FINANCIAL REPORTING AND ANALYSIS

FINANCIAL REPORTING AND ANALYSIS

2
Exhibit 10, pg 72, Vol 3, CFA Program Curriculum 2012

2011 ELAN GUIDES 28

 FINANCIAL REPORTING AND ANALYSIS

Basic EPS
Basic EPS = Net income Preferred dividends
Weighted average number of shares outstanding

Diluted EPS

Diluted EPS =
[ Net income -
Preferred
dividends ] +
Convertible
preferred +
dividends
[
Convertible
debt (1 - t)
interest
]
Shares from Shares from
Weighted Shares
conversion of conversion of
average + + + issuable from
convertible convertible
shares stock options
preferred shares debt

Comprehensive Income
Net income + Other comprehensive income = Comprehensive income

Gains and Losses on Marketable Securities

Held-to-Maturity Available-for-sale Trading

Securities Securities Securities
Balance Sheet Reported at cost or Reported at fair value. Reported at fair value.
amortized cost.
Unrealized gains or losses
due to changes in
market values are reported
in other comprehensive
income within owners
equity.

Items recognized Interest income Dividend income. Dividend income.

on the income
statement Realized gains Interest income. Interest income.
and losses.
Realized gains Realized gains and losses.
and losses.
Unrealized gains and
losses due to changes in
market values.

2011 ELAN GUIDES 29

 FINANCIAL REPORTING AND ANALYSIS

Cash Flow Classification under U.S. GAAP

CFO
Inflows Outflows
Cash collected from customers. Cash paid to employees.
Interest and dividends received. Cash paid to suppliers.
Proceeds from sale of securities held for trading. Cash paid for other expenses.
Cash used to purchase trading
securities.
Interest paid.
Taxes paid.
CFI
Inflows Outflows
Sale proceeds from fixed assets. Purchase of fixed assets.
Sale proceeds from long-term investments. Cash used to acquire LT investment
securities.

CFF
Inflows Outflows
Proceeds from debt issuance. Repayment of LT debt.
Proceeds from issuance of equity instruments. Payments made to repurchase stock.
Dividends payments.

Cash Flow Statements under IFRS and U.S. GAAP

IFRS U.S. GAAP

Classification of Cash Flows

Interest and dividends received CFO or CFI CFO

Interest paid CFO or CFF CFO

Dividend paid CFO or CFF CFF

Dividends received CFO or CFI CFO
Taxes paid CFO, but part of the tax can be CFO
categorized as CFI or CFF if it is clear
that the tax arose from investing or
financing activities.

Bank overdrafts Included as a part of cash equivalents. Not considered a part of cash equivalents
and included in CFF.

Presentation Format

CFO Direct or indirect method. The former is Direct or indirect method. The former is
(No difference in CFI and preferred. preferred. However, if the direct method
CFF presentation) is used, a reconciliation of net income
and CFO must be included.

Disclosures

Taxes paid should be presented separately If taxes and interest paid are not explicitly
on the cash flow statement. stated on the cash flow statement, details
can be provided in footnotes.

2011 ELAN GUIDES 30

 FINANCIAL REPORTING AND ANALYSIS

Free Cash Flow to the Firm

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

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

Free Cash Flow to Equity

FCFE = CFO - FCInv + Net borrowing

Inventory Turnover
Cost of goods sold
Inventory turnover =
Average inventory

Days of Inventory on Hand

365
Days of inventory on hand (DOH) =
Inventory turnover

Receivables Turnover
Revenue
Receivables turnover =
Average receivables

Days of Sales Outstanding

365
Days of sales outstanding (DSO) =
Receivables turnover

Payables Turnover
Purchases
Payables turnover =
Average trade payables

Number of Days of Payables

365
Number of days of payables =
Payables turnover

Working Capital Turnover

Revenue
Working capital turnover =
Average working capital

Fixed Asset Turnover

Revenue
Fixed asset turnover =
Average fixed assets

Total Asset Turnover

Revenue
Total Asset Turnover =
Average total assets

2011 ELAN GUIDES 31

 FINANCIAL REPORTING AND ANALYSIS

Current Ratio
Current assets
Current ratio =
Current liabilities

Quick Ratio
Cash + Short-term marketable investments + Receivables
Quick ratio =
Current liabilities

