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FN1 corporate finance > Chapter 3: financial statements > Flashcards

Chapter 3: financial statements Flashcards

1
Q

what is accounting

A

an organized way of summarizing the activities of a business

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2
Q

why do internal and external users of accounting rely on accounting information

A

to make decisions

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3
Q

why do fiancial managers require a strong understanding of accounting

A

they use that information to make significant decisions that will affect the firm

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4
Q

why is it important to report financial performance in a consistent manner between firms

A

it enhances the usefulness of those reports, allowing comparative analysis

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5
Q

what does IFRS stand for

A

international financial reporting standards

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6
Q

what is IFRS

A

a new set of accounting principles

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7
Q

who must use IFRS

A

publicly accountable companies in Canada

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8
Q

does IFRS replace GAAP

A

yes

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9
Q

How can private companies report?

A

they can use IFRS or ASPE

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10
Q

What is ASPE

A

accounting standards for private enterprises

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11
Q

which private companies are more likely to use IFRS

A

larger private companies

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12
Q

Which private companies are more likely to use ASPE

A

small to mid-size companies

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13
Q

has USA adopted IFRS

A

no, they use US GAAP

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14
Q

can any Canadian company use US GAAP

A

public companies who stock is listed on both Canadian and US stock Exchanges can use IFRS or US GAAP

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15
Q

Why was Sarbane-Oxley act (SOX) passed

A

due to scandals involving companies like Enron and worldcom
- was passed in an attempt to restore investor’s confidence by imposing new requirements for financial disclosure and oversight

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16
Q

What are the main provisions of Sarbanes Oxley (2002)

A
  1. A new public company accounting oversight board
    - register and inspect accounting firms
    - establish audit standards
  2. separation of the audit function from other services provided by auditing firms
  3. improved standards for corporate governance
    - separate board committees for finance and audit
    - require external auditors to report to the audit committee
    - require audit committee independence and financial expertise with membership dominated by external directors
  4. new requirement that annual reports indicate the state of a firm’s internal controls and asses their effectiveness
  5. the CEO and CFO must certify that the firm’s financial statements “fairly present in all material respect the operations and financial conditions of the issuer)
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17
Q

what is bookkeeping

A

the mechanical act of managing and recording transactions

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18
Q

what is accounting

A

the application of GAAp and conventions to bookkeeping data to produce financial statements that fairly represent the financial condition and operations of the economic entity

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19
Q

what are the most basic accounting principles

A
  1. the entity concept
  2. going concern principle
  3. A period of analysis
  4. a monetary value
  5. matching principle
  6. Revenue recognition
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20
Q

what is the entity concept

A

accounting is for a specific economic entity

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21
Q

what is the going concern principle

A

statements are prepared on the basis that the entity will continue to operate into the future; therefore liquidation of values are irrelevant

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22
Q

what is a period of analysis

A

usually a fiscal year

- although quarterly and monthly f.s. are also produced

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23
Q

what is monetary value

A

historical costs are usually used because of the objectivity inherent in arms length transactions

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24
Q

what is the matching principle

A

revenue must be matched to expenses in the same period (period they are incurred or earned)

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25
Q

What is revenue recognition

A

revenue is recognized in the period it is earned, even though the cash may not yet have been received

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26
Q

what should financial information have

A
  1. relevance

2. faith representation

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27
Q

what is relevance

A

information is relevant if it could potentially affect a user’s decisions and has a predictive and/or confirmatory power

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28
Q

what is faithful representation

A

the information provided should be free from bias and free form error

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29
Q

to enhance relevance and faithful representation information should have the following characteristics

A
  1. comparability
  2. verifiability
  3. timeliness
  4. understandability
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30
Q

what is comparability

A

consistent comparisons can be made across entities and across time (one year to the next)

