Derivatives Hedging Financial Reporting and Financial Statements Flashcards
Which Personal Financial Statements are required?
Statement of Financial Condition & Statement of Changes in Net Worth
How are assets and liabilities valued in a Personal Financial Statement?
Estimated current value
How are estimated taxes that would be paid if all assets were converted into cash and all liabilities paid presented on a Personal Financial Statement?
Presented on Statement of Financial Condition between Liabilities and Net Worth
What is the general presentation on a statement of financial condition?
Assets
- Liabilities
- Estimated taxes on assets sold
: Net Worth
How is life insurance presented on a Personal Financial Statement?
Only shown if there is cash surrender value
It is shown net of loans against the policy
How are business interests shown on a Personal Financial Statement?
Business Interests that constitute a large percentage of total assets should be separated from other investments
What is the discreet view in an Interim Financial Statement?
Interim period is a separate accounting period - not GAAP
Same accounting principles used for annual reporting should be used.
What is the integral view in an Interim Financial Statement?
Interim period is a part of the annual period - GAAP
Gross profit method may be used to estimate COGS and inventory
Temporary declines in inventory aren’t recognized
How are discontinued operations & extraordinary items reported in Interim Financial Statements?
Aren’t prorated
Fully recognized in Interim Period as incurred
If it occurs in Q3 - it’s recognized in Q3
How are cumulative gains and losses reported in Interim Financials?
Reported as if they occurred in the first quarter
How is inventory valuation handled in Interim Financials?
If inventory experiences a decline in value during an interim period - the loss is recognized in the interim period
If the loss is expected to be only temporary - no loss is recognized
What is one of the primary problems with interim reporting?
The matching principle gets messed up - Expenses incurred in one period may benefit future periods
For whom is Segment Reporting required?
Publicly traded companies
What factors cause a segment to be significant and therefore to be reported separately?
Revenue of segment is 10% or more of total
Profit is 10% or more of total
Segment assets are 10% or more of total
75% Test - All segment revenues must equal 75% of total external revenues
What is the disclosure requirement regarding sales of 10% or more for one customer?
If 10% or more of enterprise revenue comes from one customer - the segment making the sales must be disclosed
How are derivatives recorded?
At cost when acquired re-valued to fair value each period on Balance Sheet.
How are unrealized gains/losses on trading securities recorded?
Recorded on income statement
How are gains and losses on Available for Sale (AFS) securities recorded?
They are included in Other Comprehensive Income.
What is a Fair Value Hedge? How is it recorded?
Fair Value Hedge offsets exposure to changes in the value of a recognized asset/liability or of an unrecognized commitment
Initially recorded on Balance Sheet at Fair Value
Gains/Losses recorded on Income Statement
What is a Cash Flow Hedge? How is it recorded?
Cash flow hedges protect from exposure to fluctuations in cash flows.
Initially recorded on Balance Sheet at Fair Value
Gains/Losses going to OCI
Example: A cereal company enters into a futures contract on grain purchases to offset the risk that grain will go up in price.
Where are gains and losses on foreign currency hedges recorded?
In Other Comprehensive Income (OCI)
What disclosures are required for derivative transactions?
Objectives and Strategies
Context to help investor understand the instrument
Risk Management Policies
Complete List of Hedged Instruments
How do transactions denominated in in a currency other than a company’s functional currency affect the income statement?
Fluctuations in that currency cause a gain or loss that must be recognized on the income statement as Income from Continuing Operations
For the balance sheet which date’s translation rate is used to report assets and liabilities?
The current translation rate as of the balance sheet date is used to report assets and liabilities.
Which date’s currency translation rate is used for the reporting of revenue and expense transactions in a foreign currency?
Use the weighted average exchange rate for the current year.
If the functional currency is the reporting currency which exchange rate is used on the foreign currency financial statements?
Foreign Currency Financial Statements are remeasured into the Reporting Currency (Dollar) using the weighted-average exchange rate
Where are re-measurement gains and losses due to foreign currency translation reported?
On the income statement as Other Income.
What is the primary objective of accounting?
