Definitions Flashcards
(11 cards)
EPS
- Key performance indicator (KPI)
- Shareholder can assess the wealth-creating abilities of company
- Doesn’t reflect dividend policy it shows how much profit is available for dividends or reinvestment
- Excludes OCI so if there are profit/loss from discontinued operations the EPS is calculated and disclosed
- Fall in EPS => increase in profit but proportionately larger increase in no. of shares
- Component of all PE ratios - allows for comparability across companies
Diluted EPS
- Shows what EPS would be if all possible shares (e.g convertible loans, options) were actually turned into real shares.
- If these potential shares do exist, they usually reduce EPS, which is why it’s called “diluted.”
- Companies show both basic EPS and diluted EPS (if applicable)
- If turning them into shares would increase EPS (which is rare), then the effect is called anti-dilutive
P/E Ratio
- Measure of market confidence in the future of the company and of the market
- High PE => expectation of growth in future returns OR may be due to a one-off fall in profits which the markets believe is not an indication of future earnings and thus ignore it in pricing the shares
- Investors may profit by “outguessing” (think market is inefficient i.e stock is priced incorrectly) market expectations but could be incorrect
Why do we need the EPS accounting standard?
- Users need to have some certainty on how earnings are defined – which components to include/exclude, e.g. one-off items, discontinued operations, OCI –
comparability important - Provides definitions on how earnings and the number of shares are calculated
- Diluted EPS included
What is the purpose of impairments?
- Company is required to assess whether there are any indications that PPE is impaired (interneal or external)
- Purpose: ensure that FS are relevant and faithfully representative
- Ensure assets are not included in FS at values in excess of what they are worth (over/understate)
- Recoverable amount is the higher of value in use and FV - cost to sell
- Use the lower of RA and CA, if RA < CA => impairment
- Goodwill arising on acquisition and intangible assets where the life is indefinite are required to be tested every year for impairment
What is the criteria for a provision?
- Present obligation:
Legal or constructive (not stated by law but expected by us) - Probable outflow of economic resources
Payment is virtually certain
Onerous contracts => loss making e.g relocate to new factory but current lease at previous factory cannot be cancelled or re-let to someone else - Reliable estimate of the amount of the obligation
- Disclose as contingent liability if criteria not met
- Disclose as a contingent asset if virtually certain that there will be an inflow of resources e.g company files an insurance claim, lawsuit against another party/counterclaim. Prudent as we don’t account for gains/ profits before they have occurred unless virtually certain
- If probable outflow of economic resources:
Possible (>50%) => Recognise provision
Probable (<50%) => Disclose as contingent liability
Remote (chance of it happening v low) => Do nothing - If there’s no provision or contingent liability expense to P&L
What is the criteria for an intangible asset?
Recognised as an Intangible Asset when:
1. Identifiability (capable of being sold, transferred) or arises from contractual or other legal rights even if they can’t be transferred
2. Control
3. Future economic benefits
4. Reliable measure of cost
Different Intangible Assets:
- Externally purchased => recognised at acquisition
- Acquired as part of business combination
- Internally generated => not recognised as difficult to measure cost e.g football player developed in the academy so expensed to P&L
- Research phase expenditure can be expensed to P&L
Development phase expenditure capitalised as Intangible Asset once all criteria met:
1. Technical feasibility
2. Intention to complete and use or sell it
3. Ability to use or sell the asset
4. Future economic benefits
5. Availability of resources to complete development
6. Reliable measure of cost
How do you measure Intangible Assets after recognition?
- Account for intitially at cost and then amortise ONLY IF asset has a FINITITE useful life and only start amortising once asset ready for use
- Account for intitially at cost and then impair ONLY IF asset has an infinite useful life, must be tested yearly
Why is the measurement and impairment testing of intangible assets is so subjective?
- Intangible assets acquired as part of a business combination require FV – highly subjective
- Internally-generated intangible assets are measured at cost and are intrinsically tied to the value of a business
- By their nature many intangible assets are unique
No liquid secondary markets
Valuing intangibles often means looking forward
Value impacted by uncertainty, volatility and change - Difficult to identify costs unique to asset e.g customer satisfaction and loyalty, employee skills, brand names
- Difficulties in measurement may compromise qualitative characteristics of reliability and comparability
Liability
Present obligation arising as a result of a past event from which economic benefits are expected to flow from the entity
Why is information on intangible assets important for investors and why is it more important in respect of high tech/service industry?
- Traditional manufacturing have lots of tangible assets on their SoFP so it’s easy to see the value of assets - easily identified and measured
- High tech and service industries resources are much more intangible i.e human capital (employees), brands, customer relationships, software
- For investors to understand the true worth of a company need to have a clear picture of the intangibles values
