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CFA > Book 2: Chapter 18 > Flashcards

Book 2: Chapter 18 Flashcards

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1
Q

What does the income statement report?

A

The revenues and expenses of the firm over a period of time

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2
Q

What is the income statement sometimes referred to as?

A

Statement of operations
Statement of earnings
Profit and loss statement (P&L)

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3
Q

What is the income statement equation?

A

Revenues - expenses = net income

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4
Q

What do GAAP and IFRS say you can do with the income statement and the statement of other comprehensive income?

A

They can be presented separately or together as a single statement of comprehensive income

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5
Q

Why do investors examine a firm’s income statement?

A

For valuation purposes

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6
Q

Why do lenders examine a firm’s income statement?

A

For information about the firm’s ability to make the promised interest and principle payments on its debt

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7
Q

What are revenues?

A

The amounts reported form the sale of goods and services in the normal course of business

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8
Q

What is net revenue?

A

Revenue less adjustments for estimated returns and allowances

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9
Q

Where can you find details about the presentation of revenue

A

In the footnotes of the financial statements or sometimes in the MD&A

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10
Q

Revenue is sometimes used synonymously with what?

A

Turnover and sales
Sales are actually just one component of revenue in many firms

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11
Q

What are expenses?

A

The amounts incurred to generate revenue. This includes…
Cost of goods sold
Operating expenses
Interest
Taxes

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12
Q

True or false expenses are grouped together by their nature or function?

A

True. For example the depreciation expenses from manufacturing and administration together in one line of the income statement is an example of grouping by nature of the expense

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13
Q

What is COGS?

A

The costs associated with manufacturing eg raw materials, depreciation, labour etc

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14
Q

What is grouping expenses by function sometimes referred to as?

A

The cost of sales method

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15
Q

What are some “sneaky” things to watch for when expenses are presented?

A

Columnar data in chronological order can be from left to right or right to left
Expenses can be negative numbers, positive numbers or in parentheses

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16
Q

Other than revenues and expenses, what does the income statement also include?

A

Gains and losses

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17
Q

What is a gain?

A

Something that results in an increase in economic benefits

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18
Q

What is a loss?

A

Something that results in a decrease of economic benefits

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19
Q

Will gains and losses result from ordinary business activities?

A

Sometimes

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20
Q

How would you incorporate a firm selling surplus equipment used in its manufacturing operation that’s no longer needed into the income statement?

A

The difference between the sales price and book value is reported as a gain or loss on the income statement

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21
Q

Write 2 ways of writing the net income equation

A

Net income = income (revenues + gains) - expenses (including losses)
Net income = revenues - ordinary expenses + other income - other expenses + gains - losses

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22
Q

What happens in terms of income statements when a firm has a controlling interest in a subsidiary?

A

The statements of the two firms are consolidated ie the earnings of both firms are included on the income statement

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23
Q

In the case of a consolidated income statement, how is the proportion of the subsidiary’s income that isn’t owned by the parent reported in the parent’s income statement?

A

As non controlling interest/minority interest/minority owners’ interest

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24
Q

How do you get the net income of the parent company when it has a controlling interest in a subsidiary?

A

You subtract the non controlling interest from the consolidated total income

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25
Q

Should a firm present its income statement using a single-step or multi-step format?

A

It can do both

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26
Q

What is a single step-format income statement?

A

All revenues are grouped together and all expenses are grouped together

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27
Q

What is a multi-step format income statement?

A

It includes gross profit, revenues minus cost of goods sold

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28
Q

Define gross profit

A

The amount that remains after the direct costs of producing a product or service are subtracted from revenue

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29
Q

What is operating profit/operating income

A

Gross profit- operating expenses

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30
Q

What are operating expenses

A

SG&A, other expenses, depreciation etc

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31
Q

What is operating profit for non financial firms?

A

Profit before financing costs, income taxes and non-operating items are considered

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32
Q

What is net income/bottom line/earnings?

A

Operating profit - interest expense - income taxes

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33
Q

What is interest expense usually considered as for financial firms?

