ACC 301 CH 2

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There are two fundamental characteristics that make financial information useful:

1) Relevance 2) Faithful representation

debt-to-assets ratio =

= (total debt / total assets)

net income =

= EAT +/- below the line items adjusted for tax

Net profit margin =

Net income / revenues Shows the % of each dollar of sales that remains for shareholders after all expenses related to the generation of those sales are deducted

IASB Conceptual Framework for Financial Reporting' states that: "The objective of general purpose financial reporting is to..."

Provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling, or holding equity and debt instruments, and providing or settling loans and other forms of credit."

Issued to shareholders when there are matters that require a shareholder vote. Good source of information about the election of (and qualification of) board members, compensation, management qualifications, and the issuance of stock options:

Proxy statement

During an audit, if the statements make any exceptions to the accounting principles, the auditor can issue a...

Qualified opinion, then they explain these exceptions in the audit report

Under IFRS and GAAP, the income statement can be combined with...

Under IFRS and GAAP, the income statement can be combined with... 'other comprehensive income' and presented as a single statement of comprehensive income. (or the income statement and the statement of comprehensive income can be presented separately).

a) The center of the IASB Conceptual Framework is the objective to... b) These resource providers include:

a) provide financial information that is useful in making decisions about providing resources to an entity. b) Investors, lenders, and other creditors

A higher ROE and a higher retention rate result in a _____ sustainable growth rate.

higher

Most assets are recorded on the financial statements at their...

historical cost

Activity ratios measure _____. Activity ratios include: (9)

how efficiently a firm is managing its assets Receivables turnover Days of sales outstanding Inventory turnover Days of inventory on hand Payables turnover Number of data of payables Total asset turnover Fixed asset turnover Working capital turnover

Firms are required to report some items for significant business and geographic segments. _____ , _____ , and _____ by segment can give analysts a better understanding of the performance of the overall business.

profitability, leverage, and turnover ratios

Inventory equation:

purchases = (ending inventory - beginning inventory + COGS)

Besides the annual financial statements, an analyst should examine a company's...

quarterly or semi-annual reports (these interim reports typically update the major financial statements and footnotes but are not necessarily audited)

A statement presented by companies showing what its financial results would have been under an alternate reporting system:

reconciliation statement (For IFRS firms listing their shares in the U.S., reconciliation is no longer required)

"Growth in same-store sales" is used in the _____ and _____ industries to indicate growth without the effects of new locations that have been opened. It is a measure of how well the firm is doing at attracting and keeping existing customers and, in the case of locations with overlapping markets, may indicate that new locations are taking customers from existing locations.

restaurant and retail industries

'Operating cash flows' include... 'Investing cash flows' include... 'Financing cash flows' include...

'Operating cash flows' include cash effects of transactions that involve the normal business of the firm. 'Investing cash flows' include those resulting from the acquisition or sale of property, plant, and equipment; of a subsidiary or segments; of securities; and of investments in other firms. 'Financing cash flows' include those resulting from issuance or retirement of the firm's debt and equity securities and include dividends paid to stockholders.

An auditor's opinion will also contain an explanatory paragraph when a material loss is probable but the ongoing amount cannot be estimated. These "uncertainties" may relate to: (3)

- 'going concern assumption' The assumption that the firm will continue to operate for the foreseeable future - the valuation or realization of asset values - litigation (this type of disclosure may be a signal of serious problems and may call for close examination by the analyst)

'Classifying accounts into the financial statement elements' Liabilities are creditor claims on the company's resources. Examples of liabilities include:

- Accounts payable and traded payables - Financial liabilities (such as short-term notes payable) - Unearned revenue (items that will show up on future income statements as revenues" - Income taxes payable (taxes accrued during the past year but not yet paid) - Long term debt (such as bonds payable) - Deferred tax liabilities

International Accounting Standards (IAS) No. 1 defines which financial statements are required and how they must be presented. Which statements are required?

- Balance sheet (statement of financial position) - Statement of comprehensive income - Cash flow statement - Statement of changes in owner's equity - Explanatory notes, including a summary of accounting periods

'Classifying accounts into the financial statement elements' Assets are the firm's economic resources. Examples of assets include: (9)

- CASH AND CASH EQUIVALENTS (liquid securities with maturities of 90 days or less are considered cash equivalents) - ACCOUNTS RECIEVABLE (Accounts receivable often have an "allowance for bad debt expense" or "allowance for doubtful accounts" as a contra account. - INVENTORY - FINANCIAL ASSETS (such as marketable securities) - PREDPAID EXPENSES (items that will be expenses on future income statements) - PROPERTY, PLANT, AND EQUIPMENT (includes a contra-asset account for accumulated depreciation) - INVESTMENT IN AFFILIATES (accounted for using the equity method) - DEFERRED TAX ASSETS - INTANGIBLE ASSETS (economic resources of the firm that do not have a physical form, such as patents, trademarks, licenses, and goodwill. Except for goodwill, these values may be reduced by "accumulated amortization"

'Classifying accounts into the financial statement elements' Expenses are outflows of economic resources and include:

- COGS - Selling, general, and administrative expenses (these include such expenses as advertising, management salaries, rent, and utilities) - Depreciation and amortization (to reflect the "using up" of tangible and intangible assets) - Tax expense - Interest expense - Losses (decreases in assets from transactions incidental to the firm's day-to-day activities)

'Classifying accounts into the financial statement elements' Owner's equity is the owners residual claim on a firm's resources, which is the amount by which assets exceed liabilities. Owner's equity includes:

- Capital (par value of common stock) - Additional paid-in capital (proceeds from common stock sales in excess of par value. Share repurchases that the company has made are represented in the contra account: treasury stock) - Retained earnings (cumulative net income that has not been distributed as dividends) - Other comprehensive income (changes resulting from foreign currency translation, minimum pension liability adjustments, or unrealized gains and losses on investments)

The general features for preparing financial statements are stated in IAS No. 1:

- Fair representation - Going concern basis - Accrual basis is used to prepare the financial statements other than the statement of cash flows - Consistency - Materiality, meaning the financial statements should be free of misstatements or omissions that could influence the decisions of users of financial statements - Aggregation - No offsetting of assets against liabilities or income against expense unless a specific standard permits it - Reporting frequency must be at least annually - Comparative information for prior periods should be included unless a specific standard states otherwise

Measurement bases include: (6)

- Historical cost (amount originally paid for the asset) - Amortized cost (historical cost adjusted for depreciation, amortization, depletion, and impairment) - Current cost (the amount the firm would have to pay today for the same asset) - Realizable value (the amount for the which the firm could sell the asset) - Present value (the discounted value of the asset's future cash flows) - Fair value (the amount at which two parties in an arm's-length transaction would exchange the asset)

'Classifying accounts into the financial statement elements' Revenue represents inflows of economic resources and includes:

- Sales (revenue from the firm's day to day activities) - Gains (increases in assets from transactions incidental to the firm's day-to-day activities. - Investment income (such as interest and dividend income)

IASB and FASB are working towards a common framework, but at present they differ in several aspects:

- The IASB framework lists income and expenses as elements related to performance, while FASB framework includes revenues, expenses, gains, losses, and comprehensive income. - FASB defines an asset as a future economic benefit, whereas the IASB defines it as a resource from which a future economic benefit is expected to flow. Also, FASB uses the word "probable" in its definition of assets and liabilities - FASB does not allow the upward valuation of most assets

Analysts should also review pertinent information on economic conditions and the company's industry and compare the company to its competitors. The necessary information can be acquired from: (3)

- Trade journals - Statistical reporting services - Government agencies

Financial statement elements (5)

- assets - liabilities - owners equity - revenues - expenses

Footnotes (financial statement notes) are disclosures that provide further details about the information summarized in the financial statements. Footnotes improve the users' assessments of the amount, timing and uncertainty of the estimates reported in the financial statements. Footnotes allow users to...

- discuss the basis of presentation such as fiscal periods covered and the inclusion of consolidated entities - provide information about accounting methods, assumptions, and estimates used by management - provide additional information on items such as business acquisitions or disposals, legal actions, employee benefit plans, contingencies or commitments, significant customers, sales to related parties, and segments of the firm.

For publicly held firms in the U.S., the SEC requires that the MD&A...

- discuss trends and identify significant events and uncertainties that affect the firm's liquidity, capital resources, and results of operations - effects of inflation and changing prices if material - impact of off-balance sheet obligations and contractual obligations such as purchase commitments - accounting policies that require significant judgement by management - forward-looking expenditures and divestituters

Also stated in IAS No. 1 are the structure and content of financial statements:

- most entities should present a classified balance sheet showing current and concurrent assets - minimum information is required on the face of each financial statement and in the notes. (for example, the face of the balance sheet must show specific items such as cash and cash equivalents, PP & E, and inventories. Items listed on the face of the comprehensive income statement must include revenue, P or L, tax expense, and finance costs, among others) - Comparative information for prior periods should be included unless a specific standard states otherwise

A coherent financial reporting framework us one that fits together logically. Coherent financial reporting framework should be: (3)

- transparent (full disclosure and fair presentation reveal the underlying economics of the company to the financial statement user) - comprehensive (all types of financial transactions that have financial implications should be part of the framework, including new types of transactions that occur) - consistent (similar transactions should be accounted for in similar ways across companies, geographic areas, and time periods)

Barriers to creating a coherent financial reporting system include issues related to: (3)

- valuation (measurement bases for valuation that require little judgement, such as historical cost, may be less relevant than a basis like fair value that requires more judgement) - standard setting (three approaches to standard setting include a "principles based" approach that relies on a broad framework, a "rules based" approach that gives specific guidance on how to classify transactions, and an "objectives-oriented" approach that blends the other two approaches. IFRS is largely a principle based approach. GAAP has traditionally been more rules based, but is moving toward an objective-oriented approach - measurement (another trade-off in financial reporting is between properly valuing the elements at one point in time (as on the balance sheet) and properly valuing the elements between points in time (as on the income statement). An "asset/liability" approach, which standard setters have largely used, focuses on balance sheet valuation. A "revenue/expense" approach would tend to place more significance on the income statement.

Four characteristics that enhance relevance and faithful representation:

1) Comparability - Financial statement presentation should be consistent among firms and across time periods 2) Verifiability - Independent observers, using the same methods, obtain similar results 3) Timeliness - Information is available to decision makers before the information is stale 4) Understandability - Users with basic business and accounting knowledge should be able to understand the information presented. Useful info should not be omitted just because it is complicated

Describe the financial statement analysis framework: (6)

1) State the objective and context (determine what questions the analysis seeks to answer, the form in which this information needs to be presented, and what resources and how much time are available to perform the analysis) 2) Gather data (acquire the company'a financial statements and other relevant data on its industry and the economy. Ask questions of the company's management suppliers, and customers, and visit company sites) 3) Process the data (make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common size balance sheets) 4) Analyze and interpret the data (use the data to answer the question stated in the first step. Decide what conclusions or recommendations the information supports) 5) Report the conclusions or recommendations (prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations) 6) Update the analysis: (repeat these steps periodically and change the conclusions or recommendations when necessary)

The standard auditor's opinion contains three parts that state:

1) Whereas the financial statements are prepared by management and are its responsibility, the auditor has performed an independent review 2) Generally accepted auditing standards were followed, thus providing reasonable assurance that the financial statements contain no material errors 3) The auditor is satisfied that the statements were prepared in accordance with accepted accounting principles and that the principles chosen and estimates made are reasonable. The auditor's report must also contain additional explanation when accounting methods have not been used consistently between periods ***4) For publicly traded firms in the U.S., during an audit, the auditor must express an opinion on the firm's internal controls. The auditor can provide this opinion separately or as the fourth element of the standard opinion

current ratio =

= (current assets) / (current liabilities) The higher the current ratio the better. A current ratio of less than 1 means the firm has negative working capital and is probably facing a liquidity crisis

cash conversion cycle =

= (days sales outstanding + days of inventory on hand - number of days of payables) Cash conversion cycle is the length of time it takes to turn a firm's cash investment in inventory back into cash, in the form of collections from the sales of that inventory. High cash conversion cycles are undesirable. A cash conversion cycle that is too high implies the firm has an excessive amount of capital in the sales process.

Return on common equity =

= (net income - preferred dividends) / average common equity Return on common equity measures profits available to common shareholders. Analysts should be concerned if return on common equity is too low.

retention rate =

= (net income available to common shareholders - dividends declared) / net income available to common shareholders = 1 - dividend payout ratio dividend payout ratio = (dividends declared / net income available to common shareholders)

Under the original 3 component DuPont system, ROE is broken down into 3 separate ratios: The DuPont equation is arguably the most important equation in ratio analysis

= (net profit margin) x (asset turnover) x (leverage ratio) The DuPont equation is arguably the most important equation in ratio analysis

payables turnover = (measures use of trade credit by the firm)

= (purchases / average trade payables)

fixed asset turnover = (utilization of fixed assets)

= (revenue / average net fixed assets) desirable to have a receivables turnover close to the norm

total asset turnover = (effectiveness of the firm's use of its total assets to create revenue)

= (revenue / average total assets) desirable to have a receivables turnover close to the norm different types of industries have considerably different asset turnover ratios

debt-to-equity ratio =

= (total debt / total shareholder's equity) "total debt" here includes all long-term debt plus interest-bearing-short-term debt.

