CFA Level 1 - Financial Reporting & Analysis

Quick Ratio (Liquidity)

(Cash + short-term marketable investments + receivables)/Current liabilities Recognizes that certain current assets represent costs that have been paid in advance and cannot be converted into cash (such as prepaid expenses). It also considers that inventory cannot be liquidated at fair value immediately.

Cash Ratio (Liquidity)

(Cash + short-term marketable investments)/Current liabilities Reliable measure of entity's liquidity position. It only includes cash and highly-liquid short term investments.

Basic EPS IFRS and GAAP required EPS (basic and diluted) on the face of the income statement

(net income - preferred dividends)/weighted average number of common shares outstanding Only income from continuing operations that is available to common shareholders is considered. Preferred dividends are subtracted from net income because they are not included in expenses on the income statement calculation of net income. Shares outstanding should be adjusted for stock splits, stock dividends, and stock repurchases. Stock splits and stock bonuses increase the number of shares outstanding while stock repurchases would decrease the number of shares outstanding.

Cash Flow From Operations (CFO) - FASB

+Cash rcvd from customer +Cash dividends rcvd +Cash interest rcvd +Other cash income ((trading securities) - Payment to suppliers - Cash expenses (wages etc) - Cash interest paid - Cash taxes paid

Stock options and warrants: Use treasury stock method for diluted EPS

-Net income in numerator does not change -Number of shares outstanding increases by the number of shares issued upon exercising the option minus number of shares repurchased with the proceeds of the option exercise. Shortcut for calculating net increase in number of shares: (Market price - Exercise price) / Market Price * (Number of shares created from the exercise of options)

IFRS: Required F/S

1) Balance Sheet; 2) Comprehensive Income; 3) Statement of Changes in Equity; 4) Cash Flow Statement; 5) Accounting policies and explanatory notes.

Types of accounting changes:

1) Change in accounting principle; 2) Change in accounting estimate; 3) Prior period adjustments

IFRS: Structure and content requirements

1) Classified statement of financial position (separate current vs noncurrent) 2) Minimum information on the face of financial statement 3) Minimum information in the notes (disclosures) 4) Comparative information (prior periods)

IASB

1) Development and promote the use and adoption of a single set of high-quality financial standards 2) To ensure the standards result in transparent, comparable, and decision-useful information while taking into account the needs of a range of sizes and types of entities in diverse economic settings 3) To promote the convergence of international accounting standards and IFRS

Roles of financial reporting & analysis include:

1) Evaluating equity investments for a portfolio; 2) Evaluating potential M&A; 3) Evaluating a subsidiary of a parent company; 4) Deciding on private equity/ venture cap investment 5) Determine creditworthiness - borrowing; 6) Extending credit to customers; 7) Examining compliance with covenants/contracts; 8) Assigning a debt rating; 9) Valuing a security - Equity research/reports; 10) Forecasting future earnings/cash flows;

Sales Basis Revenue Recognitions

1) Installment Sales (If collection is certain, rev is recognized at time of sale while interest component is recognized over time) 2) Installment Method: (if collection of revenuescannot be estimated) 3) Cost-recovery (if collectability of revenues is highly uncertain)

Intangible Assets (Balance Sheet)

1) Lack physical form (patent, copyrights, etc.); 2) Finite useful life => amortized and may be impairment 3) Indefinite useful life => impairment IFRS and GAAP, costs related to the following are expensed = start-up and training costs, admin and overhead costs, advertising and promotion costs, relocation and reorg costs Accounting goodwill is based on accounting standards and is only reported for acquisitions. Economic goodwill is not reflected on the balance sheet and is based on company performance.

