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FAR CJ > FAR 1 part B > Flashcards

FAR 1 part B Flashcards

FAR Studies

1
Q

LIQUIDITY RATIOS

A

gauge a company’s ability to fulfill short term obligations when they come due, which is typically within one year.

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2
Q

CURRENT RATIO (WORKING CAPITAL RATIO):

A
  • Working Capital = Current assets ( - ) Current Liabilities
  • CURRENT RATIO = Current Assets/Current Liabilities
    (Cash+Acct Rec+Inventory)/Current Liab
  • The current ratio illustrates the number of times a company’s current assets would cover its current liabilities. A ratio of less than 1 is a red flag, indicating the company may be unable to pay ST debt as it is due.
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3
Q

QUICK RATIO (Acid-Test Ratio):

A
  • QUICK RATIO =
    Cash and Cash Equivalents ( + ) Marketable Securities ( + ) AcctsRec , net
    ——————————————————————————
    Total Current Liabilities

The quick ratio or acid-test is a gauge of a company’s ability to fulfill its ST obligations with liquid or near liquid assets. Compared to the current ratio, by excluding inventories and other current assets, the quick ratio is more conservative.

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4
Q

SOLVENCY RATIOS (Debt Utilization)

A

measure a company’s ability to meet long term financial obligations to operate as a going concern, including the company’s use of financial leverage (EXAMPLE: debit financing).

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5
Q

SOLVENCY RATIOS

DEBT TO TOTAL ASSETS RATIO

A
  • DEBT TO TOTAL ASSETS =
    Total Liabilities/Total Assets

A higher ratio is less favorable, indicating higher risk and more leverage

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6
Q

SOLVENCY RATIOS

DEBT TO EQUITY RATIO

A
  • DEBT TO EQUITY =
    Total Liabilities/Total Equity

A lower ratio is more favorable and indicates less risk. A higher ratio is unfavorable as it indicated there is more reliance on external factors, learning to higher risk (higher interest rates). The numerator can also be expressed equivalently as total Debt and denominator as total SHs’ Equity.

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7
Q

ACTIVITY RATIOS

RECEIVABLE TURNOVER

A
  • RECEIVABLES TURNOVER =
    Net Credit Sales/Average AcctsRec , net
  • AVERAGE ACCTSREC =
    Beginning AcctsRec - NRV ( + ) Ending AcctsRec - NRV
    ___________________________________________
    2
  • Managers use this ratio to evaluate how efficiently accounts receivable are collected and how well working capital is managed by the company.
  • A higher ratio is favorable indicating receivables are more liquid and quickly convert to cash. A lower ratio could signal a problem.
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8
Q

ACTIVITY RATIOS

AVERAGE COLLECTION PERIOD IN DAYS

A
  • AVERAGE COLLECTION PERIOD =
    365 days/AcctsRec Turnover

This measure is also called DAYS SALES OUTSTANDING.

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9
Q

ACTIVITY RATIOS

INVENTORY TURNOVER

A
  • INVENTORY TURNOVER =
    COGS/Average Inventory
  • AVERAGE INVENTORY =
    Beginning Inventory ( + ) Ending Inventory
    ___________________________________
    2

This ratio is an asset utilization measurement to judge how efficient a company is at managing their inventory.

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10
Q

ACTIVITY RATIOS

DAYS IN INVENTORY:

A
  • DAYS IN INVENTORY =

365 days/Inventory Turnover

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11
Q

ACTIVITY RATIOS

TOTAL ASSET TURNOVER:

A
  • TOTAL ASSET TURNOVER =

Net Sales/Average Total Assets

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12
Q

MARKET RATIOS

A

evaluate the company from an investor’s perspective, applicable to a company that is publicly traded and has a market value for its stock.

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13
Q

PRICE EARNINGS (P/E) RATIO:

A
  • PE RATIO = Stock Price per Share/ Basic EPS

A lower ratio is favorable, indicating the company needs fewer years to earn the amount the investors paid per share (assuming the PE ratio and earning remain constant).

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14
Q

BOOK VALUE PER SHARE:

A
  • BV PER SHARE =
    Common Shareholder’s Equity/
    Number of Shares of Common Stock Outstanding
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15
Q

Common Shareholder’s Equity

A

To calculate common stockholders’ equity, deduct everything that belongs to preferred stockholders. This is the amount that the common shareholders are entitled to if the company files for liquidating bankruptcy.
* COMMON SHAREHOLDERS’ EQUITY:

Total Shareholders’ Equity
( - ) Preferred Stock - par value
( - ) Preferred Stock Liquidation Premium	
( - ) Preferred Stock Dividends – including all 
          preferred dividends in arrears =
Common Shareholders’ Equity
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16
Q

PROFIT MARGIN ON SALES RATIO:

A

PROFIT MARGIN ON SALES = Net Income/

Net Sales

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17
Q

RATE OF RETURN ON ASSETS RATIO

A
  • RATE OF RETURN ON ASSETS = Net Income/
    Average Total Assets

The Rate of Return on Assets ratio would require balance sheet measures from the beginning and end of the period to compute the average total assets.

