Accounting Pre-assessment

Qualitative Characteristics of Disclosures:

1) relevant: infö could influence decisions and should be timely 2) representational faithfulness - RELIABLE/ credible (not afraid lol) - objective, complete and free from error Sometimes - there is a tradeoff between relevance (timeliness) and reliability ( ex. using market value would be more relevant but harder to objectively measure, which is why accountants usually just stick to historic value)

GUIDING PRINCIPLES IN ACCOUNTING -

1) revenue recognition principle 2) expense recognition principle 3) matching principle 4) cost principle

Present Principal Formula

= Future Value / (1 + Interest Rate)^# of years

Quick Ratio

= Liquid Current Assets / current liabilities Liquid Current Assets include - cash, marketable securities, and receivables - =excludes inventory and other less liquid items

Return on Invested Capital (ROIC)

= NOPAT / (short - term debt obligations + long-term debt + market cap) better than ROE and ROA because the numerator is a measure that's a more accurate picture of cash flow NOPAT is core earnings!, and the denominator focuses more on the core people that help to finance - however, still doesn't represent any "cash in hand" to investors... - but if using market price of equity, ALSO NEED TO USE MARKET PRICE FOR DEBT

RETURN ON ASSETs

= Net Income / Assets relates net income to the asset base rather than to owner's equity - represents a marginal improvement over ROE... BUT also... net income can still include items over which management has little or no control over...

Return on Equity

= Net Income / Equity ROE relates the earning of the firm to owner's equity - BUT the underlying assumption here is that earnings in the first place belong to the firm's owners LIMITATIONS - - uses accounting MEASURES in numerator and denominator... and these measures can misrepresent economic reality - ex. denominator is the book value of owner's equity - not actually the market value (so this doesn't represent what the equity owner is actually receiving in gains) - can behave in weird ways.... ex. if owners equity is extremely low this could artificially inflate the ROE number... - also both numbers could be negative and then you assume ROE is positive (clearly not true...)

Profit Margin Ratio

= Net Income / Sales - common size Net Income measurement, can also be called the "return on sales" (bottom line divided by top line (revenues)) - all encompassing, but can sometimes contain gains and losses that distort the results

CASH INTEREST COVERAGE

= CFO + cash payments for interest and income taxes) / cash payments for interest *remember cash payments for interest and taxes are operating cash flows.... and these are related bc interest is often tax deductible

= INVENTORY TURNOVER

= COGS / INVENTORY - measure of the number of times that a firm sell its inventory - higher the number, the faster the firm is able to sell its inventory

COST RATIO

= COGS / Sales shows how much of sales are consumed by cost of the product sold ... if it increases over time, the firm is paying more for its inventory and is unable to pass along the cost increases in its selling prices.... or that it had to cut selling price to move slow inventory

Operating Cycle

= DSO + DSI how long a firm must go before it gets the cash back from investment in inventory >> if you have a longer term operating cycle, you probably need short term borrowings (ex. pay for inventory on credit so you don't have to pay immediately / reduce your cash balance)

Interest Coverage

= EBIT / Interest Expense how much does EBIT exceed interest expense ? >> does firm have the ability to pay interest to creditors one con is that interest expense requires cash, and unfortunately, EBIT is not a perfect measurement of cash...

EBIT MARGIN

= EBIT / Sales

NOPAT

= EBIT x (1 - effective tax rate)

SG&A RATIO

= SG&A Expense / Sales how much of sales are consumed by selling, general and administrative functions... if the SG&A changes over time, this means that the firm cannot keep these in sync with sales - so SGA is usually considered a variable cost... but its not always perfectly correlated **usually a large portion of SG&A is taken up by wages !!

Asset Turnover

= Sales / Avg. Total Assets shows how many dollars of sales are generated from each dollar of assets - shed light on how efficiently the assets are used to produce sales

Current Ratio

= current assets / current liabilities is a measure of liquidity .... will the firm be able to cover its short-term obligations LENDERS (bankers) prefer a high current ratio - but a low current ratio doesn't mean firm is failing (all of these must be taken with a grain of salt...)

Dividend Yield

= dividends paid per share / price per share (using the fiscal year end price per share) - divides the dividends by the stock prices, so this also factors in appreciation in stock price

Effective Tax Rate

= income tax expense / pre-tax income >> not same as statutory rate because of various deductions... and these statutory rates change over time (there can be differences between GAAP income and taxable income)

Effective Interest Rate (pre-tax)

= interest expense / total interest bearing debt rough estimate of firms' cost of debt financing

required interest rate

= market rate of interest ** if the bondholder wishes to have an interest rate different than the stated rate, rather than adjusting the stated rate, you would make an adjustment to the issue price. **

Basic EPS

= net income / average number of shares outstanding

Cash Conversion Cycle (or Days Other Financing Required)

= operating cycle - DPO "days other financing required" >> highlights short term liquidity needs... - if there is a positive DPO, the firm needs to fund itself through subtracting from cash balance or short term loans

EARNING BEFORE INTEREST AND TAXES (EBIT)

= operating earnings = Sales - COGS - SG&A - R&D - DEPRECIATION AND AMORT >>> other performance methods use EBIT instead of net income bc it focuses on core components of Net Income... (net income can be inflated based on various gain and losses that are not central to their operations) AKA Operating Earnings and Operating Profit

Market Capitalization (M-Cap)

= price per share x shares outstanding gives the value of a firms equity at any given point in time...

DuPont Method of Calculating ROE

= profit margin x asset turnover x leverage = Net Income / Sales x Sales / Assets x Assets / Equity >> benefit is that it shows that firm cannot just prop up sales, it has to improve the efficiency (less money for more produced)

ACCOUNTS RECEIVABLE TURNOVER

= sales / accounts receivable measures the annual collection of AR, higher the number, the faster the cash is realized from credit sales

Dividend Payout Ratio

= total dividends paid / net income on a per share basis, it would be: = dividends per share / basic earnings per share dividend policy is rather sticky... firms usually don't really deviate once they have decided their policy...

Investors try to predict - "leveraged free cash flows"

>>> then they discount these using a relevant discount rate (called equity cost of capital) - these projections help stockholders decide whether or not the firm is "fairly" valued

BOOKING

Act of recording any event or transaction in the firm's financial system

Fundamental Accounting Equation

Assets = Liabilities + Owner's Equity **doesn't account for all things we should know... > SO SEC often requires disclosures in other ways to let lenders and investors have this relevant info ("NOTE DISCLOSURES" - disclosures not captured in this fundamental equation)

CapEx

Capital Expenditures... it is cash spent on buildings and other properties

Event 1

Cash increases by one bc of sale of stock, and there is a same increase in owners' equity

Common Size Ratios (CS) ratios

Create common size comparable ratios for items on the income statement and the balance sheet by... (basically just allows you to create comparable numbers between firms of different sizes or firms at different points in time) - dividing income statement item by sales - dividing balance sheet items by assets

IMPORTANT FORMULA TO KNOW -

Beginning inventory + purchases - costs of goods sold = Ending Inventory OR beginning inventory + purchases = ending inventory + COGS (GOODS AVAILABLE FOR SALE) - is the left side of the equation >> so if you are assigning most of the cost of inventory to the costs of inventory remaining - less cost is going into COGS, and companies then subsequently inflate their earnings

SENSITIVITY ANALYSIS

Conducted because you are using many assumptions that could be changing over the forecast period...

EARNINGS PER SHARE: BASIC VERSUS DILUTED

Earnings per Share - earnings attributable to each shareholder >> usually announcement of EPS is called earnings announcement BIG measure of a firm's success... and usually measured relative to EPS of other competitor / comparable firms Firms must give two types of EPS measures... 1) Basic EPS 2) Diluted EPS

LEDGERS vs. T ACCOUNTS

Ledgers - usually pictured as a table, that represent an equation with opening balances and then changes in the account balances and then ending balances in adjacent rows T- Accounts - conventional way of tracking account balances in the ledger

Major Subsequent Filings to SEC (After registration statement)

Form 10-k (annual filing, financial statements, notes, and non-financial info) - some firms also opt to report with an annual report (not SEC required, but you can do both) FORM 10-Q - quarterly FORM 8-K: filing after a significant event PROXY: request for voting rights to be exercised at annual shareholders meetings

INTRO TO BASIC RATIO ANALYSIS

Goal - make a decision about a firm - you pretty much always wanna obtain info on the company and its financial statements from the SEC bc they are required to disclose everything and the notes - which explain certain disclosures in greater detail (usually more relevant / timely and less errors as well!)