Steps of Financial Statement Analysis

1) Purpose and context 2) Data Collection 3) Data Processing 4) Analysis/Interpretation of data 5) Develop conclusions and recommendations 6) Follow-up

Qualitative Characteristics of IFRS

1) Relevance - information should be useful in making forecasts or to evaluate past decisions or forecasts; materiality states that information should be timely and sufficiently detailed with no omissions or misstatements 2) Faithful representation requires that all information is complete, neutral, and free from error Supplementary qualitative characteristics: 1) Comparability 2) Verifiability 3) Timeliness 4) Understandability

Trade-Offs Qualitative Characteristics of IFRS

1) Relevance vs. reliability; 2) Benefit > cost; 3) Excludes intangibles and non-quantifiable info.

Balance Sheet Formats

1) Report format (A/L/E presented in single column) 2) Account format (A on left, L/E on right) 3) Classified balance sheet (A/L grouped into subcategories such as current) 4) Liquidity-based presentation (IFRS only)

Financial Instrument

A contract that gives rise to a financial asset for one entity and a financial liability or equity instrument for another entity (securities, stocks, bonds, derivative).

Sarbanes-Oxley Management Report:

1) Responsibility to establish and maintain adequate internal controls 2) Mgmt's framework for evaluating internal controls 3) Assessment of the effectiveness of internal controls over the last operating period 4) Statement of auditor's attestment 5) Certify that f/s are fairly presented

Management's Discussion and Analysis (MD&A)

1) Results of operations and discussions of trend; 2) Capital resources, liquidity, and cash flow trends; 3) General business overview and prospects based on known trends; 4) Effects of trends, events, and uncertainties; 5) Discontinued operations, extraordinary items, unusual items; 6) Disclosure in interim f/s; 7) Segment cash flow 8) Critical accounting policies that have a material impact on f/s and require subjective judgment.

IFRS Revenue Recognition

1) Risk & Reward transferred; 2) No continued control; 3) Reliable measurement; 4) Probable flow of benefits; 5) Cost verifiable

IFRS Revenue Recognition For Service

1) The amount is measurable; 2) probable that benefits from transaction will flow; 3) stage of completion can be measured reliably; 4) costs incurred and to complete can be measured reliably

Characteristics of an effective framework

1) Transparency; 2) Comprehensiveness; 3) Consistency

Barriers to a single framework:

1) Valuation (reliability verseus relevance) 2) Standard setting (principles-based, rules-based, objectives-oriented) 3) Measurement (asset/liability approach or revenue/expense approach)

Fundamental features of Financial Statements (IFRS)

1) fair presentation; 2) going concern; 3) accrual basis; 4) materiality and aggregation; 5) no offsetting; 6) frequency of reporting; 7) comparative information; and 8) consistency

Days of inventory on hand (DOH) (Activity)

365/Inventory turnover The higher the inventory turnover, the shorter the period that inventory is held.

Number of days of payables (Activity)

365/Payables turnover The higher the payables turnover, the lower the number of days payable.

Days of receivables outstanding (DSO) (Activity)

365/Receivables turnover The higher the receivables turnover ratio, the lower the DSO.

Simple capital structure

A capital structure that contains NO potentially dilutive securities (contains only c/s, nonconvertible debt, and nonconvertible pref. stock)

Cash Flow: Logic (A = L + E)

A: Increase = use cash (-), Decrease = source cash (+) L: Increase = source cash (+), Decrease = use of cash (-) E: Increase = source cash (+), Decrease = use of cash (-)

Ratio Analysis

Activity ratios measure how productive a company is in using its assets and how efficiently it performs daily operations. Liquidity ratios measure the company's ability to meet short-term cash requirements. Solvency ratios measure a company's ability to meet long-term debt obligations. Profitability ratios measure a company's ability to generate an adequate return on invested capital Valuation ratios measure the quantity of an asset or flow (earnings) associated with ownership of a specific claim (common stock). Limitations Companies have many divisions in different industries One ratio says yes but another says no No set ranges that ratios must lie in Accounting methods impact ratios International comparison is difficult Business cycle

