F1 - M1 - Balance Sheet, Income Statement, and Comprehensive Income

Question 1

What do people normally use the balance sheet for? What can they calculate?

Answer 1

They normally look at it for financial risk, here are some of the things they calculate:

Short-term liquidity - This is the short term risk.

Long term solvency - The long term risk, along with performance in the future. For example, if assets go up, we can infer that sales will go up and vise versa. This is also called capital to produce.

Question 2

What are the two things that the income statement (statement of earnings) helps us determine?

Answer 2

Performance risk and operating risk

Question 3

What is the statement of comprehensive income? What is other comprehensive income (OCI)?

Answer 3

The statement of comprehensive income is a statement that includes both net income per the income statement, and other comprehensive income.

Other comprehensive income is gains or losses that do not go through equity via retained earnings. These items hit the equity account right away, and they skip hitting net income and then equity.

Question 4

What is the statement of cash flows? How this different than you net income on your income statement?

Answer 4

This is a statement that shows why cash changed hands. This simply records when the cash came in and when the cash came out. The difference with the income statement is simply timing. Income statement is on accrual basis, while statement of cash flows is the cash basis.

Statement of cash flows helps show why cash changed, indicates the quality of the earnings, and growth potential.

Question 5

What is the statement of owners equity?

Answer 5

This helps show why stockholder equity changed.

Could be a change in capital - Sold more shares of common stock, preferred stock, etc.

Could be a change in retained earnings - You got a net income or net loss.

Change in OCI - Gains or losses that went straight to equity.

Question 6

What is the liquidity ratio?

Answer 6

current assets/current liabilities

Question 7

What is the solvency equation?

Answer 7

Debt/Equity

Question 8

Would an investor be impressed if you increased your equity because you sold shares of common or preferred stock?

Would an investor be impressed if you increased your capital via earned capital? Such as an increase in retained earnings or accumulated other comprehensive income?

Answer 8

Not really, when you issue stock to raise capital, your are normally adding more partners to the firm and that is diluting your earnings per share.

Yes, raising money by earned capital is impressive because that means you made money through you ordinary course of business.

Question 9

What is contra equity, and what is an example of this?

Answer 9

Contra equity is when you buy back your own stock because you think its a great investment and your shares will go up. This is called a treasury stock and is also reported in equity. Could be a sign of optimism.

This also reduces your equity account

Question 10

Who has first claim to a companies assets?

Answer 10

The liabilities and then the equity.

Question 11

What are investments on the balance sheet? Are they current or non-current?

Answer 11

Investments are stocks/bonds in other companies and investments. They are non-current assets.

Question 12

Who gets paid first, common stockholders or preferred stock holders?

Answer 12

Preferred

Question 13

What are some of the limitations of the balance sheet?

Answer 13

The assets are not measured at FMV or the current value. They are measured at the NBV or historical cost. This makes the numbers more outdated for current value.

Some accounts can be calculated in different ways, making comparison hard. Like inventory is LIFO or FIFO, depreciation can be straight line or accelerated.

Some of the accounts are estimates such as allowance for bad debts, so it is hard for investors to know if the company is being aggressive or lenient in the their estimations.

Question 14

Who are some of the people that want to see the income statement?

Answer 14

External users such as investors, stockholders, common or preferred.

Lenders, looking at credit rating for loans.

Internal users - want to see how the company is using.

Question 15

What is the difference between operating and nonoperating on an income statement?

Answer 15

Operating - These are activities that the company does on their daily operations. Such as raising money or paying expenses for things they do in the normal course of business.

Nonoperating - This is income or expenses not in the normal course of business, such as gains or losses, interest revenue, and interest expense if not a bank.

Question 16

What is a period cost?

Answer 16

These are costs that we expense right away. They are normally reoccurring and include, selling, general research, and administrative.

Question 17

What is an unexpired cost?

Answer 17

These are costs that will be capitalized now and expensed in future periods. Some examples include:

You capitalize inventory, and when you sell it, you expense it at COGS.

You prepay something like insurance, and then you remove the prepaid as insurance expense.

You have fixed assets, and you depreciate them with depreciation expense.

Patents, you amortize those.

Question 18

What are some examples of non operating expenses.

Answer 18

These are unusual and/or infrequent. They include:

Sale of something other than inventory,

Write-down

Write offs

Sale of PP&E

Sale of an investment in another company

Unusual operating expense.

Question 19

What is income from continuing operations?

Answer 19

This is operating income + non operating income

Question 20

What is the difference between income from continued operations and income from discontinued operations?

