KCQs Chapter 4 Study Guide
KC #1: 4.1
One thing I have noticed as I began reading this chapter is that Martin likes to make things seem very important at the beginning of a section and then at the end of it let us know that they are actually not very useful at all. I am not sure if this is a trick to make us read and research into everything or a slightly cruel joke on Martin’s behalf. The best example of this is in 4.1 when Martin goes in detail explaining Cash Flow as an indicator, hopes were high when he speaks about how Free Cash Flow (FCF) is important to investors because even if companies have the same level of operating income, a company with lower investment and a higher FCF is favourable. All of a sudden it becomes apparent that cash flow in any given year is not a good indicator at all because FCF could easily be increased by simply reducing net investment. I just feel for me that that information could have been slightly condensed instead of my becoming enthralled into FCF only to find it was fairly useless as an indicator in comparison to Economic Profit.
KQ #1: 4.2
I have to admit it was rather relieving when I read that there is no need to restate a firm’s cash flow statement, as we do not need this statement to identify the key accounting drivers of economic profit and cash flow. However one of my key questions is why do we not need to restate a firm’s cash flow statement. Surely restating a document that shows the cash flow statement reports a company's major sources and uses of cash would be something important to investors and part of cash flow as well. I guess I still need to wrap my head around this, but it does make me happy I only have to restate three financial statements not four.
KQ #2: 4.2
As I am reading about restating the statement of changes in equity I am looking at my company’s statement of changes in equity and comparing them to Martin’s. To put it mildly there are some major differences. Genetic technologies is suffering continual losses, and the only thing stopping a negative closing balance is the company’s transactions with owners in their capacity as owners, in particular, contributions of equity (net) and value of shares issued on conversion of convertible notes. Because my company has so much debt I am not sure what to do when restating, because Martin says that something we need to do when restating a statement of changes in equity is to ensure equity only includes genuine equity , and debt should be excluded from a firm’s equity and included as a liability instead. Most of my transactions with owners in their capacity as owners is a debt including:
Is it as simple as just putting these under the heading, transactions with shareholders as Martin has done or is there more to it.
I also made sense of things in my statements that had confused me in Assignment 1 I didn’t quite understand before reading this chapter. Many of the items where just words to me, especially the other comprehensive income/loss (in my case it was mainly loss). After reading what Martin was saying about how firms don’t include some of its earnings in its income statement. I ‘other comprehensive income/loss’ that I had only glance over before.
KC #2: 4.3
As I read down to 4.3 Martin explains something that is somewhat a response or solution to my problem. “There is no simple ‘cookie-cut’ solution for all firms that you can simply memorise and reproduce.” I feel both relieved that I wasn’t going crazy at my statements being so different to Ryman Healthcare and also slightly nervous at the fact I have to make my own judgement calls. I guess this is what was explained right at the beginning of the course, accounting really isn’t just numbers.
KQ #3 and KC #3: 4.3
Another thing I found slightly confusing and am questioning is allocating tax to the operating and financial components of the income statement. Why are we adding a fictitious amount onto tax expenses. My assumption is that it is so the report is transparent for outside investors. It just seems slightly strange that everything is a guess or a judgement call. However I guess this relates back to what Martin talked about previously with no simple ‘cookie-cut’ solution. This leads to my final key concept I got from restating financial statements, clearly restating financial statements is a lot more than just organising things differently under different heading and sections. There is a lot more to it, calculating, judgement calls, investigative work, the list goes on and on. I certainly have a daunting task in front of me restating Genetic Technologies Limited financial statements. I feel like I need more information, but I think a fair amount of Google and talking to other students will get me on my way.
KC #4: 4.4
It’s clear when moving onto 4.4 profitability and efficiency that return on net operating assets (RNOA) is a key concept in understanding a firm’s reality. It is really interesting to see how ratios focusing on profitability and their efficiency are used to calculate the RNOA. The Ryman Healthcare example really cleared this up for me. When I was just looking at the formula on its own, it didn’t really mean much to me, but I understand now it is really comparing its operating income with the net operating assets using ratios. Determining profitability and efficiency for me is a lot more straightforward that restating and I am looking forward to doing this. I definitely work best with formulas laid out in front of me and having to make minimal judgement calls.
Summary
One of the major key concepts I have gotten from the part of Chapter 4 on restating financial statements, is the necessity to learn from other students and communicate. I was struggling through this on my own, but have now taken the advice that learning is a social activity and I am now contacting other students to see how they are going and what they are doing, especially students with companies in a similar position to mine. As far as measuring profitability and efficiency goes I actually find that quite a simple concepts to grasp and using accounting drivers to measure these is as Martin puts it, “as simple as breaking things into bits”.