Financial Accounting for Executives and MBAs, 3e

by Simko, Ferris, Wallace

ISBN: 978-1-61853-046-2 | Copyright 2014

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Welcome to Financial Accounting for Executives & MBAs.

If you have prior business experience, either working for a company or managing your own business, then you know firsthand that an understanding of financial accounting is essential to achieve your full potential on the job. Although business decisions certainly involve a careful analysis of non-financial factors, they also almost always require analysis of financial accounting information. Initiating a marketing campaign, restructuring a subsidiary, determining the sale price of a new product, or assessing whether to acquire another company (and at what price) are just a few of the business decisions that require an understanding of financial accounting. This textbook is written to facilitate that understanding and to facilitate the reader’s personal goal of gaining a more complete understanding of financial accounting and its use in business decisions.

Target Audience

Financial Accounting for Executives & MBAs is written specifically for the executive MBA and MBA markets. This concise text can be used in a wide variety of course formats, ranging from brief executive programs lasting only a few weekends to more traditional 15-week courses.

I’ve been teaching 10 years, and this is the BEST text I’ve seen for introducing financial accounting to a layperson. My major problem with texts has been that they are either too broad or too detailed. This book is the perfect mix of breadth and depth for a layperson, be they an executive who has had some exposure to accounting or a student who is just entering the study of accounting. This book is excellent.

Catherine Eason, Queens University of Charlotte

Book Organization

A succinct, flexible 12-chapter structure fits eMBA, full-time, part-time, and evening MBA programs. This book provides students with the tools and insights necessary to make informed business decisions ranging from performance evaluation to firm valuation. The chapters are organized around a decision focused structure.

The first four chapters introduce the basic financial statements and tools for financial analysis:

I. The Foundations of Accounting and Financial statement Analysis (Chapters 1–4)

The next seven chapters provide additional structure for this analysis, with each chapter including a section that discusses how the chapter’s content should be analyzed and how that analysis will impact firm value:

II. Operating resources and Decisions (Chapters 5–6)
III. investing resources and Decisions (Chapters 7–8)
IV. Financing resources and Decisions (Chapters 9–11)

The book concludes with an introduction to various methodologies to assess the value of a company:

V. equity Valuation (Chapter 12)

What is the Financial Statement Spreadsheet Approach to Illustrating Accounting Concepts?

The eMBA and MBA markets tend to be more analytical and decision-focused than the undergraduate market. Unlike undergraduate textbooks in accounting that use the classic debit and credit paradigm to explain key concepts, this textbook uses a financial statement spreadsheet approach to explain the fundamentals of financial accounting. Not only is this approach more user-friendly (because most managers routinely use spreadsheets in their daily professional lives), but it is also far less labor- and time-intensive than the classic debit/credit paradigm. The spreadsheet approach to recording transactions emphasizes user analysis and deemphasizes bookkeeping.

The financial statement spreadsheet approach builds upon the basic accounting equation to demonstrate how business events are processed and ultimately recorded. It will be appreciated by many executives and MBA students for its simplicity and intuitive appeal, as well as for its link back to how they likely see accounting information in their professional lives. That is, it presents a vertical format to the balance sheet equation, functionally following the form and presentation of the balance sheet most often observe in practice and annual reports. The format is also used to illustrate income statement accounts as inputs directly into the retained earnings account, reinforcing this important concept to students in a way that helps them more clearly understand the relation between the balance sheet and income statement. Below is an example of the financial statement spreadsheet approach used in the context of a long-term fixed asset acquisition and sale:

Decision-Relevant Focus

A key skill set for all investment professionals, lenders, managers, analysts, and shareholders is the ability to use accounting information for decision-making purposes. in this book, we link the discussion of topics to the following two business decisions:

  1. Should I extend credit, and at what terms, to this company?
  2. should I invest in this company, and if so, at what price?

Thus, the analysis of financial statements is a key organizational theme that extends throughout the book.

I believe that the concise and clear writing is a major strength of this book. The authors should also be complimented on being able to use a good number of examples while still keeping the chapters concise.