Answer 20

Income from discontinued operations is the selling off of a product line, sperate division, or a segment of a company’s operations.

These are reported separately on the income statement and have their own line.

They are reported after income from continuing operations, and they are net of tax.

Question 21

What is a single step income statement? What are the pros and cons of this?

Answer 21

This is when you take all of your income and gains - all of your expenses and losses and then take that amount minus you tax amount to get your net income amount. You sum up all income and expenses in one line.

Benefits - Gives net income in one step due to its simple design, does not make one account appear more important than other.

Cons - Does not distinguish between your core business and incidental business.

Question 22

What is a multiple-step income statement?

Answer 22

This is an income statement that has multiple steps and breaks out by each account.

Separates business from operating and nonoperating.

Provides information for ratio analysis.

Question 23

What are some of the limitations of the income statement?

Answer 23

It is subjective because it is based on accounting methods which include estimates. Revenues and expenses are booked on accrual basis.

Management bias - You have choice of accounting estimates to improve your bottom line.

Question 24

What is the difference between aggressive and conservative?

Answer 24

Aggressive - Booking higher revenue and lower expense such as;
booking revenue that should have been deferred
capitalizing expenses that should have been expenses

Conservative - booking lower revenue, but higher expense.

deferring revenue instead of recognizing.
booking expenses instead of capitalizing.

Question 25

What is an example of income smoothing with accrual basis?

Answer 25

For example, if you operate on cash basis, and you build a whole new building, you would have to expense all of that building in year 1 and that would make you look like a failure until year 5 when the building is complete.

In accrual, you can capitalize the building and expense it over time, which makes your business look better. That is income smoothing.

Question 26

What is the con to income smoothing?

Answer 26

Sometimes companies take advantage of this. If in one year, they get 30% increase in revenue, they defer that amount for future years, so it looks more consistent. If they recognize all the revenue in year one, are they going to increase revenue by more than 30% in the next year? Probably not, so that is why it is a con, makes companies look better than they are.

You record when earned or incurred to combat this.

Question 27

Difference between freight in and freight out?

Answer 27

Freight out is a is selling expense, freight in needs to be capitalized with inventory.

Question 28

What is classification shifting?

Answer 28

This is when a company puts their good non operating income on top of the income statement, and their bad operating losses on the bottom of the income statement. You cannot do this for income statement presentations, but people have done it.

Question 29

Are selling, general, and administrative expenses operating expenses?

Answer 29

Yes

Question 30

When would you know when to report the discontinuing of operations?

Answer 30

Two areas, the year it has been disposed. So if you dispose of the business segment in 2022, that is when it is discontinued.

Or when it is held for sale, if you hold it for sale in 2022, then that is when you report all the activity for that segment in discontinued.

Question 31

What are some of the ways you can identify discontinuing in operations?

Answer 31

Disposal in a major geographical area - Not doing business in Asia anymore.

Disposal of a major equity method investment - You have significant influence over one company, and you sell your interest.

Disposal of a major business line.

Question 32

How does an impairment loss work for discontinued operations?

Answer 32

If you plan to discontinue operations you have to find the net realizable value, and compare it to the book value. If the net realizable value is less than the book value, then you write down the book value by the impairment loss. Once you do this, you can not reverse the amount written by more than what it was written down by.

For example, the NRV is 8 but the book value is 10. You have an impairment loss of 2, so the new book value would be 8. Let’s say next year the NRV increases to 11, and you want to record a gain of 3. You cannot do this because you can only increase the amount up to what the loss was.

Question 33

When the discontinued operations occurs for multiple years how does that work? How is it calculated?

Answer 33

For multiple years, like they listed it for sale, but sold it later, you need to:

Record the impairment loss

Results of operations need to be moved down to discontinuance.

Do not report the gain or loss until the period in which it occurs.

Question 34

Do you still depreciate or amortize assets within the component or line that is being discontinued?

Answer 34

No you do not

Question 35

Are discontinued operations disclosed in the footnotes? If so, what needs to be disclosed?

Answer 35

Yes they do;

What product line it was

Why is this segment being sold

How might this impact business in the future.

Question 36

If a company decides to discontinue operations in the middle of the year, when do they start reporting income and expenses in the discontinued section of the income statement?

Answer 36

It does not matter when they decide to discontinue in the year, all revenue and expenses for the whole year are reported in the discontinued section. Even if they elect April 1st, all revenue and expenses starting January 1st of the year will be reported.

Question 37

For foreign currency, what is the difference between import purchases and export sales?

