chp 2 Flashcards
why are balance sheet accounts = permanent
they carry over from period to period, as the ending balance from 1 period becomes the beginning balance for the next
why companies acquire assets
to yield a return to their shareholders
how can assets produce economic benefits
in revenue from inventory directly or indirectly as a manufacturing plant that produces inventory for sale.
how can assets create stockholder value
assets must yield income that’s in excess of the cost of funds used to make to acquire the assets
what are the 2 characteristics of an assets
must be owned/controlled by company
must confer to expected future economic benefits that result from a past transaction or event.
how is the balance sheet list assets
in order of decreasing liquidity
define liquidity
ease of converting noncash assets into cash
what’s the general order of current assets
cash + cash equivalents - currency, bank deposits, investments w/maturity of 90 days or less
short-term investments - marketable securities and other investments the company expects to dispose of in the short run
AR - amounts due from customers arising from sale of products + services on credit
inventories - goods purchased/produced for sale to customers
prepaid expenses = costs paid in advance for rent/insurance/advertising/other services
why do companies require a degree of liquidity
to operate effectively as they must be able to respond to changing market conditions and take advantage of opportunities
what is included in long term assets
PP&E - land/factory buildings, items used in operating acticities - no office expenses
long-term investments - investments the company doesn’t intend to sell in the next fiscal year
intangible and other assets - assets w/out physical substance - patents/trademarks the company incurred to provide future benefits
how are assets measured?
at their historical cost less cumulative amount of depreciation/amortization if it’s a long term asset
does the balance sheet only include items that can be reliably measured
yes, If a
company cannot value an asset with relative certainty, it does not recognize an asset on the balance
sheet. This means that sizable “assets” are
not
reflected on a balance sheet.
are internally created intangible assets on the BS?
no
why are knowledge based industries hard to value
Excluded intangible assets often relate to
knowledge-based
(intellectual) assets, such as a
valuable brand, a strong management team, a well-designed supply chain, superior technology,
and the like. Although these intangible assets confer a competitive advantage to the company and
yield above-normal income (and clear economic benefits to those companies), they cannot be
reliably measured. These intangible assets are not reported on the balance sheet, and this is one
reason why companies in knowledge-based industries are so challenging to analyze and value.
can a company’s market value reflect the knowledge based assets
yes
define liabilities and stockholder’s equity
Liabilities represent a company’s future economic sacrifices. Liabilities are borrowed
funds, such as accounts payable and obligations to lenders. They can be interest-bearing or
non-interest-bearing.
■
Stockholders’ equity represents capital that has been invested by the stockholders, either directly
via the purchase of stock, or indirectly in the form of
retained earnings
that reflect profits that
are reinvested in the business and not paid out as dividends or used for share repurchases.
what does the liability and stockholders’ equity represent
sources of capital the company uses to finance acquisition of assets
why do companies go through debt financing
lower ROI, interest is tax deductible but dividends are not, - thus debt is a less expensive source of capital than equity
but companies have to pay principal and interest
why do companies split financing between debt and equity?
Thus, companies take on
a level of debt they can comfortably repay at reasonable interest costs. The remaining balance
required to fund business activities is financed with more costly equity capital.
define current liabilities
obligations that must be settled in 1 year
what are the examples fo current liabilities
Accounts payable
—amounts owed to suppliers for goods and services purchased on credit; also
called trade payables or trade credit.
Accrued liabilities
—obligations for expenses that have been incurred but not yet paid; also called
accrued expenses.
Unearned revenues
—cash the seller receives in advance from customers for goods or services
it will deliver in the future; also called advances from customers, customer deposits, or deferred
revenues.
Short-term debt
—loans from banks or other creditors; includes short-term notes and commercial
paper.
Current maturities of long-term debt
—principal portion of long-term debt that is due to be
paid within one year.
whats accrued liabilities
incomplete transactions
whats net working capital
reflects the difference between current
assets and current liabilities
Net working capital = Current assets − Current liabilities
define trade credit
inventory being purchased on credit from suppliers
why might a manager shorten the operating cycle
to complete the as many cycles as possible during the year to maximize profit and cash flow
how to shorten the operating cycle
Decrease accounts receivable with tighter credit-granting policies and more assertive collec-
tion procedures.
■
Reduce inventory levels by improved production systems and management of the depth and
breadth of inventory.
■
Increase accounts payable (supplier credit) to minimize the cash invested in inventories.
define cash conversion cycle
Analysts often use the “cash conversion cycle” to evaluate company
liquidity. The cash conversion cycle is the number of days the company has its cash tied up in
receivables and inventories less the number of days of trade credit provided by company suppliers.
DSO + DIO - DPO = CCC
how is the level of debt related to a company
Companies must monitor
their financing sources and amounts. Too much borrowing is risky in that borrowed money must
be repaid with interest. The level of debt a company can effectively manage is directly related
to the stability and reliability of its operating cash flows.
define SE, common stock, additional paid in capital, preferred stock, treasury stock, retained earnings, accumulated other comprehensive income or loss
Stockholders’ equity
reflects financing provided from company owners. Equity is often referred
to as
residual interest.