Cash Ratio
Cash + Short-term marketable investments
Cash ratio =
Current liabilities

Defensive Interval Ratio

Cash + Short-term marketable investments + Receivables
Defensive interval ratio =
Daily cash expenditures

Cash Conversion Cycle

Cash conversion cycle = DSO + DOH Number of days of payables

Debt-to-Assets Ratio
Total debt
Debt-to-assets ratio =
Total assets

Debt-to-Capital Ratio
Total debt
Debt-to-capital ratio =
Total debt + Shareholders equity

Debt-to-Equity Ratio
Total debt
Debt-to-equity ratio =
Shareholders equity

Financial Leverage Ratio

Average total assets
Financial leverage ratio =
Average total equity

Interest Coverage Ratio

EBIT
Interest coverage ratio =
Interest payments

Fixed Charge Coverage Ratio

EBIT + Lease payments
Fixed charge coverage ratio =
Interest payments + Lease payments

Gross Profit Margin

Gross profit
Gross profit margin =
Revenue

2011 ELAN GUIDES 32

 FINANCIAL REPORTING AND ANALYSIS

Operating Profit Margin

Operating profit
Operating profit margin =
Revenue

Pretax Margin
EBT (earnings before tax, but after interest)
Pretax margin =
Revenue

Net Profit Margin

Net profit
Net profit margin =
Revenue

Return on Assets
Net income
ROA =
Average total assets
Net income + Interest expense (1 Tax rate)
Adjusted ROA =
Average total assets
Operating income or EBIT
Operating ROA =
Average total assets

Return on Total Capital

EBIT
Return on total capital =
Short-term debt + Long-term debt + Equity

Return on Equity
Net income
Return on equity =
Average total equity

Return on Common Equity

Net income Preferred dividends
Return on common equity =
Average common equity

DuPont Decomposition of ROE

Net income
ROE =
Average shareholders equity

2-Way Dupont Decomposition

Net income Average total assets
ROE =
Average total assets Average shareholders equity

ROA Leverage
3-Way Dupont Decomposition
Net income Revenue Average total assets
ROE =
Revenue Average total assets Average shareholders equity

Net profit margin Asset turnover Leverage

2011 ELAN GUIDES 33

 FINANCIAL REPORTING AND ANALYSIS

5-Way Dupont Decomposition

Interest burden Asset turnover

Net income EBT EBIT Revenue Average total assets

ROE =
EBT EBIT Revenue Average total assets Avg. shareholders equity

Tax burden EBIT margin Leverage

Price- to-Earnings Ratio

Price per share
P/E =
Earnings per share
Price to Cash Flow
Price per share
P/CF =
Cash flow per share
Price to Sales
Price per share
P/S =
Sales per share
Price to Book Value
Price per share
P/BV =
Book value per share
Per Share Ratios

Cash flow from operations

Cash flow per share =
Average number of shares outstanding

EBITDA
EBITDA per share =
Average number of shares outstanding

Common dividends declared

Dividends per share =
Weighted average number of ordinary shares
Dividend Payout Ratio
Common share dividends
Dividend payout ratio =
Net income attributable to common shares
Retention Rate
Net income attributable to common shares Common share dividends
Retention Rate =
Net income attributable to common shares
Growth Rate
Sustainable growth rate = Retention rate ROE

2011 ELAN GUIDES 34

 FINANCIAL REPORTING AND ANALYSIS

LIFO versus FIFO (with rising prices and stable inventory levels.)

LIFO versus FIFO when Prices are Rising

LIFO FIFO
COGS Higher Lower
Income before taxes Lower Higher
Income taxes Lower Higher
Net income Lower Higher
Cash flow Higher Lower
EI Lower Higher
Working capital Lower Higher

Effect on Effect on
Type of Ratio Numerator Denominator Effect on Ratio

Profitability ratios. Income is lower Sales are the same Lower under LIFO.
NP and GP margins under LIFO because under both.
COGS is higher

Debt to equity Same debt levels Lower equity under Higher under LIFO
LIFO

Current ratio Current assets are Current liabilities Lower under LIFO
lower under LIFO are the same.
because EI is lower.

