Financial Reporting Flashcards
Financial Reporting
The way companies show their financial performance to investors, creditors, and other interested parties by preparing financial statements
Financial Statement Analysis
Use the information in a company’s financial statements, along with other relevant information, to make economic decisions
Balance Sheet
Reports the firm’s financial position at a point in time
- Assets: resources controlled by the firm
- Liabilities: amounts owed to lenders and other creditors
- Shareholders’ Equity: residual interest in net assets of an entity that remains after deducting liabilities
Statement of Comprehensive Income
Reports all changes in equity except for shareholder transactions (issuing, repurchasing, paying dividends)
Income Statement
Reports the financial performance of the firm over a period of time
- Revenues: inflows from delivering goods and services
- Expenses: outflows from delivering or producing goods or services
- Other Income: gains that may or may not arise in the ordinary course of business
Statement of Changes in Equity
Reports the amounts and sources of changes in equity investors’ investments in the firm over a period of time
Statement of Cash Flows
Reports the company’s cash receipts and payments
Operating Cash Flows
Cash effects of transactions that involve the normal business of the firm
Investing Cash Flows
Resulting from the acquisition or sale of property, plant and equipment, of a subsidiary or segment, of securities and of investments in other firms
Financing Cash Flows
Resulting from the issuance or retirement of the firm’s debt and equity securities (include dividends paid)
Footnotes
Disclosures that provide further details about the information summarized in the financial statements. Improve assessment of amount, timing and uncertainty of estimates
Management’s Commentary (MD&A)
Management discusses nature of the business, management’s objectives, company’s past performance, performance measures used, company’s key relationships, resources and risks
Audit
Independent review of an entity’s financial statements (fairness and reliability)
Standard Auditor’s Opinion
- Auditor has performed an independent review
- Reasonable assurance financial statements contain no material errors
- Statements prepared in accordance with accepted accounting principles and estimates are reasonable
Unqualified Opinion
Auditor believes the statements are free from material omissions and errors (clean opinion)
Qualified Opinion
Statements make exceptions to the accounting principles. Auditor report explains exceptions
Adverse Opinion
Statements are not presented fairly or are materially nonconforming with accounting standards
Disclaimer of Opinon
Auditor is unable to express an opinion (scope of limitation)
Going Concern Assumption
Assumption that the firm will continue to operate for the foreseeable future, despite probable material loss (cannot be reasonably estimated)
Internal Controls
Processes by which the company ensures that it presents accurate financial statements (responsibility of management)
Proxy Statements
Issued to shareholders when there are matters that require a shareholder vote (election of board members, compensation, management qualifications, issuance of stock options)
Earnings Guidance
Released prior to financial statements, conference call after where senior management discusses earnings
Financial Statement Analysis Framework
- Objective and Context
- Gather Data
- Process the Data
- Analyze and Interpret the Data
- Report the Conclusions or Recommendations
- Update the Analysis
Standard-Setting Bodies
Professional organizations of accountants and auditors that establish financial reporting standards (FASB and IASB)
Regulatory Authorities
Government agencies that have the legal authority to enforce compliance with financial reporting standards (SEC)
International Organization of Securities Commissions (IOSCO)
- Protect investors
- Ensure fairness, efficiency and transparency or markets
- Reduce systemic risk
Form S-1
Registration statement filed prior to the sale of new securities to the public
Form 10-K
Required annual filing including information about business and management, audited financial statements and disclosures
Form 10-Q
Filed quarterly with updated financial statements, do not have to be audited. Disclose legal proceedings or changes in accounting policy
Form DEF-14A
Company prepares a proxy statement for its shareholders prior to annual meeting or other shareholder vote
Form 8-K
Companies file to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance
Form 144
Company can issue securities to certain qualified buyers without registering the securities with the SEC
Forms 3, 4 and 5
Beneficial ownership of securities by company’s officers and directors
Convergence
Developing one universally accepted set of accounting standards
Relevance
Financial statements are relevant if the information in them can influence users’ economic decisions or affect users’ evaluations of past events or forecasts of future events
- Predictive Value
- Confirmatory Value
- Materiality
Faithful Representation
Complete, neutral (non-biased), free from error
Comparability
Financial statements should be consistent among firms and across time periods
Verifiability
Independent observers using same methods should obtain similar results
Timeliness
Information is available to decision makers before the information is stale
Understandibility
Users with a basic knowledge of business and accounting who make a reasonable effort to study the financial statements should be able to readily understand the information
Assets
Resources controlled as a result of past transactions expected to provide future economic benefits
Liabilities
Obligations as a result of past events that are expected to require an outflow of economic resources
Equity
Owners’ residual interest in the assets after deducting the liabilities
Income
