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74 Cards in this Set
- Front
- Back
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The Income Statement
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referred to as the statement of operations, statement of earnings, profit and loss statement
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Income Statement Equation
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revenues - expenses = net income
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Components of the Income Statement:
Revenues |
the amount reported from the sale of goods and services,
revenue less adjustments for estimated returns and allowances is known as net revenue |
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Components of the Income Statement:
Expenses |
the amount incurred to generate revenue and include:
COGS Operating expenses Interest Taxes |
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Components of the Income Statement:
Expenses grouping |
Expenses are grouped together by their nature or function,
example - grouping by nature of expense, depriciation from both manufacturing and administration example - grouping by function - combining all costs associated with manufacturing as COGS |
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Income Statement also includes gains and losses
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which can result from incidental transactions outside the firms primary business activities,
example - firm might sell surplus equipment used in its mfg operation that is no longer needed, the difference between the sales price and book value is reported as a gain or loss on the income statement |
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Income Statement Presentation Formats
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single step - all revenues are grouped together and all expenses are grouped together
mulit step - includes subtotals such as gross profit and operating profit |
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Income State - multi-step example
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Revenue
Costs of Goods Sold Gross Profit Selling, General, and administrative expense Depreciation expense Operating profit Interest expense Income before tax Provision for income taxes Income from continuing operations Earning (losses) from discontinued operations, net of tax Net Income |
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Components of the Income Statement:
Gross Profit |
the amount that remains after the direct costs of producing a product or service are subtracted from revenue,
subtracting operating expenses, such as selling, general, and administrative expenses, from gross profit results in another subtotal knows as operating profit or operating income, |
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Components of the Income Statement:
Firm with controlling interest in subsidiary |
pro-rata share of the sub's income for theportion of the subs that the firm does not own is reported in the parents income statement as the minority owners interest, this is subtracted since a controlling interest means the subs entire net income is included in the firms income statement
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General Principles of revenue recognition and accrual accounting:
Under the accrual method of accounting |
revenue is recognized when earned and expenses are recognized when incurrred
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General Principles of revenue recognition and accrual accounting:
According to IASB |
the term "income" includes revenue and gains, income is defined as increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
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General Principles of revenue recognition and accrual accounting:
According to FASB |
revenue is recognized in the income statement when
a) realized or realizable b) earned |
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General Principles of revenue recognition and accrual accounting:
Guidance by the SEC |
Four criteria to determine whether revenue should be recognized
1) there is evidence of an arrangement between the buyer and seller 2) the product has been delivered or the service has been rendered 3) the price is determined or determinable 4) the seller is reasonably sure of collecting money |
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General Principles of revenue recognition and accrual accounting:
Unearned Revenue |
a firm receives cash before revenue recognition, reported on the balance sheet as a liability, the liability reduced in the future as the revenue is earned
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Specific Revenue Recognition Applications:
Long Term Contracts |
The percentage -of- completion method and the completed - contract method are used for contracts that extend beyond one accounting period
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Specific Revenue Recognition Applications:
The percentage-of-completion method |
appropriate whe the projects cost and reveue can be reliably estimated; revenue, expense, and therefore profit, are recognized as the work is performed, the percentage of completion is measured by the total cost incurred to date divided by the total expected cost of the project
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Specific Revenue Recognition Applications:
The completed-contract method |
Used when the outcome of a project cannot be reliably measured or the project is short-term; revenue, expense, and profit are recognized only when the contract is complete, under either method, if a loss is expected, the loss must be recognized immediately
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Specific Revenue Recognition:
Under IFRS |
the firm cannot reliably measure the outcome of the project, revenue is recognized to the extent of contract costs, costs are expensed when incurred, and profit is recognized only at completion
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Comparison:
completed contract vs. percentage-of-completion method |
