intermediate accounting

Financial statements

Formal reports that summarize a company’s financial performance position and cash flows

Income statement

A financial statement showing revenues expenses gains losses and net income over a period of time

Balance sheet

A financial statement revealing assets liabilities and equity at a specific point in time

Statement of cash flows

A report showing how cash is generated and used through operating investing and financing activities

Statement of retained earnings

A report explaining changes in retained earnings during a period

Statement of comprehensive income

A statement including net income plus other comprehensive income items

Financial statement users

Individuals or groups who rely on financial reports for decision making such as investors lenders and management

10-K report

A detailed annual financial report filed with the SEC containing audited financial statements and disclosures

Financial scorecards

Financial indicators used to evaluate performance risk and overall company health

Financial ratios

Relationships between financial statement numbers used to assess performance and risk

Financial disclosures

Additional information required to explain financial statement numbers and assumptions

Accounting

The system used to record measure and communicate financial information for decision making

Revenue

Inflows of resources from providing goods or services to customers

Expense

Outflows of resources incurred to generate revenue

Gain or loss

Increase or decrease in equity from peripheral or incidental transactions not related to core operations

Earnings management

Intentional timing of revenues and expenses to influence reported income

Earnings quality

The usefulness of earnings for predicting future cash flows and performance

Pro forma income statement

A projected financial statement based on assumptions about future performance

Gross revenue

Total sales before deductions

Net revenue

Revenue after subtracting returns allowances and discounts

Cost of goods sold COGS

Direct costs of producing goods sold including materials and labor

Gross profit

Revenue minus cost of goods sold

Operating expenses

Costs related to running the core business such as salaries rent and utilities

Depreciation

Allocation of the cost of tangible assets over their useful life

Amortization

Allocation of the cost of intangible assets over time

Operating income EBIT

Earnings before interest and taxes calculated as gross profit minus operating expenses

Non-operating income and expenses

Revenues gains expenses or losses not related to core business operations

Income tax expense

Taxes owed based on pre-tax income

Income from continuing operations

Profit remaining after taxes from ongoing business activities

Discontinued operations

Results from disposing of a major business component representing a strategic shift

Unusual or extraordinary items

Abnormal and infrequent gains or losses requiring separate disclosure

Net income

Final profit after all revenues expenses gains losses and taxes

Earnings per share EPS

Net income minus preferred dividends divided by weighted average common shares outstanding

Revenue recognition

Recording revenue when performance obligations are satisfied and control transfers to the customer

Change of control

The point when the buyer obtains the benefits and risks of ownership

Accrual accounting

Recognizing revenues when earned and expenses when incurred rather than when cash is received or paid

Other comprehensive income OCI

Gains and losses affecting equity that bypass net income such as unrealized investment gains

Comprehensive income

Total change in equity excluding owner investments and distributions

Asset

Probable future economic benefit obtained or controlled from past transactions

Liability

Probable future sacrifice of economic benefits arising from present obligations

Equity

Residual interest in assets after deducting liabilities representing ownership

Liquidity

Ability to convert assets to cash quickly or meet short-term obligations

Solvency

Ability to pay long-term debts as they mature

Financial flexibility

Ability to adjust cash flows to respond to unexpected needs or opportunities

Historical cost

Recording assets and liabilities at original purchase price rather than current market value

Current assets

Assets expected to be converted to cash or used within one year or operating cycle

Cash equivalents

Short-term highly liquid investments easily converted to cash

Receivables

Amounts owed to the company by customers

Inventory

Goods available for sale to customers

Prepaid expenses

Payments made in advance for future benefits

Long-term investments

Investments not expected to be converted to cash within one year

Property plant and equipment PP&E

Tangible long-lived assets used in operations

Intangible assets

Nonphysical assets such as patents trademarks and goodwill

Current liabilities

Obligations expected to be settled within one year or operating cycle

Long-term liabilities

Obligations not due within one year such as bonds notes and leases

Stockholders’ equity

Owners’ claim on assets including capital stock retained earnings and other components

Capital stock

Par or stated value of issued shares

Additional paid-in capital

Amounts paid by investors above par value

Retained earnings

Accumulated undistributed profits

Accumulated other comprehensive income

Total unrealized gains and losses included in equity

Treasury stock

Repurchased company shares reducing equity

Working capital

Current assets minus current liabilities

Contingencies

Potential obligations dependent on uncertain future events

Accounting policies

Principles and methods used in preparing financial statements

Fair value hierarchy

Three-level classification of inputs used to measure asset and liability values

Level 1 fair value

Observable market prices for identical assets

Level 2 fair value

Market-based inputs using comparable assets

Level 3 fair value

Unobservable inputs based on company assumptions What is the main purpose of financial statements for external users

Why is the income statement prepared over a period of time instead of a single date

Because it measures performance such as revenues and expenses across a time interval

Why is the balance sheet prepared at a specific date

Because it reports the company’s financial position at one exact moment

How does the statement of cash flows differ from the income statement

It tracks actual cash movements rather than accrual-based revenues and expenses

Why is retained earnings important to investors

It shows how much profit has been reinvested instead of distributed as dividends

What is the relationship between revenues expenses and net income

Net income equals revenues minus expenses plus gains minus losses

Why can a company report positive net income but negative cash flow

Because accrual accounting records revenue before cash is received

What does high earnings quality indicate about a company

Reported income closely reflects real sustainable cash-generating ability

Why might managers attempt earnings management

To influence investor perception or meet performance targets

Why are financial disclosures necessary in addition to numbers

To explain assumptions risks and accounting methods behind the statements

Why is gross profit an important profitability measure

It shows how efficiently a company produces and sells its products

What does declining gross profit usually signal

Rising production costs or falling selling prices

Why are operating expenses separated from cost of goods sold

To distinguish production costs from general business costs

What does operating income reveal about a company

Profit generated from core business operations before financing and taxes

Why do analysts focus on operating income instead of net income

Because it excludes non-core and temporary effects

What is the effect of depreciation on net income

It reduces income even though no cash is paid in the current period

Why is depreciation considered a non-cash expense

Because the cash outflow occurred when the asset was purchased earlier

How does amortization differ from depreciation

It applies to intangible assets instead of tangible assets

Why are unusual or extraordinary items disclosed separately

To prevent distortion of normal operating performance

What does earnings per share measure for investors

Profit earned for each common share outstanding

Why is revenue recognition critical to financial reporting accuracy

Because recognizing revenue too early overstates performance

When is revenue generally recognized under accrual accounting

When performance obligations are satisfied and control transfers to the customer

Why does accrual accounting provide better performance measurement than cash accounting

Because it matches revenues with related expenses in the same period

What is the risk of aggressive revenue recognition

Overstated income and misleading financial statements

Why must assets provide probable future economic benefit

Because only resources expected to generate value should be recorded

How do liabilities represent future sacrifice of resources

They are obligations requiring payment or service in the future

Why is equity called residual interest

Because it equals assets minus liabilities

What does strong liquidity indicate about a company

Ability to meet short-term obligations easily

What does strong solvency indicate

Ability to survive long-term and repay debts

Why is historical cost used instead of market value for many assets

Because it is objective verifiable and reliable

What limitation does historical cost create

Book values may differ from current market values

Why are current assets listed before long-term assets

They are expected to convert to cash sooner

What does a high receivables balance potentially indicate

Strong sales or slow customer payments