Shared Flashcard Set


financial reporting and analysis - CFA level 1

Additional Accounting Flashcards




Role of financial statement analysis


To assess a company’s past performance and evaluate its future prospects using financial reports along with other relevant company information.

Role of financial statement reporting

To provide information about a company’s financial performance, financial position and changes in the financial position.

6 pts
• Business acquisitions and disposals
• Commitments and contingencies
• Legal proceedings
• Stock options and other employee benefit plans
• Related-party transactions
• Business and geographic segments
4 pts
1) Contain important details about the accounting methods, estimates and assumptions that have been used by the company in preparing its financial statements.
2) Information about the choice of revenue recognition method used, and assumptions made to calculate depreciation expense are typically found in the footnotes.
3) such information facilitates comparisons between companies (IFRS vs. U.S. GAAP).
4) financial statements footnotes are also audited.
Management’s Discussion and Analysis (MD&A)
5 pts
1) Highlights important trends and events that affect a company’s liquidity, capital resources and operations.
2) Management also discusses prospects for the upcoming year with respect to inflation, future goals, material events and uncertainties.
3)Discuss critical accounting policies that require management to make subjective judgments and have a material impact on the financial statements.
4) The MD&A section is not audited.
5) Further, under U.S. GAAP inclusion is usually required, while under IFRS it is optional.
Types of Audit Opinions

4 pts
1) An unqualified opinion states that the financial statements have been presented fairly
in accordance with applicable accounting standards.
2) A qualified opinion states that the financial statements have been presented fairly,
but do contain exception(s) to the accounting standards. The audit report provides
further details and explanations relating to the exception(s).
3) An adverse opinion states that the financial statements have not been presented
fairly, and significantly deviate from acceptable accounting standards.
4) A disclaimer of opinion is issued when the auditor, for whatever reason, is not
able to issue an opinion on the financial statements.
Describe the steps in the financial statement analysis framework

6 pts
1) Articulate the purpose and
context of the analysis

2. Collect data

3. Process data

4. Analyze/interpret the processed

5. Develop and communicate
conclusions and
recommendations (e.g., with an
analysis report)

6. Follow up
basic accounting equation + its
various forms
Assets = Liabilities + Owners’ equity

Owners’ equity = Contributed capital + Ending retained earnings

Ending retained earnings = Beginning retained earnings + Net income - Dividends declared

Ending retained earnings = Beginning retained earnings + Revenue - Expenses
- Dividends declared

Therefore, the basic accounting equation can be expanded into the following forms:
Assets = Liabilities + Contributed capital + Ending retained earnings

Assets = Liabilities + Contributed capital + Beginning retained earnings
+ Revenue - Expenses - Dividends declared
Accrual Accounting is based on the principle that:
revenues should be recognized when earned, and expenses should be recognized when incurred, irrespective of when the actual exchange of cash occurs.
Unearned (or deferred) revenue
Arises when a company receives a cash payment before it provides a good or a service to the customer.

Because the company still has to provide the good/service, unearned revenue is recognized as a liability.

Unearned revenue is subsequently earned once the good is sold or the service is provided.
Unbilled or accrued revenue
Arises when a company provides a good or service before receiving the cash payment.

Because the company is owed money, accrued revenue
is recognized as an asset.
Prepaid expenses
Arise when a company makes a cash payment before recognizing the expense.

Expenses that have been paid in advance are an asset of the company.
Accrued expenses
Arise when a company recognizes an expense in its books before
actually making a payment for it.

Because the company owes a payment, the accrued expense is treated as a liability.
Flow of information into an accounting system

4 pts
1) Journal entries
2) General ledger
3) Trial balance
4) Financial statements
Internal controls in a company
The internal control system of a company seeks to ensure the RELIABILITY of the company’s process of PREPARING financial statements.

The effectiveness of a company’s
internal controls system is MANAGEMENT’s responsibility.

