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CFA L1 Study Plan Material > Financial Reporting Analysis > Flashcards

Financial Reporting Analysis Flashcards

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1
Q

IFRS Framework. fundamental characteristics… (2)

A

relevance, faithful representation

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2
Q

IFRS Framework. enhancing characteristics… (4)

A

comparability, verifiability, timeliness, understandability

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3
Q

IFRS framework. qualitative characteristics (6)

A

relevance, faithful representation, comparability, verifiability, timeliness, understandability

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4
Q

IFRS framework. constraint

A

cost (cost/benefit considerations0

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5
Q

IFRS framework. underlying assumptions (2)

A

accrual basis, going concern

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6
Q

activity ratios measure…

A

asset utilization

operating efficiency

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7
Q

liquidity ratios measure…

A

the companys ability to meet its short term obligations

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8
Q

solvency ratios measure…

A

a companys ability to meet long term obligations. subsets are leverage and long term debt ratios

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9
Q

profitability ratios measure…

A

the companys ability to generate profits from its resources (assets)

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10
Q

valuation ratios measure…

A

the quantity of an asset or flow associated with ownership of a specified claim

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11
Q

to be in compliance with Sarbanes Oxley…

A

mandatory that mgmts Report to Shareholders discuss internal financial controls and their effectiveness, as well as the companys auditors opinion of these internal controls

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12
Q

not appropriate to use accrual method if…

A

collection of remaining balance is uncertain

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13
Q

installment method…

A

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

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14
Q

cost recovery method…

A

no profit recognized until cost is recovered

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15
Q

US GAAP requires long term contracts whose outcomes can be reliably measured…

A

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

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16
Q

non controlling interests found in the equity section represent…

A

the equity interests of minority shareholders in non-wholly-owned subsidiaries that have been consolidated

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17
Q

base for common size income statement

A

revenue

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18
Q

under US GAAP, to report revenue under gross reporting, must meet 4 criteria…

A
  1. be primary obligor under contract
  2. bear inventory/credit risk
  3. able to choose supplier
  4. reasonable latitude to establish prices
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19
Q

product costs flow through…

A

balance sheet (inventory, when acquired or converted) then to income statement (COGS, when sold)

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20
Q

product costs

A

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

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21
Q

period costs flow through…

A

go directly to income statement as expenses

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22
Q

period costs

A

abnormal costs, storage cots not part of “normal” production process. selling, marketing, admin expenses

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23
Q

LIFO reserve

A

difference between internal inventory method and LIFO

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24
Q

when converting from LIFO, LIFO reserve must be allocated…

A

LR (1-t) –> increases Retained Earnings (E)
LR (t) –> increases Deferred Taxes (L)
LR –> increases Inventory (A)

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25
Q

LIFO reserve will increase when…

A

prices are rising

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26
Q

LIFO reserve will decrease when…

A

prices decline

LIFO liquidation

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27
Q

LIFO liquidation occurs when…

A

COGS>Purchases

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28
Q

phantom profit

A

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

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29
Q

IFRS measurement of inventory

A

lower of cost or net realizable value (NRV=selling price - selling costs)

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30
Q

under IFRS, if NRV < costs

A

inventory must be written down

loss recognized on IS as COGS or expense

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31
Q

inventory valuation allowance account

A

under IFRS only. reduces carrying value of inventory

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32
Q

GAAP measurement of inventory

A

lower of cost or market (LCM)

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33
Q

under GAAP, if market < costs

A

inventory must be written down. reversals prohibited.

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34
Q

inventory methods most likely to incur write downs

A

separate ID, FIFO, AVCO.

LIFO uses oldest prices in inventory

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35
Q

inventory write downs reduce

A

profit

carrying value of inventory

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36
Q

inventory write downs have negative effect on…

A

profitability (numerators drop, no change to denominators)
liquidity (current assets drop-numerator, no change to CL)
solvency (debt no change-numerator, equity decreases-denominator)

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37
Q

inventory write downs have positive effect on…

A

activity. COGS increases, Sales no change- numerators

average assets decreases-denominator

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38
Q

high inventory turnover with low DOH…

A

inadequate inventory levels? inventory write downs?

