Analyzing Balance Sheets Flashcards
What are intangible assets?
Identifiable non-monetary assets without physical substance.
What is an identifiable asset?
An asset that can be separated from the entity or that arises from contractual or legal rights and privileges. Examples are patents, licenses, trademarks, and customer lists.
What is an example of a non-identifiable asset?
Goodwill
IFRS permits companies to report intangible assets using either a cost model or a revaluation model. US GAAP only permits the cost model!
What is the revaluation model as permitted by the IFRS?
It can only be selected when there is an active market for an intangible asset.
How does amortization and impairment principles apply to intangible assets?
A company assesses whether the useful life of the asset is finite or indefinite. An intangible asset with a finite useful life is amortized on a systematic basis over the best estimate of its useful life, with the amortization method and useful life estimate reviewed at least annually. Impairment principles for an intangible asset with a finite useful life are the same as for PP&E. An intangible asset with an indefinite useful life is not amortized. Instead, at least annually, the reasonableness of assuming an indefinite useful life for the asset is reviewed and the asset is tested for impairment.
Some analysts exclude the book value assigned to intangibles, reducing net equity by an equal amount = tangible book value. An analyst should analyze each intangible and decide if it should be adjusted.
Internally created identifiable intangibles are expensed rather than reported on the balance sheet!!!!!!!!
IFRS provides that for internally created intangible assets, the company must separately identify its research phase and development phase. The research phase must be expensed on the income statement while costs incurred in the development phase can be capitalized as intangible assets if certain criteria are met.
US GAAP wants all internally developed intangibles R&D costs expensed.
Acquired or purchased intangible assets are capitalized and reported as separately identifiable intangible, as long as they arise from contractual costs.
What is goodwill?
When one company acquires another, the purchase price is allocated to all of the identifiable assets and liabilities acquired, based on fair value. If the purchase price is greater than the fair value of the identifiable assets and liabilities acquired, the excess amount is recognized as an asset = goodwill.
What are the differences between economic and accounting goodwill?
Economic goodwill is based on the economic performance of the entity, whereas accounting goodwill is based on accounting standards and is reported only in the case of acquisitions. Economic goodwill is reflected in the stock price.
Under both IFRS and US GAAP, accounting goodwill arising from acquisitions is capitalized. Goodwill is not amortized but is tested for impairment annually. If goodwill is deemed to be impaired, an impairment loss is charged against income in the current period, reducing earnings.
How can analysts adjust the companies’ financial statements by removing the impact of goodwill?
Excluding goodwill from balance sheet data used to compute financial ratios.
Excluding goodwill impairment losses from income data used to examine operating trends.
What is a financial instrument?
A contract that gives rise to a financial asset of one entity, and a financial liability or equity instrument of another entity. Examples are a company’s investments in stocks, notes, bonds or other instruments issued by other companies.
Under IFRS, financial assets are subsequently measured at amortized cost if the asset’s cash flows occur on specified dates and consist solely of principal and interest, and if the business model is to hold the asset to maturity. In US GAAP, this is called held-to-maturity. The other model is called available-for-sale, in which asset are measured at fair value. US GAAP only allows for debt securities!
What are non-current liabilities?
All liabilities that are not classified as current are considered to be non-current or long-term.
What are deferred tax liabilities?
Result when taxable income, and the actual income tax payable in a period based on it, is less than the reported financial statement income before taxes and the income tax expense based on it.
What are liquidity and solvency?
Liquidity refers to a company’s ability to meet its short-term financial commitments.
Solvency refers to a company’s ability to meet its financial obligations over the longer term.
What is common-size analysis of the balance sheet?
Stating each balance sheet item as a percentage of total assets.
What is the current ratio?
Current assets / current liabilities.
Measures ability to meet current liabilities.
What is the quick ratio?
Cash + Marketable securities + Receivables / Current liabilities
What is the cash ratio?
Cash + Marketable securities / Current liabilities
