Chapter 2: Principles of Accounting

Question 1

Assets

Answer 1

Value of goods owned.
Current: short term receivables or liquid assets (cash, AR, inv., bonds/stock)
Fixed: items to generate revenue over long term (equipment, buildings, land)
Other: prepaid expenses, deferred items, intangible

Question 2

Liabilities

Answer 2

Value of goods owed.
Current: items due in accounting period (AP, Tax payable)
Long-term: due over long term (bank loans, mortgages, deferred items)

Question 3

SHE

Answer 3

Net worth of business=Capitol stock + Retained earnings

Question 4

Revenue vs. OPEX items

Answer 4

Revenue: sales, other (dividend received, interest received, proceeds from asset disposal)
OPEX: cost of goods sold, depreciation, income/property tax, insurance, marketing expense, interest)

Question 5

Source vs. Use

Answer 5

Souce: N/I, dep, decrease in asset, increase in liability, increase in CS, NP
Use: loss, increase in asset, decrease in liability, repurchase of CS, dividend paid, stocks/bonds

Question 7

OCF, ICF, FCF

Answer 7

OCF: (AR), (Inv), Dep, NI, AP
ICF: (NFA), (Dep)
FCF: NP, LTD, CS, Div, paid

Question 8

working capitol

Answer 8

WC=current assets-current liabilities

• funds available to sustain short term business of firm
• WC>0: otherwise risk short term insolvency

Question 9

current ratio

Answer 9

CR=current assets/current liabilities

• ability of firm to meet short term obligations
• CR>2

Question 10

quick ratio

Answer 10

QR=liquid current assets/current liabilities

• LCA=CA-inv.-raw material-finished products-prepaid expenses
• QR>1

Question 11

debt ratio

Answer 11

DR=liabilites/(liabilities+SHE)

• financial leverage of firm
  0.2<DR<0.4
  DR=1-ER

Question 12

debt to equity ratio

Answer 12

D/E=LTD liabilites/SHE

• relative magnitude of DE capital (shares and retained earnings)
• DR<1

Question 13

times interest earned ratio

Answer 13

TIER=(Before tax prodit+interest expenses

• extent to which profits can decline without causing difficulty to meet annual interest obligation
• 3<TIER<4

Question 14

inventory turnover ratio

Answer 14

ITR=Cost of goods sold/avg inv of finished products

• indicates whether inv is high/low
• liquidity of inv ie fast/slow sales
• low ITR=too high inv, slow sales
• high ITR=low finished product, fast sales

Question 15

average collection period

Answer 15

ACP=avg AR/ avg daily credit sales

• indicates promptness AR (credit sales) are collected
• too high: lax collection=debts
• too low: strict credit policy=lost sales
• ACP~60 days

Question 16

fixed asset turnover ratio

Answer 16

FTR=net sales/avg net fixed assets

• ability of fixed assets to generate sales
• high: efficiency use of FA
• FTR=5-6

Question 16

total asset turnover ratio

Answer 16

ATR=net sales/avg total assets

• ability of assets to generate sales
• ATR~2

Question 16

profit margin

Answer 16

PM=1-OR

• before tax profit of every dollar of sales

Question 16

operating cost ratio

Answer 16

OR=total OPEX (excl. int on debt and income tax)/net sales

• before tax cost of every dollar of sales
• lower=better

Question 17

net profit ratio

Answer 17

P/S=net profit/net sales

• after tax generating potential of every dollar of sales

Question 18

return on equity

Answer 18

ROE= net profit (minus preferred dividends)/avg SHE

• return on shareholders investment

Question 19

Define “depreciation”

Answer 19

• Method of allocating cost of CAPEX (long term assets) over time.
• depreciation expense deducted from revenues gen from LTA, ie cost associate with use of assets over time

Question 20

Types of depreciation

Answer 20

1. Accounting: recovery of CAPEX, reflects production cost over time.
   N/I=Div+RE=Rev-OPEX-dep-income tax
   - no SV
2. Tax: determine taxable income
   - govt allows business to recover CAPEX using dep allowance
   - taxable income determined by deducing OPEX and dep from revenue
   - SV

Question 21

Book value per share

Answer 21

BV/share=(Net income-preferred stock)/# of shares