Accounting
the recording of the day-to-day financial activities of a company and the organization of that information into summary reports used to evaluate the company’s financial status
Bookkeeping
the preservation of a systematic, quantitative record of an activity
accounting system
used by a business to handle routine bookkeeping tasks and to structure the information so it can be used to evaluate the performance and financial status of the business
Accounting information
Info that is intended to be useful in making decisions about the future.
The balance sheet, the income statement, and the statement of cashflows
What are the three primary financial statements?
External Users
Who is financial accounting information primarily prepared for and used by?
Managerial Accounting
the name given to accounting systems designed for internal users
Balance Sheet
Reports a company’s assets, liabilities, and owners’ equity
Income Statement
reports the amount of net income earned by a company during a period
Net income
the excess of a company’s revenues over its expenses
statement of cash flows
reports the amount of cash collected and paid out by a company in the following three types of activities: operating, investing, and financing
FASB
Which private body establishes accounting rules in the U.S.?
Financial Accounting Standards Board (FASB)
a private body established and supported by the joint efforts of the U.S. business community, financial analysts, and practicing accountants
The Securities and Exchange Commission (SEC)
the organization that regulates U.S. stock exchanges and seeks to create a fair information environment in which investors can buy and sell stocks without fear that companies are hiding or manipulating financial data
American Institute of Certified Public Accountants (AICPA)
the professional organization of certified public accountants (CPAs) in the United States
Public Company Accounting Oversight Board (PCAOB)
the organization that inspects the audit practices of registered audit firms and has statutory authority to investigate questionable audit practices and to impose sanctions such as barring an audit firm from auditing SEC-registered companies
Internal Revenue Service (IRS)
Gov’t agency that establishes rules to define exactly when income should be taxed. It has no role in setting financial accounting rules; and a company’s financial statements are not used in determining how much tax the company must pay
The International Accounting Standards Board (IASB)
Organization that was formed to develop a common set of worldwide accounting standards. Its standards are increasingly accepted worldwide, but FASB rules are still the standard in the United States.
- Rapid Advancements in the IT field
- the international integration of worldwide business
- Increased scrutiny associated with large corporate accounting scandals
Which 3 factors have combined to make right now a time of significant change in accounting?
Sarbanes-Oxley Act
A wave of accounting scandals starting in 2001 resulted in this act, which increases U.S. federal government scrutiny of the production of financial statements.
Balance Sheet
reports a company’s financial position at a specified point in time and lists the company’s resources (assets), obligations (liabilities), and net ownership interest (owners’ equity).
Assets
probable future economic benefits obtained or controlled by a company as a result of past transactions or events
Liabilities
probable future sacrifices of economic benefits arising from present obligations of a company to transfer assets or provide services in the future as a result of past transactions or events
Owners’ equity
the residual interest in the assets of a company that remains after deducting its liabilities
Assets = Liabilities + Owners’ Equity
What is the accounting equation?
By order of liquidity
In what order are assets typically listed on the balance sheet?
Current and Long-term
Liabilities are divided into which 2 categories on the balance sheet?
states that the financial results of an economic entity should be reported separately from the financial results of other entities, even though all those entities may be controlled by the same person
What is the entity concept?
(revenues-expense= net income)
Equation to calculate net income
When work has been done and collectability of cash can be reasonably assured
According to accounting rules, when should revenue be recognized?
Operating activities
those activities that comprise the day-to-day operations of a business.
Investing activities
The purchase and sale of long-term assets such as land and equipment are known as ___.
Financing activities
those activities through which cash is obtained from, or repaid to, creditors and investors
information on the accounting assumptions used in preparing the statements and supplemental information not included in the statements themselves
What information do the notes to accounting statements provide?
- Summary of accounting policy
- Additional info about summary totals
- Disclosure of info not included in summary
- Supplemental disclosure required by FASB or SEC
What are the 4 general types of accounting notes?
