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1. Do compa- For GAAP reporting purposes, companies generally prefer straight-line deprecia-
nies prefer tion. That's because a company will record lower depreciation in the early years
straight-line or of the asset's life than if they had used accelerated depreciation. As a result,
accelerated de- companies using straight-line depreciation will show higher net income than
preciation? under accelerated depreciation.
2. Do companies No, land is considered to have an indefinite life and is not depreciated.
depreciate land?
3. Can companies Under GAAP, public companies are not allowed to amortize goodwill. Instead, it
amortize good- must be tested annually for impairment.
will?
The longer answer is that under GAAP, public companies are not allowed to
amortize goodwill and must instead test it annually for impairment. However,
private companies may elect to amortize goodwill. In addition, for tax reporting
purposes, goodwill may be amortized over 15 years under some circumstances.
4. What is the im- The major impact to EPS is that the actual share count increases, thereby decreas-
pact of share is- ing EPS. However, there is sometimes an impact on net income. That's because
suance on EPS? assuming share issuances generate cash for the company, there will be higher
interest income, which increases net income and EPS slightly. Because returns on
excess cash for most companies are low, this impact is usually very minor and
doesn't offset the negative impact to EPS from a higher share count.
5. What is the im- The major impact to EPS is that the actual share count is reduced, thereby increas-
pact of share ing EPS. However, there is sometimes an impact on net income. That's because
repurchases on assuming share repurchases are funded with the company's excess cash, any
EPS? interest income that would have otherwise been generated on that cash is no
longer available, thereby reducing net income - and EPS - slightly. Because returns
on excess cash for most companies are low, this impact is usually very minor and
doesn't offset the positive impact to EPS from a lower share count.
6.
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How do you cal- Earnings per share (EPS) is calculated as net income divided by the company's
culate earnings weighted average shares outstanding during the period.
per share?
There are two ways to measure EPS - Basic and Diluted. Basic
EPS is net income divided by the actual shares, while Diluted EPS is net income
divided by actual shares and shares from potentially dilutive securities such as
options, restricted stock, and convertible bonds or stock.
7. A company ac- The short answer is $2 million. Except for certain liquid financial assets which can
quired a machine be written up to reflect fair market value, companies must carry the value of assets
for $5 million in at their historical cost.
2003 and has
since generated
$3 million in accu-
mulated depreci-
ation. In addition,
the PP&E now
has a fair val-
ue of $20 million.
Assuming GAAP,
what is the val-
ue of that PP&E
on the company's
balance sheet?
8. Do you amor- Intangible like customer lists, copyrights and patents - assets that have a finite life -
tize intangible as- are amortized, while others like trademarks (and goodwill) are considered to have
sets? indefinite lives and are not amortized.
9. How do capi- Leases treated as capital leases (as opposed to operating leases) create an asset
tal leases affect and associated liability for the thing that is being leased. For example, if a company
leases a building for 30 years, the building is recognized as an asset on the lessee's
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the three finan- balance sheet with a corresponding debt-like liability. The income statement im-
cial statements? pact is the depreciation expense associated with the building, as well as interest
expense associated with the financing.
10. How do operat- Under US GAAP, companies can choose to account for leases as operating or capital
ing leases affect leases.
the three finan- Operating leases primarily only impact the income statement. When leases are
cial statements? accounted for as operating leases, lease (rent) payments are treated as operating
expenses like wages and utilities: Regardless of whether you sign a 1-year lease
or a 30-year lease, every time you pay the rent, cash is credited and an operating
expense is debited.
The only significant balance sheet impacts have to do with timing differences
between payments (prepaid and accrued rent) and the matching of rent payments
to when the tenant benefits from that rent (leading to balance sheet accruals
for smoothing of rent escalations and upfront rent incentives like a free month).
Starting in 2019, operating leases will no longer be allowed under US GAAP.
11. How can a prof- To be profitable, a company must generate revenues that exceed expenses. How-
itable firm go ever, if the company is ineffective at collecting cash from customers and allows its
bankrupt? receivables to balloon, or if it is unable to get favorable terms from suppliers and
must pay cash for all inventories and supplies, what can occur is that despite a
profitable income statement, the company suffers from liquidity problems due to
the timing mismatch of cash inflows and outflows.
