accounting final definitions

future value

amount accumulated when itnerest on investment is compounded for a given number of periods

present value

value today of an amount to be paid or received in the future

annuity

receipt or payment of equal amount each period

discount rate

interest rate used in time value of money calculations

liabilities

obligations that represent “probable future sacrifice of economic benefits”

• must be present obligations

• must result from past transactions or events

current liabilities

liabilities that will be paid within one year of the current balance sheet date

examples of current liabilities

• accounts payable

• short term debt

• current maturities of long term debt

• unearned revenue or deferred credits

• other accrued liabilities

accounts payable

amounts owed to suppliers for goods and services that have been provided to entity on credit

short term debt

debt expected to be repaid within year

• often used to finance seasonal fluctuations

revolving line of credit

can borrow money as you need it and can also pay it back sooner if you don’t need the whole loan

• allows company to pay less interest and maybe pay it off sooner

• risky for bank: doesn’t know when you’re going to need the money

note payable

written promise to pay a specific amount of money at a specified future date

working capital loan

money you need to borrow to finance your working capital (like inventory)

current maturities of long term debt

payments on long term debt which are due in the current year

unearned revenue/deferred credits

liability arising from receipt of cash before the related revenue has been earned

other accrued liabiltiies

• accrued expenses

  • accrued payroll taxes

  • accrued property taxes

  • accrued wages and salaries (sometimes shown separately)

• estimated warranty liability

payroll taxes payable

payroll taxes due to federal and state governments

examples of noncurrent liabilities

• long term debt

• deferred tax liabilities

• obligations to pension plans and other employee benefit plans

• contingent liabilities

why use debt

use someone elses’ money in order to make money

• interest id deductible

• lower economic cost to firm

• financial leverage

leverage

financing with debt (i.e. using debt to potentially increase returns on an investment or business)

• firms earns more on assets than it pays to borrow money

• use of borrowed money to enhance return to owners

financial leverage and ROE

company can increase its ROE by using financial leverage

bonds

formal document, usually in denominations of $1000

• may be sold at premium (more than face) or discount (less than face)

• reported at present value of amounts to be paid in future

how bonds work

• investor buys bond from borrower to earn interest

• borrower borrows $ from investor to use in business and pays interest to investor

deferred tax liabilities

arise from temporary differences between income tax and financial statement recognition of revenues and expenses

other noncurrent liabilities

• defined benefit and defined contribution plans

• contingent liabilities

employee retirement income security act (ERISA)

• minimum funding of plans

• minimum rights to employees upon termination of their employment

• creation of the pension benefit guranty corporation

defined benefit plan

• defines the benefits to be received

• employer must fund sufficiently to achieve benefit

defined contribution plan

• contributions to the plan are specified

• employer bears no risk for future growth of plan

• no complex expense or liability issues

• 401K is type of this

contingencies

existing conditions or circumstances that create uncertainty about whether a future event will lead to a potential gain or loss for a company

when are contingencies accrued

• probable asset has been impaired or liability incurred

• amount of less can be reasonably estimated

• loss contingencies that are not accrued are footnoted if it is reasonable possible that an asset has been impaired or a liability has been incurred

• gain contingencies not accrued

financing with debt

company borrows finds, pays interest, and repays loan at end

• interest is tax deductible

pros of debt

• interest (that you pay when you borrow) is tax deductible

• has high priority in bankruptcy, especially compared to common and preferred stock

• debtholderes are not owners and are only entitled to itnerest and principal repayment (do not take part of ownership of company)

• means that you are using someone else’s money to make money

loan covenants

agreements that company keeps certain financial ratios (debtholders can require these)

common stock

ownership of company; issuances almost always have a par value

• may provide dividends (newer companies or startups typically don’t)

• may have preemptive right

preemptive right

right of stockholder to purchase shares from any additional sale of share in proportion to % of ownership (have to announced beforehand)

authorized shares

the maximum number of shares a company is legally allowed to issue, as approved in its corporate charter

issued shares

the number of shares of class of stock that has been issued (usually sold) to stockholders

outstanding shares

the number of shares of a class of stock held by stockholders

treasury stock

shares of a firm’s previously issues stock that have been reaquired by the firm

• gives investors the option to sell their stock back, but they do not have to sell

• can help increase leverage and increase ROE

par value

an arbitrary value assigned to a share of stock when the corporation is organization

preferred stock

the class of stock representing an ownership interest with certain preferences relative to common stock, usually including a priority claim to dividends

