L1 flash cards financial reporting (ss10)

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L1 flash cards financial reporting (ss10)

  1. 1. Reasons for Over-Reporting Earnings• To meet analysts’ earnings expectations• To meet debt covenants.• Need additional debt or equity financing• To obtain higher remuneration & commission based onperformance.Study Session 10, Reading 33
  2. 2. • To obtain trade relief.• Negotiate lower payments for a prior business transaction.• Negotiate concessions from unions, creditors, vendors, employeesetc.• To save on income taxes.Study Session 10, Reading 33
  3. 3. • The use of some of the accounting method choices• Taking advantage of loopholes in accounting standards to structurea transaction in a desired way• Using inappropriate and unrealistic estimates and assumptions• Stretching accounting principles in a way to achieve desired results.• Engaging in fraudulent financial reporting.Study Session 10, Reading 33
  4. 4. • If pressure or incentive to report fraudulent financial statementssuch as meeting debt covenants or analysts’ expectation exist.• If the opportunity to commit fraud due to a lack of proper internalcontrol systems in existence.• If individuals can rationalize their behaviour themselves.Study Session 10, Reading 33
  5. 5. • Aggressive revenue recognition techniques - this can be detected bythe study of revenue recognition policies.• Earnings are positive and growing, while operating cash flow isnegative or declining - analysts should checked whether the cash flowearning index is consistently below 1 or continuously declining.• Excess use of operating leases to show better financial ratios -Financial statements should be adjustedStudy Session 10, Reading 33
  6. 6. • Stretching out payables means slowing the rate of payments tovendors.• Stretching out payables is an indication that a company is strugglingto generate cash.Study Session 10, Reading 34
  7. 7. • refers to involving a third party financial institution to pay thevendor in the current accounting period, and paying off the financialinstitution in the next accounting period.• used to show higher operating cash flows in the current period.Study Session 10, Reading 34
  8. 8. • packaging the receivables, particularly longer-term receivables withhaving higher credit quality, and transferring them to a financialinstitution or variable interest entity (VIE).• used to show an increase in cash flow from operationsStudy Session 10, Reading 34
  9. 9. • Used to reduce taxes payables, increase paid-up capital, and isadded by some companies to net income and in the operating cashflows.Study Session 9, Reading 32
  10. 10. • If the tax benefit of stock options is added to income in the cashflow statement, it results in an increase in operating cash flows.• In a period of rising stock price because of an increase in theexercise of stock options, operating cash outflows will increase.Study Session 10, Reading 34
  11. 11. Parameters Used For Evaluation of Past Performance• Profitability, liquidity, solvency and efficiency over the period ofanalysis.• Comparison• Analysis of the business model and strategy• Study the aspects of performanceStudy Session 10, Reading 35
  12. 12. Projecting future financial performance can be undertaken in twoways:1) Projection of near term financial performance that can be usedas an input to market based valuation2) Complex projections that forecast multiple-period performance.Study Session 10, Reading 35
  13. 13. • Projections made by the company about its future financialperformance.• Previous financial statements of the company.• Structure and outlook of the industry.• Macroeconomic forecasts.Study Session 10, Reading 35
  14. 14. • Credit analysis is the evaluation of the risk of loss due to a default inthe payment of principal and interest by the borrower.• Credit analysis focusses on cash flows instead of accrual-incomereturns.Study Session 10, Reading 35
  15. 15. • Scale and diversification• Operational efficiency• Tolerance for leverage• Margin stability.Study Session 10, Reading 35
  16. 16. • Market data and financial ratios are used by investors whenscreening for potential equity investments.• Screening is the application of a set of criteria that shortlistspotential investment candidates from the available investmentuniverse.• Back testing is a process by which analysts evaluate how a portfoliobased on a particular screen would have performed in the past.Study Session 10, Reading 35
  17. 17. • Top-down analysis• Bottom-up analysisStudy Session 10, Reading 35
  18. 18. Adjustments made by analysts are generally related to• Investments• Inventory• Property, plant and equipment• Goodwill, and off-balance sheet financingStudy Session 10, Reading 35

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