CMA Review Part 1 Flashcards

1
Q

Name 5 External Users of Financial Statements

A
  1. Investors
  2. Creditors
  3. Financial Advisers
  4. Stock Exchanges
  5. Regulatory Agencies
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2
Q

Why do investors need financial information?

A

To decide whether to increase, decrease or obtain an investment in the firm.

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3
Q

Why do creditors need financial information?

A

To determine whether to extend credit and under what terms.

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4
Q

Why do financial advisers need financial information?

A

Need financial statements to help investors evaluate particular investments.

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5
Q

Why do stock exchanges need financial information?

A

Need financial statements to evaluate whether to accept a firm’s stock for listing or whether to suspend the stock’s trading

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6
Q

Why do regulatory agencies need financial information?

A

Need financial statements to evaluate the firm’s conformity with regulations and to determine price levels in regulated industries.

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7
Q

Name 3 internal users of financial statements

A
  1. Management
  2. Employees
  3. Board of Directors
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8
Q

Why do management and BOD need financial information?

A

Need financial statements to assess financial strengths and deficiencies, to evaluate performance results and past decisions, and to plan for future financial goals and steps toward accomplishing them.

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9
Q

Why do employees need financial information?

A

Want financial information to negotiate wages and fringe benefits based on the increased productivity and value they provide to a profitable firm.

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10
Q

A full set of financial statements includes what 5 statements?

A
  1. Statement of Financial Position (Balance Sheet)
  2. Income Statement
  3. Statement of Comprehensive Income
  4. Statement of Changes in Equity
  5. Statement of Cash Flows
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11
Q

Why are financial statement notes important?

A

Notes are considered part of the basic financial statements because they amplify or explain information recognized in the statements and are an integral part of statements prepared in accordance with GAAP.

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12
Q

What is the first footnote accompanying any set of complete financial statements?

A

Generally describe significant accounting policies, such as the use of estimates and rules for revenue recognition.

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13
Q

How does net income from the income statement relate to equity on the statement of financial position?

A

Net income or loss from the statement of income is reported and accumulated in the retained earnings account, a component of the equity section of the statement of financial position.

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14
Q

How does the components of cash and equivalents relate to the statement of cash flows?

A

The components of cash and equivalents from the statement of financial position are reconciled with the corresponding items in the statement of cash flows.

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15
Q

How are items of equity from the statement of financial position related to the statement of changes in equity?

A

Items of equity from the statement of financial position are reconciled with the beginning balances on the statement of changes in equity.

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16
Q

How are ending inventories related to the COGS on the statement of income?

A

Ending inventories are reported in current assets on the statement of financial position and are reflected in the calculation of cost of goods sold on the statement of income.

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17
Q

How is amortization related to the statement of financial position?

A

Amortization and depreciation reported in the statement of income also are reflected in asset and liability balances in the statement of financial position.

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18
Q

What is accrual accounting?

A

Accrual accounting records the financial effects of transactions and other events and circumstances when they occur rather than when their associated cash is paid or received.

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19
Q

When do you recognize revenue?

A

Revenues are recognized in the period in which they were earned even if the cash will be received in a future period.

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20
Q

When are expenses recognized?

A

Expenses are recognized in the period in which they were incurred even if the cash will be paid in a future period.

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21
Q

What is the statement of financial position?

A

The statement of financial position is also called the balance sheet and reports the amounts of assets, liabilities, equity, and their relationships at a moment in time, such as at the end of the fiscal year.

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22
Q

What is the basic accounting equation?

A

Assets = Liabilities + Equity

The entity’s resources consist of the assets the entity deploys in its attempts to earn a return. The capital structure consists of the amounts contributed by outsiders (liabilities) and insiders (equity)

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23
Q

Name 4 examples of Assets

A
  1. Inventory
  2. Accounts Receivable
  3. Investments
  4. PPE (Property Plant & Equipment)
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24
Q

How are assets/liabilities separated on the Balance Sheet?