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31
Q

what is verifiability

A

information can be verified by an independent knowledgeable party

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32
Q

what is timeliness

A

information is presented in a timely manner

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33
Q

what is understandability

A

the information is clear and concise

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34
Q

what is the balance sheet

A

a snapshot at one point in time

  • usually dated for the last day of the firm’s fiscal year
  • shows what the firm owns (assets) and what it owes (Liabilities)
  • and how those assets were financed (liabilities and onwer’s equity)
  • items are listed vertically in order of liquidity
  • fixed assets like machinery are listed last
35
Q

what is the income statement also called

A

profit and loss statement

36
Q

what is the income statement

A

income earned over a given period of time (usually a monthly, yearly or quarterly)

37
Q

what principle is applied ot income statement

A

matching principle

38
Q

how is the income statement setup

A

revenues is the top line and expenses are listed below
- expenses are often reported separately by type (variable/direct, indirect/fixed, interest, amortization, income taxes ect)

39
Q

GAAP provides flexibility in the accounting treatment of economic events such as

A
  1. when to recognize revenue
  2. when to capitalize an expense (as an asset)
  3. what rate to use for depreciation
40
Q

Managers often face considerable pressure to make the firm’s financial performance appear as good as possible this causes what

A
  • managers may change accounting policies within the limits allowed by GAAp to suit their needs
41
Q

if there is a change in the application of GAAP what must happen

A

it must be disclosed in the audited F.s. and could jeopardize the audit opinion offered by the external auditors if it is not in compliance with GAAP

42
Q

How do companys report income statements to the government

A

they report to CRA and remit income taxes in accordance with the income tax act (ITA)

43
Q

what does cra require business to sue for asset depreciation

A

CCA
capital cost allowance
- specified in the ITA’s regulations

44
Q

firms in Canada tend to produce how many sets of f.s?

A

two
1. for shareholders
and one for CRA according to tax rules

45
Q

what kind of method is CCA for depreciation

A

accelerated method and assets are often replaced more frequently than they are fully depreciated

46
Q

actual income tax liabilities based on the ITA and CCA is usually what

A

less than what is estimated when reporting to shareholders under GAAP

47
Q

What does CCA create

A

a difference in tax liability called deferred taxes which is capitalized on balance sheet when reporting to shareholders

48
Q

what does deferred tax not mean

A

does not mean the firm has an unpaid tax liability

49
Q

deferred tax means

A

??

50
Q

What is the cash flow statement show

A

helps to provide a clearer picture of sources and uses of cash (cash doesn’t lie)
- analysts are very interested in cash flow because it indicates a firm’s solvency

51
Q

What are the two methods to prepare the cash flow statement

A
  1. examine the changes in the balance sheet accounts and reconcile them through the cash account
    (Formula)
  2. add non-cash items to net income
52
Q

the federal and provincial governments in Canada tax individuals and corporations based on what

A

income earned

53
Q

corporations pay income taxes and then use after0tax income for what

A

to distribute dividends to shareholders

54
Q

how are dividends taxed?

A

dividends received by shareholders are taxed again as one form of personal investment income

55
Q

due to double taxation of dividends what happens to corporations

A

they get some partial relief through the dividend gross0up tax credit
- dividends received from non-Canadian companies do not qualify for this special tax treatment

56
Q

how are corporate taxes taxed

A

paid at a flat or fixed ate on taxable income
- small business are defined as those which earn income of $300,00 or less, and usually pay a lower rate of tax (depending on province)

57
Q

what does the income statement show

A

shows the variable costs and period overhead costs can be subtracted to determine earnings before interest and taxes (EBIT)

58
Q

interest expenses on debt borrowed to earn income is what

A

generally deductible form taxable income

59
Q

since CCA affects a firm’s net income and its net cash flow, what must be addressed

A

taxation issues in each financial decision a firm makes and decision makers need to understand CCA

60
Q

what does CCA give rise to

A

tax-shield benefit

61
Q

What is CCA

A

is a non-cash deduction from income that would otherwise be subject to income tax. taxable income is reduced as a result of the deduction and the result is a savings in tax payable

