Business Analysis & Reporting (BAR) Cheat Sheet

Enterprise Risk Management (ERM) Framework & Risk Responses

The ERM framework helps organizations manage risk to create and preserve value. Management assesses inherent risk (risk if no action is taken) and residual risk (risk after management action).

Core Concepts

• Mission: The organization's core purpose.
• Vision: The organization's aspirations and goals for the future.
• Core Values: The organization's beliefs and ideals.

ERM Components & Principles

• Governance & Culture: Defines desired culture, exercises board oversight, demonstrates commitment to core values, attracts and retains capable individuals, and establishes operating structure. Culture is influenced by individualism vs. collectivism, uncertainty avoidance, short-term vs. long-term orientation, and acceptance of leadership hierarchy.
• Strategy and Objective-Setting: Evaluates alternative strategies, formulates business objectives, defines risk appetite, and analyzes business context.
• Performance: Assesses severity of risk, prioritizes risk, identifies risks (events), implements risk responses, and develops a portfolio view.
• Review & Revision: Assesses substantial change, pursues improvement in enterprise risk management, and reviews risk and performance.
• Information, Communication, and Reporting: Leverages information and technology, communicates risk information, and reports on risk, culture, and performance.

Cost-Benefit Analysis & Risk Attitudes

• Net Benefit: Calculated as Benefit minus Cost.
• Benefit Formula: $Impact \times (\% \text{ risk} - \text{proposed } \%)$.
• Risk Attitudes: Entities can be Risk-Averse (the general rule), Risk-Seeking (the rarest), or Risk-Indifferent (rare).

Risk Responses

• Avoid: Exiting the activities giving rise to risk.
• Reduce: Action taken to reduce risk likelihood or impact.
• Transfer (Share): Reducing risk by transferring a portion of it (e.g., buying insurance).
• Self-Insure (Accept): No action taken; accepting the risk.
• Pursue: Accepting increased risk to achieve increased performance.

COSO Internal Control Framework

The COSO framework is a model used to help organizations design, implement, and evaluate internal controls. It is comprised of five integrated components:

• Control Environment: The set of standards, processes, and structures that provide the basis for carrying out internal control across the organization. It includes the "tone at the top" regarding the importance of control and ethical values.
• Risk Assessment: The process of identifying and analyzing risks to the achievement of objectives, which forms a basis for determining how the risks should be managed.
• Control Activities: Actions established through policies and procedures that help ensure management's directives to mitigate risks are carried out.
• Information and Communication: The continual process of providing, sharing, and obtaining necessary information to enable personnel to carry out their responsibilities.
• Monitoring Activities: Ongoing or separate evaluations used to ascertain whether each of the five components of internal control is present and functioning effectively.

Risk Categories & Exposures

Market vs. Firm-Specific Risk

• Systematic Risk: Also known as market or nondiversifiable risk. It is inherent to the entire market (e.g., inflation, interest rates).
• Unsystematic Risk: Also known as firm-specific or diversifiable risk. It can be eliminated through portfolio diversification (e.g., strikes, lawsuits).

Credit & Liquidity Risk

• Credit Risk: Risk that a borrower will default.
• Liquidity Risk: Risk of being unable to sell an investment quickly without a price concession.

Currency Exchange Risk Exposures

• Transaction Risk: Risk of exchange rate fluctuations between the transaction date and the settlement date.
• Economic Risk: Risk that fluctuations in exchange rates will impact the overall present value of the organization's future cash flows.
• Translation Risk: Risk related to translating a foreign subsidiary's financial statements into the parent's reporting currency.

Supply & Demand Shifts

Factors that Shift Demand

• Tastes and Preferences: Changes in consumer tastes, trends, and preferences for a product.
• Prices of Related Goods: The price of substitutes (a good used in place of another) or complements (a good used together with another).
• Income: Changes in consumers' income, affecting demand for normal and inferior goods differently.
• Number of Buyers: An increase or decrease in the total number of consumers in the market.
• Expectations: Consumer expectations about future prices, income, or product availability.

Factors that Shift Supply

• Input Prices: Changes in the cost of resources used for production (e.g., labor, raw materials, energy).
• Technology: Advancements in production technology that can lower costs and increase output.
• Government Policies: The effect of taxes (which increase production costs) or subsidies (which decrease them).
• Number of Sellers: An increase or decrease in the number of firms producing the good.
• Expectations: Producer expectations about the future selling price of the good.

Market Equilibrium & Economic Systems

Market Equilibrium

Equilibrium occurs where the supply and demand curves intersect. Government intervention can shift this:

• Price Ceiling: A legally established maximum price. Set below the equilibrium price, it causes a shortage.
• Price Floor: A legally established minimum price. Set above the equilibrium price, it causes a surplus.

Economic Systems

• Centrally Planned Economies: Governments heavily restrict or control economic activity (e.g., China).
• Market Economies: Economic activity is driven by individuals and industry (e.g., US, Japan).
• Conglomerates: Self-sustaining entities with cross-shareholders. Note that these generally violate U.S. anti-trust laws.

Elasticity Concepts

Strategic Management Frameworks

Strategic tools used to analyze internal/external factors and create competitive advantages.

Competitive Strategies

• Cost Leadership: Match or sell for less than rivals.
• Differentiation: Offer a "superior" or unique product.
• Best Cost: Combination of cost leadership and product differentiation.
• Niche/Focus: Target a small group or specific market segment.

Porter's Five Forces

• Barriers to Entry: Impediments to new competitors.
• Market Competitiveness: Intensity of current rivalry.
• Existence of Substitutes: Alternative products available.
• Bargaining Power of Customers: High if one customer is a large % of business (bad).
• Bargaining Power of Suppliers: High if few suppliers exist or it is difficult to switch (bad).

SWOT Analysis

• Strengths (Internal): Attributes that help achieve the objective.
• Weaknesses (Internal): Attributes that harm achieving the objective.
• Opportunities (External): Conditions helpful to achieving the objective.
• Threats (External): Conditions harmful to achieving the objective.

Value Chain Analysis

• Primary Activities: Inbound logistics, Operations, Outbound logistics, Marketing & Sales, Service.
• Support Activities: Procurement, Human Resources, Technology Development, Infrastructure.