Charles Leflar, University of Arkansas

Grounded in the Context of Corporate Decisions

Accounting information is an integral part of decision making at every level in business. Consequently, the book’s discussion of important accounting concepts is grounded in the context of actual corporate decisions. To this end, the book contains an abundance of excerpts and illustrations from actual corporate financial reports and disclosures that highlight the role and impact of accounting information, and financial statements specifically, in business decision making. Following is one example in the context of accounting for leases:

Does the Book Reflect contemporary knowledge?

In our experience, eMBAs and MBAs frequently seem interested in exploring empirical questions such as: "How do the capital markets respond to accounting policy changes?" and "Which EPS measure -Basic PS or Diluted EPS- is used by the capital market to value a company's stock?" Where appropriate, we have made reference to, and discussion of, the existing research in accounting and finance to address some of these empirically-based questions. By doing so, we enable the interested reader to further her/his knowledge of these questions.

Important Pedadogical Elements

The book applies several pedagogical elements to help readers further understand the ramifications of accounting for business.

Global Perspective

Global Perspective boxed inserts emphasize the similarity of u.s. GAAP and iFrs, but they also identify key differences. exposure to similarities and differences is important as the pressure mounts to harmonize accounting standards globally.

Ethics Perspective

Ethics Perspective boxed inserts emphasize ethical decision making, as well as the importance of ethics in accounting. in today’s environment post-implementation of sarbanes-Oxley, this information is pertinent to business students and accounting students alike.

Business Perspective

Business Perspective boxed inserts illustrate key chapter topics using real-world examples and financial statements.

Tax Perspective

Tax Perspective boxed inserts highlight select aspects of U.S. tax law and how they differ from generally accepted accounting principles. Executives and MBAs very often are interested in understanding how their decisions affect both financial accounting earnings and the cash flows related to the tax treatment of those same decisions. While this text is clearly focused on the former, high-level overviews of some key tax reporting differences are offered throughout the text. Below is an example related to investments:

In Practice

In Practice boxed inserts help bridge the gap between the classroom and what students encounter in the real world. "In Practice" illustrations document situations a reader is likely to encounter and present the choices that companies make in reporting financial results.

Tools that Reinforce Reader Comprehension

Each chapter includes many tools that reinforce an understanding of the chapter contents. These tools include:

  • Review Problem, with solution
  • Executive Summary
  • Key Concepts and Terms, with page references
  • Discussion Questions
  • Exercises
  • Problems
  • Corporate Analysis
  • Check figures to accompany select exercises and problems, denoted by Check Figure

The discussion questions are great for an Executive MBA or MBA audience because they are targeted at a more sophisticated student than the typical introductory financial accounting text. They should help a professor stimulate interesting discussions in the classroom

Jeffrey Wong, University of Nevada, Reno

Changes in the Third Edition

This edition of Financial Accounting for Executives & MBAs includes a number of important new features. These include:

  • Paul Simko of University of Virginia’s Darden School of Business has joined the author team.
  • A (vertical) financial statement spreadsheet approach for analyzing transactions that reinforces the way in which students engage with financial statements in practice.
  • extensive reference to recent accounting issues facing high profile companies such as Apple, Groupon, American Airlines, Bank of America, and Under Armour.
  • Tax perspectives boxes provide high-level contrasts between financial accounting rules and those that govern u.s. tax law.
  • Expanded discussion of relevant international accounting practices around the globe.
  • Many of the assignments have been revised and updated.
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  • The new edition features an exciting new full color design to engage students. The authors have used color as a pedagogical tool to highlight important points for students.
  • Appendix D covers the basic mechanics of accounting for those instructors that want to expose their students to the fundamentals of the debit-credit paradigm.

