Study Session 8

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  1. Difference between GAAP and IFRS Income Statements
    IFRS and GAAP can choose to report income statement and statement of comprehensive income seperatley. GAAP firms can choose to report comprehensive income in statement of equity
  2. Describe components of income statement and alternative presentation formats of the Statement.
    Income Statement is used to project a companies revenues, expenses, gains and losses during a reporting period.

    Multi-step income statement provides subtotal for gross profit and a single step income statement does not. Expenses can be grouped by function or by nature. Function would be cost of goods sold grouping.
  3. Is interest expense considered an operating expense for financial firms?
    yes
  4. Methods for accounting for long term contracts. What happens if Loss is exepcted?

    Revenue recognition for installment rates?

    Revenue from barter transactions?

    Gross Revenue Vs. Net Revenue?
    Percentage of completion - recognizes revenue in proportion to costs incurred Both GAAP and IFRS.ONLY if outcome can be estimated

    IFRS if firm can't reliable easure outcome of project, revenue is recognized to extent of contract costs are expensed when incurred, and profit recognized at completion.

    Completed - contract - recognizes revenue ONLY when contract cannot be estimated. Revenue, expense, and profit recognized when contract is complete. ONly GAAP.


    Under both policies if loss is expected, must mark down immediatley.

    • Installment
    • -Normal revenue recognition at time of sale f collectability is reasonably assumed.

    • -If not reasonably assumed, must use installment method multiplies expected profit times % of sales regained.
    • -Cost recovery is used if profit exceeds costs incureed at the end.

    -Barter Transactions is two party's exchanging goods with no cash. Roundtrip involves sale of goods to one party with simultaneous purchase of almost identical good from same party.

    Under GAAP revenue from barter can be recognized at fair value only if firm historically received cash payments for good, and can use historical expericen to detrmine fair value. IFRS revenue from barter must be based on a simliar nonbarter transaction with unrealted parties.

    -Gross Revenue shows cost of goods sold, sales, and net income. Net just shows net income. In order to use gross in US, firm must, be obligor under contract, bear inventory and credit ris, be able to choose supplier, have reasonable latiturde to establish price.
  5. FiFO LIFO weighted AVG
    LIFO is affiliated with lower taxable income, bc more expenseive things get sold first and lower income taxes bc of higher COGS. LIFO is allowed under Gaap but not IFMS
  6. SL Depreciation. Declingin balance depreciation.
    Straight line is Cost-residual/Usefull Life.

    • Declingang balance is 2* (Cost/Total Years), do not subtract residual life like in SL. Subtract prior period depreciation from costs.
    • Declining balance starts more,but ends up with less depreciation.
  7. Amortization? Good will
    allocation of cost of intantgible asset over useufl life. Should match proportion of assets benefits used during perio, typically straight line.

    Goodwill is intangible asset with indefinite life, and is not amortized. But is tested for impariment annually. If asset value is impaired, expense of impai9rment is recongzed in income statment.
  8. Discountinued Operations?
    When managment want to dispose of a business. Occurs when mgmt has not yet done so, or has in the current year. Must by physically and operationally distinct from rest of firm. Any income or loss is reported seperate of income statement, net of tax, after income from continutin operations. Any past income statements must be restaed.
  9. Unsual or infrequent Items?Extraordinary items?
    Unual or infrequent (gain/loss from sale of assets, impairment, write off write down)are included in cioncome from continuing operations and reported before tax.