To measure income
What is the most authoritative set of accounting pronouncements?
The FASB Codification
All pronouncements fall under the Codification umbrella
What are the 2 Levels of Authority within the FASB codification?
Authoritative and Non-Authoritative
How does managerial accounting differ from financial accounting?
Managerial Accounting has a timeliness focus
Managerial Accounting is not required to follow GAAP
Which financial reports are required to be filed with the SEC?
Form 10K - Annual and Audited
Form 10Q - Quarterly and Reviewed
What is the focus of financial reports for individual companies?
Focus is on the needs of users to help them make decisions and assessments about the company
Does not make assessments of the economy
What are the Primary Constraints of Financial Reporting?
Cost vs. Benefit
Materiality
What are the Secondary Constraints of Financial Reporting?
Consistency - Year vs. Year
Comparability - Company vs. Company
What are the Qualitative Characteristics of Financial Reporting?
Relevance & Faithful Representation
Relevance - Makes a difference to the user
Includes:
Predictive Value - Future Trends
Confirming Value - Past Predictions
Materiality - Could affect User Decisions
Faithful Representation
Includes:
Completeness - Nothing omitted that would impact the decision-making of a user
Neutrality - Information is presented is without bias
Free from Error - No material errors or omissions
What are the Enhancing Qualitative Characteristics of Financial Reporting?
Comparability Verifiability Timeliness and Understandability
Comparability - Allows users to compare different items among various periods
Verifiability - Different people would reach a similar conclusion on the information presented
Timeliness - Information is made available early enough to impact the decision making of users
Understandability - Information is easy to understand
How does Conservatism affect the recording of accounting transactions?
When an estimate is necessary due to uncertainty conservatism chooses the best option that won’t overstate the financial position of the company
What is an accrual?
Earned (Revenue) or Incurred (Expense) but no Cash Receipt/Outlay yet
What is a deferral?
Cash Receipt/Outlay but not Earned (Revenue) or Incurred (Expense)
What is recognition in accounting?
When an item is recorded and included in the financial statements
Describe fair value with respect to an asset
The price you would receive if you sold the asset
Assumes asset is at its highest and best value
Assumes asset is sold at its most advantageous market to get the best price possible
What market assumptions are made in a fair value assessment?
Buyer and Seller are not Related
Buyer and Seller are Knowledgeable
Buyer and Seller are able to transact - i.e. This isn’t a hypothetical transaction for Fair Value measurement purposes. The buyer actually does have the $10M to purchase the asset you’re trying to value at $10M
Buyer and Seller are both motivated to buy/sell
What items are included in a Level 1 input in the fair value hierarchy?
Price quotes or market prices
For example NYSE or NASDAQ
What items are included in a Level 2 valuation input?
Interest rates
Prime rate
What items are included in Level 3 inputs of the fair value hierarchy?
Unobservable inputs such as assumptions or forecasts
Lowest priority for valuation
What are acceptable valuation techniques for fair value?
Market approach - uses market transactions and prices to value the asset
Income approach - uses present value discounts earnings
Cost approach - uses replacement cost to value the asset
What are current assets?
Cash
Inventory or Assets expected to be converted or consumed during a business’ operating cycle
Deferred Gross Profit on Installment Sales (Contra Asset)
Receivables expected to be collected in 12 months or less
What are current liabilities?
Liabilities that will use current assets during the present operating cycle
What is an accrued liability?
Expense that has been incurred but not paid
Example: rents payable
What is a deferred revenue?
A type of current liability
Payments that have been received but cannot be recorded as revenue yet
Example: Tenant pre-pays rent - Landlord still must perform to earn it and is a liability until this happens
When are revenues recognized?
When they have been earned; i.e. company has performed
What is a gain?
Increase in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is a loss?
Decrease in equity from an activity or event that is not central to the main activities of the business
Can be operating or non-operating
What is an operating cycle?
Average time it takes to turn materials or services into Cash
What is the present value of future cash flows?
Valuation method - the current value of a future amount of money using a specific interest rate
What is historical cost?
