................................................................................................................................... 40

Business unit ......................................................................................................................................... 42

Corporate cost allocations ................................................................................................................ 43

Transfer Pricing ................................................................................................................................. 45

Accenture .............................................................................................................................................. 48

UA 1

Introduction & recovery

• Accounting: is a system that identifies, records, and communicates information that are relevant, reliable, and comparable to help users make better decisions —> Accounting is the language of business.

Topics: financial recovery, financial statement analysis and financial statement consolidation.

• Finance: includes the activity of managing money and the process of acquiring new resources. There are different types of finance: personal, public, and corporate finance.

Topics: cash flow, relative evaluation, and value proxies.

• Control: is carried out by an organization for pursuing its goal and maintaining viable patterns of behavior. It comprises a set of techniques that facilitate setting objectives, defining actions and resources, controlling the achievement of objectives, implement corrective actions…

Topics: planning and control cycle, budgeting, KPIs, corporate costs, TPS, variance analysis and reporting and dashboard.

We need AFC together to support decision making internally (top management level, management level and operating level) and externally (investment and financing).

Financial accounting is the branch of accounting intended for users outside the organization (External Accountability). Its main goal is to report information on the organization in financial terms (Financial Reporting) through mandatory financial reports. These provide information about the financial position, financial performances, and cash flows of an entity.

Financial accounting is a fundamental part of company evaluation, for example it contributes to determine:

• Share’s price and market capitalization of a company in the day-by-day trading on stock exchange. (Market Capitalization: the total dollar market value of a company’s outstanding shares of stock. It is calculated by multiplying the total number of a company’s outstanding shares by the current market price of one share)
• The economic value and then the target price in Merger & Acquisition (M&A).
• The credit stability (rating services).

Financial Reports include two time-frames documents:

• Annual Report: published yearly and referring to the accounting year (in Italy and several Europeans countries the accounting year goes from 1 January to 31 December, but there are several variations around the world.)
• Interim Reports: published quarterly or twice a year.

The difference in accounting periods is a relevant element in AFC:

• Consolidation of financial performances: a corporation is very often composed by several sub-companies (subsidiaries) located in many countries. To have a global view (consolidation) of economic and financial performances, the diversity in accounting periods must be considered.
• Real practice analysis: benchmarking is a crucial part in analyzing companies’ performances. Your benchmark companies can be in different countries with different accounting period, it needs to be considered.

Financial Reports are drafted according to General Accepted Accounting Principles (GAAP), and in particularly we refer to the International Financial Reporting Standards (IFRS) (previously named International Accounting Standards (IAS)). Standards adopted:

• IAS-IFRS are the GAAP adopted by: Europe, Australia, New Zealand and developing countries.
• US GAAP is adopted by USA, but there is a roadmap for US companies to adopt IAS/IFRS.
• CAS (China Accounting Standards) is adopted in China, but there is a roadmap for Chinese companies to adopt IAS/IFRS.
• FASF (Financial Accounting Standards Foundation) is adopted in Japan.

IAS-IFRS define where to register, what to register and how to register any item or event with an economic and/or financial impact. However, companies select alternative rules and from allowable estimates under IAS-IFRS. This affects the performances and indicators that we find in the annual and interim reports.

UA 2

For IAS-IFRS the compulsory documents in the Annual Reports are:

• Balance Sheet (BS)
• Income Statement (IS)
• Cash Flow Statement (CFS)
• Statement of changes in equity
• Notes to the financial statements

Listed companies are also requested to provide within Annual Report:

• The report of external auditors, stating that the annual report gives a true and fair view of the situation of the company.
• The report of supervisory board, stating that the decisions undertaken by the company’s management are compliant with the normative and statutory requirements.
• A management report, providing the view of the management and also additional comments to the results reported in the annual report.