the percentage-of-completion method is more aggressive since revehue is reported sooner, is more subjective because it involves cost estimates, however, provides a smoother earnings and results in better matching of revenues and expenses over time, CF is same under both methods
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Specific Revenue Recognition:
Under Installment sales |
occurs when a firm finances a sale and payments are expected to be recieved over an extended period:
collectibility certain - revenue is recognized at the time off sale collectibility uncertain - installment method is used collectibility highly uncertain - cost recovery method is used |
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Specific Revenue Recognition:
Installemnet method |
profit recocognized as cash is collected, profit is equal to cash collected during the period multipiled b y the total expected profit as a percentage of sales, used in limited situations, usually involving the sale of real estate
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Specific Revenue Recognition:
recovery method |
profit is recognized only when cash collected exceeds costs incurred
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Specific Revenue Recognition:
Under IFRS installment sale |
the date when title to the property is transferred and the date when the buyer acquires a vested interest mey differ, installment sale treatment may be required when the risks and rewards of ownershiup are not transferred because the seller remains involved in the property, sifnigicannt uncertainity that the buyer can complete the transaction may require installment sale treatment
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Specific Revenue Recognition:
Barter Transactions |
two parties exchanbe goods or sercies without cash payment
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Specific Revenue Recognition:
Round trip transaction |
hte sale of goods to one party with the simultaneous purchase of almost identidal goods from the same party, the underlying issue with thses transactions is whether revenue should be recognized
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Specific Revenue Recognition:
According to GAAP barter transaction |
cann be recognized at fair value only if the firm has historically received cash payments for such goods and service and can use this histroical experience to determine fair value
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Specific Revenue Recognition:
According to IFRS barter transaction |
must be based on the fiar vbalue of revennue from similar nonbarter transactions with unrelated parties
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Specific Revenue Recognition:
Gross revenue reporting |
the selling firm reports sales revenue and cost of goods sold separately
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Specific Revenue Recognition:
Net reveue reporting |
onlyh the difference in slaes and cost is reported, while profit is the same, sales are higher using gross revenue reporting
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Specific Revenue Recognition:
According to GAAP to use gross revenue reporting |
- be primary obligor under the contract
- bear the inventory risk and credit risk - be able to choose its supllier - have reasonable latitude to establish the price |
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What are the implications of revenue recognition principles ffor financial analysis
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- firms can recognize revenue before delivery, at the time of delivery, or after delivery takes place, different revenue recognitions methods can be used, this is disclosed in teh financial statement footnotes
- must consider two points a) how conservative are the firms revenue recognition policies, b) extent to which the firms policies rely on judgment and estimates |
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General principles of expense recognition:
According to IASB |
expenses decresases in economic benefits during the accounting period in the from of outflows or depletions of assetsor incurrence of leabilities that result in decreases in equity other than those relating to distributions to equity participants
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General principles of expense recognition:
matching principle |
whereby expenses to gennerate revenue are recognied in the same period as the revenue,
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General principles of expense recognition:
period costs |
expenses not tied directly tied to revenue generation, such admin costs, are expensed in the period occured
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Specific expense recognition applications:
depreciation of long-term assets |
must also be matched revenue, expected to provide economic benefits beyond on accounting period
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Specific expense recognition applications:
Inventory method |
the matching principle requires the firm to estimate bad debt expense and/or warranty expense, by doing so, the firm is recognizing the expense in the period of the sale, than than a later period
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The Implications of expense recognition principles for financial analysis
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it is possible for firms to delay or accelerate the recognition of expenses, must consider underlying reasons for a change in an expense estimate, should compare a firms estinates to thsoe of other firms within the firms industry
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Methods of depreciation:
straight line depreciation |
recognizes an equal amount of depreciation expense each period, assets gererate more benefits in the early years of thier econommic life and fewer benefits in the later years,
early years of an assets life, result in lower depreciation expense as compared to an accelerated method, SL Depreciation expense = cost - residual value / useful life |
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Methods of depreciation:
accelerated depreciation methhod |
more appropriate for matching the expenses to revenues
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Methods of depreciation:
accelerated depreciation methhod vs. straight line depreciation |
assets generate more benefits in the early years of their econommic life and fewer benefits in the later years,
early years of an assets life, result in lower depreciation expense as compared to an accelerated method, in later years, the effect is reversed, |
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Methods of depreciation accounting for inventory:
FIFO |
the first item purchased i sassumed to be the first item sold, appropriate for inventory that has a limited shelf life; example would be food
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Methods of depreciation accounting for inventory:
LIFO |
last item purchased is assumed to be the first item sold, appropriate for inventory that does not deteriorate with age; example would be coal
LIFO is popular because of its tax benefits, in an inflationary environment, LIFO results in higher cost off goods sold, higer cost of goods sold results in lower taxable income, and therefore lower income taxes |
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Methods of depreciation accounting for inventory:
weighted average cost method |
not affecte by the physical flow of the inventory
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Methods of depreciation accounting for inventory:
GAAP vs. IFRS |
GAAP - FIFO and average cost can be used, LIFO allowed
IFRS - LIFO is prohibited |
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Inventory Method Comparison:
FIFO |
US and IFRS
assumptions: the items first purchased are the first to be sold cost of goods sold consists of - first purchased ending inventory consists of - most recent purchases |
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Inventory Method Comparison:
LIFO |
US GAAP only
assumptions - the items last purchased are the first to be sold COGS constist of - last purchased ending inventory consists of - earliest purchases |
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Inventory Method Comparison:
weighted average cost |
US and IFRS
assumption - items sold are a mix of purchases COGS sodl consists of - average coast of all items ending inventory consists of - average cost of all items |
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Methods of depreciation accounting for inventory:
Intangible assets |
amortization expense for intangible assets with limited lives is similar depreciation, the expense should match the proportion of the assets economic benefits used during the period
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Methods of depreciation accounting for inventory:
Double - declining balance |
DDB uses 200% of the SL rate as the % rate applied to the declining balance
DDB depreciaton = (2/useful life)(cost - accumulated depreciation) |
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Distinguish between the operating and nonoperating components of the income statemnet
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usually reported separately on the income statement,
nonfinancial firm - nonoperating transactions may result from investment income and financing expenses |
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Financial reporting treatment:
Discontinued operations |
one that management has decided to dispose of but has yet to do so, or has disposed of in the current year, to be accounted for must be physically and operatinoally distinct from the rest of the firm
Measurement date - the formal plan for disposing of an operation Phaseout period - the time between the measurement period and tha actual disposal date, Any income or loss, reported separately net of tax, after income from continuing operations, Analytical implications - straight forward, does not affect net income from continuing operations, may provide info on future CF |
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Financial reporting treatment:
Unusual or infrequent items |
unusual or infrequennt items are included in income from continuing operatins and are reported before tax
Analytical implications - may want to review them to determine whether they tryly should be included when forecasting future firm earnings |
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Financial reporting treatment:
Extraordinary items |
a material transaction or event that is both unusual and infrequent in occurrence, Under GAAP reported separately in the income statement, net of tax, after income from continuing operation,
Under IFRS does not allow exptraordingary items to be separated from operating results in teh income statement Analytical implications - judgement required in determining whether a transaction or a exent is extraordinary, may want to review them to determine whether some portion should be included when forecasting future income, some companies seem to have extraordinary bad luck every year |
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Discuss changes in accounting standards
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requires retrospective application, SFAS No. 154
change in accounting estimate - a change in managements judgement due to new information Analytical implications - typically do not change CF, analyst should review changes in accounting estimates to determine the impact on future operations Prior period adjustment - a change from an incorrect accounting method to one that id aceeptable under GAAP or IFRS or a correction of an error Analytical implications - prior period adjustments usually involve errors or new accounting standards, do not typically affect CF, anaylists should review because any errors may indicate wearknesses of internal controls |
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The Components of Earnings per share:
EPS |
one of the most commonly used used corporate profitability performance measures publicly traded firms (nonpublic not required to report EPS)
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The Components of Earnings per share:
Simple captial structure |
conatins no potentially dilutive securities, contains only commons stock, nonconvertible debt, and conconvertible preferred stock
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The Components of Earnings per share:
Complex captial structure |