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Expand/Collapse All
Chapter 01: The Economic Environment of Accounting Information (pg. 2)
Financial Accounting and Its Relevance (pg. 4)
Why Accounting Information Is Important (pg. 5)
Financial Accounting: What Is It? (pg. 5)
Qualitative Attributes of Accounting Information (pg. 12)
Amazon’s Accounting Methods and the Role of the Independent Auditor (pg. 13)
Generally Accepted Accounting Principles (pg. 15)
Role of Financial Accounting in Investment Decisions: An Overview (pg. 18)
Changing Economic Landscape (pg. 20)
Seven Accounting Myths (pg. 21)
Executive Summary (pg. 22)
Key Concepts and Terms (pg. 22)
Appendix 1A: Agency Costs and the Separation of Management and Capital Providers (pg. 23)
Conflicts Between Managers and Shareholders (pg. 24)
Conflicts Between Debtholders and Shareholders (pg. 24)
Appendix 1B: Generally Accepted Accounting Principles: Purpose, Concepts, and Elements (pg. 25)
Questions (pg. 26)
Exercises (pg. 28)
Problems (pg. 30)
Corporate Analysis (pg. 32)
Chapter 02: From Business Events to Financial Statements (pg. 34)
Balance Sheet Equation (pg. 36)
Defining Some Accounting Terms (pg. 39)
Preparing Financial Statements from Business Events (pg. 39)
The Russian River Valley Winery (pg. 40)
Projected Business Events (pg. 42)
Preparing the Financial Statements (pg. 51)
Articulation of the Financial Statements (pg. 55)
Accounting Policy Decisions at Russian River Valley Winery (pg. 56)
Evaluating Business Performance and Making Financial Decisions (pg. 57)
Evaluating Firm Profitability (pg. 57)
Return on Equity Analysis (pg. 59)
Evaluating Financial Risk (pg. 60)
Managerial Discretion and Accounting Methods (pg. 61)
Operating Revenues at B.J.’s Wholesale Club (pg. 61)
Operating Expenses at America Online (pg. 62)
Review Problem (pg. 63)
Executive Summary (pg. 64)
Key Concepts and Terms (pg. 64)
Questions (pg. 64)
Exercises (pg. 66)
Problems (pg. 67)
Corporate Analysis (pg. 74)
Solution to Review Problem (pg. 75)
Chapter 03: Measuring Performance: Cash Flow and Net Income (pg. 78)
Analyzing and Computing Cash Flow Information (pg. 80)
Statement of Cash Flow (pg. 80)
Presenting Cash Flow Information (pg. 81)
Computing Cash Flow Under the Indirect Method (pg. 83)
Analysis of the Statement of Cash Flow (pg. 89)
Cash Flow Ratios (pg. 91)
Alternative Measures of Cash Flow (pg. 92)
Identifying and Understanding Sustainable Earnings (pg. 94)
Special Items and Extraordinary Items (pg. 96)
Discontinued Operations (pg. 98)
Earnings per Share (pg. 98)
Pro Forma Earnings (pg. 99)
Executive Summary (pg. 101)
Key Concepts and Terms (pg. 102)
Appendix 3A: Converting Indirect Method Cash Flows to Direct Method Cash Flows (pg. 102)
Questions (pg. 103)
Exercises (pg. 105)
Problems (pg. 108)
Corporate Analysis (pg. 116)
Solution to Review Problem (pg. 117)
Chapter 04: Using Financial Statements for Investing and Credit Decisions (pg. 118)
Analyzing Financial Performance (pg. 120)
Fundamentals of Financial Statement Analysis (pg. 120)
Percentage Change and Common-Size Financial Statements (pg. 122)
Financial Ratios (pg. 125)
Credit Risk Analysis (pg. 129)
Benchmarking: Comparisons with Similar Companies (pg. 130)
ROE Model Framework (pg. 131)
Estimating Sustainable Growth (pg. 133)
Limitations of Financial Statement Analysis (pg. 134)
Review Problem (pg. 136)
Appendix 4A: Unlevering Financial Ratios (pg. 137)
Appendix 4B: Pro Forma Financial Statements (pg. 138)
Appendix 4C: Calculating the Cost of Equity Financing (pg. 139)
Questions (pg. 140)
Exercises (pg. 142)
Problems (pg. 145)
Corporate Analysis (pg. 152)
Solution to Review Problem (pg. 153)
Chapter 05: Operating Cycle, Revenue Recognition, and Receivable Valuation (pg. 154)