The performance of financial companies that lend funds is often summarized as the net interest margin. net interest margin =

= interest income / interest earning assets

income available to common shareholders =

= net income - preferred dividends

ROA

= net income / average total assets This measure is a bit misleading because interest is excluded from net income but total assets include debt as well as equity. Adding interest adjusted for tax back to net income puts the returns to both equity and debt holders in the numerator. The interest expense that should be added back is gross interest expense, not net interest expense (net income expense is gross interest expense less interest income). Adding back gross interest expense results in: = (net income + int. expense (1 - tax rate)) / average total assets

net profit margin =

= net income / revenue Net profit margin should be based on income from continued operations because analysts should be primarily concerned about future expectations, and below-the-line items such as discontinued operations will not affect the company in the future.

Per-share valuation includes EPS. Basic EPS =

= net income available to common shareholders / weighted avg # of common shares outstanding

earnings before taxes (EBT) =

= operating profit (EBIT) - interest

Neither net income nor EPS are reduced by dividends. Net income - dividends =

= retained earnings

CV sales = (coefficient of sales variation) CV operating income = CV net income =

= stand. deviation of sales / mean sales = stand. deviation of operating income / mean operating income = stand. deviation of net income / mean net income

The standard deviation of revenue, operating income, and net income are all indicators of the variation and uncertainty about a firm's performance. Since they all depend on the size of the firm to a great extent, analyst employ a size-adjusted measure of variation called the coefficient of variation. Coefficient of variation for a variable =

= standard deviation / expected value

debt-to-capital ratio =

= total debt / (total debt + total shareholder's equity)

At the end of an accounting period, an A)______________ is prepared that shows the balances in each account. If any adjusting entries are needed, they will be recorded and reflected in an B)______________.

A) Initial trial balance B) Adjusted trial balance

The specific records within each financial statement element where various transactions are entered are called:

Accounts (On the financial statements, accounts are typically presented in groups such as 'inventory' or 'accounts payable'

Requires that revenue is recorded when the firm earns it and expenses are recorded as the firm incurs them, regardless of whether cash has actually been paid.

Accrual accounting

Category of accrual accounting in which the firm owes cash for expenses it has incurred:

Accrued Expense Expenses increase and a liability for accrued expenses increases as well.

Which accruals involve recording the revenue or expense first and the cash exchange later?

Accrued revenue Accrued expenses

Category of accrual accounting in which the firm provides goods or services before it receives a cash payment:

Accrued revenue Revenue increases and accounts receivable (asset) increases When the customer pays cash for the good or service, accounts receivable decreases (A typical example would be a manufacturer that sells good to retail stores "on account". The manufacturer records revenue when it delivers the goods but does not receive cash until after the retailers sell the goods to customers)

Financial ratios can be segregated into different classifications. these include: (5)

Activity ratios Liquidity ratios Solvency ratios Profitability ratios Valuation ratios

The detailed list of the accounts that make up the five financial statement elements and the line items presented in the financial statements is called a company's:

Chart of accounts

Written by management and are often viewed as public relations or sales material. Not all of the material is independently reviewed by outside auditors (usually available on the company's website).

Corporate report (also known as press release)

Barriers to accounting standard convergence

Different standard setting bodies and regulatory authorities of different countries can and do disagree on the best treatment of a particular item or issue. Other barriers result from the political pressures that regulatory bodies face from business groups and others who will be affected by changes in reporting standards.

Operating profit is soemtimes referred to as ____

EBIT. Strictly speaking, EBIT includes some non-operating expenses, such as gains on investment. For this reason, analysts must be consistent in their calculation method and know how published ratios are calculated.

Per-share measures include: (5) Per-share measures are not comparable because the number of outstanding shares differ among firms.

EPS Diluted EPS Cash flow per share EBIT per share EBITDA per share

Before financial statements are released, firms often provide guidance on:

Earnings (Once an earnings announcement is made, a conference call may be held whereby senior management is available to answer questions)

Define: balance sheet

Financial statement that reports a firm's financial position at a point in time. (balance sheet is also known as the 'statement of financial position' or 'statement of financial condition'

Income statement

Financial statement that reports on the financial performance of a firm over a time period. (income statement is also known as the 'statement of operations' or the 'profit and loss statement')

Define: statement of changes in equity

Financial statement that reports the amounts and sources of changes in equity investors' investment in the firm over a period of time.

Define: statement of cash flows

Financial statement that reports the company's cash receipts and payments.

The extended 5-step ROE decomposition (DuPont system) is:

Follow the same steps as 3 step method, then break down net profit margin into 3 parts: (tax burden) x (interest burden) x (EBIT margin) x (asset turnover) x (financial leverage) tax burden = (net income / EBT) OR (1 - tax rate) interest burden = EBT / EBIT EBIT margin = EBIT / revenue EBIT in the second two expressions can be replaced with operating profit. In this case, "EBIT margin" becomes "operating margin". The "interest burden" term would then show the effects of non operating income as well as the effect of interest expense. Generally, high profit margins, leverage, and asset turnover will lead to higher ROE. However, by replacing EBIT with operating income, the equation includes both the effect of interest expense and non-operating income on ROE. So, as leverage rises, so does the interest burden.

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

Form 144

Companies must file this form to disclose material events including significant assets acquisitions and disposals, changes in management or corporate gonvernance, or matters related to its accountants, its financial statements, or the markets in which its securities trade.

Form 8-K

When a company prepares a proxy statement for its shareholders prior ro the annual meeting or other shareholder vote, it also files this statement with SEC

Form DEF-14A

Forms that involve the benficial ownership of securities by a company's officers and directors. Analysts can use these filings to learn about the purchases and dales of company securities by corporate insiders.

Forms 3, 4, 5

The Europen Union requires publicly listed companies to report financials according to ________

IFRS

Solvency ratios that determines a firm's ability to repay its debt obligations include: (2)

Interest coverage ratio Fixed charge coverage ratio

LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis. (pg 48) a) According to the IASB, _____ are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity other than those relating to distributions to equity partners. b) If the financial statements were performed on a _____ basis, neither revenue recognition nor expense recognition would be an issue. c) Under the accrual method of accounting, expense recognition is based on the _____ principle, whereby expenses to generate revenue are recognized in the same period as the revenue (Example: Assume inventory is purchased during the 4th quarter of year 1 and sold during the 1st qtr of year 2. Both revenue and expenses (cogs) are recognized in the 1st qtr of year 2 when the inventory was sold) d) Not all expenses can be tied to revenue generation. These costs are known as _____ costs. These costs, such as administrative costs, are expensed in the period incurred, e) If a firm can identify exactly which items were sold and which items remain in inventory, the firm can use the _____ method. (Example: An auto dealer records each vehicle sold or in inventory by its identification #) f) Under the _____ method, the first item purchased by a firm is assumed to be the first item sold. This method is appropriate for inventory with a limited shelf life. g) Under the _____ method, the last item purchased by a firm is assumed to be the first item sold. This method is appropriate for inventory that does not deteriorate with age. h) In the U.S., the _____ method is popular because of its income tax benefits. (In an inflationary environment, the this method results in higher COGS. Higher COGS result in lower taxable income and therefore, lower income taxes.) i) The _____ cost method makes no assumptions about the physical flow of inventory. It is popular because of its ease to use. It is calculated by (cost of available goods / total units available)It results in COGS and ending inventory between those of LIFO and FIFO. j) FIFO and average cost are allowed under both GAAP and IFRS. _____ is allowed under GAAP, but prohibited under IFRS. k) The allocation of costs over an assets life is knows as _____ for tangible assets l) The allocation of costs over an assets life is knows as _____ for intangible assets (e.g., franchise agreement) m) The allocation of costs over an assets life is knows as _______ for natural resources n) To allocate costs over an assets life, most firms use the _____ method for financial reporting. This method recognizes an equal amount of depreciation expense each period. o) If assets generate more benefits in the early years of their life and fewer benefits in later years, the _____ method is more appropriate for matching expenses with revenues. In the early years of an asset's life, the straight-line method will result in lower depreciation expense as compared to an accelerated method. Lower expense results in higher net income (more taxes). In the later years of the asset's life, the effect is reversed and straight-line depreciation results in higher expense and lower net income compared to accelerated methods. p) Annual straight-line depreciation formula: q) Total depreciation over an assets life in the _____ using both methods. r) The _____ method applies a constant rate of depreciation to an asset's declining book value each year. s) The most common declining balance method is _____ , which applies two times the straight-line rate to the decline balance. If an asset's life is 10 years, the straight-line rate is 10% (1/10), and the _____ is 20% (2/10). t) DDB depreciation formula u) Firms can compute declining balance depreciation based on any _____ (e.g., 1.5, double, triple) v) Most firms use the _____ method to calculate annual amortization expenses for financial reporting. w) Intangible assets with indefinite lives, such as _____ , are not amortized. However they must be tested for impairment at least annually. If the asset value is impaired, an expense equal to the impairment amount is recognized on the income statement. x) If a firm sells goods/services on credit or provides a warranty to the customer, the matching principle requires the firm to estimate bad debt and/or warranty expense. By doing so, the firm is recognizing the expense _____ , rather than a later period. y) Like revenue recognition, expense recognition requires a number of estimates, making it possible to delay or accelerate the recognition of expenses. Delayed expense recognition increases current _____ net income and is therefore more aggressive. z) Firms disclose their accounting policies and significant estimates in the _____ and in the _____ section of the annual report.

LOS 24. e: Describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis. (pg 48) a) expenses b) cash basis c) matching principle d) period costs e) specific identification method f) first-in, first-out (FIFO) method g) last-in, first-out (LIFO) method h) LIFO method i) weighted average cost j) LIFO k) depreciation l) amortization m) depletion n) straight line depreciation o) accelerated depreciation p) (cost - residual value) / useful life q) same r) declining balance method s) double-declining balance method (DDB) t) DDB depreciation = (2/useful life) x (cost-accumulated depreciation) u) factor v) straight-line amortization (straight-line amortization is calculated exactly like straight-line depreciation) w) goodwill x) in the period of the sale y) net income z) footnotes, management discussion & analysis (MD&A)

LOS 24. f: Describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations and unusual or infrequent items) and changes in accounting policies. (pg 54) a) A _____ operation is one that management has decided to dispose of, but either has not done so yet, or or has disposed of in the current year after after the operation had generated income or losses. b) The date when the company develops a formal plan for disposing of an operation is referred to as the _____ c) The time between the measurement date and the actual disposal date is referred to as the _____ d) Any income or loss from discontinued operations is reported separately on the _____ , net of tax, after income from continuing operations. Any past income statements must be restated, separating the income or loss from the discontinued operations. e) On the measurement date, the company will _____ any estimated loss during the phaseout period and any estimated loss on the sale of the business. Any expected gain on the disposal cannot be reported until after the sale is complete. f) Discontinue doperations do not affect net income from _____ g) Unusual or infrequent items are included in income from _____ and are reported before tax. h) Under GAAP, historically, a(n) _____ item was a material transaction that was both unusual and infrequent in occurrence. These items were reported separately on the income statement, net of tax, after income from continuing operations. For periods beginning after December 15, 2015, GAAP no longer allows items to be treated as such. IFRS also does not allow items to be treated this way. i) Accounting changes include: (3) j) A change from one GAAP or IFRS method to another refers to a change in _____ (e.g., change in inventory account from LIFO to FIFO) k) A change in accounting principles requires _____. Accordingly, all of the prior-period financial statements are restated to reflect the change. This enhances the compatibility of financial statements over time. l) Under GAAP, a firm that changes to _____ from another inventory cost method does not apply the change retrospectively, but instead uses the carrying value of inventory as the first LIFO layer. m) A change in _____ is the result of a change in management's judgement, usually due to new information. (Example: Management may change the estimated useful life of an asset because new information indicates the asset has a longer or shorter life than originally expected) A change in estimate is applied prospectively and does not require the restatement of prior financial statements. n) A change form an incorrect accounting method to one that is acceptable under GAAP or IFRS, or the correction of an accounting error made in previous financial statements is reported as a _____ . These changes are made by restating results for all prior periods presented in the current financial statements. Disclosures of the nature of the adjustments and its effect on net income is also required. o) Analysts should review prior-period adjustments very carefully because errors may indicate weakness in the firm's _____________ .