Under U.S. GAAP, an auditor is
also REQUIRED to express an opinion regarding the company’s internal controls system.
Forms 10-K, 20-F and 40-F
must be filed annually.
In these forms, companies provide a comprehensive business overview and disclose important financial data
(historical overview of performance, MD&A report and
audited financial statements).
This information is also available in a company’s annual report.
However, annual reports are prepared for shareholders and are not required by the SEC.
Forms 10-Q and 6-K:
U.S. companies file form 10-Q quarterly while non-U.S. firms file form 6-K semiannually.
These submissions require unaudited financial statements, MD&A reports and disclosure of any nonrecurring events.
Proxy Statement/ Form DEF-14A:
A proxy is an authorization
from a shareholder granting another party the right to vote on her behalf. The following information is contained in a proxy statement:

o Details of proposals that require shareholder vote.
o Ownership stakes of senior management and principal owners.
o Director biographies.
o Executive compensation disclosures.

The proxy statement that is filed with the SEC is known as Form DEF-14A.
Form 8-K:
This form must be filed for significant events that include
the acquisition or disposal of corporate assets,
changes in management or corporate governance,
changes in securities and trading markets,
and matters related to accountants and
financial statements.
Under the IFRS Framework, the objective of financial statements
is fair presentation of a company’s financial performance, financial position and changes in financial position to make it useful to all users, including investors, creditors, employees, customers, the public and analysts.
The IFRS Framework specifies four qualitative characteristics:
short cut(URFR)

4 pts + 5 sub pts
1. Understandability
2. Relevance: Information should be timely and sufficiently detailed with
no material omissions or misstatements of information that could make a difference to users’ decisions. This is known as the criterion of materiality.

Comparability: The presentation of financial statements should be consistent over time and across firms to facilitate comparisons.

Reliability: Financial statements should be reflective of economic reality and free from material errors and biases. The following factors contribute to reliability:
a) Faithful representation of transactions and events.
b) Substance over form: Transactions should be presented in accordance with
their substance and economic reality (not merely their legal form).
c) Neutrality: The information should be unbiased.
d) Prudence: Conservative estimates should be used.
e) Completeness within the confines of materiality and cost.
Constraints on Financial Statements

3 pts
1) There is a trade-off between the desirable characteristics, eg
reliability and relevance.
2) There is a cost of providing useful financial information. The benefits from information should exceed the cost of providing it.
3) Intangible aspects (e.g. company reputation, brand name, customer loyalty and corporate culture) cannot be quantified and reflected in the financial statements.
Unfortunately, non-quantifiable information is omitted from financial statements
Fundamental Principles for Preparation of Financial Statements
(5 pts)
• Fair presentation: This requires faithful representation of transactions, in compliance
with the definitions and recognition criteria for reporting elements (assets, liabilities,
equity, income and expenses) set out in the Framework.
• Going concern: Financial statements should be prepared on a going concern basis
unless management has plans to liquidate the company.
• Accrual basis: All financial statements, except the cash flow statement, should be
prepared on an accrual basis.
• Consistency: Items should be presented and classified in the same manner every
• Materiality: Financial statements should be free from omissions and misrepresentations
that could influence decisions taken by users.
Financial Statement Presentation Requirements

5 pts
• Aggregation: Similar items should be grouped and presented as a material class.
Dissimilar items, unless immaterial, should also be presented separately.
• No offsetting: Assets and liabilities, and income and expenses should not be used to offset each other, unless a standard requires or allows it.
• Classified balance sheet: Current and non-current assets and current and non-current liabilities should be shown separately on the balance sheet.
• Minimum information: Certain items must be explicitly disclosed on the face of, or in the notes to the financial statements. For example, inventory must be
disclosed as a separate line item on the face of the balance sheet, while the notes to
the financial statements must detail the measurement bases used in preparing the financial statements.
• Comparative information: Comparative amounts should be presented for prior
periods unless a specific standard permits otherwise.
Barriers to Creating a Single Coherent Framework (hint: VSM)
1) Valuation: When choosing a measurement base, it is important to remember the
tradeoff between reliability and relevance
2) Standard-setting approach: Reporting standards can be based on one of the
following approaches:
a) A principles-based approach provides a broad financial reporting framework with limited guidance on how to report specific transactions. It requires the
use of subjective judgment in financial reporting.
b) A rules-based approach provides strict rules for classifying elements and transactions.
c) An objectives-oriented approach is a combination of a principles-based
and rules-based approach. This approach includes a framework of principles
and appropriate levels of implementation guidance.

