CFAI 4- Financial Reporting and Analysis Flashcards
The ability to meet short-term obligations is generally referred to as …..,
and the ability to meet long-term obligations is generally referred to as ……..
The ability to meet short-term obligations is generally referred to as liquidity, and the ability to meet long-term obligations is generally referred to as solvency. Cash flow in any given period is not, however, a complete measure of performance for that period because, as shown in Example 1, a company may be obligated to make future cash payments as a result of a transaction that generates positive cash flow in the current period.
basic and diluted earnings per share on the face of the income statement.
Basic earnings per share is calculated using the weighted-average number of common (ordinary) shares that were actually outstanding during the period and the profit or loss attributable to the common shareowners.
Diluted earnings per share uses diluted shares—the number of shares that would hypothetically be outstanding if potentially dilutive claims on common shares (e.g., stock options or convertible bonds) were exercised or converted by their holders—and an appropriately adjusted profit or loss attributable to the common shareowners.
Financial Reporting Documents
Balance Sheet,
Statement of Comprehensive Income
(Income Statment; Other Compreensive Income)
The statement of changes in equity, variously called the “statement of changes in owners’ equity” or “statement of changes in shareholders’ equity,” primarily serves to report changes in the owners’ investment in the business over time.
Cash Flow Statment
Financial flexibility
is the ability of the company to react and adapt to financial adversities and opportunities.
Porque é que as Financial Notes são importantes?
IMPORTANTE PARA EXAME E VIDA BROW!
Porque nos dão uma ideia de como são calculados os financial statments. Para compararmos duas empresas os financial statments devem ter seguido as mesmas normas.
Overall, flexibility in accounting choices is necessary because, ideally, a company will select those policies, methods, and estimates that are allowable and most relevant and that fairly reflect the unique economic environment of the company’s business and industry. Flexibility can, however, create challenges for the analyst because the use of different policies, methods, and estimates reduces comparability across different companies’ financial statements. Comparability occurs when different companies’ information is measured and reported in a similar manner over time. Comparability helps the analyst identify and analyze the real economic differences across companies, rather than differences that arise solely from different accounting choices. Because comparability of financial statements is a critical requirement for objective financial analysis, an analyst should be aware of the potential for differences in accounting choices even when comparing two companies that use the same set of accounting standards.
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MD&A como é que pode auxiliar um analista na hora de investir?
The management commentary or MD&A is a good starting place for understanding information in the financial statements. In particular, the forward-looking disclosures in an MD&A, such as those about planned capital expenditures, new store openings, or divestitures, can be useful in projecting a company’s future performance. However, the commentary is only one input for the analyst seeking an objective and independent perspective on a company’s performance and prospects.
Under international standards for auditing (ISAs), the objectives of an auditor in conducting an audit of financial statements are
- To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
- To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.8
Quando são feitas auditorias às empresas a empresa que faz a auditoria emite uma opinião relativa ao conteúdo nos financial statment.
Os financial statment são classificados segundo 3 categorias….
An unqualified audit opinion states that the financial statements give a “true and fair view” (international) or are “fairly presented” (international and US) in accordance with applicable accounting standards. This is often referred to as a “clean” opinion and is the one that analysts would like to see in a financial report. There are several other types of opinions.
A qualified audit opinion is one in which there is some scope limitation or exception to accounting standards. Exceptions are described in the audit report with additional explanatory paragraphs so that the analyst can determine the importance of the exception.
An adverse audit opinion is issued when an auditor determines that the financial statements materially depart from accounting standards and are not fairly presented. An adverse opinion makes analysis of the financial statements easy: Do not bother analyzing these statements, because the company’s financial statements cannot be relied on.
“contra account.”
The estimated uncollectible amount is recorded in an account called allowance for bad debts. Because the effect of the allowance for bad debts account is to reduce the balance of the company’s accounts receivable, it is known as a “contra asset account.”
Any account that is offset or deducted from another account is called a “contra account.”
