4. Financial Reporting And Analysis

Front 1

Quality of Earnings

Back 1

Quality of reported earnings can be judged based on the sustainability of the earnings as well as on their level.

Sustainability can be evaluated by determining the proportion of reported earnings that can be expected to continue into the future.

Front 2

Financial Reporting Quality

Back 2

Refers to the characteristics of a firm's financial statements. Primary criterion for judging financial reporting quality is adherence to GAAP in the jurisdiction in which the firm operates.

Must be decision useful - relevance and faithful representation

Front 3

Valuation Allowance

Back 3

A contra account that reduces the deferred tax assets value on the balance sheet.

If it is more likely than not that some or all of a DTA will not be realized, then the DTA must be reduced by a [XX].

Increasing the [XX] will increase income tax expense and reduce earnings.

If circumstances change, DTA can be revalued by decreased [XX].

Front 4

Deferred Tax Assets

Back 4

Created when taxes payable are greater than income tax expense due to temporary differences. Occur when:

- Revenues are taxable before they are recognized in income statement

- Expenses are recognized in the income statement before they are tax deductible

- Tax loss carry forwards are available to reduce future taxable income

Front 5

Deferred Tax Liabilities

Back 5

Created when income tax expense is greater than taxes payable due to temporary differences.

Occur when:

- Revenues are recognized in the income statement before they are included on the tax

- Expenses are tax deductible before they are recognized in the income statement

Front 6

Temporary Difference

Back 6

A difference between the tax base and the carrying value of an asset or liability that will result in taxable accounts or deductible amounts in the future.

If a [XX] is expected to reverse in the future and the balance sheet item is expected to provide future economic benefits, a DTA or DTL is created.

Front 7

Permanent Difference

Back 7

A difference between taxable income and pretax income that will not reverse in the future.

Can be caused by revenue that is not taxable, expenses that are not deductible, or tax credits that result in a direct reduction of taxes.

Front 8

Cash Conversion Cycle

(Days sales outstanding) + (Days of inventory on hand) - (number of days of payables)

Back 8

The length of time it takes to turn the firm's cash investment in inventory back into cash, in the form of collections from the sales of that inventory.

Front 9

Defensive Interval Ratio

(Cash + marketable securities + receivables) / average daily expenditures

Back 9

A measure of liquidity that indicates the number of days of average cash the firm could pay with its current liquid assets.

Front 10

Cash Ratio

Cash + marketable securities / current liabilities

Back 10

Useful to creditors when deciding how much debt, if any, they would be willing to extend to the asking party

Front 11

Quick Ratio

Cash + marketable securities + receivables / current liabilities

Back 11

A more stringent measure of liquidity because it does not include inventories and other assets that might not be very liquid.

Front 12

Current Ratio

Current Assets / Current Liabilities

Back 12

The higher the [XX] ratio, the more likely it is that the company will be able to pay its short term bills.

A ratio less than 1 means that the company has negative working capital and is probably facing a liquidity crisis.

Front 13

Free Cash Flow to Equity

1. Cash flow from operations

2. (Capital spending)

3. Sale of fixed assets

4. Debt issued

5. (Debt repaid)

Back 13

How much cash can be paid to the equity shareholders of the company after all expenses, reinvestment and debt repayment.

Front 14

Free Cash Flow to the Firm

1. Operating cash flow

2. (Expenses)

3. (Taxes)

4. (Changes in NWC)

5. (Changes in investments)

Back 14

The cash available to all investors, both equity owners and debt holders

Front 15

Indirect Method of Presenting Cash Flows from Operating Activities

Back 15

Net income is adjusted for transactions that affect net income but do not affect operating cash flow, such as depreciation, and for changes in balance sheet items.

The main advantage of this method is that it focuses on the differences between net income and operating cash flow. This provides a useful link to the income statement when forecasting future operating cash flow.

Front 16

Direct Method of Presenting Cash Flows from Operating Activities

Back 16

Each line item of the accrual-based income statement is adjusted to get cash receipts or cash payments.

