Session 7 Flashcards
Multistep I/S
Revenue - Cogs = Gross Profit
Gross Profit - SG&A - Depreciation = Operating Profit (EBIT)
Operating Profit - Interest Expense = Income before tax (EBT)
Income before tax - Provision for income tax = Income from continuing business unit
Income from continuing business unit +/- Income (loss) from discontinued business unit (net of tax) = Net Income (NI)
Net income - dividend = Income Available to Common
Net Revenue
Net Revenue = Revenue - Adjustment for Estimated Returns and Allowances
Expense
Cost incurred to generate revenue
- typically group by expense nature (e.g. Cogs)
- and by function (e.g. Interest Expense)
Non-controlling Interest
“Minority Interest”
Gross Revenue vs Net Revenue Reporting
Net Revenue Reporting: reports only the difference in Sales and Cost
Gross Revenue Reporting: Reports sales and cogs in separate line items
-US GAAP: to use gross revenue reporting, a firm must:
1. Be the primary obligator under contract
2. Bear the inventory risk & credit risk
3. Be able to choose its suppliers
4. Have reasonable latitude to establish price
Revenue Recognition
IASB - Sales of Goods:
- Risk and reward of ownership is transferred
- No continuing control / mgmt over goods sold
- Revenue must be reliably measure
- Cost must be reliably measure
- Probable flow of economic benefit
IASB - Sales of Service:
- Revenue must be reliably measure
- Cost must be reliably measure
- Stage of completion can be measured
- Probable flow of economic benefit
FASB - Earned or Realized / Realizable
- Evidence of arrangement between buyer and seller
- Products have been delivered / services have been rendered
- Price is determined / determinable
- Sellers have a reasonable means of collecting the money
Revenue Recognition - Long Term Contracts
If the outcome can be reliably measured:
IFRS & US GAAP: Percentage of Completion Method
-Revenue and Cost are recognized as work performed based on % completion
% Completion = Total Cost Incurred to Date / Total Expected Cost of Project
If the outcome cannot be reliably measured:
IFRS: Revenue is recognized to the extent of the contract costs, showing profit as be zero. Cost are expensed as incurred. Profit are recognized at completion.
US GAAP: Completed Contract Method: Revenue, Expenses and Profits are recognized after the contract is completed
If a loss is expected:
IFRS & US GAAP: Must be recognized immediately
Revenue Recognition - Installment Sales
If Collectibility is Certain:
US GAAP: regular Revenue Recognition rules apply
IFRS: Discounted PV (installment pmt) are recognized at the time of sales. The difference PV(installment pmt) and actual installment pmt are recognized as interest
If Collectibility cannot be reliably measured:
US GAAP: Installment Method
-Profit is recognized as cash collected
Profit = Cash collected during the period * Total expected profit as % of sales
IFRS: Cost Recovery Method
If Collectibility is HIGHLY uncertain:
US GAAP: Cost Recovery Method
-Profit is recognized only if CASH > COST INCURRED
Revenue Recognition - Barter Transaction
Round Trip Transaction: sales of goods to one party with simultaneous purchase of almost identical goods from the same party
US GAAP:
- Fair Value
- if the firm has historically received cash pmt for such goods / services - Carrying Value
- otherwise..
IFRS: Fair Value
from similar non-barter transactions with unrelated parties
Revenue Recognition - Converged Standards (2014)
Principles Based Approach: a firm should recognize revenue when it has transferred goods/ rendered services to a customer
5 Steps:
- Existing Contract between buyers and sellers
- There’re Performance Obligations in the contract
- There’s a Transactional Price
- Allocate transactional price with performance obligations
- Revenue is recognized when / as sellers fulfill their performance obligations
Performance obligations: a promise to deliver a DISTINCT goods/service
-distinct if:
1. the customer can benefit from the goods/services on its own or combined with other resources that are readily available
or
2. The promise to transfer the goods/services can be identified separately from any other promises
Required Disclosures:
- Contracts with customers by category
- A/L related to contracts
- Outstanding performance obligations and transaction prices allocated to them
- Mgmt judgements & changes used to determine the amount and timing of revenue recognitions
For LT Contracts, revenue is recognized based on firm’s progress toward completion
Expense Recognition
Matching Principle: generate revenue and expense at the same time period
Period Cost
Any cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets. A period cost is more closely associated with the passage of time than with a transactional event.