While reliably profitable companies who simply have these working capital issues
can usually secure financing to deal with it, theoretically, if financing becomes
unavailable for some reason (the 2008 credit crisis is an example where even
profitable companies couldn't secure financing), even a profitable company could
be forced to declare bankruptcy.
12. Is it bad if Not necessarily. Retained earnings will be negative if the company has generated
a company has more accounting losses than profits. This is often the case for early-stage compa-
nies that are investing heavily to support future growth. The other component of
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negative retained retained earnings is common or preferred dividends, which could contribute to a
earnings? lower or even negative retained earnings.
13. What's more im- hey are both important and any serious analysis requires using both. However,
portant: the in- I would think that the cash flow is slightly more important because it reconciles
come statement net income, the accrual-based bottom line on the income statement to what's
or the cash flow happening to cash, while also showing you the critical movement of cash during
statement? the period. Without the cash flow statement, I can only see what's happening from
an accrual profitability standpoint. The cash flow statement on the other hand can
alert me to any liquidity issues, as well as any other major investments or financial
activities that do not hit the income statement.
The one situation in which I would prefer the income statement is if I also have
the beginning and end-of-year balance sheet. That's because I could reconcile
the cash flow statement simply by looking at the balance sheet year over changes
along with the income statement.
14. Why are increas- Since cash flow statements start with net income, and net income captures all of a
es in accounts re- company's revenue - not just cash revenue - an increase in accounts receivable
ceivable a cash suggests that more customers paid with credit during the period and so an
reduction on the adjustment down needs to be made to net income when arriving at cash since the
cash flow state- company never actually received those funds - they're still sitting on the balance
ment? sheet as receivables.
15. How should in- Increases in inventory, as well as any other working capital assets, reflect a usage of
creases in inven- cash and should thus be reflected as an outflow on the cash from operations sec-
tory get handled tion of the cash flow statement. Conversely, increases in working capital liabilities
on the cash flow represent a source of cash and should be presented as an inflow in the section.
statement?
16. Do inventories There is no inventory line on the income statement, but it does get captured, if
get captured on only partially, and indirectly in cost of goods sold (and potentially other operating
expenses).
Study online at https://quizlet.com/_7hjkg3
1. Do compa- For GAAP reporting purposes, companies generally prefer straight-line deprecia-
nies prefer tion. That's because a company will record lower depreciation in the early years
straight-line or of the asset's life than if they had used accelerated depreciation. As a result,
accelerated de- companies using straight-line depreciation will show higher net income than
preciation? under accelerated depreciation.
2. Do companies No, land is considered to have an indefinite life and is not depreciated.
depreciate land?
3. Can companies Under GAAP, public companies are not allowed to amortize goodwill. Instead, it
amortize good- must be tested annually for impairment.
will?
The longer answer is that under GAAP, public companies are not allowed to
amortize goodwill and must instead test it annually for impairment. However,
private companies may elect to amortize goodwill. In addition, for tax reporting
purposes, goodwill may be amortized over 15 years under some circumstances.
4. What is the im- The major impact to EPS is that the actual share count increases, thereby decreas-
pact of share is- ing EPS. However, there is sometimes an impact on net income. That's because
suance on EPS? assuming share issuances generate cash for the company, there will be higher
interest income, which increases net income and EPS slightly. Because returns on
excess cash for most companies are low, this impact is usually very minor and
doesn't offset the negative impact to EPS from a higher share count.
5. What is the im- The major impact to EPS is that the actual share count is reduced, thereby increas-
pact of share ing EPS. However, there is sometimes an impact on net income. That's because
repurchases on assuming share repurchases are funded with the company's excess cash, any
EPS? interest income that would have otherwise been generated on that cash is no
longer available, thereby reducing net income - and EPS - slightly. Because returns
on excess cash for most companies are low, this impact is usually very minor and
doesn't offset the positive impact to EPS from a lower share count.
6.
, Wall Street Prep
Study online at https://quizlet.com/_7hjkg3
How do you cal- Earnings per share (EPS) is calculated as net income divided by the company's
culate earnings weighted average shares outstanding during the period.
per share?
There are two ways to measure EPS - Basic and Diluted. Basic
EPS is net income divided by the actual shares, while Diluted EPS is net income
divided by actual shares and shares from potentially dilutive securities such as
options, restricted stock, and convertible bonds or stock.
7. A company ac- The short answer is $2 million. Except for certain liquid financial assets which can
quired a machine be written up to reflect fair market value, companies must carry the value of assets
for $5 million in at their historical cost.
