R. G. QUINTERO & CO.
CFA LEVEL I Q-NOTES
STUDY SESSION 8 (EXCERPT)
FINANCIAL STATEMENT ANALYSIS:
UNDERSTANDING THE
FINANCIAL STATEMENTS
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SESSION 8 OVERVIEW
 Understanding the Income Statement
 Understanding the Balance Sheet
 Understanding the Cash Flow Statement
Level I - Session 8
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UNDERSTANDING THE
INCOME STATEMENT
by Thomas R. Robinson, Hennie van Greuning,
Elaine Henry, and Michael A. Broihahn
Level I - Session 8
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EXAMPLES OF INCOME STATEMENT PRESENTATION FORMATS
MULTI-STEP FORMAT
SINGLE-STEP FORMAT
Net sales
$100,000 Revenues:
Cost of goods sold
(75,000) Net sales
$100,000
Gross profit
25,000 Other income, net
1,000
Selling, general & admin.
(15,000)
101,000
Operating income
10,000 Expenses:
Other income, net
1,000 Labor costs
(30,750)
Interest
(3,000) Materials
(26,250)
Income before taxes
8,000 Overhead
(18,000)
Income tax expense
(3,000) Depreciation
(2,000)
Net income
$5,000 Other costs
(13,000)
Interest
(3,000)
Income taxes
(3,000)
(96,000)
Net income
$5,000
Expenses are grouped by nature
Level I - Session 8
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WHEN TO RECOGNIZE REVENUES*
 Evidence of arrangement between buyer and
seller
 Product has been delivered or services
rendered
 Price has been determined or is determinable
 Seller has reasonable assurance of payment
*SAB 101
Level I - Session 8
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SPECIAL SITUATIONS AFFECTING
REVENUE RECOGNITION
 Long-term contracts
 Pct. of completion vs. completed contract A/C
 Installment sales
 Barter T/A’s
 Gross and net reporting
Level I - Session 8
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PERCENTAGE OF COMPLETION vs.
COMPLETED CONTRACT ACCOUNTING
Percentage of Completion
Completed Contract
LT contracts extending over > 1 A/C period
Applicability
• Costs subject to estimation • Costs may or may not be
subject to estimation
Revenue recognition
• Costs incurred as % of total • At end of project
• Job progress estimates as
% of total job
Expense recognition
• % of total costs x % of total
revenues recognized
• At end of project
Earnings recognition
• Throughout term of project
• At end of project
Loss recognition
• Entire is amount as soon as it is subject to estimation
Cash flow
Level I - Session 8
Identical under both methods
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% OF COMPLETION (POC) vs. COMPLETED CONTRACT (C/C) REVENUES AND NET INCOME (NI)
$700
$600
$500
$400
$300
$200
$100
$0
1st Qtr
2nd Qtr
POC Rev
Level I - Session 8
3rd Qtr
POC NI
C/C Rev
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4th Qtr
C/C NI
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PERCENTAGE OF COMPLETION vs. COMPLETED CONTRACT ACCOUNTING
Facts
Contract size
Projected expense
Annual billings
Annual collections
Costs incurred
Annual disbursements
% of total job costs
Year 1
Year 2
$200,000 (a)
160,000
85,000
115,000
80,000
120,000
70,400
89,600
65,000
95,000
44.00%
56.00%
Percentage of
Completion
Year 1
Year 2
(b)
(c)
(d)
(e)
(f)
Completed
Contract
Year 1
Year 2
Income Statement
Revenues
$88,000
112,000 (a) x (f)
0
200,000 ∑(b)
Cost of goods sold
(70,400)
(89,600) (d)
0 (160,000) ∑(d)
Gross profit
$17,600
22,400 (g)
0
40,000 (h)
Balance Sheet
Cash
$15,000
40,000 (c) – (e)
15,000
40,000 (c) – (e)
Accounts receivable
5,000
0 (b) – (c)
5,000
0 (b) – (c)
Contracts in progress (asset)
3,000
0 (d)+(g)–(b)
0
0
Payables and accruals
5,400
0 (d) – (e)
5,400
0 (d) – (e)
Contracts in progress (liability)
0
0
14,600
0 (d) – (b)
Retained earnings
17,600
40,000 ∑(g)
0
40,000 ∑(h)
Note: difference between contract in progress of 2 methods = pct. of completion gross profit
Cash Flow Statement
Collections
$80,000
120,000 (c)
80,000
120,000 (c)
Disbursements
(65,000)
(95,000) (e)
(65,000)
(95,000) (e)
$15,000
25,000 (c) – (e)
15,000
25,000 (c) – (e)
Level I - Session 8
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PERCENTAGE OF COMPLETION
vs. COMPLETED CONTRACT
 Income statement and balance sheet differ
during project; identical at end
 Cash flows are identical
 Pct of completion can result in errors or
manipulation
 Completed contract can cause
 Sales and earnings volatility
 Erroneous view of earnings during period
Level I - Session 8
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1. Rudlen Company had an $80 million contract with a 20% gross
margin that was completed during the 4th quarter of 2007. It
incurred costs of $10 million on the contract during that
quarter. Its 4th quarter revenues under percentage of
completion and completed contract accounting would be
reported as:
a.
b.
c.
d.
$10 million and $16 million, respectively.
$12 million and $80 million, respectively.
$12.5 million and $80 million, respectively.
$16 million and $80 million, respectively.
Level I - Session 8
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Excludes pages 12 – 119
for Study Session 8
Level I - Session 8
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