Final Exam study guide
Final Exam study guide MGMT 200
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This 18 page Study Guide was uploaded by jin soo kim on Tuesday March 29, 2016. The Study Guide belongs to MGMT 200 at Purdue University taught by Kimberly Fatten in Summer 2015. Since its upload, it has received 22 views. For similar materials see Introductory Accounting in Economcs at Purdue University.
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Date Created: 03/29/16
MGMT 200 Final Review Spring 2016 • May 2, 2016. 1PM-3PM ELLIOT HALL OF MUSIC • NO BAGS OF ANY TYPE! • BRING PUID Financial Accounting (Chapter 1) FOUR Primary financial statements • Income statement: Reports the company’s revenues and expenses over an interval of time • Revenues – Expenses = Net Income • Statement of stockholders’ equity: Summarizes the change in owner’s equity over an interval of time • Stockholder’s Equity = Common Stock + Retained Earnings • Balance sheet: Presents the financial position of the company on a particular date • Assets = Liabilities + Stockholder’s Equity • Statement of cash flows: Measures activities involving cash receipts and cash payments over an interval of time • Operating CF + Investing CF + Financing CD = Net Change in CF Know how to from all 4 of the statements! (Possible Written Question!) • Be able to do basic calculations on the statement (ex: solve for Total Assets or Retained Earnings, etc.) Object of Financial Accounting: • useful to investors and creditors in making decisions. • helps to predict cash flows. • tells about economic resources, claims to resources, and changes in resources and claims. GAAP: Generally Accepted Accounting Principles During the Period (Chapter 2) Accounts Definition: Summary of all transactions related to a particular item over a period of time. Debits: Dividends, Expenses, Assets (DEA) Credits: Liability, Owner’s Equity, Revenue(LOR) • Permanent Accounts – accounts that are ongoing through the company’s history. They accumulate, they get used up, but they do not get closed at month-end or year-end during the closing process • Temporary Accounts – accounts that accumulate information for a specific period of time and then are closed during the closing process. When the accounts are closed, they return to a zero balance and the company begins accumulating activity in the temporary account again Journal Entries & Adjusting Entries • Journal entry: format used for recording transactions • Purpose of Adjusting Entries • To account for transactions that have not been recorded by the end of the period • To record revenues in the period earned • To record expenses in the period they are incurred to generate those revenues • To correctly state assets and liabilities End of the Period (Chapter 3) Four Types of Adjusting Entries • Prepaid Expenses: Cost of assets acquired in one period that will be expensed in a future period • Prepaid – Paid • Unearned Revenues: Cash received in advance from a customer for products or services to be provided in the future • Revenue – Received • Accrued Expenses: Company has incurred a cost but hasn’t yet paid cash or recorded an obligation • Accrued Revenues: Revenue earned but hasn’t yet received cash or recorded an amount receivable • CASH IS NEVER PART OF THE ADJUSTING ENTRY! Closing Entries • To transfer the balances of temporary accounts to the Retained Earnings • Temporary Accounts: Revenue, Expense, Dividends (RED) • To reduce the balances of these temporary accounts to zero • Permanent (Balance Sheet) accounts are NOT closed Cash and Internal Controls (Chapter 4) Bank Reconciliation • matching the balance of cash in the company's bank account with the balance of cash in the company’s own records (journal entries into the general ledger) • Timing Differences or Errors Internal Control • Errors—accidental errors in recording transactions or applying accounting principles • Fraud—a person intentionally deceives another person for personal gain or to damage that person • Occupational fraud: the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employer’s resources. • Collusion: Two or more people acting together to circumvent internal controls. Motive Fraud Triangle: Three reasons for fraud are Motive, Rationalization, and Opportunity. (or pressure) • Easiest to eliminate is Opportunity. Rationalization • Safeguard the asset • Improve accuracy and reliability of information Opportunity Sarbanes-Oxley Act of 2002 (AKA Public Accounting Reform and Investor Protection Act of 2002) • Passed by Congress and established guidelines on internal controls and auditor – client relations • Applies to ALL companies that file financial statements with SEC (publically traded companies) • Main components: • Oversight board (The Public Company Accounting Oversight Board PCABO) • The board, five members appointed by the Securities and Exchange Commission, has the authority to establish standards on auditing, quality control, ethics, independence, and other activities relating to the preparation of audited financial reports. • 100% corporate executive accountability • Corporate executives must personally certify the company’s financial statements and financial disclosures. Severe financial penalties and the possibility of imprisonment are consequences of fraudulent misstatement. • Non audit services • It’s unlawful for auditors of