Organization of Income Statement

Operating: Sales/Revenues - COGS - selling and general expense - R&D - depreciation expense Non-Operating: -interest expense + investment income - income tax - discontinued operations (components that it plans to sell(?))

Okay so they are teaching how to calculate it but i just don't really care...

INDIRECT METHOD - - you just adjust net income for the non-cash expenses included in the net Income >> then you get CASH INCOME **statements of cash flow is the best place to find these non-cash expenses, because if you look at the income statement there will be a bunch of non-cash expenses embedded in the income statement all over the place - so its just easier to find on cash flow

IASB

International Accounting Standards Board the IASB's GAAP is also referred to as (IFRS) - International Financial Reporting Standards

Pages 24 - 25 for examples of entries...

Inventory Expense - reduces Retained Earnings (bc its a COGS) >> when you start getting accounts receivables coming in, it doesn't affect retained earnings bc you already recorded the revenue. Just changes the asset balance because it changes the amount of cash versus Accounts Receivable you have... >. if you are starting to pay off accounts payable... this changes the amount you have payable and your balance of cash >> for accounts / expenses payable - you still record this as a reduction in retained earnings (bc you are still record as an expense (same thing with interest payable - goes under liabilities, and then reduced owners equity) > bc not affecting assets at all... (this is the same for taxes payable: positive account under liabilities which is cancelled out by the reduction in retained earnings / equity) >> accumulated depreciation decreases the asset value, and then also decreases Retained Earnings (bc its an expense)

more vocab...

Stated Rate - the coupon rate or the nominal rate of interest yield - another way of saying market rate (or the effective interest rate)

Types of incorporation

Sole proprietorship, partnership, and corporation > harder for first two to expand / access private capital because they are liable LLC - and S-Corps: certain benefits not granted to sole proprietorships

CHAPTER 4 - WORKING CAPITAL ACCOUNTS:

Working Capital = current assets - current liabilities - usually measured on a net basis CURRENT RATIO: relative measure, current assets / current liabilities Current ratio - basically saying... is the firm able to meet its current obligations?

events 9 and 10 (adjusting entires) 0

adjusting entries are usually a function of time, and do not involve cash... (made at end of period before closing the entry)

Allowance for Doubtful Accounts

an estimate of uncollectible receivables - firms are required to estimate the amount of receivables they don't think they can get from customers >>> this is factored in through a contra account called ALLOWANCE FOR DOUBTFUL ACCOUNTS, which when subtracted from AR allows us to get at NET REALIZABLE VALUE >>> records the EXPENSE as BAD DEBT EXPENSE

Days Payable Outstanding (DPO)

average number of days it takes for a firm to pay its suppliers for inventory To calculate: Purchases = Ending inventory + COGS - beginning inventory Accounts Payable Turnover = purchases / accounts payables DPO = 365 / Accounts Payable Turnover

Repairs and maintenance on factory equipment

costs of preparing and maintaining physical assets - these are always expensed!! **BUT if you are affecting the actual life of an asset, then you would capitalize that... (or gains in efficiency) - bc these represent future benefits - definition of an asset

Implication of Conservatism

produces asymmetry... and raises the following questions: 1) is it not important to let investors know about the upside, as well as the downside? 2) why do we tend towards conservatism

Inventory Valuation

role of financial accountants is to report the value of the inventory itself, and also to value the expense of that inventory Three Types: direct materials, work in progress, and finished goods **you need direct labor (DL - direct) and overhead (OH - indirect manufacturing costs) to get from inputs >> finished goods stages

but we need present value...

so relevant question is: what principal would be required today (present value) to grow to the value of 121 in two years? Assuming the bank pays interest of 10% per year? > we would need to deposit 100 dollars today in order to have 121 in two years

CONVENTIONAL CLOSING ENTRY

so using intuitive... you make revenues negative and then all of the expenses positive to close out the books BUT WITH CONVENTIONAL - >> YOU MAKE REVENUES A DEBIT, and then CREDIT all of the expenses (reverses the original entries and sets the revenue and expense balance to zero)

Consolidation -

so you would net out the investment account and then just add in the fair value of the other companies assets and liabilities

last note on depreciation..

sometimes its not its own line item... and it will be built into SG&A ALSO some depreciation is capitalized as a part of inventory (in this case it becomes an expense when the inventory is finally sold)

Journal Entries

the panels that show what happens to assets, liabilities, and owners equity with every business decision are known as JOURNAL ENTRIES ( keep track of actions and how they affect this general accounting equation) >> journal entries always have two parts because they are part of a double entry system these entries are recorded in the "JOURNAL" or the "BOOK OF ORIGINAL ENTRY" (eventually these roll up to the financial statements > which are presented to lenders and investors) (can either be recorded in pluses and minuses, or using debits and credits)

interest expense -

the cost to generate returns that are greater than cost of borrowing ... and the returns above this point then accrue to stockholders

Retained Earnings

the cumulative amount of Net Income that a firm has earned since its inception (carried over year to year rather than being zeroed out) >> changes to Retained Earnings correspond to the individual items on the Income Statement - dividends is another adjustment to retained earnings... (keep in mind for later)

Amortizing a Loan

the principal is reduced over time since the borrower's cash payments are to the lender are greater than the periodic interest rates amortization tabe - (similar to accretion of interest): but shows how the amount of principal you paid off increases

Linking Cash Flows with Specific Accounts

the process of deriving a statement of cash flows is facilitated who we associate cash flows with a Balance Sheet account - you can extend this type of analysis to the full Balance Sheet if you group accounts by cash flow category

LOSSES

they result from peripheral activities, and its a loss on something (opposite value of gains but same concept) - ex. so if the asset you liquidated had a lower fair value than the book value

POST ACQUISITION -

this phase of accounting for fixed assets, the following events may occur: 1) repairs and maintenance 2) depreciation 3) restructuring (employee severance) 4) impairments (lower of cost or market for fixed assets) 5) disposition of individual assets

what to use - debt or equity?

this question is answered through the practice of corporate finance (big source of income for IB analysts)

positive NPV projects

the expected benefits exceed to cost / risk of the investment

Current Assets

will be converted to cash (or already are) within a year ex. Accounts receivable, inventory, prepaid expenses

Recognition of intangibles

you can't recognize these assets until you actually have them... if still in R&D stages then that would be an expense...

Sale of Inventory Entry

you get positive revenue (credit) and cash (asset / debit), and a decrease in inventory assets and increase in inventory expense >> so it affects your assets (the cash and inventory amount) and the owner's equity (revenues and COGS) A FIRM CANNOT SHOW SALES WITHOUT ALSO SHOWING EXPENSES

other currency conversions

determined by date of disclosure

SEC PURPOSE

ensure that full and fair disclosures are made to all investors before IPOs - and then afterwards in secondary markets: main part of registration statement is: - audited financial statements - description of the intended use of money raised through IPO - description of the risks of the securities - description of the line of business in which the firm operates

Credit Rating

ensures that firms don't exploit their creditors, bc if they do, credit rating will fall, and their cost of borrowing money will increase >> also creditors can put provisions in loans to ensure compliance as well ex. of credit rating services: moody's, S&P, Fitch, and AM Best

Preferred Stock

get certain rights: - right to receive dividend payments before common holders - get higher rank in terms of claims on leftover assets

SWOT Analysis

gives qualitative background on strengths, weaknesses, opportunities, and threats

accretion

growing a balance because of interest

LIFE CYCLE OF A FIRM

has four phases: 1) Introduction 2) growth 3) maturity 4) decline **usually you can look at a time series of a firm's cash flows and net income to identify where the firm may be in its life cycle >> the stage of the firms life cycle influences its need for capital and helps make predictions about the future

cash equivalents

highly liquid, but get better returns then just holding purely cash - and usually combined with cash on a firms' balance sheet

Year-Over- Year Ratios

how did it change from year to year, expressed as a percent ex. in YOU terms, cash balance fell 48%

Days Sales in Inventory (DSI)

how many days does it take to sell your inventory?