The main advantage of the direct method is that it presents clearly the firm's operating cash receipts and payments.

Front 17

Goodwill

Back 17

The excess of purchase price over fair value of the identifiable net assets acquired in an acquisition.

Is not amortized but must be tested for impairment at least annually.

Front 18

Comprehensive Income

Back 18

Measures all changes to equity other than those from transactions with shareholders.

Front 19

Straight Line Depreciation

Back 19

Equal amount of depreciation expenses in each year of the asset's useful life.

Front 20

Declining Balance Depreciation

Back 20

Apply a constant rate of depreciation to the declining book value until book value equals residual value.

Front 21

Matching Principle

Back 21

Requires that firms match revenue with expenses required to generate them.

One application of [XX] principle is seen in accounting for inventory, with COGS as the cost of units sold from the inventory that are included in current period revenue.

Other costs are period costs and are taken without regard to revenues generated during the period.

Front 22

1. There is evidence of an arrangement between the buyer and the seller

2. The product has been delivered or service rendered

3. Price is determined or determinable

4. Seller is reasonably sure of collecting money

Back 22

According to guidance by the SEC, what are the 4 additional criteria to determine whether revenue should be recognized?

Front 23

- Risk/reward of ownership is transferred

- There is no continuing control or management over goods sold

- Revenue can be reliably measured

- There is a probable flow of economic benefits

- The cost can be reliably measured

- Stage of completion can be measured

- Cost incurred and cost of completion can be reliably measured

Back 23

According to the IASB, when is revenue recognized from (1) the sale of goods and (2) services rendered?

Front 24

When a bond is redeemed before maturity, a gain or loss is recognized equal to the difference between the redemption price and the book value of the bond liability at re-acquisition date.

GAAP requires that any remaining unamortized bond issuance costs must also be written off and included in the gain and loss calculation.

Back 24

Derecognition of Debt (& GAAP)

Front 25

Cash Flows From Operating Activities

Back 25

Consist of the inflows and outflows of cash resulting from transactions that affect a firm's net income.

Front 26

Cash Flows From Investing Activities

Back 26

Consist of the inflows and outflows of cash resulting from the acquisition or disposal of long-term assets and liabilities.

Front 27

Cash Flows From Financing Activities

Back 27

Consist of the inflows and outflows of cash resulting from transactions affecting a firm's capital structure, such as issuing or repaying debt/stock.

Front 28

Other Comprehensive Income

Back 28

Transactions with shareholders are not reported in the income statement.

Includes other transactions that affect equity but do not affect net income.

- Gains/losses from FX translation

- Pension obligation adjustments

- Unrealized gains/losses from cash flow from hedging derivatives

- Unrealized gains/losses on available for sale securities

Front 29

Statement of Comprehensive Income

Back 29

Reports all changes in equity except for shareholders transactions.

Front 30

Statement of Changes in Owners Equity

Back 30

Stockholders' equity from last year is reconciled from this year.

Buyback of shares, issuance of shares, dividends, Net income from the income statement, and other comprehensive income (unrealized gains and losses).

Front 31

1. Basis of presentations

2. Accounting methods and assumptions

3. Further information on amount in primary statements

4. Business acquisition and disposals

Back 31

What are the importance of footnotes?

Front 32

Management Discussion and Analysis

Back 32

Not Audited: (Therefore not completely dependable)

A description of how the firm has done in the past and how it will preform in the future.

It breaks down its operations and explains how they are doing it.

It is basically an overview of the business.

Cash flow trends

Discussion on critical accounting choices (also discussed here as well as at disclosure.)

Uncertainty and risk is discussed here.

Front 33

Audit Report

Back 33

The Audit is an independent review of the companies financial statements

- Appointed by the shareholders

- It strives to reduce agency cost (making sure the management isn't hiding anything from the shareholders.

