Conceptual Accounting Questions Flashcards
What are the 3 financial statements?
Income statement, Balance Sheet, and cash flow statement
What does the income statement show?
A company’s revenue, expenses, and taxes over a period and ends with Net Income, which represents the company’s after-tax profits.
What does the Balance Sheet show?
The company’s assets - its resources - as well as how it paid for those resources - its Liabilities and Equity - at a specific point in time.
Assets must equal Liabilities plus Equity
What does the Cash Flow Statement show?
It begins with Net Income, adjusts for non-cash items and changes in operating assets and liabilities (working capital), and then shows the company’s cash from Investing or Financing activities; the last lines show the net change in cash and the company’s ending cash balance.
How do the 3 statements link together?
- The income statement starts with revenue and subtracts expenses and your bottom line is Net Income.
- The top line of the statement of cash flows is Net income, adjust net income for any non-cash items such as depreciation and amortization. This gives you cash flow from operations.
- The ending number on CFS is the Cash number on the balance sheet, Net Income on the income statement is reflected as retained earnings within the equity category on the balance sheet.
- Link each non cash adjustments to the appropriate asset or liability, subtract links on the assets side and add links on the L&E side
What is the most important financial statement?
The Cash Flow Statement is the most important statement
It tells you how much cash a company is generating.
The income statement is misleading because it includes non-cash revenue and expenses and excludes cash spending such as capital expenditures.
What if you could use only 2 statements to assess a company’s prospects - which ones would you use, and why?
You would use the Income Statement and Balance Sheet because you can create a Cash Flow Statement from both of those. (Assuming there are beginning and ending balance sheets that correspond to the same period shown on the income statement).
How do you know when a revenue or expense line item should appear on the Income Statement?
Two conditions Must be true:
- It must correspond to only to the period shown on the income statement.
- It must affect the company’s taxes
How can you tell whether an item should be classified as an Asset, Liability, or Equity on the Balance Sheet?
Asset: It will generate future cash flow for the company or can be sold for cash
Liability: It will cost the company cash in the future and cannot be sold.
Equity: Funding sources for the company - but they will NOT result in future cash costs.
Why is Accounts Receivable (AR) an Asset, but Deferred Revenue (DR) a Liability?
Accounts receivable is an asset because it corresponds to future cash payments that customers are expected to make.
Deferred Revenue is a Liability because it will cost the company cash in the future.
What are the two difference ways to fund a company’s operations and how do they impact the financial statements?
The two main methods of funding a company’s operations are debt and equity.
Debt is cheaper for most companies, so most companies prefer debt.
Both equity and debt show up on only the Cash Flow Statement initially, so they boost the company’s cash balance.
The after effect of equity is that the company’s share count increases
With debt, the company must pay interest, which will be recorded on its Income statement
How do Goodwill and Other Intangible Assets change over time?
Goodwill remains constant unless it is impaired, the acquirer decided that the acquired company is worth far less and therefore writes down the Goodwill. That appears as an expense on the Income Statement and a non-cash adjustment on the Cash Flow Statement.
Other Intangible Assets amortize over time, and that Amortization shows up on the Income Statement and as a non-cash adjustment on the Cash Flow Statement. The balance decreases until it has amortized completely.
What is Common Stock?
Amount of stock issued by a company at par value.
Retained earnings
Accumulated income
Additional paid in capital
Includes stock-based compensation, stock created by employee option exercises, amount over par raised due to equity offering /IPO
