ACCOUNTING TEST 4 LOCK IN

CH 8, 9, 10

Liability*:

Probable future sacrifices of economic benefits; liabilities usually require the payment of cash, the transfer of assets other than cash, or the performance of services

Contingent liability*:

An obligation whose amount or timing is uncertain and depends on future events

Current liabilities*:

Obligations that require a firm to pay cash or another current asset, create a new current liability, or provide goods or services within one year or one operating cycle, whichever is longer

Account payable*:

An obligation that arises when a business purchases goods or services on credit.

Accrued liabilities*:

Liabilities that usually represent the completed portion of activities that are in process at the end of the period

Unearned revenue*:

A liability that occurs when a company receives payment for goods that will be delivered or services that will be performed in the future

Sales taxes*:

Money collected from the customer for the governmental unit levying the tax

Withholding taxes*:

Businesses are required to withhold taxes from employees’ earnings; standard withholdings include federal, state, and possibly city or county income taxes, as well as Social Security and Medicare

Payroll taxes*:

Taxes that businesses must pay based on employee payrolls; these amounts are not withheld from employee pay, rather they are additional amounts that must be paid over and above gross pay

Which of the following payroll taxes is paid by both the employee and the employer?

Social Security and Medicare tax (F I C A)

F I C A tax is paid in equal amounts by both the employee and employer. Federal income tax is paid only by the employee. Federal and state unemployment tax is paid only by the employer

Warranty*:

A guarantee to repair or replace defective goods during a period (ranging from a few days to several years) following the sale.

− Expense recognition requires that all expenses required to produce sales revenue for a given period be recorded in that period

In financial accounting, a contingency is an

“. . . existing condition, situation, or set of circumstances involving uncertainty” as to possible gain or loss.

• A contingent liability is not recognized in the accounts unless both of the following are true:

− The event on which it is contingent is probable

− A reasonable estimate of the loss can be made

Lakeside Marina, Inc. is currently engaged in a lawsuit from a customer who was badly hurt in one of their rental boats. Lakeside’s attorneys believe it is probable the marina will lose the lawsuit and will be required to pay $2,000,000 in damages.

How should Lakeside Marina recognize this contingent liability?

A journal entry is required in the amount of the probable damages.

Because it is deemed probable they will lose the lawsuit and the damages can be reasonably

estimated, a journal entry is required to record a $2,000,000 contingent liability

Current Ratio:

 Compares all or parts of current assets to current liabilities

 Calculation greater than 1.0 implies a company can meet its obligations

Quick Ratio:

 Compares current assets (less inventory) to current liabilities

Operating Cash Flow:

 Looks at the ability of cash generated from operating activities to meet current obligations

Current Ratio Formula =

Current Assets

___________________

Current Liabilities

Quick Ratio Formula =

(Cash + Short − Term Investments + Accounts Receivable)

________________________________________________

Current Liabilities

Cash Ratio Formula=

(Cash + Short − Term Investments)

_____________________________

Current Liabilities

Operating Cash Flow Ratio Formula=

Cash Flows from Operating Activities

______________________________

Current Liabilities

Account-based Earnings Management

What it is: Tweaking the accounting rules or estimates to alter profits

Common tactics:

• Changing depreciation methods or useful lives

• Adjusting the allowance for doubtful accounts to lower expenses

• Recognizing revenue early

• Avoiding an impairment or net realizable value adjustment

Risk level: Can easily became fraud if there is manipulation

Example: A company changes its warranty expense estimate from 5% to 3%

Real (Economic) Earnings Management

What it is: Altering actual business operations to influence financial results

Common tactics:

• Offering deep discounts to customers to boost year-end sales

• Cutting R&D or marketing spending to save money

• Delaying hiring or maintenance until after the reporting period

• Refinancing long-term debt at a more favorable interest rate

Risk level: In some instances, can harm long-term performance

Example: Reduced hiring resulted in service level decline, and thus revenues

Classification Shifting Earnings Management

What it is: Moving expense items between line items to be certain financial metrics look better

Common tactics:

• Reclassify recurring expenses as “one-time” or “non-recurring”

• Classifying operating expenses as non-operating

• Recording non-operating income as operating

Risk level: Often subtle, may mislead investors, frequently Non-GAAP info

Example: Recording routine maintenance costs as non-operating expenses

Long-term debt*:

Obligations that extend beyond one year.

