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ACCT 5301 Midterm

by: Gladys Serrano

ACCT 5301 Midterm ACCT 5301

Gladys Serrano
GPA 3.5

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About this Document

These notes cover CH.1-5
Accounting Analysis 1
Ramgopal Venkataraman
Study Guide
financial accounting
50 ?




Popular in Accounting Analysis 1

Popular in Accounting (ACCT)

This 10 page Study Guide was uploaded by Gladys Serrano on Sunday October 9, 2016. The Study Guide belongs to ACCT 5301 at University of Texas at Arlington taught by Ramgopal Venkataraman in Summer 2016. Since its upload, it has received 50 views. For similar materials see Accounting Analysis 1 in Accounting (ACCT) at University of Texas at Arlington.


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Date Created: 10/09/16
ACCT 5301 with Ram Exam 1 Review CH.1-5 CH.1 Introducing Financial Accounting DEMAND FOR ACCOUNTING INFORMATION  Accounting – process of identifying, measuring, and communicating financial information to help people make economic decisions  Accounting – process of recording, summarizing, and analyzing financial transactions. Financial Accounting – for decision makers outside the company Decision Makers Decisions Information  Investors, analysts  Buy or sell stock?  Sales and costs  Creditors  Lend or not?  Cash in and out  Suppliers,  Purchase/sell goods  Assets and customers or not? liabilities Managerial Accounting – for decision makers inside the company Decision Makers Decisions Information  Top management  Develop a new  Product sales and  Marketing teams strategy? costs  Production and  Launch a new  Department operations product or not? performance  Manage operations reports  Budgets and quality reports WHO USES FINANCIAL ACCOUNTING INFORMATION?  Shareholders and Potential Shareholders – corporate shareholders are an important group of decision makers that have an interest in financial accounting information. o A Corporation – has a lot of owners who are not involved in managing day-to-day operations of the company. It’s a legal entity that issues shares of stock to its owners (aka shareholders) in exchange for cash. o A Sole Proprietorship – has one owner that manages the daily operations like a small family business or corner grocery store. o A Partnership – has 2 or more owners managing the business like lawyers and CPA’s. o Corporations with stock are known as publicly traded corporations o Financial statements give information on the risk and return associated with owning shares of stock in a corporation, and tell how well management has performed. o Financial Statements provide insight into future performance by revealing management’s plans for new products, new operating procedures, and new strategic directions. Corporate management provides this information because it reduces uncertainty about future prospects, which increases the market price of its shares and helps the company raise funds it needs to grow.  Creditors and Suppliers – a lot of companies rely more than just on shareholders for the cash needed to operate a business like creditors and suppliers help. Creditors rely on borrower’s ability to repay. Suppliers establish credit sales terms and long term commitments to supply-chain relationships. Both rely on financial statements to monitor and adjust their contracts and commitments with a company.  Managers and Directors – shareholders elect directors to represent their interests and oversee management. The board of directors hires executive management and regularly reviews company operations. Directors use financial information to review the results of operations, evaluate future strategy, and assess management performance. Both managers and directors perform comparative analyses and establish performance benchmarks.  Financial Analysts – like credit rating agencies, portfolio managers, and security analysts; help to identify and assess risk, forecast performance, establish prices for new issues of stock, and make buy-or-sell recommendations to investors  Other Users – prospective employees, labor unions, customers, and government agencies. COSTS AND BENEFITS OF DISCLOSURE  Providing financial information to external users is called Disclosure.  Companies like showing external decision makers their financial information because it lowers financing and operating costs (a benefit of financial disclosure) o Reducing the company’s cost of borrowing from a bank  Costs of disclosing financial information is that other companies can use it to their advantage and compete with more innovative products and new strategies, hiring accountants to prepare the financial statements, and political costs involving regulation and increased taxes BUSINESS ACTIVITIES Businesses produce accounting information to help develop strategies, attract financing, evaluate investment opportunities, manage operations, and measure performance. All businesses PLAN activities, FINANCE those activities, INVEST resources into those activities, and then engage in OPERATING activities.  