Macroeconomic Concepts & GDP

Gross Domestic Product (GDP) Expenditure Approach

The total market value of all finished goods and services produced within a country's borders in a specific time period.

• C (Consumption): Personal consumption expenditures (largest component).
• I (Investment): Gross private domestic investment (business spending, inventory, new housing).
• G (Government Spending): Government consumption and gross investment (excludes transfer payments).
• NX (Net Exports): Exports (X) minus imports (M).

Business Cycles

1. Expansion: GDP is rising, unemployment is falling.
2. Peak: GDP stops rising, hits its highest level.
3. Contraction: GDP is falling, unemployment is rising.
4. Trough: GDP stops falling, hits its lowest level.

Economic Indicators

• Leading: Predict future economic activity (e.g., stock market).
• Lagging: Follow economic activity (e.g., unemployment rate).
• Coincident: Change at the same time as the economy (e.g., industrial production).

Unemployment Types

• Frictional: Normal unemployment from workers changing jobs.
• Structural: Mismatch between job skills and employer needs.
• Cyclical: Caused by downturns in the business cycle.

Government Policy

• Fiscal Policy: Government spending and taxation.
• Monetary Policy: Actions by a central bank to control the money supply and credit conditions.

Market Structures

• Perfect Competition: Many small firms, identical products, no barriers to entry. Firms are price takers.
• Monopolistic Competition: Many firms, differentiated products, few barriers to entry. Firms have some control over price.
• Oligopoly: A few large firms dominate the market, significant barriers to entry. Firms are interdependent.
• Monopoly: Single firm, unique product, significant barriers to entry. Firm is a price setter.

International Business Operations

Motivations for International Business

• Comparative Advantage: Specialization in the production of a good where the country has a lower opportunity cost.
• Imperfect Markets: Overcoming restrictions on the flow of resources.
• Product Cycle: Expanding abroad when domestic growth matures.

Methods of Operations

• Franchising & Licensing: Providing rights to use a brand or production process.
• Joint Ventures: Partnering with a foreign entity.
• Direct Foreign Investment (DFI): Purchasing or establishing foreign subsidiaries.
• Global Sourcing: Using worldwide supply chains.

Financial Calculations

Cost of Capital, Equity & Growth

Weighted Average Cost of Capital (WACC)

The hurdle rate. A lower WACC is desirable.

• Cost of Debt (Rₔ): Use the effective interest rate on new debt. Multiplied by (1 - Tax Rate) for the after-tax tax shield.
• Cost of Preferred Stock (Rₚ): Dividend per share / Net proceeds per share.

Cost of Common Equity (Rₑ)

Calculated via 3 methods. If all 3 are available, take the average.

• CAPM Formula: $R_e = R_f + \beta (R_m - R_f)$
• Discounted Cash Flow (Gordon Growth): $R_e = \frac{D_1}{P_0} + g$
• Bond Yield Plus Risk Premium: Pretax cost of long-term debt + Firm-Specific Equity Risk Premium.

Sustainable Growth Rate (g)

Where: Retention Rate = 1 - Dividend Payout Ratio

Internal Growth Rate

Optimal Capital Structure & Leverage

The optimal capital structure is the mix of debt and equity that minimizes the WACC and maximizes the value of the firm.

Debt vs. Equity Financing Characteristics

Financing Strategies

• Short-Term Financing: Provides increased liquidity, higher profitability, and lower financing costs, but comes with increased interest rate risk and decreased capital availability.
• Long-Term Financing: Decreases interest rate risk and increases capital availability, but results in decreased liquidity, lower profitability, and higher financing costs.
• Asset Structure: Higher current assets increase liquidity and decrease distress risk but lower the return on assets. Higher non-current assets decrease liquidity and increase distress risk but yield higher returns on assets.

Operating Leverage

Measures the degree to which a firm uses fixed operating costs. Higher fixed costs mean higher operating leverage, leading to higher risk but higher potential return.

Financial Leverage

Measures the degree to which a firm uses debt financing. Firms must generate sufficient EBIT to cover fixed interest costs.

Value of a Levered Firm

Working Capital Management

Key Formulas

Cash Conversion Cycle

Cash Management Motives

• Transaction Motives: Holding cash to meet routine payments.
• Speculative Motives: Holding cash to take advantage of unexpected investment opportunities.
• Precautionary Motives: Holding cash as a safety cushion for unexpected needs.

APR for Quick Payment Discounts

Methods to Delay Disbursements

• Centralized payables with zero-balance accounts
• Use of drafts (checks payable by a bank)
• Lines of credit

Inventory Management & EOQ

The Economic Order Quantity (EOQ) model calculates the ideal order size to minimize the sum of ordering costs and carrying costs. The formula is:

Opposing Costs

• Ordering Costs: Costs of placing and receiving an order (e.g., purchase order processing, receiving department costs). Decrease as order size increases.
• Carrying (Holding) Costs: Costs of holding inventory (e.g., storage, insurance, obsolescence). Increase as order size increases.

Key Assumptions

• Demand is known and constant.
• Lead time is reliable and does not vary.
• Ordering costs are fixed per order.
• No quantity discounts are available.

Inventory Techniques & Metrics

• Reorder Point: Safety Stock + (Lead Time x Sales during Lead Time).
• SCOR Model: A framework for supply chain management: Plan, Source, Make, Deliver.
• Just-in-Time (JIT): Reduces inventory by receiving goods only as they are needed in the production process.
• Kanban: A visual system to manage and control JIT workflow.

Capital Budgeting & Investment Analysis

Internal Rate of Return (IRR) Specifics

The discount rate at which the Net Present Value (NPV) of a project's cash flows equals zero.

Decision Rule: Accept the project if the IRR is greater than the company's required rate of return (hurdle rate).

IRR is generally less reliable than NPV when comparing mutually exclusive projects or projects with unconventional cash flows.

