2 - A Further Look At Financial Statements Flashcards
1
Q
What do companies do to improve users’ understanding of a company’s financial position?
A
They group similar types of asses and similar types of liabilities together.
2
Q
What is the order of assets in a classified statement of financial position?
A
- Current Assets
- Investments
- Property, Plant, and Equipment
- Intangible Assets
- Goodwill
3
Q
What is the order of liabilities in a classified statement of financial position?
A
- Current Liabilities
- Non-Current Liabilities
- Shareholders’ Equity
- Share Capital
- Retained Earnings
4
Q
What are current assets?
A
Assets that are expected to be converted into cash or will be sold or used within one year of the company’s financial statement date or its operating cycle, whichever is longer.
5
Q
What is a company’s operating cycle?
A
The average period of time it takes for a business to pay cash to obtain products or services and then receive cash from customers for these products or services.
6
Q
What is the operating cycle like in a merchandising business?
A
The time it takes to purchase inventory, pay cash to suppliers, sell the inventory on account, and then collect cash from customers.
7
Q
What is the operating cycle like in a service business?
A
The time it takes to pay employees, provide services on account, and then collect the cash from customers.
8
Q
What are the common types of current assets? (7)
A
- Cash
- Trading investments
- Accounts receivable
- Notes receivable, including loans receivable
- Merchandise inventory
- Supplies
- Prepaid expenses
9
Q
What are trading investments?
A
Investments in debt securities such as bonds of another company, or equity securities such as shares of another company, that are bought with the intention of selling the investments after a short period of time in order to earn a profit.
10
Q
What are accounts receivable?
A
Amounts owed to the company by customers who purchased products or services on credit and are normally supported by an invoice.
11
Q
What are accrued revenues?
A
Other types of receivables that arise when payments for revenues earned by the company have not yet been received in cash.
eg: amounts owed to the company for interest, sales tax, rent, and like items.
12
Q
What are notes receivable?
A
Amounts owed to the company by customers or others that are supported by a written promise to repay.
13
Q
What are loans receivable?
A
Types of notes receivable.
14
Q
Are supplies a current or non-current asset?
A
They are a current asset because we expect that these will be used up by the business within the year.
15
Q
What do prepaid expenses represent?
A
The cost of expenses like rent and insurance paid in advance of use.
16
Q
Why are prepaid expenses current assets?
A
They are current assets because they reflect unused benefits such as office space and insurance coverage available for future use during the year.
17
Q
How do North American companies typically list current assets?
A
In the order in which they are expected to be converted into cash; that is, in their order of liquidity.
18
Q
What are cash equivalents?
A
Short-term, highly liquid investments with very little risk that can be easily sold.
19
Q
What are non-current assets?
A
Assets which are not expected to be converted into cash, sold, or used up by the business within one year of the financial statement date or its operating cycle.
i.e. all assets that are not classified as current assets.
20
Q
What are the 4 common types of non-current assets?
A
- Investments
- Property, plant, and equipment
- Intangible assets and goodwill
- Other assets
21
Q
What’s are the 2 general types of long-term investments?
A
Multi-year investments in
-debt securities
-Equity securities
of other companies that management plans to hold for many years to generate investment revenues or for strategic reasons.
22
Q
Why are multi-year investments in debt securities and equity securities classified as long-term?
A
Because they are not readily marketable or because management is not intending to sell the investment and convert it into cash within one year.
23
Q
If the word investment is used without any modifier, which type of investment is it considered to be?
A
Long-term investments.
24
Q
How are property, plant, and equipment items typically ordered in the statement of financial position?
A
In order of their permanency.
25
How do most companies record their property, plant, and equipment?
At cost. However, some companies choose to record these assets at fair value instead.
26
What model is a company following if it records property, plant, and equipment at fair value instead of cost?
Revaluation model. (Often used in the real estate industry)
27
What does it mean for something to be recorded at fair value?
