Chapter 13 Powerpoint

Question 1

Authorized shares

Answer 1

The board of directors can issue this amount of shares

The maximum amount that can be issued

Question 2

Issued shares

Answer 2

Shares that are owned by the company (Treasury Stock) and owned by the stockholders

Question 3

Outstanding Shares

Answer 3

Shares that are owned by the stockholders only

Question 4

Sustainable Income notes

Answer 4

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)

Question 5

Irregular Items include:

Answer 5

Discontinued Operations

Extraordinary Items

Question 6

Discontinued Operations

Answer 6

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

Question 7

Extraordinary items:

Answer 7

Extraordinary items should be recognized when meet two conditions:

1. Unusual in Nature
2. 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

Question 8

Unusual in Nature

Answer 8

The item should be abnormal and only incidentally related to the customary activities of the entity

Question 9

Infrequent in Occurrence

Answer 9

The event or transaction should not be reasonably expected to recur in the foreseeable future

Question 10

Effects of major natural casualties, if rare in the area

Answer 10

Yes - extraordinary

Question 11

Write-down of inventories or write-off of receivables

Answer 11

No - not extraordinary

Question 12

Expropriation (takeover) of property by a foreign government

Answer 12

Yes- extraordinary

Question 13

Losses attributable to labor strikes

Answer 13

No - not extraordinary

Question 14

Gains or losses from sales of property, plant, or equipment

Answer 14

No - not extraordinary

Question 15

Significant damage resulting from a hurricane in Florida

Answer 15

No - not extraordinary

Question 16

Significant loss in derivative instruments due to unexpected financial collapse

Answer 16

No - not extraordinary

Question 17

Changes in Accounting Principle

Answer 17

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

Question 18

A change in accounting principle occurs when:

Answer 18

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

Question 19

We know that most revenues, expenses, gains, and losses are included in net income. However, _____________________

Answer 19

certain gains and losses are not

ex. Unrealized Gain / Loss on an AFS Security

Question 20

Comprehensive income includes _____________________

Answer 20

all changes in stockholders’ equity except:

• Changes resulting from Stockholder Investments
• Changes resulting from distributions to Stockholders

*This measure provides a more comprehensive measure

Question 21

Three types of comparisons to improve the decision usefulness of financial information:

Answer 21

1. Intracompany Basis - Historical Trend Analysis
2. Intercompany Basis - Direct Comparison to Competitor
3. Industry Averages - Relative Position within Industry

Question 22

Three basic tools to highglight significance in financial statement data

Answer 22

1. Horizontal Analysis - Trend Analysis
2. Common-Size Analysis
3. Ratio Analysis

Question 23

Horizontal Analysis

Answer 23

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%

Question 24

Vertical Analysis

Answer 24

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%

Question 25

Liquidity

Answer 25

Measures short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash

Question 26

Solvency

Answer 26

Measures the ability of the company to survive over a long period of time

Question 27

Profitability

Answer 27

Measures the income or operating success of a company for a given period of time

Question 28

Woring capital

Answer 28

Current assets - Current liabilties

Question 29

Current Ratio

Answer 29

_Current assets_ Current liabilities

Question 30

Current cash debt coverage ratio

Answer 30

_Cash provided by operations_ Average current liabilties

Question 31

Inventory turnover ratio

Answer 31

_Cost of goods sold_ Average Inventory

Question 32

Days in inventory

Answer 32

_365 days_ Inventory turnover ratio

Question 33

Receivables turnover ratio

Answer 33

_Net credit sales_ Average net receivables

Question 34

Average collection period

Answer 34

_365 days_ Receivables turnover ratio

Question 35

Debt to total assets ratio

Answer 35

_Total Assets_ Total Liabilities

Question 36

Cash debt coverage ratio

Answer 36

_Cash provided by operations_ Average total liabilities

Question 37

Times interest earned ratio

Answer 37

_Net income + Interest expense + Tax expense_ Interest expense

Question 38

Free cash flow

Answer 38

Casy provided by operations - Capital expenditures - Cash dividends

Question 39

Solvency ratios

Answer 39

Debt to total assets ratio Cash debt coverage ratio Times interest earned ratio Free cash flow

Question 40

Liquidity ratio

Answer 40

Working capital Current ratio Current cash debt coverage ratio Inventory turnover ratio Days in inventory Receivables turnover ratio Average collection period

Question 41

Earnings per share

Answer 41

_Net income - Preferred stock dividends_ Average common shares outstanding

Question 42

Price-earings ratio

Answer 42

_Stock price per share_ Earnings per share

Question 43

Gross profit rate

Answer 43

_Gross profit_ Net sales

Question 44

Profit margin ratio

Answer 44

_Net income_ Net sales

Question 45

Return on assets ratio

Answer 45

_Net income_ Average total assets

Question 46

Asset turnover ratio

Answer 46

_Net sales_ Average total assets

Question 47

Payout ratio

Answer 47

_Cash dividends declared on common stock_ Net income

Question 48

Return on common stockholders' equity ratio

Answer 48

_Net income - Preferred stock dividends_ Average common stockholders' equity

Question 49

Profit Margin x Asset turnover ratio =

Answer 49

Return on assets ratio

Question 50

Profitability ratios

Answer 50

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

Question 51

Quality of Earnings

Answer 51

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

Question 52

Issues relating to quality of earnings:

Answer 52

1. Alternative accounting methods 2. Pro Forma Income 3. Improper Recognition (Channel Stuffing)

Question 53

Explain why the municipalities may be reluctant to disclose the additonal pension obligations on their balance sheets?

Answer 53

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.

Question 54

2. 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?

Answer 54

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.

Question 55

3. 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?

Answer 55

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)

Question 56

4. As an investor considering investing in municipal bonds, how would the exclusion or inclusion affect your decision to invest?

Answer 56

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.

Question 57

5. How would recognition of pension obligations better align the actions of state and local government officials with the interests of taxpayers?

Answer 57

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.