2003 and has
since generated
$3 million in accu-
mulated depreci-
ation. In addition,
the PP&E now
has a fair val-
ue of $20 million.
Assuming GAAP,
what is the val-
ue of that PP&E
on the company's
balance sheet?
8. Do you amor- Intangible like customer lists, copyrights and patents - assets that have a finite life -
tize intangible as- are amortized, while others like trademarks (and goodwill) are considered to have
sets? indefinite lives and are not amortized.
9. How do capi- Leases treated as capital leases (as opposed to operating leases) create an asset
tal leases affect and associated liability for the thing that is being leased. For example, if a company
leases a building for 30 years, the building is recognized as an asset on the lessee's
, Wall Street Prep
Study online at https://quizlet.com/_7hjkg3
the three finan- balance sheet with a corresponding debt-like liability. The income statement im-
cial statements? pact is the depreciation expense associated with the building, as well as interest
expense associated with the financing.
10. How do operat- Under US GAAP, companies can choose to account for leases as operating or capital
ing leases affect leases.
the three finan- Operating leases primarily only impact the income statement. When leases are
cial statements? accounted for as operating leases, lease (rent) payments are treated as operating
expenses like wages and utilities: Regardless of whether you sign a 1-year lease
or a 30-year lease, every time you pay the rent, cash is credited and an operating
expense is debited.
The only significant balance sheet impacts have to do with timing differences
between payments (prepaid and accrued rent) and the matching of rent payments
to when the tenant benefits from that rent (leading to balance sheet accruals
for smoothing of rent escalations and upfront rent incentives like a free month).
Starting in 2019, operating leases will no longer be allowed under US GAAP.
11. How can a prof- To be profitable, a company must generate revenues that exceed expenses. How-
itable firm go ever, if the company is ineffective at collecting cash from customers and allows its
bankrupt? receivables to balloon, or if it is unable to get favorable terms from suppliers and
must pay cash for all inventories and supplies, what can occur is that despite a
profitable income statement, the company suffers from liquidity problems due to
the timing mismatch of cash inflows and outflows.
While reliably profitable companies who simply have these working capital issues
can usually secure financing to deal with it, theoretically, if financing becomes
unavailable for some reason (the 2008 credit crisis is an example where even
profitable companies couldn't secure financing), even a profitable company could
be forced to declare bankruptcy.
12. Is it bad if Not necessarily. Retained earnings will be negative if the company has generated
a company has more accounting losses than profits. This is often the case for early-stage compa-
nies that are investing heavily to support future growth. The other component of
, Wall Street Prep
Study online at https://quizlet.com/_7hjkg3
negative retained retained earnings is common or preferred dividends, which could contribute to a
earnings? lower or even negative retained earnings.
13. What's more im- hey are both important and any serious analysis requires using both. However,
portant: the in- I would think that the cash flow is slightly more important because it reconciles
come statement net income, the accrual-based bottom line on the income statement to what's
or the cash flow happening to cash, while also showing you the critical movement of cash during
statement? the period. Without the cash flow statement, I can only see what's happening from
an accrual profitability standpoint. The cash flow statement on the other hand can
alert me to any liquidity issues, as well as any other major investments or financial
activities that do not hit the income statement.
The one situation in which I would prefer the income statement is if I also have
the beginning and end-of-year balance sheet. That's because I could reconcile
the cash flow statement simply by looking at the balance sheet year over changes
along with the income statement.
14. Why are increas- Since cash flow statements start with net income, and net income captures all of a
es in accounts re- company's revenue - not just cash revenue - an increase in accounts receivable
ceivable a cash suggests that more customers paid with credit during the period and so an
reduction on the adjustment down needs to be made to net income when arriving at cash since the
cash flow state- company never actually received those funds - they're still sitting on the balance
ment? sheet as receivables.
15. How should in- Increases in inventory, as well as any other working capital assets, reflect a usage of
creases in inven- cash and should thus be reflected as an outflow on the cash from operations sec-
tory get handled tion of the cash flow statement. Conversely, increases in working capital liabilities
on the cash flow represent a source of cash and should be presented as an inflow in the section.
statement?
16. Do inventories There is no inventory line on the income statement, but it does get captured, if
get captured on only partially, and indirectly in cost of goods sold (and potentially other operating
expenses).
