Income Statement: reports the economic value created/destroyed by the Revenue recognition: when the company transfers promised
s promised goods or
organization.
Four types of accounts on Income Statement: revenues, expenses, gains
and losses. Gain and loss are non-recurring and non-operating items,
reported separately below operating income.
Common size Income Statement: scales each income statement line by net
sales à expressed as a percentage of the value of revenue or sales.
Balance sheet: reports what the organization owns and owes: assets,
liabilities and equity.
A common-size balance sheet standardizes each line item on the balance
sheet using total assetsà useful for assessing if significant change in asset
mix and/or financing mix across time
Statement of Cash Flows: tells where cash came from and where it went,
predicts future cash flow and evaluates cash flow efficiency. Provides
information on the liquidity of the firm. 3 main sections in SCF: operating,
investing and financing.
Statement of Shareholder Equity: provides information about the
investments made by the owners of the firm.
Auditor’s opinions: Unqualified opinion: free of material
misrepresentations. Dirty Opinion: qualified, disclaimer of opinion, adverse
opinion. Going Concern Opinion: whether the firm will be able to continue
to operate into the future. Going concern: good.
Definitions on accounting terms:
Net Income (after tax) = Revenue - Expenses + Gains - Losses
Balance Sheet Valuation: monetary assets are valued at their fair value,
while non-monetary assets are valued at historical cost (objectivity
principal, assume companies are a going concern, and conservatism).
Accrual based accounting: revenues and expenses should be recognized
when economic activity that produces them occurs, not when cash is
paid/received.
The Adjusted Trial Balance reflects totals after the AJEs are posted to the
general ledger accounts.
Financial statements should be prepared in the following order: Income
Statement, SSE, Balance Sheet
SCF is not prepared from the adjusted trial balance, but from a detailed
analysis of the cash flow activities of the company.
Closing the books: establishing a zero balance in each of the temporary
accounts à 1) Debit all revenue/gain accounts, 2) Credit expense/loss
accounts, 3) Transfer net income (or loss) to Retained Earnings
Restatement: when a company’s financial statements are found to have
material mistakes, it needs to re-prepare the former reports.
services to customers in the amount it expects to receive. Transfer promised
goods or services to customers at delivery, i.e., the title and risk of
ownership passes to the buyer as per stated in the contract. For long term
contracts, the most common method is % of completion à recognizes
revenues and expenses as the contract progresses (% of costs and outputs).
The direct method directly reports major classes of cash receipts and
payments. Direct format: cash sales – cash expenses = operating cash flow
Indirect method: use net income as a starting point. Net income +
depreciation expense + losses (- gains) – change in non-cash current assets
+ change in current liabilities
Working Capital: If cash flow from operations is declining, too small, or even
negative, it is important to evaluate the working capital. NWC = Cash + AR +
Inventory – AP (Broad = current assets – current liabilities). Negative NWC
can be a result of lean business model or it could mean the company is
facing bankruptcy.
Optimizing working capital: 1) reduce A/R and inventories 2) increase A/P
ROA = NOPAT/Avg. total assets, ROE = net income/Avg. equity
Dupont Analysis (average):
NOPAT = Net income + [Interest expense x (1 - tax rate)]
We recognize the estimated bad debt expense in the same period as the
sales. When we know that a customer definitely will not pay à write off.
Allowance for Bad Debt is a contra-account to assets. It is linked to A/R with
opposite balance. A company normally reports Net A/R (i.e., Gross A/R –
Allowance for Bad Debt) on Balance Sheet. A company normally reports bad
debt expense on its income statement as an operating expense.
Methods of estimating bad debt: % of sales à bad debt estimation based
on % of credit sales. % of A/R balance à based on % of A/R balances, may
apply different % to different A/R age group.
A/R Turnover: credit sales/avg. net receivables à average collection
method: 365 days/AR turnover
Perpetual method: Updates inventory records after every purchase and
every sale à Records COGS after every sale
FIFO: oldest costs à COGS, recent costs à ending inventory. LIFO: oldest
costs à inventory, recent costs à COGS.
FIFO has the highest inventory balance, lowest COGS, and highest income.
LIFO has the lowest inventory balance, highest COGS, and lowest income.
This means that LIFO pays the least taxes, and not allowed in most countries.
LIFO reserve represents the current difference between LIFO and FIFO
ending inventory, cumulative difference between LIFO and FIFO COGS à Δ
LIFO reserve = current difference in COGS between LIFO and FIFO
Inventory turnover: COGS/average inventory à high efficiency selling inv. Transaction Debit Credit
Inventory holding period: 365 days/inventory turnover Unearned Revenues
Cash Unearned Revenues
(L)/Receiving cash
Tax Rate = tax expense/EBIT
Unearned Revenues/Rev
LCF rule and inventory impairment: inventories are reported at the lower of Unearned Revenues Sales Revenues
Recognition
cost or market value à conservatism. To recognize inventory impairment: Accrual of Expenses Wages Expense Wages Payable
Accrual of Revenues Interest Receivable Interest Revenue