Includes:
1. Abnormal waste of labor, material, OH
2. Storage cost (unless its required during production)
3. Administrative OH
4. Selling Cost
Expense Recognition - Inventory Expense
- Specific Identification
“Cost Flow Methods”, “Cost Flow Assumption”, “Cost Flow Formula”
2. FIFO (IFRS & US GAAP)
- suitable for limited shelf life inventory
3. LIFO (US GAAP only)
- suitable for unlimited shelf life inventory
- have TAX BENEFIT due to inflationary environment
4. Weighted Average Cost (IFRS & US GAAP)
WA Cost = Total Inventory Cost / # Inventory
LIFO COGS and FIFO Inventory cost are good representation of the economic reality (Replacement Cost)
Expense Recognition - Depreciation Expense
Regardless which of the following depreciation method is used, the accumulative depreciation will be the same but the timing would be different
__________
1. Straight-Line (SL) Depreciation
SL Depreciation = (Cost - Residual Value) / # Useful Life
- Accelerated Depreciation
Typically asset generates more revenue in the earlier of their useful life and it would be more appropriate to recognize more depreciation expense in earlier years
Declining Balance (DB) Method
applies a constant rate of depreciation for an asset’s book value each year
-Double Declining Balance (DDB) Method
DDB = (2/N) (Cost - Accumulated Depreciation)
whereas N = # Useful Life
… typically it would switch back to SL depreciation over time
- Units of Production Method (Mainly for Natural Resources)
Units of Production Depreciation = (Original Cost - Salvage Value) / Output over life * Output in Period
__________
Component Depreciation: useful life for each component is estimated and depreciation expense is computed separately for each component
^Allowed in US GAAP; Required in IFRS
Depreciation vs. Amortization vs. Depletion
Impairment in value for:
Depreciation - tangible asset
Amortization - Intangible asset
Depletion - natural resources
Expense Recognition - Amortization Expense
SL Amortization = SL Depreciation
For indefinite lives intangible assets:
Annual check for impairment.. instead of amortization
Expense Recognition - Bad Debt Expense & Warranty Expense
Matching principle: Recognized at the time of sales by using an estimated amount
- Direct Bad Debt Expense - by identifying the customer a/r and write it off
- Using anticipated Allowance for Doubtful Account to recognize at the time of sales (preferred method)
Discontinued Operations
Operation(s) that the management has decided to dispose of, but either has not yet done so, or has disposed of in the current year after the operation had generated income or losses
Measurement Date: the date when the management decided to dispose the selected operations
-Accrued any estimated loss at this time
Phaseout Period: time between the measurement date and actual disposal date
-Record Gains only after the operation is disposed
Unusual or Infrequent Items
Are included in income from continuing operations before tax
Examples: G/L from sales of asset / business (outside usual operating activities) Impairment Write offs Restructuring Cost
Extraordinary Items
No longer allowed in IFRS or US GAAP
Unusual & Infrequent
Reported separately in I/S, net of tax, after income from continuing operations
Changes in Accounting Priniciples
E.g. Changing from IFRS -> GAAP, vice versa
Required Retrospective Application: restating the presented f/s to reflect changes
Exception: if Inventory is changing into LIFO method
No need for retrospective application. The company will use the carrying value of the inventory as the first LIFO layer. Inv Method changes - Must explains why the change is more reliable or preferrable
Changes in Accounting Estimates
Typically due to 1. new information, or 2. changes in management judgment
Apply Prospectively
Changes in Incorrect Accounting Method
Prior Period Adjustment: restating the result for all prior periods presented in current f/s
-Must disclose the nature of the adjustment and its affect on Net Income
An indication of weakness in the firm’s internal control
EPS - Earnings Per Share
Profitability Ratio
How much of the current earnings available to common shareholders
Basic EPS: (NI - Preferred Div) / WA (# Common Stock)
Diluted EPS =
[(NI-Pref Div) + (Convertible Pref Div) + (Convertible Debt Interest * (1-t))] /
