FR&A - Income Statement (part 2 of 2)

9:30 AM

Inventory

• Specific identification method - e.g. each vehicle in an inventory
• FIFO - appropriate for limited shelf life items
• LIFO - e.g. coal will sell off the top of the pile
• Tax benefits - higher COGS in inflationary environment
• Weighted Avg Cost Method
• Somewhere between LIFO/FIFO
• Divide total cost of goods available by total units
• FIFO and Wtd Avg Cost are ok under both GAAP and IFRS, but LIFO only under GAAP

Intangible Assets

• Amortization - allocation of the cost of an intangible
• Expense should match proportion of asset's economic benefits used during period
• Most use straightline
• Things with indefinite life (e.g. goodwill) are not amortized but must be tested for impairment at least annually.  Expense any amount of impairment.

Operating/Nonoperating Expenses

• For nonfinancial firm, nonoperating might include investment income/financing expense
• Interest expense is based on capital structure - which is also independent of firm operations

Discontinued Operations

• One you are disposing of but either haven't done so yet or have disposed in current year after the operation had generated income or losses
• Must be physically distinct in terms of assets and operations
• Measurement date - when formal plan to discontinue is made
• Time between this and actual disposal is phaseout period
• Income reported net of tax after income from continuing ops
• Past income statements must be restated
• On measurement date, accrue any expected loss.  Expected gain cannot be recorded until sale completed.

Unusual/Infrequent Items

• Unusual in nature or infrequent in occurrence but not both
• E.g. gains/losses from asset sales/parts of business
• Included in income from continuing operations, reported before tax - must consider this when forecasting

Extraordinary Items

• Under US GAAP, item that is both unusual and infrequent
• E.g. expropriation losses, natural disasters, etc.
• Reported separately, net of tax, after income from continuing operations
• IFRS does not allow these expenses to be separate from operating results in income statement
• Judgment is required to determine if an event is really extraordinary

Changes in Accounting Standards

• Three types
• Change in accounting principle: e.g. FIFO to LIFO
• Requires retrospective application
• Change in accounting estimate - change in judgment, usually due to new information
• Does not require retro application - apply prospectively
• E.g. changing useful life of an asset
• These typically do not affect cash flow
• Prior period adjustment - correction of an error in method or accounting
• Must apply retrospectively and explain
• Again usually do not affect cash flow
• Errors may indicate weaknesses in internal control

Earnings per Share

• Simple capital structure - no dilutive securities
• Complex capital structure - potentially dilutive securities - warrants, options, converts
• Must report basic and diluted EPS

Basic EPS

• EPSb = (net income - preferred dividends) / wtd avg number common shares outstanding
• EPS is earnings available to common - this is why we subtract preferred
• Number of shares is weighted over the year by portion of the year they were outstanding

Effect of stock split/stock dividend

• Each holder will still have same percentage of total shares outstanding
• To calc EPS, first find wtd average
• Convert pre-split amounts to post-split equivalents
• Multiply by months out, and then divide sum by 12
• Done

Diluted EPS

• Dilutive - options etc. that decrease EPS; Antidilutive are the opposite
• Adjust numerator for:
• Convert preferred stock - if dilutive - convert preferred dividends must be added to earnings available to common
• Convert bonds - if dilutive - after tax interest expense of bonds is not considered interest expense for diluted EPS, so interest expense * (1-taxrate) is added to numerator
• Adjust denominator:
• Assume conversion of all dilutive securities
• Consider each security separately to determine if dilutive
• If dilutive was issued during year, only weighs for the portion of the year it was outstanding
• Dilutive options/warrants increase shares out.  No adjustment to numerator.
• Only dilutive when exercise price < avg mkt price over the year
• If dilutive, use treasury stock method

Treasury stock method

• Assumes funds received by company from exercise of options would be used to purchase shares in the market at the average price
• Net increase in shares outstanding is number of shares created by exercising, less the number of shares hypothetically repurchased with the proceeds

Antidilutive securities are NOT included in diluted EPS

• Antidilutive might include conversion of preferred - not having to pay preferred dividend is good, and if this outweighs effect of additional shares you are fine

Changes in EPS

• Notes will typically explain - e.g. shares were repurchased

Comprehensive Income

• Includes all changes to equity other than owner contributions and distributions
• Aggregates net income AND other comprehensive income
• OCI = foreign currency translation gains/losses, pension liability adj, unrealized gains/losses on cash flow hedging derivs and available for sale securities)

Transactions that affect equity but do not show up on income statement

• Issuing stock / reacquiring stock
• Dividends
• OCI

End

10:45 AM

1.25 hours