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203 Cards in this Set

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Primary propurse for cash for statement of cash flow
1. infos about cash recive and cash paid
2. infos about operating, investing, fiancing activities.
2 of them
important info for investment decidion making presented in the statement of cash flows includes whether:
1.regular operations generate enough cash to sustain the business
2.enough cash to pay debts as they mature
3.need addition financing
4.unexpected obligations can be met
5.the firm can take advatage of new business opportunities as they arise.
The Financial Accounting standards Board(FASB) stats that financial statement should include info about
1.how the firm get and spend $
2.the firm's borrowing and pay debts activities.
3.The firm's sale and buyback of its ownership secuities.
4.Dividend payment and other cash distributions.
5.Other factors affecting liquidity and solvency.
Net cash flow from operations focuses on:
liquidity of the company rather than on profitability.
L or P
interest and dividend revenue and expense, are they considered cash flow from what?
I renvenue and expense are CFO, dividend rev are CFO, Dvi exp are CFF
income tax are cash flow from what activities?
operating, even if some arise from finacing or investing.
Operating, investment or finance.
what Cash flow from investing represents?
buy or sale of productive assets(physical assets and investments)
Cash flow from investing (CFI) deal with what assets?
lower left-hand portion of the balance sheet(fixed assets)
Cash flow from Investing include:
1.capital expenditure from long term assets
2.sales fo assets
3.CF form investments in joint ventures and affiliates and long term investment in securities.
Cash flow from financing deal what in balance sheet
lower right hand portion
aka long term debt and equity
exaple of cash flow from financing
1.debts financing shor or long term
2.divident paid becase div flow through the retained earnings statement.
Key element of operating cash flow
1.cash from sales
2.inputs into manuf.or retail(COGS)
3.cash interest expense
4.cash tax payments
Key elements of investing cash flow
1.buy property, plant, equipment.
2.investments in joint ventures and affiliates.
3.payments for business aquired.
4.sales of assets.
5.buy or sales of marketabke securities.
Key elemetn of financing cash flow
1.cash dividents paid
2.increases or decrease in short term borrowing
3.long term borrowing and repayment of long term borrowing
4.stock buy and sales.
receivables, cash for what for balance sheet?
CFO
inventories, cash for what for balance sheet?
CFO
Prepaid expenses,cash for what for balance sheet?
CFO
Taxes, interest payment, and miscellaneous payables,cash for what for balance sheet?
CFO
Cash sales, cash for what for Income statement?
CFO
COGS, cash for what for Income statement?
CFO
Cash general and administrative expenses,cash for what for Income statement?
CFO
Cash taxes,cash for what for Income statement?
CFO
Interest paid and received,cash for what for Income statement?
CFO
Dividends received,cash for what for Income statement?
CFO
cash from fixed asset,cash for what?
CFI
Martetable securities, cash for what?
CFI
Dividents paid,cash for what for Income statement?
CFF
liability accounts that represent debt,cash for what?
CFF
change in equity accounts,cash for what?
CFF
Direct method of cash flow
taking each item form income stetement, converting it by adding of subtracting the changes in the corresponding balance sheet acounts.
Cash outflows in CFO
cash input, cash operating expense, cash interest, cash taxes.
how to deal with deferred tax in cash flow
add them back as it's non cash expense
constructing the statement of cash flows using the indirect method
1.calculate the change in cash
2.calculate the change in all other balance sheet items
3.identify changes as potential adjustments for operating, investing, and financing activities
4.determing CFO,CFF,CFI
5.compute CFO,CFF,CFI
Free cash flow
FCF attempts to measure the cash available for discretionary purposes,which is cash flow minus those cash flows necessary to maintain the firm's present productive capacity.