Deferral of Expenses/Cash
Prepaid Insurance Cash
Day
Deferral of Expenses/Year
Initial CapEx when buying long term assets should include all the costs Insurance Expense Prepaid Insurance
End
incurred before the production of the first item. Depreciation/Amortization Dep/Amor Expense Accumulated Dep/Amor
Depreciation/amortization is to allocate unrecoverable costs of long-term COGS Cost of Goods Sold Inventory
assets to those periods when assets provide benefits. Bad Debt Recognition Bad Debt Expense Allowance for Bad Debt
Internally generated assets cannot be capitalized EXCEPT: Development cost Bad Debt Writing Off Allowance for Bad Debt Accounts Receivable
(IFRS), Software costs (IFRS&GAAP), Direct-response advertising (GAAP) COGS Inventory
Inventory Sold
A/R or Cash Sales Revenue
Straight line depreciation: depreciation expense for period = (cost –
PPE Acquisitions/ Cash/Notes Payables/
residual value)/useful life Betterments
PPE
Construction in progress
To capitalize intangible assets, future benefits must be objectively PPE Depreciation/ used in Accumulated
WIP Inventory
measurable (clear link to future benefits) production Depreciation
Goodwill: Purchase price - the fair market value of the net assets acquired = PPE Depreciation/ NOT Accumulated
Depreciation Expense
used in production Depreciation
Goodwill (the excess amount paid)
Impairment Impairment Loss PPE or intangibles
Betterment: increase useful life; improve quality/quantity, reduce costs of PPE Revaluation/used by
operating the asset à capitalize if meets one of the above PPE Revaluation Reserve (E)
the firm
Revising depreciation (betterment): (revised BV – revised residual value) / PPE
Gain from Asset
remaining useful life at date of change Revaluation/investment PPE
Revaluation (P/L)
property
Revised BV = original value – accum. Dept + additional cost
Intangible Asset
Long-term operating assets need to be assessed for impairment à compare Revaluation (IFRS)
Intangible Asset Equity
BV to fair value. Cash
PPE
Asset disposal: proceeds from sale > net book value à gain; proceeds from PPE Disposal Accumulated Depreciation
(Gain)
sale < net book value, loss. NBV = BV – accumulated depreciation (Loss)
Current ratio: current assets/current liabilities Bonds issued at par Cash Bonds Payable
Interest Cash Payment Bonds Interest Expense Cash
Quick ratio: (cash + marketable securities + A/R)/current liabilities Interest adjusting entry at
D/E ratio: total liabilities/total equity Bonds Interest Expense Accrued Interest Payable
year end
A contingent liability is a potential obligation that maybe incurred Interest Expense (Interest
Interest Pay day Cash
depending on the outcome of a future event. Accrue only if it’s probable payable)
and its amount can be estimated. It typically includes contingent liability for Bond Retirement - At
Bonds Payable Cash
Maturity
lawsuits, decommissioning costs, environmental liabilities and pension.
Bond Retirement – Buy Gain on bond
Leases: 1) operating leases: a rental agreement (payments expensed, record Bonds Payable
Back retirement/Cash
no A and no L) 2) capital leases: a combination of a purchase and a loan Contingent
Expense (or Asset) Liability
The amount initially recorded for both the asset and the liability is the lower Liabilities(when possible)
of: Present value of the lease payments or Fair market value of leased Contingent
Liability Cash
Liabilities(when happen)
item.
Pension Pension expense Future pension liability
OCI: other comprehensive income à AFS trading impact on OCI à creating Periodic pension payment Pension liability Cash
an item on the Asset side to cancel out the OCI under equity once an asset is Available for Sales
Available for Sales Unrealized gain & loss –
sold à OCI created to shield P/L from market fluctuations Investment(Market Value
Investment equity
Trading securities: current assets and holding gains/losses will go to P/L Change)
- Available for Sales
Investment
Available for Sales
Cash Unrealized gain & loss–
Investment Sale
equity(Cancel out)
Realized gain – income
Equity Method (no entry
Investment in associates Cash
on market value change)
Share of profit of
P&L prom Associates Investment in associates
AFS: can be current or non-current, and holding gains/losses will go to either associates (Gain)
P/L or OCI. HMS: valued at amortized cost. Only the classification of AFS and Dividend from Associates Cash Investment in associates
HMS can be reversed.

Significant influence: ownership between 20% to 50% à equity method,

using the % shares owned multiply by the P/L of the ownership company

Between US GAAP and IFRS:

• LIFO reserve possible under GAAP à adjustment
• Capitalizing R&D possible under IFRS à BV of assets at the point
of commercialization = accumulated expenses (R&D,
Construction). Under GAAP, expense the R&D (Debit expense,
credit cash)
• Under IFRS companies can re-evaluate PPE and intangibles (other
Controlling interest: owns more than 50% of the voting stock. If two than goodwill)
companies continue as separate entities: parent company vs. subsidiary, and
• US GAAP only allows P/L method for AFS (same as TS), IFRS allows
the statements will be Consolidated.
OCI methods which shields the P/L
Acquisition method: The assets and liabilities of the acquired company are
recorded by the investor company at their fair value on the date of the
merger or acquisition. If the amount paid is more (less) than the fair value of
net assets acquired à goodwill (bargain)
If < 100% owned, the portion of the subsidiary not owned by the parent is
called the Noncontrolling Interest (Minority Interest)