Intermediate Accounting Exam 1 Review
Intermediate Accounting Exam 1 Review acc 301
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This 11 page Study Guide was uploaded by Ally Rose on Monday October 3, 2016. The Study Guide belongs to acc 301 at University of Miami taught by McMartin in Fall 2016. Since its upload, it has received 3 views.
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Date Created: 10/03/16
ACC 311: Exam 1 Review Chapter 0: Accounting Cycle Review Assets = Liabilities + Stockholders Equity Assets: Debit increase Liabilities: Credit increase Common stock: Credit increase Retained Earnings: Credit increase Dividends: Debit increase Expenses: Debit increase Revenues: Credit increase Consolidated Income Statement: Statement of Retained Revenues Earnings: Beginning Retained -COGS Earnings =Gross Profit +Net income -expenses -dividends =Net Income Chapter 1: Financial =Ending Retained Accounting and Accounting Standards Earnings General Characteristics of Accounting: 1) The identification, measurement and communication of financial information about 2) Economic entities to 3) Interested parties Capital Allocation: financial reporting helps users (investors and creditors) with capital allocation decisions. - Contract Example: if friend wants you to invest in his app, the contract that specifies the terms of your investment should: restrict the investment for the app, specify annual financial statements. - The process of determining how and at what cost money is allocated among competing interests Information Asymmetry: when raising capital to start a business this is a main challenge between the firm and outside stakeholders that leads to 2 Principal Agent Problems: 1) Moral Hazard: when outside stakeholders cannot directly observe the firm’s private information. Ex: management tempted to follow own incentives 2) Adverse Selection: when firm insiders cannot credibly communicate their private information to outside stakeholders. Ex: outsiders cannot tell if firm has genuine or false prospects General Purpose Financial Statements: help to better understand financial position and related performance to a wide variety of users. - Least cost and most useful information possible - Primary users: investors and creditors The Economy Entity Concept: (entity perspective) We view the companies as separate from the owners/shareholders. Decision Usefulness Approach: 1) The company’s ability to generate net cash inflows 2) Managements ability to protect and enhance the capital providers investments Organizations Involved in GAAP: 1) SEC: established by the financial government to help develop and standardize financial information presented to stockholders. - Established by the securities and exchanged acts of 1933 and 1934 - Congress gives the SEC ultimate authority to set accounting standards but the SEC delegates this responsibility to the accounting profession. 2) AICPA: professional organization to represent the interest of professional accountants. - Committee on Accounting Procedures: issued 59 Accounting Research Bullentins - Accounting Principles Board: issued 31 APB Opinions 3) Financial Accounting Foundation: parent organization to FASB - FASB: Statements on financial accounting standards 1973-2009 o Accounting Standards Updates 2009 – present o Financing Accounting Concepts GAAP: Explicit objective: provide general purpose financial statements to shareholders and creditors who are reasonably familiar with financial statements. –does NOT seek to set standards that provide financial information to “mom and pop” investors. Shortcomings: 1) Nonfinancial measures: other key performance indicators 2) Softs Assets: such as brand recognition 3) Forward-looking information: earnings forecasts Additional Information: Non GAAP -presidents letter, prospectuses, reports filed with government agencies, news releases, forecasts, environmental impact statements. Demands of Stakeholders: - Shareholders: information to value ownership - Bondholders: information to assess the creditworthiness of their debtors - Management: information to credibly convey their performance - General Public: information about overall health of the economy Chapter 3: Accounting Information System Double Entry Bookkeeping: recording done by debiting at least one account and crediting another. Debits = credits Transactions Journalization Posting Trial Balance Adjustments Adjusted Trial Balance Statement Preparation Closing Post-closing Trial Balance Common Journal Entries: a) Stockholders invest cash Cash Common stock b) Receive Cash in advance for