Study Guide (Chapters 9-13)
Study Guide (Chapters 9-13) ACCT201A
Cal State Fullerton
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This 11 page Study Guide was uploaded by Melinda Chou on Tuesday December 8, 2015. The Study Guide belongs to ACCT201A at California State University - Fullerton taught by Glen Hatton in Summer 2015. Since its upload, it has received 171 views. For similar materials see Financial Accounting in Accounting at California State University - Fullerton.
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Date Created: 12/08/15
Accounting 201A Study Guide (Chapter 9-‐13) CHAPTER 12: STATEMENT OF CASH FLOWS Classification of Cash Flows Operating Activities • Income Statement Items Investing Activities • Changes in Investments and Long-‐Term Asset Items Financing Activities • Changes in Long-‐Term Liabilities and Stockholders’ Equity Preparing the Statement of Cash Flows Indirect Method • Easier and less costly to prepare • Focuses on differences between net income and net cash flow from operating activities Step 1: Operating Activities • Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis o Add back non-‐cash expenses (depreciation, amortization or depletion expense) o Deduct gains and add losses o Changes in noncash current assets and current liabilities Adjustment to Convert Net Income to Net Cash Provided Noncash charges Depreciation expense Add Patent amortization expense Add Gains and losses Loss on sale of plant asset Add Gain on sale of plant asset Deduct Changes in current Increase in current asset account Deduct Assets and current Decrease in current asset account Add Liabilities Increase in current liability account Add Decrease in current liability account Deduct Step 2: Investing and Financing Activities Cash flows from investing activities • Purchase of building • Purchase of equipment • Sale of equipment Cash flows from financing activities • Issuance of common stock • Payment of cash dividends Step 3: Net Change in Cash • Compare the net change in cash on the Statement of Cash Flows with the change in the cash account reported on the Balance Sheet to make sure the amounts agree Free Cash Flow • Describes the cash remaining from operations after adjustment for capital expenditures and dividends = Cash provided by operating activities – Capital Expenditures – Cash Dividends Assessing Liquidity and Solvency Liquidity – the ability to pay obligations expected to become due within the next year Current cash debt coverage ratio = Cash provided by operations Average Current Liabilities Solvency – the ability of a company to survive over the long term Cash debt coverage ratio = Cash provided by operations Average Total Liabilities CHAPTER 9: REPORTING AND ANALYZING LONG-‐LIVED ASSETS Plant Assets • Physical substance (definite size and shape) • Used in the operations of a business • Not intended for sale to customers • Expected to provide service to the company for a number of years, except for land Determining the Cost of Plant Assets Cost Principle – requires that companies record plant assets at cost • Revenue expenditure – costs incurred to acquire a plant asset that are expensed immediately • Capital expenditures – costs included in a plant asset account Cost – cash paid in a cash transaction or the cash equivalent price paid Land – all necessary costs incurred in making land ready for its intended use increase (debit) the Land account • Cash purchase price • Closing costs (title and attorney’s fees) • Real estate brokers’ commissions • Accrued property taxes and other liens on the land assumed by the purchaser Land Improvements – includes all expenditures necessary to make the improvements ready for their intended use Ex. Driveways, parking lots, fences, landscaping, etc. • Limited useful lives • Expense (depreciate) the cost of land improvements over their useful lives Buildings – includes all costs related directly to purchase or construction • Purchase price, closing costs • Remodeling and replacing or repairs • Contract price plus payments for architects’ fees, building permits, and excavation costs Equipment – includes costs incurred in acquiring equipment and preparing it for use • Cash purchase price • Sales tax • Freight charges • Insurance during transit paid by the purchaser • Expenditures required in assembling, installing, and testing the unit Accounting for Plant Assets Process of allocating to expense the cost of a plant asset over its useful (service) life in a rational and systematic manner • Process of cost allocation, not asset valuation • Applies to land improvements, buildings, and equipment, not land Factors in Computing Depreciation Cost • All expenditures necessary to acquire the asset and make it ready for intended use Useful Life • Estimate of the expected life based on need for repair, service life, and vulnerability to obsolescence Salvage Value • Estimate of the asset’s value at the end of its useful life Plant Asset Disposals Eliminate asset by (1) debiting accumulated depreciation, and (2) crediting the asset account Sale of Plant Assets Compare the book value of the asset with the proceeds received from the sale • Proceeds exceed book value, a gain on disposal occurs • Proceeds less than book value, a loss on disposal occurs Retirement of Plant Assets • NO Cash received • Decrease (debit) Accumulated Depreciation for full amount of depreciation taken over the life of the asset • Decrease (credit) the asset account for the original cost of the