4. Financial statements and accounting

Accounting equation: Assets = ?

Assets = Liabilities + Shareholders' Equity

What are Assets ?

Assets are the resources owned or controlled by the company and available for use. The IASB define an asset as being a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected'.

What is company stock = ?

Company stock = (Number of shares issued x Nominal value) - Treasury stock

What does the cash flow statement show?

Core operations, Investing, Financing // That provides the summary of cash inflows/outflows as they relate to operating, investment and financing activities.

What is on the income statement? (5)

-Turnover -Cost of goods sold (cost of sales) -Selling and distribution costs -Operating costs -Retained profit

Assets of industry are ?

...fixed and working capital (tangible assets like plant, equipment or inventories)

Liabilities of bank are ?

...largely deposits... low equity reflecting high gearing

Assets of bank are ?

...largely loans to customers and liquid securities

Liabilities of industry are ?

...long and short term borrowings and equity

[296007] The net asset value of a company can be identified using which of the following? A Non-current assets. B Working capital. C Shareholders' equity. D Current liabilities.

Explanation - Correct Answer: C The accounting equation is: Assets = Liabilities + Shareholders' equity or Assets - Liabilities = Shareholders' equity, i.e. Net assets (Assets - Liabilities) = Shareholders' equity. Reference: 4.3.1

What are other reserves ?

For example, revaluation reserves. When a company is formed - or it undertakes a substantial change, such as a revaluation of long-term assets - the 'liability' to the 'asset change' is recorded here.

What does IFRS stand for ?

International Financial Reporting Standards

Market capitalization of a company = ?

Number of shares issued x Market price of a share

See picture page 10 with cash flow end balance calculations

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How is EBITDA calculated

Operating profit + Depreciation/Impairments = EBITDA

What is company performance ?

Profit generated, loss incurred, cash generated and investment returns

What are retained earnings?

The corporation's cumulative earnings not yet distributed to its stockholders // Accumulated profits not distributed as dividends or used for share buybacks

What are non-current assets (fixed assets) ?

They are assets used over more than one accounting period, and are either tangible (e.g. property, plant and machinery) or intangible (e.g. patents and goodwill).

What are the 2 sub-categories of liabilities ?

They are categorized into two sub-categories: Current (short-term) liabilities are amounts payable within one year and non-current (long-term) liabilities are amounts due after one year.

What are selling and distribution costs ?

They are directly attributable costs incurred when selling and distributing - e.g. transport costs for delivery.

What are operating costs ?

They are the general costs associated with running a business, which may include administrative costs. Rent, utility bills, maintenance, management and HR are examples of operating costs.

What are Reserves (typically as part of shareholders' equity)

They generally represent profits earned and retained by a company since it began trading.

What are 3 types of reserves ?

■ Retained earnings ■ Capital surplus ■ Other reserves

How is operating profit calculated ?

Operating profit = Turnover - (Cost of goods sold + Selling and distribution costs + Operating costs)

What is a financial position ?

Assets compared to liabilities (net asset position), liquidity and amount of leverage

What is minority interest or non-controlling interest ?

A group of companies will have balance sheets fully consolidated into one entity. However, the 'holding/parent company' may not have 100% ownership on some of the group companies, and the interests of such non-group shareholders will be reported as 'minority interests' in the equity section.

What is a balance sheet? (long answer)

A statement of the financial position (assets and liabilities) of a company at a specific point in time, such as the year end. It is called a balance sheet because total assets always equal total liabilities (including equity)

What are liabilities?

All the firms debts or what a company owes // It represent the amounts owed by a company to outside parties, such as suppliers and lenders.

What is capital surplus ?

Capital surplus is used to account for the capital that a firm raises in excess of the par value (nominal value) of the shares (common stock). Taken together, common stock (and sometimes preferred stock) issued and paid plus capital surplus represent the total amount actually paid by investors for shares when issued (assuming no subsequent adjustments or changes). // Excess received by the company when shares were issued at a price above the nominal value.

What do CFO, CFI and CFF stand for?

Cash flows from operations, from investing and from financing.

What are current assets?