A

Into 2 categories:

  1. Current
  2. Non Current
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25
Q

Name 3 examples of liabilities

A
  1. Loans Payable
  2. Bonds issued by the entity
  3. Accounts Payable
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26
Q

List 5 examples of current assets

A
  1. Cash
  2. Certain investments
  3. Accounts and Notes receivable
  4. Inventories
  5. Pre-paid expenses
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27
Q

List 4 examples of non current assets

A
  1. Certain investments and funds
  2. PPE (Property Plant Equipment)
  3. Intangible assets
  4. Other non current assets
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28
Q

List 3 examples of current liabilities

A
  1. Accounts payable
  2. Current notes payable
  3. Current maturities of non current liabilities
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29
Q

List 2 examples of non current liabilities

A
  1. Non current notes payable

2. Bond payable

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30
Q

What are the 5 classifications of the Balance Sheet?

A
  1. Equity
  2. Investments by owners
  3. Retained earnings
  4. Accumulated other comprehensive income
  5. Non controlling interest in a consolidated entity
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31
Q

List 3 examples of Equity

A
  1. Common stock
  2. Preferred stock
  3. Retained earnings
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32
Q

What are investments by owners?

A

Increases in equity of a business entity. They result from transfers of something of value to increase ownership interests. Assets are the most commonly transferred item, but services also can be exchanged for equity interests.

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33
Q

What are distributions to owners?

A

Decreases equity. They result from transferring assets to owners. A distribution to owners decreases the ownership interest in the company.

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34
Q

How are assets/liabilities classified as current and non current?

A

They are classified as current if it is expected to be realized in cash or sold or consumed within the entities operating cycle or 1 year, whichever is longer. Non current do not qualify as current.

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35
Q

List 4 major items of equity

A
  1. Capital contributions by owners – Par value of common and preferred stock issued and additional paid-in capital.
  2. Retained Earnings – Accumulated net income not yet distributed to owners
  3. Treasury stock – is the firms own stock that has been repurchased
    Reported either at cost (as a deduction from total equity) or at par (as a direct reduction of the relevant contributed capital account) Is reported as a reduction of the total equity
  4. Accumulated other comprehensive income – items not included in net income
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36
Q

What are the 3 limitations to the balance sheet

A
  1. A balance sheet shows a company’s financial situation at a single point in time; accounts may vary significantly a few days before or after
  2. Many balance sheet items, such as fixed assets, are valued at historical costs, which may not equal their fair value
  3. The preparation of the balance sheet requires estimates and management judgment
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37
Q

What is off-balance sheet financing

A

May be used when a business is close to its borrowing limit and wants to purchase something, as a method of lowering borrowing rates, as a way of managing risk, or to improve debt-to-equity and leverage ratios

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38
Q

List 4 examples of off-balance sheet financing

A
  1. Operating leases – the asset itself is kept on the lessor’s balance sheet and the lessee reports only the required rental expense for use of the asset
  2. Factoring receivables with recourse – The firm remains contingently liable to the finance company in the case of debtor default and the contingent liability does not have to be reported on the company’s balance sheet.
  3. Special purpose entities – A firm may create another firm for the sole purpose of keeping the liabilities associated with a specific project off the parent firm’s books.
  4. Joint venture – Generally accounted for on the equity basis; hence, the joint venture’s debts are not reflected as debt of the members of the joint venture
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39
Q

What is the income equation?

A

Income (Loss) = Revenues + Gains – Expenses – Losses

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40
Q

What are the 4 elements of the income statement?

A
  1. Revenues – are inflows or other enhancements of assets or settlements of liabilities (or both) from delivering or producing goods, providing services, or other activities that qualify as ongoing major or central operations.
  2. Gains – increases in equity (or net assets) other than from revenues or investments by owners
  3. Expenses – outflows or other usage of assets or incurrences of liabilities (or both) from delivering or producing goods, providing services, or other activities that qualify as ongoing major or central operations
  4. Losses – are decreases in equity (or net assets) other than from expenses or distributions to owners.
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41
Q

All transactions affecting the net change in equity during the period are included in income except:

A
  1. Transactions with owners
  2. Prior-period adjustments (such as error correction or a change in accounting principle)
  3. Items reported initially in other comprehensive income
  4. Transfers to and from appropriated retained earnings
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42
Q

Revenues, expenses, gains, and losses are recorded in Temporary (nominal) accounts because they record the transactions, events, and other circumstances during a period of time. These accounts are closed (reduced to zero) at the end of each accounting period, and their balances are transferred to real accounts.

