FAR - Financial Accounting and Reporting
Financial Statements Overview
Balance Sheet:
Also known as the statement of financial position.
Assesses assets, liabilities, and equity.
Evaluates risk, liquidity, and solvency.
Income Statement:
Also known as the statement of earnings.
Measures sales revenue, operating profits, and net income.
Includes discontinued operations.
Statement of Comprehensive Income:
Comprehensive income is net income plus other comprehensive income (OCI).
Statement of Cash Flows.
Statement of Owner's Equity:
Assesses changes in stockholders' equity from the beginning to the end of the period.
Classified Balance Sheet:
Differentiates between current and noncurrent assets and liabilities.
Current items are expected to be settled within the next year.
Noncurrent items extend beyond the next year.
Balance Sheet Details
Assesses financial risk (short-term and long-term).
Gauges capacity to produce.
Comprises assets, liabilities, and equity accounts.
Evaluates liquidity (ability to pay short-term obligations).
Evaluates long-term solvency (ability to pay long-term debts).
Basic accounting equation:
Assets:
Represent probable future economic benefit.
Examples: cash, receivables, prepaid expenses, inventory, short-term investments, stocks, bonds, derivatives, property, plant, and equipment (PP&E), intangible assets (patents, copyrights, trademarks, goodwill).
Liabilities:
Represent obligations to others.
Have a maturity date.
Current Liabilities:
Mostly operating liabilities.
Satisfied within twelve months using current assets.
Long-term Liabilities:
Mostly financial liabilities like notes payable and bonds payable.
Satisfied beyond the next year.
Equity:
Includes preferred stock, common stock, additional paid-in capital (APIC), retained earnings, and accumulated other comprehensive income (AOCI).
Preferred stock, common stock and APIC are considered financing.
Retained earnings and AOCI are considered earned capital.
Treasury Stock:
Contra-equity account.
Represents the corporation's own stock that has been repurchased.
Income Statement Overview
Indicates performance for a period of time (typically one year).
Provides information about revenues, expenses, gains, and losses (REGL).
Revenues and Expenses:
Operating: Core business activities.
Non-operating: Non-core business activities.
Gains and Losses:
Non-operating items reported at net amounts (sales price vs. cost).
Unexpired Cost:
Treated as an asset.
Can become an expired cost, which is then recognized as an expense.
Example: Inventory becomes cost of goods sold (COGS) when sold.
Net Book Value of Fixed Assets:
Depreciated over useful life.
Depreciation recognizes the loss in value of an asset.
Income from Continuing Operations:
Includes both operating and non-operating income.
Discontinued Operations:
Separate section on the income statement.
Represents a segment that has been or will be disposed of.
Reported net of tax.
Multiple-Step Income Statement
Differentiates between operating and non-operating activities.
Provides detailed information about a company's core business performance.
Net income accounts for both income from continuing operations and discontinued operations.
Accrual vs. Cash Basis Accounting
Accrual Accounting:
Required by GAAP.
Provides a better assessment of performance.
Involves some subjectivity.
Cash Basis Accounting:
More objective.
Considered a poor indicator of performance.
Still important to understand for exam, especially for reconciliation with accrual basis in unit F2.
Discontinued Operations Details
Reported separately from continuing operations, net of tax.
Must represent a strategic shift with a major effect on operations and financial results.
Can be reported even if not yet sold if held for sale.
Potential components:
Impairment loss.
Results of operations between decision and actual sale.
Gain or loss on ultimate sale.
Can span multiple fiscal years.
Advantage: Allows company to present a clearer picture of ongoing operations.
Foreign Currency Transactions
Involve imports and exports.
Imports: Buying from overseas vendors often paid in their currency.
Exports: Selling to overseas customers often paid in their currency.
Exchange rate fluctuations between transaction date and settlement date can impact financial results.
Exchange Rate:
Price of one currency in terms of another.
Direct Method: €1 = $1.47.
