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ACCT 5010 > Module 1 > Flashcards

Module 1 Flashcards

1
Q

What is the main objective of financial reporting?

A

To provide users with information that supports investment and management decisions

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2
Q

What are the three main user groups of financial reporting?

A
  1. Investors & equity analysts
  2. Lenders & credit analysts
  3. Company managers
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3
Q

What do investors & equity analysts use financial statement information for?

A

to judge the company’s profitability and financial strength, and to make reasonable estimates of the value of the company’s equity securities (stock)

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4
Q

What do lender & credit analysts use financial statement information for?

A

to assess the company’s ability to repay its debts and to determine how to manage credit risk associated with the company’s debt securities

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5
Q

What do company managers use financial statement information for?

A

to inform decisions such as where to invest scarce resources, how to finance those investments, how to maximize the company’s profitability, and how much cash to maintain

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6
Q

Operating Activities

A

companies hire & train employees, manufacture products, deliver services, market & sell their products & services, and manage after-sale customer support

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7
Q

Investing Activities

A

companies acquire land, buildings & equipment, grow the business with new products & services, or acquire other companies to expand into new markets

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8
Q

Financing Activities

A

companies raise cash to fund the operating & investing activities (this includes selling stock to equity investors and borrowing funds from banks & other lenders)

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9
Q

What are some examples of business forces & how do they affect the way the company does business?

A

Market conditions, competitive pressures, regulations. Shapes the company’s overarching goals & objectives along with the company’s strategy & strategic planning process

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10
Q

What does a company’s strategic (or business) plan reflect?

A

how the company plans to achieve its goals & objectives

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11
Q

What does a company’s business plan’s success depend on?

A

Effective analysis of market demand & supply.

Specifically, a company must assess demand for its products & services and assess the supply of its inputs (both labor & capital)

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12
Q

What must the strategic plan contain?

A

Competitive analyses, opportunity assessments, & consideration of business threats

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13
Q

What broad classes of users demand financial accounting information?

A
  • managers & employees
  • investment analysts & information intermediaries
  • creditors & suppliers
  • stockholders & directors
  • customers & strategic partners
  • regulators & tax agencies
  • voters & their representatives
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14
Q

Why do managers & employees demand financial accounting information?

A

They are interested in the company’s current & future financial health, therefore they desire accounting information on the financial condition, profitability, and prospects of their company, as well as comparative financial information on competing companies and business opportunities

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15
Q

Which users of financial accounting information use that information for compensation & bonus contracts that are tied to such numbers?

A

Managers & Employees

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16
Q

Which users of financial accounting information use that information for union contracts that link wage negotiations to accounting numbers and for monitoring pension & benefit plans whose solvency depends on company performance?

A

Managers & Employees

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17
Q

What questions do financial statements help company managers address?

A
  • What product lines, geographic areas, or other segments are performing well compared with our peer company’s and our own benchmarks?
  • Should we consider expanding or contracting our business?
  • How will current profit levels impact incentive and share-based compensation?
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18
Q

What are two types of information intermediaries?

A

financial press writers & business commentators

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19
Q

Why are investment analysts & information intermediaries interested in financial accounting information?

A

they’re interested in predicting a company’s future performance & condition in order to make informed stock recommendations or write commentaries

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20
Q

What questions do financial statements help investment analysts & information intermediaries address?

A
  • What are expected future profits, cash flows, and dividends for input into stock-price models?
  • Is the company financially solvent and able to meet its financial obligations?
  • How do expectations about the economy, interest rates, and the competitive environment affect the company?
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21
Q

Why are creditors & suppliers interested in financial accounting information?

A

to help determine loan amounts, loan terms, interest rates, and required collateral

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22
Q

What are covenants?

A

contractual requirements in loan agreements

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23
Q

What questions do financial statements help creditors & suppliers address?

A
  • Should we extend the credit in the form of a loan or line of credit for inventory purchases?
  • What interest rate is reasonable given the company’s current debt load and overall risk profile?
  • Is the company in compliance with the existing loan covenants?
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24
Q

What does EBITDA stand for?

A

earnings before interest, tax, depreciation, and amortization

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25
Q

What does EPS stand for?

A

earnings per share

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26
Q

Why are stockholders & directors (and others, such as investment analysts, brokers, & potential investors) interested in financial accounting information?