R&D Ratio = R&D Expense / Sales

how much of sales are consumed by the R&D functions of the firm

ACCRUED EXPENSE (PAGE 45)

i think this is a liability because you haven't paid yet but pretty sure you got the service... YES - so this is the same as an accounts PAYABLE , which goes under the liabilities section, and then also you subtract the same amount from equity >> when you actually pay for it... you subtract from cash and liabilities examples of ACCRUED EXPENSES: Wages, utilities, taxes, interest (usually paid for after the firm has received the service...) BENEFIT OF DEFERRING EXPENSES - helps with liquidity.. bc when you finally pay it reduces your cash assets...

DISCOUNTED VALUE OF LEVERAGED CASH FLOWS

if the estimate of the firm's fair value... is lower than the observed value (MARKET CAPITALIZATION) ... then perhaps the company is overvalued >> SELL

INVESTMENTS IN DEBT SECURITY

investments in debt securities include: 1) trading : does not plan on holding for an extended period - use fair value 2) available for sale : simply not trading, holding period is just a bit longer on these (relative to trading) - use fair value 3) held to maturity - remain on the balance sheet at (historic) cost >>> these categories are based on intent with respect to the holding period

Accumulated Depreciation (A/D)

is a contra account - instead of expensing depreciation directly, this account allows you to see how old the PP&E is.. .

GAIN

is the difference between the fair value and the book value

INVENTORIES

items purchased (or manufactured) for resale - "necessary evil" bc hard to find an appropriate balance: necessary to have when a customer wants it, but costly if customers don't have need for it

"cash"

items that are immediately "spendable" without restriction - so this is physical cash as well as checking and savings accounts

cash equivalents

items with maturities of three months or less, and include for example treasury bill and commercial papers

on the question of WHO are managers responsible for...

just shareholders, or communities / environment too? >> legal protections ensure that managers do not exploit these other constituencies even beyond shareholders

IMPAIRMENTS

occur generally when the future benefits that the firm expected to realize from its investment in an asset are not being realized >. when this happens, you have to "write down the asset..." reduce the asset value by the loss you estimated, and then place that loss under equity as "impairment loss"

where to find depreciation and amort

often have to refer to Cash Flows statement bc usually is embedded within SG&A expense rather than having a separate line item (also some is embedded in COGS due to depreciation expense affecting inventory)

GROSS MARGIN

= (Sale - COGS) / Sales *cost ratio and gross margin sum to a value of 1! (so 1 - cost ratio = gross margin)* usually watch this ratio for any firm with significant levels of inventory, like retailers. Shows the relationship between selling prices and costs of products sold... - when costs cannot be passed along to customers - we say that margins are being squeezed or that there is margin contraction - margin expansion (opposite scenario - good thing to have happen)

TOTAL RETURN TO SHAREHOLDERS (TRS)

= (current price per share(little t) - previous price per share(little t - 1) + dividends per share(little t) / previous Price per share(little t - 1) shows how the firm performed in the past year for its shareholders (in terms of increasing the value of their investment) BUTTT this gain from the increase in value is not completely realized unless the shareholder sells the share... - how much better or worse off is the stockholder after purchasing the stock? CON - calculates historical changes in wealth, which are notoriously poor predictors of future changes in wealth...

Total Debt To Capital

= (short and long term debt) / (short and long term debt + owners equity) how is the firm finance (another way of showing leverage) >> higher ratios mean more coming from debt...

DAYS SALES OUTSTANDING (DSO)

= 365 / accounts receivable turnover shows in days how long it takes firms to collect their AR - usually if a payment is delayed over 30 day credit cycle, the seller can charge interest for the delayed credit payment

Leverage

= Assets / Equity so for each dollar of equity... the firm has a certain number of dollars in assets AKA "debt burden ratio" Other Ratios include: Debt / Equity or Debt / (debt + equity) - debt to capital ratio

FUTURE VALUE (w interest) FORMULA

FUTURE VALUE = PRINCIPAL x (1 + interest rate)^# of years

Usually calculate cash flow as a total within CFO, CFF, and CFI

(as opposed to the net per account...)

these accounts are important because if you have really high returns that's an indication that you have poor quality products

(gross sales disclosure shows all of these forms of discounts, and then Net Sales disclosure shows the end impact of all of these discounts)

LONG LIVED ASSETS -

*inventory still considered a current asset btw!* Non-current assets - divided into tangible and intangible Intangible assets - provide rights and protections that allow the firm to continue making money without needing to spend money to ward off competition

DISPOSITION

- basically describes the gain or loss a firm receives from getting rid of an asset before the end of its depreciable life (if they ask me something about this i probably just won't know haha) okay it seems pretty straight forward you just put the cash you got from the liquidation at the top, look at the original asset value minus accumulated depreciation to that point >>> net that and whatever you get you apply either as a gain or loss to owner's equity

examples of CFI - cash flow from investing

- cash flow received or paid in the sale or purchase of PP&E - cash received or paid in the sale or purchase of certain passive equity securities (Available for Sale and Held-to Maturity investments in debt securities and equity method investments in stock) -

examples of Operating Cash Flow (CFO)

- cash from customers - cash paid to suppliers, employees, insurers - taxes paid - interest received and paid - cash dividends received - cash received or paid in sale or purchase of investments classified as TRADING SECURITIES (so if they are active) ( operating defined on the income statement is much more easy to do - bc its a more straightforward and narrow category - whereas it is a bit less intuitive for cash flow. ) ** differences arise from interest and dividends: why isn't this under CFI??or the payment for interest in CFF? Why aren't the purchase of the equity and debt securities classified as CFI? ** - kind of a nonintuitive reason... so just remember that it is...

examples of CFF

- cash received and paid in short and long term borrowing - cash received from stock issuance (including strike price from stock option exercises) - cash paid as dividends - cash paid o repurchase own stock (treasury stock)

HISTORY OF CAPITALIZED INTEREST:

- controversial, but arose in the 1970s in a very high interest rate environment >> basically means that interest shows up on the balance sheet as part of the building , rather than on the Income Statement >> and eventually gets put back on the income statement as the building is depreciated

Consequence of Pros and Cons of these types of financing...

- debt holders don't want companies to take as much risk....

Dividend stuff

- if the firm declares a cash dividend, they are legally liable to pay that dividend - dividends are a liability under: "dividends payable" - and then they balance by reducing retained earnings ' (bc remember retained earnings is net income - dividends) - and the payment date is about TWO WEEKS after the declaration date ... >> so once actually paid, you would reduce cash, and then reduce dividends payable

Accounting for Treasury Stock in the Books

- its a contra equity account ... purchases of other firms stocks are considered investments , but purchases of its own stock are CONTRA EQUITY (treasury stock) - usually, dividends are expressed as a percent of par value

EBITDA (earnings before interest, taxes, depreciation and amortization

- often used as a crude proxy for cash flows from operating activities (mainly bc its pretty easy to calculate) **HOWEVER: not completely accurate estimate of CFO because it fails to adjust for changes in WORKING CAPITAL (assets - liabilities), AND it does not include the effects of INTEREST Limitations - doesn't include change in working capital and interest (which are both technically included in CFO)

CONTROL AND CONSOLIDATIONS

- once you get above 50% ownership, you no longer show the amount that you earn in investment activities, but you own that companies assets and liabilities (so you merge the balance sheet between investor and investee) >> when you merge the balance sheet, for the company acquiring, you use the fair value