Valuation Models

Dividend Discount Models (DDM)

General Formula:

Zero Growth (Perpetuity):

Gordon Growth (Constant Growth):

Relative Valuation Models

• P/E Ratio: Price per Share / Expected EPS
• PEG Ratio: (P/E Ratio) / Earnings Growth Rate (g)
• Price-to-Sales: Price per Share / Expected Sales per Share
• Price-to-Cash-Flow: Price per Share / Expected CF per Share
• Price-to-Book: Price per Share / Book Value per Share

Option Pricing Models

• Black-Scholes Model: Evaluates options at one point in time (European-styled, meaning they can only be exercised at maturity) and assumes no transaction costs.
• Binomial Model: Evaluates options over a period of time (American-styled, meaning they can be exercised at any time until maturity).

Valuing Tangible Assets

• Cost Method: Original Cost - Accumulated Depreciation = NBV.
• Appraisal Method: Based on professional appraisal.
• Liquidation Method: Amount if sold today.
• Market Value Method: Selling Price - Cost to Sell = NRV.

Valuing Intangible Assets

• Market Approach: Valuation based on similar markets.
• Income Approach: Uses discount rates (FCF to PV).
• Cost Approach: Based on Replacement or Reproduction Cost.

Financial Statement Analysis & Ratios

Financial statement analysis involves using ratios to evaluate an entity's liquidity, solvency, profitability, and operational performance.

Profitability Ratios

• Gross Margin: (Net Sales - COGS) / Net Sales
• Profit Margin: Net Income / Net Sales
• Return on Assets (ROA): Net Income / Average Total Assets
• Return on Equity (ROE): Net Income / Average Total Equity

DuPont Return on Assets

The DuPont model breaks down ROA into two distinct components to better analyze performance drivers:

(Net Income / Net Sales) × (Net Sales / Avg Total Assets)

Liquidity Ratios

Measures short-term ability to pay maturing obligations.

• Current Ratio: Current Assets / Current Liabilities
• Quick Ratio: (Cash & Equivalents + Short-term Marketable Securities + Net Receivables) / Current Liabilities
• Working Capital: Current Assets - Current Liabilities

Solvency & Capital Structure

Measures security for long-term creditors/investors.

• Debt-to-Equity: Total Liabilities / Total Equity
• Total Debt Ratio: Total Liabilities / Total Assets
• Times Interest Earned: EBIT / Interest Expense
• Equity Multiplier: Total Assets / Total Equity

Fair Value Measurement Hierarchy

Fair value is a market-based measurement representing the price to sell an asset or transfer a liability. Inputs are prioritized by reliability.

• Level 1 (Highest Priority): Quoted prices in active markets for identical assets or liabilities.
• Level 2: Observable inputs other than Level 1, such as quoted prices for similar assets in active markets, or identical assets in inactive markets.
• Level 3 (Lowest Priority): Unobservable inputs reflecting management's assumptions (e.g., Discounted Cash Flow models).

Principal vs. Most Advantageous Market

Fair value assumes the transaction occurs in the Principal Market (the market with the greatest volume/activity). If no principal market exists, use the Most Advantageous Market (the market maximizing the price received for the asset after considering transaction costs). Note: Transaction costs are used to determine the most advantageous market, but are NOT included in the final fair value measurement.

Data Analytics & Management

Types of Data Analytics

• Descriptive: Describes or explains what has occurred (backward-looking).
• Diagnostic: Explains exactly why an event occurred.
• Predictive: Uses historical data to predict what will occur in the future (forward-looking).
• Prescriptive: Prescribes what actions should be taken to optimize an outcome.

Data Structuring & Transformation

• Structured vs. Unstructured: Structured data is highly organized (tables/rows) while unstructured data is unmodified original content (text, images).
• Primary Key: A database attribute that uniquely identifies a record.
• Foreign Key: An attribute that contains values from a primary key in another table, linking the two.
• Data Cleaning: Ensuring data is complete, current, and formatted correctly prior to analysis.

Projection & Forecasting Techniques

Analytical Models

• Sensitivity Analysis: Also known as "What-if" analysis, it uses probabilities to approximate reality by changing one variable at a time.
• Scenario Analysis: Evaluates multiple scenarios which represent alternative possible outcomes.
• Linear Regression: Uses the formula $y = a + Bx$ where $y$ is total cost, $a$ is fixed cost, $B$ is variable cost per unit, and $x$ is total activity.

Statistical Metrics

• Coefficient of Correlation (r): Measures the strength of the linear relationship between variables. Ranges from +1 (perfect positive correlation) to -1 (perfect inverse correlation). A value of 0 indicates no correlation.
• Coefficient of Determination ($R^2$): Measures the proportion of the variance in the dependent variable ($y$) that is predictable from the independent variable ($x$).

Cost Estimation

• High-Low Method: A technique to estimate the fixed and variable portions of costs. The calculation steps are:
  1. Take the difference between the high and low total costs and volume.
  2. Divide the cost difference by the volume difference to find the variable cost per unit.
  3. Calculate the total variable cost using either the high or low volume numbers.
  4. Plug these figures into the total cost formula ($y = a + Bx$) to calculate total fixed costs.
• Learning Curve: The principle that as workers become more familiar with a task, production will be more efficient. This is most applicable for repetitive, intense labor with little to no labor force turnover or breaks.
  • The average time for 2 units equals the first unit's hours multiplied by the learning curve percentage.
  • The average time for 4 units equals the new average time multiplied by the learning curve percentage.
  • To find the total time required, multiply the new average time by the total number of units.

Cost Accounting Systems & Inventory Flows

Product vs. Period Costs

• Product Costs (Inventoriable): Capitalized as an asset until sold. Composed of Prime Costs (Direct Materials + Direct Labor) and Conversion Costs (Direct Labor + Manufacturing Overhead Applied).
• Period Costs: Expensed in the period incurred (e.g., SG&A, interest). Abnormal costs are always classified as period costs, whereas normal spoilage is treated as a product cost.

Cost Accumulation Systems

• Job Costing: For custom orders; costs are tracked by individual job.
• Process Costing: For mass-produced, homogeneous products; costs are averaged over all units using Equivalent Units (EU).
• Operations Costing: A hybrid utilizing components of both job and process costing.
• Backflush Costing: Accounts for costs only at the end of the manufacturing process.
• Life-Cycle Costing: Monitors costs throughout a product's entire life cycle.

Activity-Based Costing (ABC)

Assigns overhead based on multiple activities (cost pools and drivers) rather than a single plant-wide rate. An overhead rate must be calculated for each distinct cost pool.

