Chapter 3 Flashcards
The balance sheet provides information useful for:
- assessing future cash flows
- liquidity
- long-term solvency
What is liquidity?
refers to the period of time an asset is converted to cash or until a liability is paid.
What is book value?
a company’s assets minus is liabilities
What is long-term solvency?
refers to the riskiness of a company with regard to the amount of liabilities in its capital structure.
What is financial flexibility?
the ability of a company to alter cash flows in order to take advantage of unexpected investment opportunities and needs.
What is the key classification of assets and liabilities in the balance sheet?
Current vs Non current distinction
What are current assets?
include cash and all other assets expected to become cash or be consumed within one year or the operating cycle, whichever is longer.
What is the operating cycle?
the period of time necessary to convert cash to raw materials, raw materials to a finished product, the finished product to receivables, and then finally receivables back to cash.
What are cash equivalents?
frequently include certain negotiable items such as commercial paper, money market funds, and U.S. treasury bills.
Investments are classified as __________ if management has the ability and intent to liquidate the investment in the near term.
current
What is accounts receivable?
result from the sale of goods or services on credit.
What are inventories?
consist of assets that a retail or wholesale company acquires for resale or goods that manufacturers produce for sale.
What are typical classifications of non current assets?
- investments
- property, plant, and equipment
- intangible assets
What are some examples of investments?
- Investments in equity and debt securities of other corporations
- Land held for speculation
- Non current receivables
- Cash set aside for special purposes (such as future plant expansion)
What are some examples of property, plant, and equipment?
- Land
- Buildings
- Machinery
- Furniture
- Natural resources (e.g. mineral mines, timber tracts, and oil wells)
What are intangible assets?
Generally represent exclusive rights that a company can use to generate future revenues. (e.g. patents, copyrights, and franchises)
What are current liabilities?
are expected to be satisfied within one year or the operating cycle, whichever is longer.
What are examples of current liabilities?
- Accounts payable
- Notes payable
- Unearned revenues
- Accrued liabilities
- Current maturities of long-term debt
What is shareholder’s equity composed of?
- Paid-in capital (invested capital)
2. Retained earnings (earned capital)
What is the summary of significant accounting policies?
Conveys valuable information about the company’s choices from among various alternative accounting methods.
What is a subsequent event?
A significant development that occurs after a company’s fiscal year-end but before the financial statements are issued or available to be issued.
What are irregularities?
are INTENTIONAL distortions of financial statements
What are illegal acts?
bribes, kickbacks, illegal contributions to political candidates, and other violations of the law.
What is the full-disclosure principle?
requires that financial statements provide all material relevant information concerning the reporting entity.
The management discussion and analysis (MD&A) provides a biased but informed perspective of a company’s:
- operations
- liquidity
- capital resources
The management’s responsibilities sections avows the responsibility of management for the company’s:
- financial statements
2. internal control system
What is the auditor’s report?
Provides the analyst with an independent and professional opinion about the fairness of the representations in the financial statements and about the effectiveness of internal controls.
Which circumstances cause the auditor’s report to include and explanatory paragraph in addition to the standard wording, even though the report is unqualified:
- Lack of consistency
- Uncertainty
- Emphasis of a matter concerning financial statements
Some audits result in the need to issue other than an unqualified opinion due to exceptions such as:
- nonconformity with generally accepted accounting principles
- inadequate disclosures
- a limitation or restriction of the scope of the examination
What is a qualified opinion?
This contains an exception to the standard unqualified opinion but not of sufficient seriousness to invalidate the financial statements as a whole.
What is adverse opinion?
This is necessary when the exceptions (a) nonconformity with generally accepted accounting principles and (b) inadequate disclosures are so serious that a qualified opinion is not justified. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report.
What is a disclaimer?
An auditor will disclaim an opinion for item (c) “a limitation of the scope of the examination that insufficient information” has been gathered to express an opinion.
The auditor should assess the firm’s ability to continue as ____________.
going concern
What is a proxy statement?
contains disclosures on compensation to directors and executives
What are comparative financial statements?
allow financial statement users to compare year-to-year financial position, results of operations, and cash flows
What is the difference between horizontal and vertical analysis?
Horizontal: expressing the same item as a percentage in a year-to-year comparison
Vertical: expressing each item as a percentage, but within the same year
Evaluating information in __________ form allows analysts to control for size differences over time and among firms.
ratio
What is default risk?
a company’s ability to pay its obligations when come due
What is operational risk?
how adept a company is at withstanding various events and circumstances that might impair its ability to earn profits
What is working capital?
the difference between current assets and current liabilities, is a popular measure of a company’s ability to satisfy its short-term obligations
How do we calculate the Current ratio?
Current assets/Current liabilities
Working capital may not present an accurate or complete picture of a company’s _________.
liquidity
What is the acid-test ratio (quick ratio)?
Quick assets (i.e. cash, short-term investments, A/R)/Current liabilities
It provides a more stringent indication of a company’s ability to pay its current obligations.
Liquidity ratios should be assessed in the context of both __________ and __________ of managing assets.
profitability
efficiency
What is the debt to equity ratio?
Total liabilities/Shareholder’s equity
It indicates the extent of reliance on creditors, rather than owners, in providing resources.
What is favorable financial leverage?
means earning a return on borrowed funds that exceeds the cost of borrowing the funds
What is the times interest earned ratio?
(Net income + Interest expense + Income taxes)/Interest expense
It indicates the margin of safety provided to creditors.
What is the purpose of the balance sheet?
To report a company’s financial position on a particular date.