Chapter Four Flashcards
statement of operations/statement of earning
income statment
reports a co’s profit during a particular reporting period
comprehensive income
includes a few types of gains/losses excluded from income statement
statement of cash flows
provides info about cash receipts and cash payments
FULL Income statement example
Income from Continuing Operations:
Sales Revenue
COGS
Gross Profit
Operating Expenses:
Selling Expenses
General and Admin Expenses
Research and Development expense
restructuring costs
total operating expenses
Operating income
Other Income:
interest revenue
interest expense
gain/loss on sale of investments
income from continuing operations before income taxes
income tax expense
Income from Continuing Operations
Discontinued Operations:
Loss from operations of discontinued component
income tax benefit
Loss on discontinued operations
Net Income
Earnings Per Share - Basic:
Income from continuing operations
discontinued operations
Net Income
Earnings per common share - diluted:
Income from continuing operations
Discontinued operations
Net Income
Income from continuing operations
reports the revenues, expenses, gains and losses that have occured during reporting period
is it possible to establish a causal relationship between rev and exps?
Expenses: YES: because reported in the same period that related revenue is recognized
Example: if sell toy today, money you pay to make that toy (COGS) is part of what helped earn you money (rev)
Revenues: NO: because expense to a particular period, allocate it over several periods, or expense it as incurred
Example: spread out or happen at different times
How do gains and losses arise
when a co sells investments or PP&E for amount that differs from recorded amount
Income from continuing operations consists of what three parts
operating items
non operating items
income tax
operating items
Sales rev
COGS
GP
Operating expenses:
Selling
G&A
R&D
Restructuring costs
Total Operating expenses
Operating income
nonoperating items
Other income:
interest income
interest expense
gain on sale of investment
income from continuing operations before income taxes
income taxes
income tax expenses
income from continuing operations
What is the major difference between single and multiple step income statement
multiple step separately classifies income statment items by operating and nonoperating
GP
reports series of intermediate subtotals:
example: operating income, income before tax expenses, etc.
income statement single step
Revenues and gains:
SR
Interest Revenue
Gain on sale of investments
Total Rev/gains
Expenses and losses:
COGS
Selling exp
G&A exp
R&D exp
Interest exp
total expenses and losses
income before taxes
income tax expenses
net income
income smoothing
within rules allowed by GAAP
smoother patterns in earnings over time by altering assumptions and estimates
overestimating expenses in current year to reduce net income
reversing those estimates in future years to increase net income
classification shifting
shifting operations and expenses to a non operating expenses classification to report fewer operating expenses and higher operating income
what are restructuring costs
money you spend to make big changes in how your business works hoping it will help you in the long run (one time expenses to improve long term)
include costs associated with management’s plans to materially change the scope of business operations
recognized in the period the exit or disposal cost obligation actually is incurred
examples of restructuring costs:
termination benefits payable to employee to be terminated:
to be accrued in periods the employees render their service
costs associated with closing facilities:
recognized when s/g associated with those activities received
operating income and earnings quality
restructuring costs
long lived asset impairments
revenue issues affecting earnings quality
long lived asset impairments
tangible or intangible
asset balance reduced if there has been significant impairment of value
BS (BV value) > market or fair value wil lead to loss on impairment
revenue issues affecting earnings quality
company loses major customer that cannot be replaced
misstatement of revenue
premature revenue recognition
non-operating income and earnings quality
basically what is non operating income
some items in an IS relate only tangentially to normal operations
ex:
interest income or interest expenses
gains/losses on sales of investments
this is nonoperating items
what is earnings quality
is a company’s profits reliable and sustainable - not fraudulent
ability of current earnings to predict future earnings
what are non-GAAP Earnings
companies required to report earnings, revs, exps based on GAAP
NON GAAP EARNINGS exclude certain revs and exps
what are examples of non GAAP earnings
restructuring costs, acquisition costs, write-downs of impaired assets, stock based compensation
why are non GAAP earnings controversial
since expense exclude are at the discretion of management
Sarbanes Oxley Act requires reconciliation between non GAAP earnings and earnings determined according to GAAP
discontinued operations
when co decides to sell a component of their business –> these profits from the discontinued operations will not continue
discontinued operations are reported when:
- a component of an entity or group of components have ben sold/disposed - considered held for sale
- disposal represents a strategic shift, that has, will have, a major effect on a co’s operations and financial results
where is Discontinued operations reported?
separately (below income from continuing operations)
example:
income from continuing operations before income tax
income tax expense
income from continuing operations
income from discontinued operations, $200 net of $50 tax expense
net income
reporting discontinued operations - when the component is held for sale
when discontinued component has NOT been sold when the reporting period ends –> income effects are reported but modified
how is discontinued operations reported but modified when the component has not been sold when the reporting period ends
1) income or loss from operations of the component from the beginning of the reporting period to the end of reporting period
+
2) an impairment loss if the fair value of assets of component (minus cost to sell) is less than the book value
reference examples in snapshots
accounting changes
change in:
accounting principle
estimate
reporting entity
correction of error - same as acct changes
change in accounting principle
change from one acceptable accounting method to another
mandated changes
voluntary changes
mandated changes in accounting principles
retrospective approach - applied to all periods in financial statemetns
modified retrospective approach - adjustment to beginning balance of RE in adoption period
prospective approach - change implemented in current and all future periods
voluntary changes in accounting principles
accounted for retrospectively
ex: change in inventory costing method
change in accounting estimate
changes due to modificaiton of estimate as new information comes to light
how are changes in accounting estimates accounted for?
