Financial Statements Flashcards
How must the sale of an asset you bought for £5,000 and sold for £6,000 be recorded on the cash flow statement?
It will be £6,000 into CFI. However, the income statement will show this as a gain of £1,000 in the net income figure, so we must remove £1,000 from CFO.
What are the components of closing assets on the balance sheet?
Opening assets
+ purchases
- depreciation
- disposals (at NBV)
What is free cash flow to the firm, and how do you calculate it?
The cash available to all of the company’s suppliers of debt and equity capital.
Net income + non-cash charges + interest(1 - tax rate) - fixed capital expenditures - working capital expenditures
Or
CFO + interest(1 - tax rate) - fixed capital expenditures
What is the difference between free cash flow to the firm and free cash flow to equity?
FCFF is the cash available to the company’s suppliers of debt and equity capital (common and preference shares, bonds, etc.)
FCFE is the cash available to common shareholders ONLY
How do you calculate free cash flow to equity (FCFE)?
CFO - fixed capital expenditure - net debt repayment
Or
CFO - fixed capital expenditure + net borrowing
How do you calculate cash flow to revenue, and what does it measure?
CFO / Net revenue
Measures cash generated per dollar of revenue
How do you calculate cash return on assets, and what does it measure?
CFO / Average total assets
Measures the cash generated from all resources
How do you calculate cash return on equity, and what does it measure?
CFO / Average shareholder equity
Measures the cash generated from owner resources
How do you calculate cash to income, and what does it measure?
CFO / Operating income
Measures the cash generating ability of operations
How do you calculate cash flow per share, and what does it measure?
(CFO - Preferred dividends) / Number of common shares outstanding
Measures operating cash flow on a per share basis
How do you calculate interest cover, and what does it measure?
(CFO + Interest paid + Taxes paid) / Interest paid
Measures the company’s ability to meet its interest obligations
(The numerator is a stand in for EBIT)
What are the four enhancing qualitative characteristics of useful financial information?
Comparability
Verifiability
Timeliness
Understandability
What are the two fundamental qualitative characteristics of useful financial information?
Faithful representation
Relevance
What does it mean when an auditor adds a disclaimer of opinion to their report?
The auditor cannot give a fair opinion on a company’s financial statements as they have been prevented from carrying out their function properly due to significant uncertainties, limitations in obtaining evidence, or lack of independence. This can have serious consequences for the company.
What does it mean when an auditor adds a qualified opinion to their report?
The auditor finds the financial statements generally accurate, but with some exceptions. This is still generally acceptable to investors, lenders and creditors.
What does it mean when an auditor adds an adverse opinion to their report?
The auditor has found that the company’s financial statements are materially misrepresented.
What does it mean when an auditor adds an unqualified opinion to their report?
The auditor has found the company’s financial statements to be an accurate and compliant with accounting standards.
In which financial statement would you find information about the compensation of directors and management?
The proxy statement.
Under US GAAP, how would issues that involve “especially challenging, subjective, or complex auditor judgment” be described?
Critical audit matters
What is meant by going concern?
The assumption that a company will continue to operate into the foreseeable future and not go into liquidation.
What is the fundamental principle of materiality in financial statements?
Materiality suggests that the financial statements should be free from misstatements and omissions that could influence the decisions of an investor.
A company issues 100 shares at £1.50. The shares have a par value of £1.00. What is the increase in share capital?
£100
The additional £50 raised is the share premium.
Current assets are those expected to be used up within how much time?
Either one year or within the firm’s operating cycle, whichever is longer.
If it takes the firm 18 months to produce an asset then current assets are those expected to be used up within 18 months.
On the balance sheet, a company’s current liabilities are those that they are expected to pay within how long?
One year or one operating cycle, whichever is longer.
Under US GAAP, what is the formula for cash flow from financing?
CFF = Issue of stock + Issue of bonds - Dividends paid - Bank overdrafts
How do you calculate cost of goods sold (COGS)?