A

For example, income or loss for the period is closed to retained earnings at the end of the reporting period.

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43
Q

Typical Items of Cost and Expense - COGS

A
Cost of Goods Sold
For a retailer, cost of goods sold is calculated based on changes in inventory:
Beginning Inventory 		$10,000
Plus: Net purchases		$14,000
Plus: Freight-in		        $1,000
Good available for sale		$25,000
Minus: Ending Inventory	($5,000)
Cost of Goods Sold		$20,000
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44
Q

Typical Items of Cost and Expense - COGS

A

For a manufacturer, cost of goods sold is calculated as follows:

Beginning raw materials inventory $3,000
Purchases during the period $3,000
Ending raw materials inventory ($1,000)
Direct materials used in production $5,000
Direct labor costs $5,000
Manufacturing overhead costs (fixed + variable)
$4,000
Total manufacturing costs $14,000 *TAKEN FROM SECOND COLUMN
Beginning work-in-process inventory $5,000
Ending work-in-process inventory $ (4,000)
Cost of goods manufactured $15,000
Beginning finished goods inventory $ 6,000
Ending finished goods inventory $(11,000)
Cost of goods sold $10,000

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45
Q

Common share-based payment arrangements between employers and employees include:

A
  1. Call options that give employees the right to purchase an entity’s shares in exchange for their services
  2. Share appreciation rights that entitle employees to cash payments calculated by reference to increases in the market price of an entity’s shares, and
  3. Share ownership plans where employees receive an entity’s shares in exchange for their services.
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46
Q

List the 2 income statement formats

A
  1. Single-Step provides one grouping for revenue items and one for expense items.
  2. Multiple-Step presents operating revenues and expenses in a section separate from non-operating items.
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47
Q

Example of a multiple-step income statement

A
Income Statement
		Net Sales				$200,000
			Cost of goods sold		$(150,000)
		Gross Profit				$    50,000
			Selling Expenses		$    (6,000)
			Administrative Expenses	$    (5,000)
		Income from Operations		$    39,000
			Other revenues and gains	$       3,500
			Other expenses and losses	$      (2,500)
		Income before Taxes			$    40,000
			Income taxes			$  (16,000)
		Net Income				$   24,000
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48
Q

Discontinued Operations

A
  1. When an entity reports a discontinued operation, it must be presented in a separate section after income from continuing operations
  2. Discontinued operations, if reported, may have 2 components
    Income or loss from operations of the component that has been disposed of or is classified as held for sale from the first day of the reporting period until the date of disposal (or the end of the reporting period if it is classified as held for sale)
    Gain or loss on the disposal of this component.
  3. An entity is required to separately present items that are of an unusual nature and/or occur infrequently on a pre-tax basis within income from continuing operations. The standard took effect for fiscal years beginning after December 15, 2015.
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49
Q

Income Statement Note Disclosure Examples

A
Note disclosures and schedules specifically related to the income statement include the following:
Earnings per share
Depreciation schedules
Components of income tax expense
Components of pension expense
50
Q

What are the limitations of the income statement?

A
  1. The income statement does not always show all items of income and expense. Some of the items are reported on a statement of other comprehensive income and not included in the calculation of net income
  2. The financial statements reported accrual-basis results for the period. The company may recognize revenue and report net income before any cash was actually received.
  3. The preparation of the income statement requires estimates and management judgment.
51
Q

Statement of Comprehensive income

A

Comprehensive income includes all changes in equity (net assets) of a business during a period except those from investments by and distributions to owners. It consists of Net income or loss and Other comprehensive income (OCI)

52
Q

What items are excluded from the calculation of net income and are instead included in comprehensive income?

