Acct E1

ndifranco94's version from 2015-06-29 11:43


Question Answer
Where do accting rules come from?Financial Accounting Standards Board (FASB), which uses GAAP; internationally, IASB relies on IFRS
What is the purpose of accting?Decision Making, Stewardship
Decision MakingManager makes operating, investing, financial decisions; Investors decide whether or not to buy/sell stock; Rating agencies decide creditworthiness and lending terms
StewardshipWorkers need to report successes/failures to owner; need set of regulations to prevent LYING; operates on Agent Theory
Agent TheoryPrincipal = owner, Agent = worker; Agent reports to principal, regulations in place to prevent lying
Why is stewardship not as relevant today?not just one owner, many stockholders
GAAPGenerally Accepted Accounting Principles; common set of principles, standards, procedures to compile fin statements; combination of authoritative rulings and common practice
Consequences of Accounting Choiceinfluence output of accounting system, including fin statements
Different ways of recording inventoryAverage Cost = ignores changing cost impact; FIFO = use if margins are higher on first purchased inventory -> REPORT HIGHER PROFIT, higher inventories, lower expenses; LIFO = use to avoid higher taxes if you show lower margins w/ LIFO, higher expenses, lower inventories
What does statement of owner's equity tell us?Summary of changes to all equity accounts over a period; allows you to see accounts like dividends and treasury stock to see what events have increased/decreased owner's equity
Balance Sheet vs Income StatementBS = future benefit/cost, snapshot at single point in time; IS = immediate benefit/cost, changes to BS over period of time; Asset = future economic benefit (ex. inventory), but once used up, BECOMES AN EXPENSE ON IS
Cash Flow Statement allows us toAssess Cash Management; ability to generate cash from transaction, sources of generated cash, what is done with cash; more cash allows companies to increase dividends, buy back stock, reduce debt, acquire companies; more cash increases quality of company's income
Three areas of Cash Flow StatementOperating = normal operations like revenues; Investing = acquisiton or disposition of assets; Financing = cash raised by stock, debts
Ex. of Importance of Cash Flow Statementcompany receives big contract, immediate revenues, but no cash right away. could be profitable on BS but still be LOSING CASH in the period
How to build ISSubtract COGS from revenue --> PROFIT, subtract Operating Expenses --> NET OPERATING INCOME --> subtract Nonoperating Expenses/add Nonoperating Revenues --> NET BUSINESS INCOME
Why have diff categories in IS?Don't let one-time. unusual costs mask sound operations; monitor nonoperating expenses and associated problems (like high interest)
Order of Assets on BSorder of LIQUIDITY, most liquid first = current assets (cash, or will be used up/converted to cash w/in year), least liquid last = long term assets (PPE)
Order of Liabilities on BSorder by WHEN PAYMENT IS DUE, First = current liabilities (settled w/in one year); Last = noncurrent liabiltities (due after one year)
Connection Among Accounting statementsIS+SE+BS = linked by Retained Earnings; Cash Flow + BS = linked by cash; SE + BS = linked by total shareholders' equity
In general, what do income statement and cash flow statements do?IS - shows how assets and liaiblities were used during a period; CF = reveals amount of cash on hand
How to account for not being paid?Subtract an uncollectable amount from Accounts Receivable; Causes a reduction in assets and retained earnings; Amount is decided based on historical percentages and is reported as a bad debt expense
How to account for sale of equipment?buy equipment = remove cost from cash, add cost to noncash assets; record depreciation = remove depreciated value from noncash and retained earnings each year; Record sale as a gain or loss on income statement and remove asset from BS
Pay for three years rent in advance, how to acct?Entire amount taken out of cash, two prepaid years are added to noncash assets, current year is covered in a loss from retained earnings and added as an expense on the IS; each year, remove rent from noncash assets and retained earnings + record as expense
Customers pay for 5 years of service in advance, how to acct?Record an increase in cash, record payment as Unearned Revenue under Liabilities, For each period of payment, decrease liabilities and increase retained earnings by same amount!
When does market value matter in accounting?Historical cost rules, market value can be biased; market value is reflected in financial statements; ONLY considered when buying/selling company (ex. passive investment = mark up/down marketable securities) and considering goodwill
How is market value biased?cannot account for intangibles like great management; manager can intervene and bias results to a particular objective like enhancing stock price
How is market value reflected in financial statementsassets are eventually sold and liabilities are eventually settled; intangibles are recognized in PROFIT
