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1) Objective of FR
- Provide financial information to existing or potential users
- Evaluate financial position and past performance and form opinion about its future ability to earn profits
4) Statement of comprehensive income reports all changes in equity except shareholders transactions
(Change in foreign currency translation; pension liabilities adjustments; Unrealized G/L on investments)
IFRS - Can combine with P&L
US GAAP - Can combine with statement of SH's equity
7) Footnotes - Accounting methods; assumptions; estimates by management; addn information pertaining to Legal matters,
Acquisition, disposals
8) MDA - Nature of business, past and future performance; SEC requires - Effect of inflation; off b/s items; accounting policies
requires judgement by mngt
9) Audit report
Objective - To provide fairness and reliability of financial statements
Std auditors statement contains 3 parts - Independent review; Auditing stds were followed; FS prepared based on accepted
accounting principles
4 Type of opinion - Unqualified (clean); Qualified (exceptions); Adverse (-ve); disclaimer of opinion (unable to express)
10) Steps in financial statement analysis framework
State the objective
Gather data
Process the data
Analyze and interpret the data
Report the conclusion or recommendations
Update the analysis
3) Accrual accounting
- Unearned revenue (Cash recd in adv + Service yet to be provided)
- Accrued revenue (Cash to be recd + Service provided)
- Prepaid expense (Cash paid in adv + Service yet to be recevied)
- Accrued expense (Cash to be paid + Service recevied)
1) Financial Reporting is not designed solely for valuation purposes, however it does provide important inputs for valuation purposes
2) Standard setting bodies - Establish financing reporting standards (US GAAP - FASB; IFRS - IASB)
Regulatory authorities - Legal authority to enforce compliance with financial reporting standards (US - SEC; UK - FCA)
4) SEC filings
- Form S-1
- Form 10K, 40F, 20F
- Form 10Q,6K
- Form 8K
- Form DEF14A
- Form 144A
- Form 3,4,5
5) SEC no longer requires IFRS reporting firms to reconcile their financial statements to US GAAP
6) Qualitative characteristics
2 fundatmental characteristics - FR
- Faithful representation (Free from error and complete)
- Relevance (Materiality - Can influence economic decision)
7) 2 assumptions - Accrual accounting and going concern ( If going concern not there - record at liquidation value)
Excludes:
Abnormal waste
Adminstrative cost
Selling cost
4) Effects when prices are increasing and stable or increasing inventory level
Items FIFO LIFO
COGS Lower Higher
Ending Inventory Higher Lower
Gross profit Higher Lower
Cash flow (higher taxes) Lower Higher
Current Ratio Higher Lower
Working Capital Higher Lower
5) 2 Type of systems
- Periodic method (end of accounting period)
FIFO and specific idenfication ans will be
- Perpetual method (Updated continuously) same in any method; but not same for LIFO
6) Measurement of inventory
IFRS Cost
Or
NRV (Selling price - selling cost)
US GAAP Cost
Or
Mkt Value =
Replacement cost
provided its between
range of
1) NRV
2) NRV (-) normal profit margin
8) Inventory Management
Inv T/O = COGS/ Avg inventory
Low Inv T/O means slow-selling or even obsolete products
High Inv T/O means low days of inventory in hand is
desirable; however enough inventory should be in place
to satisfy demand
High Inv T/O can be due to writedown of inventories
1) Expenditure providing future economic benefits over multiple accounting period is capitalized
Otherwise expensed
2) Recorded at cost = Acq cost + other expense to prepare the asset for use
3) Subsequent expenditure = if future economic benefit den Capitalized (Rebuilt, installation cost)
Otherwise expense (training cost, repairs and maintenance)
6) Intangible Assets
Amortized Impairment
Type
Identifable Unidentifable
7) R&D
Under IFRS
- Research cost is expensed
- Development cost is capitalized
Under US GAAP
- Research cost is expensed
- Development cost is expensed
9) Depreciation: 3 Methods
SLM
Dep = (Cost - Salvage value)/Life
10) Change in estimates like useful life, salvage cost = effect is prospectively
11) Component depreciation - IFRS requires firms to do it; US GAAP - allowed but rarely used
IFRS
Impaired if Carrying value
or
Recoverable amount
Loss in P&L
Subsequent receoveries are allowed bt not above carrying value
US GAAP
Impaired only if events and circumstances indicates firm may not be able to recover the carrying value thru future use
Carrying value
or
Future undiscounted cash flow
Loss in P&L
Subsequent receoveries are allowed bt not above carrying value
1) Statement of Other comprehensive income reports all changes in equity except shareholders transactions
- Foreign currency translation