Indirect Method Cash Flow formulas

Additions to net income Non cash items (depreciation, amortization, depletion, amortization of bond discount) Non operating losses (loss on sale or write-down, loss on retirement of debt, loss on investments under equity method) Increase in deferred income tax liability Changes in working capital (decrease in current operating assets AR, inventory, and prepaid expenses, increase in current operating liabilities AP, accrued expenses) Subtractions from net income Non cash items (amortization of bond premium) Non operating items (gain on sale of assets, gain on retirement of debt, income on investments under equity method) Decrease in deferred income tax liability Changes in working capital (increase in current operating assets AR, inventory, prepaid expenses, decrease in current operating liabilities AP and accrued expense liabilities)

Types of accounting changes: prior period adjustments

Adjustment involves errors or new accounting standards. Restate prior period and disclose nature and effect on net income.

Current Ratio (Liquidity)

Current assets/current liabilities A company's ability to meet short-term obligations. Measures how quickly a company can convert its assets to cash. Higher ratio indicates more liquidity. Low ratio indicates a greater reliance on CFO and outside financing to meet short-term obligations. Assumes inventory and AR can be converted to cash.

Calculating CFI

Beginning gross fixed assets + Purchase price of new fixed assets - Historical cost of disposed fixed assets = Ending gross fixed assets Net Fixed assets = Gross fixed assets - accumulated depreciation Beginning accumulated depreciation + Current year's depreciation on all assets - Accumulated depreciation on sold asset = Ending accumulated depreciation Book value of sold equipment = Historical cost - Accumulated Depreciation Selling price - Book value = Gain/loss on sale of equipment

IFRS/US GAAP Frameworks: Measurement of Elements:

Both: Broadly consistent, lack fully developed concepts FASB: Assets revaluations prohibited (except some financial instruments)

IFRS/US GAAP Frameworks: underlying assumptions:

Both: Recognize going concern & accrual assumptions IASB: Going concern & accruals given more prominence in framework FASB: Going concern assumption not well developed in framework.

Cash Flow Statement to Income Statement and Balance Sheet

CFO + CFI + CFF = Change in Cash Year-end cash balance - Beginning of year cash balance = Change in cash CFI is calculated from changes in asset balances under the noncurrent assets section of balance sheet. CFF is calculated from changes in equity and noncurrent debt sections of the balance sheet Beginning accounts receivable + Revenues - cash received from customers = Ending accounts receivable Beginning accounts payable + Purchases - cash paid to suppliers = Ending accounts payable Beginning retained earnings + Net income - Dividends declared = Ending retained earnings

Analysis of Cash Flow Statements

CFO changes: Changes in A/L should be used to determine whether business operations are the source or use of cash. Operating CF should be compared to net income. If high NI does not mean high operating CF then the company is using aggressive revenue recognition policies. Operating CF should exceed NI and volatility reflects risk CFI changes: Changes in LT asset and investment accounts are used to determine the source or use of cash. Increasing outflows may imply capital expenditures, how will these be financed? CFF changes Changes in interest-bearing debt and equity are used to determine sources and uses of cash flow. Debt issuances need to consider repayment schedule. Increasing use of cash to repay debt, repurchase stock, or make dividend payments might indicate lack of lucrative investment opportunities.

CFO - Indirect method steps

CFO is calculated by applying a series of adjustments to net income 1) Start with NI 2) Subtract gains or add losses from financing or investing cash flows 3) Add non-cash charges (depreciation/amortization) & subtract all non cash revenue. 4) Add/Subtract changes to working capital accounts. Add all sources cash (+ in current liabilities and - in current assest) and subtract uses of cash (- in current liabilities and + in current assets)

Inventory turnover (Activity)

COGS/Average inventory Measures the effectiveness of a company's inventory management. High turnover might indicate effective management or inadequate inventory levels. Low turnover indicates obsolete inventory or too much resources tied up in inventory.

