FSA: Understanding the Balance Sheets Flashcards Preview

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Flashcards in FSA: Understanding the Balance Sheets Deck (39):
1

Elements of the balance sheet =

Assets

Liabilities

Equity

A financial statement item should be recognized if future economic benefit is probable and the item's value/cost can be measured reliably.

2

Use of BS/liquidity/solvency/value =

The balance shows how liquid, solvent and able to make distributions to shareholders a firm is.

Liquidity = ability to meet short term obligations

Solvency = ability to meet long term obligations

NOTE: value on the BS is not consistent - some items are valued at historical cost, some at fair value, some at amortized value.

Some value adding items are not on the balance sheet - firm's employees, reputation etc.

3

Classified balance sheet and liquidity based format =

IFRS and GAAP reguire a classified balance sheet, which separates current/non current assets and liabilities.

IFRS allows liquidity based format if more relevant/reliable - items are ordered by liquidity

4

(Non) Current Assets =

cash and other assets that will likely be converted to cash within the greater of one year or one operating cycle (time to produce, sell, collect cash).

CA are usually ordered by liquidity, with cash being the most liquid. 

CA gives info about the operating activities of the firm.

NON CURRENT ASSETS: provide info about the firm's investing activites

5

(Non) Current liabilities =

obligations that will be satisfied within the greater of one year or one operating cycle

  • settlement is expected in the normal operating cycle
  • settlement is expected within one year
  • Held primarily for trading purposes
  • There is not an unconditional right to defer settlement for more than one year

NONCURRENT LIABILITIES: provide info about long term financing activities

6

Working capital =

current assets - current liabilities

Not enough working capital may indicate liquidity problems, to much may indicate an inefficient use of assets

7

CA: Cash and cash equivalents =

cash equiv includes T bills, commercial paper, money market funds - close enought to maturity that interest risk is insignificant.

Considered financial assets.

financial assets are usually reported on the BS at amortized cost or fair value - should be about the same for C&CE

8

CA: Marketable securities =

Financial assets traded in public market

Value can be readily determined

Incl T bills, notes, bonds, equities.

Details of these investments are disclosed in the footnotes.

9

CA: Accounts receivable =

Gross receivables - allowance for doubtful accounts (a contra account) = AR (at net realizable value)

Bad debt expense increases the allowance for doubtful accounts.

AR: financial assets showing how much the firm is owed for goods/services sold on credit

When AR are written off (uncollectable) gross receivables and the allowance for doubtful accounts are reduced.

Underestimating bad debt expense will inflate AR (and look make reported earnings bigger). 

Firms are required to disclose significant concentrations of credit risk (customer, geographic etc)

10

CA: Inventories =

Incl standard costing & retail method (for measuring inventory costs), cost flow assumptions

**P89 - DETAILS FOR REPORTING INVENTORY VALUE UNDER IFRS/GAAP

Goods held for sale or the manufacture of other goods

Includes costs such as purchase, conversion, transport, processing costs. 

Excludes abnormal waste of material, labor, labor overhead, storage costs (unless part of production), administrative overhead and selling costs.

Standard costing: inventory cost is based on a predetermined amount of material/labor/overhead for production of a good (used by manufacturers)

Retail Method: retail prices of inventory - gross profit = inventory cost

Cost flow: IFRS allos FIFO +avg cost, GAAP allows FIFO +LIFO + avg cost

 

 

11

CA: Other current assets =

Including prepaid expenses and deferred tax assets

immterial ammounts combined into one account.

Prepaid Expenses: operating costs paid in advance. Cash goes down, PE goes up. As the the cost is incurred, expense is recognized on the IS and PE decreases.

Deferred Tax assets: taxes payable exceeds the amount of income tax expense recognized in the income statement.  

 

12

CL: Accounts Payable =

AKA trade payables

amounts the firm owes to suppliers for goods and services purchased on credit

Payables relative to purchases can signal credit problems with suppliers

13

CL: Notes payable and current portion of long term debt =

obligations - promissory notes owwed to lenders. 

If maturity is greater than one year these can be reported as noncurrent liabilities

The current portion of long term debt is the principle portion of debt due within the greater of one year or operating cycle

14

CL: accrued liabilities =

expenses that have been recognized in the IS bur are not yet contractually due. 

