Lecture 13 - Financial Performance

Question 1

Give three reasons why it matters how firms report financial performance?

Answer 1

• Firm outsiders use financial performance.
• The assessment of past actions involves an evaluate of past performance.
• The predicted future development involves forecasts using past performance measures.

Question 2

Give 4 example of firm outsiders who may asses a firms financial performance.

Answer 2

1. Existing owners
2. Potential future owners
3. Financial analysts
4. Creditors

Question 3

What is meant by the term ‘capital maintenance’?

Answer 3

In general term, capital maintenance means the entity has maintained the amount of capital within the firm from the start of the period to the end. The amount over or under this is profit or loss.

Question 4

Under IASB, all changes in…

Answer 4

Equity (excluding transactions with the owner) are to be taken as measures of financial performance

Question 5

What is the ‘statement of comprehensive income’?

Answer 5

The statement of comprehensive income includes income not stated on the profit or loss statement. It helps to give a more thorough view of financial performance.

Question 6

Contrary to what may be suggested by its name, other comprehensive income can also include…

Answer 6

Expenses and can therefore be negative.

Question 7

Give an example of an income that would go on the statement of comprehensive income.

Answer 7

The revaluation of PPE or intangibles

Question 8

The format of a statement of comprehensive income can either be…

Answer 8

A. A single statement

B. Two separate stamens, the statement of profit or loss and a statement that includes profit and loss along with OCI.

Question 9

Regardless of the format chosen (2 statements or not), firms must present…

Answer 9

Figures showing

Profit or loss
Comprehensive income
The sum of both

Question 10

In the statement of comprehensive income, expenses are grouped either by…

Answer 10

The nature of the expense

Or

The function of the expense

Question 11

Give example of the sort of categories that would be used if expenses were classified by ‘nature’.

Answer 11

Depreciation
Employee benefits
Material expenses

Question 12

Give example of the sort of categories that would be used if expenses were classified by ‘function’

Answer 12

Cost of sales
Distribution costs
Administrative costs

Question 13

In theory, earnings can be split into three components, what are they?

Answer 13

1. Permanent earnings (recurring items)
2. Transitionary earnings (non-recurring items)
3. Noise (unrelated to current or future cash flows)

Question 14

What is the difference between ‘transitionary earnings’ and ‘noise’?

Answer 14

Transitionary earnings have an earnings multiple not greater than one, noise has an earnings multiple at or near zero.

Question 15

What is the menacing of the term ‘earnings multiple’?

Answer 15

You can think of earning multiples as coefficients on the earnings component in a valuation model.

Question 16

Because of the theory of ‘earning multiple’ it means firms with identical….. may have different…… because…..

Answer 16

Earnings may have different values because a firm with £100,000 of permanent earnings will be worth more than a firm with £100,000 of transitionary earnings.

Question 17

What is meant by their term ‘windfall gains’?

Answer 17

Windfall gains include earnings that occur as a result of a profit being made on the sale of assets.

Question 18

OCI can be presented in two categories, what are they?

Answer 18

1. Items of OCI that can be reclassified as profit or loss in a subsequent reporting period. (When unrealized gains become realized gains)
2. Items of OCI that cannot be reclassified into profit or loss. (Revaluation reserve for PPE)