A

An operating expense

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34
Q

What is often used as a proxy for EBIT?

A

Operating income- there may be some differences between the two

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35
Q

Name 12 steps of a multi-step income statement in order!

A

Revenue
Cost of goods sold
Gross profit
Selling, general and administrative
Depreciation expense
Operating profit
Interest expense
Income before tax
Provision for income taxes
Income from continuing operations
Earnings (losses) from discontinued operations, net of tax
Net income

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36
Q

When is the revenue recognised when goods are exchanged for cash and returns aren’t allowed?

A

At the time of the exchange

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37
Q

What is recognition of revenue not dependent on?

A

Receiving cash payment

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38
Q

What happens to revenue if the sale of goods is made on credit?

A

Revenue is recognised at the time of the sale and an asset called accounts receivable is created on the balance sheet

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39
Q

What happens if payment of the goods is received before the goods are transferred?

A

A liability called unearned revenue is created when the cash is received (offsetting the increase in the asset “cash”)

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40
Q

When is revenue recognised?

A

When the goods are transferred to the buyer

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41
Q

Explain the changes in revenue and liabilities when a magazine subscription is purchase/magazine delivered?

A

When the subscription is purchased an unearned revenue liability is created
When the magazine is delivered revenue is recorded and the liability is decreased

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42
Q

What type of approach to converged standards under IFRS and US GAAP towards revenue recognition issues?

A

A principles-based approach

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43
Q

What is the central principle that the IFRS and US GAAP takes towards revenue recognition issues?

A

That a firm should recognise revenue when it has transferred a good or service to a customer
This is consistent with the familiar accrual accounting principle that revenue should be recognised when earned

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44
Q

Which 5 steps do the converged standards under IFRS and US GAAP take for recognising revenue?

A

1) identify the contract(s) with a customer
2) identify the separate or distinct performance obligations in the contract
3) determine the transaction price
4) allocate the transaction price to the performance obligations in the contract
5) recognise revenue when (or as) the entities satisfies a performance obligation

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45
Q

What do the converged standards under US GAAP and IFRS define as a contract?

A

An agreement between two or more parties that specifies their obligations and rights. Collectibility must be probable for a contract to exist but probable is defined differently under IFRS and US GAAP, so an identical activity could still be accounted for differently by IFRS and US GAAP reporting firms

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46
Q

What is a performance obligation?

A

A promise to deliver a distinct good or service

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47
Q

What is a distinct good or service?

A

One that meets the following criteria:
- the customer can benefit from the good or service on its own or combined with other resources that are readily available
- the promise to transfer the good or service can be identified separately from any other promises

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48
Q

Define a transaction price

A

The amount a firm expects to receive from a customer in exchange for transferring a good or service to the customer

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49
Q

Is a transaction price fixed or variable?

A

It’s usually fixed but it can be variable

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50
Q

When should a firm recognise revenue?

A

Only when it’s highly probable they will not have to reverse it.
Eg a firm may need to recognise a liability for a refund obligation (and an offsetting asset for the right to returned goods) if revenue from a sale can’t be estimated reliably

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51
Q

For long-term contracts how is revenue recognised?

A

Based on a firm’s progress toward completing a performance obligation

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52
Q

How can progress towards completion be measured?

A

From the input side- eg using the % of completion costs incurred as of the statement date
From the output side- using engineering milestones or % of the total output delivered to date

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53
Q

What are separate deliverables?

A

When you can use different stages of the eg building process as mini performance obligations, rather than just having the completed building as the performance obligation

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54
Q

What happens if part way through a project you realise you will be eligible for the conditional bonus payment?

A

You can now add that into your revenue. So you add this bonus to the total revenue, times that by the % of the work you’ve done in total now (eg from % of costs incurred) then take off the revenue you’ve already put in last year or the year before etc

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55
Q

What is the issue for revenue recognition when a contract is changed during the construction period?

A

Whether to treat a contract modification as an extension of the excising contract or as a new contract

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56
Q

When should the contract revision be considered as an extension of the existing contract?

