Notes

Question 1

Introductory Phase characteristics:

Answer 1

Purchasing fixed assets and beginning to produce/sell products

Operating = Negative because there are no profits yet

Investing = Negative

Financing = Positive because we need to raise cash through stock and/or debt

Question 2

Growth Phase Characteristics

Answer 2

Striving to expand production and sales
Operating = becoming less negative/small positive since we are starting to make profits
Investing = Negative
Financing = becoming less positive since we are starting to make more from operations than we were before

Question 3

Maturity Phase Characteristics:

Answer 3

Sales and production level off
Operating = Positive
Investing = less negative and perhaps even positive if we begin to sell off assets
Financing = less positive for sure and most likely negative since we are paying off debts and paying out dividends

Question 4

Decline Phase Characteristics:

Answer 4

Sales of product fall due to a weakening consumer demand
Operating = smaller positive since sales are decreasing
Investing = positive since we are selling off assets at this point
Financing = Negative since we are now buying back shares, paying off any remaining debt, and maybe paying dividends as well

Question 5

What is the weakness of the current ratio?

Answer 5

Current ratio uses year-end balances of current asset and current liability accounts. These year-end balances may not be representative of company’s position during most of the year.

Question 6

What does the current cash debt coverage ratio tell us?

Answer 6

Better representation of liquidity on the average day because cash provided by operating activities involves the entire year

Question 7

What does the cash debt coverage ratio tell us?

Answer 7

Ability to repay its liabilities from cash generated from operations without having to liquidate productive assets such as PP & E

Question 8

Statement of Cash flows header

Answer 8

Wellmeyer Company

Statement of Cash Flows

For the Year Ended December 31, 1012

Question 9

Header right under net income on statement of cash flows

Answer 9

Adjustments to reconcile net income to net cash provided by operating activities

Question 10

What does a low payout ratio mean?

Answer 10

A low ratio may suggest that the company is retaining its earnings for future growth, or the company may not be stable enough to pay out dividends.

Question 11

What does a high payout ratio mean?

Answer 11

A high ratio may suggest that the company is well established and stable. It could alarm investors that the company is not retaining enough earnings in order to grow.

Question 12

Where is the unrealized gain or loss on trading securities reported?

Answer 12

Income Statement: Other revenues and gains

Question 13

Where is the unrealized gain/loss on avaiable for sale securities reported?

Answer 13

Stockholder’s Equity – Unrealized gain or loss on available for sale securites

Question 14

d. (30 % ownership)For 2012 Matt Forte Corp reports net income of $100,000. It declares a $50,000 cash dividend. Record the entries for Antoine Winfield Corp.

Answer 14

1) Net Income: 100,000 * 30%
Dr. Stock Investment 30,000
Cr. Revenue from Investment in Matt Forte Corp 30,000

2) Dividends: 50,000 * 30%
Dr. Cash 15,000
Cr. Stock Investment 15,000

Question 15

e. (10 % Ownership)Antoine Winfield Corp receives net proceeds of $85,000 on the sale of its Matt Forte Corp stock on February 14th, 2013. Record the entry of the sale.

Answer 15

Dr. Cash 85,000
Dr. Loss on Sale of Stock Investment of Matt Forte 15,500
Cr. Stock Investment 100,500

Question 16

Potential reasons to buy or effects of buying back treasury stock?

Answer 16

Will help fund stock compensation plans

Will reduce excess cash

Will increase EPS

Question 17

Some reasons for companies to pay dividends

Answer 17

Have consistent and sustainable cash flows

They are big, mature, and stable

Choose to pay dividends, but are not required

Question 18

Debt Advatnages

Answer 18

-Stockholder control is not affected. Debt issuers do not get voting rights
-The company saves taxes because interest expense lowers taxable income
-Using debt increases leverage, which may increase return on stockholder equity
-Considered cheaper than equity, because interest payments are lower than
stockholders’ expected return

Question 19

Debt Disadvantages

Answer 19

• Debt holders will have first claim to the company’s assets during liquidation
• Interest payments may be hard to pay, and they are required
• Too much debt worries investors

Question 20

Equity Advantages

Answer 20

• Often easy, due to the liquidity of the market
• You don’t have to make payments to shareholders

Question 21

Equity Disadvantages

Answer 21

-Stockholders demand a higher return than debt holders

Question 22

What does buying back stock communicate to investors?

Answer 22

Investors tend to like when companies repurchase stock, because it usually means that the
company has a lot of excess cash, and is therefore operating well. Also, it usually means the
company thinks it will continue to do well and the share price will rise.

Question 23

Differences betwen common stock and preferred stock:

Answer 23

Preferred stock usually has priority with dividends and with receiving value during
liquidation/bankruptcy. However, common shareholders have voting rights, while preferred
shareholders almost always do not.

With dividends, preferred shareholders are often guaranteed dividends and have a stated
dividend rte. For common shareholders, dividends are optional.

During liquidation, debt holders get paid first, then preferred shareholders’, then common
shareholders.

Question 24

Effect of Cash Dividend

Answer 24

Cash Dividends: cash is going from the company to the investor, so there is value being
exchanged. No change in the number of shares or the par value etc.

Question 25

Stock Dividend effects

Answer 25

Stock Dividends: no real value is being exchanged. The amount of shares will increase by the %
stock dividend, and the price/share will decrease by that same percentage. Total stockholder’s
equity does not change, hpwever. Also, par value does not change.

Question 26

Stock Split information

Answer 26

Stock Splits: no value is being exchanged. Shares increase by the magnitude of the stock split.
Share price is divided by the magnitude of the stock split, as is par value.