public companies to also perform certain non-audit services • Retention of work papers • Auditors of public companies must retain all work papers for seven years or face a prison term for willful violation. • Auditor rotation • The lead auditor in charge of auditing a particular company, AKA the audit partner, must rotate off that company within five years and allow a new audit partner to take the lead. • Conflicts of interest • Audit firms are not allowed to audit public companies whose chief executives worked for the audit firm and participated in that company’s audit during the preceding year. • Hiring auditor • Audit firms are hired by the audit committee of the board of directors of the company, not by company management. • Internal Controls • Requires that company management document and assess the effectiveness of all internal control processes that could affect financial reporting and auditors express an opinion on whether management’s assessment of the effectiveness of internal control is fairly stated. Receivables and Sales (Chapter 5) Accounts Receivable • Cash owed to the company by its customers from sales on account • Recorded at the time of the credit sale • Net Revenue = Sales Revenue – Sales Discounts – Sales Returns and Allowance • Sales Return: Seller issues a full refund and Customer returns the product • Sales Allowances: Seller reduces the balance partially and Customer does not return the product. • Sales Discount: Discount is given if payment is made within a specified period of time • 2/10, n/30 = 2% discount if paid within 10 days. Full due before 30 days. • Percentage-of-receivable method • Based on the percentage of receivables expected not to be collected • Also called the balance sheet method because we look at a balance sheet account for the source (Accounts Receivable) • Aging of Accounts Receivable Accounts receivable Aging Schedule • Uses a lower percentage for recent accounts • Uses a higher percentage for older accounts Notes Payable/Receivable • Similar to accounts receivable but are more formal • Evidenced by a written debt instrument, or note • Classified as either current or noncurrent asset • Interest = Face Value X Annual Interest X Fraction of the year Notes Payable Notes Receivable Inventory and Cost of Goods Sold (Chapter 6) Inventory Methods of Inventory Calculation • Specific Identification • Each inventory item may have a different cost and is specifically tracked • Weighted-Average Cost • Both cost of goods sold and ending inventory consist of a random mixture of all the goods available for sale • Each unit of inventory has a cost equal to the weighted-average unit cost of all inventory items • WAC per Unit = Cost of goods / Number of Units • First-In First Out • Assume inventory sold chronologically, starting with beginning inventory • Ending inventory is made up of later purchases • Last-In First Out • Assume latest purchases are sold first • Ending inventory is made up of earliest purchases and beginning inventory Lower-of-Cost-or-Market • When the market value of inventory falls below its original cost, companies report inventory at the lower market value. The market value of inventory is considered to be the replacement cost of that inventory. The cost of inventory is the amount initially recorded in the accounting records. • Once both the cost and market value of inventory are determined, the company reports ending inventory in the balance sheet at the lower of the two amounts. This is known as the lower-of-cost-or-market (LCM) method to valuing inventory. • Cost of Goods Sold + Ending Inventory = Total Goods Available for Sale • If one is over or under, the other will be opposite to balance it out Long-Term Assets (Chapter 7) Long-term asset is an asset that will not turn into cash or be consumed within one year of the date shown in the heading of the balance sheet. Depreciation: The process of allocating to an expense the cost of an asset over its service life Capitalized costs include the purchase price of the land plus closing costs such as fees for the attorney, real estate agent commissions, title, title search, and recording fees. If the property is subject to back taxes or other obligations, we include these amounts as well. Depreciation Methods • Straight-line method: allocates an equal amount of the depreciable cost to each year of the asset’s service life. • Mainly used for financial reporting • Declining-balance method: The declining-balance method is an accelerated depreciation method. Declining- balance depreciation will be higher than straight-line depreciation in earlier years, but lower in later years. • Mainly used for tax reporting • Activity-based method: This method calculates depreciation based on the use of the asset. Book Value = Original Cost – Current Balance in Accumulated Depreciation Residual value: salvage value or the amount the company expects to receive from selling the asset at the end of its service life Disposal of an Asset Sale: Can result in either a gain or loss Retirement: Occurs when the asset is no longer useful but cannot be sold Exchange: Occurs when two companies trade assets Current Liabilities (Chapter 8) Current vs. Long-Term Liability Current: Payable within one year or an operating cycle Long-Term: Payable more than one year or an operating cycle Employee Costs (Deductions from Gross Pay) • Employee = person working for the company • Federal and state income taxes • FICA taxes • 7.65% (6.2% + 1.45%) • Collectively, Social Security and Medicare taxes • Employees may opt to have additional amounts withheld from their paychecks • Employer records the amounts deducted and pays them to the appropriate organizations Employer Costs (Additional Costs Above Salary Expense) • Additional (matching) FICA tax on behalf of the employee • Employers also pay federal and state unemployment taxes on behalf of its employees • FUTA and SUTA • Fringe benefits: Additional employee benefits paid for by the employer Warranties • Most common example of contingent liabilities • Help increase sales • Warranty expense is recorded in the same accounting period as the sale • It should be probable and the amount can be reasonably estimated Time Value of Money (Appendix C) Time Value of Money: Decrease in value of money due to passage of time (Interest) • Four Tables! • PV, FV, PVA, FVA • Simple interest: interest earned on the initial investment only • Compound interest: interest earned on the initial investment and on previous interest • Annuity: Cash payments of equal amounts over equal time intervals Long-Term Liabilities (Chapter 9) Bond: • Formal debt instrument • Usually issued to many lenders • Borrower repays the principal or face amount, at a specified maturity date • Pay interest over the life of the bond • Private placement: selling debt securities directly to a single investor Stockholders’ Equity (Chapter 10) Corporations • Nature of business activities • Shares of stock to be issued • Initial board of directors • The board of directors establish corporate policies and appoints officers who manage the corporation • More regulations around Corporations than any other form of business Stages of Equity Financing • Corporations first raise money from founders of the business, friends, and family • Seek investments from: • Angel investors: Individuals, $25-100K+ • Venture capital firms • Companies that specialize in bringing startups to market after the Angel investment round, more dollars, more ownership • Initial public offering (IPO) • An IPO is what brings a company to the market • Companies trade on a stock exchange where the public can purchase the stock Common Stock • Types of Stock: • Authorized: Shares available to sell (Issued and unissued) • Issued: Shares actually sold (Includes treasury stock) • Outstanding: Shares held by investors (Excludes treasury stock) Par Value • Legal capital per share of stock that’s assigned when the corporation is first established • Creates a liability to the company if assets fall below the par level (The corporation is not up to par!) • Has no relationship to the market value today • Par value, Face Value, Stated Value, Nominal Value Preferred Stock • Issued in addition to common stock to attract wider investment – par values are usually higher than common par values • Preferred stockholders have: • First rights to a specified amount of dividends • Preference over common stockholders in the distribution of assets at the time of dissolution • Most preferred stock does not have voting rights • Types: • Convertible: shares of preferred can be exchanged for shares of common stock by the owner • Redeemable: shares can be returned by the shareholder to the corporation at a fixed price • Cumulative: preferred shares receive priority for dividends, if dividends are not paid in a given year • Dividends in arrears - unpaid dividends Treasury Stock • Corporation’s own stock that it has reacquired at the current market price • Companies buy back their own stock for various reasons: • To boost underpriced stock • To distribute surplus cash without paying dividends • To boost earnings per share • To satisfy employee stock ownership plans Dividends • Distributions of cash or stock by a corporation to its stockholders • Declaration date: date on which board of directors declare the cash dividend to be paid • Legal obligation incurred • Record date: specific date on which the company will determine who will receive the dividend (registered owners of stock) • Review of our records • Payment date: date of the actual cash distribution • Cash is going out Earnings per Share (KNOW EQUATION) • Measures net income earned per share of common stock • Useful in comparing earnings performance for the same company over time • Not useful for comparing earnings performance of one company with another Price-Earnings Ratio (KNOW EQUATION) • Indicates how the stock is trading relative to current earnings • Commonly are in the range of 15 to 20 • Growth stocks: stocks whose future earnings investors expect to be higher • Value stocks: stocks that are priced low in relation to current earnings Return on Equity (Don’t have to know formula, but know concepts) • Measures the income earned for each dollar in stockholders’ equity • So if I invest in this company, for every dollar I have invested the company was able to get a .22 cent return • This is NOT what each owner will get in dividends! Statement of Cash Flows (Chapter 11) Cash Flow Activities • Operating activities: cash receipts and cash payments for transactions relating to revenue and expense activities Indirect Method • Both net income and cash flows from operating activities represent the same operating activities • Net income includes both cash and noncash