The income statement (I/S) measures performance. When prepared for the IRS, it is reported on a cash basis. When prepared for financial reporting, it is reported on an accrual basis.
|
Common Income Statement
|
| Revenue: |
Sales |
| Gains (Market Value > Book Value) |
| Investment |
| Expenses: |
Cost of Goods Sold (COGS) – LIFO vs. FIFO |
| Selling, General, and Administrative (SG&A) |
| Depreciation and Amortization (accounting depreciation) – matching principal, matching costs with benefit |
| Interest |
| Tax Expense |
| Losses |
|
Net Income
|
Revenue – COGS = Gross Profit
Gross Profit – SG&A = Operating Profit
Gross Profit + Other Income and Revenues – Financing Costs ± Unusual or infrequent items = Income before Tax
Income before Tax – Provision for Income Taxes = Income from Continuing Operations (“The Line”)
Income from Continuing Operations ± Income from discontinued operations ± Extraordinary items = Net Income (The “Bottom Line”)
Notes on terminology above:
- “Gross” on I/S means before tax and expenses
- Operating profit is almost the same as Earnings Before Interest and Taxes (EBIT) but not identical
- Other incomes and revenues is interest received and dividends received. These are ancillary, not part of core business
- Financing costs is accrued interest expense
- Provision for income taxes is tax expenses minus deferred tax asset (DTA) / deferred tax liability (DTL)
- DTA = paid too much
- DTL = paid too little
- Above the line = pre tax, below = post tax
- Extraordinary items (GAAP only): Unusual AND infrequent events. For example, natural disasters and expropriation
- Unusual or infrequent:
- Disposal of business segment (10% of total profit, assets, or revenue)
- Gain or loss from sale of investment of subsidiary (20-50%)
- Provisions of environmental remediation (clean up costs)
- When Market Value < Book Value, B/S goes down, I/S shows loss only on financial reporting, not IRS (not sold yet), will create DTA
- Discontinued operations – company hasn’t done anything yet, forward looking. It is below the line so it is a relatively large accounting decision
Net Income (NI):
Revenue – Expenses = NI
NI has 2 components:
1) Dividends declared
2) Retained earnings
NI is accounting income not adjusted for risk
Accounting point of view on $500 NI = Good
Finance point of view on $500 NI = May or may not be good, depends on how much risk was involved in getting $500.
Example: Declare a dividend, dividend payable goes up, retained earnings goes down
Comprehensive Income: this is a more inclusive measure of equity than net income, which is only revenue minus expenses. This measure is necessary for financial analysis from the shareholders’ point of view.
Comprehensive Income = Net Income (I/S) + Other Comprehensive Income (B/S)
Other Comprehensive Income (OCI): It is comprised of certain transactions that affect shareholder wealth that bypass the I/S.
There are 4 components to OCI (B/S):
1) Unrealized gains and losses on available for sale securities (ex. GOOG buys 2% AAPL, If AAPL increases at the end of year, marketable securities and OCI goes up on the B/S. When position is closed, put gain/loss on the I/S. This is kept on B/S to decrease fluctuations the on I/S
2) Pension expenses – pensions are all about guesses and expectations, therefore it isn’t accurate to put it on the I/S. Keep on the B/S
3) Hedging with derivatives – The market fluctuations would cause variations on the I/S is unnecessary, keep on B/S
4) Currency translation adjustment for foreign exchange – Same as above
Revenue Recognition:
GAAP: Risk and reward of ownership transferred
IFRS: Probable flow of economic benefits
Example: An item with a 90 day warranty isn’t a sale until 90 day expires
Types of revenue recognition: sales basis, percentage of completion, completed contract, installment sales, cost recovery method
- Sales Basis: This is the majority of most businesses. Buy inventory with cash and sell it for cash (or credit card transactions, basically no accruals are necessary)
- Percentage of Completion: Reliable estimate of cost and completion required. Expense/cost drives revenue. If it takes 4 years and costs $1.6M to build a plane, and the cost is uniformly distributed, 1/4 of revenue will be recognized every year. Assets go up, NI goes up, volatility goes down, cash flow (CF) remains the same. Example: Total Revenue (TR) = $2M, Total Cost (TC) = $1.6M, Profit = $400K
|
Year 1 |
Year 2 |
| Revenue |
500,000 (400K/1.6M)=.25(2M) |
625,000 (500K/2M)=.3125(2M) |
| Expense |
(400,000) |
(500,000) |
| Profit |
100,000 |
125,000 |
| CF |
500,000 |
500,000 |
- Completed Contract (US GAAP only): No reliable estimate of cost and completion. Show everything at end.
|
Year 1 |
Year 2 |
Year 3 |
Year 4 |
| Revenue |
0 |
0 |
0 |
2M |
| Expense |
0 |
0 |
0 |
1.6M |
| Profit |
0 |
0 |
0 |
400K |
| CF |
500,000 |
500,000 |
500,000 |
500,000 |
Installment Sales: Cost is certain, collectability is not. Example: TR = $200K, TC = $100K, Profit = $100K
|
Year 1 |
Year 2 |
| Revenue |
40%(Profit)=4K |
(profit)=6K |
| Expense |
8K/20K=.40 |
12K/20K=.30 |
| Profit |
0 |
0 |
| CF |
8,000 |
12,000 |
- Cost Recovery Method: Cost is not certain, collectability is not certain. Every dollar coming in goes to recover cost until all cost is paid off
|
Year 1 |
Year 2 |
| Revenue |
8000 |
12000 |
| Expense |
8000 |
2000 |
| Profit |
0 |
10000 |
| CF |
8,000 |
12,000 |
Because of its importance, earnings per share (EPS) are required to be disclosed on the face of the income statement.
Basic EPS = NI – Preferred dividends (all convertible and non-convertible)
Diluted EPS
| Stock Options |
Are dilutive, warrants less dilution than stock options |
| Warrants |
| Convertible Debt |
May be dilutive |
| Convertible Preferred Stock |
Treasury stock method
-Hypothetically repurchased. 15 x 100,000/20 = 75,000 shares (hypothetical number of shares needed, short 25,000 which needs to be issued)
-Stock options: if you exercise the shares, you will get it as salary, so they can claim as expense and pay lower taxes. They won’t actually let you exercise the options, they will give you the difference.
-Stock split is a special case of a stock dividend
Example: 1/1: 10,000 common shares outstanding, 4/1: 5,000 convertible preferred shares are converted, 7/1: 10% stock dividend, 9/1: repurchased 5,000 shares
Weighted average = (11000*12/12)+(5500×9/12)-(5000×4/12) =
The easiest way to adjust for these shares is to check the date of conversion or stock dividend/split and multiply the change in shares by the months, i.e. Convertible Preferred Shares are converted on April 1, multiple the number of converted shares by 9/12
Dupont formula
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My Level 1 Status as of 3/8/2012:
Hours studied: 50
Practice questions taken: 316
Ethics:
-QBank- Quiz 1: 23/30; Quiz 2: 25/30
QM:
-QBank- Quiz 1: /60; 38/60
-SchweserNotes: Technical Analysis- 6/9
Portfolio Management:
-QBank- Quiz 1: 26/30
-SchweserNotes: 10/13; 10/13; 3/5; 2/6
Accounting:
-QBank – 39/60
-SchweserNotes: 5/6; 7/8; 14/22
-Other: 19/25;
