Financial Statements and Income Flashcards
FINANCIAL STATEMENTS LIMITATIONS
PERIODICITY
HISTORICAL INFORMATION
VALUATION
ACCOUNTING METHODS
OMISSIONS
PERIODICITY LIMITATION
FISCAL PERIODS ARE NOT GOOD INDICATORS OF NATURAL BUSINESS CYCLE
HISTORICAL INFORMATION LIMITATION
THE INFORMATION IS PURELY HISTORICAL AND MAY NOT BE DIRECTLY RELEVANT TO ONGOING OPERATIONS
VALUATION LIMITATION
1) HISTORICAL COST
some non-monetary accounts use historical cost because it’s objectively measured but becomes less relevant with time (inventory, Property ;Equipment)
2) ESTIMATES
some accounts are based on management estimates and judgments. This adds a level of uncertainty (Warranty reserves, allowance for doubtful accounts)
3) FAIR VALUE
accounts with objective market prices are often recorded at market value (marketable securities, bonds)
ACCOUNTING METHODS
CREATES DIFFICULTIES WHEN COMPARING RESULTS OF TWO DIFFERENT ORGANIZATIONS (depreciation method, inventory cost flow assumptions such as LIFO &FIFO)
Organizations must disclose significant accounting policy changes in the notes of financial statements
OMISSIONS
For Balance Sheet:
Value of workforce
Customer base
Reputation
Statement of Cash Flows:
Non-cash investing and financing transactions.
Ex: purchase of building through the issuance of stock (included in the notes)
STATEMENT OF CHANGES IN EQUITY
what’s included?
PREFERRED STOCK
COMMON STOCK
ADDITIONAL PAID-IN CAPITAL
TREASURY STOCK
RETAINED EARNINGS
ACCUMULATED OTHER COMPREHENSIVE INCOME
PREFERRED STOCK
CONTRIBUTED CAPITAL FOR NON-VOTING STOCK
IT GENERALLY CARRIES A STATED DIVIDEND RATE
IT’S PAID FIRST IN THE EVENT THE ORGANIZATION DECLARES A DIVIDEND
COMMON STOCK
CONTRIBUTED CAPITAL FOR VOTING STOCK
WITH NO SPECIFIED RETURN (growth or dividend)
AT PAR VALUE
ADDITIONAL PAID-IN CAPITAL
CONTRIBUTED CAPITAL IN EXCESS OF PAR VALUES
TREASURY STOCK
A CONTRA EQUITY ACCOUNT
RECORDS STOCK REPURCHASED BY THE ORGANIZATION
RETAINED EARNINGS
ACCUMULATED NET INCOME EARNED BY THE ORGANIZATION FROM INCEPTION LESS ANY DIVIDENDS DECLARED DURING THAT SAME TIME
ACCUMULATED OTHER COMPREHENSIVE INCOME
ITEMS NOT INCLUDED IN THE CALCULATION OF NET INCOME
OPERATING CASH FLOW
CASH FLOWS FROM YHE CENTRAL OPERATIONS OF THE ORGANIZATION.
FROM CUSTOMERS
TO EMPLOYEES
SUPPLIERS
INTEREST AND TAXES
INVESTING CASH FLOW
ASSOCIATED WITH LONGER TERM INVESTING ACTIVITIES
PURCHASE OF PROPERTY AND EQUIPMENT
SALE OF PROPERTY AND EQUIPMENT
FINANCING CASH FLOW
ASSOCIATED WITH FINANCING STRATEGY OF THE COMPANY
+ BORROWING (bank or bond)
+ SALE OF THE STOCK (common/preferred)
- PRINCIPAL REPAYMENTS ON DEBT
- REPURCHASE OF TREASURY STOCK
- CASH PAYMENT OF DIVIDENDS TO OWNERS
PURPOSE OF MULTI-STEP INCOME STATEMENT
IT SPLITS REVENUES, EXPENSES, GAINS , AND LOSSES INTO OPERATING &;NON-OPERATING ACTIVITIES
DISCONTINUED OPERATIONS
SHOWN SEPARATELY AFTER THE RESULTS FROM CONTINUED OPERATIONS
1) disposal of a component of the business and those operations (cash flow must be clearly distinguishable)
2) Gains and losses are shown net of their tax impact
3) For public companies, Earnings per common share must be shown for:
Income from Continuing Operations
Discontinued Operations
Net income
OTHER COMPREHENSIVE INCOME (OCI)
1) UNREALIZED HOLDING GAINS AND LOSSES ON AVAILABLE-FOR-SALE (AFS) SECURITIES
2) GAINS AND LOSSES ON CASH FLOW HEDGES
3) +/- IN EQUITY DUE TO FOREIGN CURRENCY TRANSLATION ADJUSTMENTS ARISING FROM THE TRANSLATION OF FOREIGN SUBSIDIARIES INTO U.S. DOLLARS
4) CERTAIN GAINS AND LOSSES RELATED TO DEFINED BENEFIT PENSIONS
OCI CAN BE PRESENTED IN ONE OF TWO WAYS:
1) in a combined Statement of Income and Comprehensive Income
2) in a separate fifth financial statement titled Statement of Comprehensive Income
Net Income
Components of OCI
Total Comprehensive Income
OCI amounts are accumulated in equity through ‘Accumulated Other Comprehensive Income’
