F1 Flashcards
What does a full set of financial statements includes
Statement of financial position (balance sheet)
Statement of earnings (income statement)
Statement of comprehensive income (include net income per the income statement + Other comprehensive income)
Statement of cash flow (indicator of quality of earnings and growth potential)
Statement of owners equity (why stockholders equity changed)
Notes
What are the functions of a balance sheet?
Provides lists of assets and liabilities
Types of assets and liabilities (current vs, long-term, tangible vs. intangible)
To evaluate liquidity and long-term solvency (current ratio, quick ratio, degree of financial leverage)
Formula: Assets = Liability - Equity
Assets
Current assets are cash and assets that are expected to convert to cash within one year (e.g. cash, receivables, prepaids)
Investments and funds: non-current, not directly used in operations
Property, plant and equipment: tangible, long-lived, used in operations
Intangibles: no physical substance, long-lived, used in operations (patent, copyright, trademark)
Other non-current assets
What does liability include?
Current liabilities: obligations to be satisfied with current assets
Long-term liabilities: obligations to be satisfied beyond one year
Equity:
Preferred stock, common stock and additional paid-in capital (contributed equity)
Retained earnings (earned capital)
Treasury stock (reduces stockholders equity)
Limitations of Balance Sheets
Amounts on the balance sheet do not represent the market value of the entity
Many assets and equity issuances are measured at historical cost
Some measurements are subjective, making comparison difficult (e.g. LIFO vs. FIFO)
Estimates may be used in preparation of the balance sheet
Purpose of the Income Statement
Indicated its performance for a period of time
Helps determine operating risk
Provides information about is Revenues, Expenses, Gains and Losses ( REGL)
Predict information about future cash flows
Calculation of Income from Continuing Operations
Operating income (revenues and expenses) + Nonoperating income (gains and losses)
Net gain or loss = Selling price/Net realizable value - book/carrying value
Income from discontinues operations
Reported separately on the income statement
Comes after the income from continuing operations in the income statement
Reported as net of tax
Components of the Income Statement - Single-Step
All revenues and gains
- All expenses and losses
= Pretax income
- Income tax expense
= Net income
- does not distinguish between core business and incidental business
Components of the Income Statement - Multiple-Step
Sales
- Cost of goods sold
= Gross profit
- Operating expenses
= Operating income
- Nonoperating (gains) and (losses)
= Pretax income
+ Other revenue and gains
- Other expenses and losses
= Income before income tax
- Income tax expense
+ Income from continuing operations
- discontinued operations (net of tax)
= Net income
Limitations of the Income Statement
Based on accounting methods which include estimates
Revenues and expenses are booked on accrual basis (not when cash is paid/received)
Management Bias - manapulated through assumptions, choices of accounting methods, aggressive (higher revenue, lower expense)/ conservative (lower revenue, higher expense), depreciation (method, useful life and salvage value), bad debts and warranties
Classigication shifting occurs when companies shift
Accrual Basis vs. Cash Basis
Accrual Basis:
- not booking revenue when cash is received if goods and/ or services have not been delivered or performed
- gives better assessment of performance
- is subjective
– income smoothings, better indication of performance
Cash Basis:
- booking cash in and cash out as they occur
- is objective
Preparation of a Multiple Step Income Statement
Net sales = Gross sales - Return and discounts
Total sales = Net sales + Service revenue + Rental revenue
Cost of sales = Cost of goods sold + cost of services sold + cost of rental income
Gross profit = Total sales - Cost of sales
Total selling expenses = Freight out (selling expense) + Commissions + Advertising + Salaries for salespeople
General and administrative expenses = Insurance expense + Salaries for officers
Nonoperating = Interest revenue, Other revenue, Gain on sale of available-for-sale securities, Interest expense, Loss on sale of fixed assets, Restructuring expense, Loss on discontinued operations
Multiple-Step Income Statement
Gross profit margin = Gross profit/Sales
Operating margin = Operating income/ Net sales
Profit margin = Net income/ Net sales
Effective tax rate = Tax expenses/ income before income tax
Single-Step Income Statement
Earnings before tax = Total revenues and gains - total expenses and losses other than tax
Tax expense = Earnings before tax * Effective tax rate
Types of Entities to Be Considered as discontinued operations
Has been disposed of during that year (regardless of selling date)
or
Is classified as held for sale in that year (even if a buyer is not found yet)
Examples:
Disposal of a major geographical area
Disposal of a major equity method investment
