Confidential Draft

BUSINESS ANALYSIS AND VALUATION

Week 8
October, 2017
Our Journey Today

Introduction

Inventory:

• Reporting

• Analysis

Fixed Asset

• Reporting

• Analysis

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Introduction

My Personal Data:
 Undergraduate from Universitas Indonesia, Graduated in 2004
 MBA from the University of Washington, Seattle, Graduated in 2016

What about You? Presence/ Cold-Calling

Additional: Can we assume that you already understand the basic concept, related PSAK, and its
calculations?

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Introduction

Financial Reporting Financial Statement Analysis

• Providing financial information • Using financial information to

about an entity to enable users
to make decisions
• Financial information includes
financial statements and other
types of reports
assess prior performance and
likely future performance to make
decisions
• Typical decision: equity investing.

• HOW: When Investing/ Buying a company, we usually consider, whether it is:

• Cheap or Expensive. We use the valuation calculation from Investasi Pasar Modal (IPM)
• Good or Bad. We apply Ratios from this course

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Preliminary Discussions: Inventories

 The recording of Ending Inventory in the Balance Sheet using Lower of Cost or Market (LCM) concept
 This is an application of Conservatism of Accounting.

 Cost of Inventories: Consistency is required!

 What to be included in the cost of inventories?
 The difference between Periodic/Perpetual and FIFO/ LIFO?
 FIFO/ LIFO/ Average method is the cost flow assumption
 LIFO is NOT acceptable in IFRS. In US GAAP?
 The Choice of Cost is important as it affects inventory carrying amount in BS, and Cost of Sales
(HPP) in PL. At the end, it will affect:
 BS: Current Asset, and Total Assets
 PL: Gross Profit and Net Income

 Market
 IFRS: The Market is the Net Realizable Value. US GAAP: the market is?

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Preliminary Discussions: Inventories

 Inventory Adjustments: Inventory is measured and carried on the BS at the lower of cost of market.
• IFRS:
 Lower of cost or net realizable value
 Subsequent reversals allowed
• U.S. GAAP:
 Lower of cost or market, defined as current replacement cost subject to upper and lower limits
– Upper limit of market: net realizable value
– Lower limit of market: net realizable value less a normal profit margin
 Subsequent reversals prohibited

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Analytical Issues: Inventories

 Ratios related to Inventories:

• Inventory Turnover (ITO): COGS/ Average Ending Inventory
• Days of Inventory on Hand: 365/ITO
• Gross Profit Margin: Gross Profit/ Net Sales

 Examine changes in inventory ratios relative to sales growth.

• High turnover + sales growth slower than industry: Is the company’s level of inventory adequate?
• High turnover + sales growth same or faster than industry: Probably indicates efficient inventory
management

 Examine changes in inventory components relative to other components and relative to sales growth.
• Significant increase in finished goods inventories while raw materials and work-in-progress
inventories are declining could signify a possible decline in demand
• Growth of finished goods inventory higher than sales growth could also signify a possible decline in
demand

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Analytical Issues: Putting it all together, Always!

 Remember, single ratio is not really meaningful.

 Use DuPont Analysis: Simple but beautiful.

• ROE: Net Income/Average Total Equity
• ROE: ROA times Leverage
• ROA: Net Income/Average Total Assets
• ROA: Net Profit Margin times Total Assets Turnover (TATO)
• NPM: Net Income/Net Sales
• TATO: Net Sales/Average Total Assets

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Summary: Inventories

 Total cost of inventories comprises all costs of purchase, costs of conversion, and other costs incurred
in bringing the inventories to their present location and condition.

 The choice of inventory valuation method determines how the cost of goods available for sale during
the period is allocated between inventory and cost of sales. It affects the financial statements and any
financial ratios that are based on them.

 IFRS allow three inventory valuation methods (cost formulas): first-in, first-out (FIFO); weighted
average cost; and specific identification.

 U.S. GAAP allow the three methods above plus the last-in, first-out (LIFO) method.

 Companies that use the LIFO method must disclose in their financial notes the amount of the LIFO
reserve. This information can be used to adjust reported LIFO inventory and cost of goods sold
balances to the FIFO method for comparison purposes.

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Preliminary Discussions: Intangible Assets

 Long-lived assets (noncurrent assets or long-term assets)

• Assets that are expected to provide economic benefits over a future period of time, typically greater
than one year.
• May be tangible (plant, property, and equipment, or PP&E), intangible, or financial assets.

 At acquisition, capitalize
• purchase price and
• expenditures necessary to prepare asset for intended use.