Cost of Goods Manufactured (COGM)

COGM represents the total cost of goods completed and transferred from WIP to Finished Goods inventory during a period.

Cost of Goods Sold (COGS)

COGS represents the manufacturing costs of products that were completely manufactured and sold during the period.

Cost of Quality

Costs of quality are categorized as either conformance or non-conformance costs. The goal is to invest in conformance costs to minimize non-conformance costs.

Conformance Costs (Good)

Costs incurred to prevent or detect defects before they reach the customer.

• Prevention Costs: Costs to prevent defects from occurring (e.g., employee training, quality control).
• Appraisal Costs: Costs to identify defective products before shipment (e.g., testing, inspection).

Non-Conformance Costs (Bad)

Costs incurred because defects were produced.

• Internal Failure Costs: Costs of defects found before the product reaches the customer (e.g., rework, scrap).
• External Failure Costs: Costs of defects found after the product reaches the customer (e.g., warranty costs, returns, lost sales).

Joint & By-Product Costing

• Joint Products: Two or more products generated from a common input. Joint costs are allocated to these main products.
• By-Products: Products with a low sales value relative to the main product. Revenue from by-products can be used to reduce the joint costs allocated to the main products.
• Split-off Point: The point in the production process where joint products can be individually identified.
• Separable Costs: Costs incurred after the split-off point that are assignable to specific products.

Joint Cost Allocation Methods

Joint costs are incurred in a single process that yields multiple products. These costs must be allocated to the main (joint) products at the split-off point.

1. Relative Sales Value Method

Allocates joint costs based on each product's share of total sales value at the split-off point. This is the preferred method.

2. Net Realizable Value (NRV) Method

Used when products cannot be sold at split-off. Allocation is based on final sales value minus identifiable costs incurred after split-off (separable costs).

3. Physical Unit Method

Allocates joint costs based on a physical measure (e.g., pounds, gallons) of the units produced. This method does not consider the revenue-generating power of products.

Accounting for By-Products

By-products have a relatively minor sales value. The proceeds generated from their sale are accounted for using one of two methods:

• Applied to Main Product: By-product revenue is credited to Joint Costs (reducing the COGS of the main products).
• Miscellaneous Income: By-product revenue is credited directly to a miscellaneous income account on the income statement.

Marginal Analysis & Relevant Costs

• Relevant Costs: Avoidable costs that result from choosing one course of action over another. Unavoidable costs are the same regardless of the chosen course and are not relevant.
• Make vs. Buy Decision: The goal is to select the lowest cost alternative.
  • Excess Capacity: Make the product if the cost to buy is greater than the variable and avoidable cost per unit.
  • No Excess Capacity: Opportunity costs must be included. Make the product if the cost to buy is greater than the variable and avoidable cost per unit plus the opportunity cost.
• Special Order Decisions: Accept if incremental revenue > incremental costs. Consider opportunity cost if there is no excess capacity.
• Sell or Process Further: Process further if incremental revenue from processing > incremental processing costs. Incremental revenue is the new selling price minus the current selling price. Joint costs are untraceable, sunk costs, and therefore irrelevant. Separable costs incurred after the split-off point are traceable and relevant.
• Keep or Drop a Segment: Drop a segment if the unavoidable fixed costs exceed the current net income. Keep the segment if the lost contribution margin is greater than the fixed costs. Drop the segment if the lost contribution margin is less than the fixed costs.
• Lease vs. Buy: Compare the NPV of the cash flows for each option.

CVP, Target Costing & Margin Analysis

Absorption vs. Contribution Margin

The core difference is the treatment of Fixed Factory Overhead.

• Absorption Costing (GAAP): Fixed OH is a product cost (inventoried).
• Contribution/Variable Costing (Internal): Fixed OH is a period cost (expensed immediately).

Rule of thumb:
If Production > Sales → Absorption Income > Variable Income.
If Sales > Production → Variable Income > Absorption Income.

Break-Even & CVP Analysis

BE Point (Units)

BE Point ($)

Sales for Target Profit (Units)

Margin of Safety

Target Costing

Used to establish the maximum cost allowed to ensure profitability per unit and total sales volume.

Business Process Management

• Plan-Do-Check-Act (PDCA): A cycle for continuous improvement.
• Lean Manufacturing: Focuses on waste reduction and efficiency.
• Six Sigma: A data-driven approach for quality control and eliminating defects.
• Theory of Constraints: Identifies and improves the most significant bottleneck in a process.

Performance Metrics & Responsibility Centers

Metrics used to evaluate management, operational efficiency, and investment center performance. A responsibility center is a segment of a business for which a manager has control and accountability.

Responsibility Centers

• Cost Center: Manager responsible for costs only (e.g., production department).
• Revenue Center: Manager responsible for revenues only (e.g., sales department).
• Profit Center: Manager responsible for both revenues and costs (e.g., a specific product line).
• Investment Center: Manager responsible for revenues, costs, and invested capital (e.g., a subsidiary).

Investment Center Metrics

• Return on Investment (ROI): $\text{Net Income} / \text{Avg Investment Capital}$. Simple, but can lead to underinvestment.
• Residual Income (RI): Income earned in excess of the required return. Promotes goal congruence.
• Economic Value Added (EVA): Net operating profit after taxes (NOPAT) minus the Required Return. A positive EVA indicates economic profit and strong performance.

Non-GAAP Measures

• EBITDA: Removes factors that do not impact operating performance (interest, taxes, D&A).
• Free Cash Flow: Cash remaining after paying operating expenses and capital expenditures.
• Core Earnings: Profits derived exclusively from the main/principal business.

Operational & Nonfinancial Measures

Balanced Scorecard

• Financial: Financial performance (e.g., ROI, profit).
• Internal Business Processes: Efficiency and quality (e.g., defect rate).
• Customer Satisfaction: How customers view the organization (e.g., satisfaction surveys).
• Growth: Human capital and innovation (e.g., employee training).

Comprehensive Variance Analysis

Cost Variances

Sales & Profit Variances

Master Budget Components

The Master Budget is a comprehensive plan for an organization, typically for one year. It is composed of operating and financial budgets.

Operating Budgets

Describe the income-generating activities of a firm. Based on the Sales Budget.