Disposal of a major line of business
Accounting Rules for Discontinued Operations Calculations
Results of Discontinued Operations:
- all results for a product line sold during the year at the end of the year
- all results of operations for that period will be moved down and classified as gain or loss on operations
Gain or loss on disposal of the component:
- date of product line does not matter, as long as it was sold during the year
- calculated based on the selling price vs. the carrying value at the time of sale
- would be reported unter the heading “discontinued operations”
Impairment loss :
- Initial and Subsequent Impairment Losses = Recording the impairment of the component (any initial or subsequent write-down to fair value - costs to sell)
- Subsequent Increases in Fair Value
= Gain is recognized for any subsequent increase in fair value - costs to sell
Measurement and Valuation of Discontinued Operations
Measurement is NRV = Fair value - Cost of sell
Impairment loss is = NRV - Book value
Subsequent increase = not more than NRV
Impairment gains = not more than impairment loss
Foreign Currency Terminology
Direct Method = Domestic price of one unit of another currency = $1.47/€1 = $1.47 buys 1€ or 1€ buys $1.47
Indirect Method = €1/$1.47 = 0.68€ buys 1$ or 1$ buys 0.68€
Comprehensive Income
Change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources.
Includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.
Other Comprehensive Income (PUFI)
Pension Adjustments
Unrealized Gains and Lossess (Available for Sale Debt Securities and Hedges)
Foreign Currency Items
Instrument Specific Credit Risk
Accumulated Other Comprehensive Income
Includes the total of other comprehensive income for the current period and all previous periods. Other comprehensive income for the current period is closed to this account, which is reconciled each period similar to the manner in which retained earnings are reconciled.
Comprehensive Income
Sum of all Net Income +/- Other Comprehensive Income
Accumulated Other Comprehensive Income
Beginning +/- Current Year +/- Reclassification Adjustments
Two Statement Approach for Comprehensive Income
- Income Statement from Revenue to Net Income
- Net Income +/- other comprehensive income, net of income tax
Accumulated Other Comprehensive Income on Balance Sheet
Accumulated other Comprehensive Income
+/- PUFI adjustments
+/- Reclassification adjustment
= Ending accumulated other comprehensive income
Required Disclosures of Comprehensive Income
-Tax effects of each component of comprehensive income
- Tax effects must be allocated to each component (either on the face of the statement of comprehensive income OR in the notes)
- Changes in Accumulated balances for each of the components of other comprehensive income
- Change due to reclassification adjustments, even if there were not any current year adjustments
- Reclassification adjustments to avoid double counting –> need to reverse any gain or loss that previously went direct to equity
Changes in Accumulated Other Comprehensive Income
Beginning Balance
+/- Other comprehensive income before reclassifications
+/- amount reclassified from AOCI (could have a seperate disclosure, if the amount is significant)
+/- net current period other comprehensive income
= ending balance
Single-step income statement
Include in total revenues all sales of goods, services and rentals. Purchase discounts are not included, but instead reduce cost of goods sold. Recovery of accounts written off does not hit the revenue account.
Comprehensive income
Includes all changes in equity during a period except those resulting from owner investments and distributions to owners.
Foreign currency transaction loss
Liability in 31.12. - Liability in year
Liabilities
Current liabilities consist of all payables due within one year
Deferred income tax payable = non-current liability
Net Income calculation
Net sales (=gross sales - sales returns)
- cost of goods sold
= Gross profit
- selling and administrative
= operating income
+ other income
= income from continuing operations
- income tax expense (income from continuing operations *tax)
= income before discontinued operations
+ gain from discontinued segments (gains * tax)
= net income
Point of time when component of an entity can be reported in discontinued operations
When component meets the “held for sale” criterias:
- management commits to a plan to sell the component
- the component is available for immediate sale in its present condition
- an active program to locate a buyer has been initiated
- the sale of the component is probable and the sale is expected to be completed within one year
- the sale of the component is being actively marketed
- it is unlikely that significant change to the plan to sell will be made or that the plan will be withdrawn.
Net income and OCI
Net income is closed to retained earnings in the same way that other comprehensive income is closed to accumulated other comprehensive income. Retained earnings and acculumated other comprehensive income both serve to sum up the undistributed earnings of a corporation over its operating life