Accrual vs. cash logic

• Accrual principle: the effects of transactions and other events are recognized when they occur. It registers economic activity rather than cash activity. Revenues are recorded in the financial year when the accrual events occur. Expenses are matched to revenues. From this we can get the Net Profit.

Accrual event: moment in which the transaction has its effect.

—> underlying logic for Balance Sheet and Income Statement

• Cash accounting: cash flows are registered when they actually take place. From this we can get the Net Cash.

Financial event: moment in which cash or its equivalent is received or paid.

—> underlying logic for Cash Flow Statement

Balance sheet (BS)

Balance Sheet is a snapshot of the company at a precise moment in time. For annual reports, the snapshot moment is the end of the accounting year. It is divided in two columns, assets and equity & liabilities, and every item is expressed in monetary value.

• Assets (resources): are identified by the presence of a direct or indirect contribution to the financial flows (or equivalents) that will arrive to the company. Ownership is not essential in recognizing assets.
• Equity & Liabilities (rights). Liabilities are defined as present obligations of an entity arising from past transaction or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

—> Total Assets = Total Equity & Liabilities

Assets (resources)

Resources retained for the long term, over the enterprise’s normal operating Non-current assets cycle.

Tangible assets retained by the company for a long-term use, which are Property, plant, and equipment instrumental to the profit production (direct use in the production of goods and services or used in the administrative activities).

A property held (by the owner or by the lessee) under a financial lease to earn Investment property rentals or for capital appreciation, or both.

It is an intangible asset with indefinite life representing the future economic Goodwill benefits arising from other assets acquired in a business combination that are not individually identified and separately recognized.

Other intangible assets They are identifiable non-monetary assets without physical substance.

Equity investment Interest of a parent company in subsidiaries, associated and joint venture.

Financial assets comprise several types of resources: cash, equity investment in Other non-current financial assets other entity, contractual rights to receive cash.

It is provided in full for all temporary differences arising between the tax bases of Deferred tax assets and liabilities and their carrying amounts.

UA 3

Resources retained for short-term, within the enterprise’s normal operating cycle Current assets (12 months).

Trade and other receivables Assets held for sale in the ordinary course of business (finished goods), assets in the production process for sale in the ordinary course of business (work in Inventories process), and materials and suppliers that are consumed in production (raw materials).

Ordered work in progress

Short-term financial assets Trade receivables or short-term financial activities.

Cash and cash equivalents

Assets classified as held for sale Non-current resources held for sale within 12 months. and disposal group

The following conditions must be true to be classified as held for sale:

• 1) Commitment to a plan to sell.
• 2) The asset is available for immediate sale.
• 3) An active program to locate a buyer is initiated.
• 4) The sale is highly probable, within 12 months of classification as held for sale (subject to limit exceptions).
• 5) The asset is being actively marketed for sale at a sale price reasonable in relation to its fair value.
• 6) Actions required to complete the plan indicate that is unlikely that plan will be significantly changed or withdrawn.

Asset evaluation (IFRS)

Asset evaluation (IFRS), three concepts useful the logic behind evaluation of assets:

• Cost model vs. Revaluation model

o Cost model: is based on historical cost, an item is evaluated at the original monetary value paid for its purchase and/or for its construction (if made internally).

o Revaluation model: is based on the fair value, an item is evaluated based on the amount for which it could be exchanged between knowledgeable, willing parties in an arm’s length transaction. Fair value usually refers to market values and reflects an objective evaluation external to enterprise, which is related to the knowledge of seller and buyers.

(For the items there is the need of an active market, in which price are readily available and representative of “customer-based value”.)

There is a third evaluation principle for assets and liabilities, considered as reference by IAS/IFRS standard: value in use, an item is evaluated at the discounted present value of estimated future cash flows expected to arise from its continuing use plus its disposal at the end of its useful life.

