Financial Reporting & Analysis Flashcards
Under IFRS and GAAP Purchasing Power Gain/Losses are
Recognized on the income statement
Accruals Ratio CF
NI - CFO - CFI
(NOAend + NOAbeg) / 2
Accruals Ratio BS
NOAend - NOAbeg
(NOAend + NOAbeg) / 2
NOA = (Total assets - cash) - (total liabilities - total debt)
NI FIFO Formula
NI FIFO = NI LIFO + [∆ in reserve * (1 - t)]
Analyzing the B/S
- Put assets as a % of total assets
- Then compare
Note: Can do the same for capital structure
Beneish Model
Altman Model
Beneish
Purpose: Determine probability of earnings manipulation
Analysis: Lower the better. Should be below -1.78
Altman
Purpose: Probability to file bankruptcy
Analysis: Higher the better
Warnings Signs of Overstated Operating Cash Flows
- Increase in payables with decrease in inventory/receivables
- Capitalized expenditures
- Sale and leaseback of assets
Warning Signs of Misstated Earnings
- CFO lower than earnings
- Revenue growth higher than peers
- Receivables growth higher than revenue growth
- High customer returns
- Boost in operating income
Measuring Earnings Quality
Aggregate Accruals = Accrual based earnings - cash earnings
Cash = quality
Accrual = not quality
Reporting and Earning Quality
Reporting: need to be accurate and relevant, decision useful
Earnings: Adequate (meets required return) Sustainable
Hyperinflation G/L under IFRS are treated how?
Hyper inflation is 100% over 3 years
GAAP: Use the temporal method
IFRS: Restate monetary assets/liabilites. Use current rate method
Take monetary assets - monetary liabilities
a. depreciating currency and net liability = gain
b. appreciating currency and net liability = loss
Passive Investments are:
Security Reported as G/L
- Marketable securities fair value R and UR on I/S
- Trading securities fair value R and UR on I/S
- Available-for-sale fair value R on I/S, UR in OCI
- Held-to-maturity amoritized cost R and UR on I/S
Available for Sale Securities vs. Trading Securities
AFS: Only realized G/L are reported on the I/S
Trading Securities: Realized and uncrealized G/L are reported
Monetary Assets/Liabilities are:
- Cash
- AR
- AP
- STD
- LTD
When do you use the current rate method? Temporal method?
Current Method: 1. functional currency NOT same as parent
- local is functional
Temporal Method: 1. Functional currency same as parent
- Local is NOT functional
Temporal Method Affects….. Current Rate Method Affects….
Temporal: I/S - this means G/L go there
Current Rate: B/S - G/L goes to OCI equity on the B/S
Temporal Method I/S Rates
Revenues & Expenses: Average Rate
Rest at historical (this includes COGS, Dep, and Amortization)
Current Rate Method B/S Rates Current Rate Method I/S Rates
Use: when functional currency NOT same as parent
B/S:
Retained earnings - average rate
Capital Stock - historical rate
Everything else - current rate
I/S: All average rates
Temporal Method BS Rates
Monetary Assets/Liabilities at Current Rate
Everything else at historical
PBO Balance Sheet
Funded Status = plan assets - PBO
Will be an asset or liability or the B/S
PBO Total Periodic Pension Cost for GAAP and IFRS
GAAP
service costs + interest costs + actuarial loss - actual return on plan assets
Recognized on OCI
IFRS
Service cost + interest costs + past service costs
Both GAAP and IFRS:
Plan contributions - ∆ in funded status
Note: Interest cost = discount rate * beg funded stats
PBO Ending Value of Plan Assets
Beg value + actual return + contributions - benefits paid
PBO What happens if we raise or lower the discount rate?
Discount rate lower
- Higher PBO
- Higher Pension cost
- Lower stockholders equity
Discount rate higher
- Lower PBO
- Lower Pension cost
- Lower service cost
- Higher funded status
- Higher stockholders equity
PBO Expected Return
a. Does not affect PBO
b. Does affect PBO expenses
PBO Prior service cost is treated by GAAP and IFRS
GAAP: amortized from OCI over years
IFRS: Expensed immediately
PBO Funded Stats equals
Fair value of plan assets - PBO
PBO Change in Funded Status
Company contributions - total periodic pension cost
PBO Cash Flow Adjustments
If TPPC < Firm contributions: reclassify the differences from CFF to CFO —> Make to to multiply by (1 - T)
If TPPC > Firm Contributions: CFO to CFF after-tax –> Make to to multiply by (1 - T)
SPE
Special Purpose Entity
Purpose: Isolate certain assets and liabilities
Must be consolidated
Also Variable Interest Entity (VIE) if:
- Insufficient at risk equity
- lack of decision rights
- Shareholders do not absorb losses
- Does not have to be managed by the parent
Goodwill Formula
Formula: Purchase price - FMV of new assets
IFRS: Allows partial or full
GAAP: Only full
Equity vs Acquisition Method
Both report same NI
Equity; Only reports what you own
Formula: FV + % of earnings - % of dividends - amort.
Loss is recognized on the IS
Has higher NPM, ROE, and ROA
Acquisition: consolidates everything.