Fair value is a rational and unbiased estimate of the potential market price of a good, service, or asset.
28
How is the cost of property, plant, and equipment allocated?
Because these assets benefit future periods, their cost is allocated over their estimated useful lives through a process called depreciation.
29
How do companies calculate depreciation?
By systematically assigning a portion of the asset's cost to depreciation expense each year rather than expensing the full cost in the year the asset was purchased.
30
What kind of assets are depreciated and what kind are not?
Only assets with estimated useful lives are depreciated.
Land also generates revenue, but its estimated useful life is considered to be infinite as land doesn't usually wear out or lose its value.
31
How should assets that are depreciated be reported on the statement of financial position?
Assets that are depreciated should be reported on the statement of financial position at cost less their accumulated depreciation.
32
What does accumulated depreciation show?
The amount of depreciation taken so far over the life of the asset.
33
What kind of account is accumulated depreciation?
It's a contra asset account, that is, its balance is subtracted from the balance of the asset that it related to.
34
What is the difference between cost and accumulated depreciation referred to as?
The carrying amount, also commonly known as net book value or just simply book value.
35
Which 2 groups are intangible assets normally divided into?
- Those with definite useful lives
| - Those with indefinite useful lives
36
How is the cost of intangible assets with definite useful lives allocated?
The cost of intangible assets with definite useful lives is allocated over these future periods through the use of amortization.
37
How are the costs of intangible assets with definite useful lives amortized?
They aren't
38
How is goodwill calculated?
The difference between the price paid for the company and the fair value of the assets less liabilities acquired from the purchased company.
39
What does the calculated goodwill represent?
A value not attributable to any recorded asset or liability and relates to something intangible like the reputation of the company and the quality of its employees.
40
How is goodwill similar to intangible assets?
They both have no physical substance and will generate future value.
41
What do deferred income tax assets represent?
The income tax that is expected to be recovered in a later year or years due to deductions that a company is able to take when preparing its future corporate income return.
42
What are the 2 general categories of liabilities?
- Current liabilities
| - Non-current liabilities
43
What are current liabilities?
Obligations that are to be paid or settled within one year of the company's statement date or its operating cycle, whichever is longer.
44
What are 5 common current liabilities?
- Bank indebtedness
- Accounts payable
- Unearned revenue
- Notes payable, including bank loans payable
- Current maturities of long-term debt.
45
What do accounts payable represent?
Amounts owed by the company to suppliers for purchases made on credit.
46
What are bank indebtedness and accounts payable often called and when do they arise?
These types of payables are often called accrued payables and arise when expenses incurred by the company have not yet been paid in cash.
47
What does unearned revenue represent?
Cash received in advance from a customer before revenue is earned.
48
What are notes payable?
Amounts owed, often to banks but also suppliers or others, that are supported by a written promise to repay.
49
What are amounts owed to banks usually known as?
Bank loans payable.
50
What is current maturities of long-term debt?
The portion of the payment due to be made sometime during the next year. The remainder of the loan is classified as a non-current liability.
51
How do North-American companies often list their current liabilities?
In the order in which they are expected to be paid; that is, in their order of liquidity by due date.
52
What are non-current liabilities?
Obligations that are expected to be paid or settled after one year.
53
What are the 4 common types of non-current liabilities?
- Notes payable, including bank loans payable, mortgages payable, and bonds payable
- Lease Obligations
- Pension and benefit obligations
- Deferred income tax liabilities
54
What are mortgages payable?
Mortgages payable are similar to long-term notes but have property pledged as security for the loan.
55
What are bonds payable?
Bonds payable are used by large corporations and governments to borrow large sums of money.
56
What are lease obligations?
Lease obligations include amounts to be paid in the future on long-term rental contracts used for equipment and other property.
57
What are Pension and benefit obligations?
Pension and benefit obligations are amounts companies owe past and current employees for retirement benefits.