PLANNING – goals and strategies adopted to reach goals are the product of its planning activities. Creating value for owners (shareholders) and making it happen is its strategy. The assess demand for its g/s and supply of its labor & capital. It also includes competitive analyses, opportunity assessments, and consideration of business threats.  INVESTING – consists of acquiring and disposing of resources (assets) needed to produce and sell a company’s goods and services. (Short term assets – inventory; long term assets – equipment) o Ex. Nike has few long-term assets because it outsources its product production to other companies  FINANCING – methods that companies use to fund investments. Financial mgmt. is planning of resource needs, including the proper mix of financing sources. Companies get financing in 2 ways: from equity (owner) financing and creditor (liabilities) financing. INVESTING = CREDITOR FINANCING + OWNER FINANCING ASSETS = LIABILITIES + EQUITY  OPERATING – refers to the production, promotion, and selling of a company’s products and services. INCOME = REVENUES – EXPENSES PRIMARY ACCOUNTING RULE – NO FREE LUNCH; give up something to get something & both are recorded. This idea permeates all of accounting. FINANCIAL STATEMENTS Four financial statements are used to report a company’s business activities: Balance Sheet – lists the company’s investments and sources of financing using the accounting equation; reports amount of assets, liabilities, and equity of an accounting entity at a point in time; reports a company’s financial position at a point in time. ASSETS = LIABILITIES + STOCKHOLDER’S EQUITY ASSETS LIABILITIES Current Assets: less than a year Current Liabilities: Cash Accounts payable $ Accrued expenses (accrued interest Cash Equivalents (aka Short-term payable, accrued wages payable, investment- money market funds, accrued Income tax payable) treasury bill, commercial paper) Unearned Revenue Accounts Receivable Short term Borrowings – (Notes Notes Receivable payable, Bonds Payable) Inventory (to be sold) Advance to Suppliers Supplies Noncurrent Liabilities: Prepaid expenses (Prepaid Rent, Prepaid Long Term Debt Insurance) Deferred (unearned) income taxes Security Deposit Total Liabilities Noncurrent Assets: $ Aka Long-term investments STOCKHOLDER’S EQUITY Equipment/ Furniture & Fixtures Contributed Capital - Less: Accumulated Depreciation Common Stock Buildings Paid In Capital Land Treasury Stock Intangibles (patents, goodwill, Employee Stock Loan Receivable trademarks) Earned Capital - Retained Earnings (aka earned capital) = amount of income retained in the company. Accumulated comprehensive income Total Assets Total Liabilities & Stockholder’s $$ Equity $$ Income Statement – reports the results of a company’s operating activities over a period of time. REVENUES – EXPENSES = NET INCOME Sales $ Less: COGS Gross Profit Operating Expenses: Advertising Expense Depreciation Expense Insurance Expense Supplies Expense Rent Expense Salaries Expense TOTAL Operating Expense OPERATING INCOME Less: Interest Expense PROFIT BEFORE TAX Less: Income Tax Expense NET INCOME $ Statement of Stockholder’s Equity – reports on changes in equity over a period of time Common Stock Retained Earnings Total Beg. Balance 60,000 6,400 66,400 Add Stock 0 0 0 Add Net Income --- 13,820 13,820 Less: Dividends --- (600) (600) End Balance 60,000 19,620 79,620  Contributed Capital: amounts from issuing new stock during the period o Common Stock and additional Paid-In Capital  Retained Earnings: cumulative income since the company began business minus dividends paid out to shareholders  Beg R.E. add Net Income (Loss) – Dividends = End R.E. Statement of Cash Flows – reports net cash flows from operating, investing, and financing activities over a period of time  Operating cash flows differ from net income o Due to differences in the time that revenues and expenses are recorded and the time the cash is received and paid Cash Flows from Operations NET INCOME $ Add back Depreciation Dec in A/R add Inc in Inventory ( ) Dec in Prepaid Expenses add Dec in A/P ( ) Dec in Accrued Liabilities ( ) Cash Flows from Operating Activities Cash Flows from Investing Inc in Equipment purchase ( ) Proceeds from Equipment Disposal add Cash Flows from Investing Activities Cash Flows from Financing Inc in Short Term Debt add Inc in Long Term Debt add Inc in Contributed Capital add Dividends Paid ( ) Cash Flows from Financing Activities Net Change in Cash Beg Cash Balance END CASH BALANCE $ Financial Statement Linkages – the link among the four financial statements  “Articulation of Financial Statements”  How did cash on the balance sheet change --- look at Statement of Cash Flows  How did equity on the balance sheet change - look at Statement of Stockholder’s Equity  How did Operations affect Retained Earnings on Balance Sheet - look at Income Statement Institutions that Regulate Financial Accounting & their role in establishing GAAP  Generally Accepted Accounting Principles are established standards and accepted practices designed to guide the preparation of the financial statements  While the Securities and Exchange Commission has ultimate authority over financial reporting by companies in the U.S., it has ceded the task of setting accounting standards to the accounting profession  The Financial Accounting Standards Board (FASB) has the primary responsibility for setting financial accounting standards in the U.S.  