Financial Reporting II Final Exam

All accounts associated with Cash Flows From Operating Activities

1) Depreciation

2) Deferred Income Tax

3) Stock Based Compensation

4) Gain on Sale of Property and Equipment

5) Change in Receivables - net

6) Change in Inventories

7) Change in Prepaid expenses

8) Change in Cash surrender value of insurance

9) Change in other Assets

10) Change in Accounts payable

11) Change in Accrued Expenses

12) Change in Salary Continuation Plan

13) Change in Accrued Income Taxes

From the Income Statement;

Depreciation Expense and (Loss) on Sale of Equipment must be...

Added Back to Net income in the CFOA

From the Income Statement; Gain on Sale of Marketable Securities AND Gain on Early Extinguishment of Debt must be...

Subtracted from Net income in the CFOA

From the Balance Sheet;

Increases in A/R and Inventories and any other CURRENT ASSET must be...

Subtracted* from Net Income In the CFOA

From the Balance Sheet;

Increases in A/P and Accrued Wages and any other CURRENT LIABILITIES must be...

Added* back to Net Income in the CFOA

Cash Flows from Operating Activities reflect....

Changes in Current Assets and Current Liabilities (Working Capital)

Cash Flows from Investing Activities reflect...

Changes in Non-Current Assets

Cash Flows from Financing Activities reflect...

Changes in Long-term Liabilities and Owners Equity Accounts

In Cash Flows from Investing Activities, PURCHASES of Land and/or Marketable Securities should be...

An OUTFLOW of Cash in Investing Activities

In Cash Flows From Investing Activities, SALE of Marketable securities and/or Equipment should be...

An INFLOW of Cash in Investing Activities

In Cash Flows from Financing Activities, Payments to Retire Bonds or Payments of Dividends should be...

An Outflow of Cash in Financing Activities

In Cash Flows from Financing Activities, Issuance of Stock should be...

An Inflow of Cash in Financing Activities

The main (and only) difference between the Direct Method and Indirect Method for the statement of Cash Flows involves what?

It involves the Cash Flows from Operating Activities.

What does the Indirect Method of Statement of Cash Flows START WITH?...

Net Income, Followed by Adjustments

In the Direct Method of the Statement of Cash Flows, Net Income is...

Not the starting Point. Instead, the direct method lists the cash amounts received and paid by the corporation. This method also requires a reconciliation of net income to cash provided by operating activities (automatically done through the other method)

Operating Cash Flows

Transactions related to production and delivery of goods and services. Can think of it as cash basis income.

Investing Cash Flows

Buying or selling of PP&E, intangibles, marketable securities, acquisitions and divestitures.

Financing Cash Flows

Borrowing or repayments (debt), issuance and buyback of stock, payment of dividends.

FASB "Encourages" use of the direct method....

But 98% of companies use the indirect method

Direct Method

Minimum Categories

-Cash Collected from customers

-interest & dividends received

-other operating cash receipts

-cash paid to employees

-cash paid to other suppliers of goods and services

-interest paid

-income taxes paid

-other operating cash payments

Indirect Method

Start with net income

-Add back noncash Expense

-Deduct noncash revenues

-Reclassification of items included in net income that belong in investing and financing activities (e.g. gains/losses on disposal of assets)

-Changes in operating assets and liabilities (Working Capital accounts)

Reconciliation among statements

Changes in working capital accounts on the balance sheet don't always (in fact rarely) correspond with amounts shown on the statement of cash flows

Reasons for Reconciliation among statements...

1) Asset write-offs

2) Translation adjustment for assets/liabilities of foreign subsidiaries

3) Acquisitions (or divestitures)

4) noncash investing/financing activities

Can Operating Cash flows Be distorted?

Yes

How can operating Cash Flows be distorted?

Changes in Working Capital accounts

1) Accelerate A/R collections

2) Delay A/P and other payments

3) Factoring A/R

4) Capitalizing Versus Expensing

5) Software Development Costs - MGMT discretion - Investing CFs could move to operating

6) capital vs. Operating Leases

7) Stock Option Expensing

Its important to note that for Stock Option Expensing....

There is no DTA created at the time the options are granted for the excess tax benefit because we cannot know how much it will be, if any! But there is a DTA related to the stock compensation.

Income or loss comes ONLY from transactions with "outsiders."

