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92 Cards in this Set

  • Front
  • Back

Roles of Financial Reporting:

Financial Reporting is used to provide shareholders, potential investors, lenders and creditors the necessary resources to make their decisions.

Income Statement
Statement of operations
Profit Loss Statement

It is a dynamic statement - it spans a period of time.

It is divided into 3 segments: revenues, expenses, and other income (gains and losses).
Statement of Comprehensive Income:
Reports all changes in equity except for shareholders transactions (dividends distribution, buy backs...)
Balance Sheet
At a point in time
Cashflow Statement
A dynamic statement that tracks changes in cash.

There are 3 categories:

Operating Cashflow (CFO):
Cash generated from core activities.

Investment Cashflow (CFI):
Buying assets for generating revenue (plants, equipment, etc.)

Financing Cashflow (CFF):
Issuing debt, dividends, etc.
Statements of Changes in Owners Equity:
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).
What are the importance of footnotes?
Basis of presentations

Accounting methods and assumptions

Further information on amount in primary statements (more details like pension liability)

Business acquisitions and disposals

Contingency (liability of future events)

Legal proceeds

Stock options and benefit plans

Significant customers

Segment data (breaks down key information like sales, assets, operating profits on divisional level)

Quarterly data (If it is a European company they report semi-annually)

Related Party Transactions (any transactions between employees)
Management Discussion and Analysis:
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.
The Audit Report Objective:
The Audit is an independent review of the companies financail statements

- Appointed by the shareholders
- It strives to reduce agency cost (making sure the management isn't hiding anything from the shareholders.
Reasonable Assurance:
Reasonable assurance that the financial statements are free from material error.
Audit Opinions:
Unqualified: Clean

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

Adverse Opinion: We do not believe the accounts are true. This states that the financial statements can not be trusted.

Disclaimer of Opinion: There is insufficient data to make an opinion.
What does the US GAAP require from auditors?
A opinion on the companies internal controls.
Audit Report :
1) Responsibility of management to prepare accounts
- Independence of auditors.

2) Properly prepared in accordance with relevant GAAP:
IFRS (IS) or US GAAP.

3) Accounting principles and estimates chosen are reasonable.
Supplementary Sources of Information:
Quarterly, semi-annual reports.

Proxy Statements

Corporate reports, press releases

Economic, Industry data.
Quarterly, semi-annual reports.
Updates of major accounting statements (Balance sheet, cash flow, income statement and footnotes.
Proxy Statements:
Contain information on what shareholders are voting on.
Economic, and industry data.
Wall street journal is an example.
Financial Statement Analysis Framework.
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.
Regarding the report of of independent auditors under U.S. GAAP, the audit report:
Must provide opinion on companies internal controls.

Does not cover the management discussion.
Owners Equity Formula:
Contributed Capital + Retained Earnings.
Capital at Par Value
Shares at par value.
Additional Paid in Capital
Any increases in share value.

Contributed Capital

Contributed Capital = Capital at par Value + Additional Paid in Capital
Retained Earnings
RE =
Last years RE
+/- Earnings (Loss)
- Dividends.
Accrual and Valuation Adjustments
Accrued expenses (Liability)
Bad/Doubtful Accounts (Asset)
Prepaid expenses (Asset)
Accrued Revenue (Asset)
Impairment/Write-down (Asset)
Unearned Revenue (Liability)
FASB:
Financial Accounting Standards Board:

The major standards board of US.
IASB:
International Accounting Standard Board:

You meant to assume this in CFA unless otherwise stated.

SEC:

The listing services of US.
IOSCO:
International Organization of Security Commission

1) Protect investors
2) Insuring markets are fair, transparent, and efficient.
3) Reduce systematic risk.
Convergence of IFRS and IASB.
1) Increase Comparability.

2) Decrease the problems and expenses in raising capital in foreign capital markets.

3) Decrease problems in creating consolidated financial statements for foreign subsidiaries.
Barriers in Convergence:
1) Difference in views

2) Pressure from industry groups

3) Many different countries involved.
IFRS Framework:
1) Relevance
- The information can influence users opinion.
- Materiality

2) Characteristics:
- Comparability
- Verifiability
- Timeliness
- Understandability
IFRS Framework Trade offs:
Relevance vs. verifiability (more time given will give a better idea of certain accounts.)

Benefits vs. Costs

Exclude non-quantifiable information.
IFRS Assets:
Resources controlled by the entity resulting from past transactions.

Probable future economic benefits flow to enterprise

IFRS Liability:

Obligations results from past events

Settlement results in probable resource outflow
IFRS (Equity)
Shareholders' residual interest

Assets - Liabilities
IFRS (Income):
Result in an increase in equity
IFRS (Expenses):
result in a decrease in equity.
IASB Required Statements:
- Balance Sheet
- Income Statement
- Statement of Comprehensive Income
- Changes in Equity
- Cash Flow Statements
- Accounting Policies, notes
IASB Fundamental Principles:
- Fair Presentation
- Going Concern
- Accrual Basis
- Consistency
- Materiality
IASB Presentation Requirements
- Aggregation where appropriate
- No Offsetting (separate adding up expenses and revenues into one total)
- Classified balance sheet
- Minimum information on face
- Minimum disclosure
- Comparative info.
- Reporting frequency needs to be at least annual.
IFRS/ U.S. GAAP Differences
- 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

Barriers to Single Framework:

Valuation:
Historic value - Reliable
Fair Value - Relevant

Standard Setting
Princple based - very ew specific rules about transactions

Rules bases - Respective but not flexible

Object bases - Combines principles and rules; what IFRS and US GAAP use.

