Understanding Income Statements , BS, S of C SS8

Under IFRS , the income statement can be combined with

"other comprehensive income" and presented as a single statement of comprehensive income. They can also be presented seperately Presentation is similar under GAAP

Noncurrent assets

do not meet the def of current assets because they will not be converted into cash or used up within one year of op. provide info about the firm's investing activities, which form the foundation upon which the firm operates.

Matching principle

expenses to generate revenue are recognized in the same period as the revenue. Inventory provides a good example. Assume inventory is purchased during the 4Q of one year and sold the next year. Using the matching principle ,both revenue and expenses (cogs) are recognized in the next year, when the inventory is sold, not the period it was purchased.

Common-size income statement

expresses each category of the income statement as a percentage of revenue. The common-size format standardizes the income statement by eliminating the effects of size. This allows for comparison of income statement items over time and across firms.

Expenses

the amt incurred to generate revenue and include cost of goods sold, operating expenses, interest, and taxes. Expenses are grouped together by nature or function. Presenting all depreciation expense from manufacturing and admin together in one line of the IS is an example of grouping by nature of the expense. Combining all costs associated with Man (raw mat, depreciation, labor) as COGS is an example of grouping by function. This is the COGS method

Revenues

the amt reported from sale of goods and services in the normal course of business.

Weighted Average Cost method

makes no assumption about the physical flow of inventory. It is popular because of its ease of use. Cost per unit is calculated by dividing the cost of available goods sold by total units available. This Av Cost is used to determine COGS and ending inventory. Average cost results in cost of goods sold and ending inventory values between those of LIFO and FIFO.

Treasury Stock Method

measure the dilutive effect of potential conversion using this method. This method assumes the exercise the option or warrants at the beginning of the year and that the company uses those proceeds to purchase common stock for the treasury

Straight-line depreciation

method used by most firms Recognizes an equal amount of depreciation expense each period. SL depreciation expense = (Cost - Residual Value )/ Useful life

Accelerated Depreciation method

most assets generate more benefits in the early years of their economic life and fewer benefits in the later years. in this case , an accelerated depreciation method is more appropriate for matching the expenses to revenues. Total depreciation expense over the life of the asset will be the same as it would be if SL depreciation was used In early years, SLM will result in lower depreciation expense as compared to an accelerated method. Lower expense results in higher net income. 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 accelerate methods.

weighted average number of CS

number of shares outstanding during the year, weighted by the portion of the year they were outstanding.

Installment Method

profit is recognized as cash is collected. Profit equal to the cash collected during the period multiplied by the total expected profit as a percentage of sales.

Cost Recovery Method

profit is recognized only when cash collected exceeds costs incurred.

Change in Accting Principle

refers to a change from one GAAP or IFRS method to another (eg a change in inventory accounting from LIFO to FIFO).

Retrospective Application

refers to the application of a different accounting principle to recast previously issued financial statements

Stock split

refers to the division of each "old" share into a specific number of "new" shares.

EPS

reported only for shares of common stock and is one of the most common corporate profitability performance measures for publicly traded cos

Balance Sheet

reports the firm's financial position at a point in time. The BS consists of A L and E

Gains and Losses

result in an increase or decrease of economic benefits. Gains and losses may or may not result from ordinary business activities. For example, a firm might sell surplus equipment used in its man operation that are no longer needed.

Percentage-of-Completion Method is used under IFRS and GAAP

revenue, expense, and profit are recognized as the work is performed. The percentage of completion is measured by the total cost incurred to date divided by the total expected cost of the project

Net Income =

revenues - ordinary expenses + Other Income - Other Expense +Gains - Losses

Dilutive securities

securities that can be converted to common stock; upon conversion or exercise by the holder reduce (dilute) earnings per share

Gross Revenue Reporting

selling firm reports sales revenue and costs of goods sold seperately

Gross Profit

the amt that remains after the direct costs of producing a product or service are subtracted from revenue. Subtracting operating expenses, such as selling, general , and administrative expenses, from gross profit results in another subtotal known as operating profit.