True or False

True

Owners' equity is the owner's net investment:.....

its comes from owner contributions OR amounts earned or retained by the firm

Earnings Per Share (EPS)

only financial statement ratio that is AUDITED

Basic EPS

=(Net Income - Preferred Dividends)/(Weighted avg. # of shares outstanding)

complex capital structure

Company has convertible securities and/or options or warrants

EPS

Reported Earnings subject to "Management" or Manipulation. Number of Shares outstanding can be reduced with stock repurchases.

ignores amount of Capital Required

types of Dividends

1) Cash

2) Small Stock

3) Large Stock

4) Stock Splits

Types of Share based Compensation

1) Employee Stock Options

2) Restricted stock

3) Restricted Stock Unit

*****CHECK THIS

What must company's record for employee stock options?

employee compensation expense for stock options

How are employee compensation expenses recognized?

on S/L basis over the vesting period

Restricted stock

compensation issued by an employer to an employee in the form of company stock after achieving required performance milestones or upon remaining with their employer for a particular length of time.

With restricted stock units, upon vesting......

They are considered income, and a portion of shares is withheld to pay income taxes. The employee receives the remaining shares and can sell them at his or her discretion.

Agency Relationship

a formal or informal contract under which one or more individuals (principles) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent.

Agency Costs

what the principles pay (in reduced wealth or utility) when they delegate decisions to the agent.

Agency Conflict

a conflict of interest inherent in any relationship where one party is expected to act in another's best interests. In corporate finance, this problem usually refers to a conflict of interest between a company's management and the company's stockholders.

types of debt covenants

1) limitation on Incurrence of Funded Debt

2) Fixed Charges Coverage

3) Minimum Consolidated tangible Net Worth

Ways to avoid Debt Covenant Violations on Fixed Charges ratio...

1) Accelerate Revenue Recognition

2) Delay recognition of Expenses

3) Postpone Discretionary expenses like maintenance, etc.

4) Sell assets that have MVs excess of BVs

5) Change one or more accounting methods

6) Change one or more accounting estimates

Ways to avoid debt covenant violations on Tangible net worth...

1) Issue Common Stock

2) Reissue Treasury Stock

3) All that Apply to Fixed Charges Ratio Covenant Violations

Way to avoid Violating the consolidated Debt to Total Capitalization...

Retire some debt before the end of the year. If the debt could be retired for a price close to its carrying amount, net worth would not change much.

Debt covenants serve 3 main purposes

1) Preservation of repayment capacity

2) Protection against credit damaging events

3) Signals and triggers

Affirmative Covenants

1) Using the loan for agreed upon purpose

2) providing periodic, audited financial statements

3) complying with financial covenants

4) complying with laws

5) allowing the lender to inspect business assets and business contracts

6) maintaining business records and business properties and carrying insurance on them.

Negative covenants

tend to be more significant and more intensely negotiated than affirmative covenants,,, restricting the borrower's action.

Negative Covenants include

1) total indebtedness

2) investment of funds

3) capital expenditures

4) leases

5) corporate loans

etc...

restricted stock

typically an award of stock that is nontransferable or subject to forfeiture for a period of years.

permanent earnings

expected to persist into the future and is therefore valuation-relevant. In theory, the multiple for this component should approach 1/r.

Transitory earnings

valuation-relevant but is not expected to persist into the future.

*one time events or transactions,,, multiple should approach 1.

Value-irrelevant earnings (or NOISE)

unrelated to future free cash flows or future earnings and is NOT pertinent to assessing current share price.

Income from continuing operations falls into...

the permanent earnings category

Income (loss) from discontinued operations

are nonrecurring, and fall into transitory components of earnings.

The current-year impact of a change in accounting principles....

May be viewed as NOISE and value-irrelevant, because it has no future cash flow consequences to shareholders.

Paid in Capital or Contributed Capital

1) Common Stock

2) Preferred stock

3) Additional Paid in Capital

Earned Capital

1) Retained Earnings

2) accumulated other comprehensive income (loss)

Assets minus liabilities

is net capital deployed or THE FIRM

Owners Equity is....

Owner's net investment

** either contributed or

** Earned and retained by the firm.

preferred stock

*preference as to dividends

*Preference as to distribution of assets if the company is liquidated

order of dividend Dates

1) Date of Declaration

2) Date of Record

3) Date of Payment

4) Date of Distribution

stock-based compensations

1) Incentive stock options

2) Non qualified stock option plans

3) Restricted Stock

Incentive stock option

employer does not get a tax deduction, BUT have expense under U.S. GAAP.

******Creates permanent difference difference.

Non qualified Stock Option Plans

Employee owes tax at date of EXERCISE,

*****Employer gets to deduct Intrinsic Value of Options @ Exercise date.

Restricted Stock

Shares issued top employees, but cannot be sold until after a specified period of time.

Dates of interest for stock based compensation

1) Grant date

2) Vesting Date

3) Exercise Date

4) expiration date

Convertible Debt that may be settled in cash

If conversion can be settled with cash, then U.S. GAAP requires the convertible debt debt be separated into debt and equity components

Still learning (15)

You've started learning these terms. Keep it up!