Chapter Three Flashcards
Balance Sheet
reports a company’s financial position at a point in time
organized list of A, L and E
the usefulness of the BS
assets are classified according to common characteristics
liquidity
long term solvency
financial flexibility
liquidity
the ability of a company to convert its assets to cash
long term solvency
whether a co will be able to pay all its liabilities (also long term)
financial flexibility
ability of co to alter cash flows in order to take advantage of unexpected investment opps and needs
does the BS have limitations
a co book value will show in BS but it will not directly measure the company’s market value
1) many assets are measured at their historical costs rather than the amounts for which assets could be sold
2) many aspects of a co may represent valuable resources, but these items are not recorded as assets in the BS so no BV
book value
assets - liabilities
current assets
expected to be converted to cash/consumed within coming year/normal operating cycle of business
operating cycle
use cash to acquire inventory
prepare inventory for sale to customers
deliver inventory to customers
collect cash from customers
elements of current assets listed in decreasing order of liquidity
cash/cash equiv.
short term investments
AR
inventory
prepaid expensesc
cash and cash equiv
on hand and in banks
bank drafts, cashier’s checks, money orders, cash equiv
maturity date no longer than three months from the date of purchase: commercial paper, money market funds, US treasury bills
short term investments
in stock and debt securities of other corps.
company has ability/intent to sell within next 12m or op cycle
(HTM, trading securities, AFS)
AR
result from g/s on account
also known as trade receivables
non trade receivables are from loans by the co to individuals/other entities
NR - formal agreement/note specific payment terms
inventory
merchandise
manufacturer:
RM
WIP
FG
prepaid expenses
when co incurs a cost of acquiring an asset in one period that will not be expensed until a future period
current/noncurrent depends on period in which item is consumed
long term assets
expected to be converted to cash/consumed for more than one year (op cycle)
investments
PPE
other long term assets
intangible assets
investments
not used directly in the operations of the business
examples:
investments in equity/debt securities of other corp
land held for speculation
long term receivables
cash set aside for special purposes
PPE
tangible, long lived assets used in ops of business
reported as a single amt in BS at ORIGINAL cost less Accumulated Deprec
intangible assets
exclusive rights
valuable resources in generating future rev
reported in BS net of accumulated amortization
other long term assets
catch all classification of long term assets not reported separately in one of the other long term classifications
long term operating lease
sometimes long term prepaid expense’s too (deferred charges)
mangement intent
key to understanding which category of asset is reported as what
current liabilities
expected to be satisfied through the use of CA or the creation of other current liabilities
AP
NP (short term)
deferred revenues (unearned SR)
accrued liab
currently maturing portion of long term debt
AP
obligations to suppliers of merchandise or services purchased on acct
NP
written promises to pay cash at some future date
usually explicit interest in addition to face value
deferred revenues
represent cash received from a customer for goods or services to be provided in a future period
accrued liab
represent obligations created when exp have been incurred but will not paid until a subsequent reporting periods
current maturities of long term debt
long term notes/loans/mortgages/BP due within next year or payable in installments
long term liab
due to be settled
contractual right by the borrowing company to be settled in more than one year (op cycle) after BS date
impact on future cash flows and long term solvency is assessed by reporting payment terms, interest rates, details in disclosure notes
shareholders eq
assets - liab
arises from:
paid in cap
retained earnings
also known as nets assets or BV
sometimes includes AOCI (other equity components)
AOCI
accumulated other comprehensive income
special gains/losses listed as special items on equity section of BS
at end of fiscal year, what are companies required to provide shareholders (especially if they have public securities)
examples of additonal disclosures (5)
annual report with
financial statements (BS)
additional disclosures - business conditions, risk factors, legal proceedings, stock performance, internal control procedures
examples of disclosure notes
what do they deal with on the BS
pension plans, long term debt, income taxes, ppE, leases, investments, employee benefit plans
what do disclosure notes need to include
summary of significant acct policies
description of subsequent events
related third party transactions
summary of significant acct policies
conveys valuable info about a company’s choices from among various alternative acct methods
subsequent events
occurs after a company’s fiscal year end but before the financial statements are issued
examples of subsequent events
issuance of debt/equity securities
business combo or sale of business
sale of assets
event that sheds light on the outcome of a loss contingency
what are noteworthy events and transactions
occur only occasionally but are important:
related party transactions (more frequent)
errors and fraud
illegal acts
related party transactions
Transactions between the company
and owners, management, families of owners or management,
affiliated parties, etc
errors and fraud
Misstatements that are unintentional (errors) or
intentional (fraud)
illegal acts
Bribes, kickbacks, illegal contributions to political
candidates, and other violations of the law.