Measuring Bond Liability

- solve for present value of cash payments >> BUT you discount the payments (coupon and face value using the market rate of interest, not the stated rate of interest) - only thing you use the stated rate for is to calculate the coupon payment PRESENT VALUE OF THESE CASH FLOW = the price that the bondholder (inventors) will pay for the bond - so the value of bond on the Bond Issuer's books (get that PV in cash from debt funding) OR - the amount the bondholder is wiling to loan a bond issuer (given a certain return structure) >> so basically looking at PV of all future annuity payments PAGE 87 for excel calculations (remember to keep the values negative bc the bond issuer is paying ... and its for their books)

DEFERRED TAXES (liability - you still gotta pony up... )

- these liabilities are defined by tax laws... which determine which items are taxable (and WHEN they are taxable) and which items are deductible (and when)

INVESTMENTS AND LONG LIVED ASSETS

- this is the consideration of firms with excess cash who want to invest in other companies ! (equity investments)

Alternative Systems of Accounting

1) Cash: only tracks cash flows, usually only used by smaller private companies 2) accrual : can help better predict future cash flows (utilizes matching and revenue principles) 3) fair value: requires the recognition of unrealized losses and unrealized gains, but ONLY for certain assets and liabilities - ( so it violates conservatism constraint in accrual accounting - is also a "non-transaction based" system, bc the gains and losses are from changes in values (not actual transactions) - only applies to certain firms with certain asset classes... pretty controversial stuff haha

BIG FOUR ACCOUNTING FIRMS

1) Deloitte 2) EY 3) KPMG 4) PwC Accounting auditing standards are written by PCAOB (public company accounting oversight board)

Cash Flow Classification

1) Operating cash flows - from customers to suppliers 2) Investing Cash Flows (from purchases of buildings and other items that help the business expand in the future) 3) Financing - to and from lenders and investors >> use the cash section from the general ledger to create the cash flows statements CASH FLOW EXPLAINS THE CHANGE IN CASH BALANCE

Measuring Inventory Costs when Prices Change:

1) Specific Identification: if the inventory item is particularly special - knows exactly which item was used and sold, so can assign value completely accurately (for large/big ticket items - usually not the case) 2) LIFO: the price of the last inventory item that came in is the price used (until those inventory raw materials are used up) >> but key thing to remember is that the last in cost is assigned to the good sold (becomes COGS) and then the rest of inventory based on what's leftover - same with the other methods - basically just a way to determine the value of goods sold, and the value of inventory you still have 3) FIFO: first in first out, so the oldest inventory is used to produce the next finished product 4) Average

Three Categories of Cash Flows

1) operating cash flow (CFO) 2) Cash Flows from investing activities (CFI) 3) Cash flows from financing (CFF)

CAUTIONS ABOUT RATIO ANALYSIS

1) a ratio for the sake of a ration is meaningless (the two numbers you pick could be completely random) 2) some ratios do not mean much in certain contexts 3) ratios act as proxies for constructs (constructs are ideas) - they cannot be seen or measured scientifically... ex's: - Leverage: measure by looking at debt / assets , usually higher ratios here mean more risk - profitability: measures firm's performance, ex. of metrics could be Net Income / Total Assets (return on assets) 4) Ratios can badly mis-measure a construct. A ratio can be distorted for reasons that do not actually reflect underlying economic reality... ex. ROE = Net Income / Owner's Equity - what if both of these numbers were negative? That would yield a positive results even though clearly the firm is experiencing loss...

Order of Liquidity on the Balance Sheet (assets)

1) cash 2) accounts receivable 3) marketable investments (stocks of another company) 4) Inventory 5) prepaid rent / insurance / expenses 6) PP&E 7) intangible assets

Classification of Intangible Assets

1) identifiable - specific, known rights 2) non identifiable 3) amortizable - have known, definite lives 4) non-amortizable - definite life (trademark) *goodwill - is non-identifiable, and non-amortizable nothing is non-idenfiable and amortizable (that just doesn't make sense)

CONCLUDING REMARKS

1) is the stated rate of interest < market (required rate), than the bond is issued at a discount 2) if the stated rate of interest > market (required) rate than the bond is issued at a premium 3) if the stated rate of interest = market (required) rate, the bond is issued at face value (AKA par value)

SOLUTIONS TO AGENCY PROBLEM:

1) monitoring 2) incentive contracting - controlling the risk and rewards of the outcomes with the agent... (usually done through compensation packages)

STATUTORY TAX RATES VS EFFECTIVE TAX RATES

35% and 40% tax rates (that you just assume) are known as Statutory Rates EFFECTIVE TAX RATES = tax expense / pre-tax income (so you calculate the effective tax rate...) STATUTORY TAX RATES: are set by a nation's govt... and these vary around the world... can also vary within nations ex) interest earned on municipal bonds in the US is not taxed **WHY IT MATTERS - when a company operates in multiple jurisdictions... and is subject to multiple statutory rates, the effective tax rate can differ from the local tax rate (the tax rate and differences between effective and statutory rates can be found in the financial disclosure section)

R&D, Advertising, and Intellectual Property

ARE ALL EXPENSED - rather than capitalized - bc they don't want people overestimating these and "cooking the books: - bottom line: firms cannot consider R&D and advertising to be assets

Accounts Receivable

Accounts Receivable: rights to receive future cash from a customer from a previous sale on credit - when a firm sells to customers on credit, there is a CREDIT RISK, that they won't pay back what they owe ** also credit card company pays for the expense, and then customer pays the CC company (this usually happens ~3 - 5 days after credit sale)

Revenue and Matching Principles:

Accrual Accounting - based on revenue and matching principles, which mean that revenues and expenses do not always correspond to cash receipts Revenue Principle: a firm may only recognize revenue after it has satisfied the performance obligations with the customer (these can be either formal or implies) >> all about when and if a service/good was delivered Matching Principle (or expense recognition principle) - says to book the expense when the benefit is received, bc theoretically you can't deliver a benefit to someone without incurring an expense - expense must be matched with the revenue recognized!

Flow Costs in an Accounting System: (page 60)

Ahhhhh this part is hard... but if you are trying to depreciate an asset associated with inventory, if you capitalized it, you would use accumulated depreciations and then add inventory??? hahahah WHAT page >>> i guess what they are saying is that the depreciation expense in the value of inventory bc the COGS increases (reduces your profit margin) >>> so this depreciation does become an expense when it is included in COGS when inventory is sold... but for now it is capitalized... (okay actually makes sense) >>> also should have relatively even amounts of inventory between all the different stages of production

Excel Helps you out with this !!

Also this stuff on annuities / principal is relevant to the next topic of LEASES

TOO MUCH OF A GOOD THING - when debt becomes an issue...

BAD PART - is debt holders don't share in the excess returns, and also don't get returns when companies aren't turning a profit ... but companies still owe it to the debt holders. so shareholders continue to accrue the negative return?

decline

CFO - can turn negative CFF - does not increase (even though company wants it to) bc no one is going to invest in the declining company CFI - can become positive if the company starts liquidating its assets to get money...