How to register non-current Cost model Revaluation model assets over the years Book value – Market value

Balance Sheet Σamortization, depreciation, impairment (Shareholders’ equity: market value – book value)

Income Statement Amortization, depreciation of the year Amortization, depreciation of the year

Book value= Carrying value: it is calculated netting the asset against its accumulated depreciation.

• Benchmark treatment (BT) vs. Allowed treatment (AT): IAS-IFRS suggest the use of the Benchmark treatment, but also indicates a possible alternative criterion in accounting (Allowed treatment).
• Impairment test: according to IAS-IFRS, companies must periodically review almost all assets to look for any indication an unrecoverable loss of their value. Unrecoverable loss may occur as a result of:

o Market value declines.

o Negative changes in technology, markets, economy, or laws.

o Obsolescence or physical damage.

o Worse economic performance than expected.

The impairment test identifies the recoverable amount of an assets, that is the higher value between the fair value and the value in use.

UA 4

o If recoverable amount > expected carrying value, it means that the real value of the asset is higher than what is reported —> the item is not impaired.

o If recoverable amount < expected carrying value, it means that the real value of the asset is lower than what is reported —> the item is impaired at the recoverable amount.

—> the impairment loss is an expense in the Income Statement

The impairment test is regulated by IAS 36. The impairment test is applied to: land, buildings, machinery and equipment, investment property carried at cost, intangible asset, goodwill, investments in subsidiaries, associates, and joint ventures carried at costs, and assets carried at re-evaluated amounts under IAS 16 and IAS 38. The impairment test is applied to all the assets, both if they follow cost model or revaluation model for the registration.

Plant, property, and equipment

Plant, property, and equipment: tangible assets retained by the company for a long-term use, which are instrumental to the profit production (direct use in the production of goods and services or used in the administrative activities).

• Initial value: the initial measurement is at cost.
• Measurement subsequent to initial recognition:

o Cost model (BS): the asset is carried at cost less accumulated depreciation and impairment. Land must not be depreciated, as they have an unlimited useful life (there are some exceptions as for example caves).

o Revaluation (Fair Value) (AT): the asset is carried at a revalued amount, being its fair value at the date of revaluation less subsequent depreciation, provided that fair value can be measured reliably.

▪ If a revaluation results in an increase in value, it should be credited to equity under the heading “revaluation surplus” unless it represents the reversal of a revaluation decrease of the same asset previously recognized as an expense, in which case it should be recognized as income.

▪ A decrease arising as a result of a revaluation should be recognized as an expense to the extent that it exceeds any amount previously credited to the revaluation surplus relating to the same asset.

When a revalued asset is disposed of, any revaluation surplus may be transferred directly to retained earnings, or it may be left in equity under the heading revaluation surplus. The transfer to retained earnings should not be made through the Income Statement.

Investment property

Investment property: is a property (land or building or part of a building or both) held (by the owner or by the lessee under a finance lease) to earn rentals or for capital appreciation or both.

• Initial value: the initial measurement is at cost.
• Measurement subsequent to initial recognition:

o Revaluation (Fair Value): gains or losses arising from changes in the fair value of investment property must be included in Net Profit or Loss for the period in which it arises, the assets are not depreciated (BT).

o Cost: investment property is accounted for in accordance with the cost model as set out for PPE. Companies adopting this method must disclose in the note the fair value of investment property (AT).

IAS-IFRS encourage the fair value valuation. If this criterion is adopted the impairment test is not required.

Intangible assets

Intangible assets: an identifiable non-monetary asset without physical substance. The three critical attributes of an intangible asset are: identifiability, control (power to obtain benefits from the asset) and future economic benefits (such as revenues or reduced future costs).

Not all the categories of intangible assets included by IAS-IFRS, the main items excluded from Balance Sheet are: start-up, pre-opening and pre-operating costs, training costs, and advertising costs —> these excluded costs are accounted in the Income Statement.

Once defined the initial recognition IAS-IFRS divide Intangible Assets in two categories: other intangible assets with finite life and intangible assets with