free cash flow = operating cash flow - net capital expenditures

where:
net capital expendiures = total capital expenditures - after-tax procceds from asset sales
IAS GAAP, interest and dividends received, CFO,CFI or CFF?
CFO or CFI
Dividend and iterest paid, CFO,CFI or CFF?
CFF or CFO
Interpret common-sizew balance sheet and income statements.
cz bal.sheet express all accounts as a % of total asset
c-z inc.statement expresses all income statement items as a % of sales
which circumstances does the use of common-size financial statements is appropriate.
easier for comparision of financial data across firms and time;in addition, cz is good for quickly viewing certain fianancial rations. ex,gross profit margin, operating profit margin, net profit margin.
limitations of financial ratios
1.not useful when viewed in isolation. must compare other firms or time.
2.difficult compare with othrer firms when accounting method of priciple are different.(us and isa gaap)
3.difficult in firms in multiple industries.
4.conclusions can't be made from viewing on set of ratios.
5.determining the target or comparision value is difficult without values.
ask urself Qs when viewing financial ratios:
1.similar accounting practices for all firms?
2.comparable divisions within a firm?
3.do the ratios being used give consistent reading?
4.do the ratios yield a reasonable figure for the industry?
how to compare firms in same indusry by financial ratios?
1.compare with industry averages, if variations is large, use medians.
2.don't use all firms but a subset with similar characteristics, sizes.
3.for multi-industry firms,use cross-sectional analysis to find a group of firms that in similar mix of industries,or calculate composite industry average by average based on the proportion of the company's sales in each industry segment.
Operating performance ratio can be divide into :
1.Operating Efficiency ratio
2.Operating Profitability ratio
Operating efficiency rato include
1.total asset turnover
2.net fixed asset turnover
3.equity turnover
Operating profitablility ratios include:
1.gross profit margin
2.operating profit margin
3.net profit margin
equataion: total asset turnover
Total asset turnover = net sales/ average total net assets
equation: fix asset turnover
Fix asset turnover = net sales / average net fixed assets
equity turnover equation
equity turnover = net sales / average equity
(equity include all preferred and common stock, paid-in capital, and retained earnings)
gross profit margin equation
Gross Profit Margin = gross profit/ net sales. where gross prfit = net sales - COGS
Operatin profit margin equation
Operating profit margin = operating profit(EBIT) / net sales, where operating profit= gross profit - operating expense
Net profit margin equation
Net profit margin = Net income / net sales
Return of total capital ratio equation
ROTC = (Net income + gross interest expense) / average total capital, where gross interest expense = net interest expense + interest income
two group of risk analysis
1.financial risk
2.business risk
3 calculation measure business risk
1.business risk
2.sales volatility
3.operating leverage
Coefficient of variation of business risk
business risk = stdv. of operating income(EBIT)/mean of operating income(EBIT)
note: data should be b/w 5 to 10 years. less is not reliability, more is not relevant.
sales variability equation
sales variability = stdv. of sales / mean sales
note: data should b/w 5 to 10 years.
operating leverage equation
operating leverage = mean |%change in operating earnings / % change in sales|

it measure how much of te company's production cost are fixed. the greater the use of fixed costs, the greater the risk.
debt-to-equity ratio
DTE ratio = total long-term debt / total equity = (long term - liabilities + deferred tax + PV of leases) / (common + preferred equity)
long-term capital equation
long term capital = long term debt + common and prefferd shares
interest coverage equation
interest coverage = earnings b4 interest and taxes / interest expense
fixed financial cost ratio
fixed financial cost ratio = EBIT + ELIE / gross interest expense + ELIE

ELIE = estimated lease interest expense
cash flow coverage of fixed financial costs
cash flow coverage of fixed financial costs = CFO + interest expense + ELIE / interest expens + ELIE
Cash flow to long-term debt
cash flow to long term debt = CFO / Book Value of long-term debt + PV of operating leases
cash flow to total interest-bearing debt
cash flow to total interest-bearing debt = CFO / total long-term debt + current interest-bearing liabilities
Sustainable growth rate equation
g = RR X ROE

