F2 - Financial Reporting and Disclosures

Question 1

Rules for Converting Cash-Basis Net Income to Accrual-Basis Net Income

Answer 1

Cash Basis to Accrual Basis:

+ Add increases in current assets.
- Subtract decreases in current assets.
+ Add decreases in current liabilities.
- Subtract increases in current liabilities.

Question 2

Rules for Converting Accrual-Basis Net Income to Cash-Basis Net Income

Answer 2

Accrual Basis to Cash Basis:

• Subtract increases in current assets
  + Add decreases in current assets
• Subtract decreases in current liabilities
  + Add increases in current liabilities

Question 3

Rules for Converting Cash-Basis Revenue to Accrual-Basis Revenue

Answer 3

Cash-Basis Revenue to Accrual-Basis Revenue:

Cash-basis revenue
- Subtract beg. A/R
+ Add end. A/R
+ Add beg. U/R (contract liability)
- Subtract end. U/R (contract liability)
= Accrual-basis revenue

Question 4

Rules for Converting Cash Paid for Purchases to COGS

Answer 4

Cash-Basis Purchases to Accrual-Basis COGS:

Cash paid for purchases
- Subtract Beg. A/P
+ Add End. A/P
+ Add Beg. Inv.
- Subtract End. Inv.
= COGS

Question 5

Rules for Converting Cash-Basis Expenses to Accrual-Basis Expenses

Answer 5

Cash-Basis Expenses to Accrual Basis Expenses

Cash-Basis Expenses
+ Add beg. PPD expenses
- Subtract end. PPD expenses
- Subtract beg. accrued expenses (accrued liabilities)
+ Add end. accrued expenses (accrued liabilities)
= Accrual-basis expenses

Question 6

Special Purpose Frameworks: Cash-Basis to Modified Cash Basis Method of Accounting

Answer 6

Modifications made to cash basis financial statements to adjust the statements to the modified cash basis should have substantial support, meaning that the modification is logical and equivalent to the accrual basis of accounting for that item (e.g. accrual rules are followed for inventory, COGS, fixed assets, etc.)

Question 7

Days Sales in Accounts Receivable

Answer 7

Ending A/R (net) / (Sales (net) / 365 days)

Question 8

Days in Inventory

Answer 8

Ending Inventory / (COGS / 365 days)

Question 9

Days in Payables Outstanding

Answer 9

Ending A/P / (COGS / 365 days)

Question 10

Cash Conversion Cycle (net operating cycle) : How long to generate cash from core business.

Answer 10

*Cash Conversion Cycle = Days sales in A/R + Days in Inventory - Days in Payables Outstanding.

*Should be less than or equal to the standard.

Question 11

“DuPont” Return on Assets Formula

Answer 11

The DuPont return of assets formula explains why ROA is what it is. Is your ROA high because of high profit margin and/or high turnover. The formula is:

DuPont Return on Assets = Profit Margin * Asset Turnover.

DuPont Return on Assets = (Net Income/ Sales (Net)) * (Sales (net) / Average total Assets)

Question 12

Return of Sales

Answer 12

Used for comparing two or more companies with different capital structures (debt to equity ratios).

> = Std. Operating margin - excludes impact of degree of financial leverage.

Return on Sales = EBIT / (Sales (net))

Question 13

Operating Cash Flow Coverage Ratio

Answer 13

*Operating Cash Flow Coverage Ratio = Cash flow from operations / Current Liabilities

*The higher the operating cash flow coverage ratio, the less risk of short-term financial distress.

Question 14

Degree of Financial Leverage

Answer 14

Degree of Financial Leverage = 1 + Debt to Equity Ratio

Question 15

Equity Multiplier

Answer 15

Equity Multiplier (DFL) = Total assets / Total equity

Used in the DuPont model.

ROA * DFL = ROE

A higher equity multiplier means greater risk is assumed by the company, but also means a greater potential return on equity

Question 16

Times Interest Earned Formula

Answer 16

*Times Interest Earned = EBIT / Interest Expense

*Ratio reflects the company’s ability to cover interest expense. The higher the ratio, the lower the risk. Implies the company has lower debt (borrowings) and higher equity (shareholders).

Question 17

Earnings per Share

Answer 17

EPS = (NI - preferred dividends) / Weighted-Average Common Shares Outstanding (WACSO)

Question 18

Price Earnings Ratio

Answer 18

Price Earnings Ratio = Price per Share / Basic EPS

Could be interpreted by investors two different ways. A low EPS multiplier could mean that the stock is relatively undervalued. A high EPS multiplier could mean that investors are pleased with the company’s opportunity for growth (willing to pay more for less EPS).

Question 19

Dividend Payout Ratio

Answer 19

*Dividend Payout Ratio = Cash Dividends (dividend per share * # of shares outstanding) / Net Income

A lower dividend payout ratio could be interpreted as the company is in a growth phase (higher opportunity for growth) and wants to re-invest their earnings. A higher dividend payout ratio could be interpreted as the company is a mature company with less opportunity for growth, in which case investors expect dividend payouts.

Question 20

Return on Equity Formula

Answer 20

ROE = (NI - Preferred Dividends) / Average Common Equity