Front 34

Reasonable Assurance

Back 34

Reasonable assurance that the financial statements are free from material error.

Front 35

Unqualified Opinion

Back 35

The auditor believes the statements are free from material omissions and errors.

Front 36

Qualified Opinion

Back 36

Exceptions to accounting principles. The auditors disagree with certain parts of the treatment of the financial statements.

Front 37

Adverse Opinion

Back 37

We do not believe the accounts are true. This states that the financial statements cannot be trusted.

Front 38

Disclaimer of Opinion

Back 38

There is insufficient data to make an opinion

Front 39

1. Responsibility of management to prepare accounts

2. Properly prepared in accordance with relevant standards

3. Accounting principles and estimates chosen are reasonable

Back 39

Audit Report

Front 40

Quarterly, Semi-Annual Reports

Back 40

Updates of major accounting statements (Balance sheet, cash flow, income statement and footnotes.

Front 41

Proxy Statements

Back 41

Contain information on what shareholders are voting on.

Front 42

Financial Statement Analysis Framework

Back 42

1. Purpose and context of analysis

2. Collect data

3. Process data

4. Analyze/interpret data

5. Conclusion and recommendations

6. Update analysis on periodic basis

Front 43

1. Must provide opinion on company's internal controls

2. Does not cover the management discussion

Back 43

Regarding the report of of independent auditors under U.S. GAAP, the audit report:

Front 44

Additional Paid In Capital

Back 44

Any increases in share value.

Front 45

= last year's RE + earnings - dividends

Back 45

Retained Earnings

Front 46

Financial Accounting Standards Board

Back 46

The major standards board of the US

Front 47

1. Protect investors

2. Ensure markets are fair, transparent, and efficient

3. Reduce systematic risk

Back 47

International Organization of Security Commission

Front 48

1. Relevance

- The information can influence users opinion

- Materiality

2. Characteristics:

- Comparability

- Verifiability

- Timeliness

- Understandability

Back 48

IFRS Framework

Front 49

- Balance Sheet

- Income Statement

- Statement of Comprehensive Income

- Changes in Equity

- Cash Flow Statements

- Accounting Policies, notes

Back 49

IASB Required Statements

Front 50

- Fair Presentation

- Going Concern

- Accrual Basis

- Consistency

- Materiality

Back 50

IASB Fundamental Principles

Front 51

IFRS/GAAP Differences

Back 51

- FASB defines income and expenses as elements related to performance while IASB also includes gains, losses, and comprehensive income.

- FASB defines an asset as a future economic benefit where IASB defines it as a resources from which economic benefits comes from.

- FASB Does not allow upward valuation

Front 52

Sales Basis Method

Back 52

Used for when a good or service is provided at time of sale

Front 53

Percentage of Completion

Back 53

A construction revenue recognition criteria.

Must have reliable estimates of total costs, revenues, and completion time.

Same for IFRS and GAAP.

Front 54

Completed Contract Method

Back 54

Keeps everything out of the income statement until the contract is actually fulfilled.

So just total the costs and sale in the end!

Not allowed under IFRS! US GAAP only!

Front 55

Cost Recovery Method

Back 55

There are two sources of uncertainty:

1) Whether the customer will pay you.

2) You don't know the total cost of the service or goods provided.

Match costs against revenue and not recognize revenue till the end.

Front 56

Installment payments under IFRS

Back 56

You record the PV value of the installments and record whatever difference you actually receive from the installments as interest earned over time.

If the outcome of the project cannot be estimated reliably, revenue recognition under IFRS is similar to cost recovery method.

Front 57

Non-Operating Items

Back 57

1. Interest

2. Dividends

3. Gain/loss on disposal

Front 58

Tax Loss Carry Forward

Back 58

When you have a net loss you get a deferred tax for next year

Front 59

Tax Base

Back 59

Net amounts of assets or liabilities used for tax reporting purposes

Front 60

Reasons for temporary tax differences

Back 60

- Different amortization rates

- Impairments

- Changes in tax rates

- Inventory accounting

- Warranty expenses

- Unrealized gains and losses with securities.

