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Objectives of Financial Statements

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1) Provide useful info to current & potential investors, lenders, and other creditors 2)Info on economic resources and claims against the entity (BS) 3)Changes in economic resources and claims (IS) 4) Financial performance related to accrual accounting (IS; provides a better basis for assessing the entity's past & future) 5)financial performances reflected by cash flow (SCF) 6)Change in economic resources NOT related to the normal course of business (ex. issuing stock)

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Primary Qualitative Characteristics (Useful Information)

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[Roger] is PC but materialistic and he is never on the [F]ENCe. Relevance & Faithful Representation **Constraint: Cost/benefit-> cost of obtaining and presenting the information should not exceed the benefit

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Relevance

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[Roger is PC but materialistic] and he is never on the FENCe. Predictive value, confirmatory value (feedback), and material.

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Faithful Representation

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Roger is PC but materialistic and [he is never on the FENCe.] free of Error, Neutral, Complete

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Enhancing Qualitative Characteristics

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CUT like a V Comparable/Consistent, Understandability, Timeliness, Verfiability

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A full set of financial statements include:

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Statement of Position (BS), Statement of Earnings Financial & Comprehensive Income (IS), Statement of Cash Flows, Statement of Changes in Owner's Equity

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3 Basic Elements of Financial Statements

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Assets, Liability, Equity/Net Assets

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3 Elements of Equity

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Contributions/investments by owners, Distributions to owners (dividends), Comprehensive income (all changes in equity other than the owner's resources)

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Elements that affect Comprehensive Income but not NI

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DENT Derivative cash flow hedges, Excess adjustment of pension plan assets at year end, Net unrealized gains or losses on AVS securities, Translation adjustment for foreign currencies.

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physical capital maintenance concept

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only recognize an event as income when an as set is sold or a liability is settled (measures the effects of price changes in $$) current accounting methods emphasize this method with fixed assests

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financial capital maintenance concept

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recognize an event as income as a change in the value of the asset or liability occurs (recognize holding gains and losses) current accounting methods emphasize this method with most marketable securities

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4 Elements of Comprehensive Income

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Revenues, Expenses, Gains, Losses

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Accounting rules & concepts for the key elements

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Consistency, Conservatism, Cost/Benefit, Matching (recognize costs as expense at the same period in which the benefit is recognized), Allocation (spreading costs over more than one period), Full Disclosure, Recognition, Realization (converting non-cash resources into cash or claim to cash)

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When to recognize a financial statement and how to measure it

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-meets the definition of an element (asset, liability) -element is capable of being measured in monetary terms -item is relevant and faithful represntation

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Historical cost

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amount you paid for it (PP&E)

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Replacements Cost

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what it would cost to replace an item (inventory)

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Fair Market Value (FMV)

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"price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date" not intended to be an application of conservatism. assets are values based on their 'highest and best use'

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Net Realizable Value (NRV)

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amount expected to be converted (A/R)

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Impairment losses

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the reduction in the carrying values of an asset to its fair value in the period of the impairment--> A/R, goodwill and other intangible assets are test annually, depreciable assets and amortizable intangibles

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Derevatives

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All reported at fair value (unrealized gains and losses)

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financial instrument

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cash, evidence of an ownership interest in an entity, or a contract that both imposes on one entity a contractual obligation and on the second entity a contractual right

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exit price. exchange price notion

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the price that would be received to sell the asset or paid to transfer the liability --> the main price point used for the exchange price notion

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entry price

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the price that would be paid to acquire the asset or received to assume the liability

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How to measure assets 'in use'

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some combination of potential revenues earned and costs saved that result from their use. A transaction will occur in the principal market (where the asset/liability is most frequently traded) or the most advantageous market

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Three valuation techniques for measuring @ FV