• no voting rights

• preferred dividends paid before common dividends, but may be skipped, unlike interest

cumulative dividend

a feature of preferred stock that requires any missed dividends to be paid before dividends are paid on common stock

preference in bankruptcy

preferred stockholders have this, order paid off:

1. liabilities

2. preferred stock

3. common stock

callable preferred stock

preferred stock that can be redeemed by the corporation at its option (i.e. company can buy back the stock at anytime)

convertible preferred stock

preferred stock that can be converted to common stock of the corporation at the option of the stockholder (kind of rare)

stock split

a distribution of additional shares to existing stockholders in proportion to their existing holdings. the additional shares issued usually amount to 100 percent or more of the previously issued shares

discontinued operations

• once a company decides to discontinue a business, the financial statements separate this, even if it has not yet been sold or separated

• the income statement excludes the business to be discontinued from revenues through income from continuing operations after tax

net income from continuing operations

an income statement subtotal that is presented before income or loss from discontinued operations

• usually only labeled as “continuing” when the company has discontinued, otherwise called “net income”

income (loss) from discontinued operations

income from businesses the company is not keeping

• all revenues and expenses from this business is removed from income statement and the net amount is in this category

• historical is also restated

• always shown after tax

cost of goods sold

all the costs of making or buying the product

• raw materials, packaging, labor (wages), distribution costs (usually), manufacturing overhead

manufacturing overhead

• depreciation of manufacturing buildings and equipment

• salaries and benefits of manufacturing people

• repair and maintenance

• other costs in the manufacturing setting

gross profit

net sales less cost of goods sold

operating income

measure of management’s ability to use firms operating assets to create profit

earnings per share

net income available to the common stockholders divided by the average number of share of common stock outstanding during the period

• required disclosure for corporate income statements

statement of cash flows

the financial statement that explains why cash changed during a fiscal period. cash flows from operating, investing, and financing activities are shown

cash flows from investing activities

purchase and sale of noncurrent (long lived) assets

cash flows from financing activities

changes in non-operating liabilities and owners’ equity accounts

managerial accounting

use of accounting information for internal decision making (e.g.pricing, new products or eliminating products, budgeting, operational control, planning, sourcing, etc.)

who cares about managerial accounting

• brand managers

• operations analysts and consultants

• plant managers

• financial managers

• division managers

• senior management

standard cost

costs expected to be incurred under normal efficient operations (e.g. par on a golf course)

• the one thing in business that can help you fix something the same day

ideal standards

a standard cost or production standard that assumes ideal operating conditions and maximum efficiency at all times; based on perfection, are unattainable and discourage employees

attainable standards

a standard cost or production standard that is achievable under actual operating conditions (i.e. with reasonable and efficient effort)

controllable costs

costs that can be affected by a manager’s decisions

incremental costs

costs that are changed as a result of a particular action or decision

avoidable costs

a sort of incremental cost; costs that would otherwise be incurred but are avoided as a result of a particular decision

variable cost

total cost varies directly with volume (or some other measure of activity)

fixed cost

total cost does not vary with level of activity

mixed cost

fixed ad variable components

relevant range

range of activity for approximation of cost behavior

contribution margin income statement

used internally for planning, budgeting, and pricing analysis

• separates variable costs from fixed costs

• shows same bottom line operating income

• every company has their own format

cost-volume-price (CVP) analysis

analysis of the impact on profit of volume and cost changes using knowledge about the behavior pattern of the costs involved

CVP assumptions

• one product

• production = sales

• analysis is in relevant range

margin of safety

measure of risk that describes company’s current sales relative to break-even

• helps us understand how close or far ahead we are from break-even sales

the production budget

production must be adequate to meet budgeted sales and to provide sufficient ending inventory relevant future sales

sunk costs

costs that were incurred in the past. irrelevant for decisions because they cannot be changed

relevant costs

costs that will change based on a particular decision (also called differential costs)

opportunity costs

profit foregone by selecting one alternative over another

allocated costs

assigned to a product or activity through an arithmetic process

relevant cost

cost that can be avoided by buying the component from an outside supplier

• decision rule: costs avoided must be greater than outside supplier’s price to consider buying the component

capital investment

commit money now in anticipation of return over many years

cost of capital

the rate of return that must be earned to permit the firm to meet it’s obligations to its long-term creditors and provide the expected return to stockholders

discounted cash flow

• develop an annual cash flow for the desired number of years

• calculate the net present value of the cash flow

positive NPV

project is acceptable since it promises a return greater than the cost of capital

NPV equals zero

the project is acceptable since it promises a return equal to the cost of capital

negative NPV

project is not acceptable since it promises a return less than the cost of capital