That is, stockholders have a claim on any assets in excess of what is needed
to meet company obligations to creditors. The following are examples of items typically included
in equity.
Common stock
—par value received from the original sale of common stock to investors.
Additional paid-in capital
—amounts received from the original sale of stock to investors in
excess of the par value of stock.
Preferred stock
—value received from the original sale of preferred stock to investors; preferred
stock has fewer ownership rights than common stock.
Treasury stock
—amount the company paid to reacquire its common stock from shareholders
(with the shares being held for resale).
Retained earnings
—accumulated net income (profit) that has not been distributed to stockholders as dividends or as stock repurchases.
Accumulated other comprehensive income or loss
—accumulated changes in asset and liability
fair values that are not reported in the income statement.
define contributed capital
the net funding a company received from issuing
and reacquiring its shares; that is, the funds received from issuing shares less any funds paid to
repurchase such.
define earned capital
primarily includes Retained earnings, which is the cumula-
tive net income (loss) that the company has earned but not paid out to stockholders as dividends.
Retained earnings also includes the cost of repurchased stock that the company has retired.
what the point fo AOCI
reports the accumulated
changes in asset and liability fair values that are not reported in the income statement. AOCI
includes gains and losses on certain types of investments in debt securities, pension plans, securi-
ties used to hedge certain risks (like the risks of changing interest rates or commodity prices), as
well as the effects of consolidating foreign subsidiaries.
retained earnings formula
beginning retained earnings + net income/loss - dividends - stock repurchased and retired = ending retained earnings
market value vs book value
Stockholders’ equity is the “value” of the company determined
by generally accepted accounting principles (GAAP) and is commonly referred to as the company’s
book value
. This book value is different from a company’s
market value
(market capitalization or
market cap), which is computed by multiplying the number of outstanding common
shares by the company’s stock price.
GAAP generally reports assets and liabilities at historical costs, whereas the market attempts
to estimate fair market values.
■
GAAP excludes resources that cannot be reliably measured (due to the absence of a past
transaction or event), such as talented management, employee morale, recent innovations, and
successful marketing, whereas the market attempts to value these.
■
GAAP does not consider the business environment in which companies operate, such as
competitive conditions and expected changes, whereas the market attempts to factor in these
differences in determining value.
■
GAAP does not usually capture expected future performance, whereas the market attempts to
predict and value future performance.
what’s the role of an income statement
reports revenues earned from products sold and services provided during a
period, the expenses incurred to produce those revenues, and the resulting net income or loss.
when does noncontrolling interest arise
when a subsidiary company is partially owned by shareholders other than the
parent company.
define operating expenses
sual and customary costs a company incurs to support its oper-
ating activities. Those include cost of goods sold (most often reported as a separate line item),
selling expenses, depreciation expense, and research and development expense (often reported as
highly aggregated numbers). Not all of these expenses require a cash outlay; for example, depre-
ciation expense is a noncash expense, as are many accrued expenses, such as wages payable, that
recognize the expense in advance of cash payment.
define nonoperating income and expenses
relate to the company’s financing and investing activities
and include interest expense, interest or dividend income, and gains and losses from the sale of securi-
ties.
what’s the revenue recognition principle and expenses recognition principal
Revenue recognition principle
—revenue is recognized when it is
earned
; this means we
recognize revenue when a performance obligation is satisfied by transferring to a cus-
tomer a promised good or service.
2
Expense recognition (matching) principle
—recognize expenses when
incurred
; this is
when the company receives the benefit associated with the expense (not necessarily when
cash is paid).
follows accrual accounting - when performance contract is satisfied, utilizes estimates and assumptions
what are the 2 components of discontinued operations
- Net income (loss) from the discontinued segment’s business activities prior to sale.
- Any gain or loss on the actual sale of the discontinued segment.
how to be classified as a discontinued operation
the disposal of the business unit must represent
a strategic shift that has, or will have, a major effect on the company’s financial results. Because
these divestitures represent strategic shifts with material financial effects, the reporting of discon-
tinued operations is relatively infrequent.
why are discontinued segregated from income from continuing operations
discontinued operations affect the current and prior periods but will not recur. Many financial
statement users analyze current-year financial statements to help predict future performance.
Although transitory items help us understand past performance, they are largely
irrelevant to predicting future performance. Consequently, investors and other financial statement
users focus on income from continuing operations because it represents the profitability that is
likely to persist (continue) into the future. Likewise, the financial press tends to focus on income
from continuing operations when it discloses corporate earnings (often described as earnings
before one-time charges, or street earnings).
what influences the gross profit margin
is influenced by both the selling price of the company’s products
and the cost to make or buy those products
We analyze the gross profit margin by
comparing the ratio over time and with peer companies’ ratios. Typically, a high and/or increasing
gross profit margin is a positive sign. A low or declining margin signals more intense competition or a lessening of the desirability of the company’s product line or increasing inventory costs.
what do you do in an analysis of operating expenses
focuses on each expense category reported by the company as
a percentage of sales over time and compared with peer companies. Any deviations from historical
trends or significantly higher or lower levels from peer companies should be investigated to uncover
causes. A particularly worrisome sign is when margins for operating expenses are declining in the
face of falling profits. The concern is that the company might have tried to address declining profits
by reducing critical expenses such as R&D, marketing, or compensation costs. If so, this might lead
to a short-term improvement at a long-term cost as market share declines and employee morale suffers.
