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406 Cards in this Set
- Front
- Back
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Audit
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provides an opinion on the fairness and reliability of financial statements
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Standard auditors opinion contains three parts, what are they?
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1. auditor has performed independent review 2. reasonable assurance that the financial statements contain no material errors 3. used accepted accounting principles and principles chosen/estimates made are reasonable |
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Going concern assumption
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firm will continue to operate for the foreseeable future
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When must an 8-K be filed
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to report events such as acquisitions or disposals of major assets or changes in management/corporate governance
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Proxy statements
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issued to shareholders when there are matters that require shareholder vote
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Financial statement analysis framework
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1. Objective and context 2. Gather data 3. Process the data 4. Analyze and interpret the data 5. Report the conclusions or recommendations 6. Update analysis O.G. P.A.R.U. |
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Unqualified opinion
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clean opinion (auditor believes free of errors/omissions)
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Qualified opinion
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if statements make any exceptions to the accounting principles
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Adverse opinion
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if statements not presented fairly or don't conform to accounting standards
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Disclaimer of opinion
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if auditor is unable to express an opinion
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What is contained in financial statement notes?
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-basis of presentation - information about accounting methods, assumptions, and estimates |
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What is contained in management's discussion and analysis?
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- nature of business, past performance, and future outlook - some parts of management's commentary may be unaudited |
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In the US, the SEC requires that MD&A also contain...
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trends and significant events/uncertainties in firms liquidity
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Which of the following statements least accurately describes a role of financial statement analysis? A. Use the information in financial statements to make economic decisions B. Provide reasonable assurance that the financial statements are free of material errors C. Evaluate an entity's financial position and past performance to form opinions about its future ability to earn profits and generate cash flow |
B. this statement describes role of an auditor
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Operating activities
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those undertaken in firms ordinary course of business (buying/selling short term assets)
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Investing activities
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buying/selling long term assets
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Financing activities
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issuing long term debt/common stock, repurchasing stock, paying dividends
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Unearned revenue vs. Accrued revenue
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- unearned= earns cash before providing good/service - accrued= provides good/service before receiving cash |
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Journal entries
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record every transaction and show which accounts changed
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General ledger
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sorts the entries in the general journal by account
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Initial trial balance vs. Adjusted trial balance
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Initial= at end of accounting period, initial trial balance prepared that shows balances in each account Adjusted= if any adjusting entries need to be made |
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General Journal
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lists all company transactions by date
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What financial statement should accumulated depreciation be in?
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Assets (contra asset account)
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What financial statement should allowance for bad debts be in?
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Asses (contra account to accounts recievable)
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What financial statement should deferred tax items be in?
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Both deferred tax assets and deferred tax liabilities are record (Assets and Liabilities)
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What financial statement should prepaid expenses be in?
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Assets (accrual account)
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What financial statement should unearned revenue be in?
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Liabilities (accrual account)
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The two primary standard setting bodies are..
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- Financial Accounting Standards Board (FASB) in the US - International Accounting Standards Board (IASB) outside US |
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What are the two primary regulatory authorities?
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- Securities and Exchange Commission (SEC) in US - Financial Services Authority (FSA) in UK |
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International Organization of Securities Commission (IOSCO)
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- three primary objectives of financial market regulation: - 1. protect investors - 2. ensure fairness, efficiency, and transperancy - 3. reduce systematic risk |
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Form S-1
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registration statement filed prior to the sale of new securities to the public
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Form DEF-14A
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when company prepares a proxy statement, it must also file a corresponding statement with SEC
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Form 144
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company can issue securities to qualified buyers without registering them to the SEC but must notify SEC that it intends to do that
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Form 3, 4, and 5
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- ownership of securities by officers and directors - can use these filing to learn about purchases and sales of company securities by company insiders |
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What are the barriers to convergence for IFRS and US GAAP?
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- countries disagree on best treatment of particular item - political pressures |
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What are the two fundamental characteristics that make financial information useful?
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1. Relevance (should have predictive value, confirmatory value, and materiality) 2. Faithful representation (complete, neutral, no errors) |
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What are the four characteristics that enhance relevance and faithful representation?
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1. Comparability 2. Verfiability 3. Timeliness 4. Understandability |
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When should an item be recognized in its financial statements?
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- if a future economic benefit from the item is probable and its value can be measured reliably
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Different types of measurement bases
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1. historical cost 2. amortized cost (historical cost adjusted for depreciation, amortization, depletion, impairment) 3. current cost (amount firm would have to pay today for same asset) 4. realizable value (amount that firm could sell asset for) 5. Present value (discounted value of expected future cash flows) 6. Fair value (amount by which two parties would agree to exchange asset for) |
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Accrual accounting
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financial statements should reflect transactions at time they occur not when cash is paid
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What are the required financial statements according to the International Accounting Standard (i.e. IFRS)?
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1. balance sheet 2. statement of comprehensive income 3. cash flow statement 4. statement of changes in owners equity 5. explanatory notes |
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What are the features for preparing financial statements according to the IFRS?
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- fair presentation - going concern basis - accrual basis - consistency - materiality - aggregation - no offsetting - reporting frequency must be at least annually - comparative information from prior periods should be provided |
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What are the structure and content of financial statements according to the IFRS?
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- classified balanced sheet showing current and noncurrent assets/liabilities - minimum information is required on the face of each financial statement - comparative information for prior periods |
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Where do IFRS and US GAAP differ (big differences don't list all of them)?
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- IFRS lists income and expenses related to performance, US GAAP includes revenues, expenses, gains, losses, and comprehensive income - US GAAP defines asset as a probable future economic benefit, IFRS defines asset as a resource from which future economic benefit is expected - US GAAP does not allow upward valuation |
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Reconciliation statment
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shows what financial results would have been under an alternative reporting system
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A coherent financial reporting framework should be ...
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- transparent - comprehensive - consistent |
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What are the barriers to a coherent financial reporting framework?
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- Valuation - Standard setting (IFRS is principles based, US GAAP is rules based) - Measurement (asset/liability approach vs. Revenue/expense approach) |
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Companies that prepare financial statements using IFRS or US GAAP must disclose their accounting policies and estimates in the ________________.
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footnotes
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Which is least likely one of the conclusions about the impact of a change in financial reporting standards that might appear in managements discussion and analysis? A. Management has chose not to implement the new standard B. Management has chosen not to implement the new standard C. The new standard will not have a material impact on the company's financial statements |
A. Management can discuss the impact of adopting the new standard, conclude that it does not apply or will have no material impact, or state that they are still evaluating the potential impact
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If a firm has noncontrolling interest in a subsidiary, the pro rata share of the subsidiary's income not owned by the parent is reported in ...
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the parents income statement as noncontrolling interest (or minority interest)
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Operating profit
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Revenue - COGS - SG&A
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Gross Profit
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Revenue - COGS
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Under US GAAP, revenue is recognized for sale of goods when ..
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1. ownership transferred 2. no continuing control 3. revenue can be reliably measured 4. probable flow of economic benefits 5. cost can be reliably measured |
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Under IFRS, revenue is recognized for services when...
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1. amount of revenue can be reliably measured 2. probable flow of economic benefits 3. stage of completion can be measured 4. cost incurred and cost of completion can be reliably measured |
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Under US GAAP, revenue is recognized when..
