ACC 305 1 Flashcards
Assets
Liab.
Equity
Assets
- -ECONOMIC RESOURCES that are owned or controlled by comp. that are expected to provide probable (AR/inv.) FUTURE econ. benefit
- -economic resources, legal control, value comes in its FUTURE BENEFIT
Liabilites
- -expected OBLIGATION to pay cash, transfer assets, or provide some services in future
- -taxes payable…owned but not yet paid to fed./state gov.
- -unearned rev. - amt. owed in services or product (not money) ro a customer who paid in adv. (magazine subscription)
Equity
- -residual claim on assets after liab. taken care of
- -net worth or owners quity
- -broken up into contributed capital (when outside/external investors put $ into comp.) and RE (internal)
- –“NET ASSETS” - Bc A-L, paid in capital (amt. contributed by owners) and RE
- -INC. by owners and proficts (+NI) and dec. by div. to owners
Accounting assumptions (3)
- Economic entity assumption
- -comp. keeps its activity separate and distinct from its owners and other businesses
- -comp (etc.) used by employee belong to comp., not owners - monetary unit assumption
- -money is common denominator of econ. activity and provies basis for acc. measurement - periodicity assumption
- -implies a a comp. can divide its economic activiies into artificial time periods (monthly, quarterly, ann.) - for reporting (ncome)
revenue
expenses
NI
revenue
- -amt. of assets generated through operations (sale of goods/services)
- -DOES NOT mean cash inflows
- -can also be generated by SATISFYING liabilities - instead of paying back to someone you owe, do work to satisfy
- -goods/services inc. revenue = inc. OE
expenses
- -amt. of assets consumed through operations
- -DOES NOT mean cash outflows
- -costs incurred in normal bus. operations
- -salaries and ututilies and deprec. = dec. assets so dec. OE
- -also amt. of LIABILITIES CREATED in generating rev.
NI
–net of Rev. - exp.
T-accounts review
all T-accounts have “normal balance” - differs based on type accounted for
–assets have normal DEBIT balance and L&E have normal CREDIT balance
assets inc. with DEBITS and dec. with CREDITS
–L&E inc. with CREDIT and dec. with DEBIT
2 exceptions!!!! Expenses and dividends
1. Expenses - are debited! inc. with debits and dec. with credits – while revenues are credited
- dividends - inc. with debits and dec. with credits
if sum of debit entries > sum of credits = acct. has debit balance
T accounts are SCOREBORADS and journal entries are indiv. scores
–T accounts = total transactions, journal entries = indiv. transactions
How are fin. stmts. connected?
IS is a nominal stmt. (1 YR. or 1 Q) - where BS and OE stmt. are real and continuous
income stmt. connects to BS through RE
–CF connects to BS by cash
journal entries
- -way we record the occurrence of an economic activity
- -but not all events lead to a transaction
JOURNAL ACCTS.
- determine which accts. are involves (2+ accounts)
- which accts. inc. or dec.
- what is amt. of change
inc./dec. rules change depending on type of acct.
Assets inc. D and dec. C, liab. inc. C and dec. Debit, equity Inc. credit and dec. debit
sum of debits = sum of credits each entry
double entry system - at least 2 things happen at all times = balance
journal entry examples
1. owners invest $40,000 in exchange for common stock
- dispurse 600 cash in wages
- comp. buy equipment for 100,000 and make down pmt. of 20% and finance with loan
- cash 40,0000
common stock. 40000 - wage expense. 600
cash. 600 - equipment. 100000
cash. 20000
note payable.80000
revenue recognition practie problems review
2. ABC sells inv. with original cost of 6000 to customer for 11500 - customer pays 10% up fron and balance is due in 30 days
- LMN borrows 10,000 in July 20X1 and will repay loan in July 20X2 with interest of 800
- -adjustment made 12/31/X1 to record accrued int. ($400 interest in 6 mo.) - truck orig. cost $44000 with $14000 accum. depreciation
- -sold for 26000 - rec. 6000 in cash on date of sale and provided financing to buyer
2. cash 1150
AR 10350
sales rev. 11500
COGS 6000
inventory. 6000
3. July 20X1 entry
cash 10,000
note payable. 10,000
--12/31/X1 entry
interest expense. 400
interest payable 400
July 20X2 entry
note payable 10000
interest expense. 400
interest payable. 400
cash 10800
4. cash 6000
note receivable. 20000
accum. deprec. 14000
loss on sale 4000
truck 44000
review adjusting entries
adjusting entries - o bring the accounts CURRENT to account for any missing or unaccounted fo transactions or econ. events
–look at acc. cycle- will have your unadjusted trial balance –> need to adjust to make fin. stmts. - usually at end of fiscal year – using rev. recognition and matchin principle
- fix BS
- -make sure any A & L reflect current value - fix IS
- -see which rev/exp account is impaced
- –wages earned during dec. but do not pay until Jan –> need to report in fiscal year
- -fix things that should have been recorded but did not have a trigger (cash outflow)
in adjusting entries rarely adjust CASH - bc actually lack of cash flow (Trigger) is what causes NEED for adjustments
some types of adjusting entries (deferals)
DEFERRALS
- PREPAID EXPENSES (Assets)
- –exp. paid in cash before they are used or consumed - cash pre-pmt. of an expense
- -insurance for one year - pay jan. in cash but record as exp. as used up each month - UNEARNED REVENUES (liability)
- -cash rec. before services performed – someone paid us in advance to provide some service obligation in future
- -insurance company - rec. my cash but records as rev. as they perform the service throughout time
DEFERRALS
–CASH FLOW occurs BEFORE book entry (Rev./exp. recorded)
some types of adjusting entries (accruals
ACCRUALS
- ACCRUED REVENUES (asset)
- -rev. for services performed but not yet rec. as cash or recorded
- -did work/performed service but no cash inflow yet
- -recorded as revenue!!!