The Sarbanes-Oxley Act established the Public Company Accounting Oversight Board (PCAOB) to approve auditing standards and monitor the quality of financial statement and audits  International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board (IASB)  IFRS are an attempt to achieve a greater degree of commonality in financial reporting across countries Qualitative Characteristics of Accounting Information were developed to help managers, accountants, auditors, and standard setters make reasonable choices among accounting alternatives.  Benefits need to outweigh the costs; reported accounting information must be cost effective  Materiality - refers to whether or not a particular amount is large enough to affect a decision.  Understandability and decision usefulness – accounting information should be presented so that a reader can understand how it relates to the decision problem at hand  Relevance – accounting information must have the ability to make a difference in a decision. Such information may be useful in making predictions about future performance of the company or in providing feedback to evaluate past events. In either case, the timeliness of the disclosure is paramount to its relevance. o Predictive value –ability of the information to increase the accuracy of a forecast o Feedback value – quality of information that enables users to confirm or correct prior expectations.  Reliability – accounting information should be accurate and free of misstatement or bias; it must be reasonably neutral, verifiable (free of error), and possess representational faithfulness  Comparability – accounting information should enable users to identify similarities and differences between sets of economic phenomena; firms in the same industry should use the same or similar reporting technique  Consistency – information supplied to decision makers should exhibit conformity from one reporting period to the next with unchanging policies and procedures; the same accounting methods from one period to the next increases the quality of accounting information. Underlying Assumptions 1. Separate Economic Entity – activities of a company are independent, distinct, and separate from the activities of its stockholders and other companies 2. Going Concern – companies are assumed to have continuity in that they can be expected to continue in operation over time 3. Accounting Period – while continuity is assumed, company operations must be reported periodically. Quarterly or monthly reporting allow companies to supplement the annual financial statements with more timely information. 4. Measuring Unit – unit of measure is the monetary unit of the country in which the firm’s accounting reports are issued. The dollar is the monetary unit in the U.S. CH.2 Constructing Financial Statements Reporting Financial Condition  ASSETS – Economic resources with probable future benefits o Owned or controlled by the entity measured by the historical cost (price paid to get the asset)  LIABILITIES – debts or obligations that are paid with assets or services  EQUITY – financing from owners and business operations o Contributed Capital – amount contributed by owners o Earned Capital - consists of Retained Earnings – money earned not yet paid out by Dividends & comprehensive income ASSETS – used assets are reported on the Balance Sheet at historical cost  CURRENT ASSETS o Cash o Marketable securities – short term investments that can be quickly sold to raise cash o Accounts Receivable – amount due to the company from customers from a sale on account o Inventory – goods purchased or produced for sale o Prepaid Expenses – costs paid in advance for rent, insurance, etc.  NONCURRENT ASSETS o Long term investments – shares of other firms that management does not intend to sell in the near future o Property, Plant, Equipment – land, factory buildings, warehouses, machinery used in operations of the company o Intangibles – patents, trademarks, goodwill and other items that provide future benefits, but don’t possess physical substance  Assets historical cost is reliable  Current Fair Value may be more relevant LIABILITIES – reported on the balance sheet when 3 conditions are met: 1. A future sacrifice is probable 2. The amount of the obligation is known or can be reasonably estimated 3. The transaction or event that caused the obligation has occurred a. Ex. A future cash payment or obligation to deliver g/s to a customer  CURRENT LIABILITIES o Accounts Payable – amount owed to suppliers on credit o Accrued Liabilities – obligations for expenses that have been recorded but not yet paid o Short term Borrowings – short term debt payable to banks or other creditors o Unearned Revenue – when a company accepts payment