COGS = Opening inventory + Purchases - Closing inventory
What would be the effect of misstating closing inventory as higher than it actually is on the balance sheet and the income statement (assuming indirect accounting method)?
Balance sheet: Assets are overstated
Income statement: COGS are understated, and therefore profit is overstated
What are the assumptions of first-in first-out (FIFO) inventory valuation?
Oldest goods are sold first.
Cost of sales (COGS) reflects the oldest prices, and are therefore relatively understated.
Ending inventory is based on current prices.
What are the assumptions of last-in first-out (LIFO) inventory valuation? And when is it allowed to be used?
Newest goods are sold first.
Cost of sales (COGS) reflects the newest prices, and are therefore relatively overstated.
Ending inventory is based on oldest prices.
LIFO is only permitted under US GAAP.
Which, if any, of these figures will differ from each other under FIFO, LIFO and weighted average inventory valuation methods? Opening inventory, purchases, closing inventory.
Only closing inventory.
Opening inventory is taken from the previous year’s balance sheet, and purchases are recorded as they happen so we don’t need to calculate them.
What is the LIFO reserve?
The difference between LIFO and FIFO
In periods of inventory liquidation (no purchases), which valuation method will have a higher profitability of FIFO and LIFO?
LIFO
Given that the remaining inventory is worth less under LIFO, the COGS will be lower, meaning profit will be higher.
Under IFRS, what measure of closing inventory is used, cost (using FIFO or weighted average) or net realisable value?
Whichever one is lower
What adjustments to the financial statements are needed when an inventory write down is required? (e.g. when sudden reputational damage reduces the NRV of your inventory)
If NVR is now less than the cost of the inventory on the balance sheet, it must be reduced.
Since closing inventory is now worth less, COGS increases, which decreases profits. This must be reflected in the income statement.
Can impairments of inventory value be reversed?
Under IFRS: Yes
Under US GAAP: No
How do you calculate inventory turnover and what does it measure?
Inventory turnover
= COGS / Average inventory
Measures how many times inventory turns over in a year
How do you calculate days of inventory on hand?
(Ending inventory / COGS) * 365
How are research and development costs recorded under US GAAP and IFRS?
Under US GAAP: Both are expensed
Under IFRS: Research costs are expensed but development costs (when the research results in something viable) are capitalised
In a period where development costs are rising faster than amortisation, how will the income statement be affected under US GAAP and IFRS? Assume that development costs are permanently ongoing.
Under US GAAP the development costs will be expensed and income will be lower.
Under IFRS the development costs will be capitalised and will spread out over a number of years, resulting in a higher net income.
When one company acquires another and pays more than the fair value of the assets of the other company, what is this premium recorded as?
Purchased goodwill
True or false, expensing development costs will result in a lower net income in the year the cost occurs than if the cost was capitalised, but higher net income in subsequent years?
Trick question
While this is almost always true, the assumption for development costs is that they are ongoing and will likely increase over time, meaning that expensing cost will always result in a lower net income
What development costs are allowed to be capitalised under US GAAP, and at what point is the transition from research cost to development cost made?
Software development costs.
Transition from research cost to development cost is made once feasibility and economic viability have been established.
When is a reversal of impairment allowed under US GAAP?
Only on long-lived assets that are being held for sale
Under what circumstances is a reversal of impairment of a revaluation of goodwill allowed?
It is never allowed
Under what circumstances is a reversal of impairment of a revaluation of goodwill allowed?
It is never allowed
What is the current ratio?
Current assets / Current liabilities
What is the quick ratio?
(Current assets - Inventory) / Current liabilities
In lessor accounting, why would you recognise a higher net income at inception for leasing the same asset under a sales-type financing lease than a direct financing lease?
A sales-type lease is for lessors who produced the leased asset. We can assume that the value of the lease will be greater than the value of the asset. Therefore, when we replace the asset on the balance sheet with the receivable value of the lease, the receivable will be greater than the asset value. To balance this, we treat the difference as if the asset was sold. The profit goes onto the income statement, and is then added back to the balance sheet as retained earnings.