Indirect Method: $1 = €0.68 (inverse of direct method).
Example: Olinto purchases goods for 100,000 pesos.
12/1 Year 1: 10¢ per peso.
12/31 Year 1: 8¢ per peso.
2/1 Year 2: 9¢ per peso.
Initial entry: Debit purchases $10,000, credit accounts payable $10,000 (100,000 pesos * 10¢).
12/31 Year 1: Book a gain because it would now only cost $8,000 to cover the $10,000 payable. If you were Alinto, you would book a Gain because it went from 10 cents on December 1st to 8 cents on December 31st. So this is better for Alinto.
2/1 Year 2: Book a loss because it now takes 9 cents to cover every peso.
Statement of Comprehensive Income (SCI)
Items not on the income statement follow the PUFI mnemonic: Pension adjustments, unrealized gains/losses on certain securities and hedges, foreign currency items, instrument-specific credit risk.
Comprehensive Income Defined:
Net income + Other Comprehensive Income (OCI).
All changes in equity except investments by owners and distributions to owners.
Other Comprehensive Income (OCI):
Use the PUFI mnemonic.
Accumulated Other Comprehensive Income (AOCI):
Balance sheet line item.
Accumulated OCI over all years.
Think of it as a parking lot: OCI is cars entering the parking lot; reclassifications out of AOCI are cars leaving to the income statement (highway).
Presentation of SCI:
Single statement approach or two-statement approach (income statement followed by SCI).
Both are acceptable.
Key takeaway: Comprehensive income = net income + other comprehensive income.
Public Company Reporting
SEC (Securities and Exchange Commission) filings for US-registered companies (issuers).
Form 10-K (Annual Report):
Information about company's business, risks, financial and operating results, and executive perspective.
Key parts specifically called out in the blueprint:
Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
Part II, Item 7A: Quantitative and Qualitative Disclosures about Market Risk.
Part II, Item 8: Financial Statements and Supplementary Data.
Filing Deadlines:
Large Accelerated Filers (market cap ≥ $700 million): 60 days.
Accelerated Filers: 75 days.
All Other Filers: 90 days.
Form 10-Q (Quarterly Report):
Filed for each of the first three quarters.
Information on business operations, financial and nonfinancial information, and key disclosures.
Filing Deadlines:
Large Accelerated and Accelerated Filers: 40 days.
All Other Registrants: 45 days.
Timeliness emphasized over reliability to a degree.
Key parts specifically called out in the blueprint:
Part I, Item 1: Financial Statements.
Part I, Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
Part I, Item 3: Quantitative and Qualitative Disclosures about Market Risk.
Form 8-K:
Discloses material events such as bankruptcy, acquisition/disposition of assets, changes in public accounting firm, changes in directors/officers, amendments to articles of incorporation/bylaws.
No set timeline; issued when material events occur.
Earnings Per Share (EPS)
A critical number for the investment community and the company.
Can be stated quarterly or annually.
Simple Capital Structure:
No potentially convertible securities.
Basic earnings per share = (Income available to common stockholders) / (Weighted Average Common Shares Outstanding WACC)
Income available to common stockholders = Net income - Preferred dividends.
Preferred Dividends:
Cumulative Preferred Stock: Subtract any dividends in arrears.
Noncumulative Preferred Stock: Subtract only declared dividends.
Calculating WACC:
Adjust for shares issued or reacquired during the year.
Stock dividends, stock splits, and reverse stock splits are treated as if they happened at the beginning of the period.
Methods for Calculating WACC:
There are two methods for calculating weighted average common shares outstanding (WACC).
Cumulative Balance Approach:
The cumulative balance approach calculates the total shares outstanding for a defined period.
Formula Balance Approach:
The formula is shares outstanding (cumulative) MULTIPLIED BY the fraction of the year.
Diluted Earnings Per Share
Complex Capital Structure: Includes items that can potentially be converted into common stock.
Presents a worst-case scenario if all dilutive securities are converted.