Operating Cycle of a Business (pg. 156)
Fundamentals of Revenue Recognition (pg. 157)
Revenue Recognition by Retail and Service Companies (pg. 159)
Revenue Recognition by Manufacturing Companies (pg. 160)
Valuing and Reporting Accounts Receivable (pg. 164)
Percentage-of-Credit-Sales Method (pg. 165)
Aging Method (pg. 166)
Managing a Company’s Investment in Receivables (pg. 171)
Sales Discounts (pg. 171)
Sales Returns (pg. 173)
Monetizing Accounts Receivable to Manage Operating Cash Flow (pg. 174)
Factoring (pg. 174)
Pledging (pg. 174)
Securitization (pg. 174)
Analyzing Operating Revenue and Receivables (pg. 175)
Revenue Recognition Policy (pg. 175)
Receivable Valuation Policy (pg. 176)
Executive Summary (pg. 178)
Key Concepts and Terms (pg. 178)
Appendix 5A: Revenue Recognition: SAB No. 101 (pg. 179)
General Guidance on Revenue Recognition (pg. 179)
Persuasive Evidence of a Sales Arrangement (pg. 179)
Delivery and Performance (pg. 179)
Fixed or Determinable Sales Price (pg. 180)
Other Issues (pg. 180)
Exercises (pg. 182)
Problems (pg. 184)
Corporate Analysis (pg. 188)
Solution to Review Problem (pg. 189)
Chapter 06: Operating Expenses, Inventory Valuation, and Accounts Payable (pg. 190)
Operating Cycle of a manufacturer (pg. 192)
Measuring Cost of Goods Sold and Ending Inventory (pg. 193)
Case Illustration: How Much are Earnings? (pg. 193)
Inventory Management Systems (pg. 195)
The Inventory Count (pg. 196)
Valuing Inventory using FIFO, LIFO, and Weighted-average—a Closer Look (pg. 197)
Choosing an Inventory Method (pg. 200)
Lower-of-Cost-or-Market (LCM) (pg. 201)
Inventory Accounting Under International Reporting Standards (pg. 203)
LIFO Layers and the LIFO Inventory Reserve (pg. 203)
Liquidating LIFO Layers (pg. 205)
Managing a Company’s Investment in Inventories (pg. 208)
Accounts Payable and a company’s Operating Cycle (pg. 208)
Analyzing Inventory and Cost of Goods Sold (pg. 209)
Review Problem (pg. 210)
Executive Summary (pg. 212)
Key Concepts and Terms (pg. 212)
Questions (pg. 213)
Exercises (pg. 214)
Problems (pg. 217)
Corporate Analysis (pg. 223)
Solution to Review Problem (pg. 224)
Chapter 07: Long-Lived Fixed Assets, Intangible Assets, and Natural Resources (pg. 226)
Acquisition Cost of a Long-Lived Asset (pg. 228)
Betterment Versus Maintenance Expenditures (pg. 229)
Matching: The Allocation of costs to future periods (pg. 230)
Straight-Line Method (pg. 230)
Accelerated Methods (pg. 232)
Units-of-Production Method (pg. 233)
Choosing a Depreciation Method (pg. 234)
Accounting Policy Changes (pg. 236)
Revaluing Long-Lived Assets (pg. 238)
Sale or Retirement of Long-Lived Assets (pg. 239)
Distortion Caused by Aging Assets (pg. 239)
Intangible Assets (pg. 240)
Research and Development Costs, Patents, and Copyrights (pg. 240)
Goodwill (pg. 240)
Marketing Costs (pg. 242)
Natural Resources (pg. 242)
Long-Term Fixed Asset Accounting Under International Financial Reporting Standards (pg. 243)
Analyzing Capital Investments (pg. 244)
Review Problem (pg. 245)
Executive Summary (pg. 246)
Key Concepts and Terms (pg. 246)
Questions (pg. 246)
Exercises (pg. 248)
Problems (pg. 249)
Corporate Analysis (pg. 253)
Solution to Review Problem (pg. 254)
Chapter 08: Investing In Other Entities (pg. 256)
Investments in Other Entities (pg. 258)
Overview of Accounting for Debt and Equity Securities (pg. 258)
Illustration of Accounting for Marketable Debt and Equity Securities—Passive investments (pg. 261)
Valuation Adjustments (pg. 262)
Recording the Sale of Investment Securities (pg. 262)
Managerial Discretion (pg. 264)
Equity Method and Consolidation Accounting (pg. 266)
Deconsolidation (pg. 273)
Accounting for Joint Ventures (pg. 274)
Accounting for Special Purpose Entities (pg. 275)