Measurement date

the date when the company develops a formal plan for disposing of an operation

Stock Dividend

the distribution of additional shares to each shareholder in an amount proportional to their current number of shares. Ex 10% div , the holder of 100 would receive 10 additional shares.

Gross profit margin

the ratio of gross profit (rev - COGS) to revenue GP = Gross profit / Revenue

Change in Accounting Estimate

the result of a change in management's judgement , usually due to new info. These typically do not affect CF but should be reviewed to determine impact on future operating results. Ex: Chg in estimated useful life of asset.

Phaseout date

the time between the measurement period and the actual disposal date.

Completed Contract method

used when the firm cannot reliably measure the outcome of the project IFRS : revenue is recognized to the extent of contract costs (rev = costs until completion), costs are expensed when incurred, and profit is recognized only at completion. GAAP : revenue , expense, and profit are recognized only when the contract is complete If losses are expected, the loss must be recognized immediately under IFRS and US GAAP

Operating vs. Non-operating components

usually reported separately in the IS . For nonfinancial firm, nonoperating transactions may result from investment income and financing expenses. Ex: Non FI may receive dividends and interest from investments in other firms. The Investment income or gain and loss is not part of the normal firms business Int Exp is based on firms capital structure and is not part of the firms ops. Conversely, for Fin fims, investment income and financing expenses are usually consider operating activities.

Declining Balance Method

Applies a constant rate of depreciation to an asset's (declining ) book value each year. Most common Double-declining balance

Current Liabilities

Are obligations that will be satisfied within one year or one operating cycle, whichever is greater. More specifically, a lib that meets any of the following criteria is considered current. 1. Settlement is expected during the norm operating cycle 2. Settlement is expected within one year 3. Held primarily for trading purposes 4. There is not an unconditional right to defer settlement for more than one year.

Antidilutive securities

Are stock options, warrants, convertible debt, or convertible preferred stock that would increase EPS if exercised or converted to common stock

Operating Profit

Gross profit - expenses

Classified Balance Sheet

IFRS and US GAAP require firms to seperately report their current assets and noncurrent assets and current and noncurrent lib. The Current/NonCurrent format is known as classified balance sheet

Long-Term Contracts don't apply to the above recognition criteria.

Percentage-completion method and completed contract method are both used for contracts that extend beyond one accounting period, often contracts related to construction projects.

IS Equation

Revenue - Expenses = net income

Under IFRS (Barter Transactions)

Revenue from Barter Transactions must be based on the fair value of revenue from similar non-barter transactions with unrelated parties.

US GAAP (Barter Transactions)

Revenue from a barter transaction can be recognized at fair value only if the firm has historically received cash payments for such goods and services and can use this historical experience to determine fair value. Otherwise, revenue is recorded at the carrying value of the asset surrounded

Accrual Method of Act

Revenue is recognized when earned and expenses are recognized when incurred. The important point to remember is that accrual accounting does not necessarily coincide with the receipt or payment of cash.

Net Revenue

Revenue less adjustments for estimated returns and allowances

Understanding BS

SS8

Implications of expense recognition on FS

Since estimates are invovled, it is possible for firms to delay or accelerate the recognition of expenses. Delayed expense recognition increases current NI and is more aggressive. Analysts should compare a firm's estimates to those of other firms within the peer group. If a firms warranty expense is significantly less than that of peers, is the lower warranty expense a result of higher quality or a more aggressive expense recognition

Other names for the IS

Statement of Operations Statement of Earnings P and L Statement

Other Comprehensive Income

1. Foreign currency translation gains and loss 2. Adjustments for minimum pension liability 3. Unrealized gains and losses from cash flow hedging derivates 4. Unrealized gains and losses from available-for-securities

Two points to consider when analyzing a firm's revenue:

1. How conservative are the firm's revenue recognition policies (recognize revenue sooner rather than later is aggressive). 2 The extent to which the firm's policies rely on judgement and estimates.