Increase in the economic benefits, either increasing assets or decreasing liabilities in a way that increases owners’ equity
Expenses
Decreases in economic benefits, either decreasing assets or increasing liabilities in a way that decreases owners’ equity
Measurement Base
Determines the amounts at which items are reported in the financial statements
Historical Cost
The amount originally paid for the asset
Amortized Cost
Historical cost adjusted for depreciation, amortization, depletion and impairment
Current Cost
Amount the firm would have to pay today for the same asset
Net Realizable Value
Estimated selling price of the asset in the normal course of business minus the selling costs
Present Value
Discounted value of the asset’s expected future cash flows
Fair Value
Price at which an asset could be sold, or a liability transferred, in an orderly transaction between two willing parties
Accrual Accounting
Financial statements should reflect transactions at the time they actually occur, not necessarily when cash is paid (revenue recognize when earned, expenses recognized when incurred)
Going Concern
Assumes the company will continue to exist for the foreseeable future
Fair Presentation
Faithfully representing the effects of the entity’s transactions and events according to the standards for recognizing assets, liabilities, revenues
Going Concern Basis
Financial statements are based on the assumption the firm will continue to exist unless its management intends to liquidate it
Consistency
How items are presented and classified between periods, with prior-period amounts disclosed for comparison. Also across geographic areas and companies
Materiality
Financial statements should be free of misstatements or omissions that could influence decisions of users
Aggregation
Similar items grouped, dissimilar items separated
Offsetting
Assets can’t be offset against liabilities or income against expenses unless a certain standard permits it
Classified Balance Sheet
Shows current and non-current assets and liabilities
Minimum Information
Required on the face of each financial statement and in the notes (must show specific items)
Reconciliation Statement
Showing what financial results would have been under an alternative reporting system
Transparency
Full disclosure and fair presentation reveal underlying economics
Comprehensiveness
All types of transactions that have financial implications should be part of the framework
Valuation
Some measurement bases require little judgement and may be less relevant
Principles Based Approach
Relies on a broad framework
Rules Based Approach
Gives specific guidance about how to classify transactions
Objectives Based Approach
Combination of principles and rules based
Measurement
Properly valuing the elements at one point in time and properly valuing the changes between points in time (asset/liability approach vs revenue/expense approach)
Net Revenue
Revenue less adjustments for estimated returns and allowances
Expenses
Cost of goods sold, operating expenses, interest and taxes. Grouped by nature or by function
Net Income
revenues - ordinary expenses + other income - other expenses + gains - losses
Noncontrolling Interest
Pro rata share of the subsidiary’s income not owned by the parent is reported in parent’s income statement (minority interest). Subtracted when arriving at net income
Single Step Income Statement
All revenues are grouped together and all expenses are grouped together
Multi-Step Income Statement
Revenues - COGS to get gross profit and then net income
Gross Profit
Amount that remains after the direct costs of producing a product or service are subtracted from revenue
Operating Income
Subtracting operating expenses (selling, general and administrative expenses) from gross profits
Net Income
Subtracting interest expense and income taxes from operating profit (bottom line)
Revenue Recognition: Sale of Goods
- Risk and reward of ownership transferred
- No continuing control or management over goods sold
- Revenue reliably measured
- Probable flow of economic benefits
- Cost reliably measured
Revenue Recognition: Services Rendered
- Amount of revenue reliably measured
- Probable flow of economic benefits
- Stage of completion measured
- Cost incurred and cost of completion reliably measured
SEC Revenue Recognition
- Evidence of an arrangement between buyer and seller
- Product has been delivered or service rendered
- Price is determined or determinable
- Seller reasonably sure of collecting money
Unearned Revenue
Firm receives cash before revenue recognition is complete. reported on the balance sheet as a liability. Liability is reduced in the future as cash is earned
Percentage of Completion Method
Outcome of a long term contract can be reliably estimated. Revenue, expense, profit recognized as work is performed (total cost incurred to date divided by total expected cost of the project)
Completed Contract Method
If the firm can’t reliably measure the outcome of the project, revenue is recognized to the extent of contract costs. Costs expensed when incurred and recognized only at completion (loss must immediately be recognized)
Installment Sale
Occurs when a firm finances a sale and payments are expected to be received over an extended period of time
Installment Method
Used when collectibility cannot be reasonably estimated. Profit is recognized as cash is collected. Profit equal to cash collected during period multiplied by total expected profit as percentage of sales
Cost Recovery Method
Collectibility is highly uncertain. Profit is recognized only when cash collected exceeds costs incurred
Barter Transaction
Two parties exchange goods or services without cash payment. Recognized at fair value can use historical experience to determine
Round Trip Transaction
Sale of goods to one party with the simultaneous purchase of almost identical goods from the same party
Gross Revenue Reporting
Selling firm reports sales revenue and cost of goods sold separately (sales higher than in net revenue reporting)
- Primary obligor under contract
