Financial Reporting Flashcards
Describe ROE and DuPont
Return on Equity = (NI/Average Equity)
DuPont Original
ROE = Net Profit Margin * Asset Turnover * Leverage (or equity multiplier)
(NI/Revenue) * (Revenue/Total Assets) * (Total Assets/Equity)
DuPont Extended: Breakout of Net Profit Margin into 3 ratios. Start at the bottom on income statement at net income, considering Tax and Interest. Look at operating profit separate from Tax and Interest.
NI/Revenue is broken out into 3 ratios:
EBIT Margin * Interest Burden * Tax Burden
(EBIT/Revenue) * (EBT/EBIT) * (NI/EBT) *
(Revenue/Total Assets) * (Total Assets/Equity)
EBIT Margin * Interest Burden * Tax Burden * Asset Turnover * Leverage
Tax burden = 1 – effective tax rate
Double Declining Depreciation Method
Double-declining balance (DDB), an accelerated depreciation method:
DDBdepreciationinyearx =
2/depreciablelifeinyears *
bookvalueatbeginningofyear x
Trade Payable and Trade Receivable
AKA Accounts Payable and Accounts Receivable
Interest Coverage Ratio
EBIT / INT EXP
Higher interest coverage means greater ability to cover required interest and lease payments.
LIFO vs FIFO when prices rise: Inventory, COGS, Net Income, tax
These four relations hold when prices have been rising over the relevant period:
LIFO inventory < FIFO inventory.
LIFO COGS > FIFO COGS.
LIFO net income < FIFO net income. (lower retained earnings)
LIFO tax < FIFO tax.
What adjustments need to be made to the balance sheet for LIFO reserve
LIFO Reserve is the amount by which LIFO inventory is less than FIFO inventory.
add the LIFO reserve to LIFO inventory on the balance sheet. This gives you FIFO ending inventory.
net income increases by the increase in the LIFO reserve multiplied by (1 - tax rate)
after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 − t)
increase the retained earnings component of shareholders’ equity by the LIFO reserve.
As it relates to LIFO, COGS FIFO
COGS FIFO = COGS LIFO - (ending LIFO reserve - beginning LIFO reserve)
Diluted Shares - Treasury Stock Method
The treasury stock method assumes that the funds received by the company from the exercise of the options would be used to hypothetically purchase shares of the company’s common stock in the market at the average market price.
Basic EPS
= net income - pref divd / weighted average shares of common
Note: divd to common shareholders is not included in EPS calc. So if it’s part of the question ignore it.
deferred tax asset vs liability
Tax reporting shows what you paid in taxes, while financial reporting shows what you should have paid. If you paid less than you should have you have a tax liability. If you paid more than you should have you have a tax asset. Also, you must look at tax payable under tax reporting vs tax expense under financial reporting
Note: if tax assets or liability is expected to reverse, than it hits assets or liability. If not, it hits equity.
CFO Indirect Method - Steps
Step 1 - Start with Net Income
Step 2 - Subtract gains or add losses resulting from financing or investing cash flows (i.e. sale of land)
Step 3 - add back all non-cash charges to income (i.e. depreciation and amortization). and subtract all noncash components of revenue. Include impairments, write-offs, write-downs, provisions (warranty, restructuring, legal), deferred tax
Step 4 - Add or subtract changes in balance sheet items
- an increase in an asset is a use of Cash (-)
- an increase in a liability is a source of Cash (+)
- YOU DO NOT ACCOUNT FOR CHANGE IN CASH
CFO - which sections of the balance sheet are typically used
With a few exceptions, operating activities relate to the firm’s current assets and current liabilities.
What happens to deferred tax assets/liabilities when the tax rate increases?
An increase in the tax rate increases the value of both deferred tax assets and deferred tax liabilities to reflect the future tax rate.
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When are financial markests considered operationally efficient?
When transaction costs are low
When are financial markets considered informationally efficient
when prices reflect new info quickly
when are financial markets allocationally efficient
when resources are allocated to their most productive uses.
Calc Margin Call Price
original price × [(1 - initial margin) / (1 - maintenance margin)]
Remember that the initial margin is in the numerator by thinking as “initial” as being first.