Note(s) payable*:

A payable that arises when a business borrows money or purchases goods or services from a company that requires a formal agreement or contract

Bond*:

A type of note that requires the issuing entity to pay the face value of the bond to the holder when it matures and, usually, periodic interest at a specified rate

Face value*:

The amount of money that a borrower must repay at maturity; also called par value* or principal*.

Interest rate*:

A percentage of the principal that must be paid in order to have use of the principal. It is multiplied by the beginning-of-period balance to yield the amount of interest for the period. (Also called stated rate*, coupon rate*, or contract rate*.)

Interest rate formula:

Face Value × Interest Rate × Time (in years)

Secured*:

A term used for a bond that has some collateral pledged against the corporation’s ability to pay

Mortgage bonds*:

Bonds that are secured by real estate

Unsecured*:

A term used for bonds in which the lender is relying on the general credit of the borrowing corporation rather than on collateral.

Debenture bonds*: Another name for ________ bonds

Junk bonds*:

Unsecured bonds where the risk of the borrower failing to make the payments is relatively high

Callable bonds*:

Bonds that give the borrower the right to pay off (or call) the bonds prior to their due date. The borrower typically “_____” debt when the interest rate being paid is much higher than the current market conditions.

− This is similar to homeowners “refinancing” to obtain a lower interest rate on their home mortgage

Convertible bonds*:

Bonds that allow the bondholder to convert the bond into another security—typically common stock.

− _________ will specify the conversion ratio

Market rate*:

The ______ rate of interest demanded by creditors.

Yield*:

The market rate of interest demanded by creditors; _____ may differ from stated rate because the underwriter disagrees with the borrower as to the correct _____ or because of changes in the economy or creditworthiness of the borrower between the setting of the stated rate and the date of issue

Premium*:

When a bond’s selling price is above face value

Discount*:

When a bond sells at a price below face value, due to the yield being greater than the stated rate of interest

There are three basic cash flows for which the issuing corporation must account:

− Issuance: The cash received when the bonds are issued (the issue or selling price)

− Interest: The interest payments

− Repayment: The repayment of the principal (or face value)

Interest amortization*:

The process used to determine the amount of interest to be recorded in each of the periods the liability is outstanding

Effective interest rate method*:

A method where the amortization of premiums and discounts results in the interest expense for each accounting period being equal to a constant percentage of the book value (or carrying value) of the debt

Straight-line method*:

A method where equal amounts of premiums and discounts are amortized to interest expense each period resulting in constant interest expense across the life of the liability.

To use the effective interest method, you must distinguish between the cash interest payments being made, which are calculated as:

Face Value × Stated Rate × Time (in years)

the effective interest expense being recorded, which is calculated as:

Carrying Value × Yield Rate × Time (in years)

Interest expense, under the effective rate method, is calculated by using the

Carrying Value (Face Value – Discount Balance or Face Value + Premium Balance) and the yield, or market rate, of interest

The straight line and effective interest rate method of amortization are identical in which situation?

When a bond is sold at par

When a bond is sold at par, the straight-line method and effective interest rate method are identical because there are no premiums or discounts to amortize.

Leverage*:

The use of borrowed capital to produce more income than needed to pay the interest on a debt

The primary negative attribute of debt is related to which of the following?

Payment schedule

The primary negative attribute of debt is the inflexibility of the payment schedule

Lease*:

An agreement that enables a company to use property without legally owning it.