A

to assess the profitability & risks of companies and to obtain other information useful in their investment decisions

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27
Q

Fundamental analysis

A

uses financial information to estimate company value and to form buy-sell stock strategies

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28
Q

What questions do financial statements help stockholders & directors (and others, such as investment analysts, brokers, & potential investors) address?

A
  • Is company management demonstrating good stewardship of the resources that have been entrusted to it?
  • Do we have the information needed to critically evaluate strategic initiatives that management proposes?
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29
Q

Why are customers interested in financial accounting information?

A

to assess a company’s ability to provide products or services and to assess a company’s staying power & reliability

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30
Q

Why are strategic partners interested in financial accounting information?

A

wish to estimate the company’s profitability to assess the fairness of returns on mutual transactions & strategic alliances

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31
Q

What questions do financial statements help customers and strategic partners address?

A
  • Will the company be a reliable supplier?
  • Is the strategic partnership providing reasonable returns to both parties?
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32
Q

Why are regulators & tax agencies interested in financial accounting information?

A

for antitrust assessments, public protection, setting prices, import-export analyses, and setting tax policies

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33
Q

Why are voters & their representatives interested in financial accounting information?

A

to inform policy decisions & to monitor government spending. Contributors to nonprofit organizations also demand information to assess the impact of their donations.

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34
Q

What are the two main filings that publicly traded firms in the US must file with the SEC?

A

Form 10-K & Form 10-Q

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35
Q

What is the form 10-K and what does it include?

A

audited annual report that includes the four financial statements with explanatory notes and the management’s decision & analysis (MD&A) of financial results

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36
Q

What does MD&A stand for?

A

management decision & analysis

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37
Q

What is the form 10-Q and what does it include?

A

unaudited quarterly report that includes summary versions of the four financial statements and limited additional disclosures

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38
Q

What benefits incentivize companies to disclose financial accounting information?

A
  • A company’s performance in the input/output market depends on success with its business activities AND the market’s awareness of that success
  • Companies reap the benefits of disclosure with good news about the products, processes, management, etc.
  • Real economic incentives for companies to disclose reliable (audited) accounting information, enabling them to better compete in capital, labor, input and output markets.
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39
Q

What are the costs associated with a company’s disclosure of financial accounting information?

A
  • Preparation & dissemination costs
  • Competitive disadvantages
  • Litigation
  • Political costs
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40
Q

What does GAAP stand for?

A

Generally Accepted Accounting Principles

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41
Q

What does IFRS stand for?

A

International Financial Reporting Standards

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42
Q

What does IASP stand for?

A

International Accounting Standards Board

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43
Q

What does FASB stand for?

A

Financial Accounting Standards Board

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44
Q

Why are comparable global accounting standards desirable?

A
  • improve the quality of financial reports
  • benefit investors, companies, and other market participants who make global investment decisions
  • reduce costs for both users & preparers of financial statements
  • make worldwide capital markets more efficient
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45
Q

What are the four financial statements?

A
  • balance sheet
  • income statement
  • statement of stockholders’ equity
  • statement of cash flows
46
Q

What does a balance sheet report?

A
  • reports a company’s financial position AT A POINT IN TIME
  • reports on the cumulative effects of investing & financing activities
  • reports the company’s resources (assets), what the company owns
  • reports the sources of asset financing
47
Q

What are the two ways companies can finance their assets?

A

owner financing & nonowner financing

48
Q

Where is money raised from with owner financing?

A

stockholders

49
Q

Where is money raised from with nonowner financing?

A

banks or other creditors/suppliers

50
Q

What are owner claims on assets referred to as?

A

equity

51
Q

What are nonowner claims on assets referred to as?

A

liabilities (or debt)

52
Q

Balance Sheet Equation

A

Assets = Liabilities + Equity

53
Q

What are investing activities represented by?

A

the company’s assets

54
Q

In what order are assets listed on the balance sheet?

A

in order of their nearness to cash, with short-term assets (also called current assets) expected to generate cash within one year of balance statement date (i.e., cash > accounts receivable > inventories)

55
Q

What are some examples of long-term assets?

A

land, buildings, and equipment

56
Q

What are financing activities for?

A

to pay for assets (can be with a combination of owner & nonowner financing)

57
Q

What are the two components of owner financing?

A
  1. Resources (mostly cash, but sometimes non-cash assets) contributed to the company by its owners
  2. Profits retained by the company
58
Q

What does an income statement report?

