Accounting Questions (BASIC) Flashcards
What are the three major financial statements?
The three major financial statements are the Income Statement, the Balance Sheet, and the Cash Flow Statement.
What does the Income Statement indicate?
The Income Statement indicates the profitability of a company and works from revenues and expenses down to net income.
What does the Balance Sheet show?
The Balance Sheet shows a company’s assets or resources and the sources of funding for those assets, which are made up of shareholder’s equity and liabilities.
What is the key equation for the Balance Sheet?
The key equation for the Balance Sheet is that assets must equal liabilities plus shareholder’s equity.
What does the Cash Flow Statement reconcile?
The Cash Flow Statement reconciles from net income to the actual ending cash balance by adjusting for non-cash expenses and working capital changes.
What are major line items on the Income Statement?
Major line items on the Income Statement include revenues, cost of goods sold, selling, general, and administrative expenses, operating income, pretax income, and net income.
What are major line items on the Balance Sheet?
Major line items on the Balance Sheet include cash, accounts receivable, inventory, property, plants, and equipment, accounts payable, accrued expenses, debt, and shareholder’s equity.
What are major line items on the Cash Flow Statement?
Major line items on the Cash Flow Statement include net income, depreciation and amortization, stock-based compensation, changes in operating assets and liabilities, cash flow from operations, capital expenditures, cash flow from investing, sale and purchase of securities, dividends issued, and cash flow from financing.
How do the three statements link together?
Net income from the Income Statement flows into shareholder’s equity on the Balance Sheet and into the top line of the Cash Flow Statement.
If stranded on a desert island, which statement would you use to review a company’s health?
I would use the Cash Flow Statement because it gives a true picture of how much cash a company is generating independent of non-cash expenses.
If you could only look at two statements to assess a company’s prospects, which would you use?
I would look at the Income Statement and the Balance Sheet because you can reconcile from net income to the actual ending cash balance.
How does a $10 increase in depreciation affect the three statements?
A $10 increase in depreciation lowers operating income and pre-tax income by $10, resulting in a $6 decrease in net income after tax. The Cash Flow Statement adds back the $10 depreciation, resulting in a $4 increase in ending cash. The Balance Sheet shows a $6 decrease in assets and a $6 decrease in retained earnings.
Why does depreciation affect cash balance if it’s a non-cash expense?
Depreciation is tax-deductible, reducing the amount of taxes paid, which affects cash.
Where does depreciation usually show up on the Income Statement?
Depreciation could be in a separate line item or embedded in cost of goods sold or operating expenses.
What happens when accrued compensation goes up by $10?
Accrued compensation increases operating expenses by $10, resulting in a $6 decrease in net income. This flows to the Cash Flow Statement, increasing cash from operations by $10, resulting in a $4 increase in ending cash.
What happens when inventory goes up by $10, assuming you pay for it with cash?
There will be no changes to the Income Statement. The Cash Flow Statement will show a $10 decrease in cash from operations, and the Balance Sheet will reflect a $10 increase in inventory and a $10 decrease in cash.
Why is the Income Statement not affected by changes in inventory?
The expense is recorded only when the goods are sold, due to the matching principle.
What happens when Apple buys $100 worth of new iPod factories with debt?
The Income Statement is unaffected. The Cash Flow Statement shows a $100 decrease in cash from investing and a $100 increase in cash from financing, resulting in no net change. The Balance Sheet shows a $100 increase in PP&E and a $100 increase in debt.
What happens at the start of Year 2 after Apple buys new factories?
Depreciation expense of $10 decreases operating income, and interest expense increases by $10, resulting in a $20 decrease in pre-tax income and a $12 decrease in net income. The Cash Flow Statement shows a $2 net decrease in cash. The Balance Sheet reflects a $12 decrease in assets and a $12 decrease in shareholder’s equity.
What happens when the factories break down and are written down to $0?
The write-down decreases pre-tax income by $80, net income by $48, and cash from operations increases by $32. Cash from financing decreases by $100. The Balance Sheet shows a total decrease of $148 in assets and a corresponding decrease in liabilities and shareholder’s equity.
What happens when Apple orders $10 of additional iPod inventory using cash?
There will be no changes to the Income Statement. Cash from operations decreases by $10, and on the Balance Sheet, cash decreases by $10 while inventory increases by $10.
What happens when Apple sells iPods for revenue of $20 at a cost of $10?
Revenues increase by $20 and expenses by $10, resulting in a $10 increase in pre-tax income and a $6 increase in net income. The Cash Flow Statement shows a $16 increase in cash. The Balance Sheet reflects a $6 increase in assets.
Can you end up with negative shareholders’ equity?
Yes, negative shareholders’ equity can occur due to leveraged buyouts or consistent losses leading to declining retained earnings.
What is working capital?
Working capital is equal to current assets minus current liabilities.