LOS 24. f: Describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations and unusual or infrequent items) and changes in accounting policies. (pg 54) a) discontinued operation (To be accounted for as a discontinued operation, the business must be physically and operationally distinct from the rest of the firm) b) measurement date c) phaseout period d) income statement e) accrue f) continuing operations g) continuing operations h) extraordinary items i) changes in accounting principles, accounting estimates, and prior-period adjustments j) accounting principles k) retrospective application l) LIFO m) change in accounting estimate (accounting estimate changes typically do not affect cash flow) n) prior-period adjustment (prior-period adjustments typically do not affect cash flow) o) internal controls

LOS 24. h: Describe how EPS is calculated and calculate and interpret a company's EPS (both basic and diluted EPS) for both simple and complex capital structures. (pg 56) LOS 24. i: Distinguish between dilutive and anti-dilutive securities and describe the implications of each for the EPS calculation. (pg 56) a) _____ is one of the most commonly used corporate profitability measures for publicly-traded firms (non-public firms are not required to report this). b) EPS is reported only for shares of _____ stock. c) A company may have either a _____ capital structure or _____ capital structure. d) A _____ capital structure is one that contains no potentially dilutive securities. This capital structure contains only common stock, non-convertible debt, and non-convertible preferred stock. Firms with this structure report only basic EPS. e) A _____ capital structure contains potentially dilutive securities such as options, warrants, or convertible securities. All firms with this capital structure must report both basic and diluted EPS. f) Basic EPS equation: g) The current year's _____ dividends are subtracted from net income because EPS refers to the per-share earnings available to common shareholders. Net income minus preferred dividend is the income available to common shareholders. Common stock dividends are not subtracted from net income because they are part of the net income available to common shareholders. h) The _____ is the number of shares outstanding during the year, weighted by the portion of the year they were outstanding. i) A _____ is the distribution of additional shares to each shareholder in an amount proportional to their current number of shares. (Example: If a 10% stock dividend is paid, the holder of 100 shares of stock would receive 10 additional shares) j) A _____ refers to the division of each "old" share into a specific number of "new" (post-split) shares. (Example: The holder of 100 shares will have 200 shares after a 2-for-1 split or 150 shares after a 3-for-2 split) k) _____ securities are stock options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to common stock. l) _____ securities are stock options, warrants, convertible debt, or convertible preferred stock that would increase EPS if exercised or converted to common stock. m) The numerator of the basic EPS equation contains _____. If there are dilutive securities, then the numerator must be adjusted. n) If convertible preferred stock is dilutive (meaning EPS will decrease if converted to common stock), the convertible preferred dividends must be added to _____. o) If convertible bonds are dilutive, then the bonds' after-tax interest expense is not considered an interest expense for diluted EPS (interest expense multiplied by (1 - tax rate) must be added back to the _____. p) Interest paid on bonds is typically _____ for firms. q) If convertible bonds are converted to stock, the firm saves the _____ cost but loses the _____. r) The basic EPS denominator is the _____. s) When the firm has dilutive securities outstanding, the denominator is the basic EPS denominator adjusted for the equivalent number of common shares that would be created by the conversion of all dilutive securities outstanding. Dilutive securities outstanding may include: (4) t) If a dilutive security was issued during the year, the increase in the weighted average number of shares for diluted EPS is based on only the portion of the year the diluted security was _____. u) Stock options and warrants are dilutive only when their exercise prices are _____ than the average market price of the stock over the year. v) Dilutive stock options and warrants increase the number of common shares outstanding in the denominator for diluted EPS (there is no adjustment to the numerator). If the options or warrants are dilutive, the _____ method is used to calculate the number of shares used in the denominator. w) The _____ method assumes that the funds received by the company from the exercise of the options would be used to hypothetically purchase shares of the company's common stock in the market at the average market price. The net increase in the number of shares outstanding (the adjustment to the denominator) is the number of shares created by exercising the options less the number of shares hypothetically repurchased with the proceeds of exercise. x) Diluted EPS = y) Full diluted EPS = z) If diluted EPS is less than basic EPS, the convertible debt is _____, and the effects of conversion should be included in the calculation of diluted EPS.

LOS 24. j: Convert income statements to common-size income statements (pg 65) a) A _____ expresses each category of the income statement as a % of revenue. b) The common-size format standardizes the income statement by eliminating the effects of _____. This allows for comparison of income statements over time (time-series analysis, also called trend analysis) and across firms (cross-sectional analysis). c) Common-size analysis can also be used to examine a firm's _____. d) Tax expense is more meaningful when expressed as a percentage of pre-tax income. This result is known as the _____.

LOS 24. j: Convert income statements to common-size income statements (pg 65) a) vertical common-size income statement b) size c) strategy d) effective tax rate

LOS 24. k: Evaluate a company's financial performance using common-size income statements and financial ratios based on the income statement. (pg 67) a) Margin ratios can be used to measure a firm's _____ quickly. b) gross profit equation c) Gross proft margin equation d) Gross profit can be increased by raising prices or reducing _____ costs. e) _____ margin measures the profit generates after generated after considering all expenses. Like gross profit margin, _____ margin should be compared over time and with the firm's industry peers. f) Any subtotal found in the income statement can be expressed as a percentage of revenue. For example, (operating profit / revenue) = g) Pretax profit / revenue =

LOS 24. k: Evaluate a company's financial performance using common-size income statements and financial ratios based on the income statement. (pg 67) a) profitability b) gross profit = revenue - COGS c) gross profit margin = gross profit / revenue d) production costs e) Net profit margin f) operating profit margin g) pretax margin

LOS 24. l: Descrive, calculate, and interpret comprehensive income (pg 67) LOS 24. m: Describe other comprehensive income and identify major types of items included in it. (pg 67) a) At the end of each accounting period, the net income of a firm is added to the stockholders' equity through an account known as _____. b) Therefore, any transaction that effects the income statement (net income) will also affect _____. c) Net income = d) _____ is a more inclusive measure of net income that includes all changes in equity except for owner contributions and distributions (it measures all changes to equity except those that are transactions with shareholders, such as dividends paid and shares issued or repurchased.) It is the sum of net income and other comprehensive income (it is excluded from net income on the income statement and is instead listed after net income on the income statement) e) Other comprehensive income includes transactions that are not included in net income, such as: (4) f) Securities that are not expected to be held to maturity or sold in the near term are called a(n) _____. g) Available-for-sale securities are reported on the _____ at _____ value. h) The unrealized gains and losses are not reported in the income statements, but are reported directly in _____ as a component of comprehensive income. i) Effective in 2018, _____ reporting firms will no longer be able to include the available for sale classification. However, firms will still be able to choose, at the time of purchase, to treat an equities security investment as "financial assets measured at fair value through other comprehensive income" j) Under IFRS, firms can choose to report certain long-lived assets at fair value rather than _____. In this case, the changes in fair value are also included in other comprehensive income. k) Because firms have some flexibility of including or excluding transactions from net income, analysts must examine comprehensive income when comparing financial performance with other firms.

LOS 24. l: Descrive, calculate, and interpret comprehensive income (pg 67) LOS 24. m: Describe other comprehensive income and identify major types of items included in it. (pg 67) a) retained earnings b) stockholders' equity c) Net income = revenue - expenses d) comprehensive income e) foreign currency translation gains and losses adjustments for minimum pension liability unrealized gains/losses from cash flow hedging derivatives unrealized gains/losses from available-for-sale securities f) available-for-sale securities g) balance sheet, fair value h) stockholders' equity i) IFRS reporting firms j) historical cost k) comprehensive income

LOS 24.d: Describe key aspects of the converged accounting standards for revenue recognition issued by the IASB (International Accounting Standards Board) and FASB (Financial Accounting Standards Boards) in May 2014. (pg. 47) a) In May 2014, IASB and FASB issued converged standards for revenue recognition that are currently scheduled to go into effect for periods beginning after _____ for GAAP reporting firms and after _____ for IFRS reporting firms. b) When can firms adopt these new standards? c) The new revenue recognition standards take a _____ approach to revenue recognition issues (the central principle is that firms should recognize revenue when it has transferred a good or service to a customer. This is consistent with the accrual accounting principle that revenue should be recognized when earned). d) The converged standards identify a five-step process for recognizing revenue: e) A promise to deliver a distinct good or service is called a _____. f) A "distinct" good or service is one that meets the following criteria: (2) g) A transaction price is the amount a firm expects to receive from a customer in exchange for transferring a good or service to the customer. A transaction price is usually fixed but can also be _____, for example if it includes a bonus for early delivery. A firm can only include a _____ price if they are almost certain that they will not have to reverse it. h) For long-term contracts, revenue is recognized base on a firm's progress toward completing a performance obligation. This treatment is consistent with the _____ method currently in use, but the new standards do not call it that. I) Required disclosures under the converged standards include: (4) J) For many transactions, revenue recognition under the converged standards will be little changed. Industries that are expected to be affected most are those that often sell _____ , such as the software and telecommunications industry.

LOS 24.d: Describe key aspects of the converged accounting standards for revenue recognition issued by the IASB (International Accounting Standards Board) and FASB (Financial Accounting Standards Boards) in May 2014. (pg. 47) a) December 15, 2017 (GAAP) January 1, 2018 (IFRS) b) IFRS may adopt these new standards early. GAAP firms may adopt them for periods beginning after December 15, 2016 c) principles-based approach d) 1. Identify the contract(s) with a customer 2. Identify the performance obligations in the contract 3. Determine the transaction price 4. Allocate the transaction price to the performance obligations in the contract 5. Recognize revenue when (or as) the entity satisfies a performance obligation (Collectability must be probable for a contract to exist, but "probable" is defined differently under GAAP and and IFRS so an identical activity could still be accounted for differently by IFRS and GAAP firms) e) performance obligation f) - The customer can benefit from the good or service on its own or combined with other resources that are readily available - The promise to transfer the good or service can be identified separately from any other promises g) variable price h) percentage of completion I) - Contracts with customers by category - Assets and liabilities related to contracts, including balances and changes - Outstanding performance obligations and the transaction prices allocated on them - Management judgements used to determine the amounts and timing of revenue recognition, including any changes to those judgements J) bundles of good and services

LOS 24.g: Distinguish between the operating and non-operating components of the income statement. (pg 56) a) Operating and non-operating transactions are usually reported separately on the _____ . b) For _____ firms, non-operating transactions can include investment income and financing expenses (interest) c) For financial firms, investment income, financing expenses, and interest income are all _____ transactions. d) For financial or non-financial firms, depreciation is included in the computation of _____ expenses.

LOS 24.g: Distinguish between the operating and non-operating components of the income statement. (pg 56) a) income statement b) non-financial firms c) operating transaction d) operating

LOS 25.F: Describe the components of shareholder's equity (pg. 90) a) _____ is the residual income in assets that remains after subtracting an entity's liabilities. b) Owner's equity includes: (6) c) _____ is the amount contributed by the common shareholders. d) The _____ value of a common stock is a stated or legal value. It has no relationship to fair value. e) Some common shares are issued without a par value. But, when par value exists, it is reported separately in _____. f) _____ shares are the number of shares that may be sold under a firm's articles of incorporation. g) _____ shares are the number of shares that have been actually been sold to shareholders. h) The number of _____ is equal to the issued shares less the shares that have been reacquired by the firm (treasury stock). i) _____ stock has certain rights and privileges not conferred by common stock. j) Preferred shareholders are paid _____ at a specified rate (% of par value), and have priority over the claims of common shareholders in the event of liquidation. k) Preferred stock can be classified as debt or equity. For example, perpetual preferred stock that is non-redeemable is considered _____. However, preferred stock that calls for mandatory redemption in fixed amounts is considered _____. l) _____ interest is the minority shareholders' pro-rata shares of the net assets (equity) of a subsidiary that is not wholly owned by the parent. m) _____ are the undistributed earnings (net income) of a firm since inception, the cumulative earnings that have not been paid out to shareholders as dividends n) _____ stock is stock that has been reacquired by the firm but not yet retired. o) Treasury stock reduces _____ and does not represent an investment in the firm. Treasury stock has no voting rights and does not recieve dividends. p) _____ includes all changes in stockholders' equity except for transactions recognized in the income statement (net income) and transactions with shareholders, such as: (3) q) Comprehensive income aggregates net income and certain special transactions that are not reported in the income statement but that affect _____. These special transactions compromise what is known as _____. r) comprehensive income = s) _____ is an income measure over a period of time that includes net income and other comprehensive income for the period. t) _____ does not include net income and is a component of stockholders' equity at a point in time. u) The _____ summarizes all transactions that increase or decrease the equity accounts for the period. v) The statement of changes in stockholders' equity includes transaction with shareholders and reconciles the beginning and denying balance of each equity account, including: w) In the statement of changes in stockholders' equity, the components of other accumulated other comprehensive income are disclosed. These components could be: (4). These components could be

LOS 25.F: Describe the components of shareholder's equity (pg. 90) a) owner's equity b) contributed capital preferred stock treasury stock retained earnings non-controlling interest accumulated other comprehensive income c) contributed capital (also known as issued capital) d) par value e) stockholders equity f) authorized shares g) issued shares h) shares outstanding i) preferred stock j) dividends k) perpetual preferred stock is equity. mandatory redemption perpetual preferred stock is debt (financial liability). l) noncontrolling interest m) retained earnings n) treasury stock o) stockholders' equity p) accumulated other comprehensive income transactions with shareholders: issuing stock, reacquiring stock, paying dividends q) stockholder's equity, other comprehensive income r) net income + other comprehensive income s) comprehensive income t) accumulated other comprehensive income u) statement of changes in stockholders' equity v) capital stock additional paid-in-capital retained earnings accumulated other comprehensive income w) cash flow hedging derivatives foreign currency translation adjustments for minimum pension liability unrealized gains/losses from available-for-sale securities

LOS 25.b: Describe uses and limitations of the balance sheet in financial analysis. (pg. 81) a) The _____ can be used to asses a firm's liquidity, solvency, and ability to make distributions to shareholders. b) From the firm's perspective, _____ is the ability to meet short-term obligations. c) From the firm's perspective, _____ is the ability to meet long-term obligations. d) For most firms, the balance sheet consists of a mixture of values including _____ cost, amortized _____, and _____ value. Balance sheet elements should not be interpreted as market value or intrinsic value. Some assets and liabilities are difficult to quantify and are not reported on the balance sheet.