A
  1. The effective portion of a gain or loss on a hedging instrument in a cash flow hedge
  2. Unrealized holding gains and losses due to changes in the fair value of available-for-sale securities
  3. Translation gains and losses for financial statements of foreign operations
  4. Certain amounts associated with accounting for defined benefit post-retirement plans
53
Q

Example of a Statement of Comprehensive income

A

Net income $70,000
Other comprehensive income (net of tax)
Loss on defined benefit post-retirement plans
$(15,000)
Gains on foreign currency translation
$6,000
Gains on remeasuring available-for-sale securities
$4,000
Effective portion of losses on cash flow hedges
$( 3,000)
Other Comprehensive income(loss)
$ 8,000
Total Comprehensive income
$62,000

54
Q

Statement of Changes in Equity

A

A statement of changes in equity presents a reconciliation for the accounting period of the beginning balance for each component of equity to the ending balance.

55
Q

List the common changes in the equity component balances during an accounting period on the Statement of Changes in Equity

A
  1. Net income (loss) for the period, which increases (decreases) retained earnings balance
  2. Distributions to owners (dividends paid), which decreases the retained earnings balance.
  3. Issuance of common stock, which increases the common stock balance. If the amount paid for the stock is above the par value of stock, the balance of additional paid-in capital is increased for the difference.
  4. Total change in other comprehensive income during the period.
  5. Repurchase of common stock (treasury stock) decreases the total shareholders’ equity
56
Q

Statement of Retained Earnings

A

A statement of retained earnings reconciles the beginning and ending balances of the account. This statement is reported as part of the statement of changes in equity in a separate column

57
Q

Retained Earnings Reconciliation

A
Retained earnings beginning balance
\+ Net income (loss) for the period
Dividends distributed during the period
\+ Positive (Negative) prior-period adjustments
    Retained Earnings ending balance
58
Q

Retained earnings are sometimes appropriated (restricted) to a special account to disclose that earnings retained in the business (not paid out in dividends) are being used for special purposes, list 4 purposes

A
  1. Compliance with a bond indenture (bond contract)
  2. Retention of assets for internally financed expansion
  3. Anticipation of losses
  4. Adherence to legal restrictions
59
Q

What is ‘Stock Authorized’

A

is the maximum amount of stock that a corporation is legally allowed to use

60
Q

What is ‘Stock Issued’

A

is the amount of stock authorized that has actually been issued by the corporation

61
Q

What is ‘Stock Outstanding’

A

the amount of stock issued that has been purchased and is held by shareholders

62
Q

Common Shareholders

A

Common shareholders are entitled to receive liquidating distributions only after all other claims have been satisfied, including those of preferred shareholders. Common shareholders ordinarily have preemptive rights. Preemptive rights give current common shareholders the right to purchase any additional stock issuance in proportion to their ownership percentages. This way the preemptive rights safeguard a common shareholder’s proportionate interest in the firm.

63
Q

Preferred Stock

A

Preferred Stock has features of debt and equity. It is classified as an equity instrument and presented in the equity section of the firm’s balance sheet. Preferred stock has a fixed charge, but payment of dividends is not an obligation. The payment of dividends is at the firm’s discretion. Preferred shareholders tend not to have voting rights.

64
Q

Preferred Shareholders rights

A
  1. Dividends at a specified fixed rate before common shareholders may receive any and
    2 Distributions before common shareholders, but after creditors, in the event of firm bankruptcy (liquidation)
65
Q

2 common features of preferred stock

A
  1. Cumulative preferred stock accumulates unpaid dividends (called dividends in arrears). Dividends in arrears must be paid before any common dividends can be paid
  2. Holders of convertible preferred stock have the right to convert the stock into shares of another class (usually common stock) at a predetermined ratio.
66
Q

Example of Issuance of Stock transaction

A

A company issued 50,000 shares of its $1 par-value common stock. The market price of the stock was $17 per share on the day of issue.
Cash (50,000 shares* $17 market price) $850,000
Common stock (50,000 shares * $1 par value) $ 50,000
Additional Paid-in Capital – Common (difference) $800,000

67
Q

Direct costs of issuing stock

A

Direct costs of issuing stock (underwriting, legal, accounting, tax, registration, ect) must not be recognized as an expense. Instead, they reduce the net proceeds received and additional paid-in capital.