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MIC Market, Income, Cost

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3 levels of inputs

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Level I: observable data from the actual market for identical assets/liabilities (ex. Apple shares) Level II: same as I but the transactions did not occur in an active market or assets/liabilities are similar but not identical Level III: unobservable data and largely based on management's judgement

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How to measure fair value

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1. ID the assets/liabilities being measured 2. Determine the principal/most advantageous market (highest and best use) 3. Determine the valuation premise (in-use or in-exchange) 4. Determine the appropriate valuation technique (MIC) 5. Obtain inputs for valuation (Levels 1, 2, or 3) 6. Calculate the FV

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Traditional CF approach

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use most likely CF amounts to calculate PV of CF

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Expected CF approach

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use weighted avg of different possibilities

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accrual accounting

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revenues and expenses are recognized when realized, realizable, and/or earned

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Revenue is recognized when:

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a binding agreement exists, services rendered or delivery has occurred, fixed or determinable price exists, collection is reasonably assured

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Expenses are recognized when incurred:

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economic benefit is used up (consumed) or assets lose future benefits (as incurred). -Cause & effect: expenses that produce revenue at identifiable points -Systematic and rational allocation: expenses that produces revenue over long periods of time and matched to those periods using a reasonable mean of allocation -Immediate recognition: expenses cannot directly be related to specific benefits and are expensed as incurred (ex. manager salaries)

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Risk and Uncertainty 4 areas of disclosure

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1. Nature of Operations: description of how the entity generates revenues such as major products and principal market served 2. Use of Estimates: indicated the preparation of the financial statements in accordance with GAAp, other applicable financial reporting frameworks 3. Certain significant material estimates 4. Current vulnerability due to certain concentrations: occurs when an entity does no diversify

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FASB Accounting Standards Codification (ASC)

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Single source of authoritative US GAAP for non-governmental entities

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Statements on Financial Accounting Concepts (SFAC)

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represent the ideas of the FASB as to the theoretical framework which it believes should guide financial accounting and reporting

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Emerging Issues Task Force (EITF)

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Created by the FASB to reach a consensus on how to account for new and unusual financial transactions that have the potential for creating differing financial reporting practices. FASB works on longterm problems while EITF works on short term problems.

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International Accounting Standards Board (IASB)

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replaced the International Accounting Standards Committee (IASC) and created the International Financial Reporting Standards (IFRS)

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International Financial Reporting Standards (IFRS)

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Considered to be more principle-based while GAAP is considered to be more rules based. Income is a financial statement element according to the IFRS.

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Capital Maintenance Adjustment

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IFRS only. results from the revaluation or restatement of assets and liabilities that cause an increase or decrease in equity (Fixed assets) but nor from income or expenses

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Current Assets

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assets that will be used up or converted into cash within one year or the operating cycle, whichever is longer

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Current Liabilities

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liabilities that will be settled within one year or the operating cycle, whichever is longer

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Cash Equivalent

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a security that is easily converted into cash with an orignial maturity of 90 days (3 months) or less

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IFRS Current Asset and Current Liability

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GAAP + OR entity holds the __ primarily for the purpose of trading

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IFRS Financial assets are measure at amortized cost if:

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-entity's business is to hold the asset to collect scheduled cash flows AND -the terms of the instrument call for cash flows that are exclusively payments of principal and interest on specified dates

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Trading Securities

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investments in equity or debt instruments which the investor has acquired in an attempt to make profits by buying and selling a short period of time. (unrealized gains/losses go on I/S under non-operating income)

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Available For Sale (AFS)

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investments in equity or debt instruments that do not fit the definitions of trading or HTM. Can be current or non-current. (unrealized gains/losses recognized in the B/S under Other Comprehensive Income)

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Held to Maturity (HTM)

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investments in debt instruments that investors plan on holding until maturity.

