Chapter 2 Financial Statements, Cash Flow, and Taxes Flashcards
What is a statement of financial position?
Also referred to as the balance sheet.
It is a snapshot of the organization’s financials on a particular date. Specifically of its accounting value
What year did Canadian public traded firms switch to new reporting standards?
In 2011 they switched to international financial reporting standards (IFRS).
What does GAAP stand for?
General accepted accounting principles
What are the two categories of assets?
Current or fixed
Current assets have a life of less than one year (cash, inventory, accounts receivable)
Fixed assets are long term assets
What do bonds and bondholders generally refer to?
Long term debt and long term creditors
What is the accounting equation?
Assets = Liabilities + Shareholders’ equity
What is Net Working Capital?
The difference between a firm’s current assets and its current liabilities
How are assets listed on a sheet?
In order of the length of time it takes for them to convert to cash in the normal course of business
How are liabilities listed on a sheet?
In the order in which they would normally be paid
What are particularly important things to keep in mind when examining a statement of financial position?
Liquidity, Book to Market value comparison, Debt versus equity
What is liquidity?
The ease and efficacy of converting an asset to cash whilst retaining the highest possible value exchange for that asset
What is the use of debt in an organization’s financial structuring called?
Financial leverage
What are the pros and cons of financial leveraging?
Financial leveraging can help a company utilize a greater amount of cash to effectively grow the company whilst opening it up to the risk of being stuck with payments and loss if the company is not successful in its mission.
When a company adopts the revaluation method, when should all of its assets be revalued?
All items in a class of assets should be revalued simultaneously
Revaluation should be performed with enough regularity that at the statement of financial position date, the carrying amount is not too different than the fair value amount
How often should assets with unpredictable fair value changes be revalued?
Every one or two years
What is a customary accounting practice when market values are below book values?
Write down assets, write-downs are also indicative of overstated profits in previous years, as assets were not expensed properly.
What does it mean when the IFRS (International Financial Reporting Standards) permits reversals of impairment losses?
Impairment losses are the amount by which the carrying value of an asset or cash-generating unit exceeds its recoverable amount
What is the accounting value of a firm?
The firm’s value when looking at their financial statement of position
What is the statement of comprehensive income?
The statement of comprehensive income summarizes a company’s performance over a certain period.
Formally called an income statement
What is the market value of a firm?
The firm’s value in reference to what the market is willing to pay for it
What are the options under the IFRS for a company in terms of presenting a statement of comprehensive income?
Two options:
- A single comprehensive statement
- Or two statements with one representing the company’s revenues and expenses
The other presents unrealized gains and losses
Give me a simple process of how you would look at a statement of comprehensive income
- First look at revenue and subtract the costs of producing that revenue, COGS to get Gross Profit
- Subtract any other expenses required to earn that revenue
To get earnings before tax, interest, depreciation - Take into account depreciation and amortization to get operating income
- After that we pay interest and taxes which leaves us with our Net Profit
- After paying out shareholder dividends we get Net Income
How is net income often expressed?
On a per-share basis, called earnings per share (EPS).
What is the primary reason that accounting income differs from cash flow in the comprehensive income statement?
A comprehensive income statement contains non-cash items. The most important one being depreciation
Why is the depreciation deduction an application of the representational faithfulness principle in accounting?
The revenues associated with an asset would generally occur over some length of time. So the accountant seeks to expense the purchase of the asset with the benefits produced from owning it as a way of representing the use of the asset over time
How do accountants tend to classify costs?
As product costs or period costs
What is the net income equation?
Essentially all the components that are subtracted from sales revenue to come to net income
Give me two reasons why accounting income is not the same as cash flow
When an asset is bought the cash flow out is immediate however the realization of that asset is stretched out.
There can be other sources of income that are not related to cash
What is the cash flow from assets equation?
Cash flow from assets = Cash flow to bondholders + Cash flow to shareholders
What are the three components that make up cash flow from assets
Cash flow, capital spending, additions to net working capital
Give me the operating cash flow equation
Operating Cash Flow = EBIT + Depreciation - Taxes
Give me the Net Capital Spending Equation
Net Capital Spending = Ending capital assets - beginning capital assets + depreciation
Depreciation is added back to get a realistic amount that was invested into capital
Give me the Changes in Working Capital equation
Changes in Working Capital = NWC - OWC
What else can we call cash flow from assets?
Free cash flow - since its fee to distribute to creditors and shareholders
Give me the cash flow to / from creditors equation
Net borrowing - Interest paid = Cash flow to/from creditors
Essentially we see what money was borrowed and brought into the organization and any cash that left as a result of paying interest
Give me the cash flow to shareholders equation
Cash flow to shareholders = Dividends paid - Net new equity
Dividends paid go to shareholders etc.
What are the two equations for Cash flow from assets?
Cash flow from assets = Operating cash flow - Net Capital Spending - Changes in working capital
Cash flow from assets = Cash flow to creditors + cash flow to shareholders
Are cash flows measured before or after taxes?
After taxes
What are the three ideal features of a ideal tax system in economic theory
- Distribute the tax burden equitably
- Should not change the efficient allocation of resources by markets
- The system should be easy to administer
What is the average tax rate?
The amount of tax paid divided by your taxable income
What is the marginal tax rate?
The tax you would pay on the next dollar earned
What is the dividend tax credit?
The tax formula that reduces the effective tax rate on dividends
What is loss carry-back?
Carrying present losses into past years to receive a refund of prior years’ taxes. In Canada, the limit is up to 3 years
What is loss carry-forward?
Carrying past losses into the future indefinitely
What is Capital Cost Allowance (CCA)?
Depreciation for tax purposes in Canada
When is CCA deducted?
When determining income
Is CCA the same as depreciation under IFRS the same?
No, they can use different rates
Such as Accelerated rules for CCA and straight-line depreciation for IFRS reporting.
What systems for depreciation are used in Canada and the USA
Capital Cost Allowance (CCA) in Canada
Accelerated Cost Recovery System (ACRS) in USA
Is the life of an asset considered in CCA calculations?
No
What is the CRA’s Accelerated Investment Incentive?
The Accelerated Investment Incentive allows us to figure CCA at one and a half times the prescribed rate in the first year only
What does UCC stand for?
Undepreciated Capital Cost
What is the net acquisitions rule?
From the total installed cost of all acquisitions, we subtract the adjusted cost of disposal of all assets in the pool
What does a positive UCC lead to if the adjusted cost of disposal is smaller?
The firm has a terminal loss equal to the remaining UCC. This loss is deductible from income for the year