A

If the goods and services to be provided are not distinct from those already transferred

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57
Q

If there is an extension to a contract during the project how should revenue be recognised?

A

Work out what % of the way through you are now taking into account the costs you’ve incurred and how many costs left.
Work out total new revenue when project is completed. Times this by your % of the way through
Finally take off the revenue you’ve already accounted for so in prev years

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58
Q

Give an example of a party acting as an agent

A

A travel agent- isn’t responsible for providing the flight and bears no credit or inventory risk

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59
Q

How should an agent report revenue?

A

Equal to the commission, the net amount of the sale (eg flights are $10, commission $1)

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60
Q

What must you do to the costs to secure a long-term contract (eg sales commissions)?

A

Capitalise them ie the expense for these costs needs to be spread over the life of the contract

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61
Q

What are the required disclosures under the IFRS and US GAAP converged standards?

A
  • contracts with customers by category
  • assets and liabilities related to contracts including balances and changes
  • outstanding performance obligations and the transaction prices allocated to them
  • management judgements used to determine the amount and timing of revenue recognition, including any changes to those judgements
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62
Q

How does the IASB define expenses?

A

Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants

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63
Q

What is not an issue if financial statements were prepared on a cash basis?

A

Revenue recognition and expense recognition. The firm would simply recognise cash received as revenue and cash payments as expense

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64
Q

Under accrual accounting expense recognition is based on which principle?

A

The matching principle

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65
Q

What is the matching principle?

A

Expenses to generate revenue are recognised in the same period as the revenue

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66
Q

Give an example of the matching principle working

A

Inventory bought in Q4 2022, sold in Q1 2023, revenue and expense are both recognised in Q1 2023 when the inventory is sold

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67
Q

What is the name of expenses that can’t be directly tied to revenue generation?

A

Period costs

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68
Q

What is an example of a period cost?

A

An administrative cost

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69
Q

When are period costs expensed?

A

In the period incurred

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70
Q

What should a principle report revenue based on?

A

The gross amount billed to the customer

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71
Q

What should an agent report revenue based on?

A

The net amount retained (eg the amount billed to the customer - the amount paid to the supplier)

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72
Q

When can a firm use the specific identification method for inventory expense recognition?

A

If it can identify exactly which items were sold and which items remain in inventory eg an auto dealer records each vehicle sold or in inventory by its identification number

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73
Q

What is the first in first out (FIFO) method?

A

The first item purchased is assumed to be the first item sold

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74
Q

How is COGS calculated for the period using FIFO?

A

Using the cost of inventory acquired first (beginning inventory and early purchases)

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75
Q

How do you calculate the ending inventory using FIFO method?

A

Using the cost of the most recent purchases

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76
Q

When is FIFO appropriate?

A

For inventory that has a limited shelf life eg a food production company (keeping the inventory on hand fresh)

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77
Q

Explain the last in first out (LIFO) method of inventory expense recognition

A

The last item purchased is assumed to be the first item sold

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78
Q

How do you calculate COGS for the period using LIFO?

A

The cost of inventory most recently purchased is assigned to the cogs for the period

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79
Q

What are the costs of beginning inventory and earlier purchases assigned to under LIFO?

A

Ending inventory

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80
Q

When is LIFO appropriate?

A

When the inventory doesn’t deteriorate with age (eg a coal distributor will sell coal off the top of the pile)

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81
Q

Why is LIFO popular in the US?

A

It has income tax benefits. In an inflationary environment LIFO results in a higher COGS, this results in lower taxable income and therefore lower income taxes

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82
Q

What assumption does the weighted average cost of inventory method not make?

A

It makes no assumption about the physical flow of the inventory

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83
Q

Why is the weighed average cost inventory method popular?

A

It’s ease of use

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84
Q

How do you calculate the cost per unit using the weighted average cost method for inventory?

A

Divide the cost of available goods by the total units available, this average cost is used to determine both the cost of goods sold and the ending inventory

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85
Q

Average cost results in COGS being where in relation to LIFO and FIFO?

