3.1 Financial Statements & Accounting Principles

EPS (earnings per share)

=net income/number of common shares outstanding A firm's earnings per share tell a stockholder how much the firm has earned (or lost) for each share of stock outstanding.

common stock is a

equity

Extraordinary Items

nonoperating gains or losses. unusual and infrequent occurrences, such as gains or losses from floods, fires, earthquakes, or accidents

market value

the price at which an item can be sold(amnt they worth today)

Certain basic rights of ownership typically come with common stock; those rights are as follows:

1. T he right to vote on corporate matters, such as the election of the board of directors or important actions such as the purchase of another company. 2. T he preemptive right, which allows stockholders to purchase any additional shares of stock issued by the corporation in proportion to the number of shares they currently own. This allows common stockholders to retain the same percentage of ownership in the fi rm, if they choose to do so. 3. The right to receive cash dividends if they are paid. 4. I f the fi rm is liquidated, the right to all remaining corporate assets after all creditors and preferred stockholders have been paid.

Certain basic rights of ownership typically come with common stock; those rights are as follows:

1. The right to vote on corporate matters, such as the election of the board of directors or important actions such as the purchase of another company. 2. The preemptive right, which allows stockholders to purchase any additional shares of stock issued by the corporation in proportion to the number of shares they currently own. This allows common stockholders to retain the same percentage of ownership in the firm, if they choose to do so. 3. The right to receive cash dividends if they are paid. 4. If the firm is liquidated, the right to all remaining corporate assets after all creditors and preferred stockholders have been paid.

Five important accounting principles:

1. assumption of arm's length transactions. 2.cost principle. 3. realization principle 4. matching principle 5. going concern assumption

equation for CFI

CFI = CFOA − CFNWC − CFLTA

IFRS

International Financial Reporting Standards

CFLTA

cash flow invested in long-term assets

issuing common stock is cash inflow or outflow

inflow

an asset's liquidity has two dimensions:

(1) the speed and ease with which the asset can be sold and (2) whether the asset can be sold without loss of value.

annual report

-most important report that firms issue to their stockholders & the public -summarizes the overall performance of a firm for the most recent fiscal year

Amortization Expense

Amortization is the process of writing off expenses for intangible assets—such as patents, licenses, copyrights, and trademarks—over their useful life. Since depreciation and amortization are very similar, they are often lumped together on the income statement noncash expenses

summary of key equations

Balance sheet identity-> Total assets = Total liabilities + Total stockholders equity Net working capital Net working capital = Total current assets − Total current liabilities Income Statement identity Net income = Revenues − Expenses Cash flow from operating activity CFOA = EBIT − Current taxes + Noncash expenses Cash flow invested in net working capital CFNWC = NWC(current period) − NWC)previous period)

Specifically, the cash flow invested in long-term assets (CFLTA) is computed as:

CFLTA = Long-term assets current period − Long-term assets previous period

Cash flow to investors from operating activity (CFOA) can be formally written as:

CFOA= EBIT− Current taxes+Noncash expenses

Operating Activities

Cash flow activities that include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income.

Financing Activities

Cash flows from financing occur when cash is obtained from or repaid to creditors or owners (stockholders) Typical financing activities involve cash received from the issuance of common or preferred stock, as well as cash from bank loans, notes payable, and long-term debt. Cash payments of dividends to stockholders and cash purchases of treasury stock reduce a company's cash position.

Long-Term Investing Activities

Cash flows from long-term investing activities relate to the buying and selling of long-term assets.

Cash outflows

Cash payments of dividends to stockholders and cash purchases of treasury stock reduce a company's cash position.

marketable securities

Current Asset, Balance Sheet is not a cash outflow or inflow

Accounting principles and reporting practices for U.S. firms are promulgated by the

Financial Accounting Standards Board (FASB),

Annual reports typically are divided into three distinct sections

First are the financial tables, which contain financial information about the firm and its operations for the year, and an accompanying summary explaining the firm's performance over the past year The second part of the report is often a corporate public relations piece discussing the firm's product lines, its services to its customers, and its contributions to the communities in which it operates The third part of the annual report presents the audited financial statements: the balance sheet, the income statement, the statement of retained earnings, and the statement of cash flows

GAAP

Generally Accepted Accounting Principles. The standards and rules that accountants follow while recording and reporting financial activities. -GAAP are guidelines, not rules

cash inflow

Typical financing activities involve cash received from the issuance of common or preferred stock, as well as cash from bank loans, notes payable, and long-term debt.

cash flow invested in net working capital (CFNWC) CFNWC=

NWC current period−NWC previous period

deferred revenues

Revenues previously received as cash but not yet earned

Deferred Revenue

Revenues previously received as cash but not yet earned (deferred revenues). An example of deferred revenue would be prepaid magazine subscriptions to a publishing company that are recorded as revenue in a period after the cash has been paid (noncash revenue).

FASB derives its authority from the

Securities and Exchange Commission (SEC)

EBIT

Subtracting depreciation and amortization from EBITDA yields the next intermediate figure, EBIT, or earnings before interest and taxes

5. Going Concern Assumption

The assumption is that the company will continue to be in operation for the foreseeable future.