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Arbitrage

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the ability to take advantage of price differentials in separate markets allowing the entity to enter into transactions that are potentially profitable without significant risk of loss (ex. futures)

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Fair Value Hedge

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hedging against a recognized asset or liability on the balance sheet or a firm purchase commitment. changes in value are reported in income from continuing operations

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Cash Flow Hedge

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against a forecasted transaction that is expected to take place in the future, but which is not yet a legal commitment, the changes in the value are reported under OCI

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Transactional Currency

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Local "recording currency" -> the currency of a particular country. Usually Books and Records are kept

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Functional Currency

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Greatest economic impact on the company (currency in which entity generates and expends cash)

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Reporting Currency

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Currency in which it prepares its financial statement

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Pledging (receivables)

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client borrows necessary cash and pledges (offers) the receivable to the lender as collateral to secure the loan. Must be adequately disclosed in a footnote in the financial statements.

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Assigning (receivables)

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client borrows the necessary cash and agrees to use the proceeds from the receivable to repay the lender. Sometimes, the customer is notified to pay the lender instead of the client

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Factoring (receivables)

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Company converts its A/R into cash by selling it either with or w/o recourse factor w/ recourse: buyer of the A/R retains the right to get repaid by the client if the customers of the A/R does not pay w/o: buyer assumes the risk that the A/R may not be collectible

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Term Bond

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a bond that will pay the entire principal upon maturity at the end of the term

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Serial Bond

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a bond in which the principal matures in installments

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Debenture Bond

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unsecured bonds that are not supported by any collateral

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Stated, face, coupon, nominal rate

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rate printed on bond and the amount of cash the investor will receive every payment

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Carrying amount

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the net amount at which the bond is being reported on the BS. Equals the fave of the bond plus premium or minus discount. AKA book value or reported amount. Is initially the same as issue price

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Effective rate, yield, market interest rate

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the actual rate of interest the company is paying on the bond based on the issue price

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issued @ premium

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when the effective rate < the coupon rate, because the cash interest and principal payment are based on face value but the company actually received more money than that

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issued @ discount

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the effective rate > coupon rate, because the company received less money than that

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convertible bond

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bond that is convertible into common stock

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callable bond

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a bond which the issuer has the right to redeem prior to its maturity

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covenants

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restrictions that borrowers must often agree to

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Cumulative Preferred Stock

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dividends missed in earlier years must also be paid before the common shareholders receive anything

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Participating Preferred Stock

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if the common shareholders get a high rate than what is stated on the preferred shares, the preferred shareholders must also get the same higher rate

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Convertible Preferred Stock

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has the option of converting for common stock at a specific ration

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Callable Preferred Stock

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Corp has the option of repurchasing preferred stock at specific price

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Preferred w/ warrents

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warrants are convertible to shares of common stock

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stock rights

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contractual rights held by shareholders to purchase a proportional share of new shares to maintain their preexisting ownership %

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measurement date

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the date on which the amount of compensation is determined

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grant date

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the date on which the options are granted to the employees

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Current Ratio

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ability of company to pay upcoming bills current assets/current liabilities

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Quick (acid test) ratio

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ability of company to pay upcoming bills quick assets (cash marketable securities, accounts receivable)/ current liabilities

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Inventory turn over ratio

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efficient use of inventory; # of times the average inventory is sold COGS/Average inventory (Beginning inventory +ending inventory/2)

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Number of days sales in average inventory

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efficient use of inventory average inventory/daily cost of sales (COGS/ #of working days in a year)

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receivables turnover ratio

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credit sales/average recievables

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# of days sales in average receivables

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average receivables/ day credit sales

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working capital

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Measures company's solvency current assets - current liabilities

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length of operating cycle

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# of days sales in avg receivables + # of days supply in avg inventory

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Debt to total assets

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total debt/ total assets

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Debt to equity

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total debt/ stockholder's equity

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Book value per common share

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common stockholder's equity/ # of common shares outstanding

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Dividend payout

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Dividends per common share/ EPS

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Return on total Assets

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Net income + Interest expense (net of tax)/ average total assets

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