contains potentially dilutive securities, such as warrants, or convertible securities
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The Components of Earnings per share:
Basic EPS |
Basic EPS = net income - preferred dividends / weigghted average number of common shares outstanding
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The Components of Earnings per share:
weighted average number of common shares |
the number of shares outstanding during the year, weighted by the portion of the year they were outstanding
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The Components of Earnings per share:
Effect of stock dividends and stock splits |
stock dividend - the distribution of additional shares to each shareholder in ann amount proortional to their current number of shares,
stock split - the division of each old share into a specific number of new shares remember, each shareholders proportional ownership in the company is unchanged, the shareholder has more shares but the same percentage of the total shares outstanding |
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The Components of Earnings per share:
Things to know about the weighted average shares calculation |
1. the weighting system is days outstanding divided by the number of days in a year, but on the exam, the monthly approximation method will probably be used
2. shares issued enter into the computation from the dates of issuance 3. reacquired shares are excluded from the computation from the date of reacquisition 4. shares sold or issued in a purchase of asssets are included from the date of issuance 5. a stock split or stock dividend is applied to all shares outstanding prior to the split or dividend and to the befiining of period weighted average shares, a stock split or stock dividend adjustment is not applied to any shares issued or repurchased after the split or dividend date |
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The Components of Earnings per share:
Diluted EPS |
before diluting know the following terms:
1. dilutive securities are stock options, worrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to commont stock 2. antidilutive securitiesare stock options, worrants, convertible debt, or convertible preferred stock that would increase EPS if exercised or converted to common stock |
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The Components of Earnings per share:
EPS numerator |
1. if convertible preferred stock is dilutive, the convertible preferred dividends must be added to earnings available to common shareholders
2. if convertible bonds are dilutive, then the bonds after tax interest expense is not considered an interest expense for diluted EPS, hence, interest expense multiplied by (1 - the tax rate) must be added back to the numerator |
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The Components of Earnings per share:
EPS denominator |
is the weighted average number of shares, when dilutive securities exist, the denominator adjusted for eh equivalennt number of common shares that would be created by teh conversion of all dilutive securities outstanding, each one considered separately to determine dilutive, based only of the portion of the year hte dilutive security outstanding,
increase the number of common shares outstanding in the denominator, there is no adjustment to the numerator, |
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The Components of Earnings per share:
Treasury stock method |
1. assumes that the hypothetical funds received by the company from the exercise of the options would be used to purchase shares of the companys common stock in the market at the average market price
2. the net increse in the number of shares outstanding (adjustment to denominator) is the number of shares created by exercising the options less the number of shares hypothetically repurchased with the proceeds of exercise |
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The Components of Earnings per share:
The diluted EPS equation |
if - converted method
diluted EPS = net income / weighted average number of shares outstanding + new common shares that would have been issued at conversion |
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The Components of Earnings per share:
The adjusted diluted EPS equation |
diluted EPS = (net income + after tax interest on convertible debt - preferred dividends) / (weighted average shares + new common shares that could have been issued at conversion)
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The Components of Earnings per share:
Diluted EPS when a company has stock options, warrants, or their equivalents outstanding |
diluted EPS = (net income - preferred dividends) / (weighted average number of shares + new shares that could have been issued at option exercise - shares that could have been purchased with cash received upon exercise)
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Common size analysis of the I/S:
the common size income statement |
expresses each income statement item as a percentage of sales, facilitates comparison across time periods (time series anaylysis) and across companies of different sizes (cross-sectional analysis)
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Common size analysis of the I/S:
net profit margin |
net profit margin = net income / revenue
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Common size analysis of the I/S:
gross profit margin |
gross profit margin = gross profit / revenue
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Accounting classification for items that are excluded from the I/S:
Comprehensive Income |
- issuing stock
- reacquiring stock - dividends paid - foreign currency translation gains and losses - adjustments for minimum pension liability - unrealized gains and losses from cash flow hedging derivatives - unrealized gains and losses from available-for-securities - available for sales securities |
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Comprehensive income
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a measure that inclues all changes to equity other than owner contributions and distributions, that is, comprehensive income aggregates net income annd other comprehensive income
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