service Cash Unearned Revenue c) Pay office rent Rent Expense Cash d) Receive cash and bills company for service Accounts Receivable Cash Revenue Trial Balance: list of each account and its balance to prove equality of debits and credits Common Adjusting Entries: a) Prepaid Expenses: expenses paid in cash before they are used or consumed. Insurance Expense x Prepaid Insurance x b) Accrued Expenses: expenses incurred but not yet paid in cash or recorded (Interest) Expense x Interest Payable x c) Unearned Revenues: Cash received before services are performed Unearned Revenues x Revenues x d) Accrued Revenues: Revenues for services performed but not yet received in cash or recorded. Accounts Receivable x Revenue x e) Depreciation Expense x Accumulated Depreciation x f) Supplies Expense x Supplies x g) Bad Debt Expense x Allowance for Doubtful Accounts x Adjusted Trial Balance: After the adjusting entries shows the balance of all accounts at the ending of the period. (first balance sheet accounts then income statement accounts) checks that debits = credits. Preparing the Financial Statements: directly from the adjusted trial balance to: 1) Income Statement then 2) Retained Earnings Statement then 3) Balance Sheet. Closing Entries: a) Temporary (Nominal) Accounts: revenues, expenses and dividends must be reduced to zero in order to prepare the accounts for the next periods transactions. - Transfer net income (net loss) and dividends to Retained Earnings so that the balance in Retained Earnings agrees with the Retained Earnings Statement. b) Permanent (Real) Accounts: All balance sheet accounts are NOT CLOSED. Income Summary: temporary account - Revenues and expenses transfer to this account - Income Summary is then closed which transfers the net income or net loss to Retained Earnings. - Entries: Service Revenue x Income Summary x Income Summary x Expenses x Income Summary x Retained Earnings x Retained Earnings x Dividends x Chapter 4: Income Statement and Related Information 1) Profit Margin = Net Income Total Revenues What percentage of every $1 in sales is converted to equity 2) Gross Profit Ratio = Gross Profit Total Revenues What percentage of every $1 in sales is available to cover operating expenses (Revenues – COGS = Gross Profit) 3) Effective Tax Rate = Tax Expense Income Before Taxes How much of every $1 in operating income is paid in tax 4) P/E Ratio = Price Per Share Earnings Per Share How much am I paying for every $1 in EPS Earnings Yield = Earnings Per Share Price Per Share For every $1 you invest, what percent do you get back each year in earnings Income Statement: measures the success of the company operations for a given period of time. - Investors demand it help project profitability in future periods - High Quality Earnings: when earnings reported are useful to user decision making Multi-Step Income Statement: Revenues Less: Cost of Goods Sold =Gross Profit Less: Sales/Marketing Expenses Research and Development General and Administration Expenses = Income from Operations Non-operating Revenues and Expenses Other Gains and Losses = Income before Taxes Less: Tax Expense = Income from continuing operations Discontinued Operations (net of taxes) = Consolidated Net Income Less: Net income Attributable to Noncontrolling Interests = Net Income Earnings Per Share: Income from Continuing Operations/ Shares Outstanding Discontinued Operations/ Shares Outstanding Net Income Attributable to Noncontrolling Interests/ Shares Outstanding Net Income Per Share EPS = Net Income – Preferred Dividends Weighted Average common shares outstanding Reporting Non-Recurring Items: 1) Unusual and Infrequent Gains and Losses: gains/ losses and revenues/expenses that are not incurred in ordinary course of business -destruction of PP&E due to natural disaster - one time expenses to restructure business - abandoned property - labor strike or terrorist event 2) Discontinued Operations: Entire subsidiary a) results of operations of a component of a company has been eliminated from ongoing operations, and b) there is no significant continuing involvement in that component after the disposal transaction. - presented “below the line” and net of taxes (deduct tax before listing) - EPS must also be modified to present the per share impact (net of taxes) 3) Noncontrolling Interests: portion of profit/loss from a subsidiary that cannot be attributed to the parent company. Ex: parent corporation owns 100% of subsidiary A and 80% of subsidiary B. Another corporation owns the 20% of subsidiary B. - Parent Corp. Reports: 100% of revenues and expenses