[WA(#common stock) + (# from conversion of conv pref shares) + (# from conversion of conv debt) + (# from stock options)]
–Note: each security needs to be evaluated individually as dilutive before calculating diluted EPS
For # shares from stock options & warrants:
Treasury Stock Method: assumes the firm would hypothetically buy back company’s stock at an average market price using the fund received by exercising options / warrants
Dilutive: if EPS increased after being exercised
Anti-Dilutive: if EPS decreased after being exercised
Shortcuts:
1. Convertible debt securities are dilutive if:
[(convertible debt interest)*(1-t) / # convertible debt)] < EPS
2. Convertible Pref. stocks are dilutive if:
[(preferred dividend) / # convertible pref. stock] < EPS
3. # shares from stock options/warrant =
((AMP-EP)/AMP) (N)
whereas
AMP = Average Market Price
EP = Exercise Price
N = # options/warrants that can be converted into common stocks
Simple vs Complex Capital Structure
Simple Capital Structure: no potentially dilutive securities
Complex Capital Structure: carrying dilutive securities
Common Sized Statement
Allows time-series and cross-sectional analysis
Horizontal Common Sized Stmt
Express I/S and B/S items as % of Year 1 I/S and B/S items accordingly
Vertical Common Sized Stmt
Express I/S as percentage of Revenue
Express B/S as percentage of TA
Comprehensive I/S
I/S that includes all changes in Equity except for investors contributions / distributions
Other Comprehensive I/S
I/S that includes transactions that are not included in NI
1. FX G/L
2. Adjustment for minimum pension liability
3. Unrealized G/L from Hedging Activities
4. Unrealized G/L from AFS securities
^ In 2018, IFRS will no longer recognize AFS
5. Changes in LT Assets Fair Value (Applies to only IFRS)
Conceptual Framework For Financial Reporting (2010)
Asset: resources controlled as a result of past transactions that are expected to provide future economic inflows
Liability: obligations as a result of past events that are expected to require an outflow of economic resources
Equity: “Net Asset”; Owners’ Residual Interest
Balance Sheet
Should recognize an item if:
- There’s a probable future economic inflow/outflow
- The cost / value can be measured reliably
Classified Balance Sheet
Required by IFRS and US GAAP
Report items on B/S separately for current asset, current liability, non-current asset, non-current liability
Liquidity-Based Format
Recommended by IFRS
Present asset and liability items on b/s in the order of liquidity
Operating Cycle
the time it takes to provide / purchase inventory, sell the product and convert into cash
Current vs. Non current
Current: conversion of cash or obligation due within one year or one operating cycle (whichever is longer)
Non-current: more than one year or one operating cycle
Working Capital
WC = CA - CL
-indicates liquidity issue or inefficiency
Cash & Cash Equivalent
Asset - CA
Cash or securities with insignificant interest rate risk and can be converted into cash quickly
E.g. Treasury Bills, Commercial Paper, Money Market Fund (an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper)
Marketable Securities
Asset - CA
Securities or debts that are to be sold or redeemed within a year. These are financial instruments that can be easily converted to cash such as government bonds, common stock or certificates of deposit
Account Receivables
Asset - CA
“Trade Receivable”
Reported on B/S as Net Realizable Value adjusted for Bad Debt Expense
Firms are required to disclosure significant concentration of credit risk
NRV Net Realizable Value
NRV: Value of an asset that can be realized upon the sale of the asset, less a reasonable estimate of the costs associated with either the eventual sale or the disposal of the asset in question
Inventory
Asset - CA
Mfg: Raw Material (RM), Work in Progress (WIP), Finished Goods (FG)
Retail: Purchase Inventory Cost
See Product cost vs. Period Cost
See Cost Flow methods
See LIFO Reserve
See LIFO Liquidation
Required Disclosures (IFRS & US GAAP):
1. Cost Flow Method used
2. Total carrying value of Inventory (and by classification if applicable. e.g. RM, WIP, FG)
3. Carrying value of Inventory reported at Fair Value - Selling Costs
4. COGS that is recognized during the period
5. Amount of Inventory Writedowns
6. Amount of inventory WRiteups (IFRS only)
