chp 2 Flashcards

Question

why might a manager shorten the operating cycle

Answer 1

to complete the as many cycles as possible during the year to maximize profit and cash flow

Answer 2

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.

Answer 3

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

Answer 4

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.

Answer 5

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.

Answer 6

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.

Answer 7

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.

Answer 8

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.

Answer 9

beginning retained earnings + net income/loss - dividends - stock repurchased and retired = ending retained earnings

Answer 10

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.

Answer 11

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.

Answer 12

when a subsidiary company is partially owned by shareholders other than the parent company.

Answer 13

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.

Answer 14

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.

Answer 15

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

Answer 16

1. Net income (loss) from the discontinued segment’s business activities prior to sale. 2. Any gain or loss on the actual sale of the discontinued segment.

Answer 17

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.

Answer 18

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).

Answer 19

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.

Answer 20

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.

Answer 21

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.

Answer 22

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

Answer 23

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.

Answer 24

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.

Answer 25

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?

Answer 26

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.

Answer 27

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

Answer 28

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).

Answer 29

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.

Answer 30

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