Current Assets (Balance Sheet)

Cash and cash equivalents - less than 90 days - measured at amortized cost or fair value Marketable securities - debt and equity securities traded on public markets - measured at market value Trade receivables - amounts owed to company from sales - reported at net realizable value Inventories - physical stock held by the company in the form of finished goods, work-in-progress, or raw material, excluding abormal wasted labor/materials, storage costs after production, admin overhead, selling costs - IFRS = lower of cost & net realizable value (selling price minus selling costs) GAAP = lower of cost & market value (current replacement cost is between NRV minus normal profit margin) Other current assets - items not material enough to be reported as a separate line item are aggregated here including prepaid expenses and deferred tax assets

Direct Method Cash Flow formulas

Cash collections = Sales - Increase in accounts receivable Cash paid to suppliers = -COGS - increase in inventory + increase in accounts payable Cash salaries and wages = -Wages and salaries + Increase in wages and salaries payable Other operating expenses (cash) = -Other operating expenses (accrual basis) + decrease in prepaid expenses + increase in other accrued liabilities Cash interest paid = -Interest expense - Decrease in interest payable Cash taxes paid = -Income tax expense + Increase in tax payable Net CFO = Cash collections + cash paid to suppliers + cash paid to employees + cash paid for other operating expenses + cash paid for interest + cash paid for taxes

Cash Flow Ratios: Performance Ratios

Cash flow to revenue = CFO/net revenue Measures cash generated per unit of revenue Cash return on assets = CFO/average total assets Measures cash generated from all resources, equity, and debt Cash return on equity = CFO/average shareholders' equity Measures cash generated from owner resources Cash to income = CFO/Operating income Measures the ability of business operations to generate cash Cash flow per share = (CFO - Preferred dividends)/Number of common shares outstanding Measures operating cash flow available for each shareholder

Cash Flow Ratios: Coverage Ratios

Debt coverage = CFO/total debt Measures leverage and financial risk Interest coverage = (CFO + Interest paid + taxes paid)/ interest paid Measures ability to satisfy interest obligations Reinvestment = CFO/cash paid for LT debt repayment Measures ability buy LT assets with CFO Debt repayment = CFO/cash paid for LT debt repayment Measures ability to meet debt obligations with CFO Dividend payment = CFO/Dividends paid Measures ability to make dividend payments with CFO Investing and financing = CFO/cash outflows for investing and financing activities Measures ability to buy LT assets, settle debt obligations and make dividend payments from CFO

Direct versus Indirect method

Direct method lists sources of operating cash inflows and outflows, indirect provides net results Direct method is useful in evaluating past performance and making CF projections Indirect method provides a list of items that are responsible for the difference between net income and operating cash flow.

Free Cash Flow

Excess of a company's operating cash flows over capital expenditures. Fixed capital investment = FCInv Working Capital Investment = WCInv Free Cash Flow to the Firm (FCFF) = NI + Noncash charges + [Interest Expense*(1-tax rate)] - FCInv - WCInv CFO = NI + Noncash charges - WCInv FCFF = CFO + [Interest Expense*(1-tax rate)] - FCInv FCFF is cash available to equity and debtholders after meeting all operating expenses and capital expenditures. Free Cash Flow to Equity (FCFE) = CFO - FCInv + Net Borrowing FCFE available to common shareholders. If positive, the company has CFO available after payments for capital and debt, this excess belongs to shareholders.

Barter (IASB & FASB)

Exchange of goods or services between two parties (no cash, round-trip transaction) IASB: Revenue = revenue reporting in income statement based on fair value of revenues from similar nonbarter transactions with unrelated parties FASB: Revenue = revenue from barter transactions can be reported on the income statement at fair value only if the company has a history of making or receiving cash payments for services and can estimate FV

Common-size Cash Flow Statement

Express each item as a percentage of net revenues OR Express each item as a percentage of total cash inflows and each cash outflow as a percentage of total cash outflows.

