Chapter 2 - Accounting Overview Flashcards
What is an income statement and why is it important?
An income statement shows the revenues, costs, and profits of a company
over a period of time. It is important because it contains some
of the most basic and important metrics used to analyze a company’s
operating performance and profitability.
What is a balance sheet and why is it important?
A balance sheet shows the financial position of a company and specifically
the company’s assets, liabilities, and shareholders’ equity at a
given point in time. It is important because it contains key metrics used
to understand and analyze a company’s financial stability and to measure
the book value of key types of assets (such as cash, inventory, and
PP&E) and key types of liabilities (such as debt).
What is a cash flow statement and why is it important?
A cash flow statement shows the net cash flows relating to a company’s
operating, investing, and financing activities for a period of
time corresponding to the time period of the income statement. It is
important because it helps one understand how much cash a company
generates or uses from its operations, and lists key sources and uses
of cash.
What are the differences between accrual accounting and cash‐based
accounting?
Accrual accounting recognizes revenue when a firm sells goods or
services, and attempts to match the costs associated with producing
those revenues and record them at the same time. Cash‐based accounting
recognizes revenues and costs when cash is received or spent.
What are the advantages of accrual accounting versus cash‐based
accounting?
The advantages of accrual accounting are that because revenues and
costs are matched, the income statement reflects a much more accurate
and meaningful measure of profitability than does cash‐based accounting.
In addition, accrual accounting provides less opportunity for management
to manipulate its operating performance by timing purchases
or sales.
How is EBITDA calculated?
EBITDA is calculated as earnings before interest and taxes (EBIT), or
synonymously, operating income plus depreciation and amortization.
Why is EBITDA a frequently used metric in corporate finance?
EBITDA is a proxy for operating cash flow, and it is easy to calculate.
Why does EBITDA not equal operating cash flow?
While EBITDA is a proxy for operating cash flow, it ignores many
uses of cash, such as capital expenditures and the change of working
capital.
In a period of inflation (rising prices), which method of inventory (LIFO
or FIFO) would likely result in a higher level of inventories on the
balance sheet?
In a period of inflation, the FIFO method of inventory will likely result
in a higher level of inventories on the balance sheet because older
inventory at lower prices will be used first, leaving the value of newer
inventory at higher prices on the balance sheet.
What is the difference between an operating lease and a capital lease?
In an operating lease, the lessee does not take risk of ownership, and
the rent that it pays is treated as an expense. In a capital lease, the lessee
does take risk of ownership and enjoys some of the benefits, and the
lease is treated as if the company owned the property and borrowed to
help finance the property.
What is a deferred tax asset or liability?
A deferred tax asset or deferred tax liability is a balance sheet item
reflecting the difference between taxes reported on financial statements
and taxes actually paid to the government, mostly resulting from timing
differences.
Give an example of a transaction that would result in a deferred tax
asset or liability.
An example of a transaction that would result in a deferred tax is if
a company depreciated an asset using a different method for financial
reporting purposes than for tax reporting purposes. For instance, a deferred
tax liability would be created if the asset was depreciated using a
straight‐line method for financial reporting and an accelerated method
for tax reporting.
Why do we depreciate fixed assets?
Fixed assets are depreciated so as to try to match the cost of the fixed
assets with the benefits of using them (i.e., to generate revenues).
What are intangible assets?
Intangible assets are assets that have no physical or tangible form.
Examples of intangible assets include in‐process research and development
(R&D), patents and trade secrets, trademarks and copyrights, and
a special category called goodwill.
What is goodwill?
Goodwill is a special type of intangible asset that is created when a
company makes an acquisition. Goodwill reflects the excess purchase
price over the fair market tangible book value of the acquired company’s
assets.