    If unuasla aAND infrequent, reported seperately in income statement, net of tax, after income from contuing ops.(Loss from expropration of assets, gains or losses from early retriment of debt, uninsured losses from natural disasters)
  10. Change in acct principle requires? Change in accounting Estimate?
    Requires retrospective application. All prior period financial stametns curently presneted are restated to reflect change. Retrospective application enhance comparability of finacial statemnts over time. Meaning must just change all statement

    Meanwhile, change in estimate is reported prospectivley, meaning going forward.
  11. Earnings per Share.
    Warrants, Prefered convertible opritons, debt.

    first check if security is dilutive or antidilutive. For warrant if average is less than Beginning price, then it is antidiultive. For debt make sure to multiply by tax rate.
  12. Common size income statemetn
    • When everything is the same size and can be easily compared. Everything can be said as a proportion of revenues. The only exception is effective tax rate which is tax expense as percent of rpetax income.
    • Gross Profit Margin is gross profit over revenue. Net income margin is net income over revenue
  13. Comprehenseive other income? Comprehnsive Income?
    Comprehensive income is more inclusive measure that includes all changes in equity except for owner contributions and distributions. Comprehensive is suem of net income and other comprehensive income. Other Comprehensive Income includes 1.Foriegn currency translation gain and losses2.Adjustment for minimum pension liability3.Unrealized gains and losses from cash flwo hedging derivatives4unrealized gains and losses from availble for sale securities (not including distributions gained)
  14. Elements of Balance Sheet
    Assets - Resources controlled as result of past transation expected to provide future economic benefits

    Libailities - Obligations requirings outflow of economic resources

    Equities - Owners' residual interst in assets afterdeducting liabilities.

    Financial statement item should be recognized if a future economic befenfit from the item is probable and ite'ms fvalue can be measured reliably
  15. Balnce sheet uses and limitations
    Balance sheet can be used to assess a firms liquidity, solvency and ability to make distributions to shareholders. Liquidity is ability to meet short-term obligations, Solvency is ability to make long-term obligations.

    Balance sheet should not be interpreted as market value or intrinsic value. Numerous valuation bases, also, number of assets and liabs not appearing on balance sheet. for example, value of firm's employees, and reputation is not captured.
  16. What is classified balance Sheet. What is liquidity based format. Which one's are mandated by IFRS and GAAP?
    Both IFRS and GAAP require firms to seperately report current assets/Liabs and noncurrent assets/Liabs which is knows as classified balance sheet.

    Under IFRS, firms can choose to use a liquidity based format which is presenting assets and liabs in order of liquidity. Typically good for banking industry.
  17. Operating cycle, Current Assets, Current Liabilities, Working Capital, Noncurrent Assets, Noncurrent Liabs.
    Operating cycle is the time it takes to produce or purchase inventory, sell the product, and collect the cash.

    Current assets include cash and other assets that will likely be converted into cash or used up within one yera or one operating cycle, whicher is greater. Presented in order of liquidity, with cash being most liquid.

    Current liabilities are obligations that will be satisifed within one year or one opeartingcycle, whichever is greater. Meets criteria if, settlement is expeded during normal operating cycle/ one year. Held for trading purposes. There is not an unconditional right to derf settlement for more than one year.

    Working capital is Current assets minus current liabilities.

    Noncurrent assets - Do not meet definition fo current assets.Will not be converted into cash or used up within one year. provide info about long term investing activities.

    Non current liabs - Provide info about firm's long term financing activities
  18. Describe different types of Assets and measurment basis
    Cash and cash equivalents - short term, highly liquid investments that are readily convertible to cash and near maturity that interest rate risk is insignifcatn. Cash and cash equivalents considered vinancial assets. Generally reported at amortized cost or fair value.

    Marketable securities - Finacial assets traded in public markets with values readily easy to determine. Disclosed in finacial footniotes.

    Accout receivable - Use net realizable value, which is based on bad debt expense. Increases allowance for doubtful account, which is a contra asset account. Firms required to disclose signifcant concentrations of credit risk, including customer, geographic, and inudstury concentrations.

    Inventories - costs included in inventory include purchase cost, conversion costs, and other costs neccessary to bring the inventory to its present location and condition. Costs exlcluded are abnormal waste of material, labor, and overhead, storage costs, admin overhaed, adn selling costs.