RR: the retention rate of earnings
ROE is a function of which 3 components?
1. Net profit margin (Net income / net sales)
2. Total asset turnover(net sales / total asset)
3. Financial leverage(total asset / equity)
retention rate equation
RR = 1 - divident payout ratio (Divident declared / operating income after taxes)
under EPS requirement, a public company muse:
1. Report EPS for all components of net income
2.Reconcile basic EPS and diluted EPS numerators and denominators.
distinguish b/w simple capital structure and complex capital structure
1.SCS is one that contains no portencially dilutive secuirityis(only common stock, nonconvertible debt, and preferred stock)
a complex captital structure has potentially dilutive secuirities(options, warrants, of convertible securities)
types of EPS that simple or complex capital structues must report:
simple: basic EPS
complex: basic and dilutive EPS
what should a company reporting intermediate component of income(income from continuing operations, income b4 extraordinary items) do ?
a company reporting intermediate component of income(income from continuing operations, income b4 extraordinary items) must report EPS amounts for these components in either the income statement or in the notes to the financial statement.
baisc EPS equation
basic EPS = (net income - preferred dividends)/(weighted average # of common shares outstanding)
why not deducted dividends of common stock in basic EPS
because basic EPS refers to the per-share earnings availabl to common shareholders, and dividends of common share is a part of net income to common holders.
A quick way to determine if a convertible bond is dilutive
compare
convertible debt interest (1- t)/ convertible debt shares with basic EPS, the convertible is antidilutive if it is greater than basic EPS
A quick way to calculate the net increase in commons shares from potential exercise of stock options or warrents
[(average market price of CS - option or warrants' exercise price) / average price of CS] # of CS option or warrants can be converted into
under what condition should the previously reported EPS be restated ?
stock split, so that comparisons of EPS over time ar not misleading.
under what condition should the beginning balance of outstanding share be re-adjusted?
stock split, it is treated as if it were done at the beginnig of the accounting period.
Define capital budgeting process
it is the process of evaluating and identiflying capital projects, whici is the project that expected cash flow last longer than one year.
FIFO,LIFO, which one has bigger COGS?
normally LIFO as under assumption that prices are always getting higher and higher.
FIFO,LIFO, which one has bigger Current ratio?
FIFO, due to lower COGS, the lower expense will higher current income and assets.
FIFO,LIFO, which one has bigger inventory turnover?
LIFO,due to higher COGS, which means higher inventory turnover(COGS / average inventory)
LIFO liquidation concept
firm can match sell old stock with higher price under LIFO by selling more than purchasing in a single period.

see http://www.investopedia.com/terms/l/lifoliquidation.asp
How US. firms gain profit under LIFO liquidation?
By LIFO liquidation, more GOGS, then lower income on the book, then, lower tax. but actual income is higher due to lower COGS than on the book as old stock are counted at recent cost level.
FIFO,LIFO, which one provide the most useful eastimate of the inventory value ?
FIFO
FIFO,LIFO, which one provide the most useful eastimate of COGS ?
LIFO
In what part of financial statement should accounting method located in?
Footnotes.
LIFO to FIFO conversion equation:
FIFO inven. = LIFO inven. + LIFO reserve
COGS f to COGS l conversion equation:
COGS f = COGS l - change in LIFO reserve
An estimation of COGS l RSPT COGS f:
COGS l = COGS f + (BI f X inflation rate)

wehre BI = Beginning inventory
Infl.rate = infl.rate of the industry the firm belongs
An estimation of COGS l RSPT COGS w:
COGS l = COGS f + 1/2(BI w X inflation rate)

wehre BI = Beginning inventory
Infl.rate = infl.rate of the industry the firm belongs
Working capital definition:
Current Asset - Current Liability
FIFO,LIFO,which one is better to estimate firm's profitabilty?
LIFO
FIFO,LIFO,which one is better to estimate firm's cost?
LIFO
FIFO,LIFO,which one is better to estimate firm's liquidity?
FIFO,as data under LIFO is outdated and unrelevant.
FIFO,LIFO,which one is better to estimate firm's inventory turnover?
average of both(which is call current method.),since COGS are affected by price change under LIFO, FIFO is better but is still misleading.
FIFO,LIFO,which one is better to estimate firm's solvency(debt ratio, debt-equity ratio)?
FIFO since it produce higher inventory level that are more relevant.
Reasons that why LIFO reserve might decline:
1.Invent. quantity is falling
2.prices are falling
The principles of Lower of cost or matket method(LCM):
Under normal case, inventories are record under historical cost even if market value is higher. However, if market value or replacement cost is lower than historical cost, a writedown is required.



