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