IFRS has a principles-based approach. FASB (U.S. GAAP) has historically followed a rules-based approach, but has now explicitly stated that it is moving towards an objectives-oriented approach.
3) Measurement: Reporting of financial statement elements can be based on the
asset/liability approach (where the elements are properly valued at a point in time)or the revenue/expense approach (where changes in the elements are properly valued over a period of time).
Operating profit is calculated:
after subtracting all direct and indirect (period) costs from

It represents the profit earned by a company from its ordinary business activities before accounting for taxes and interest.

Operating profits are useful in evaluating the profitability of individual businesses as they are not affected by financing decisions of the firm.
The IASB framework defines income as:
“increases in economic benefits during the accounting period in the form of inflows or enhancements of assets, or decreases in liabilities that result in increases in equity, other than those relating to contributions from equity participants”.

Income includes revenues and gains.

Revenues arise from ordinary, core business activities,whereas gains arise from non-core or peripheral activities.
Under IASB, revenue is recognized for a sale of goods when:
1. Significant risks and rewards of ownership are transferred to the buyer.
2. The entity retains no managerial involvement or effective control over the goods
3. The amount of revenue can be measured reliably.
4. It is probable that the economic benefits from the transaction will flow to the entity.
5. Costs incurred or to be incurred for the transaction can be measured reliably.
Under FASB, revenue is recognized for a sale of goods when:
Revenue is recognized on income statement when it is “realized or realizable and earned”.

There is evidence of an arrangement between the buyer and seller.
The product has been delivered, or the service has been rendered.
The price is determined, or determinable.
The seller is reasonably sure of collecting money.
the completed-contract method under IFRS and USGAAP.
If the outcome cannot be measured reliably, the completed-contract method is used under
U.S. GAAP. Under this method, no revenues or costs are recognized on the income statement until the entire project is completed.

Under IFRS, when the outcome cannot be measured reliably, revenue is recognized on the income statement to the extent of costs incurred during the period. No profits are recognized until completion of the project.
Under IFRS and U.S. GAAP, if a loss is expected on the contract:
the loss must be recognized immediately, regardless of the revenue recognition method used.
Installment Sales:
If it is certain that the payments will be collected from customers, revenue is recognized at the time of sale.

If receipt of installments is uncertain, two methods of revenue recognition can be used. What are these 2 methods?
Installment method: Under this method, profits are recognized as cash is received. The percentage of profit recognized in each period equals the proportion of total cash received in the period.

Profit for the period = (Cash collected in the period/ Selling price) ´ Total profit.

Cost-recovery method: This method is used when collectability of revenues is highly uncertain.
Under this method, profits are only recognized once total cash collections exceed total costs.
Round trip transaction and its revenue recognition under IFRS and US GAAP.
One form of barter transactions is a round-trip transaction, in which a good is sold by one party in exchange for the purchase of an identical good.

• Under IFRS, revenue from barter transactions can be reported on the income statement based on the fair value of revenues from similar non-barter transactions with unrelated parties.

• Under U.S. GAAP, barter transactions can be reported on the income statement at their fair value if the company has a history of making or receiving cash payments for such goods and services.
Declining balance depreciation
This is an accelerated method of depreciation, which
applies a constant rate of depreciation to a declining book value.

The double declining balance method uses an acceleration factor of 200 (it depreciates the asset at a rate that is two times the straight line rate).
DDB Depreciation = (2 / Useful life) ´ (Cost - Accumulated depreciation)

Accumulated Dep = total dep expense charged against the assest to date

Net book value = historical cost - Accumulated depreciation

Under the declining balance method, the asset is only depreciated until its net book value equals its residual value.
Discontinued Operations
Under both IFRS and U.S. GAAP, the income statement must separately report an operation as a ‘discontinued operation’ when the company disposes of, or decides to dispose of one of its component operations, and the component is operationally and physically separable from the rest of the firm.