58
What does deferred income tax liabilities represent?
Income tax related to the current year's profit that is expected to be paid in a later year or years when a company prepares its future corporate income return.
59
What is the generally prescribed order for reporting non-current liabilities?
There is none.
60
What are the 2 categories of shareholders' equity?
- Share capital
| - Retained earnings
61
What is share capital also known as?
capital stock
62
How are retained earnings and share capital reported on the statement of financial position?
The ending balances of retained earnings and share capital, determined on the statement of changes in equity, are combined and reported as shareholders' equity on the statement of financial position.
63
What does additional contributed capital represent in statements of financial position?
Amounts contributed by shareholders (in addition to share capital) as a result of certain types of equity transactions.
64
What is the order of liquidity in statements of financial position? (5)
- Current assets
- Non-current assets
- Current liabilities
- Non-current liabilities
- Shareholders' equity
65
What is the reverse order of liquidity in statements of financial position? (5)
- Non-current assets
- Current assets
- Shareholders' equity
- Non-current liabilities
- Current liabilities
66
For which 2 financial statements can ratio analysis be used to make more meaningful evaluations of a company?
- Statement of financial position
| - Income statement
67
What does ratio analysis express?
The relationship between selected items of financial statement data.
68
What are the 3 general types of ratios that are used to analyze financial statements?
- Liquidity ratios
- Solvency ratios
- Profitability ratios
69
What are liquidity ratios?
Measures of a company's short-term ability to pay its maturing obligations and to meet unexpected needs for cash.
70
What are solvency ratios?
Measures of a company's ability to survive over a long period of time by having enough assets to settle its liabilities as they fall due.
71
What are profitability ratios?
Measures of a company's operating success for a given period of time.
72
What are the 3 ratio comparisons?
- Intracompany comparisons covering two or more periods for the same company.
- Intercompany comparisons based on comparisons with a competitor in the same industry.
- Industry average comparisons based on average ratios for particular industries with specific company ratios.
73
What is working capital?
A measure of liquidity which is the difference between current assets and current liabilities.
74
What does it mean for working capital to be positive?
There is a greater likelihood that the company will be able to pay its liabilities.
75
What does it mean for working capital to be negative?
A company may have to borrow money; otherwise, short-term creditors may not be paid.
76
What is the current ratio?
A measure of liquidity which is calculated by dividing current assets by current liabilities.
77
Why is the current ratio a more dependable indicator of liquidity than working capital?
Because it measures the relative relationship between current assets and current liabilities and therefore makes comparisons between smaller companies and larger companies possible. Furthermore, two companies with the same amount of working capital may have significantly different current ratios.
78
What does it mean for a company to have a current ratio of 0.1:1?
For every dollar of current liabilities, the company has 10 cents of current assets.
79
Why is it more worthwhile to compare the ratios of competitors within an industry than the ratios of companies operating in different industries?
Because this ratio will be different for companies in different industries.
80
What is a downside to using the current ratio?
It doesn't take into account the composition of the current assets. The composition of the assets matters because a dollar of cash is more easily available to pay current liabilities falling due than is a dollar of inventory.
81
What are the 2 ratios which measure liquidity?
- Working capital
| - Current ratio
82
Which ratio measures solvency?
Debt to total assets ratio
83
What does the Debt to total assets ratio measure?
The percentage of assets that are financed by lenders and other creditors rather than by shareholders.
84
Why is financing provided by lenders riskier than financing provided by shareholders?
Because debt and the related interest must be repaid at specific points in time, whether the company is performing well or not. On the other hand, equity doesn't have to be repaid and there is no requirement for companies to pay dividends.
85
How is the Debt to total assets ratio calculated?
By dividing total debt (both current and non-current liabilities) by total assets.
86
What's the first thing a high Debt to total assets ratio indicates?
The higher the percentage of debt to total assets, the greater is the risk that the company may be unable to pay its debts as they come due.