A

Between them

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86
Q

Is LIFO permitted under IFRS and US GAAP?

A

No, only US GAAP

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87
Q

Is FIFO permitted under IFRS and US GAAP?

A

Yes

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88
Q

Is the average cost method for inventory permitted under US GAAP and IFRS?

A

Yes

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89
Q

What must be matched with revenues?

A

The cost of long-lived assets

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90
Q

What is a long-lived asset?

A

An asset that’s expected to provide economic benefits beyond one accounting period

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91
Q

What is the allocation of cost over a tangible asset’s life called?

A

Depreciation

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92
Q

What is the allocation of the cost of an intangible asset’s life known as?

A

Amortisation

93
Q

What is the allocation of cost over a natural resource’s life known as?

A

Depletion

94
Q

Which depreciation method do most firms use for financial reporting purposes?

A

The straight-line depreciation method

95
Q

What is the straight-line depreciation method?

A

This recognises an equal amount of depreciation expense each period

96
Q

When is an accelerated depreciation method more appropriate for matching expenses to revenues?

A

When an asset generates more benefits in the early years of its economic life and fewer benefits in the later years

97
Q

Explain the difference to net income from using the straight line depreciation method vs the accelerated method over the asset’s lifetime

A

In the early years of an asset’s life there’ll be lower depreciation expense compared to the acceleration method meaning higher net income.
In the later years of the asset’s life the effect is reversed so lower net income compared to the accelerated method

98
Q

Define straight line depreciation

A

It allocates an equal amount of depreciation each year over the asset’s useful life

99
Q

Write the equation for straight line (SL) depreciation expense

A

SL depreciation = (cost-residual value)/useful life

100
Q

What does the accelerated depreciation method do?

A

It speeds up the recognition of depreciation expense in a systematic way to recognise more depreciation expense in the early years of the asset’s life and less depreciation expense in the later years of its life

101
Q

Which method straight line or accelerated results in a higher total depreciation expense over the life of the asset?

A

Neither, they’re the same

102
Q

What is the declining balance method?

A

This applies a constant rate of depreciation to an asset’s (declining) book value each year

103
Q

What is the declining balance method also known as?

A

The diminishing balance method

104
Q

What is the most common declining balance method?

A

The double declining balance

105
Q

What is the double declining balance method?

A

This applies 2x the straight line rate to the declining balance

106
Q

What is the double declining balance (DDB) method equation?

A

DDB= (cost-accumulated depreciation)*(2/useful life)

107
Q

Is the asset’s residual value used in the calculations of the declining balance method?

A

Not explicitly, but depreciation ends once the estimated residual value has been reached

108
Q

What happens if you use the declining balance method for an asset that’s assumed to have no residual value?

A

Then the asset will never be fully depreciated. So the double balance method is typically changed to the straight line depreciation method at some point in the asset’s life

109
Q

what is an example of an intangible asset?

A

a franchise agreement

110
Q

what should amortization expense match?

A

The proportion of the asset’s economic benefits used during the period

111
Q

what method do most firms use to calculate annual amortization expense for financial reporting

A

Straight-line, and this is calculated exactly like straight-line depreciation

112
Q

what kind of intangible assets are not amortized?

A

intangible assets with indefinite lives (eg goodwill)

113
Q

what must intangible assets with indefinite lives be tested for at least annually?

A

Impairment

114
Q

what happens if an intangible asset shows some signs of impairment?

A

an expense equal to the impairment amount is recognised on the income statement

115
Q

what is the bad debt expense or warranty expense?

A

if a firm sells goods or services on credit or provides a warranty to the customer, the matching principle requires the firm to estimate bad debt expense and/or warranty expense. by doing so the firm is recognizing the expense in the period of the sale, rather than in a later period

116
Q

what, like revenue recognition, also requires a number of estimates?

A

expense recognition

117
Q

since estimates are involved in revenue recognition, what can firms do to it

A

delay or accelerate the recognition of expenses

118
Q

which is more aggressive delayed or accelerated expense recognition?