- -assset but once they bill custoemr for service becomes an AR –> then cash when it is paid off - ACCRUED EXPENSES (liability)
- -exp. incurred but not yet paid out yet in cash
- -but recorded as exp. bc they have rec. service
- -ex. accrued interest over time and int. payable
ACCRUAL - recorded on books as rev BEFORE rec./pay CASH
Deferral example
5. On May 1, paid 12000 cash in advance for 1 year rent
- Prepaid expense
5/1 entry (A up and A down)
prepaid rent 12000
cash 12000
12/31 adjusting entry (A down and equity down bc exp.)
rent expense 8000
prepaid rent 80000
balance at end of fiscal year = 4000 on debt side (bc prepaid rent is asset)
rent exp. T-account balance is 8000 on debit side too
Accrual ex.
- employees earn 22000 per work day
- -Dec. 31st is Tues. and employees paid at end of day on Fri.
- -business closed on 12/31 and 1/1 but rec. vacation day full pay
- accrued expense
12/31 adjusting entry (equity down and Liab. up)
wage expense 44000
wage payable 44000
1/3 entry
wage expense 66000
wage payable 44000
cash 110000
review quiz!! review before test!!!!
Which is NOT closed at year end?
how would rev. acct. be closed?
–unearned rent rev. is not closed at year end (salaries exp.,, sales rev., and dividends ARE closed)
–rec. acct closed by debited REV. and crediting RE
general purpose fin. stmts.
–2 key users fin. stmts.
2 key users: lenders and investors
—give info. to external users - mutually beneficial to present accurate fin. stmts. bc investor is more willing to purchase and company will rec. lower rate if proven less risky through fin. stmts.
“General purpose fin. stmts.”
answers 3 questions
- what is company’s current fin. status?
- what were comps. operating results from period?
- how did comp. obtain and use cash during period?
BS - resources and obligations – diff. btwn what is owed and owned
IS - stmt. of earnings over a period
CFS - amt. of cash collected and paid in op., fin., inv.
Classified BS
comparable BS
limitations to BS
Classified
–when A &L on BS have been separated into current and LT
–current = converted to cahs within on eyar or operating cycle (whichever is LONGER)
LTA = all other productive assets-LT inc. in other companies not exp. to be sold within a year, land, fixed assets, intangible assets (pantents, copyrights, goodwill)
comparable
–has fin. info. from the current year and prev. years next to it
limitations of BS
–does not reflect current worth of a company - if it was, the BV of equity on BS woul = mkt. value of equity
due to 2 factors:
- accts. reported at PURCHASE COST, not PV
- –mkt. value is price would pay for assets today - not all econ. assets are included on BS (not quantifiable)
- -reputation, goodwill, brandname, intangibles
result BV < MV
Stmt. of CFS
NI is MOST IMP. measure of company’s economic performance - but also imp. to know how much cash is generated and how it is used (Sources and uses)
cash inflows
- OPERATING CFS
- -selling goods, providing services - INVESTING
- -selling buildings and land - FINANCING
- -borrowing $, rec. inv. from owner, inc. ST and LT borrowing
cash outflows
- CFO
- -int. expense - buy inventory, pay wages/utilities, taxes, operating and admin. exp. - CFI
- -buy B & L - CFF
- -repay loans, distribute to owners, treasury stock pruchase, pmts. of ST/LT borrowing
O - day to day business
I - buy/selling LT assets - PP&E/land - investing in productive capacity of the firm
F - ash to/from lenders/borrowers
MOST IMP. RELATIONSHIP is how CFO relates to how much they had to spend in CFI to inc. productive capacity
articulation
relationship btwn operating stmt. (IS and CFS) and comparable BS - where an item on the op. stmt. explains change in BS item from 1 period to next
BS is fundamental fin. stmt - other stmt. show why BS changes from yr/period to period
The external audit
all public comp. by LAW and enforced by SEC
–private comp. also do to provide assurance to banker/lender
audit by independent certified public accountant
–CPQ qualifications - exam, education, understand industry, independent and no relation to comp.
choose auditoy by
- reputation - quality = trust they will not sign off on questionable fin. stmts.
- lawsuits - auditors sued freq. bc investors lose $ on comp. that auditors signed off on
THE APPARENT CONFLICT
- -auditor is PAID by client (comp. asing for audit)
- -but MOST audit opinions are CLEAN
1. know audiors are coming so keeps reporting systems running properly – incentive for honesty
2. a good reporting system is good business - build relatinoship of trust/loyalty
look at the risks of auditing
Accrual accounting
recording exp. and div. when incurred and earned regardless of hen cash is rec.