Vertical common-size balance sheet

Expresses each balance sheet item as a percentage of total assets (Balance Sheet account/Total Assets) * 100

% of Completion Method for long term contracts

FASB & IASB - outcome can be measured reliably (cost, time, revenue estimates are reliable) Revenue, costs, and profits are allocated to each accounting period in proportion to the percentage of the contract completed during the period. Percentage is calculated by dividing total cost incurred during period by the total cost of the project. Losses must be recognized immediately regardless of IFRS or GAAP.

IFRS/US GAAP Frameworks: F/S elements:

FASB: Asset is a future economic benefit IASB: Asset is a RESOURCE from which future economic benefit is expected to flow. FASB also recognizes gains, losses, and comprehensive income as elements (in addition to assets, liabilities, owners' equity, revenues and expenses)

IFRS/US GAAP Frameworks: Recognition of Elements:

FASB: No discussion of "probables" in revenue recognition critera IASB: Asset, liabilities, are probable flows

Operating vs. Non-operating Income

Financial Services Companies: Operating activities: Interest, Dividends, G/(L) on disposal Non-Financial Services Companies: Non-operating activities: Interest, Dividends, G/(L) on disposal

Objective of audits

Financial statements in annual reports must be audited by an independent accounting firm. 1) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement and are prepared in accordance with an applicable financial reporting framework 2) To report on the financial statements and communicate in accordance with the auditor's findings. Unqualified opinion - f/s have been presented fairly in accordance with applicable standards Qualified opinion - f/s have been presented fairly but do contain exceptions to accounting standards Adverse opinion - f/s have not been presented fairly and significantly deviate from accepted accounting standards Disclaimer of opinion - an auditor cannot issue an opinion on the financial statements

SEC guidance for Revenue Recognition

GAAP recognizes revenue when it is realized or realizable and earned. 1) Evidence of an arrangement; 2) Completion of earnings process; 3) Price is determined or determinable; 4) Assurance of payment

Calculating CFF

Generated from the issuance and repayment of capital (LT debt and equity) and distributions in the form of dividends to shareholders. Long-term debt = an increase implies cash inflows from new borrowings, a decrease implies debt repayment cash outflows Equity = an increase in common stock implies inflows from issuance of new shares, a decrease implies share repurchases cash outflow Dividends = Cash dividends paid out: Cash dividends paid out = Beginning dividends payable + Dividends declared - Ending dividends payable Dividends declared = Beginning retained earnings + Net Income - Ending retained earnings

Financial Analysis Tools

Graphs facilitate comparison over time Pie charts illustrate composition of total value Line graphs identify trends and detect changes in direction or magnitude Stacked common graph illustrates changes in various items over the period Regression analysis helps identify relationships between variables over time for forecasting

CFO - Direct method

Income Statement items that are reported on an accrual basis are all converted to cash basis. To get to CFO: 1) Start with cash sales and adjust each income statement account for changes in related working capital accounts on the balance sheet 2) Determine whether changes in working capital accounts indicate a source or use of cash 3) Ignore all nonoperating items (gains/loss on sales) and noncash changes (depreciation and amortization)

Other Comprehensive Income

Income and expense items that are excluded from the income statement and reported directly in shareholders' equity (GAAP) or on a separate statement of comprehensive income (IFRS and GAAP). It is the change in equity from transactions from nonownership sources. Comprehensive Income = NI + OCI Ending shareholders' equity = Beginning shareholders' equity + Net income + OCI - Dividends declared Includes: Foreign currency translation adjustment Costs relating to the company's defined benefit post-retirement plan Unrealized gains or losses on derivative contracts that qualify as hedges Unrealized holding gains and losses on AFS securities

Effective tax rate

Income taxes / Pre-tax income

Sources versus uses of cash

Increases in current assets are uses of cash Decreases in current assets are sources of cash Changes in asset balances and cash are negatively related (think of inventory). Increases in current liabilities are sources of cash Decreases in current liabilities are uses of cash Changes in liability balances and cash are positively related (think of accounts payable).