- Restructuring.

Front 61

1. IFRS allows revaluation of PPE

2. Undistributed profits from subsidiaries, JVs, and associates

3. IFRS recognizes if recoverable is probably

4. GAAP includes full amount and just reduces by valuation allowance (don't see VA under IFRS)

5. Tax rate used to measure deferred tax rates because simply there are different tax authorities

6. Presentation differs

Back 61

Differences between US GAAP and IFRS in regards to tax deferral.

Front 62

Proxy Statement

Back 62

Contain information related to matters that come before shareholders for a vote, such as elections of board members.

Front 63

General Journal

Back 63

A listing of all the journal entries in order of their dates.

Front 64

General Ledger

Back 64

Sorts the entries in the general journal by account.

Front 65

Form S-1

Back 65

Registration statement filed prior to the sale of new securities to the public.

Front 66

Form 10-K

Back 66

Required annual filing that includes information about the business and its management, audited financial statements and disclosures, and disclosures about legal matters involving the firm.

Front 67

Form 10-Q

Back 67

U.S. firms are required to file this form quarterly, with updated financial statements and disclosures about certain events.

Front 68

Form DEF-14A

Back 68

When a company prepares a proxy statement for its shareholders prior to the annual meeting or other shareholder vote, also files this form.

Front 69

Form 8-K

Back 69

Companies must file this form to disclose material events including significant asset acquisitions and disposals, changes in management or corporate governance, or matters related to its accountants, FS, or the markets.

Front 70

Form 144

Back 70

A company can issue securities to certain qualified buyers without registering the securities with the SEC but must notify the SEC that it intends to do so.

Front 71

Forms 3, 4, and 5

Back 71

Involve the beneficial ownership of securities by a company's officers and directors. Analysts can use these filings to learn about purchases and sales of company securities by corporate insiders.

Front 72

Installment Sale

Back 72

Occurs when a firm finances a sale and payment are expected to be received over an extended period.

Front 73

Revenue can be recognized at fair value only if the firm has historically received cash payments for such goods.

Back 73

Barter Transactions Under GAAP

Front 74

Must be based on the fair value of revenue from similar nonbarter transactions with unrelated parties.

Back 74

Barter Transactions Under IFRS

Front 75

1. Effects of inflation and changing prices if material

2. Impact of off-balance-sheet obligations and contractual obligations

3. Accounting policies that requires significant judgment by management

4. Forward-looking expenditures and divestitures

Back 75

What does the management's discussion and analysis discuss (4 items)?

Front 76

Classified Balance Sheet

Back 76

Current and non current assets/liabilities are reported separately.

Front 77

Liquidity-Based Balance Sheet

Back 77

Only permissible under IFRS, present assets and liabilities in the order of liquidity.

Front 78

Held-to-Maturity Securities

Back 78

Debt securities acquired with the intent to be held to maturity.

Front 79

Trading Securities

Back 79

Debt and equity securities acquired with the intent to profit over the near term.

Front 80

Available-for-Sale Securities

Back 80

Debt and equity securities that are not expected to be held to maturity or traded in the near term.

Front 81

1. Under IFRS, interest and dividends received may be classified as either operating or investing activities

2. Dividends paid to the company's shareholders and interest paid on the company's debt may be classified as either operating or financing activities

3. Under GAAP, all taxes paid are reported as operating activities. Under IFRS, income taxes are also reported as operating activities unless the expense is associated with an investing or financing transaction

Back 81

Contrast cash flow statements prepared under IFRS and GAAP

Front 82

1. Net income

2. (Gain from sale of land)

3. Depreciation

4. Decrease in receivables

5. (Increase in inventory)

6. Increase in accounts payable

7. (Decrease in wages payable)

8. Increase in deferred tax liabilities

9. (Unrealized gain)

Back 82

What is included in Operating Activities?

