I have to issue and would appreciate your help. 1) in the equity method, let’s say company A owns 20% of company B. it says interest coverage ratio ( EBIT/interest) is not affected by this investment. its it therefore correct, that when using the equity method - equity income from company B is listed in the income statement below EBIT ? 2) unearned revenue: in the cfai(reading 25) : revenue can be overstated or understated. examples for overstatement: recording smaller provisions for doubtful acounts and warranty provisions. examples for understatement: opportunistic use of unearned revenue. So my question is actually from the example.: microsoft has an increase in unearned revenue, , and also a increase in gross accounts receivables. then it shows that: revenue - cash collected = increase in gross A/R + write offs - Increase in unearned revenue. …the net effect of the increse in receivables , write offs and increse in unearned revenue is to report revenue greter by 0.278 billion relative to cash collected from customers. the magnitude of this absolute changes in these accoutns is over 3.5 billion…suggesting that microsoft has consierable felxibility in reporting revenue in a given fiscal period. what does this sentence exactley mean? is an increase in unearned revenue a warning sign or is this ok?? does this mean revenue would actually be larger but is deferred for future periods where one might need it… because a unexpected decrease in unearned revenue could signal accelerated revenue recognition. and this would mean that revenue is actually smaller than reported. 3. large increases in accounts receivables:is this due to reducing provisions for doubtful accoutns and warranty provisions? thank you
when unearned revenue is present - as in the Microsoft case presented - company has some reserve built up. It is not showing those in the current account, but much like a squirrel keeping nuts in storage for winter - they have the ability to extract the 3.5 Billion in reserves and show it as revenue in a future period, when e.g. they had poor sales. So if there are large increases in the Unearned Revenue account - as an analyst - do not look directly at the Revenue number. Look instead at what is being shown as Revenue, and how the Accounts receivables and Unearned Revenue accounts have changed between the two reporting periods. If Accounts receivables (after adjustment for Doubtful accounts) has increased - again this is not really cash available as revenue to the company. If Unearned revenues has decreased -> this really is indicating that the company has used its stored reserves, since the sales figure this period was low. To accurately calculate what was actually received, calculate the Cash collected from Customers figure. Cash Collected from Customers = Revenues - Delta AR + Delta Unearned Revenue Look at both Change in AR and Change in Unearned Revenue with their correct signs.
thank you, this is a good insight! what about my question concering the equity method…? (EOC, reading 26, q8) 1) in the equity method, let’s say company A owns 20% of company B. it says interest coverage ratio ( EBIT/interest) is not affected by this investment. its it therefore correct, that when using the equity method - equity income from company B is listed in the income statement below EBIT ?
If you look at Exhibit 2, pg 320 - it is pretty clear that Shares of results of Associates (Equity Method income) lies below EBIT and EBT. Only is a part of Net Income, not a part of EBT and EBIT.