Cash or an item that will become cash within the accounting period, includes cash,accounts receivable(debts that others owe the business),and inventories (goods expected to be sold during the coming accounting period). // They are assets acquired for conversion to cash during the ordinary course of business. Examples include stocks of goods available for sale (i.e. inventory) to clients, or clients' account balances (which will be settled in cash).

How is EBIT calculated?

EBIT = Revenue - Operating costs.

What is EBITDA?

EBITDA is Earnings before interest taxes depreciation and amortization. Good metric for evaluating a companies profitability. Rough estimate of free cash flow and it is used in the EV/EBITDA multiple to establish a quick evaluation// EBITDA is an acronym for Earnings Before Interest, Taxes, Depreciation, and Amortization. It's a good high-level indicator of a company's financial performance. Since it removes the effects of financing and accounting decisions such as interest and depreciation, it's a good way to compare the performance of different companies. It serves as a rough estimate of free cash flow, and is used in the EV/EBITDA multiple to quickly establish a company's high-level valuation.

[4047808] A client is reviewing the financial statements of the company they are considering investing in and have observed that there is a significant minority interest disclosed on the balance sheet. Which of the following most accurately describes what this figure represents? A Some of the shares of one or more subsidiaries are held by someone other than the group holding company. B The company has undertaken a revaluation of a minority of its long-term assets. C The company has received a premium on issuing new shares at a price above their nominal value. D The company has bought back some of its own shares from minor shareholders.

Explanation - Correct Answer: A Minority interest arises where some of the shares of one or more subsidiaries are held by someone other than the group holding company. Reference: 4.3.3

[296020] Which of the following cash flow classes is NOT normally visible on the face of a cash flow statement? A Selling activities. B Investing activities. C Financing activities. D Operating activities.

Explanation - Correct Answer: A On a cash flow statement the cash flows are broken down into three headings: operating activities (which includes all sales and purchases, etc.); investing activities; and financing activities. Reference: 4.5

[296011] Which of the following would NOT be found on an income statement? A Non-current assets. B Cost of sales. C Turnover. D Interest expense.

Explanation - Correct Answer: A The income statement shows income (turnover) and expenditure (cost of sales, selling and distribution costs, administration costs, interest expense, tax charge etc.). The balance sheet shows assets, liabilities and shareholders' equity. Non-current assets are long-term assets, such as motor vehicles and property. Reference: 4.4

[296006] What is the accounting equation? A Assets = Shareholders' equity. B Assets - Liabilities = Shareholders' equity. C Total assets - Current liabilities = Shareholders' equity. D Fixed assets - Total liabilities = Shareholders' equity.

Explanation - Correct Answer: B The accounting equation is: Assets = Liabilities + Shareholders' equity or Assets - Liabilities = Shareholders' equity, i.e. Net assets (Assets - Liabilities) = Shareholders' equity. Reference: 4.3.1

[296015] A retail company buys inventory (goods to sell) and sells these at a profit. It also buys plant and machinery that it uses in its stores. How should one categorize the cash flow due to the acquisition of inventory, and the cash flow from the acquisition of plant and machinery, respectively? A Investing cash flow and not financing cash flow. B Operating cash flow and investing cash flow. C Financing cash flow and not investing cash flow. D Financing cash flow and not operating cash flow.

Explanation - Correct Answer: B The cash flow in respect of the purchase of inventory, an asset held for sale, would be an operating cash flow, whereas the cash flow from acquiring plant and machinery would be an investing cash flow. Reference: 4.5

[296012] A company's income statement and its accompanying notes show all of the following, with the exception of: A Turnover. B Overdraft. C Depreciation. D Investment income.

Explanation - Correct Answer: B The income statement shows income (turnover) and expenditure (cost of sales, selling and distribution costs, administration costs, interest expense, tax charge etc.). Depreciation is an expense that would be included under one of those headings. The balance sheet shows assets, liabilities and shareholders' equity; a bank overdraft would be included among the liabilities. Reference: 4.4

[296013] Information in the income statement helps users to: A Assess the risk of achieving future cash flows. B Evaluate the past performance of the company. C Evaluate the financial position of the company. D Determine changes in the financial position of the company.

