CFA 3_FRA Flashcards
Unearned revenue
Liability. Entity has received cash before it provides goods/services.
Accrued revenue
Asset. Entity provides goods/services before it receives payment (accounts receivable).
Prepaid expenses
Asset. Entity pays cash prior to incurring expense.
Accrued expenses
Liability. Entity has incurred expenses but has not paid cash (accounts payable).
Form DEF-14A
Definitive proxy statement. The form used to file a proxy statement with the SEC.
Form 144
Permits sale of unregistered shares to qualified institutional buyers (QIBs) (Rule 144)
Form S-1
Registration statement filed prior to sale of new securities
Fundamental qualitative characteristics (IFRS)
Relevance, Faithful representation
Characteristics that enhance fundamental qualitative characteristics (IFRS)
Comparability, Verifiability, Timeliness, Understandability (enhance Relevance and Faithful representation)
Long-term Contracts (can reliably estimate outcome)
GAAP and IFRS: Use Percentage-of-completion method.
1) (% of completion) = total cost incurred to date / total expected cost of the project
2) Multiply (% of completion in period) by (total expected contract revenue) to get (gross revenue to recognise)
3) Subtract revenue recognised in prior period from (gross revenue to recognise) to get (revenue to recognise in period).
4) Subtract expenses incurred in period from (revenue to recognise in period) to get net income for period.
Long-term Contracts (cannot reliably estimate outcome)
eg total project costs have significant uncertainty
IFRS: Recognise revenue to extent of contract costs, expense costs as incurred, and only recognise profit on completion.
GAAP: Use completed-contract method. Recognise revenue, expense, and profit only when contract is complete.
IFRS and GAAP: If a loss is expected on contract, recognise immediately.
Installment sales
Collectibility certain: Recognise revenue at time of sale (normal treatment).
Collectibility cannot be reasonably estimated: Use installment method. Profit = (cash collected in period) * (total profit / total sale)
Collectibility highly uncertain: Use cost recovery method. Recognise profit only when cash collected exceeds costs incurred.IFRS: discounted PV of installment payments recognised at sale. Difference between PV and contract amount is amortised as interest. If collectibility is uncertain then use similar to cost recovery method.
Barter transactions
GAAP: Revenue can only be recognised at FV if the firm has historically received cash for such goods/services and can use that to determine FV. Otherwise revenue is carrying value of asset surrendered.
IFRS: Revenue based on FV of revenue from similar nonbarter transactions with unrelated parties.
Double declining balance method
Ignores residual value. See DDB method = (2 / useful life) * (cost - accumulated depreciation)
Bad debt expense; warranty expense recognition
The matching principle requires that entities estimate and recognise bad debt expense as EXPENSE in period of sale for applicable goods/services sold; and warranty expense as LIABILITY in period of sale.
Discontinued operations (presentation)
Presented separately, net of tax, after income from continuing operations. Same treatment for extraordinary items (GAAP).
Basic EPS
basic EPS = (net income - preferred dividends) / (weighted avg number common shares outstanding)
Effect of stock dividend or stock split on weighted shares outstanding (EPS)
Apply to (increase) all shares outstanding prior to split/dividend (not to shares issued or repurchased after).
Diluted EPS
diluted EPS = (net income - preferred dividends) + (convertible preferred dividends) + (convertible debt interest net of tax) / (weighted avg shares) + (shares from conversion of conv. pfd. shares) + (shares from conversion of conv. debt) + (shares issuable from stock options [using treasury stock method])
Determining dilution effect of stock options/warrants (treasury stock method)
Only dilutive if exercise prices are less than average market price of stock. Then increase in denominator is # shares created by exercising options less # shares “repurchased” with proceeds of exercise.
Shortcut: (Avg Mkt Price - Exercise Price / Avg Mkt Price) * # shares can convert into
Determining dilution effect of convertible debt/preferred shares
Dilutive EPS should be larger than basic. Convertible debt interest (net of tax) or preferred dividend / # of shares that’ll be created
Gross/net profit margin
Gross/net profit / Revenue
Accounts receivable (measurement)
Measured at net realizable value, with gross amount reduced by allowance for doubtful accounts (increased by bad debt expense)..