Occurs as a result of accrual accounting - ie a year end interest payment will be recognized in expenses (on IS) and an increase in accrued liabilities throughout the year - even though the liability is not due until the end of the year

includes: interest payable, wages payable, accrued warranty expense, and sometimes income tax payable (taxes recognized on the IS but not yet paid)

15

CL: unearned revenue =

AKA unearned income, deferred rev, deferred income

cash collected in advance of providing goods and services.

When payment is received, assets (cash) and liabilities (unearned rev) both go up. 

On delivery the firm recognizes revenue on the IS and reduces the liability (unearned revenue)

When analyzing liquidity, keep in mind that unearned rev doesnt require a future outflow of cash as accounts payable does. 

URev may be an indication of future growth, as revenue will ultimately be recognized on the income statement.

16

NCA: PP&E, cost and revaluation model =

NB. both the IS and BS are affected by the depreciation method and related estimates (useful life, salvage values) through this!!

tangible assets used in production

land, buildings, machinery, equipment, furniture, natural resources

Cost Model: PP&E reported at amortized cost (historical cost minus accumulated depreciation, amortization, depletion, impairment losses). Historical cost is the original purchase price plus costs necessary to get that asset up and running. Refer to NB on front...

Testing for impairment: reqd under cost model. see other slide

Revaluation model: PP&E is reported at fair value minus depreciation. Change in fair value are reflected in owners' equity (may be recognized in the IS in certain circumstances)

IFRS: PP&E can be reported using the cost model or the revaluation model

GAAP: only the cost model is allowed

 

 

17

NCA: Impairment test for PPE under cost method = 

an asset is impaired if its carrying value exceeds the recoverable amount. 

IFRS: recoverable amount of an asset is the greater of fair value less any selling costs, or the asset's value in use.

Value in use is the present value of the asset's future cash flow stream.

if impaired, the asset is written down to its recoverable amount and a loss is recognized on the income statement. 

Loss recoveries are allowed under IFRS but not GAAP

18

NCA: Investment property =

IFRS: includes assets that generate rental income/capital appreciation. Can either be reported at amortized cost (like PPE) or fair value. Under the fair value model, any change in fair value is recognized on the income statement.

GAAP: Does not have specific definiteion of investment property

19

NCA: Intangible Assets =

non monetary assets lacking physical substance (not securities)

Identifiable IA: can be acquired separately or the result of the priveleges/rights conveyed to their owner: patents, trademarks etc. 

Unidentifiable IA: cannot be acquired separately, may have unlimited life: goodwill.

 

20

NCA: IA, reporting methods =

IFRS: purchased identifiable intangibles can be reported on the BS: using COST or REVALUATION METHOD if an active market exists for the IA.

internally created IA (r&d costs) can be expensed if in the research stage (discovery of new knowledge) but can capitalize costs during development stage (using research to design plan/design products)

GAAP: purchased identifiable intangibles can be reported only with cost model  (same as PPE)

internally created IA are expensed as incurred

Under both GAAP and IFRS: All of the following should be expensed as incurred - start up and training costs, administrative overhead, advertising and promotion costs, relocation and reorganization costs, termination costs.

21

NCA: IA, Finite & Infinite lifespans =

Finite lived intangible assets are amortized over their useful lives and tested for impairment the same way as PP&E

Amortization and useful life estimates are reviewed at least annually.

IAs with infinite lives are not amortized, but are tested for impairment at least annually.

22

NCA: Goodwill =

is the excess of purchase price over the fair value of the identifiable net assets (A -L) acquired.

A buyer could be willing to pay more than the identifiable net assets for unquantifiable assets: customer loyalty/brand/R&D assets/potential synergies.

Goodwill is not amortized, but must be tested for impairment annually. If impaired, goodwill is reduced and a loss is recognized on the IS (does not affect cash flow)

For the analyst:  firms can manipulate net income upward by allocating more acquisition price to goodwill, reducing depr/amor expense. When calculating ratios Analysts should remove goodwill from the BS and goodwill impairment charges from the IS.

23

NCA: Financial Assets & Held to Maturity =

FINANCIAL ASSET: Contract that is an asset for one party, libaility for another. 

Includes investment securities, derivatives, loans, receivables.

Measured at historical cost, amortized cost, fair value.

 HELD TO MATURITY SECS: (debt securities bought in order to hold till maturity). Are reported on the balance sheet at AMORTIZED COST.

