Exam 1 Flashcards
What are the 4 financial statements?
1) Balance Sheet
2) Income Statement/Statement of Comprehensive Income
3) Statement of Cash Flows
4) Statement of Shareholders Equity
Capital Markets:
Provide a mechanism to help the economy allocate resources effectively
What are the 2 key variables in investment decisions?
1) Rate of Return
2) Uncertainty of Risk
Rate of Return Formula =
(Dividend + Share Price Appreciation) / Initial Investment
Cash basis accounting:
Measurement of cash receipts/payments from transactions related to providing good/service
Net Operating Cash Flow Formula =
Cash Receipts - Cash Payments
Accrual basis accounting:
Measurement of revenue and expenses, regardless of when cash is received/paid
Net Income/Loss Formula =
Cash Received - Cash Paid
GAAP:
Generally Accepted Accounting Principles
-Set of both broad and specific guidelines that companies should follow when measuring/reporting the information in the financial statements.
FASB:
Established to set U.S accounting standards
Conceptual Framework/ Accounting Constitution:
Provides an underlying foundation for U.S accounting standards
-Guides the selection of events to be accounted for
-Provides structure and direction to financial accounting and reporting
What are the 2 Fundamental Qualitative Characteristics of Financial Information?
1) Relevance
2) Faithful Representation
Relevance definition and key terms:
Must possess predictive/confirmatory values and materiality
Predictive Value:
Confirmation of investor expectation to future cash-generating ability
Confirmatory Value:
Validate the previous investor expectation of future cash-generating ability
Materiality:
All items that could affect investors’ decision making must be recorded in the footnotes or disclosure
Faithful representation definition and key terms:
Agreement between measure/description and the real world phenomenon the item represents
-Complete
-Neutral
-Free from error
Cost Effectiveness:
Benefit to get information exceeds the cost to get it
Enhancing qualitative characteristics:
1) Comparability
2) Consistency
3) Verifiability
4) Timeliness
5) Understandability
Comparability:
Helps users see similar/differences between events and conditions
Consistency:
Permits valid comparison between periods
Verifiability:
Measure that would reach consensus regarding whether the information is a faithful representation
Timeliness:
Available to users early enough for them to use it in their decisions
Understandability:
Users must be able to understand the information with the context of the decision being made.
What are the 4 Underlying Assumptions:
1) Economic entity
2) Going concern
3) Periodicity
4) Monetary unit
Economic entity:
Economic events can be identified specifically with an economic entity
Going concern:
Assumption that a business will operate indefinitely
Periodicity:
Life of a company to be divided into artificial time periods to provide timely info
Monetary Unit:
U.S dollar
Recognition:
Process of admitting information into financial statements
Measurement:
Process of associating numerical amounts with elements
Disclosure:
Process of including additional pertinent information in the financial statement and notes
Revenue Recognition:
Recognize revenue when good/service is transferred to the customer
Expense Recognition:
Matches revenue that arises from the same transaction or other events
Historical Cost:
Original transaction value adjusted for depreciation and amortization
Net realizable value:
Amount of cash into which an asset is expected to be converted in the ordinary course of business
Current Cost:
Cost to purchase or reproduce the item
Present Value:
Current value of the future cash flows
Fair value:
Price that would be received to sell assets
Full-disclosure principle:
Requires that the financial reports should include any information that could affect the decisions made by external users
Revenue/Expense Approach:
Recognizes revenue/expenses with assets and liabilities recognized as necessary to make balance sheet reconcile with the income statement
Asset/Liability Approach:
Recognize and measure the assets/liability that exist as of the balance sheet date
Balance Sheet:
Reports companies financial position at a point in time
Cash Operating Cycle:
1) Use cash to get inventory
2) Prepare inventory for sale to customer
3) Deliver inventory to customer
4) Collect cash from customer
Deferred Revenue:
Cash received from a customer for a good/service prior to the service being provided
Accrued Liability:
When expenses have been incurred but will not be paid until next reporting period
Shareholders Equity:
SE = Assets - Liabilities
SE = Paid in Capital + Retained Earnings
Related party transactions:
Transaction between the company and owners, management and affiliated parties
Errors and fraud:
Misstatements that are unintentional(errors) or intentional(fraud)