A

delayed because it increases current net income

119
Q

what must an analyst do when they see a change in an expense estimate?

A

consider the underlying reason for this, eg if a firm’s bad debt expense has recently decreased is this because its collection experience improved or was the expense decreased to manipulate net income?

120
Q

what should an analyst compare a firm’s expense estimates to?

A

other firms within the same industry and ask is this difference eg a lower warranty expense because of higher quality products or does this firm have a more aggressive expense recognition?

121
Q

where do firms disclose their accounting policies and significant estimates?

A

in the financial statement footnotes and in the MD&A section of the annual report

122
Q

what is a discontinued operation?

A

one that management has decided to dispose of, but either has not yet done so, or has disposed of or in the current year after the operation had generated income or losses

123
Q

what qualities does a business need to have in order to be counted as a discontinued operation?

A

the business in terms of assets, operations and investing and financing activities must be physically and operationally distinct from the rest of the firm

124
Q

what is the measurement date?

A

the date when the company develops a formal plan for disposing or an operation

125
Q

what is the phaseout period?

A

the time between the measurement period and the actual disposal date

126
Q

where is the income/loss from a disposed of operation reported in the income statement?

A

separately, net of tax and after the income from continuing operations

127
Q

once an asset has been disposed of what must happen to past income statements?

A

they must be restated separating the income or loss from the discontinued operations

128
Q

on the measurement date what does the company report about any estimates losses or gains from the disposal?

A

it will accrue any estimated loss during the phaseout period and any estimated loss on the sale of the business.
expected gains can’t be reported until after the sale is completed

129
Q

what part of the income statement should analysts looking to forecast future earnings ignore?

A

discontinued operations because they don’t effect net income from continuing operations.
But bear in mind that the actual event of discontinuing a business segment or selling assets may provide information about the future cash flows of the firm

130
Q

give some examples of unusual or infrequent items

A

gains or losses from the sale of assets or part of a business, if these activities are not a firm’s ordinary operations
impairments, write-offs, write-down and restructuring costs

131
Q

where are unusual or infrequent items reported on the income statement?

A

in the income from continuing operations and are reported before tax

132
Q

why should an analyst review the unusual or infrequent items?

A

to determine if they should really be included when forecasting future firm earnings, some companies appear to be accident-prone and have “unusual or infrequent” losses every year or a few years

133
Q

list some examples of accounting changes

A

changes in accounting policies, accounting estimates and prior-period adjustments

134
Q

what type of application do accounting changes require

A

either retrospective application or prospective application

135
Q

what is retrospective application of accounting policies?

A

when any prior-period financial statements presented in a firm’s current financial statements must be restated, applying the new policy to those statements as well as future statements. This enhances the comparability of the financial statements over time

136
Q

what is prospective application of accounting changes

A

prior statements aren’t restated and the new policies are applied only to future financial statements

137
Q

who can sometimes issue a change in accounting policy?

A

standard setting bodies

138
Q

what is an example of a change in accounting policy?

A

eg changing inventory costing method or capitalizing rather than expensing specific purchases

139
Q

unless it’s… changes in accounting policies require retrospective application

A

impractical

140
Q

in the recent change to revenue recognition standards what were firms given the option of?

A

modified retrospective recognition

141
Q

what does modified retrospective recognition mean?

A

this doesn’t require a restatement of prior-period statements but the beginning values of affected accounts are adjusted for the cumulative effects of the change

142
Q

what is a change in accounting estimate usually a result of?

A

management’s change in judgement eg new information indicates a longer/short useful life of the asset than originally expected

143
Q

are changes in accounting estimates applied retrospectively or prospectively?

A

prospectively and don’t require the restatement of prior financial statements

144
Q

what do changes in accounting estimates typically not affect?

A

cash flow, but an analyst needs to review these changes to determine their impact on future operating results

145
Q

what is a correction in an accounting error made in previous financial statements reported as?

A

a prior-period adjustment

146
Q

true or false a prior-period adjustment requires retrospective application?

A

true

147
Q

what is required as part of a prior-period adjustment?

