L10: Accounting Issues in Financial Analysis

Question 1

What does the use of financial reports look like?

Answer 1

1. Transaction/event
   –> Accounting method
2. Effects on financial statements
   –> Interpretation by user
3. Consequences/actions

Question 2

What tradeoffs can we see in classification of long-term/intangible assets as investment (capex) or expenses (opex)?

Answer 2

• Investment vs. maintenance?
• Will the R&D lead to a sellable product?
• Short useful life - laptops?

Question 3

What is accounting depreciation?

Answer 3

The allocation of acquisition cost to periods in which the asset is used in order to generate revenues; a measure of consumption.

Question 4

What are some depreciation methods?

Answer 4

Allowed under IFRS:
- Straight-line method (dominant).
- Accelerated depreciation/diminishing balance method (common for purpose of taxation)
- Units-of-production method. Drawback: the lower depreciation during low production periods may overstate profit, if the lower production reflects a decline in asset value.

Question 5

What is the depreciable amount?

Answer 5

Acquisition cost minus the Residual (salvage) value.

Residual: estimated net realizable value of the asset at the end of its useful life.

Question 6

What is the useful life of an asset?

Answer 6

The period over which an asset is expected to be available for use.
(Alternatively, the number of produced units expected to be obtained from the asset)

Question 7

What does an impairment charge reflect?

Answer 7

A decline in the ability of the asset to generate future economic benefits to the company. The impairment may signal a need for investment in improved technology.

Question 8

What is current tax?

Answer 8

The income tax for a period based on taxable income

Question 9

What is tax expense/income?

Answer 9

The sum of current tax and deferred tax for the period

Question 10

What are temporary differences?

Answer 10

Difference between:
- The carrying amount of an asset or a liability in the balance sheet prepared according to financial accounting regulation, and
- Its tax base (the amount attributed to an asset or a liability for tax purposes)

Question 11

What are deferred tax liabilities?

Answer 11

• DTL are the amounts of income taxes payable in future periods in respect of taxable temporary differences.
• DTL recognized for assets indirectly acquired in a business combination signify a tax disadvantage compared to a direct acquisition.
• A DTL is not recognized with regard to goodwill on consolidation.

Question 12

What are deferred tax assets?

Answer 12

• DTA are the amounts of income taxes recoverable in future periods in respect of deductible temporary differences.
• DTA recognized for assets indirectly acquired in a business combination signify a tax advantage compared to a direct acquisition.
• DTA are also recognized when a company has recoverable income taxes in future periods due to loss carryforwards (statutory tax rate * loss carryforward)

Question 13

Holding all else equal, what does capitalising an expenditure imply?

Answer 13

• Enhanced current profitability and increases reported CFs from operations (go under investments instead)
• Effect continues as long as capital expenditures exceed depreciation expense

Question 14

Holding all else equal, what does expensing a cost imply?

Answer 14

• Reduces current period profits, but enhances future profitability, and thus the profit trend
• If identical methods are required for fin. reporting and taxes: creates opportunity to earn interest on the cash saved in earlier periods