Dividends and interest in CF statement
IFRS: Interest/dividends received either operating or investing. Interest/dividends paid either operating or financing.
GAAP: Dividends paid in financing. Rest in operating.
Relationship between changes in liability/asset account and use of cash
Change in asset: inverse relationship. Increase in asset is use of cash.Change in liability: Direct relationship. Increase in liability is source of cash.
Cash received from asset sold
book value of asset + gain (- loss) on sale
Cash collections from customers
1) Begin with sales; 2) Subtract (add) any increase (decrease) in AR balance from indirect method; 3) Add (subtract) an increase (decrease) in unearned revenue. Cash has been received in unearned revenue but it hasn’t been included in sales,s o must be added in
Cash payments to suppliers
1) Begin with COGS; 2) Add back depreciation included in COGS; 3) Reduce (increase) COGS by any increase (decrease) in AP; 4) Add (subtract) any increase (decrease) in inventory, because it was capitalised but not expensed; 5) Subtract inventory write-offs
Free cash flow to firm (FCFF)
FCFF = NI + Noncash charges + (Interest expense * (1 - tax rate)) - Net Capital Expenditures - Working Capital Investment
Free cash flow to firm (FCFF) (from CFO)
FCFF = CFO + (Interest expense * (1 - tax rate)) - Net capital expenditures
Free cash flow to equity (FCFE)
FCFE = CFO - Net capital expenditures + net borrowing
Debt coverage ratio
CFO / total debt
Interest coverage ratio
CFO + interest paid + taxes paid / interest paid
Reinvestment ratio
CFO / cash paid for LT assets
Debt payment ratio
CFO / cash LT debt repayment
Receivables turnover
sales / avg receivables
Days of sales outstanding
365 / receivables turnover; (receivables turnover = sales / avg receivables)
Inventory turnover
COGS / avg inventory
Days of inventory on hand
365 / inventory turnover; (inventory turnover = COGS / avg inventory)
Payables turnover
purchases / avg trade payables
Number of days of payables
365 / payables turnover (payables turnover = purchases / avg trade payables)
Asset turnover
revenue / avg assets
Fixed asset turnover
revenue / avg net fixed assets
Working capital turnover
revenue / avg working capital
Current ratio
current assets / current liabilities
Quick ratio
cash + marketable securities + receivables / current liabilities
Cash ratio
cash + marketable securities / current liabilities
Defensive interval
cash + marketable securities + receivables / avg daily expenditures
Cash conversion cycle
days sales outstanding + days inventory on hand - number of days payables
Cash conversion cycle (expanded)
(365 / receivables turnover) + (365 / inventory turnover) - (365 / payables turnover)
Debt-to-equity
debt / equity
Debt-to-capital
debt / debt + equity
Financial leverage
avg assets / avg equity
Interest coverage
earnings before interest and taxes (EBIT) / interest payments
Fixed charge coverage
EBIT + lease payments / interest payments + lease payments
Net profit margin
net income / revenue
Gross profit margin
gross profit (net sales - COGS) / revenue
Operating profit margin
operating profit (EBIT) / revenue
Pretax margin
EBT / revenue
Return on assets
net income (+ interest expense*[1-tax rate]) / avg assets
ie
ROA = net income / assets
ROA = (net income / sales) * (sales / assets)
ROE = ROA * (assets / equity)
Operating return on assets
operating income (EBIT) / avg total assets
Return on capital
EBIT / avg capital
Return on equity
net income / avg equity
Return on common equity (simplified)
net income - preferred dividends / avg common equity
Return on equity (simplified)
net income / equity
Return on equity (extended)
(net income / sales [net profit margin]) * (revenue / assets [asset turnover]) * (assets / equity [leverage ratio aka equity multiplier])
Return on equity (DuPont disaggregated)
(net income / EBT) * (EBT / EBIT) * (EBIT / revenue) * (revenue / assets) * (assets / equity); NB first three terms are disaggregated net profit margin
Return on equity (DuPont aggregated)
(tax burden) * (interest burden) * (EBIT margin) * (asset turnover) * (financial leverage, aka equity multiplier)