87
What's the second thing a high Debt to total assets ratio indicates?
The higher the ratio, the higher the amount of interest expense that a company will incur.
88
What's the third thing a high Debt to total assets ratio indicates?
If liabilities are too high, there is a lower equity "cushion" available to lenders and other creditors if the company becomes insolvent (unable to pay its debts).
89
Why is it that cash provided by operating activities might not be a perfect measure of a company's cash-generating ability?
Because Cash provided by operating activities fails to take into account the fact that a company must invest in new property, plant, and equipment (capital expenditures) just to maintain its current level of operations. A company must also try to maintain dividends at current levels to satisfy investors.
90
What is a solvency measure which offers additional insight regarding a company's cash-generating ability?
Free cash flow.
91
What does free cash flow describe?
The cash remaining from operating activities after adjusting for capital expenditures and dividends paid.
92
What are the 2 ratios to measure profitability?
- Earnings per share
| - Price-earnings ratio
93
What does earnings per share measure?
The profit earned on each common share. Accordingly, earning per share is reported only for common shareholders.
94
How is earnings per share calculated?
By dividing the profit available to the common sharholders by the weighted average number of common shares.
95
What are the profits available to shareholders if there are only common shares?
The profit available to common shareholders will be the same as the profit reported on a company's income statement.
96
How does profit available to shareholder differ if there are also preferred shares?
If a company has preferred shares, preferred share dividends must be deducted from profit before they become available to common shareholders.
97
Why is reducing profit to a per-share amount give a useful number for determining investment return?
Because shareholders usually think in terms f the number of shares they own - or plan to buy or sell. In fact, Earning per share is such an important measure that it must be presented in the financial statements for publicly traded companies.
98
Which ratio is the only one which must be presented on the financial statements of publicly traded companies?
Earnings per share
99
Why are comparisons among companies of earning per share not very meaningful?
Because of the wide variation in the number of shares issued by each company and because some companies use financing structures with different levels of debt and equity.
100
What is the Price-earnings (P-E) ratio?
A frequently quoted statistic that measures the ratio of the stock market price of each common share to its earnings per share.
101
How is the p-e ratio calculated?
By dividing the market price per share by earning per share.
102
Who uses the p-e ratio?
The P-E ratio isn't really a measure of "corporate" profitability but rather a profitability ratio used by investors for valuation purposes.
103
What does the p-e ratio show?
The p-e ratio shows what investors expect of a company's future profitability
104
When will the p-e ratio be higher?
When investors think that current profit levels will increase.
105
When will the p-e ratio be lower?
When investors think that current profit levels will decline.
106
What are the 5 aspects of the framework for the preparation and presentation of financial statements?
- Objective of general purpose financial reporting
- Qualitative characteristics of useful financial information
- Underlying assumption
- Elements of financial statements
- Measures of the elements of financial statements
107
What is the objective of general purpose financial reporting?
To provide information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company.
108
What is the accrual basis of accounting?
Under the accrual basis of accounting, the effects of transactions on a company's economic resources and claims are recorded in the period when a transaction occurs and not when cash is received or paid.
109
What are the 2 categories of Qualitative characteristics of useful financial information?
- Fundamental
| - Enhancing
110
What are the 2 fundamental qualitative characteristics of useful financial information?
- Relevance
| - Faithful representation
111
When does accounting information have relevance?
If knowledge of it will influence a user's decision.
112
Which 2 values does relevant accounting information posses?
- Predictive value
| - Confirmatory value
113
When does financial information have predictive value?
If it helps users make predictions about future events.
114
When does financial information have confirmatory value?
If it helps users confirm or correct their previous predictions or expectations.
115
Materiality is an important component of relevance but what is materiality?
Information is considered material if its omission or misstatement could influence the decision of users.
116
When might financial information be omitted from financial statements?
A decision not to disclose certain information may be made, say, because users have no need for that kind of information (it isn't relevant) or because the amounts involved are too small to make a difference (they are not material).