LOS 25.b: Describe uses and limitations of the balance sheet in financial analysis. (pg. 81) a) balance sheet b) liquidity c) solvency d) historical cost, amortized cost, fair value

LOS 25.c: Describe alternative formats of balance sheet presentation. (pg. 81) a) Both IFRS and GAAP require firms to separately report their _____ assets and _____ assets, as well as their _____ liabilities and _____ liabilities. b) The current/non-current format is known as a _____ balance sheet. c) The classifed balance sheet is useful in evaluating _____. d) _____ presentations present assets and liabilities in the order of liquidity (often used in the banking industry).

LOS 25.c: Describe alternative formats of balance sheet presentation. (pg. 81) a) current and non-current assets, current and non-current liabilities b) classified balance sheet c) liquidity d) liquidity-based presentations (under IFRS, firms can choose to use a liquidity-based format if the presentation is more relevant and reliable)

LOS 25.d: Distinguish between current and non-current assets and current and non-current liabilities. (pg. 81) a) _____ assets include cash and other assets that will likely be converted into cash or used up within one year or one operating cycle, whichever is greater. b) The _____ cycle is the time it takes to produce or purchase inventory, sell the product, and collect the cash. c) Current assets are usually presented in order of their _____, with cash being the most liquid. d) Current assets reveal information about the _____ activities of the firm. e) _____ liabilities are obligations that will be satisfied within one year or one operating cycle, whichever is greater. f) More specifically, a liability that meets any of the following criteria is considered current: (4) g) working capital = h) Not enough working capital could indicated _____ problems. i) Too much working capital may indicate an inefficient use of _____. j) Non-current assets provide information about the firm's _____ activities, which form the foundation upon which the firm operates. k) Non-current liabilities provide information about the firm's _____ activities.

LOS 25.d: Distinguish between current and non-current assets and current and non-current liabilities. (pg. 81) a) current assets b) operating cycle c) liquidity d) operating activities e) current liabilities f) - settlement is expected during the normal operating cycle - settlement is expected within one year - held primarily for trading purposes - There is not an unconditional right to defer settlement for more than one year g) current assets - current liabilities h) liquidity i) assets j) investing activities k) long-term financing activities

LOS 25.g: Convert balance sheets to common-size balance sheets and interpret common-size balance sheets. (pg 92) a) A _____ expresses each item of the balance sheet as a percentage of total assets. b) The common-size balance sheet standardizes the balance sheet by eliminating the effects of _____. c) By eliminating the effects of size, the common-size balance sheet allows for comparison _____ and _____. d) Carrying higher inventories may be an indication of _____. e) Common-size analysis can be used to examine a firm's _____. f) A firm reporting goodwill could mean the firm is growing through _____. g) A firm reporting no goodwill is growing _____.

LOS 25.g: Convert balance sheets to common-size balance sheets and interpret common-size balance sheets. (pg 92) a) common-size balance sheet b) size c) over time (time-series analysis) across firms (cross-sectional analysis) d) inventory obsolescence e) strategies f) acquisitions g) internally

LOS 25.h: Calculate and interpret liquidity and solvency ratios. (pg 94) a) Balance sheet ratios compare b) Liquidity ratios measure a firm's ability to satisfy its _____ obligations. c) Solvency ratios measure a firm's ability to satisfy its _____ obligations. d) Liquidity ratios include: (3) e) Solvency ratios include: (4) f) current ratio = g) quick ratio = h) cash ratio = i) long-term debt-to-equity = j) total debt-to-equity = k) debt ratio= l) financial leverage = m) The quick ratio (also known as acid-test ratio) excludes _____ from currents assets. n) The cash ratio excludes _____ and _____. o) When calculating solvency ratios, debt is considered to be a _____ obligation. p) The financial leverage ratio captures the impact of _____ obligations. q) Limitations of balance sheet ratio analysis: (4)

LOS 25.h: Calculate and interpret liquidity and solvency ratios. (pg 94) a) balance sheet items only b) short-term c) long-term d) current ratio, quick ratio (acid-test ratio), cash ratio e) long-term debt-to-equity, total debt-to-equity, debt ratio, financial leverage f) current assets / current liabilities g) (cash + marketable securities + receivables) / current liabilities h) (cash + marketable securities) / current liabilities i) long term debt / total equity j) total debt / total equity k) total debt / total assets l) total assets/ total equity m) inventory n) inventory and receivables o) interest-bearing obligation p) all obligations (both interest bearing and non-interest bearing) q) - comparisons with other firms are limited by differences in accounting standards and estimates - lack of homogeneity because firms operate in different industries - interpretation of ratios requires significant judgement - balance sheet data are only measured at a single point in time

LOS 26.b: Describe how non-cash investing and financing activities are reported: (pg. 105) a) Non-cash _____ and _____ activities are not reported in the cash flow statements since they do not result in inflows or outflows of cash. Example 1: If a firm acquires real estate with financing provided by the seller, the firm has made an investment and financing decision. However, since no cash is involved in the transaction, it is not reported as an investing and financing activity in the cash flow statement. Example 2: Suppose a firm exchanges debt for equity. Such an exchange results in a reduction of debt and increase in equity. No cash is exchanged, and it is not reported on the cash flow statement. b) Non-cash transactions must be disclosed in either a _____ or _____ to the cash flow statement. c) Analysts should be aware of non-cash transactions and incorporate them into analysis of _____ and _____ performance, and include their effects in estimating future cash flows.

LOS 26.b: Describe how non-cash investing and financing activities are reported: (pg. 105) b) investing and financing activities b) footnote or a supplemental schedule c) current and past performance

LOS 26.c: Contrast cash flow statements prepared under IFRS and GAAP. (pg. 105) a) Firms reporting under _____ have more flexibility in the classification of cash flows. b) Under IFRS, interest and dividends received may be classified as either _____ or _____ activities. c) Under IFRS, Dividends paid to the company's shareholders and interest paid on the company's debt may be classified as either _____ or _____ activities. d) Another important different relates to income taxes paid. Under GAAP, all taxes paid are reported as _____ activities (this includes taxes related to all activities) e) Under IFRS, income taxes are also reported as operating activities, UNLESS the expense is associated with a(n) _____ or _____ transaction. Then they are reported as such. f) Example: Consider a company that sells land that was held for investment for $1 million. Income taxes on the sales total $160,000. Under GAAP the firm reports an inflow of cash from investing activities of $1 million and an outflow of cash from operating activities for $160,000. Under IFRS, the firm can report a net inflow of $840,000 from investing activities. GAAP inflows & outflows = IFRS inflows & outflows =

LOS 26.c: Contrast cash flow statements prepared under IFRS and GAAP. (pg 105) a) IFRS b) operating or investing activities c) operating or financing activities d) operating activities e) investing or financing transaction f) GAAP - inflow (investing activities) of $1 million - outflow (operating activities) of $160,000 IFRS - inflow: (investing activities) $840,000

LOS 26.d: Distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method. a) There are two methods of presenting the cash flow statement: b) Both the direct and indirect methods are permitted under IFRS and GAAP. Use of the _____ method, however, is encouraged by both standard setters. c) Even though IFRS and GAAP encourage firms to use the direct method, most firms use the _____. d) There difference between the direct and indirect method relates to the presentation of cash flow from _____ activities. The presentation of cash flow from investment and financing activities is the same under both methods. e) Under the _____ method, each line item of the accrual-based income statement is converted into cash receipts or cash payments. Simply stated, the direct method converts an accrual-basis income statement to a cash-basis income statement. ____________________________________________________________________________________ f) Below is a presentation of operating cash flow for ABC Company for year end Dec. 31, 20X7 using the _____ method. Cash collections from customers......................................$429,980 Cash paid to suppliers............................................................(265,866) Cash paid for operating expenses...................................(124,784) Cash paid for interest..................................................................(4,326) Cash paid for taxes.....................................................................(14,956) Operating cash flow..................................................................$20,048 ____________________________________________________________________________________ g) Below is a presentation of ABC Company's operating cash flow for year end Dec. 31, 20X7 using the _____ method. Net income ......................................................................................$18,788 Adj. to recon net income to cash flow provided by operating activities: Depreciation and amortization...................................................7996 Deferred income taxes..................................................................... 416 Increase in A/R................................................................................(1,220) Increase in inventory.................................................................(20,544) Decrease in prepaid expenses......................................................494 Increase in A/P.................................................................................13,406 Increase in accrued liabilities..........................................................712 Operating cash flow...................................................................$20,048 ____________________________________________________________________________________ h) Under the _____ method, cash flow presentation begins with cash inflows from customers and then deducts cash outflows for purchases, operating expenses, interest, and taxes. i) Under the _____ method, net income is converted to operating cash flow by making adjustments for transactions that affect net income but are not cash transactions. These adjustments include eliminating non-cash expenses (depreciation & amortization), non-operating items (gains & losses), and changes in balance sheet accounts resulting from accounting events. j) Under the indirect method, the starting point is _____ (also called the bottom line). k) Total cash flow from operating activities is _____ under both the direct and indirect method, only presentation methods differ. l) The advantage of the _____ method is that it presents the firm's operating cash receipts and payments (this method provides more information, which is useful in estimating future operating cash flows). m) The _____ method only presents the net result of these operating cash receipts and payments. n) The main advantage of the _____ method is that it focuses on the differences in net income and operating cash flow. o) Under _____ reporting standards, a direct method presentation must also disclose the adjustments necessary to reconcile net income to cash flow from operating activities. Under both methods, net income must be reconciled to net cash flows from operating activities. p) _____ reporting standards require that along with the direct presentation format of the cash flow statement, the adjustments made to reconcile net income and net operating cash flow is also disclosed. This reconciliation is nothing but the indirect format of cash flow statement. Therefore, _____ reporting firms presenting the cash flow statement under the direct method also need to present it under the indirect method. q) Reconciliation is not required under _____. r) Under _____ reporting standards, payments for interest and taxes must be disclosed separately in the cash flow statement under both the direct and indirect method. s) Under _____ reporting standards, payments for interest and taxes can be reported in the cash flow statement or disclosed in the footnotes.

LOS 26.d: Distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method. a) direct method & indirect method b) direct method c) indirect method d) CFO (cash flow from operating activities) e) direct method ________________________________________________________________________ f) direct method ________________________________________________________________________ g) indirect method ________________________________________________________________________ h) direct method i) indirect method j) Net income k) the exact same l) direct method m) indirect method n) indirect method o) GAAP p) GAAP q) IFRS r) IFRS s) GAAP

LOS 26.e: Describe how the cash flow statement is linked to the income statement and the balance sheet. (pg. 108) a) _____ activities typically result in increase or decrease of current assets and liabilities. b) _____ activities typically result in increase or decrease of non current assets. c) _____ activities typically result in increase or decrease of non current liabilities and equity. d) Ending A/R =

LOS 26.e: Describe how the cash flow statement is linked to the income statement and the balance sheet. (pg. 108) a) operating activités b) investing activities c) financing activities d) = (beginning A/R) + (sales) - (cash collections)

LOS 26.f: Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data. (pg. 109) a) CFO is calculated differently, but the result is _____ under both methods. b) The calculation of CFI and CFF is _____ identical under both methods c) There is a(n) _____ relationship between changes in assets and changes in cash flows. In other words, an increase in an asset account is a use of cash, and a decrease in an asset account is a source of cash. d) There is a(n) _____ relationship between changes in liabilities and changes in cash flows. In other words, an increase in a liability account is a source of cash, and a decrease in a liability account is a use of cash. e) Sources of cash are _____ and uses of cash are _____. f) The _____ method of presenting a firm's statement of cash flows shows only cash payments and cash receipts over the period. The sum of these inflows and outflows is the company's CFO. g) The _____ method gives analysts the most information. The analyst can see the actual amounts that went to each use of cash and that were received for from each source of cash. This information can help the analyst to better understand the firm's performance over time and to forecast future cash flows. h) Common components of cash flow that appear on a statement of cash flow presented under the direct method: (5) i) Ignore _____ expense when using the direct method (it is a non-cash charge). j) CFI is calculated by examining the change in gross asset accounts that result from investing activities, such as: (3) Related accumulated depreciation or amortization amounts are ignored since they do not represent cash expense (in this context, "gross" simply means an amount that is presented on the balance sheet before deducting any accumulated depreciation or amortization). k) When calculating cash paid for a new asset, it is necessary to determine whether old assets were sold. If assets were sold during the period, the following formula must be used: cash paid for new asset = l) When calculating the cash flow from an asset that has been sold, it is necessary to consider any gain or loss from the sale using the following formula: cash from asset sold = m) Cash flow from _____ activities are determined by measuring the cash flows occurring between the firm and its suppliers of capital and shareholders. n) CFF between a firm and its creditors result from: (2) o) CFF between the firm and its shareholders occur when: p) Interest payments are technically a cash flow to creditors, but are included in _____ under GAAP. q) net cash flows from creditors = r) net cash flows from shareholders = s) Total cash flow = t) If calculated correctly, the total cash flow will equal the change in _____ from one balance sheet to the next. u) Under the _____ method, we begin with net income and adjust it for differences between accounting items and actual cash receipts and cash disbursements. Depreciation, for example, is deducted in calculating net income. We must add depreciation (and amortization) to net income in calculating CFO. v) Under the indirect method, gains on the sales of fixed assets need to be _____ from net income. w) Under the indirect method, losses on the sales of fixed assets need to be added to net income. x) Steps in calculating the CFO under the indirect method are as follows: (4) y) _____ is a measure of cash that is available for discretionary purposes. It is the cash that is available one a firm has covered all of its capital expenditures. z) _____ is the cash available to all investors, both equity and debt holders. aa) ab)

