FRA 3 - UNDERSTANDING INCOME STATEMENTS

gross profit margin

Gross profit / revenue

cumulative catch-up adjustment

sometimes the contract might change -> we need to account for adjustments.

basic EPS

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

operating vs non-operating components

*IFRS* - does not define operating activities *GAAP* - activities as those that generally involve producing and delivering goods and providing services, and include all transactions and other events that are not defined as investing or financing activities

Single step vs multi step income statement

*Single* - all revenues are grouped together and all expenses are grouped together *multi* - includes subtotals such as gross profit and operating profit

changes in accounting policies

*retrospective* - any prior financial statements must be restated - change accounting policy (if the company chooses), errors *prospective* - new rules apply only to future statements, e.g changes in accounting estimates if the new accounting standard is imposed by standard setting bodies - the company can choose

unusual or infrequent items

- *IFRS* requires separate disclosure of unusual or infrequent items *GAAP* - part of continued operations, but disclosed separately -> affects Operating income Impairments, write-offs, write-downs, and restructuring costs - considered either unusual or infrequent, but not both

IFRS Income Statement Presentation

1. A section of a single statement of comprehensive income 2. Separate statement followed by a statement of comprehensive income Expenses can be grouped by *nature* and by *function*.

example: A company had 500,000 common shares and $3 million of a 6% convertible bond issue, which was outstanding throughout the last accounting period. The convertible bond is convertible into 20 shares per $1,000. If the company's net income was $5 million and the tax rate was 30%, the diluted earnings per share were closest to:

1. Calculate interest: 6% * 3mil * 0.7 = 126k 2. Calculate new shares issued: we have 3 mil of convertible into 20 shares per 1000. So we have 3mil / 1000 * 20 = 60k new shares.

summary:

1. For convertible debt and preferred shares: If dilutive EPS < Basic EPS -> we must calculate new dilutive EPS and account for that. Otherwise, we just ignore that and our dilutive EPS = basic EPS. this is If converted method. 2. For warrants and options, we compare average price and exercise price. If average price < exercise price -> we do not convert. Here, also remember the the firm buys converted securities at average price. This is treasury stock method.

other comprehensive income

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

recognizing revenue converged standards

1. Identify a contract with the customer 2. identify separate or distinct performance obligations in the contract - promise to deliver a distinct good or service 3. determine the transaction price 4. allocate the transaction price to the performance obligation in the contract 5. recognize revenue when the entity satisfies performance obligation

IFRS securities

1. Securities measured at fair value through profit and loss (corresponds to trading securities under U.S. GAAP). 2. Securities measured at amortized cost (corresponds to held-to-maturity under U.S. GAAP). 3. Securities measured at fair value though other comprehensive income (corresponds to available-for-sale under U.S. GAAP).

US GAAP securities

1. Trading securities - Debt securities that a firm owns, but intends to sell. unrealized gains and losses during the period are reported on the income statement. 2. Held to maturity - Debt securities the firm does not intend to sell prior to maturity. Securities classified as held to maturity are reported at amortized cost on the balance sheet (not fair value) 3. Available-for-sale - Debt securities that are not expected to be held to maturity or sold in the near term. Unrealized gains and losses on available-for-sale securities are reported as other comprehensive income, not on the income statement.

calculation of average shares outstanding example

1. When there are stock splits or stock dividends, apply this retrospectively.

other comprehensive income items

1. foreign currency translation adjustments 2. adjustments for minimum pension liability 3. unrealized gain and losses from cash flow hedging derivatives 4. unrealized gains and losses from *available-for-sale* securities *(GAAP)* or *securities measured at fair value through other comprehensive income* (IFRS)

GAAP Income statement presentation

1. section of a single statement of comprehensive income 2. separate statement followed by a statement of comprehensive income that begins with net income 3. separate statement with the components of other comprehensive income presented in the statement of changes in shareholders' equity

example of calculating Weighted average shares

Answer is 430. Here, remember that stock splits are retroactive - on 1st of Jan, 180k*2 = 360k shares outstanding. On June 1, 60k*2 = 120k shares outstanding.

by nature vs by function example

By nature - tax expense, interest expense by function - COGS

period costs

Expenses that are not tied directly to generating revenue, such as administrative costs, are called period costs and are expensed in the period incurred

check if preferred shares were actually converted

If diluted EPS < Basic EPS => they were - dilutive -> effects of the conversion should be included in the calculation of diluted EPS (if converted method) If diluted EPS > Basic EPS -> antidilutive.

comprehensive income

Net Income + other comprehensive income

net profit margin

Net Income / revenue

operating profit margin

Operating profit / revenue

by nature vs by function

Presenting all depreciation expense from manufacturing and administration together in one line of the income statement is an example of grouping by nature of the expense. Combining all costs associated with manufacturing (e.g., raw materials, depreciation, labor, etc.) as cost of goods sold is an example of grouping by function. Grouping expenses by function is sometimes referred to as the cost of sales method.

treasury stock method (for options and warrants)

Stock options and warrants are dilutive only when their exercise prices are less than the average market price of the stock over the year. If the options or warrants are dilutive, use the treasury stock method to calculate the number of shares used in the denominator. For the price that the firms buys back, we use average price.

measurement date

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

dilutive securities

are stock options, warrants, convertible debt, or convertible preferred stock that would decrease EPS if exercised or converted to common stock.

antidilutive securities

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

treasury stock method

assumes that the hypothetical funds received by the company from the exercise of options or warrants are used to purchase shares of the company's common stock at the average market price over the reporting period.

matching principle

expenses for producing goods and services are recognized in the period in which the revenue for the goods and services is recognized

vertical common size income statement

expresses each category of the income statement as a percentage of revenue. This allows for comparison of income statement items over time (time-series analysis)and across firms (cross-sectional analysis).

Modified retrospective approach

not required to revise previously reported financial statements. Instead, they must adjust the opening balances of retained earnings (and other relevant accounts) for the cumulative impact of the change

Discontinued Operations

reported separately when a company sells, abandons, or otherwise disposes of a segment of its operations, net of tax, after income from continuing operations, but before Net Income

long term contracts recognizing revenue

revenue must be recognized over time based on progress make toward satisfying the obligation - *percentage of completion*

phaseout period

the time between the measurement period and the actual disposal date