Asset + liabilities + equity

(= contributed capital (=common stock + additional

paid-in capital)+ retained earnings (= revenues -
expense))

Blue: asset
Green: liability
Purple: equity
Red: revenue
Orange: expense
earnings management (if booked revenue for sales
revenue instead of cash to notes receivable -> company can mislead owners by inflating the revenues / earnings) or
channel stuffing (booking sold but not sold) or any other way that credits revenue instead of accounts receivable etc
absolute = (SG&A of 2018 – SG&A of 2017 ) / SG&A of
2017

relative = (SG&A 2018 / income 2018 - SG&A 2017 /

income 2017) / (SG&A 2017 / income 2017)

Revenue recognition: revenue, cash, unearned revenue,

accounts receivable affected
4 SAB 101 criteria: conditions that must be met to be able
to recognize revenue:
1. Persuasive evidence that an agreement exists
2. Delivery of goods and services has occurred
3. Fee is fixed and determinable
4. Collection is probable
Must recognize revenue if: company transfers goods or
services to customers and in the amount it expects to
receive
Transaction Debit Credit
Cash Sale Cash (up) Sales revenue (up)
Sale on credit Accounts receivable (up Sales Revenue (up)
Collection of cash Cash (up) Accounts receivable (down)
Cash reception in advance of Cash (up) Unearned revenue (up)
service (cash for flight tickets)
Cash reception after each Unearned revenue (down) Sales Revenue (up)
service delivery
Issue 6000 common stock and Cash (up) Common Stock (up)
receive 10000
Additional Paid-in capital (up)
Purchase of supplies in cash Supplies (up) Cash (down)
Purchase of equipment in cash Equipment (up) Cash (down)
Purchase of supplies on credit Supplies (up) Accounts payable (up)
Collect cash for consulting Cash (up) Consulting Revenue (up)
services
Payment for insurance in cash Prepaid insurance (up) Cash (down)
Payment of rent in advance in Prepaid expense Cash
cash
Sign of a loan Cash Notes payable
Purchase of inventory in cash / Inventory Cash / Accounts payable
on account
For every sale COGS Inventory
A/R or Cash Sales Revenue
To recognize inventory COGS Inventory
impairment
Payment for existing account Accounts payable Cash
payables
Payment of salary / wages Wages expense Cash
Payment of dividends Retained earnings Cash
Earning sales revenue in cash Cash Sales Revenue

Adjustments
Ending inventory Costs of Goods sold Inventory
Depreciation expense Depreciation Expense Accumulated Depreciation
Interest payment for loan Interest Expense Interest Payable
Rent paid in advance Rent Expense Prepaid Rent Expense
Providing service in advance of Sales Revenue
payment Account Receivable
Receive money in advance of Sales Revenue
service Unearned Revenues
Bad debt expense recognition
(not sure yet if will pay or not) –
Allowance for bad debt (up)
in same accounting period Bad debt expense (up)
Bad debt expense recognition Accounts receivable
(sure will not pay / write-off) – Allowance for bad debt (down)/ (down)/Trade receivables
in next accounting period doubtful accounts
Purchase of trading securities Trading securities (up) Cash (down)
After purchase of trading Unrealized gain & loss –
Trading securities (up)
securities (market value moves income (up)
up)
After purchase of trading Trading securities (down)
securities (market value moves Unrealized gain & loss –
down) income (down)
Sales of trading securities (for Trading securities (down)
more than initially purchased)
Cash (up) Realized gain – income (up)
Purchase of Available for sale Available for sales investment Cash (down)
securities (OCI) (up)
Payment receipt for sold cars Cash Trade receivable
 Purchase of equipment Cash
PPE (Notes payable) or
(Construction in progress)
Purchase of equipment (after WIP Inventory Accumulated Depreciation
period for used in production)

Purchase of equipment (after Accumulated Depreciation

period – not used in
production) Depreciation Expense
Acquisition of intangible assets License Cash
(license)

If acquired value of intangible Amortization expense Accumulated Amortization

asset reduces over time

Recognize impairment Impairment loss PPE or intangibles

Revaluation if used by firm Revaluation Reserve (equity)
PPE (up) (up)
Revaluation if investment Gain from asset revaluation
property PPE (up) (up)
Revaluation of intangibles
Intangible Asset (up)
(other than goodwill) to fair
Equity (up)
value – ok under IFRS

Adjustments / Deferrals
Wage expense incurred before Wages expense (up) Wages payable
cash payment (accrued
expense)
Revenues earned (interest) for Interest receivable (up) Interest revenue (up)
loan before cash received
(accrued revenue)
Payment for insurance in cash Insurance Expense (up) Prepaid insurance (down)
(prepaid insurance) (deferred
expense)
Revenue recognition after Unearned revenues (up) Ticket revenues (up)
flights completed (deferred
revenue)
 If CAPEX is
bigger than
depreciation -
> positive
change
(expansion in
PPE)
If current
assets < current liabilities: sign of managerial efficiency
since very low inventory or very low accounts receivable
(depends on industry / perishable goods etc)