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18
Q

RATE OF RETURN ON COMMON STOCK EQUITY RATIO:

A
  • RATE OF RETURN ON COMMON STOCK EQUITY = Net Income ( - ) Preferred Dividends/
    Average Common Stockholders’ Equity

The Rate of Return on Common Stock Equity would require balance sheet measures from the beginning and end of the period to compute the average common stockholders’ equity.

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19
Q

EARNINGS PER SHARE RATIO:

A
  • BASIC EARNINGS PER SHARE =
    Net Income ( - ) Preferred Dividends/
    Weighted Average Common Share O/S

The EPS ratio would require the computation of the WEIGHTED-AVERAGE NUMBER OF COMMON SHARES OUTSTANDING during the period.

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20
Q

PAYOUT RATIO:

A
  • PAYOUT RATIO = Cash Dividends/
    Net Income
  • The Payout ratio provides the percentage of net income paid out in cash dividends for the period.
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21
Q

TIMES INTEREST EARNED RATIO:

A
  • TIME INTEREST EARNED = EBIT/
    Interest Expense
  • EBIT is earnings before interest and taxes.
  • A higher value is favorable, showing the company is able to pay for the interest due on its debt many time over.
  • A low value is a red flag, signaling that the company might be headed towards bankruptcy if it is consistently unable to pay the interest.
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22
Q

HISTORICAL COST/CONSTANT DOLLAR is inflation based and increases due to inflation.

A
  • Constant dollar accounting is a method of reporting financial statement elements in dollars which have the same purchasing power. Purchasing power indicates the ability of a dollar to command goods or services.
  • Monetary Assets and Liabilities include Cash, Accts Receivable, Note Receivable, Accts Payable, Note Payable, Bond Payable, and Held-to-Maturity investments in Bonds.
23
Q

Monetary assets and liabilities

A

Monetary assets and liabilities are netted together to create a monetary asset position (if your monetary assets are greater than your monetary liabilities) or a monetary liability position (if your monetary liabilities s are greater than your monetary assets).
Then you calculate your PURCHASING POWER GAIN/ LOSS which is facilitated by the Consumer Price Index (CPI) as opposed to changing the nominal dollar value (Historical Cost) of the monetary assets and liabilities on the balance.

24
Q

PURCHASING POWER GAIN/ LOSS

A

which is facilitated by the Consumer Price Index (CPI) as opposed to changing the nominal dollar value (Historical Cost) of the monetary assets and liabilities on the balance.
PURCHASING POWER GAIN/LOSS =
Historical Cost( - ) Historical Cost ( x )
(Ending CPI/ Beginning CPI)

25
Q

Nonmonetary Items include everything else.

A
  • Nonmonetary items however are converted or adjusted to constant dollars on the balance sheet. The adjustment is made by multiplying the nominal dollar value (Historical Cost) by the TO/FROM ratio.

Restated Historical Cost (Constant Dollar) = Historical Cost ( x ) (Ending CPI/ Beginning CPI)

26
Q

CURRENT COST

A

CURRENT COST is demand based and increases in price are due to demand/market appreciation (FAR1- partA notes).

  • Nothing is done with the values of monetary items under current cost accounting
  • Nonmonetary Items are restated to current costs and a HOLDING GAIN OR LOSS is calculated.
  • The holding gain or loss for property, plant, and equipment would be calculated using their current costs.
  • The holding gain or loss for depreciation expense and COGS would be calculated using their average current cost.
27
Q

COMPREHENSIVE INCOME:

A

The sum of net income plus other comprehensive income (OCI) equals Comprehensive Income.
Comprehensive income requires disclosure of changes during a period of the following components of OCI…
* Unrealized Gains and Losses on AFS Investments
* Unrealized Gains and Losses Foreign Currency Translations
* Adjustments necessary to recognize the funding status of pension plans or other post-retirement benefits.
* Reclassification Adjustments
- As unrealized gains or losses are recorded and reported in OCI for the current period or prior periods are later realized, they are recognized and reported in net income. To avoid double counting it is necessary to reverse the unrealized amounts that have been recognized. A company must separately disclose info about net income reclassifications out of OCI effects on the face of the financial statements or in a separate disclosure in the notes.

