Reporting of Postretirement Benefits

Reporting requirements for postretirement benefits (pensions and OPEBs) are

specified in SFAS 132, which prescribes similar disclosure formats for both OPEBs
and pension benefits. While companies rarely separately report either the current or
accrued benefit cost (pension or OPEB) in the financial statements, the standard
mandates extensive note disclosure. This includes details about both economic and
reported amounts relating to liabilities, assets, and costs of postretirement benefits
separately for both OPEBs and pensions.
The note for pensions and other postretirement benefits consists of three main
parts: (1) an explanation of the reported position in the balance sheet; (2) details of
net periodic benefit costs; and (3) information regarding actuarial and other
assumptions.
Analyzing Postretirement Benefits
Analysis of postretirement benefit disclosures is an important task, both
because of the magnitude of these obligations and because of the distortions
introduced by accounting rules.
There is three-step procedure for analyzing postretirement benefits:
1) Determine and reconcile the reported and economic benefit cost and liability
(or asset)
2) Make necessary adjustments to financial statements, especially the balance
3) Evaluate actuarial assumptions and their effects on financial statements

Cash Flow Implications of Postretirement Benefits

Cash flow implications of postretirement benefits are straightforward. That is,
cash outflow is equal to the contribution made to the plan by the company.
Commitments
Commitments are potential claims against a companys resources due to
future performance under contract. They are not recognized in financial
statements since events such as the signing of an executory contract or
issuance of a purchase order is not a complemented transaction.

OFF-BALANCE-SHEET FINANCING
Off-balance-sheet financing refers to the nonrecording of certain financing
obligations.
Off-Balance-Sheet Examples
1) Through-put agreements; where a company agrees to run a specified amount
of goods through a processing facility.
2) Take-or-pay arrangements; where a company guarantees to pay for a
specified quantity of goods whether needed or not.
3) Product financing arrangements; where a company sells and agrees either to
repurchase inventory at a price equal to the original selling price plus
carrying and related costs or to guarantee a selling price to third parties.
Special Purpose Entities (SPEs)

o
o
o

A special purpose entity is formed by the sponsoring company and is

capitalized with equity investment, some of which must be from independent
third parties.
The SPE leverages this equity investment with borrowings from the credit
markets and purchases earning assets from or for the sponsoring company.
The cash flow from the earning assets is used to repay the debt and provide a
return to the equity investors.

There are two primary reasons for the popularity of SPEs:

1) SPEs may provide a lower-cost financing alternative than borrowing from the
credit markets directly.
2) Under present GAAP, so long as the SPE is properly structured, the SPE is
accounted for as a separate entity, unconsolidated with the sponsoring
company.
SHAREHOLDERS EQUITY
Equity refers to owner (shareholder) financing of a company which is viewed as
reflecting the claims of owners on the net assets of the company.
An analysis of equity must take into account several measurement and
reporting standards for shareholders equity. The analysis would include:
o Classifying and distinguishing among major sources of equity financing
o Examining rights for classes of shareholders and their priorities in liquidation
o Evaluating legal restrictions for distribution of equity
o Reviewing contractual, legal, and other restrictions on distribution of retained
earnings
o Assessing terms and provisions of convertible securities, stock options, and
other arrangements involving potential issuance of shares
Capital Stock

1)
2)
3)
4)
5)

Reporting of Capital Stock

Reporting of capital stock includes an explanation of changes in the number
of capital shares. This information is disclosed in the financial statements or
related notes.
Sources of increases in capital stock outstanding:
Issuance of stock
Conversion of debentures and preferred stock
Issuances pursuant to stock dividends and splits
Issuances of stock in acquisitions and mergers
Issuances pursuant to stock options and warrants exercised

Sources of decreases in capital stock outstanding:

1) Purchases and retirements of stock
2) Stock buybacks
3) Reverse stock splits

Components of Capital Stock

a. Contributed (or paid-in) capital; the total financing received from

shareholders in return for share capital, usually divided into two parts: (1)
common (or preferred stock); financing equal to par or stated value; if stock
is no-par, then equal to total financing, and (2) contributed (or paid-in) capital
in excess of par or stated value; financing in excess of any par or stated
value.
b. Treasury stock (or buybacks; the shares of a companys stock reacquired
after having been previously issued and fully paid for.

Classification of Capital Stock

a. Preferred stock; a special class of stock possessing preferences or features
not enjoyed by common stock, typical features include: (1) dividend
distribution preferences, (2) liquidation priorities, (3) convertibility
(redemption) into common stock, (4) nonvoting rights, and (5) call provisions.
b. Common stock; a class of stock representing ownership interest and
bearing ultimate risks and rewards of company performance.

Analyzing Capital Stock

Items that constitute shareholders equity usually do not have a marked
effect on income determination and, as a consequence, do not seriously
impact analysis of income. The more relevant information for analysis relates
to the composition of capital accounts and to their applicable restrictions.

Retained Earnings
Retained earnings are the earned capital of a company that reflects the
accumulation of undistributed earnings or losses of a company since its inception.

Cash and Stock Dividends

a. Cash dividend; a distribution of cash to shareholders.
b. Stock dividend; a distribution of a companys own shares to shareholders
on a pro rata basis.

Prior Period Adjustments

Prior period adjustments are mainly corrections for errors in prior periods
financial statements.

Appropriations of Retained Earnings

Appropriations of retained earnings (sometimes referred to as reserves) are
reclassifications of retained earnings for specific purposes, usually recognize
that a company does not intend to distribute these amounts as dividends, but
rather to reserve them for litigation, plant expansion, self-insurance, and
other business contingencies.

Restrictions on Retained Earnings

Restrictions (or covenants) on retained earnings are constraints
requirements on the retention of a certain retained earnings amount.

or

Analyzing Retained Earnings

Analysis restrictions imposed on distributions of retained earnings by loan or
other agreements usually reveals a companys latitude in areas like dividend
distributions or in maintaining required levels or working capital.

Book Value per Share

Book value per share is the per share amount resulting from a companys
liquidation at amounts reported on its balance sheet. Book value is conventional
terminology referring to net asset value that is, total assets reduced by claims
against them.

Computation of Book Value per Share

A simple means of computing book value is to add up the common stock
equity accounts and reduce this total by any senior claims not reflected in the
balance sheet (including preferred stock dividend arrearages, liquidation
premiums, or other asset preferences to which preferred shares are entitled).

Relevant of Book Value per Share

Book value plays an important role in analysis of financial statements.
Applications can include the following: (1) book value, with potential
adjustments, is frequently used in assessing merger terms, (2) analysis of
companies composed of mainly liquid assets (finance, investment, insurance,
and banking institutions) relies extensively on book values, and (3) analysis
of high-grade bonds and preferred stock attaches considerable importance to
asset coverage.

Liabilities at the Edge of Equity

Redeemable Preferred Stock

These securities require a company to pay funds at specific dates. The SEC
asserts that redeemable preferred stocks are different from conventional
equity capital and should not be included in shareholders equity nor
combined with nonredeemable equity securities.

Minority Interest
Minority interest is not an immediate claim on company resources. Instead,
minority interest represents the proportionate stake of minority shareholders
in a companys majority-owned subsidiary that is consolidated.