Investment Accounting under International Financial Reporting Standards (pg. 277)
Accounting for Investments in Foreign Entities (pg. 277)
Currency Exchange Rate Fluctuations (pg. 278)
Illustration of Current Rate Method (pg. 278)
Analyzing Intercorporate Investments (pg. 279)
Review Problem (pg. 281)
Executive Summary (pg. 282)
Key Concepts and Terms (pg. 282)
Questions (pg. 282)
Exercises (pg. 284)
Problems (pg. 287)
Corporate Analysis (pg. 293)
Solution to Review Problem (pg. 295)
Chapter 09: Debt Financing: Bonds, Notes, and Leases (pg. 298)
Financing Operations and Assets with Debt: Bonds and Notes (pg. 300)
Credit Ratings and the Cost of Debt (pg. 301)
Valuing Bonds and Notes (pg. 302)
Interest Expense (pg. 304)
Market Rates of Interest and the Book Value of Debt (pg. 306)
Early Debt Retirement (pg. 307)
Zero-Coupon Bonds and Notes (pg. 308)
Lease Financing (pg. 310)
Accounting for Leases (pg. 310)
Lease Accounting, Disclosures and Security Prices (pg. 313)
Calculating the Weighted-average Cost of Debt (pg. 316)
Managing Reported Debt (pg. 317)
Analyzing a Company’s Use of Leverage (pg. 317)
Review Problem (pg. 320)
Executive Summary (pg. 321)
Key Concepts and Terms (pg. 321)
Questions (pg. 321)
Exercises (pg. 323)
Problems (pg. 325)
Corporate Analysis (pg. 329)
Solution to Review Problem (pg. 331)
Chapter 10: Commitments and Contingent Liabilities, Deferred Tax Liabilities, and Retirement Obligations (pg. 332)
Commitments and Contingent Liabilities (pg. 334)
Deferred Income Tax Liabilities (pg. 337)
Analyzing Deferred Income Taxes (pg. 341)
Employee Retirement Obligations (pg. 345)
Estimating Retirement Obligations and Their Cost (pg. 346)
Retirement Benefit Disclosures (pg. 346)
Managing Retirement Obligations (pg. 349)
Analyzing Other Potential Liabilities (pg. 349)
Review Problem (pg. 350)
Executive Summary (pg. 351)
Key Concepts and Terms (pg. 351)
Appendix 10A: Illustration of Pension Accounting (pg. 351)
Appendix 10B: Financial Instruments and Derivatives (pg. 354)
Questions (pg. 355)
Exercises (pg. 358)
Problems (pg. 360)
Corporate Analysis (pg. 366)
Solution to Review Problem (pg. 368)
Chapter 11: Equity Financing and Shareholders’ Equity (pg. 370)
Equity financing (pg. 372)
Going Public (pg. 372)
Issuances and Repurchases of Equity (pg. 374)
Dividends (pg. 379)
Cash Dividends (pg. 379)
Free Share Distributions (pg. 382)
Stock Dividends (pg. 382)
Stock Splits (pg. 383)
Other Comprehensive Income (pg. 385)
Employee Stock Options (pg. 387)
Analyzing Equity Financing and Shareholders’ Equity (pg. 392)
Executive Summary (pg. 394)
Key Concepts and Terms (pg. 394)
Questions (pg. 395)
Exercises (pg. 396)
Problems (pg. 400)
Corporate Analysis (pg. 405)
Solution to Review Problem (pg. 406)
Chapter 12: Using Accounting Information in Equity Valuation (pg. 408)
Pro Forma Financial Statements (pg. 410)
Introduction to Equity Valuation (pg. 414)
Using Cash Flow Data to Value a Company (pg. 415)
Developing Cash Flow Data (pg. 415)
Valuation using the Discounted Cash Flow Model (pg. 418)
The Operating Value of a Firm (pg. 418)
Free Cash Flow (pg. 419)
Valuing a Firm’s Equity (pg. 420)
Valuing the Russian River Valley Winery Shares (pg. 421)
Valuation using the Residual Income Model (pg. 424)
Valuing the Russian River Valley Winery Shares (pg. 425)
Valuation using Price-Earnings Multiples (pg. 426)
Executive Summary (pg. 427)
Key Concepts and Terms (pg. 428)
Questions (pg. 428)
Exercises (pg. 429)
Problems (pg. 432)
Corporate Analysis (pg. 448)
Appendix A: The Time Value of Money (pg. 450)
Appendix B: Financial Statement Ratios and Metrics (pg. 458)
Appendix C: IFRS Illustrated: LVMH Moet Hennessey-Louis Vuitton S.A. (pg. 460)
Appendix D: Accounting Mechanics (pg. 466)
Paul J. Simko