- Bear inventory and credit risk
- Choose its supplier
- Reasonable latitude to establish price
Net Revenue Reporting
Only the difference in sales and cost is reported
Contract
Agreement between two or more parties that specifies their obligations and rights (collectibility must be probable)
Performance Obligation
Promise to deliver a distinct good or service (customer benefits from good or service on its own or with other readily available resources, promise to transfer is separately identifiable from other promises)
Matching Principle
Expenses to generate revenue are recognized in the same period as revenue
Period Costs
Expenses that cannot directly be tied to revenue generation (administrative expenses). Expensed in period incurred
Specific Identification Method
Identify exactly which items were sold and which items remain in inventory
FIFO
First item purchased is assumed to be the first item sold. Cost of inventory acquired first used to calculate cost of goods sold for the period. Cost of most recent purchases used to calculate ending inventory
LIFO
Last item purchased is assumed to be the first item sold. Cost of inventory most recently purchased assigned to cost of goods sold for the period. Costs of beginning inventory and earlier purchases assigned to ending inventory
Weighted Average Cost
Makes no assumption about the physical flow of the inventory. Used to determine COGS and ending inventory (between LIFO and FIFO)
Long Lived Assets
Expected to provide economic benefits beyond one accounting period
Depreciation
Allocation of cost over a tangible asset’s life
Depletion
Allocation of cost over a natural resource’s life
Amortization
Allocation of cost over an intangible asset’s life
Straight Line Depreciation
Recognizes an equal amount of depreciation expense each period (assets generate more benefits in early years –> accelerated depreciation)
Accelerated Depreciation
Speeds up the recognition of depreciation expense in a systematic way to recognize more depreciation expense in the early years of the asset’s life and less in later years
Declining Balance Method
Applies a constant rate of depreciation to an asset’s declining book value each year
Double Declining Balance
Applies two times the straight-line rate to the declining balance
Discontinued Operations
Operation management has decided to dispose of, but has not yet done so, or disposed in current year after the operation had generated income or losses
Measurement Date
Date when the company develops a formal plan for disposing of an operation
Phaseout Period
Time between the measurement period and the actual disposal date
Unusual or Infrequent Items
Gains or losses from sale of assets of part of a business, impairments, write-offs, write-downs, restructuring costs
Extraordinary Items
Material transaction or event that was both unusual and infrequent (no longer allowed)
Change in Accounting Principles
Change from one GAAP or IFRS method to another
Retrospective Application
After change in accounting principle, all prior period financial statements currently presented are restated to reflect the change
Change in Accounting Estimate
Result of a change in management’s judgment, usually due to new information (prospective, no restating prior statements)
Prior Period Adjustment
Change from an incorrect accounting method to one that is acceptable under GAAP or IFRS or correction of accounting error in previous statements (restate prior periods in current statement, disclosure required)
Earnings per Share
Corporate profitability performance measure for publicly traded firms (only for shares of common stock)
Simple Capital Structure
Contains no potentially dilutive securities. Contains only common stock, nonconvertible debt, nonconvertible preferred stock
Complex Capital Structure
Contains potentially dilutive securities such as options, warrants or convertible securities (report basic and diluted EPS)
Weighted Average of Common Shares
Number of shares outstanding during the year weighted by the portion of the year they were outstanding
Stock Dividend
Distribution of additional shares to each shareholder in an amount proportional to their current number of shares
Stock Split
Division of each old share into a specific number of new shares (proportional ownership unchanged)
Dilutive Securities
Stock options, warrants, convertible debt, convertible preferred stock that would decrease EPS if exercised or converted to common stock
Antidilutive Securities
Stock options, warrants, convertible debt, convertible preferred stock that would increase EPS if exercised or converted to common stock
Treasury Stock Method
Assumes that funds received by the company from the exercise of options would be used to hypothetically purchase shares of the company’s common stock in the market at the average market price
Common Size Income Statement
Expresses each category of the income statement as a percentage of revenue (standardizes)
Effective Tax Rate
Tax expense when expressed as a percentage of pretax income
Gross Profit Margin
Ratio of gross profit (Revenue - COGS) to revenue (sales)
Net Profit Margin
Net income to revenue. Profit generated after considering all expenses
Retained Earnings
At the end of each accounting period, net income of the firm is added to stockholders’ equity through this account
Comprehensive Income
Includes all changes in equity except for owner contributions and distributions
Available for Sale Securities
Investment securities that are not expected to be held to maturity or sold in the near term. Reported on the balance sheet at fair value
Other Comprehensive Income
Not included in net income
- Foreign currency translation gains and losses
- Adjustments for minimum pension liability
- Unrealized gain and losses from cash flow hedging derivatives
- Unrealized gains and losses from available for sale securities
Liquidity
The ability to meet short term obligations
Solvency
The ability to meet long term obligations
Classified Balance Sheet