Quick ratio Assets are higher as Current liabilities Higher under LIFO
a result of lower are the same
taxes paid

Inventory turnover COGS is higher Average inventory Higher under LIFO

under LIFO is lower under LIFO

Total asset turnover Sales are the same Lower total assets Higher under LIFO
under LIFO

2011 ELAN GUIDES 35

 FINANCIAL REPORTING AND ANALYSIS

Financial Statement Effects of Capitalizing versus Expensing

Effect on Financial Statements

Initially when the cost is Noncurrent assets increase.

capitalized Cash flow from investing activities decreases.

In future periods when the asset Noncurrent assets decrease.

is depreciated or amortized Net income decreases.
Retained earnings decrease.
Equity decreases.

When the cost is expensed
Net income decreases by the entire after-tax
amount of the cost.
No related asset is recorded on the balance
sheet and therefore, no depreciation or
amortization expense is charged in future
periods.
Operating cash flow decreases.
Expensed costs have no financial statement
impact in future years.

Capitalizing Expensing
Net income (first year) Higher Lower
Net income (future years) Lower Higher
Total assets Higher Lower
Shareholders equity Higher Lower
Cash flow from operations Higher Lower
Cash flow from investing Lower Higher
Income variability Lower Higher
Debt to equity Lower Higher

2011 ELAN GUIDES 36

 FINANCIAL REPORTING AND ANALYSIS

Straight Line Depriciation

Original cost - Salvage value
Depreciation expense =
Depreciable life

Accelerated Depriciation
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DDB depreciation in Year X = Book value at the beginning of Year X
Depreciable life

Estimated Useful Life

Gross investment in fixed assets
Estimated useful life =
Annual depreciation expense

Average Cost of Asset

Accumulated depreciation
Average age of asset =
Annual depreciation expense

Remaining Useful Life

Net investment in fixed assets
Remaining useful life =
Annual depreciation expense

Treatment of Temporary Differences

Carrying amount is greater.

Tax base is greater.
Carrying amount is greater.
Tax base is greater.

2011 ELAN GUIDES 37


Income Tax Accounting under IFRS versus U.S. GAAP
ISSUE SPECIFIC TREATMENTS
Revaluation of fixed
assets and intangible
assets.
Treatment of
undistributed profit
from investment in
subsidiaries.
Treatment of
undistributed profit
from investments in
joint ventures.
Treatment of
undistributed profit
from investments in
associates.
DEFERRED TAX MEASUREMENT
Tax rates.
Deferred tax asset
recognition.
DEFERRED TAX PRESENTATION
Offsetting of deferred
tax assets and liabilities.
Balance sheet
classification.
2011 ELAN GUIDES
IFRS
Recognized in equity as deferred
taxes.
Recognized as deferred taxes
except when the parent company
is able to control the distribution
of profits and it is probable that
temporary differences will not
reverse in future.
Recognized as deferred taxes
except when the investor controls
the sharing of profits and it is
probable that there will be no
reversal of temporary differences
in future.
Recognized as deferred taxes
except when the investor controls
the sharing of profits and it is
probable that there will be no
reversal of temporary differences
in future.
Tax rates and tax laws enacted
or substantively enacted.
Recognized if it is probable that
sufficient taxable profit will be
available in the future.
Offsetting allowed only if the
entity has right to legally enforce
it and the balance is related to a
tax levied by the same authority.
Classified on balance sheet as
net noncurrent with
supplementary disclosures.
FINANCIAL REPORTING AND ANALYSIS
U.S. GAAP
Revaluation is prohibited.
No recognition of deferred
taxes for foreign subsidiaries
that fulfill indefinite reversal
criteria.
No recognition of deferred
taxes for domestic
subsidiaries when amounts
are tax-free.
No recognition of deferred
taxes for foreign corporate
joint ventures that fulfill
indefinite reversal criteria.
Deferred taxes are recognized
from temporary differences.
Only enacted tax rates and
tax laws are used.
Deferred tax assets are
recognized in full and then
reduced by a valuation
allowance if it is likely that
they will not be realized.
Same as in IFRS.
Classified as either current or
noncurrent based on
classification of underlying
asset and liability.
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 FINANCIAL REPORTING AND ANALYSIS

