# Miscellaneous other accounting elements ## Valuation Typically, valuations take more work than most standard accounting activities, so they're made annually at most, or when needed. - The measurement will be very specific when investors, governments, or equity-holders want to see it. [Estimations](imagination.md) and [reality](reality.md) don't always match, and variance is the difference between them. The book value is the lesser of the original cost paid for the asset (historical value) and its current value (fair market value). - Sometimes, a buyer can pay a premium on top of the advertised price. - Other times, the asset can be discounted. Cost-based pricing determines the price of the sold good on how much it costs to manufacture, *not* on [marketing](marketing.md). - Typically, a highly competitive market *requires* cost-based pricing, and increasing profits involves cutting costs while maintaining the product's quality. One of the most severe procedures associated with valuations is when it goes bankrupt (or insolvent if it's an LLC): 1. All secured debt is reconciled first, typically by those organizations claiming their assets. 2. Any remaining assets are liquidated to pay the rest, based on a specific order. The discrepancy between the appraised net worth and publicly interpreted value by a company is often different. - Gross margin is the difference between the cost of making/getting something and how much it's sold for. - Accountants only concern themselves with Fair Market Value (what its assets are worth, minus its liabilities) and Historical Value (what people originally paid for it), so they plug in Goodwill for the price will people *actually* pay for the company. ## Ratios There are *tons* of ratios, which take several numbers to create a third number. - Most of the ratios can be useful to determine the health of an organization, barring [Goodhart's Law](lawsaxioms.md). - Numerous ratios serve as key performance indicators, and new ones are constantly arising. Ratios which measure profitability: - Operating profit margin = operating profit / total sales - Net profit margin = net income / net sales Ratios that indicate how prepared a company is for short-term changes: - Current ratio (or working capital) = current assets - current liabilities - Quick ratio = (current assets - inventory - prepaid expenses) / current liabilities Ratios that indicate long-term financial strength relative to debt: - Debt ratio (or debt-to-total-assets) = total liabilities / total assets - Long-term debt ratio = long-term liabilities / total assets - Debt-to-capital ratio = total liabilities / (total liabilities + total equity) - Debt-to-equity ratio = total liabilities / shareholder equity - Fixed-charge coverage = EBIT / all interest and lease payments Ratios that can indicate investment performance and profitability: - Return on equity = net income / average shareholder equity - Gross margin = gross profit / net sales - Return on assets = net income / total assets Ratios for multiple owners' return on their investment: - Earnings per share = total profit / number of shares - Price to earnings (or P/E) = the market price of a share / earnings per share - Can use the previous 12 months (trailing P/E) or projected 12 months (forward P/E). - Price to book value = share's market price / (share's book value - intangible assets) - Price to sales = price per share / revenue per share - Dividend yield = annual dividend / share's market price ## Primary roles While [computers](computers.md) have completely automated every aspect of accounting, the two remaining domains that require humans for the role are in [taxes](money-accounting-taxes.md) and auditing. ## Auditing Audits are an extremely mind-numbing process of examining an organization's entire accounting system. There are 3 types of audits: - Internal audits - company employees examine issues with financial and business practices. - External audits - independent evaluators examine financial records to provide an objective opinion that affirms their financials are accurate and complete, or offers guidance to help them make more informed financial decisions. - Internal Revenue Service (IRS) audits - financial examinations conducted by the IRS to ensure tax was sufficiently paid. Irrespective of whom, the process is straightforward: 1. Start with the first accounting period to audit. 2. Start with the first account. 3. Grab a sample transaction from that account. 4. Thoroughly examine the sample transaction and all supporting evidence. 5. Ensure the transaction has material evidence and is accurate. 6. Repeat Step 3 a few more times. 7. Move to the next account and repeat Steps 3-6. 8. Repeat Step 7 until all accounts have been audited. 9. Move to the next accounting period. 10. Repeat Steps 2-8 for that accounting period. 