Financial Reporting Analysis Flashcards
IFRS Framework. fundamental characteristics… (2)
relevance, faithful representation
IFRS Framework. enhancing characteristics… (4)
comparability, verifiability, timeliness, understandability
IFRS framework. qualitative characteristics (6)
relevance, faithful representation, comparability, verifiability, timeliness, understandability
IFRS framework. constraint
cost (cost/benefit considerations0
IFRS framework. underlying assumptions (2)
accrual basis, going concern
activity ratios measure…
asset utilization
operating efficiency
liquidity ratios measure…
the companys ability to meet its short term obligations
solvency ratios measure…
a companys ability to meet long term obligations. subsets are leverage and long term debt ratios
profitability ratios measure…
the companys ability to generate profits from its resources (assets)
valuation ratios measure…
the quantity of an asset or flow associated with ownership of a specified claim
to be in compliance with Sarbanes Oxley…
mandatory that mgmts Report to Shareholders discuss internal financial controls and their effectiveness, as well as the companys auditors opinion of these internal controls
not appropriate to use accrual method if…
collection of remaining balance is uncertain
installment method…
the portion of the total profit that is recognized in each period is determined by the percentage of the total sales price for which the seller has received cash
cost recovery method…
no profit recognized until cost is recovered
US GAAP requires long term contracts whose outcomes can be reliably measured…
should be accounted for using the percentage of completion method. if not reliably measured, completed contract method - no revenue recognized until contract is substantially completed
non controlling interests found in the equity section represent…
the equity interests of minority shareholders in non-wholly-owned subsidiaries that have been consolidated
base for common size income statement
revenue
under US GAAP, to report revenue under gross reporting, must meet 4 criteria…
- be primary obligor under contract
- bear inventory/credit risk
- able to choose supplier
- reasonable latitude to establish prices
product costs flow through…
balance sheet (inventory, when acquired or converted) then to income statement (COGS, when sold)
product costs
cost of purchase less discounts and rebates, and conversion costs (raw material, direct/indirect labor, direct/indirect manufacturing overhead
Freight Out is NOT product cost
period costs flow through…
go directly to income statement as expenses
period costs
abnormal costs, storage cots not part of “normal” production process. selling, marketing, admin expenses
LIFO reserve
difference between internal inventory method and LIFO
when converting from LIFO, LIFO reserve must be allocated…
LR (1-t) –> increases Retained Earnings (E)
LR (t) –> increases Deferred Taxes (L)
LR –> increases Inventory (A)
LIFO reserve will increase when…
prices are rising
LIFO reserve will decrease when…
prices decline
LIFO liquidation
LIFO liquidation occurs when…
COGS>Purchases
phantom profit
an increase in gross profit as a result of LIFO liquidation (because we are pulling cheaper inventory to fulfill orders)
adjustments must be made to remove phantom profit
IFRS measurement of inventory
lower of cost or net realizable value (NRV=selling price - selling costs)
under IFRS, if NRV < costs
inventory must be written down
loss recognized on IS as COGS or expense
inventory valuation allowance account
under IFRS only. reduces carrying value of inventory
GAAP measurement of inventory
lower of cost or market (LCM)
under GAAP, if market < costs
inventory must be written down. reversals prohibited.
inventory methods most likely to incur write downs
separate ID, FIFO, AVCO.
LIFO uses oldest prices in inventory
inventory write downs reduce
profit
carrying value of inventory
inventory write downs have negative effect on…
profitability (numerators drop, no change to denominators)
liquidity (current assets drop-numerator, no change to CL)
solvency (debt no change-numerator, equity decreases-denominator)
inventory write downs have positive effect on…
activity. COGS increases, Sales no change- numerators
average assets decreases-denominator
high inventory turnover with low DOH…
inadequate inventory levels? inventory write downs?
critical ratios for inventory management evaluation
inventory turnover, DOH, gross profit margin
any ratio with inventory or COGS in either num or den.