Similar to how revenues, expenses, gains, losses, and dividends are accumulated in equity through Retained Earnings
PREFERRED STOCK
Generally non-voting stock ownership
Generally carries specified dividend rate stated as a % of par value
Must be paid before any common shareholders
May be convertible into common stock at specified conversion rate (at option of the owner)
May be callable at a specified price (at the option of the organization)
Behind company creditors but ahead of common shareholders for preference in the case of bankruptcy or liquidation
COMMON STOCK
Usually carried at par value unless the stock is no par stock
Dividends are not pre-determined like preferred stock and only paid when declared after preferred shareholders
Last in line for preference in the case of bankruptcy or other liquidation
ADDITIONAL PAID IN CAPITAL
Amount received by the organization for stock over the par value of the shares
Can be affected by various equity transactions including stock dividends, resale of treasury stock and issuance of options and warrants
Only if the stock has par value
TREASURY STOCK
Amount paid by the organization to re-purchase its own stock
Shown as contra equity or a reduction to the equity section
RETAINED EARNINGS
Income from inception
Net income or loss for the organization is ultimately recorded in retain earnings
Dividends declared are a reduction to retain earnings
ACCUMULATED OTHER COMPREHENSIVE INCOME
Other comprehensive income or loss for the organization is ultimately recorded in accumulated other comprehensive income
Items accumulated here are not part of the calculation of net income
NON-CONTROLLING INTEREST
Ownership in subsidiary entities that is outside of the controlling entity
When organization has a controlling interest in another entity
Not complete ownership
100% of the assets and liabilities of the subsidiary are included in the balance sheet of the organization
And the portion of the subsidiary that is owned by third parties is segregated as a separate component of equity
Common transactions that affect equity accounts
Sale of new shares
Issuance of options
Dividends
Net Income/Loss
Other Comprehensive Income items
Repurchase of Treasury Stock
Resale of Treasury Stock
Stock split
Stock dividends
SALE OF NEW SHARES
Generally sold for an amount above par value.
Cash received is recorded
the common stock/preferred stock account is increased for the par value
the additional paid in capital account is increased for the balance
ISSUANCE OF OPTIONS
Usually issued as a form of compensation
recorded as part of additional paid-in capital as compensation expense is recognized
1) total compensation expense is valued at the fair value of the options on the date they are granted
2) compensation expense is recognized over the service period required for the employee to become vested in the options
DIVIDENDS
Retain earnings is reduced with the cash dividend is declared.
His payment of the dividend is delayed
a payable is also recorded and then reduced when the payment is later made
NET INCOME/LOSS
Increases/Decreases retained earnings each year
OTHER COMPREHENSIVE INCOME ITEMS
Change in economic position of the company that’s not part of net income
Increase/Decrease accumulated other comprehensive income each year
REPURCHASE OF TREASURY STOCK
Treasury stock is increased (reduction to equity) for the cost of the treasury shares
RESALE OF TREASURY STOCK
1) when sold for an amount in excess of the repurchase price, the cost is taken out of the treasury stock and the excess is added to additional paid-in capital
2) when sold for an amount below the repurchase price, the cost is taken out of treasury stock and the difference is taken from additional paid-in capital to the extend it was previously increased for treasury stock transactions.