7. Carrying value of Inventory pledged as collaterial
_________________________________
Reports at lower of…
IFRS: Cost vs. Net Realizable Value
US GAAP: Cost vs. Market
(NRV) Net Realizable Value = Expected Sale Prices - (Estimated Selling Cost + Completion Cost)
^if Inv Cost < NRV, write down Inv Cot to NRV and recognize loss. Under IFRS, firm can write up Inv Cost as much as it has written down
Market…
- If Replacement Cost > NRV, Market = NRV
- If Replacement Cost < NRV - Profit Margin, Market = NRV - Profit Margin
- Otherwise, Market = Replacement Cost
Inventory - Standard Costing
Assign predetermined amount of material, labor, OH to goods
typically for mfg firms
Inventory - Retail Costing
Inventory Cost = Retail Price - Gross Profit
Prepaid Expense
Asset - CA
Operating costs that have been paid in advance
Deferred Tax Asset
Asset
Tax Payable > Tax Expense Recognized
Account Payable
Liability - CL
“Trade Payables”
Amount owes on credit
Notes Payables & Current Portion of LTD
Liability - CL
Obligations that are due < 1 year or 1 operating cycle
Accrued Liability
Liability - CL
Expenses that are recognized but not yet contractually due
Some recognize tax payable as part of accrued expenses
Unearned Revenue
Liability - CL
“deferred revenue”
Cash Collected in advance of goods transferred or service rendered
PP&E Property, Plant, Equipment
Non-Current Asset
tangible asset used in production of goods and services
Revaluation Method: IFRS only
^report at Fair Value - Accumulated Depreciation
Cost Method: IFRS and US GAAP
^report at amortized cost except for land
Recognize loss in I/S
–Loss recovery is allowed only in IFRS
Amortized Cost = Historical Cost - Accumulated Depreciation
= Purchase Price + Cost necessary to get asset ready for sales - Accumulated Depreciation
Investment Properties
Non-current Asset
IFRS: includes assets that generate rental income or capital appreciation
^reports at amortized cost or fair value
US GAAP: no definition
Held to Maturity Securities (HTM)
Debt securities acquired with the intent to be held to maturity.. typically less than a year
^report at amortized cost & ignore changes in MV
Amortized cost = original issued price - principal pmt + amortized discount - amortized premium - impairment losses
Trading Securities
“Held for trading”
Debt and equity acquired with the intent to profit in near terms
^reported at fair value and recognize unrealized G/L on I/S
Derivates
reported at fair value and recognize unrealized G/L on I/S
Available for Sales Securities (AFS)
Debt and equity that are not expected to be held to maturity or traded the near terms (not within a year)
^ reported at MV
^Unrealized G/L are reported in Comprehensive Income not in Net Income
Financial Assets at Historical Cost
Unlisted Equity Investment
Loans & A/R made to or will receive from another entity
Intangible Asset
Non-monetary assets that lack physical substance (excluding securities)
Identifiable Intangible Asset: can be acquired separately or are the result of rights privileged conveyed to their owners (e.g. patients, trademarks). Cost must be reliably measurable. Have probable future economic benefits. Is controlled by the firm.
Unidentifiable Intangible Asset: cannot be acquired separately and may have an unlimited life
-Good will: Excess of purchase price over Fair Value of identifiable net asset (Asset - Liability) acquired in a business acquisition
^Note: Accounting goodwill =/= Economic goodwill (derives from the expected future performance)
-Not amortized but annually tested for impairment
-Firm can manipulate goodwills to increase NI
-If purchase price < MV of identifiable Net Asset, then its a gain in I/S for acquirer
IFRS & US GAAP List Expensed as Incurred: 1. Startup and training cost 2. Administrative OH 3. Advertising and Promotion Cost 4. Relocation and Reorganization Cost 5. Termination Cost \_\_\_\_\_\_\_\_\_\_\_\_\_\_\_
Obtained Through:
I. CREATED INTERNALLY
-IFRS: Expense Research cost & Capitalize Development cost
-US GAAP: Expense all cost (including R&D); Expense Software development cost & Capitalize Salable Software development cost
II. PURCHASED
-US GAAP: Value at Cost Method
-IFRS: Value at Revaluation Method or Cost Model
-Analyst are more interested in the type rather than the assigned value.