• Discontinued operations are reported net of tax as a separate line item after income from continuing operations
• As the disposed operation will not earn revenue for the company going forward, it will not be taken into account when formulating expectations regarding the future performance of the company.
Extraordinary Items
IFRS does not allow any items to be classified as extraordinary. U.S. GAAP defines extraordinary items as being BOTH unusual in nature AND infrequent in occurrence.
• Extraordinary items are reported net of tax and as a separate line item after income from continuing operations (below discontinued operations).
• Analysts can eliminate extraordinary items from expectations about a company’s future financial performance unless there is an indication that these extraordinary items may reoccur.
Basic EPS
Income available to common shareholders/(Weighted average number of shares outstanding)

Basic EPS = (Net income - Preferred dividends) /(Weighted average number of shares outstanding)
If a company declares a stock split or a stock dividend, the weighted average number of shares outstanding should be calculated based on:
based on the assumption that the additional (newly granted) shares have been outstanding since the date that the original shares were outstanding.
Diluted EPS when a Company has Stock Options, Warrants, or their Equivalents
Outstanding using Treasury stock method.
The treasury stock method assumes that all the funds received by the company from the exercise of options and warrants are
used by the company to repurchase shares at the average market price for the period.
The resulting net increase in number of shares outstanding equals the increase in shares from the exercise of options and warrants minus the number of shares repurchased.

Stock options and warrants are assumed to be exercised if the strike or exercise price is lower than the AVERAGE MARKET price during the year.

A shortcut for calculating the net increase in the number of shares is:
(Market price - Exercise price)/Market price * Number of shares created from the exercise of options

Diluted EPS = Net income / (Weighted average number of shares outstanding + New shares issued at option exercise - Shares repurchased from proceeds of option exercise)
Diluted EPS when a Company has Convertible Debt Outstanding
Diluted EPS = [Net income - Preferred dividends + Convertible debt interest ´ (1-t)]/ [Weighted average number of shares outstanding + New common shares issued upon conversion]
Diluted EPS when a Company has Convertible Preferred Stock Outstanding
Diluted EPS = [Net income - Preferred dividends + Convertible preferred dividends]/ [Weighted average number of shares outstanding + New common shares
issued upon conversion]
Common size income statement + company's effective tax rate.
Common-size income statements present each line item on the income statement as a percentage of sales.

This facilitates financial statement analysis as the data can be used to conduct time-series (across time periods) and cross-sectional (across companies) analysis.

While common-size income statements present most items as a percentage of sales, it is more appropriate to present income taxes as a percentage of pre-tax income.

This ratio is known as the company’s effective tax rate.

In cross-sectional analysis, effective tax rates are compared across companies and sources of any differences are analyzed in detail.
Comprehensive income
Comprehensive income is composed of net income and other comprehensive income.

Comprehensive income is defined as “the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner sources.

It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners.”

Under U.S. GAAP, there are three alternative ways in which comprehensive income can be reported in the financial statements:

• At the bottom of the income statement.
• As a separate statement of comprehensive income.
• As a column in the statement of changes in shareholders’ equity.
Other comprehensive income (different from comprehensive income)
There are certain income and expense items that are excluded from the income statement; instead these items are reported directly in shareholders’
equity as a part of other comprehensive income.

Ending shareholders’ equity = [Beginning shareholders’ equity + Net income + Other comprehensive income – Dividends declared]

Under U.S. GAAP, there are four types of items that are classified as other comprehensive income:

• Foreign currency translation adjustments.
• Minimum pension liability adjustments.
• Unrealized gains or losses on derivatives contracts, accounted for as hedges.
• Unrealized holding gains and losses on available-for-sale securities.

Important points:

• We do not include dividends from available-for-sale securities and the realized loss on machinery in other comprehensive income because they are already included in net income.

• We do not include reacquisition of common stock and dividends paid in the calculation because they are transactions that relate to owners. Other comprehensive income does not include the effect of investments by owners and distributions to owners. These transactions are accounted for in the statement of changes in shareholders’ equity.
Operating activities
These are related to the day-to-day business activities of a company. Typical activities that
fall in this category are:
• Sales of goods and services to customers.
• Costs associated with the provision of goods and services.
• Income tax expenses.
• Investments in working capital to support the firm’s ordinary business.
Investing activities
These are related to the acquisition and disposal of long-term assets. Examples of transactions
that fall in this category include:
• Acquisition or disposal of fixed assets like property, plant and equipment.
• Purchase or sale of other corporations’ equity and debt securities.
Financing activities
These are related to raising and repaying capital. Examples of financing activities include:
• Issuance or repurchase of common or preferred stock.
• Issuance or redemption of debt.
• Dividend payments on common and preferred stock.
Assets that are commonly
found on company balance sheets include:
• Cash and Cash equivalents
• Inventories
• Accounts receivable
• Prepaid expenses
• Financial assets
• Deferred tax assets
• Property, plant and equipment
• Investment property
• Intangible assets
• Investments accounted for using the equity method
• Natural resource assets
• Assets held for sale
Liabilities that are typically found on company balance sheets include:
• Bank borrowings/ notes payable
• Trade and other payables
• Provisions
• Unearned revenues
• Financial liabilities
• Accrued liabilities
• Deferred tax liabilities
Equity related information usually disclosed on the balance sheet includes:
4 main pts
• Issued capital and paid-in capital attributable to equityholders of the parent
• Retained earnings
Order Date :2011-01-29 8520 Costa Verde Blvd Apt 3327
• Minority interest
• Parent shareholders’ equity