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1. realized or realizable 2. earned SEC provides additional guidance 1. arrangement between buyer/seller 2. product delivered/service rendered 3. price determined 4. seller is reasonably sure of collecting money |
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Percentage of completion method for long term contracts
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(cost to date/total cost) x revenue
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Under US GAAP, when the outcome of the long term contract cannot be reliably estimated, the ____________________ method is used.
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completed-contract method (don't recognize revenue until expenses fully paid)
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Installment sale
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firm finances a sale and payments are expected to be received over an extended period of time (car sales)
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If collectability of an installment sale can be reasonably estimated, the ___________________ method is used. If collectability is highly uncertain, the ________________ method is used.
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installment method cost recovery method |
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Installment method
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cash recognized as cash collected
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Cost recovery method
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profit recognized only when cash collected exceeds costs incurred
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Round trip transaction
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sale of goods to one party with simultaneous purchase of almost identical goods from same party
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Under US GAAP, how is revenue from a barter transaction recognized?
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- at fair value if firm has historically received cash payments for such goods - otherwise, at carrying value |
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Under IFRS, how is revenue from a barter transaction recognized?
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- based on fair value of revenue from similar nonbarter transactions
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Gross revenue reporting
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firm reports sales and cost of goods sold seperately
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Net revenue reporting
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firm reports difference between sales and COGS
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What are the criteria to use gross revenue reporting under US GAAP?
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- be primary obligor under contract - bear inventory and credit risk - be able to choose its supplier - have reasonable latitude to establish price |
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Where do firms disclose their revenue recognition policies?
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footnotes
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True or False: In May 2014, the IASB and FASB issued converged standards for recognizing revenue which go into effect December 15, 2016.
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True
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The converged standards for revenue recognition for IFRS and US GAAP are..
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1. Identify contract with customer 2. Identify performance obligations in contract 3. Determine transaction price 4. Allocate the transaction price to performance obligation in contract 5. Recognize revenue when entity satisfies obligation |
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What is a performance obligation?
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promise to deliver distinct good or service
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Matching principle
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expenses that generate revenue are recognized in same period as revenue
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Period costs
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such as administrative costs are expensed in period incurred
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First in, first out
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- first item purchased is assumed to be first item sold - appropriated for inventory with short shelf life |
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Last in, first out
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- last item purchased is assumed to be first item sold - appropriate for inventory that doesn't deteriorate with age |
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Under inflationary environment, which inventory expense recognition method has higher COGS?
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Last in, first out (higher COGS -> lower taxable income -> lower income taxes)
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Weighted average cost
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cost of available goods/units
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What inventory expense recognition method does US GAAP use?
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FIFO, LIFO and weighted average cost
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What inventory expense recognition method does IFRS use?
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FIFO and weighted average cost
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Depreciation, depletion, amortization
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depreciation (tangible assets) depletion (natural resources) amortization (intangible assets) |
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Straight line depreciation
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(Cost-residual value)/useful life
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Accelerated depreciation
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more depreciation in early years and less in later years
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Double Declining balance method of depreciation
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(2/useful life) (cost-accumulated depreciation)
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Intangible assets with indefinite lives are not amortized. How often must they be tested for impairment?
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at least annually
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If firm sells goods/services on credit and provides a warranty to the customer, when does the firm recognize the expense
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in the period of sale (must also estimate bad debt expense)
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The date when the company develops a formal plan to discontinue a certain subsection of operation is the ______________________, and the time until the actual disposal date is the ________________
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measurement date phaseout period |
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How are revenues from discontinued operations reported in the income statement?
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- reported separately in income statement - all past income statements must be restated, separating income from discontinued operations |
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Where are unusual and infrequent items reported in the income statement?
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income from continuing operations and are reported before tax - can be unusual or infrequent but not both |
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Where do extraordinary items get reported in the income statement?
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- extraordinary= unusual and infrequent - reported separately, net of tax, after income from continuing operations - IFRS doesn't allow items to be treated as extraordinary |
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True or False. A change in accounting policy requires all prior financial statements to be restated to reflect change.
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True
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Prior-period adjustment
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correction of an accounting error made in previous financial statement
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True or False: Operating and non operating transactions are usually reported separately in the income statement
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True
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Simple capital structure
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contains only common stock, nonconvertible debt, and nonconvertible preferred stock
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Complex capital structure
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contains potentially dilutive securities such as options, warrants, or convertible securities
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basic EPS formula
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(net income - preferred dividends)/ weighted average number of common shares
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Weighted average number of common shares
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number of shares outstanding weighted by portion of the year they were outstanding
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Stock dividend
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distribution of additional shares to each shareholder in an amount proportional to current number of shares
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Stock split
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- division of each old share into a specific number of new shares - each shareholders proportional ownership in the company is unchanged |
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During the past year, R&J had net income of $100,000, paid dividends of $50,000 to its preferred stockholders, and paid $30,000 in dividends to its common shareholders. January 1- 10,000 shares issued. April 1- 4,000 shares issued. July 1- 10% stock dividend. September 1- 3,000 shares repurchased Compute EPS.