Paul J. Simko

Paul J. Simko is Associate Dean of the MBA for Executives Program and Associate Professor of Business at the University of Virginia's Darden School.

He received Bachelor of Science and Master in Accountancy degrees from the University of Florida, and a Ph.D. from the University of Texas at Austin. Professor Simko was previously on the faculty at Emory University, and has served as a Visiting Professor at Indiana, INSEAD, the Helsinki School of Economics, and the Indian School of Business. He was a Senior Analyst with Citicorp and is a Certified Public Accountant, and he remains a frequent consultant to government agencies and public and private corporations. Professor Simko has received numerous recognitions for his research and teaching. His research has appeared in such journals as The Accounting Review, Journal of Accounting Research, Financial Analysts Journal, and the Stanford Journal of Law, Business and Finance.

Kenneth R. Ferris

Kenneth R. Ferris

Professor in the W.P. Carey School of Business at Arizona State University where he teaches the undergraduate, introductory financial accounting course.

He received a B.B.A. and an M.B.A. from The George Washington University and an M.A. and a Ph.D. from The Ohio State University. He previously served on the faculties of Northwestern University, The Claremont Graduate University, Southern Methodist University, and Thunderbird School of Global Management, and he has taught at numerous academic institutions in Australia, Hong Kong, Japan, and New Zealand. Professor Ferris is the author or co-author of eleven books, over fifty academic and professional publications, and over eighty case studies. He previously served as a director of several NYSE listed companies and is active in executive education programs around the world.

James S. Wallace

James S. Wallace

Associate Professor at The Peter F. Drucker and Masatoshi Ito Graduate School of Management at The Claremont Graduate University.

He received his Bachelors of Arts from the University of California, Santa Barbara, his MBA from the University of California, Davis, and his PhD from the University of Washington. Professor Wallace also holds a CPA certification from the state of California. He previously served on the faculty of the University of California, Irvine and has served as a visiting professor at the University of California, San Diego. Professor Wallace's work has appeared in leading academic journals including the Journal of Accounting and Economics, the Journal of Corporate Finance, and Information Systems Research, along with leading applied journals such as the Journal of Applied Corporate Finance, the Journal of Accountancy, Issues in Accounting Education and Accounting Horizons. Prior to his career in academics, Professor Wallace worked in public accounting and in industry with a Fortune 500 company. He has done consulting work with numerous companies in multiple industries.

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