Additional information that is usually provided for each class of equity includes:
• Number of authorized shares.
• Number of shares issued and fully paid.
• Number of shares issued and not fully paid.
• Par (or stated) value per share.
• Reconciliation of shares at the beginning and end of the reporting period.
• Rights, preferences and restrictions attached to the particular class.
• Shares in the entity held by the entity, subsidiaries or associates.
• Shares reserved for issue under options and sales contracts.
Describe the various formats of balance sheet presentation
• Report format: Assets, liabilities and equity are presented in a single column.
This format is the most commonly used balance sheet presentation format.
• Account format: Assets are presented on the left hand side of the balance sheet,with liabilities and equity on the right hand side.
• Classified balance sheet: Different types of assets and liabilities are grouped into subcategories to give a more effective overview of the company’s financial position. Classifications typically group assets and liabilities into their current and non current portions.
Current liabilities (along with exceptions)
These are obligations that are likely to be settled within one year or one
operating cycle, whichever is longer.

IAS allow some liabilities such as trade payables and accruals for employees to be classified as current liabilities even though they might not be settled within one year.
IFRS and U.S. GAAP Balance Sheet Presentation : Assets/Liabilities + minority interest + comprehensive income
• Under IFRS, non-current assets are presented before current assets, and non-current liabilities before current liabilities.
• Under U.S. GAAP, current assets are listed before non-current assets, and current liabilities before non-current liabilities.

• Under IFRS, minority interest is presented in the equity section of the consolidated balance sheet.
• Under U.S. GAAP, minority interest must be presented as a separate component of shareholders’ equity.

Under U.S. GAAP, comprehensive income and other comprehensive income can be reported on the income statement (below net income), in a separate statement of comprehensive income or in the statement of changes in shareholders’ equity.

Under IFRS, the component changes must be reported in the statement of equity, but firms are not required to report an other comprehensive income amount.
Inventories and amounts that should be included and excluded from inventory cost. + standard cost + retail method.
Inventories are reported on the balance sheet at the lower of cost or net realizable value (NRV).
NRV is calculated as selling price minus selling costs, while cost is determined by the cost flow assumption (LIFO, FIFO or average cost) that is used.
Inventory costs should include direct materials, direct labor and overheads.

However, the following amounts should
not be included when calculating inventory cost:
• Abnormal amounts of wasted materials, labor and overheads.
• Storage costs incurred after the production process is complete.
• Administrative overheads.
• Selling costs.

In limited cases, standard cost or the retail method can be used for valuing inventory.
Standard cost should take into account normal levels of materials, labor, and actual capacity.

The Retail method reduces selling price by gross profit margin to determine the cost of inventory.
Goodwill is the excess of the amount paid to acquire a business over the fair value of its net assets.

Accounting goodwill is based on accounting standards and is only reported for acquisitions when the purchase price exceeds the fair value of the acquired company’s net assets.
Economic goodwill, which is not reflected on the balance sheet, is based on a company’s performance and its future prospects. Analysts are more concerned with economic goodwill as it contributes to the value of the firm and should be reflected in its stock price.

Under U.S. GAAP and IFRS, goodwill is not amortized, but is tested for impairment annually.
An impairment charge reduces net income and decreases the carrying value of goodwill to its actual value.

