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ACC 202 Exam 6

by: Sharon Liang

ACC 202 Exam 6 ACC 202

Sharon Liang

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Final Exam Notes. Covers powerpoint notes of Chapter 16.
Managerial Accounting
Dr. Stephen Weissmueller
Study Guide
Managerial, Accounting
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This 6 page Study Guide was uploaded by Sharon Liang on Thursday April 28, 2016. The Study Guide belongs to ACC 202 at University of Kentucky taught by Dr. Stephen Weissmueller in Spring 2016. Since its upload, it has received 32 views. For similar materials see Managerial Accounting in Accounting at University of Kentucky.


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Date Created: 04/28/16
ACC 202 Exam 6 Common Size Analysis  To make the analysis more meaningful, percentages can be used  Common size analysis expresses line items or accounts in the financial statements as percentages  2 major forms of common size analysis are horizontal and/or vertical Horizontal Analysis  Another term is called trend analysis  Expresses a line item as a percentage of some prior-period amount - Allows trend to be assessed over time  Line items are expressed as a percentage of a based period amount  The base period can be the immediately preceding period or the period further in the past  Involves relationships among items over time Vertical Analysis  Concerned with relationships among items within a particular time period - Expresses the line item as a percentage of some other line item for the same period  With this approach, within-period relationships can be assessed  Line items on income statements are often expressed as percentages of net sales  Items on the balance sheets are often expressed as a percentage of total assets Ratio Analysis nd  2 major technique for financial statement analysis  Ratios are fractions or percentages computed by dividing one account or line item amount by another  Example: operating income divided by sales produces a ratio that measures profit margin on sales Standards for Comparison  Ratios alone tell little about the financial well-being of a company  For a meaningful analysis, ratios should be compared with a standard  Only through comparison, can someone using a financial statement assess the financial health of a company  2 standards commonly used are the past history of the company and the industrial averages Classification of Ratios  Ratios are classified into 3 categories 1) Liquidity ratios measure the ability of the company to meet its current obligations 2) Leverage ratios measure the ability of a company to meet its long term and short term obligations - These ratios provide a measure of the degree of protection provided to a company’s creditors 3) Profitability ratios measure the earning ability of a company - These ratios allow investors, creditors, and managers to evaluate the extent to which invested funds are being used efficiently Current Ratio  Measure of the ability of a company to pay its short term liabilities out of short term assets  Current ratio = current assets/current liabilities  Current liabilities must be paid within an operating cycle (usually a year)  Current assets can be converted to cash within an operating cycle  Current ratio provides a direct measure of the ability of the company to meet short term obligations Quick or Acid-Test Ratio  Measure of liquidity comparing only the most liquid assets with current liabilities  Excluded from the quick ratio are non-liquid current assets such as inventories  Quick ratio = (cash + marketable securities + accounts receivables)/current liabilities Accounts Receivable Turnover Ratio  A company’s liquidity problem can be further investigated by examining the liquidity of its receivables or how long it takes the company to turn its receivables into cash  A low liquidity of receivables signals more difficulty since the quick ratio would be overstated  Accounts receivable turnover ratio = net sales/average accounts receivable  Average accounts receivable = (beginning receivables + ending receivables)/2 Accounts Receivable Turnover in Days  The accounts receivable turnover ratio determines the number of days the average balance of accounts receivable is outstanding before converted to cash  Turnover in days = 365/receivables turnover ratio  Whether result is good or bad depends to some extent on what other companies in the industry are experiencing  A low turnover ratio may suggest a need to modify credit and collection policies to speed up the conversion of receivables to cash Inventory Turnover Ratio  Inventory turnover is also an important liquidity measure  Inventory turnover ratio = cost of goods sold/average inventory  This ratio tells an analyst how many times the average inventory turns over, or is sold, during the year  A low turnover ratio may signal the presence of too much inventory or sluggish sales  Average inventory = (beginning inventory + ending inventory)/2 Times-Interest-Earned Ratio  The first leverage ratio uses the income statement to assess a company’s ability to service its debt  Times-interest-earned ratio = (income before taxes + interest expense)/interest expense  Income before taxes must be recurring income; thus, unusual or infrequent items appearing on the income statement should be excluded in order to compute the ratio  Recurring income is used because it’s the income available annually to cover interest payments Debt Ratio  Investors and creditors are 2 major sources of capital  As percentage of assets financed by creditors increases, the risk of the company increases too  Debt ratio = total liabilities/total assets  Since total liabilities are compared with total assets, the ratio measures the degree of protection afforded to creditors in case of insolvency  Creditors often impose restrictions on the percentage of liabilities allowed. If percentage exceeds, the company is in default and foreclosure can take place Debt-to-Equity Ratio  Another ratio useful in assessing leverage used by a company  Compares the amount of debt financed by stockholders  Debt-to-equity ratio = total liabilities/total stockholder’s equity  Creditors would like this ratio to be relatively low indicating that stockholders have financed most of the assets of the firm  Stockholders may wish this ratio to be higher because it indicates that the company is more highly leveraged and stockholders can reap the return of the creditors’ financing Profitability Ratios  Investors earn a return through receipt of dividends and appreciation of the market value of their stock  Both dividends and market price of shares are related to the profits generated by the companies  Since they’re the source of debt-servicing payments, profits are also of concern to creditors  Managers also have a vested interest in profits  Bonuses, promotions, and salary increases often are tied to reported profits  Profitability ratios are given particular attention by both internal and external users of financial statements Return on Sales  Profit margin on sales  Represents the percentage of each sales dollar that’s left over as net income after all expenses have been subtracted  Measure of the efficiency of a firm  Return on sales = net income/sales Return on Total Assets  Measures how efficiently assets are used by calculating return on total assets used to generate profits  Return on assets = (net income + {interest expense [1 – tax rate]})/average total assets  Average total assets = (beginning total assets + ending total assets)/2  By adding back the after tax cost of interest, this measure reflects only how the assets were employed  It doesn’t consider the manner in which they were financed (interest expense is a cost of obtaining assets, not a cost of using them) Return on Common Stockholder’s Equity  Return on total assets is measured without regard to the source of invested funds  For common stockholders, the return they receive on their investment is of paramount importance  Of special interest to common stockholders is how they’re being treated relative to other suppliers of capital funds  Provides a measure that can be used to compare against other return measures such as preferred dividend rates and bond rates  Return on stockholder’s equity = (net income – preferred dividends)/average common stockholder’s equity Earnings Per Share  Investors also pay considerable attention to a company’s profitability on a per-share basis  Earnings per share = (net income – preferred dividends)/average common shares  Average common shares outstanding is computed by taking a weighted average of the common shares for the period under study Price Earnings Ratio  Price earnings ratio = market price per share/earnings per share  Price earnings ratio is viewed by many investors as important indicators of stock values  If investors believe that a company has good growth prospects, then the ratio should be high  If investors believe that the ratio is low based on their view of future growth opportunities, the market price of the stock may be bid up  The ratio should be interpreted with caution since it’s comprised of stock price  This number can be manipulated to meet certain targets involving analyst expectations, managerial bonuses, and other organizational goals Dividend Yield and Payout Ratios  Divided yield = dividends per common share/market price per common share  By adding the dividend yield to the percentage change in a stock price, a reasonable approximation of the total return accruing to an investor can be obtained  Dividend payout ratio = common dividends/(net income – preferred dividends)  The payout ratio tells an investor the proportion of earnings that a company pays in dividends - Investors who prefer regular cash payments instead of returns through price appreciation will want to invest in companies with a high payout ratio - Investors who prefer gains through appreciation will generally prefer a lower payout ratio


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