http://www.investopedia.com/terms/l/lowerofcostandmarketmethod.asp
The range where replacement cost of inventory must fall into:
the replacement cost must fall within the selling priceor net realized value(higher end) and the selling price minus normal profit margin
2 main charactoristics of long-term asset:
1.are used in production process
2.have useful life greater than one year
3 main categories of long-term asset:
1.tangible asset
2.natural resources
3.intangible asset
problems with sraight line depriciation method
1.Actual cost are normally higher than it stated due to higher repair and maintainance expense
2.An increasing rate of return is realized under this method due to lower value of asset with constant output
the sum of the year's digits(SYD) method in depriciation equation
Depreciation in year x = (original cost - salvage value) x (n-x+1) / SYD
An easy way to calculate SYD
n(n+1) / 2
3 ways to change depreciation method:
1.change in method in new assets.
2.change in method in exisiting assets.
3.change in depreciable live or salvage values.
changes occur in depreciation change in existing assets:
1.shown effect on past results.
2.existing depreciation will change.
3.because it changes account principle, effect of cumulative change on past income will be shown net of tax on income statement.
4.estimated future income will be revised.
changes will occur when changing depreciable live or salvage value:
1.current income
2.estimated future income

note: past income will not be revised as account principle hasn't changed.
If a firm change from accelerated to straight line depreciation method to all asset, what will happen to financial statement?
1.increase net income
2.no change in income from continuing operations
If a firm change from accelerated to straight line depreciation method to new assets, what will happen to financial statement?
nothing
If a firm change from accelerated to straight line depreciation method, what will happen to depreciation expense?
decrease
If a firm change from accelerated to straight line depreciation method to all asset, what will happen to net income from continuing operations ?
increase
If a firm change from accelerated to straight line depreciation method to all asset, what will happen to ROA and ROE?
increase due to increase in net income.

note: asset and equity also increase, but the ratio still increase due to larger in income
3 calculations that are useful in quality of fixed assets:
1.average age
2.relative age
3.average depreciable life.
Deprication: average age equation:
accumulative depreciation / depreciation expense
the importance of using average age is that:
1.it helps identify older, less-efficient assets, which may make the firm less competitive.
2.an analyst can estimate when major capital expenditures will be required,which will help the analyst forecast when the firm will face significant financing requirements.
Depreciation: relative age, or average age as a percentage of deprecialbe life equation:
accumiulated depreciation / ending gross investment