Reporting current assets and noncurrent assets, and current liabilities and noncurrent liabilities (evaluate liquidity)
Liquidity Based Format
Present assets and liabilities in order of liquidity (IFRS)
Current Assets
Include cash and other assets that will likely be converted into cash or used up within one year or one operating cycle (whichever is greater). Order of liquidity
Operating Cycle
Time it takes to produce or purchase inventory, sell the product and collect the cash
Current Liabilities
Obligations that will be satisfied within one year or one operating cycle (settlement dates, held for trading purposes)
Working Capital
Current assets minus current liabilities (indicates liquidity)
Noncurrent Assets
Will not be converted to cash or used up within one year or operating cycle. Firm’s investing activities
Noncurrent Liabilities
Provide information about firm’s long term financing activities
Cash Equivalents
Short term, highly liquid investments that are readily convertible to cash and near enough to maturity that interest rate risk is insignificant (T bills, commercial paper, money market funds)
Marketable Securities
Financial assets traded in a public market and whose value can be readily determined (T bills, notes, bonds, equities)
Accounts Receivable
Financial assets that represent amounts owed to the firm by customers for goods or services sold on credit
Contra Account
Used to reduce the value of its controlling account (allowance for doubtful accounts)
Written Off
Receivables removed from the balance sheet because they are uncollectible (gross receivables and allowance accounts reduced)
Inventories
Goods held for sale to customers or used in manufacture of goods to be sold (raw materials, work in process, finished goods)
Standard Costing
Assigning predetermined amounts of materials, labor and overhead to goods produced
Retail Method
Measure inventory at retail prices and then subtract gross profit in order to determine cost
Net Realizable Value
Equal to the selling price less any completion costs and selling costs
Other Current Assets
Amounts that may not be material if shown separately, so items are combined into a single amount (prepaid expenses, deferred tax assets)
Prepaid Expenses
Operating costs that have been paid in advance
Deferred Taxes
Result of temporary differences between financial reporting income and tax reporting income
Deferred Tax Assets
Created when the amount of taxes payable exceeds the amount of income tax expense recognized in the income statement
Accounts Payable
Amounts the firm owes to suppliers for goods or services purchased on credit
Notes Payable
Obligations in the form of promissory notes owed to creditors and lenders (can be noncurrent if greater than a year)
Current Portion of Long Term Debt
Principal portion of debt due within one year or operating cycle
Accrued Liabilities
Expenses that have been recognized in the income statement but are not yet contractually due
Taxes Payable
Current taxes that have been recognized in the income statement but have not yet been paid
Unearned Revenue
Deferred income. Cash collected in advance of providing goods and services
Property, Plant and Equipment
Tangible assets used in the production of goods and services (land, buildings, machinery, furniture, natural resources)
Cost Model
PP&E other than land (indefinite life) is reported at amortized cost (historical minus accumulated depreciation, amortization, depletion). IFRS and GAAP
Historical Cost
Purchase price plus any cost necessary to get the asset ready for use (delivery, installation costs)
Impairment
If an asset’s carrying value exceeds the recoverable amount
Recoverable Value
Greater of fair value less any selling costs, or an asset’s value in use
Value in Use
Present value of an asset’s future cash flow stream
Revaluation Model
PP&E is reported at fair value less any accumulated depreciation (IFRS)
Investment Property
Assets that generate rental income or capital appreciation
Fair Value Model
Any change in fair value is recognized in the income statement
Intangible Assets
Non-monetary assets that lack physical substance
Identifiable Intangible Assets
Can be acquired separately or are the result of rights or privileges conveyed to their owner (patents, trademarks, copyrights)
Unidentifiable Intangible Assets
Cannot be acquired separately and may have unlimited life (goodwill)
Accounting Goodwill
Excess of purchase price over the fair value of the identifiable net assets acquired in a business acquisition (result of past acquisitions)
Economic Goodwill
Derives from the expected future performance of the firm (price paid relative to the earning power of the acquired asset)
Held to Maturity Securities
Debt securities acquired with the intent to be held to maturity (measured at amortized cost –> issue price minus principal payment, plus amortized discount or minus amortized premium, minus impairment losses)
Mark to Market Securities
Financial assets measured at fair value (trading securities, available for sale securities, derivatives)
Trading Securites
Debt and equity securities acquired with the intent to profit over the near term
Holding Period Gains and Losses
Unrealized gains and losses recognized on the income statement
Available for Sale Securities
Debt or equity securities not expected to be held to maturity or traded in the near term (reported at fair value, unrealized gains or losses not in income statement, in other comprehensive income)
Long Term Financial Liabilities
Bank loans, notes payable, bonds payable, derivatives. Not issued at face value, reported on balance sheet as amortized cost
Deferred Tax Liabilities
Amounts of income taxes payable in future periods as a result of taxable temporary differences. Created when income tax expense recognized in the income statement is greater than taxes payable
Owners’ Equity
Residual interest in assets that remains after subtracting an entity’s liability (contributed capital, preferred stock, treasury stock, retained earnings, etc.)
