F2 - Financial Reporting and Disclosures Flashcards
5 Step Recognition Model
- Identify the Contract
- Identify the Performance Obligations
- Determine the transaction price
- Allocate the transaction price to the performance obligations
- Recognize revenue as the performance obligation is satisfied
Revenue Recognition
Rev is recognized when a “performance obligation is satisfied”
When Control of goods has passed to customer.
Timing of payment or contract signing does NOT determine rev recognition
When in Consignment recognize revenue after the consignment period ends!!
% of Completion
Percentage of Completion Method calculates revenue or profit based on the actual costs incurred to date as a % of total estimated costs for procject
Recognizing Losses in Construction Contracts
For long-term contracts, any projected losses are recognized immediately, regardless of the project’s completion %
Ensuring accurate financial reporting of expected outcomes
Agent VS Principal Revenue Recognition
An agent recognizes only the commission or fees earned for facilitating a transaction
NOT the total gross transaction amount handled on behalf of the principal
Consignment arrangements are considered an agent selling for principal
Upfront Payments & Unearned Revenue
If Cash is given upfront the amount is recorded under (Unearned REV)
Revenue is recognized systematically over the period as the services are performed.
Under Bill-and-Hold
They can recognize REV when they are done with the “product” according to customizations
If it was just any other product then NO
Commission Costs
Commission costs would not been incurred if the contract had not been obtained and can be recognized as an asset
Fair Value
Is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Valuation Approaches
3 Approaches:
Market Approach - Market prices
Income Approach - Discounted Cash Flows
Cost Approach - replacement costs (adjusted for Depreciation and Obsolescence)
Market Participants
Are independent, Knowledgeable, and willing buyers and sellers acting in their economic best interest in the principal or most advantageous market
Most Advantageous Market
When no principal market exists
The most advantageous market is the one that provides the best price
Do NOT include Costs
But need to net the costs, after net see which one is the most advantageous and go with the selling price.
Level 1
Quoted prices in active markets
for IDENTICAL assets or liabilities
Most reliable and require NO adjustments
Level 2
Inputs include observable,, similar assets or liabilities in active markets or data from Less active/inactive markets
These require adjustments to reflect differences in characteristics between the observed data and the asset or liability measured
“observable, similar, adjustments, inactive market”
Level 3
Unobservable and rely on the entity’s own assumptions or internally developed data
“unobservable, assumptions, internally developed, no market data”
Need to compare at NET
then the FV is the Quoted Price
NI Calculation on Cash Basis
Recognizes Rev & Exp only when cash is received or paid,
ignoring AR & Payable
PP&E Treatment
Cash basis expenses PP&E fully in the purchase year, while modified cash basis capitalizes & depreciates over time
Liabilities Recording
Cash basis doesn’t record liabilities
Modified cash basis recognizes certain liabilities like loans and their payments
COGS Calculation
Cash basis includes all cash paid for inventory, while modified cash basis considers beginning and ending inventory to match costs with revenue
Interest & Income Tax Expenses
Cash basis recognizes these expenses only when paid;
Modified Cash basis accrues and recognizes them if unpaid
Special Purpose Framework
AKA
OCBOA
Includes Cash Basis, modified cash basis, tax basis, and regulatory basis
These are not required to follow GAAP
Not interchangeable with GAAP - make sure you know the differences between Financial Stmts titles
OCBOA TITLES
Cash Basis: Statement of Cash Receipts and Disbursements and Statement of Assets and Equity
Modified Cash Basis: Statement of Assets, Liabilities, and Equity (Modified Cash Basis) & Statement of Rev Collected and Expenses Paid
Tax Basis: Statement of Revenues and Expenses & Statement of Assets and Equity
Accrual Net Income Calculation
Cash Basis Net Income + (End AR- Beg AR) + (Beg AP- End AP)
For Pre-Paid balances it will be End - Beg
Accrual Basis Pretax Income Calculation
Cash Basis Pretax Income-Decrease in AR - Increase in AP
