Chapter 13 Powerpoint Flashcards
Authorized shares
The board of directors can issue this amount of shares
The maximum amount that can be issued
Issued shares
Shares that are owned by the company (Treasury Stock) and owned by the stockholders
Outstanding Shares
Shares that are owned by the stockholders only
Sustainable Income notes
Income that is the most likely level of income to be obtained in the future
Determined by removing irregular items from net income (net of income taxes)
Irregular Items include:
Discontinued Operations
Extraordinary Items
Discontinued Operations
A disposal of a significant component of a business
ex. Elimination of a Major class of Customers
*The income statement should recognize a gain (or loss) from discontinued operations, net of tax
Extraordinary items:
Extraordinary items should be recognized when meet two conditions:
- Unusual in Nature
- Infrequent in Occurrence
*The company must consider the environment in which it operates
**These amounts are reported net of income taxes on a seperate section of the income statement, below discontinued operations
Unusual in Nature
The item should be abnormal and only incidentally related to the customary activities of the entity
Infrequent in Occurrence
The event or transaction should not be reasonably expected to recur in the foreseeable future
Effects of major natural casualties, if rare in the area
Yes - extraordinary
Write-down of inventories or write-off of receivables
No - not extraordinary
Expropriation (takeover) of property by a foreign government
Yes- extraordinary
Losses attributable to labor strikes
No - not extraordinary
Gains or losses from sales of property, plant, or equipment
No - not extraordinary
Significant damage resulting from a hurricane in Florida
No - not extraordinary
Significant loss in derivative instruments due to unexpected financial collapse
No - not extraordinary
Changes in Accounting Principle
Users expect financial statements to be prepared on a basis consistent with the preceding period
When management can show that the new principle is preferable to the old principle, accounting rules permit a change
It is important that most changes in principle are reported retroactively
- this treatment improves comparability
A change in accounting principle occurs when:
The principle used in the current period is different from te one used in the previous period
ex. Change in Inventory Costing Methods - FIFO vs. LIFO
We know that most revenues, expenses, gains, and losses are included in net income. However, _____________________
certain gains and losses are not
ex. Unrealized Gain / Loss on an AFS Security
Comprehensive income includes _____________________
all changes in stockholders’ equity except:
- Changes resulting from Stockholder Investments
- Changes resulting from distributions to Stockholders
*This measure provides a more comprehensive measure
Three types of comparisons to improve the decision usefulness of financial information:
- Intracompany Basis - Historical Trend Analysis
- Intercompany Basis - Direct Comparison to Competitor
- Industry Averages - Relative Position within Industry
Three basic tools to highglight significance in financial statement data
- Horizontal Analysis - Trend Analysis
- Common-Size Analysis
- Ratio Analysis
Horizontal Analysis
A technique for evalutaing a sries of financial statement data over a period of time to determine increase or decrease
*commonly applied to the balance sheet and income statement
**expressed in dollar amounts and percent change
e. 2006 current assets = $10; 2007 current assets= $15
Percent = 50%
Vertical Analysis
A “common-size analysis”
A technique that expresses each financial statement item as a percent of a base amount
Commonly applied to the balance sheet and income statement
ex. Current assets = 25%, Property assets = 25%, Other assets = 50%, Total assets = 100%
Liquidity
Measures short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash
Solvency
Measures the ability of the company to survive over a long period of time
Profitability
Measures the income or operating success of a company for a given period of time
Woring capital
Current assets - Current liabilties
Current Ratio
Current assets
Current liabilities
Current cash debt coverage ratio
Cash provided by operations
Average current liabilties
Inventory turnover ratio
Cost of goods sold
Average Inventory
Days in inventory
365 days
Inventory turnover ratio
Receivables turnover ratio
Net credit sales
Average net receivables
Average collection period
365 days
Receivables turnover ratio
Debt to total assets ratio
Total Assets
Total Liabilities
Cash debt coverage ratio
Cash provided by operations
Average total liabilities
Times interest earned ratio
Net income + Interest expense + Tax expense
Interest expense
Free cash flow
Casy provided by operations - Capital expenditures - Cash dividends
Solvency ratios
Debt to total assets ratio
Cash debt coverage ratio
Times interest earned ratio
Free cash flow
Liquidity ratio
Working capital
Current ratio
Current cash debt coverage ratio
Inventory turnover ratio
Days in inventory
Receivables turnover ratio
Average collection period
Earnings per share
Net income - Preferred stock dividends
Average common shares outstanding
Price-earings ratio
Stock price per share
Earnings per share
Gross profit rate
Gross profit
Net sales
Profit margin ratio
Net income
Net sales
Return on assets ratio
Net income
Average total assets
Asset turnover ratio
Net sales
Average total assets
Payout ratio
Cash dividends declared on common stock
Net income
Return on common stockholders’ equity ratio
Net income - Preferred stock dividends
Average common stockholders’ equity
Profit Margin x Asset turnover ratio =
Return on assets ratio
Profitability ratios
Earnings per share
Price-earnings ratio
Gross profit rate
Profit margin ratio
Return on assets ratio
Asset turnover ratio
Payout ratio
Return on common stockholders’ equity
Quality of Earnings
A company that has a high quality of earnings provides full and transparent information that will not confuse or mislead users
*It is increasingly important because of recent accounting scandals involving earnings management
Issues relating to quality of earnings:
- Alternative accounting methods
- Pro Forma Income
- Improper Recognition (Channel Stuffing)
Explain why the municipalities may be reluctant to disclose the additonal pension obligations on their balance sheets?
These municipalities may be reluctant to disclose these additional obligations, as this could potentially lead to credit rating downgrades, thus making it more difficult for the municipality to borrow funds in the future. Also, additional debt would make the balance sheet look worse and could spark a negative reaction from taxpayers.
- Although currently allowable by US GAAP for government organizations, what qualitative accounting characteristic do government organizations violate by not including information on pension obligations in their financial statements and why?
Transparency or Faithful Representation. Both emphasize giving a clear, concise, and balanced view of a company’s financial situation to its shareholders. The stakeholders in this situation are not only debt holders, but also taxpayers. Government organizations do not provide their stakeholders a clear image of their financial position.
- If government organizations are required to recognize these additional obligations, what is the effect on the balance sheet? Name 2 financial ratios that would be affected. Would these ratios be better or worse?
Disclosing the additional obligations would add more debt to the balance sheet.
Each of the following ratios would look worse as a result of disclosing additional obligations:
Solvency: Debt to Total Assets Ratio (Total Liabilities/Total Assets); Cash Debt Coverage Ratio (Cash Provided by Operations/Average Total Liabilities)
- As an investor considering investing in municipal bonds, how would the exclusion or inclusion affect your decision to invest?
Exclusion: Need to estimate pension obligation and the municipality’s ability to make pension payments as they come due, then assess the risk that the municipality may not be able to repay debts from bonds as they come due
Inclusion: Increases relevance of reported financial information. Increases faithful representation. Provides more information about pension obligation and the government’s ability to make pension payments as they come due, which reduces the risk that your estimation of the pension obligation is not accurate. Then more likely to invest, or require a lower rate of return on investment, than if obligation is excluded.
- How would recognition of pension obligations better align the actions of state and local government officials with the interests of taxpayers?
Provides more and better information to the public about the performance of government officials. Creates incentive for government officials to better fund pension plans to improve the funded status of plans in financial statements.
