Analysing Operating Activities

1)Income
1) Economic vs Accounting
1) Accounting income
Consists of
Permanent
Transitory (Non Recurring)
Value irrelevant (distortions)
Beware of,
Sale of assets or operations not producing cash flows to fund interest or
dividends
Lack of equity capital
Existence of contingent liabilities
based on accrual accounting and is determined by recognizing revenues
and matching costs to the recognized revenues.
Consist of
Revenue
Revenue
earned inflows or prospective inflows of cash from operations
Permanent concept
Gain
recognized inflows or prospective inflows of cash from non-operations
Transitory concept
Recognition
Revenue recognition (recording on the book) does not necessarily
occur when cash is received (accrual basis principle)
they are realized or realizable
they have been earned through substantial completion of the
activities involved in the earnings process
Recognize revenue in the accounting period when the performance
obligation is satisfied
Risk of ownership is effectively passed to the buyer
results to
an increase in cash,
receivables (claims to cash), or
securities (from the exchange of inventory or other assets)
steps process for revenue recognition
Identify the contract with customers
Identify the separate performance obligations in the contract
Type of Transaction-description of revenue-timing of recognition
Sale of product from inventory
revenue of sales
Date of sale (date of delivery)
Rendering a service
revenue of services
Services performed and billable
Permitting use of an asset
revenue from rent
As time passes or assets are used
Sale of asset other than inventory
sales other than inven
Date of sale or trade-in
Determine the transaction price
easy to determined, however beware of the modifications
Variable considerations
if the price of goods or services is dependent on future events
(discounts, rebates, credits, performance bonuses, or royalties),
expected value, which is a probability-weighted amount
May be appropriate if a company has a large number of contracts with similar
characteristics
the most likely amount
May be appropriate if the contract has only two possible outcomes
If those criteria are not met, revenue recognition is constrained
TVM
Allocate the transaction price to the separate performance
obligations
FV as basic allocation price is unobtainable
Adjusted market assessment approach
refer to market price/competitor price
Expected cost plus a margin approach
Residual approach
total transaction less observable price
Recognize revenue when each performance obligation is
satisfied
The company has a right to payment for the asset
The company has transferred legal title to the asset
The company has transferred physical possession of the asset
The customer has significant risks and rewards of ownership
The customer has accepted the asset
Special Recognition
Right of return
Repurchase agreement
Bill and hold
Result when the buyer is not yet ready to take delivery but does take title
and accept billing
Principal agent relationship
Dropshipper
Consignments
Installment sales method
Cost-recovery (zero profit) method for long term (construction & service)
contract
Percentage of completion method for long term construction contract
Layaway sales
This is agreement in which seller reserves an item for a customer until the
consumer completed all the payments necessary to pay for that item
Customer Acceptance Provisions
This is agreement in which the sale is not complete until the product item is
installed at the customers place of business.
Cost
resources consumed, spent, or lost in pursuing revenues and gains
Expense
incurred outflows, prospective outflows, or allocations of past outflows of cash
from operations
Losses
decreases in a companys net assets arising from non-operations
loss on sale of investment securities, and an impairment of goodwill
Recognition
Direct matching (matching expense to specific revenue)
COGS, & selling expense = Revenue - Margin
Systematic & rational allocation
spread cost of assets that benefit more than one period across the periods of
expected benefit i.e
Depreciation, amortization, depletion, & insurance expense
Immediate recognition
The expenses in which are not related to specific revenues but are
incurred to obtain goods & services
that indirectly help to generate revenues;
recognized in the period in which they are incurred
administrative expense
The result is Income
Classifications
Operating vs Non Operating
depends primarily on the source of the revenue or expense
Operating excludes,
gains and losses from a companys peripheral activities, i.e
disposal of property or equipment, or realized and unrealized
gains or losses arising from investment securities;
impairment losses from write down of operating assets such as
inventory, fixed assets, and goodwill;
unusual or infrequent items, such as restructuring
charges, or the effects of strike or work stoppage;
other revenues or expenses, such as interest income or
interest expense and dividend income.
Analysis
Analyst can redetermine NOPAT. In most cases by rearranging the
income statement and making proper adjustments for taxes (interest tax
shield ; operating lease)
Recurring vs Non Recurring
depends primarily on the behavior of the revenue or expensenamely,
whether it is expected to persist or it is a one-time event.
Extraordinary items
Unusual nature and Infrequent occurrence
Uninsured losses from a major casualty (earthquake,hurricane, tornado),
excludes extraordinary items when computing recurring income.
Extraordinary items also are excluded from income when making
comparisons over time or across companies
Discontinued segments
Companies sometimes dispose of entire divisions or product lines
All effects of discontinued operations must be removed from current
and past income.
Adjust assets and liabilities to remove discontinued operations
Retain cumulative gain or loss from discontinued operations in equity
This rule applies regardless of whether the objective is determining economic
or permanent income or in determining operating or nonoperating income.
Accounting changes
accounting changes are cosmetic and yield no cash flow consequences
either present or future. This means the financial condition of a company is
not affected by a change in accounting.
use the new method and ignore the cumulative effect
Special items
refer to transactions and events that are unusual or infrequent, but not both
Impairment of Long-Lived Assets
asset write-offs of property, plant, and equipment (PP&E)
Restructuring charges
Restructuring usually entails extensive reorganization including divestment of
business
units, termination of contractual agreements, discontinuation of product lines,
worker
retrenchment, change in man- agement, and writing off of assets often
combined with new
investments in plant, technology, and manpower
Restructuring comes at a cost
Most special charges constitute operating expenses that need to be reflected
in permanent income
If a going-concern analysis, then retain
If a liquidating value analysis, then offset against equity
Beware of the distinction
non recurring item such as loss of inventory from fire is an operating loss.
non operating item such as interest income may be recurring in nature
Alternatives
Net Income
Comprehensive income
includes most changes to equity that result from non-owner sources (include
unrealized)
Unrealized gains or losses on investment securities and derivatives provide
very important information about potential future gains or losses that may be
expected when the securities are sold. This information is particularly
important for financial institutions
Continuing income
extraordinary items, cumulative effects of accounting changes, and the
effects of discontinued operations from net income
Core income
excludes all non-recurring items from net income