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Step 1. Adjust pre-stock dividends to post stock dividends (multiply pre stock dividends by 1.1) Step 2. Compute weighted average number of shares (11,000 x 12)+(4,400 x 9)+(-3000x4) =159600/12 months= 13,300 Step 3. Calculate EPS (100,000-50,000)/13,300 = $3.76 |
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Dilutive securities
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stock options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if converted to common stock
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Antidilutive securities
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stock options, warrants, convertible debt, or convertible preferred stock that would increase EPS if exercised or converted to common stock
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Diluted EPS equation
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= [(net income-preferred dividend)+(convertible preferred dividends)+(convertible debt interest x (1-t)]/[(weighted average shares)+(shares from conversion of preferred shares)+(shares from conversion of convertible debt)+(shares issuable from stock options)]
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When calculating diluted EPS, if convertible debt or preferred stock is antidilutive do you include it in the calcualtion
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No, to check compute [convertible debt interest x (1-t)]/convertible debt shares if greater than basic EPS do not include in calcuation To check preferred stock: preferred dividend/number of shares |
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During 20X6, ZZZ Corp reported net income of $115,600 and had 200,000 shares of common stock outstanding for the entire year. ZZZ also had 1000 shares of 10%, $100 par preferred stock outstanding during 20X6. During 20X5, ZZZ issued 600, $1000 par, 7% bonds for $600,000 (issued at par). Each of these bonds is convertible to 100 shares of common stock. The tax rate is 40%. Compute the 20X6 basic and diluted EPS
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basic = (115,600 - 10,000)/200,000 = $0.53 dilutive= (115,600)-(10,000)-(600 x 1000 x 0.07 x (1-0.40))/200,000 + (600 x 100) = 115,600 - 10,000 - 25,200 / 200,000 + 60,000 = $0.50 To check whether convertible debt is dilutive 25,200/60,000= $0.42 which is less than basic EPS of $0.53 so it is indeed dilutive and does need to be included in calculation |
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Common size income statement
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expresses each category of income statement as a percentage of revenue
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Effective tax rate
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tax expense as a percentage of pretax income
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Gross Profit margin
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gross profit/revenue
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Net Profit Margin
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net income/revenue
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Comprehensive income
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includes all changes in equity except for owner contributions and distributions
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Other comprehensive income
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1. foreign currency gains/losses 2. adjustments for minimum pension liability 3. unrealized gains/losses from cash flow hedging derivatives 4. unrealized gains/losses from available for sale securities |
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Available for sale securities
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- investment securities expected to be held to maturity or sold in near term - unrealized gains/losses reported in other comprehensive income |
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AAA has a contract to build a building for $100,000 with an estimated time to completion of three years. A reliable cost estimate for the project is $60,000. In the first year of the project AAA incurred costs totaling $24,000. What profit should AAA report at the end of the first year under percentage of completion method, under completed contract method? A. $16,000 : $0 B. $16,000 : $40,000 C. $40,000 : $0 |
A. Asking for PROFITS (revenue - costs)
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CC Corporation reported the following inventory transactions (in chronological order): Assuming inventory at beginning of year was zero, calculate year end inventory using FIFO and LIFO |
FIFO: $2,100 LIFO: $1280 |
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At the beginning of the year, Triple W Corporation purchased a new piece of equipment to be used in its manufacturing operation. The cost of the equipment was $25,000. The equipment is expected to be used for 4 years and then sold for $4000. Depreciation expense to be reported for the second year using the double-declining balance method is closest to: A. $5250 B. $6250 C. $7000 |
B. Year 1: 0.5 * 25,000 = $12,500 Year 2: 0.5 * (25,000-12,500) = $6,250 |
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Changing an accounting estimate: A. is reported prospectively B. requires restatement of all prior-period statements presented in the current financial statements C. is reported by adjusted the beginning balance of retained earning for the cumulative effect of the change |
A. a change in accounting estimate is reported prospectively. No restatement of prior periods is required
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How many shares should be used in computing diluted EPS? - 300,000 shares outstanding - 100,000 warrants exercisable at $50 per share - Average share price is $55 - Year end share price is $60 A. 9091 B. 90,909 C. 309,091 |
C. Since exercise price is less than average share price, warrants are dilutive. Using treasury stock method to determine denominator impact 55-50/55 x 100,000 = 9,091. Thus the denominator will increase by 9091 to 309,091. |
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- 100,000 common shares outstanding from beginning of year - Earnings of $125,000 - 1000, 7%, $1000 par bonds-convertible into 25 shares each, outstanding as of the beginning of the year - Tax rate is 40% The company's diluted EPS is A. $1.22 B. $1.25 C. $1.34 |
B. - Basic EPS= 125,000/100,000 = $1.25 - Test if shares dilutive ($1000 x 1000 x 0.07)(1-0.4)/(25*1000) = $1.68 which is higher than basic EPS of $1.25 |
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Which of the following is least likely to be included when calculating comprehensive income? A. Unrealized loss from cash flow hedging derivatives B. Unrealized gain from available for sale securitiese C. Dividends paid to common shareholders |
C. Comprehensive income includes all equity transactions except those to shareholders
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Working Capital
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Current assets - Current liabilities
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True or False: Accounts receivable are reported at net realizable value
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True
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Standard costing
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used by manufacturing firms: involves assigning predetermined amounts of materials, labor, etc
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Retail method
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measures inventory at retail prices and then subtracts gross profit to determine cost
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At what value are inventories reported under IFRS?
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Lower of cost or net realizable value
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At what value are inventories reported under U.S. GAAP?
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lower of cost or market (usually equal to replacement cost)
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Deferred tax assets
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created when taxes payable>income tax expense
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Under IFRS, PPE can be reported using..
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the cost model or revaluation model
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Under US GAAP, PPE can be reported using..
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only the cost model
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Cost model
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- PPE tested for impairment (carrying value > recoverable amount) - if impaired, asset written down to recoverable amount |
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Recoverable amount
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: fair value - selling costs or : value in use (present value of future cash flows) whichever is greater |
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Revaluation moodel
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Fair value - accumulated depreciation
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Investment property
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- Under IFRS: asset that generates rental income or capital appreciation - Under US GAAP: no specific definition |
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Under IFRS, investment property can be reported at either ______________ or ________________
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amortized cost or fair value
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Fair value model
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any change in fair value is recognized in the income statement
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Identifiable intangible asset
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can be acquired separately (such as patents, trademarks, and copyrights)
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Unidentifiable intangible assets
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Cannot be acquired separately and may have unlimited life (goodwill)
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under IFRS, identifiable intangibles that are purchased can be reported using the _____________ model while under US GAAP they must be reported using the ______________ model
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cost model or revaluation model cost model |
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Under US GAAP, how are intangible assets that are created internally such as research and development costs expensed?
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as incurred
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Under IFRS, how are intangible assets that are created internally expensed?
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expensed during research stage but can capitalize costs incurred during development phase
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Goodwill
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Purchase price - fair value
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True or False: when computing ratios, analysts should eliminate goodwill from balance sheet and goodwill impairment charges from income statement for comparability
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True
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Financial assets measured at amortized cost are known as ____________________
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held-to-maturity securities
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Financial assets measured at fair value are known as ____________________
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mark to market
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Trading securities
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- debt and equity securities acquired with intent to profit over near term
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Available for sale securities
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- debt or equity securities that are not expected to be held to maturity or traded in the near term
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What assets are measured at historical cost?
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- unlisted equity investments - loans and recievables |
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What assets are measured at amortized cost?
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held to maturity securities
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What assets are measured at fair value?
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trading securities available for sale securities derivatives |
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Deferred tax liabilities
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income tax expense > taxes payable
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Authorized shares vs. Issued shares vs. Outstanding shares
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Authorized= number that are allowed to be sold Issued= number that are actually sold Outstanding= Issued shares - shares reacquired |
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Retained earnings
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cumulative earnings that have not been paid out to shareholders as dividends
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Treasury stock
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stock reacquired by firm (does not represent investment in firm- no voting rights and no dividends)
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Accumulated Other Comprehensive Income
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Includes all changes in stockholders equity except for transactions recognized in the income statement
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Common-size balance sheet
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expresses balance sheet as percentage of total assets
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What are the liquidity ratios
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- Measure firms ability to satisfy short term obligations Current Ratio= current assets/current liabilities Quick Ratio= (cash + marketable securities + receivables)/current liabilities Cash Ratio= cash + marketable securities/current liabilities |
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What is the difference between quick ratio and current ratio
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quick ratio excludes inventories
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Solvency ratios
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Measure firms ability to satisfy long term obligations 1. Long term debt-to-equity ratio= long term debt/total equity 2. Total debt-to-equity= total debt/total equity 3. Debt ratio= total debt/total assets 4. Financial leverage= total assets/total equity |
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Limitations of balance sheet ratios
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- differences in accounting standards - many firms operate in different industries - balance sheet data only measured at single point in time |
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Which of the following would most likely result in a current liability? A. Possible warranty claims B. Future operating lease payments C. Estimated income taxes for the current year |
C. To recognize warranty expense it must be probable not possible. Future operating lease payments are not on balance sheet
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How should the proceeds received from the advance sale of tickets to a sporting event be treated by the seller, assuming the tickets are nonrefundable? A. Unearned revenue is recognized to the extent that costs have been incurred B. Revenue is recognized to the extent that costs have been incurred C. Revenue is deferred until sporting event is held |
C. Ticket should not be recognized until it is earned. Even though tickets are nonrefundable, seller is still obliged to hold the event
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Items on the cash flow statement come from two sources:
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1. Income statement items 2. Changes in balance sheet accounts |
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Cash flow from operating activities
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current assets/current liabilities
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Cash flow from investing activities
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noncurrent assets
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Cash flow from financing
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noncurrent liabilities and equity
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Operating cash flows Inflows and Outflows
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- inflows= cash, interest/dividends, proceeds from trading securities - outflows= cash, buying trading securities, interest paid, taxes paid |
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Investing cash flows Inflows and Outflows
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- inflows= sale of fixed assets, sale of debt/equity instruments, principal from loan payments - outflows= buying fixed assets, buying debt/equity instruments, loans made to others |
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Financing cash flows Inflows and Outflows
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- inflows= principal amounts of debt issued, proceeds from issuing stock - outflow= principal paid on debt, repurchasing stock, dividends paid to shareholders |
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Where are noncash investing and financing activities reported |
Not reported in cash flow statement since no inflow or outflow
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Under IFRS, interest and dividends received may be classified as either ...
