accounting chap 7-9

Question 1

Current and Long-Term Liabilities

Answer 1

Liabilities are debts

Borrowing is one way a company finances its operations

Liabilities are classified as current or long-term

Question 2

Current Liabilities

Answer 2

Current liabilities are obligations due within one year or within the company’s normal operating cycle if it is longer

Examples: accounts payable, short-term notes payable, taxes payable, current portion of long-term debt, accrued expenses, unearned revenue, etc.

Question 3

Bonds

Answer 3

A bond is an interest bearing long-term note payable.

Bonds are groups of notes payable issued to multiple lenders called bondholders.

Includes principal, interest rate, payment dates (look at slide for context)

Question 4

Issuing Shares

Answer 4

Creates no liabilities or interest expense
Less risky to the issuing corporation

Journal entry: Dr Cash
Cr common shares

Question 5

Issuing notes or bonds

Answer 5

Does not dilute share ownership or control of the corporation

Results in higher earnings per share because the earnings on borrowed money usually exceeds interest expense

Journal entry: Dr Cash
Cr Liability

Question 6

Earning per share

Answer 6

(Net income - Preferred shares) / Average number of common shares

Question 7

Format of calculating earnings per share after expansion (issuing bonds or shares)

Answer 7

Net income before exapansion:
Project income before tax and interest
Less: interest expense
Project income before tax
Less: tax expense
Expected project income: (add up sums for everything then take net income before expansion + sum)

Earnings per share after expansion:
(New total/number of shares outstanding + shares issued if any)

Question 8

Using Debt in Decision Making

Answer 8

Liabilities are a popular way to finance operations

Managers use ratios to determine how much credit risk it is taking

Both creditors and investors worry when a company’s debt grow

There is a risk that the company cannot pay its debts as they become due

Question 9

Accounts payable turnover

Answer 9

Cost of goods sold/Average accounts payable

• Measures the number of times a year a company is able to pay its accounts payable

Days’ payable outstanding = 365/AP turnover

Question 10

Leverage ratio

Answer 10

Total assets / Total shareholders’ equity

• Shows a company’s total assets per dollar of shareholders’ equity

Question 11

Times interest earned

Answer 11

Operating income / Interest expense

• It measures the number of times that operating income can cover interest expenses.
• A high ratio indicates ease in paying interest expense

Question 12

Chap 8 dif between public and private corporations

Answer 12

Public corporations – shares are traded on the stock exchange, use IFRS

Private corporations – shares are privately held, use ASPE

Question 13

Shareholders’ Equity represents the ownership interest in the assets of the business
It is divided into 4 components:

Answer 13

1. Share capital
2. Contributed surplus
3. Accumulated other comprehensive income
4. Retained earnings

Question 14

Share Capital

Answer 14

Corporate ownership is evidenced by a share certificate, which may be for any number of shares.
- Public corporations can have unlimited amount of shares, or have a maximum amount

The total number of shares authorized is limited by the articles of incorporation.

Question 15

Common shares vs preferred shares

Answer 15

Common Shares:
- Voting rights
- Receive dividends after preferred dividend
- Shareholders benefit most if corporation succeeds

Preferred shares:
- No voting rights
- Fixed dividend
- Receive dividends first
- Receive assets first in liquidation

• Accounting for preferred shares follows the pattern illustrated for common shares.
• Shareholders’ equity on the balance sheet lists preferred shares, common shares, contributed surplus, retained earnings and accumulated other comprehensive income – in that order

Question 16

Share Repurchase Transactions

Answer 16

Repurchased shares are shares that a company has issued and later reacquired.

Reasons:
- Fulfill future share issuance
- Help support the share’s current market price
- Prevent another company from acquiring them

Question 17

Cash Dividends

Answer 17

Company must have both:
- Enough Retained earnings to declare the dividend
- Enough Cash to pay the dividend

Board of directors has authority to declare a dividend
- Company not obligated to pay dividend until declared

Three dates:
1. Declaration date - debit retained earnings, credit dividends payable
2. Date of record - no entry
3. Payment date - Debit dividends payable, credit cash

Question 18

Dividends on Preferred Shares

Answer 18

• When a company has issued both preferred and common shares, the preferred shareholders receive their dividends first
• Common shareholders receive dividends only if the total declared dividend is large enough to pay preferred dividends first
• Dividend rate – stated as a dollar amount
• Cumulative – if dividends are omitted in any given year, they must be paid before common shareholders receive their dividend
• Non-cumulative – if dividends are not paid in any given year, they are lost
  (see notes for example)

Question 19

Why Issue a Stock Dividend?

Answer 19

• To continue dividends, but conserve cash
• To reduce the per-share market price of its shares

Question 20

Recording stock dividend dates

Answer 20

1. Declaration date: Debit retained earnings, credit stock dividends distributable (equity)
2. Date of record (no entry)
3. Date of payment: Debit Stock dividends distributable, credit common shares

Question 21

Stock Splits

Answer 21

• A stock split is an increase in the number of issued, and outstanding shares, but does not affect any financial statement balances
• A stock split decreases the market price of shares.

