ACC 380K.

7 Financial Statement Analysis Spring 2012

The University of Texas at Austin Financial Statement Analysis (ACC 380K.7) Spring 2012
Professor: Office: Office Hours: E-mail: TA: Office: Office Hours: E-mail: I. Yong Yu CBA 4M.254 Tuesday and Thursday 1-3PM or by appointment yong.yu@mccombs.utexas.edu Chris Yust CBA 5.334Z Monday 8-10AM and Wednesday 9-11AM or by appointment christopher.yust@phd.mccombs.utexas.edu

Course objectives and overview

The goal of this course is to develop students ability to use financial statement information to evaluate economics of a business, including industry characteristics, competitive strategy, past performance, risk, the quality of accounting numbers, etc. adjust GAAP accounting numbers to make it more meaningful for understanding the past performance and predicting the future performance forecast future performance and estimate the fundamental value of the companys common equity using parsimonious valuation frameworks

What we learn in this class is often referred to as fundamental analysis, an investment approach used by sell-side analysts, investment management, hedge funds, investment bankers, management consulting, etc. Some of the best-known fundamental analysts include Peter Lynch, the legendary manager of the best performing mutual fund in history - Fidelity Magellan mutual fund, and Warren Buffet. The perspective we will take is primarily an equity investor (i.e., sell-side analysts). The framework and techniques we learn in this course, however, are also widely used in making decisions in many other business settings. One such example will be CEOs and CFOs who are now required by Sarbanes-Oxley to certify the integrity of periodic financial statements. The primary information source for our analysis is the firms financial statements. To first have a clear picture of where we are heading, we start with the question of how to value a firm. Valuing a firm is science and art. We study both parsimonious valuation frameworks such as the discounted dividend model and the residual income model as well as quick-and-dirty market multiple methods such as price-to-earnings and priceto-book ratios; we focus on building a deep understanding of the key factors that drive the firms value. Next, we study how to clean and adjust GAAP financial statements to make the accounting numbers tell a better story of a firms underlying economic performance and the core business activities that create firm value. We also study how to

ACC 380K.7 Financial Statement Analysis Spring 2012

make forecasts of the firms future performance - the inputs that make the valuation models work. To ensure the quality of these inputs (garbage in, garbage out), we then study how to analyze the quality of accounting numbers and make necessary adjustments to tease out the noise added by inefficient GAAP standards or managements earnings management. Our objective is to make the data tell the true story about the underlying economics of the firm. The course contains a substantial amount of financial accounting. We review some key accounting concepts in class, however, this is not a debit-and-credit class per se and our goal is not to improve your understanding of GAAP. Instead, we focus on how to analyze, interpret and adjust reported accounting numbers to have good inputs we can use to value a firms equity. A combination of concepts, examples, discussion questions and homework problems is the learning tool of this course. Throughout the course, we use real companies as examples to see how we can apply our analysis. Nike is a company we use to gain greater insights into the real-world application of what we learn. We also use other companies which fit well for our discussion of individual topics. II. Course materials Required: Financial statement analysis (McGraw-Hill custom 9781121385702, available at the University Co-Op) Class notes (distributed in class) Optional: Financial Reporting and Statement Analysis, by Stickney, Brown and Whalen, 7th edition. Business Analysis and Valuation Using Financial Statements, by Palepu, Healy and Bernard, 4th edition III. Course requirements and grading Grading Summary Homework Two exams Research report and presentation Total Percent 20% 50% 30% 100% text ISBN

The historical distribution has been roughly as follows: 45-50% A, 45-50% B, and 0-5% below B. Plus/Minus grading applies to this course. 2

ACC 380K.7 Financial Statement Analysis Spring 2012

Homework Homework accounts for 20% of your grade. The main objective of homework assignments is to help you both prepare for classes and review what we have discussed after classes. Written assignments will be posted on Blackboard in the week prior to their due dates (see "Tentative Course Schedule" for due dates; all homework assignments are due by noon of the indicated due dates). Assignments will be graded on an effort basis. You will receive a 0 if you did not hand in the assignment, a 1 if your effort appears to be unreasonably low or incomplete and a 2 if you made a concerted effort to answer all of the questions. There are 17 tentative assignments in total, but you are only required to submit 14 of them. In other words, you are allowed 3 free passes. You can work in small groups, but each student must participate and turn in her/his own solutions. All assignment solutions should be submitted electronically through Blackboard using Microsoft Office 2003 or 2007.