A

restatement of prior-period results, disclosure of the nature of any significant prior-period adjustment and its effect on net income

148
Q

do prior-period adjustments usually effect cash flow?

A

not usually, they normally involve errors or new accounting standards

149
Q

what should analysts look into if there are prior-period adjustments

A

they should review the adjustments carefully because errors may indicate weaknesses in the firm’s internal controls

150
Q

for a nonfinancial firm what might nonoperating transactions results from?

A

investment income and financing expenses

151
Q

are operating and nonoperating transactions reported together in the income statement?

A

no they’re reported separately

152
Q

give an example of investing income for a (nonfinancial) firm

A

receiving dividends and interest from investments in other firms.
the investment income and any gains/losses from the sale of these securities are not part of the firm’s normal business operations

153
Q

what is interest expense for a firm?

A

this is based on the firm’s capital structure, this is independent of the firm’s operations

154
Q

what are investment income and financing expenses usually considered as for a financial firm?

A

operating activities

155
Q

What is one of the most commonly used corporate profitability performance measures for public ally-traded firms?

A

EPS, non-public companies are not required to report EPS data

156
Q

What type of stock is EPS reported for

A

Common stock ie ordinary stock

157
Q

What is a simple K structure?

A

One that contains no potentially dilutive securities. Containing only common stock, non convertible debt and non convertible preferred stock

158
Q

What is a complex K structure

A

One that contains potentially dilutive securities such as options, warrants or convertible securities

159
Q

What kind of EPS must firms with complex K structures report?

A

Basic and dilutive EPS

160
Q

What kind of EPS must firms with simple K structures report?

A

Simple EPS only

161
Q

What does the basic EPS calculation not consider?

A

Effects of any dilutive securities

162
Q

What is the equation for basic EPS?

A

Net income-preferred dividends/weighted average number of common shares outstanding

163
Q

Why is preferred dividends subtracted from net income in the basic EPS calculation?

A

Because EPS refers to the per-share earnings available to common shareholders. Common stock dividends aren’t subtracted, only preferred dividends because they are a part of the net income available to common shareholders

164
Q

What is the weighted average number of common shares

A

The number of shares outstanding during the year weighted by the portion of the year they were outstanding

165
Q

What is a stock dividend?

A

The distribution of additional shares to each shareholder in an amount proportional to their current number of shares. Eg if a 10% stock dividend is paid the holder of 100 shares of stock would receive 10 additional shares

166
Q

What is a stock split?

A

This refers to the division of each “old” share into a specific number of “new” (post-split) shares. The holder of 100 shares will have 200 share after a 2-for-1 split or 150 after a 3-for-2 split

167
Q

Is a shareholder’s proportional ownership in a company changed after a stock dividend or a stock split?

A

No, the shareholder will have more shares but the same % of the total shares outstanding

168
Q

Does the weighted average shares outstanding calculation use days or months?

A

Days outstanding/days in a year but in the exam the monthly approximation method should be fine

169
Q

In the weighted average shares outstanding calculation when are shares issued entered into the calculation?

A

From the date of issuance

170
Q

In the weighted average of shares outstanding calculation re-aquired shares are excluded from the computation when?

A

From the date of reacquisition

171
Q

In the weighted average shares outstanding calculation what do you do with shares sold or issued in a purchase of assets?

A

They’re included from the date of issuance

172
Q

In the weighted average shares outstanding calculation, which shares do you apply a stock split or stock dividend to?

A

All shares outstanding prior to the split/dividend and to the beginning-of-period weighted average shares. A stock split or dividend adjustment isn’t applied to any shares issued or repurchased after the split or dividend date

173
Q

What are dilutive securities?

A

Stock options, warrants, convertible debt or convertible preferred stock that would decrease EPS if exercised or converted into common stock

174
Q

What are anti dilutive securities?

A

Stock options, warrants, convertible debt or convertible preferred stock that would increase EPS is exercised or converted into common stock

175
Q

If convertible preferred stock is dilutive what do you need to do to the numerator for the equation to get from basic to diluted EPS?