Effective Tax rate

Income tax expense
Effective tax rate =
Pretax income

Income Tax Expense

Income tax expense = Taxes Payable + Change in DTL - Change in DTA

Income Statement Effects of Lease Classification

Income Statement Item Finance Lease Operating Lease

Operating expenses Lower Higher
Nonoperating expenses Higher Lower
EBIT (operating income) Higher Lower
Total expenses- early years Higher Lower
Total expenses- later years Lower Higher
Net income- early years Lower Higher
Net income- later years Higher Lower

Balance Sheet Effects of Lease Classification

Balance Sheet Item Capital Lease Operating Lease

Assets Higher Lower

Current liabilities Higher Lower
Long term liabilities Higher Lower
Total cash Same Same

Cash Flow Effects of Lease Classification

CF Item Capital Lease Operating Lease
CFO Higher Lower
CFF Lower Higher
Total cash flow Same Same

2011 ELAN GUIDES 39

 FINANCIAL REPORTING AND ANALYSIS

Impact of Lease Classification on Financial Ratios

Numerator Denominator Ratio Better or

under Finance under Finance Worse under
Ratio Lease Lease Effect on Ratio Finance Lease

Asset turnover Sales- same Assets- higher Lower Worse

Return on assets* Net income lower Assets- higher Lower Worse

in early years

Current ratio Current assets- Current Lower Worse

same liabilities-
higher

Leverage ratios Debt- higher Equity same. Higher Worse

(D/E and D/A) Assets higher

Return on equity* Net income lower Equity same Lower Worse

in early years

* In early years of the lease agreement.

Financial Statement Effects of Lease Classification from Lessors Perspective

Financing Lease Operating Lease
Total net income Same Same
Net income (early years) Higher Lower
Taxes (early years) Higher Lower
Total CFO Lower Higher
Total CFI Higher Lower
Total cash flow Same Same

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Definitions of Commonly Used Solvency Ratios
Solvency Ratios
Leverage Ratios
Debt-to-assets ratio
Debt-to-capital ratio
Debt-to-equity ratio
Financial leverage ratio
Coverage Ratios
Interest coverage ratio
Fixed charge coverage ratio
2011 ELAN GUIDES
FINANCIAL REPORTING AND ANALYSIS
Description Numerator Denominator
Expresses the percentage Total debt Total assets
of total assets financed by
debt
Measures the percentage Total debt Total debt + Total
of a companys total capital shareholders equity
(debt + equity) financed by
debt.
Measures the amount of Total debt Total shareholders
debt financing relative to equity
equity financing
Measures the amount of Average total assets Average shareholders
total assets supported by equity
one money unit of equity.
Measures the number of EBIT Interest payments
times a companys EBIT
could cover its interest
payments.
Measures the number of EBIT + Lease Interest payments +
times a companys earnings payments Lease payments
(before interest, taxes and
lease payments) can cover
the companys interest and
lease payments.
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 FINANCIAL REPORTING AND ANALYSIS

Adjustments related to inventory:

EIFIFO = EILIFO + LR

where
LR = LIFO Reserve

COGSFIFO = COGSLIFO - (Change in LR during the year)

Net income after tax under FIFO will be greater than LIFO net income after tax by:
Change in LIFO Reserve (1 - Tax rate)

When converting from LIFO to FIFO assuming rising prices:

Equity (retained earnings) increase by:

LIFO Reserve (1 - Tax rate)

Liabilities (deferred taxes) increase by:

LIFO Reserve (Tax rate)

Current assets (inventory) increase by:

LIFO Reserve

Adjustments related to property, plant and equipment:

Gross investment in fixed assets Accumulated depreciation Net investment in fixed assets
= +
Annual depreciation expense Annual depreciation expense Annual depreciation expense

Estimated useful or depreciable Average age of asset Remaining useful life

life
The historical cost of an asset
divided by its useful life equals
annual depreciation expense under
the straight line method. Therefore,
the historical cost divided by annual
depreciation expense equals the
estimated useful life.
Annual depreciation expense times The book value of the asset divided
the number of years that the asset by annual depreciation expense
has been in use equals equals the number of years the asset
accumulated depreciation. has remaining in its useful life.
Therefore, accumulated
depreciation divided by annual
depreciation equals the average
age of the asset.

