Accounting II

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Accounting II
2010-05-09 21:22:52
Financial Statements II

Ch. 2 A further look at financial statements.
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  1. Classified Balance Sheet
    • A balance sheet that contains a number of standard classifications
    • and sections.
  2. Current Assets
    • Cash and other resources that companies reasonably expect to convert to
    • cash or use up within one year or the operating cycle, whichever is
    • longer.
    • (Companies list current assets in the order in which they expect to
    • convert them into cash).
  3. Operating Cycle
    • The average time required to go from cash to cash in producing revenues—to purchase inventory, sell it on account, and then collect cash from
    • customers.
  4. Long-term Investments
    • Generally, (1) investments in stocks and bonds of other corporations
    • that companies hold for more than one year, and (2) long-term assets,
    • such as land and buildings, not currently being used in the company's
    • operations.
    • (Long-term investments are often referred to simply as investments.)
  5. Property, plant, and equipment.
    • Assets with relatively long useful lives that companies use in operating
    • the business and are not intended for resale.

    • (Property, plant, and equipment is sometimes called fixed assets or
    • plant assets.)
  6. Depreciation...
    • is the practice of allocating the cost of assets to a number of years.
    • Companies do this by systematically assigning a portion of an asset's
    • cost as an expense each year (rather than expensing the full purchase
    • price in the year of purchase). The assets that the company depreciates
    • are reported on the balance sheet at cost less accumulated depreciation.
    • The accumulated depreciation account shows the total amount of depreciation that the company has
    • expensed thus far in the asset's life.
  7. Intangible Assets
    Assets that do not have physical substance.

    (Sometimes intangible assets are reported under a broader heading called “Other assets.”)

    • One common intangible is goodwill. Others include patents, copyrights,
    • and trademarks or trade names that give the company exclusive right of use for a specified
    • period of time.
  8. Current Liabilities
    • Obligations that a company reasonably expects to pay within the next
    • year or operating cycle, whichever is longer.

    • Common examples are accounts payable, wages payable, bank loans payable,
    • interest payable, and taxes payable. Also included as current
    • liabilities are current maturities of long-term obligations—payments to
    • be made within the next year on long-term obligations.
  9. Long-Term Liabilities
    Obligations that a company expects to pay after one year.

    • Liabilities in this category include bonds payable, mortgages payable,
    • long-term notes payable, lease liabilities, and pension liabilities.
  10. Stockholder's Equity consists of two parts: ____ and ____.
    commong stock and retained earnings.

    • Companies record as common stock the investments of assets into the business by the stockholders. They
    • record as retained earnings the income retained for use in the business. These two parts, combined, make
    • up stockholders' equity on the balance sheet.

    Stockholder's net claim on total assets.
  11. Ratio Analysis
    • A technique for evaluating financial statements that expresses the
    • relationship among selected financial statement data.

    • The relationship is expressed in terms of either a percentage, a
    • rate, or a simple proportion.
  12. Ratio
    • An expression of the mathematical relationship between one quantity
    • and another; may be expressed as a percentage, a rate, or a proportion.

    • To illustrate, Best Buy has current assets
    • of $9,081 million and current liabilities of $6,301 million. We can
    • determine a relationship between these accounts by dividing current
    • assets by current liabilities, to get 1.44. The alternative means of
    • expression are:

    • Percentage: Current assets are 144% of current liabilities.
    • Rate: Current assets are 1.44 times as great as current liabilities.
    • Proportion:The relationship of current assets to current liabilities is 1.44:1.
  13. For analysis of the primary financial statements, we classify ratios as
    follows.... _____ ,_______, ________.
    Profitibility Ratios: Measure the income or operating success for a company for a given period of time.

    Liquidity Ratios: Measure short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.

    Solvency Ratios: Measure the ability of a campany to survive over a long period of time.
  14. (Profitibility Ratio) EPS (Earnings Per Share; Earnings/Share)
    A measure of the net income earned on each share of common stock;

    • We compute EPS by dividing net income
    • by the average number of common shares
    • outstanding during the year.