Growth Phase

CFO - eventually turns positive (CFO "positive") CFI - probably still negative as firm continues to invest CFF - stays positive bc firm still needs outside funding

mature phase

CFO - positive CFI - slows down (fewer investment opps) CFF - turns negative, firm is starting today down its debt and return cash to investors

Capitalization vs Expense

Capitalize - means you increase assets (change cash and asset stock) >> when something is capitalized, the effect at that point (to the firm) is net zero. HOWEVER, it then must be expensed over a period of time through depreciation expense. Expense - means you decrease Owner's Equity (change cash and retained earnings) USUALLY, the decision to capitalize or expense is set by GAAP Assets - have value and future benefits beyond the current year (usually), and it has to be material! (big enough to actually give a shit) > each firm / accounting project has its own materiality threshold bc its all relative

Event Two

Cash and Note Payable increase

EPS relevance to financial accounting

Firm could announce EPS that includes effects of a contingent loss, and can provide current and future values based on GAAP and pro form basis (so they can show EPS value with and without contingent losses) this is known as "cleaning up" - but they can't mislead the markets , controlling for that one random thing... here's what Net Income and EPS would have been >> to do this the company would recast the GAAP income statement as a pro-forma (non-GAAP) income statement usually shown in the GAAP reconciliation table

GAINS AND LOSSES VS REVENUES AND EXPENSES

Gains - similar to revenues but they are the result of peripheral activities, which are activities that are not central and ongoing activities of the firm ex) company sells a piece of equipment for 1,000 (original asset worth was 800) >> so gets a 200 dollar gain (not from selling its products though **key is this piece of equipment was used to make its inventory that is actually its product... the machine itself was just an asset they liquidated (not central to operations/ business model) IF THIS WAS THE BUSINESS OF THE FIRM - it would have been recorded as increase in cash, decrease in inventory (under assets) AND increase in revenue and increase in expense/COGS (under equity / retained earnings) REASON WE SEPARATE GAINS AND LOSSES VS REVENUES AND EXPENSES - revenues and expenses are more stable and persistent whereas gains and losses are less likely to be recurring (be sure to look for whether or not net income is being "propped up" by these one time sales of assets )

Order of MATURITY for Liabilities

Maturity - means how quickly do they have to be paid? 1) accounts payable 2) taxes payable 3) short-term debt 4) long term debt 5) bond payable

Order of PERMANENCE for Owner's Equity

PERMANENCE - means relative expectation about returning capital to the owners 1) stock 2) retained earnings Retained earnings are less permanent because dividends are paid from this pool of money... stock is more permanent because firms often pay dividends are repurchase shares

Lenders and Investor are private capital

Public capital is cash from the government

SEC

SEC created by US govt, but relies on expertise of FASB - which is an independent rule-making body funded through fees paid by publicly traded firms 1933 - Securities Act : regulates IPOS SEC created in 1934 under Securities and Exchange Act - regulates the subsequent trading of securities

Interest Calculation

SIMPLE Interest = principal x rate x time CAPITALIZED INTEREST INCURRED = expenditure x rate x time (uhhhh i guess bc you aren't paying interest on this part bc you are turning it into an asset...) Net interest expense = total interest incurred - amount capitalized (use the second formula to calculate capitalized interest) - so you include the amount spent on the building you built under assets, under liabilities you put the full loan amount (total amount of liabilities you owe), and then the NET is your Interest Expense (that goes under equity)

**LIFO is pretty common in the US, but not allowed in many other countries

^ beneficial to use LIFO because its beneficial from a taxation standpoint >> if price rises, LIFO gives lowest Net Income (bc you take higher cost inventory), and then undervalues the inventory left over ' **LIFO usually gives firms the highest tax deductions , usually its used in inflationary periods (basically a govt subsidy for the effects of inflation)

Double Declining balance

accelerated method - recognizes more depreciation early in life of asset > this helps even out relevant expenses because as an asset ages, the maintenance costs increase (so you aren't facing the brunt of the two costs at the same time) >> usually just applies a factor of two to the straight line depreciation method (then you keep applying this ratio to the remaining balance)

CONTRAC ACCOUNTS

also part of full disclosure principle - these are accounts used to re-value other accounts (ex. accumulated depreciation) >> basically just increases transparency and understanding of what is going on

CONSERVATISM

always use WCS! Don't overestimate... better to underestimate ex. contingent losses - an event that could require the firm to make payments to another party - accountants predict and estimate these losses before they are realized (you recognize these losses before payment - these are also known as "paper losses" - if a loss or risk is NOT estimable, or not likely > usually firms will just disclose in the note disclosure section - expensing R&D would be another example of this... BUT ... this is only for losses. accountants cannot include contingent gains

additional paid in capital (APIC)

amount of equity financing from investors that is above the stock's par value ... (nominal value on the certificate) AKA "share surplus" -

Depreciation Entry

amount reduction in assets, and then same amount in expenses (reduced from owner's equity)

BONDS PAYABLE

amounts owed to bondholders BOND HOLER = LENDER is the bond holder (bc they get the return) BOND ISSUER = the borrower (bc you issue it to get debt ! ) Bonds Payable are also measured at the outset of the present value of the required cash payments

Accounts Payable

amounts owed to suppliers for inventory and other items (and for the seller of the buyer, their books look the same as when a firm sells its inventory

events 4,5, 6, and 7

are all connected... but represent a series of entries associated with the business cycle...

Overhead costs

are indirect, and these include: salaries, depreciations, insurance, utilities (costs that are associated but difficult to trace to a specific product)

LOWER OF COST OR MARKET

at end of the year, after inventory has been valued at cost, it may have to be written down - inventory cost is compared to market value to replace, and may have to adjust from there. SO in this way inventory is carried on the books at the lower cost or market... - another aspect of conservatism, and a lot of inventory is often rendered obsolete

Firm's Financial Statements

balance sheet, statement of cash flows, income statement, statement of owners equity, and note disclosures

Units of production is the last way to do it

basically take the amount it produces in a year / total it produces over its lifespan MULTIPLIED by the cost of production

"Mixed Attribute" accounting Model

because we use all three of those systems simultaneously...

why is this difference then general tax expense?

because you are applying certain laws to certain types of expenses... its not just a single rate applied to your full income.. >> so in this sense, your tax return is different from your income statement (form of an adjustment) - deduction comes from tax return - you need to account for deferred taxes when the income statement and tax return are not identical (and when these differences are temporary in nature)

for treasury stock..

board of directors may declare they are going to do it... but theres never a specific time where it all happens... if firms resell at a different value and receive either gains or losses, this should be absorbed by the APIC account

MORE CONCLUDING

borrowing from the bank, measuring both a finance lease and an operating lease, and measuring issue price of a bond all require present value calculations

trading and available for sale...

both marked to market on each reporting date - if security is trading, then the gain or loss occurs on the income statement (same as passive, where its Fair Value through net income) - if available for sale - recorded in AOCI : Accumulated Other comprehensive income (so not on income statement unless the investment is actually sold) >> but if you switch from trading to gain, then you would have to switch subtract the AOCI and convert it to a gain

depreciable value

cost - salvage value (never fear ! there's an excel function for this)

Direct Method to Derive Cash Flows

cash flows are identified through transaction analysis - you recreate an account or a journal entry from data given in the income statement and balance sheets , and use this to create the account or journal entry in order to identify cash flows AKA cash flows in real time >>> you collect data on each transaction, but wait until the end of the period to group these cash flows and then label them as a group

CapEx

cash paid for purchase of PP&E - important for projecting future cash flows of a company

Ordinary Annuity

cash payments are made at the end of the year or AKA "annuities in arrears" annuity in due - (or annuity in advance) >> are annuities that have payments at the beginning of the year

"restricted cash"

cash that cannot be used on everything, and thus, is not immediately "spendable" - so it can't be cash These assets would fall under "other assets" on the balance sheet

How to Use these Ratios?

compare the CS and YOY changes to industry averages to a comparable firm,

LEASES

contract between a lessor and a lessee in which the lessor grants to the lessee the right the use property owned by the lessor > similar to a loan, but you are renting out property rather than cash TWO TYPES OF LEASES : 1) operating 2) finance BOTH OF WHICH ARE CAPITALIZED - meaning the lessee can recognize the lease as an asset and the lease liability at the beginning of the lease term

CONVENTIONAL VS INTUITIVE JOURNAL ENTRIES / T ACCOUNTS

conventional journal entries: use debits and credits - no positive and negative numbers... you can tell whether or not its a credit or debit based on the indentation / position on the page - basically anything that influences assets, has to do the opposite thing for owner's equity and liabilities to ensure that the entries balance out - good way to figure this out is just to identify the account that's changing, and then determine whether or not that is a credit or debit impact intuitive journal entries: pretty sure they only specify whether or not its an asset, liability or owner's equity (use positive and negative numbers) The "CRUTCH" is where and how you record the journal entries conventionally... ***REMEMBER - whatever happens to assets must have an equal and opposite reaction in liabilities / owners equity if nothing else about assets is changing