1. Sales Budget
2. Production Budget
3. Direct Materials, Direct Labor & OH Budgets
4. COGS Budget
5. Selling & Administrative Expense Budget

Financial Budgets

Detail the inflows and outflows of cash and the overall financial position.

• Capital Expenditures Budget
• Cash Budget
• Budgeted Balance Sheet
• Budgeted Statement of Cash Flows

Budgeting Standards

Standards are per-unit budgets integral to the development of a flexible budget.

• Ideal standards: Assume perfect efficiency and effectiveness (e.g., no spoilage or downtime).
• Current attainable standards: Represent work by employees with appropriate training without extraordinary effort (allows for normal spoilage/downtime).
• Authoritative standards: Set exclusively by management.
• Participative standards: Set by managers and the individuals held accountable for meeting them.

Business Combinations, Acquisitions & Divestitures

Companies combine or divest to achieve strategic goals, such as centralized management or cost reduction.

Types of Combinations

• Horizontal: Combinations between competitors.
• Vertical: Companies in a similar industry, but in different stages of production.
• Circular: Remote connections between entities.
• Diagonal: An entity that provides ancillary support.
• Mergers & Acquisitions: A merger is when Company A plus Company B equals Company C. An acquisition is when Company A buys Company B to become a bigger Company A.
• Consolidations: Combined financial statements of a parent company and its subsidiaries.
• Tender Offers: An acquiring company makes an offer directly to the target's shareholders.
• Purchases of Assets: Buying a division or product line from a larger conglomerate.
• Management Acquisitions: Executive management buys out the company.

Acquisition: Goodwill vs. Bargain Purchase

In a business combination, Goodwill is recognized if the purchase price exceeds the fair value of the net assets acquired. The calculation is as follows:

• If the result is positive, it is Goodwill, which is capitalized as an intangible asset and tested for impairment.
• If the result is negative, it is a Bargain Purchase Gain. This gain is recognized immediately in the acquirer's current earnings.

Types of Divestitures

• Sell-Offs: Sale of a subsidiary, typically because it is underperforming.
• Spin-Offs: Creating a new independent company separate from the parent to unlock potential value, resulting in no cash inflow.
• Equity Carve-Out: A subsidiary is made public through an IPO, which generates cash and provides the parent with a controlling interest.

Consolidation & Intercompany Transactions

A parent must consolidate a subsidiary when it has control (over 50% voting interest), with exceptions requiring the equity method for bankruptcy or legal reorganization.

Treatment of Combination Costs

• Acquisition Costs: Expensed immediately (e.g., legal and consulting fees).
• Registration & Issuance Costs: Deducted from the value of the stock issued (debit to APIC).

Consolidation Elimination Entry

This journal entry eliminates the subsidiary's equity and the parent's investment account:

• DR: Common Stock - Sub
• DR: APIC - Sub
• DR: Retained Earnings - Sub
• DR: Balance Sheet FV Adjustments
• DR: Intangibles FV
• DR: Goodwill (or CR: Gain)
• CR: Investment in Sub
• CR: Noncontrolling Interest

Noncontrolling Interest (NCI) Rollforward

To calculate the Noncontrolling Interest at year-end, use the following formula:

Measurement Period

A period not exceeding one year from the acquisition date. It ends when it becomes obvious no better information will be available to adjust provisional amounts recognized at the acquisition date.

Intercompany Inventory

All intercompany transactions must be eliminated during consolidation. Any unrealized profits on assets that remain within the consolidated entity at year-end must be deferred.

• Profit Deferral: Defer 100% of the gross profit on inventory that remains unsold to outsiders at year-end.
• Subsequent Period: When the inventory is sold to an outsider in the next period, the deferred profit is recognized.

Intercompany Fixed Assets

• Gain/Loss Deferral: Defer 100% of any gain or loss on the intercompany sale in the year of the sale.
• Restore Basis: The asset must be restored to its original cost basis on the consolidated books.
• Correct Depreciation: "Excess" depreciation (depreciation on the gain) must be reversed in all subsequent periods until the asset is sold externally.

Variable Interest Entities (VIE)

A VIE is an entity where control is not based on majority voting rights. The primary beneficiary must consolidate the VIE. A company is the primary beneficiary if it meets the criteria below:

• Recipient: The company is the recipient of the VIE's profits and losses.
• Variable Interest: The company has a financial stake in the VIE.
• Characteristics: The VIE lacks the basic characteristics of a normal company (e.g., insufficient equity at risk).

Stock Compensation (Options & SARs)

Compensation for stock-based plans is recognized as an expense in the financial statements.

Employee Stock Options

• Measurement: Compensation expense is measured at the fair value of the options on the grant date, using a pricing model like Black-Scholes.
• Allocation: The total compensation cost is allocated on a straight-line basis over the vesting period (the period during which the employee earns the right to the options).
• Journal Entry: Each period, the entry to record the expense is:

  DR: Compensation Expense
  CR: APIC - Stock Options

• Expiration: If vested options expire, the APIC - Stock Options balance is reclassified to APIC - Expired Stock Options. No reversal of previously recognized expense is permitted.

Stock Appreciation Rights (SAR)

SARs entitle employees to receive cash equal to the excess of the market price of stock over a predetermined strike price. No cash is received by the corporation.

• Accounting Treatment: The company records a Compensation Expense and a Liability (not APIC).
• Subsequent Adjustments: Because it is a liability, the compensation expense must be adjusted annually based on the current market price until the rights are exercised.

Revenue Recognition

5-Step Model

The framework for recognizing revenue under ASC 606 is based on the following five-step process:

1. Identify the contract(s) with a customer.
2. Identify the separate performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.

Advanced Scenarios

Specialized scenarios alter the standard timing of revenue recognition under ASC 606.

• Principal vs. Agent: The principal maintains inventory, while the agent receives a percentage commission as revenue.
• Bill & Hold: Revenue is recognized when the product is ready if the customer requested to hold it, not when payment is received.
• Refund Liability: Recognize revenue when the refund period ends.
• Repurchase Agreements: A forward or call option where the repurchase price is less than the original selling price acts as a lease. If the repurchase price is greater, it is a financial arrangement.
• Put Options: If the repurchase price is less than the original selling price and there is an economic incentive, it is treated as a lease; if there is no economic incentive, it is a sale with a right of return.