A

The convertible preferred dividends must be added to earnings available to common shareholders

176
Q

If convertible bonds are dilutive what must be done to the numerator on the basic EPS calculation?

A

The bonds’ after-tax interest expense isn’t considered an interest expense for diluted EPS.
So interest expense times (1-tax rate) needs to be added back to the numerator (bc interest paid on bonds is usually tax deductible for the firm)

177
Q

What is the denominator for Diluted EPS?

A

The basic EPS denominator (weighted average number of shares) adjusted for the equivalent number of common shares that would be created by the conversion of all the dilutive securities outstanding (convertible bonds, convertible preferred shares, warrants and options) with each one considered separately to determine if it’s dilutive

178
Q

If a dilutive security is issued during the year how do you adjust the weighted average number of shares?

A

It will increase based on the proportion oft he year the dilutive security was outstanding

179
Q

Look at the simpler version of the flash card for diluted EPS equation

A

Tap score

180
Q

Look at the flash card for the complicated fully written out equation for diluted EPS

A

Tap score

181
Q

What must an analyst do if a firm has multiple potentially dilutive securities outstanding?

A

Examine separately to determine if it’s actually dilutive (ie would reduce EPS if converted to common stock)

182
Q

How do you work out the preferred dividend paid by X% $Y par value preferred stock?

A

0.0X$Y eg 7% $5000–>0.07$500

183
Q

What should you do after calculating basic and diluted EPS when there’s preferred stock involved?

A

Check that diluted EPS is less than basic EPS, if yes then the preferred stock is dilutive so must be included in dilutive EPS using a dilutive EPS a calculation, if no then preferred stock is anti dilutive and conversion effects aren’t included in dilutive EPS

184
Q

How to check if convertible preferred stock is dilutive (other than comparing results from basic and dilutive EPS calculations)?

A

Divide the preferred dividends by the number of stocks that would be created if the preferred stock is converted and if this is less than basic EPS then the convertible preferred stock is dilutive

185
Q

When there’s a x% after a bond what is this talking about?

A

Interest rate

186
Q

How to calculate convertible debt interest - is on the numerator of the diluted EPS calculation ?

A

Number of bonds * price per bond * interest rate eg 5% would be 0.05

187
Q

What happens if you calculate basic and diluted EPS when there’s convertible debt and dilutive EPS is more than basic?

A

Then the convertible bonds are antidilutive and shouldn’t be treated as common stock when computing diluted EPS

188
Q

How to calculate if convertible debt is dilutive or not (other than computing basic and dilutive and EPS and comparing them)?

A

Convertible debt interest (1-t)/number of convertible debt shares, if this number is more than basic EPS then convertible debt is antidicultive and the effects of conversion should not be included when calculating diluted EPS

189
Q

When can stock options and warrants be dilutive?

A

When their exercise price is less than the average market price of the stock over the year

190
Q

If options and warrants are dilutive which method should you use to calculate the number of shares in the denominator?

A

The treasury stock method

191
Q

What does the treasury stock method assume?

A

The funds received by the company from the exercise of the options would be used to hypothetically repurchase shares of the company’s common stock in the market at the average market price

192
Q

What is the net increase in the number of shares outstanding when using the treasury stock method?

A

This is the number of shares created by exercising the options less the number of shares hypothetically repurchased with the proceeds of the exercise

193
Q

What’s a quick way to work out the net increase in the common shares from the potential exercise of stock options or warrants when the exercise price is less than the average market price?

A

([Average market price over the year - exercise price]/average market price over the course of the year )*number of common shares or options that the warrants can be converted into

194
Q

What is a vertical common income statement?

A

One that expresses each category of the income statement as a % of revenue

195
Q

The common-size income statement eliminates the effect of size (by standardising the income statement), why is this useful?

A

For comparisons of income statement items over time (time-series analysis) and across firms (cross-sectional analysis)

196
Q

Which part of the income statement shouldn’t be represented as a % of revenue?

A

Income tax expense

197
Q

What is the effective tax rate?

