Final Exam Study Guide
Final Exam Study Guide ACCT 2010-012
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This 8 page Study Guide was uploaded by Rachel Notetaker on Sunday April 24, 2016. The Study Guide belongs to ACCT 2010-012 at Clemson University taught by Tonya Smalls in Spring 2016. Since its upload, it has received 66 views. For similar materials see Financial Accounting Concepts in Business at Clemson University.
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Final Exam Study Guide Chapter 11:Stockholders’ Equity I. Corporate Ownership (90% of total sales reported by US businesses) a. If it’s so costly, why is it so popular? i. Shares of stock can be purchased in small amounts ii. Ownership interests are transferable iii. Stockholders are not liable for the for the corporation’s debt In the most basic form, a corporation must have one type of stock, appropriately called common stock. Owners of common stock usually enjoy a number benefits: 1. Voting Rights. For each share you get a number of votes 2. Dividends. Share of corporation’s profits 3. Residual claim. Share in closing asset distribution 4. Preemptive rights. First chance at newly issued stock II. Equity vs. Debt Financing Whenever a company needs a large amount of long-term financing, its executives will have to decide whether to obtain it by issuing new stock to investors (called equity financing) or borrowing money from lenders (debt financing) Advantage of Equity financing 1. Equity doesn’t have to be repaid. Debt must be repaid or refinanced. 2. Dividends are optimal. Interest must be paid on debt. Advantage of Debt Financing 1. Interest on debt is tax deductible. Dividends on stock are not tax deductible. 2. Debt does not change stockholder control. In contrast, a stock issue gives new stockholders the right to vote and share in the earnings, diluting existing stockholders’ control. *All transactions between a company and its stockholders affect the company’s balance sheet account only * III. Common Stock Transaction a. Contributed Capital reports the amount of capitol the company received from investors’ contributions in exchange for the company’s common stock and preferred stock b. Retained Earnings reports the cumulative amount of net income earned by the company less the cumulative amount of dividends since the corporation was first organized c. Treasury Stock reports shares that were previously issued to and owned by stockholders but have been required and are now held by the corporation d. Accumulated Other Comprehensive Income (loss) reports unrealized gains and losses, which are temporary changes in the value of certain assets and liabilities the company holds. IV. Authorization, Issuance, and Repurchase of Stock A corporation’s charter indicates the maximum number of shares of stock that the corporation is authorized to issue. Issued shares will be owned forever by one stockholder or another, unless the company has repurchased them Shares that have been repurchased by the corporation are called treasury stock. (+xSE, which means treasury stock is not an asset) Shares that are owned by stockholders (not the corporation itself) are called outstanding shares. A. Stock Authorization No-par value stock is similar to stock with par value, except it does not have a specified legal value per share. * some states charge corporate fees based on total par value * B. Repurchase of Stock A corporation may want to repurchase its stock from existing stockholders to (1) send a signal to invetors that the company itself believes it own stock is worth acquiring, (2) obtain shares that can be reissued as payment for purchases of other companies, (3) obtain shares to reissue to employees as part of employee stock purachase plans, and (4) reduce the number of outstanding shares to increase par-share measures of earning and stock value. C. Cash Dividends on Common Stock Some investors prefer to buy stocks that pay little or no dividends (called a growth investment) because companies that reinvest a majority of their earnings tend to increase their future earnings potential, along with their stock price. An income investment is a stock that consistently pays dividends Ex: Coca-Cola When deciding whether to declare a cash dividend, a company’s board of directors considers not only possible law tax changes but also the following two key financial requirements: A. Sufficient retained Earnings Because restrictions on Retained Earnings can severely limit the ability to pay dividends, accounting rules require that companies disclose any restrictions in their financial statement notes. B. Sufficient Funds The company must have sufficient cash to pay the dividend. A cash dividend involves four important dates, only three of which require accounting entries. 