Financial Reporting and Analysis

Question 1

Requirements of Revenue Recognition

Answer 1

(1) completion of earnings process and (2) reasonable assurance of payment

Question 2

Revenue Recognition Methods

Answer 2

• Percentage-of-completion method.
• Completed contract method.
• Installment sales.
• Cost recovery method.

Question 3

Unusual or Infrequent Items

Answer 3

• 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.

Question 4

Extraordinary Items

Answer 4

Both unusual and infrequent (e.g., losses from expropriation of assets). U.S. GAAP only. IFRS does not allow extraordinary items.

Question 5

Discontinued Operations

Answer 5

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.

Question 6

Compute Cash Flows From Operations (CFO)

Answer 6

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.

Question 7

Free Cash Flow

Answer 7

Free cash flow (FCF) measures cash available for discretionary purposes. It is equal to operating cash flow less net capital expenditures.

Question 8

Common-size financial statement analysis

Answer 8

• 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.

Question 9

Horizontal common-size financial statement analysis

Answer 9

Expresses each line item relative to its value in a common base period.

Question 10

current ratio =

Answer 10

(current assets) / (current liabilities)

Question 11

quick ratio =

Answer 11

(cash + marketable securities + receivables) / (current liabilities)

Question 12

cash ratio =

Answer 12

(cash + marketable securities) / (current liabilities)

Question 13

defensive interval =

Answer 13

(cash + marketable securities + receivables) / (daily cash expenditures)

Question 14

receivables turnover =

Answer 14

(annual sales) / (average receivables)

Question 15

inventory turnover =

Answer 15

(cost of goods sold) / (average inventory)

Question 16

payables turnover ratio =

Answer 16

(purchases) / (average trade payables)

Question 17

days of sales outstanding =

Answer 17

(365) / (receivables turnover)

Question 18

days of inventory on hand =

Answer 18

(365) / (inventory turnover)

Question 19

number of days of payables =

Answer 19

(365) / (payables turnover ratio)

Question 20

cash conversion cycle =

Answer 20

(days of inventory on hand) + (days of sales outstanding) - (number of days of payables)

Question 21

total asset turnover =

Answer 21

(revenue) / (average total net assets)

Question 22

fixed asset turnover =

Answer 22

(revenue) / (average net fixed assets)

Question 23

working capital turnover =

Answer 23

(revenue) / (average working capital)

Question 24

gross profit margin =

Answer 24

(gross profit) / (revenue)

Question 25

operating profit margin =

Answer 25

(operating profit) / (revenue)

(EBIT) / (net sales)

Question 26

net profit margin =

Answer 26

(net income) / (revenue)

Question 27

return on assets (total capital) =

Answer 27

(EBIT) / (average total capital)

Question 28

debt-to-equity ratio =

Answer 28

(total debt) / (total equity)

Question 29

total-debt-ratio =

Answer 29

(total debt) / (total assets)

Question 30

interest coverage =

Answer 30

(EBIT) / (interest)

Question 31

fixed charged coverage =

Answer 31

(EBIT + lease payments) / (interest + lease payments)

Question 32

growth rate (g) =

Answer 32

RR X ROE

Question 33

retention rate =

Answer 33

1 - (dividends declared / operating income after taxes)

Question 34

liquidity ratios

Answer 34

indicate a company’s ability to pay its short-term liabilities

Question 35

operating performance ratios

Answer 35

indicate how well management operates the business

Question 36

Traditional DuPont equation: return on equity =

Answer 36

(net income / sales) * (sales / assets) * (assets / equity)
or
(net profit margin) * (asset turnover) * (equity multiplier)

Question 37

Expanded DuPont equation: return on equity =

Answer 37

(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)

Question 38

Held-for-traiding

Answer 38

fair value on balance sheet; dividends, interest, realized and unrealized G/L recognized on income statement

Question 39

Available-for-sale

Answer 39

fair value on balance sheet; dividends, interest, realized G/L recognized on income statement; unrealized G/L is other comprehensive income

Question 40

Held-to-maturity

Answer 40

amortized cost on balance sheet; interest, realized G/L recognized on income statement

Question 41

Inventory Accounting

Answer 41

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

Question 42

basic EPS =

Answer 42

(net income - preferred dividends) / (weighted average number of common shares outstanding)
[does not consider effects of any dilutive securities]

Question 43

diluted EPS =

Answer 43

(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)]

Question 44

capitalizing vs. expensing

Answer 44

capitalizing lowers income variability and increases near-term profits. Increases assets and equity
expensing has the opposite effect

Question 45

Straight-line depreciation =

Answer 45

(cost - residual value) / (useful life)

Question 46

Double declining balance depreciation =

Answer 46

(2 / useful life) * (cost - accumulated deprecation)

Question 47

Units of production deprecation =

Answer 47

[(cost - salvage value) / (useful life in units)] * output units

Question 48

Revaluation of Long-Lived Assets

Answer 48

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

Question 49

Deferred Taxes (DTL, DTA)

Answer 49

• 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

Question 50

Long-Term Liabilities (premium bond, discount bond, interest expense)

Answer 50

• 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

Question 51

Leases

Answer 51

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

Question 52

Pensions

Answer 52

• Defined contribution: employer contribution expensed in period incurred
• Defined benefit: overfunded plan recognized as asset, underfunded plan recognized as liability