68
Q

Cash Dividend

A

On the date of declaration, the BOD formally approves a dividend. (Decreases (debits) the Retained Earnings account)

69
Q

Cash Dividend Entry Example - Declaration Date

A

September 12 - Declaration Date

Retained Earnings (40,000 * $3)    120,000
Dividends Payable                                              120,000
70
Q

Cash Dividend Entry Example - Payment Date

A

October 15 - Payment Date

Dividends Payable 120,000
Cash 120,000

71
Q

Property Dividend

A

When an entity declares a dividend consisting of tangible property,

  1. The property is remeasured to fair value as of the date of declaration, and any gain or loss on the re-measurement is recognized in the statement of income.
  2. The carrying amount of retained earnings is decreased for the fair value of the property to be distributed
  3. The property is distributed as a dividend.
72
Q

Property Dividend Transaction Example

A

August 1 – Declaration Date
Land (80,000 – 50,000) $30,000
Retained Earnings $80,000
Gain on land re-measurement $30,000 Property Dividend payable $80,000

December 1 - Payment Date
Property Dividend Payable $80,000
Land $80,000

73
Q

Stock Dividend

A

A stock dividend involves no distribution of cash or other property. Stock dividends are accounted for as a reclassification of different equity accounts, not as liabilities.

74
Q

Stock Dividend Accounting

A

The accounting for stock dividends depends on the percentage of new shares to be issued:

  1. An issuance of shares less than 20 – 25% of the previously outstanding common shares should be recognized as a stock dividend.
  2. An issuance of more than 20-25% of the previously outstanding common shares should be recognized as a stock split in the form of a dividend.
75
Q

Stock Dividend Example

A

May 1 – declaration date
Retained earnings [(45,000 shares * 10%) * 15 market price] $67,500(DR)
Common stock [(45,000 shares * 10%) * $1 par value] $ 4,500(CR)
Additional paid-in capital (difference) $63,000(CR)

76
Q

Stock Split

A

Stock splits are issuances of shares that do not affect any aggregate par value of shares issued and outstanding or total equity. Stock splits reduces the par value of each stock and increases the number of shares outstanding.

No entry is made, and no transfer from retained earnings occurs.

77
Q

Changes in Equity Footnotes

A
  1. Class of Stock
  2. Share-based payment compensation
  3. Dividends
  4. Retained Earnings
  5. Stockholders’ Equity
78
Q

Limitations of Changes in Equity

A
  1. The company may recognize revenue and/or expense and report net income before any cash was actually received and/or paid. Hence, the data for retained earnings is not sufficient for assessing the amount actually available to be reinvested in the company or to pay debt.
  2. The statement of changes in equity illustrates a company’s equity based on a specific time period; equity may vary significantly a few days before or after publication of the statement.
79
Q

Changes in Equity IFRS Difference

A

An entity presents a statement of changes in equity that displays, for each component of equity, a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing changes in ownership interests in subsidiaries that do not result in a loss of control.

80
Q

Statement of Cash Flows

A

The Primary purpose of the statement of cash flows is to provide relevant information about the cash receipts and cash payments of an entity during the period.

81
Q

Statement of Cash Flows Example

A

Net cash provided by (used in) operating activities $20,000
Net cash provided by (used in) Investing activities $(5,000)
Net cash provided by (used in) financing activities $ 9,000
Net increase (decrease) in cash and cash equivalents during the year $24,000
Cash and cash equivalents at beginning of year (January 1, Year 1) $ 6,000
Cash and cash equivalents at end of year (December 31, Year 1) $30,000

82
Q

Operating Activities

A

Operating activities are all transactions and other events that are not financing or investing activities. Cash flows from operating activities are primarily derived from the principal revenue-producing activities

83
Q

Cash Inflows

A
  1. Cash receipts from the sale of goods and services (including collections of accounts receivable)
  2. Cash receipts from royalties, fees, commissions, and other revenue
  3. Cash received in the form of interest or dividends
84
Q

Cash Outflows

A
  1. Cash payments to suppliers
  2. Cash payments to employees
  3. Cash payments to government for taxes, duties, fines, and other fees or penalties
  4. Payments of interest on debt
85
Q