Long-Term Contracts

Under ASC 606, revenue recognition is determined by when control of a good or service transfers to the customer, which can occur either over time or at a point in time.

Revenue Recognized Over Time: An entity recognizes revenue over time if certain criteria are met (e.g., the customer controls the asset as it is created). Progress toward completion is measured using either input or output methods.

• Input Method (e.g., Cost-to-Cost): Revenue is recognized based on the proportion of costs incurred to date relative to total estimated costs.
• Output Method: Revenue is recognized based on direct measurements of the value transferred to the customer (e.g., milestones achieved).

Anticipated losses on the contract are recognized in full immediately.

Revenue Recognized at a Point in Time: If the criteria for recognizing revenue over time are not met, revenue is recognized in full at the point in time when the customer obtains control of the completed asset. Costs are capitalized and expensed upon completion. Anticipated losses are still recognized immediately.

Earnings Per Share (EPS)

Basic EPS

Diluted EPS

Considers the effect of all potential dilutive common shares (e.g., stock options, convertible bonds). Uses the if-converted method for convertible securities and the treasury stock method for options and warrants.

Partnership Accounting Basics

• Formation: Assets contributed are recorded at their fair market value.
• New Partner Admission: Can be done by purchasing an interest from existing partners or by investing new assets into the partnership.
• Bonus Method: When a new partner's capital account differs from their investment, the difference is allocated as a bonus to/from the existing partners' capital accounts based on their P&L ratio.
• Liquidation: All liabilities are paid first, then loans to partners, and finally capital balances are distributed.

Statement of Cash Flows (Commercial)

Summarizes the cash inflows and outflows over a period.

• Operating Activities: Cash effects of transactions that determine net income (e.g., cash from customers, payments to suppliers). Can be presented using the direct or indirect method.
• Investing Activities: Cash flows from making and collecting loans and acquiring/disposing of investments and long-lived assets.
• Financing Activities: Cash flows from issuing debt and equity, paying dividends, and repurchasing stock.

Foreign Currency Accounting & Transactions

This applies when a company buys or sells goods/services in a currency other than its functional currency. The key is that transaction gains and losses are always reported in Net Income.

Transaction Gains and Losses

1. Transaction Date: Record the accounts receivable or payable using the exchange rate (spot rate) on this date.
2. Balance Sheet Date: Remeasure the receivable/payable using the current spot rate. The difference creates an unrealized gain or loss, which is reported in current period income.
3. Settlement Date: Remeasure the receivable/payable using the spot rate on the settlement date. A further gain or loss is calculated and reported. The transaction is then settled.

Remeasurement vs. Translation

Derivatives & Hedge Accounting

Derivatives are financial instruments tied to an underlying notional amount. Risk types include Market Risk (incurring a net loss) and Credit Risk (default/nonperformance).

Common Instruments

• Futures Contract: Publicly traded, higher liquidity.
• Forward Contract: Privately negotiated.
• Swap Contract: Private agreement where only the loser makes payment.
• Options Contract: Call (right to buy); Put (right to sell).
  • Call Option: The buyer pays a premium hoping the underlying price will increase. The buyer will exercise the option if the market price is greater than the strike price, otherwise they let it expire.
  • Put Option: The buyer pays a premium hoping the underlying price will decrease. The buyer will exercise the option if the market price is less than the strike price, otherwise they let it expire.

Foreign Currency Hedging

• Hedging an A/R (Asset): Fear currency will weaken. Strategy: Sell a Forward/Future, or Buy a Put Option.
• Hedging an A/P (Liability): Fear currency will strengthen. Strategy: Buy a Forward/Future, or Buy a Call Option.

Fair Value Hedge

Included in current earnings as an offset to the gain/loss from the change in fair value of the hedged item.

Cash Flow Hedge

Included in other comprehensive income (OCI) until the hedged transaction impacts earnings.

Defined Benefit Pension Expense

The components of net periodic pension cost are:

• Service Cost: The present value of benefits earned by employees in the current period. (Increases expense)
• Interest Cost: The interest accrued on the Projected Benefit Obligation (PBO). (Increases expense)
• Expected Return on Plan Assets: The anticipated earnings on the pension fund's investments. (Decreases expense)
• Amortization of Prior Service Cost: The allocation of the cost of retroactive benefits from plan amendments. (Increases expense)
• Amortization of Gains and Losses: The amortization of actuarial gains (which decrease expense) or losses (which increase expense).

Lease Classification & Accounting (ASC 842)

Lease classification determines the accounting treatment for both the lessee and the lessor, and it is based on a universal set of criteria that assess whether the lease effectively transfers control of the underlying asset.

Lease Classification Criteria

The classification hinges on the following two sets of criteria:

• Criteria for Transfer of Control:
  • Ownership of the asset transfers to the lessee by the end of the lease term.
  • A written purchase option exists that the lessee is reasonably certain to exercise.
  • The Net Present Value of lease payments is 90% or more of the asset's fair value.
  • The economic life of the asset is primarily consumed during the lease term (75% or more).
  • The asset is specialized with no alternative use to the lessor at the end of the term.
• Additional Lessor-Only Criteria:
  • The present value of the sum of lease payments, lessee-guaranteed residual value, and third-party guaranteed residual value is equal to or substantially exceeds the asset's fair value.
  • Collection of the lease payments is probable.

Accounting Treatment Flow

Lessor Accounting Distinctions

• Sales-Type & Direct Financing Leases: The lessor removes the asset from the balance sheet and recognizes Interest Income over the lease term.
• Operating Lease: The lessor keeps the asset on the balance sheet, continues to record depreciation, and recognizes Rental Income.

Segment & Public Company Reporting

Segment Reporting

A segment is reportable if it meets the 10% "Size" Test for:

• Combined Revenue (internal & external)
• Absolute value of Profit or Loss
• Identifiable Assets

75% Reporting Sufficiency Test: Total external revenue of all reportable segments must be at least 75% of total consolidated revenue. If not, add the next highest segment until the 75% threshold is reached.