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39
Q

critical ratios for inventory management evaluation

A

inventory turnover, DOH, gross profit margin

any ratio with inventory or COGS in either num or den.

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40
Q

LIFO effect on net/gross margin

A

Num-income lower under LIFO
Den-no change

lower ratio under LIFO

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41
Q

LIFO effect on debt to equity

A

Num- no change
Den- lower equity & assets under LIFO

higher ratio under LIFO

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42
Q

LIFO effect on current ratio

A

Num- lower Ending Inventory (CA)
Den- no change

lower ratio under LIFO

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43
Q

LIFO effect on quick ratio

A

Num- lower taxes, higher cash
Den- no change

higher ratio under LIFO

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44
Q

LIFO effect on inventory turnover

A

Num- COGS higher under LIFO
Den- avg inventory lower under LIFO

higher ratio under LIFO

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45
Q

LIFO effect on total asset turnover

A

Num- no change
Den- lower total assets under LIFO

higher ratio under LIFO

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46
Q

requirements when changing inventory valuation methods…

A

retrospective restatement of

GAAP exception: changing TO LIFO= prospective basis

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47
Q

capitalization vs. expensing

A

capitalize if the asset is expected to provide benefits for more than 1 year
expense if current year only

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48
Q

revaluation of assets effects…

A

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

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49
Q

impairment of assets effect…

A

subjective judgements (projecting future cash flows, assessing fair values)

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50
Q

derecognition of assets effects…

A

loss - decreases total assets, net income
gain - increases total assets, net income

either will increase CFI

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51
Q

inventory turnover and DOH

A

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

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52
Q

receivables turnover and DSO

A

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.

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53
Q

payables turnover and number of days of payables

A

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

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54
Q

working capital turnover

A

activity ratio. indicates how efficiently the company generates revenue with its working capital. higher indicates greater efficiency.

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55
Q

working capital

A

current assets minus current liabilities

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56
Q

if “purchases” amount is not available, it can be calculated by…

A

COGS + ending Inventory - beginning Inventory

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57
Q

fixed asset turnover

A

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

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58
Q

total asset turnover

A

activity ratio. measures the company overall ability to generate revenues with a given level of assets. higher is more efficient.

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59
Q

defensive interval ratio

A

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.

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60
Q

to obtain daily cash expenditures…

A

total expenses minus non-cash expenses/365

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61
Q

cash conversion cycle

A

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)

62
Q

current ratio

A

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

63
Q

quick ratio

A

liquidity ratio. higher is more liquid.

a more conservative ratio than the current ratio. better indicator of liquidity if inventories are illiquid.

64
Q

cash ratio

A

liquidity ratio. represents a reliable measure of a company liquidity in a crisis situation.

65
Q

debt to assets ratio

A

solvency ratio. measures the percentage of total assets financed with debt

66
Q

debt to capital ratio

A

solvency ratio. measures the percentage of a company capital (debt + equity) is represented by debt

67
Q

debt to equity ratio

A

solvency ratio. measures the amount of debt capital relative to equity capital.

68
Q

financial leverage ratio

A

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

69
Q

interest coverage ratio

A

solvency ratio. measures the number of times a companies EBIT could cover its interest payments. higher means greater solvency

70
Q

fixed charge coverage ratio

A

solvency ratio. measures the number of times a companys earnings can cover the interest and lease payments. higher means greater solvency

71
Q

gross profit margin

A

profitability ratio. indicates the percentage of revenue available to cover operating and other expenses and to generate profit.

72
Q

operating profit margin

A

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

73
Q

pretax margin

A

profitability ratio. reflects the effects on profitability of leverage and other non-operating income and expenses.

74
Q

ROA

A

profitability ratio. measures the return on its assets. the higher the ratio, the more income is generated by a given level of assets

75
Q

return on total capital

A

profitability ratio. measures the profits a company earns on all of the capital that it employs (ST debt, LT debt, and equity).

76
Q

ROE

A

profitability ratio. measures the return earned on its equity capital, including minority equity, preferred equity, and common equity.