LOS 26.f: Describe the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data. (pg. 109) a) the same b) identical c) inverse relationship d) direct relationship e) sources of cash: inflows (positive numbers + ) uses of cash: outflows (negative numbers - ) f) direct method g) direct method h) cash collected from customers cash paid to suppliers cash paid for operating activities cash paid for interest cash paid for taxes i) depreciation & amortization expense j) PP&E, intangible assets, and investment securities k) (ending gross assets) + (gross cost of old assets sold) - (beginning gross assets) l) = book value of asset +(-) gain (loss) on sale m) cash flow from financing activities (CFF) n) new borrowing (inflows) debt principle repayments (outflows) o) equity is issued, shares are repurchased, or dividends are paid. p) cash flow from operating activities (CFO) q) = (new borrowings) - (principle amounts repaid) r) = (new equity issued) - (share repurchases) - (cash dividends paid) s) = CFO + CFF + CFI t) cash u) indirect method v) subtracted w) added x) 1. Begin with net income 2. Subtract gains or add losses that resulted from financing or investing cash flows (such as gains from sale of land) 3. Add back all non-cash charges to income (such as depreciation and amortization) and subtract all non-cash components of revenue 4. Add or subtract changes it balance sheet operating accounts as follows: - increases in the operating asset accounts (uses of cash) are subtracted, while decreases (sources of cash) are added - increases in the operating liability accounts (sources of cash) are added, while decreases (uses of cash) are subtracted y) Free cash flow (FCF) z) Free cash flow to the firm (FCFF) aa) ab)

LOS 27.a: Describe the tools and techniques used in financial analysis, including their uses and limitations.

LOS 27.b: Classify, calculate, and interpret activity, liquidity, solvency, probability, and valuation ratios.

LOS 27.c: Describe relationships among rations and evaluate a company using ratio analysis. (pg. 152)

LOS 27.d: Demonstrate the application of DuPont analysis of return on equity and calculate and interpret effects of changes in its components.

LOS 27.e: Calculate and interpret ratios used in equity analysis and credit analysis.

LOS 27.g: Describe how ratio analysis and other techniques can be used to model and forecast earnings.

Common-size statements are used to:

Normalize balance sheets and income statements and make it easier to compare performance across firms or for a single firm over time Quickly view certain financial ratios

Limitations of financial ratios:

Not useful when viewed in isolation Different accounting methods between firms Firms operate in different industries Ratios must be viewed relative to one another Hard to determine range of acceptable values

Describe the criteria of the different classes of business activities (operating activities, investing activities, and financing activities)

Operating activities: Activities undertaken in a firm's ordinary course of business, such as producing and selling goods and services. Investing activities: Buying or selling long-term assets Financing activities Issuing debt (borrowing money), redeeming debt (repaying money), issuing common stock, repurchasing common stock, or paying cash dividends

Category of accrual accounting in which the firm pays cash ahead of time for an anticipated expense:

Prepaid expense Cash (asset) decreases and prepaid expenses (asset) increases

Financial ratios can be used to:

Project earnings and future cash flow Evaluate a firm's flexibility Asses management's performance See changes within a firm and industry over time Compare the firm with its competitors

Examples of double-entry accounting: Purchase equipment for $10,000 cash

Property, plant, and equipment (asset) increase by $10,000 and cash (asset) decreases by $10,000

The role of financial reporting is to...

Provide a variety of users with useful information about a company's performance and financial position.

The IASB framework details the __________ characteristics of financial statements and specifies the required reporting elements. The framework also notes certain constraints and assumptions that are invloved in financial statement preparation.

Qualitative

Financial analysis techniques: (4)

Ratio Analysis Common-Size Analysis Graphical Analysis Regression Analysis

Ratios that compare a balance sheet account (such as receivables) with an income or cash flow item (such as sales), the balance sheet account value used will be the average of the beginning year account value and end-of-year account value If turnover ratios are based off quarterly statements rather than annual, the number of days in a quarter should be used rather than 365

There effect of all four cases of accrual accounting is to...

Recognize revenues or expenses in the appropriate period

Define: Journal entries

Record every transaction, showings which accounts are changed and by what amounts

Government agencies that enforce compliance with financial reporting standards:

Regulatory authorities

STUDY SESSION 7: UNDERSTANDING BALANCE SHEETS LOS 25.a: Describe the elements of the balance sheet: assets, liabilities, and equity. (pg. 80) a) The _____ is a financial statement that reports a firm's financial position at a point in time. b) The balance sheet consists of: c) _____ are resources controlled as a result of past transactions that are expected to provide future economic benefits. d) _____ are obligations as a result of past events that are expected to require an outflow of economic resources. e) _____ is the owner's residual residual interest in the assets after deducting the liabilities. f) A financial statement item should be recognized if a future economic benefit from the item (inflow or outflow) is _____ and the item's value or cost can be measured reliably.

STUDY SESSION 7: UNDERSTANDING BALANCE SHEETS LOS 25.a: Describe the elements of the balance sheet: assets, liabilities, and equity. (pg. 80) a) balance sheet (also called a statement of financial position or statement of financial condition) b) assets, liabilities, and equity c) assets d) liabilities e) equity (also known as stockholders' equity, shareholders' equity, or owner' equity. Analysts sometimes refer to equity as net assets) f) probable

STUDY SESSION 7: UNDERSTANDING CASH FLOW STATEMENTS LOS 26.a: Compare cash flows from operating, investing, and financing activities and classify cash flow items as relating to one of those three categories given a description of the items. (pg. 103) a) Since the income statement is based on the accrual method, net income may not represent cash generated from _____. b) The cash flow statement provides: (3) c) The cash flow statement provides information to assess a firm's: (3) d) An analyst can use the statement of cash flows to determine whether: (5) e) Items on the cash flow statement come from two sources: f) A firm's cash receipts and payments are classified on the cash flow statement as either: (3) g) Cash flow from _____ activities, sometimes referred to as "cash flow from operations", consists of the inflows and outflows of cash resulting from transactions that affect net income. h) Cash flow from _____ activities consists of the inflows and outflows of cash resulting from the acquisition or disposal of long-term assets and certain investments. i) Cash flow from _____ activities consists of the inflows and outflows of cash resulting from transactions that affect a firm's capital structure. GAAP CASH FLOW CLASSIFICATIONS j) Cash flow from operating activities (CFO) inflows (+) outflows (-) k) Cash flow from investing activities (CFI) inflows (+) outflows (-) l) Cash flow from financing activities (CFF) inflows (+) outflows (-) --------------------------------------------------------

STUDY SESSION 7: UNDERSTANDING CASH FLOW STATEMENTS LOS 26.a: Compare cash flows from operating, investing, and financing activities and classify cash flow items as relating to one of those three categories given a description of the items. (pg. 103) a) operations b)- information about a company's cash receipts and cash payments during an accounting period - Information about a company's operating, investing, and financing activities - An understanding of the impact of accrual accounting events on cash flows c) liquidity, solvency, financial flexibility d)-regular operations generate enough cash to sustain the business - enough cash is generated to pay off existing debts as they mature - a firm is likely to need additional financing - unexpected obligations can be met - a firm can take advantage of new business opportunities as they arise e) income statement items changes in balance sheet accounts f) operating activities investing activities financing activities g) cash flow from operating activities (CFO) h) cash flow from investing activities (CFI) i) cash flow from financing activities (CFF) GAAP CASH FLOW CLASSIFICATIONS j) Cash flow from operating activities (CFO) inflows (+) - cash collected from customers - interest and dividends received - sale proceeds from trading securities outflows (-) - cash paid to employees and suppliers - cash paid for other expenses - acquisition of trading securities - interest paid - taxes paid k) Cash flow from investing activities (CFI) inflows (+) - sale proceeds from fixed assets - sale proceeds from debt & equity investments - principle received from loans made to others outflows (-) - acquisition of fixed assets - acquisition of debt & equity investments - loans made to others l) Cash flow from financing activities (CFF) inflows (+) - principle amounts of debt issued - proceeds from issuing stock outflows (-) - principle paid on debt - payments to reacquire stock - dividends paid to shareholders --------------------------------------------------------

STUDY SESSION 7: UNDERSTANDING INCOME STATEMENTS LOS 24.a: Describe the components of the income statement and alternative presentation formats of that statement. (pg. 39) a) The income statement is sometimes referred to as b) Income statement equation: c) Net revenue equation d) Extended income statement equation e) The portion of equity ownership in a subsidiary not attributable to the parent company, who has a controlling interest (greater than 50% but less than 100%) and consolidates the subsidiary's financial results with its own f) A multi-step income statement provides a subtotal for _____, a single step income statement does not. g) Expenses on the income statement can be group by _____ or by _____. h) Net Income equation (single-step, multi-step) i) Gross profit is the amount that remains after the direct costs of producing a good or service are subtracted from revenue. Gross profit equation j) operating profit equation k) For financial firms, interest expense is usually considered a(n) _____. l) Earnings (also called bottom line) = m) The income statement shows an entity's: (4)

STUDY SESSION 7: UNDERSTANDING INCOME STATEMENTS LOS 24.a: Describe the components of the income statement and alternative presentation formats of that statement. (pg. 39) a) statement of operations, statement of earnings, P & L statement b) income = revenues - expenses c) net revenue = revenue - cost of sales d) income = revenues - ordinary expenses + other income - other expenses + gains - losses e) Noncontrolling interest (NCI, also known as minority interest or minority owner's interest) f) gross profit g) Expenses can be grouped on the income statement by the nature of the expense items or by their function (such as with expenses grouped into COGS) h) single step: net income = revenue - expenses multi-step: gross profit = revenue - COGS i) gross profit = revenue - COGS j) operating profit = gross Profit - operating expenses k) operating expense l) Earnings (or bottom line) = operating profit - interest expenses - income taxes m) Income statement shows: revenues, expenses, gains, losses during a reporting period

_____ analysis is based on specific scenarios (a specific set of outcomes for key variables) and will also yield a range of values for financial statement items. Examples include the loss of customers, the loss of a supply source, or a catastrophic event. If the list of events is mutually exclusive and exhaustive and the events can be assigned probabilities, the analyst can evaluate not only the range of outcomes but also standard statistical measures such as the mean and median value for various quantities of interest.

Scenario analysis

A restriction on the applicability of an auditor's report that may arise from the inability to obtain sufficient appropriate evidence about a component in the financial statements

Scope of limitation

MD&A (management's discussion and analysis) (also called) - management's commentary - management's report - operating and financial review

Section in a firm's annual report where management discusses a variety of issues, including the nature of the business, past performance, and future outlook. Analysts must be aware that some parts of managements commentary may be unaudited.

_____ analysis is based on "what if" questions such as "What will be the effect on net income if sales increase by 3% rather than the estimated 5%?"

Sensitivity analysis

_____ is computer-generated sensitivity or scenario analysis based on probability models for the factors that drive outcomes. Each event or possible outcome is assigned a probability. Multiple scenarios are then run using the probability factors assigned to the possible values of a variable.

Simulation

Define: General ledger

Sorts the entries in the general journal by account

Professional organizations of accountants and auditors (private sector organizations) that establish financial reporting standards:

Standard-setting bodies

If ROE is relatively low, at least one of the following must be true: (3)

The company: Has a poor profit margin Has poor asset turnover Is not using enough leverage

Examples of double-entry accounting: Buy inventory for $8,000 cash and sell it for $10,000 cash

The purchase decreases cash by $8,000 and increases inventory (asset) by $8,000 The sale increases cash by $10,000 and decreases inventory by $8,000 (so assets increase by $2,000) At the same time, sales (revenue account) increase by $10,000 and COGS (expense) increases by the $8,000 cost of inventory. The $2,000 difference is an increase in net income and, therefore, in retained earnings and owner's equity.

Under GAAP, firms can choose to report comprehensive income in the...

Under GAAP, firms can choose to report comprehensive income in the... statement of shareholders equity.

Category of accrual accounting in which the firm receives cash before it provides a good or service to customers:

Unearned revenue Cash increases and unearned revenue (liability) increases by the same amount When the firm finally provides the good or service, revenue increases and liability decreases (For example, a newspaper or magazine subscription is typically paid in advance. The publisher records the cash received and increases the unearned revenue (liability) account. The firm recognizes revenues and decreases the liability as it fulfills the subscription obligation.)

Which accruals involve cash changing hands first and the revenue or expense is recorded later?

Unearned revenue Prepaid expenses

Because of the increasing globalization of securities markets, IOSCO has a goal of...