LIFO effect on net/gross margin
Num-income lower under LIFO
Den-no change
lower ratio under LIFO
LIFO effect on debt to equity
Num- no change
Den- lower equity & assets under LIFO
higher ratio under LIFO
LIFO effect on current ratio
Num- lower Ending Inventory (CA)
Den- no change
lower ratio under LIFO
LIFO effect on quick ratio
Num- lower taxes, higher cash
Den- no change
higher ratio under LIFO
LIFO effect on inventory turnover
Num- COGS higher under LIFO
Den- avg inventory lower under LIFO
higher ratio under LIFO
LIFO effect on total asset turnover
Num- no change
Den- lower total assets under LIFO
higher ratio under LIFO
requirements when changing inventory valuation methods…
retrospective restatement of
GAAP exception: changing TO LIFO= prospective basis
capitalization vs. expensing
capitalize if the asset is expected to provide benefits for more than 1 year
expense if current year only
revaluation of assets effects…
increase in carrying value - increased total assets, shareholders equity. decreases financial leverage ratio
decrease in carrying value - decreased total assets, net income. decreases ROA/ROE in Yr 1, but increases in subsequent years
impairment of assets effect…
subjective judgements (projecting future cash flows, assessing fair values)
derecognition of assets effects…
loss - decreases total assets, net income
gain - increases total assets, net income
either will increase CFI
inventory turnover and DOH
activity ratios. inventory turnover indicates the resources tied up in inventory (carrying costs).
a higher inventory turnover ratio implies shorter period inventory is held, and a lower of DOH
receivables turnover and DSO
activity ratios. measures the efficiency with which a company collects on their receivables. a higher receivables turnover, and lower DSO implies shorter period of time between sale and collection.
payables turnover and number of days of payables
activity ratios. number of days of payables reflects average number of days it takes to pay its suppliers, and turnover ratio measures how many times per year the company pays off all its creditors. low ratio and high number of days could indicate trouble making payments
working capital turnover
activity ratio. indicates how efficiently the company generates revenue with its working capital. higher indicates greater efficiency.
working capital
current assets minus current liabilities
if “purchases” amount is not available, it can be calculated by…
COGS + ending Inventory - beginning Inventory
fixed asset turnover
activity ratio. measures how efficiently the company generates revenues from its investments in fixed assets. a higher ratio indicates more efficient use of fixed assets in generating revenues
total asset turnover
activity ratio. measures the company overall ability to generate revenues with a given level of assets. higher is more efficient.
defensive interval ratio
liquidity ratio. measures how long a company can pay its daily cash expenditures using only its existing liquid assets, without additional cash flow coming in. higher is more liquid.
to obtain daily cash expenditures…
total expenses minus non-cash expenses/365
cash conversion cycle
liquidity ratio. measures the length of time required for a company to go from cash paid (used in operations) to cash received (a result of operations)
current ratio
liquidity ratio. measures current assets in relation to current liabilities. higher is more liquid. ratio equal to 1 indicates that the book value of its current assets exactly equals the book value of its current liabilities
quick ratio
liquidity ratio. higher is more liquid.
a more conservative ratio than the current ratio. better indicator of liquidity if inventories are illiquid.
cash ratio
liquidity ratio. represents a reliable measure of a company liquidity in a crisis situation.
debt to assets ratio
solvency ratio. measures the percentage of total assets financed with debt
debt to capital ratio
solvency ratio. measures the percentage of a company capital (debt + equity) is represented by debt
debt to equity ratio
solvency ratio. measures the amount of debt capital relative to equity capital.
financial leverage ratio
solvency ratio. measures the amount of total assets supported for $1 of equity. the higher the ratio, the more leveraged the company in the sense of using debt and other liabilities to finance assets
interest coverage ratio
solvency ratio. measures the number of times a companies EBIT could cover its interest payments. higher means greater solvency
fixed charge coverage ratio
solvency ratio. measures the number of times a companys earnings can cover the interest and lease payments. higher means greater solvency
gross profit margin
profitability ratio. indicates the percentage of revenue available to cover operating and other expenses and to generate profit.
operating profit margin
profitability ratio. calculated as gross profit minus operating costs. an operating profit margin increasing faster than the gross profit margin can indicate improvements in controlling operating costs
pretax margin
profitability ratio. reflects the effects on profitability of leverage and other non-operating income and expenses.