77
Q

price to earnings ratio

A

valuation ratio. tells us how much an investor in common stock pays per dollar of earnings

78
Q

price to cash flow ratio

A

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)

79
Q

price to sales ratio

A

valuation ratio. similar to PE, used when a company does not have positive net income

80
Q

price to book value ratio

A

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

81
Q

basic and diluted EPS

A

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.

82
Q

dividend payout ratio

A

valuation ratio. measures the percentage of earnings that the company pays out as dividends to shareholders

83
Q

retention rate

A

valuation ratio. measures the percentage of earnings that the company retains. complement of dividend payout ratio

84
Q

sustainable growth rate

A

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

85
Q

3 types of depreciation methods…

A

straight line, accelerated, and units of production

86
Q

finance lease

A

like a standard lease

87
Q

operating lease

A

similar to a rental

88
Q

a company reporting a lease as an operating lease will…

A

show higher profits in early years, higher return measures in early years, and stronger solvency

89
Q

a company reporting a lease as a finance lease will…

A

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

90
Q

if a lessor enters into an operating lease, they record…

A

any lease revenue when earned. they also continue to record the asset on the balance sheet, as well as depreciation

91
Q

if a lessor enters into a financing lease, they record…

A

a lease receivable based on PV of future lease payments, and reduces its assets by the carrying amount of the asset leased.

92
Q

GAAP defines 2 types of financing leases from lessor perspective…

A

direct financing lease, sales type lease

93
Q

direct financing lease vs sales type lease

A

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)

94
Q

bond reporting… when rates decrease…

A

market rate at the time of issuance will be higher, understating leverage levels

95
Q

bond reporting… when rates increase…

A

market rate at the time of issuance will be lower, overstating leverage levels

96
Q

4 C’s of credit

A

character, capacity, collateral, covenants

97
Q

“available for sale” securities reported…

A

bypass IS, go directly to shareholders equity and then to OCI

98
Q

“trading securities” reported…

A

on IS

99
Q

total comprehensive income calculation

A

= NI + OCI

100
Q

common size balance sheet base

A

total assets

101
Q

IFRS, interest and dividends RECEIVED

A

reported as either Operating or Investing

102
Q

GAAP, interest and dividends RECEIVED

A

Operating only

103
Q

IFRS, interest and dividends PAID

A

reported as either Operating or Financing

104
Q

GAAP, interest and dividends PAID

A

Interest PAID = Operating

Dividends PAID = Financing

105
Q

Direct Cash flow statement derived from..

A

income statement, format flows like Income statement

106
Q

Indirect cash flow statement derived from…

A

balance sheet. NI is adjusted for non-operating activities, non-cash expenses, and changes in working capital accounts. reconciles NI to cash

107
Q

Direct vs. Indirect

A

differ only in CFO section

108
Q

Direct Method steps

A

start w/ sales and adjust (i.e. cash collected from customers = sales - changeAR)

109
Q

cash received from customers calculation

A

sales - change in AR

110
Q

cash paid to suppliers calculation

A

COGS + change in Inv. + change in AP.

Purchases = COGS + change in Inv.

111
Q

cash paid to employees calculation

A

(wages/salaries) + change in wages/salaries payable.

parenthesis is negative

112
Q

cash paid for other non-op expenses calculation

A

(other operating expenses) + change in prepaid exp + change in other accrued liabilities

113
Q

cash paid for interest calculation

A

(Int Exp) + change in interest payable

114
Q

cash paid for tax calculation

A

(tax Exp) + change in taxes payable

115
Q

conversion from Indirect to Direct

A
  1. aggregate all revenue and expenses
  2. remove all non-cash items from aggregated revenues and expenses, and break out remaining item into cash flow items.
  3. convert accrual amounts to cash flow amounts by adjusting for working capital changes (i.e. changes to AR, AP, etc.)
116
Q

under GAAP, bank overdrafts should be classified as a…

A

financing cash flow

117
Q

direct method benefit

A

provides details on the specific sources of operating receipts and payments

118
Q

indirect method benefit

A

provides insight on differences between net income and operating cash flows

119
Q

CFA Institute advocates for…

A

financial reporting that reflects economic reality. specifically identifies a preference for using the direct format for CFO in cash flow statements