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operating or investing cash flows
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Under IFRS, interest and dividends paid may be classified as either..
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operating or financing cash flows
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Direct method vs. Indirect method of presenting cash flows
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- direct method shows each line item of income statement converted to cash payments (starting point is revenues) - indirect method starts with net income and adjusts as needed (starting point is net income) - US GAAP and IFRS allow both |
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True or False: Under US GAAP, the direct method must also disclose adjustments to reconcile net income. This reconciliation is not required for IFRS.
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True
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Payments for interest and taxes using IFRS vs. US GAAP
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IFRS= disclosed separately from cash flow statement US GAAP= in cash flow statement or disclosed in footneotes |
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Does the direct or indirect method provide more information and why?
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Direct because analyst can see actual amounts that went to each use of cash and that were received from each source of cash
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How does depreciation get treated in investing cash flows?
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depreciation is ignored since it does not represent a cash expense
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True or False: Under U.S. GAAP, a statement of cash flows under the direct method must include footnote disclosure of the indirect method
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True
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Uses of cash
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increase in asset or decrease of liability = you are using cash
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Sources of cash
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decrease a asset or increase a liability
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Free cash flow
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cash flow that is available once the firm has covered its capital expenditures
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Free cash flow to the firm definition
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cash available to all investors, both equity owners and debt holders
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Free Cash Flow to the Firm formula using net income
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FCFF= NI + NCC + [Int * (1-t)] -FCInv - WCInv NI: net income NCC: noncash charges (depreciation and amortization) Int: interest expense FCInv: fixed capital investment WCInv: working capital investment |
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Free cash Flow to the firm formula using cash flow from operations
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FCFF= CFO + [Int x (1-t)] -FCInv
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Free Cash Flow to Equity
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FCFE= CFO -FCInv + net borrowing - if firms subtracted dividends from CFO using IFRS rules, they must add dividends back |
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Performance ratios
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1. Cash flow-to-revenue= CFO/net revenue 2. Cash return on assets= CFO/average total assets 3. Cash return-on-equity= CFO/average total equity 4.Cash-to-income= CFO/operating income 5. Cash flow per share= CFO-preferred dividends/weighted average number of common shares |
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Coverage Ratios
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1. Debt coverage= CFO/total debt 2. Interest coverage ratio= CFO + Interest paid + taxes paid/ interest paid 3. Reinvestment ratio= CFO/cash paid for long term assets 4. Debt payment ratio= CFO/cash long term debt repayment 5. Dividend payment= CFO/dividends paid 6. Investing and financing= CFO/outflows from investing and financing |
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An increase in notes payable would be classified as.. A. investing cash flow B. financing cash flow C. no cash flow |
B.
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Continental Corporation reported sales revenue of $150,000 for the current year. If accounts recievable decreased $10,000 during the year and accounts payable increased $4,000 during the year, cash collections were: A. $154,000 B. $160,000 C. $164,000 |
B.
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Vertical common size balance sheet
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express everything as percentage of total assets (divisor is assets)
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Vertical common income statment
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express everything as percentage of sales (divisor is sales)
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Horizontal common-size balance sheet or income statement
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divisor is first year values
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Activity ratios
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- Receivables turnover= annual sales/average receivables - Days of sales outstanding= 365/receivables turnover - Inventory turnover= COGS/average inventory - Day of inventory ono hand/inventory turnover - Payables turnover= purchases/average trade payables - Number of days of payables= 365/payables turnover ratio - Total asset turnover= revenue/average total assets - Fixed asset turnover= revenue/average net fixed assets - Working capital turnover= revenue/average working capital |
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Receivables turnover
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annual sales/average receivables
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Days of sales outstanding
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365/receivables turnover
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Inventory turnover
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COGS/average inventory
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Days of inventory on hand
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365/inventory turnover
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Payables turnover
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purchases/average accounts payable
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Number of days of payables
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365/payables turnover ratio
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Total asset turnover
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revenue/average total assets
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Fixed asset turnover
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revenue/average net fixed assets
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Working capital turnover
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Revenue/average working capital
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Defensive interval
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(cash + marketable securities + receivables)/ average daily expenditures
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Cash conversion cycle
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(days sales outstanding) + (days of inventory on hand) - (number of days of payables)
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Interest coverage ratio
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EBIT/interest payment
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Fixed charge coverage
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EBIT + lease payments/interest payment + lease payment
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Gross profits, Operating profits, Net Income, Total Capital
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Gross profits= net sales - COGS Operating= EBIT Net Income= Earnings after taxes but before dividends Total capital= long term debt + short term debt + common and preferred equity |
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Return on Assets
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Net Income/Average Total Assets
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Operating return on assets
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EBIT/assets
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Return on total capital
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EBIT/Average total capital
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Return on Equity
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Net Income/Average Total Equity
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Return on Common Equity
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Net Income-Preferred dividends/Common Equity
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3-Part DuPont Return on Equity |
ROE= (net profit margin)(asset turnover)(leverage ratio) P.A.L. |
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5-Part DuPont Return on Equity
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ROE= (tax burden)(interest burden)(EBIT margin)(asset turnover)(financial leverage) = (NI/EBT)(EBT/EBIT)(EBIT/Revenue)(Revenue/Assets)(Assets/NI) - note NI/EBT = (1-tax rate) T.I.E. A.F. |
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Sustainable growth rate formula
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g= Retention Rate * ROE RRR E |
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Retention Rate formula
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= NI available to common-dividends declared/NI available to common = 1- dividend payout ratio |
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Dividend payout ratio
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Dividends declared/NI available to common
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Coefficient of Variation of sales, operating income, and net income
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CV sales= STDEV sales/sales CV operating income= STDEV operating income/operating income CV net income= STDEV net income/net income |
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Business segment
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portion of a company that accounts for more than 10% of companies revenues or assets and is distinct from companies other line of business
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Geographic segments
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portion of company that accounts for more than 10% of companies revenues and has business environment different than other regions
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Sensitivity analysis
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"what if" questions -change one variable and see what happens
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Scenario analysis
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based on specific scenarios
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Simulation
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technique where probability distribution for key variables are selected and a computer is used to generate a distribution of values
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An analyst who is interest in a company's long term solvency would most likely examine the: A. Return on total capital B. Defensive interval ratio C. Fixed charge coverage ratio |
C.