28
Q

COMPREHENSIVE INCOME:

A

Accounting standards allow for two choices for presenting OCI…

(01) Present a combined statement of income and comprehensive income with OCI at the bottom.
- An advantage of the combined statement is that it does not require the creation of a new financial statement; the disadvantage is that net income is buried in the subtotal.
(02) Present a second statement that directly follows the income statement.

29
Q

ACCUMULATED OTHER COMPREHENSIVE INCOME shall be presented separately from retained earnings and additional paid-in capital on the balance sheet.

A

The changes in accumulated comprehensive income are to be presented in the notes to or on the face of the financial statements with each component of other comprehensive income and reclassifications presented separate and net of tax.

30
Q

Errors that could occur in calculating OCI include…

A
  • Putting OCI items into net income, such as AFS unrealized gains or losses, assuming FV Option is not elected, are recorded in the income statement instead of OCI.
  • When using the EQUITY METHOD, assuming FV Option is not elected, the investor’s share of the investee’s earnings (or Equity in Earnings) is reported as OCI instead of properly showing it on the income statement.
31
Q

Errors that could occur in calculating OCI include…

A
  • When adjusting the Pension Liability account, the journal entry is to debit the Accrued Pension Liability account if overfunded or credit the Accrued Pension Liability account if underfunded and the corresponding debit or credit is to OCI, net of tax. An error could occur, if instead of debiting OCI the entry shows a debit or credit to Pension Expense.
  • These errors have to be corrected as a PRIOR PERIOD ADJUSTMENT, which is an adjustment to the beginning retained earnings net of tax.
32
Q

STATEMENT OF CHANGES IN EQUITY:

A

Statement of changes in equity provides for a reconciliation of beginning and ending equity account balances.

33
Q

STATEMENT OF CASH FLOWS:

objective

A

The objective of the statement of cash flows is outlined in ASC Topic 230. In addition to those transactions involving cash, those transactions not involving cash such as stock or debt in exchange for a fixed asset must be disclosed as follows

  • Conversion of debt to equity.
  • Conversion of preferred equity to common equity.
  • Acquisitions of assets through capital leases.
  • Acquisitions of LT assets by issuing notes payable.
  • Acquisitions of non-cash assets, such as patents or licenses, in exchange for shares or debt securities.
34
Q

STATEMENT OF CASH FLOWS:

Cash includes cash equivalents

A

Cash includes cash equivalents short tern or current highly liquid investments that can readily be converted to a known amount of cash and the original maturity is 3 months or less. Treasury bills (not Treasury Bonds), commercial paper, and money market funds are examples of cash equivalents.

35
Q

Cash inflows and cash outflows are to be classified into

A

OPERATING, FINANCING, and INVESTING activities.

36
Q

OPERATING ACTIVITIES include

A

OPERATING ACTIVITIES include delivering or producing goods for sale or providing services.

  • Include all transactions that are not investing or financing activities.
  • A gain/loss on extinguishment of debt should be properly classified as a FINANCING ACTIVITY.
  • A gain/loss from disposal of property should be classified as an INVESTING ACTIVITY.
37
Q

INVESTING ACTIVITIES

A

INVESTING ACTIVITIES include the acquisition and disposition of LT productive assets or securities that are not considered cash equivalents. If the transactions do not include inflow or outflows of cash they are not included in the statement of cash flows.

  • Collection of loans.
  • Lending of money.
  • Proceeds from sales of Property, Plant, and Equipment.
  • Acquisition of Property, Plant, and Equipment.
  • Proceeds from sales of Investments in Stock (AFS) and Bonds (AFS).
  • Proceeds from sale or redemption of Investments in Bonds (Held-to-Maturity).
  • Acquisition of Investments in Stock and Bonds (AFS or Held-to-Maturity).
  • Cash paid or received for Securities (Trading)
  • Can be shown on operating activities or Investing activities section based on nature and purpose acquired.
  • Acquiring other businesses.
38
Q

FINANCING ACTIVITIES

A

includes the methods that the company raises capital. They can raise capital by issuing either common or preferred stock or borrowing money on a ST or LT basis.

