Book 3 - Financial Accounting

liquidity ratio: current ratio

current asset/current liabilities

working capital

current assets - current liabilities

Activity Ratio: Total Asset Turnover

indicates the efficiency with which the firm uses its assets to generate sales =sales/ avg. total assets

current liabilities

liabilities due within a short time, usually within a year criteria: - settlement is expected during normal operating cycle - settlement is expected in 1 year - held primarily for trading purposes - there is not an unconditional right to defer settlement for more than 1 year Includes - A/P - Notes payable and current portion of long-term debt - accrued liabilities (expenses that have been recognized in the IS) - unearned revenue

Management's Commentary (MD&A)

management talks about business, objectives, past performance, performance measures used, risk and resources

retained earning

net income - dividends added to stockholder's equity

complex capital structure

potentially dilutive securitites [options, warrants, convertible securities] - decrease EPS

multistep income statement

presents important subtotals, such as gross profit, to help distinguish core operating results from other, less significant items that affect net income revenue COGS gross profit selling/general expense depr. expense op. profit interest expense income before tax provision for income taxes income from operations NET INCOME

historical cost

price paid for the asset

activity ratio: payables turnover

purchases/avg. trade payables

Changes in accounting policy

retrospective change in financial statements

Net income =

revenue - ordinary expenses + other income - other expenses + gains - losses

activity ratio: fixed asset turnover

revenue/ avg. net fixed asset (closer to industry norm)

activity ratio: working capital turnover

revenue/avg. working capital

Classified Balance Sheet

separates current and non-current A and L

what do non-current liabilities show us?

show us firm's long term financing acitivities

unqualified opinion

statements are free from material error

treasury stock

stock that has been reaquired by the the issuing firm but not yet retired - reduces stockholders' equity - no investment in firm - no voting rights/no dividends

fair value

the amount that a business could sell an asset

current cost

the amount the firm would have to pay today for the same asset

present value

the current value of future cash flows discounted at the appropriate discount rate

Diluted EPS

the earnings per share a company would have based on the total number of shares including the effects of all stock options and convertible bonds

authorized shares

the number of shares that the business can issue

solvency ratio: debt to assets

total debt / total assets

solvency ratio: debt to EBITDA

total debt/EBITDA

solvency ratio: debt to equity

total debt/shareholders equity

solvency ratio: debt to capital

total debt/total debt + shareholder equity

GAAP Cash flows

- dividends paid to shareholders are reported as financing activities - interest paid is reported as operating activities along with interest and dividend received

liquidity ratio: quick ratio

(Current Assets - Inventory) / Current Liabilities

basic eps

(Net Income - Preferred Dividends)/(Weighted Average of Shares Outstanding)

Required Financial Statements

+Balance sheet +Income statement +Cash flow statement +Statement in Changes of Owner's equity +Footnotes, explanatary notes, summary of accounting policies

Standard Auditor's Opinion

- independent review - reasonable assurance the financial statements have no material errors - satisfied that accounting principles have been followed

IFRS Cash Flows

- interest and dividend recieved may be operating or investing - dividends and interest paid may be operating or investing - income tax = operating activities unless the expense is associated with an investing or financing transaction

deferred tax assets

- temporary differences between financial reporting income and tax reporting income - gain - can result from tax loss carryforwards - pay less tax in the future tax payables > income tax expense

assumptions

- accrual accounting: transactions when they occur - going concern: company will exist in the foreseeable future

CFI

- acquisition or disposal of long term assets and certain investments - acquisition of D/E - sale PPE

comprehensive income

- all changes in equity

how to deal with finite lived tangible assets?

- amortized over useful life and tested for impairment in the same way as PPE

revenue recognition when acting as an agent

- commission based, don't care if transaction isn't competed

what does owner's equity include?

- contributed capital: capital contributed by equity shareholders - preferred stock - R/E - non-controlling interest - accumulated OCI

PPE models

- cost model: PPE other than land is amortized and tested for impairment - revaluation model: PPE is reported at fair value - accumulated depreciation

Trading securities (IFRS: securities measured at fair value)

- debt securities that a firm owns, but intends to sell - any unrealized gains/losses are reported on the IS - reported at fair value - dividend and interest income and realized gains and losses on IS

available for sale (IFRS: securities measured at fair value through OCI)

- debt securities that are not expected to hold till maturity or sold off in the near term - unrealized gains/losses on the OCI - reported at fair value - dividend and interest income and realized gains and losses on IS

Held to maturity (IFRS: securities measured at amortized cost)

- debt securities that the firm doesn't intent to sell prior to maturity - not on OCI or income statement - measured at amortized cost - dividend and interest income and realized gains and losses on IS

limitations of bs analysis

- different accounting standards and estimates - lack of homogenity: different industries - interpretation of ratios: requires, significant judgement - balance sheets on measuring at a single point in time

CFF

- transactions affecting firm's capital structure - no depreciation - principal # borrowed and dividends paid - issuing stock or bonds - pay cash dividends

CFO

- transactions that affect net income

what is measured at historical cost? (GAAP)

- unlisted equity investments - loans and notes recievables

Financial statement analysis framework

1. State the objective and context 2. Gather data 3. Process the data 4. Analyze and interpret the data 5. Report the conclusions or recommendations 6. Update the analysis

activity ratio: days of inventory on hand

365/inventory turnover

activity ratio: number of days of payables

365/payables turnover

activity ratio: days of sales outstanding

365/recievables turnover

Accounting error

A correction of an accounting error made in previous financial statements is reported as a prior-period adjustment and requires retrospective application.