of both subsidiaries - Parent Corp. Noncontrolling Interest= 20% of subsidiary B’s net income. (deduction) Other Comprehensive Income: bypasses the income statement and is recorded on a separate statement of comprehensive income. Total Comprehensive Income = Net Income + Other Comprehensive Income Statement of Comprehensive Income: Net Income - Currency/Translation adjustments - Unrealized gains/losses investments or derivatives Other Comprehensive Income Total Comprehensive Income Does not increase retained earnings/net income, instead it is recorded as a change in balance sheet account: Accumulated Other Comprehensive Income (AOCI) Statement of Equity: replaces statement of retained earnings, shows changes in all equity balance sheet accounts (CS and RE). Retained AOCI Common Earnings Stock Beginning Balance X X X Net Income X Dividends (X) Other Comprehensive X Income New Stock Issues X Ending Balance X X X Reporting Changes in Accounting Rule Estimates and Errors: A) Changes in Accounting Principals: when company adopts a new accounting rule or method (LIFO FIFO) the effect of the rule is applied RETROSPECTIVELY - Historical income statements are recast to make them comparable to new standard B) Changes in Accounting Estimates: when new facts lead to a change in an estimate the change is applied PROSPECTIVELY. - Do not correct historical statements C) Correction Errors: when new facts lead company to conclude that historical financial statements were wrong - RESTATE the historical financial statements old ones cannot be relied on. - Does not apply to immaterial errors (restate = bad / recast = ok) Chapter 5: Balance Sheet and Statement of Cash Flows Balance Sheet: statement of financial position (assets les accumulated depreciation = total liabilities and stockholder’s equity) Liquidity: current/liquid assets ability to cover liabilities Solvent: Assets cover liabilities, ability to pay debts as they mature. Solvent but not liquid = chapter 11 bankruptcy helps protect from creditors for a period of time Liquid but not solvent = chapter 7 bankruptcy Financial Flexibility: the ability of an enterprise to take effective action to alter the amounts and timings of cash flows so that it can respond to unexpected needs/opportunities. 1) Current Ratio = Current Assets Current Liabilities o Measures the ability to pay short term obligations ( greater than 1) 2) Working Capital = Current Assets – Current Liabilities o How much in current assets remains after paying off current liabilities 3) Financial Leverage = Total Debt (TD= current maturities + notes payable + LT debt) Total Assets o What percentage of assets is financed with debt Limitations of the Balance Sheet: - Failure to reflect current fair value information - Extensive use of judgements/estimates - Failure to include items of financial value that cannot be quantified objectively: workforce, managerial skills, customer base, reputation Cash Flows: - GAAP net income represents the economic earnings but not necessarily cash flows because it uses the accrual method EBITDA: Earnings Before Interest Depreciation and Amortization - Add back non-operating expenses and significant non-cash expenses to net income - Flaw of EBITDA = it does not add back non cash revenues and expenses - Main idea: obtain a measure of cash flow by making appropriate adjustments to net income to unwind the effects of accrual to return to a cash basis. - If there is a loss before taxes and company receives a tax benefit you would deduct it from net income rather than add it back. Statement of Cash Flows: provide relevant information about cash receipts and payments during a period. 1) How much cash was generated/lost from operations? 2) How much cash was invested/divested from the business? 3) How much cash was raised/returned to investors? Activities of Statement of Cash Flows: 1) Operating Activities: always begin with net income and then add back non-cash expenses and remove non-cash revenues. -increase in accounts payable: add to net income (represents expense > cash paid) -decrease in accounts payable: deduct from net income -increase in receivables: deduct from net income -decrease in receivables: add to net income (represents cash > revenue) (decrease/increase in (asset) inventory) -gain on sale deduct from net income -loss on sale: add to net income -depreciation expense: add to net income -amortization of patent: add to net income 2) Investing Activities: making and collecting loans, acquiring and disposing of investments and productive long lived assets. Cash flows generally resulting from