Chapter 3: Accounting and Finance Flashcards
What information is contained in the balance sheet, income statement, and statement of cash flows? (LO3-1)
The balance sheet provides a snapshot of the firm’s assets and liabilities. The assets consist of current assets that can be rapidly turned into cash and fixed assets such as plant and machinery. The liabilities consist of current liabilities that are due for payment within a year and long-term debts. The difference between the assets and the liabilities represents the amount of the shareholders’ equity.
The income statement measures the profitability of the company during the year. It shows the difference between revenues and expenses.
The statement of cash flows measures the sources and uses of cash during the year. The change in the company’s cash balance is the difference between sources and uses.
What is the difference between market and book values? (LO3-2)
It is important to distinguish between the book values that are shown in the company accounts and the market values of the assets and liabilities. Book values are historical measures based on the original cost of an asset. For example, the assets in the balance sheet are shown at their historical cost less an allowance for depreciation. Similarly, the figure for shareholders’ equity measures the cash that shareholders have contributed in the past or that the company has reinvested on their behalf.
In contrast, market value is the current price of an asset or liability.
Why does accounting income differ from cash flow? (LO3-3)
Income is not the same as cash flow. There are two reasons for this: (1) On the reported income statement, investment in fixed assets is not deducted immediately from income but is instead spread (as charges for depreciation) over the expected life of the equipment, and (2) the accountant records revenues when the sale is made, rather than when the customer actually pays the bill, and at the same time deducts the production costs even though those costs may have been incurred earlier.
What are the essential features of the taxation of corporate and personal income? (LO3-4)
For corporations, the marginal rate of tax on income is 21%. In calculating taxable income, the company deducts an allowance for depreciation and interest payments. It cannot deduct dividend payments to the shareholders.
Individuals are also taxed on their income, which includes dividends and interest on their investments. Capital gains are taxed, but only when the investment is sold and the gain realized.