components • Net cash flows from operating activities removes noncash components • Depreciations • Gains & Losses • Changes in operating accrual accounts (CA, CL) • Current Assets: • – Increase in a current asset • + Decrease in a current asset • Current Liabilities – do the opposite! • + Increase in a current liability • – Decrease in a current liability KNOW HOW TO CALCULATE A STATEMENT OF CASH FLOW WITH THE INDIRECT METHOD!!!! Direct Method • Report the cash inflows and cash outflows directly • Converts each revenue and expense item to its cash-basis amount • Income statement items that have no cash effect are not reported • Direct method gives the exact same number for net cash flows from operating activities as the indirect method • Why direct method? • It makes sense, it is logical, it helps everyone understand cash as a result of operations • Which helps everyone make more informed decisions about the company • Why not direct method? • It is more difficult to prepare, more expensive to prepare • But….it all comes back to why we do financial reporting. • Direct is just a better method giving better information • Investing activities: cash transactions involving the purchase and sale of long-term assets and current investments • Increase or decrease in long-term assets (yes, investments go here too, but I’m just concerned you know what to do with the LTAs) • Did I spend cash? Purchased new equipment for $200,000 (Subtract) • Did I receive cash? Sold old equipment for $30,000 (Add) • Financing activities: inflows and outflows of cash resulting from the external financing of a business • Examine changes in long-term liabilities and stockholders’ equity accounts from the balance sheet • Did I sell more stock (and receive cash)? Add • Did I buy treasury stock (and spend cash)? Subtract • Did I pay dividends? (and spend cash)? Subtract • Noncash Activities: Significant investing and financing activities that do not affect cash • Reported after the cash flow statement or in a note to the financial statements Financial Statement Analysis (Chapter 12) Vertical Analysis • Express each item in a financial statement as a percentage of the same base amount • Income statement items expressed as a percentage of sales • Balance sheet items expressed as a percentage of total assets Horizontal Analysis • Analyze trends in financial statement data for a single company over time • Can be year over year • Can be one base year and show growth (decline) from the base year Quality of Earnings • Ability of reported earnings to reflect true earnings • Usefulness of reported earnings to predict future earnings • Conservative Accounting Practices: Results in reporting lower income, lower assets, and higher liabilities • Aggressive Accounting Practices: Results in reporting higher income, higher assets, and lower liabilities RATIOS MUST KNOW EQUATIONS! Current ratio • Compares current assets to current liabilities • High ratio indicates sufficient assets to cover current liabilities • Your book is happy with a 1:1 ratio, I like to see current ratios in at least the 1.5:1 to 2:1 range! Acid-Test Ratio • More conservative measure of ability to pay current liabilities • Ignores current assets such as inventories and prepaid expenses • These are items we cannot turn to cash SUPER quick Debt to Equity Ratio • Indicates the risk of bankruptcy • You can’t go bankrupt if you don’t have debt! • Higher ratio (more debt than equity) indicates higher risk Gross Profit Net sales – Cost of Goods Sold • Amount of profit remaining to spend on operating expenses, etc. after our product is paid for • Important first measure of profitability Gross Profit Ratio • Indicates the portion of each dollar of sales above its cost of goods sold Net income • Gross margin (gross profit) less operating expenses, +/- non-operating revenues or expenses and income tax expense • The Bottom Line – what is available to reinvest in our company or pay our shareholders Profit margin • Measures the income earned on each dollar of sales MUST KNOW CONCEPTS! Receivables Turnover Ratio • Measures how many times receivables are collected during the year • Low ratio indicates trouble collecting its accounts receivable • High ratio indicates quick collection of receivables into cash • Too high might mean our credit policies are too tight! Average Collection Period • Days it takes to convert receivables into cash • Shorter collection period is better • But we might be missing some sales by not extending credit to some customers who might be credit worthy Inventory Turnover Ratio • Measures how many times average inventory is sold during the year • Low ratio means we might have some inventory that is obsolete or dated • High ratio indicates that inventory is selling quickly • Extremely high ratio might indicate lost sales due to inventory shortages Average Days in Inventory • Days it takes to sell inventory • Lower is better Times interest Earned Ratio • Compare interest payments with income available to pay them • Associated with long-term liabilities • Higher means we may have enough liquidity to stay out of bankruptcy • Lower is a bankruptcy caution Return on Assets • Measures the income the company earns on each dollar invested in assets Asset Turnover • Measures sales volume in relation to the investment in assets
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