chap1_EoCB_Before_You_Go_On_Q&A Flashcards
Section 3.1
1. What types of information does a firm’s annual report contain?
A firm’s annual report is typically divided into three sections: financial tables with an accompanying verbal explanation of the firm’s performance over the past year; a corporate public relations section discussing the firm’s operations, and the audited financial statements (balance sheet, income statement, statement of cash flows, and statement of retained earnings).
Section 3.1
What is the realization principle, and why may it lead to a difference in the timing of when revenues are recognized on the books and cash is collected?
According to the realization principle, revenue should only be recognized when the earning process is completed and the exchange of goods or services can be determined by an arm’s length transaction. Although this principle works in theory, it still does not specify whether this is the point when the goods are ordered, when they are shipped, or when the payment is actually received from the customer. Also, not many purchases are paid for in cash any more. Therefore, even if the transaction is recognized at the point at which the customer receives the goods, the actual cash flow might not occur until days later (depending what the terms are).
Section 3.2
1. What is net working capital? Why might a low value for this number be considered undesirable?
Net working capital is the difference between total current assets and total current liabilities. A low value for this number is undesirable, for it indicates that the company may not have enough cash on hand to cover its immediate expenses.
Section 3.2
2. Explain the accounting concept behind depreciation.
Depreciation in accounting is a noncash expense that helps to allocate the cost of an item over its expected life. It reflects the estimated decrease in the value of an asset due to wear and tear and obsolescence.
Section 3.2
3. What is treasury stock?
Treasury stock is the stock that the company purchased back from its investors. These shares do not pay dividends, have no voting rights, and should not be included in shares- outstanding calculations.
Section 3.3
1. What is the difference between book value and market value?
Book value is the price you paid for a particular asset. This price does not change as long as you own the asset. On the other hand, market value is the price at which you can sell an asset today, as it takes into account how much it can earn in the future.
Section 3.3
2. What are some objections to the preparation of marked-to-market balance sheets?
Marked-to-market balance sheets list the firm’s assets and liabilities at their current market prices. Even though a balance sheet constructed with actual market values might paint a more accurate picture of the company’s financial situation, current values are difficult to estimate, and a lot of the complicated models are potentially open to abuse. Therefore, as of the present, the norm is to use book values.
Section 3.4
1. How is net income computed?
Net income is calculated as revenues minus expenses. It is the most comprehensive accounting measure of a company’s performance because it reflects the firm’s accomplishments (revenues) relative to its efforts (expenses) during a time period.
Section 3.4
2. What is EBITDA, and what does it measure?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. EBIT is defined as earnings before taxes and interest. The main difference between these two figures is that EBITDA shows the income earned purely from operations and reflects how efficiently a firm can manufacture and sell its products without taking into account the cost of the productive asset base.
Section 3.4
3. What accounting events trigger changes to the retained earnings account?
Two events will trigger changes to the retained earnings account: (1) a firm’s report of a net income or loss and (2) the board of directors’ declaration of a cash dividend.
Section 3.5
1. How do increases in fixed assets from one period to the next affect cash holdings for the firm?
An increase in fixed assets from one period to the next is a use of cash. If a company purchases fixed assets during the year, it decreases cash because it must use cash to pay for the purchase.
Section 3.5
2. Name two working capital accounts that represent sources of cash for the firm.
An increase in current liabilities is a source of cash. Two common current liabilities are accounts and notes payable. An increase in either of these accounts from one period to the next will represent a source of cash for the firm.
Section 3.5
3. Explain the difference between cash flows from financing and investing activities.
Cash flows from financing activities occur when cash is obtained from (cash inflow) or paid to (cash outflow) creditors or owners (stockholders). Cash flows from investing activities relate to the buying (cash outflow) and selling of long-term assets (cash inflow).
Section 3.6
- Explain how the four financial statements are related.
The four financial statements are linked together as follows: the ending cash balance from the statement of cash flows is used as the cash balance on the balance sheet, and the net income reported in the income statement is transferred to retained earnings on the balance sheet. So as you can see, the balance sheet is the one financial statement that ties all four statements together.
Section 3.7
1. How does the calculation of net income differ from the calculation of cash flow to investors from operating activity?
Net income is calculated as the difference between revenues and expenses from the income statement. Cash flow from operating activity is the firm’s earnings before interest and taxes (EBIT) minus taxes paid in cash plus the firm’s noncash expenses, including depreciation and amortization.