- –better reflects comp. performance (Cfs are volatile and timely)
- -have to include partially completed projects/rev./exp.
time period concept
- -divides life of firm into distinct, short (<12 mo.) acc. periods
- -12 mo. period called “Fiscal year”
- -if comp clsoes books o Dec. 31, reports are based on calendar year (NJD were closing June bc season ends April)
60-70% comps. use calendar year
revenue recognition principle
matching principle
rev. recorded when:
1. the earnings process is substantially complete (sale made or services performed)
2. cash has been cllected or collectibility is assured
- -rec. WHEN customers rec. VALUE
- -ex. GM sold and shipped $800M cars in 2012, when it is earned and pmt. is promsied in 2013
- -800M rec. in 2012 is rev. - but if GM is paid in 2012 but ships in 2013, rev. recognized in 2013
matching principle
–all costs/exp. incurred to generate recognized rev. must be recognized in same accounting period as related rev.
metohds of exp. reocognition
- direct matching - COGS (when make sale, report COGS)
- systematic and rational allocation
- -deprec., rent, interest - things that build up systematically (ann. rate = 1/12 performance) - immediately - don’t know - advertising, R&D
matching principle determines amt. of NI reported on income stmt. - reflects profitability
accrual basis acc. provides more accurate picture of company’s profitability (how much econ. value did they generate, not just cash)
preparing fin. stmts.
- make sure have done all adjusting entries
- make sure all journal entries have been posted
- make sure all trials balances balance!!!
noacct. on that balance shows up on both IS and BS
order for fin. stmts.
- from trial balance - identify all rev. and exp.
- compute NI (make IS first!!)
- compute end RE balance
- prepare BS using BS accts. frm trial balance and new ending RE
dividends not on any stmts.
adusted trial balance
–all prepared and ready for fin. stmts. - has totals from each indiv. ledger for diff. accounts
on adjusted trial balance:
- REVENUES are CREDITS (bc represent inc. in equity)
- expenses are DEBITS (bc dec. in OE)
risks and tools of audit
matrix with horizontal top being too low and too high
- -vertical top is A and L
- -the top left (assets = too low) is not possible bc no company will report assets too low
- -the right bottom (L too high) also not possible bc comp. woudl not want to do this
- -so to overcome top right (A too high) - uses “THE LIST” where looks list of assets and checks if correct
- -bottom left (L too low) does detective work to determine true liabilities
TOOLS of AUDITOR
- Sample of selected accounts - check if items on BS exist
- review of acct. systems
- -if good/stable acct. system, trust fin. stmts. are reliable - using a worksheet
- -only interval viewers - prepare own fin. stmts. and compare - fin. stmt. analysis
- -examine fin. stmts. and historical trends
the income stmt.
BS is whwat you have/owe at a period of time - IS is hw much did you MAKE over period of time
–results of operations over time
Net Income
- -“bottom line” - earnings/profit - measure of company’s econ. performance - gain or loss
- -rev. = one source of an asset (others are borrowing or inv.)
- -exp. = one use of asset - there are others
gains/losses - $ made/lost on activities outside of normal business of company
–ex. when Smith’s sells groceries = rev., when sells delivery truck = GAIN
earnings (loss) per share = NI / # shares oustadning
- -tells owner of single share how much NI for year belongs to him/er
- -BASIC EPS - based on historical transaction = NI/actual shares outstanding during period
- -diluted EPS = estimating EPS if certain transacions have occurred
comprehensive income = # reflects overall change in company’s wealth during period
basic formula with equity broken out
A = L + (capital stock + cumulative NI - cumulative div.)
RE = NOT cash, usually used for other assets (inv., LT investment) or pay off liabilities
sometimes have stmt. of stockholder’s equity
CFO/CFI/CFF broken out
OPERATING
- -DAIL - day to day activities - selling products/services, buying inv., incurring and paying for expenses associated with primary activities, paying employees
- -operations revolve around sale of product/service
INVESTING
- -in productive capacity of firm - buying productive assets
- -purchase of assets for use in business - PP&E investments
- -also inv. in stocks/bonds of other companies
- -large amts. and less freq. than operating
- -buy/sell buildings, equip., stocks/bonds
FINANCING
- -raising money to fin. a business by means other than oeprations
1. borrow forom creditors (debt)
2. raise $ by selling stock to investors (equity) - -pay off loans and pay out dividends
rev. recognition again!!! 2 criteria
recorded when 2 criteria are met
- work has been substanitally completed
- cash or valid promise of future pmt. has been rec.
timing imp. = bc comp. apply for big loan, or prepare for IPO, or manager committed to sales target
rec. when CUSTOMER REC. VALUE
ex. farm land customers obught $500 fertilizer - paying $300 cash and $200 promised later = $500 rev. reported immediately
- -but if ex. asked for free deliver = NOT reported as rev. until delivered
- -or if freq. return in industry and have 30 day refund policy = not reported until after 30 days
but hard to determine WHEN customers rec. value
ex. google paid by companies to advertise products
1. when user clicks on add, google rec. revenue
2. cost-per impression pricing - rec. rev. when ads are displayed on website
Walmart selling gift cards - not recognized until customer uses card (when rec, value) so has infinite life - but at end of yr. walmart recognizes SOME rev. for cards they guess will NEVER be used
contract approach
FASB/IASB concerned with rev. recognition when seller enters contraact with buyer = accepts liabilities in exchange for promised assets assets
–AGREE = rev. recognized when seller satisfies performance obligation to buyer
three steps (estimate!!! contract approach)
- identify the PERFORMANCE OBLIGATIONS accepted by the seller
- if contract has distinct elements ALLOCATE contract price over separate elements
- rec. rev. as performance obligations are satisfied
- -ex. satisfy contract to delivery iPhone - then satisfy portion of cont. service over time
MOST CASES - rev. recognized at POINT OF SALE
#@ of contract approach --how to determine indiv. pricing of parts of sale
VENDER-SPECIFIC OBJECTIVE EVIDENCE (VSOE)
–indiv. prices the seller itself uses in arrangement = best measure
THIRD PARTY EVIDENCE
- -prices things are sold by other comps. (compare)
- -best estimate with costs, profit margins, seling prices of other items
- -in ex. used profit margins to find low estimate and high estimate and used the average
on BS
- -cash inc. 2000 (TV example) and L inc. 2000 (no rev. recognized yet bc didnt provide service but rec. cash)
- –edliver TV = L dec. and rev. inc. 1700
cash collection
discounts and returns can impact cash collected from sale
COMMON MISTAKE - rev. recorded when cash collected - ONLY SHOULD BE REC. WHEN REV. EARNED
–remember rev. is a CREDIT to inc.