Formula: (Income available to common stockholders + Interest expense * (1 - Tax rate)) / Shares + Shares from conversion of potential diluters.
Treasury Stock Method
Options and Warrants: * Gives holder the right to buy shares at a specific price. * Treasury Stock Method: If average stock price exceeds the option, then the outstanding options are dilutive.
Dilution vs. Anti-Dilution:
If the average price is below the exercise price, the options are not dilutive (anti-dilutive).
Only calculate if dilutive.
Treasury stock is for shares that the company goes and buys back in the marketplace. In other words, they buy back their own shares.
If converted method
Convertible Bonds: bonds are converted into common stock.
Formula for Convertible securities:
Adjusted numerator = Income + (Interest Expense (1 - Tax Rate)).
Income tax = how much the company saved on tax.
Adjusted denominator = WACSO + new shares from conversion.
DILUTION-ANTILUTION, apply to convertible securities. Only have to do the calculations if it is dilutive
Stockholders Equity
Represents the owners' claim to the net assets of a corporation.
Shareholder's equity = ownership’s equity, often used.
Capital Stock:
Legal capital that must be retained to protect creditors. This is the state of a company.
Authorized shares, legal max # of shares.
Issued shares, is the number of shares the company has sold.
Outstanding shares, is the number of shares currently in the shareholder's hands.
(Authorized >= Issued >= outstanding)
Common Stock Rights:
Right to vote.
Right to share in earnings.
Right to assets upon liquidation.
Preferred Stock:
Hybrid security with features of both equity and debt.
Preference regarding dividends. Has a preference for assets when liquidated.
May or may not have voting rights, depends on the state.
Dividends can be fixed, but in the percentage of state value.
Fixed at the beginning of year, but may have more at the end.
Cumulative vs Non-Cumulative.
Cumulative, has cumulated dividends.
Dividends in arrears (DIA), how far apart / behind the companies.
Have to get paid before common stockholders can get paid.
*Non-Cumulative, are only paid if board declares the dividends for the year
Preferred stock can be Participating or nonparticipating.
Participating, these stocks participate in other excess dividend is a company has to offer.
Nonparticipating, do not get more even though other people do
Preference in LiquidationIf the company goes out of business, the preferred stockholders might have to get paid before common stockholders.
If > Par/ state value disclosed.
Disclosures about state of the company MUST be disclosed.
Additional paid in capital (APIC)
The origin of APIC where you see it typically first is when a company issues new stock in the marketplace, and they issue it at a price above par or stated value.
Selling treasury stock at a gain leads to APIC.
Bond conversion can produce APIC.
Small stock conversion could produce APIC.
Retained earnings
What are the accumulated earnings and net loss of a corp, closed over time.
*Net profit or loss closes over to retained earnings, same way dividends closes to retained earnings.
Dividends are basically the net loss.
We could have the property dividend.
*Formula: Retained Earnings ending: Beg RE + Ni/loss – Divs + Prior Period Adjustment + Accounting changes.
OCM, other complex income is impacted by many elements, and it goes back to the old car example as mentioned before.
These topics are asked whether it has to do with COM or AOCI, so be familiar with each.
Treasury Stock
A situation where the company has shares of stocks, then get bought back from shareholders.
Remember: If you acquire debt from a corporation, you're NOT apart if the corporation. It just means that the corp has taken their investments.
Cost method and par value method. You have to do/understand these two because some states don’t use cost method
Cost method is used by far the most by companies out there and the states use this method.
Different types of ways can impact the game or loss/the difference on when the game or loss is being used/ recognized.
Par value method every-time we hit the treasury account/ the state of treasury is that it cost that we paid for it
Treasury Stock is a contra-equity account, not in the pocket of shareholder.
*You cannot credit to retain earnings in treasury stock transaction (because that implies you earned something), will be to credit APIC account instead
Issued stocks that are not sold to employees, is a capital source to the company/ fin flow.