Financial, Reporting and Analysis Flashcards
Revenue recognition principle (converged 2014)
“Revenue should be recognised to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which entity expects to be entitled in an exchange of goods or services”
5 steps of recognising revenue
- Identify the contracts with a customer
- Identify the separate or distinct performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when the entity satisfies the performance obligation
IASB definition of expense recognition
Decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants
Matching priniciples
Matching of costs wiht revenues
Period costs
If expenses cannot be directly matched with revenues then recognize in the period they are incurred
Treatment of dilution
Each potentially dilutive issue treated separately. Anti-dilutive issues are ignored in the calculation
Interest received (GAAP)
CFO
Interest received (IFRS)
CFO or CFI
Interest paid (GAAP)
CFO
Interest paid (IFRS)
CFO or CFF
Dividends received (GAAP)
CFO
Dividends received (IFRS)
CFO or CFI
Dividends Paid (GAAP)
CFF
Dividends Paid (IFRS)
CFO or CFF
Taxes paid (IFRS)
CFO but some can be allocated to CFI/CFF if appropriate
Direct method
Cash collection
(-) Cash inputs
(-) Other cash outflows
(=) Cash flows from operations (CFO)
Indirect method
Net income
(+) Non-cash expenses
(-) Non-cash revenues
(+) Decreases in accounts receivables & inventories
(-) Increases in AR & Inv
(+) Increase in AP/Tax payables/interest payable
(-) Decrease in AP/Tax payables/interest payable
(-) Gain on disposal of an asset
Gains and losses on disposal of assets
Included in net income
Gain = proceeds > net book value
Remove from net income to calculate CFO
Free cash flow to the firm (FCFF)
Activity ratios
Activity Ratios Days
Operational activity ratios
Liquidity ratios
Solvency ratios
Coverage ratios
Profitability ratios
Return ratios
Basic DuPont decomposition of ROE
Medium DuPont decomposition
Advanced DuPont
Cost of inventory
- All costs of purchase
- Costs of conversion
- Other costs incurred bring inventories to present location and condition
- Exclude: abnormal costs from waste of materials, labor, or other production. Admin, treat as expense
Inventory when prices are rising
LIFO inventory < FIFO inventory
COGS when prices are rising
LIFO COGS > FIFO COGS
Balance sheet inventory valuation
FIFO inventory values resemble current cost or market value
LIFO inventory values resemble out-of-date costs
LIFO reserve
Inventory lidation
When number of items sold is greater than that purchased.
LIFO income > FIFO income
due to low cost LIFO items being included in cost of sales
Inventory value (IFRS)
Lower of cost and net realizable value
Inventory write-down if carrying value > NRV
Impairment expense deducted in income statement
Inventory value (GAAP)
Lower of cost and net realizable value
Exceptions - inventories under LIFO and retail inventory methods. Lower of cost and fair value, but cannot exceed NRV, lower limit is NRV - normal profit margin, reversal of impairment not permitted
Inventory ratios
Companies constructing their own assets
All costs incurred in bringing the asset to its present location and condition are capitalized. The cost of asset and the freight costs borne by the purchaser. Includes capitalization of interest expense associated with construction of assets
Long-lived assets issues for analyst
Capitalized interest is included in CFO. Normally interest payments are included in CFO (GAAP) or CFO/CFF (IFRS)
Analyst should consider adjusting cash flow for this treatment
Analyst should restate interest coverage ratios. Increase interest expense to include capitalized interest
IFRS criteria for recognition on balance sheet
- Identifiable
- Under the control of the company
- Expected to generate future economic benefits
- Probable that future economic benefits will flow to the company
- Cost of the asset can be reliable measured
Exception to R&D expense
Capitalized under IFRS if certain criteria are met
Under GAAP software capitalized if for sale or fintended to be used internally, if technical feasibility demonstrated
Double declining balance
Units of production method
Depreciation choices on key financial ratios
Impairment treatments
Carrying amount in balance sheet > recoverable amount
In US GAAP impaired value = fair value (higher of fair value less costs to sell and value in use (PV of expected future cash flows)
In IFRS impaired value = recoverable amount
Intangible with indefinite lives
No amortization charged during life of asset. Annual impairment review, carrying amount > fair value
Impairment of assets
Accounting profit
Based on accounting standards. Pre-tax income or income beforre taxes
Taxable income
Income subject to income taxes under tax law of jurisdiction. Basis for income tax payable taxable income x statutory income tax rate.