  • Obtaining resources from creditors and repaying the amount borrowed.
  • Proceeds from issuing common and preferred stock.
  • Proceeds from reissuing treasury stock.
  • Repurchasing common stock (treasury stock).
  • Proceeds from issuing ST Debt.
  • Repaying ST Loans (principal only).
  • Proceeds from issuing LT Debt.
  • Repaying LT loans, including capital lease obligations (principal only).
  • Payment of Dividends (Dividends received is an OPERATING ACTIVITY)
39
Q

STATEMENT OF CASH FLOWS:

A

There are two formats available for the preparation of the statement of cash flows. They differ only with respect to the OPERATING ACTIVITIES section of the statement of cash flows. They are precisely the same with respect to the INVESTING and FINANCING sections of the statement of cash flows.

40
Q

The DIRECT METHOD

A

uses a framework that comes directly from the income statement format. Under the direct method the preparer looks at every component on the income statement such as Sales, COGS, exc. Each of these items is directly converted from Accrual to Cash basis.

41
Q

The direct method goes directly to each item on the income statement and converts that item from accrual to cash, by using the changes of current assets and current liabilities, from one period to another.

A
  • Items on the income statement that are used in the direct method, that have to be converted from accrual to cash and the applicable current asset and liability accounts that are used to convert the income statement items from accrual to cash are as follows…To Arrive At: Income Stmt Item: Adjust for Change in Bal Sheet Items

CASH COLLECTED FROM CUSTOMERS
Sales AcctsRec

INTEREST RECEIVED
Interest Revenue Interest Rec

DIVIDEND RECEIVED
Dividend Revenue Dividend Rec

CASH PAID TO EMPLOYEES
Salary & Wage Expense Salary and Wages
Payable

CASH PAID TO SUPPLIERS
COGS Inventory
AcctsPay

INTEREST PAID
Interest Expense Interest Payable
Discount on Bond Payable
Premium on Bond Payable

INCOME TAXES PAID
Income Tax Expense Income Tax Payable
Deferred Income Tax Asset
Deferred Income Tax Liability

OTHER OPERATING CASH PAID
Rent Expense Prepaid Rent
Supplies Prepaid Supplies
Advertising Prepaid Advertising

42
Q

The INDIRECT METHOD

A

is done by starting with INCOME FROM CONTINUING OPERATIONS and adjusting for changes in OPERATING related accounts, such as Inventory and AcctsPayable, and noncash expenses, revenues, losses, and gains.

  • Nearly all corporations prepare the statement of cash flows using the Indirect Method.
  • With the Indirect Method, a company starts with net income on the accrual basis and converts the net income to the cash basis. In order to convert from accrual to cash certain adjustments must be made to net income.
43
Q

INDIRECT METHOD

A
  • One type of adjustment is to add back non-cash expenses and deduct non-cash income.
  • Noncash Expenses to add back to net income

Depreciation expense Amortization expense
Bad debt expense Amortization of bond discount
Losses from sale of assets

  • Noncash Income to be subtracted from net income
    Gains from sale of assets
    Amortization of bond premium
    Equity in earnings (Investor’s share of the investee’s earnings)
44
Q

Other adjustments to net income which are considered an inflow of cash are changes in current assets and current liabilities. To determine whether these changes are inflows or outflows of cash, the FAKE CASH METHOD is used

A
  • If AcctsRec increases from one period to the next by $10,000 the entry would be…

Accounts receivable $ 10,000
Fake Cash - Out $ 10,000

Since the increase in AcctsRec creates a credit to fake cash, the increase in AcctsRec is an outflow of cash. Because net income is an inflow, deduct the fake cash outflow due to the increase in AcctsRec.

  • If AcctsPay increased from one period to the next by $15,000 the entry would be…

Fake Cash - In $ 15,000
Accounts payable $ 15,000

The increase in AcctsPay of $15,000 is an inflow of cash because fake cash is debited. Therefore, the $15,000 is added to net income.

45
Q

Required disclosure for the statement of cash includes…

A
  • Policy and treatment for cash and cash equivalents
  • SIGNIFICANT NONCASH INVESTING AND FINANCING ACTIVITIES
  • Reported in a separate schedule as supplemental info to the statement of cash flows and includes…
  • Acquiring an asset through a capital lease.
  • Conversion of debt to equity.
  • Conversion of LT Debt (mandatory cash payment) to Common Stock (optional cash payment).
  • Conversion of Preferred Stock into Common Stock
  • Converting from a mandatory payment of cumulative preferred stock where the dividends can go into arrears to an optional payment, which are common stock dividends.
  • Exchange of noncash assets or liabilities for other noncash assets or liabilities.
  • Issuance of stock to acquire assets.
  • If the DIRECT METHOD is used, the company must disclose a reconciliation of net income to cash from OPERATING ACTIVITIES.
  • If the INDIRECT METHOD is used, the company must disclose the INTEREST PAID and the TAXES PAID.
46
Q

NOTES TO THE FINANCIAL STATEMENTS:

A

The FULL DISCLOSURE PRINCIPAL requires that basic financial statements be supplemented by notes providing users with sufficient detail on matters that make a difference to users.