Inventory Turnover
COGS / average inventory
Free Cash Flow to Firm ( FCFF)
FCFF = Cash flow from operations + interest net of taxes - net capital expenditures
int net of taxes = (interest expense * (1 - t))
LIFO Liquidation
For a firm that uses the LIFO inventory cost method, a LIFO liquidation occurs if: the quantity of inventory decreases during a reporting period. In an increasing price environment this results in older, lower costs being included in COGS for the period.
Impairment under IFRS
Tested for impairment annually.
Asset is impaired if Carrying Value (original cost minus depreciation) exceeds the recoverable value.
Recoverable Value is the greater of its fair value less any selling costs and its value in use. The value in use is the present value of its future cash flow stream from continued use.
Impairments Under US GAAP
tested for impairment only when events and circumstances indicate the firm may not be able to recover the carrying value through future use.
Recoverability. An asset is considered impaired if the carrying value (original cost less accumulated depreciation) is greater than the asset’s future undiscounted cash flow stream.
The recoverable amount of an asset is defined as “the higher of its fair value less costs to sell and its value in use.” Value in use is a discounted measure of expected future cash flows. Under US GAAP, assessing recoverability is separate from measuring the impairment loss. An asset’s carrying amount is considered not recoverable when it exceeds the undiscounted expected future cash flows. If the asset’s carrying amount is considered not recoverable, the impairment loss is measured as the difference between the asset’s fair value and carrying amount.
Cash Ratio
Cash + Marketable Securities / Current Liabilities
deferred tax calc difference
The deferred tax liability is equal to the tax rate × temporary difference between the Financial reporting and Tax reporting #.
step 1 calc the carrying value (subtract accumulated depreciation) for Financial and Tax reporting.
step 2 - take the difference and multiply it by the tax rate.
Describe a firm’s primary source of liquidity
A company’s primary sources of liquidity are the sources of cash it uses in its normal day-to-day operations : selling goods and services, collecting receivables, and generating cash from other sources such as short-term investments.
increasing cash flow management efficiency is a primary source of liquidity.
increasing bank lines of credit is a primary source of liquidity.
Describe a firm’s secondary source of liquidity
Secondary sources of liquidity include liquidating short-term or long-lived assets, negotiating debt agreements (i.e., renegotiating), or filing for bankruptcy and reorganizing the company.
Financial Statement Analysis Framework
1 - State purpose and context of analysis 2 - Collect Data 3 - Process Data 4 - Analyze/interpret data 5 - state conclusion 6 - follow up
Free cashflow to the firm
Free cash flow to the firm can be computed as operating cash flows plus after-tax interest expense less capital expenditures.
Tax Expense calc
Income tax expense = income tax payable (the tax rate * taxable income) + the increase in the deferred tax liabilities.
Total Comprehensive Income and Comprehensive Income
DOES NOT INCLUDE DIVDs
Total comprehensive income = Net income + Other comprehensive income
Other Comprehensive Income
- gains/losses on available for sale securities
- Foreign currency translation gains and losses.
- Adjustments for minimum pension liability.
- Unrealized gains and losses from cash flow hedging derivatives.
- Unrealized gains and losses from available-for-sale securities.
Derecognition of an Asset
If asset is sold, the asset is removed from the balance sheet and the difference between the sale proceeds and the carrying value reported as a gain or loss in the income statement.
If a long-lived asset is abandoned, the treatment is similar to a sale, except there are no proceeds. In this case, the carrying value of the asset is removed from the balance sheet and a loss of that amount is recognized in the income statement.
Percentage of Completion Method - reliable estimate
Used for GAAP and IFRS when outcome of project can be reliably estimated.
The percentage of completion is measured by the total cost incurred to date divided by the total expected cost of the project. That % is applied to revenue of the project to calculate period revenue and profit
Unreliable estimate of project cost - IFRS vs GAAP
Under IFRS, revenue is recognized to the extent of contract costs, costs are expensed when incurred, and profit is recognized only at completion.
Under GAAP, the completed contract method must be used. Rev, exp and profit are recognized when project is complete
If a loss is expected, the loss is recognized immediately.
Installment Sales
Under U.S. GAAP, if collectibility is certain, revenue is recognized at the time of sale using the normal revenue recognition criteria. If collectibility cannot be reasonably estimated, the installment method is used. If collectibility is highly uncertain, the cost recovery method is used.
Under the installment method, profit is recognized as cash is collected. Profit is equal to the cash collected during the period multiplied by the total expected profit as a percentage of sales. Under the cost recovery method, profit is recognized only when cash collected exceeds costs incurred
