Financial Reporting & Analysis Flashcards
Income Tax Expense
expense recognized in the income statement that includes taxes payable and changes in deferred tax assets and liabilities (DTA and DTL)
Income Tax Expense = taxes payable + Change in DTL - Change in DTA
Valuation Allowance
Reduction of deferred tax assets based on the likelihood the assets will not be realized. A contra account. If circumstances change, the DTA can be increased by reducing the valuation allowance
Tax Loss Carryforward
A current or past loss that can be used to reduce taxable income (thus taxes payable) in the future. Can result in a deferred tax asset
Differences between the treatment of an accounting item for tax reporting and for financial reporting can occur when….
timing of revenue and expense recognition in the income statement and the tax return differ
Certain revenues and expenses are recognized in the income statement but never on the tax return (or vice-versa)
Assets and / or liabilities have diffe
Deferred Tax Liability
Created when income tax expense is greater than taxes payable (tax return) due to temporary differences. Most common way they are created is through different depreciation methods
Deferred Tax Asset
Created when taxes payable (tax return) are greater than income tax expense due to temporary differences. Post employment benefits, warranty expenses, and tax loss carryforwards are typical causes of deferred tax assets
Tax Base
The amount that will be deducted on the tax return in the future as the economic benefits of the asset are realized
If deferred tax liabilities are expected to reverse in the future, they are best classified by an analyst as a ______
Liability
If the deferred tax liability is not expected to reverse in the future, they are best classified as ______
Equity (DTL decreased and equity increased by the same amount)
Carrying Value
Value of the asset reported on the financial statements, net of depreciation and amortization
DTL and DTA values on the balance sheet must be changed because _____
the new tax rate is expected to be in force when the associated reversals occur.
Permanent Difference
A difference between taxable income and pretax income that will not reverse in the future. It is caused by revenue that is not taxable, expenses that are not deductible, or tax credits that result in a direct reduction in taxes.
Permanent differences will cause the firm’s effective tax rate to differ from the statutory tax rate
Statutory Tax Rate
The tax rate of the jurisdiction where the firm operates
According to US GAAP, if it is more likely than not that some or all of a DTA will not be realized then the DTA _____
Must be reduced by a valuation allowance
Impairments (deferred tax asset)
Generally result in a deferred tax asset since the writedown is recognized immediately in the income statement but the deduction on the tax return is generally not allowed until the asset is sold or disposed of
Restructuring (deferred tax asset)
Generates a deferred tax asset because the costs are recognized for financial reporting purposes when the restructuring is announced, but not deducted for tax purposes until it is actually paid
Information flows through an accounting system in four steps, they are ….
- Journal entries - record every transaction
- General Ledger - sorts the entries in the general journal by account
- Initial trial balance at the end of the accounting period
- Present account balances from the adjusted trial balance in the financial statements
Accounting Equation
Assets = Liabilities + Equity
Assets = Liabilities + contributed capital + retained earnings
Assets = liabilities + contributed capital + beginning retained earnings + revenue - expenses - dividends
Form 144
A company can issue securities to certain qualified buyers without registering the securities with the SEC but must notify the SEC that it intends to do so
Form 3,4,5
involve the beneficial ownership of securities by a company’s officers and directors. Analysts can use these filings to learn about purchases and sales of company securities by corporate insiders
International Organization of Securities Commissions (OSCO)
Three objectives - protect investors, ensure the fairness, efficiency, and transparency of markets and reduce systemic risk
Two fundamental characteristics that make financial statements useful
Relevance and faithful representation
Four characteristics that enhance relevance and faithful representation
Comparability, verifiability, timeliness, and understandability
Two important underlying assumptions of financial statements
accrual accounting and going concern
Two primary standard setting bodies are the IASB and the FASB
True
What have been barriers to developing universally accepted set of financial reporting standards?
Political pressure from business groups and disagreements among national standard-setting bodies and regulatory agencies
Differences between the IASB and the FASB
IASB lists income and expenses as performance elements while the FASB lists revenues, expenses, gains, losses and comprehensive income
Minor differences in the definition of assets.
