1The Analysis of the Statement of Shareholders Equity

GAAP Statement of Shareholders EquityGAAP Statement of Shareholders EquityOpening book value of equity (common and preferred)

+ Net share transactions with common stockholders

+ Capital contributions (paid in capital from share issues)- Share repurchases (into treasury stock or against paid-in capital)

+ Net share transactions with preferred shareholders

+ Capital contributions (share issues)- Share redemptions

+ Change in retained earnings

+ Net income- Common dividends- Preferred dividends

+ Accumulated other comprehensive income

+ Change in unearned (deferred) stock compensation

Closing book value of equity (common and preferred)

TheGoverningAccountingRelation

Bookvalue,beginningofperiod

+ Comprehensive income+Comprehensiveincome

Netpayouttoshareholders

=Bookvalue,endofperiod

2ReformulatedStatementofStockholdersEquity

Opening book value if common equity (CSEt-1)

+ Net transactions with common shareholders

+ Capital contributions (share issues)

- Share repurchases

- Common dividends

+ Comprehensive income to common shareholders

+ Net income

+ Other comprehensive income

- Preferred dividends

Closing book value of common equity (CSEt)

Note that preferred equity is taken out of the common shareholders' equity statement (and treated as a liability).

Reformulation:TheSteps1. Restatebeginningandendingbalancesforitemsincorrectlyincludedin

orexcludedfromcommonequity Preferredstock Dividendspayable Unearned(deferred)compensation

2. Calculatenettransactionswithshareholders

Cashdividends+sharerepurchases shareissues

3. Calculatecomprehensiveincome

Netincome+OthercomprehensiveincomePreferreddividends

TheGAAPStatement:NikeInc.,2004

3Nike:TheReformulatedStatementBalance, May 31, 2003 $4,028.2

Transaction with Shareholders

Stock issues 308.1 Stock repurchases (416.3) Common dividends (179.2) (287.4)

Comprehensive Income

Net income reported 945.6 Currency translation gains 27.5 Gains on hedge derivatives 125.9 1099.0

Balance, May 31, 2004 4,839.8 Balances: 2003 2004

Reported $3,990.7 4,781.7Dividends payable 36.9 52.6Unearned compensation 0.6 5.5Restated balance $4,028.2 $4,839.8

TheGAAPStatement:ReebokInternationalLtd.,2004

Reebok:ReformulatedStatementBalance, December 31, 2003 $1,034.9

Transaction with Shareholders

Stock issues $62.3 Stock repurchases (88.1) Common dividends (17.8) (43.6) Comprehensive income Net income reported 192.4 Currency translation gains 37.7 Gains on hedge derivatives 4.4 234.5

Balance, December 31, 2004 1,225.8

Balances:

2003 2004Reported 1,033.7 1,220.0Unearned compensation 1.2 5.8Restated balance 1,034.9 1,225.8

4Dirty Surplus Accounting in the USDirty Surplus Accounting in the US

Operating Income:

Some income-increasing accounting changes (APB No. 20) a. change from LIFO valuation of inventory b. change in long-term contract accounting c. change to or from full cost accounting in extractive industries d. a change triggered by a red line in an accounting standard (e.g. change from cost to equity method for long-term equities) e. a change made for the first time in conjunction with a IPO or business combination Changes in accounting for contingencies (FASB No. 11) Foreign currency transaction gains and losses (FASB No. 52) Minimum pension liability adjustment (FASB No. 87) Some write-downs of deferred tax valuation allowances (FASB No. 109) Tax benefits of loss carry forwards acquired (FASB No 109) Tax benefits of loss carry forwards acquired (FASB No. 109) Tax benefits of preferred dividends paid to ESOPS (FASB No. 109) Unrealized gains and losses on equity securities available for sale (FASB No. 115) Financing Income or Expenses:

Preferred Dividends Unrealized gains and losses on debt securities available for sale (FASB No. 115) Operating or Financing Income Items:

Foreign currency translation gains and losses (FASB No. 52) Gains and losses on derivative instruments designated (FASB No. 133) as cash flow hedges

Balance Sheet Items to be Reclassified:

Deferred compensation relating to grant of (APB No. 25 and FASB No. 123) employee stock options and stock Dividends payable Preferred stock

FASBStatementNo.130

Requiresthereportingofcomprehensiveincomeinoneofthreeways

WithintheincomestatementInseparatestatementWithi th it t t tWithintheequitystatement

Ratio AnalysisRatio Analysis

DividendsDividend Payout = Comprehensive Income

Dividends + Stock RepurchasesTotal Payout Ratio=Comprehensive Income

Payout and Retention Ratios

DividendsDividends-to-Book Value=Book Value of CSE +Dividends +Stock Repurchases

Dividends+StockRepurchsesTotal Payout-to-Book Value=Book Value of CSE + Dividends + StockRepurchases

Comprehensive Income - DividendsRetention Ratio= =1- Dividend Payout RatioComprehensive Income

5RatioAnalysis(continued)

( )t

t

t t-1

Comprehensive EarningsROCE = 1 CSE +CSE2

Shareholder Profitability Ratio

Growth Ratios

T ti ith h h ldTransactions with shareholdersNet Investment Rate=Beginning Book Value of CSE

Change in CSE Comprehensive Income+Net Transactions with ShareholdersGrowth Rate of CSE= =Beginning CSE Beginning CSE

HiddenDirtySurplus

Shareholderslosewhensharesareissuedatlessthanthemarketprice(e.g.exerciseofoptions)

Thisloss,however,isnotrecordedasexpense.