- Adjustment for minimum pension liability
- Unrealized G/L from cash flow hedging derivatives
- Unrealized G/L from available for sale securities (Reported in B/S at F.V)
IFRS - Can combine with P&L
US GAAP - Can combine with statement of SH's equity
2) Minority interest should be dedcuted from Income (Since subsidiary profits are wholly included in P&L)
3) P&L presentation
- Single step statement
- Multiple step statement - Pg 49
4) Revenue Recongnition
IFRS - Services
- Revenue can be measured
- Probable flow of economic benefit
- Cost can be measured
- Stage of completion can be measured
Steps:
a) % completed = Cost/Total Cost
b) Revenue to be recg = % completed * Total Revenue
If loss is expected. The loss must be immediately recognized under IFRS/US GAAP
Installment Sales
US GAAP - 3 methods
- Collectibility is certain; Revenue at the time of sale
IFRS
Interest income = Installment value - Disc P.V of installment value
Barter transactions
US GAAP; Revenue = F.V if received cash for such goods, otherwise C.V of the goods
IFRS; Revenue = F.V from similar non barter transaction with unrelated parties
US GAAP
- Primary obligator
- Bear inventory and credit risk
- Be able to choose its supplier
- reasonable attitude to establish the price
6) Matching concept - Income should be recg when expense is made or vice versa (Warranty/Bad debts)
7) Inventory
8) Depreciation
9) Amortization
a) Discontinued opertaions (Reported separately, net of tax after income from continuing operations)
Measurement date = Company develops a plan for disposing of operations
Phaseout period = Time between actual disposal and measurement date
On measurement date = Company will estimate loss during phaseout period and loss on sale of business; gains cannot be reported
b) Unusual or infrequent items (Included in income from continuing operations before tax)
G/L from sale of business, write off
1) Liquidity is the ability to meet short term obligations; Solvency is the ability to meet long term obligations
Liquidity Ratio
a) Current ratio = Current assets/Current liabilities
b) Quick ratio = (Cash + marketable securities + receivables)/current liabilties
c) Cash ratio = (Cash + marketable securities)/current liabilties
Solvency ratio
a) L.T debt to equity ratio = L.T debt/Equity
b) Total debt to equity ratio = Total debt/Equity
c) Total debt ratio = Total debt/Assets
d) Financial leverage = Total assets/Equity
2) US GAAP needs current assets/liab and non current assets/liab to be reported seprately - Called as classified balance sheet
Useful in evaluating liquidity
IFRS- Can choose to use liquidity based format - Normally banking industry use it
Present Assets and Liab in order of liquidity
3) Current Asset/Liabilities:
One year
or
One operating cycle (Purchase inventory, Sell product and collect cash)
5) Financial Assets
- Held to maturity
- Trading securities
- Available for sale securities
*** Dividend, Interest and realized gains for all 3 types are recorded in Income statement
1) Cash flow is based on cash accounting (Non cash activities are not reported)
2) 3 type of activities:
Inflow Outflow
Operating activities Cash collected from customers Cash paid to suppliers and employees
Interest and dividend received Cash paid for expenses
Sale proceeds from trading activities Acquisition of trading securities
Interest paid
Taxes paid
Investing activities Sale proceeds from fixed assets*** Acquisition of fixed assets
Sale proceeds from debt and equity investments*** Acquisition of debt and equity investments
Principal recd from loans made to others Loan made to others
3) Dividend/Interest:
4) Taxes:
6) US GAAP - Direct method must also disclose the necessary adjustment to reconcile net income to C.F from operating activities
This is not the requirment for IFRS
3) Line graph
4) Regression Analysis - identify relationship between variables (GDP growth and Sales)
7) Dupont Analysis
9) Business risk is std deviation of revenue, operating income and net income
2) Def tax Liab is when Income tax expense > Income tax payable
- Depreciation (Tax - DDB; Accounting - SLM) - Pg 247
Def tax asset is when Income tax expense < Income tax payable
- Bad debts/Warranty liab (Income tax wont allow)
- R&D (expense in the year; Tax - capitalized and amortize over 3 years)
- Customer advance but shipping left (Income tax recognized as Revenue)
3) When income tax rate changes; Def tax asset/liab reflect the new rate and find corresponding increase/decrease in tax expense
If tax rate increase; increase in DTL and DTA
If tax rate decrease; decrease in DTL and DTA
4) Permenant difference is a difference between taxable income (as per tax law) and pretax income (accounting income) which cannot be reversed in future
Example: Donation not allowed by income tax
Due to the above, effective tax rate are different and no financial adjustment is required
