LM 2: Analyzing Income Statements Flashcards
What 2 things does income include?
income includes both revenue and gains
When is revenue recognized?
When it is earned, when company delivers the product or provides the service
What are the 5 steps in revenue recognition? IIDAR
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to each performance obligation
- Recognize revenue when the entity satisfies a performance obligation
Under IFRS 15, which is the new revenue recognition standard for firms that adhere to IFRS, when is revenue recognized?
revenue is recognized when control of an asset has been transferred to the customer.
What are 5 factors to consider when determining whether a seller has satisfied its obligations? CCLSS
- customer has physical possession of the asset
- customer accepts that the asset meets the terms of the contract
- Legal title of the asset belongs to the customer
- seller has met all contractual obligations and is entitled to payment
- “significant risks and rewards” of owning the asset belong to the customer
What is the difference between a principal vs. an agent?
a principal provides goods or services directly to the end customer
an agent arranges for another party to provide its goods or services to the end customer
How does revenue recognition for principals differ from revenue recognition of agents?
principal: recognizes the full amount of any revenue derived from a sale, as well as the associated cost of goods sold (COGS) and selling, general, and administrative (SG&A) expenses.
agents: must only recognize their commission as revenue.
What is a franchisor?
franchisor sells the right to open stores and sell products or services using its brand, expertise, and intellectual property
How must a franchisor recognize revenue?
recognize only royalty fees as its own revenue, which are typically a percentage of a franchisee’s sales
How would upfront franchise fees be recorded?
Upfront franchise fees received must be initially recorded as unearned revenue, with revenue being recognized on a straight-line basis over the term of the agreement.
How must revenue for software sales vs software services be recognized?
portion of a sale that is purely for the right to use the software may be recognized immediately
portion related to after-sales service must be amortized over the term of the license.
How is revenue for long-term contracts recognized?
Revenue from long-term contracts is recognized as goods are produced or services are completed.
What are 2 ways IFRS allows progress to be measured for long-term contracts? OI
- outputs (e.g., percentage of units delivered)
- inputs (e.g., share of total estimated costs incurred)
Under a “bill and hold” arrangement when is revenue recognized?
revenue is recognized from a sale even though the seller retains physical possession of the asset
What are the 3 commonly used expense recognition methods? MED
- Matching Principal
- Expensing as incurred
- Depreciation or amortization of capitalized assets
What is the matching principle?
The company recognizes some expenses when associated revenues are recognized (eg. Don’t expense the cost of inventory purchases until the revenue from the sale of the goods is recognized)
What are period costs?
costs that are not tied to or related to the production of inventory. expensed as they are incurred.
What is the difference between costs being capitalized vs expensed?
capitalized: fixed assets or intangible assets expected to provide longer than >1-year benefits must be capitalized and expensed over time.
expensed: Items expected to provide short-term benefits less than <1-year such as inventory must be expensed in the period incurred.
What is capitalized interest?
interest paid on loans to construct assets.
when a company uses a loan to pay for a long-term asset, they capitalize the interest with the life of the asset instead of expensing it.
What is an interest coverage ratio, formula, and is a higher or lower interest coverage ratio better?
companies’ ability to use their EBIT to repay their interest obligations
interest coverage: EBIT / Interest Expense
higher ratio means better position to repay its interest obligations.
Are internally developed costs expensed or capitalized?
most internally developed costs are expensed.
What is the one rule to internally developed costs being expensed?
expensed unless software feasibility is established.
Under non-recurring revenue and expense items, what are 4 items that should be reported separately under US GAAP and IFRS? DUCC
- Discontinued operations
- Unusual or infrequent items
- Changes in accounting policies
- Changes in Scope and Exchange Rates
What are unusual or infrequent items, and discontinued operations?
Unusual or infrequent items: restructuring costs, costs incurred due to natural disasters.
Discontinued operations: parts of a company’s core business or product line that have been divested or shut down. decision to dispose of an operating division.
How are unusual or infrequent items and discontinued operations recorded?
unusual and/or infrequent: to be included as operating activities and presented separately on the income statement.
discontinued operations: assets and liabilities are recognized as held for sale on the balance sheet.
What are 2 approaches to handling changes in accounting policies?
- Prospective approach
- Retrospective approach
What is retrospective approach?
Restate past financial statements as if the new standard was in effect back then, only for the periods in the report that are affected
What is prospective approach?
Only financial statements in the future are affected.
What changes in accounting policies approach would be used when voluntarily making changes to an account policy or there’s an error?
Retrospective approach
What changes in accounting policies approach would be used when company makes changes in account estimates?
Prospective approach
What is changes in scopes and exchange rates?
international business can materially affect statements due to fluctuating exchange rates
What is a complex capital structure?
a capital structure that includes instruments that can be on converted into common stock.
What is basic EPS formula?
(Net income -preferred dividends) / weighted average number of shares outstanding
What is the formula for diluted EPS with convertible preferred stock outstanding, also known as the If converted method?
Assumes preferred shares have been converted so no need to subtract preferred dividends
diluted EPS = net income / (weighted average number of shares outstanding + new shares issued at assumed conversion)
Whats the difference in formulas for the diluted EPS with convertible debt outstanding vs diluted EPS with convertible preferred stock outstanding?
for diluted EPS with convertible debt outstanding, you add both after-tax interest on convertible debt and subtract preferred dividends from net income.
What is the formula for the treasury stock method of Diluted EPS?
(Net income -preferred dividends) / weighted average # of shares outstanding + (new shares issued at opinions exercise - shares repurchased with cash at exercise) * proportion of year outstanding)
What is the common size analysis of the income statement and when facilitating comparisons across time and companies what effect does it remove?
When each line item is expressed as a percentage of revenue.
removes the effect of size.
What is net profit margin tell us and formula?
Amount of net income earned for each dollar of revenue
Net profit margin = net income / revenue
What is the formula for gross profit margin?
Gross Profit Margin = gross profit/ revenue
What is operating profit margin formula?
Operating Profit Margin: operating income/ revenue
What is the pretax margin formula?
Pre-tax margin = (EBT/ revenue)
What does the income statement show?
Shows financial results over a period of time
What are 3 depreciation methods?
- Straight line
- Double-declining
- Units of production
Expenses on the income statement may be grouped by:
A. Nature, but not by function
B. Function, but not by nature
C. Either function or nature
C. IAS No.1 states that expenses may be categorized by either nature or function
With a complex capital structure is diluted EPS greater or lower than basic EPS?
Diluted EPS is lower than basic EPS
What is the cost recovery method of account?
Business doesn’t record income related to sale of its services until the money collected from a client exceeds the cost of services rendered.
What is the completed contract method?
Recognize revenues and gross profit only when the contract is completed
What is percentage of completion method?
Recognize revenues and gross profit each period based upon the progress of construction
Percentage of total profit, includes bonuses.
What is installment method?
Approach to revenue recognition in which business owner defers gross profit on a sale until receiving cash for the sale from buyer
What are barter transactions?
Act of trading goods or services between 2 parties or more without the use of money
Building fence for crops instead of money
What 4 items bypass income statement and are included in OCI? FUUC
- foreign currency adjustments
- unrealized gain or losses on derivative contracts used for hedging
- unrealized gains and losses on available for sale investment securities
- certain costs related to defined benefit pension plan