Exams There will be two out-of-class exams. Each exam will be worth 25% of your grade. Both exams are closed-book and must be finished independently. You are allowed to bring a one-page note (writing on both sides is acceptable). The first exam is tentatively scheduled for the night of Wednesday, March 7, 2012 from 7:00-9:00 pm and will cover materials from class sessions 1-14. The second exam is tentatively scheduled for the night of Wednesday, April 25, 2012 from 7:00-9:00 pm and will cover materials from class sessions 1626. Please notify me immediately if you have a conflict with these two dates.

Research project The research project accounts for 30% of your grade. The main objective is to provide you an opportunity to apply what we have learned in class to analyze a real company. The project is to be done in teams of no more than 3 students. Each team will conduct a complete analysis, from collecting and cleaning accounting numbers to estimating firm value, for a company, and submit a research report and make a short research presentation to the class. The presentations will be on the last two classes, and the reports are due at noon of Wednesday, May 9. There is an optional peer evaluation that each team could submit along with the report. More details about the project will be posted to Blackboard in the course documents section.

ACC 380K.7 Financial Statement Analysis Spring 2012

Class participation Class attendance is crucial for your understanding of the key concepts, examples and questions. In-class examples and questions prepare you for exams. Evidence from my prior classes shows a strong positive relation between class attendance and final grades - students who do well are those who always attend classes and vice versa. Students are highly encouraged to ask questions, raise related issues, and offer answers to others questions in class. This is both your opportunity and your responsibility. An active classroom environment makes the learning process efficient and enjoyable.

IV. Honor code McCombs Classroom Professionalism Policy

The highest professional standards are expected of all members of the McCombs community. The collective class reputation and the value of the McCombs experience hinges on the execution of this policy. Faculty are expected to be professional and prepared to deliver value for each and every class session. Students are expected to be professional in all respects. The McCombs classroom experience is enhanced when:

Students arrive on time. On time arrival ensures that classes are able to start and
finish at the scheduled time. On time arrival shows respect for both fellow students and faculty and it enhances learning by reducing avoidable distractions.

Students display their name cards. This permits fellow students and faculty to
learn names, enhancing opportunities for community building and evaluation of in-class contributions.

Students minimize unscheduled personal breaks. The learning environment

improves when disruptions are limited.

Students are fully prepared for each class. Much of the learning at McCombs
takes place during classroom discussions. When students are not prepared they cannot contribute to the overall learning process. This affects not only the individual, but their peers who count on them, as well.

Students attend the class section to which they are registered. Learning
is enhanced when class sizes are optimized. Limits are set to ensure a quality experience. When section hopping takes place some classes become too large and it becomes difficult to contribute. When they are too small, the breadth of experience and opinion suffers.

Students respect the views and opinions of their colleagues.

Disagreement and debate are encouraged. Intolerance for the views of others is unacceptable.

Laptops are closed and put away. When students are surfing the web,
responding to e-mail, instant messaging each other, and otherwise not devoting their full

ACC 380K.7 Financial Statement Analysis Spring 2012

attention to the topic at hand they are doing themselves and their peers a major disservice. Those around them face additional distraction. Fellow students cannot benefit from the insights of the students who are not engaged. Faculty office hours are spent going over class material with students who chose not to pay attention, rather than truly adding value by helping students who want a better understanding of the material or want to explore the issues in more depth. Students with real needs may not be able to obtain adequate help if faculty time is spent repeating what was said in class. There are often cases where learning is enhanced by the use of laptops in class. Faculty will let you know when it is appropriate to use them. In such cases, professional behavior is exhibited when misuse does not take place.

Phones and wireless devices are turned off. Weve all heard the annoying
ringing in the middle of a meeting. Not only is it not professional, it cuts off the flow of discussion when the search for the offender begins. When a true need to communicate with someone outside of class exists (e.g., for some medical need) please inform the professor prior to class.

Academic Dishonesty
The McCombs School of Business has no tolerance for acts of scholastic dishonesty. Students who violate University rules on scholastic dishonesty are subject to disciplinary penalties, including the possibility of failure in the course and/or dismissal from the University. Because dishonesty harms the individual, all students, and the integrity of the University, policies on scholastic dishonesty will be strictly enforced. You should refer to the Student Judicial Services website at http://deanofstudents.utexas.edu/sjs/ or the General Information Catalog to access the official University policies and procedures on scholastic dishonesty. If the application of that Policy Statement to this class and its assignments is unclear in any way, it is your responsibility to ask me for clarification

Students with Disabilities

Upon request, the University of Texas at Austin provides appropriate academic accommodations for qualified students with disabilities. Services for Students with Disabilities (SSD) is housed in the Office of the Dean of Students, located on the fourth floor of the Student Services Building. Information on how to register, downloadable forms, including guidelines for documentation, accommodation request letters, and releases of information are available online at http://deanofstudents.utexas.edu/ssd/index.php. Please do not hesitate to contact SSD at (512) 471-6259, VP: (512) 232-2937 or via e-mail if you have any questions.

