Accounting Exam 2

Non-controlling interest

what is reported when companies own a large portion of the other companies

change

Accounting changes are treated differently depending upon the…

voluntary changes

_____________________ to accounting principle are shown retrospectively, where it would be as if it was changed in the previous period as well

preferable

Companies can change principles, however if must be demonstrated that the newly adopted principle is ___________ to the old one

consistency

Changes in accounting principle result in lost ___________ from period to period

examples of change in estimates

changes in useful live, changes in estimated uncollectible accounts, and changes in depreciation method

prospective

Changes in estimates are _______________, meaning they are only included in current and future periods (no need to change past periods)

prior period adjustments 

if the error is material, it requires and adjustment to beginning retained earnings in a Statement of Retained Earnings 

prior period adjustments

if a correction of an error needs to be made for a prior period, use…

just fix it

if there is an error within the same period, then…

statement of stockholder’s equity

reports the changes in each stockholders’ equity account and in total stockholders’ equity during the year

columnar form

Statement of stockholders’ equity is usually prepared in ___________

columnar form

format where they use columns for each account and for total stockholders’ equity

contributed capital, retained earnings, and the accumulated balance in other comprehensive income

stockholders’ equity is generally comprised of…

common and preferred stock and additional paid-in capital

What is contributed capital?

earnings quality

ability of reported earnings to predict a company’s future earnings

manipulating income and income smoothing

_____________________ can impact earnings quality

“Big bath” accounting

Make a bad year look worse by taking lots of write-offs of assets so that the next year looks much better 

balance sheet

reports a company’s financial position on a particular date

assets, liabilities, and stockholders’ equity

the balance sheet contains ________________________________, at a point in time

future cash flows, liquidity, and long-term solvency

Balance sheet provides information useful for assessing…

market value

the balance sheet is not likely to be representative of the ______________ of the entity, as it misses intangibles such as skills and knowledge of eployees

judgements and estimates

the balance sheet uses…

liquidity 

How quickly will assets convert to cash?

long-term solvency

does the company have a lot of debt relative to assets?

financial flexibility

liquidity and solvency impact…

operating cycle

one year or one operating cycle, whichever is longer

merchandise inventory —> sales —> accounts receivable —> cash

what is the order of the operating cycle for a merchandising company?

raw materials —> work in process —> finished goods —> sales —> accounts receivable —> cash

What is the order of the operating cycle for a manufacturing company?

current assets

cash and all other assets expected to become cash or be consumed within on year or the operating cycle, whichever is longer

liquidity

current assets are presented in the balance sheet in the order of…

3 months or less

cash and cash equivalents typically have maturity dates of ________________________ from the date of purchase

cash and cash equivalents —> short term investments —> account receivable —> notes receivable —> inventory —> prepaid expenses

what is the order of liquidity for current assets?

investments

non-operating assets not used directly in operations

investments

_______________ include equity and debt securities in other corporations, land held for speculation, noncurrent receivables, and cash set aside for special purposes

Example of cash set aside for special purposes

future plant expansion or for repayment of bonds

trading, available-for-sale, and held-to-maturity

types of debt securities:

property, plant, and equipment

tangible, long-lives assets used in the operation of the business

intangible assets

exclusive rights that a company can use to generate future revenues 

amortized

Intangible assets may be ___________ if they have limited lives, or check periodically for impairment

patents, copyrights, franchises, trademarks, and goodwill

Examples of intangible assets include…

other assets

non-current assets that don’t fit into the other categories, which includes long-term prepaid expenses and deferred charges

current liabilities

expected to be satisfied within one year or the operating cycle, whichever is longer

accounts payable, nots payable, unearned revenue, accrued liabilities, and the current portion of long term debt

Current liabilities include…

long-term liabilities

payables beyond the current year

bonds payable, long-term notes payable, pension obligations, deferred income taxes payable

Long-term liabilities typically include…

common stock, additional paid-in capital, retained earnings, accumulated other comprehensive income, treasury stock, non-controlling interest