Contributed Capital
Issued capital, amount contributed by equity shareholders
Authorized Shares
The number of shares that may be sold under the firm’s articles of incorporation
Issued Shares
Number of shares that have actually been sold to shareholders
Outstanding Shares
Equal to the the issued shares less the shares that have been reacquired by the firm (treasury stock)
Preferred Stock
Certain rights and privileges not conferred by common stock. Paid dividends at a specified rate, have priority over claims of common shareholders in event of liquidation
Noncontrolling Interest
Minority shareholders’ pro-rata share of the net assets (equity) of a subsidiary that is not wholly owned by the parent
Retained Earnings
Undistributed earnings (net income) of the firm since inception, cumulative earnings not paid out to shareholders as dividends (Net Income - Dividends Declared)
Treasury Stock
Stock that has been reacquired by the issuing firm but not yet retired (reduces shareholders’ equity). No voting rights and no dividends
Accumulated Other Comprehensive Income
All changes in stockholders’ equity except for transactions recognized in the income statement and transactions with shareholders (issuing/reacquiring stock, paying dividends)
Statement of Changes in Stockholders’ Equity
Summarizes all transactions that increase or decrease the equity account for the period (capital stock, additional paid in capital, retained earnings, accumulated other comprehensive income)
Common Size Balance Sheet
Expresses each item of the balance sheet as a percentage of total assets (eliminates effects of size). Time series and cross sectional comparisons
Liquidity Ratios
Measure the firm’s ability to satisfy its short term obligations as they come due
Current Ratio
Current Assets/Current Liabilities
Quick Ratio
Cash + Marketable Securities + Receivables/Current Liabilities –> excludes inventory from current ratio
Cash Ratio
Cash + Marketable Securities/Current Liabilities –> excludes inventory and receivables
Solvency Ratios
Measure the firm’s ability to satisfy its long term obligations
Long Term Debt to Equity Ratio
Long Term Debt/Total Equity
Total Debt to Equity Ratio
Total Debt/Total Equity
Debt Ratio
Total Debt/Total Assets
Financial Leverage
Total Assets/Total Equity
Cash Flow Statement
Provides information beyond that available from the income statement (cash accounting rather than accrual)
- Cash receipts and cash payments
- Company’s operating, investing and financing activities
Cash Flow from Operating Activities
Inflows and outflows of cash resulting from transactions that affect the firm’s net income (cash collected from sales, interest and dividends received, taxes paid, interest paid on debt or leases, cash paid to employees)
Cash Flow from Investing Activities
Inflows and outflows of cash resulting from the acquisition or disposal of long term assets and certain investments (sales of fixed assets, sales of debt or equity investments, loans made to others, acquisition of debt and equity investments)
Cash Flow from Financing Activities
Inflows and outflows of cash resulting from transactions affecting the firm’s capital structure (proceeds from issuing stock, principal from debt issuance, principal paid on debt or leases, payments to reacquire stock, dividends paid)
Noncash Activities
Not reported in cash flow statement since they do not result in inflows or outflows of cash. Disclosed in a footnote or supplemental schedule
Direct Method
Each line item of the accrual based income statement is converted into cash receipts or cash payments (revenue and expense recognition occur when cash is received or paid) –> Converts accrual based income statement to cash based. Results in operating cash flow
Indirect Method
Net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions (eliminate noncash expenses such as depreciation and amortization, nonoperating items)
Converting Indirect to Direct
Find CFO using a combination of the income statement and a statement of cash flows prepared under indirect method. Adjust each income statement item for its corresponding balance sheet accounts and eliminate noncash and nonoperating transactions
Cash Collections
Sales - Increase in Accounts Receivable –> Beginning Receivables + Sales - Cash Collections = Ending Receivables
Cash Paid to Suppliers
-COGS + Decrease in Inventory + Increase in Accounts Payable
Free Cash Flow
Measure of the cash that is available for discretionary purposes (cash available once firm has covered capital expenditures)
Free Cash Flow to the Firm (FCFF)
Cash available to all investors, both equity owners and debt owners
Free Cash Flow to Equity (FCFE)
Cash flow that would be available for distribution to common shareholders
Cash Flow to Revenue
Amount of operating cash flow generated for each dollar of revenue –> CFO/Net Revenue
Cash Return on Assets Ratio
Return of operating cash flow attributed to all providers of capital –> CFO/Avg Total Assets
Cash Return on Equity Ratio
Return of operating cash flow attributed to shareholders –> CFO/Avg Total Equity
Cash to Income Ratio
Ability to generate cash from firm operations –> CFO/Operating Income
Cash Flow per Share
CFO - Preferred Dividends/Weighted Avg Number of Common Shares
Debt Coverage Ratio
Financial risk and leverage –> CFO/Total Debt
Interest Coverage Ratio
Firm’s ability to meet its interest obligations –> CFO + Interest Paid + Taxes Paid/Interest Paid –> EBIT/Interest
Reinvestment Ratio
Firm’s ability to acquire long-term assets with operating cash flow –> CFO/Cash Paid for Long Term Assets
Debt Payment Ratio
Firm’s ability to satisfy long term debt with operating cash flow –> CFO/Cash Long Term Debt Repayment
Dividend Payment Ratio
Firm’s ability to make dividend payments from operating cash flow –> CFO/Dividends Paid
Investing and Financing Ratio