Criteria to use Gross Rev Reporting under US GAAP

1. Primary obligor under the contract. 2. Bear the inventory risk and credit risk. 3. Be able to choose its supplier 4. Have reasonable latitude to establish the price

Prior Period adjustment

A change from an incorrect method to one that is acceptable under GAAP or IFRS or the correction of an accounting error made in previous FS. MAde by restating results for all prior periods presented in the current financial statements. Disclosure of the nature of the adjustment and its effect on NI is also required. Usually involves errors or new accounting standards and do not typically affect CF. Analyst should review adjustments carefully because errors may indicate weakness in internal controls.

Presentation Formats

A firm can present its IS using a single-step or multi step format

Single-step format

All revenues are grouped together and all expenses are grouped together.

Denominator of Diluted EPS

Basic EPS denom adjusted for the equivalent number of common shares that would be created by the conversion of all dilutive securities outstanding, with each one considered separately to determine if its dilutive. (warrants, PS, Con Bonds, Options)

Which Inventory Expense Recognitions are permitted under IFRS and US GAAP

Both FIFO and Average Cost US GAAP Only LIFO

Bad Debt Expense and Warranty expense

Firm must estimate the bad debt or warranty expense when they sell a good or service on credit or provide a warranty. The firm is recognizing the expense in the period of the sale, rather than later.

Working Capital

Current Assets minus current liabilities

Analytical implications of Discontinued Ops

Do not affect net income from continuing operations. Discontinued ops should be excluded by the analyst when forecasting future earnings.

Period Costs

Expenses that are not tied directly to revenue generation. PC, such as Administrative costs, are expenses paid in the period incurred.

Multi-step format

Includes Gross Profit, revenue minus cost of gods sold.

Retained Earnings

NI of the firm is added to stockholders' equity through RE. Therefore, any transaction that affects the IS will also affect stockholders' equity.

Net Profit Margin

Net Income / Revenue Measures the profit generated after considering all expenses. Like gross profit margin, net profit margin should be compared over time and with the firm's industry peers

Ex: Calculating Comprehensive Income

Note: dividends received for AFS securities and the realized gain on the sale of land are already included in NI. Div Paid and the reacquisition of CS are transactions with shareholders, so they are not included in comprehensive income.

Numerator of Diluted EPS

Numerator must be adjusted as follows If convertible PS is dilutive, the convertible preferred dividends must be added to earnings available to common stockholder. If convertible bonds are dilutive, then the bonds' after-tax interest expense is not considered an interest expense for diluted EPS. Hence, interest expense multiplied by (1- t) must be added back to the numerator.

Effective Tax Rate

Tax expense is more meaningful when expressed as a percentage of pretax income.

Installment Sale under IFRS

The discounted present value of the IP is recognized at the time of the sale. The difference between the installment payments and the discounted PV is recognized as interest over time. If the outcome of the project cannot be reliably estimated, rev recognition is similar to the cost recovery method.

Barter Transaction

Two parties exchange goods or services without cash payment.

Liquidity-based format

Under IFRS , frims can choose to use liquidity based format if the presentation is more relevant and reliable. Liquidity-based pre , which are often used in the banking industry , present assets and lib in the order of liquidity.

Extraordinary items (IFRS vs. GAAP)

Under US GAAP , its a material transaction or event that is both unusual and infrequent in occurrence. Reported separately in the IS , net of tax, after income from continuing ops IFRS does not allow extraordinary items to be separated from op results in the IS. Ex: Loss from an expropriation of assets. Gain of less from early retirement of debt Uninusred loss fro disaster.

Non-Controlling interest

allocation of income to noncontrolling shareholders Is subtracted in arriving at net income because the parent is reporting all of the subsidiary's revenue and expense.

Amortization

allocation of the cost of an intangible asset (such as franchise agreement) over its useful life. Amortization expense should match the proportion of the asset's economic benefits used during the period. Most firms use the straight-line method to calculate annual amortization expense for financial reporting. SL amortization is calculated exactly like straightline depreciation. Intangible assets with indefinite lives (goodwill) 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 is recognized on the IS.