IFRS vs US GAAP
SEC requires three years of comparative income statements, whereas IFRS requires only two.
■
GAAP income statements categorize expenses by their function (such as cost of sales, selling,
or administrative). For IFRS, expenses can be shown either by function or by nature (such as
materials, labor, or overhead), whichever provides more reliable and relevant information.
interpreting a statement of SE
Common stock and additional paid-in capital increase by the proceeds from the sale of stock.
Retained earnings increase by the net income (or decrease by the net loss) reported in the income
statement and decrease by the dividends to shareholders. Retained earnings also decrease if a
company repurchases shares from stockholders and then retires the repurchased shares. These
“buybacks” are another form of distribution to shareholders similar to the payment of dividends
(which also decreases retained earnings).
3
Accumulated other comprehensive income (loss)
increases and decreases by changes in asset and liability fair values that are not reported in the
income statement
what info does the cash flow statement provide
provides information about the company’s ability to generate cash
from those same transactions. It tells us from what sources the company has generated its cash
(so we can evaluate whether those sources are persistent or transitory) and what it has done with
the cash it generated.
what are cash flows form operating activities vs investing activities, financing activities
Cash flows from operating activities
Cash flows from the company’s transactions and
events that relate to its operations.
■
Cash flows from investing activities
Cash flows from acquisitions and divestitures of
investments and long-term assets.
■
Cash flows from financing activities
Cash flows from issuances of and payments toward
borrowings and equity.
what are the general questions used in analyzing a cash flow - sources and uses of cash
Is the company generating cash from operating activities?
■
Is the operating cash flow sustainable?
■
Is the company investing its cash to grow its infrastructure (PP&E) or to enter new markets
by acquiring other companies?
■
Is the company using its excess cash to build liquidity (purchase of marketable securities)?
■
Is the company paying down debt or paying dividends?
■
Is the company repurchasing stock?
what’s the 4 step accounting cycle
Step 1
Record transactions in the accounting records. Each transaction is the result of an
external or internal transaction or event, such as a sale to a customer or the payment of wages
to employees.
■
Step 2
Prepare accounting adjustments, which recognize a number of events that have
occurred but that have not yet been recorded. These might include the recognition of wage
expense and the related wages payable for those employees who have earned wages but have
not yet been paid or of depreciation expense for buildings and equipment.
■
Step 3
Construct the financial statements.
■
Step 4
Close the books in anticipation of the start of a new accounting cycle.
what are the 4 types of accounting adjustments
Deferred (prepaid) expenses
Deferred expenses reflect advance cash payments that will
ultimately become expenses. An example is the payment for radio advertising or the purchase of PP&E that will be used in future period(s).
■
Deferred (unearned) revenues
Deferred revenues reflect cash received from customers
before any services or goods are provided. An example is cash received from patrons for
tickets to an upcoming concert.
■
Accrued expenses
Accrued expenses are expenses incurred and recognized on the income
statement even though they are not yet paid in cash. An example is wages owed to employees who performed work but who have not yet been paid. Accrued expenses are also called
accrued liabilities.
■
Accrued revenues
Accrued revenues are revenues earned and recognized on the income
statement even though cash is not yet received. Examples include sales on credit and revenue earned under a long-term contract
whats the order in preparing financial statements
First, a company prepares its income statement using the income statement accounts. It then
uses the net income number and dividend information to update the retained earnings account.
■
Second, it prepares the balance sheet using the updated retained earnings account along with
the remaining balance sheet accounts.
■
Third, it prepares the statement of stockholders’ equity.
■
Fourth, it prepares the statement of cash flows using information from the cash account (and
other sources).
what’s the closing process
refers to “zeroing out” the temporary accounts by
transferring their ending balances to retained earnings. Income statement accounts—revenues
and expenses—and the dividend account are
temporary accounts
because their balances
are zero at the start of each accounting period so that only the current period’s activities are
included. Balance sheet accounts carry over from period to period and are called permanent
accounts. The closing process is typically carried out via a series of journal entries that succes-
sively zero out each revenue and expense account and the dividend account, transferring those
balances to retained earnings. The result is that all income statement accounts and the dividend
account begin the next period with zero balances. The balance sheet accounts do not need to be
similarly adjusted because their balances carry over from period to period.
what are general categories in a form 10-K
Item 1.
Business
Item 1A.
Risk Factors
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Mine Safety Disclosures
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities
Item 6.
[Reserved]
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of
Operations
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Item 9C.
Disclosure Regarding Foreign Jurisdictions That Prevent Inspections
Item 10.
Directors, Executive Officers, and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accountant Fees and Services
Item 15.
Exhibit and Financial Statement Schedules
Item 16.
Form 10-K Summary
