Accounting I-IV Flashcards
What is the overall objective of financial statements?
Restate reported earnings by eliminating non-recurring or transitory items
Income Statement Organization
Operating items
+ Non-operating items
+ Items unrelated to current operations
Comprehensive items (likely to reverse)
Business Restructuring Charges (Included in Operating Items)
Companies incur restructuring charges when they change the way they conduct business, for example, by closing plants and refocusing on a smaller geographical area
Restructuring charges are typically made up of…
asset write-offs, severance (layoff costs), and plant closure and relocation costs
Restructureing expense recognition and the payment of restructuring costs (write-off of assets) may…
be in different periods
Non-operating income and expenses include
- gains and losses on sales of PPE
- gains and losses on investments in securities (whether realized-from a sale, or not)
- impairment losses (write-downs of long-lived assets)
When should you recognize impairment losses?
Required when the asset’s carrying amount exceeds the undiscounted future cash flows from the asset
How large an impairment loss should you recognize?
The loss is calculated as the difference between the asset’s carrying cost and its fair value. “Fair value” is the market price, if available, or the discounted present value of future cash flows from the asset
Discontinued Operations
Recorded when a company decides to exit an area of business with clearly distinguisable operations and cash flows. For example, an operating segment, reporting unit, subsidiary, or group of assets.
All income for the discontinued business is reported…
separately once management decides to exit the businesses. Appears on an after-tax basis on the income statement
What is the balance sheet treatment for discontinued operations?
The assets and liabilities of the discontinued operations are classified separately on the balance sheet as “held for sale.”
What are the possible tax rates you could use?
- The specific taxes on the adjusted item
- The statutory tax rate (21%)
- The average tax rate on all the company’s income
(Companies explain their taxes in the tax foot note to the financial statements)
Why was Pfizer’s tax rate only 5.9% in 2018?
Tax breaks on operations in Ireland, Puerto Rico, and Singapore lowered the tax rates
When should you use the specific taxes on the adjusted item?
Best choice if the tax effects are disclosed
When should you use the statutory tax rate (21%)?
Next best alternative to the specific tax rates on an adjusted item
When should you use the average tax rate on all the company’s income?
Generally a poor choice; ignores reasons why a company’s overall tax rate is high or low
Insights on sales revenue from financial analysis:
- Examine disclosures about revenue recognition in notes to the financial statements
- Explain changes in revenue recognition policies
Sales revenues as indicators of operating income:
- Explain changes in receivables collection patterns: comparisions of sales revenue with accounts receivable may provide an indication that revenues may not be collected
- Compare sales revenues with changes in inventory: increasing inventory may predict slowing sales
The reliability and plausibility of sales revenues:
- Comparisions of sales with company’s assets (asset turnover) and with inventories may show whether the reported revenues are credible
- Sales revenue recognition policies may comply with accounting rules but misstate the company’s performance (for example, Apple’s revenue deferral)
Why do many companies use LIFO?
Because it reduces their taxable income (the most recent inventory costs are included in COGS first - if prices are rising then the resulting LIFO income is lower than FIFO income)
Differences in inventory methods (LIFO vs FIFO) can…
reduce the comparability of financial statements
Inventory assumptions affect:
- Income estimates
- ROE and ROA calculations
- Inventory turnover and days’ sales in inventory estimates
Why might some companies’ LIFO reserves be small?
Big price differences of inventory (ex: oil prices fluctuate frequently)
Limits on retail LIFO (products change)
What is the overall objective in analyzing leased assets?
- Measure the firm’s PPE to make measures such fixed asset turnover more meaningful and comparable
- Companies acquire PPE to use by purchase and leasing. Differences in this mix could mae comparisons across companies difficult
How do companies gain access to PPE for thier use?
- Purchase
- Lease
- Rental
Purchase
Ownership rights. Record an asset and depreciation expense.
Lease
Has characteristics of both purchase and rental
Rental
No ownership rights, therefore, no balance sheet records.
Finance Leases
Resembles a purchase becuase of any of the following:
1. Transfers of ownership by end of lease term
2. Bargain purchase option
3. Use asset over 75% or more of its useful life
4. PV of rentals >=90% of FMV
5. Specialized asset with no alternative use
Operating Leases
Resembles a rental:
Non of hte finance lease criteria are met
Why do companies use leases?
- Convenient form of financing a purchase for many buyers
- Tax Considerations: Structure the lease so that the tax benefits of depreciation go to the party best able to use them
- Operational flexibility - ease of changing locations or other assets
Who uses leases?
Widely used, but common among
1. Retail firms
2. Airlines
3. Railroad companies
What is the accounting treatment of finance and operating leases?
Both are recorded on the balance sheet even though operating leases resemble rentals - companies must record right-of-use asset and related liability for operating leases
What is the accounting treatment for leases with terms of 12 months or less?
They do not have to be capitalized
(this is an exception to the general rule)