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Which of the following equations least accurately represents return on equity? A. (net profit margin)(equity turnover) B. (net profit margin)(total asset turnover)(assets/equity) C. (ROA)(interest burden)(tax retention rate) |
C.
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Ending inventory=
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beginning inventory + purchases - COGS
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Product costs
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- these costs are capitalized in inventory account - purchase cost - trade discounts/rebates - conversion costs including labor and overhead - other costs necessary to bring inventory to its present location and condition |
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Period costs
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- costs are incurred - abnormal waste of materials, labor, or overhead - storage costs - administrative overhead -selling costs |
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Specific Identification Method
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each unit sold is matched with the units actual cost
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Periodic inventory system
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Inventory values and COGS are determined at end of accounting period
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Perpetual inventory system
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Inventory values and COGS are updated continuously
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During periods of stable prices, FIFO will be _____(<, =, >) LIFO
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=
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Which provides the best approximation of inventory (LIFO or FIFO)? What about the best approximation of COGS?
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Inventory= FIFO COGS= LIFO |
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Four relations between FIFO and LIFO hold when prices have been rising, what are they?
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1. LIFO inventory < FIFO inventory 2. LIFO COGS > FIFO COGS 3. LIFO Net Income < FIFO Net Income 4. LIFO tax < FIFO tax |
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LIFO Reserve
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amount LIFO Inventory is less than FIFO Inventory
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Convert LIFO financial statements to FIFO financial statements
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- Inventory: add LIFO reserve to inventory - COGS: FIFO COGS= LIFO COGS - (ending LIFO reserve - beginning LIFO reserve) - Cash: Decrease cash by (LIFO reserve * tax) - Shareholders Equity: Increase by LIFO reserve* (1-t) |
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How do FIFO and LIFO affect ratios?
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- Profitability: any profitability measure that includes COGS will be higher under FIFO - Liquidity: Current ratio higher under FIFO (because higher inventory) - Activity: FIFO results in lower turnover and higher days on hand - Solvency: higher assets/stockholders equity under FIFO so debt ratios are lower under FIFO |
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LIFO liquidation
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firms LIFO inventory declines - results in higher profit margins and higher income taxes |
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Under IFRS, inventory is reported at the lower of _______________ or __________________
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cost or net realizable value (selling price-selling costs)
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Under US GAAP, inventory is reported at the lower of ______________ or ______________
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cost or market (replacement cost)
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Where are inventory disclosures usually found?
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financial statement footnotes
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Under what grounds are you allowed to recast inventory (retrospectively change inventory) for IFRS and US GAAP?
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IFRS: firm must demonstrate that change will provide reliable and more relevant info US GAAP: firm must explain why change in cost flow method is preferable |
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What happens when the firm changes to using LIFO inventory?
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no adjustments made for prior periods
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Manufacturing firms normally report inventory using three separate accounts:
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raw materials, work in process, and finished goods
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Under which inventory cost flow assumption does inventory on the balance sheet best approximate its current cost? A. First in, first out B. Weighted average cost C. Last in, first out |
A. Under FIFO, ending inventory is made up of most recent purchases
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A firm that uses LIFO for inventory accounting reported COGS of $300,000 and ending inventory of $200,000 for the current period, and a LIFO reserve that decreased from $40,000 to $35,000 over the period. If the firm had reported using FIFO, its gross profit would have been: A. the same B. $5,000 higher C. $5,000 lower |
C. your measuring change in gross profit not change in COGS
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Poulter Products reports under IFRS and wrote its inventory value down from cost of $400,000 to net realizable value of $380,000. The most likely financial statement effect of this change is a(n): A. increase in cost of sales B. decrease in depreciation C. loss reported as other comprehensive income |
A. writedown in inventory value from cost to net realizable value is reported on the income statement as either an addition to cost of sales or as a separate line item, not as other comprehensive income
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Expensing a cost vs. Capitalizing a cost
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- Capitalize: expense is expected to provide future economic benefit over multiple accounting periods - Expensed if future economic benefit is uncertain |
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Under IFRS, are research costs and development costs expense or capitalized?
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research costs are expensed development costs are capitalized |
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Under US GAAP how are research costs and development costs treated?
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expensed as incurred
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Acquisition method
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purchase price accounts for fair value of assets/liabilities (anything extra is goodwill)
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True or False: Capitalizing an expenditure delays recognition of an expense in the income statement
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True
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In the period that the expenditure is capitalized, the firm will report _______________ (lower/higher) net income compared to immediately expensing. In subsequent periods, the firm will report ___________ (lower/higher) net income compared to expensing
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higher lower |
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True or False: Over the life of the asset, total net income is identical whether the asset's cost is capitalized or expensed.
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True
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How is an expenditure that is capitalized treated on the balance sheet/income statement?
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- recorded as an asset on balance sheet at fair value - cost allocated to income statement over life of asset as a depreciation or amortization expense |
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How does capitalizing an expenditure affect cash flow from operations and cash flow from investing
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increase CFO decrease CFI |
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How does capitalizing an expense affect financial ratios?
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capitalizing an expenditure initially results in higher assets and higher equity
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Carrying value for PP&E
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Historical cost - accumulated depreciation
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Historical cost for PP&E
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original purchase price of asset including installation and transportation costs
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Units of depreciation method
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(Original cost - salvage value)/life in output units * output units in that period
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Component depreciation
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- useful life of each component is estimated and depreciation expense is computed separately for each - allowed under US GAAP but rarely used |
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How is net income, net profit margin, and pretax income affected by using double declining depreciation vs. straight line depreciation?
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- All lower at first and then higher at end using double declining - all the same in the long run though |
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Under IFRS, long lived assets can be reported using the __________ model or the ____________ model
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cost model (reported at depreciated cost) revaluation model (reported at fair value) |
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When using the revaluation model, how do you report any increase in the assets value above historical cost?
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- NOT reported as gain - reported in shareholders equity in an account called revaluation surplus |
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An asset is impaired under IFRS when..
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carrying value (original cost-depreciation) > recoverable amount
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Recoverable amount
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greater of -fair value-selling cost - value in use (present value of future cash flows) |
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An asset is impaired under US GAAP when..
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carrying value > assets future undiscounted cash flow stream
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True or False: If a firm reclassifies a long lived asset from held for use to held for sale, the asset is no longer depreciated
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True
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Derecognition
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occurs when assets are sold, exchanged, or abandoned
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Gain/loss of PP&E
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Sale proceeds - carrying value
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In the year of impairment, ROA and ROE will _____________ (decrease/increase)
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decrease (impairment charge reduces net income)
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How can management use impairments to manipulate earnings?
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can wait to recognize an impairment loss until a period of relatively high earnings to smooth earnings
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Average age
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accumulated depreciation/annual depreciation expense
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Total useful life
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= historical cost/annual depreciation expense
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Remaining useful life
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= ending net PP&E/annual depreciation expense
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For investment property, how do you recognize revaluation above historical cost
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gain on income statement
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How do you treat a transfer from owner occupied -> investment property on financial statements?