How much an asset cost - (net of depreciation and amortization)
What is replacement cost?
How much it would cost to reacquire an asset today (Entrance Cost)
What is a market cost?
The sale price of an asset (Exit Cost)
What is Net Realizable Value?
Sale Price of an Asset - Selling/Disposal Fee
When is royalty income recognized? How is it recognized?
Recognized when earned
If the royalty % is applied against net sales then subtract the estimated return amount from the gross sales first and then apply the royalty rate
When is revenue recognized in an installment sale?
Revenue recognized upon receipt of cash
Only used when cash collection is uncertain
What is deferred gross profit?
Gross Profit that can’t be recognized until cash is received
D.GP : Gross Profit % x Accounts Receivable
Pay attention to the year if GP% varies
What is the cost recovery method?
No revenue recognized until all costs are recovered from purchase of the asset
Most conservative method of revenue recognition when collection of sale price is uncertain
What is subscription revenue? How is it recorded?
Payment has been received but performance is not complete.
As company performs revenue is recognized.
Recorded as a Deferred Revenue (Liability) on Balance Sheet
How are franchise revenues recorded?
Franchisor - Startup franchise fee revenue deferred until substantial performance
Franchisee - Costs are deferred until corresponding revenue is recognized
How do you calculate sales revenue starting from cash basis income?
Mnemonic: SPEAR-BAR
Sales (i.e. Customer Payments)
+ Ending Accounts Receivable
- Beginning Accounts Receivable
: Sales Revenue on an Accrual Basis
How do you calculate COGS starting from Cash Basis?
Mnemonic: CRAP-I
Cash Remitted (i.e. paid)
+Increase in Accounts Payable
-Increase in Inventory
:COGS on an Accrual Basis
How are discontinued operations reported? When are they used?
Reported Net of Tax after Continuing Operations but before Extraordinary Items
Company decides to cease operating a segment of its business
Includes Income (or loss) from the period plus the gain (or loss) from disposal
What qualifies as an extraordinary item? How is it recorded?
Both unusual AND infrequent
Reported Net of Tax after Discontinued Operations
Note: Usual or Infrequent Items are reported as part of Continuing Operations
What is constant dollar accounting?
Adjusts assets to reflect a consistent level of purchasing power due to inflation
Uses the Consumer Price Index (CPI)
When are expenses recognized?
When they are incurred. Accrue if not yet paid.
What are accrued expenses?
Those incurred but not paid.
Product costs - Expenses should be matched with associated revenues as they are recognized (sales commission on a used car sale)
Period costs - Expenses amortized and recognized with the passage of time
When should impaired assets be written down to fair value and expensed?
Immediately.
What major items should be classified under General & Administrative (G&A) expenses?
Office staff salaries
Office/building rent
Office supplies
Note: Sales staff salaries and portions of the building assigned to Sales should be allocated to Selling Expense not G&A
What are business start-up costs?
One-time costs for opening a new business
Expensed as they are incurred
When is interest not expensed?
Interest on projects (software) for internal use is not expensed but is instead capitalized
What are the major components of Comprehensive Income?
Net Income + Other Comprehensive Income (OCI):
Revenues/Expenses
Gains/Losses
Cumulative accounting adjustments
Reclassifications adjustments
Non-owner changes in equity
What items are considered cumulative accounting adjustments?
Foreign Currency Translation Adjustments
Unrealized gains on AFS Securities
Minimum Pension Liability adjustment for defined benefit plans
What is the purpose of a reclassification adjustment?
Avoids double counting items that were included in both Net Income and OCI
Example: AFS Securities previously included in OCI are now sold at a loss and reported on the Income Statement
Where is Comprehensive Income reported?
Reported in a Single or Combined Income Statement
What disclosures on accounting policies are required in financial statements?
Accounting Principles used
Basis of Consolidation
Inventory Pricing Methods
Depreciation Method
Amortization of Intangibles
What are some major risks and uncertainties that must be disclosed?
Nature of Operations
Use of Estimates and listing of Significant Estimates
Concentration vulnerability