If no additional paid-in capital from treasury stock transactions exists, the difference is taken from retained earnings
STOCK SPLIT
Generally has no impact on any of the equity accounts as long as the par value is also changed to reflect the new share size
No journal entry is needed
STOCK DIVIDENDS
A stock dividend occurs when an organization distributes additional shares of stock to existing shareholders as a dividend rather than paying them cash
1) Small stock dividend: <20-25% of the number of shares outstanding. Retained earnings is reduced for the fair value of the stock being issued, common stock is increased for the par value of the stock issued, and the difference is included in additional paid-in capital
2) Large stock dividend: >20-25% of the number of shares outstanding. Retained earnings is reduced for the par value of the stock being issued and common stock is increased for the same amount. No impact on additional paid-in capital, similar to stock split
BALANCE SHEET
Assets and claims to those assets
ASSETS
Resources available for the organization to carry out its purpose
Presented in order of liquidity
Current: expected to be realized within one year (or operating cycle, if longer)
Non-current: expected to benefit the company for longer than one year (or the operating cycle if longer)
LIABILITIES
Represent third party claims to the assets of the organization
Current liabilities: expected to be settled with cash or other current assets within one year
Examples: A/P, accrued expenses, deferred revenue, principle portions of long-term debt due in the coming year
Long-term liabilities: due after one year
Examples: bonds or bank debt, deferred tax
EQUITY
Owner claims to the assets
BALANCE SHEET KEY DISCLOSURES
1) significant accounting policies
2) significant estimates made within accounts
3) amounts with major classes of inventory
4) Gross amounts with major classes of PP&E
5) components of deferred tax assets and liabilities
6) expected annual principal payments on debt for the next five years and all amounts due thereafter
7) sinking fund provisions for bonds
8) Par values and contractual provisions for preferred and common stocks
9) details about employee stock compensation program
10) significant commitments or contingencies not recorded in the Balance Sheet
11) other information as may be needed for a full understanding of the items reported
THE INCOME STATEMENT
Shows results of the operations
1) Revenues and expenses generally result from the primary operations of the organization
2) Gains and losses result from peripheral activities
3) Elements on the Income Statement are recorded on the accrual basis. Revenues are recorded when earned and realized and expenses are recorded when incurred
4) The Income Statement is often combined with a presentation of Other Comprehensive Income items. These items are not considered part of net income, but represent additional changes to the organization’s economic position during the period presented. When this information is included, the financial statement is called the Statement of Comprehensive Income.
Examples of noncash expense and revenue items that must be added back to net income
1) Depreciation expense and amortization of intangible assets
2) amortization of deferred costs, such as bond issue cost
3) changes in deferred income taxes
4) amortization of a premium or discount on bonds payable
5) income from an equity method investee
Cash Flows from Operating Activities- Indirect Method
Net Income
+ Noncash expenses (typically depreciation and amortization expenses)
- Gains from investing and financing activities
+ Losses from investing and financing activities
+ Decreases in current assets
- Increases in current assets
+ Increases in current liabilities
- Decreases in current liabilities
+ Amortization of discounts on bonds
- Amortization of premiums on bonds
= Operating cash flow
Items from Investing Activities
Most items come from changes in long-term asset accounts.
+ Sales of PP&E
+ Sales of investments in another entity’s debt or equity securities
+ Collections of the principal on loans to another entity
- Purchases of PP&E
- Purchases of other company’s debt or equity securities
- Granting of loans to other entities
Items for Financing Activities
Most items come from changes in long-term liability or equity accounts.
+ Sale of the entity’s equity securities
+ Issuance of debt, such as bonds or notes
- Payments to stockholders for dividends
- Payments to reacquire capital stock
- Payments to redeem a company’s outstanding debt
Footnotes for the Statement of Cash Flows
Requires:
- footnote disclosure of any significant noncash investing and financing activities (ex: issuing stock for fixed assets or the conversion of debt to equity)
- if Indirect method for cash flow from operations is used, both interest paid and income taxes paid need to be disclosed
Footnotes and Disclosures to financial statements
1) CONTINGENCIES
2) CONTRACTUAL SITUATIONS
3) ACCOUNTING POLICIES
4) SUBSEQUENT EVENTS
CONTINGENCIES
Are material events with an uncertain outcome dependent on the occurrence or non occurrence of one or more future events.
- can be gain or loss contingencies
- income recognition is not given to gain contingencies
- loss contingencies must be recognized if it’s both 1) probable that the loss was incurred, and 2) the amount of the loss is reasonable estimable.
Examples of loss contingencies: pending litigation, warranty and premium costs, environmental liabilities, and self-insurance risks
Examples of gain contingencies: pending litigation, possible refunds of disputed tax amounts, and tax loss carryforwards.
CONTRACTUAL SITUATIONS
Contractual agreements such as pension obligations, lease contracts, and stock option plans
ACCOUNTING POLICIES
Most companies prepare a separate note, “Summary of Significant Accounting Policies “, in which the report on the methods used to recognize revenue, calculate depreciation, value inventory, etc
SUBSEQUENT EVENTS
Event that is occurring between the balance sheet date and the issuance date of the annual report.
- if the event provides additional evidence about conditions that existed as of the balance sheet date and alters the estimates used in preparing the financial statements, then the financial statements should be adjusted.
- subsequent events that provide evidence regarding conditions that didn’t exist on the balance sheet date should be disclosed in a note
FAIR VALUE STANDARDS
-It assumes that the asset or liability is exchanged between market participants on the measurement date
-When a principal market exists, fair value is defined as price in that market
-If multiple markets, then highest price is used
Three approaches to determining fair value
1) Market approach
use prices for transactions involving comparable assets
2) Income approach
uses valuation techniques to convert future amounts to a single discounted present value
3) Cost approach
based on the replacement value of the asset
Advantage and disadvantage of using fair value
Advantage: provides more current information about the valuation of assets
Disadvantage: increased volatility in the reported value