SEC Reporting Regulations

• Regulation S-X (Financials): Dictates the presentation of financial statements. Requires Balance Sheets for the 2 most recent fiscal years, and Statements of Income, Cash Flows, and Owners' Equity for the 3 most recent fiscal years.
• Regulation S-K (Non-Financials): Dictates qualitative disclosures including Business details, Registration of Securities, Management information, and Industry Guides.

R&D, Software, and Intangible Costs

Specific Intangible Rules

• Start-up and Organizational Costs: Must be expensed immediately as incurred.
• Legal Fees: Unsuccessful legal fees are expensed. Successful legal fees (e.g., successfully defending a patent) are capitalized.

Research & Development (R&D)

Under US GAAP, R&D costs are generally expensed as incurred. However, there are exceptions:

• Materials/equipment with alternative future uses are capitalized and depreciated over their useful lives (only the depreciation is charged to R&D).
• R&D performed under contract on behalf of others is treated as a normal operating expense (not R&D).

Computer Software Development Costs (To be sold/licensed)

• Before Technological Feasibility: All costs (planning, designing, coding, testing) are expensed as R&D.
• After Technological Feasibility: Costs incurred (coding, testing, producing product masters) are capitalized.
• Amortization: Capitalized costs are amortized using the greater of the straight-line method over the economic life, or the percentage-of-revenue method.

Employee Benefit Plan Financial Statements

Defined Benefit Plans

Risk is borne by the employer to fund specific retirement benefits. Required statements include:

• Statement of Net Assets Available for Benefits (Assets)
• Statement of Changes in Net Assets Available for Benefits (Income Statement equivalent)
• Statement of Accumulated Plan Benefits (Liabilities)
• Statement of Changes in Accumulated Plan Benefits

Defined Contribution Plans

Risk is borne by the employee; the employer simply contributes a set amount. Required statements include:

• Statement of Net Assets Available for Benefits
• Statement of Changes in Net Assets Available for Benefits

Goodwill Impairment Test

Goodwill is tested for impairment at the reporting unit level. Under US GAAP, the evaluation can involve up to two steps:

1. Qualitative Assessment (Optional)

Management may first assess qualitative factors to determine whether it is more likely than not (a greater than 50% chance) that the fair value of a reporting unit is less than its carrying amount. If so, the quantitative test is required.

2. Quantitative Test

1. Compare the Fair Value (FV) of the reporting unit with its Carrying Value (CV), including goodwill.
2. If the CV > FV, an impairment loss is recognized for the difference.
3. The loss cannot exceed the carrying amount of goodwill, and the reversal of a previously recognized impairment loss is prohibited (unless held for disposal).

XBRL (eXtensive Business Reporting Language)

XBRL uses tags to define financial data for digital reporting. The tagging structure operates on four distinct levels:

• Level 1: Each complete footnote or schedule is tagged.
• Level 2: Each significant accounting policy is tagged.
• Level 3: Each table within a footnote or schedule is tagged.
• Level 4: Individual amounts within each footnote or schedule are tagged.

Governmental Fund Accounting Overview

Governmental Funds

Modified Accrual, Current Resources

• General Fund: Accounts for public safety, culture, and recreation.
• Special Revenue Funds: Legally restricted or committed for specific purposes, such as a gasoline tax to finance road repairs.
• Capital Projects Funds: Accounts for construction and capital improvements. These have a short life limited to 1-3 years.
• Debt Service Funds: Pays off the debt principal and interest of other governmental funds.
• Permanent Funds: Legally restricted funds where only the earnings, not the principal, may be used.

Proprietary Funds

Full Accrual, Economic Resources

• Internal Service Funds: Customers pay fees for services provided to other governmental funds, such as motor pools or building maintenance.
• Enterprise Funds: Fees are charged to external users to recover costs, similar to a for-profit motive. Examples include public utilities and state-operated hospitals.

Fiduciary Funds

Full Accrual, Economic Resources

• Custodial Funds: Collects cash to be held temporarily for an authorized recipient, such as sales tax collections.
• Investment Trust Funds: Accounts for sponsor investment pools.
• Private Purpose Funds: Not for general public use, such as abandoned or escheat property funds.
• Pension & Employee Benefit Funds: Accounts for government-sponsored defined benefit and contribution plans.

Fund Balance & Net Position Categories

Fund Balance Categories (Governmental Funds)

Presented in a hierarchy of spending constraints:

• Nonspendable: Amounts not in spendable form (e.g., inventory, prepaids) or legally required to be maintained intact (e.g., corpus of a permanent fund).
• Restricted: Amounts constrained for specific purposes by external parties (creditors, grantors) or by law.
• Committed: Amounts constrained for specific purposes by the government's highest level of decision-making authority (e.g., a city council ordinance).
• Assigned: Amounts the government intends to use for a specific purpose, without a formal commitment.
• Unassigned: The residual classification for the General Fund. It is the only category that can have a negative balance.

Net Position Categories (Gov-Wide & Proprietary)

(Assets + Def. Outflows) - (Liab. + Def. Inflows)

• Net Investment in Capital Assets: Capital assets, net of accumulated depreciation and related outstanding debt.
• Restricted: Net position subject to externally imposed constraints by creditors, grantors, or law.
• Unrestricted: The residual amount of net position that does not meet the other two definitions.

Non-Exchange Revenue

In Governmental Funds (Modified Accrual), revenue is recognized when it is measurable and available. "Available" means collectible in the current period or soon enough thereafter to pay current liabilities.

Major Fund Reporting

A governmental or enterprise fund is considered a "major fund" and must be reported in a separate column if it meets both parts of a two-step test:

Interfund Activity

Flows of resources between a government's funds and its primary government or component units.

Reciprocal (Exchange-like)

• Interfund Loans: Temporary extensions of credit, expect repayment.
• Interfund Services: Sales and purchases of goods/services between funds at market-based prices. These are treated as revenues for the providing fund.

Nonreciprocal

• Interfund Transfers: Flows of assets without an expectation of repayment (e.g., annual transfer from General Fund to Debt Service Fund). These are eliminated in the government-wide financial statements.
• Interfund Reimbursements: Repayments from a fund that is ultimately responsible for an expenditure to a fund that initially paid for it. These are also eliminated in the government-wide statements.