Conservatism
the practice of recognizing all losses but not recognizing gains until they are certain
Materiality
the concept that weighs whether a certain dollar amount is large enough to make a difference to anyone
Articulation
the idea that the three primary financial statements are interrelated
Debt Ratio
Total Liabilities/
Total Assets
Percentage of funds needed to purchase assets that were obtained through borrowing
Current Ratio
Current Assets/
Current Liabilities
Measure of liquidity; number of times current assets could cover current liabilities
Return on Sales Ratio
Net Income/
Sales
Number of pennies earned during the year on each dollar of sales
Asset Turnover
Sales/
Total Assets
Number of dollars of sales during the year generated by each dollar of assets
Return on Equity
Net Income/
Stockholder’s Equity
Number of pennies earned during the year on each dollar invested
Price-earnings Ratio
Market Value of Shares/
Net Income
Amount investors are willing to pay for each dollar of earnings; indication of growth potential
1) to predict a company’s future profitability and cash flows
2) to identify and improve potential problem areas
What are the two main purposes of financial statement analysis?
financial ratios
relationships between two financial statement numbers and are often used in analyzing and describing a company’s performance
financial docs that allow comparison of financial statements across years and between companies and are prepared by dividing all financial statement numbers by sales for the year
Common-size financial statements
Return on sales is computed as net income divided by sales
In terms of ROE, define profitability.
Asset turnover is computed as sales divided by assets and is interpreted as the number of dollars in sales generated by each dollar of assets
In terms of ROE, define efficiency.
Assets-to-equity ratio is computed as assets divided by equity and is interpreted as the number of dollars of assets a company is able to acquire using each dollar invested by stockholders
In terms of ROE, define leverage.
the profitability of each dollar in sales and turnover is the degree to which assets are used to generate sales
Margin
NOTE: Companies with a low margin can still earn an acceptable level of return on assets if they have a high turnover.
current asset
an asset that is expected to be used within one year of the balance sheet date
cash, accounts receivable, and inventory
What are the most common current assets?
Property, plant, and equipment (PPE)
What are the primary long-term assets?
companies report the intangibles that they have purchased from other companies but not the intangibles that they have developed themselves
Which intangible assets are reported on the balance sheet?
current liability
those obligations that are expected to be paid or otherwise satisfied within one year
long-term bank loans, mortgages, and bonds
What are 3 common sources of long-term debt?
Common stockholders are the true owners of a business; Preferred stockholders give up some of the rights of ownership enjoyed by common stockholders in exchange for some of the safety promised to creditors
What is the difference between a common stockholder and a preferred stockholder?
Retained Earnings
the cumulative amount of corporate profits that have been retained within the business rather than being paid out to stockholders as dividends
treasury stock
the amount the corporation has spent to buy back its own shares from stockholders
2 years, Comparative side-by-side format
How many years worth of balance sheets does a company usually provide and how are they typically formatted?
Cash
What is the first item that is usually listed on a U.S. balance sheet?
Long-term assets
What is the first item that is usually listed on a non-U.S. balance sheet?
working capital
The difference of current assets-current liabilities
Recognition (In terms of accounting)
the process of condensing all estimates and judgments into one number and reporting that one number in the formal financial statements
disclosure
An alternative way to report information, describing details in a narrative note
Transaction Analysis
is the process of determining how an economic event impacts financial statements
Asset Mix
the proportion of total assets in each asset category that is largely determined by the industry in which the company operates
Income from Continuing Operations
What is the best measure of sustainable profitability?
Gross Profit
the difference between the selling price of a product and the cost of the product
Operating Income
gross profit minus all other expenses except for interest and taxes; measures the performance of the fundamental business operations conducted by a company
Income from Continuing Operations
operating income minus interest expense, minus income tax expense, and plus or minus other miscellaneous revenue and expense items, and gains and losses from peripheral transactions and events
Net Income
income from continuing operations plus or minus the results of discontinued operations and extraordinary items, net of their respective income tax effects
Comprehensive Income
net income plus or minus adjustments for changes in company wealth stemming from changes in certain exchange rates, interest rates, or financial instruments’ values
Gains, Losses, Revenues, and Expenses
What are the 4 primary item categories listed on the income statement?
selling goods, providing services, Earning interest by providing loans
What are some common business activities that generate revenue?
cost of goods sold; selling, general, and administrative expense, depreciation expense, income tax expense, and interest expense
What are the key expense items commonly found on the income statement?
