INCOME STATEMENT

 revenues – expenses = net income

 Investors examine a firm’s income statement for valuation purposes while lenders
examine the income statement for information about the firm’s ability to make the
promised interest and principal payments on its debt. Revenue less adjustments for
estimated returns and allowances is known as net revenue.
 Combining all costs associated with manufacturing (e.g., raw
materials, depreciation, labor, etc.) as cost of goods sold is an example of grouping
by function. Grouping expenses by function is sometimes referred to as the cost of
sales method.
 The difference between the sales price and book value is reported as a gain or loss
on the income statement.
 net income = revenues – ordinary expenses + other income – other expense +
gains – losses
 If a firm has a controlling interest in a subsidiary, the pro rata share (dividend divide
as per the share of holding %) of the subsidiary’s income not owned by the parent is
reported in parent’s income statement as the noncontrolling interest (also known
as minority interest or minority owners’ interest). The noncontrolling interest is
subtracted in arriving at net income because the parent is reporting all of the
subsidiary’s revenue and expense.
 accrual accounting does not necessarily coincide with the receipt or payment of
cash.
 Consequently, firms can manipulate net income by recognizing revenue earlier or
later or by delaying or accelerating the recognition of expenses.
 Gross profit: After deducting direct expenses from sales
 Operating profit: Gross profit- operating expenses (SGA,depreciation)
 Net income (earnings) = operating profit-intrest-taxes
 If a firm receives cash before revenue recognition is complete, the firm reports it as
 unearned revenue. Unearned revenue is reported on the balance sheet as a liability.
 Assets & liab both increase first then after service/product delivery occurs liab
decrease.
 if the firm cannot reliably measure the outcome of the project, revenue is
recognized to the extent of contract costs, costs are expensed when incurred, and
profit is recognized only at completion.
 Under U.S. GAAP, the completed-contract method is used when the outcome of the
project cannot be reliably estimated. Accordingly, revenue, expense, and profit are
recognized only when the contract is complete.
 If a loss is expected, the loss must be recognized immediately under IFRS and
U.S. GAAP.
 Under gross revenue reporting, the selling firm reports sales revenue and cost of
goods sold separately. Under net revenue reporting, only the difference in sales and
cost is reported. While profit is the same, sales are higher using gross revenue
reporting.
 Matching principle: the cost of a good sold is incurred during the period it is sold
 LIFO & FIFO methods are used to see ending and opening inventory.
 Allocation of cost over an asset’s life is known as depreciation (tangible assets),
depletion (natural resources), or amortization (intangible assets)
Depreciation
 Straight line method: (Cost of asset-residual value)/useful life, equal expense each yr
 Residual value is the value of an asset at the end of its lease or at the end of its
useful life.
 Accelerated acceleration is better because asset generate more benefits in its early
yrs than later years
 DDB(declining balance method) method: (2/useful life)(cost - accumulated dep)
 Amortization is the allocation of the cost of an intangible asset (such as a franchise
agreement) over its useful life.
 Intangible assets with indefinite lives (e.g., goodwill) are not amortized.
 Any income or loss
 from discontinued operations is reported separately in the income statement, net of
tax, after income from continuing operations. Any past income statements
presented must be restated, separating the income or loss from the discontinued
operations
 Unusual or infrequent items: write downs, P&L from sale of a part of business,write
offs.All removed because forecasting
 Accounting estimate changes typically do not affect cash flow.
 An analyst should review changes in accounting estimates to determine the impact
onfuture operating results.
 for a financial firm,
 investment income and financing expenses are usually considered operating
activities for finance for,. Not the case in non finance these are considered as non
operating costs
 Net income minus
 preferred dividends is the income available to common stockholders. Common stock
dividends are not subtracted from net income because they are a part of the net
income available to common shareholders.
EPS= (NI- preferred dividends)/weighted avg no. of share outstanding)
 Common size conversion should be there to compare relative profitability
  Tax expense is more meaningful when expressed as a percentage of pretax income.
The result is known as the effective tax rate.
 Gross profit margin: gross profit/revenue
 Increases if costs reduce or sales increases or if prices are more because of
differentiated products.
 Net profit margin (after considering all expenses) operating profit, pretax margin
 At the end of each accounting period, the net income of the firm is added to
stockholders’ equity through an account known as retained earnings. Therefore, any
transaction that affects the income statement (net income) will also affect
stockholders’ equity.
Comprehensive income includes (in addn to NI)
-Foreign currency gains and losses
-Available minimum pension hedging
-derivatives securities gains losses
-available for sale gains/losses
BALANCE SHEET
CA: presented in order of liquidity with cash being most liquid
Operating cycle: The time required to produce and purchase goods of inventory and collect
cash.
CL: short term obligation, (within 1 year or within 1 operating cycle whichever is greater)
WC: CA-CL
NCA: gives info about the firms investing activities which forms foundation of how the firm
operates
NCL: Long term financing activities
CA
Examples of cash equivalents include Treasury bills, commercial paper,and money market
funds. Cash and equivalents are considered financial assets.
Marketable sec: FA traded in market, bonds, equity securities, T-bills, notes
Acc. Recievables: reported at net realizable value.
Gross recievables-allowances for doubtful debt= net acc recievables
When recievables are written off i.e considered uncollectibles then both acc. Recievable and
allowances decrease.
Inventory: includes all the cost incurred to bring inventory to the current location and state
Excludes overhead costs, labour costs etc
Standard costing: assigns predetermined labour, material and overheads to goods
produced. (mfg companies)
Retail costing; retail prices – gross profit to get cost
Net realizable value is equal to the selling price less any completion costs and disposal
(selling) costs