Impairment of goodwill is a non cash expense and therefore, does not affect cash flows.
Off-balance sheet disclosures
Off-balance sheet disclosures are found in the notes to the financial statements and in the
management discussion and analysis report. They offer useful information relating to:
• Accounting policies, accounting methods and judgments used in preparing the financial statements.
• Uncertainty involved in estimates, including risky assumptions that might cause material adjustments to assets and liabilities’ values.
• Terms of debt agreements.
• Information on lease arrangements.
• Sources of off-balance sheet financing.
• Business segments.
• Other disclosures, including the firm’s description, legal identification details and nature of operations.
is a process of adjusting the values of trading assets and liabilities to reflect their current market values. These adjustments are usually made on a daily basis.

Assets that are classified as held for trading and available for sale are subject to mark-to-market adjustments.
Available for sale securities:
These are debt or equity securities that are neither expected to be traded in the near term, nor held till maturity.
They may be sold to address the liquidity needs of the company.

These securities are reported at fair market value on the balance sheet.

Dividend income, interest income and realized gains and losses on AFS securities are reported on the income statement,

Unrealized gains and losses are reported in other comprehensive income as a part of shareholders’ equity.
Trading securities:
These are debt and equity securities (e.g. stocks and bonds) that are acquired with the intent of earning trading profits over the near term.

These securities are measured at fair market value on the balance sheet.

Dividend income, interest income, realized gains and losses, and unrealized gains and losses are all reported on the income statement.
Held-to-maturity securities:
These are debt securities that are purchased with the intent of holding them till maturity.
Held-to-maturity securities are carried at amortized cost (Amortized cost = Face value - Unamortized discount + Unamortized premium).

For these securities, unrealized gains or losses from changes in market value are IGNORED and not recognized on the financial statements.

Only interest income and realized gains and losses (gains and losses when these securities are sold) are recognized on the income statement.
Statement of Changes in Owners’ Equity includes
This statement includes the effects of all transactions that increase or decrease owners’ equity
over the period. The statement includes:
• Contributions by, and distributions to shareholders.
• Reconciliation of the beginning and ending values of each class of stock, share premium, retained earnings and accumulated other comprehensive income.
• Components of other comprehensive income (unrealized gains and losses on available-for-sale securities; foreign currency translation adjustments arising from foreign subsidiaries; adjustments for minimum pension liability and gains or losses from cash flow hedging derivatives).
Common-Size Balance Sheets
A vertical common-size balance sheet expresses each balance sheet item as a percentage of total assets.
This allows an analyst to perform historical analysis (time-series analysis) and cross-sectional analysis across firms within the same industry.

Horizontal common-size balance sheets express each item relative to a specified base year value.
They only facilitate time-series analysis, not cross-sectional analysis.
Treasury stock
These are shares that have been bought back by the company.

Repurchases result in a reduction in owners’ equity and in the number of shares outstanding.

These shares do not receive dividends and do not have voting rights.
Limitations of ratio analysis

4 pts
Companies may have divisions that operate in different industries. This can make it difficult to find relevant industry ratios to use for comparisons.

• There are no set ranges within which particular ratios for a company must lie
analyst must use her own judgment to evaluate

Firms enjoy significant latitude in the choice of accounting methods that are acceptable given the jurisdiction that they operate in. For example, under U.S. GAAP, companies can:
o Use the FIFO, AVCO or LIFO inventory cost flow assumption.
o Choose from a variety of depreciation methods.

• Comparing ratios of firms across international borders is even more difficult in that most countries use IFRS.
Activity ratios
Activity ratios are also known as asset utilization ratios or operating efficiency ratios.
They measure how well a company manages its operations, and particularly how efficiently it manages its assets- working capital and long-lived assets.
Cash collected from customers.
Interest and dividends received.
Proceeds from sale of securities held for trading

Cash paid to employees.
Cash paid to suppliers.
Cash paid for other expenses.
Cash used to purchase trading securities.
Interest paid.
Taxes paid.

• Changes in relevant asset and liability accounts should be used to determine whether business operations are a source or use of cash.
• Operating cash flow should be compared to net income. If high net income is not being translated into high operating cash flow, the company might be employing aggressive revenue recognition policies.
• Companies should ideally have operating cash flows that exceed net income.
• The variability of operating cash flow and net income is an important determinant of the overall risk inherent in the company.
CFI Classification under US GAAP
Sale proceeds from fixed assets.
Sale proceeds from long-term investments

Purchase of fixed assets.
Cash used to acquire LT investment securities.
CFF Classification under US GAAP

Proceeds from debt issuance.
Proceeds from issuance of equity instruments

Repayment of LT debt.
Payments made to repurchase stock.
Dividends payments.
Describe how noncash investing and financing activities are reported plus examples of noncash investing act
Noncash investing and financing activities are not reported on the cash flow statement because these transactions do not involve any receipt or payment of cash.