External
Do gains/losses reported on the income statement arise from internal or external activities?
Income from discontinued operations and extraordinary items
Which items are considered “below-the-line” items?
Earnings per Share (EPS)
the amount of net income associated with each share of stock
When value has been delivered to customers (typically only after the required work has been performed and after the collection of cash is reasonably assured)
When should revenue be recognized on an income statement?
matching
the concept that states that an expense should be recognized in the same period in which the revenue it was used to generate is recognized
- Prepare 2. Analyze 3. Gather 4. Make decisions 5. Implement 6. Observe.
Accounting steps.
Inside, Internal
Managerial info is inside or outside the business?
True. Financial accounting is only outside. Managerial accounting can be inside AND outside.
True or false, managerial accounting uses BOTH managerial and financial accounting?
Outside, External, includes lenders and investors
Financial is inside or outside the business?
Balance sheet, income statement, and statement of cash flows
The financial statement includes what 3 documents
Balance Sheet
Point in time, Assets (resources) and liabilities (obligations)
Income Statement
Period of time (usually 1 year), amount of profit made
Statement of Cash flows
Period of time, where money came from, and where it went. Inflow and outflow of cash (Cash Flows). Change in money for the period.
Balance sheet equation
Assets= liabilities + equity
Revenue equation
Net income=Revenue – Expenses
Operating, investing, and financial activities
The statement of cash flows includes what three activities
FASB: Financial accounting standards. Private, no government involvement. It is a public process, includes individuals experienced in business and accounting (7 members).
The decision makers in the U.S. (accounting rules)
GAAP: General accepted accounting principles
Developed by accounting rule makers. No Legal authority.
comparability
We need accounting rules for…
SEC: Security and exchange commission. Located in Article 1, Sec 8, Clause 3
U.S. gov agency responsible for ensuring that investors, creditors, and other financial statement users are provided with reliable information. It watches behavior in financial markets.
Registration statements (prospectus), Form 10-K, Form 10-Q, and schedule 14A (proxy statement). These are all publicly viewable.
What forms do the SEC regulate?
Oversees stock exchanges, can suspend a company, investigate and suspect violations of the SEC rules.
What does the SEC do?
YES. The SEC has legal authority to establish accounting rules and disclosure requirements.
Does the SEC have legal authority?
USA congress->SEC->FASB
Financial accounting rule per the US constitution
FASB: Financial accounting standards board
The SEC created the
GAAP (has no legal authority)
FASB created
AIPCA: American INSTITUTE of certified public accountants.
What sets auditory standards, continue education credits, CPA exam, and is the code of professional conduct?
Only CPA’s: Certified public accountants.
Who is the only person who can sign audit reports?
PCAOB: Public company accounting oversight board.
The Sarbanes-Oxley Act “SOX” created?
Under supervision of the SEC.
PCAOB is under supervision of?
PCAOB: Public Company Accounting OVERSIGHT Board.
Who appoints members, approves actions, gov standards, inspections, and investigations? It is a private group and OVERSEES. AUDITORS?
U.S. Gov agency that collects and regulates income taxes. Their primary goal is to collect revenue.
IRS
Economic income and accounting income books. & Tax income, and cash flow books.
There are two sets of books. Tax Books and Financial accounting books.
Similar to the FASB, but not 100% the same. It is international, everywhere but the U.S.
IASB: Internatonal Accounting Standard Board
Who enforces and national policies.
Barriers to international convergence are?
Condorsement
Rules set centrally, but legally adopted and enforced locally?
The SEC, SOX, and PCAOB.
To increase government regulation, one would use:
Reduce uncertainty and allows lenders and investors to target their financing and investing to the level of risk they are willing to take.
Financial statements
Adudit
A financial statement that furthermore decreases uncertainty.