A

a company’s performance over a period of time. Lists amounts for its top line revenues (sales) and its expenses

59
Q

Income Statement Formula

A

Revenues - Expenses = Net Income

60
Q

What are the two kinds of operating expenses?

A

Cost of Goods Sold (COGS) - can also be called cost of sales

Selling, general, & administrative expenses (SG&A)

61
Q

What do COGS represent?

A

while revenues represent retail selling price of the goods sold to customers, COGS is the amount the company paid to purchase or manufacture the goods (inventories) that it sold

62
Q

Gross profit formula

A

Gross profit = revenues - COGS

63
Q

What does gross profit mean?

A

gross means profit available to cover all other expenses

64
Q

What does the SG&A represent?

A

overhead. including salaries, marketing costs, occupancy costs, HR & IT costs, and all other operating expenses the company incurs other than the cost of purchasing or manufacturing inventory (which is included in COGS)

65
Q

To generate income, companies engage in what?

A

Operating activities that use company resources to produce, promote, and sell products and services.

These activities extend from input markets involving suppliers of materials and labor to a company’s output markets, involving customers of products & services

66
Q

Input markets generate most…

A

expenses (costs), such as inventory, salaries, materials & logistics

67
Q

Output markets generate most…

A

revenues (sales), but also generate some expenses such as marketing & distributing products & services to customers

68
Q

Relative profitability

A

Relative profitability = net income as a percentage of sales

69
Q

What does the statement of stockholders’ equity report?

A

Year-over-year changes in the equity accounts that are reported on the balance sheet

For each type of equity, the statement reports the beginning balance, a summary of the activity in the account during the year, and the ending balance

70
Q

What is contributed capital?

A

the stock/shareholders’ net contributions to the company

71
Q

What does contributed capital represent?

A

the assets the company receives from issuing stock to stockholders

72
Q

What are retained earnings?

A

net income over the life of the company minus all dividends ever paid (also called earned capital or reinvested capital)

73
Q

What do retained earnings represent?

A

the cumulative total amount of income the company has earned and that has been retained in the business (that is, not distributed to stockholders in the form of dividends)

74
Q

Statement of stockholders’ equity formula (retained earnings formula)

A

Beginning Retained Earnings
+ Net income for the period
- dividends for the period
= Ending Retained Earnings

75
Q

What does the statement of cash flows report?

A

the change (either an increase or decrease) in a company’s cash balance over a period of time

also reports cash inflows & outflows from operating, investing, and financing activities over a period of time

76
Q

What are PP&E assets?

A

property, plant & equipment

77
Q

Other means of communicating important financial info about a company to various decision makers other than the four financial statements include:

A
  • management discussion & analysis (MD&A)
  • independent auditor report
  • financial statement footnotes
  • regulatory filings, including proxy statements & other SEC findings
78
Q

Since the enactment of the Sarbanes-Oxley Act (SOX) in 2002, the SEC requires CEO & CFO to personally sign a statement attesting to the accuracy & completeness of financial statements. These statements include the following declarations:

A
  • Both the CEO & CFO have personally reviewed the financial report
  • There are no untrue statements of a material fact that would make the statements misleading
  • Financial statements fairly present in all material respects the financial condition of the company
  • All material facts are disclosed to the company’s auditors & board of directors
  • No changes to its system of internal controls are made unless properly communicated
79
Q

A company’s profitability must be assessed with respect to what?

A

The size of its investment

80
Q

ROA formula

A

Return on assets = net income for that period divided by the average total assets during that period

ROA = PM x AT

(PM = net income/sales ; AT = sales/avg. asset)

81
Q

What are the two components of ROA?

A

productivity & profitability

82
Q

Describe profitability as it relates to ROA

A

Profitability relates profit to sales

83
Q

What is profit margin and what does it reflect?

A

(PM) ratio relating profit to sales - reflects the net income (profit after tax) earned on each sales dollar

84
Q

Describe productivity as it relates to ROA

A

productivity relates sales to assets

85
Q

What is asset turnover and what does it reflect?

A

(AT) ratio relating sales to average assets - reflects sales generated by each dollar of assets

86
Q

Does management want high or low PM & AT?

A

High for both. Management wants to earn as much profit as possible from sales and wants to maximize asset productivity to achieve the highest possible sales level for a given level of assets (or to achieve a given level of sales with the smallest level of assets)

87
Q

Profitability (Profit Margin) formula

A

net income divided by sales

88
Q

Productivity (Asset Turnover) formula

A

Sales divided by average assets

89
Q

What is ROE?