Note: it is more accurate when straight-line depreciation is used.
average depreciable life equation:
ending gross investment / depreciation expense
Recverability test: under what circumstances is an asset considered impaired?
When the carry value(asset cost less accumulated depreciation) is more than the undiscounted cash flow from the asset's use and disposal.
Loss measurement of impaired long-live asset.
the relevant portion of tis booke value should be immediately recognized as a loss on the income statement.
What is the fair value of asset retirement obligations(ARO)?
either the market value of the liability or the expect cash flow necessary to retire the liability if market value can't be recognized.
effects on financial statement of SFAS 143 ARO:
1.fixed asset and liabilities reported on the balance sheet will increase
2.net income will be lower of the additional depreciation of the asset and the accretion of the liability.The accretion will increase each year.
What is the effect of SFAS 143 on Asset turnover?
decrease due to increase in fix asset and liability.
What is the effect of SFAS 143 on Liability-to-equity ratio?
increase due to increase in liability and decrease in net income and retain earnings.
What is the effect of SFAS 143 on return on asset?
decrease due to decrease in net income and increase in asset.
What is the effect of SFAS 143 on interest coverage?
decrease due to decrease in EBIT and increase in interest expense due to accretion of ARO liability.
Should past income be changed if a firm change its depriable life or savage value?
NOp....
should the current and future income estimations be changed if a firm change its depreciable life or salvage value of the fixed asset?
yeh....
issues that arises in capitalization include:
1.which conponenents of cost are capitalized
2.what method should be determine the amount capitalized.
For analysis purpose, "assets" represent:
1.intial investment outlay
2.firms represent "wealth"
3.input of production
Is marchinery acquired under an operating lease an asset in balance sheet? how about in secuirity analysis?
not an asset in balance sheet but should be a asset under security analysis.
should the amount of capitalized expenses be added to assets?
yes.
Should the cash flow of capitalization be treated as CFO,CFI or CFF?
CFI.
will capitalizing expenses increase equity? how?
yes. by increasing net income and retained earnings in the current period.
will capitalizing expenses increase equity? how?
yes. by increasing net income and retained earnings in the current period.
how the income variability differs b/w capilized and expense?
capitalizing: smooth
cost: greater viariance in reported income
How is the profitability of capitalized expense Vs one-time cost during the early year?
capitalizing will have greater income.
How is the profitability of capitalized expense Vs one-time cost during the later year?
capitalizing will have lower income due to continuing depreciation, and assets will be higher by the capitalized amount.
How is the cash flow of capitalized expense Vs one-time cost?
as capitalization wil be classified as CFI outflow, CFO will be higher and CFI will be lower.
How is the cash flow from CFO of capitalized expense Vs one-time cost ?
bigger since cash flow from capitalization is consider CFI,we have bigger CFO but lower CFI
How is the leverage ratio(debt to asset, debt to equity) of capitalized expense Vs one-time cost?
better for capitalized expense since bigger retain earnings enlarge the asset and equity.
effects of capitalize interest on interest expense and net income
interest expense decreased and net income increased (see note p 161 book 3)
effects of capitalized interest on interest expense and net income
interest expense decreased and net income increased (see note p 161 book 3)
effects of capitalized interest on interest expense and net income
interest expense decreased and net income increased (see note p 161 book 3)
effects of capitalize interest on interest expense and net income
interest expense decreased and net income increased (see note p 161 book 3)
effects of capitalize interest on interest expense and net income
interest expense decreased and net income increased (see note p 161 book 3)
effects of capitalized interest on CFI and CFO
since capitalized interest in counted in CFI(while other interest is counted in CFO), CFO is overstated and CFI is understated.
how to adjust the distortion of classification of cash flows.
Adding the capitalized interest back to CFI and deducting it with other interest payment from the CFO.
effects of capitalized interest on interest coverage ratios(EBIT / interest expense)
greater in capitalization period since interest expense decreases greater than depreciation increases.
smaller in the subsequent period since the depreciation increases in the following period.
When should the capitalizaion of interest inccur ?
in the construction period.
how to measure the value of capitalized interest if the borrowing is not identical?
Use the weight-average interest rate on outstanding debt(up to the aboumt invested in the project)
Should the Research and Development Cost (R&D) be capitalized or treated as expense?
Expense under US GAAP.
note: development cost may be capitalized under IAS 9
Should the patents and copyrights be capitalized or treated as expense?
expense except the registration fee(treated as R&D)if it is generated internally. If it is purchased fully from other firm, all cost are capitalized.
Should the Franchises and license be capitalized or treated as expense?
the cost of purchasing it can be capitalized.
Should the Brands and trademarks Cost be capitalized or treated as expense?
can be capitalized if it is purchased. However, if it is generated internally, it is treated as expense.
Should the Advertising Cost be capitalized or treated as expense?
expense since the sales generated from it is hard to identify.
Should the Goodwill be capitalized or treated as expense?
The US and most other GAAP limit the recognition of goodwill to causes where it i acquired in purchase method transactions.
Should the Advertising Cost be capitalized or treated as expense?
expense since the sales generated from it is hard to identify.For direct-response advertising, the cost can be capitalized.
Should the software development Cost be capitalized or treated as expense?
If it is for sale, the cost of evaluation of technology and economic feasibility is treated as expense, subsequent cost may be treated as inventory.If it is for internal use, the cost of after technological feasibility evaluation should be capitalized.
What might be implied if a firm shift its operating to financing liabilities?
the firm may encounter a liquidity crisis, as reduced access to trade credit results in increased reliance on borrowing.