    Standard costing is used by manufacting firms and involves assigning amount of material, labor, and overhead to goods produced. Retail method measure invenotry at retail prices and subtract gross profit in order to determine cost.

    IFRS, inventories reported at lower of cost or net realizable value. Net realizable value is equal to selling price less and compeltion costs and selling costs.

    Gaap, reported at lower of cost or market. Market is usually equal to replacement cost, however cannot be greater than net realizable value or less than net realizable value less a normal profit margin. If net realizaable value is less than carrying value, inventory s written down and loss incurredi n income statement.

    Can be written back up in IFRS but not Gaap.

    Other current assets, - deferred tax assets, prepaid expenses
  19. Current liabiliites
    Accounts payable - amount firm owes to suppliers on credit.

    Notes payable - Maturities greater than year

    -Accrued liabilities - Sometimes taxes payable. have been reconized in income statement but have not yet been paid. Interest payable, wages payable, and accrued warranty expense.
  20. Non Current Assets
    Property, plant and quipment - tangible assets used in production of goods and services. Under IFRS can be reported using cost model or revaluation model. Under gaap only cost model. cost model, pp&E reported at amortized cost (historical cost minus depreciation, amortization, depletion, and impairment loss) Historical cost include purchase price plus any costs to get asset ready for use such as delivery or installation costs.

    Under cost model, must be tested for impairment. Asset impaired if carrying value exceeds recoverabgle amount. Under iFRS recoverable amount of asset is either fair value less any selling costs, or assets value in use, whichever greater. If imparied, writen down and recognized in income statment.

    Revaluation mode, reproted at fair value less accumulated depreciation. Changes in fair value reflect in sharehoders' equity.

    Investment property - IFRS can be either amortized costs or fair value. Gaap has no specific defintion.

    Intaginble assets - non monetary assets lacking physical substance. Identifiable or unidentifiable. Example of identifaible are patents, trademarks, copyrights. Unidentifiable are goodwill.

    Under gAAP, intagible assets created internally, such as research and dev costs, are expnsed as incurred. Under IFRS, firm must id research stage and develpment statge. Under IFRS, firm must expense costs incurred during research stage but can capitalize costs incured during devlopment stage.

    Finit, lived intagible are tested for impariment at least anualy. Under IFRS and US GAAp all of following should be expenses incurred,

    • -start up and traing costs
    • -admin overhaed
    • -advertising and promo costs
    • -realocation and reorg costs
    • -termination costs.

    Goodwill - is excess purchase price over fair value of net assets. Current Asset+Plant and Equip minus liabs. Purchase price - nubmer above. Do not take into account past goodwill. Tested for impairment atleast annually, if reduced loss recongized on income statement.
  21. Financial assets
    Can be classified at historic cost, amortized cost, or fair value depending on investment.

    Financial assets measured at amortized costare know as held-to maturity securities. Debt securities intended to be held to maturity. Market value changes not included. Amortized ocst is equal to original price minus principal payments. Principal payment included in income statement.

    Mark-to market, fair value, include trading securities, avialble for sale securities and deriviatives.

    Trading securites are debt and qequity acquired with inten to profit. reported on balance sheet at fair value and unrealized gains and losses recongnized in income statement. Derivative instruments treated like trading securities.

    Available-for sale securites securites not expted to be held to maturity or traded in near term.Reported at BS at fair value. Any unrealized gains and losses not recognized in income statement but reported in comprehensive income as part of shareholder equity.


    2 question:

    At begining of year company P purchase 1000 shares of company S for 80$ per share. During year, company S paid dividen of 4$ per share. At end of year company S share price was 75$.

    1. What amount should company p report on balance sheet if company s is considered trading and available for sale.

    Balance Sheet fair price, 75 each.

    2. what amount of income should be reocnized in income statemnt.for tdaing, and available for sale securities.

    -1000 and 4000.