What is the nature of this loss? If options are part of aWhatisthenatureofthisloss?Ifoptionsarepartofacompensationpackage,thislossisanemployeecompensationexpense.Iffromaconversionofabond,preferredstockorwarrants,thelossisafinancingexpense.

Whatistheamountoftheloss?Marketprice exerciseprice.

Specialcase:optionsgrantedinthemoneyarerecordedasdeferredcompensation

FASBStatementNo.123R Statement123Rrequiresanexpensetoberecognizedatoption

grantdate,equaltothevalueoftheoptionatthatdate

Upto2006,proformanetincome,includingtheexpense,wasreportedinfootnotes.Theexpensemustnowbereportedintheincomestatement.

Noexpenserecordedastheoptionmovesintothemoneyoratexercisedate.

Firmsrecordataxbenefit(fornonqualifiedoptions)atexercisedate,andcreditthistoshareholdersequity.

IFRS2hassimilarrequirements

6MeasuringtheLossfromExerciseofStockOptions:

Method1(Reebok)Expense is implied from the tax benefit:

Stock option expense $11,477/0.359 $31,969

Tax benefit at 35.9% (11,477)

Stock option expense, after tax $20,492

MeasuringTheLossfromExerciseofStockOptions:

Method2(Reebok)Calculate difference between average stock price and exercise price:

Estimate market value of shares issued 1,751 x $38.00 $66,538

Exercise (issue) price, from equity statement 41,080

Stock option expense before tax 25 458 Stock option expense, before tax 25,458

Tax benefit at 35.9% 9,139

Stock option expense, after tax $16,319

Use when tax benefit is not reported, or for incentive options (where there is no tax benefit).

Reebok:ReformulatedStatementBalance, December 31, 2003 $1,034.9

Transaction with Shareholders

Stock issues (62.3 + 20.5) $82.8 Stock repurchases (88.1) Common dividends (17.8) (23.1) C h i iComprehensive income Net income reported 192.4 Currency translation gain 37.7 Gains on hedge derivatives 4.4 Loss on employee options (20.5) 214.0

Balance, December 31, 2004 1,225.8

Shares are issued at market value, and the difference between the market value and after-tax receipts for the shares issued is a loss from exercise of options.

7HiddenLossesonPutOptions:DellComputer

From the 2002 equity statement (see Chapter 2): Shares Amount

Repurchase of common shares (millions) 68 $3,000

The Loss:

Market price of shares repurchased $24 x 68 million $1,632 million

Amount paid for shares repurchased 3,000

Loss on exercise of put options $1,368 million

TheGAAPStatementofShareholdersEquity:DellComputer,2002

CommonStock

andCapitalin

ExcessofParValue TreasuryStock

Other

RetainedComprehensive

SharesAmount Shares Amount

Earnings IncomeOther Total

Balanceat

February2,2001 2,6014,795

83962

(74) 5,622Netincome

1,246

1,246Changeinunrealizedgainoninvestments,netoftaxes

(65)(65)

(65)

Foreigncurrencytranslationadjustment

2

2Netunrealizedgainonderivativeinstruments,netoftaxes

39

39Totalcomprehensive incomeforfiscal2002

1,222

Stockissuancesunderemployeeplans,includingtaxbenefits

69843

10 853

Purchasesandretirements

(16) (30)52

(2,249) (721)

(3,000)Other

(3)

3Balancesat

February1,2002 2,654$5,605 52$(2,249) $1,364

$38$(64) $4,694

Dell:ReformulatedStatementDellComputerCorporation

ReformulatedStatementofShareholdersEquity

Balance,February2,2001

$5,696

Transactionswithshareholders:

Sharesissuedinstockoptionexercises(atmarket)$1,747

Sharesrepurchased(atmarket)(1,632)

115

Comprehensiveincome

Comprehensive income reportedComprehensiveincomereported1,222

Lossonexerciseofemployeestockoptions $1,391Taxbenefitforemployeestockoptions 487(904)

Lossonputoptions

(1,368)(1,050)

Other(3)

Balance,February1,2002

$4,758

8LossesonConvertibleSecuritiesLoss=Marketpriceofcommonissued

Bookvalueofconvertiblesurrendered

The market value method vs. the book value methodThemarketvaluemethodvs.thebookvaluemethod

Themarketvaluemethodrecognizeslossesonconversion

Thebookvaluemethodrecordsthesharesatthebookvalueoftheconvertiblesecurities,withnolossrecognized

Almostallfirmsusethebookvaluemethod.