why does management need to discuss/analyze
need discussion/analysis because biased but informed perspectives on
significant events
trends
uncertainties
to….
results of operations, liquidity, cap resources, off balance sheet arrangements, critical acct estimates
what is management responsible for in annual report?
assessment of co’s internal control procedures
executives personally certify FS per Sarbanes-Oxley Act of 2002
what does SEC require for disclosure on compensation to directors and executives
proxy statement - invites shareholders to annual meeting to elect board members and vote on issues/vote by proxy
includes compensation and stock option info
provided each year with annual report
what are sustainability disclosures
companies detail practices and policies related to sustainability of business ops
environmental disclosures
social disclosures
governance disclosures
environmental disclosures
environment impact - green house immissions
social disclosures
issues of interest to broader stakeholders/society at large
CEO pay ratio
gender pay ratio
gender diversity ratio
governance disclosures
co’s actions and policies related to division of power within a co.
gender diversity
independence of Board of Directors
ethical policies
Role of auditor
examine FS and internal control procedures
attest to fairness of FS
opinion stated in auditor’s report
four basic types of auditor reports
unqualified - FS presented fairly
unqualified with explanatory/emphasis paragraph
qualified - scope of limitation or departure from GAAP (overall FS are presented fairly)
adverse - FS not presented fairly
disclaimer - insufficient evidence or not independent
unqualified auditor’s report
“clean opinion”
sufficient planning of audit
understanding of co’s internal control procedures
gathering of evidence to accuracy of amounts reported in FS
unqualified with explanatory paragraph (emphasis of matter)
auditor believes FS are in conformity with GAAP, BUT other important info needs to be emphasized to FS users
so:
lack of consistency
going concern
material misstatement
when audit are issue other than unqualified opinion
qualified opinion
adverse opinion
disclaimer
because:
nonconformity with GAAP
inadequate disclosures
a limitation or restriction of scope of audit examination
users are most interested in the _____
outlook for the future
investors are interested in?
default risk
operational risk
default risk
the risk the company won’t be able to
pay its obligations when they come due
operational risk
to how a company
can withstand various events and circumstances that
might impair its ability to earn profits
liquidity
Liquidity most often refers to the ability of
a company to convert its assets to cash to pay its
current obligations
liquidity ratios
provide information about a company’s
ability to pay its short-term obligations
current ratio
acid test ratio
current ratio
CA/CL
acid test ratio
Quick assets/CL
working capital
CA - CL
popular measure of a company’s ability to satisfy its
short-term obligations is the relation between current
assets and current liabilities
current ratio interpretation
Nike’s current ratio of 2.48 indicates that the company has a $2.48 of CA for each $1 of CL
interpretation of WC
Nike has 10,000 more in CA than in CL.
solvency ratio
indication of the riskiness of a company with
regard to its ability to pay its long-term debts
debt to equity ratio
times interest earned ratio
debt to equity ratio
compares resources provided by creditors with resources provided by owners - so how reliant is the company on creditors vs owners
provides measure of creditor’s protection in the event of insolvency
HIGHER RATIO HIGHER RISK
Total Liab/Shareholders EQ
times interest earned ratio
[net income + interest expense + income taxes]/interest expense
for a co to be solvent or take on more debt, co needs to have funds available to pay interest charges
if incomes is many times greater than interest expense, creditor’s interests are more protected than if income just barely covers this expense
risk and profitability
default risks exist, but sometimes there is a greater return to shareholders with borrowing
this is known as?
hint: FFL
favorable financial leverage
common but risky business activity
borrowing funds provides greater returns to shareholders
what are the alternatives when a co needs money
debt and equity
sometimes more debt can mean a higher return on shareholders equity
what is a reportable operating segment
determined by using a management approach
evident from structure of co’s internal organization
component of a public business entity: recognize revs/exps, regular reviewed by entity chief operating decision maker, discrete financial info available
what amounts are reported by an operating segment
required disclosures:
general info about OS
info reported segment profit/loss and segment assets
reconciliations of totals of segment revs, reported profit/loss, assets, other items to corresponding entity amts
interim period info
so could be: net sales, operating earnings, total assets, depreciation/amort, capital expenditures
what does US GAAP require in regards to certain geographic areas
certain reporting based on geo -
revenues from external customers:
domestically
attributed to foreign countries
long lived assets, long term customer relationships and other policies
domestically
attributed foreign countries
why is info about major customers important?
is business depending on certain customers for prosperity
if 10% or more of revenue from certain customer must disclose:
total amount of rev from them
identity of operating segment(s) reporting the rev