asset Analyzing Plant Assets Return of Assets Ratio = Net Income Average Total Assets è Indicates the amount of net income generated by each dollar of assets Asset Turnover Ratio = Net Sales Average Total Assets è Indicates how efficiently a company uses its assets to generate sales Profit Margin Ratio (Profit Margin) (Asset Turnover) = Return on Assets Net Income Net Sales Net Income Net Sales Average Total Assets Average Total Assets è Tells how effective a company is in turning its sales into income Intangible assets Rights, privileges, and competitive advantages that result from ownership of long-‐lived assets that do not possess physical substance Ex. Patents, copyrights, trademarks, trade names, goodwill, franchises or licenses Limited-‐Life Intangibles • Amortize to expense • Credit asset account or accumulated amortization Indefinite-‐Life Intangibles • No foreseeable limit on time the asset is expected to provide cash flows • No amortization Annual Depreciation Expense = (Book Value at Beginning of Yr.)(Declining Balance Rate) CHAPTER 10: REPORTING AND ANALYZING LIABILITIES Current Liabilities Include notes payable, accounts payable, unearned revenues, and accrued liabilities (taxes, salaries and wages, and interest payable) Two key features: • Pay the debt from existing current assets or through the creation of other current liabilities • Pay the debt within one year or the operating cycle, whichever is longer Notes Payable • Require the borrower to pay interest Sales Tax Payable • Retailer collects tax from the customer • Retailer remits the collections to the state’s department of revenue Unearned Revenue Revenues that are received before the company delivers goods or provides services • Debits Cash and Credits a Current Liability account (unearned revenue) • When the company earns the revenue, it debits the unearned revenue account and credits a revenue account Ex. Airline, Hotel, Magazine publisher Payroll and Payroll Taxes Payable Salaries – managerial, administrative, and sales personnel (monthly or yearly) Wages – store clerks, factory employees, and manual laborers (rate per hour) Payroll Tax Expense Three taxes that levy on employers • FICA tax, Federal unemployment tax, State unemployment tax Bond: Long-‐Term Liabilities Bonds – form of interest-‐bearing notes payable issued by corporations, governmental agencies, and universities Issuing Procedures • Bond Certificate: Issues to the investor and provides name of the company issuing bonds, face value, maturity date, and contractual (stated) interest rate • Face Value: Principal due at the maturity • Maturity Date: Date final payment is due • Contractual Interest Rate: Rate to determine cash interest paid, generally semiannually Determining the Market Value of Bonds 1. Dollar amounts to be received 2. Length of time until the amounts are received 3. Market rate of interest Discounting: Process of finding the present value Accounting for Bond Issues Records bond transactions when it • Issues or buys back bonds • When bondholders convert bonds into common stock Bonds may be issued at • Face value • Below face value (discount) • Above face value (premium) Assume contractual rate of 10% Market Interest Bonds Sold At 8% -‐> Premium 10% -‐> Face Value 12% -‐> Discount Ex. Long-‐term liabilities Bonds payable $100,000 Less: Discount on bonds payable 2,000 $98,000 DISCOUNT ON BONDS PAYABLE IS A CONTRA ACCOUNT Ex. Long-‐term liabilities Bonds payable $100,000 Add: Premium on bonds payable 2,000 $102,000 Redeeming Bonds at Maturity The carrying value of the bonds is the face value of the bonds less unamortized bond discount or plus unamortized bond premium at the redemption date è When bonds are converted into common stock: the carrying value of the bonds is transferred to paid-‐in capital accounts Amortizing Bond Discount Bond Discount = Bond Discount Amortization Number of Interest Periods CHAPTER 11: REPORTING & ANALYZING STOCKHOLDERS’ EQUITY The Corporate Form of Organization Other Forms of Business Organization • Limited partnerships • Limited liability partnerships (LLPs) • Limited liability companies (LLCs) • S corporation Stockholders Rights 1. Vote in election of board of directors and on actions that require stockholder approval 2. Share the corporate earnings through receipt of dividends 3. Keep the same percentage ownership when new shares of stock are issued 4. Share in assets upon liquidation in proportion to their holding – residual claim Paid-‐in capital The total amount of cash and other assets paid in to the corporation by stockholders in exchange for capital stock Retained Earnings Net income that a corporation retains for future use Accounting for Common Stock Issues 1. Identify the specific sources of paid-‐in capital 2. Maintain the distinction between paid-‐in capital and retained earnings Accounting for Treasury Stock Treasury Stock – corporation’s own stock that it has reacquired from shareholders, but not retired • Debit treasury stock for the price paid • Contra stockholders’ equity account, not an asset • Reduces stockholders’ equity Preferred Stock • Paid-‐in Capital in Excess of Par Value – Preferred Stock • Paid-‐in Capital in Excess of Par Value – Common Stock Dividends A distribution of cash or stock to stockholders on a proportional to ownership basis • Cash dividends • Property dividends • Stock dividends • Scrip Cash dividends Must have – Retained earnings Adequate cash Declaration by the Board of Directors ENTRIES FOR