The Ledger

data from the journal entries are "posted" to the individuals accounts to accumulate account balances (accounts = cash, debt, stock, etc.) THE LEDGER STORES ACCOUNT BALANCES , beginning balance at top, and ending balance at the end

how to calculate the deferred tax liability ...

difference between depreciation expense from income statement and depreciation deduction on tax return is called the TEMPORARY DIFFERENCE - its temporary because there is a future tax consequence JOURNAL ENTRY WOULD BE - your reduction in equity is the total amount you need to pay in taxes , and then your liability would be positive ( because you are getting money back ) and then you subtract that deferred tax liability from tax expense to get the full cash amount you owe PAGE 91... *most firms prefer accelerated deductions over future ones bc it allows them to save money TODAY which is worth more

DEPRECIATION

difference between the PP&E account and accumulated depreciation = book value BOOK VALUE = capitalized cost - accumulated depreciation *most common form of depreciation - straight line! SALVAGE VALUE - the terminal value that you can sell an asset for ... so using straight line... you depreciate an equal amount every year until you get to the salvage value

CGM - cost of goods manufactured

dollar value of the complete product

auditors...

don't pretend to be perfect... but also provide opinion on whether the financial statements are "presented fairly, in all material respects" "free of MATERIAL misstatements"

face value

equals the principal and the future value... all the same thing here and the maturity value AND (goddammit) also the PAR VALUE > all of these reflect value that bond holder will pay at maturity

Debt vs. equity financing

equity is more expensive than debt financing... BC lenders usually use legal means to protect their claims and reduce lender risk - and this risk reduction lowers the cost of capital equity is more risky (bc there is no guarantee of being paid back) which increases the cost of capital DEBT IS ALSO CHEAPER BC... govts often subsidize debt financing by allowing TAX DEDUCTIONS FOR INTEREST PAYMENTS - whereas dividends are pretty much never tax deductible... (so debt has a tax advantage - lowers your taxable income - which also contributes to its cheapness) DEBT ALSO ALLOWS TO FIRM TO LEVERAGE earnings to the benefit of shareholders... - debt holders claims on assets of the firm are limited to the debt agreement - basically if you earn more than what you need to pay back in interest, you can use that return to accue benefits to shareholders (bc debt holders do not expect greater than required interest return > their returns are fixed)

FINANCIAL LEVERAGE

ex. the magnification of a 10% increase in revenue to a 20% increase in Net Income >> how does this happen? its because not all costs are variable... so not every cost will increase as revenue increases. Thus, Net Income is not proportionally affected by the increase in revenues >> financial leverage results from fixed interest expense ! BUT VICE VERSA AS WELL... bc revenue can fall be a certain percentage... and then net income can fall even more drastically

VARIABLE OPERATING EXPENSES

expenses necessary to generate sales and that vary with sales ex. COGS and SG&A (selling, general, and administrative) total revenue after subtracting these expenses is: EARNING BEFORE INTEREST AND TAXES (EBIT) *Interest expense is fixed bc it does;t vary with how much you produce... you always have to pay it off...

BOND TERMINOLOGY

face value = principal (what you have to pay at maturity) coupon payments = interest payments in addition to the face value (function like annuities) >>> calculate coupon payments by multiplying the stated rate of return by the face value

adjustments when market interest rate changes

face value of asset (cash) and bond payable (liabilities) >> the amount of the bond payable / liability you pay off every year changes with new interest rate >> if the market rate doesn't change... then your coupon rate stays the same... but in this case, you have to pay an additional amount of interest per year >> (would just solve for this accretion table in excel) >>> oh i see they got the interest premium from whatever the present value of incremental payments over 100 was...

FULL DISCLOSURE PRINCIPLE

firms must disclose all "relevant" financial information... which is all info that could influence the decisions of a "reasonable" lender of investor >>> additionally, this principle also regulates the presentation of financial statements (so they are more easily accessible to investors)

Publicly Traded Company

firms that have missed public debt or who stock is publicly traded on a public securities exchange (ex. NYSE) Private companies are owned by private investors ("private equity")

NOTES RECEIVABLE - pg 56

firms that have to wait 90 days or more to be be paid often charge interest.... and this long waiting period (for a transaction) is the Note Receivable (rather than AR) * simple interest is common and calculated through Interest = principal x rate x time where the principal is the amount owed so you have the Note Receivable as an asset until its turned to cash... and then you continually factor in the interest expense earned (DON'T DOUBLE COUNT THOUGH) - subtract interest earned from an earlier period when adding it back on ...

CORPORATE VALUATION:

five most popular techniques: 1) public comparables 2) acquisition comparables 3) DCF 4) merger consequences analysis 5) LBO

Pro Forma Statements

forecasted / future financial statements >> big point of these is to predict future cash flows

Financial Lease

if the lessee is the de facto owner of the asset >> so if the contract contains a provision whether the title of the asset transfers to the lessee (or if they are likely to obtain ownership at some point) >> or if they own it for its total useful life (and rent payments basically cover its full value) TO RECORD - do present value of leased asset in liabilities and assets, then when you start to pay off the lease: - reduce by cash amount - reduce liabilities by amount of principal you pay off - reduce owners' equity by the interest expense - AND DON'T FORGET SEPARATE LINE ITEM OF DEPRECIATION (which subtracts from the asset using accumulated depreciation, and under depreciation expense)

Tax Liability

in the US the tax rate for corporations is 21%, but this rate will vary across international tax jurisdictions Taxes Payable is a LIABILITY >> and it reduces owners equity bc reduces net income

The Accounting Cycle

in the US, it is quarterly (meaning companies report their financial results on a quarterly basis) ACCOUNTING CYCLE HAS FOUR BASIC STEPS: 1) identification of accounting events (either in the statements as statement disclosures or note disclosures) 2) Valuation of accounting Events (put a monetary value on it) 3) Recording of accounting events - must formally record this 4) Disclosure of accounting events - this is the generation of the financial statements and supplemental note disclosures

"cooking the books"

incorrectly capitalizing assets that clearly should have been expensed... ex. WOLRDCOM (avoided expensing to artificially inflate profit numbers and meet "earnings expectations")

Event Three

increase in asset (PP&E) and then decrease in asset to pay for it (cash), and increase to liability

Interest payments

increase in liabilities, and then decrease in owner's equity from the expense >> expense must be booked in the current period (even it doesn't pay yet) ... bc it is benefiting in that period...

accreting

increasing the principal

Compound Interest

interest earned on principal and interest (keeps on growing - niceeee) ex. future value at end of year one = principal x (1 + interest rate) future value for year 2 = principal + interest year one + interest for second year = 100 + (100 x 0.1) + (100 x 1.1 x .1) or 100 x (1 + .1)^2

OPERATING LEASE

lessee recognizes only one expense, which is the sum of depreciation and interest (which has to sum to the yearly payment amount) >> so you solve for the interest component, and whatever is left over in the total amount paid annually is your depreciation component > so in this case the reduction of lease liability is the same value as the depreciation component (and you have to express that in a separate entry) LEASE EXPENSE (for operating leases) is usually referred to as rent expense

balance sheet

listing of balances from the ledger, shows balances of assets, liabilities and equities at a certain point in time

LONG TERM LIABILITIES and OWNER's EQUITY

long term liabilities include: 1) long term debt 2) pension and healthcare obligations 3) leases 4) bonds 5) deferred tax liabilities Many long term liabilities are measured at the present value of required cash payments ...

to calculate return for shareholders...

look how much is leftover after paying debt / interest payments... and then see how much you made out of the total profit (profit - interest expense / profit margin) SEE PAGE 38 FOR GOOD EXAMPLE OF THIS CALCULATION ...

what is the relevance to accounting?

many items on the Balance sheet are measured in present value - so you need to be able to match stuff up with one another in the same terms > ex. so if you know the future principal value plus interest rate, you can solve for how much the loan would be to get to that future value