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treat as revaluation: recognize gain only if it reverses previously recognized loss
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How do you treat a transfer from Inventory -> Investment property on financial statements?
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Recognize gain or loss if fair value is different from carrying amount
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How do you treat a transfer from Investment property -> Owner occupied or inventory on financial statements?
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Fair value of asset at date of transfer will be its cost under new classification
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Finance lease vs. operating lease
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- Finance lease (capital lease): purchase of an asset financed with debt - operating lease: essentially a rental agreement |
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How do you report an operating lease on financial statements?
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inception of lease no entry made - rent expense recognized in income statement during term of lease - lease payment reported as outflow from operating activity |
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How do you report a finance lease on financial statements?
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at inception of lease - PV of minimum lease payments or fair value (whichever is lower) over term of lease - depreciation expense and interest expense in income statement |
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Under US GAAP, the interest expense is reported as an outflow from _____________and the principal payment is reported as an outflow from _____________
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operating activity financing activity |
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Which of the following statements about indefinite-lived intangible assets is most accurate? A. They are amortized on a straight line basis over a period not to exceed 40 years B. They are reported on the balance sheet indefinately C. They never appear on the balance sheet unless internally developed |
B.
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Which of the following is least likely considered in determining the useful life of an intangible asset? A. Initial cost B. Legal, regulatory, or contractual provisions C. Provisions for renewal or extension |
A.
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At the beginning of the year, Fairweather Corp incurred $200,000 of research costs and $100,000 of development costs to create a new patent. The patent is expected to have a useful life of 40 years with no salvage value. Calculate the carrying value of the patent at the end of this year, assuming Fairweather follows US GAAP A. $0 B. $97,500 C. $292,500 |
A. Under US GAAP, research and development costs are expensed as incurred. Thus the entire $300,000 of R&D is expensed this year. The result is zero carrying value
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Two years ago, Metcalf Corp purchased machinery for $800,000. At the end of the last year, the machinery had a fair value of $720,000. Assuming Metcalf uses the revaluation model, what amount, if any, is recognized in Metcalfs net income this year if the machinery's fair value is $810,000? A. $0 B. $80,000 C. $90,000 |
B. Recover up to original amount, any extra recognized in shareholders equity and revaluation surplus
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Which of the following disclosures would least likely be found in the financial statement footnotes of a firm? A. Accumulated depreciation B. Carrying value by asset class C. Average age of assets |
C. Average age is not a required disclosure
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Metallurgy, Inc. reported depreciation expense of $15 million for the most recent year. Beginning-of-year gross PP&E and accumulated depreciation were $287 million and $77 million, respectively If end of year gross PP&E and accumulated depreciation were $300 million and $80 million, the estimated remaining useful life of PP&E is closest to: A. 10 years B. 15 years C. 20 years |
B. (300-80)/15 = 14.66 years
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Tax loss carryforward
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current or past loss that can be used to reduce taxable income in the future
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Deferred tax liabilities
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Income tax expense > taxes payable
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Deferred tax assets
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Income tax expense < taxes payable
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Income tax expense
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= taxes payable + Change in DTL - Change in DTA
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Tax base
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amount that will be deducted on tax return
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When revenue is received in advance, when is it taxable?
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when it is collected
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True or False: An increase in the tax rate will increase both deferred tax liabilities and deferred tax assets.
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True
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Permanent difference
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difference between taxable income and pretax income that will not reverse in the future - can be caused by revenue that is not taxable, expenses that are not deductible, or tax credits that result in direct reduction of taxes |
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True or False: Permanent differences will cause the effective tax rate to differ from the statutory tax rate.
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True
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Effective tax rate
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Income tax expense/pretax income
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Statutory tax rate
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tax rate of the jurisdiction where the firm operates
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Temporary differences
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difference between tax base and carrying value of an asset or liability
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Taxable temporary differences
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result in expected future taxable income (create DTL) - Assets: tax base < carrying value - Liabilities: tax base > carrying value |
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Deductible temporary differences |
result in expected future tax deductions (create DTA) - Assets: tax base > carrying value - Liabilities: tax base < carrying value |
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According to US GAAP, if it is more than likely that some or all of DTA will not be realized, what will happen?
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DTA must be reduced by valuation allowance (contra account to DTA)
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True or False: Companies are required to disclose details on the source of the temporary differences that cause the defined tax assets and liabilities reported on the balance sheet
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True
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Common examples of temporary differences you may encounter
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- DTL results from using accelerated depreciation - Impairments result in DTA (writedown recognized immediately but deduction of tax return not allowed until asset sold) - Restructuring generates DTA |
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Why do some firms report an income tax expense that differs from the amount based on statutory income tax rate
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- different tax rates in different tax jurisdictions - permanent tax differences - Changes in tax rates and legislation - Tax holidays in some countries |
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Differences in revaluation of fixed/intangible assets for US GAAP vs. IFRS
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- US GAAP: no revaluation allowed - IFRS: Deferred taxes recognized in equity |
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Deferred tax asset recognition for US GAAP vs. IFRS
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- US GAAP: recognized in full then reduced if more likely than not that some or all of tax asset will not be realized - IFRS: Recognized if probable that sufficient taxable profit will be available |
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Presentation of deferred taxes on the balance sheet for US GAAP vs. IFRS
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- US GAAP: classified as current or noncurrent based on classification of underlying asset/liability - IFRS: netted and classified as noncurrent |
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In its first year of operations, a firm produces taxable income of - $10,000. The prevailing tax rate is 40%. The firm's balance sheet will report a deferred tax rate: A. asset of $4,000 B. asset of $10,000 C. liability of $4,000 |
A. tax loss carryforward = loss x tax rate
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An analyst is comparing a firm to its competitors. The firm has a deferred tax liability that results from accelerated depreciation for tax purposes. The firm is expected to continue to grow in the foreseeable future. How should the liability be treated for analysis purposes? A. It should be treated as equity at its full value B. It should be treated as a liability at its full value C. The present value should be treated as a liability with the remainder being treated as equity |
A.
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While reviewing a company, an analyst identifies a permanent difference between taxable income and pretax income. Which of the following statements most accurately identifies the appropriate financial statement allowance? A. The amount of tax implications of the difference should be added to the deferred tax liabilities B. The present value of the amount of the tax implications of the difference should be added to the deferred tax liabilities C. No financial adjustment is necessary |
C.
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If the tax base of an asset exceeds the assets carrying value and a reversal is expected in the future: A. a deferred tax asset is created B. a deferred tax liability is created C. neither a deferred tax asset nor a deferred tax liability is created |
A.
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The author of a new textbook received a $100,000 advance from the publisher this year. $40,000 of income taxes were paid on the advance when received. The textbook will not be finished until next year. Determine the tax basis of the advance at the end of the year A. $0 B. $40,000 C. $100,000 |
A. The advance was already taxed you don't tax it twice
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According to the IFRS, the deferred tax consequences of revaluing held-for-use equipment upward is reported on the balance sheet: A. as an asset B. as a liability C. in stockholders equity |
C.
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When the market rate=coupon rate, the bond is a ________ (discount, par, premium) bond.
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par
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When the market rate > coupon rate, the bond is a _________ (discount, par, premium) bond
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discount
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When the market rate < coupon rate, the bond is a ________ (discount, par, premium) bond
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premium
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How are bonds issued at par treated on the balance sheet, income statement, and cash flows?