    Triple D Corporation purchase bond at 6% and paid par at 1 mil. Declined in value 20 K. What is effect on fianncial statemtn

    Held to Maturity - 1 mil on BS 60K on income

    Tradin Sec 980 K on BS to reflect Fair value, 60 K in interest income -20K in unrealized loss both on income stmt

    Available for sale - 980K fair value, 60K interest income on income stmt, -20K reflected in stockholder equity, not in Income Stmt.
  22. Non current liablities -
    Long term financila liabs, include bank lonans, note payable, etc. If not reported at face amount, reported on bs at amortized cost.

    Deferred tax liabs - amts of income tax apable in future periods as a result of taxable temprary differences. Income tax expense recognized in income stamtent is greater than taxes payable. Using accelerated for tax purposes, and straight line for financial reporting.
  23. Componets of shareholder equity
    Owner's equity

    Contributed Capital - amount contributed by shareholders.

    Par value - reported seperately in stockholder equity

    • Authorized share are number of share that MAY be sold
    • Issued share - number of shares actually sold to shareholders
    • Outstanding shares is issued shares less shares that ahve been reqauired by firm.

    Prefered stock clasified as debt or equity. If preered stock non redeemable is considered equity. Mandatory redemption in fixed amount is finacial liability.

    Retained earnings, are undersitrbuted earnings of firm sinceinception. Cumulutavie earnings not paid out to shareholders as dividend.

    Treasury stock- no voting rights, reacuired by issuing firm. Does not represent investment in firm. no dividneds

    Accumulated comprehensive income include all changes in stockholder equity except for transactions recongnized in income statemnt, and transactions with shareholders.
  24. Stament of change in stockholder equity
    Summarize all trasaction increasing or decreasing equity for period. Inlclude common stock movements, retained eranigns, and accumulated other comprehnsive income(loss on availble for sal e securites, unrealized losso n cash flow hedges, minimum pension liability, cum translation adjustment).
  25. Liquidity Ratios, Current ratio, quick ratio, cash ratio

    Solvency Ratio's Long term debt to equity, Debt Ratio, total debt to equity, finacial leverage.
    • Current - Current assets/Current Liabs
    • Cash Ratio - Cash + Marketable Sec/ Current Liabs
    • Quick Ratio Cash + Marketble sec + Receivable/Current Liabs

    • Quick ratio calculated excluded invenotry from current assets. Means if firm A has higher current ratio but lower quick ratio than B, Firm A has higher inventory than B.
    • Long term debt to equity - long term debt/total equity

    total debt to equity ratio - debt/equity

    debt ratio - debt/assets

    finacial levearge - total assets/total equity

    Solvency ratios considered any interest bearing obligation. Finacial levearge ratio caputres inmpact of all obligations, both interest and non interst bearin.
  26. Cash Flow Statement provides what information/ what do analysts use cash flow statemetn to determine?
    • provides:
    • -Information about a company's cash receipts and payments during an accounting period.
    • -Information about a company's operating, investing, and financing activities
    • -An understanding of ipact of accrual accoutning events on cash flow.

    • Analysts use to determine whether:
    • -Regular operations generate enough cash to sustain the business
    • -enough cash is generated to pay offexisting debts as the mature
    • -firm is lieklye to need more financing
    • -unexpected obligations can be met
    • -firm can take advantage of new businss opportunities as they arise.
  27. Cash flow statement comes from which two sources?
    • -Income statement
    • -Changes in balance sheet accounts.
  28. Cash flow from oeprating activities? Inflow/Outflows
    • Inflows
    • Cash collected from customers
    • Interest and dividends received
    • Sale proceeds from trading securities

    • Outflows
    • Cash paid to employees and suppliers
    • Cash for buying trading securities
    • Taxes paid
    • Interest paid
    • Cash paid for other expenses
  29. Cash flow from Investing activities? Inflow/Outflows
    • Inflows
    • Payment of principal on loans given out
    • Payment from sale of fixed asset
    • sale proceeds from debt and equity investments