sales discounts
(Cash discounts) - reduction in selling price allowed if pmt. is rec. within a specified period
- -encourage quick pmt.
- -2/10 n/30 - buyer rec. 2% discount from sale price ifpmt. made within 10 days of purchase price – then must be. paid by 30 days or will be past due
- -strong incentive = 36% int. rate if pays after discount period (2/98) * (360/20)
- -also called 2/10 n/EOM “end of month”
ex. 2/10, n/30 $200 credit sale - rec. IN discount period
at time of sale
AR 200
sales rev. 200
when rec. pmt.
cash 196
sales discount. 4
AR 200
contra account
acct. that is offset/deduced from another account
contra-rev. account = sales discount (Acct. is deducted from rev. acct = debit bc rev. is credit)
contra- asset account = accum. depreciation - taken from asset account (so credit bc dec. asset)
accepting returns and allowances
sales returns and allowances is a contra-rev. account
ex. goods sold for $150 are returned $100 cash and $50 from credit customers
sales returns and allowances 150
cash 100
AR 50
the credit customers are sent a credit memorandum for return = shows balance is now $150 ($200 original credit pruchase less $50 returns)
on income stmt. sales rev. 500 less: discounts. (3) less: returns. (150) net sales rev. = 437
sales discounts above granted only on selling price of items NOT returned = ($200 - 50) * .02 = $3
cash
coins, currency, money orders and cheks and money on deposit with banks or institutions that are availableto be used
- -cash is the RISKIEST of assets - easy to lift, steal, overruse, and lose
1. separate handling of cash fro accounting for cash (less likely for fraud)
2. daily deposits so NO cash on hand (less likely to lose)
3. expenditures made with pre-numbered checks - -bc pmts. with cash easy to target where checks are well documented
must wisely manage acsh - control and budget
account for credit customers who don’t pay
receivables - comp. claim to $, goods services - created with sale of merchandise on crdedit
AR - amt. owed bu credit customers and usually collected btwn 10-60 days
- -formal contract with interest on unpaid balance = note receivable
- -BAD DEBT EXP. - when AR becomes uncollectible = bad debt/loss —> most comp. expect small % of sales to be bad debt
- -if report rev. for year!! must estimate bad debt expense for year too!! bc same yr. recorded
DIRECT WRITE OFF
—waiting until sure they are not going to pay before write off = goes against matching principle - bc would match this years rev. with prev. years expenses
bad debt exp.
allowance method
allowance method = satisfies matching principle bc accts. for uncollectibles during same period sales occurred
- -uses industry ave/ or historical exp. to estimate for year
- -estimate with aging method or % of sales method
to estimate bad debt exp.
bad debt exp. 4500
allowance for bad debt. 4500
debit the exp. and credit the allownce acct. bc CONTRA ASSET acct.
to record write offs (giving up on ppl)
allowance for bad debt. 1500
AR 1500
AR is actual asset account - allowance for bad debt is an estimate and is a contra-asset account
–together make net AR as of end of year!! = net estimate
so when actually write-off ensrued bad debt = NO change to net balance bc AR dec. and dec. allowance acct. bc were expecting it
but if customer actually pays = reverse it
AR 1500
allowance 1500
then record the collection of cash
cash 1500
AR 1500
(reverse the write-off then go through as if write off didn’t happen)
2 ways of estimating bad debt expense
1. % of sales = income stmt. method
–bad debt exp. is ESTIMATE DIRECTLY - then subract to get net AR
ex. historical = 1.5% of AR never collected
so if have $30000 sales * .015 = 4500 estimated
bad debt exp. 4500
allowance 4500
then net AR would be AR balance - allowance = net
2 ways of estimating bad debt expense
2. aging or % of receivables method = focus on BS
–ending. balance of AR estimated DIRECTLY and solve for bad debt expense
ex. 12% of yr end acct. estimated to be uncollectible
- -yr. end AR = 50000 and unadjusted balance in allowance acct. = 2000
so do 50000 * 12% = 6000 = desired ending balance in allowance account!!!
–guess and verify
allowance T acct.
7000 (beg. balance)
5000 (Actual over year)
want end to be 6000
so solve and th eestimated bad debt for yr which wil become exp. is 4000
REMEMBER AGING METHOD GIVES END BALANCE IN ALLOWANCE ACCT. NOT BAD DEBT EXPENSE = HAVE TO SOLVE FOR THAT
bad debt exp. 4000
allowance. 4000
aging method pt. 2
process of categorizing each acct. rec. by # of days it has been outstanding
- -current (1-50 days past due), (31-60 days), (61-90) etc.
