S8 Account Notes

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Level 1

Study Session 8Notes By James Haischer, CFA

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Learning Outcome Statements Copyright 1999, Level 1 CFA® Study Guide . Reproduced and Republished with permission fromthe Association for Investment Management and Research. All Rights Reserved. The Association for Investment Management and

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Pass101.com, Inc. Notes Copyright 1999, Pass101.com, Inc. All Rights Reserved.

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Key:New LOS for 2000 Modified LOS from 1999 Old LOS from 1999

Number LOS Answer

1 A. “Accounting Income and Assets: The Accrual Concept”

1 A. a) Discuss different revenuerecognition methods and

their implications forfinancial analysis.

At time of sale: revenue recognized at time of sale;Percentage of Completion: recognizes revenues in proportion to work

completedCompleted Contract: recognizes revenues and costs at end of contract periodInstallment: recognizes revenue as received in payments.

Cost recovery: cash receipts are accounted for recovery of costs until all costsare covered then revenue is recognized.

1 A. b) Describe components of

net income.

Sales

-Cost of Goods Sold

= Gross Margin- Operating Expenses

= Operating Income aka EBIT (Earnings Before Interest & Taxes)- Interest & Taxes- Discontinued operations, extraordinary items, effects of accounting changes

= Net Income

1 A. c) Discuss ways that

management canmanipulate earnings byusing its discretion in

presenting financialstatements.

*Deferral and accrual of expenses or revenue.

*Different methods/lives of amortization/depreciation.*Expensing vs capitalization of certain expenses.*Timing of recognization of revenue earning process.

*Classification of items in income statement such as extraordinary events.

1 A. d) Identify the appropriate

revenue recognition

method, given the statusof completion of the

earning process and theassurance of payment.

At time of sale: earning process complete; payment assured.

Percentage of Completion: earning process incomplete; payment assured.

Completed Contract: earning process complete; payment assured.

Installment: earning process incomplete; payment assured.

Cost recovery: earning process incomplete; payment not assured.

1 A. e) Calculate and analyze the

effects on the financialstatements of the choiceamong revenue

recognition methods inaccounting for long-termcontracts.

Completed Contract Method: revenue delayed and then recognized in lump

sum.

Percentage of Completion Method: revenue smoothed, recognized as a stream

over life of project.


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Number LOS Answer

1 A. f) Describe the types andanalysis of unusual or

infrequent items,discontinued operations,extraordinary items, and

accounting changes.

Key is to identify a firm’s permanent income!Separate recurring from nonrecurring items.

Unusual items: either unusual in nature or infrequent, but not both. Reported asan operating item. Example: impairment or restructuring cost.

Discontinued operations: discontinuation or sale of business segment.

Extraordinary items: unusual in nature and infrequent in occurrence and arematerial in amount. Example: gains and losses on the early retirement of debt.

Accounting Changes: cumulative impact on prior period earnings, net of tax.Example: adoption of new accounting standards.

1 A. g) Describe the componentsof the balance sheet.

Assets: Cash, Marketable securities, Accounts receivable, Inventory, Prepaidexpenses, Deferred Taxes, Fixed assets, Capital leases, Investments, Prepaid

pension costs, Intangible assets.

Liabilities: Accounts payable, Current liabilities, ST debt, Capital leases,Pension & postretirement liabilities, LT Debt, Minority interest.

Equity: Shareholder’s equity, Comprehensive income adjustments; translations,minimum pension liabilities, unrealized gains/losses.

1 A. h) Describe the format,classification, and use of

each component of theStatement ofShareholders' Equity.

Preferred StockCommon Stock

Treasury StockRetained Earnings

1 B. “Analysis of Cash Flows”

1 B. a) Explain the relevance ofcash flows to analyzing

business activities.

To predict the firm’s ability to generate cash from current operations and examinetrends in investing and financing activities.

1 B. b) Describe the elements ofoperating cash flows.

Direct Method: Cash flow classified by collections and payments.

Indirect Method: Net income adjusted for noncash items such as depreciation,accruals, reclassification of items to investing and financing sections.

1 B. c) Describe the elements of

investing cash flows.

Purchases/Sales of plant assets

Investments in affiliatesShort-term investment changes

1 B. d) Describe the elements offinancing cash flows.

DividendsChanges in debtCommon stock issuance

Treasury stock changes

1 B. e) Classify a particular itemas an operating cash flow,

an investing cash flow, ora financing cash flow.

See above


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Number LOS Answer

1 B. f) Present, explain, andinterpret a statement of

cash flows using the directand indirect methods.

See questions

Key:New LOS for 2000 Modified LOS from 1999 Old LOS from 1999

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