    • Outflows
    • Payments for fixed assets
    • Payment for debt and equity investments
    • Loans made to others
  30. Cash flow from Financing activities? Inflow/Outflows
    • Inflows
    • Cash from equity offering
    • Cash from Principal of Loans issued

    • Outflows
    • Principal paid on debt
    • Payments to reaquire stock
    • Dividends paid
  31. How are noncash investing and financing activities booked? Where must they be disclosed?
    They aren't booked on CF Statement. One exampple of a non cash transaction is exchange of debt for equity. Another is if a firm acquires real estate with financing provided by the seller

    Must be disclosed in the footnotes.
  32. What are differences in how GAAP is booked compared to IFRS.
    GAAP is stricter. Divdends and Interest inflow is booked as an operating activity. Interest outflow is Operating activity, while dividend outflow is a financing.

    Under IFRS, Dividends and interest received can be either investing or operating activities. Dividends and interest ouflow can be either operating or financing.

    Another major difference is income taxes outflow. Under GAAP all taxes paid are operating activities. Under IFRS, income taxes are operating activites, unless expense is associated with investing or finacne transaction.

    For example if you sell building for 1 mil, and pay 160 k in taxes, under gaap, it is 1 mil inflow investing activities, 160k outflow of operating. In IFRS, it's a net of 840k investing activite.
  33. Direct method/ Indirect Method

    Arguments for each

    Disclousre requirements GAAP and IFRS
    Ech line item of accrual based income statement is converted into cash receipts or cash payments. Direct method converts from accrual to cash basis (when shit actually gets paid)

    Indirect method, net income is converted to operating cash flow by making asjustments for transactions that affect NET INCOME, but aren't cash transactions.

    Advantage of direct is that it presents firms operating cash and receipt payments, while indirect only presents net result of these paayments. Direct method provides more information.

    Indirect focuses on differences in net income and oeprating cash flow, whic provides usuflu link to income statement.

    Under GAAP, direct method must disclose to renconcile net income to cash flow. Meaning if direct is done must provide infor for indirect. This is not required by IFRS.

    Under IFRS interest and taxes must be disclosed seperatley from cash flow statment under either method. Under GAAP, can be reported in cash flows or disclosed in footniotes.
  34. How is cash flow statement linked to income statement?
    Operatin+Investing+Finaincng activites = Change in cash balance +begining cash balance=Ending Cash Balance

    Begining account receivables + Sales-Cash= Edning account receivable.
  35. CFI and CFF are calculated the exact same under both methods.
  36. Direct Method thignst that are listed in CFO. Steps.
    • Common things that are listed in Direct Method
    • -Cash collected from customers,
    • -Cash used in production of goods and services
    • -cash operating expenses
    • -cahs paid for interest
    • -cash paid for taxes
    • *Depreciation not used in Direct, only indirect.
  37. Direct method CFI is what? equations
    change in gross asset accounts resulting in investing activities, such as property, plan, and equipment, intagnible assets,a dn investment securities.

    Cash paid for new asset = Ending gross assets + cost of old asset sold-begining gross assets.

    Cash from asset sold= book value of asset + gain or loss on sale.
  38. Direct method CFF. Equations.
    determine by measuring cash flows occuring between firm and suppliers of capital.

    Net cash flows from crediters = new borrowings - principal amounts repaid

    Net cash flow from shareholders = new equity issued - share repurchases - cash dividends paid.
  39. Indirect method differences? Breakout.
    Main difference is how CFO is shown, but ending CFO is the same. Taking net income and making deductions from that.

    2 main things for CFO are that depreciation is deducted to calculating net income. Therefore, we must add it back bc it's not a cash transaction

    Additionally, gains on disposals of assets are investing operations, and we don't want to double count by adding both investing and Operating, therefore we subtract from net income when cacluating.

