Chapter 2 Flashcards
A further look at financial statements
Current assets
Assets that are expected to be converted into cash, sold or used up within one year of the company’s financial statement date.
Usually listed in order of liquidity on financial statements.
Operating cycle
Average period of time it takes for a business to pay cash to obtain products or services, then receive cash from customers for these products or services
Held for trading investments
CURRENT ASSETS: Investments in debt/equity securities of other companies, that are bought with the intention of selling them after a short period of time in order to earn income from their price fluctuations.
Accounts receivable
CURRENT ASSETS: Amounts owed by customers who purchased products or services on credit (on account)
Notes receivable
CURRENT ASSETS: Amounts owed by customers or others, that are normally interest-bearing and supported by a written promise to repay.
Inventory
CURRENT ASSET: Goods held for sale to customers.
Supplies
CURRENT ASSETS: Consumable items used in running a business, such as office and cleaning supplies.
Prepaid expenses
CURRENT ASSETS: Costs paid in advance of use (such as rent and insurance), that benefit more than one accounting period.
Non-current assets
Assets that are not expected to be converted into cash, sold or used up within one year of the company’s financial statement date.
Long-term investments
NON-CURRENT ASSETS
Investments in:
-debt securities, intended to be held for many years to earn interest;
-equity securities of other companies, held to generate investment revenue, or for strategic reasons.
Property, plant & equipment
NON-CURRENT ASSETS: Tangible assets, such as land, buildings, and equipment, with relatively long useful lives that are being used to operate the business.
Usually listed in order of permanency on financial statements.
Depreciation
Contra asset account
Account that is offset against (reduces) another related asset account on the statement of financial position.
Examples: Allowance for doubtful accounts; Accumulated depreciation.
Intangible assets
NON-CURRENT ASSETS: Assets of a long-lived nature that do not have physical substance, but represent a privilege or a right granted to, or held by, a company.
Amortization
Examples: Patents, copyrights, franchises, trademarks, trade names, and licences
Current liabilities
Obligations that will be paid or settled within one year of the company’s financial statement date.
Bank indebtedness
CURRENT LIABILITY:
Short-term loan, such as an operating line of credit, pre-arranged with a bank to cover cash shortfalls.
Accounts payable
CURRENT LIABILITIES: Amounts owed to suppliers for purchases made on credit (on account).
Unearned revenue
CURRENT LIABILITY:
Cash received when a customer pays in advance of being provided with a service or product. It is received before revenue is earned, and is recorded as a liability until it is earned.
Notes payable
CURRENT LIABILITIES:
Amounts owed to suppliers, banks, or others, that are normally interest-bearing and supported by a written promise to repay.
Current maturities of long-term debt
CURRENT LIABILITIES: The portion of a non-current/long-term loan that is repayable within the current year.
Non-current liabilities
Obligations that are not expected to be paid, nor settled, within one year of the company’s financial statement date.
Liquidity ratios
Measures of a company’s short-term ability to pay its maturing obligations (usually current liabilities) and to meet unexpected needs for cash.
Working capital, current, receivables turnover, average collection period, inventory turnover and days in inventory are all liquidity ratios.
Working capital
A measure of liquidity used to evaluate a company’s short-term debt-paying ability.
Working Capital = Current Assets - Current Liabilities
Current ratio
A measure of liquidity used to evaluate a company’s short-term debt-paying ability.
Current Ratio = Current Assets / Current Liabilities
**Useful for comparing different-sized companies
Solvency ratios
Measures of a company’s ability to survive over a long period of time, by having enough assets to settle its liabilities as they fall due.
Example: Debt-to-total-assets ratio
Debt-to-total-assets ratio
A measure of solvency, showing the percentage of total financing that is provided by lenders and other creditors.
DTA Ratio = Total Liabilities / Total Assets
Profitability ratios
Measures of a company’s operating success for a specific period of time.
These include the gross profit margin, profit margin, EPS, P-E, dividend yield ratios.
Basic earnings per share (EPS)
A measure of profitability showing the income earned by each common share.
EPS = Income available to common shareholders / Weighted average number of common shares
Price-earnings (P-E) ratio
A profitability measure reflecting investors’ beliefs about a company’s future income potential.
P-E Ratio = Market share price / EPS
Conceptual framework
A coherent system of interrelated objectives and fundamentals that can lead to consistent standards, and that prescribes the nature, function, and limits of financial accounting statements.
What is the objective of financial reporting?
The provision of financial information about a company that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the company.
Fundamental qualitative characteristic of financial information: Relevance
Relevant information should have predictive and/or confirmatory value, and be material.
Fundamental qualitative characteristic of financial information: Faithful Representation
Faithfully represented information represents economic reality. It must be complete, neutral, and free from material error.
Enhancing qualitative characteristic of financial information: Comparability
Enables users to identify and understand similarities in, and differences among, items.
Enhancing qualitative characteristic of financial information: Verifiability
Different knowledgeable and independent users could reach a consensus that the information is faithfully represented.
Enhancing qualitative characteristic of financial information: Timeliness
The information is available to decision-makers in time to be capable of influencing their decisions.
Enhancing qualitative characteristic of financial information: Understandability
The information is clearly and concisely classified, characterized, and presented.
Cost constraint
The pervasive constraint that ensures that the value of the information provided in financial reporting is greater than the cost of providing it.
Going concern assumption
The assumption that the business will remain in operation for the foreseeable future.
Elements of financial statements
A set of broad categories/classes used to group financial information for presentation in the financial statements.
Assets, liabilities, equity, income, expenses.
Historical cost basis of accounting
Measurement basis that states that assets and liabilities should be recorded at their cost at the time of acquisition.
Current value basis of accounting
Measurement basis that states that certain assets and liabilities should be recorded at their current value
What are the three general types of ratios, and why are they used?
Liquidity Ratios: Measure a company’s short-term ability to pay its maturing obligations and to meet unexpected needs for cash
Solvency Ratios: Measure a company’s ability to survive over a long period of time by having enough assets to settle its liabilities when they are due
Profitability Ratios: Measure a company’s operating success for a given period of time
What are the two qualitative characteristics of useful information?
- Revelance
- Faithful Representation
What are four qualities that enhance the usefulness of financial information?
- Comparability
- Verifiability
- Timeliness
- Understandability
