FIA Analyzing Financing Activities

Overview of the Chapter
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Current and Noncurrent Liabilities
Lease Obligations
Pension Liabilities
Contingent Liabilities & Commitments
Deferred credits or income
Off-Balance-Sheet Financing
Liabilities at the Edge of Equity
Equity Financing
Book Value per Share

Analysis of Liabilities
Areas of observations:
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We need to make sure that companies account for all of them with proper details as to their amounts, due dates including conditions, encumbrances and limitation Most companies look for ways to reduce the amount of liabilities reported in the financial statements
We must recognize that companies can misclassify or inadequately describe liabilities

Where and How to Look?
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Auditors are one source of assurance in our search
Auditors tools include; direct confirmation, review board minutes, reading contract and agreement, inquiry In double entry system helps auditors and us
Most difficult item includes commitment and contingent liabilities require no entry
To understand it, we need to management discussion, reconciliation, notes

Example of motivated transactions
SEC determined Ampex Corporation failed to fully disclose:  Its obligation to pay royalty guarantees of 80 million
 A several million dollar understatement in the allowance for doubtful accounts receivable
 Income overstatement from inadequate credit allowances for returned tapes

Important Features in Analyzing Liabilities
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Terms of indebtedness ( maturity, interest rate)
Restrictions on deployment of resources and freedom in business activities
Ability and flexibility in pursuing further financing
Working capital, debt to equity
Dilutive conversion features that liabilities are subject to Prohibition on certain disbursements such as dividends Noncurrent Liabilities
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Information on noncurrent liabilities should include interest rate, maturity date, conversion privileges, call features, subordination provision, and restrictions
Companies