Income taxes owed or payable
Income tax expense
Income taxes payable. Changes in deferred tax assets/liabilities (deferred tax expense)
Income tax paid
Actual amount paid for income taxes
Reduces income tax liability in balance sheet
Effective tax rate (ETR)
ETR = Income tax expenses / Pre-tax income
Temporary differences between accounting profit and taxable income
Carrying amount and tax base of asset may differ (e.g. due to depreciation methods)
Deductibility of gains and losses of assets and liabilities may vary for accounting and income tax purposes
Deferred tax liabilities
Pre-tax income > Taxable income
Deferred tax assets
Pre-tax income < Taxable income
Decrease in deferred tax expense
Tax losses (GAAP)
Recognize a deferred tax asset
Recognize a valuation allowance for the extent that the losses cannot be deducted in future (doubts of profitability)
= DTA - valuation allowance
Tax losses (IFRS)
Asset is created only to the extent that it is probable that there will be sufficient future taxable income to offset the losses
Deferred tax asset treatment
Characteristics of long-term debt
Interest expense
Reflects the true cost of the bond, calculated based on yield at date of issue
Coupon + discount/premium
Amortized cost method
Issue proceeds or opening liability
(+) interest expense (opening liability x yield at issue
(-) coupons paid in period
= closing liability in balance sheet
Lease advanntage
Contract between owner of an asset and another party who wishes to use the asset
In exchange for use of the asset, lessee makes payments to lessor
Form of financing provided by lessor allowing lessee to purchase the use of the asset
Can provide less costly financing (often little down-payments)
Lease contract may contain less restrictive provisions than other forms of borrowing
Leases at inception
Recognize a lease asset (right-of-use asset) and a lease liability
Lease asset = lease liability = PV of fixed lease payments
Lease after inception
Not needed for short term leases
IFRS - report depreciation expense on ‘right-of-use’ asset, interest expense and reduce lease liability
GAAP:
Finance lease - accounting same as above for IFRS
OPerating lease - recognize a single lease expense
Accounting for a finance lease
Cash flow statement: Interest portion of lease payment = CFO (GAAP) or CFO/CFF (IFRS)
Principal payment = CFF
Accounting for an operating lease
Income statement lease expense
Cash flow statement: lease payment = CFO, CFO lower with operating lease
US GAAP accounting for leases
IFRS accounting for leases
Unqualified audit opinion
True and fair (IFRS)
Fairly presented (IFRS and US)
Adverse opinion
Financial statements materially depart from accounting standards
Not fairly presented
No point in performing fianncial analysis
Disclaimer of opinion
Auditors unable to have an opinion (e.g. records destroyed)
IFRS Audit Matters
Key Audit Matters
issues that the auditor considers to be most important, such as those that have a higher risk of misstatement, involve significant management judgment, or report the effects of significant transactions during the period
GAAP Audit Matters
Critical audit matters
issues that involve “especially challenging, subjective, or complex auditor judgment” and similarly include areas with higher risk of misstatement or involving significant management judgment and estimates
Step 1 of Financial Analysis Framework
- Source: analyst’s function, communication with client, institutional guidelines
- Output: statement of purpose, list of specific questions, nature and content of report, timetable and budget
Step 2 of Financial Analysis Framework
Collect Data
Input: Financial statements, financial data, questionnaires, discussions with management, customers, suppliers and competitors, company site visits
Output: Organised financial statements, financial data tables, completed questionnaires
Step 3 of Financial Analysis Framework
Process Data
- Input: collected data
- Output: adjusted financial statements, common size statements, ratios and graphs, forecasts
Step 4 of Financial Statements Framework
Analyze results of data processing
- Input: input and processed data
- Output: analytical results
Step 5 of Financial Statements Framework
Conclude recommendation and communicate
- Input: analytical results and previous reports
- Output: Analytical report answering questions from step 1, recommendations
Monopoly Supply Demand
Intersects in elastic portion, because marginal revenue intersects cost in elastic portion
Investment proporties
Elect to use cost model or a fair value model
Must apply same method to all class of asset
Fair value changes recognised in P&L
IFRS measurement of intangible assets
Either cost or revaluation model.
Revaluation only allowed if there is an active market
Treatment of Land
Not depreciated
Revaluation of long-lived assets IFRS
Any increase that reverses a revaluation recognised in P&L
Increase in excess of this is carried in equity
IFRS Impairment
Carrying Value > Recoverable amount
Recoverable amount = Max(Fair value - costs to sell; PV future cash flows)
Write down to recoverable amount
GAAP Impairment
Carrying amount > Recoverable amount
Recoverable amount = undiscounted CF
Writedown to fair value
Accounting for long-term debt
Opening liability (funds received) x original YTM = Interest expense
- Closing liability
=opening liability
(+)Interest expense
(-)coupon paid