Endingretainedearnings
Endingretainedearnings
Assets
Equation (4a)
Endingretainedearnings=Beginningretainedearnings+ Netincome−Dividends
Or, substituting Equation 3 for Net income, equivalently:
Equation (4b)
Endingretainedearnings=Beginningretainedearnings+Revenues− Expenses−Dividends
This becomes the expanded accounting equation:
Equation (5a)
Assets = Liabilities + Contributed capital + Ending retained earnings
Or equivalently, substituting Equation 4b into Equation 5a, we can write:
Equation (5b)
Assets=Liabilities+Contributedcapital+Beginningretainedearnings+ Revenue−Expenses−Dividends
Accrual accounting
Accrual accounting requires that revenue be recorded when earned and that expenses be recorded when incurred, irrespective of when the related cash movements occur. The purpose of accrual entries is to report revenue and expense in the proper accounting period.
Accounting system:
Journal
Ledger
Trial Balance
Financial Statments
A journal is a document or computer file in which business transactions are recorded in the order in which they occur (chronological order). The general journal is the collection of all business transactions in an accounting system sorted by date. All accounting systems have a general journal to record all transactions. Some accounting systems also include special journals. For example, there may be one journal for recording sales transactions and another for recording inventory purchases.
A ledger is a document or computer file that shows all business transactions by account. Note that the general ledger, the core of every accounting system, contains all of the same entries as that posted to the general journal—the only difference is that the data are sorted by date in a journal and by account in the ledger. The general ledger is useful for reviewing all of the activity related to a single account. T-accounts, explained in Appendix 23, are representations of ledger accounts and are frequently used to describe or analyze accounting transactions.
A trial balance is a document that lists account balances at a particular point in time. Trial balances are typically prepared at the end of an accounting period as a first step in producing financial statements. A key difference between a trial balance and a ledger is that the trial balance shows only total ending balances. An initial trial balance assists in the identification of any adjusting entries that may be required. Once these adjusting entries are made, an adjusted trial balance can be prepared.
The financial statements, a final product of the accounting system, are prepared based on the account totals from an adjusted trial balance.
When, at the end of an accounting period, cash has not been paid with respect to an expense that has been incurred, the business should then record:
A.an accrued expense, an asset.
B.a prepaid expense, an asset.
C.an accrued expense, a liability.
- B is correct. Payment of expenses in advance is called a prepaid expense which is classified as an asset.
- C is correct. When an expense is incurred and no cash has been paid, expenses are increased and a liability (“accrued expense”) is established for the same amount.
When, at the end of an accounting period, cash has been paid with respect to an expense, the business should then record:
A.an accrued expense, an asset.
B.a prepaid expense, an asset.
C.an accrued expense, a liability.
•C is correct. When an expense is incurred and no cash has been paid, expenses are increased and a liability (“accrued expense”) is established for the same amount.
Long Term Contracts can be divided in accounting by
Under the percentage-of-completion method, in each accounting period, the company estimates what percentage of the contract is complete and then reports that percentage of the total
p.e: 50% of the cost on the first year means 50% of the revenue
Under the completed contract method, the company does not report any income until the contract is substantially finished (the remaining costs and potential risks are insignificant in amount), although provision should be made for expected losses. Billings and costs are accumulated on the balance sheet rather than flowing through the income statement.
UNDER IFRS and GAAP
Year 1. Under IFRS, Kolenda would recognize $3 million cost of construction, $3 million revenue, and thus $0 income. Under US GAAP, Kolenda would recognize $0 cost of construction, $0 revenue, and thus $0 income. The $3 million expenditure would be reported as an increase in the inventory account “construction in progress” and a decrease in cash.
Year 2. Under IFRS, Kolenda would recognize $2.4 million cost of construction, $2.4 million revenue, and thus $0 income. Under US GAAP, Kolenda would recognize $0 cost of construction, $0 revenue, and thus $0 income. The $2.4 million expenditures would be reported as an increase in the inventory account “construction in progress” and a decrease in cash.
Year 3. Under IFRS, Kolenda would recognize the $0.6 million cost of construction incurred in the period. Because the contract has been completed and the outcome is now measurable, the company would recognize the remaining $4.6 million revenue on the contract, and thus $4 million income. Under US GAAP, because the contract has been completed, Kolenda would recognize the total contract revenue (i.e., $10 million). Kolenda would recognize $6 million cost of construction and thus $4 million income. The inventory account “construction in progress” would be eliminated.