Explanation - Correct Answer: B The income statement shows profits (income less expenses) which may be used to evaluate performance. The financial position (and changes in the financial position) is determined from the assets and liabilities (and changes in those assets and liabilities) that are found on the balance sheet. Cash flow information will be derived from the cash flow statement. Reference: 4.1

[296018] Which one of the following cash receipts or outlays is an investing activity under the statement of cash flows? A Repayment of debt. B Purchase of investment assets. C Payment of dividends to stockholders. D Selling inventory.

Explanation - Correct Answer: B The purchase of investment assets is considered an investing activity under the statement of cash flows. The repayment of debt and the payment of cash dividends are considered financing activities under the statement of cash flows. Selling inventory would be an operating cash flow. Reference: 4.5

Which of the following statements regarding increasing or decreasing cash flows is FALSE? A An increase in long-term debt is an increase in cash flow. B A decrease in payables account is a decrease in cash flow. C An increase in tangible fixed assets is an increase in cash flow. D A decrease in creditors is a decrease in cash flow.

Explanation - Correct Answer: C An increase in tangible fixed assets, such as new equipment being purchased, would result in a cash outflow, decreasing cash flows. Decreasing payables (creditors) by making payments would decrease cash flow, and borrowing money by issuing long-term debt would increase cash available, and thus cash flow. Reference: 4.5

[296019] Bank size is normally measured by: A The number of bank branches. B The volume of sales. C The value of the bank's assets. D The size of the bank's debt.

Explanation - Correct Answer: C Bank size is typically expressed in terms of value, but is often directly linked to its total assets. Reference: 4.6

[4000511] A client has been examining the cash flow statements of a company in which they hold shares and are a little confused between the three categories of cash flows. Which of the following cash flows would be categorized as a financing cash flow? A Cash received on the disposal of an intangible asset. B Cash paid on the purchase of a capital asset. C Cash received from an increase in capital. D Cash received from the sale of goods.

Explanation - Correct Answer: C Cash received from an increase in capital is the only financing cash flow. Cash received from the sale of goods is an operating cash flow and cash flows in relation to tangible and intangible assets are investing cash flows. Reference: 4.5

[296008] Which of the following would you NOT expect to find on a balance sheet? A Shareholders' funds. B Current assets. C Cost of sales. D Tax liability.

Explanation - Correct Answer: C Cost of sales belongs on the income statement. The balance sheet contains all assets (split between non-current and current), liabilities (split between non-current and current), and shareholders' equity assets. Reference: 4.3.2

[296014] What impact will a reduction in depreciation have on the financial statements? A Increase net cash flow. B Decrease profit. C Increase profit. D Decrease net cash flow.

Explanation - Correct Answer: C Depreciation is an expense that is charged against (reduces) profits. A reduction in the depreciation expense will lead to an increase in profit. Note that depreciation is not a physical cash flow. Reference: 4.4

[296005] What can be described as the process of deliberately changing the weightings of the portfolio in order to benefit from short-term opportunities across asset classes? A Strategic asset allocation. B Hedging. C Tactical asset allocation. D Diversification.

Explanation - Correct Answer: C Tactical asset allocation is the process of deliberately changing the weightings of the portfolio in order to benefit from short-term opportunities across asset classes. Reference: 4.3.2

[296017] If a company raises cash by issuing debt in the form of a long-term loan, which of the following statements reflects the initial receipt of the loan? A Balance sheet, cash flow statement and statement of owner's equity. B Balance sheet, income statement and cash flow statement. C Balance sheet and cash flow statement. D Income statement, cash flow statement and statement of owner's equity.

Explanation - Correct Answer: C The cash inflow will appear in the cash flow statement as cash inflow from financing. The cash receipt will increase cash on the balance sheet and the loan will be recorded as a liability (on the balance sheet.) The income statement and statement of owner's equity are unaffected by the debt issuance. Reference: 4.5

[296010] Which of the following cash receipts or outlays is recorded on the income statement? A Repayment of debt. B Purchase of capital assets. C Payment of rent on premises. D All of these.