Reporting Interfund Balances

• Interfund receivables and payables between a governmental fund and an enterprise fund must be reported as "internal balances" on the government-wide financial statements.

Budgetary Accounting & Expenditures

Expenditure Classifications

• Function/Program: Broad purposes like public safety or culture and recreation.
• Character: Fiscal period relevance, such as current operating, capital outlay, or debt service.
• Object Classes: The chart of accounts level, detailing specific items like salaries, wages, or supplies.

Budgetary Journal Entry (Beginning of Year)

DR Estimated Revenue Control

CR Appropriations Control

DR/CR Budgetary Control (Plug for surplus/deficit)

Encumbrance Journal Entries

To record a purchase order:

DR Encumbrances, CR Budgetary Control

To reverse and record actual expenditure:

DR Budgetary Control, CR Encumbrances

DR Expenditures, CR Vouchers Payable

Year-End Treatment of Unused POs

If a purchase order remains unused at year-end, the original encumbrance entry is reversed. The unassigned fund balance is then decreased while the committed (or assigned) fund balance is increased to reserve the funds for the next year.

Governmental Lease Accounting

Lease treatment in governmental accounting depends heavily on the fund type and whether the lease transfers ownership.

Short-Term Leases (< 12 months)

Handled identically across all funds. The lessee records a Lease Expense when payments are made, and the lessor records Revenue.

Contracts that Transfer Ownership (Modified Accrual - Gov. Funds)

Because governmental funds use the current financial resources measurement focus, no asset is capitalized, and no amortization is recorded.

• Initial Entry (Lessee): Debit Capital Outlay Expenditure and Credit Other Financing Sources.
• Subsequent Payments: Debit Expenditure - Principal, Debit Expenditure - Interest, and Credit Cash.

Contracts that Transfer Ownership (Full Accrual - Proprietary/Gov-Wide)

Handled similarly to commercial accounting.

• Initial Entry (Lessee): Debit Right-of-Use (ROU) Asset and Credit Lease Liability.
• Subsequent Entries: Recognize Interest Expense on the liability and Amortization Expense on the ROU asset over the lease term.

The Financial Reporting Entity & Accountability

Primary Government vs. Component Units

• Primary Government: Must be legally separate, have a separately elected board, and be fiscally independent of other state/local governments.
• Component Unit: A legally separate entity for which the primary government is financially accountable.

Component Unit Presentation

• Discrete Presentation (Default): Used when the component unit is a separate legal entity and the primary government approves its budget. It is presented in a separate column, indicating it is "influenced" by the primary government.
• Blended Presentation (Rare): Used when the component unit is substantially the same as the primary government, or serves the primary government exclusively. It is controlled by and consolidated with the primary government.

Levels of Accountability

• Operational Accountability: Assessed by the Government-wide financial statements.
• Fiscal Accountability: Assessed by the Fund financial statements.

Government-Wide Financial Statements & Reconciliation

Presents a consolidated overview of the government's financial position. Uses Full Accrual and the Economic Resources measurement focus.

• Statements: Statement of Net Position & Statement of Activities.
• Key Features: Includes capital assets and long-term debt. Fiduciary funds are excluded. Internal Service Fund activity is allocated.
• Reconciliation: A reconciliation from the governmental fund financial statements to the government-wide statements is required for both the balance sheet and the income statement.

Net Position Reconciliation (Balance Sheet)

Change in Net Position Reconciliation (Statement of Activities)

This reconciliation adjusts the Net Change in Governmental Fund Balance to the Change in Net Position of Governmental Activities.

Proprietary Fund Statement of Cash Flows

This statement uses four distinct categories, different from commercial accounting:

• Operating Activities: Includes cash flows from sales, services, and payments to suppliers/employees.
• Noncapital Financing Activities: Includes grants and subsidies, and cash paid/received to other funds (not for capital purposes).
• Capital and Related Financing Activities: Includes issuing debt for capital assets, purchasing capital assets, and capital grants. Interest expense is reported here.
• Investing Activities: Includes interest and dividends received, and sales/purchases of investment securities.

Annual Comprehensive Financial Report (ACFR)

The ACFR is the official annual report of a government. It has three main sections:

1. Introductory Section: Includes a letter of transmittal, organizational chart, and list of principal officers. (Unaudited)
2. Basic Financial Statements: Includes government-wide F/S, fund F/S, notes to the F/S, and the auditor's report. (Audited)
3. Statistical Section: Presents multi-year data (e.g., 10-year trends) on financial, economic, and demographic information. (Unaudited)

Infrastructure Capitalization: Required vs. Modified Approach

Governments can account for eligible infrastructure assets (e.g., roads, bridges) using one of two approaches.

The Required Approach

The standard method mandates recording the historical cost of the asset and depreciating it over its useful life.

• Asset Additions: Capitalized as Capital Assets and recorded as Capital Outlay Expenditures.
• Maintenance: Routine repairs and maintenance are recorded as expenses.
• Depreciation: Depreciation expense is recorded, reducing the net position of the asset through accumulated depreciation.

The Modified Approach

This is an alternative to depreciating eligible infrastructure assets in the government-wide financial statements. Instead of recording depreciation, expenditures to maintain and preserve the assets are expensed in the period incurred.

• Asset Additions: Still capitalized just as they are under the required approach.
• Maintenance: Recorded as an expense.
• Depreciation: NO depreciation is recorded; no entry is made for depreciation expense.

To use the Modified Approach, two requirements must be met:

1. An asset management system is in place.
2. Documentation shows the infrastructure assets are being preserved at or above a disclosed condition level.

Not-for-Profit (NFP) Financial Statements

NFP entities have a unique set of financial statements that focus on the organization as a whole.

• Statement of Financial Position: Shows Assets, Liabilities, and Net Assets. Net assets are broken into two classes:
  • Net Assets with Donor Restrictions: Subject to donor-imposed stipulations that are temporary or perpetual.
  • Net Assets without Donor Restrictions: No donor-imposed restrictions.
• Statement of Activities: Reports revenues and expenses, showing the change in each net asset class. Expenses must be reported by functional classification (e.g., program services, management & general).
• Statement of Cash Flows: Can use either the direct or indirect method. Financing activities include donor-restricted contributions for long-term purposes.