Firm’s ability to purchase assets, satisfy debts and pay dividends –> CFO/Cash Outflows from Investing and Financing Activities
Stacked Column Graph
Shows changes in items from year to year
Activity Ratios
Indicate how well a firm utilizes various assets such as inventory and fixed assets (inventory turnover, receivables turnover, total asset turnover)
Liquidity Ratios
Ability to pay short term obligations as they come due
Solvency Ratios
Financial leverage and ability to meet longer term obligations
Profitability Ratios
How well the company generates operating profits and net profits from its sales
Valuation Ratios
Compare the relative valuation of companies (sales per share, earnings per share)
Receivables Turnover
Annual Sales/Average Receivables
Days of Sales Outstanding
Average collection period. 365/Receivables Turnover
Inventory Turnover
Firm’s efficiency with respect to its processing and inventory management. COGS/Average Inventory
Days of Inventory on Hand
365/Inventory Turnover
Payables Turnover
Use of trade credit. Purchases/Average Trades Payable
Payables Payment Period
Average amount of time it takes the company to pay its bills. 365/Payables Turnover Ratio
Total Asset Turnover
Effectiveness of firm’s use of its total assets to create revenue. Revenue/Average Total Assets
Fixed Asset Turnover Ratio
Revenue/Average Net Fixed Assets
Working Capital Turnover Ratio
Revenue/Average Working Capital
Defensive Interval Ratio
Number of days of average cash expenditures the firm could pay with its current liquid assets
Cash + Marketable Securities + Receivables/Average Daily Expenditures
Cash Conversion Cycle
Length of time it takes to turn the firm’s cash investment in inventory back into cash, in the form of collections from the sales of that inventory
Days Sales Outstanding + Days of Inventory on Hand - Number of Days Payables
Debt Ratios
Solvency ratios based on the balance sheet
Coverage Ratios
Solvency ratios based on the income statement
Debt to Equity Ratio
Use of fixed cost financing sources. Total Debt/Total Shareholders’ Equity
Debt to Capital Ratio
Total Debt/Total Debt + Total Shareholders’ Equity
Debt to Assets Ratio
Total Debt/Total Assets
Financial Leverage Ratio
Average Total Assets/Average Total Equity
Interest Coverage Ratio
Earnings Before Interest and Taxes/Interest Payments
Fixed Charge Coverage Ratio
EBIT + Lease Payments/Interest Payments + Lease Payments
Net Profit Margin
Net Income/Revenue
Gross Profits
Net Sales - COGS
Operating Profits
Earnings Before Interest and Taxes (EBIT)
Net Income
Earnings after taxes but before dividends
Total Capital
LT Debt + ST Debt + Common and Preferred Equity or just Total Assets
Gross Profit Margin
Gross Profit/Revenue
Operating Profit Margin
Operating Profit/Revenue = EBIT/Revenue
Pretax Margin
EBT/Revenue
Return on Assets
Net Income/Average Total Assets or Net Income + Interest Expense (1 - Tax Rate)/ Average Total Assets
Return on Total Capital
EBIT/Average Total Capital
Return on Equity
Net Income/Average Total Equity
Return on Common Equity
Net Income - Preferred Dividends/Average Common Equity
DuPont Equation
Breaks Return on Equity down into components of Net Profit Margin, Asset Turnover and Leverage
Price to Earnings Ratio
Current Market Price per Share/Earnings per Share
Retention Rate
Proportion of earnings reinvested (1 - dividend payout ratio)
Sustainable Growth Rate
How fast the firm can grow without additional external issues while holding leverage constant
g = RR x ROE
Coefficient of Variation
Standard Deviation/Expected Value
Capital Adequacy
Ratio of some dollar measure of risk (operational and functional) of the firm to its equity capital
Value at Risk
Estimate of the dollar size of the loss that a firm will exceed only some specific percent of the time, over a specific period
Liquid Asset Requirement
Ratio of a bank’s liquid assets to certain liabilities
Net Interest Margin
Performance of financial companies that lend funds. Interest Income/Firm’s Interest Earning Assets
Business Segment
Portion of a larger company that accounts for more than 10% of the company’s revenues or assets, distinguishable from the company’s other lines of business in terms of risk and return characteristics
Geographic Segments
Business segment that has an environment that is different from other segments or the remainder of the company’s business
Sensitivity Analysis
Based on “what if” questions
Scenario Analysis
Based on a specific set of outcomes for key variables. Will yield a range of values for financial statement items
Simulation
Probability distributions for key variables selected on a computer used to generate a distribution of values for outcomes based on repeated random selection
Product Costs
Capitalized in inventories account on balance sheet:
- Purchase cost less trade discount and rebates
- Conversion costs (labor, overhead)
- Transportation costs
Period Costs
Costs expensed in the period incurred:
- Abnormal waste of materials, labor, overhead
- Storage costs (unless part of production)
- Administrative overhead
- Selling costs
Cost Flow Assumption/Cost Flow Formula
GAAP/IFRS. Cost flow method used when cost of purchasing or producing inventory will change over time
- Specific Identification
- FIFO
- Weighted Average Cost
- LIFO (GAAP only)
Specific Identification
Each unit is sold and matched with the unit’s actual cost (used when inventory items are not interchangeable –> small number of costly and easily distinguishable items)
First In, First Out
First item purchased is assumed to be the first item sold. Ending inventory based on most recent purchases, COGS understated compared to current costs in inflationary
Last In, First Out
Item purchased most recently is assumed to be the first item sold, COGS higher and earnings lower in inflationary (lower taxes).
