Financial 7 (Financial Instruments, Stockholders Equity and CF)

FINANCIAL INSTRUMENTSU Fair Value Options Unrealized G/L reported in earnings, irrevocable Disclose in Body of F/S and Notes Derivative Instruments and Hedging Activites Derivative Instrument under/over contract, derives its value from value of other instru. Underlying what we gamble on, strike price Notional Amount used to calculate G/L, specified unit of measure Hedging reduce risk of holding/trading certain assets Common Derivatives OFFS Option Contracts Contract between 2 parties that gives one party the right, but not the obligation, to buy or sell something at a specified price o Call option hope P Gives holder the right to buy at a certain price o Put option hope P Gives holder the right to sell at a certain price Futures Contract Agreement to exchange a commodity or currency at a specified price on a specified future date through a clearinghouse o a) Long/Buy, Profit if P b) Short/Sell, Profit if P Forward Contract Similar to futures contracts, except they are privately negotiated instead through a clearinghouse Swap Contract private agreement to exchange future cash payments o I.e. interest rate swaps, currency swaps, equity swaps, and commodity swaps o Equivalent to a series of forward contracts Derivative Risks Market Risk Risk that the entity will incur a loss on the derivative contract Credit Risk Risk that the other party will not perform according to the terms (pay extra)

SHAREHOLDERS EQUITY Capital Stock Common Stock basic ownership interest in a corp. o Bear ultimate risk of loss and receive the ultimate benefits of success Not guaranteed dividends or assets upon dissolution

Step 1 o Common Shareholders Equity Formula

Step 2 o Book Value per Common Share

Preferred Stock Cumulative Preferred Stock o All or part of the preferred dividends not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders Non-Cumulative Preferred Stock o Dividends not paid in any year do no accumulate, lose right to receive dividends Participating Preferred Stock o Participate with common shareholders in dividends in excess of a specific amount Convertible Preferred Stock complex o May be exchanged for C/S (at the option of stockholder) at a specified rate Callable (Redeemable) Preferred Stock o Stock maybe called (repurchased) at a specified price (at the option of issuing corp) Mandatorily Redeemable Preferred Stock (Liability) o Issued with a maturity date, o Similar to debt, must be bought back by the company on the maturity date Note: maturity date = debt = liability APIC contributed capital in excess of par or stated value Examples: sale of treasury stock at gain, quasi-reorganization, issuance of liquidating dividends, conversion of bonds, and declaration of small stock dividend Retained Earnings Formula:

Classification of Retained Earnings (appropriations) Appropriated disclose to shareholders that some of R/E are not available for dividends When the purpose of appropriation has been achieved, leftover goes to unappropriated R/E

Quasi-Reorganization accounting adjustment that revises the capital structure Allows a corp. with a sig. deficit in R/E to eliminate that deficit and have a fresh start Treasury Stock Two Methods, only difference is timing of recognizing G/L on treasury stock 1) Cost Method required by IFRS and used by GAAP 95% of the time o Recorded and carried at their reacquisition cost o Never reported on the I/S

2) Legal (Par/Stated Value) Method prohibited by IFRS and use by GAAP 5% of the time o Recorded by reducing the amounts of par (or stated) value and APIC received at the time of the original sale Stock Dividend 1) Treatment of a Small Stock Dividend (<20%-25%) o Reduce R/E by the FMV of the Stock 2) Treatment of a Large Stock Dividend (>20-25%) o Reduce R/E by the Par Value of the Stock Accounting for Stock Issued to Employees Non-compensatory Stock Option/Purchase Plans Compensatory Stock Options/Purchase Plans valued at FV of the options issued

EARNINGS PER SHARE Simple Capital Structure (Report Basic EPS only) Basic EPS Formula:

issues C/S only (no convertible or preferred)

WACSO:

Complex Capital Structure (Report Basic & Diluted EPS) When securities that can potentially be converted to C/S and would dilute (reduce) EPS (C/S) o Potential dilutive securities include: Convertible securities, warrants/options, contract settled in cash/stock, contingent shares o Diluted EPS Formula:

Dilution from Options, Warrants, and Their Equivalents o 1) Dilutive vs. Anti-dilutive Dilutive when avg mkt price of the underlying C/S exceeds the exercise price of the options/warrants exercise price < market price in the money Unlikely to exercise exercise price > market price out of the money Called Anti-Dilutive o 2) Treasury Stock Method

Exercise price < market price in the money Assume warrant was exercised at the beg of the period

STATEMENT OF CASH FLOWS Methods of Presenting the Statement of CF 1) Direct Method Operating activities section of the stmt of CF shows the major classes for operating cash receipts and disbursements

Note:

Reconciliation of net income to net CF for operating activities required for GAAP Not required for IFRS 2) Indirect Method Adj. net income to reconcile it to the net CF from operating activities o

1) Operating Activities Dividends received (increases operating CF) Dividends PAID financing CF A/R decrease ( CF), A/R increase ( CF) Sale of trading securities ( CF), sale of all other securities = financing or investing Inv decrease ( CF), Inv increase ( CF) Interest Paid ( CF), repaying principal financing outflow Indirect Method:

2) Investing Activities CF from the purchase or sale of non-current assets o Making loans to other entities (CF outflow) o Purchase or disposal of trading securities (if non-current), AFS, held to maturity o Acquiring or disposing of PP&E o Acquiring another company under the acquisition method 3) Financing Activities a) CF from non-current liability (creditor-oriented) o Issuing bonds, notes, and other borrowings (cash inflow) o Payments of principal on amount borrowed (cash outflow)

b) CF from equity (owner-oriented) activities o Issuing stock (cash inflow) o Paying dividends or repurchasing stock (cash outflow) IFRS Differences in Reporting CF

RATIO ANALYSIS A) Liquidity Ratios

Measures a firms ST ability to pay maturing obligations

B) Activity Ratios

Measures of how effectively an enterprise is using its assets

C) Profitability Ratios

Measures of the success of failure of an enterprise for a given time period

D) LT Debt-Paying Ability Ratios (coverage ratios)

Measures of security for LT creditors / investors