Financial Statements, Cash Flows, and Taxes

Flashcards covering key financial statements, accounting principles, balance sheet identities, cash flow reconciliations, and corporate tax concepts.

What are Generally Accepted Accounting Principles (GAAP), and who establishes them?

GAAP are the accounting rules and standards that public companies must adhere to when preparing financial statements. They are established by the Financial Accounting Standards Board (FASB) and authorized by the Securities and Exchange Commission (SEC).

What is the arm's length transaction assumption in accounting?

It is the assumption that the parties involved in an economic transaction arrive at a decision independently and rationally.

What is the realization principle in accounting?

The realization principle states that revenue is recognized when a transaction is completed, although cash may be received earlier or later.

What is the matching principle in accounting?

The matching principle requires that revenue be matched with the expense incurred to generate that revenue.

What is the basic balance sheet identity?

$$\text{Total assets} = \text{Total liabilities} + \text{Total stockholders' equity}$$

What is the equation for Net Working Capital (NWC)?

$$\text{Net Working Capital} = \text{Total Current Assets} - \text{Total Current Liabilities}$$

How do the FIFO and LIFO inventory accounting methods differ when the cost of inventory is increasing?

When inventory costs rise, FIFO yields a higher inventory balance, a lower cost-of-goods-sold (COGS), and higher net income. LIFO yields a lower inventory balance, a higher COGS, and lower taxable income and net income.

What basic ownership rights are held by common stockholders?

Common stockholders have the right to vote on corporate matters, the preemptive right to purchase additional shares proportionally, the right to receive cash dividends if paid, and the right to corporate assets upon liquidation after all creditors and preferred stockholders.

How does a market-value balance sheet differ from a book-value balance sheet?

A book-value balance sheet reports assets at historical acquisition cost (adjusted for depreciation), whereas a market-value balance sheet records assets and liabilities at their current market values through marking to market.

Based on the balance sheets for Marvel Airlines, why did stockholders' equity fall from $300 million on a book-value basis to $100 million on a market-value basis?

Stockholders' equity fell because the market value of the aircraft fleet dropped from $600 million to $400 million, while long-term debt remained unchanged at $300 million ($400 million - $300 million = $100 million).

What is the basic equation for the income statement?

$$\text{Net income} = \text{Revenues} - \text{Expenses}$$

What are the step-by-step earnings subtotals on an income statement down to net income?

Sales minus cost of goods sold and selling/administrative expenses equals EBITDA; EBITDA minus depreciation and amortization equals EBIT; EBIT minus interest expense equals EBT; and EBT minus taxes equals Net Income.

What is the formula for calculating ending retained earnings on the statement of retained earnings?

$$\text{Ending Retained Earnings} = \text{Beginning Retained Earnings} + \text{Net Income} - \text{Dividends}$$

On the statement of cash flows, how do changes in balance sheet accounts reflect sources and uses of cash?

Sources of cash are represented by decreases in assets or increases in liabilities and equity. Uses of cash are represented by increases in assets or decreases in liabilities and equity.

What three main activity categories comprise the statement of cash flows?

Operating activities, long-term investing activities, and financing activities.

How are the four major financial statements interrelated as shown in Exhibit 3.5?

Net income from the Income Statement flows into both the Statement of Cash Flows and the Statement of Retained Earnings. The Statement of Retained Earnings updates ending Retained Earnings on the Balance Sheet, and the Statement of Cash Flows reconciles the change in Cash on the Balance Sheet.

What is the formula for Cash Flow Available to Investors from Operating Activity (CFOA)?

$$\text{CFOA} = \text{EBIT} - \text{Current taxes} + \text{Non-cash expenses}$$

What is the formula for total Cash Flow to Investors (CFI)?

$$\text{CFI} = \text{CFOA} - \text{CFNWC} - \text{CFLTA}$$

What flat tax rate for C-Corps was introduced by the Tax Cuts and Jobs Act of 2017 starting in 2018?

A single flat tax rate of $21\%$ on taxable income.

What is the difference between average tax rate and marginal tax rate?

The average tax rate is total taxes paid divided by total taxable income for the period. The marginal tax rate is the rate paid on the last dollar earned or the next dollar that will be earned.

Why does debt financing have a lower relative cost than equity financing under U.S. tax law?

Interest payments on debt are tax-deductible (they reduce taxable income), whereas dividend payments to equity holders are not tax-deductible.

What is the going concern assumption?

The assumption that a company will continue to operate for the foreseeable future.

What is treasury stock?

Treasury stock refers to shares of its own stock that a firm holds rather than sells to the public.