Interest efficiency can result in low interest costs, and as

such, possible to increase leverage and vv

Du Pont Analysis
NOPAT = Net income + [Interest expense x (1 - tax rate)]

tax rate = Income taxes ÷ Earnings before income taxes

Average total assets = (Start-of-period total assets + End-of-period total assets) ÷ 2

Average total equity = (Start-of-period total equity + End-of-period total equity) ÷ 2
ROE = Net income ÷ Average shareholders’ equity
ROE = Leverage (= 1 + (Liabilities/Equity)) x Asset turnover x Profit margin x Interest efficiency
ROE =
Average Total Assets Sales NOPAT Net income
= Average x Average Total x Sales x NOPAT
Shareholders’ Equity Assets

ROA =
Sales NOPAT
Average Total x Sales
Assets
ROE = Leverage (what source of funds to finance assets) x Sales efficiency (at using the assets = sales efficiency) x
Operating efficiency (turning into profit) x Interest efficiency (costs of debt)
Indirect Method
If A/R or inventory goes up, the change is written in negative because that means we have less cash We have not
received cash from sales or we have prepaid

If A/P or unearned revenue goes up, the change is written in positive because that means we have more cash We
have not paid or we have received cash in advance

Two definitions of working capital

Narrow: Cash + AR + Inventory –AP
Broad: current assets –current liabilities

Where on the Statement of Cash Flows can one find information about the cash necessary to open new outlets?
Investing section - “Investment in PPE”: 1,589 (millions of euros)

Focusing just on the data in SCF, compare the amount of depreciation and amortization to the amount of capital
expenditure. Does this analysis suggest the level of expansion described by management in the text disclosures?
Depreciation and amortization equal 963
Capex amounted to 1,589
This is consistent with the expansion.
Investment in PPE is greater than “consumption” of PPE

Consider these dividend plans in light of the expansion plans. Do these two strategies appear consistent? What are
the risks and rewards of these important managerial decisions considered jointly? This dual approach can attract
investors interested in either value or growth, which may raise the stock price. -> expectation management (have to
raise dividends every time)
The potential danger is to deplete cash too much and to over-expand the firm.
However, Inditex is profitable and generates a lot of cash.

COGS for the period = Beginning inventory + Purchases – Ending inventory

The actual
write-off does
not affect the
Balance
Sheet, Income
Statement
and CFS but it
does affect gross accounts receivables

A/ R turnover = Credit Sales / Average net receivables

 High turnover: high A / R quality

Average collection period = 365 days / A / R turnover

Number of days it takes to collect the accounts receivable

IFRS does not allow LIFO

Option 1: LIFO

Option 2: FIFO

Matching COGS with Revenue: LIFO better

Comparing Ending Inventory with current replacement cost: FIFO better

Income management: LIFO better (WHY???)

 Because for option 2 (FIFO): uses old price for inventory -> lower cost -> higher profit -> higher tax
 Whereas for option 1 (LIFO): uses new, higher price for COGS -> higher cost -> lower profit -> lower tax

Restate to be able to compare 2 companies on FIFO basis

What is the LIFO Reserve? Δ LIFO reserve = current difference in

COGS between LIFO and FIFO

The LIFO reserve is an accounting term that measures the

difference between the first in, first out (FIFO) and last in, first
out (LIFO) cost of inventory for bookkeeping purposes. The LIFO
reserve is an account used to bridge the gap between FIFO and
LIFO costs when a company uses the FIFO method to track its
inventory but reports under the LIFO method in the preparation of its financial statements. In periods of rising prices,
constant increases in costs can create a credit balance in the LIFO reserve, which results in reduced inventory costs
when reported on the balance sheet.

Inventory turnover= COGS ÷Avg. Inventory

High turnover generally means high efficiency in selling Inventory.

The average inventory holding period represents a more intuitive way to think of inventory turnover

Inventory turnover = Credit sales / average net trade receivables

Average collection period = 365 days ÷Inventory turnover

•This ratio represents the number of days it takes on average for company to sell inventory.

Impairment is done to avoid overstating inventory and understating COGS. IFRS allows recoveries of previously
written-down amounts – US GAAP does not.

Deere Case:
Gross balance of trade receivables: total trade receivables (year) + allowance

Depreciation expense for period = (cost – residual value) / useful life

(Revised book value* – revised residual value) / remaining useful life at date of change

*revised book value = original cost – accumulated depreciation + additional cost

Purchase price – fair market value = goodwill (the excess amount paid) – net amortized liabilities (subject to
impairment test)

Internally generated intangible assets cannot be capitalized

Costs to maintain current level of productivity

Repairs and maintenance

Expensed as incurred

Costs classified as betterments are capitalized – one

of the following must apply Increase useful life
beyond the initial estimate

Improve quality of output

Increase quantity of output

Reduce costs of operating the asset

Revised book value = original cost – accu. dep. +

additional cost

Under IFRS, an impairment loss can be reversed if events in subsequent years suggest that the asset is no longer
impaired. Earnings can be more volatile -Goodwill impairment cannot be reversed

Under IFRS, companies can revalue PPE to fair value This is not possible under US GAAP.