WGU C214 Financial Managment Topic 2

Accounting

is backward-looking and risk free

Finance

is forward-looking and involes massive uncertainty

Income Statement

- show results of operation over time;

- revenues - expenses = net income

- Think of the income statement as a video camera tracking performance for a period.

- usually regarded as the most difficult to analyze and interpret.

Balance Sheet

- a "snap shot" of a firm's assests & financing at a paticular point in time

- viewed as a still shot of what the firm has at one particular moment.

- Assets= Liabilities + Owner's Equity

Statement of Cash Flows

tracks all cash in and out of the firm

Cash Accounting

cash in =revenue

cash out=expense

Accrual Accounting

- revenues are recognized when the earnings process is complete;

- expenses are "matched" to recongized revenues

Cash-based income

- an informal metric based on cash in & cash out of the firm

- cash-based income is similar to what we call Cash Flow from Operations (i.e., CFO)

Income for tax purposes

based on the government's definition of income, this is the amount of income the government will tax

Accounting income

- the income calculated using accrual accounting (aka, GAAP); best

- most complicated metric for understanding the operations of the firm

= reported on the firm's income statement as net income

On the Income statement

Revenues- Cost of goods sold= Gross profit

- Operating expenses= earning before interest & taxes

- interest expenses, - taxes= Net income

Revenue

- recognized when "earned"

- Management's discretion over revenue recognition is significant.po[

Cost of Goods Sold

direct costs of materials & labor

Gross profit

revenue - cost of goods sold

Operating Expenses

expenses not directly associated with production (office expenses, administrative expenses, depreciation, research & development)

EBIT

Earnings before interest & tax; Gross profit - operating expenses

* also known as operating income

Net Income on balance sheet

EBIT - interest - taxes

Current Assets

cash, marketable securities, A/R, inventory= total current assets

Marketable securities

- short-term, high-quality securities such as US Treasury Bills and certificates of deposit (CDs).

Account receivable (AR)

- balance in AR represents cash not yet collected from customers on goods previously sold

- management should take action to reduce the AR balance.

- To the extent that management does not recognize potentially bad debt, the listed AR balance is deceiving.

Fixed Assests

gross fixed assets- accumulated depreciation = net fixed assets

Gross fixed assets

represent the original cost of the fixed assets currently owned by the firm.

Current Liabilities

A/P, accruals, notes payable

- obligations that require cash in the next year and are usually listed in order of maturity (shortest first).

Accounts Payable (AP)

- money owed to suppliers as a result of purchases made on credit

- opposite of AR

Notes Payable (NP):

involves an explicit interest-bearing arrangement with the lender.

Accrued wages

wages that the company owes to employees, but has not paid yet

Long-term liabilities

debt to be paid in more than 1 year

Equity

= Assets - Liabilities

= Common stock(CS), additional paid-in capital (APIC), retained earnings (RE)

* Value of all common stock issued by the firm = CS + APIC

Gross PP&E

orginal cost of property, plant & equipment

Accumulated depreciation

total of all depreciation claimed against the firms fixed assets

basic equation for the balance sheet is:

Equity = Assets - Liabilities

Net PP&E

original cost (Gross PP&E) - accumulated depreciation

Net Income (linking balance sheet & income statement)

= dividends + change in retained earnings

* Retain within the firm and dividends

* There are only two things a company can do with its net income: 1) pay it out as dividends to shareholders, or 2) retain it within the firm.

New Retained earnings

= old retained earnings + change in retained earnings or

= old retained earnings + net income - dividends

* represent the accumulated net income of the firm less dividends paid.

Q2 - The basic balance sheet equation states that Assets are equal to Liabilities plus Owner's equity. This is because all assets are:

Financed either by other people's money or by the firm's owners' money.

Q-4:The matching principle in accrual accounting requires that:

Revenues are matched to the expenses incurred to generate the revenues

Q-6: The evolution of retained earnings is best described by:

Change in retained earnings= net income - dividends

Net fixed assets represents:

The original cost of the firm's assets held for use less accumulated depreciation

Q-8 A firm can use retained earnings to pay bills

False

q-10: Tax expense as shown on the income statement is the amount of cash the firm paid to the taxing authority during the period.

False; Income tax expense (aka provision for taxes) is rarely the actual amount of tax paid during the period. The tax provision on the income statement is calculated as if the tax code is identical to financial accounting standards. In reality, the tax code differs in many ways from financial accounting. Hence, the actual tax liability can be higher or lower than the reported income tax expense

Q11: Accrual accounting recognizes:

Revenues when the earnings process is complete and matches expenses to revenues recognized.

Q12: An income statement always provides an accurate measure of a firm's cash flows.

false. The income statement may help you understand firm operations, but net income does not necessary show cash to the company.

Q13: Retained earnings represents:

The cumulative amount of the firm's earnings not distributed to shareholders.

The firm can only do two things with net income - pay dividends or retain in the firm. The retained earnings balance represents the cumulative total of earnings retained (i.e., not paid as dividends) over the entire history of the firm.

Q16: A firm reported retained earnings of $305 in 20x2. For 20x3, the firm reports retained earnings of $400 and pays dividends of $25. What was net income in 20x3?

Solution: New RE = Old RE + NI - Div; 400 = 305 + NI - 25; NI = 120

Q19: the use of the historial cost principle on the balance sheet means:

That most assets are stated at the original cost less depreciation