CASH DIVIDENDS ARE REQUIRED ON THE DECLARATION DATE AND THE PAYMENT DATE Stock Dividends Results in decrease in retained earnings and increase in paid-‐in capital • Issued stock dividends to satisfy stockholders’ dividend expectations without spending cash • To increase the marketability of the corporation’s stock • To emphasize that a portion of stockholder’s equity has been permanently reinvested in the business Effects: -‐Changes the composition of stockholder’s equity -‐Total stockholders; equity remains the same -‐No effect on the par or stated value per share -‐Increases the number of shares outstanding Retained Earnings Net income that a company retains for use in the business • New income increases Retained Earnings and a net loss decreases Retained Earnings • Part of the stockholders’ claim on total assets of the corporation • Debit balance in Retained Earnings is identified as a deficit Dividend Record Payout Ratio = Cash Dividends Declared on Common Stock Net Income Payout ratio measures the percentage of earnings a company distributes in the form of cash dividends Earning Performance Return on Common Stockholders’ Equity Ratio = Net Income – Preferred Stock Dividends Average Common Stockholders’ Equity This ration shows how many dollars of net income a company earned for each dollar of common stockholders’ equity CHAPTER 13: FINANCIAL ANALYSIS: THE BIG PICTURE Sustainable Income Net income adjusted for irregular items Irregular items – separately identifies on the income statement • Discontinued operations • Extraordinary items Discontinued Operations • Disposal of significant component of a business • Income statement should report a gain (or loss) from discontinued operations, net of tax Extraordinary Items Events and transactions that meet two conditions • Unusual in nature • Infrequent in occurrence Income Statement Sales $XX Cost of goods sold XX Gross profit XX Operating expenses XX Income from operations XX Other revenues (expenses) and gains (losses) XX Income before income taxes XX Income tax expense XX Income before irregular items XX Discontinued operations (net of tax) XX Extraordinary items (net of tax) XX Net income XX Other comprehensive income items (net of tax) XX Comprehensive income $XX Comparative Analysis Horizontal Analysis also called trend analysis – technique for evaluating a series of financial statement data over a period of time -‐>Purpose: to determine increase or decrease that has taken place Vertical Analysis also called common-‐size analysis – technique that expresses each financial statement item as a percent of a base amount -‐>Balance sheet and the income statement Ratio Analysis Ratio Analysis – expresses the relationship among selected items of financial statement data Liquidity • Measures short-‐term ability of the company to pay its maturing obligations and to meet unexpected needs for cash Solvency • Measures the ability of the company to survive over a long period of time Profitability • Measures the income or operating success of a company for a given period of time Quality of Earnings Price-‐Earnings (P-‐E) Ratio = Stock Price per Share Earnings per Share -‐>Price earnings ratio will be higher if investors think that earnings will increase substantially in the future -‐>Price earnings ratio will be lower when there is the belief that a company has poor-‐quality earnings Liquidity Ratios Current Ratio -‐ Expresses the relationship of current assets to current liabilities Cash Debt Coverage Ratio -‐ Because it uses cash provided by operating activities, it may provide a better representation of liquidity Receivables Turnover Ratio – Measures the number of times, on average, a company collects receivables during the period Average Collection Period – Converts the receivable turnover ratio into days Inventory Turnover Ratio -‐ Measures the number of times average inventory was sold during the period Days in Inventory -‐ Measures the average number of days inventory is held Solvency Ratios Debt to Total Assets Ratio – Indicates the degree of financial leveraging. Provides some indication of the company’s ability to withstand losses Times Interest Earned Ratio -‐ (also called interest coverage) indicates the company’s ability to meet interest payments as they come due Cash Debt Coverage Ratio -‐ Indicates a company’s ability to repay its liabilities from cash generated from operating activities without having to liquidate the assets used in its operations Free Cash Flow -‐ Ability to pay dividends or expand operations Profitability Ratios Return on Common Stockholders’ Equity Ratio -‐ Shows how many dollars of net income the company earned for each dollar invested by the owners Return on Assets Ratio -‐ Measures the overall profitability of assets in terms of the income earned on each dollar invested in assets Profit Margin Ratio -‐ Or rate of return on sales, is a measure of the percentage of each dollar of sales that results in net income Asset Turnover Ratio -‐ Measures how efficiently a company uses its assets to generate sales Gross Profit Rate -‐ Indicates a company’s ability to maintain an adequate selling price above its cost of goods sold Earnings Per Share -‐ A measure of the net income earned on each share of common stock Price-‐Earnings (P-‐E) Ratio -‐ Reflects investors’ assessments of a company’s future earnings Payout Ratio -‐ Measures the percentage of earnings distributed in the form of cash dividends
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