changes in long term asset items. -purchase PP&E: deduct from net income -sale PP&E: add to net income -purchase/sale of financial assets (investment securities) 3) Financing Activities: include all long term liabilities, all stock accounts, dividends payable and some short term notes payable to determine cash flow effects. -issuance of long-term debt (bonds notes payable) increase in notes payable: add to net income -payment to liquidate long-term bonds or notes payable decrease in notes/bonds payable: deduct from net income -payment of dividends or sale/purchase treasury stock: deduct from net income returns cash to shareholders -increase in common stock: add to net income Non-Cash Flow Events: - Cash dividends declared - Issuance of stock to acquire land (asset) Basic Format of Statement of Cash Steps: Flows: 1) Calculate change in each BS Cash flows from Operating Activities account Cash flows from Investing Activities 2) Classify each change as belonging Cash flows from Financing Activities to OA, II, or FI 3) Classify each change as an addition Net increase/decrease in cash (total cash flows) = or cash distribution (-) + Cash at Beginning of year 4) Prepare statement of cash flows Cash at End of the year = Ending Balance in Retained Earnings = Beginning Balance in RE + Net Income – Dividends Total Cash Flows = Change in Cash (net increase or decrease) Ending Year Cash = Total Cash Flows + Cash and Beginning Usefulness of Statement of Cash Flows: 1) Debt Coverage = Cash Flows from Operations Average Current Liabilities = (Beginning Balance + Ending)/2 Are the cash flows from operations sufficient to pay off the company’s current liabilities 2) Free Cash Flow = Operating Cash Flow – Capital Expenditures – Cash Dividends What cash flow is available for discretionary spending? Chapter 6: The Time Value of Money Values of Single Amounts (lump sum): Future Value of a Single Amount: amount accumulated at a future time from a single payment or investment. Present Value x Future Value Factor (that correspond with I and N) - When interest rates increase, future value increases. Annual Percentage Rate (APR): the periodic rate x number of periods per year o does not measure the true cost/return on loan Periodic Rate = APR/n periods Annual Effective Yield: annual cash as a percentage of principal amount Present Value of a Single Amount: the amount at present time that is equivalent to a payment or an investment at a future date. Future Value x Present Value Factor (that corresponds with I and N) - Present value factor of $1 is always less than 1 therefore we “discount” future cash flows to its present value - As interest rates increase, the present value decrease Values of Annuities: Annuity: A series of payments of equal amounts over a specified period of time. Ex: annuity will pay $100 at end of each year - Ordinary Annuity: payments at the end of each period - Annuity Due: payments at the beginning of each period Future Value of an Ordinary Annuity: the sum of future values of a series of payments Question: If you were to deposit P at the end of each year into an account that earns I, how much would you have after N periods? Payment (P) x FV of an Ordinary Annuity Rate = Total Earnings Present Value of an Ordinary Annuity: the sum of present values from a series of cash payments Question: If you were promised to receive C at the end of each year for the next N years, and you require a return of I, how much would you be willing to pay for this investment today? C x PV of an Ordinary Annuity Rate = worth of investment today Net Present Value: the difference between the present value of all inflows less the present value of all outflows. Invest in projects with at least ZERO NPV and avoid negative NPV investments. Ex: you have a machine that generates cash flows of X per year (annuity) and will be sold for Y at the end of n years (lump sum). NPV = PV of cash flows (X) - sale price (Y) Bond Pricing: Long Term Bond: produces two cash flows: 1) Periodic coupon payments over the life of the bond and 2) the principal face value paid at maturity Periodic Coupon Payments = annuities Principal = single-sum Present Value of Bond (market price): the combined present value of the coupon annuity and the principal amount. ***Always use market rate (not coupon rate) to discount the cash flows Premium: when bond sells at more than face value The stated (coupon) rate is greater than the market rate Discount: when bond sells at less than face value The stated (coupon rate) is less than the market rate
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