11. Repeat Steps 9-10 until all accounting periods have been audited. Auditors are hunting for specific things that may represent worse problems: - Compensating errors - two mistakes that curiously canceled each other, since it may belie worse problems. - Creative accounting - clever methods that make accounts appear like the balance is higher or lower than they really are. Underneath all of it, auditors work to expose unethical or criminal activity: - Fraud - intentionally misusing a company's resources. - Money laundering - hiding illegally obtained money by merging it in with legal activities. - Negligence - disregarding the rules or failing to exercise proper care in keeping records. Auditors, like claims adjusters, do *not* believe in mere coincidences, and they will issue an opinion after their investigation: - Unqualified opinions indicate that the information is sound. - Qualified opinions indicate they have a "qualification" that demonstrates a problem with the information. There are also specific audits for [ESG](politics-leftism.md) and [cryptocurrency](computers-blockchain.md), but they're new enough [trends](trends.md) that there's not as much precedent as a standard audit. ## Mergers/acquisitions Generally, a company that isn't growing is dying, and they grow through several approaches: 1. Growing larger and expanding their operations, which will reflect somewhere on their financials. 2. Acquisitions of other companies, though they themselves may grow larger as a unit of a larger company acquiring *them*. When a company is purchased, the relationship between the entities gets complicated. - A merger combines the accounts together from two entities to form a singular, separate third entity. - An acquisition keeps the accounts separate, with a parent and subsidiary company. - A consolidation combines all of a subsidiary company's accounts into a parent company, and shares being exchanged in a stock-for-stock merger. - Consolidated financial statements track *all* activities of a parent company, along with its subsidiaries. Most of the issues tie into [conflicts](people-conflicts-why.md) about company valuations, along with the [rights and privileges](people-boundaries-why.md) that naturally emanate from the forms of the final business entities from the procedure. Beyond the value of an asset (which may have [sentimental value](mind-feelings.md) for some investors), there's a Total Cost of Ownership (TCO) that diminishes the simple value of something: - New software - Installation costs - Transition costs - Employee training - Security costs - [Disaster recovery planning](safety-riskmgmt.md) - Ongoing support costs - Necessary future upgrades ### Merger games An IPO is pricier and more complicated compared to a merger/acquisition, so a relatively new vehicle for companies is to create a special purpose acquisition company (SPAC): 1. Someone creates a corporation that's publicly traded, but with zero assets or liabilities. - Its $0 or negative IPO net worth is therefore tax-free. - People will trade that IPO on a market based on their understanding that the company *will* purchase other companies. 2. After the first accounting period or tax year, the company purchases other companies. - Those other companies were privately held, but are now part of a mega-merger with other companies. 3. After a few purchases of those other companies, the corporation operates like any other corporation. - The legitimate value of the SPAC is based on the performance of those other companies, give or take how well they were [managed](mgmt-1_why.md) during the entire time up to that point. - SPACs are particularly popular among industries that lean heavily into [intellectual property](legal-ip.md), such as [software](computers-software.md) or pharmaceuticals. ## Breakups A company can sometimes become too large. At that point, it may need to break up: - The company has too much [bad publicity](people-image-why.md) and needs a [new brand](marketing.md). - The leadership had a [difference of opinion](people-conflicts-why.md), and they agree to segment the company internally into several subsidiaries. - A government considers them too large as a [monopoly](politics-monopolies.md), and uses [laws](people-rules.md) to break them apart. However it happens, the accounting typically records the information as at least a partial liquidation of the original entity, then the formation of a new entity. ## Accounting fraud There are many ways to violate GAAP and lie on accounting reports. Money laundering involves moving money across multiple entities to make the accounting appear legitimate. - Income must be overstated (to move money in). - Expenses must be proportionately embellished (to move money out as well as avoid the risks of a tax audit). Losses that *should* be indicated as expenses can easily be obscured as future losses if the liabilities aren't closely tracked. Using shell companies offloads expenses or revenue onto subsidiary companies. - The concept is relatively simple: 1. Create a subsidiary organization. 2. Pass on all expenses to that organization. 3. The publicly traded entity will make obscene profit, creating an [investing](money-investing.md) boom (e.g., Enron). - This can also be reversed to avoid taxation, with shell companies in more tax-favored situations receiving the revenues. In [unregulated](people-rules.md) [cryptocurrency](computers-blockchain.md), traders can use wash trading (inspired by wash subscribing in [marketing](marketing.md)) to magnify the value of their assets: 1. Make a cryptocurrency that mines across at least a few servers. 2. Perform many, many trades (often with fees) with yourself, which makes it look wildly [popular](trends.md). 3. [Advertise](marketing.md) to as many people as possible that your cryptocurrency is wildly popular. 4. If you can acquire enough actual users, you've created a legitimately popular cryptocurrency and can sell your assets for actual cash.