    • Steps are to begin wiht net income
    • subtract or add finacing or investing cash flows
    • add back all nocnash charges and subtract all noncash ccomponents

    add or subtract changes to balance sheet operating accounts. If asset is increased, subtract, asset decreased add. If liablility increased add, if liab decreased subtract.
  40. Most companies report cash flows using which way?
    Report using indirect
  41. When converting from a indirect method to direct must know these equations relationg to cash from operations. Cash collections, cash paid to suppoiers, cash wages, cash interests, and cash taxes.
    Sources are positive, Uses are negative.Depends on whether or not an asset or liabiilty/equity

    • Cash collections = Sales - increase in A/R
    • Cash Paid to suppliers= -COGS + Decrease in inventory + increase in accounts payable
    • Cash wages = -wages-decrease in wages payable
    • Cash interest=-interest expnese+increase in interest payable
    • Cash Taxes = -tax expense + increase in taxes paybe+ increase in deferred tax liabiltiy
  42. What is common size format?
    Shows cash flows tatment as percentage of revenue.

    Alternativley each inflow can be stated as a percentage of total inflows, and each outflow can be stated as percent of outflows.
  43. Definitions:
    Free cash flow
    Free cash flow to firm
    Free cash flow - measure of cash available for discritonary purposes. Cash flow available after ecapital expenditures covered.

    Free cash flowss to firm is cash available to investors both equity and debt holders. FCFF = Net Income + Noncash charges (depreciaton amortiz) + Interest expense*(1-tax rate) - fixed capital investments- working capital investments.

    Because interest is paid to debt and equity holder, must include this in calculation. Therefore, we take the expense, which is usually paid out before taxes are taken out rate and multiply it by tax rate to reflect what shareholders woudl get. Fixed capital investments are Fixed assets minus cash received from selling fixed assets.

    Can also be calculated as CFO +Interest expense*(1-tax rate)-FixedCapitalINV

    Working capital is already reflected in CFO.. Firms following IFRS, not necesary to adjust interest expense if included in financing activites. In case dividends paid in operating activities, dividends would be added back to CFO.
  44. Free Cash Flow to Equity
    Cash flow available for distributing to common Shareholders.

    • CFO-Fixed capital Inv(net capital expenditures)+ net borrowing(debt issued-debt repaid)
    • If firm follows IFRS have subtracted dividens paind in calculating CFO, dividends must be addec back when calculating FCFE
  45. Cash Flow-to Revenue ratio
    Cash return on assets ratio
    cash retun on eqity ratio
    cash to income ratio
    cash flow per share
    Cash Flow-to Revenue ratio - CFO/Net Revenue - Amount of operating cash flow generated from each $ of revenue

    Cash return on assets ratio - CFO/Average total assets -Amount of operating cash flow attributed to all providers of capital

    Cash return on Equity ratio - CFO/Average total equity -Amount of operating cash flow attributed to shareholders

    Cash to income ratio - CFO/Operating income -measures ability to gerneate cash from firm operations

    Cash flow per share- CFO-prefered dividends/weighted average number of common shares - variation of basic earnigs per share measured by using CFO insted of net income. If common dividends classified as operating activites under IFRS, shoudl be added back to CFO
  46. Debt coverage ratio
    Interest coverage ratio
    reinvestment ratio
    debt payment ratio
    dividend payment ratio
    investing and finacning ratio
    Debt coverage ratio - CFO/Total Debt - measures finacil risk and leverage

    Interest coverage ratio- CFO+Interest paid+taxes paid/Interest paid- measures finacil risk and leverage If interest paid was classified as financing under iFRS, no interest adjustment necesary

    reinvestment ratio - CFO/cash paid for long term ratio- measures firms ability to acquire long term assets with operating cash flow

    debt payment ratio - CFO / Long term debt repayment - measures ability to satisfy long term debt with operating cash flow

    Dividend payment ratio CFO/Div paid , measure ability to make dividend payment with CFO

    Investing and financing ratio = CFO/CFI+CFF Measures firms ability to purchase assets, satisfy debts, adn pay dividends

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