A

Tax expense expressed as a % of pretax income

198
Q

What can margin ratios be used for?

A

Measuring a firm’s profitability quickly

199
Q

Gross profit margin equation

A

GPM=gross profit/revenue, revenue is basically sales i think

200
Q

What 2 ways can you increase gross profit margin?

A

Raising prices or reducing production costs

201
Q

Equation for net profit margin

A

Net profit margin= net income/revenue

202
Q

Equation for pretax margin

A

Pretax accounting profit/revenue = pretax margin

203
Q

Equation for operating profit margin

A

OPM=operating profit/revenue

204
Q

What is retained earnings?

A

This is what results from the fact that after every accounting period the net income off the firm (minus any dividends declared) is added to shareholders’ equity- “through an account known as retained earnings”

205
Q

True or false any transaction that affects the income statement (net income) will also effect shareholders’ equity?

A

True

206
Q

What is comprehensive income?

A

This includes all changes in equity expect for owner contributions and distributions.
Net income plus other comprehensive income (OCI)

207
Q

What does comprehensive income include under US GAAP and IFRS?

A

Transactions that are not included in net income

208
Q

Give 4 examples of other comprehensive income (OCI)

A

Foreign currency transaction gains and losses
Adjustments for minimum pension liability
Unrealised gains and losses from cash flow hedging derivatives
Unrealised gains and losses form available-for-sale securities

209
Q

What do you call gains and losses in the value of securities that a firm owns and has not yet sold?

A

Unrealised gains and losses

210
Q

What are the 3 options for reporting unrealised gains and losses on investment securities?

A

Income statement, other comprehensive income or neither

211
Q

What determines where the firm reports unrealised gains/losses on investment securities?

A

This depends on how the firm has classified the securities

212
Q

Where are dividends or interest received from securities owned by the firm reported?

A

The income statement

213
Q

Under US GAAP how do you classify debt securities that the firm owns but intends to sell?

A

Trading securities

214
Q

Where do you report unrealised gains and losses from trading securities?

A

The income statement

215
Q

How do you classify debtor securities that the firm doesn’t intend to sell prior to maturity?

A

Held to maturity

216
Q

How do you report held to maturity securities?

A

At amortised cost on the balance sheet (not fair value)
So unrealised gains and losses aren’t reported in the income statement or on other comprehensive income

217
Q

How do you classify debt securities that aren’t expected to be held to maturity or sold in the near term?

A

Available-for-sale securities

218
Q

Where do you report unrealised gains and losses from available-for-sale securities?

A

Other comprehensive income

219
Q

How does the IFRS determine where unrealised gains and losses should be reported?

A

Using the same 3 options and classification into them as US GAAP, only they use different names for the 3 different types

220
Q

What do the 3 categories for securities under IFRS reflect?

A

How they’re valued and how unrealised gains and losses are reported in the financial statements

221
Q

What is the IFRS equivalent of trading securities (US GAAP)?

A

Securities measured at fair value through profit and loss

222
Q

What is the IFRS equivalent of held to maturity securities (US GAAP)?

A

Securities measured at amortised cost

223
Q

What is the IFRS equivalent of available-for-sale securities (US GAAP)?

A

Securities measured at fair value through other comprehensive income

224
Q

US GAAP and IFRS have the same 3 available treatments of unrealised gains and losses so specific securities will be treat the same, true or false?

A

False

225
Q

Which differences must an analyst account for when comparing ratios that involve net income eg net profit margin and price to earnings?

A

US GAAP vs IFRS classification of securities

226
Q

How can an analyst examine the impact on specific ratios of the US GAAP and IFRS accounting differences wrt securities classification?

A

Compare the ratios calculated with net income to those calculated using comprehensive income

227
Q

Assuming no fixed costs will an increase in sale quantities increase or decrease gross profit margin?

A

Neither, it wont have an impact on it

228
Q

Will repaying the face amount of a bond issued at par increase or decrease shareholder equity?

A

Neither it wont have an impact on owner’s equity

CFA (3 decks)

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