To Convert from Cash Basis to Accrual
Current Assets/Receivables:
Add Increases
Subtract decreases
Current Liabilities/Payables:
Subtract Increases
Add Decreases
Profitability Ratios
GROSS PROFIT MARGIN
RETURN ON SALES
RETURN ON ASSETS
RETURN ON EQUITY
Gross Profit Margin
Get Gross Profit = Total Rev - COGS
(Gross Profit / Total Revenue)
Operating Income (EBIT or Earning Before Interest and Taxes)
OPERATING PROFIT MARGIN AKA RETURN ON SALES
OPERATING INCOME = GP - TOTAL OPERATING EXP
Operating Profit Margin (Operating Income / Total Revenue X 100
Return on Sales (Operating Profit Margin)
Operating Income/ Revenue
Net Profit Margin
Net Income / Revenue
Return on Assets (ROA)
Net Income / Average Total Assets
DuPont ROA = Net Profit Margin X Total Asset Turnover
Return on Equity (ROE)
Net Income / Average Shareholders’ Equity
DO NOT INCLUDE COMMON DIVIDENDS
LIQUIDITY RATIOS
CURRENT RATIO
QUICK RATIO
ACCOUNTS RECEIVABLE TURNOVER
INVENTORY TURNOVER
ACCOUNTS PAYABLE TURNOVER
CURRENT RATIO
CURRENT ASSETS / CURRENT LIABILITES
Include Prepaid Expenses in Current Assets Calculations AND Include Inventory in this one
Meet ST obligations
Higher ratio means better short term health
QUICK RATIO
QUICK ASSETS / CURRENT LIABILITIES
In this ratio do NOT include the Inventory
DO NOT include Prepaid Assets or expenses
Stricter measure of Liquidity
Higher quick ratio means ability to quickly meet its ST liabilities
ACCT RECEIVABLE TURNOVER
NET CREDIT SALES / AVERAGE ACCT RECEIVABLE
Do not add cash sales in Net Credit Sales
How quickly we are collecting
Higher ratio means CO is more efficient at converting credit sales to cash
INVENTORY TURNOVER
COGS / AVERAGE INVENTORY
COGS = BEG INV + PURCHASES - ENDING INVENTORY
Higher means selling & replenishing inventory quickly
ACCOUNTS PAYABLE TURNOVER
TOTAL PURCHASES / AVG ACCT PAYABLE
How quickly we are paying people
How quickly does CO pays off its suppliers
If question doesn’t specify purchases you can use COGS as a subs
SOLVENCY RATIOS
DEBT TO EQUITY RATIO
TOTAL DEBT
TIMES INTEREST EARNED
DEBT TO EQUITY RATIO
TOTAL LIABILITIES / TOTAL EQUITY
Measure the financing that comes from debt compared to equity
Higher ratio means more reliance on debt financing, which can increase financial risk but may also lead to higher returns if managed well
Lower ratio means the CO relies less on debt for financing
TOTAL DEBT RATIO
TOTAL LIABILITIES / TOTAL ASSETS
CO assets that are financed by debt
Higher ratio means potential risk, lower means less reliance on debt
TIMES INTEREST EARNED RATIO (TIE)
EBIT / INTEREST EXPENSE
EBIT means Earnings (income) before interest expense and taxes
Might have to add the Interest Expense to Net Income Before Taxes
Performance Metrics
EBITDA, Price-to-Earnings, Dividend Payout, Asset Turnover
EBITDA
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION, AND AMORTIZATION
NI + INT EXP + INC TAX EXP + DEP + AMORTIZATION
Measure a CO core profitability by excluding non-operational expenses
P/E Ratio
Price-to-Earnings Ratio
Stock Price / EPS
EPS = NI / Shares Outstanding
Make sure you use NET INCOME, not total SALES
How much investors are willing to pay for each dollar of earnings
Dividend Payout Ratio
Dividends Paid / NI
% of earnings distributed to shareholders as dividends
ASSET TURNOVER RATIO
REVENUE / AVG TOTAL ASSETS
How efficiently the CO uses its assets to generate sales
Net Income Variance
Actual NI - Budgeted NI
MATERIAL VARIANCE
(ACTUAL QUANTITY USED X ACTUAL PRICE) - (STANDARD QUANTITY EXPECTED X STANDARD PRICE)
SALES VARIANCE
(ACTUAL UNITS SOLD X ACTUAL PRICE) - (BUDGETED UNITES SOLD X BUDGETED PRICE)
OR
ACTUAL SALES -BUDGETED SALES
DAYS IN ACCT RECEIVABLE
ENDING AR (NET) / [ NET SALES / 365 ]
When the EFFECT of a CHANGE in Accounting Principle is Inseparable from the EFFECT of a Change In Accounting Estimate
To report it the overall effect it will be a CHANGE IN ESTIMATE
So it will be reported PROSPECTIVELY as a component from CONTINUING OPERATIONS
Know how to calculate
Cash Basis when they give you
Cash Basis Expenses
AND
Cash Basis Income
For Cash Basis Expense
+ Beg Bal Exp
-End Bal Exp
Accrued Exp
-Beg Bal
+End Bal
Disclosure of Accounting Policies
Is an integral part of the financial stmts
Inventory Turnover Ratio = COGS / AVG Inventory
In order for Inventory Turnover Ratio to increase
COGS increases
or
AVG Inventory must decrease
If COGS sold increased and sales remained constant, GP % would decrease
Trading Securities are calculated to get
Quick Ratio
AND
Current Ratio