Income Statement
Provides accountants the best attempt at measuring the economic performance of a company.
Balance sheet
Mother of all financial statements.
Accounting equation
Assets=liabilities+equity
Assets (resoures)
Resources owned or controlled by a company that will provide probable future economic benefit.
Liabilities (obligations)
Obligations that require the probable future sacrifice of economic benefits in the form of the transfer of assets or the providing of services.
Equity
Investment amount in the business PLUS how much profit they have left in the business. L-A=E
1 paid in capital, 2 retained earnings, 3 treasure stock, 4 accumulated other comprehensive income.
Owners Equity
PIC: Paid in capital
The amount originally paid in exchange for share of stock
Retained earnings
CUMMULATIVE earnings that have been retained in the business
Treasury stock
Company buys back its own shares of stock, shown as a subtraction from equity.
AOCI: Accumulated other comprehensive income.Market related gains and losses that are not included on the income statement.
MARKET EVENTS that result in an increase or decrease in equity are:
Classified balance sheet
Breaking items down into current and long term results (current=with in one year)
Entity Concept
small and large businesses
International Property rules
What allows property, plant, and equipment (PPE) to be reported at CURRENT APPRISED VALUE rather than historical cost?
NO
Are assets recorded at liquidity prices?
Revenue, expenses, and net income.
The income statement contains what three things?
Income statement equation
Revenue-Expenses=Net Income
Revenue (gains)
Amount of assets created from the sale of goods or services. Also, REVENUE CAN BE GENERATED BY SATISFYING LIABILITIES. One SOURCE of an asset.
Expenses (losses)
Amnt of ASSETS CONSUMED in generating revenues. Expenses are also used when liabilities are created in generating revenues. one USE of an asset. It is ONE way to create a liability.
NEVER. Divedends are not expenses.
Are Dividends located on the income statement?
Net income
Overall measure of a companies economic performance during a period of time.
Never
Are revenues assets?
Never
Are expenses liabilities?
Earnings per share (EPS)
Net income / outstanding number of share stock.
Revenue recognition
Recognize revenue when value has been delivered to the customers. Not before or after.
Operating, investing, and financing activities
Statement of cash flows. Inflow of cash comes from what three activities.
Operating activities
Things that a business does every day hundreds of times
Investing activities
NOT investing in stock or bonds. It is investing in the productive capacity of the business. Time to time things, not usually daily, Ex: buying, selling long term assets such as buildings, equipment, land.
Financing activities
Obtaining the capital or financing that a business requires to buy needed resources. Time to time things, not every day. Ex: Borrowing, repaying, receiving cash invested by shareholders, and paying dividends.
Summary of significant accounting policies, additional info about summary totals, disclosure of info not recognized, and supplementary info.
Notes to the financial statement:
The SEC
The external audit is enforced by what?
External. But, private companies who want to provide assurance to a banker or new investor may do an external audit too.
Public companies by law have to do what kind of audit?
Become a CPA (certified public accountant), CE, CPA exam, and be completely INDEPENDENT to any company you audit.
To become an external auditor you have to?
General accepted accounting principles (GAAP), and General accured auditory standards (GAAS). Certifies that the companies information is not misleading.
An audit certifies what two things?
NO. An audit does NOT certify that a company is good or not good to invest in. It does certify that a company is following GAAP, and GAAS.
Does an audit ensure that a company is a good investment for a possible investor?
Relevance: FAST, but not precise/certain. Reliability: Can count on it. Slow, carefully verified, precise, historically in the past, this was used most often.
Relevance Vs. Reliability
Comparability
Across time for the same company and across company at same point. Subcategory is consistency.
Conservatism
Telling bad news immediately, wait on good news till you are positive about it. Lenders encourage this.
Materiality
size of the thing that makes a difference and could impact decisions. Important to auditors. If an item is material, it equals or exceeds 2% of the sales, or 5% of owners equity, or 10% of net income.
Never
Does materiality replace accounting judgment?