Stockholders’ equity is divided into six parts which include…

reduction

treasury stock is shown as a ___________ of stockholders’ equity

full disclosure principle

requires that financial statements provide all material, relevant information concerning the reporting entity

disclosure notes

certain important information that describes the nature of the entity and its risks, as well as other supplemental information to suit the disclosure needs of the reporting enterprise

summary of signification accounting policies

conveys valuable information about the company’s choices from among various alternative accounting methods

subsequent event

a significant development that takes place after the company’s fiscal year-end but before the financial statements are issued

related-party transactions

economic substance of ___________________ should be disclosed, including dollar amounts involved

contractual situations

restrictions or covenants attached to certain assets of liabilities

contingencies

material events with uncertain outcomes

Factors of disclosure notes

summary of significant accounting policies, subsequent event, related-party transactions, contractual situations, contingencies, and fair values

statement of cash flows

tells us about the cash we have received and paid during the period 

operating activities, investing activities, and financing activities

three sections to the statement of cash flows which include…

net income, current assets and current liabilities

operating activities include…

noncurrent assets

investing activities include…

non-current liabilities, stockholder’s equity

financing activities include…

operating section

shows the cash received or paid for elements of the income statement

investing activities

companies may invest in assets or, alternatively, sell these assets

examples of cash inflows for investing activities

selling property, plant, and equipment, selling investment securities, and collecting loans

examples of cash outflows for investing activities

purchasing property, plant, and equipment, purchasing investment securities, and lending to others

future plans

investing transactions provide clues to the companies…

financing activities

when companies make investments which are often paid for with external funding

examples of cash outflows for financing activities

repaying debt, purchasing treasury stock, and paying dividends 

examples of cash inflows for financing activities

borrowing and issuing stock

significant non-cash activities

investing or financing activities that do not involve cash, and are typically reported at the bottom of the Statement of Cash Flows

examples of significant non-cash activities

purchase of assets by issuing stock or debt, converting bonds into common stock, and the exchange of long-lived assets

direct and indirect

there are two methods for preparing SOCF, which include…

direct method

the cash effect of each operating activity is reported directly in the SOCF

indirect method

cash flow from operating activities is derived indirectly by starting with reported net income and adding or subtracting items to convert that amount to a cash basis

special adjustments

________________ to the SOCF include depreciation expense, gains and losses, change in deferred income taxes, stock options, and post-retirement benefit costs

comparative financial statements

allow financial statement users to compare year-to-year financial position, results of operations, and cash flows

ratio analysis

the most common way of comparing accounting numbers to evaluate the performance and risk of a firm

liquidity

the readiness of assets to be converted to cash

working capital

popular measure of a company’s ability to satisfy its short-term obligations

current assets - current liabilities

equation for working capital

current ratio

expresses working capital as a ratio that allows for inter-firm comparisons

current assets/current liabilities

equation for current ratio

acid-test ratio

provides a more stringent indication of a company’s ability to pay its current obligations, which excludes inventories and prepaid expenses from current assets before dividing by current liabilities

liquidity ratios

provide measures of a company’s ability to satisfy it’s short-term obligations

quick assets/current liabilities

equation for acid-test ratio

quick assets

can be quickly converted to cash, and do not include inventories and prepaid expenses

net cash provided by operating activities - capital expenditures - dividends

equation for free cash flow

financial flexibility

a lack of free cash flow can indicate a lack of….

financing ratios

provide some indication of the riskiness of a company with regard to its ability to pay its long-term debts

total liabilities/shareholders’ equity 

equation for debt to equity ratio

(net income + interest expense + taxes)/interest expense

equation for times interest earned ratio

vendors

________________ would be interested in current ratio and acid-test ratio if they are considering extending credit to a company

long-term creditors

__________________ would be interested in debt to equity ratio and times interest earned ratio because it can indicate a higher default risk if you compare to similar companies

debt to equity ratio and times interest earned ratio

financing ratios include…

current ratio and acid-test ratio

liquidity ratios include…

cash

includes currency and coins, checking accounts, check, and money orders readily available to pay off debts or use in operations

noncurrent asset

cash that is restricted and can not be used in current operations

cash equivalents

include money market funds, treasury bills, and commercial paper

3 months

to be classified as cash equivalent, the investment must have a maturity date of no longer than __________________ from the date of purchase

restricted cash

_________________ is usually included with investments or other assets