Cash Reconciliation

The first step in reconciling(reunion) the company's beginning and ending cash positions is to add together the amounts from the first three sections of the statement of cash flows

marking to market

The process of recording assets at their current market value is often called marking to market.

2. cost principle.

This says that asset values are recorded at the cost (historical) for which they were acquired.

Net working capital= ______ _______ ______-________ __________ ____________

Total current assets−Total current liabilities

EBT

When interest expense is subtracted from EBIT, the result is EBT, or earnings before taxes.

Preferred Stock (liability)

a cross between common stock and long-term debt. it pays dividends at a specified fixed rate, which means that the firm cannot increase or decrease the dividend rate, regardless of whether the firm's earnings increase or decrease. preferred stock dividends are declared by the board of directors, and in the event of financial distress, the board can elect not to pay a preferred stock dividend.

par value

a value assigned to a share of stock set by management usually a nominal amount of $1

Balance Sheet

a financial statement that shows a firm's financial position (assets, liabilities, and equity) at a point in time

depreciation

allocates the cost of a limited-life asset to the periods in which the firm is assumed to benefit from the asset.

noncash expenses examples on I/S

amortization and deprection

1. assumption of arm's length transactions.

assumes that the parties to a transaction are economically rational and are free to act independently of each other (This means that if you have a company with multiple divisions, transactions between the different divisions, for example, are recorded as though they were arm's length transactions, as though they were transactions done with other companies not within the companies. And there are other kinds of related-party transactions that get recorded that are done as arm's length transactions in the financial statements.)

LIFO (last in, first out)

assumes the sale is from the newest, highest-cost inventory—last in, first out. During a period of inflation, firms using LIFO will have the highest cost of goods sold, the lowest net income, and the lowest inventory value.

(CFNWC) is what

cash flow invested in net working capital

CFI

cash flow to investors

total stockholders' equity is made up of four accounts

common stock, additional paid-in capital, retained earnings, and treasury stock

marketable securities

current asset

Statement of Retained Earnings

identifies the changes in the retained earnings account from one accounting period to the next two events can affect the retained earnings account balance: 1. When the firm reports net income or loss. 2. When the board of directors declares and pays a cash dividend

income statement

income statement illustrates the flow of operating activity and tells us how profitable a firm was between two points in time. ****summarizes the revenues, expenses, and the profitability (or losses) of the firm over some period of time, usually a month, a quarter, or a year. Net income= Revenues− Expenses

net plant and equipment

indicates that accumulated depreciation has been subtracted to arrive at the net value

Unequal Treatment of Dividends and Interest Payments

interest paid on debt obligations is a tax-deductible business expense. Dividends paid to common or preferred stockholders are not deductible, however.

goodwill

is an intangible asset that arises only when a firm purchases another firm goodwill is a measure of how much the price paid for the acquired firm exceeds the sum of the values of the acquired firm's individual assets

Maturity

length of time remaining before the obligation must be paid.

Financial Accounting Standards Board (FASB),

not-for-profit body that operates in the public interest. Accounting principles and reporting practices for U.S. firms are promulgated by the Financial Accounting Standards Board (FASB)

the statement of cash flows is organized around three business activities—

operating activities, long-term investing activities, and financing activities—and the reconciliation of the cash account.

Retained Earnings ((liability & S.H. equity)

represents earnings that have been retained and reinvested in the business over time rather than being paid out as cash dividends

Stockholders' Equity

represents the residual claim of the owners on the remaining assets of the firm after all liabilities have been paid

4. matching principle

revenue is matched with the expense

3. Realization Principle

revenue is recognized when a transaction is completed, although the cash might be received earlier or later.

statement of cash flows

shows the company's cash inflows (receipts) and cash outflows (payments and investments) for a period of time We derive these cash flows by looking at the firm's net income during the period and at changes in balance sheet accounts from the beginning of the period (end of the previous period) to the end of the period. the statement of cash flows is a summary of the changes in a firm's balance sheet from the beginning of a period to the end of that period.

EBITDA earnings before interest, taxes, depreciation, and amortization

shows what is earned purely from operations and reflects how efficiently the firm can manufacture and sell its products without taking into account the cost of the productive asset base (plant and equipment and intangible assets).

treasury stock (liability & S.H. equity)

stock that the firm has repurchased from investors

cash flow to investors

the cash flow that a firm generates for its investors in a given period, excluding cash inflows from the sale of securities to investors The cash flow to investors is calculated as the cash flow to investors from operating activity, minus the cash flow invested in net working capital, minus the cash flow invested in long-term assets

book value

the net value of an asset or liability recorded on the financial statements—normally reflects historical cost

marginal tax rate

the tax rate that is paid on the last dollar of income earned.

average tax rate

the total taxes paid divided by taxable income

FIFO (first in, first out)

when the firm makes a sale, it assumes the sale is from the oldest, lowest-cost inventory—first in, first out. Thus, during rising prices, firms using FIFO will have the lowest cost of goods sold, the highest net income, and the highest inventory value.