1. Declaration Date debit credit Dividends 118,139,000 Dividends Payable 118,139,000 2. The record-date= cut-off date for determining dividend payouts 3. Date of Payment debit credit Dividends Payable 118, 139,000 Cash 118,139,000 4.Year-End All temporary accounts, including dividends, are closed into retained earnings at each accounting year-end. Debit credit Retained Earnings 118,139,000 Dividends 118,139,000 V. Stock Dividends and Stock Splits a. Stock Dividends Some dividends are not paid in cash but in additional shares of stock. These dividends, called stock dividends, are distributed to a corporation’s stockholders on a pro rata basis at no cost to the stockholder. b. Stock Splits In a stock split, the total number of authorized shares is increased by a specified amount, such as 2-for-1. In this instance, each issued share is called in and two new shares are issued in its place. *Cash is not affected * VI. Preferred Stock In addition to common stock, some corporations issue preferred stock to a select group of investors. This special form of stock differs from common stock, typically in the following ways: 1. Preferred stock allows different voting rights 2. Dividends on preferred stock, if any, may be paid at a fixed rate, specified as either a dollar amount or a percentage per share. 3. Preferred Stock carries priority over common stock. Preferred stock Issuance Just like a common stock issuance, a preferred stock issuance increases a company’s cash and stockholders’ equity. Debit credit Cash 19,704,000 Preferred Stock 400,000 Additional Paid-In Capital—Preferred 19,304,000 VII. Preferred Stock Dividends Preferred stock offers dividend preferences. The two most common dividend preferences are called current and cumulative. A. Current Dividend Preference A current dividend preference requires that preferred dividends be paid before paying any dividends to holders of common stock A cumulative dividend preference states that if all or a part of the current dividend is not paid in full, the cumulative, unpaid amount, known as the dividends in arrears, must be paid before any future common dividends can be paid. The most famous of all ratios, earnings per share (EPS), reports how much profit is earned for each share of common stock outstanding. Net Income –Preferred Dividend =Average number of Common Shares Outstanding Like EPS, return on Equity (ROE) reports a company’s return to common stockholders. Net Income-Preferred Dividends =Average Common Stockholders’ Equity The Price per Earnings (P/E) measures how many times more than current year’s earnings investors are willing to pay for a company’s stock. Current Stock Price (per share) =Earnings per Share (annually) Chapter 12: Statement of Cash Flows The statement of cash flows shows each major type of business activity that caused a company’s cash to increase or decrease during the accounting period. The Statement of Cash Flows Focus on: Investing Financing Cash paid and received from Cash received and paid for Buying and selling long-term exchanges with lenders and Assets stockholders Operating Cash received and paid for day-to-day Activities with customers, suppliers, and employees Inflows Outflows -Operating activities: Purchasing services (electricity, etc. ) and Collecting from customers goods for resale Receiving dividends Paying salaries and wages Receiving interest Paying income taxes, Paying interest -Investing Activities: Sale or disposal of equipment Purchase of equipment Sale or maturity or investment in Purchase of investments in securities securities -Financing Activities Borrowing from lenders through formal repurchasing stock from owners Debt contracts Paying cash dividends to owners Issuing stock to owners repaying principal to lenders Relationships between Classified Balance Sheet and Statement of Cash Flows (SCF) Categories SCF Categories Classified Balance Sheet Categories Operating Current Assets Current Liabilities Investing Noncurrent Assets Noncurrent liabilities Financing Stockholders’ Equity To prepare a statement of cash flows, you need the following: 1. Comparative balance sheets, showing beginning and ending balances, used in calculating the cash flows from all activities (operating, investing, and financing). 2. A complete income statement, used primarily in calculating cash flows from operating activities 3. Additional data concerning selected accounts that increase and decrease as a result of investing and/or financing activities Rearrangement of balance sheet equation Change in cash = change in (liabilities + Stockholders’ Equity – Noncash Assets) A. Preparing the Statement of Cash Flows 1. Determine the change in each Balance Sheet Account From this year’s ending balance, subtract this year’s beginning balance 2. Identify the cash flow category/ies to which each account relates Retained Earnings can include financing cash flows (paying dividends) and operating cash flows (generating net income) Accumulated Depreciation can be affected by operating activities (depreciation for using equipment in daily operations) as well as investing activities (disposing of equipment). 