ROIIncome/Assets; Rate of return you were able to earn on your assets; includes investor monet + borrowed funds
ROEIncome/Average Equity; rate of return on average owner contribution; Large than ROI b/c not putting all investments in denominator, ONLY INVESTOR MONEY, NOT BORROWED
Why does the DuPont disaggregation of ROI add insight?measures profitability by both profitability on sales and how effectively you utilize assets; encourages managers to consider both balance sheet (Asset Turnover) AND income statement (Profit Margin), instead of just income/sales, which doesn't show how well you are performing in individual sectors
Two key components of DuPontProfit Margin: amount of profit a company earns on each dollar of sales; Asset Turnover: productivity measure; reflects volume of sales generated from each dollar invested in assets
Analysis of Liquidityanalysis of available cash and a company's ability to service debt in the short run; basically the ability to sell assets quickly and generate cash
Analysis of solvencyanalysis of ability to generate sufficient cash to service debt in the long run; a solvent company OWNS MORE THAN IT OWES = positive net worth and manageable debt load
Comparison of liquidity and solvency analysisboth measure financial health, just in different time scales; liquidity is for short term debt, solvency for long term debt; company could have adequate liquidity to cover bills, but could still be heading for long-term disaster
Turnoversales/asset; can be categorized into inventory, PPE, accounts receivable, etc; number of times an asset is replaced during a financial period (things s/a inventory); higher is better (ex. high accounts receivable turnover means the company is getting fast credit payoff and converting receivables to cash)
Examples of varying turnoverRestaurants = very high turnover b/c assets are constantly being consumed and replaced (on a daily basis), operate on lower profit margins to achieve sufficient RNOA; Oil and Gas = extremely capital intensive (high levels of assets and low turnover), must earn high profit margin to offset low asset turnover
Why use Common-Size Statement AnalysisVertical analysis and horizontal analysis
Vertical AnalysisAllows us to compare companies of different size; set total assets as base value and make all BS percentage of it; set net sales as base value and make all IS values a percentage of it
Horizontal AnalysisAllows us to analyze financial data over time; Allows us to see trends and predict future performance; set values in one year as base and compare other years to it (Ex. See proportion of assets vs. sales over span of x years)
Why would you be paid more than face value for bonds?Coupon rate ? market rate so investors are willing to pay more than face value to get the better rate
Accounting for premium bondsAdd total to cash, Add Total - Premium to Bonds Payable (Liailibity), Add Premium to Premium on Bonds Payable (Liability); every time an interest payment is made, portion of premium is applied to reduce cost of interest payment
Retained EarningsPortion of net income not paid out as dividends, but retained by company to be reinvested in its core business or to pay debt
Dividendscause retained earnings to decrease
What causes Retained Earnings to inc/dec?Dividends cause decrease; Anything that affects net income causes inc/dec (revenues, COGS, expenses)
How is a loss reported?negative retained earnings
Accounting for stock buybackReduce cash by amount of buyback; Reduce owner's equity by amount of buyback using treasury stock account (negative number)
Passive Investment<20%, acct as Marketable Securities (Asset): next to cash b/c very liquid (can sell at any time); Carried at market value: have to mark up/down w/ market b/c it is so close to cash
Larger Minority Interests20-50%, Equity Method of Accounting -> Single Line Asset= Cost +- % Income each year (Ex. own 25% of company, net income of company is 100k, record initial investment + 25k as single line asset)
Control Investment>51%, Sum all accounts of the two corporations; add up on a line by line basis; eliminate intercompany transactions; eliminate sub's equity accounts
Purchase inventory on creditIncrease NONCASH ASSETS (asset) and ACCOUNTS PAYABLE (liab)
Sell inventory on creditincrease ACCOUNTS RECEIVABLE (asset) and decrease INVENTORY (asset)...Inc and dec RETAINED EARNINGS BY SAME AMOUNTS
Goodwillintangible asset that arises when a buyer acquires an existing business, but pays more than the fair market value of their net assets
Three moments of goodwillCreation= paying more than fair market value for something intangible; Testing= once per year to determine if value is retained; Disposition= taken off balance sheet w/ gain or loss to income statement once sold
Depreciation is always recorded as anexpense + loss in retained earnings
Wages are always recorded as anexpense + loss in retained earnings

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