Examples of noncash investing and financing activities include:

• Barter transactions where one non-monetary asset is exchanged for another.
• Issuance of common stock for dividends, or when holders of convertible bonds or convertible preferred stock convert their holdings into ordinary shares of the company.
• Acquisition of real estate with financing provided by the seller.

Remember that companies are required to disclose any significant noncash investing and financing activities in a separate note or a supplementary schedule to the cash flow statement.
Direct method:
Direct method: Under the direct method, income statement items, which are reported on an accrual basis are all converted to cash basis.

The direct method explicitly lists the actual sources of operating cash inflows and outflows, whereas the indirect method only provides net results for these inflows and outflows
The information provided in the direct format is very useful
in evaluating past performance and making projections of future cash flows

Cash Flow from Operating Activities
Cash collected from customers $100,000
Cash paid to suppliers (30,000)
Cash paid to employees (12,000)
Cash paid for interest (5,000)
Cash paid for taxes (3,000)
Operating cash flow $50,000

All cash receipts are reported as inflows,
while cash payments are reported as outflows.
Indirect method
Indirect method: Under the indirect method, cash flow from operations is calculated by applying a series of adjustments to net income.

These adjustments are made for noncash
items (e.g. depreciation), nonoperating items (e.g. gains on sale of noncurrent assets), and changes in working capital accounts resulting from accrual accounting.

The indirect method provides a list of items that are responsible for the difference between net income and operating cash flow. These differences can then be used when estimating future operating cash flows.

Cash Flow from Operating Activities

Net income $120,000
Depreciation 10,000
Gain on sale of machinery (1,000)
Increase in inventory (2,000)
Decrease in accounts receivable 3,000
Decrease in accounts payable (1,000)
Operating cash flow $129,000
Free cash flow to equity (FCFE)
Free cash flow to equity (FCFE) refers to cash that is available only to common shareholders.

FCFE = NI +NCC -WCInv - FCInv + Net borrowing - Net debt repayment

FCFE = CFO - FCInv + Net borrowing - Net debt repayment

NI = net income.
NCC = noncash charges.
FCInv = fixed capital investment (net capital expenditure).
WCInv = working capital investment.

A positive FCFE suggests that the company has operating cash flows available after payments
have been made for capital expenditure and debt repayment. This excess belongs to common shareholders.

Note: Under IFRS, if the company has deducted dividends paid in calculating CFO, dividends must be added back to calculated FCFE.
Free cash flow to the firm (FCFF)
Free cash flow to the firm (FCFF) is cash that is available to equity and debt holders after the company has met all its operating expenses, and satisfied its capital expenditure and working capital requirements.

FCFF = NI + NCC + [Int ´ (1 - tax rate)] - FCInv - WCInv

FCFF = CFO + [Int ´ (1 - tax rate)] - FCInv

NI = net income.
NCC = noncash charges.
FCInv = fixed capital investment (net capital expenditure).
WCInv = working capital investment.
Int = Interest expense.
Formula for Cash dividends paid out and dividend declared
Cash dividends paid out = Beginning dividends payable + Dividends declared -
Ending dividends payable.

Dividends declared = Beginning retained earnings + Net income - Ending retained
Calculation of proceeds from sale of equipment: 4 step process
step1: Calculation of historical cost of sold equipment:

Beginning gross fixed assets + Purchase price of new fixed assets - Historical cost of disposed fixed asset = Ending gross fixed assets

Step2: Calculation of accumulated depreciation on sold equipment:

Beginning accumulated depreciation + Current year’s depreciation on all assets - Accumulated depreciation on sold asset = Ending accumulated depreciation.

Step3: Calculation of book value of sold equipment:

Book value of sold equipment = Historical cost - Accumulated depreciation

Step4: Calculation of proceeds from sale of equipment:

Selling price - Book value = Gain/loss on sale of equipment
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