Accounting midterm

Going concern concept

Assumption that the entity will continue operating indefinitely

Matching principle

Expenses are reported on the same income statement as the revenue they helped earn

Expanded accounting equation

Assets = Liabilities + Paid-in Capital + Beginning RE + Revenues − Expenses (− Dividends)

Net assets

Assets − Liabilities; same as stockholders' equity

Current assets

Cash or assets expected to become cash within one year

Current liabilities

Obligations due within one year

Common stock (at par)

Shares issued × par value

APIC

Additional paid-in capital; shares issued × (issue price − par value)

Ending retained earnings formula

Beginning RE + Net income − Dividends

Net income − dividends equals

Only this year's CHANGE in retained earnings, not the balance

Statement of stockholders' equity

Shows all changes in paid-in capital and retained earnings over a period

Statement of cash flows

Reports cash inflows and outflows by operating, investing, and financing activities

Cash flow equation

Operating + Investing + Financing = Net change in cash

Gross profit

Net sales − Cost of goods sold

Income from operations

Gross profit − SG&A expenses

Income before taxes

Income from operations − Interest expense

Net income

Income before taxes − Income tax expense; also Revenues − Expenses

T-account formula

Beginning balance + Increases − Decreases = Ending balance

Deferrals

Prepaid expenses and unearned revenues

Accruals

Accrued expenses and accrued revenues

Contra-asset account

Reduces an asset's balance without changing the original account (e.g., accumulated depreciation)

Net book value

Cost − Accumulated depreciation

FIFO

First in, first out; oldest costs go to COGS first

LIFO

Last in, first out; newest costs go to COGS first

Inventory profits

Extra profit from using FIFO during inflation

Gross profit percentage

Gross profit ÷ Net sales

Margin (return on sales)

Net income ÷ Net sales

Asset turnover

Net sales ÷ Average total assets

ROA / ROI

Net income ÷ Average total assets

ROE

Net income ÷ Average stockholders' equity

DuPont model

ROI = Margin × Turnover

Working capital

Current assets − Current liabilities

Current ratio

Current assets / Current liabilities; about 2.0 is healthy

Acid-test (quick) ratio

(Cash + Short-term investments + Accounts receivable) / Current liabilities; about 1.0 is healthy

Book value of equity

Assets − Liabilities

Market value of equity

Stock price × Shares outstanding

Market-to-book ratio

Market value ÷ Book value of equity

Why distressed firms show both extreme MTB

Book value near zero makes MTB huge; negative book value makes MTB negative

Direct write-off method

Expense bad debts only when an account is confirmed uncollectible

Income statement (% of sales) method

Historical % of net credit sales that go bad = bad debts expense for the period

Balance sheet (aging) method

Group AR by age, apply historical % per category to get the required ending allowance

Aging method: bad debts expense

Required allowance − Current allowance balance (credit)

% of sales method: existing allowance balance

Ignored; the % calculation IS the expense

Write-off entry (allowance method)

Dr Allowance for Bad Debts / Cr Accounts Receivable when a customer actually defaults

Effect of a write-off on net AR

None; both AR and the allowance drop by the same amount

Capitalizing

Recording an expenditure as an asset instead of an expense

Units-of-production depreciation per unit

(Cost − Salvage value) ÷ Estimated total units to be produced

Units-of-production expense each period

Units produced that period × Per-unit depreciation

Declining-balance depreciation

2 × Straight-line rate × Net book value at beginning of year

Financing (capital) lease

Lease where the lessee assumes the benefits and risks of ownership

Financing lease criteria

Transfers ownership; purchase option; term covers most of economic life; PV of payments ≥ fair value; asset has no alternative use to lessor

Depreciation vs amortization vs depletion

Tangible assets are depreciated, intangibles are amortized, natural resources are depleted

Leasehold improvements

Amortizable intangible representing improvements a lessee makes to leased property

Goodwill

Excess of purchase price over fair value of net assets acquired; not amortized