Cash Outflows (Inflows) from investing activities examples

A
  1. Cash payments to acquire (cash receipts from sale of) property, plant, and equipment; intangible assets; and other long-lived assets
  2. Cash payments to acquire (cash receipts from sale and maturity of) equity and debt instruments of other entities for investing purposes
  3. Cash advances and loans made to other parties (cash reciepts from repayment of advances and loans made to other parties)
86
Q

Cash Inflows from Financing activities examples

A
  1. Cash proceeds from issuing shares and other equity instruments(obtaining resources from owners)
  2. Cash proceeds from issuing loans, notes, bonds, and other short-term or long-term borrowings.
87
Q

Cash Outflows from Financing activities examples

A
  1. Cash repayments of amounts borrowed
  2. Payments of cash dividends
  3. Cash payments to acquire or redeem the entity’s own shares
  4. Cash payments by a lessee for a reduction of the outstanding liability relating to a capital lease.
88
Q

Non-cash Investing and financing activities

A

Information about all investing and financing activities that affect recognized assets or liabilities but not cash flows must be disclosed in the notes, outside the body of the statement of cash flows.

89
Q

Non-cash Investing and financing activities examples

A
  1. Conversion of debt to equity
  2. Acquisition of assets either by assuming directly related liabilities or by means of capital lease
  3. Exchange of a non-cash asset or liability for another
90
Q

Under the indirect method (also called the reconciliation method), the net cash flow from operating activities is determined by adjusting the net income of a business for the effect of the following:

A
  1. Non cash revenue and expenses that were included in net income, such as depreciation and amortization expenses, impairment losses, undistributed earnings of equity-method investments, and amortization of discount and premium on bonds
  2. Items included in net income whose cash effects relate to investing or financing cash flows, such as gains or losses on sales or property and equipment and gain or looses on extinguishment of debt
  3. All deferrals of past operating cash flows, such as changes during the period in inventory and deferred income
  4. All accruals of expected future operating cash flows, such as changes during the period in accounts receivable and accounts payable
91
Q

The reconciliation of net income to net cash flow from operating activities must disclose all major classes of reconciling items. At a minimum, this disclosure reports changes in:

A
  1. Accounts Receivable and Accounts Payable related to operating activities
  2. Inventories
92
Q

Indirect Method of Presenting Operating Cash Flow Example

A

Cash Flows from Operating Activities:
Net Income $5,000
Increase in accounts receivable ($7,000 - $6,000) $(1,000)
Decrease in inventory ($11,5000 - $14,000) $2,500
Decrease in accounts payable ($3,000 - $5,000) $(2,000)
Total Adjustments $(500)
Net Cash provided by operating activities $4,500
Cash at beginning of Year $10,000
Cash at end of Year $14,500

93
Q

The following rules will help reconcile the net income to net cash flow from operating activities under the indirect method:

A

Increase in current operating liabilities Add to net income
Decrease in current operating assets Add to net income
Increase in current operating assets Subtract from net income
Decrease in current operating liabilities Subtract from net income

94
Q

The following rules will help reconcile net income to net cash flow from operating activities under the indirect method:

A
  1. Non-cash losses and expenses included in net income Added to net income
  2. Losses and expenses whose cash effects are related to investing or financing Added to net income
  3. Non-cash gains and revenues included in net income Subtracted from net income
  4. Gains and revenues whose cash effects are related to investing or financing Subtracted from net income
95
Q

Under the direct method, the entity presents major classes of actual gross operating cash receipts and payments and their sum (net cash flow from operating activities). At a minimum, the following must be presented:

A
  1. Cash collected from customers
  2. Interest and dividends received
  3. Other operating cash receipts, if any
  4. Cash paid to employees and other suppliers of goods and services
  5. Interest paid
  6. Income taxes paid
  7. Other operating cash payments, if any
96
Q

Limitations of the Statement of Cash Flows

A
  1. A cash flow statement is not sufficient for forecasting the profitability of a firm as non-cash items are not included in the calculation of cash flow from operating activities
  2. A cash flow statement may not represent the true liquid position of an entity. Hence, decisions regarding large expenditures could be based on misconceived information when decisions are based only on the statement of cash flows. This statement must be viewed in conjunction with other financial statements, such as the balance sheet and the income statement.
  3. Information can be manipulated in the statement of cash flows. For instance, management can schedule vendor payments until after year-end to increase net cash flows reported on the statement of cash flows.
97
Q