Financial Ratio based on Income Statement

Indicators of profitability. Any income statement subtotal is expressed a margin ratio (to revenues): Gross profit margin = Gross Profit / Revenue Net profit margin = Net Income / Revenue Operating profit margin = EBIT / Revenue Pre-tax margin = EBT / revenue Operating margin = EBIT / sales

Cash categories: Cash flow from financing activities (CFF)

Inflows and outflows generated from issuance and repayment of capital (interest-bearing debt and equity). [Proceeds from debt issuance + proceeds from issuance of equity instruments] - [Repayment of LT debt + Payments made to repurchase stock + dividend payments]

Cash categories: Cash flow from investing activities (CFI)

Inflows and outflows generated from the purchase and disposal of long-term investments (PP&E, intangible, nontrading investments). [Sale proceeds from fixed assets + sale proceeds from long-term investments] - [Purchase of fixed assets + cash used to acquire LT investment securities]

Cash categories: Cash flow from operating activities (CFO)

Inflows and outflows related to a firm's day-to-day business activities. [Cash collected + interest and dividends received + proceeds from sale of securities held for trading] - [Cash paid to employees + cash paid to suppliers + cash paid for other expenses + cash used to purchase trading securities + interest paid + taxes paid]

IFRS versus GAAP classification of cash flow

Interest received - IFRS = Op or Inv, GAAP = Op Interest paid - IFRS = Op or Inv, GAAP = Op Dividends received - IFRS = Op or Inv, GAAP = Op Dividends paid - IFRS = Op or Inv, GAAP = Finance Bank overdrafts - IFRS = Cash equiv, GAAP = Finance Taxes paid - IFRS = Op, Inv, Finance, GAAP = Op Format of CF statement - IFRS = Direct or indirect (direct encouraged), GAAP = Direct or indirect with a reconciliation of net income to CFO regardless of the method used

FASB

Issues new and revised standards with the aim of improving standards of financial reporting so that information provided to users is useful for decision-making. Standards are contained in the Codification, which is the source of all authoritative US GAAP for nongovernmental entities. US GAAP is recognized as authoritative by SEC.

Noncurrent Liabilities (Balance Sheet)

Long-term financial liabilities and deferred tax liabilities (income tax expense > taxes payable, current and non-current portion). Measured at fair value: Derivatives Financial liabilities held for trading Non-derivative instruments with face value exposures hedged by derivatives Measured at cost or amortized cost All other liabilities (bonds payable and notes payable)

Discontinued Operations:

Reported BELOW the line. Operations management has decided to dispose of but: 1) has not yet done so or 2) did so in calendar year after it generated profit/(loss) Must be physically and operationally distinct from the rest of the firm.

Measurement Bases of Various Financial Assets

Measured at fair value: Held for trading (stocks and bonds) - divident income, interest income, realized gains and losses, URGL due to changes in market value are all recognized on income statement Available for sale (stocks and bonds) - in between trading and held to maturity - realized gains/losses, dividends, interest income are reported on income statement, URGL hit OCI as part of equity Derivatives Non-derivative instruments with face value exposures hedged by derivatives Measured at cost or amortized cost: Unlisted instruments Held to maturity - debt securities carried at amorized cost (face value - unamortized discount + unamortized premium), realized gains and losses and interest income are recognized on income statement, URGL are not recognized on financial statements Loans and receivables

Net Reporting of Revenue

Only the difference between sales and cost of goods sold is reported on the income statement (disclose in footnotes). Users are usually: 1) internet-based merchandising companies; 2) Sell product but never hold inventory; 3) Arrangement for supplier to ship directly to end customer.