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- balance sheet: assets and liabilities increase by bond proceeds (face value) - income statement: interest expense=coupon payment - cash flows: issue proceeds= inflow CFF, coupon payments= outflow CFO, at maturity repayment of face value= outflow CFF |
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True or False: Interest expense and the book value of a bond liability are calculated using the bond's yield at the time it was issued, not its yield today
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True
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Effective Interest Rate method
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Book value x yield at issuance= interest expense
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For a premium bond, interest expense is _____ (less/more) than coupon payment
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less (yield < coupon rate) - interest expense will decrease over time as bond liability decreases |
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For a discount bond, interest expense is ______ (less/more) than a coupon payment
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more (yield > coupon rate) - interest expense will increase over time as bond liability increases |
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Does both IFRS and US GAAP use effective interest rate method?
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- required by IFRS - preferred by US GAAP but straight line method is allowed (amortized by equal amounts instead of decreasing or increasing amounts) |
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On December 31, 20X2, a company issued a 3 year, 10% annual coupon bond with a face value of $100,000. Calculate the book value of the bond at year-end 20X2, 20X3, and 20X4, assuming the bond was issued at a market rate of interest of (a) 10% (b) 9% (c) 11%
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Step 1. Calculate PV Step 2. Ending book value Year 1= Beginning Book value (which is PV) + Interest Expense - Coupon payment Step 3. Repeat for years 2 and 3. |
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Zero coupon bond
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- make no periodic interest payments - actual interest payment is included in face value that is paid at maturity - effects on financial statement are same as any discount bond, but larger because discount is larger |
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Issuance costs under US GAAP and IFRS
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- US GAAP issuance costs capitalized as asset and allocated to income statement as expense over term of bond - IFRS: initial bond liability reduced by issuance cost |
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Consider a $1 million bond issued for $980,000 with issuance costs of $5,000. How would this be treated under US GAAP and IFRS?
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US GAAP: assets increase by $980,000 ($975,000 cash $5000 deferred charge), liabilities increase by $980,000 IFRS: assets and liabilities increase by $975,000 |
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What is the cash flow impact of issuing a bond?
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CFF: increased by cash received (PV of bond at market interest rate) CFO: no effect |
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What is the cash flow impact of periodic interest payments?
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CFF: no effect CFO: decreased by interest paid (coupon rate x face value) |
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What is the cash flow impact of payment at maturity?
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CFF: decreased by face value CFO: no effect |
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Explain the impact of issuing a bond at par on the income statement |
- market rate = coupon rate - interest expense= coupon rate x face value - interest expense constant |
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Explain the impact of issuing a bond at a premium on the income statement
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- market rate < coupon rate - interest expense= cash paid - amortization of premium - interest expense decreases over time |
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Explain the impact of issuing a bond at a discount on the income statement
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- market rate > coupon rate - interest expense= cash paid + amortization of discount - interest expense increases over time |
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What is the effect of issuing a bond at par on the balance sheet?
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carried at face value
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What is the effect of issuing a bond at a premium on the balance sheet?
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- carried at face value + premium - liability decreases as the premium is amortized |
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What is the effect of issuing a bond a discount on the balance sheet?
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- carried at face value - discount - liability increases at the discount is amortized to interest expense |
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What happens when bonds are redeemed before maturity?
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gain or loss recognized (redemption price - book value)
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Debt covenants
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restrictions imposed by the lender on the borrower
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Affirmative covenants vs. Negative covenants
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affirmative= borrower promises to do certain things Negative= borrower promises not to do certain things |
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Technical default
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immediate repayment of principal if the firm violates a covenant
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What does the firm disclose about its long term assets in the footnotes?
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- maturity dates - interest rates - call provisions/conversion priveleges - restrictions imposed by creditors - assets pledged as security |
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Benefits of having a lease
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- less costly financing - reduced risk of obsolescence - less restrictive provisions - off-balance sheet financing - tax reporting advantages |
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Synthetic lease
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- lease is treated as ownership - owner can deduct depreciation expense and interest expense for tax purposes |
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What is required for a lease to be treated as a finance lease under IFRS vs. US GAAP?
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IFRS- substantially all the rights and risks of ownership are transferred to the lessee US GAAP- lessee must treat lease as a capital lease |
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A lessee must treat a lease as a capital lease if ...
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- title to leased asset is transferred - bargain purchase option - lease period is 75% or more of the assets economic life - PV of lease payments is 90% or more of fair value |
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Reporting an operating lease from lessors perspective
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lessor recognizes rental income and continues to report and depreciate leased asset
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Reporting a capital (finance) lease from lessors perspective
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removes leased asset from balance sheet and replaces it with lease investment account (lease receivable)
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Reporting an operating lease from a lessee's perspective
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lease payment is reported as outflow from operating expense
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Reporting a finance lease from a lessee's perspective
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lower of PV of minimum lease payment or fair value is recognized as asset and liability- asset depreciated in income statement and interest expense recognized
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Leverage ratios will be higher with __________________ (finance leases/operating leases).
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finance leases
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Why are operating leases sometimes referred to as off-balance sheet financing activities?
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Because the liability for an operating lease does not appear on the lessee's balance sheet
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What is the effect of an operating/financing lease on the income statement?
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- operating: entire lease payment = CFO expense - finance: only depreciation is CFO expense - net income lower for finance lease in early years and higher in later years |
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How do lessor's report leases?
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- sales-type lease or direct financing lease - PV lease payments = carrying value , lease is treated as a direct financing lease - IFRS does not distinguish between sales/direct |
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Sales lease
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- sold asset for PV of lease payment and provided a loan to the buyer in same amount - asset removed from balance sheet and a lease receivable is created - principal reduction is reported as inflow from investing activities |
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Direct financing lease
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- no gross profit recognized by lessor at inception - lessor removes asset form balance sheet and creates a lease receivable in the same amount |
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True or False: In the early years of the lease, the income reported from the direct financing lease is higher than the income reported from the operating lease.
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True. Interest is higher in early years
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Pension
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deferred compensation earned over time through employee service
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Defined contribution plan
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retirement plan in which the firm contributes a sum each period to the employees retirement account
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Defined benefit plan
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firm promises to make periodic payments to employees after retirement
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Net pension asset
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fair value of plans assets > estimated pension obligation - plan is overfunded and firm records net pension asset on balance sheet |
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Net pension liability
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fair value < estimated pension obligation - plan is underfunded and firm records net pension liability |
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IFRS reporting of change in net pension asset/liability
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1. service costs - income statement 2. interest expense- income statement 3. gain/loss - balance sheet |
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US GAAP reporting off change in net pension asset/liability
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1. service cost- income statement 2. interest expense- income statement 3. expected return on plan assets- income statement 4. past service costs- balance sheet 5. gains/losses- balance sheet |
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Service costs
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PV of additional benefits earned by an employee over year
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For manufacturing companies, under IFRS or US GAAP, pension expense is allocated to ...
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- inventory/COGS for employees who provide direct labor - SG&A for other employees |
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A firm issues a $10 million with 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The bond can be classified as a: A. discount bond B. par bond C. premium bond |
A.