According to the revenue recognition principle, revenues and gains should be recognized when:

A
  1. Realized or realizable

2. Earned

98
Q

Realized Revenues and Gains

A

Revenues and gains are realized when goods or services have been exchanged for cash or claims to cash. Revenues and gains are realizable when goods or services have been exchanged for assets that are readily convertible into cash or claims to cash

99
Q

Earned Revenues

A

Revenues are earned when the earning process has been substantially completed, and the entity is entitled to the resulting benefits or revenues.

Thus, revenue on sales can be recognized in the statement of income even if the cash from sales is not yet received.

100
Q

The Installment method

A

The installment method is only acceptable when receivables are collectible over an extended period and no reasonable basis exists for estimating the degree of collect ability.

101
Q

Gross Profit Percentage Equation

A

Gross Profit Percentage = Gross profit on installment sales/Installment sales

102
Q

The Installment method Example

A

Cash $100
Installment receivable, Year 1 $900
Cost of installment sales $600
Inventory $600
Installment Sales $1,000

103
Q

The Installment method Example Part 2

A

In December, when the first installment is received the entry is:
Cash $100
Installment receivable, Year 1 $100

At December 41, installment sales and cost of installment sales are closed, and deferred gross profit is recognized. Moreover, deferred gross profit must be adjusted to report the portion that has been earned. Given that $200 of the total price has been received, $80 of the gross profit ($200 cash collected *40% gross profit percentage) has been earned. The entry is:
	Installment sales			$1,000
		Cost of installment sales		$600
		Deferred gross profit			$400
	Deferred gross profit (Year 1)		$80
		Realized gross profit			$80
104
Q

Cost Recovery Method

A

The cost recovery method may be used in the same circumstances as the installment method. However, no profit is recognized until collections exceed the cost of the item sold. Subsequent receipts are treated entirely as revenues.

105
Q

Cost Recovery Method Example

A
In year 1, creditor made a $100,000 sale. The cost of the item sold was $70,000, and year 1 collections equaled $50,000. In year 2, collections equaled $25,000. The net receivable (receivable – deferred profit) was $0 at the end of year 2. The following entries are based on the cost-recovery method:
	Year 1:
Receivable			$100,000
	Inventory				$70,000
	Deferred gross profit		$30,000
	Year 2:
Cash				$25,000
Deferred gross profit		$5,000
	Receivable			$25,000
	Realized gross profit			$5,000
106
Q

Deposit Method

A

This method is used when cash is received, but the criteria for a sale have not been met. Thus, the seller continues to account for the property in the same way as an owner. No revenue or profit is recognized because it has not been earned, i.e. by transferring the property the entry is:
Cash $XXX
Deposit liability $XXX

107
Q

Buyback (Repurchase) Agreements

A

An agreement under which the transferor (repo party) transfers a financial asset to a transferee (repo counter party or reverse party) in exchange for cash and concurrently agrees to reacquire that financial asset at a future date for an amount equal to the cash, letters of credit, or other financial instruments exchanged plus or minus interest.

108
Q

Buyback (Repurchase) Agreements: FASB Accounting Standards Update (ASU) 2014-11

A

Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, expanded the accounting guidance for certain repurchase agreements to be accounted for as a secured borrowing.

109
Q

Buyback (Repurchase) Agreements: Topic 860

A

prescribes when an entity may recognize a sale upon the transfer of financial assets. Transfers of financial assets currently are accounted for as a sale of financial assets if all of the following conditions are met:

  1. The transferred assets have been isolated from the transferor even in bankruptcy
  2. The transferee has the right to pledge or exchange the transferred assets
  3. The transferor does not maintain effective control over the transferred financial assets, for example, through an agreement that entitles and obligates the transferor to repurchase or redeem them before their maturity
110
Q

Secured borrowing transactions are recorded as follows:

A

Cash $XXX
Transferor Encumbered Inventory $XXX
Inventory $XXX
Transferor Repurchase Obligation $XXX