Answer 37

Import purchases, this is accounts payable in a foreign currency

Export Sales: Accounts receivable in foreign currency

Depending on if the currency goes up or down, you could have a gain or loss to report.

Question 38

What is the difference between direct method and indirect method?

Answer 38

Direct method: the home currency is in the numerator, and foreign currency is in the denominator. For example $1.47/1 euro. This says that one euro gets you 1.47 dollars.

Indirect method: This is where the home currency is in the denominator. For example, 1 euro/$1.47. These divided by each other are .68, which says that .68 euros buys one dollar.

Question 39

How does the value go up or down on foreign currency accounts receivable? What about accounts payable?

Answer 39

For Accounts Rec:

If foreign currency goes up, the asset goes up, so you have a gain.

If foreign currency goes down, the asset goes down, so you have a loss.

For Accounts Payable:

If foreign currency goes up, the liability goes up, that is a loss.

If the foreign currency goes down, the liability goes down, that is a gain.

Question 40

What are the accounts that go direct to equity and do not hit the income statement? (PUFI)

Answer 40

Pension adjustment

Unrealized gains and losses [Available for sale debt securities and hedges]

Foreign Currency items

Instrument specific credit risk

Question 41

What is the formula to calculate comprehensive income?

Answer 41

This would be your Net Income + Other Comprehensive Income

Question 42

How do pension adjustments work and what are they?

Answer 42

This is when an employer has gain or losses from a defined benefit pension plan that must be recognized in OCI the year the change occur.

These pension gains and losses get amortized over the service life of the employees and recognized as a pension expense.

Question 43

How do the foreign currency items work in PUFI?

Answer 43

This happens when a parent company owns a foreign subsidiary, and when the financials need to be consolidated, the currency that is used will be the parents currency. In that conversion, you will have either a gain or loss in currency conversion, and have to recognize that in OCI.

Also, gains or losses in your foreign currency payables and receivables.

Question 44

What is instrument specific credit risk?

Answer 44

This is when you hold a security in a company, but the companies security that you are invested in, has their risk change. If the risk changes, that impacts the discount rate, which in turn, would either decrease or increase the value of the investment.

If the risk goes up for the company, the FMW goes down which causes a gain for the company holding the security.

If the risk goes down, the FMW goes up, which is a loss for the company holding the security.

Question 45

How are PUFI items moved out of other comprehensive income? What is this called?

Answer 45

Reclassification adjustments;

When they can be recognized, these items are moved out of equity and into the income statement, which would roll into retained earnings just like any other normal net income amount.

Question 46

What is accumulated other comprehensive income?

Answer 46

Any gains and losses that go directly to equity that have been accumulating over time go to accumulated other comprehensive income.

Once you can recognize these, they go on the income statement, and rolled into retained earnings.

Question 47

When would a statement of comprehensive income not be needed?

Answer 47

Non profit or you don’t have any PUFI items.

Question 48

For the comprehensive income statement, how would you know if it is a single statement or multi statement approach?

Answer 48

For single statement - They start with revenue, work all the way down to net income, and then add or subtract their OCI amounts.

For multi statement - You have a separate income statement and comprehensive income statement. It starts with net income.

Question 49

Can the PUFI items be presented net of tax or before tax?

Answer 49

Either way is fine

Question 50

What is the reporting requirement for comprehensive income?

Answer 50

Must be presented in the financial statements

In interim periods (quarterly)

Question 51

It is required that the tax effect of each component of comprehensive income must be disclosed. How can this be disclosed?

Answer 51

Either on the face of the income statement of in the notes.

Question 52

Do you need to disclose any changes in the accumulated other comprehensive income amounts?

Answer 52

Yes, this can be additions, losses, reclassifications, etc.

You can do this on the financial statements, or in the notes.

Question 53

What does equity comprise of?

Answer 53

Paid-in capital minus treasury stock

earned capital (retained earnings); and

ending accumulated other comprehensive income

Question 54

What are the two reasons a PUFI item was changed in the current fiscal year?

Answer 54

Could be due to two reasons;

A current period gain or loss or reclassification adjustments.

Have to be disclosed, either on the face of the financials or in the notes.

Question 55

Is recovery of accounts written off recorded in revenue?

Answer 55

No

Question 56

Where do you report foreign transaction gains and losses, and where do you report foreign translation gains and losses?

Answer 56

Transaction - Income Statement

Translation - OCI

Question 57

What are some examples of selling expenses?

Answer 57

Advertising, freight out, office space for selling department, sales salaries and commissions.