120
Q

warranty expenses are…

A

operating expenses and are not netted from revenues

121
Q

accrued expenses, aka accrued liabilities, are recognized on…

A

the income statement, but have not been paid as of the balance sheet date

122
Q

deferred expenses refer to…

A

payments that have been paid but will not be reported as an expense until a future accounting period

123
Q

accounts payable are…

A

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

124
Q

limitation of the balance sheet

A

determining market/intrinsic value, since some assets/liabilities are measured at historical cost while others on current value

125
Q

when must a company present consolidated financial statements

A

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

126
Q

cash to income ratio

A

=CFO/operating income

127
Q

indirect to direct conversion, 3 steps

A
  1. total operating expenses = total revenue-net income
  2. adjust for non cash expenses/revenues
  3. adjust for accrual in working capital accounts
128
Q

under the cost model, IFRS requires disclosure of…

A

carrying amount by companies using revaluation model, and how fair value was obtained. does NOT require disclosure for the original date of acquisition

129
Q

indications of impairment

A
  1. IFRS = higher of FV-SC (selling costs) or sum of DCF
    GAAP = sum of UNDISCOUNTED CF
  2. compare step 1 with carrying cost.
  3. if carrying step 1 is less than step 2 (carrying cost), must recognize loss, and adjust carrying value for depreciation expenses
130
Q

when an asset is acquired through an exchange, the cost of the asset acquired is…

A

the FV given up unless the FV of the asset acquired is more known

131
Q

under GAAP, the result of initial capitalization of interest but not its subsequent expensing…

A

CFO will be higher

132
Q

under GAAP, the result of never capitalizing interest…

A

interest expenses would be greater, and net income/CFO will be lower

133
Q

under IFRS, revaluation is limited to the amount…

A

of the original write down and is reported as a decrease in the cost of sales

134
Q

when calculating interest coverage, you must add back…

A

the depreciation related to interest

135
Q

under IFRS, R+D costs are expensed until…

A

technical feasibility has been determined

136
Q

carrying amount and coupon rate information can be found…

A

coupon rates = notes to financial statements

carrying amount = non-current liabilities section of the BS

137
Q

when a lease is classified as a finance lease, the lease payment is classified as…

A

interest portion = CFO

principal portion = CFF

138
Q

recording G/L when retiring bonds…

A

book value - market value (FV) = G/L

139
Q

stock screening. if events are independent…

A

multiply all individual probabilities to determine actual percentage

140
Q

financial reports need not be conservative, they must be…

A

neutral

141
Q

excluding recurring items from non-GAAP financial measures…

A

strictly prohibited by the SEC, and should raise concern for additional analysis

142
Q

if a company uses non-GAAP measures in its SEC filings, it must display…

A

the comparable GAAP measure with equal prominence and provide reconciliation between the two

143
Q

impact on earnings for adjusting salvage value…

A

straight line/ units of production = earnings will be affected
double declining = no change

144
Q

channel stuffing overstates…

A

inventory

145
Q

combining the results from two segments as a combined entity, is an example of

A

biased reporting

146
Q

depreciating equipment/assets over shortest useful life is…

A

conservative accounting, since earnings are decreased in earlier years

147
Q

non-GAAP earnings allowable exclusions…

A

asset impairment charges for long lived assets, goodwill, or other tangible assets, as well as EBIT/EBITDA

148
Q

calculating a non-GAAP performance measure intended to eliminate or smooth out non-recurring items…

A

is strictly prohibited by the SEC

149
Q

excluding charges or liabilities requiring cash settlement from any non-GAAP liquidity measure

A

is strictly prohibited by the SEC

150
Q

affects of transacting with an unconsolidated special purpose entity

A

outside the view of investors.

may initially produce the appearance of a positive or negative cash flow for the controlling company

151
Q

conservative accounting choices decrease…

A

a companys reported performance and results in the current period and may increase its reported performance and financial position in later periods

152
Q

affects on financial reporting of one-time transactions

A

will decrease the quality of reporting

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