Question 27

What does the payout ratio tell us?

Answer 27

It is usually expressed in a percentage. It tells us what % of the company’s earnings or profits
are being directly passed onto investors. Investors who like receiving dividends, look closely
at a company’s payout raito.

Question 28

What does Return on common stockholders’ equity tell us?

Answer 28

Also expressed as a %. This tells us how much profit the company made/earned per dollar of
equity provided by investors. For instance, if net income= 200 and avg common stock=
1,000, then that is a 20% return on common stock. This means that as an investor, if you
paid $1 to invest in the company, you essentially just made 20 cents

Question 29

Free Cash Flow provides an indication of a company’s ability to:

Answer 29

Generate cash to pay dividends

Generate cash to invest in new capital expenditures

Question 30

Significant investing and financing activities that do not affect cash are reported:

Answer 30

In a seperate schedule at the bottom of the statement of cash flows

In the notes of the financial statements

Question 31

The payment of cash dividends is a __________________

Answer 31

financing activity

Question 32

Amortization expense of intangibles is an ______________

Answer 32

operating activity

Question 33

Using a loan to purchase land is a(n)

Answer 33

noncash activity

Question 34

A company has high cash inflows from financing activities, and high cash outflows from both operating and investing activities.

Answer 34

Introductory phase

Question 35

A company has positive operating and investing cash flows, but has seen its net financing cash flows decrease to roughly even.

Answer 35

Maturity phase

Question 36

Companies in the growth stage often have positive cash flows from financing activities, yet negative cash flows from both investing and operating activities. Why?

Answer 36

Companies that are growing need to buy assets, so therefore they have net cash outflows for
investing. As for operations, the net cash outflows are because they have high expenses because of
paying larger rent, hiring employees, and selling products cheaper than they would like to in order
to attract customers. In order to fund operations and the need to grow their asset base, they must raise money from
outside investors. They do this through financing issuances of debt and equity.

Question 37

What operating activities tells investors:

Answer 37

Operating cash flows are the core of the business. It involves their revenues from selling goods,
selling expenses, salaries, rent etc. It also incorporates the changes in stuff like receivables and
inventories and payables, all that are needed to run a company. It tells us how much cash they are
making from their core operations.

Question 38

What investing activities tells investors:

Answer 38

Investing cash flows deal with fixed assets, mostly PP&E. This tells us whether a company is buying
or selling more of these items. If they are buying more, they are probably growing, expanding their
abilities. If they are selling more, they are probably a mature or declining company that is finding
ways to get rid of excess assets. Also, they may need the money and are selling non-essential assets
for cash.

Question 39

What financing activities tells investors:

Answer 39

Financing activities focuses on cash flows between the company and outsiders. If the cash flows are
positive, they are still raising money, which means they probably are growing and need to fund
operations and the purchase of assets. Negative financing is for mature companies who are paying
dividends, or buying back stock and debt.

Question 40

Why are free cash flows important?

Answer 40

Free cash flow includes cash from operations, which is cash flows from core operations. CAPEX is
expenses to purchase required assets to continue operations. And dividends are direct cash
payments to investors.

When you calculate free cash flow, it is considered the left-over excess cash for the company to
make any decision they want. I they want to grow, acquire a company, pay more dividends, buy
back stock etc., they must have free cash flow.

Question 41

What is true regarding trading securities?

Answer 41

Recorded at fair value

Bought and held primarily for short-term gains

Impact the income statement with changes in fair value

Question 42

Trading securities effects

Answer 42

Trading securities: the changes in fair value are journalized to two accounts. The “Market
adjustment-trading” account and the “unrealized G/L-income” account. Therefore, any changes in
the fair value of trading securities is shown on the income statement and affects net income.
Because of this, trading securities lead to net income being more volatile.

Question 43

Available-for-sale securities effects

Answer 43

AFS securities: the two accounts for AFS securities are “market adjustment-AFS” and “Unrealized
g/l-equity”. As you can see, the unrealized g/l goes to stockholders’ equity and not the income
statement. Therefore, gains and losses do not impact net income until the securities are sold.

Question 44

short-term stock investments =

Answer 44

trading securities

Question 45

Dividend Revenue reported under:

Answer 45

“Other gains and Revenues”

Question 46

Loss on sale of stock investments

Answer 46

“Other expenses and losses”

Question 47

What would be included in “Other comprehensive income”

example

Answer 47

Unrealized loss on AFS securities

Question 48

What is an example of something found in the Stockholders’ Equity section on the balance sheet?

Answer 48

Unrealized gains and losses on AFS securities

Question 49

Where are discontinued operations shown?

Answer 49

Discontinued operations are shown after “income before irregular items” and before
net income. They are shown, net of tax, meaning you take out the amount impacted by the tax rate.

Question 50

Two characteristics of extraordinary items

Answer 50

Unusual in nature

Infrequent in occurrence

Question 51

What do high and low quality of earnings mean?

Answer 51

High quality of earnings means that the financial information is clear, transparent, and reflective of
how the company is doing. You can trust the net income numbers.

Poor Quality of earnings arises
when companies alter the numbers. Therefore, net income isn’t reflective of how the company is
doing.

Question 52

Some things that may lower quality of earnings

Answer 52

Companies often alter revenues by changing revenue recognition. Most companies who do this try
to boost revenues by recognizing them early. As for expenses, companies can do a lot of things. Stuff
like bad debt expense and depreciation expense are management estimates. Also, companies may
choose to defer an impairment loss