Installment Sales
sales in which proceeds are to be paid in installments over an extended period. For installment sales, IFRS separate the installments into the sale price, which is the discounted present value of the installment payments, and an interest component. Revenue attributable to the sale price is recognized at the date of sale, and revenue attributable to the interest component is recognized over time.
Under US GAAP, when the seller has completed the significant activities in the earnings process and is either assured of collecting the selling price or able to estimate amounts that will not be collected, a sale of real estate is reported at the time of sale using the normal revenue recognition conditions.22 When those two conditions are not fully met, under US GAAP some of the profit is deferred. Two of the methods may be appropriate in these limited circumstances and relate to the amount of profit to be recognized each year from the transaction: the installment method and the cost recovery method. Under the installment method, the portion of the total profit of the sale that is recognized in each period is determined by the percentage of the total sales price for which the seller has received cash. Under the cost recovery method, the seller does not report any profit until the cash amounts paid by the buyer—including principal and interest on any financing from the seller—are greater than all the seller’s costs of the property. Note that the cost recovery method is similar to the revenue recognition method under international standards, described above, when the outcome of a contract cannot be measured reliably (although the term cost recovery method is not used in the international standard).
Expense Recognition
2 methods
Matching principle- as despesas que se podem relacionar diretamente com as vendas são declaradas no mesmo período que os revenue. p.e. Cost of goods
Period Costs- as despesas que não se podem relacionar diretamente com as vendas feitas são declaradas no período em que incorrem. (p.e. admistrative expenses)
Under US GAAP what can u consider an operating activitie?
Under US GAAP, operating activities generally involve producing and delivering goods and providing services and include all transactions and other events that are not defined as investing or financing activities
Specifically, under IFRS, interest and dividends received can be shown either as operating or as investing on the statement of cash flows, while under US GAAP interest and dividends received are shown as operating cash flows. Under IFRS, interest and dividends paid can be shown either as operating or as financing on the statement of cash flows, while under US GAAP, interest paid is shown as operating and dividends paid are shown as financing.)
Complex capital structure vs simple capital structure?
When a company has issued any financial instruments that are potentially convertible into common stock, it is said to have a complex capital structure. Examples of financial instruments that are potentially convertible into common stock include convertible bonds, convertible preferred stock, employee stock options, and warrants.48 If a company’s capital structure does not include such potentially convertible financial instruments, it is said to have a simple capital structure.
Diluted EPS vs Basic EPS
The distinction between simple versus complex capital structure is relevant to the calculation of EPS because financial instruments that are potentially convertible into common stock could, as a result of conversion or exercise, potentially dilute (i.e., decrease) EPS. Information about such a potential dilution is valuable to a company’s current and potential shareholders; therefore, accounting standards require companies to disclose what their EPS would be if all dilutive financial instruments were converted into common stock. The EPS that would result if all dilutive financial instruments were converted is called diluted EPS. In contrast, basic EPS is calculated using the reported earnings available to common shareholders of the parent company and the weighted average number of shares outstanding.
BasicEPS=
Netincome−PreferreddividendsWeightedaveragenumberofsharesoutstanding
The weighted average number of shares outstanding is a time weighting of common shares outstanding. For example, assume a company began the year with 2,000,000 common shares outstanding and repurchased 100,000 common shares on 1 July. The weighted average number of common shares outstanding would be the sum of 2,000,000 shares × 1/2 year + 1,900,000 shares × 1/2 year, or 1,950,000 shares. So the company would use 1,950,000 shares as the weighted average number of shares in calculating its basic EPS.
It is possible that some potentially convertible securities could be antidilutive
what is that?
By antidilutive means that basic EPS could be lower than diluted EPS.
Analysis of the income statment methods
Common Size analysis:
Neste método de análise colocamos os income statment lado a lado e calculamos os rácios para apreender de onde poderão vir as discrepâncias. Mais usado para comparar empresas do mesmo sector.
Income Statment ratios:
Profit Margin : net income/revenue,
gross profit margin….
Comparar indicadores e o porque dos indicadores subirem de ano para ano ou descerem.. mais profit? menos revenue? sustentável? etc…
Standard Setting Bodies Vs Regulatory Authorities
Standard Setting Bodies definem as regras que as regulatory authorities por sua vez vão legislar.
Objectives of securities Regulation
Protecting Investors
Ensuring that markets are fair, efficient and transparent
Reducing systemic risk