Complex Cap Strucutre

contains potentially dilutive securities such as options, warrants, or convertible secs All firms report basic and diluted EPS

First In, First Out (FIFO)

first item purchased is assumed to be first sold. Cost of inventory acquired first (beginning inventory and early purchases) is used to calculate the cost of goods sold for the period. Appropriate for inventory with limited shelf life. Ex: A food products company will sell its oldest inventory first to keep the inventory on hand.

Simple capital strucutre

has no potentially dilutive securities. Contains only CS, nonconvertible debt, and nonconvertible PS

Specific Identification method

if a firm can identify exactly which items were sold and which items remain in inventory, it can use SIM ex: auto dealers

Dilutive securities issued during the year

if there were securities issued during the year, the increase in the weighted avg number of shares for diluted eps is based on only the portion of the year the dilutive security was outstanding.

Current 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

Unusual or infrequent items

included in income from continuing operations and reported before tax. Even though they affect NI from Continuing operations, an analyst may want to review whether they should truly be included in forecast future earning

Change in fair value of certain long-lived assets

included in other comprehensive income

Dilutive stock options or warrants

increase the number of CS outstanding in the denominator for diluted EPS. No adj to the numerator needed Only dilutive when their exercise prices are less than the average market price of the stock over the year.

Available for sale securities

investment securities that are not expected to be held to maturity or sold in the near future. Reported on the BS as fair value.

Round-trip transaction

involves the sale of goods to one party with the simultaneous purchase of almost identical goods from the same party. The underlying issue with these transactions is whether revenue should be recognized. Ex: internet companies buying equal values of ad space on eachothers websites.

Comprehensive Income

is a more inclusive measure that includes all changes in equity except for owner contributions and distributions. Sum of net income and other comprehensive income.

Op Cycle

is the time it takes to produce or purchase inventory, sell the product, and collect the cash.

Last In , First Out (LIFO)

last item purchased is assumed to be first sold. The cost of inventory most recently purchased is assigned to the cost of goods sold for the period. Cost of BI and earlier purchases are assigned to ending inventory. LIFO is appropriate for inventory that does not deteriorate with age. Ex: Coal off the top of the pile. Popular in the US because of tax benefits. In an inflationary environment , LIFO results in higher COGS. Higher COGS result in lower taxable income , and therefore , lower income taxes.

Depreciation Expense recognition

long-lived assets are expected to provide economic benefits beyond one accounting period. The allocation of cost over an asset's life is known as depreciation (tangible asset), depletion (natural resources), or amortization (intangible assets).

EPS with Convertible Debt

look at pg 69 - 72 please for how to calculate EPS

Installment Sale under GAAP

occurs when a firm finances a sale and payments are expected to be received over an extended period. Under GAAP , if collectibility is certain, revenue is recognized at the time of sale using the normal revenue recognition criteria. If collectibility cannot be reasonably estimated, the installment method is used. If collectibility is highly uncertain, the cost recovery method is used. Both Installment and cost recovery methods are typically used only for sales of real estate.

Discontinued operations

one that management has decided to dispose, but either has not yet done so, or has disposed of in the current year after the operation had generate profit or loss To be accounted for as a discontinued operation, the business, in terms of assets, ops, and investing and financing activities, must be physically and operationally distinct from the rest of the firm. Any income or loss from discontinued operations is reported separately in the IS , net of tax, after income from continuing operations. Any past income must be restated , separating the income or loss from the discontinued operations. on the measurement date, the company will accrue any estimated loss during the phaseout period and any estimated loss on the sale of the business. Any expected gain cannot be reported until after the sale.

Net Revenue Reporting

only the difference in sales and cost is reported. While profit is the same, sales are higher using gross revenue reporting. Ex: Travel agent who arranges a first class ticket for a customer. If tickets are 10k and travel agent receives 1 k commission, using gross reporting the travel agency reports 10 k rev , 9 expense, 1 k profit. Using Net reporting, the travel agency reports 1k of revenue and no expenses.

Operating profit

operating profit / revenue.