III. ACQUISITION - Goodwills
-Acquisition Method: a set of formal guideline describing how asset, liability, non-controlling interest and goodwill of a target firm should be reported by a purchasing company on its consolidated stmt f
Long Term Financial Liabilities
Non-Current Liability
includes bank loans, note payables, bond payables, derivatives
^Reported at 1. Amortized Value, or 2. Fair Value
Deferred Tax Liability
Non-Current Liability
Tax Payable < Incurred Tax Liabilities
Contributed Capital
Par Value
Authorized vs. Issued vs. Outstanding shares
Preferred Stock
-Can be classified as Debt or Equity
Classified as Equity
^nonredeemable preferred stock
Classified as Debt
^mandatory redemption in fixed amount
Retained Earnings
undistributed earnings (NI) of firms since inception
Treasury Stock
Stock that has been reacquired by the issued firm but not yet retired
Accumulated Other Comprehensive Income
Doesn’t include NI but is a component of stockholders’ equity at point in time
Includes all changes in equity except for
- Transaction recognized in I/S
- Transactions with shareholders (e.g. issuing stocks, dividends)
Statement of Changes in Stockholders’ Equity
f/s that summarizes all the transactions that increase/decrease the equity accounts for the period
Current Ratio
Liquidity Ratio
CR = CA/CL
Quick Ratio
“Acid Test Ratio”
Liquidity Ratio
QR = (Cash & Cash Equivalent + Marketable securities + A/R) / CL
Cash Ratio
Liquidity Ratio
^The most conservative liquidity ratio
Cash Ratio = (Cash & Cash Equivalent + Marketable securities) / CL
Long Term Debt to Equity
Solvency Ratio
LTD/TE
Total Debt to Equity
Solvency Ratio
TD/TE
Debt Ratio
Solvency Ratio
TD/TA
Financial Leverage Ratio
Solvency Ratio
TA/TE
Cash Flow Statement
CFO Operating Cash Flow - transactions that affect firm's NI; typically related to Current Asset and Liability Includes: 1. Cash collected from customers 2. Cash paid for expenses 3. Interest Received / Paid (US GAAP) 4. Dividend Received (US GAAP) 5. Taxes Paid (US GAAP) 6. Sales Proceeds from Trading Securities 7. Acquisition of Trading Securities
CFI Investing Cash Flow - acquisition or disposal of LT asset and investment; typically related to Non-Current Assets
Includes:
1. Sales proceeds from fixed asset, debt, equity
2. Acquisition of fixed asset, debt, equity
3. Principal Received from loans made to others
4. Loans made to others
CFF Financing Cash Flow - transactions that affect a firm's capital structure; typically related to Non-Current Liability and Equity Includes: 1. Debt & Stock issued 2. Debt Repayment / Treasury Stock 3. Dividend paid to investor (US GAAP)
IFRS: Interest/ Dividend Received can be either CFO or CFI; Interest/ Dividend Paid can be either CFO or CFF
IFRS: Tax Paid is typically CFO unless its associated with an investing or financing activity
Non-cash investing and financing activities are not reported in CFS but must be disclosed in footnotes or a supplemental schedule
Direct Method
Permitted and encouraged by US GAAP and IFRS
^US GAAP requires disclosure of the indirect method
The only difference between direct vs. indirect is their operating CF
Direct Method: Cash Collected from Customers \+Cash Used in Production of Goods and Services \+Cash Operating Expenses \+Cash Paid for Interest \+Cash Paid for Taxes =Operating CF
Indirect Method
Permitted by US GAAP and IFRS
Net Income
+/- Gains/Losses Investing / Financing Activities
+/- Non-cash Charges (e.g. + depreciation)
+/- Changes on B/S Operating Asset / Liability Accounts
=Operating CF
USE OF CASH: Increase in asset accounts/ Decrease in liability accounts
SOURCE OF CASH: Decrease in asset accounts / Increase in liability accounts
BEG A/R + Sales - Cash Collection = END A/R
Product Cost
Costs that can be capitalized in the inventory account
^ delay recognition of expense till sold
Includes:
1. Purchase cost - Trade discounts & Rebates