Diluted EPS

measures earning attributable to not only the existing shareholders, but also to those who could become shareholders by exercising their right to do so SO DILUTED ... measures the earnings per share if these potential shareholders actually bought (bc they would be for lower price - SO DILUTED EPS IS ALWAYS LOWER THAN BASIC EPS) ... this is bc the denominator is larger (more people would want to buy the stock) = Adjusted Net Income / Adjusted average number of shares of stock outstanding ADJUSTMENTS: - people who hold stock options have the right to purchase shares of stock at a predetermined price (the EXERCISE PRICE or STRIKE PRICE) ... - so they don't technically own this stock, they just have the right to repurchase it in the future ... >>> people will exercise this option if the MARKET PRICE is higher than the EXERCISE/STRIKE price ANOTHER ADJUSTMENT - for convertible debt, if convertible debt holders decide they want to exercise their right to hold shares ! >> so denominator would get larger, but SO WOULD NUMERATOR (bc you are adjusting the interest expense... which impacts Net Income)

Record Amortization Expense

minus 121 for cash (or whatever payment you are making) minus 100 in debt (liabilities) - which represents that amount of principle you are paying down minus 21 from retained earnings (expense) bc its interest expanse TO CALCULATE INTEREST - use the principal balance from the year before Okay yeah you still need to review this stuff... TABLE ON THIS STUFF IS ON PAGE 82 ... probably just print this off of commit to memory

Convertible Debt

mix between debt and equity , and while the terms may vary, its usually that debt can be converted into shares of stocks - so debt holders earn a fixed return, but could trade in for equity and get a higher return

common stokc

most popular form of equity financing , but does have the right to vote for shareholder resolutions and for members of the Board of Directors (preferred holders often do not)

Annuities

multiple payments that are the same amount and that are separated in time by a constant interval ( like years )

Introduction of a Firm:

negative net income (at a loss) negative cash flows from operating activities (CFO) Negative cash flow from investing (CFI) - bc firm is investing heavily in CapEx CFF (cash flow from financing) is positive because most of the firms cash is coming from external sources! *takes time and money to "set up shop" and eat a customer base

CLOSING THE BOOKS

or the "Closing Entry" - its purpose is to re-set the balances in the revenue and expense accounts to zero so that they can accumulate the next period's revenues and expenses >> this is because revenues and expenses are "temporary accounts" >> YOU CLOSE OUT THESE TEMPORARY ACCOUNTS BY TRANSFERRING THEIR BALANCES TO RETAINED EARNINGS (so retained earning is the final entry) > is the final link between the statements and allows accountants to produce the financial statements

FINAL SECTION - OWNERS EQUITY

owners equity is the net book value of the firm (assets - liabilities) , aka "book value" or "residual interests of the firm" **basically it means that owners receive that leftovers of assets after the firms obligations (liabilities) have been satisfied

UNEARNED REVENUE

payment received but performance has not yet been carried out... these are considered to be liabilities (bc you owe someone a service) AKA deferred revenue - get yo money up front but you still gotta do something... FOR BOOKING IT - when it first comes in - you increase assets in form of cash, and then you increase liabilities by the same amount >>> when you finally deliver it: you reduce liabilities (bc you don't owe it to someone anymore), and you can also recognize revenues by the same amount ! (bc you finally delivered on your promised service)

RESTRUCTURINGS

pertain mainly to severance pay for employees that are being terminated

COST PRINCIPLE (AKA HISTORICAL COST )

pertains to measurement of asset purchases.... assets recorded on balance sheet are based on their cash equivalent value CASH EQUIVALENT VALUE: present value of future cash flows THIS PRINCIPLE: requires inclusion of all cash or cash equivalent outlays to bring the asset its place of intended use by the firm ex. cost of a machine includes the INVOICE PRICE, but also cost of shopping, insurance and installation (like what you get charged for shopping online... tax + shipping + tag price)

Purpose of Financial Accounting

provides information that helps assess the risks and rewards before making a lending or investing decisions Major decisions are made based off of these numbers, so its important that these numbers are correct

RECORDING THESE PAYMENTS

record the initial amount you get through: - increase in assets and increase in liabilities (bonds payable - by same amount) - decrease cash every year for the coupon payments, and then expense those payments under owners equity - at maturity date, minus the principal value in cash, and reduce the amount of bonds payable by the same amount

Write off for Allowance for Doubtful Accounts

reduce AR (by the same amount) and then add it as a positive under assets for Allowance for Doubtful Accounts

amortizing

reducing the principal

Wage Entry

reduction in cash / assets, and reduction in owners equity (expense)

"consensus"

refers to all stock analysts responsible for covering a firms stock

SEC

regulates financial accounting in the US, also regulates the markets and imposes fines on firms who break the rules

SARBANES OXLEY (2002)

requires that the CEO and CFO certify the firm's financial statements before submitting them (to make financial statements more transparent and reliable to users)

"below the line"

results from other (non central operations) - ex. non-operating expenses

recaptures

reversals of impairment... but pretty heavily regulated (and you can't do this for Goodwill)

Sales and Discounts, Returns and Allowances

sales discount - encourage buyers to buy / pay earlier when you get a discount... the discount is subtracted from the value of the inventory for the seller, and then is a contra revenue account for the seller bc they aren't actually getting the full amount of AR sales return (obj) >> you create an expense called "sales expense" to show value of items that were returned (important to show that not full sale stuck) > is a contra-revenue account sales allowances - price concessions to buyers after the initial sale if they see the product and not return it > another contra-revenue account (for the seller) - they reduce the revenue by the amount of the sales allowance (discount) >> no reversal of COGS because the items weren't actually returned

commercial paper

short term corporate debt

treasury bills

short term, guaranteed federal govt. bonds

Recording Depreciation

so at first you transfer cash assets the physical equipment, and then after the first year, you put accumulate depreciation under the asset value (in assets) >>. and ALSO record this as Depreciation Expense under owners equity

What if scenario ? Investor has a different required rate of return (based on the market)

so basically what would happen is if interest rates rise, than the bond issuer would have to lower the price of the bond in order to entice people to buy / lend / invest anyways To calculate new present value / issue price - you use the same present value formula for all of the annuity payments, but you use the market rate of interest this time PAGE 88 for excel calculation

Tax Law stuff -

sometimes tax laws require firms to postpone deductions until future periods... but also sometimes laws allow firms to accelerate deduction to the current period DEFERRED TAX ASSETS - you will get a deduction, but you have to wait until a later date (postponed deductions, bc its something you can use in the future) ex. Contingent liability or a restructuring expense (bc you have to recognize these expenses early bc of conservatism principle) - basically you have to record these in anticipation before you actually pay the expense... and the govt. will not give you the deduction unless the liability was actually paid **** SO ITS COUNTERINTUITIVE BC YOUR LIABILITY (the contingency expense) BECOMES AN ASSET **** (bc the govt pays you for your loss) > think about it in the sense that govts. often reward the losers DEFERRED TAX LIABILITIES - you accelerate deductions to the current period (accelerated deductions) >> bc if they are used in the current period to reduce taxes, then future taxes will be higher (bc you used up all your deductions presently, so you have no other deductions left for future periods) - that's why your high future tax burden is reflected in Deferred Tax Liabilities reasoning behind deferred tax liabilities - if you reduce tax incidence in the current period, allows company to hold on to cash and perhaps invest it in areas that can benefit the economy ex. purchase of depreciable assets (like equipment)

Management's Discussion & Analysis (MD&A)

special section in the Annual Report of 10-K, in this section, management must discuss the reasons for major changes in the Financial Statements

FASB

stands for Financial Accounting Standards Board - (in Norwalk CT) , under jurisdiction of the SEC SEC authorizes FASB to write accounting rules for publicly traded companies THE RULES THAT FASB WRITES MAKE UP GAAP - public companies must submit financial reports to the SEC, and these financial reports must abide by GAAP principles (AND they must be audited by a third part auditor)