5) Valuation allowances - under US GAAP def tax asset and liab are shown seprately and not netted off
If >50% chances of DTA not reversing then it must be reduced and added to valuation allowance as contra account
LIFO method will have more COGS, Lower income and Low inventory
Firm needs to report LIFO reserve (difference between FIFO and LIFO COGS)
Capital lease are shown as liability and asset on B/s, however operating lease are not to be shown in B/s
Analyst needs to treat operating lease as liab and asset for better comparision
1) Bond Terminology
- Face value - Amount that will be paid at maturity
- Coupon rate - Interest rate stated
- Coupon payment - Periodic Interest payment (F.V * Coupon rate)
- Effective rate - Interest rate = P.V of future cash flow (Mkt rate required by BH's - This rate changes and is not fixed like coupon rate)
- Balance sheet liability = P.V of remianing cash flow, discounted at mkt rate
- Interest exp = Book value at beginning * Mkt rate of interest
A premium bond is reported at B/S at more den its face value. As premium is amortized , book value will decrease and reaches face value at maturity (Interest exp decrease every year)
A discount bond is reported at B/S at less den its face value. As discount is amortized , book value will increase and reaches face value at maturity (Interest exp increases every year)
Interest expense and book value are caluated using bond yeild at issue and not today's yield
4) Issuance Cost
US GAAP - Capitalized
IFRS - Deduct from Bond Liability
5) Debt covenants
- Affirmative covenants - Make timely payment of int and principal; maintain certain ratios and collateral
- Negative covenants - Do not increase dividend and re-purchase share; do not issue more debts
6) Lease is an agreement whereby lessor (owner) allows lessee (tenant) to use the asset in return of periodic payment
Finance lease - Like purchase of asset with debt (Dep + Interest Exp; Asset + Liab)
Operating lease - Rental agreement (Rental expense; No Asset + no Liab)
7) Finance lease
a) Lessee Perspective
IFRS
If substantial all risk is trfd to lessee
- Title is transferred to lessee at the end of the lease
- Lessee can purchase the leased asset at price lower than fair value at some future date
- Lease cover major life of asset
- P.V of lease payment = Fair value of the leased asset
- Lease asset is so specialized that only lessee can use the asset without significant modifications
b) Lessor's Perspective
IFRS
If substantial all risk is trfd to lessee, otherwise operating lease
8) Reporting by Lessee
Finance lease is to be reported @ P.V of lease payment
Pg 282 or
Fair value of asset
***Total expense across operating lease and financing lease is the same
Only presentation of expense in Income statement and C.F is different
Finance lease ( Int payment - Operating act; principal payment - Financing act)
Operating lease ( Rental - Operating activity)
9) Reporting by Lessor
US GAAP
a) Sales type lease (Manufacture or Dealer) and if P.V > carrying value of Asset
b) Direct financing lease
IFRS do not distinguish, however if Manufacture or dealer can follow Sales type approach
***Total income across operating lease and financing lease is the same
Only presentation of expense in Income statement and C.F is different
10) Disclosure requirment - Both Lessee and Lessor
- General description of leasing agreement
- Nature,timing and amount to be paid in next 5 years. Lease payment after 5 years can be clubbed
- Amount of lease exp/rev reporting in income statement for each period presented
- Amount receviable/unearned from lease arrangement
- Restiction imposed by lease agreements
11) Pension
Pension is a form of deferred compensation for employees
a) Defined contribution plan - Company only contributes and risk is bear by employees (No future obligations as straight forward)
b) Defined benefit plan - firm will make periodic payments after retirement of employees
Reporting is complicated and net pension asset and liability is key element for analysis
Pg 291 - Imp
Financial Reporting Quality
1) Quality level of FR
- Reporting is compliant with US GAAP, earnings quality are sustainable and adequate
- Reporting is compliant with US GAAP, earnings quality are low and not adequate
- Reporting is compliant with US GAAP, earnings quality are low, reporting choices and eastimates are biased
- Reporting is compliant with US GAAP, earnings is actively managed
- Reporting is not compliant with US GAAP, numbers are presented on company's actual economics activities
- Reporting is not compliant with US GAAP and includes fictitious numbers
2) Conservative accounting - Report losses at that point when expected and not when actually incurred
Tend to decrease earnings now, but increase earnings in future