Class Web Sites and Student Privacy

Password-protected class sites will be available for all accredited courses taught at The University. Syllabi, handouts, assignments and other resources are types of information that may be available within these sites. Site activities could include exchanging e-mail, engaging in class discussions and chats, and exchanging files. In addition, class e-mail rosters will be a component of the sites. Students who do not want their names included in these electronic class rosters must restrict their directory information by notifying the Office of the Registrar in the Main Building, Room 1. For information on restricting directory information see: http://www.utexas.edu/student/registrar/catalogs/gi02-03/app/appc09.html.

ACC 380K.7 Financial Statement Analysis Spring 2012

Tentative Course Schedule (as of 1/10/2012)*

Session 1 2 3 4 5 6 7 8 9 10 11 12 13 14 Date Jan. 18 (W) Jan. 23 (M) Jan. 25 (W) Jan. 30 (M) Feb. 1 (W) Feb. 6 (M) Feb. 8 (W) Feb. 13 (M) Feb. 15 (W) Feb. 20 (M) Feb. 22 (W) Feb. 27 (M) Feb. 29 (W) Mar. 5 (M) Mar. 6 (T) 15 Mar. 7 (W) Mar. 12 -17 16 Mar. 19 (M) No class (Exam 1 in the evening) Spring break Overview of accounting analysis 9. Accrual accounting and income determination, p.289-301 Introduction Overview of financial statements Valuation: Dividend discount model Valuation: Residual income model Valuation: Market multiples Risk and cost of capital ROE and DuPont model Industry and strategy Business activities and financial statements Reformulating equity statement Reformulating balance sheet Reformulating income statement Ratio analysis Ratio analysis HW 7 due 5. The analysis of profitability, p. 150-161 18. The five competitive forces that shape strategy, p.868-884 6. Viewing the business through the financial statements, p.180-197 7. The analysis of the statement of shareholders' equity, p.204-212 8. The analysis of the balance sheet and income statement, p.238-249 8. The analysis of the balance sheet and income statement, p.249-260 p.162-166, 212-214, 260-266 HW 6 due HW 5 due HW 4 due Topic Readings 1. Introduction to investing and valuation, p. 1-17 2. Introduction to the financial statements, p. 32-53 3. Cash accounting, accrual accounting and discounted cash flow valuation: p. 72-94 4. Accrual accounting and valuation: Pricing book values: p. 106-131 p.107-108, 131-135 HW 3 due HW 2 due HW 1 due Homework

ACC 380K.7 Financial Statement Analysis Spring 2012

17 18 19 20 21 22 23 24 25 26

Mar. 21 (W) Mar. 26 (M) Mar. 28 (W) Apr. 2 (M) Apr. 4 (W) Apr. 9 (M) Apr. 11 (W) Apr. 16 (M) Apr. 18 (W) Apr. 23 (M) Apr. 24 (T)

Income tax Transitory items Account receivable Inventory Long-term assets Lease Derivative Stock options Forecasting future performance Forecasting future performance

14. Income tax reporting, p.605-628, 634-642 9. Accrual accounting and income determination, p.301-315 10. Receivables, p.363-373, 379-389 11. Inventories, p.415-446 12. Long-lived assets, p.489-520 13. Financial reporting for leases, p.549-568 15. Financial instruments as liabilities, p.709-726 16. Financial reporting for owners' equity, p.781-794 17. Full-income forecasting, valuation and business strategy analysis, p.820-841

HW 8 due HW 9 due HW 10 due HW 11 due HW 12 due HW 13 due HW 14 due HW 15 due HW 16 due

HW 17 due No class (Exam 2 in the evening) Research presentation Research presentation Research report due

27 28 29

Apr. 25 (W) Apr. 30 (M) May 2 (W) May 9 (W)

*Schedule may be amended Note: All homework assignments are due by noon (i.e., 12:00PM) of the indicated due dates Homework solutions should be submitted electronically through Blackboard using Microsoft Office 2003 or 2007.