1.
Matching Principal:
a. Product costs: directly associated w revenue
(raw material, wages) as expenses, during Cash movement scenario Impact in Accrual Accounting
revenue recognition Rcvd before revenue is earned L++ (deferred/unearned revenue)
b. Period costs: admin salary, utility bills, etc as Paid before expense is incurred A++ (accured/prepaid expense)
expenses, in the period benefitted Rcvd after revenue is earned A++ (Accounts Receivable)
c. Capitalized costs (benefits realised in future) Paid after expense is incurred L++ (Accounts Payable)
as assets, expensed costs (realised in same
period) as expense
2. Journal Entries:
a. DEBITS(LHS++) MUST EQUAL CREDITS (RHS++)
b. DEAD CLEAR: Debit – Expenses, Assets, Dividends; Credit – Liabilities, Equity, and Revenue
c. 2 ways of journal entries for exams: Dr/Cr (same order) or +/- (any order)
3. Income Statement
a. Revenue: economic benefits → increase
in net assets (A-L)
b. Expense: economic sacrifices →
increase in net assets (A-L)
c. Gains/Losses: Increase/decrease in net
assets
d. Net Income (NI) = Revenue – Expenses +
Gains – Losses
4. Ind AS vs GAAP:
a. GAAP: Assets (decreasing order of
liquidity) → Liabilities → SE
b. Ind AS: Assets (increasing order of
liquidity)→ Equity → Liabilities
c. in GAAP, Accts pybl is operational debt
rather than fin debt
d. US/IFRS categorises expenses by
functions (COGS/SG&A/R&D…), hence
total employee costs, depreciation, etc. are not determined in IS
e. Ind AS categorises expenses by nature (material, duties, wages, depreciation, etc.), hence factory vs office expenses are
not determined in IS
f. Revenue recognition stage is
based on individual contracts
(dispatch, delivery, 3rd party
handover, etc)
g. Companies are obligated to
report revenues) sales across
segments; the choice clustering
of segments is up to them
5. Profitability Analysis (see img) →
6. Cash Flow Categories:
a. Operating: sales, royalties, fees,
commissions, costs, salaries, tax
refunds – main biz operations
b. Investing: CAPEX/PP&E/intangible purchase, Interest Interest Dividend Dividend
acquisition/divestiture, loans to/repayments from others, Payable Receipt Payment Receipt
investments US GAAP O O F O
c. Financing: issuance/buyback of stock, purchase/reissue of Ind AS F I F I
treasury stock, borrowing/principal repayment of loans
d. IFRS gives flexibility in interest/dividend classification but demands uniformity of logic
7. Indirect/Direct method for CFO:
a. CF Investing/Financing logic remains same
b. Direct method: convert each line item in BS to cash
equivalent (cols like sales, cogs, salary, depreciation, etc)
c. Indirect method: Start w Net income, add/deduct/adjust
for increase/decrease due to each operation(increase in AR,
increase in salary payable, adding depreciation, etc).
8. Practicalities:
a. Non-cash investing/financing shown in supplemental
disclosure
b. Investing activities from acquisitions/divestitures result in
operating asset and liability accounts
c. Foreign currency translation adjustments/exchange rates
lead to cash change, shown separately
d. Different subsidiaries perform transactions that are investing activities for one but operating for another
9. Free Cash Flow: To increase firm
value, NOPAT++ and/or control
NOA growth
10. ARs on BS are at net realizable
value, after adjusting for
uncollectibles and returns, and make AR as close to actual potential recovery from customers
11. Accounting for Uncollectibles/Bad Debt/Doubtful Credit:
a. Direct Write-off:
i. Assume sale is fully collectible until default happens
ii. Reduce AR equivalent to uncollectible amount
iii. To balance reduced AR, record write-off equal to amount not collected under bad debt expense
b. Allowance as a %age of AR:
i. Create reserve/ allowance as a contra-asset account (XA) called allowance for bad debt
ii. No loss/gain is recorded on defaulting – it only changes the XA balance
iii. Use ageing accounts to figure out allowance value
c. Bad Debt as a %age of sales:
i. Record bad debt expense as a %age of sales, create an allowance AR contra-asset to balance
ii. Write-offs reduce allowance
iii. Ending balance of allowance is netted off gross AR to report net AR
12. Best Practices for receivables management:
a. Determine whom to extend credit: policy should neither be so tight it loses sales, nor so loose that customers default
b. Establish a payment period: longer periods encourage sales but reduce cashflow
c. Monitor collections: prepare ageing schedules and identify problem accounts. Track AR days
d. Accelerate cash receipts through pledging (using AR as collateral for loans), factoring (selling AR to a financial institution
at a discount that reflects an interest charge and risk of uncollectibility), and securitization (selling AR to a Variable
Interest Entity, that borrows money from investors and buys AR from parent)
13. Inventory Accounting:
a. Inventory is acquired and capitalized and put on BS as an asset.
b. When it is sold, cost of acquisition and readiness is put in as COGS (expense)
c. Gross Profit = Sales – COGS
14. Common cost flow assumptions include FIFO, LIFO, average-cost, and specific identification
a. If prices are increasing:
i. LIFO shows lower profit as more recent COGS are higher
ii. FIFO shows lower value of inventory asset, reflecting older market price
b. Opposite is true for decreasing prices
c. Since replacement cost for LIFO can be significantly lower, companies must declare FIFO inventory too.
In those cases, FIFO inventory – LIFO inventory = FIFO reserve (an unrealised holding gain).
15. Lower of Cost or Market value (LCM) – companies “write down” the price of their inventory during price decline as XA+
a. If price recovers, US GAAP says it will be realised during sale (do nothing)
b. Under IFRS/Ind AS, XA can be reversed (only up to the allocated value)
16. Operation Efficiency: Ideally, you want to sell inventory fast, get money from customers quickly, and pay suppliers on time:
a. Receivable days = 365 / Receivables turnover, where receivables turnover = Sales / Average AR
Average days taken by the firm to collect dues from customers. Lower days indicate efficient credit and collection
policies. Opposite might indicate difficulties in collection, extended credit terms to increase current period sales, or
unsatisfied customers refusing to settle AR due to poor product/service quality
b. Inventory days = 365 / Inventory turnover where, inventory turnover = COGS / Average Inventory
Lower days indicate fast moving inventory, opposite may indicate old tech or changed consumer preferences
c. Payable days = 365 / Payable turnover where, Payable turnover = COGS / Average AP
Low turnover would indicate trouble in making payments or bargaining power over supplier and hence extending payment
terms while opposite might imply suppliers unwilling to offer credit or good cash/quick payment discounts from suppliers.
d. Working capital days = Receivables days + Inventory days — Payable days
Indicates the number of days cash is stuck in the operating cycle. Generally, lower the better for liquidity purposes.