- -once the AR are classified by age, each total is multiplied by an appropraite uncollectible %
- -older the rec. = less likely to collect
USED TO ESTIMATE ENDING ALLOWANCE ACT BALANCE
—then goes to guess and verify method to solve for bad debt exp.
ratio analysis with AR
–AR turnover
ratio analysis = becomes comparable with others/competitors
AR Turnover = deterimines how many times during yr. comp. “turns over” or collects their AR - how many times old AR are collected and replaced with new
sales rev. / Ave. AR
(ave. AR = beg. AR + end AR / 2
higher # = more quickly turn over bc turn over more times during yr.
average collection period
of days it takes to collect AR
365 / AR turnover
68.735B / 5.6075 = 12.3x turnover during yr.
then 365 / 12.3 = 29.7 DAYS
—shows if there were 12.3 cycles/turn overs during yr. = each happened about 29.7 days
recording warranty and service costs
warranty is potential obligation in future = acct. for it as an estimate = 8% of total sales
estimated liability for warranties acct. (Tacct.)
beg. balance
actual warranty cost
estimated warranty exp.
ending balance
liab. = go inc. on credit side and dec. on debit side
to record warranty exp. (Estimate!!)
warranty exp. xxx
estimate liab. for warranties xxx
to record actua warranty costs
estimate liab. for warranties xxx
cash (supplies) xxx
chart of product/service processes
- accept order
- deliver product
- collect cash
- accept returns
- struggle - non pmt.
- provide cont. service (Warranty)
- accept order
- – No journal entry until give value to customer - deliver product
AR
sales
— AR inc. and sales rev (OE) inc. - collect cash
cash
AR - accept returns
sales returns
AR(cash)
exp. inc. and Assets dec. - struggle - non pmt.
bad debt exp.
allowance
ex. inc. and asset dec. - provide cont. service (Warranty)
warranty exp.
warrant liab.
exp. inc. and liab. inc
service liability (warranty)
- -50 units sold, 1 in 10 req. follow up service - cost of follow up is $35 per service
- -50/10 * 35 = $175 = expected promised services(estimate)
to record service exp
customer service expense 175
estimated liabilities for service. 175
to record actual providing services = 100 in wages and 45 in supplies
estimated liab. for services. 145
wage payable 100
supplies 45
t account for estimated service liab.
175
45
30 remaining estimated services oto e provided
–if made the promise have to acct. for the obligation
Class notes!!! ACC IS GOOD AT
IS NOT good at
4 reasons we must learn acc.
GOOD AT:
- creating a univ. lang. for business
- creating reliable accts. and amts. related to transactions
- applying GAAP or IFRS
- providing info. for ALL stakeholders (not just investors)
NOT GOOD
- capturing econ. reality
- dealing with uncertainty - historical, not real ,lt. value bc uncertainty in diff. valuation
- delaing with probablities
- dealing with future events
acc. integral to finance
- -must learn to: understand fin. stmts, adjust ccounting assumptions, identify and fix acc. distortions, undo acc. that is not relevant/helpful for valuation
the accounting system
- -who uses it
- -what is GAAP
- -what is IFRS
WHAT IS 10K/10Q
The acc. system - the collection, storage, and processing of fin. and acc. data that is used by decision makers
- -purpose to provide useful info. for decision makers (fin.)
- -objective to provide info. that can be used to make economic decisions!!!
who uses - ALL stakeholders (not just inventors) - universal bus. lang = reliable and recognizable
–all public, private, large non-profits, univ., athletic teams, departments
GAAP - generally accepted accounting principles - rules of fin. reporting
- -problem: accounting driven by CONSERVATISM (pick low and conservative numbers)
- -GAAP set by FASB under SEC (who rec. power from CONGRESS - who’s boss is lobbyists – who come from reporting comps. (if don’t like ryles thaty push congress to change
- -“no info. > unreliable info.”
IFRS
- -international fin. reporting standards
- -set by IASB (international acc. standard board)
10K/10Q - public comps. have to report 10K - annual audited fin. stmts.
- -lists their risks!!!, MD&A (mgmt. discussion and analysis), and prediction for future (CAPEX info) and fin. stmts.
- -10Q is not audited (3 Qs and last quarter is 10K)
Balance sheet (class notes)
why would you ask for BS? info. about LIQUIDITY, SOLVENCY, Fin. STABILITY/FLEXIBILITY
A - 1. econ. benefit
- legal right to asset
- benefit in FUTURE
L 1. future econ. obligation
2. legal ownership
E. residual claim
net of A and L - so called “net assets” (more of nonprofit term for equity bc no owners)
–if it was just me, or just the prof. called “net worth” - same as OE but personal = my equity/worth
Equity has contributed capital, retained earnings, AOCI
–AOCI = accum. other comprehensive income = accum. unrealized gains/losses
Michael Kors BS 1. cash and cash equivalents 2. "net" rec. 3. breakdown inventory 2 common reasons for -equity working capital ratio
- cash and cash equivalents
- -cash equi. = ST highly liquid securities (repos, money mkt.) - rec. says “net” - bc contra asset acct = bad debt
- breakdown inv.