The % not owned goes to a minority interest account
Any Goodwill goes on the B/S
Reclassification of Investments
IFRS:
a. Does not all the FV to be reclassified
b. AFS and HtM can switch
GAAP:
a. Does allow FV to be reclassified
Business Combinations
Merger: acquiring firm absorbs all assets & liabilities
Acquisition: Both entities continue to exist
Consolidation: a new entity is formed
Take Over Methods
Cost or market/Financial assets (IFRS/GAAP same)
investment in securities
Own < 20%
Equity Method (IFRS/GAAP same)
Significant influcent, NOT control
Own 20-50%
Used for Joint Venture
Consolidation/Acquisition Method
Controlling interest
Own 50%+
Same NI as equity but higher shareholders equity
Operating Lease vs Finance Lease
Operating Lease
Is a rental agreement
- Current Ratio increase
- Asset turnover decrease
- Debt/Equity Ratio decrease
Finance lease
Increases assets, liabilities, levered ratios, operating cash flow, operating income
Different types of Depreciation Analysis
Purpose: Identify old assets that make firms less competitive
Average age (in years): accumulated depreciation / annual depreciation expense
Average Depreciable Life: Ending gross investment / annual depreciation expense
Remaining useful life: Ending net investments / annual depreciation expense
a. Net means to subtract off land
Depreciable Life
Ending Gross Investment / Depreciation expense
Capitalizing Expenses
- Reduces expenses in the current period
- Also added to assets
- Increases equity by increasing net income and retained earnings
Impairments Result In…
Means: past earnings were overstated
- Lower assets
- Lower equity
- Lower ROE and ROA first year
- No impact on earnings
Impairments IFRS vs GAAP
IFRS:
Impaired down to recoverable amount
This does include selling costs
Impairment is recognized on the IS (can b reversed)
GAAP:
Impaired down to the fair value
DOES not include selling cost
GAAP Example:
Cost: 2,800 Dep: 13% per year Future CF: 1,350
Step one: Test impairment: 2,800 x (1 - .13)4 = 1,604. Means BV is higher than MV so impairment exists
Capitalizing vs Expensing Effects
Capitalizing Expensing
Net income (first year) Increase Decrease
Assets and equity Increase Decrease
ROA and ROE (first year) Increase Decrease
CFO Increase Decrease
CFI Decrease Increase
Debt-to-equity Decrease Increase
Research & Development
R&D is always expense
However the development costs:
IFRS: Development costs are capitalized
GAAP: Development costs are expensed
ROE
NI / Shareholders Equity
ROA
NI / Total Assets
Net Profit Margin
NI / Sales
Current Ratio
current assets / current liabilities
Days on Hand
365 / Inventory Turnover
Inventory Turnover
COGS / Average Inventory
Quick Ratio
(Cash + s/t investments + receivables) / current liabilites
Total Asset Turnover
Sales/ Total Assets
Cash Ratio
(Cash + s/t securities) / current liabilities
Gross Margin
(Sales - COGS) / Sales
Operating Profit Margin
Operating Income / Revenue
LIFO to FIFO COGS
LIFO ro FIFO Taxes
FIFO COGS = LIFO COGS - (∆ LIFO Reserve)
Taxes FIFO = Taxes LIFO + (∆LIFO Reserve * Tax rate)
LIFO to FIFO Steps
Income Statement
FIFO COGS = LIFO COGS - ∆ Reserve
FIFO Taxes = LIFO Taxes + (∆ Reserve * Tax Rate)
NIFO FIFO = NI LIFO + (∆ Reserve * 1 - T)
Total Assets
FIFO Inventory = LIFO Inventory + Reserve
FIFO Cash = LIFO Cash - (Reserve * Tax Rate)
FIFO Equity = LIFO Equity + (Reserve * 1 - T)
LIFO Liquidation Means….
Reduction in inventory levels
This means we eat up old inventory
Results in:
- Decrease COGS
- Increase NPM
- Increase inventory turnover
- No impact on sales
Inflation affect on FIFO/LIFO
FIFO LIFO
Inflationary Ending Inventory Higher Lower
Inflationary COGS Lower Higher
Deflationary Ending Inventory Lower Higher
Deflationary COGS Higher Lower
LIFO Results In
- Lower WC THINK: Lower WINNTC
- Lower Inventory balances taxes
- Lower NI
- Lower Net and gross margins
- Lower Taxes
- Lower Current Ratio
- Higher debt-to-equity THINK: HIGHER DICC
- Higher inventory turnover
- Higher COGS
- Higher cash flows (b/c of less taxes)
COGS
Formula: beg inventory + purchases - ending inventory
GAAP is the only one that allows LIFO
After-Tax Operating Cash Flow
Step One: operating income:
sales - cash operating expenses - dep
Step Two: operating income x (1 - T) + dep
PBO: Adjusted Operating Profit
reported operating profit + reported pension expense − service cost
Interest Coverage Ratio
EBIT / Total Interest Paid
Finance vs Operating Lease Effects
Finance Operating
CFO Increase Decrease
Assets and equity Increase Decrease
Debt/Assets Increase Decrease
Debt-to-Equity Increase Decrease
NI (first year) Increase Increase
CFI Decrease Increase
Asset Turnover Decrease Increase
ROA Decrease Increase
ROE Decrease Increase
Extended DuPont Analysis
ROE = NIadj EBT__EBIT__Revenue Avg Assets
EBT EBIT Revenue Avg Assetsadj Avg Equity
Think: TIE A FAG
T: Tax burden
I: Interest burden
E: EBIT margin
A: Asset turnover
F: Financial leverage
Adjustments:
- *NI:** subtract off earnings from equity investment
- *Avg Assets:** Subtract off carrying value of equity investment
How to treat an operating lease like a finance lease
Step 1: Increase assets and liabilities by the PV of remaining payments
Step 2: Remove payment from the income statement and replace
with depreciation expense and interest expense
Example: PV of payments: 30M, discount rate: 10%
Lease term: 6 years, lease payment: 6.9M
- *Total debt:** increases by 30M
- *EBIT:** increases $1.9M: 6.9M - (30/6 years)
- *Interest expense:** increases $3M: ($30M * .10)