in advance for g/s delivered in the future o Current maturities of long term debt – portion of long term debt that’s due to be paid in one year  NONCURRENT LIABILITIES o Long term Debt – amount borrowed from creditors scheduled to be paid in more than a year o Warranty o Deferred compensation liabilities o Long term tax liabilities STOCKHOLDER’S EQUITY – reflects capital provided by the owners of the company; residual interest  Contributed Capital – net funding a company has received from issuing and reacquiring its equity shares o Common Stock – par value of stock given to owners o Additional Paid in Capital – amount received in addition to par value of common stock o Treasury Stock – money returned to stockholder’s not canceled “negative equity amount”  Earned Capital – cumulative net income/losses retained by company (not paid out to shareholder’s as dividends) o Retained Earnings – accumulated earnings that haven’t been distributed to stockholders as dividends  Beg R.E. + Net Income – Dividends = End R.E. (reported on the balance sheet) o Accumulated other comprehensive income or loss – accumulated changes in equity not reported on the income statement Financial Statement Effects Template – employed to analyze the financial impacts of transactions  Account – mechanism for accumulating the effects of an organization’s transactions and events Nonoperating Revenues and Expenses  These relate to a company’s financing and investing activities - o Interest revenue o Interest expense Accrual Accounting – required by GAAP and IFRS. It refers to this practice of recognizing revenues when earned through the company’s operations and recognizing expenses as the assets used and obligations incurred in carrying out those operations.  Revenue Recognition – requires that revenue be recognized (recorded) only when earned. o Revenue is earned when g/s is delivered to the customer not when payment is received from the customer  Expense Recognition – expenses are matched when incurred Evaluating Liquidity  Ability to pay debts when they’re due  The larger current assets are when compared to current liabilities, the more liquid a company is  Measured by o Net working capital = Current Assets – Current Liabilities o LIQUIDITY RATIOS o Current ratio = Current Assets “Do you have enough to pay your liabilities?” Current Liabilities o Quick ratio = Quick Assets (Quick Assets = cash, short term securities, and AR) Current Liabilities (only taking assets you can quickly turn to cash) “Do you really have money to pay me?” Ch. 3 Adjusting Accounts for Financial Statements With companies growing, financial statements should reflect the firm’s underlying economic reality. Company needs to adjust or update its financial statements to reflect the changes in its strategy and performance.  Central to the difference between accrual and cash accounting  Accrual accounting records revenues when they’re earned. The Accounting Cycle - Start of Period During Period Analyze transactions Record journal entries in the general journal Post amounts to the general ledger End of Period Prepare a trail balance to determine if debits = credits Adjust revenues and expenses and related balance sheet accounts Prepare a complete set of financial statements and disseminate it to users Close revenues, gains, expenses, and losses to Retained Earnings (Record in journal and post to ledger) How do companies keep track of account balances?  General Journal  General Ledger A = L + SE A = L + Cont. Cap + Earned Capital A = L + Cont. Cap + R - E - Div A + E + Div = L + Cont. Cap + R Ch. 4 Statement of Cash Flows Statement of Cash Flows – tells us how a company generated cash (cash inflows) & how it’s used (cash outflows). With understanding this, we can understand trends in a firm’s liquidity & solvency. Liquidity & Solvency • Liquidity - ready available cash to achieve short-term obligations • Solvency - meeting long-term obligations in the time in which they’re due  SOLVENCY RATIOS o Debt-to-Equity = Total Liabilities/Total Stockholder’s Equity o Times Interest Earned Revenue = Earnings Before Interest & Taxes/Interest Expense  Higher number is better  AKA “Interest Coverage Ratio” Why do we need this statement and other 3 statements aren’t sufficient enough: • Cash Flow Statements show how changes in balance sheet and income statement affect cash and cash equivalents, and breaks the analysis down to operating, investing and financing activities Cash Flow & Earnings  Both useful; more useful used together rather than separately  Important: Earnings are a better prediction of future cash flows than current cash flows Are there things where you can increase current earnings without increasing firm value? • Selling items on discount/lower price • Increase revenue at the cost of property • Depreciation - if you overestimate the price of an asset Example: if I advertise in December, get sales in January; expense is counted in December and sales are counted in January; so it lowers December income, but the benefits are coming later. (if you care about December