Illegal Acts:
Bribes, kickbacks, illegal contribution to political candidates and other violations
Auditor Report:
Examine financial statements
4 types of conclusions to the auditors report:
1) Unqualified
2) Unqualified w/ explanatory paragraph
3) Qualified
4) Adverse/Disclaimer
Unqualified Report:
Clean, nothing was wrong with it
Unqualified with explanatory paragraph Report:
Information conforms with GAAP but more information is needed to be provided
Qualified Report:
Everything is good but 1 area
Adverse/Disclaimer Report:
Adverse = Whole thing is not good
Disclaimer = I don’t know what this is
Quick Ratio Formula =
Quick Assets/ Current Liabilities
Current Ratio Formula =
Current Assets / Current Liabilities
Working Capital Formula =
Current Assets - Current Liabilities
Debt to Equity Formula =
Total liabilities / shareholders equity
Time interest earned ratio formula =
(Net Income + Interest Expense + Income Tax) / Interest Expense
Income Statement:
Reports a company’s profit during a particular reporting period
Comprehensive Income:
Includes gains and losses excluded from the income statement
Comprehensive Income Formula =
Net Income + Other Comprehensive Income
Statement of Cash Flows:
Provides information about cash receipts and payments
Income from continuing operations:
Reports the revenues, expenses, gains, losses that have occurred during the reporting period
Gains/Losses:
Can arise when a company sells investments or PP+E for an amount that differs from their recorded amount
Multiple Step Income Statement:
Separately classifies items by operating and non operating
-More specific compared to simple step
Income Smoothing:
Creates smoother pattern in earnings overtime by altering assumptions and estimates
-overestimate expenses in current year to reduce NI, and reverse those estimates the next year
What are the 3 Accounting Changes?
1) Accounting Principle
2) Accounting Estimate
3) Reporting Entity
Accounting Principle:
Change from one acceptable accounting method to another
Ex: LIFO to FIFO
Accounting Estimate:
Changes due to modification of estimate as new information comes up
-If change is material = disclosure note is needed
Ex: future bad debts on existing AR
Correction of Accounting Errors
A transaction being recorded incorrectly or not at all
Discontinued Operations:
Happens when a business completely cuts off/sell of a part of their product line
-Shows below the income tax line
Prior Period Adjustements:
Required when a material error is discovered in the statements
-Record a JE that:
*adjusts balance sheet accounts
*accounts for income effects by adjusting beginning retained earnings
Earnings Per Share Formula =
(NI - Preferred Stock Dividend) / Weighted average # of common shares outstanding
Diluted EPS:
Incorporates the effect of all potential common shares in calculation of EPS
Comprehensive Income:
Total change in equity for a reporting period other than from transactions with owners
Other Comprehensive Income:
Few gains/losses from nonowner transaction
*reported seperately
Comprehensive Income Formula =
Net Income + Other Comprehensive Income
Statement of Cash Flows:
Required for each period that balance sheet and income statement are present
*Shows the inflow and outflow of cash
-Operating
-Investing
-Financing
Operating Activities:
In and out of cash that results from activities reported in the income statement
Investing Activities:
Using your money to make more money
Ex: Investments, bonds in other companies
Financing Activities:
Obtaining cash from investors/creditors
Ex: Issuing stocks + bonds
* you need money
Non Cash Investing and Financing Activities:
Activities that do not involve cash flows at all
Ex: getting equipment by issuing a long term notes payable
Time Value of Money:
Money can be invested today to earn interest and grow to a larger amount in the future
Simple Interest Formula =
Initial Investment x Annual interest rate x Period of time
Compounded Interest Formula =
Includes interest on initial investment but also on the accumulated interest
Effective Rate:
Actual rate at which money grows per year
Future Value:
Amount of money that a dollar will grow to at some point in the future
Future Value Formula =
FV = I(1 + i)^n
Present Value =
Today’s equivalent to a particular amount in the future
Present Value Formula =
FV / ((1 +i)^n)
Annuity:
Series of cash flows of the same amount received or paid each period
Ordinary Annuity:
Cash payments at the end of the period
Annuity Due:
Cash payment due @ beginning of the period
Revenue Recognition:
1)Identify the contract
2) Identify the performance obligation
3) Determine transaction price
4) Allocate the transaction price
5) Recognize revenue when (or as) each performance obligation is satisfied
Where does discontinued operations show on the income statement?
Below the income tax line