- –not just finished products (bags, shoes)= includes raw materials, and work in process (leather, material)
2 common reasons for -equity
- -paid more in div. than put in
- -losses - retained deficits
working capital ratio = CA/CL = 2.1
- –<1 = bad, can;t meet ST debt
- –>1 good! but comp. could be using ST assets more efficiently
short term investments
inventory
one comps. investments in another comp. (usually equity/debt) to meet ST cash needs
inventory - assets bought/manufactured by comp. and held for sale to others
—if manufactured, also includes raw materials, work in process, finished goods = includes all stuff needed to create finished goods
Disney BS example
–unrecognized assets
unrecognized assets - intellectual property not included on BS
-Disney princesses not on BS bc not quantifiable = put Marvel on bc bought it so know what is is worth (pruchase price)…but Disney princesses are home grown so cannot reliably recognize value of Princess Mickey Mouse
BV says $45B (A-L)
MKT VA = $167B (what you would pay for it) - closer bc takes into account unrecognized assets
which is correct?
- -both approx. but neither fully capture value
- -even mkts. aren’ts always efficient bc fluctuate
- -value SHOULD BE pV FCFs - but can fluctuate bc random things
168/45 = 3.15 = mkt/bk. ratio
5 ways to report value under GAAP
- HISTORICAL COST
- -the amt. of cash paid to acquire the assets
- -LAND = can lose value, but not utility (so useable value not depreciating) - AMORTIZED COST
- -historical cost less. accum. portion of recorded cost of asset that has been charged to exp. through D or A
- -what paid less declining utility
- -ex. PP&E (machinery) - lose value and wear out over time
- -land with minerals (oil reserves) would be included - bc minerals depleted over time - so part of land would be historical reported and part amortized - NET REALIZABLE VALUE
- -amt. company expects to rec. when asset is converted into cash, less associated costs
- -ex. AR - bc don’t realize total value - adjust total va by allowances for unrealizable va to get net
- -use if look forward at an aset and think you won’t claim full value - FAIR VALUE
- -the amt. at which that asset could be bought/sold in a current transaction btwn willing parties - similar to mkt. va
- -ex. PRIVATE COMP. STOCK - acquisitions in privvate mkt.
- ex. Qualtrics bought for $8B and was bought at fair value - MKT VALUE
- -definately is a liquid mkt. with transparent price
- -often mkt. andn fair va same but sometimes diverge
ON THE SAME BS - ASSETS ARE ACCOUNTED FOR IN DIFF. WAYS
Diff. types of liabilities
- -ST
- -payable/accrued
- -LT
ST
–non int. bearing - short term IOUs to suppliers and stakeholders (landlords, employees, insurane comp., tax authorities)
payables vs. accured liability?
- -payables are to suppliers when buy on credit
- -accrued = exp. you have recorded as debit to exp. but have not paid yet = tax, wages
- -unearned rev. = have rec. cash but not performed work/service yet - so haven’t earned it
- -accrued are liabilities that arise prior to cash pmt. - never an exp!! always liab.
current portion of longterm debt
- -deferred rent (been using building but not paid rent)
- -deferred tax = delayed pauing taxes for over a year
LTliabilities
- –notes/bonds payable
- -leases, pensions
non cash liabilities
- -unearned rev.
- -warranties
- -continencies
mezzanine
hybdid of debt and equity financing
- subordinated debt with an equity component
- convertible subordinated debt
- redeemable pref. stock
working capital = CA-CL (what you need for daily operations)
—measures COMP. EFFICIENCY and SHORT TERM HEALTH
Shareholders equity formula broken out
AOCI + contrib. capital (common stock, pref. stock and APIC) + RE - treasury stock
AOCI = accum. other comprehensive income - unrelated to normal operations
- -not core income so not on income stmt.
- -junk drawer - palce we put things related to equity can’t find palces for
APIC - IPO = uses cash to inc. equity
treasury stock = negative equity acct. (subtract)
–repurchased stock - buy back their own stock
RE = not contributed = earnings generated by oeprations that they have decided to retain
–called it “earned capital”
convergence btw IASB and FASB
- inc. comparability
- dec. problems/exp. of raising capital in foreign mkt.
- dec. issues with consolidated fin. stmts. for foreign subs
problem of convergence to worldwide standards - each country adopts own “flavor” - variation in enforcement, IASB vulnerable to political influence
FASB AND IASB have converged on only ONE STANDARD = revenue
—none other in the work or planned
ex. of equity accounts
CS, PS, APIC, TS, RE, AOCI
common stock
–par value rec. from original sale of common stock to inv.
PS
–value rec. from original sale of PS to inv. - PS has fewer ownership rights compared to CS
APIC
–amts. rec. from original sale of stock to inv. in addition to par value of common stock
Treasury stock
–amt. comp. paid to reqaquire its common stock from shareholders (contra-equity account = debit balance)
RE = accum. NI that has not been distributed to stakeholders as div.
AOCI - accum. changes in equity that are not reported in income stmt. bc not related to CORE operations
Facebook ex.
majority of assets = 62% at IPO time were cash and marketable securities
- -so why going public if have so much cash? - earning extra return on savings account
- -equity financed company - mix of contributed capital and profitable operations (RE)
ANY EXPENSES ALWAYS DEC. EQUITY
–cash down and equity down (RE) bc exp.
Class IS - why would you ask for IS as an investor?