3. Create schedules that summarize operating, investing, and financing cash flows. Let’s start with operating cash flows B. Direct and Indirect Reporting of Operating Cash Flows Two alternative methods may be used: 1. The direct method reports the total cash inflows or outflow from each main type of transaction ( with customers, suppliers, and employees) The difference between these cash inflows and outflows equal the Net Cash proided by (used in) Operating Activities 2. The indirect method starts with net income from the income statement and adjusts it by eliminating the effects of items that do not involve cash (for example, depreciation) and including items that do not have cash effects. Adjusting net income for these items yields the Net Cash provided by (Used in) Operating Activities. I. Determining Operating Cash Flows Using the Indirect Method Net Income +Depreciation (doesn’t involve cash so added back) +Decreases in current assets -Increase in Current Assets +Decreases in current liabilities -Increases in current liabilities If accounts payable: Decreases—subtract (-) (cash outflows>purchases) Increases—Add(+) (Purchases>Cash outflow) If accrued liabilities Decreases—Subtract (-) (Cash outflow>purchases) Increases—add(+) (Purchases>cash outflow) A. Financing Cash Flow calculations This section of the cash flow statement includes changes in liabilities owed to owners (Dividends Payable) and financial institutions (Notes Payable and other types of debt), as well as changes in stockholders’ equity accounts. Related Balance Sheet Account / Financing Activity/ Cash Flow Effect Notes Payable/ Borrowing cash from banks or other financial institutions Inflow /Repayment of loan principle Outflow Bonds Payable/Issuance of bonds for cash Inflow /Repayment of bond face value Outflow Common Stock/Issuance of stock for cash Inflow Treasury Stock/ Repurchase of stock with cash Outflow Retained Earnings/ Payment of cash dividends Outflow To compute ash flows from financing activities, you should review changes in all debt and stockholders’ equity accounts. Increases and decreases must be identified and reported separately. B. Evaluating Cash Flows Cash flows from Operating Activities The operating activities section indicates how well a company is able to generate cash internally through its operations and management of current assets and current liabilities. All other things being equal, when net income and operating cash flows are similar, there is a high likelihood that revenues are realized in cash and that expenses are associated with cash outflows. Any major deviations should be investigated. Four potential causes to consider: 1. Seear’sasonality—variations in sales and inventory (usually not to worry) 2. The corporate life cycle (growth in sales) takes a minute for company’s to collect cash from sales while Accounts Receivable and Inventory increase, causing operating cash flows to be lower than related net income. Fine as long as financing can occur until operating activities starts generating more positive cash flows. 3. Changes in revenue and expense recognition. If recognized before received or after incurred, cash flows from operations will be significantly lower than net income, providing due that there might be an error. C. Cashflows from Investing Activities Healthy Companies tend to show negative cash flows in the investing section because it has to spend more to acquire long-term assets. It should be suspicious if a company has positive investing cash flows because they might be selling off assets. D. Cash Flows from financing activities No telling what the company is like based solely on whether financing cash flows are positive or negative. Have to look at specific line items. II. Reporting Operating Cash flows with the Direct Method The direct method presents a summary of all operating transactions that result in either a debit or credit to cash. It is prepared by adjusting each revenue and expense on the income statement from the accrual basis to the cash basis. Chapter 13: Measuring and Evaluating Financial performance I. Horizontal, Vertical, and Ratio Analyses A. Horizontal (trend) analyses are conducted to help financial statement users recognize important financial changes that unfold over time. Trend analyses are usually calculated in terms of year-to-year dollar and percentage changes. A year-to-year percentage change expresses the current year’s dollar change as a % of the prior year’s total by using the following calculation: Year-to-year Change his Year (Current Year’s Total*Prior Year’s Total) Change (%) : Prior Year’s Total X 100 = Prior Year’s Total X100 B. Vertical (common size) computations A second type of analyses, vertical (common size) analyses; focuses on important relationships within a financial statement. C. Ratio computations Ratio analyses help financial statement users to understand relationships among various items reported in the financial statement. These analyses compare the amounts for one or more line items to the amounts for other line items in the same year. Useful because they consider differences in the size of the amounts being compared, like common size statements. Most analysts classify ratios into three categories 1. Profitability ratios, which relate to the company’s performance in the current period-in particular, the company’s ability to generate income. 2. Liquidity ratios, which relate to the company’s short- term survival- in particular, the company’s ability to use current assets to repay liabilities as they are due 3. Solvency ratios, which relate to the company’s long-run survival-in particular, the company’s ability to repay lenders when debt matures and to make the required interest payments prior to the date of maturity.
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