prospectively
disclosure note will describe change and effect on Income and EPS
examples: future bad debts,
depreciation useful life to residual value, future warranty expenses
changes in depreciation, amortization or depletion method are considered _______
____to be a change in acct estimate achieved by change in acct principle
accounted for prospectively
(same as acct estimate)
correction of accounting errors
caused by transaction being recorded incorrectly or not recorded at all
errors discovered in the same year
erroneous JE is reverses and appropriate JE is recorded
errors discovered in subsequent years
prior period adjustment recorded (if matieral)
earning per share
ratio that indicated the amount of income earned by a company expressed on a per share basis
Basic EPS - reported on the face
Diluted EPS - of the income statement
Basic EPS = [net income - preferred stock divdends]/weighted average number of common shares outstanding
diluted EPS
incoprorates the dilutive effect of all potential commons shares in the calculation
so a reduction in EPS occurs as number of CS outstanding increases
AOCI
accumulated other comprehensive income
an additonal component of Shareholders equity
consistent with how accumulated net income is reported on the BS as retained earnings
beg: AOCI
Add: OCI
Add: OCI
End: AOCI
earnings management
manger exercises judgement on FS/Reports to deceive investors
this is why investors hire auditors
income smoothing manipulation
earnings management three parts
1) real earnings management (manipulate acct choices)
- adv exp
- R&D
2) accrued basis management (by accrual method) - estimates of future incomes/expenses
3) classification shifting
- will take op exp to non op exp
- or vice versa
- misleads stakeholders about econ performance of fimr and earnings management
if company files bankruptcy
violates going concern
voluntary changes in ACTG principles accounted retrospectively can create a
comparability issue
why you have to go back and adjust
examples of OCI
part of comprehensive income
foreign exchange currencies
unrealized profit/loss on AFS
pension statement
statement of cash flows
required for each period when BS and IS are presented
provides info about cash receipts and cash disbursements of an enterprise
NOTE: cash is cash plus cash equivalents and restricted cash
what does the cash flow statement help with
helpful in assessing future profitability, liquidity, and long term solvency
operating activities
inflows and outflows of cash that result from activities reported in the income statement
examples of cash inflows for OA
sales of g/s
interest and dividends from investments
examples of cash outflows from OA
purchase of inv
salaries, wages, and other operating expenses
interest on debt
income taxes
direct method
cash effect of each OA is reported directly in statement
indirect method
net cash flow is derived indirectly by starting with reported NI and working backwards to convert that amount to a cash basis
direct method example presentation
cash flows from operating activities:
cash received from customers
cash paid for gen and admin expenses
cash paid for income taxes
net cash provided (used) by OA
example of cash flows OA indirect method
net income
adjustment for noncash effects:
depreciation expense, gain/loss on sale of PA
impairment
changes in operating assets and liabilities:
increase in AR
decrease in prepaid insurance
increase in accrued liabilities
decrease in income taxes payable
net cash flow from OA
investing activities
inflows and outflows of cash related to:
long lived assets used in operations of the business
investment assets
examples of cash outflows from investing activities
purchase of long lived assets used in the business
purchase of investment securities like stocks and bonds of other entities
loans to other entities (non trade receivables)
examples of cash inflows from investing activities
sale of long lived assets used in business
sale of investment securities
collection of nontrade receivable (excluding the collection of interest, which is an OA)
financing activities
inflows and outflows of cash related to external financing of the company with:
owners
creditors
examples of cash inflows from financing activities
from owners when shares are sold to them (issuing CS)
from creditors when cash is borrowed through notes, loans, mortgages, and bonds
examples of cash outflows in financing activities
to owners in the form of dividends or other distributions
to owners for the reacquisition of shares previously sold (TS)
to creditors as repayment of the principal amounts of debt (excluding trade payables that realte to OA) - paying off
NOTE: issuing is a INFLOW
noncash investing and financing activities
acquisition of equipment by issuing long term NP or equity securities to seller of equipment
profitability analysis
how well company manages/uses assets (NOTE: the other half is related to an adequare return)
higher ratio, fewer assets are required to maintain a given level of activity
asset turnover ratio
receivables turnover ratio
inventory turnover ratio
asset turnover ratio
[net sales]/[avg total assets]
good = above 1 for asset efficiency
how efficiently assets used to generate rev
receivables turnover ratio
[net sales]/[average AR (net)]
the higher the ratio, the shorter the avg time between sales and cash collection
number of times AR is paid
inventory turnover ratio
[COGS/avg inv]
number of times the avg inv balance is sold during a specific period
activity ratios
average collection period
average days inventory
average collection period
approx of number of days the avg AR balance is outstanding
higher is lower collection period so not good - want it to be lower (better)
[365]/[receivables turnover ratio]
average days in inventory
avg days of inv measures the number of days it typically takes to sell inv
indicates how quickly inv is sold
[365]/[inv turnover ratio]
which profitability ratios deal with measuring a company’s ability to earn an adequate return relative to sales or resources devoted to operations
profit margin on sales
return on assets
return on equity
profit margin on sales
[net income/net sales]
indicates the portion of each dollar of revenue that is available after all expenses have been covered; offers measure of the company’s ability to withstand either higher expenses or lower revenues
return on assets
[net income]/[avg total assets]
profitability of companies assets/how well use to generate INCOME/profit (asset turnover ratio measure how efficiently the co utilizes its asset to generate revenue/sales)
return on equity
[net income]/[avg S/E]
return on equity with DuPont’s framework
analysis that breaks return on equity into three components:
profitability [net income/net sales]
activity [net sales/avg total assets]
financial leverage [average total assets/average total equity]
ROE
profit margine x asset turnover x equity multiplier
equity mulitplier = [avg total assets/avg total equity]
return
net incomet
turnover
net sales