Sustainable growth rate (how fast firm can grow w/o additional external equity issue)
g = retention rate * ROE
g = (1 - dividend payout ratio) * ROE
Retention rate
net income available to common - dividends declared / net income available to common (= 1 - dividend payout ratio)
Dividend payout ratio
dividends declared / net income available to common
COGS
beginning inventory + purchases - ending inventory
Product costs (costs capitalised in inventory)
Conversion costs (labor and overhead); Other costs necessary to bring inventory to present location and condition
Period costs (costs not capitalised from inventory)
Abnormal waste; storage costs (unless required to produce); administrative overhead; selling costs; interest costs; forex differences
Capitalised interest
Interest that accrues on construction costs is capitalised. Under IFRS, income earned by temporarily investing borrowed funds reduces amt available for capiatlisation, not so for GAAP. Cash outflow from investing activities.
Research and development
GAAP: expensed as incurred
IFRS: research costs are expensed; development costs are capitalised
Software development costs
Capitalised after technical feasibility is established.
GAAP exception: all costs are capitalised if software is developed for own use
Revaluation model (PP&E)
Revaluation to FV below historical cost results in a loss, a subsequent upward revaluation is a gain to extent in reverses previous loss. Any increase above historical cost is reported in equity as revaluation surplus.
Impairment (IFRS)
IFRS: Tested annually. Impairment occurs when carrying value exceeds recoverable amount (greater of FV less selling costs and its value in use [PV of future CFs]). Loss can be reversed, limited to original loss amt.
Impairment (GAAP)
Tested on loss event. 1) Recoverability test: is CV > future undiscounted CFs?; 2) if yes, write down to FV. Loss recoveries not permitted.
Income tax expense
taxes payable + change in DTL - change in DTA
Deferred tax assets
Result from excess of taxes payable (tax return) over income tax expense (IS). ie, a greater amount of deductions on the IS than the tax return. Eventually this will be reversed back to the tax return.
Deferred tax liabilities
Result from an excess of income tax expense (IS) over taxes payable (tax return). ie, a greater amount of deductions on the tax return than the IS. Eventually this will be reversed back.
Tax base of assets
Amount that will be deducted (expensed) on tax return in future.
Tax base of liabilities
Carrying value of liability minus amounts that will be deductible on tax return in future
Bond issuance costs
IFRS: Reduce initial bond liability thereby increasing EIR. In effect are treated as unamortised discount.
GAAP: Capitalised as an asset. Under both issuance costs are netted against proceeds.
Days’ sales in accounts payable
(AP / COGS) * number of days [ie 365]Used to determine if a firm is stretching accounts payable to temporarily increase CFO.
Treatment of gain/loss on disposal of assets when computing CFO
Subtract gains from net income, because sales of assets are CFI. Likewise, add back losses.
Treatment of increase in deferred taxes when computing CFO
Add increase in deferred taxes to net income.
Treatment of increase in income tax payable when computing CFO
Add increase in income taxes payable to net income.
Treatment of unusual or infrequent items and extraordinary items (US GAAP)
Unusual or infrequent: included in income from continuing operations and reported before tax
Extraordinary: reported separately net of tax, after income from continuing operations
How does an increase in minimum pension liability affect comprehensive income?
It is treated as an expense that goes through OCI.
Interest expense in any given year on bond
Calculated by multiplying the market interest rate (at time of issuance) by the bond carrying value.The amount of interest that is “too high” or “too low” is applied to the carrying value of the bond.
Total interest expense on bond
Equal to the amount paid by the issuer less the amount received from the bondholder.