Articulation
Details. All three financial statements are not isolated but rather an integrated set of reports on a companies financial status.
Statement of cash flows.
What contains detailed explanation of why the balance sheet cash amount changed form beginning to end of the year?
Income statement, combined with amount of dividends declared during the year.
This explains the change of retained earnings shown on the balance sheet.
The accounting adjustments applied to the raw cash flow date.
cash from operations on the statement of cash flows is transformed into net income through?
Diagnos existing problems and to foreceast how a company will perform it he future.
Analysis of financial statement of numbers can be used to do what?
Financial ratios
This ratio is the relationships between two financial statement numbers and is often used in analyzing and describing a companies performance
Common size financial statement (subcategory of financial ratios)
This allows comparison of financial statements across years and between companies. They are prepared by dividing all financial staement numbers by the sales for the year.
The Dupont Framework
Decomposes return on equity into profitability, efficiency, and leverage components.
Cash flow ratios
Frequently overlooked bc of traditional analysis models are based on the balance sheet and the income statement.
Financial statement analysis
The examination of RELATIONSHIPS among financial statements numbers over time for the same company and compared to other companies in the same industry. External users use this for investing decisions.
Equation for common size financial statements
Dividing all financial statement numbers by the total sales for the year.
Liquidity
ability of a company to pay it’s debt in the short run
The 6 most widely used financial ratios
Debt ratio, return on sales, return on equity, current ratio, asset turnover, and price earnings ratio
Amount to buy the company
What is market value of equity?
Debt ratio
Total liabilities/total assets. It is a measure of leverage.
Current ratio
Current assets/current liabilities. Measure of liquidity. Calculated using the balance sheet.
Return on sales
Net income/sales. A measure of the amount of profit per dollar of sales. PROFITABILITY.
Asset Turnover
Sales/total assets. A measure of a companies efficiency. This number can be understated and can be misleading. IT is the number of dollars in sales generated by each dollar of asset.
Return on equity (ROE)
Net income/Stockholder equity. A measure of the amount of profit earned per dollar of investment.
Mother of all financial ratios. if you are an investor, you want to know the ROE, the number tells you as the investor how much money you will make per year.
ROE
Price earning ratio
Market value of shares/net income. A measure of growth potential earnings stability, and management capabilities.
Price earnings ratio
Reflects market expectations of growth and earnings of the company in the future. Company with P/E ratio of 10-25 is normal. Netflix was 679 in 2012!
Common size financial statement
Solution to comparing two companies that are not the same size. DIVIDE ALL NUMBERS BY SALES FOR THE YEAR.
Common size balance sheet
Divide balance sheet items by either sales or assets. For EFFICENCY.
Sale
How efficiently are assets generating sales dollars. EFFICIENCY. Sales revenue.
Assets mix
the proportion of assets in each asset category.
Common size income statement
Each item on the statement is expressed as a % of revenue
Ratio Framework, 1st step.
Dupont framework-used to examine financially statements of any company
Assets-to-equity ratio
The number of dollars of assets acquired for each dollar invested by stockholders. LEVERAGE. Assets/equity
Profitability, efficiency, and leverage
3 ways to improve low return on equity
Profitability ratios
Common size income statement
Efficiency ratios
Average collection period, days of sales inventory, fixed asset turnover are:
Leverage ratio
Debt ratios, debt to equity ratios times interest earned.
Average collection period
Average number of days that elapse between the sale and cash collection. AVERAGE ACCOUNTS RECEIVABLE/ AVERAGE DAY OF SALES. Add all up and divide by 2.
Number of days sale in inventory
The average number of days of sales that can be made, using only the supply of inventory at hand
Fixed Asset Turnover
Number of dollars in sales generated by each dollar of assets. Sales/Avg fixed assets. Whole sale numbers. (Land, trucks, equipment, plant).
Leverage ratios
The higher leverage increases return on equity through: more Money borrowing, more assets, more sales, more net income
Debt ratio
The % of total funds, both borrowed and invested, that a company acquires through borrowing.
No, they are two different things, they are not to be compared.