  • Notes and Supplementary Info include descriptions of significant accounting policies and methods used for measurement (EXAMPLE: FIFO Inventory and SL depreciation), explanations of uncertainties and contingencies, and descriptive statistics.
  • Info pertaining to the disposition of a segment, segment sales, and anticipated future dividends, while important information, are not accounting policies.
  • Other disclosures include the CONCENTRATION OF CREDIT RISK where a significant number of unsecured trade account receivables are with companies that operate in the same industry.
  • Discontinued Operations for interim financial statements that occur at midyear are reported in the net income of the interim period and are disclosed in the footnotes to the interim financial statements.
  • When a material error exists, the prior period financial statements are required to be restated, so that previously issued financial statements will be correct. When this occurs, the audit opinion must be revised to disclose the restatement and the disclosure refers to the financial statement footnote that explains what the error was and the related correction to the error.
  • An error may be discovered that may not be material to the prior period financial statement. These errors can add up to a material amount over time. If the immaterial errors of past years are totaled and become material the accumulated error would make the current year financial statement misstated. The company then would make an adjustment or restatement to the prior period financial statement info in the current period financial statement. This restatement must be disclosed in the footnotes of the current period financial statements. This does not require a modification of the audit opinion because the prior period financial statements were not materially misstated.
  • Full disclosure is a matter of professional judgement.
47
Q

CONSOLIDATED FINANCIAL STATEMENTS:

A

Including wholly owned subsidiaries & noncontrolling interests.
Consolidated Financial Statements are covered in Chapter 3, Part B.

48
Q

DISCONTINUED OPERATIONS:

A

Discontinued Operations result from the disposal of a component or a group of entity components of an entity.

49
Q

A COMPONENT

A

is defined as comprising of operations and cash flows that can be clearly distinguished, operationally and for financial reporting purposes, from the rest of the entity.

50
Q

To be eligible for DISCONTINUED OPERATIONS

A

treatment the disposal of components must represent a STRATEGIC SHIFT that has or will have a major effect on an entity’s operations and financial results. This happens when any of the following occur…
The criteria for classification as HELD-FOR-SALE are all satisfied.

51
Q

The criteria for classification as HELD-FOR-SALE are all satisfied.

A

An entity component or group of entity components that is determined to be sold is classified as HELD-FOR-SALE for the period if ALL of the following are satisfied…

(01) Management commits to a plan to sell the entity and has the appropriate authority to do so.
(02) The entity to be sold is available for immediate sale in its present condition.
(03) The sale of the entity is probable and is expected to be recognized as a sale within one year.
(04) The entity is being actively marketed to be sold, at a market price that is indicative of an immediate sale.
(05) There is a high unlikelihood that the plan will significantly change or be withdrawn
- At any time after being classified as HELD-FOR-SALE, the criteria is no longer met, the entity to be sold can no longer be classified as HELD-FOR-SALE and must be reclassified as HELD-FOR-USE.
* The component or group of entity components is disposed of by sale.
* The component or group of entity components is disposed of in a method other than through a sale, such as abandonment or a spinoff as a distribution to the owners.

52
Q

STRATEGIC SHIFT

A

A STRATEGIC SHIFT could include the disposal of a major line of business, a major geographical area, a major equity method investment, or other major parts of an entity.

53
Q

If the requirements for reporting DISCONTINUED OPERATIONS are met, the component must be reported separately in the financial statements of the entity after INCOME FROM CONTINUING OPERATIONS.

A
  • However, if the disposal of the component does not represent a strategic shift that has or will have a major effect on an entity’s operations and financial results, the transaction is not reported in Discontinued Operations and would continue to be shown in INCOME FROM CONTINUING OPERATIONS.
  • Discontinued Operations do not assist the investor in terms of PREDICTIVE VALUE of what the company is likely to encounter in the future. Investors and other stakeholders are most interested in ongoing or continued operations, which is why we isolate the results from Discontinued Operations in the income statement.
54
Q

Gains or losses from the operation of discontinued operations realized for the period are combined with the loss of disposal to determine the total loss from discontinued operations.

A

The gain or loss on operation of discontinued operations includes the gain or loss from the beginning of the year to the measurement date plus the loss from disposal of the discontinued operations at the measurement date.

FAR CJ (2 decks)

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