Uniform financial regulations across countries.

LOS 26.i: Calculate and interpret free cash flow to the firm, free cash flow to equity, and performance and coverage cash flow ratios. (pg 120) a) _____ is a measure of cash that is available for discretionary purposes. It is the cash that is available once a firm has covered its capital expenditures. b) Two common measures of free cash flow are _____. c) Free cash flow to _____ is the cash available to all investors after expenditures (both debt and equity). d) FCFF = e) FCFF can be calculated from CFO as: FCFF = f) Free cash flow to _____ is the cash that would be available for distribution to common shareholders. g) FCFE = h) Cash flow ratios can be categorized as _____ ratios and _____ ratios. i) Performance ratios include: (5) j) Coverage ratios include: (6) k) PERFORMANCE RATIOS cash flow-to-revenue ratio = cash return-on-assets ratio = cash return-on-equity ratio = cash-to-income ratio = cash flow per share = l) COVERAGE RATIOS debt coverage ratio = interest coverage ratio = reinvestment ratio = debt payment ratio = dividend payment ratio = investing and financing ratio=

a) Cash flow b) FCFF: Free cash flow to the firm FCFE: Free cash flow to equity c) FCFF (Free cash flow to the firm) d) FCFF = net income + noncash charges (e.g., deprec. & amort.) + interest paid x (1 - tax rate) - net capital expenditures - working capital investment e) = CFO + interest paid x (1 - tax rate) - net capital expenditures f) FCFE (Free cash flow to equity) g) FCFE = CFO - net capital expenditures + (debt issued - debt repaid) i) Performance ratios Coverage ratios i) cash flow-to-revenue cash return-on-assets cash return-on-equity cash-to-income cash flow per share j) debt coverage interest coverage reinvestment debt payment dividend payment investing and financing k) = CFO / net revenue = CFO / average total assets = CFO / average total equity = CFO / operating income = (CFO - preferred dividends) / weighted avg. # of common shares l) = CFO / total debt = (CFO + int. paid + taxes paid) / int. paid = CFO / cash paid for long term assets = CFO / cash long term debt repayment = CFO / dividends paid = CFO / cash flow from investing/financing act.

a) U.S. firms are required to file this form quarterly, with updated financial statements (unlike Form 10-K, these statements do not have to be audited) and disclosures about certain events such as significant legal proceedings or changes in accounting policy. b) Non-U.S. companies are typically required to file the equivalent form semi-annually

a) Form 10-Q b) Form 6-K

a) In the United States, the FASB sets forth the: b) Outside of the United States, the IASB establishes...

a) Generally Accepted Accounting Principles (GAAP) b) (IFRS) International Financial Reporting Standards

a) Financial statements are __________ if the information in them can influence users' economic decisions or affect users' evaluations of past events or forecasts of future events b) Information should have both ___________ value, _________ value, or both. c) ________ is an aspect of this qualitative characteristic

a) Relevant b) predictive value and confirmatory value (confirm prior expectations) c) Materiality

a) Regulatory authorities in the U.S. include: b) Regulatory authorities in the United Kingdom include: c) Many national regulatory authorities belong to the:

a) SEC b) Financial Services Authority (FSA) c) International Organization of Securities Commissions (IOSCO)

a) Basis of determining fair market value (FMV), transactions between independent, unrelated, and well informed parties looking out for their individual interests. b) Basis of determining fair market value (FMV), a transactions involving family members, and parent companies and subsidiaries, are deemed arm-in-arm dealings.

a) arm's-length transaction. b) arm-in-arm dealing/transaction

a) Companies that prepare financial statements under IFRS or GAAP must disclose their accounting policies and estimates in the: b) Significant policies and estimates that require management judgement are also addressed in:

a) footnotes b) Managements Discussions and Analysis (managment's commentary) (Another disclosure that is required for public companies is the likely impact of implementing recently issued accounting standards and whether or not the standards will apply or affect financial statements materially)

a) Define: audit b) The objective of an audit is to...

a) independent review of an entity's financial statements b) enable the auditor to provide an opinion on the fairness and liability of the financial statements

LOS 24.b: Describe general principle of revenue recognition and accrual accounting, specific revenue recognition application (including accounting for long-term contracts, installment sales, barter transactions, gross and net reporting of revenue), and implications of revenue recognition principles for financial analysis. (pg. 41) LOS 24.c: Calculate revenue given information that might influence the choice of revenue recognition method. (pg 41) a) Under the accrual method of accounting, revenue is recognized when _____ and expenses are recognized when _____. Consequently, firms can manipulate net income by recognizing revenue earlier or later or by delaying or accelerating the recognition of expenses. b) According to IASB (International Accounting Standards Board), revenue is recognized from the sale of goods when: (5) c) According to IASB (International Accounting Standards Board), revenue is recognized from rendering services when: (4) d) According to FASB (Financial Accounting Standards Board), revenue is recognized in the income statement when: e) The SEC provides additional guidance by listing four criteria to determine whether revenue should be recognized: f) In cases involving service contracts or license agreements, firms may recognize revenue... g) The percentage-of-completion method and completed-contract method are used when: h) When the outcome of a long-term contract can be reliably estimated, the _____ method is used under both IFRS and GAAP. Revenue, expenses, and therefore profit, are recognized as the work is performed. Percentage of completion equation: i) Under IFRS, if 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. Under GAAP, the _____ method is used when the outcome of the project cannot be reasonably estimated. Revenue, expenses, and profits are recognized only when the contract is complete. j) If a loss is expected, the loss must be recognized immediately under both _____ and _____. k) The _____ method is more aggressive because revenue is reported sooner. It is also more subjective because it involves cost estimates. However, this method provides smoother earnings and results in better matching of revenues and expenses over time. l) Cash flows are _____ under the percentage-of-completion method and completed-contract method. m) A(n) _____ occurs when a firm finances a sale and payments are expected to be received over an extended period. n) Under GAAP, if collectibility is certain, revenue is recognized... o) If collectibility cannot be reasonably estimated, the _____ method is used. Under this method, profit is recognized as cash is collected. Profit is equal to the cash collected during the period multiplied by the total expected profit as a % of sales. This method is more aggressive than the cost recovery method. p) If collectibility is highly uncertain, the _____ method is used. Under this method, profit is recognized only when cash collected exceeds costs incurred. q) Both the installment method and cost recovery method are used only for _____. r) When two parties exchange goods or services without cash payments, it is called a _____ transaction. s) The sale of goods to one party with the simultaneous purchase of almost identical goods from the same party (example: in the late 1990s, several internet companies increased their revenue significantly by "buying" equal values of advertising space on each others' websites). t) The underlying issue with these transactions is whether or not _____. u) According to GAAP, revenue from a barter transaction can be recognized at its _____ value only if its value can be estimated from historical data on similar non-barter transactions. Otherwise, revenue is recorded at the _____ of the asset surrendered. v) According to IFRS, revenue from barter transactions must be based on the _____ value of revenue from similar non barter transactions with unrelated parties. w) _____ revenue reporting shows sales revenue and cost of of goods sold separately. x) _____ revenue reporting shows only the difference between sales and COGS is reported. This method of revenue reporting should be used when the firm is acting as a selling agent and does not stock inventory, take credit risk, or have control over supplier and price. y) While profit is the same under both methods of reporting, sales (revenues) are higher using _____. z ) The following criteria must be met in order to use gross revenue reporting under GAAP: (4) aa) Firm's disclose their revenue recognition policies in the: ab) Users of financial information must consider two points when analyzing a firm's revenue:

a) revenue is recognized when earned, expenses are recognized when incurred b) 1. Risk or reward of ownership is transferred 2. There is no continuing control or management over the goods sold 3. Revenue can be reliably measured 4. There is a probable flow of economic benefits 5. The cost can be reliably measured c) 1. Revenue can be reliably measured 2. There is a probable flow of economic benefits 3. The stage of completion can be measured 4. The cost incurred and cost of completion can be reliably measured d) Realized or realizable, and, earned e) 1. There is evidence of an arrangement between the buyer and the 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 f) equally over the term of the contract or agreement g) Contracts extend beyond one accounting period (typically construction projects) h) percentage-of-completion method = (total cost incurred to date / total expected cost of project) i) completed-contract method j) IFRS and GAAP k) percentage-of-completion method l) similar m) installment sale n) at the time of the sale using normal revenue recognition criteria o) installment sales method p) cost recovery method q) real-estate sales r) barter transaction (also called non-monetary exchange) s) Round-trip transaction t) revenue should be recognized. (Round-trip transactions have no economic benefit to either party and inflate revenue for both parties) u) fair value, carrying value v) fair value w) Gross revenue reporting x) Net revenue reporting y) Gross revenue reporting z) - Be the primary obligor under the contract - Bear the inventory risk and credit risk - Be able to choose its supplier - Have reasonable latitude to establish price aa) footnotes ab) 1. How conservative are the firm's revenue recognition policies (recognizing revenue sooner rather than later is more aggressive) 2. The extent to which the firm's policies rely on judgement and estimates

If an auditor believes the financial statements were not presented fairly or are materially nonconforming with accounting standards, they can issue a(n)...

adverse opinion

The DuPont system (decomposing ROE) can be used to _____.

analyze ROE. The DuPont method breaks down (decomposes) ROE into its separate components. There is an original 3 part approach and an extended 5 step approach.

Expanded accounting equation: The expanded accounting equation can also be stated as:

assets = liabilities + contributed capital + ending retained earnings assets = liabilities + contributed capital + beginning retained earnings + revenue - expenses - dividends

Liquidity ratios are based on _____ and measure _____. Liquidity ratios include: (5)

based on cash flows, measure the firm's ability to pay its short-term liabilities Current ratio Quick ratio Cash ratio Defensive interval ratio Cash conversion cycle

The proportion of a firm's net income that is retained to fund growth is an important determinant of the firm's sustainable growth rate. Sustainable growth rate measures: sustainable growth rate =

how fast a firm can grow without issuing new shares while holding leverage constant. = RR x ROE

Operating profitability ratios show _____. Operating profitability ratios include:

how good management is at turning their efforts into profits. Gross profit margin Operating profit margin Pretax margin

Regression analysis can be used to:

identify relationships between variables. These results are often used for forecasting (e.g., finding the relationship between GDP and sales to prepare a forecast)

The processes by which a company ensures that it presents accurate financial statements:

internal controls (For publicly traded firms in the U.S., during an audit, the auditor must express an opinion on the firm's internal controls. The auditor can provide this opinion separately or as the fourth element of the standard opinion)

Horizontal common-size statements present each item as a % of _____ (normally the first year)

its value (1) in a base year

Ratio analysis can be used in preparing _____ financial statement items for one or more future periods.

pro forma financial statements

earnings after taxes (EAT) =

= EBT - tax

Pre-tax margin =

= EBT/ revenue

Most national authorities belong to the:

(IOSCO) International Organization of Securities Commissions

inventory turnover =

= (COGS / average inventory) desirable to have a receivables turnover close to the norm

operating profit (EBIT) = Operating profit and EBIT are used interchangeably

= gross profit - operating expenses "operating expenses" consists of all expenses before interest and taxes but includes depreciation and amortization