62
Q

what is the calculation for tax shield benefit

A

corporate tax rate x dollar amount of claimed CCA

63
Q

. A firm with a 40% Corporate tax rate and a $2,000 CCA deduction will save how much in taxes

A

$800
- Because of the ½ year rule
o Only one half of the CCA rate can be applied to net acquisitions to an asset class in the year the asset is acquired
o So, the first year CCA is less than the second year’s CCA

64
Q

what are the characteristics of CCA

A
  1. similar assets are grouped into pools or classes
  2. each asset classes CCA rate is specified in the regulations to the ITA and approximates the economic wastage fo the asset
  3. no estimate of useful life or salvage value is necessary
  4. as long as the firm remains a going concern and assets remain in the pool, residual undepreciated capital cost (UCC) values remain in the pool
65
Q

what are the characteristics of accounting depreciation

A
  1. firm choose the method that best represents the economic wastage of the asset
  2. assets are depreciated individually, not in a group
  3. estimates of useful life and salvage values are necessary
66
Q

what is CCA like

A

is like a declining balance method and change each year

  • the largest benefit occurs in the early years of the asset’s life
  • residual values always remain in the pool, even after the asset is disposed
67
Q

when does taxable capital gain occur

A

if the firm sold a depreciable asset for greater than its original cost

68
Q

how is capital gain calculated

A

original cost base - salvage value

69
Q

what is recapture of depreciation

A

if salvage value of the asset exceeds the underpeciated capital cost (UCC) of the asset pool, there is a recapture of deprecation which is subject to tax
- an asset pool is closed when the last physical asset in the pool is sold and not replaced

70
Q

what is terminal loss

A

if there is a positive UCC balance remaining in the pool when it closes, that balance is called a terminal loss and is deductible from taxable income in the year the last asset is disposed of
- terminal losses are non-cash deductions just like CCA

71
Q

In Canada how is personal income tax taxed

A

on their worldwide income

72
Q

what is the personal taxation year

A

the calendar year

73
Q

Canada the tax system is ?

A

progressive in most provinces

- tax rates increase as the amount of a person’s income increases

74
Q

investment income can be earned by investors in one of 3 different forms of which is taxed differently
what are the 3 different forms

A
  1. interest
  2. dividends
  3. capital gains
75
Q

Personal tax - interest income

A

is taxed at the person’s marginal personal tax rate

- which is the same rate at which employment and business income is taxed

76
Q

marginal personal tax rates depend on what

A

the amount of income earned in a progressive tax system

77
Q

the marginal tax rates on interest income are usually

A

higher than those on dividends and capital gains (depending on a person’s circumstances)

78
Q

all sources of interest must be claimed in each calendar year

A

both cash interest payments received and interest that has accrued but not yet been paid (eg Canada savings bonds that have not yet been redeemed)

79
Q

what is the tax treatment for personal tax on dividends

A

receive a special treatment called the grow-up tax credit

80
Q

what is the gross -up tax credit

A

cash dividends form eligible corporations are grossed up by 45% and this total amount is included in taxable income
- federal and provincial tax credits, which vary form province to province are deducted form grossed up amount
federal tax credit: 18.97%
- provincial tax credits vary form a low of 14.55% in alberta to a high of 29.69% in Quebec
- tax credits reduce the marginal tax rate applied to dividend income

81
Q

personal tax - how are capital gains taxed

A

only realized capital gains are taxed which means that unrealized capital gains do not trigger tax until investments are sold

  • investors can therofre defer capital gains taxes until funds are required
  • only 1/2 of the realized capital gain is subject to income tax at the person’s marginal tax rate
  • capital losses can be used to offset taxable gains
  • at higher marginal tax rates, investors prefer to receive investment income in the form of capital gains and dividends because these often taxed at a lower marginal rate than interest income
82
Q

what is traditional cash flow

A

net income plus non-cash expenses, such as depreciation and deferred taxes

83
Q

what is free cash flow

A

the result of subtracting capital expenditures from cash flow form operations

FN1 corporate finance (44 decks)

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