income, don’t advertise); bad long term strategy. Advertise now even though it will decrease income, your income will rise more later. *Remember that under US GAAP- Income Statement - interest expense comes after operating expenses Cash Flow Statement - interest expense is an operating cash flow Operating - operations of the business; • ALL returns to investments; generating income from investments • Ex. investing in inventory or A/R; these current assets aren’t investing activities, but are in Operating Cash Flows Investing - investing long term assets for the business; • Stocks, bonds, sale of productive facilities • (Buy it - cash outflow; sell it - cash inflow) Financing - all money raising activities and all transactions with stockholders; • Do not include current liabilities because they relate to Operating; A/P, accrued expenses payable, income taxes payable is in Operating as well as pension payable, health care payable because they arise from workers who generate profit Cash Inflows and Cash Outflows: Operating Cash Inflows: • Cash received from selling to customers • Cash received from dividends and interest on investments Operating Cash Outflows: • Cash paid for expenses • Cash paid for purchases of goods for resale and services (i.e. inventory) • Cash paid for salaries and wages • Cash paid for income taxes • Cash paid for interest on liabilities Investing Cash Inflows: • Sale of operational assets • Sale of investments - sale or disposal of PPE • Sale or maturity of investments in securities • Collections of loans Investing Cash Outflows: • Purchase of operational assets • Purchase of investments - purchase of PPE • Purchase of investments in securities • Loans to others Financing Cash Inflows: • Cash received from borrowings on notes, mortgages, bonds, etc. from creditors • Cash received from issuing stock to owners Financing Cash Outflows: • Payment of dividends to owners • Repurchase of stock; buying back shares from owners • Repayment of debt; repayment of principal to creditors (excluding interest since that is an operating activity) Direct Method vs. Indirect Method  Indirect method is used mostly, but both methods give the same result Investing and Financing Cash Flows itemized: Starts with Net Income INVESTING • Purchase of PPE - Investing Cash Outflow • Proceeds from disposal of PPE - Investing Cash Inflow • Purchase of short-term investments - Investing Cash Outflow • Proceeds from sale of short-term investments - Investing Cash Inflow FINANCING • Repayment of principal on long-term debt - outflow • Proceeds from issuance of long-term debt - inflow • Purchase of treasury stock - outflow • Proceeds from issuance of stock - inflow • Payment of cash dividends - outflow Relationships to the Balance sheet and the Income Statement – Information needed to prepare a statement of cash flows: 1. Comparative balance sheets 2. Income statement 3. Additional details concerning selected accounts Assets = Liabilities + Stockholder’s Equity Cash assets + noncash assets = liabilities + stockholder’s equity Cash assets = liabilities + stockholder’s equity - noncash assets Change in cash = cash this year - cash last year Reporting and Interpreting Cash Flows from Operating Activities -The indirect method adjusts net income by eliminating noncash items. • NET INCOME • add losses • subtract gains • +/- changes in current assets and current liabilities • add noncash expenses like depreciation and amortization • = CASH FLOWS FROM OPERATING ACTIVITIES (Indirect method) Ch. 5 Analyzing and Interpreting Financial Statements Financial Statement Analysis Creating a way of interpreting and drawing inferences;  Draw from the numbers, analyzing the company.  Allows to check for any credit risk and if the company is a good investment.  Allows for you to make comparisons and look at that with the competition. Ratios to be tested over on Exam Day: 1. ROE = Net Income/Average Stockholders’ Equity 2. ROA = Earnings Without Interest/Average Total Assets 3. ROA = (EWI/Sales * Sales/Average Total Assets) = (Profit Margin * Total Asset Turnover) a. EWI = NI + interest expense (1 – Tax rate) b. The difference between ROA and ROE is dealings with financing c. ROE – ROA = ROFL (Return on financial leverage) 4. Profit Margin = EWI/Sales Revenue 5. Total Asset Turnover = Sales Revenue/Average Total Assets 6. Accounts Receivable Turnover = Sales Revenue/Average AR a. No. Of days collection = 365/AR Turnover 7. Inventory Turnover = COGS/Average Inventory a. No. Of days Inventory = 365/Inventory Turnover 8. Accounts Payable Turnover = COGS/Average AP a. No. Of days payable = 365/AP Turnover 9. Length of Operating Cycle = No. Of days collection + No. Of days Inventory – No. Of days payable a. Length of Operating Cycle = (365/Inv Turnover) + (365/AR Turnover) – (365/AP Turnover) 10.NOPAT = Net Income – (Non operating Revenues – Non operating Exp)*(1 – tax rate) 11.NOA = Operating Assets – Operating Liabilities 12.RNOA = NOPAT/Average NOA 13.NOPM = NOPAT/Sales 14.NOAT = Sales/Average NOA


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