Accounting I
what are the qualitative characteristics of useful financial information? (3)
Fundamental:
Enhancing qualitative characteristics:
Why are gains and losses from asset sales not included in operating income?
Because they are non-operating and do not reflect the company’s core business operations.
What is the formula for return on assets (ROA)?
Net Income / Average Total Assets.
It measures how effectively assets are used to generate profits.
In a Discounted Cash Flow (DCF) model, why do we discount future cash flows?
Because of the time value of money.
Which financial statement best reflects the accrual accounting principle?
Income Statement
*Recognizes revenues and expenses when earned/incurred
What is the effect of capitalizing vs. expensing an expenditure on net income in the short term?
Capitalizing increases net income in the short term because the cost is spread over time through depreciation, whereas expensing reduces current period income immediately.
What does the gross profit margin indicate?
The proportion of revenue left after covering cost of goods sold; it reflects production efficiency and pricing power.
What is the purpose of calculating the Weighted Average Cost of Capital (WACC) in valuation?
Because it reflects the average rate of return required by investors (both debt and equity holders).
Under IFRS, which measurement bases are permitted for PPE (Property, Plant, and Equipment)?
Cost model (Historical) or a revaluation model.
What is the effect of using LIFO during inflation on margins and assets?
Higher COGS, lower net income/margins, and lower inventory values, reducing total assets.
What does the interest coverage ratio measure?
The firm's ability to meet its interest obligations.
Formula: EBIT / Interest Expense
What are some limitations of using comparable company analysis?
What does a positive cash flow from operations indicate?
The business is generating cash from its core activities, a sign of good financial health.
What is the purpose of deferred tax liabilities?
They represent future tax payments due to temporary differences between accounting income and taxable income
What does a declining operating margin typically suggest?
The company is facing increased costs, reduced pricing power, or lower operational efficiency — a negative trend for profitability.
What are the three main approaches to valuation?
Market-Based Valuation
Income-based Valuation
Asset-Based Valuation
How is the purchase of equipment reflected on the cash flow statement?
It is an outflow under investing activities.
Why is depreciation added back to net income in the indirect cash flow method?
Because it is a non-cash expense that reduces net income but does not affect cash flow.
What is the purpose of performing a DuPont analysis?
To break down ROE into its components: Profitability, Efficiency, and Leverage, helping analysts understand what drives changes in ROE.
ROE = (Net Income / Sales) × (Sales / Assets) × (Assets / Equity)
How do you estimate terminal value in a DCF model, and what are the two most common methods?
Perpetuity Method
Exit Multiple Method