Shareholders' Equity (Balance Sheet)

Owners' residual claim on the assets of an entity after deducting all liabilities. Capital contributed by owners (common stock or issued capital) - authorized shares are the maximum number of shares a company can sell under the company's Articles of Incorporation, issued shares have been sold to shareholders, outstanding shares are issued less shares repurchased (treasury stock). Preferred shares - receive dividends and have priority over common shareholders in liquidation, can be equity or financial liability Treasury shares - shares that have been bought back by the company, reducing owners' equity and shares outstanding Retained earnings - cumulative earnings (net income) of the firm over the years that have not been distributed to shareholders as dividends Accumulated OCI Non-controlling interest (minority interest) - minority shareholders' pro rata share of the net assets of a subsidiary that is not wholly owned by the company

Complex Capital Structure

Potentially dilutive securitites [options, warrants, convertible securities]

Balance Sheet (Statements of Financial Position)

Present a company's assets, liabilities, and equity at a point in time. Assets = Liabilities + Owners' equity Owners' equity = Assets - Liabilities Assets are the productive resources that a company owns. Liabilities are amounts that the company owes other entities. Owner's equity represents shareholders' residual claim on the company's assets after deducting liabilities.

Common-size Income Statement

Presents each line item on the income statement as a percentage of revenues. The standardization of each item removes the effect of company size and facilitates financial statement analysis, as the data can be used to conduct time-series and cross-sectional analysis. Trends in costs and profit margins: Vertical common-size I/S = (Inc Statement account/revenue) * 100

Statement of Change in Owners' Equity

Presents the effects of all transactions that increase or decrease a company's equity over the period. Includes Total comprehensive income for the period Effects of any accounting changes that have been retrospectively applied Capital transactions with owners and distributions to owners Reconciliation of the carrying amounts of each component of equity at the beginning and end of year Analysis of Change in each component of stockholder's equity that is shown in the balance sheet (GAAP only)

Cost-recovery method

Profit is recognized only once total cash collections (including principal and interest on any financing provided to the buyer) exceed total costs.

Installment Method

Profit recognized is the proportion of cash collected x total expected profit. Profit for period = (cash collected in the period/selling price) x total profit

Noncurrent Assets (Balance Sheet)

Property, plant, and equipment (PP&E) - land, plant, building, equipment - IFRS = cost model or revaluation model and GAAP = cost model Investment property - owned for rental income or capital appreciation - IFRS = cost model or FV model, not mentioned for GAAP Intangible assets - identifiable, non-monetary assets that lack physical substance - IFRS = cost model or revaluation model and GAAP = cost model - amortization depends on finite or infinite life Goodwill - the excess of the amount paid to acquire a business over the fair value of its net assets (reputation, brand, R&D) only created in an acquisition - capitalized, not amortized but tested for impairment

Income Statement (Statement of Operations, Profit and Loss statement)

Provides operating information relating to a company's business activities over a period of time. Net income = Revenue - Expenses

Payables turnover (Activity)

Purchases/Average trade payables Purchases = Ending inventory + COGS - Opening Inventory Measures how many times a year the company theoretically pays off all its creditors. A high ratio can indicate the company is not using available credit but also could be using early payment discounts. Low ratio could indicate trouble making payments or exploiting lenient supplier terms.

Receivables turnover (Activity)

Revenue/Average receivables High turnover indicates a company's credit collection procedures are highly efficient however overly stringent credit policies may hurt sales. Low ratio is not good. Compare to industry sales growth.

Types of accounting changes: accounting estimate

Refers to change in mgmt judgement. Does NOT require restatement of prior period earnings (prospectively). Disclose in footnotes.

Types of accounting changes: accounting principle

Refers to changes from one GAAP method or IFRS method to another (LIFO to FIFO). IFRS & GAAP require prior year data shown in f/s to be adjusted (retrospectively).

Unusual OR Infrequent items:

Reported ABOVE the line. Examples include restructuring charges and gains/losses arising from selling an asset for more or less than its carrying value.

Extraordinary Items: Unusual AND Infrequent items:

Reported BELOW the line and not permitted for IFRS. Examples include losses caused by a natural disaster.