gross profit margin =

= gross profit / revenue

LOS 25.e: Describe different types of assets and liabilities and the measurement bases of each. (pg. 82) CURRENT ASSETS a) _____ assets include cash and other assets that will be converted into cash or used up within one year or in the operating cycle, whichever is greater. CASH AND CASH EQUIVALENTS b) _____ are short-term, highly liquid investments that are readily convertible to cash and near enough to maturity that interest rate risk is insignificant. c) Cash and cash equivalents are considered _____ assets. d) Generally, financial assets are reported on the balance sheet at _____ cost or _____ value. For cash equivalents, either measurement base should result in about the same value. e) Examples of cash equivalents include: (3) MARKETABLE SECURITIES f) _____ are financial assets that are traded in a public market and whose value can be readily determined. Details of the investment is are disclosed in the footnotes. g) Examples of marketable securities include: (4) ACCOUNTS RECEIVABLE h) _____ (also known as trade receivables) are are financial assets that represent amounts owed to the firm by customers for goods or services sold on credit. i) Accounts receivable are reported at _____ value, which is based on estimated _____. j) Bad debt expense increases the allowance for doubtful accounts, which is a _____ account. k) A contra account is used to reduce the value of its _____ account. l) accounts receivable at net realizable value (the amount the firm expects to collect) = m) When receivables are "written off" (removed from the balance sheet because they are uncollectible), both _____ and the _____ account are reduced. n) Firms are required to disclose significant concentrations of credit risk, including: (3) o) Analyzing receivables relative to sales can reveal _____ problems. p) The allowance for doubtful accounts should be considered relative to the level and growth rate of _____. q) Firms can underestimate bad debt expense, thereby increasing reported _____. INVENTORIES r) _____ are goods held for sale to customers or used in manufacture of goods to be sold. s) Manufacturing firms separately report inventories of: (3) t) The costs included in inventory include _____ cost, _____ cost, and other costs necessary to bring the inventory to its present location and condition. u) Costs that are excluded from inventory include: (3) v) _____ costing and the _____ method are used by some firms to measure inventory costs. w) _____ costing involves assigning predetermined amounts of materials, labor, and overhead to goods purchased. It is often used by manufacturing firms. x) Firms that use the _____ method measure inventory at retail prices and then subtract gross profit in order to determine cost. y) Standard costing and the retail method are both _____ assumptions. z) FIFO and average cost are both permitted under _____ and _____ reporting standards. aa) LIFO is permitted under _____, but prohibited under _____. ab) Under IFRS, inventories are reported at the lower of _____ or _____. Net realizable value is equal to _____. ac) Under GAAP, inventories are reported at the lower of _____ or _____. Market is usually equal to _____ cost, however, market cannot be greater than net realizable value or less than net realizable value less a normal profit margin. ad) If net realizable value (IFRS) or market (GAAP) is less than the inventory's carrying value, the inventory is written down and _____. If there is a subsequent recovery in value, the inventory can be written back up under _____. No write up is allowed under _____, the firm simply reports higher profit when the inventory is sold. OTHER CURRENT ASSETS ae) Other current assets are a firm's assets that can be convertible into cash within one business cycle (one year) that may not be material if shown separately, so the items are combined into a single amount. . Other current assets include: (4) af) Prepaid expense are _____ costs that have been paid in advance. As the costs are actually incurred, an expense is recognized in the income statement and prepaid expenses (an asset) _____. ag) If a firm makes an annual rent payment of $400,000 at the beginning of the year, an asset (cash) decreases and another asset (prepaid rent) increase by the same amount of the payment. At the end of three months, one-quarter of the prepaid rent has been used. At this point, the firm will recognize $100,000 of rent expense in its income statement, and reduce assets (prepaid rent) by $100,000. ------------------------------------------------------------------ ah) The result of the temporary differences between financial reporting income and tax reporting income: ai) Deferred tax assets are created when: aj) Deffered tax asset can occur when expenses or losses are recognized in the income statement _____ they are tax deductible, or whenever revenue or gains are taxable before they are recognized in the income statement. ak) Deferred tax assets can also be created from _____. CURRENT LIABILITIES al) Current liabilities are obligations that will be satisfied within one year or operating cycle, whichever is _____. ACCOUNTS PAYABLE am) The amounts the firm owes to suppliers for goods or services purchased on credit are called _____. an) Analyzing payables relative to purchases can signal _____ problems with suppliers. NOTES PAYABLE AND CURRENT PORTING OF LONG-TERM DEBT ao) Notes payable are obligations in the form of promissory notes notes owed to _____ and _____. ap) Notes payable can also be reported as non-current liabilities if their maturity is greater than______. aq) The current portion of long-term debt is the principle portion of debt due within _____ or _____. ACCRUED LIABILITIES ar) _____ (accrued expenses) are expenses that have been recognized on the income statement but are not yet contractually due. as) Accrued liabilities result from the accrual method of accounting, under which expenses are recognized _____. For example, consider a firm that is required to make annual year-end interest payments of $100,000 on an outstanding bank loan. At the end of March, the firm wold recognize $_____ of the total interest expense in its income statement, and an accrued liability would be increased by the same amount, even though the liability is not actually due until the end of the year. at) Taxes payable: au) Other examples of accrued liabilities include: (3) UNEARNED REVENUE av) Unearned revenue (also known as unearned income, deferred revenue, or referred income) is: aw) Unearned revenue example: A magazine publisher receives subscription payments in advance of delivery. When payment is received, both assets (cash) and liabilities (unearned revenue) _____ by the same amount. As magazines are delivered, the publisher recognizes revenue in the income statement and reduces the liability. ax) Unearned revenue may be a sign of future _____ as the revenue will ultimately be recognized in the income statement. NON-CURRENT ASSETS ay) _____ are tangible assets used in the production of goods and services. az) PP&E includes: ba) Under IFRS, PP&E can be reported using the _____ model or the _____ model. bb) Under GAAP, only the _____ model is permitted for reporting PP&E. bc) Under the cost model, PP&E other than land is reported at amortized cost. Amortized cost = bd) Land is not depreciated because it has a(n) _____ life. be) _____ cost includes the purchase price plus any cost necessary to get the asset ready for use, such as delivery and installation costs. bf) Also under the cost model, PP&E must be tested for _____. bg) An asset is impaired if its carrying value exceeds the _____ amount. bh) Under IFRS, the recoverable amount of an asset is the greater of _____ value less any selling costs, or the assets value in use. bi) Value in use is the present value of the asset's future cash flow stream. If impaired, the asset is written down to its recoverable amount and a loss is recognized in the income statement. Loss recoveries are allowed under _____ but not under _____. bj) Under the revaluation model, PP&E is reported at the fair value less any _____. bk) Changes in fair value are reflected in _____ and may be recognized in the income statement in certain circumstances. INVESTMENT PROPERTY: bl) Under IFRS, investment property includes assets that _____ or _____. bm) _____ does not have a specific definition of investment property. bn) Under IFRS, investment property can be either reported at _____ value (just the PP&E) or _____ value. bo) Under the fair value model, any change in fair value is recognized in the _____. INTANGIBLE ASSETS: bp) _____ assets are non-monetary assets that lack physical substance. Securities are not considered intangible assets. Intangible assets are either identifiable or unidentifiable. bq) Identifiable intangible assets can be acquired separately or are the result of _____ br) Examples of identifiable intangibles are: bs) Unidentifiable intangible assets cannot be acquired separately and may have an unlimited life. The best example of an unidentifiable intangible asset bt) Under IFRS, identifiable intangibles that are purchased can be reported on the balance sheet using the _____ or _____, although the revaluation model can only be used if an active market for the intangible assets assets exists. Under GAAP, only the _____ model is allowed. bu) Under GAAP, intangible assets that are created internally (such as research and development costs) must be _____. bx) Under IFRS, firms must identify the research stage and development stage. During the research stage, firms must _____. During the development stage, firms can _____ bx) Finite lived intangible assets are _____ over their useful life and tested for impairment in the same way as PP&E. The amortization method and useful life estimates are reviewed at least annually. by) Intangible assets with infinite lives are not amortized, but are tested for _____ at least annually. bz) Under IFRS and GAAP, all of the following should be expensed as incurred: (5) ca) _____ is the excess of purchase price over the fair value of the identifiable net assets (assets - liabilities) acquired in a business transaction. cb) If the purchase price of an acquisition is less than the fair value of the identifiable net assets, the difference is immediately recognized as a _____ in the acquirer's income statement. cc) Goodwill is only acquired in a _____. cd) Internally generated goodwill is _____ as incurred. ce) Goodwill is not amortized but must be tested for _____ at least annually. cf) If goodwill is found to be impaired after tested, goodwill is reduced and a _____ is recognized in the income statement. cg) As long as goodwill is not impaired, it can remain on the _____ indefinitely. ch) Since goodwill is not amortized, firms can manipulate net income by allocating more of the acquisition price to goodwill and less to the identifiable assets. The result is less _____ and _____ expenses, resulting in a higher net income. ci) Accounting goodwill should not be confused with economic goodwill. Economic goodwill derives from the expected future performance of a firm. Accounting goodwill is the result of _____. cj) When computing ratios, analysts should eliminated goodwill from the _____ and goodwill impairment charges from the _____ for compatibility. ck) Financial _____ are contracts that give rise to both a financial asset of one entity and a financial liability or equity instrument of another entity. They can be found on the asset side and liability side of the balance sheet. cl) Financial assets include: (5) cm) Financial instruments are measured at: (3) cn) Financial assets measured at amortized cost are known as _____ securities. co) Held-to-maturity securities are _____ securities acquired with the intent to be held to maturity. Amortized cost = issue price - principle payments +(-) amortized discount (premium) - impairment losses. Changes in market value are ignored. cp) Financial assets measured at fair value (also known as mark-to-market accounting) include: (3) cq) _____ securities (also known as held-for-trading securities) are debt and equity securities acquired with the intent to profit over the near-term. cr) Trading securities are reported on the balance sheet at _____ value. Unrealized gains or losses (changes in market value before the securities are sold) are recognized in the income statement. Derivate instruments are treated the same as trading securities. cs) Unrealized gains and losses are also known as _____ gains and losses. ct) _____ securities are debt and equity securities that are not expected to be held to maturity or traded in the near term. cu) Available-for-sale securities are reported on the balance sheet at _____ value. cv) Unrealized gains and losses for available-for-sale securities are reported in _____ as a part of shareholder's equity. cw) For all 3 classifications of securities (held-to-maturity securities, trading securities, and available-for-sale securities) dividends, interest income, and realized gains/losses are recognized on the _____. cx) Unlisted equity investments and loans and receivables are reported at _____ cost. cy) Held-to-maturity securities are reported at _____ cost. cz) Trading securities, available-for-sale securities, and derivatives are reported at _____ value. NON-CURRENT LIABILITIES da) Non-current liabilities include: (4) db) If financial liabilities are not issued at face amount, they are usually reported on the balance sheet at _____ cost. dc) Amortized cost = dd) In some cases, financial liabilities are reported at _____ value. Examples include held-for-trading liabilities (such as a short stock position), derivative liabilities, and non-derivative liabilities with exposures hedged by derivatives. de) _____ are created when the amount of income tax expense recognized in the income statement is greater than taxes payable. df) Deferred tax liabilities can occur when expenses or losses are tax deductible before they are recognized in the income statement. A good example is when a firm uses the _____ depreciation method for tax purposes and the straight-line depreciation method for financial reporting. dg) Deferred tax liabilities are also created when revenues or gains are recognized in the income statement before they are taxable. For example, firms often recognize the earnings of their subsidiaries before any _____ are made dh) Eventually, deferred tax liabilities will reverse when _____.

LOS 25.e: Describe different types of assets and liabilities and the measurement bases of each. (pg. 82) CURRENT ASSETS a) current assets CASH AND CASH EQUIVALENTS b) cash and cash equivalents c) financial assets d) amortized cost or fair value e) Treasury bills, commercial paper, money market funds MARKETABLE SECURITIES f) marketable securities g) Treasury bills, notes, bonds, equity securities ACCOUNTS RECEIVABLE h) accounts receivable i) net realizable value, estimated bad debt expense j) contra-asset account k) controlling account l) accounts receivable at net realizable value = gross receivables - allowance for doubtful accounts m) gross receivables and the allowance account are reduced n) customer, geographic, and industry concentrations o) collection problems p) sales q) earnings INVENTORIES r) inventory s) raw material, work-in-process, and finished goods t) purchase cost and conversion cost u) Selling cost, abnormal waste, including material, labor, administrative, and manufacturing overhead. Storage costs are excluded unless they are necessary as a part of the production process. v) Standard costing and the retail method w) Standard costing x) retail method y) cost flow assumptions (also known as cost flow methods) z) GAAP and IFRS aa) LIFO is permitted under GAAP, but prohibited under IFRS ab) lower of cost or net realizable value. Net realizable value = selling price - completion costs and disposal (selling) costs ac) lower of cost or market. Market is usually equal to replacement cost, however, market cannot be greater than net realizable value or less than net realizable value less a normal profit margin ad) a loss is recognized in the income statement. If there is a subsequent recovery in value, the inventory can be written back up under IFRS. No write up is allowed under GAAP, the firm simply reports higher profit when the inventory is sold. OTHER CURRENT ASSETS ae) cash, securities, receivables, inventory and prepaid assets (deferred tax assets as well) af) Prepaid expense are operating costs that have been paid in advance. As the costs are actually incurred, an expense is recognized in the income statement and prepaid expenses (an asset) decrease. ag) If a firm makes an annual rent payment of $400,000 at the beginning of the year, an asset (cash) decreases and another asset (prepaid rent) increase by the same amount of the payment. At the end of three months, one-quarter of the prepaid rent has been used. At this point, the firm will recognize $100,000 of rent expense in its income statement, and reduce assets (prepaid rent) by $100,000. -------------------------------------------- ah) deferred taxes ai) Deferred tax assets are created when the amount of taxes payable exceeds the amount of income tax expense recognized in the income statement (e.g., the business has overpaid taxes or taxes paid in advance on its balance sheet. These taxes are eventually returned to the business in the form of tax relief, and the over-payment is, therefore, an asset for the company.) aj) Deferred tax asset can occur when expenses or losses are recognized in the income statement before they are tax deductible, or whenever revenue or gains are taxable before they are recognized in the income statement. ak) Deferred tax assets can also be created from unused tax losses. CURRENT LIABILITIES al) greater ACCOUNTS PAYABLE am) accounts payable (also called trades payable) an) credit NOTES PAYABLE AND CURRENT PORTING OF LONG-TERM DEBT ao) creditors and lenders ap) one year. aq) one year or operating cycler, whichever is greater. ACCRUED LIABILITIES ar) Accrued liabilities as) Accrued liabilities result from the accrual method of accounting, under which expenses are recognized as incurred. at) Taxes payable: current taxes that have been recognized in the income statement but have not yet been paid. au) interest payable, wages payable, and accrued warranty expense. UNEARNED REVENUE av) Unearned revenue is cash collected in advance of providing goods and services aw) Unearned revenue example: A magazine publisher receives subscription payments in advance of delivery. When payment is received, both assets (cash) and liabilities (unearned revenue) increase by the same amount. ax) Unearned revenue may be a sign of future ________ as the revenue will ultimately be recognized in the income statement. NON-CURRENT ASSETS ay) PP&E az) land, buildings, machinery, equipment, furniture, and natural resources ba) Under IFRS, PP&E can be reported using the cost model or the revaluation model bb) Under GAAP, only the cost model is permitted for reporting PP&E. bc) Amortized cost = (historical cost - accumulated depreciation, amortized, depletion, and impairment losses.) bd) indefinite be) Historical cost = purchase price plus any cost necessary to get the asset ready for use, such as delivery and installation costs bf) impairment bg) recoverable amount bh) Under IFRS, the recoverable amount of an asset is the greater of fair value less any selling costs, or the assets value in use. bi) allowed under IFRS but not under GAAP. bj) accumulated depreciation bk) shareholder's equity INVESTMENT PROPERTY: bl) generate rental income or capital appreciation. bm) GAAP bn) amortized cost (just the PP&E) or fair value. bo) income statement. INTANGIBLE ASSETS: bp) Intangible assets bq) rights or privileges conveyed to the owner. br) patents, trademarks, copyrights bs) goodwill bt) IFRS: cost model or revaluation model GAAP: cost model bu) expensed as incurred bx) research stage: expense as incurred development stage: capitalize costs as incurred. bx) amortized by) impairment bz) start-up and training costs administration overhead advertising and promotion costs relocation and reorganization costs termination costs ca) Goodwill cb) gain cc) purchase acquisition cd) expensed ce) impairment cf) loss (the impairment loss does not affect cash flow) cg) balance sheet ch) less depreciation and amortization expenses ci) past acquisitions cj) balance sheet, income statement ck) financial instruments cl) stocks, bonds, derivatives, loans, receivables cm) historical cost, amortized cost, or fair value cn) held-to-maturity securities co) debt securities cp) trading securities, available-for-sale securities, derivatives cq) Trading securities cr) fair value cs) holding period gains and losses. ct) available-for-sale securities cu) fair value cv) other comprehensive income cw) income statement cx) historical cost cy) amortized cost cz) fair value NON-CURRENT LIABILITIES da) bank loans, notes payable, bonds payable, derivatives db) amortized cost dc) issue price - principle payments +(-) amortized discount (premium) dd) fair value de) deferred tax liabilities df) accelerated depreciation method for tax purposes, straight-line depreciation method for financial reporting dg) distributions (dividend) dh) the taxes are paid