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A firm issues a $10 million with 6% coupon rate, 4-rate maturity, and annual interest payments when market interest rates are 7%. The annual coupon payments will each be: A. $600,000 B. $676,290 C. $700,000 |
A.
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A firm issues a $10 million with 6% coupon rate, 4-rate maturity, and annual interest payments when market interest rates are 7%. Total of all cash payments to the bondholders is: A. $12,400,000 B. $12,738,721 C. $12,800,000 |
($600,000 x 4) +$10,000,000= $12,400,000 A. |
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A firm issues $10 million with 6% coupon rate, 4-rate maturity, and annual interest payments when market interest rates are 7%. The initial book value of bonds is: A. $9,400,000 B. $9,661,279 C. $10,000,000 |
B. N=4, I=7, PMT= 600,000 FV=10,000,000
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A firm issues $10 million with 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. For the first period, the interest expense is: A. $600,000 B. $676,290 C. $700,000 |
B. $9,661,279 x 0.07
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A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. If the market rate changes to 8% and the bonds are carried at amortized cost, the book value of the bonds at the end of the first year will be: A. $9,484,581 B. $9,661,279 C. $9,737,568 |
C. $9,661,279 + $676,290 -$600,000 = $9,737,568
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A firm issues a $10 million bond with a 6% coupon rate, 4-year maturity, and annual interest payments when market interest rates are 7%. The total interest expense reported by the issuer over the life of the bond will be: A. $2,400,000 B. $2,738,721 C. $2,800,000 |
Coupon payments + discount interest = coupon payments + (face value - issue value) = $2,400,000 + ($10,000,000-$9,661,279)= $2,738,721
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For analytical purposes, what is the impact on the debt-to-equity ratio if the market rate of interest increases after the bond is issued A. increase B. decrease C. no change |
B.
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At the beginning of 20X6, Cougar Corporation enters a finance lease requiring five annual payments of $10,000 each beginning on the first day of the lease. Assuming the lease interest rate is 8%, the amount of interest expense is recognized by Cougar in 20X6 is closest to: A. $2,650 B. $3,194 C. 3,450 |
N=5, I=8, PMT= 10,000, FV=0. Multiply this output by 8% - $43,121-$10,000 principal payment= $33,121. Interest expense is $33,121 x 8% = 2,650 |
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High quality financial reporting ________________
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decision useful
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Decision useful
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- relevant= material - faithful representation= completeness, neutrality, absence of errors |
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Quality of reported earnings
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determining the proportion of reported earnings hat can be expected to continue in the future
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Is it possible for a firm to have high financial reporting quality and low quality of reported earnings
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Yes. May be GAAP compliant, relevant, represent activity faithfully, and decision useful BUT may have low sustainability
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Conservative accounting
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decrease the company's reported earnings and financial position (on balance sheet) for current period
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Aggressive accounting
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choices that increase reported earnings or improve the financial position for current period
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Earnings smoothing
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- conservative accounting during high earnings - aggressive accounting during low earnings |
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Give some examples of conservative accounting US GAAP has built in
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- research costs expensed in period incurred (because of uncertainty about future benefits) - accruals for legal liabilities are recorded when a future payment becomes probable - Under U.S. GAAP write downs of inventory values are required when their future value impaired, no write ups |
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What conditions are conducive to issuing low quality or even fraudulent, financial reports
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-weak internal controls - inadequate oversight - large range of acceptable accounting treatments |
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True or False: A clean audit opinion is a guarantee that no fraud has occurred.
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False. Only offers reasonable assurance that financial reports have been fairly reportedS
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Securities regulations require
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- registration of newly publicly traded securities - independent audit - statement of financial condition - signed statement of person responsible for financial reports - review process for newly registered securities |
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In US, companies that report non-GAAP measures are required to...
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- display comparable GAAP measures - explain why not using GAAP - reconcile differences between non-GAAP and GAAP measures - include any non GAAP measure that likely to recur |
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IFRS requires firms using non IFRS measures to...
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-define and explain relevance of non-IFRS measures - reconcile differences |
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Free on Board
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whether seller or buyer has liability for goods that are damaged or destroyed during shipping
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Free on board at shipping point
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buyer is at risk while goods are being shipped
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Free on board at destination
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seller at risk until goods delivered to location
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Channel stuffing |
overloading a distribution channel with more goods than would normally be sold during a period
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Bill-and-hold transaction
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- customer buys goods but requests that goods be kept at firm location for a period of time - increase earnings in current period, decrease in future periods |
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Stretching payables
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taking longer to pay suppliers increases operating cash flows
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Warning signs for detecting manipulation of information in financial reports
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- revenue growth out of line with peer companies - receivables turnover decreasing over multiple periods - decreases in total asset turnover - declining inventory turnover ratio - LIFO liquidations |
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A firm reports net income of $40 million. The firms financial statements disclose in management's discussion and analysis that $30 million of net income is attributable to a gain on the sale of assets. Based only on this information, for this period, the firm is best described as having high quality of A. financial reporting only B. both earnings and financial reporting C. neither earnings nor financial reporting |
A.
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For the current period, inappropriate capitalization is most likely to: A.overstate revenues B. understate liabilities C. understate expenses |
C.
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A potential warning sign that a firm is engaging in channel stuffing is an unusual increase in the firms: A. receivables turnover B. days of sales outstanding C. number of days of payables |
B. Accelerating deliveries to distributors would likely increase accounts receivable (decrease accounts receivable, increase days of sales outstanding, payables not affected)
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Premium products
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- COGS higher - higher proportion of sales on R&D - ratio of gross profits to operating profits larger for firm that spends highly on R&D |
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Forecast a companies future net income and cash flow |
- begins with "top down" approach - make assumptions about future sources and uses of cash |
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Credit analysts speak of the three C's. What are they? |
Character, Collateral, and Capacity to repay |
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What are the general categories credit rating agencies such as Moodys or Standard and Poor's use |
1. scale and diversification 2. operational efficiency 3. margin stability 4. leverage |
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Backtesting |
use a specific set of criteria to screen historical data to see how portfolios would have performed |
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Average age, average useful life, and average remaining useful life |
- average age= accumulated depreciation/depreciation expense - average useful life= gross PPE/depreciation expense - average remaining useful life= net PPE/depreciation expense |
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Price to tangible book value |
removes both goodwill and intangible assets from equity to get tangible book value |
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An analyst who is projecting a companies net income and cash flows is least likely to assume a constant relationship between the companies sales and its A. interest expenses B. cost of goods sold C. non cash working capital |
A. Proportions of net income and cash flows are typically based on assumptions that cost of goods sold, operating expenses, and non cash working capital remain at a constant percentage of sales |
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When comparing a firm that uses LIFO inventory accounting to firms that use FIFO, an analyst should: A. subtract the LIFO reserve from cost of sales B. add the change in the LIFO reserve to inventories C. subtract the change in the LIFO reserve from cost of sales |
C. You must add LIFO reserve to inventories on balance sheet and subtract change win LIFO reserve from cost of sales on the income statement |
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How should an analyst most appropriately adjust the financial statements of a firm that uses operating leases to finance its plant and equipment? |
A. appropriate adjustment for operating leases is to treat them as if they were capital leases by estimating the PV of future lease obligations and adding that value to the firms liabilities and long lived assets |