Tax rate that can be used to determine DTAs and DTLs (US GAAP vs IFRS)
US GAAP: Enacted tax rates
IFRS: Enacted or substantially enacted tax rates
Presentation of deferred taxes on BS (US GAAP vs IFRS)
US GAAP: classified current or noncurrent based on underlying liability
IFRS: netted and classified as noncurrent
Deferred tax asset recognition (US GAAP vs IFRS)
GAAP: Recognised in full. Reduced by valuation allowance if “more likely than not” some or all of asset will not be realised.I
FRS: Recognised if “probable” that sufficient taxable profit will be available.
Deferred taxes for undistributed profit from an investment in an associate firm (US GAAP vs IFRS)
GAAP: Deferred taxes recognised from temporary differences.
IFRS: Deferred taxes recognised unless investor is able to control sharing of profit, and is probable temporary difference will not reverse in future.
Deferred taxes for undistributed profit from an investment in a JV (US GAAP vs IFRS)
GAAP: No deferred taxes for foreign corporate JVs that meet indefinite reversal criterion
IFRS: Deferred taxes are recognised unless venturer is able to control sharing of profit and is probable temporary difference will not reverse in the future.
Deferred taxes for undistributed profit from an investment in a subsidiary (US GAAP vs IFRS)
GAAP: No deferred taxes for foreign subsidiaries that meet indefinite reversal criterion, and none for domestic subsidiaries if the amounts are tax free.
IFRS: Deferred taxes recognised unless parent is able to control the distribution of profit and it’s probable the temporary difference will not reverse in the future.
Deferred taxes for revaluation of fixed assets and intangible assets (US GAAP vs IFRS)
GAAP: N/A, revaluation not allowed
IFRS: Deferred taxes recognised in equity
Weighted average cost of inventory
Total $ cost of inventory purchased / Total number of units purchased = Avg cost per unit of inventory
(Beginning inventory + purchases) / Number of units in beginning and purchased inventory
Effect of warranty expense being overestimated or not deductible on tax return
DTA will result, because it will be deducted on FS but not deducted on tax return. Therefore taxes payable will be greater than income tax expense. Delayed recognition of this expense in tax return results in DTA.
CF effects of financing lease payments
Lessee: interest portion is CFO outflow. Principal portion is CFF outflow.
Lessor: interest portion is CFO inflow. Principal portion is CFI inflow.*For an operating lease, all reported as CFO.
Effective tax rate
income tax expense / pretax income
Inventory, cost of sales, and gross profit can be different under periodic and perpetual inventory systems if a firm uses which inventory cost method
LIFO or weighted average cost, but not FIFO.
When using the FIFO inventory method the ending inventory, the cost of goods sold and the gross margin, are the same under either the perpetual or periodic methods. The use of a perpetual or periodic system makes a difference under weighted average, and LIFO.
Adjusting for inventory cost flow differences in financial analysis
Add LIFO reserve to both assets and equity of the FIFO entity.
FIFO ending inventory = LIFO ending inventory + LIFO reservefurthermoreFIFO after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 − t)
Price-to-book (P/B)
P/B = market price per share / book value per share
Book Value per Share = Common Equity / Common Shares Outstanding*Commonly shown as Stock price / Tangible assets - Liabilities; but that is not for our purpose
Adjusting for lease differences in financial analysis
Add the PV of an operating liability to adjust. This is added to assets and liabilities, not equity.
Fraud triangle
incentive/pressure, opportunity, and attitude/rationalization
Adjustments for repurchasing stock to offset dilution
Net cash outflow for share repurchases to avoid dilution should be reclassified from CFF to CFO.
How does an increase in non-cash working capital affect the calculation of actual cash flow?
It is subtracted from net income
Framework elements related to performance
IASB: income and expenses
FASB: revenues, expenses, gains, losses, and comprehensive income
Investment property
For investment properties, when using the fair value model of revaluing assets, all increases and decreases affect net income.