Vertical common-size income statements are taken as a % of _____.

sales (revenue)

The ideas on which the IASB bases its standards are expressed in the ________ , which the organization adopted in 2010

"Conceptual Framework of Financial Reporting"

working capital turnover = (how effectively a company is using its working capital)

= (revenue / avg. working capital)

Accruals fall into four categories:

1) Unearned revenue 2) Accrued revenue 3) Prepaid expenses 4) Accrued expenses

A measure that includes both taxes and interest in the numerator is operating ROA. operating ROA =

= EBIT / average total assets

Describe the flow of information in an accounting system; Information flows through an accounting system in four steps:

1. Journal entries record every transaction, showing which accounts are changed and by what amount. A listing of journal entries in order of their dates is called the general journal. 2. The general ledger sorts journal entries in the general journal by account. 3. At the end of the accounting period, an initial trial balance is prepared that shows the balances in each account. If adjusting entries are needed, they will be recorded and reflected in an adjusted trial balance. 4. The account balances from the adjusted trial balance journal entries are presented in the financial statements.

The three objectives of financial market regulation according to IOSCO are:

1. Protect investors 2. Ensure the fairness, efficiency, and transparency of markets 3. Reduce systematic risk

A business segment is a portion of a company that accounts for more than _____% of the company's revenues or assets, and is distinguishable from the company's other lines of business in terms of the risk and return characteristics of the segment. Geographic segments are also identified when they meet the size criterion above and the geographical unit has a business environment that is different from other segments of the business.

10%

ROTC (return on total capital) =

= EBIT / average total capital Total capital includes short-term debt, long-term debt, preferred equity, and common equity. Analysts should be concerned if ROTC is too low.

operating profit margin =

= EBIT / revenue

days of inventory on hand = (# of days of inventory)

= (365 / inventory turnover) desirable to have a receivables turnover close to the norm

number of days of payables = (avg. amount of time it takes the company to pay its bills)

= (365 / payables turnover ratio)

days of sale outstanding = (avg. number of days it takes customers to pay their bills)

= (365 / receivables turnover) desirable to have a receivables turnover close to the norm

fixed charge coverage ratio =

= (EBIT + lease payments) / (interest payments + lease payments) The fixed charge coverage ratio is the more meaningful measure for companies that lease a large portion of their assets (e.g., airlines)

interest coverage ratio =

= (EBIT / interest payments) A low interest coverage ratio means a firm will have more difficulty meeting its debt payments

receivable turnovers =

= (annual sales / average receivables) desirable to have a receivables turnover close to the norm

financial leverage =

= (average total assets / average total equity)

defensive interval ratio =

= (cash + marketable securities + receivables) / avg. daily expenditures Indicates the number of days of average cash expenditures a firm can pay with its current liquid assets. Relevant expenditures include cash expenses for COGS, SG&A, and R&D.

quick ratio =

= (cash + marketable securities + receivables) / current liabilities quick ratio excludes inventory

cash ratio =

= (cash + marketable securities) / current liabilities cash ratio is the most conservative liquidity measure higher cash ratios mean firms are more likely to pay short-term bills as they come due

ROE =

= net income / average total equity Analysts should be concerned if ROE is too low.

gross profits = Gross profits can be increased by _____ or _____.

= net sales - COGS raising prices or reducing costs

An item should be recognized in its financial statement element if a future economic benefit from the item (inflow or outflow) is probable and the item's value or cost can be measured reliably

An item should be recognized in its financial statement element if...

balance sheet elements: (3)

Assets (resources controlled by the firm) Liabilities (amounts owed to lenders and other creditors) Owners' Equity (residual interest in the net assets of an entity that remains after deducting its liabilities)

Fundamental (Basic) accounting equation:

Assets = Liabilities + Owners' Equity

Registration statement filed prior to the sale of new securities to the public. The registration includes audited financial statements, risk assessment, underwriter identification, and the estimated amount and use of the offering proceeds.

Form S-1

Owners equity consists of:

Capital contributed by the firm's owners and the cumulative earnings it has retained

Examples of double-entry accounting: Buy office supplies for $100 cash

Cash decreases by $100 and Supply expense increases by $100 An expense reduces retained earnings, so owner's equity decreases by $100

Accounts used for entries that offset some part of the value of another: (Example: Equipment is typically valued on the balance sheet at acquisition cost (historical cost), and the estimated decrease in its value overtime is recorded into a ____________ account titled "accumulated depreciation".)

Contra account

In assessing a company's ability to service and repay its debt, analysts use _____, _____, and _____ ratios. Ratios have been used to predict bankruptcies. Altman (2000) developed a Z-score that is useful in predicting bankruptcies. (a low score indicates high probabilities of failure)

Coverage ratios (calculated with EBIT or EBITDA) Return on capital (ROC) Debt-to-assets Ratios have been used to predict bankruptcies. Altman (2000) developed a Z-score that is useful in predicting bankruptcies. (a low score indicates high probabilities of failure)

Solvency ratios that show a firm's reliance on debt as a source of financing include:

Debt-to-equity ratio Debt-to-capital ratio Debt-to-assets ratio Financial leverage ratio (leverage ratio)

Solvency ratios include various debt and coverage ratios. Debt ratios are based on the _____. (financial statement) Coverage ratios are based on the _____. (financial statement)

Debt ratios are based on the balance sheet Coverage ratios are based on the income statement

This topic review deals with financial analysis for: a) internal users b) external users

External users (Management performs financial analysis everyday to make decisions. However, the may rely on internal financial information that is presented in a different format or cannot be accessed by external users)

Statement of Comprehensive Income:

Financial statement that reports all changes in equity except for shareholder transactions (e.g. issuing stock, repurchasing stock, and paying dividends)

The original DuPont system breaks down ROE in 3 components that show: DuPont system steps:

Impact of leverage Profit margins Turnover on shareholder returns Step 1: Start with ROE ROE = net income / average equity Step 2: Average or year end values for equity can be used. Multiply ROE by revenue/revenue = (net income/revenue) x (revenue/avg. equity) = (net profit margin) x (equity turnover) Step 3: Multiply by assets/assets and rearrange terms = (net income / revenue) x (revenue / avg. total assets) x (avg. total assets / equity) Therefore, ROE = (net profit margin) x (asset turnover) x (leverage ratio)

Global convergence of accounting standards

In most major countries that have not gfully adopted IFRS, accounting standard setters are attempting to converge their standards with IFRS. Many aspects of U.S. GAAP and IFRS, for example, have converged over the past decade, and the SEC no longer requires IFRS reporting firms to reconcile their financial statements to U.S. GAAP.

The two primary standard-setting bodies are:

In the U.S. - Financial Accounting Standards Board (FASB) International - International Accounting Standards Board (IASB)

LOS 27.f: Explain the requirements for segment reporting and calculate and interpret segment ratios.

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

general journal

Examples of double-entry accounting: Borrow $10,000 to purchase equipment

PP&E increases by $10,000 and notes payable (liability) increases by $10,000

Graphical analysis shows a graphic presentation of changes in financial statement items year-over-year. Types of graphs used include: (2)

Stacked column (bar) graph Line graph

a) Securities and Exchange Commission (SEC) filings are available from... b) Forms that companies file with the SEC: (3)

a) EDGAR (Electronic Data Gathering, Analysis, Retrieval System, www.sec.gov) b) - Form 8-K (reports events such as acquisitions and disposals of major assets or changes in its management or corporate governance) - Form 10-K (annual financial statements) - Form 10-Q (quarterly financial statements) - Proxy statements

a) 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. Information required in this form is similar to that which a firm typically provides in its annual report to shareholders. However, a firm's annual report is not a subsitute for this required form. b) Equivalent SEC form for Canadian issuers in the U.S. c) Equivalent SEC forms for other foreign issuers in the U.S.

a) Form 10-K b) Form 40-F c) Form 20-F

a) Accruals require an accounting entry when... b) As the exchange is completed, how many offsetting entries are required?

a) the earliest event occurs (paying or receiving cash, providing a good or service, or incurring an expense) b) One or more offsetting entries is required as the exchange is completed

Two important underlying assumptions of financial statements are:

accrual accounting (financial statements should reflect transactions at the time they actually occur, not when the cash is paid) going concern (assumes the company will continue to exist for the foreseeable future)

Fundamental/Basic accounting equation:

assets = liabilities + owner's equity

Diluted EPS is a "what if" value. It is calculated to be the lowest possible EPS if all convertible securities are actually converted into common stock. Potentially dilutive securities include:

convertible debt convertible preferred options warrants

If the auditor is unable to express an opinion (e.g., in the case of a scope limitation), they issue a...

disclaimer of opinion

Total dividends on a firm-wide basis are referred to as _____.

dividends declared

Keeping the accounting equation in balance requires:

double-entry accounting (a transaction has to be recorded in at least two accounts) (example: An increase in an asset account must be balanced by a decrease in another asset account, or by an increase in a liability or owner's equity account)

Information that is _________ is complete, nuetral (unbiased), and free from error

faithfully representative

Banks are subject to minimum reserve requirements. The ratio of the bank's liquid assets to certain liabilities is called the _____.

liquid asset requirement

Who in the company is responsible for internal controls?

management

The amounts at which items are reported in the financial statement elements depend on their...

measurement base

Profitability ratios measure _____. Profitability ratios include: (9)

overall performance of a firm relative to revenues, assets, equity, and capital. Net profit margin Gross profit margin Operating profit margin Pre-tax margin ROA Operating ROA ROTC ROE ROCE

Dividends are declared on a _____ basis.

per-common-share basis

To estimate the sustainable growth rate for a firm, the rate of return on resources is measured as the ROE and the portion of earnings reinvested is known as the _____ rate.

retention rate (RR)

Three methods of examine the variability of financial outcomes around point estimates are:

sensitivity analysis scenario analysis simulation

"Net income per employee" and "sales per employee" are used in the analysis and valuation of _____ and _____ companies.

service and consulting companies

Solvency ratios measure _____. Solvency ratios include: (6)

the firm's ability to pay its long-term liabilities

Who is responsible for seeing that the financial statements conform to the applicable accounting standards?

the independent certified public accounting firm employed by the firm's board of directors

Vertical common-size balance sheets are taken as a % of _____.

total assets

Indicates that an auditor believes the financial statements are free from material omissions and errors

unqualified opinion (also known as a clean opinion)

The role of financial statement analysis is to...

use the information in a company's financial statements, along with other relevant information, to make economic decisions

Accounting standards require balance sheet values of certain assets to reflect their current market values. Accounting entries that update these assets' values are called...

valuation adjustments To keep the accounting equation in balance, changes in asset values also change owner's equity, through gains or losses recorded on the income statement or in "other comprehensive income"

Capital adequacy is the ratio of some dollar measure of risk, both operational and financial, of a firm, to its equity capital. A common measure of capital risk is _____ risk, which is an estimate of the dollar size loss that a firm will exceed only some specific % of the time, over a specific period of time.

ACC 301 CH 2

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