IS names
most useful stmt. in forecasting
- -eval. past performance (Sales rev., margins)
- -measure of profitability over a period of time (Q/Ann)
- -helps asses risk or uncertainty of achieiving FCFs (leverage int. exp and EBITDA CF)
- -predict future performance
IS names
- stmt. of earnings
- stmt. of operations
- profit and loss stmt. (P&L)
diff. btwn income and wealth
income
–measure amt. generated during period of time
wealth
–amt. they have in bank acct. (balance sheet)
Sales and COGS
STAPLES EXAMPLE
SALES
–reported “net” of returns, rebates, discounts, sales tax
COGS - broader basket than we think - cost of goods sold net of discounts
- -inbound and outbound freight, rec. and distribution, store and distribution center occupancy (Real estate taxes and common area maintenance)
- -occupancy costs (rent) also considered “Direct cost” for retailers
- –so hard to compare margins as an analyst and should search 10K to find out what they put in COGS (Ex.AAPL had half deprec. in COGS nad half in SG&A)
EX. Staples had COGS nad occupancy costs in same line bc they rent their buildings - so lease buildings and store their goods so COGS
Operating expenses
(lots of junk)
–costs incurred to run the business
SG&A - payroll, advertising, deprec. and other operating expenses
impairment of goodwill and long lived assets = charges (write offds) related to assets that have declined in value
amortization of intangibles
–intangible assets with finite life (patents) - ann. amortization charge
integration and restructuring costs
- -costs associated with strategic restructuring plan
- -closing stores, consolidating systems or offices, reorganizing, relocating, laying off employees
- -operating exp. on staples bc changes relate to operating activities
EBIT
EBIT - most useful measure used in finance
–measure of profitability that does not take into account taxes or leverage (capital structure)
all above OPERATING INCOME (including EBIT) are pre-tax operating activities
all eloe operating income up to right before income tax exp are pre-tax non-operating activities
pre-tax non-operating activities
interest income - int. pmts. rec. from investments in fixed securitires
int. expense - int. payments made on LT debt (Revolvers, notes, bonds, capital leases)
loss on early extinguishment of debt
–inome charge for retiring debt before maturity at cost above book value
other income (expese), net = mixed bag of random things
income from cont. oeprations before income taxes
–pre-tax income from operating and non-operating activities
taxes and below
income tax exp
(loss) income from cont. operations including portion attributable to NONCONTROLLING interests
= after tax income from activities that will cont. in future
loss from discont. operations, net of income taxes
–after tax income from a bus. arm that is clearly distinguishable from other operations - that was discont. or will be discont. within one year
discontinued operations (above) occurs when
- comp. eliminates results of operations of a component of business
- there is no significant involvement int hat component after disposal transaction
- –amts. reported “net of tax”
consolidated net (loss) income
(loss) income attributed to noncontrolling interests
- NI including income that other parties have claims to
- amt. of the subsidiary’s NI that investors other than parent can claim
- -when a comp. (parent) purchases 50-99% ownership in another company (subsidiary) GAAP req. parent to consolidate 100% of subsidiary’s fin. results
- -but some other investor (the noncontrolling inv.) has claim to fraction of subsidiary that parent does not own!!! but they had reported
then finally NI = BOTTOM LINE
“big bath” earnings mgmt. = staples ex.
comp. takes a large non-recurring loss one year when profits are already depressed (Ex. staples took hit in impairment of goodwill and restructuring same year) so that future earnings are not burdened
- -result is inc. future earnings or reduced varaibility of future earnings
- -clean out the bad earnings - which does little to comp. or mgmt. reputation
limitations of IS
- Companies omit items that cannot be measured reliably
- income is affected by acc. methods employed
- rev. and exp. measurement involves judment
- quality of earnings is reduced if earnings mgmt. results in info. that is less useful for predicting future earnings and Bfs
four main earnings numbers
- operating income
- income from cont. operations before taxes
- NI
- NI attributable to staples
staples IS ex. cont.
impairment of goodwill
- -bad M&A - goodwill reported when pay premium ot acquire something
- -impairment means paid too much to acquire - din’t properly value it
- -write off bc thought asset worth more and when re-value later realize it wasn’t
recurring earnings
“recurring earnings” - amt. of earnings we expect to persist into the future
–called CORE EARNINGS, PERSISTENT earnings
to calc. recurring earnings - walk down IS and remove “transitory” items that are likely to be one-time in nature
in staples ex. would take out (called the transitory expenses!!) 1. impariment of goodwill 2. restructuring costs 3. loss on early distinguishment of debt 4. loss from dicontinued operations
recurring earnings NOT same as forecasted earnings!!!
- -not forecasting what we expect it to be next year
- -we are sanitizing the current yr. income stmt. for one time items
- -use sanitized numbers as base for forecasts
effective tax rate (ETR)
comprehensive income
= income tax expense / pre tax income
–used ETR over prior 2 years of 33.4% in example
comprehensive income (OCI)
- -another bottom line - req. as of 1998
- -reported as extension to traditional income stmt. or in stmt. of changes in OE
so have NI as a credit (bc Equity)
–then debit other comprehensive income
(foreign currency gains/losses, derivatives, investments)
–under NI bc items provide little info. about econ. performance of comp. during operations
–items from mkt. changes outside mgmt. control = volatile
—so NI is closed to RE on BS
–so the Other Comprehensive income items go on BS under equity in AOCI accumulated other comprehensive income
articulation examples btwn fin. stmts.