Debt to Equity =

Total Liabilities

____________

Total Equity

Debt to Total Assets =

Total Liabilities

____________

Total Assets

Long − Term Debt to Equity =

Long − Term Liabilities (including current portions)

___________________________________________

Total Equity

Times Interest Earned (Accrual Basis) =

Income from Operations

_____________________

Interest Expense

Times Interest Earned (Cash Basis) =

(Cash Flows from Operations + Taxes Paid + Interest Paid)

________________________________________________

Interest Paid

Straight-Line Method:

Interest Expense Per Period

○ With a Discount: Interest Payment + [Discounts / # of Periods]

○ With a Premium: Interest Payment - [Premiums/ # of Periods]

Straight-Line Method:

Interest Amortization Per Period =

Bond Discount Or Premium / # of Periods

Straight-Line Method:

Interest Payment Per Period=

Face Value X Stated Rate X Time

Effective Interest Method:

The interest expense is a constant percentage of the bond carrying value

Effective Interest Method:

Interest Payment Per Period =

Face Value X Stated Rate X Time

Effective Interest Method:

Interest Expense Per Period =

Carrying Value X Effective Interest Rate/Market Rate X Time

○ Carrying Value = Face Value - Discounts or Face Value + Premiums

Effective Interest Method:

Interest Amortization Per Period =

○ Discount: Interest Expense - Interest Payment

○ Premium: Interest Payment - Interest Expense

Stockholders’ equity (equity)*:

The owners’ claims against the assets of a corporation after all liabilities have been deducted.

Stockholders (shareholders)*:

The owners of a corporation who own its shares in varying numbers

Corporate charter (articles of incorporation)*:

A document that authorizes the creation of the corporation, setting forth its name, purpose, and the names of the incorporators.

Authorized shares*:

The maximum number of shares a company may issue in each class of stock

Issued shares*:

The number of shares actually sold to stockholders.

Outstanding shares*:

The number of issued shares actually in the hands of stockholders

Common stock*:

The basic ownership interest in a corporation

Preferred stock*:

A class of stock that generally does not give voting rights, but grants specific guarantees and dividend preferences

Par value*:

For stock, it is an arbitrary monetary amount printed on each share of stock that establishes a minimum price for the stock when issued, but does not determine its market value. For debt, par value is the amount of money the borrower agrees to repay at maturity

Additional paid-in capital*:

The amount received in excess of the par value

Capital stock*:

The portion of a corporation’s stockholders’ equity contributed by investors (owners) in exchange for shares of stock

Treasury stock*:

Previously issued stock that is repurchased by the issuing corporation

The purchase of treasury stock is a

reduction of a company’s equity.

− The account __________ is debited at cost when the company buys back some of its own stock.

Declaration date*:

The date on which a corporation announces its intention to pay a dividend on common stock.

Date of record*:

The date on which a stockholder must own one or more shares of stock in order to receive the dividend

Payment date*:

The date on which the dividend will actually be paid

Stock dividend*:

A dividend paid to stockholders in the form of additional shares of stock (instead of cash

Stock split*:

A stock issue that increases the number of outstanding shares of a corporation without changing the balances of its equity accounts

Current dividend preference*:

A provision that requires that current dividends must be paid to preferred stockholders before any dividends are paid to common stockholders

Cumulative dividend preference*:

A provision that requires the eventual payment of all preferred dividends—both dividends in arrears and current dividends—to preferred stockholders before any dividends are paid to common stockholders

Dividends in arrears*:

Cumulative preferred stock dividends remaining unpaid for one or more years are considered to be in arrears

Which of the following is an invalid reason for a company to repurchase their own shares in a treasury stock transaction?

To receive dividends from an upcoming dividend declared by the board of directors

Retained earnings (or deficit)*:

The accumulated earnings (or losses) over the entire life of the corporation that have not been paid out in dividends

Retained Earnings Formula:

Beginning Retained Earnings

+ Net Income

– Dividends

_______________________

= Ending Retained Earnings

Earnings per share (E P S)*:

The income available for common stockholders on a per-share basis. It measures the net income earned by each share of common stock

EPS Formula

Net Income – Preferred Dividends

__________________________________

Average Common Shares Outstanding

Stockholder payout*:

The amounts distributed (paid out) to owners through dividends and/or stock repurchases (treasury stock). Analysts typically evaluate these amounts as a percentage of Net Income

Dividend Yield =

Dividends per Common Share

____________________________________

Closing Market Price per Share for the Year