Weighted Average Cost
Average cost per unit of inventory (Goods Available for Sale/Total Quantity Available for Sale) –> Between FIFO and LIFO
Periodic Inventory System
Inventory values and COGS are determined at the end of the accounting period. Inventory acquired is purchases, which are added to beginning inventory to find COGS
Perpetual Inventory System
Inventory values and COGS are updated continuously. Inventory purchased and sold is recorded directly in inventory when transactions occur
LIFO Reserve
Amount by which LIFO inventory is less than FIFO inventory (add this to LIFO Inventory on the balance sheet, increase retained earnings by this as well)
- Decrease cash by tax rate times LIFO Reserve
- Increase retained earnings by LIFO reserve * (1-tax rate)
LIFO Liquidation
LIFO firm’s inventory quantities decline. Older, lower costs are included in COGS. Higher profit margins and higher income taxes
Net Realizable Value
Expected sales price less the estimated selling costs and completion costs
“Written Down”
Net realizable value is less than balance sheet value of inventory. Loss recognized on income statement by increasing COGS
“Written Up”
Recovery in inventory value, inventory on balance sheet increases, COGS on income statement is decreased by amount of recovery
Lower of Cost or Market
For GAAP companies using LIFO reporting on balance sheet.
Market is replacement cost, cannot be greater than NRV or less than NRV minus normal profit margin
Inventory Disclosures
Cost flow method, carrying value of inventory (and by classification), cost of inventory as an expense, carrying value of inventory (FV - selling costs), inventory write downs, write ups, inventories pledged as collateral
Capitalizing Costs
Expenditure that is recorded as an asset on the balance sheet at its fair value at acquisition plus any costs to prepare for use. Expected to provide future benefit over multiple accounting periods
-Regular maintenance of the asset expensed, rebuilding capitalized
Expensing Costs
Asset’s cost put on income statement in period incurred if future economic benefit is unlikely or highly uncertain
Construction Interest
Interest that accrues during construction of an asset is capitalized as part of the asset’s cost (interest not reported on income statement)
Intangible Assets
Long term assets that lack physical substance (patents, brand names, copyrights, franchises)
- Finite Lived: cost amortized over useful life
- Indefinite Lived: tested for impairment annually (reduction value recognized in income statement as loss)
Identifiable Intangible Asset
Capable of being separated from firm, controlled by the firm, expected to provide future economic benefits (probable, cost reliably measured)
Unidentifiable Intangible Asset
Cannot be purchased separately and may have an indefinite life (goodwill)
Research Costs
Costs aimed at the discovery of new scientific or technical knowledge (expensed as incurred under IFRS and GAAP)
Development Costs
Translate research findings into a plan or design of a new product or process (generally expensed as incurred, can be capitalized
Software Costs
Developed for sale to others. Expensed as incurred until product’s technological feasibility has been established, then costs of developing salable product are capitalized
Acquisition Method
Used in business combinations. Purchase price is allocated to the identifiable assets and liabilities of the acquired firm on the basis of fair value. Remaining purchase price is recorded as goodwill (capitalized if part of combination, if internal it’s expensed)
Carrying (Book) Value
Net value of an asset on the balance sheet (Historical Cost minus accumulated depreciation)
Historical Cost
Original purchase price of an asset including installation and transportation costs
Economic Depreciation
Actual decline in the value of an asset over the period
Straight Line Depreciation
Same amount each year over the asset’s life
Accelerated Depreciation
More depreciation expense is recognized in the early years of an asset’s life
Units of Production
Based on usage rather than time (depreciation higher in periods of high usage) –> depletion for natural resources
Component Depreciation
Useful life of each component of an asset is estimated and depreciation expense is computed separately for each (required under IFRS, barely used under GAAP)
Revaluation Model
IFRS permits a long lived asset to be reported at its fair value, as long as an active market exists for the asset so its fair value can be reliably estimated
Revaluation Surplus
Fair value at first revaluation date is greater than carrying value, difference is recorded as surplus (component of equity)
Impairment
Asset’s carrying value (original cost minus accumulated depreciation) exceeds recoverable amount
Recoverable Amount
Greater of fair value less selling costs and value in use (PV of future cash flows)
Recoverability Test
Based on the estimate of asset’s future undiscounted cash flow stream
Loss Measurement
If impaired, asset value written down to fair value on balance sheet, and loss equal to excess of carrying value over fair value is recognized on income statement
Held for Sale
If an asset is reclassified as held for sale instead of held for use, it is tested for impairment –> this time if carrying value exceeds net realizable value. Loss can be reversed if asset recovers in the future
Derecognition
Long lived assets are eventually removed from the balance sheet when they are sold, exchanged or abandoned
Investment Property
IFRS only. Property that a firm owns for the purpose of collecting rental income, earning capital appreciation or both (cost model or fair value)
Lease
Contractual arrangement where the lessor (owner of an asset) allows a lessee to use the asset for a specified period of time in return for periodic payments
Finance (Capital) Lease
A purchase of an asset that is financed with debt (depreciation expense on the asset, interest expense on the liability). Increase assets and liabilities
Operating Lease
Rental arrangement. Periodic lease payments recognized as rental expense on income statement of lessee
Taxable Income
Income subject to tax based on the tax return
Taxes Payable
Tax liability caused by taxable income (current tax expense)
Income Tax Paid