 Subsequent expenditures are

• capitalized if expected to provide benefits beyond one year (extend life or capacity).
• expensed otherwise.

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Preliminary Discussions: Intangible Assets

 Intangible assets:
• Assets lacking physical substance.
• Include items that involve exclusive rights, such as patents, copyrights, trademarks, and franchises.
 Accounting for an intangible asset depends on how it is acquired.
We will consider three ways:
• Purchased in situations other than business combinations,
• Developed internally, and
• Acquired in business combinations.

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Preliminary Discussions: Intangible Assets

How Acquired Treatment at Acquisition

Intangible assets Recorded at fair value, which is assumed to be
purchased in situations equivalent to the purchase price (same as long-lived
other than business tangible assets).
combinations.

Intangible assets Generally expensed when incurred, although

developed internally. capitalized in some situations.

Intangible assets acquired Identifiable assets are recorded at fair value.

in a business combination. If acquisition price exceeds the sum of amounts
allocable to individual identifiable assets and liabilities,
the excess is recorded as goodwill.

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Preliminary Discussions: Intangible Assets

 Intangible Assets developed internally

 Generally expensed when incurred, although capitalized in some situations.
 IFRS
• Expenditures on research are expensed.
• Expenditures on development are capitalized.
 U.S. GAAP
• Generally, both research and development costs are expensed.
• For costs related to software development:
 Products for sale: Both research and development expenditures are expensed until technology
feasibility is established; they are subsequently capitalized.
 Software for internal use: Both research and development expenditures are expensed until
probable completion is demonstrated; they are subsequently capitalized.

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Preliminary Discussions: Capitalized vs Expense

Item Balance Sheet Income Statement of

Statement Cash Flow
Costs that are capitalized

• At acquisition Increase assets −−−− Investing cash

outflow
• Subsequently −−−− Expensed via −−−−
depreciation
Costs that are expensed when −−−− Immediately Operating cash
incurred reduce net outflow
income

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 Preliminary Discussions: Depreciation

Accelerated

Straight-Line
Depreciation
Expense ($)

1 2 3 4 5 6 7 8 9 10

 Straight-line method: When the cost of the asset is allocated to expense evenly over its useful life.
 Accelerated method: When the allocation of cost is greater in earlier years.
 Units-of-production method: When the allocation of cost corresponds to the actual use of an asset in a
particular period.

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Analytical Issues: Depreciation

Method: The accelerated method, compared with the straight-line method, will result in
• Higher depreciation expense in earlier periods, so lower operating profit margin and operating return
on assets (ROA) in the early periods and higher operating profit margin and operating ROA in the
later periods.
• Lower average total assets in earlier periods and thus higher asset turnover ratio.
Assumptions:
• Longer useful life compared with shorter useful life: lower annual depreciation expense.
• Higher salvage value compared with lower salvage value: lower annual depreciation expense.

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Preliminary Discussions: Intangible Assets

Revaluation model:
 Alternative to historical cost model permitted under IFRS.
 Long-lived assets measured at fair value.
 May be used only if the fair values of the assets can be measured reliably.
 Unlike historical cost, may result in increases or decreases in value of long-lived assets.
 May be used for some classes of assets while historical cost is used for other classes, but the same
model must be applied to assets within a particular class.
 Permitted for intangible assets, but only if an active market for the asset exists.
 In practice, use of revaluation model is relatively rare for either tangible or intangible and is especially
rare for intangibles.

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Preliminary Discussions: Intangible Assets

 Fixed asset turnover ratio:

• Calculated as total revenue divided by average net fixed assets.
• Shows the relationship between total revenues and investment in PP&E.
• The higher this ratio, the higher the amount of sales a company is able to generate with a given
amount of investment in fixed assets.
• A higher asset turnover ratio is often interpreted as an indicator of greater efficiency.
 Asset age ratios are broad indicators of a company’s need to reinvest in productive capacity.
• The average age of the asset base is estimated as the accumulated depreciation divided by the
depreciation expense.
• The average remaining life of a company’s asset base is estimated as the net PP&E divided by the
depreciation expense.
• The total useful life of PP&E is estimated as the total historical cost of PP&E divided by the annual
depreciation expense.

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Analytical Issues: Putting it all together, Always!

 Remember, single ratio is not really meaningful.

 Use DuPont Analysis: Simple but beautiful.

• ROE: Net Income/Average Total Equity
• ROE: ROA times Leverage
• ROA: Net Income/Average Total Assets
• ROA: Net Profit Margin times Total Assets Turnover (TATO)
• NPM: Net Income/Net Sales
• TATO: Net Sales/Average Total Assets

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