Quick accounting and financial reporting hacks to always remember.

Equity analysts use the Income Statement to evaluate companies’ earnings and earnings growth rate.

• Fixed income analysts use the Income Statement to evaluate companies’ abilities to satisfy debt obligations.

• Financial statement elements include assets, liabilities, owners’ equity, revenue, expenses, gains and losses

• Revenues, finance costs, and tax expenses must be presented separately on the Income Statement

Presentation of Expenses: Expenses can be grouped;

1. According to their Nature - reporting depreciation on manufacturing equipment and depreciation on administrative facilities in a single line item i.e. “Depreciation”.

2. According to their Function - grouping expenses e.g. material & labor costs, depreciation or other costs directly related to sales into a single category i.e. Cost of Goods Sold

Subtotals:

1. Gross Profit or Gross Margin: It is equal to Revenue – Cost of Sales.

2. Operating Profit or Operating Income

Operating Profit = Gross profit–Operating expenses Operating Profit = Gross profit –Selling, General, Administrative and R&D expense

Multi-Step Format of Income Statement: I/S exhibits a gross profit subtotal.

Purpose of Multi-Step Format: To separate permanent items from transitory items.

Advantage of Multi-Step Format: It facilitates analysts to have an accurate prediction of future earnings and future cash-flows

Under IASB, “Income represents increase in economic entity benefits during the accounting period in the form of inflows or increase of assets or decrease of liabilities that eventually lead to increase in equity, (excluding contributions from equity participants). Income includes revenue and gains”.

Revenue from disposal of assets (other than inventory) is recognized at the point of sale as gain or loss

Profit = Cash collected during the period × Total expected profit as a percentage of sales

This method is used in limited situations e.g. the sale of real estate.

Steps for Installment Sales in any year: 1. Determine Gross Profit Margin.

2. Calculate realized GP by applying the rate of GP to cash collections of current year’s installment sales.

3. The GP, which is not realized is deferred

Gross versus Net Reporting Gross Revenue Reporting: Sales revenue and costs of goods sold are reported separately by the firm.

Under the U.S. GAAP, this method is used when:

• The firm is the primary obligor under the contract.

• The firm is exposed to inventory risk and credit risk.

• The firm is able to select its supplier. • The firm has reasonable authority to set the price.

Analysts must evaluate:

1. How conservative/aggressive the firm’s revenue recognition policies are.

2. The degree to which firm’s policies depend on judgment and estimates by management

Expenses are defined as “decrease in economic benefits during the accounting period in the form of outflows or depletions of assets or increase of liabilities that result in decrease in equity (excluding distributions to equity participants)”

Types of Expenses:

• Period costs: Expenses that are not directly related to revenue generation and are expensed in the period in which they are incurred

• Product Costs: Expenses that are directly related to revenue generation and thus must be matched with revenue recognition e.g. direct materials

1. Doubtful Accounts Under the matching principle, a company is required to record an estimate of revenue that will be uncollectible at the time revenue is recognized. Accounting Treatment: Estimate of uncollectible amounts is reported as an expense on the Income statement rather than as a deduction from revenues

NOTE A Direct Write-off Method is a method in which a company recognizes credit losses on accounts receivables only when a customer defaults. This method is NOT consistent with generally acceptable accounting principles.

2. Warranties Under matching principle, a company is required to estimate and recognize the amount of future expenses associated with warranties in the period of sale. A company must also update the warranty expense based on the experience over the life of the warranty.