ROA
profitability ratio. measures the return on its assets. the higher the ratio, the more income is generated by a given level of assets
return on total capital
profitability ratio. measures the profits a company earns on all of the capital that it employs (ST debt, LT debt, and equity).
ROE
profitability ratio. measures the return earned on its equity capital, including minority equity, preferred equity, and common equity.
price to earnings ratio
valuation ratio. tells us how much an investor in common stock pays per dollar of earnings
price to cash flow ratio
valuation ratio. similar to PE ratio, used as an alternative where earnings quality may be an issue (net income can be manipulated greater than cash flows)
price to sales ratio
valuation ratio. similar to PE, used when a company does not have positive net income
price to book value ratio
valuation ratio. an indicator of market judgement about the relationship between the companys required rate of return and its actual rate of return. greater than 1 indicates future profitability is expected to exceed the required rate of return
basic and diluted EPS
valuation ratios. simply the amount of earnings attributable to each share of common stock. ratio cannot simply be used to compare to another company, not enough info.
dividend payout ratio
valuation ratio. measures the percentage of earnings that the company pays out as dividends to shareholders
retention rate
valuation ratio. measures the percentage of earnings that the company retains. complement of dividend payout ratio
sustainable growth rate
valuation ratio. a function of its profitability (measured as ROE) and its ability to finance itself from internally generated funds (measured as retention rate). can be used to estimate a company’s growth rate for equity valuation
3 types of depreciation methods…
straight line, accelerated, and units of production
finance lease
like a standard lease
operating lease
similar to a rental
a company reporting a lease as an operating lease will…
show higher profits in early years, higher return measures in early years, and stronger solvency
a company reporting a lease as a finance lease will…
show higher operating cash flows because a portion of the lease payment will be reflected as a financing cash outflow rather than an operating cash outflow
if a lessor enters into an operating lease, they record…
any lease revenue when earned. they also continue to record the asset on the balance sheet, as well as depreciation
if a lessor enters into a financing lease, they record…
a lease receivable based on PV of future lease payments, and reduces its assets by the carrying amount of the asset leased.
GAAP defines 2 types of financing leases from lessor perspective…
direct financing lease, sales type lease
direct financing lease vs sales type lease
when present value of lease payments equals carrying amount of asset–> direct financing lease
when present value of lease payments is greater than carrying amount of asset–> sales type lease (will show profit in first year, and interest revenue over life)
bond reporting… when rates decrease…
market rate at the time of issuance will be higher, understating leverage levels
bond reporting… when rates increase…
market rate at the time of issuance will be lower, overstating leverage levels
4 C’s of credit
character, capacity, collateral, covenants
“available for sale” securities reported…
bypass IS, go directly to shareholders equity and then to OCI
“trading securities” reported…
on IS
total comprehensive income calculation
= NI + OCI
common size balance sheet base
total assets
IFRS, interest and dividends RECEIVED
reported as either Operating or Investing
GAAP, interest and dividends RECEIVED
Operating only
IFRS, interest and dividends PAID
reported as either Operating or Financing
GAAP, interest and dividends PAID
Interest PAID = Operating
Dividends PAID = Financing
Direct Cash flow statement derived from..
income statement, format flows like Income statement
Indirect cash flow statement derived from…
balance sheet. NI is adjusted for non-operating activities, non-cash expenses, and changes in working capital accounts. reconciles NI to cash
Direct vs. Indirect
differ only in CFO section
Direct Method steps
start w/ sales and adjust (i.e. cash collected from customers = sales - changeAR)
cash received from customers calculation
sales - change in AR
cash paid to suppliers calculation
COGS + change in Inv. + change in AP.
Purchases = COGS + change in Inv.
cash paid to employees calculation
(wages/salaries) + change in wages/salaries payable.
parenthesis is negative
cash paid for other non-op expenses calculation
(other operating expenses) + change in prepaid exp + change in other accrued liabilities
cash paid for interest calculation
(Int Exp) + change in interest payable
cash paid for tax calculation
(tax Exp) + change in taxes payable
conversion from Indirect to Direct
- aggregate all revenue and expenses
- remove all non-cash items from aggregated revenues and expenses, and break out remaining item into cash flow items.
