Financial Reporting and Analysis Flashcards
Requirements of Revenue Recognition
(1) completion of earnings process and (2) reasonable assurance of payment
Revenue Recognition Methods
- Percentage-of-completion method.
- Completed contract method.
- Installment sales.
- Cost recovery method.
Unusual or Infrequent Items
- Gains/losses from disposal of a business segment.
- Gains/losses from sale of assets or investments in subsidiaries.
- Provisions for environmental remediation.
- Impairments, write-offs, write-downs, and restructuring costs.
- Integration expenses associated with businesses recently acquired.
Extraordinary Items
Both unusual and infrequent (e.g., losses from expropriation of assets). U.S. GAAP only. IFRS does not allow extraordinary items.
Discontinued Operations
To be accounted for as a discontinued operation, a business-assets, operations, investing, financing, activities-must be physically/operationally distinct from rest of firm. Income/losses are reported net of tax after net income from continuing operations.
Compute Cash Flows From Operations (CFO)
Direct Method: start with cash collections (cash equivalent of sales); cash inputs (cash equivalent of cost of goods sold); cash operating expenses; cash interest expense; cash taxes.
Indirect Method: start with net income, subtracting back gains and adding back losses resulting from financing or investment cash flows, adding back all noncash charges, and adding and subtracting asset and liability accounts that result from operations.
Free Cash Flow
Free cash flow (FCF) measures cash available for discretionary purposes. It is equal to operating cash flow less net capital expenditures.
Common-size financial statement analysis
- balance sheet: expresses all balance sheet accounts as a percentage of total assets.
- income statement: expresses all income statement items as a percentage of sales.
- cash flow statement: expresses each line item as a percentage of total cash inflows (outflows), or as a percentage of net revenue.
Horizontal common-size financial statement analysis
Expresses each line item relative to its value in a common base period.
current ratio =
(current assets) / (current liabilities)
quick ratio =
(cash + marketable securities + receivables) / (current liabilities)
cash ratio =
(cash + marketable securities) / (current liabilities)
defensive interval =
(cash + marketable securities + receivables) / (daily cash expenditures)
receivables turnover =
(annual sales) / (average receivables)
inventory turnover =
(cost of goods sold) / (average inventory)
payables turnover ratio =
(purchases) / (average trade payables)
days of sales outstanding =
(365) / (receivables turnover)
days of inventory on hand =
(365) / (inventory turnover)
number of days of payables =
(365) / (payables turnover ratio)
cash conversion cycle =
(days of inventory on hand) + (days of sales outstanding) - (number of days of payables)
total asset turnover =
(revenue) / (average total net assets)
fixed asset turnover =
(revenue) / (average net fixed assets)
working capital turnover =
(revenue) / (average working capital)
gross profit margin =
(gross profit) / (revenue)
operating profit margin =
(operating profit) / (revenue)
(EBIT) / (net sales)
net profit margin =
(net income) / (revenue)
return on assets (total capital) =
(EBIT) / (average total capital)
debt-to-equity ratio =
(total debt) / (total equity)
total-debt-ratio =
(total debt) / (total assets)
interest coverage =
(EBIT) / (interest)
fixed charged coverage =
(EBIT + lease payments) / (interest + lease payments)
growth rate (g) =
RR X ROE
retention rate =
1 - (dividends declared / operating income after taxes)
liquidity ratios
indicate a company’s ability to pay its short-term liabilities
operating performance ratios
indicate how well management operates the business
Traditional DuPont equation: return on equity =
(net income / sales) * (sales / assets) * (assets / equity)
or
(net profit margin) * (asset turnover) * (equity multiplier)
Expanded DuPont equation: return on equity =
(net income / EBT) * (EBT / EBIT) * (EBIT / revenue) * (revenue / average total assets) * (average total assets / average equity)
or
(tax burden) * (interest burden) * (EBIT margin) * (asset turnover) * (leverage)
Held-for-traiding
fair value on balance sheet; dividends, interest, realized and unrealized G/L recognized on income statement
Available-for-sale
fair value on balance sheet; dividends, interest, realized G/L recognized on income statement; unrealized G/L is other comprehensive income
Held-to-maturity
amortized cost on balance sheet; interest, realized G/L recognized on income statement
Inventory Accounting
In periods of rising prices and stable or increasing inventory quantities:
LIFO results in: higher COGS, lower gross profit, lower inventory
FIFO results in: lower COGS, higher gross profit, higher inventory
basic EPS =
(net income - preferred dividends) / (weighted average number of common shares outstanding)
[does not consider effects of any dilutive securities]
diluted EPS =
(adjusted income available for common share) / (weighted average common shares plus potential common shares outstanding)
OR
[(net income - preferred dividends) + (convertible preferred dividends) + (convertible debt interest)(1-t)] / [(weighted average shares) + (shares from conversion of convertible preferred shares) + (shares from conversion of convertible debt) + (shares issuable from stock options)]
capitalizing vs. expensing
capitalizing lowers income variability and increases near-term profits. Increases assets and equity
expensing has the opposite effect
Straight-line depreciation =
(cost - residual value) / (useful life)
Double declining balance depreciation =
(2 / useful life) * (cost - accumulated deprecation)
Units of production deprecation =
[(cost - salvage value) / (useful life in units)] * output units
Revaluation of Long-Lived Assets
IFRS: revaluation gain recognized in net income only to the extent it reverses previously recognized impairment loss; further gains recognized in equity as revaluation surplus. (For investment property, all gains and losses from marking to fair value are recognized as income)
GAAP: revaluation is not permitted
Deferred Taxes (DTL, DTA)
- Created when taxable income (on tax return) is not equal to pretax income (on financial statements) due to temporary differences
- Deferred tax liabilities are created when taxable income < pretax income. Treat DTL as equity if not expected to reverse
- Deferred tax assets are created when taxable income > pretax income. Must recognize valuation allowance if more likely than not that DTA will not be realized
Long-Term Liabilities (premium bond, discount bond, interest expense)
- Premium bond: coupon rate > market rate at issuance
- Discount bond: coupon rate < market rate at issuance
- Interest expense equals book value at the beginning of the year multiplied by the market rate of interest at the time the bonds were issued
Leases
Financial statement/ration impact of lease accounting from the lessee perspective: capital leases result in:
- Higher: assets, liabilities, CFO, debt/equity
- Lower: net income (early years), CFF, current ratio, working capital, asset turnover, ROA, ROE
- Same: total cash flow
Pensions
- Defined contribution: employer contribution expensed in period incurred
- Defined benefit: overfunded plan recognized as asset, underfunded plan recognized as liability