117
What does it mean for information to be faithfully represented?
It represents economic reality.
118
What is necessary for information for be faithfully represented? (3)
The information must be
- Complete (nothing important was omitted)
- Neutral (not biased toward one position or another)
- Free from material error.
119
What are the 4 enhancing qualities of useful information?
- Comparability
- Verifiability
- Timeliness
- Understandability
120
When does comparability result in accounting?
When users can identify and understand similarities in, and differences among, items.
121
Consistency, although related to comparability, doesn't mean the same thing. What is consistency?
Consistency aids comparability when a company uses the same accounting principles and methods from year to year or when companies with similar circumstances use the same accounting principles.
122
When does accounting information have verifiability?
If different knowledgeable and independent users can reach consensus that the information is faithfully represented.
123
What does it mean for accounting information to be timely?
It must be available to decision makers before it loses its ability to influence decisions.
124
When does information have the quality of understandability?
If it's classified, characterized, and presented clearly and concisely. Understandable information means that users with a reasonable knowledge of business can interpret the information and comprehend its meaning.
125
What is the cost constraint?
A pervasive constraint that ensures that the value of the information provided in financial reporting is greater than the cost of providing it. That is, the benefits of financial reporting information should justify the cost of providing and using it.
126
What is the going concern assumption?
The going concern assumption assumes that a company will continue to operate for the forseeable future.
127
Why does the going concern assumption have important implications in accounting?
If a company is assumed to be a going concern, then reporting assets, such as equipment, as non-current makes sense because those assets are expected to be used for more than one year. Without the going concern assumption, we would be assuming that the business is in the process of shutting down and is selling all of its assets as soon as possible. In that case, the equipment would be a current asset so the going concern assumption is essential to the way we record items in the financial statements.
128
What is the technical definition of an asset?
An asset is a resource controlled by the company as a result of past events from which future economic benefits are expected to flow to the company.
129
What is the technical definition of a liability?
A liability is a present obligation of the company arising from past events, the settlement of which is expected to result in an outflow from the company of resources embodying economic benefits.
130
What is the technical definition of equity?
Equity is the residual interest in the assets of the company after deducting all its liabilities.
131
What is the technical definition of income?
Income includes both revenue and gains. Revenue arises in the course of the ordinary activities of the company while gains may or may not arise from ordinary activities. Income is the increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
132
What is the technical definition of an expense?
Expenses include losses as well as those expenses that arise from ordinary activities of the company. Losses may or may not arise from ordinary activities. Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrence of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
133
What are the two measurements of the financial elements?
- Historical cost
| - Fair Value
134
What is the cost basis of accounting?
The cost basis of accounting states that assets and liabilities should be recorded at their cost at the time of acquisition. This is true not only at the time when the item is purchased, but also during the time that an asset or liability is held.
135
In the cost basis of accounting, how would the purchase of land be reported and why?
The cost of land is the most relevant value because the land is intended for use in the business. It is not being held for resale.
136
In the cost basis of accounting, the land will be reported at cost until...
Either until it is sold or the going concern assumption is no longer valid.
137
What is the fair value basis of accounting?
The fair value basis of accounting states that certain assets and liabilities should be recorded and reported at fair value (the price that would be received to sell an asset or paid to transfer liability)
138
What is it that's worth noting about the fair value basis of accounting and the cost basis of accounting?
At the acquisition date, cost and fair value are generally the same. It's only as time passes that these two values diverge and fair value may become a more useful measure than cost for certain types of assets and liabilities.
139
In general, standard setters require that most assets be recorded using historical cost because fair values may not always be representationally faithful. Why is it that fair values may not always be representationally faithful?
Cost is the more faithful representation because it can be easily verified and is neutral. Only in situations where assets are actively traded, such as investment securities or investment properties in certain industries such as real estate, is the fair value basis of accounting applied.