Amortized cost = original issue price - principal payments + amortized discount/ - amortized premium - impairment loss --> Subsequent changes in market value are ignored.

income (from securities, dividends, income) and realized gains are reported on the INCOME STATEMENT

 

 

 

24

NCA: Fin Assets: Trading securities =

debt/equity acquired with the intent to profit in the near term. 

ON BALANCE SHEET:  reported at fair value.

Fair Value: = mark to market accounting, includes trading and available for sale securities and derivatives. 

ON INCOME STATEMENT: unrealized GL are recognized (also known as holding period gains and losses)

Derivatives are treated the same way as trading securites. 

income (from securities, dividends, income) and realized gains are reported on the INCOME STATEMENT

25

NCA: Fin Assets: Available for sale securities =

debt and equity not expected to be traded in the near term or held to maturity. 

ON BALANCE SHEET: like trading securities, reported at fair value. 

Fair Value: = mark to market accounting, includes trading and available for sale securities and derivatives. 

ON COMP INCOME STATEMENT: unrealized GL is recognized in other comprehensive income - NOT IN THE INCOME STATEMENT AS FOR TRADING SECURITIES.

income (from securities, dividends, income) and realized gains are reported on the INCOME STATEMENT

26

NCA: Financial Assets: CHEAT CARD: 

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27

NCL: LT Financial Liabilities =

Include bank loans, notes payable, bonds payable, derivatives.

If not issued at face amount they are reported at amortized cost.

In some cases FL are reported at fair value - held for trading liabilites (such as an equity short), deriv liab, non deriv liab with exposures hedged by derivatives

28

**NCL: Deferred tax liabilities =

amounts of income taxes payable in future periods as a result of taxable temporary differences. 

when the amount of income tax expense on the IS is greater than the taxes payable. 

This can occur when expenses or losses are tax deductible before they are recognized on the income statement. 

29

E: Owners' equity =

residual interest in assets after subtracting liabilities. 

incl contributed capital, preferred stock, treasury stock, retained earnings, non controlling interest, accumulated other comprehensive income. 

30

E: Contributed capital, outstanding shares =

aka issued capital

amount contributed by common shareholders

Outstanding shares are the issued minus repurchased (treasury) stock

Note: Authorized shares is the amount allowed to be issued under the articles of incorporation. Par value is a legal or stated value, sometimes given to a share at issuance, but is not related to fair value.

31

E: Preferred stock =

has rights not conferred by common stock.

pay a stated divided (usually a % of par) and have priority over common shareholders in the capital structure.

Can be classified as debt or equity.

Pref stock that is non redeemable = equity

Pref stock that calls for mandatory redemption in fixed amounts is a financial liability.

32

E: Non controlling interest (NCI) =

minority interest.

pro rata share of the net assets (EQUITY!) of a subsidiary not wholly owned by the parent.

33

E: Retained Earnings =

undistributed earnings (net income) of the firm since inception - have not been paid to shareholders as dividends.

34

E: Treasury Stock =

stock re acquired by the form but not yet retired. 

Treasury stock reduces stockholders' equity.

Does not have voting rights and does not receive dividends.

35

E: Accumulated other comprehensive income =

includes all changes in stockholders' equity except for transactions in the IS (net income) and transactions with shareholders - issuing/reacquiring stock and paying dividends. 

COMPREHENSIVE INCOME = NET INCOME + ACC OTHER COMPREHENSIVE INCOME

nb. other comprehensive income is a component of stock holder equity at a point in time, comprehensive income is an income measure over a period of time (net income + AOCI)

36

BS Analysis: Common size analysis =

use of percentages for BS items - allows comparison over time and against other firms.

37

BS: Liquidity Ratios =

quick ratio aka acid test ratio 

difference between current and quick ratio is INVENTORY.

cash ratio excludes INVENTORY and RECEIVABLES

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38

BS: Solvency Ratios =

measures ability to satisfy long term obligations.

nb, LTD to E, TD to E and D ratio all consider interest bearing obligations (debt) whereas the financial leverage measure includes both interest and non interest bearing. 

 

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39

BS: Limitations of ratio analysis =

  • differences in accounting standards and estimates when comparing peers
  • lack of homogeneity between firms (ie different industries)
  • judgment required when interpreting ratios
  • BS data is measured at a single point in time