- cash BS – ending cash SCF
- RE BS - RE SSE
- NI SSE - NI IS
- NI IS - NI CFS
- change RE BS - NI IS
- Equity amt. BS - Equity SSE
- working capital BS – change working capital BS
change in contingent liab. = unforeseen expenses (lawsuits) = won/lost a lawsuit = fitbit example
fin. stmt. ex. = analyzing which comp. is which based off diff. in IS
- large pharmaceutical
- clothing manufacturer
- clothing retailer
- machinery manufacturer
- high-tech. startup
- large pharmaceutical (Gilead)
- -could tell bc royalty was contra-rev. account in their IS
- -royalty due to licensing drugs to other comps. = using their patents
- -also had cash dividends and most large pharmaceutical comps. are public
- -COGS was low bc real cost is in developing the drugs - clothing manufacturer
- -NIKE ex. - had high gross margin
- -high margin but highest expense (> COGS) was in SG&A bc spend a lot on marketing and endorsements to assets - clothing retailer
- –GAP - fiscal year ended in Feb. to take into account seasonal selling
- -low NI
- -COGS and occupancy exp. included (bc pay for storage in stores) - machinery manufacturer
- -John Deere - could tell bc they have finance and int. income under total revenues - bc are financing dealers = get int. income
- -also have larger int. exp. = more debt - high-tech. startup
- -twitter - lots of R&D
- -net loss bc startup!!
net revenue
basic rev. recognition
gross revenue less
- -allowances and returns
- -discounts, coupons, promotions, rebates
- -certain taxes
basic rev. recognition
- pmt. is reasonably assured
- performance obligation is satisfied
MOST OF THE TIME HAPPENS AT POINT OF SALE (80%)
- -imp. bc rev. drive the income stmt. and are closely watched by investors, creditors
- -imp. bc also leasd to a lot of fraud risk - people are mor likely to manipulate rev. up than they are to manipulate expenses down
- -bc of this leads FASB to create/update rev. recognition standards
bill and hold example
customer pays for large order of inventory but asks comp. to hold off delivering goods for a few months. When should record rev.?
recorded NOW, not when delivered later
- -but customer must REQUEST a bill and hold
- -req. must be for LEGITIMATE BUSINESS PURPOSE
- -items must be finished!!! - not to meet fiscal yr. end sale
- -items cannot be used to satisfy another order
customer is being satisfied bc what they want and comp. has rec. cash - completed sale. just customer doesn’t have room for inv. yet
the inv. would also be credited…even though you still have it there!!
also works with AP and AR
–not necessary to have CF
when deciding when to recognize rev. ask yourself
what is the SERVICE the company performs and have they obligated it!!
IMP bc rev. recognition is # area of fraud
- -then debt/equity securities
- -then acc. for income taxes
- -then stock/deferred compensation
ex. called “on-going” delivery
- -subscriptions - tie revenue over life of delivery/usage period
now FASB has developed “new rev. recognition standard”
5 steps to rev. recognition now
- identify contract with customers
- identify separate performance obligations in contract
- determine transaction price (amt. seller is entitled to rec. from customer!!)
- allocate transaction price to separate performance obligations
- recognize rev. when each performance obligation is satisfied
rec. rev. when performance obligation is satisfied
common rev. recognition cases
- point of sale (Nordstrom)
- bill and hold (holding inv.)
- service period - “on-going” delivery
- long-term construction (go over review and notes!!!!!)
- multiple elements (find proportion and allocate)
stand-alone value
“stand-alone value” = the separable value attributable to a specific good/service in a bundle
- item is capable of being DISTINCT
- item is SEPARABLE from other goods/services in contect of contract
need to do the phone example again!!!!!!`
when does disney record rev. for:
- theme parks
- motion pictures
- merchandise
- online and mobile
- advertising
- theme parks
- ticket sales - when tickets used
- -ann. passes - spread over pass period - motion pictures
- -ticket sales - rec. when motion pictures exhibited
- -licenses - rec. when content available for telecast by licensee
- -end consumer (blue ray) - point of sale
- -streaming - deferred rev. over anticapted “availability window” - merchandise
- -products = POS
- -licenses and royalties - rec. when licensed product sold by licensee - online and mobile
- -rec. rev. as services are rendured - advertising
- -rec. rev. when commercials are aired
common “Reserves”
- sales discounts and sales returns
- -subracted from “Gross sales” to arrive at “net sales” on IS - allowance for bad debt and warranty reserve
- -tied to operating exp (bad debt exp. and warranty exp) on IS
reserves are estimates!!! req. judgment and can be manipulated
allowance = “% we expect to be uncollectible over the year”
write offs = actual customer accts. that have been written off as hopelessly uncollectible as determined by AR manager
AR gross roll forward
allowance for doubtful accounts
–roll fwd
AR gross roll fwd BEG AR, gross \+ credit sales - cash collections -actual AR writeoffs = END AR, GROSS
allowance for doubtful accounts BEG allowance \+ bad debt expense - actual write offs = END allowance
then if you take the AR end balance minus the allowance END balance gives the NET AR
in ex. to find the estimated uncollectible we did the estimate uncollectible / total (Gross) AR = 8.9%
warranty exp. ex.
estimate warranty claim bc know how often it happens based on historical experience
balance = 19
less pmts. made during period = (27)
plus exp. recorded during period = +24
= end balance