Explanation - Correct Answer: C The income statement shows the income or turnover that has been generated during the year and the associated expenses incurred in generating that income, including: Cost of goods sold, sales and distribution costs, and operating costs.The balance sheet shows the assets and liabilities of the business and reflects any payments or receipts that alter the value of those assets or liabilities. Reference: 4.4

[296004] Which of the following is NOT a purpose of accounting regulations? A To promote and/or enforce the consistency of treatment of valuation and presentation. B To facilitate comparison over time and across companies. C To provide a framework for auditors to assess financial statements. D To ensure national regulators adopt exactly the same accounting treatments.

Explanation - Correct Answer: D Accounting regulations can be interpreted differently by different countries who tend to have country-specific interpretations, hence they do not adopt exactly the same accounting treatments. Reference: 4.2

4047809] Where would depreciation appear within the cash flow statement? A Cash flows from operations. B Cash flows from investing. C Cash flows from financing. D Nowhere.

Explanation - Correct Answer: D Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and does not, in itself, appear in the cash flow statement. The purchase cost and ultimate sales cost (if any) appear in cash flow from investing. Reference: 4.5

[296003] Which of the following is NOT TRUE of a firm's accounting records? A Accounts must comply with GAAP. B GAAP is enforced at a national level. C Many national regulators utilize IFRSs. D Accounts must show exactly the firm's current financial position.

Explanation - Correct Answer: D GAAP (generally accepted accounting principles) requires that accounting records should disclose, with reasonable accuracy, the company's financial position at any time, and the role of the auditor is to assess whether they do, indeed, fulfil this requirement. GAAP Is enforced by national regulators, many of whom adopt International Financial Reporting Standards (IFRS). Reference: 4.2

[296009] In a balance sheet, retained earnings are part of: A Assets. B Liabilities. C Expenditure. D Shareholders' equity.

Explanation - Correct Answer: D Shareholders' equity is comprised of share capital and reserves - the main reserve that will be found in the accounts of all companies being retained earnings. Reference: 4.3.1

What does GAAP stand for?

Generally Accepted Accounting Principles

What are changes in financial position ?

Growth in net assets, increase in debt, and size relative to industry peers

What is a balance sheet? (easy answer)

It is a list of assets and liabilities

What is the cash flow statement? (easy answer)

It is a list of cash inflows and outflows

What is shareholders' equity ?

It is the amount of money invested in a company by its shareholders - i.e. money subscribed for shares (capital stock or company stock) - and can include: ■ Company stock ■ Treasury stock

What is turnover (sales or revenue) ?

It is the income generated by a company from selling its goods and services. It is recognized (i.e. dated) at the point of sale and the transfer of ownership of goods/services sold to the customer. Note that the accrual concept means that sales are recorded not when payment is received, but when the income is 'earned'.

What does the income statement show?

It provides a detailed report of how the company has generated its profit or loss for the accounting period, reconciling the change in retained earnings figures from one year to the next.

What are PBIT and/or EBIT ?

Profit or earnings before interest and tax (PBIT or EBIT) (This is a measure of the underlying profitability of the company.)

On which key concepts and principles are GAAP based on?

Prudence // going concern // accruals and matching // historic cost

Accounting Equation: Shareholders' Equity = Net assets = ?

Shareholders' Equity = Net assets = Assets - Liabilities

What does the IASB stand for and do?

The International Accounting Standards Board - They establish IFRS reporting standards, but they do NOT have enforcement power. Enforcement is the responsibility of the securities regulators in the national jurisdictions // Independent global body which sets accounting standards

What does the accounting equation describe ?

The accounting equation describes the relationship between assets, liabilities and equity. The rearrangement showing "Shareholders equity = Net assets" reflects the fact that the shareholders 'own' the business.

What are cost of goods sold (cost of sales) ?

They are the costs directly associated with producing or purchasing a product or service. These costs may include raw materials, manufacturing wages and factory expenses. Note that the accrual concept means that these costs are recognized as they are matched to the incomes they helped generate, not when they are paid.

What is treasury stock = ?

Treasury stock = Shares that have been repurchased (buybacks) and not yet cancelled. These may be held on behalf of other shareholders and interested parties, such as employees in a share option scheme

What is the income statement and what does it show? (easy answer)

profit and loss account, which shows revenues, expenses and net income (profit)