Total asset turnover (Activity)

Revenue/Average total assets Measures the company's overall ability to generate revenues with a given level of assets. A high ratio indicates efficiency. It also identifies strategic decisions by management - a business that uses highly capital-intensive techniques for production will have a lower total asset turnover compared to a business that uses labor-intensive methods.

Working capital turnover (Activity)

Revenue/Average working capital Working capital = current assets - current liabilities Indicates how efficiently the company generates revenue from its working capital. A higher ratio indicates higher operating efficiency.

Gross Reporting of Revenue

Sales and cost of goods sold are reported separately. GAAP company must: 1) must be primary obligor under the contract; 2) bear inventory and credit risk; 3) choose its supplier; 4) have reasonable latitude to set the price.

Dilutive Securities

Securities that could be converted into common stock would decrease EPS if exercised If X< Avg. stock price then could be exercised If X> Avg. stock price then will not be exercised Antidilutive securities would increase EPS if exercised.

Convert from Indirect to Direct cash flow method

Step 1: Aggregate all revenues and all expenses, operating and nonoperating Step 2: Remove the effect of noncash items from aggregated revenues and expenses and separate the adjusted revenues and expenses into their respective cash flow items Step 3: Convert accrual-based items into cash-based amounts by adjusting for changes in corresponding working capital An increase (decrease) in asset accounts is a cash outflow (inflow). An increase (decrease) in liability accounts is a cash inflow (outflow).

Potentially Dillutive Securities

Stock options, Warrants, Convertible debt, Convertible preferred stock

Solvency Ratios

The higher the ratio, the LESS likely a company is to meet long-term liabilities (high ratio => high leverage). Long-term debt-to-equity ratio = Total long-term debt / total equity Debt-to-equity = Total debt / total equity Total debt ratio = Total debt / total assets Financial leverage ratio = Total assets / total equity

Liquidity Ratios

The higher the ratio, the greater likelihood of meeting short-term liabilities. Current ratio = Current assets / Current liabilities Quick ratio (acid test) = (Cash + marketable securities + receivables) / current liabilities Cash ratio = (Cash + marketable securities) / current liabilities

The objective of financial reporting

To provide financial information that is useful in making decisions about providing resources to the entity to existing and potential providers of resources to the entity (investors, lenders, and creditors).

Current Liabilities (Balance Sheet)

Trades payable (accounts payable) - owed by business to suppliers for purchases on credit Notes payable (current borrowings) - borrowing from creditors depending on repayment Current portion of long-term liabilities - portion of long-term debt obligations that are expected to be paid within on year Income taxes payable - taxes that have not actually been paid yet Accrued liabilities - expenses that have been recognized on the income statement bu still have not been paid for as of the balance sheet date Unearned revenue - cash received in advance for goods or services still to be delivered

Funded status of the pension plan (under US GAAP & IFRS) is reported where?

US Gaap: Balance Sheet IFRS:Disclosed in Footnotes May be mentioned in MD&A if mgnt considers it significant

Under Completed Contract Method for long term contracts

Used when estimates of revenue or cost are unreliable or short-term contracts. (US GAAP only) Revenue, expense, and profit is recognized when substantially finished, costs are accumulated under a construction-in-progress asset (IFRS) Revenue is recognized to the extent of contract cost, cost are expensed when incurred, and no profit is recognized at completion. Losses must be recognized immediately regardless of IFRS or GAAP.

Diluted EPS IFRS and GAAP required EPS (basic and diluted) on the face of the income statement

[net income - preferred dividends + convertible preferred dividends + (convertible debt interest)*(1-t) ] / [weighted average number of common shares outstanding + new shares from conversion + new shares issued from stock options exercised - shares repurchased from proceeds of option exercise] Evaluate each instrument independently to determine whether they are dilutive. Test: Convertible preferred shares/new shares issued upon conversion < basic EPS => dilutive or Convertible bond interest*(1-t)/new shares issued upon conversion

Statement of Cash Flow - relevance:

assess liquidity, solvency and financial flexibiliy