Actual cash flow for income taxes including payments or refunds from other years
Tax Loss Carryforward
Current or past loss that can be used to reduce taxable income in the future (reduce taxes payable)
Tax Base
Net amount of an asset or liability used for tax reporting purposes. Amount that will be deducted on the tax return in the future as the economic benefits of the asset are realized
Accounting Profit
Pretax financial income based on financial accounting standards (earnings before tax)
Income Tax Expense
Expense recognized in the income statement that includes taxes payable and changes in deferred tax assets and liabilities
Deferred Tax Liabilities
Balance sheet amounts that result from an excess of income tax expense over taxes payable (temporary difference) that are expected to result in future cash outflows –> Pretax income exceeds taxable income
Deferred Tax Assets
Balance sheet amounts that result from an excess of taxes payable over income tax expense (temporary difference) that are expected to be recovered from future operations
Valuation Allowance
Reduction of deferred tax assets based on the likelihood the assets will not be realized
Carrying Value
Net balance sheet value of an asset or liability
Permanent Difference
Difference between taxable income (tax return) and pretax income (income statement) that will not reverse in the future
Temporary Difference
Difference between tax base and the carrying value of an asset or liability that will result in either taxable amounts or deductible amounts in the future
Carrying Value
Value of the asset reported on the financial statements, net of depreciation and amortization
Customer Advance
Revenue received in advance is taxable when collected. Tax base is carrying value minus amounts that will not be taxed in the future
Warranty Expense
Not deductible on tax return until the warranty work is actually performed. Tax base is carrying value minus amount deductible in future
Note Payable
Principal balance is carrying value and tax base. interest paid is included in both pre-tax income on income statement and taxable income on the tax return
Statutory Tax Rate
Tax rate of the jurisdiction where the firm operates
Effective Tax Rate
Income Tax Expense/Pretax Income
Valuation Allowance
Contra account that reduces the net balance sheet value of the DTA. Used if it is more likely than not that some or all of a DTA will not be realized
Bond
Contractual obligation between a borrower (bond issuer) and a lender (bondholder) that obligates the issuer to make payments to the bondholder over the term of the bond
Face Value
Par or maturity value. Amount of principal that will be paid to the bondholder at maturity. Used to calculate coupon payments
Coupon Rate
Interest rate stated on the bond used to calculate payments
Coupon Payments
Periodic interest payments to bondholders calculated by multiplying face value by coupon rate
Effective Rate of Interest
Interest rate that equates the present value of the future cash flows of the bond and the issue price. Market rate of interest required by bondholders
Balance Sheet Liability of a Bond
Book value or carrying value. Present value of its remaining cash flows discounted at market rate of interest at issuance (at maturity, liability equals face value)
Interest Expense
Reported on income statement. Multiplying book value of bond liability at beginning of period by market rate of interest when bond was issued
Discount Bonds
Coupon rate is less than the bond’s yield (proceeds received less than face value). Investor pays less than face value
Premium Bonds
Coupon rate is greater than the bond’s yield. Bond price greater than face value (investors pay more than face value)
Zero Coupon Bonds
Make no periodic interest payments (pure discount bond). Issued at a deep discount. Interest payment is instead included in the face value paid at maturity
Redeeming Bonds
Happens before maturity if interest rates fall, firm has generated surplus cash, or funds from issuance of equity make it possible
Debt Covenants
Restrictions imposed by the lender on the borrower to protect the lender’s position (reduce default risk and borrowing costs)
Affirmative Covenants
Borrower promises to do certain things such as make timely payments of principal and interest, maintain certain ratios, maintain collateral
Negative Covenants
Borrower promises to refrain from from certain activities that might adversely affect ability to repay outstanding debt (won’t increase dividends, repurchase shares, issue more debt, engage in M&A)
Technical Default
Bondholders can demand immediate repayment of principal if firm violates a covenant
Synthetic Lease
Lease is treated as an ownership position for tax reporting. Allows lease to deduct depreciation expense and interest expense
Bargain Purchase Option
Permits lessee to purchase leased asset for a price significantly lower than fair market value at some future date
Sales Type Lease
PV of lease payments exceeds carrying value of the asset. Treated as if the lessor sold the asset for PV of lease payments and provided a loan to the buyer in the same amount
Direct Financing Lease
PV of the lease payments is equal to the carrying value. No gross profit recognized by lessor at inception.
Lease Receivable
When an asset is leased, asset is removed from the balance sheet and receivable is created, equal to PV of lease payments (reduced by principal portion of lease payments)
Pension
Form of deferred compensation earned over time through employee service
Defined Contribution Plan
Retirement plan in which the firm contributes a sum each period to the employee’s account (years of service, employee’s age, compensation, profitability). Firm makes no promise to the employee on future value of assets. Employee assumes investment risk
Defined Benefit Plan
Firm promises to make periodic payments to employees after retirement (based on employee’s years of service and employee’s compensation at or near retirement). Employer assumes investment risk
Net Pension Asset
Fair value of plan’s assets is greater than estimated pension obligation (overfunded)
Net Pension Liability
Fair value of plan’s assets is less than the estimated pension obligation (underfunded)
Fixed Charge Coverage
(EBIT + Lease Payments)/(Interest Payments + Lease Payments)