Measurement:
IFRS and US GAAP mostly focus on the balance sheet and the income statement comes as residual of that.
IASB Requirements for Revenue Recognition:
1) Risk and reward transferred to new owner.
2) No continuing control over the good sold
3) Reliable revenue measurement
4) Probable flow of economic benefit
5) Measurable.
SEC Additional Guidance for Revenue Recognition:
1) Evidence of an arrangment between buyer and seller.

2) Completion of the earning process, firm has delivered product or service.

3) Price is determined.

4) Assurance of payment, able to estimate probability of payment.
Sales Basis Method:
Used for when a good or service is provided at time of sale.
Percentage of Completion:
A construction revenue recognition criteria.

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

Same for IFRS and GAAP.

Revenue = (Total Cost to Date / Total Project Cost) x Sales Price

Profit = Revenue - Cost incurred that year

Remember for subsequent years to deduct the revenue that you have already recorded.
Completed Contract Method:
If you don't have reliable estimates of total costs, revenues, and completion time.

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!

Under IFRS you match expenses with sales, so no profit, until completion.

So 1st year expense = 1st year revenue and so on until completion.
At completion you then record a profit.
Installment:
Allows a customer to pay in installments.

Used when a company cannot determine the likelihood of collection but does know relatively the expenses it will occur. Thereby, the expenses and sales are matched.

The amount of revenue recognized during a period is what ever the installment amount is. However, the expense is a percentage of how much the installement is paying off.

For example: if the total sale value is 30,000, total expense is 10,000, and the installment amount in the first year is 8,000 then:
revenue: 8,000 (installement amount)
expense: 2,666.67 (8,000/30,000 x 10,000)

Cost Recovery Method:

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.

So for instance if the total sale value is 30,000 but you don't know the expenses quite YET so you write down the revenue and expenses until the final year when you know the total expenses.

First year say you received 14,000.
Revenue: 14,000
Expenses: 14,000 (you simply match)

Second year the project is completed and your figure out that the total expenses incurred were $18,000 and you receive a second payment of 16,000 from your client.

Revenue: 16,000
Expenses: 4,000 (whatever is left from the total expenses).

What ever left is profit, in this case it is 12,000.
What are the effects of POC vs. CC method in regards to the income statement?
Income volatility?
Cash flow?
POC will result a higher income statement.

CC will result in a significantly higher income volatility since there will be no revenue recognized until the final year where upon a massive revenue recognition occurs.
Remember: volatility is risk!

Cashflow methods are not effected! The reason for this is because no actual cash is seen received the end.
Installment payments under IFRS:
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.
Barter:
An exchange of goods and services instead of cash.

Records the sale at the price of the fair market value.

The value should be at arms length (not insiders.)

IFRS:

US GAAP: Fair value only if the goods were sold for cash in the past, or otherwise you use the carrying value (asset - accumulated depreciation.)
Net reporting:
Sell products but never hold it in their own inventory.

US GAAP should report gross if:

1) Is the primary obligator
2) Bears inventory risk
3) Bears credit risk
4) Can choose supplier
5) Has latitude to set price
Give example of "aggressive revenue recognition"
Percentage of completion (because you recognize revenue sooner.)
Conservative:
Cost recovery.

Expense: Accrual basis

Match expenses to revenue so they don't pile up.
COGS Calculation:
BGN Inventory
+ Purchases
- Ending inventory
= COGS
Amortization for good will:
It isn't amortized. Instead it is checked for impairment.
Accounting Changes: Principle
Principle: for example: LIFO to FIFO

You have to show the past financial statements restated under the new accounting changes.
Accounting Changes: Estimates
You do not have to restate prior statements.
Prior Period Adjustments:
Typically requires a restatement of financial statements

Must disclose the nature of the error.
Non-Operating Items:
Interest
Dividends
Gain and Loss on disposal.
Simple Capital Structure:
No potentially diluted security.