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 FINANCIAL REPORTING AND ANALYSIS

Categories of Marketable Securities and Accounting Treatment

Unrealized and
Balance Sheet Realized Gains and Income (Interest &
Classification Value Losses Dividends)
Held-to-maturity Amortized cost Unrealized: Not Recognized on
(Par value +/- reported income statement.
unamortized Realized:
premium/ discount). Recognized on
income statement.

Held-for-trading Fair Value. Unrealized: Recognized on

Recognized on income statement.
income statement.
Realized:
Recognized on
income statement.

Available-for-sale Fair Value. Unrealized: Recognized on

Recognized in other income statement.
comprehensive
income.
Realized:
Recognized on
income statement.

2011 ELAN GUIDES 43

 FINANCIAL REPORTING AND ANALYSIS

Inventory Accounting under IFRS versus U.S. GAAP

Permitted Cost Changes in Balance
Balance Sheet Recognition Methods Sheet Value

U.S. GAAP Lower of cost or LIFO. Permits inventory

market. FIFO. write downs,
Weighted average but not reversal of
cost. write downs.

Permits inventory
IFRS Lower of cost or net FIFO.
realizable value. Weighted Average write downs,
Cost. and also reversals of
write downs.

Property, Plant and Equipment

Effects of Changes
Changes in Balance in Balance Sheet
Balance Sheet Sheet Value Value

U.S. GAAP Cost minus Does not permit upward No effect.

accumulated revaluation.
depreciation.

IFRS Cost minus Permits upward The increase in the assets

accumulated revaluation. value from revaluation is
depreciation. reported as a part of equity
Asset is reported at fair unless it is reversing a
value at the revaluation previously-recognized
date less accumulated decrease in the value of the
depreciation following asset.
the revaluation.
A decrease in the value of
the asset is reported on the
income statement unless it
is reversing a previously-
reported upward
revaluation.

2011 ELAN GUIDES 44

 FINANCIAL REPORTING AND ANALYSIS

Long-Term Investments
Percent Ownership Extent of Control Accounting Treatment

Less than 20% No significant control Classified as held-to-maturity, trading,

or available for sale securities.

20% - 50% Significant Influence Equity method.

More than 50% Significant Control Consolidation.

Shared (joint ventures) Joint Control Equity method/ proportionate

consolidation.

Treatment of Identifiable Intangible Assets

Changes in Effects of Changes in

Balance Sheet Balance Sheet
Balance Sheet Value Value

U.S. GAAP Only purchased intangibles Does not permit No effect.

may be recognized as upward
assets. Internally developed revaluation.
items cannot be recognized
as assets.

Reported at cost minus

accumulated amortization
for assets with finite useful
lives.

Reported at cost minus

impairment for assets with
infinite useful lives.

IFRS Only purchased intangibles Permits upward An increase in value is

may be recognized as
assets. Internally developed
items cannot be recognized
as assets.
Reported at cost minus
accumulated amortization
for assets with finite useful
lives.
Reported at cost minus
impairment for assets with
infinite useful lives.
revaluation. recognized as a part of
equity unless it is a
Assets are reversal of a
reported at fair previously recognized
value as of the downward revaluation.
revaluation date
less subsequent A decrease in value is
accumulated recognized on the
amortization. income statement
unless it is a reversal
of a previously
recognized upward
revaluation.

2011 ELAN GUIDES 45

 FINANCIAL REPORTING AND ANALYSIS

Long-Term Contracts

Outcome can be reliably Outcome cannot be reliably

estimated estimated
U.S. GAAP Percentage-of-completion Completed contract
method. method.
IFRS Percentage-of-completion Revenue is recognized to the
method. extent that it is probable to
recover contract costs.

Profit is only recognized at project

completion.

2011 ELAN GUIDES 46