Statement of changes in equity

A financial statement that summarizes the changes in total shareholders' equity, as well as each component of shareholders' equity, for a specific period of time. - increase or decrease the equity accounts for the period

Indirect method for CFO

A method of preparing a statement of cash flows in which net income is adjusted for items that do not affect cash, to determine net cash provided by operating activities. - add depr. and amortization -

stock dividend

A pro rata (proportional to ownership) distribution of the corporation's own stock to stockholders. - don't apply stock dividend after stock split - January 12/12

modified opinion

A qualified opinion, an adverse opinion, or a disclaimer of opinion. opposite of unqualified opinion

Statement of Comprehensive Income

All changes in equity, except for shareholders transactions

amortization

Amortization is the allocation of the cost of an intangible asset (such as a franchise agreement) over its useful life. Amortization expense should match the proportion of the asset's economic benefits used during the period.

Are discounted operation on the IS?

Any income or loss from discontinued operations is reported separately in the income statement, net of tax, after income from continuing operations.

Investment property

Held by a firm for the purpose of collecting rental income and gaining capital appreciation; ONLY DISTINGUISHED BY IFRS; Can be valued using fair value or cost model ie. amortized; Fair value: Any upside revaluation is recognized as a gain on the income statement; Must disclose the the valuation model used

activity ratio: inventory turnover

COGS/avg. inventory

free cash flow

Cash available for distribution to investors after firm pays for new investments or additions to working capital

Deferred Tax Liability

Created when income tax expense is greater than taxes payable; - when expenses or losses are tax-deductible before they are realized on the income statement - revenues or gains are recognized in the IS before they are included in the tax returns MOST COMMON REASON IS USING DIFFERENT DEPRECIATION METHODS ON TAX RETURN AND INCOME STATEMENT - paying less tax now, but will pay more later - temporary expense > expense in income - straight line for income tax expense and accl. depreciation for taxes payable

economic goodwill

Derives from the future expected performance of the firm

solvency ratio: interest coverage

EBIT/interest payments

Regulatory authorities

Government agencies that have the legal authority to enforce compliance with financial reporting standards

IS: Cost of Sales

Grouping expenses by function (ex. raw materials + depr = COGS)

common size

IS: Compute all line items as a percent of sales. Takes away the effects of size BSL Common size is % of total assets Cash flow: % of revenue or % cash inflows or % cash outflows appropriate for quickly viewing certain financial ratios: - gross profit margin - operating profit margin - net profit margin

simple capital structure

Only contains common stock and nonconvertible stock

liquidity based balance sheet

Presents in order of liquidity. Under IFRS, a firm may present a liquidity-based balance sheet if this format is more reliable and relevant than a classified balance sheet.

Financial reporting

Process of communicating information relevant to investors, creditors, and others in making investment, credit, and business decisions.

Standard setting bodies

Professional organizations of accountants and auditors that establish financial reporting standards - GAAP - IFRS

qualitative characteristics

Relevance and Faithful representation enhance - comparability - verifiability - timeliness - understandability

operating cycle

The average time required to purchase inventory, sell it on account, and then collect cash from customers—that is, go from cash to cash.

Unearned Revenue

The liability created by receiving revenue in advance.

Are unusual or infrequent items included in IS?

Unusual or infrequent items are included in income from continuing operations and are reported before tax.

are financial assets measured at fair value?

Yes includes derivatives, trading securities and available for sale securities

If a firm has controlling interest in a subsidary, are the statements consolidated?

Yes, both incomes are on the income statement non-controlling interest: share of the subsidiary's income not owned by the parent

par value

a value assigned to a share of stock and printed on the stock certificate - no relationship to market value

accumulated OCI

all changes in stockholders equity expect for transaction recognized in the income statement and transactions with shareholders - issuing stock - reacquired stock - paying dividends

depreciation expense

allocation of the cost of a tangible asset over its service life

long term financial liabilites are written down at

amortized cost if not issued at face amount fair value if short position

activity ratio: receivables turnover

annual sales/annual recievables

current assets

cash and other assets expected to be exchanged for cash or consumed within a year - cash (treasury bills, commercial paper, money market funds) - marketable securities (treasury bills, notes, bonds, equity securities) - accounts receivable (reported at NRV) - inventories (at standard costing [assign predetermined cost] or retail method [retail prices - gross profit]) - prepaid expenses

other comprehensive income

certain gains and losses that are excluded from the calculation of net income, but included in the calculation of comprehensive income 1. foreign currency translation gains and losses 2. adjustments or min. pension liability 3. unrealized gains/losses from cashflow hedging derivatives and available for sale securities

Changes in accounting estimates

are applied prospectively and do not require the restatement of prior financial statements.

Intangible assets

assets that do not have physical substance - identifiable: acquired separately - unidentifiable: cannot be acquired separately IFRS: purchased on BS cost model or revaluation GAAP: cost model

solvency ratio: financial leverage

avg. total assets/avg, total equity

liquidity ratio: defense interval

cash + marketable securities + recievables /avg. daily expenditures

liquidity ratio: cash ratio

cash + marketable securities/current liabilities

liquidity ratio: cash conversion cycle

days sales outstanding + day of inventory on hand - number of days payables

Direct Method for CFO

each line item of accrual based IS is converted into cash reciept or payment

net realizable value

estimated selling price - selling costs

goodwill

excess of purchase price over fair value of net assts - not amortized - tested for impairment every year

Balance sheet shows the company's

financial position A = L + Shareholders Equity

what do non-current assets show?

firm's investing activities

amortized cost

historical cost adjusted for depreciation, amortization, depletion, and impairment

how is land valued?

historical cost under GAAP

accelerated depreciation

includes DDB