    • EPS= Net Income - Preferred Stock Dividends
    • Average Common Shares Outstanding
  15. Statement of Stockholder's Equity
    • A financial statement that presents the factors that caused
    • stockholders' equity to change during the period, including those that
    • caused retained earnings to change.
  16. Liquidity
    • The ability of a company to pay obligations that are expected to become
    • due within the next year or operating cycle.

    • (You would look closely at the relationship of its current assets to
    • current liabilities.)
  17. One measure of liquidity is _____ _____, which is the difference between the amounts of current
    assets and current liabilities:
    working capital

    Working Capital= Current Assets - Current Liabilities

    • When current assets exceed current liabilities, working capital is
    • positive. When this occurs, there is greater likelihood that the company
    • will pay its liabilities. When working capital is negative, a company
    • might not be able to pay short-term creditors, and the company might
    • ultimately be forced into bankruptcy.
  18. Current Ratio (Liquidity Ratio)
    • A measure used to evaluate a company's liquidity and short-term
    • debt-paying ability; computed as current assets divided by current
    • liabilities.

    Current Assets/Current Liabilities
  19. Solvency
    • The ability of a company to pay interest as it comes due and to repay
    • the balance of debt at its maturity.
  20. The ____ __ ____ _____ ____ is one source of information about long-term
    debt-paying ability.
    debt to total assets ratio

    • Measures the percentage of total financing provided by creditors;
    • computed as total debt divided by total assets.

    total debt / total assets

    • Some users evaluate solvency using a ratio of liabilities divided by
    • stockholders' equity. The higher this “debt to equity” ratio, the lower
    • is a company's solvency.
  21. statement of cash flows
    • provides financial information about the sources and uses of a
    • company's cash.
  22. To aid in the analysis of cash, the statement of cash flows reports the
    cash effects of a company's ____, ____, ____?
    Operating activities, investing activities, and financing activities.
  23. Free Cash Flow
    • Cash remaining from operating activities after adjusting for capital
    • expenditures and dividends paid.

    free cash flow = cash provided by operations - capital expenditures* - cash dividends

    * example: on property, plant, and equipment.
  24. Relevance
    The quality of information that indicates the information makes a difference in a (business) decision.
  25. Reliability
    The quality of information that gives assurance that it is free of error (verifiable), is factual (faithful representation), and is neutral.
  26. Comparability
    The ability to compare the accounting information of differe.mpanies because they use the same accounting principles.
  27. Consistency
    Use of the same accounting principles and methods from year to year within a company.
  28. Monetary Unit Assumption
    An assumption that requires that only those things that can be can be expressed in money be included in the accounting records.
  29. Economic entity Assumption
    An assumption that every economic entity can be separately identified and accounted for.
  30. Time period assumption
    An assumption that the life of a business can be divided into artificial time periods and that useful reports covering those periods can be prepared for the business.
  31. Going concern assumption
    The assumption that the company will continue in operation for the foreseeable future.
  32. Cost principle
    An accounting principle that states that companies should record assets at their cost (what they purchased them for).

    • For example, if Best Buy were to purchase some land for $30,000, the
    • company would initially report it on the balance sheet at $30,000. But
    • what would Best Buy do if, by the end of the next year, the land had
    • increased in value to $40,000? Under the cost principle the company
    • would continue to report the land at $30,000.
  33. Full disclosure principle
    Accounting principle that dictates that companies disclose circumstances and events that make a difference to financial statement users.
  34. Materiality
    The constraint determining whether an item is large enough to influence the decision of an investor or creditor.

    • To illustrate, assume that Best Buy made a $100 error in recording
    • revenue. Best Buy's total revenue is almost $36 billion; thus a $100
    • error is not material.
  35. Conservatism
    The approach of choosing an accounting method, when alternatives exist, that will least likely overstate assets and net income.