- convert accrual amounts to cash flow amounts by adjusting for working capital changes (i.e. changes to AR, AP, etc.)
under GAAP, bank overdrafts should be classified as a…
financing cash flow
direct method benefit
provides details on the specific sources of operating receipts and payments
indirect method benefit
provides insight on differences between net income and operating cash flows
CFA Institute advocates for…
financial reporting that reflects economic reality. specifically identifies a preference for using the direct format for CFO in cash flow statements
warranty expenses are…
operating expenses and are not netted from revenues
accrued expenses, aka accrued liabilities, are recognized on…
the income statement, but have not been paid as of the balance sheet date
deferred expenses refer to…
payments that have been paid but will not be reported as an expense until a future accounting period
accounts payable are…
amounts that a company owes its suppliers for purchases that have already been delivered. represent purchase amount on credit as of the balance sheet date
limitation of the balance sheet
determining market/intrinsic value, since some assets/liabilities are measured at historical cost while others on current value
when must a company present consolidated financial statements
if company A owes more than 50% of company B, 100% of revenues/expenses of company B are reported on company A’s financial statements
cash to income ratio
=CFO/operating income
indirect to direct conversion, 3 steps
- total operating expenses = total revenue-net income
- adjust for non cash expenses/revenues
- adjust for accrual in working capital accounts
under the cost model, IFRS requires disclosure of…
carrying amount by companies using revaluation model, and how fair value was obtained. does NOT require disclosure for the original date of acquisition
indications of impairment
- IFRS = higher of FV-SC (selling costs) or sum of DCF
GAAP = sum of UNDISCOUNTED CF - compare step 1 with carrying cost.
- if carrying step 1 is less than step 2 (carrying cost), must recognize loss, and adjust carrying value for depreciation expenses
when an asset is acquired through an exchange, the cost of the asset acquired is…
the FV given up unless the FV of the asset acquired is more known
under GAAP, the result of initial capitalization of interest but not its subsequent expensing…
CFO will be higher
under GAAP, the result of never capitalizing interest…
interest expenses would be greater, and net income/CFO will be lower
under IFRS, revaluation is limited to the amount…
of the original write down and is reported as a decrease in the cost of sales
when calculating interest coverage, you must add back…
the depreciation related to interest
under IFRS, R+D costs are expensed until…
technical feasibility has been determined
carrying amount and coupon rate information can be found…
coupon rates = notes to financial statements
carrying amount = non-current liabilities section of the BS
when a lease is classified as a finance lease, the lease payment is classified as…
interest portion = CFO
principal portion = CFF
recording G/L when retiring bonds…
book value - market value (FV) = G/L
stock screening. if events are independent…
multiply all individual probabilities to determine actual percentage
financial reports need not be conservative, they must be…
neutral
excluding recurring items from non-GAAP financial measures…
strictly prohibited by the SEC, and should raise concern for additional analysis
if a company uses non-GAAP measures in its SEC filings, it must display…
the comparable GAAP measure with equal prominence and provide reconciliation between the two
impact on earnings for adjusting salvage value…
straight line/ units of production = earnings will be affected
double declining = no change
channel stuffing overstates…
inventory
combining the results from two segments as a combined entity, is an example of
biased reporting
depreciating equipment/assets over shortest useful life is…
conservative accounting, since earnings are decreased in earlier years
non-GAAP earnings allowable exclusions…
asset impairment charges for long lived assets, goodwill, or other tangible assets, as well as EBIT/EBITDA
calculating a non-GAAP performance measure intended to eliminate or smooth out non-recurring items…
is strictly prohibited by the SEC
excluding charges or liabilities requiring cash settlement from any non-GAAP liquidity measure
is strictly prohibited by the SEC
affects of transacting with an unconsolidated special purpose entity
outside the view of investors.
may initially produce the appearance of a positive or negative cash flow for the controlling company
conservative accounting choices decrease…
a companys reported performance and results in the current period and may increase its reported performance and financial position in later periods
affects on financial reporting of one-time transactions
will decrease the quality of reporting