Front 83

1. Cash from fixed assets

2. (Purchase of machinery)

3. (New fixed assets)

Back 83

What is included in Investing Activities?

Front 84

1. Sale of bonds

2. (Repurchase of stock)

3. (Cash dividends)

4. Sale of stock

5. (Principal payments on bank borrowings)

6. (Payment of mortgage)

7. Increase in dividends payable

Back 84

What is included in Financing Activities?

Front 85

1. (Interest expense)

2. Increase in interest payable

3. (Tax expense)

Back 85

What is included in other cash expenses?

Front 86

Annual sales / average receivables

Back 86

Receivables Turnover Ratio

Front 87

365 / receivables turnover

Back 87

Days of Sales Outstanding Ratio

Front 88

COGS / average inventory

Back 88

Inventory Turnover

Front 89

365 / inventory turnover

Back 89

Days of Inventory on Hand Ratio

Front 90

Purchases / average trade payables

Back 90

Payables Turnover Ratio

Front 91

365 / payables turnover ratio

Back 91

Number of Days of Payables Ratio

Front 92

Revenue / average total cost

Back 92

Total Asset Turnover Ratio

Front 93

Revenue / average net fixed assets

Back 93

Fixed Asset Turnover Ratio

Front 94

Revenue / average working capital

Back 94

Working Capital Turnover Ratio

Front 95

Total debt / total shareholders' equity

Back 95

Debt-to-Equity Ratio

Front 96

Total debt / (total debt + total shareholders' equity)

Back 96

Debt-to-Capital Ratio

Front 97

Total debt / total assets

Back 97

Debt-to-Assets Ratio

Front 98

Average total assets / average total equity

Back 98

Financial Leverage Ratio

Front 99

EBIT / interest payments

Back 99

Interest Coverage Ratio

Front 100

(EBIT + lease payments) / (interest payments + lease payments)

Back 100

Fixed Charge Coverage Ratio

Front 101

[Net income + interest expense (1 - tax rate)] / average total assets

Back 101

Return on Assets

Front 102

DuPont System of Analysis

Back 102

An approach that can be used to analyze return on equity that breaks down ROE into a function of different ratios.

Front 103

Dividends declared / net income available to common

Back 103

Dividend Payout Ratio

Front 104

1 - dividend payout ratio

Back 104

Retention Rate

Front 105

Capital Adequacy

Back 105

The ratio of some dollar measure of the risk of the firm to its equity capital.

Front 106

1. Increase in consumers' wealth

2. Business expectations

3. Consumer expectations of future income

4. High capacity utilization

5. Expansionary monetary policy

6. Expansionary fiscal policy

7. Exchange rate

8. Global economic growth

Back 106

Factors affecting aggregate demand

Front 107

1. Increase in the supply and quality of labor

2. Increase in the supply of natural resources

3. Increase in the stock of physical capital

4. Technology

Back 107

Factors affecting long run aggregate supply

Front 108

1. Labor productivity

2. Input prices

3. Expectations of future output prices

4. Taxes and government subsidies

5. Exchange rates

Back 108

Factors affecting short run aggregate supply

Front 109

J-Curve

Back 109

A plot of the trade deficit over time when the domestic currency depreciates.

The trade deficit gets worse initially but then improves over time, either because export and import demand are more elastic in the long run or because existing contracts for future delivery are fixed in foreign currency terms in the short run.

Front 110

1. Transaction costs

2. Taxes

3. Risk

Back 110

When are results statistically significant but not economically significant?

Front 111

Inventories are value at the lower of cost or net realizable value.

Inventory write-ups are allowed but only to the extent that a previous write-down to net realizable value was recorded.

Back 111

Inventory reporting under IFRS

Front 112

Inventories are valued at the lower of cost or market.

Market is usually equal to replacement cost but cannot exceed net realizable value or be less than net realizable value minus a normal profit margin.

No subsequent write-up is allowed.

Back 112

Inventory reporting under GAAP