Treasury Stock

stock that firm repurchases from stockholders (or just repurchased stock) Reasons to repurchase: - may be better than dividends because stock repurchases could result in capital gain (and this gain would need to be taxed lower than dividends) - so loss from taxes would need to be less than loss from dividends - counteract dilution - boost earning per share by decreasing the number of shares outstanding - could be necessary to have an inventory of shares available for expected exercise of stock options - may indicate managements' belief that the stock is a good deal (as in it is underpriced - so they could gain by selling it back at a higher price later) - may prevent hostile take over / acquisition

Seasoned Equity Offerings (SEO)

subsequent sales of publicly traded stock (after the IPO)

"ABOVE THE LINE"

the results from a firm's central, ongoing operations THE EBIT - which is considered the high quality component of Net Income (as its more sustainable / more likely to occur in the future - rather than gains or losses)

Stock analysts

their jobs are to forecast future basic and diluted EPS - (earnings expectations) >> if they have positive expectations, then the stock price may jump as more people want in

TANGIBLE (FIXED) ASSETS

these are always capitalized! - and include all associated costs to get it up and off the ground ... >>> can be financed in multiple ways, but the associated cost with financing (like interest payments on debt financing) - are added on top as an expense and at present value (you don't depreciate that aspect) - financing with debt is a non cash transaction but you still gotta record it >> to show that you would reduce the cash (bc the cash goes towards the original note payable) >> and then also goes towards interest expense (in equity)

when these contra revenue accounts are more relevant (like in retail shops),

these contra-revenue allowances will be estimated (similarly to allowance for bad debts)

OH AND SOMEHOW ONE MORE SUPER WEIRD THING ABOUT DEFERRED TAX LIABILITIES

they aren't measured in present value of future cash payments!! - one bc we don't know the interest rate to use - AND we do not know when the cash payments will be made ** bc of this uncertainty , they are recorded as the future value

three considerations for the value of equity investments

three types of ownership: 1) passive - less than 20% ownership: use the FAIR VALUE METHOD 2) significant influence - 20-50% of ownership : EQUITY METHOD 3) control: 51-100% ownership: Investor consolidates the invests financial results with its own having significant influence leads people to report - "investments in affiliates" control is also known as "consolidation:" and the company that is being invested in = becomes a subsidiary

INTEREST CAPITALIZATION -

typically interest is considered an expense and is recorded as a charge to owners equity BUT interest is capitalized for assets that are built for the firms own use... "SELF CONSTRUCTED ASSETS"

expenses end up totaling to the same amount over the lease period (between financial and operational) but they are front-end loaded for the finance lease (you pay more of your principal in year one)

ultimately, classification of the lease influences your EBIT

PASSIVE EQUITY INVESTMENTS

use Fair Value - adjust original value of investment to current fair value >> so firm can recognize if the value of the investment increases (gain vs. loss) - even though it technically goes against conservatism, relevance is considered to be more relevant than conservatism >> gains and losses realized through Net Income - so it is abbreviated as FVTNI (but you have to mark it as unrealized until you actually sell it) ... >>> these are temporary accounts .... so you can't realize it / translate it to income statement / retained earnings until the equity is sold

Indirect Method to Derive Cash Flows

use Net Income (accrual based) and then adjust to remove non-cash items ( MOST FIRMS USE THE INDIRECT METHOD ) - including me

Cost Principle

use cost principle in all types of influences, for the initial acquisition period. INITIAL VALUE OF INVESTMENT IS ITS COST >> also you would include broker fees capitalized in the investment account (so how much you paid plus transaction costs)

BASICALLY BIG RELEVANCE HERE IS THAT YOU ARE RECORDING LIABILITIES IN THE PRESENT VALUE - not as what you may ultimately owe these lenders...

use the present value formula to determine the value you will have on your books

EQUITY METHOD

used for significant influence cases... the investment account is adjusted up or down depending on the Net Income of the invested (basically you take a percentage of the net income that your invest earned... ) AND you treat this as an asset / investment income - because you are realizing it / assuming the investee is sharing the earnings with you *** you would usually not report this type of income in operating section - would be typically under investments - unless the business model of the company invested in was central to your own

Articulation -

used to refer to the concept of interrelated financial statements... ex. income statement articulates RETAINED EARNINGS (equity), and statement of cash flows articulates the CASH ACCOUNT (assets) REMEMBER - balance sheet is at a particular time, and the cash flow and income statements are over a particular period of time ... > this is bc balance sheet is a cumulative statement (summation of events over a period of time, at a particular point in time)

Return on Invested Capital (ROIC)

uses EBIT, NOPAT, effective tax rate, and Market Cap NOPAT = net operating profit after taxes (but before interest expense)

Amortization

usually, these assets are amortized over their remaining useful lives (and usually done on a straight line basis) > those that are non-amortizable, are tested for impairment, but that's it...

Valuing leases

value assigned to each is the present value of the lease payments (so rent payments owed to the lessor) TWO MAIN EXPENSES AFTER THE RECOGNITION OF THE LEASE: 1) depreciation on the leased asset 2) interest on the lease liability >> for operating leases, both of these costs are shown as EXPENSE and as part of EBIT >> for financial leases, depreciation will be kept with EBIT, but the interest moves below EBIT

PRESENT VALUE -

value of cash TODAY hell yeah > cash has a time value, which is "interest"

GOODWILL

what results from consolidation, defined as the excess of the purchase price over the fair values of identifiable assets, net liabilities Reason investors pay more is that they predict there will be synergies between the two sets of assets, so they can gain (and will pay for the value add of combining the two sets of assets) become a INTANGIBLE ASSET - but you don't amortize it... so it stays on the balance sheet at its original cost HOWEVER - it is tested yearly for "impairment"

The AGENCY PROBLEM

when one party (the principal) delegates work to another party (the agent). >> the principal may want the agent to act of his behalf, but the agent may desire to fulfill his or her own goals instead (which may be counter to goals of the principal) in this context... - stakeholders/shareholders/owners are the principals - managers are the agents... but managers do not always maximize the principal goals > adverse selection is when the principal chooses someone that cannot fulfill their goals (more about ability) "moral hazard" - when agent doesn't follow through mainly because of effort, not because of ability (wrong incentives) SOLUTIONS TO AGENCY PROBLEM - MONITORING AND INCENTIVE CONTRACTING >> govt bodies and auditors do this monitoring for owners who can't do it themselves

DISCOUNT

when you reduce issue price because interest rates go up, it means the bond was issued at a discount. - and you just adjust the initial issue cost to reflect that (so the cash asset value and bond payable liabilities section) >> and then once you adjust the issue price, you then have to adjust the coupon payments so you still hit the par value

PREPAID/DEFERRED EXPENSE -

you paid for the expense in cash, but the benefit has not yet been received (THESE ARE CONSIDERED ASSETS - bc similar to accounts receivable, someone is giving something to you in the future... you didn't just put down that money for shit...) - IN THIS CASE, you first increase assets in the form of prepaid expenses, and then decrease your cash assets >> when you finally get the service.... you can then recognize it as an expense... which at that point you subtract from Ret. Earning and then also reduce your assets EXAMPLES : rent and insurance - usually pay rent and insurance at the beginning of the period... >>> if this is a lump payment for multiple payments... you subtract assets as you use up the benefits in the contact... ex. if its 12 month contracts and you have received 9 months of benefits, then subtract 9/12 the original prepaid expense asset value >>> and that's when you expense it!

TO CLOSE OUT TEMPORARY ACCOUNTS (INCOME STATEMENT)

you reverse all of the signs of the temporary accounts, so sales become negative and expenses become positive >> and then you are able to close out these accounts to RETAINED EARNINGS (and this is because of the debit credit weirdness I'm pretty sure...)

what if you sell the bond at a premium? market rate is lower than coupon rate...

you would be selling the bond at a PREMIUM >> calculate the present value given the current market rate (but using projected coupon payments) would issue the bond at the premium... and then you pay less than one hundred every year from the face value point to get to the principal amount of 1,000 >> and now you would make the bonds payable / liabilities section NEGATIVE because you are reducing your liability (lower payments with higher up front cost)