Question 22

Return on Equity

Answer 22

Net income – Preferred dividends / Average common shareholders’ equity

• It indicates how much profit it has generated for each dollar of common shareholders equity it has
• Higher is better

Question 23

Shareholders’ Equity and the Statement of Cash Flows
–> 3 main financing categories that affect shareholders’ equity are:

Answer 23

1. Issuance of shares
2. Repurchase of shares
3. Payment of dividends

Question 24

The Statement of Cash Flows

Answer 24

The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period.

Question 25

Purposes of the Cash Flow Statement

Answer 25

1. Predict future cash flows
2. Evaluate management decisions
3. Determine ability to pay dividends and interest
4. Assess the relationship of net income to cash flows
5. Compare the operating performance of different companies

Question 26

What is Cash?

Answer 26

• Cash in the bank and cash equivalents
• Cash equivalents are highly liquid, Such as money-market investment accounts and three-month government treasury bills that can be converted into cash within three months.

Question 27

Types of activities listed on the statement of cash flows

Answer 27

1. Operating activities - create revenues, expenses, gains, and losses.
2. Investing activities - include the purchase and sale of long-term assets, investments, and loaning money
3. Financing activities - include changes relating to contributed equity (investors) & borrowings (creditors)

Question 28

Indirect method of statement of cash flows format

Answer 28

Net income
Adjustments:
Decrepitation, etc.
Net income provided by operating activities

Question 29

Cash Flows from Operating Activities

Answer 29

• Operating activities are related to the transactions that make up net income
• It begins with net income, taken from the net income, and is followed by adjustments to reconcile net income to cash

Sales revenue –> cash and accounts receivables, Expenses –> cash and payables
*Depreciation does not affect cash
*Income statement uses accrual, so cash flow must adjust net income from accrual basis to cash basis

Question 30

Adjustments to net income include:

Answer 30

Start with Net income
Add: Depreciation/amortization expense,
Losses from sales of assets
Deduct: Gains from sales of assets

Add/Deduct: Non-cash changes in working capital

Add: Decreases in current assets (not cash)
Increases in current liabilities
Deduct: Increases in current assets (not cash)
Decreases in current liabilities

Question 31

Operating Activities – Indirect Method Steps

Answer 31

1. Determine the change in non-cash working capital accounts using the balance sheet
2. Start with net income and add back depreciation and losses and deduct any gains.
3. Add or subtract where applicable, the change (increase or decrease) in non-cash working capital accounts

Question 32

Notes receivable entries

Answer 32

Loan money –
Dr notes receivable
cr cash (cash decreases)

Collection of notes
Dr cash
cr notes receivable (cash increases)

Question 32

Investing Activities

Answer 32

Cash receipts:
- Sales of assets (investments, land, building, equipment, intangible assets and so on)
- Collections of loans receivable

Cash payments:
- Purchase of assets (investments, land, building, equipment, intangible assets and so on)
- Loans to others

Question 33

Computing acquisition of property, plant and equipment under investing activities format

Answer 33

Cash flows from investing activities:
Acquisition of property plant equipment $(…)
Loan to another company (…)
Proceeds from sale of ppe ….
——
Net cash used for investing activities $….

Question 34

The Indirect Method: Financing Activities

Answer 34

Cash receipts
- Issuance/sale of shares
- Borrowing (issuance of notes or bonds payable)

Cash payments
- Repurchase of shares
- Payment of notes or bonds payable
- Payment of dividends

Question 35

Financing activities format

Answer 35

Cash flows from financing activities:
proceeds from issuance of common shares $…
proceeds from issuance of long term debt ….
payment of long term debt (…)
payment of dividends (…)
——–
Net cash provided by financing activities $….

Question 36

Noncash Investing and Financing Activities

Answer 36

• Non cash investing and financing activities are disclosed in a note to the financial statements
• They are not reported on the cash flow statement because they do not involve cash

Question 37

Operating Cash Flow Ratio

Answer 37

Cash flow from Operations / Current Liabilities

• Measures how well a company can pay off its current liabilities with the cash it generates from its operating activities

Question 37

Measuring Cash Adequacy: Free Cash Flow

Answer 37

• Free cash flow is the amount of cash available from operations after paying for planned investments in property, plant & equipment,
• Free cash flow = Net cash flow from operating activities - Cash expenditures on property, plant & equipment

Question 38

Computing dividend payments

Answer 38

Retained earnings t account

Beginning balance (credit normal) + NI - Dividends declared = Ending balance

Question 39

Computing issuance and repurchase of shares

Answer 39

Common shares T account

Beginning balance (credit normal) + issuance of new shares - repurchase of shares = Ending balance

Question 40

Computing notes receivable and their collections

Answer 40

Notes receivable T account

Beginning balance + New loans made - collections = ending balance

Question 41

Calculating the aquisition of property, plant and equipment

Answer 41

= Property, plant and equipment ending balance,
+ carrying amount of capital assets sold
+ depreciation expense
- PPE beginning balance.

Question 42

Calculating proceeds from the sale of long term investments

Answer 42

= Long term investments beginning balance
+ purchase of investments
- Long term investments ending balance.