Short-term Debt $XXX
Cash $XXX

Inventory $XXX
Transferor Repurchase Obligation $XXX
Interest $XXX
Transferor Encumbered Inventory $XXX
Cash $XXX

111
Q

Repurchase financing transactions considered a sale are recorded as follows:

A

Cash $XXXX
Option to Repurchase $ XXX
Inventory $XXX

Short-term Debt $XXXX
Cash $XXXX

Inventory $XXXX
Interest $ XX
Option to Repurchase $XXXX
Cash $XXXX

112
Q

When sales are made with the understanding that unsatisfactory goods may be returned, and these returns are expected to be material, revenue and cost of goods sold may be recognized and inventory may be credited when all of the following conditions exist:

A
  1. The seller’s price is substantially fixed or determinable;
  2. The buyer has paid or is obligated to pay, and the obligation is not contingent on resale;
  3. The buyer’s obligation is not changed if the product is stolen, damaged, or destroyed;
  4. The buyer has economic substance apart from the seller;
  5. The seller is not substantially obligated to directly bring about resale; and
  6. The amount of FUTURE RETURNS CAN BE REASONABLY ESTIMATED
113
Q

If the conditions are met from last card, a sale is recorded in the usual way. In addition, the following entries are made under the perpetual inventory system:

A

Sales Returns (Contra Revenue) $XXX
Allowance for sales returns (Contra AR)
$XXX
Inventory – Adjustment for estimated sales returns $XXX
COGS – adjustment for estimated sales returns
$XXX

114
Q

Trade Loading (Channel Stuffing)

A

Trade loading is the practice of inflating sales figures by forcing more products through a distribution channel than the channel can sell in the normal course of business.

115
Q

Possible instances of trade loading include:

A
  1. Cash that does not follow earnings;
  2. Accruals (the difference between earnings and cash) that do not correspond to either earnings or revenue;
  3. Accounts receivable aging analysis, which indicates a high amount of slow-paying customers and;
  4. Shipments not supported by sales orders
116
Q

Revenue Recognition before Delivery: The Completed-Contract Method

A

The completed-contract method is used to account for long-term project when the percentage-of-completion method is inappropriate.

  1. It defers all contract costs in the inventory account ‘construction in progress’ until the project is completed. It records progress billings in the contra-inventory account ‘progress billings’
  2. Revenue and gross profit are recognized only upon completion of the contract.
117
Q

Revenue Recognition before Delivery: Percentage-of-Completion Method of Long-term Construction Contracts

A

Percentage-of-Completion is the preferable method. It records all contract cots in construction in progress and all amounts billed in progress billings.

118
Q

The percentage-of-completion method differs from the completed-contract method because it recognizes revenue on long-term contracts when:

A
  1. Extent of progress toward completion, contract revenue, and contract cots are reasonably estimable;
  2. Enforceable rights regarding goods or services to be provided, the consideration to be exchanged, and the terms of settlement are clearly specified; and
  3. Obligations of the parties are expected to be fulfilled.
119
Q

Revenue Recognition before Delivery: Percentage-of-Completion Method of Long-term Construction Contracts Example

A

A contractor is constructing an office complex for a real estate developer. The agreed-upon contract price was $75,000,000. As of the close of year 4 of the project, the contractor had incurred $44,000,000 of costs. By its best estimates as of that date, costs remaining to finish the project were $19,000,000. Gross profit of $6,255000 had been recognized as of year 4.

Contract price $75,000,000
Minus: Costs incurred to date (44,000,000)
Minus: Estimated costs to complete (19,000,000)
Estimated total gross profit $12,000,000

120
Q

Progress Billings Entry Example

A
The customer billed:
	Accounts Receivable		$XXX
	   Progress billings			          $XXX
The customer pays:
	Cash				                   $XXX
	   Accounts Receivable			        $XXX
121
Q

Progress Billing if construction in progress exceeds total billings Closing entry:

A

Progress billings $XXX

Construction in progress $XXX

122
Q

IFRS Difference: Progress billings

A

The completed-contract method is not used when the outcome of a long-term construction contract cannot be reliably estimated, revenue recognition is limited to recoverable costs incurred. Contract costs must be recognized as an expense in the period in which they are incurred.