A diluted security is any security that is convertible (convertible bonds, warrants, etc.)
Complex Capital Structure:
You have diluted shares.
Potentially diluted securities:
- Stock options (employee)
- Warrants
- Convertible Bonds
- Convertible preferred shares

- Dilutive securities decrease EPS
Antidilutive securities increase EPS
Basic EPS
Basic EPS =
(Net Income - Preferred Dividends) / (Weighted average # of common stock)
How is stock Dividend accounted for in a weighted average # of shares question:
It is applied to the amount of shares outstanding for the previous months.
Income Tax Expense =
Taxes Payable + Changes in Deferred Tax
Tax Loss Carry forward:
When you have a net loss you get a deferred tax for next year.
Tax Base:
Net amounts of assets or liabilities used for tax reporting purposes
Income Tax Expense:
Tax payable + Change in DTL - DTA (Deferred Tax Asset)
DTL:
Deferred Tax Liability:
By paying less taxes now, you will have to pay more in the future.
DTA:
Deferred Tax Asset:
Paying more taxes now will result in less taxes in the future.
Valuation Allowance:
In order to benefit from DTA you need to be profitable in the future in order to have something to tax.
Therefore, if a company belives that it will not have the sufficient profits in the future they create what is known as Valuation Allowance. It nets against a DFA and appears as an expense in the income report.

Carrying Value:

Balance sheet value of an asset or liability.

Remember that netting accounts is no no and therefore both DTL and DTA appear on the balance sheet!

Under IFRS they appear as non-current

GAAP US depends on the length of time that they are deferring for.
Differences between accounting and Taxable profits.
Timing Difference:
In the instance of warranty repairs the tax authority will not allow you to estimate the warranty expenses and instead you will write down the expenses when they occur.

Gains and losses are also accounted for differently.
DTA if:
DLA if:
DTA if Expenses > Tax deduction
DTL if Expenses < Tax deduction

Remember, these are caused from timing differences and
therefore will reverse.

DTA - pay more now, less in the future.
DLA - pay less now, more in the future.
Give an example of how a DTL occurs:
Remember that a DTL or DTA is caused by timing differences.

A great example of timing differences is different depreciation methods.

For example:
Say on your tax reporting your assets are depreciated by DD while on your financial reporting they are depreciated by straight line. This thereby makes you taxes in the tax report much less due to the signifiactly higher expenses. So for example lets say that you have $10 tax due in the tax report and $40 due in the Financial report, that difference of $30 is the DTL! You are paying less now on your tax report but that $30 is going to occur and you will have to pay it!
This must be accounted for and that is why it is classified as a liability!
Tax base of Asset:
The future amount of the asset that will eventually go through tax deductions.

The difference between the tax reporting and financial reporting multiplied by the tax rate is the DTA or DTL.
Tax Expense and DTL and DTA
Remember that the Delta DCL is included in the tax expense!

So if your tax payable is 500 and Delta DTL is 1,500 the tax expense is 2,000.
What is the difference between a permanent time difference and a temporary time difference?
Permanent differences do not cause tax deferral. They are caused from tax exempt assets and therefore will never change.

The result of this is that the effective tax rate =/= statutory tax rate.

Effective tax rate being:
Income tax expense / pretax income

Temporary differences are caused by the tax base rate being different from the carrying amount.
Business:
- No deferred tax on good will.
- Deferred tax may arise on fair value adjustment.
- Subsidiaries, JVs, Associates:
On the income statement they show as one, however we must pay taxes on dividends which do not arise on the income statement.
Valuation Allowance:
Reduces a differed tax asset.
Basically creating a fake revenue to show on the financial statement that there is more taxes.

Therefore if you see valuation allowance in the footnotes, this hints that the company thinks that it will not be as profitable in the future.
Comparison of deferred tax items:
Looking in the disclosure you will find the DTL and DTA by source and the changes in valuation allowance.
You want to look why they were created since they state facts about the future profitability of a company.
Reasons for temporary tax differences:
- Different amortization rates
- Impairments
- Changes in tax rates
- Inventory accounting
- Warranty expenses
- Unrealized gains and losses with securities.
- Restructuring.
Required deferred tax disclosures:
- DTL and DTA
- VA and changes in VA
- Changes in DTL and DTA by sources
- Component of income tax such tax payable, delta DTL DTA, correction due to tax rate changes.
- Tax loss carry forward.
- Reconcile difference between income tax expense as a % of pre-tax and statutory tax rate.
What do growth rate have to do with deferred tax rates?
For a company that is going to be growing for the foreseeable future, the DTL might become bigger and bigger from the expenses arising from DD depreciation on the tax report. So an analyst might choose to just remove that liability from the balance sheet and insert it into owners equity because a cash outflow will not happen for a long time.
Effects of asset impairments from an analyst point of view?
Hints at a decrease in revenue generation due to the loss of asset.

Remember, in order for an asset be classified in accounting it must be able to generate profit.
Differences between US GAAP and IFRS in regards to tax deferral.
- IFRS allows revaluation of PPE.
- Undistributed profits from subsidiaries, JVs, and associates.
- IFRS recognizes if recoverable is probable
- U.S. GAAP includes full amount and just reduces by valuation allowance.
Basically you do not see valuation allowance under IFRS.
- Tax rate used to measure deferred tax rates because simply there are different tax authorities.
- Presentation differs, in the US GAAP DTL and DTA can be current or non-current depending on the length of time. IFRS they are always non-current.
What are the effects of deferred tax changes?
If the deferred tax goes up then a you need to increase the DTA and DTL, if it goes down you need to decrease DTA and DTL.