2. Conversion (mfg) costs (e.g. Labor and OH)
3. Other cost necessary to bring the inv to its current location / condition
Periodic vs. Perpetual Inventory System
Periodic Inventory System: Inventory Cost & COGS are determined at the end of the period
Perpetual Inventory System: Inventory Costs & COGS are updated continuously
FIFO & Specific Identification Method would yield the same result; whereas, LIFO & WACost Method would yield different result depending on which system is used
LIFO Reserve
Required by IFRS and US GAAP
Amount by which LIFO Inventory is less than FIFO Inventory
Convert LIFO to FIFO:
- Inventory: + LIFO Reserve
- COGS: + Changes of LIFO Reserve
- CASH: - LIFO Reserve * Tax Rate
- Retained Earnings: + LIFO Reserve (1-Tax Rate)
LIFO Liquidation
When a firm using LIFO sells more Inventory than it products during the periods
In an inflationary environment, it…
- Increase Profit Margin
- Increase Tax
Not sustainable because a firm cannot indefinitely write off inventory without replenish it
Capital Expenditure
If the future economic benefit is:
- Unlikely, Uncertain, 1-off … Expense It as Incurred
- Multiple Accounting Period … Capitalized it
Capitalized Expenditure
- For subsequent expenditure:
1. If it provides more future economic benefits: Capitalized it
2. If it merely sustains the usefulness of the asset: Expensed It - Typically valued at F.V. - Cost Necessary to prepare the asset for use (including Tax)
Capitalized Interested - typically construction interest when the firm constructs an asset for its own use/ resales
^allocated to depreciation expense (if held for use) or COGS (if held for sale)
Cost Model
For Long Term Asset
^Required by US GAAP; Widely used by IFRS
B.V. = Historical Cost - Accumulative Depreciation - Impairment Adjustment
Revaluation Model
For Long Term Asset (Held for Use)
^Allowed by IFRS if there’s an active market for it
B.V. = Previous Revaluation - Depreciation
First Revaluation Date:
- If FV < BV, report loss
- if FV > BV, record gain in Revaluation Surplus Account, it’s reflected in Equity but not in NI
Subsequent Revaluation Date:
- If Gain <= Previously recorded loss, recover loss (only in IFRS)
- If Gain > Previously recorded loss, excess amount recorded in Revaluation Surplus Account
- if Loss < Revaluation Surplus Account, deduct loss from the account
- if Loss > Revaluation Surplus Account, report loss
Fair Value Model
See Revaluation Model for PP&E (Held for Use)
PP&E (Held for Sale)
- Asset is no longer depreciated or amortized
- Similar to Revaluation Model except there’s no Revaluation Surplus Account ..directly reporting gain to NI
- Loss Recovery is allowed in both IFRS and US GAAP
Impairment
For infinite live intangible asset: tested for impairment annually
IFRS
- Annually tested for impairment
- Impaired if: B.V. > Recoverable Amount
- If impaired, write down B.V. to recoverable amount and recognize loss
- Recoverable Amount is the greater of:
1. FV - Selling Cost
2. Value in Use = PV (Future CF) - Loss Recovery is allowed
US GAAP
-Tested for impairment only when events & circumstances indicate the firm may not be able to recover B.V. through future use
Recoverability Test
Step 1: Impaired if B.V. > Asset’s UNDISCOUNTED CF
Step 2: If impair, B.V. is written down F.V. & Recognize Loss
^ Loss is either, 1. B.V. - F.V. or 2. B.V. - PV (CF)
Derecognition of PP&E
- Sold: asset is removed from B/S. Recognize G/L through Sales Proceeds - B.V.
- Exchange: comparing old asset’s B.V. and F.V. (or New asset’s F.v.). Recognize the difference as G/L. record new asset at F.v.
- Abandoned: asset is removed from B/S and recognize loss
Useful Life Esimation
- Average Age = Accumulated Depreciation / Annual Depreciation Expense
- Total Useful Life = Historical Cost / Annual Depreciation Expense
- Remaining Useful Life = Ending PP&E / Annual Depreciation