What part of cash flow does periodic interest payment affect?
CFO
What part of cash flow does repayment of principle affect?
CFF
what kind of rate does the balance sheet liabilities use to represent the present value of the remaining cash payments?
market interest rate.
What kind of rate is used in calculating the book value of the liabilities.
the market rate at the time the bonds are issued.
How is (greater or smaller)the interest expense compare with the coupon payment for the bond issued at premium?
interest expense less than coupon payment.
How is (greater or smaller)the interest expense compare with the coupon payment for the bond issued at discount?
interest expense will be larger than coupon payment.
Criteria to meet capital lease:
1.The title of the asset is transfered to leasee at the end of the last leas period.
2.A bargain purchase option exist.
3.have lease period of 75% or more of the asset's lifetime.
4.The present value of the lease payment is 90% or more of the asset's value.
Reasons for leasing asset instead of purchasing:
1.the period of use compared to the useful life is short.
2.the lessor may be better to resell the asset.
3.the lessee may not want the risk of resale the asset.
4.If the lessor has more market power, it may maximize the profit by leasing assets and maintain more control of its use.
5.Assets less specialized to the firm are more likely to be leased.(office space..)
6.there may be risk reduction to the firm from leasing when firms have highly correlated value over time.
Operating VS Capital lease, which one has more operating income?
Capital lease, as the interest expense is not included in operating expense.
Operating VS Capital lease, which one has greater turnover rate?
Operating lease, as assets are smaller under this method.
For operating lease, where is the lease payment recognized in cash flow?
All payment is treated as CFO outflow
For capital lease, where is the lease payment recognized in cash flow?
the interest expense goes to CFO, whereas the principle payment goes to CFF.
Operating VS Capital lease, which one has more CFO?
Capital lease, as for operating lease the whole payment is treated as CFO outflow, where under capital lease only the interest payment are treated as so.
Definition:taxable income
income subject to tax based on tax return
Definition: Taxes payable
the tax liability on the balance sheet caused by taxable income. this is also known as current tax expense, but do not confuse this with income tax expense.
Definition: income tax paid
Actual cash flow for income taxes, including payments or refunds for other years.
definiton: income tax expense
the expense recognized on the income statement that includes taxes payable and deferred income tax expense.it is important to note that income tax exp. is composed of taxes payabole + noncash items such as change in deferred tax assets and liabilities (DTA and DTL)
equation: Income tax expense
Income tax expense = taxes payable + delta DTL - delta DTA
definition: deferred tax expense
the difference b/w taxes payable and income tax expense. this results form changes in deferred tax assets and liabilities.
Deferred tax assets
Balance sheet amounts that result from an excess of taxes pyable over income tax expense that are expected to be recovered from future operations.
Definition: Deferred liability.
Balance sheet amounts that result from an excess of income tax expense over taxes payable that are expected to result in future cash outflows. Deferred tax liabilities are created when more expense is applied to the tax return relative to the income statement (eg. more depreciation).This results in lower taxable income and lower taxes paypable on the tax return relative to the pretax income and tax expense that are shown on the income statement.
How deferred tax liability created?
it is created whnen income or expense item is treated differently on financial statements than it is on the company's tax returns, and that difference results in greater tax expense on the financial statements than tax payable on the tax return.
What is the mos common source of deferred liability?
different depreciatio methoc used in on tax return and income statement
how deferred tax asset are created?
when income and expense are treated differently on income statement and tax return, and such a difference make tax payable smaller on income statement than on tax return.
definition: temporary differences in tax
differences taxable and pretax incomes that will reverse in future years.
how do the temporary differences created in current liability?
installment sales method differences in tax and income statement creates it.
how are the temporary differences created in long-term liability?
differnces in depreciation methods b/w tax and financial statements.
how do the temporary differences created in current asset?
it is created by deferred tax assets due to warrenty expense that can't recognized in tax return.
how are the temporary differences created in long-term asset?
when post-retirement benefits expense in pretax income exceeds that allowed for a deduction on tax returns.
how are the temporary differences created in equity?
when gains or losses from carrying marketable securities at market value are deferred tax adjustments to stockholders' equity.
Definition: permanent differences in tax
differences in taxable and pretax incomes that will not reverse
equation: reported effective tax rate
RET = income tax expense / pretax income
equation: reported effective tax rate
RET = income tax expense / pretax income
do permanent differences result in deferred tax liabilities or assets?
no.
If the tax rate increases, and deferred tax liabilities exceed deferred tax assets, what will be the net impact on the tax expense, net income and equity?
tax higher, net income and equity lower.
If the tax rate decreases, and deferred tax liabilities exceed deferred tax assets, what will be the net impact on the tax expense, net income and equity?
tax decrease, net income increase and equity increase.
When should be revenue recognized?
1.earning process is complete
2.cost ar reliabe
3.payment is assured.
when to use sales basis method?
1.earning process complete
2.revenure assured
when to use Percetage-of-completion-method
1. earning incomplete
2.cost estimatalbe
3.revenue assured.
When to use Completed contract method
1.earning imcompleted
2.cost unestimatable or revenue not assured
When to use installment sales method
1.earning completed
2.revenue not assured.
when to us cost recovery method》
1.earning complete
2.contingence of unknown cost exist.
unusal or infrequent items
above or below the line?
above
extraordinary item : above or below the line?
below
discontinued income: above or below the line?
below