FASB does not allow the upward revaluation of most assets
General features in preparing financial statements under IAS No 1
fair presentation, going concern basis, accrual basis, consistency, materiality, aggregation, no offsetting, reporting frequency, comparative information
SEC guidnace on four criteria to recognize revenue
- Evidence of an arrangement between the buyer and seller
- Product has been delivered or service has been rendered
- The price is determined or determinable
- The seller is reasonably sure of collecting money
Percentage of Completion Method
When outcome of a LT contract can be reliably estimated, the PoC method is used under both IRS and GAAP. Rev, expenses, and profit are recognized as the work is performed
How to record if the firm cannot reliably measure the outcome of the project
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 is used when the outcome of the project cannot be reliably estimated. Accordingly, revenue, expense, and profit are recognized only when the contract is complete
Percentage of Completion Method vs. Completed Contract Method
PoC method is more aggressive since revenue is reported sooner. PoC method is more subjective because it involves cost estimates
Installment Sales
Occurs when a firm finances a sale and payments are expected to be received over an extended period. If collectibility is certain, normal revenue is recognized at the time of sale. If collectibility cannot be reasonably estimated, use the installment method
Cost Recovery Method
Profit recognized only when cash collected exceeds cost incurred
Round Trip Transaction
involves the sale of goods to one party with the simultaneous purchase of almost identical goods from the same party
Barter Transaction
Under US GAAP, revenue from a barter transaction can be recognized at fair value only if the firm has historically received cash payments for such goods and services and can use this historical experience to determine fair value
Gross Revenue Reporting Criteria
The firm must: be the primary obligor under the contract, bear the inventory risk and credit risk, be able to choose its supplier, have reasonable latitude to establish the price
FIFO
First item purchased is the first item sold.
LIFO
Last item purchased is the first item sold
Why LIFO?
Popular due to income tax benefits. During inflationary periods, LIFO results in higher COGS and lower taxable income
SL Depreciation expense equation
(Cost - residual value) / Useful life
Declining Balance Method
Applies a constant rate of depreciation to an asset’s book value each year. Most common is the DDB method. Depreciation ends once the estimated residual value has been reached
DDB = (2 / useful life) (cost - accum depr)
Unusual or infrequent items
Cannot be both unusual or infrequent. Examples includ gains / losses form sale of assets. Impairments, write-offs, write-downs, and restructuring costs
Extraordinary Items
Material transaction or even that is both UNUSUAL AND INFREQUENT. Retirement of debt, uninsured losses from hurricane, loss from an expropriation of assets
A change in accounting principles
Requires retrospective application. All prior period fin stmts currently presented are restated to reflect the change
Change to LIFO from another inventory method does not apply change retrospectively. Instead uses carrying value of inventory as the first LIFO layer
Diluted EPS
Numerator = net income - preferred dividends + convertible preferred dividends + (convertible debt interet x (1-t))
Denominator = Weighted avg. shares + shares from conv. pfd shares conversion + shares from conv. debt conversion + shares issuable from stock options
Net profit margin
net income / revenues
Other Comprehensive Income
Foreign currency translation gains and losses, adjustments for minimum pension liabilities, unrealized gains and losses from CF hedging derivatives, unrealized gains and losses from AFS securities
Under IFRS
Firms can choose to report certain long lived assets at fair value rather than historical cost
Quick ratio
Cash + marketable securities + receivables / current liabilities
Cash Ratio
cash + marketable securities / current liabilities
Direct Method
Each line item of the accrual based income statement is converted into cash receipts or cash payments
Indirect Method
Net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions (normal cf)
Payment of interest - IFRS and GAAP
Under IFRS, payments for int and taxes must be disclosed separately in the cf statement under either method. Under GAAP, payments for interest and taxes can be reported in CF statement or disclosed in the footnotes
Cash Return on Assets
cfo / avg. total assets
Cash Return on Equity
CFO / avg. total equity
Cash to Income
CFO / operating income
debt coverage
CFO / Total debt
Reinvestment
CFO / Cash paid for LT assets
Debt Payment Ratio
CFO / cash long term debt repayment
Dividend payment ratio
CFO / dividends paid
Interest coverage
CFO + Interest paid + taxes paid / interest paid
Investing and financing ratio
CFO / cash outflows from investing and financing activities
Liquidity Ratios
ability to pay short term obligations
Solvency
firms financial leverage and ability to meet longer term obligations
Activity ratios
working capital ratios, asset utilization
Total asset turnover
revenue / avg. total assets
fixed asset turnover
revenue / average net fixed assets
Defense interval
cash + marketable securities + receivables / avg. daily expenditures
Debt to capital
total debt / (total debt + SE)
Debt to assets
total debt / total assets
Financial Leverage
avg. total assets / avg. total equity
Interest coverage
EBIT / Int. Payments
Fixed charge coverage
(EBIT + lease payments) /( Int payments + lease payments)
Return on Equity
net income / avg. total equity
Return on Common Equity
(net income - pref. div) / (avg. common equity)
Return on Total Capital
EBIT / Avg. Total Capital
Operating Return on Assets
Operating Income / Avg. Total Assets
Leverage ratio also called the _____
equity multiplier
DuPont Analysis
Break ROE down into its individual components
ROE = TAX Burden (net income / EBT) x interest burden (EBT / EBIT) x EBIT margin x asset turnover x financial leverage
Retention Rate
1 - dividend payout ratio