A

return on equity

90
Q

ROE formula

A

ROE = net income/avg. stockholders’ equity

91
Q

average equity formula

A

avg. equity = (beginning year equity + ending year equity) / 2

92
Q

What does ROE reflect and how does it differ from ROA?

A

return to stockholders

ROA is the return for the entire company

93
Q

What are the 5 forces that influence financial statements by determining competitive intensity and serving as key determinants of profitability?

A
  • Industry competition
  • Bargaining power of buyers
  • Bargaining power of suppliers
  • Threat of substitution
  • Threat of entry
94
Q

Describe how industry competition influences financial statements

A

competition and rivalry increase the cost of doing business as companies must hire and train competitive workers, advertise products, research & develop products, and engage in other related activities

95
Q

Describe how bargaining power of buyers influences financial statements

A

buyers with strong bargaining power can extract price concessions and demand a higher level of service and delayed payment terms; this force reduces both profits from sales and the operating cash flows to sellers

96
Q

Describe how bargaining power of suppliers influences financial statements

A

Suppliers with strong bargaining power can demand higher prices and earlier payments, yielding adverse effects on profits and cash flow to buyers

97
Q

Describe how threat of substitution influences financial statements

A

as the number of product substitutes increases, sellers have less power to raise prices and/or pass on costs to buyers; therefore the threat of substitution places downward pressure on profits of sellers

98
Q

Describe how threat of entry influences financial statements

A

new market entrants increase competition; to mitigate that threat, companies expend money on activities such as new technology, promotions, and human development to erect barriers to entry and to create economies of scale

99
Q

What does SWOT (in SWOT analysis) stand for?

A

Strengths & Weaknesses (internal factors) and Opportunities & Threats (external factors)

100
Q

What is a proxy statement?

A

a document containing the information the SEC requires companies to provide to shareholders so they can make informed decisions about matters that will be brought up at annual or special stockholder meetings

101
Q

What are some issues that can be covered in a proxy statement?

A

proposals for new additions to the board of directors, information on directors’ salaries, information on bonus or options plans for directors, and declarations made by the company’s management

102
Q

How are proxy statements used?

A

must be filed by a publicly traded company before shareholder meetings - discloses material matters of the company relevant for soliciting shareholder votes and final approval of nominated directors

103
Q

What is the proxy statement form called?

A

DEF 14A

104
Q

What does EDGAR stand for?

A

Electronic Data Gathering, Analysis, & Retrieval system

105
Q

What are the benefits of proxy statements?

A

can aid potential investors in assessing qualifications and compensation of management teams and the board of directors

106
Q

What is a shareholder letter?

A

letter written by a firm’s top executives to its shareholders to provide a broad overview of the firm’s operations throughout the year

107
Q

What does the shareholder letter typically cover?

A

the firm’s basic financial results, its current position in the market, and some of its plans. Can also speak to specific events that have happened throughout the year, changes in the company’s stock price, or reiterate aspects of its vision. It’s a chance for executives to speak directly to shareholders.

108
Q

How often is the shareholder letter typically shared and where can it be found?

A

generally written once a year and is included at the beginning of the firm’s annual report

109
Q

In regards to ethical conduct, what does management do to ensure accuracy of a company’s financial info?

A
  • maintains a system of controls over the records and assets
  • hires external independent auditors
  • forms a committee of the board of directors to review these other two safeguards
110
Q

What assertions does a “clean” audit report include?

A
  • financial statements are management’s responsibility. Auditor responsiblity is to express an opinion on those statements
    *auditing involves a sampling of transactions, not an investigation of each transaction
  • audit transaction provides reasonable assurance that the statements are free of material misstatements, not a guarantee
  • Auditors review accounting policies used by management and the estimates used in preparing the statements
  • Financial statements present fairly, in all material respsects, a company’s financial condition in conformity with GAAP
111
Q

SOX contains several provisions designed to encourage auditor independence. What are they?

A
  • it established the Public Company Accounting Oversight Board (PCAOB) to oversee the development of audit standards and to monitor the effectiveness of auditors
  • it prohibits auditors from offering certain types of consulting services and requires audit partners to rotate clients every 5 years
  • it requires audit committees to consist of independent members

ACCT 5010 (3 decks)

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