accounting chap 7-9 Flashcards
Current and Long-Term Liabilities
Liabilities are debts
Borrowing is one way a company finances its operations
Liabilities are classified as current or long-term
Current Liabilities
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.
Bonds
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)
Issuing Shares
Creates no liabilities or interest expense
Less risky to the issuing corporation
Journal entry: Dr Cash
Cr common shares
Issuing notes or bonds
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
Earning per share
(Net income - Preferred shares) / Average number of common shares
Format of calculating earnings per share after expansion (issuing bonds or shares)
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)
Using Debt in Decision Making
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
Accounts payable turnover
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
Leverage ratio
Total assets / Total shareholders’ equity
- Shows a company’s total assets per dollar of shareholders’ equity
Times interest earned
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
Chap 8 dif between public and private corporations
Public corporations – shares are traded on the stock exchange, use IFRS
Private corporations – shares are privately held, use ASPE
Shareholders’ Equity represents the ownership interest in the assets of the business
It is divided into 4 components:
- Share capital
- Contributed surplus
- Accumulated other comprehensive income
- Retained earnings
Share Capital
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.
Common shares vs preferred shares
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
Share Repurchase Transactions
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
Cash Dividends
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
Dividends on Preferred Shares
- 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)
Why Issue a Stock Dividend?
- To continue dividends, but conserve cash
- To reduce the per-share market price of its shares
Recording stock dividend dates
- Declaration date: Debit retained earnings, credit stock dividends distributable (equity)
- Date of record (no entry)
- Date of payment: Debit Stock dividends distributable, credit common shares
Stock Splits
- 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.
Return on Equity
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
Shareholders’ Equity and the Statement of Cash Flows
–> 3 main financing categories that affect shareholders’ equity are:
- Issuance of shares
- Repurchase of shares
- Payment of dividends
The Statement of Cash Flows
The statement of cash flows reports the entity’s cash flows (cash receipts and cash payments) during the period.
Purposes of the Cash Flow Statement
- Predict future cash flows
- Evaluate management decisions
- Determine ability to pay dividends and interest
- Assess the relationship of net income to cash flows
- Compare the operating performance of different companies
What is Cash?
- 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.
Types of activities listed on the statement of cash flows
- Operating activities - create revenues, expenses, gains, and losses.
- Investing activities - include the purchase and sale of long-term assets, investments, and loaning money
- Financing activities - include changes relating to contributed equity (investors) & borrowings (creditors)
Indirect method of statement of cash flows format
Net income
Adjustments:
Decrepitation, etc.
Net income provided by operating activities
Cash Flows from Operating Activities
- 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
Adjustments to net income include:
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
Operating Activities – Indirect Method Steps
- Determine the change in non-cash working capital accounts using the balance sheet
- Start with net income and add back depreciation and losses and deduct any gains.
- Add or subtract where applicable, the change (increase or decrease) in non-cash working capital accounts
Notes receivable entries
Loan money –
Dr notes receivable
cr cash (cash decreases)
Collection of notes
Dr cash
cr notes receivable (cash increases)
Investing Activities
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
Computing acquisition of property, plant and equipment under investing activities format
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 $….
The Indirect Method: Financing Activities
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
Financing activities format
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 $….
Noncash Investing and Financing Activities
- 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
Operating Cash Flow Ratio
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
Measuring Cash Adequacy: Free Cash Flow
- 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
Computing dividend payments
Retained earnings t account
Beginning balance (credit normal) + NI - Dividends declared = Ending balance
Computing issuance and repurchase of shares
Common shares T account
Beginning balance (credit normal) + issuance of new shares - repurchase of shares = Ending balance
Computing notes receivable and their collections
Notes receivable T account
Beginning balance + New loans made - collections = ending balance
Calculating the aquisition of property, plant and equipment
= Property, plant and equipment ending balance,
+ carrying amount of capital assets sold
+ depreciation expense
- PPE beginning balance.
Calculating proceeds from the sale of long term investments
= Long term investments beginning balance
+ purchase of investments
- Long term investments ending balance.