Should you compare debt to debt ratio and debt to equity ratio?
Debt to equity ratio
The number of dollars of borrowing for each dollar of equity investment. Total liabilities/stockholders equity.
Time interest earned
indication of a companies ability to meet interest payments
Cash flow to net income
reflects the extent to which accrual accounting assumptions and adjustments have been included in computing net income. Cash flow from operations/net income
Indicates how well a companies cash flow from operations does at covering the company acquisition and fixed asset additions.
Cashflow adequacy ratio
Indicates a companies ability to meet its interest payments and its cash flow from operations. Cash from from operations and cash paid for interest and taxes/ cash paid for interest and taxes.
Cash times interest earned
Inapproproate to compare two companies
Lack of compatibility in accounting numbers make it…
The total of assets in each asset category and is largely determined by the industry in which the company operates.
A companys asset mix
the result of management decisions
Financing Mix
Expected to be used, sold, or replaced with in one year. Ex: Cash, accounts receivable, inventory, prepaid expenses, investment securities.
Current assets
Credit arrangement, OLD sales technology. It is an asset. The amount collected.
Accounts receivable
Expenses paid in advance. NOT an expense, it IS an asset.
Prepaid expenses
Stocks and bonds
investment securities
Trademarks, brand names, copyrights, franchise, Good will (relationships). Recorded ONLY when purchased from another company. NOT recorded on balance sheet.
Intangible assets
Borrow Money (called liability) OR the money can be invested by business owners in various ways (called equity)
Where do you get money to buy assets?
Accounts payable, accured liabilities, short term loans payable, current portion of long term debt, unearned revenue.
Examples of current liabilities
Wages, taxes, utilities, interest.
Accrued liabilities
OBLIGATION to deliver services for which customers have already paid for
Unearned revenue
Common stock, preferred stock, retained earnings, treasury stock
Stock holders equity
Market related gains and losses that are not included on the income statement
AOCI: Accumulated other comprehensive income
Total amount invested to acquire part ownership interest in a corperation
Common and preferred stock
Equipment, accounts recievable, prepaid expenses. NOT ACCOUNTS PAYABLE.
Assets
Notes payable
Liabilities
how close is something to cash.
Liquidity
balance sheet
First thing listed on this document is cash. this document goes in order of liquidity
If it satisfies the definition of an asset or a liability, and is measurable, reliable, and quantifiable
An item can ONLY be reported on the balance sheet if…
Recognition
Summarizes the complexity of an event in ONE single number.
Disclosure
Not included in the financial statment
Fair value
Price that would be received from selling an asset in an orderly transaction.
Dividing each asset item on the balance sheet by the total assets.
Asset mix is determined by
the companies industry
A companies asset mix is highly influenced by:
The degree to which a company finances assets using liabilities or owners equity
Financing mix measures
Income from continuing operations
The best measure of a companies sustainability
Expenses (losses) and Revenues (gains)
Primary categories of income statement items
when value has been delivered to a customer, which is typically only after the required work has been performed and after the collection of cash is reasonably assured
Revenue should be recognized when:
Increase in dollar amount of equity (excluding effects of new investments or investment withdraws). Ex: bought for 200,000, sold for 220,000-gain of 20,000.
Financial capital maintenance
Increase in physical resources, productive capacity (excluding effects of new investments or investment withdrawals). The previous example, that 20,000 had to be used to buy the next house, so therefore, no income.
Physical capital maintenance
Gross profit, operating income, income from continuing operations, net income, comprehensive income.
Practical measure of income
Sales-Cost of goods sold=GP
Gross Profit (where the income statement starts)
Gross profit-operating expenses/all expenses EXCEPT interest/income tax=operating income
Operating income
It is the “pie” eaten by lenders (interest), Government (income tax), and owners (net income).
Operating income
Operating EBIT income (interest expenses +/- miscellaneous revenues, expenses, gains, losses (income tax expenses).
Income from continuing operations
The value of the goods or services provided TO CUSTOMERS as part of normal business operations. *The amnt generated through normal operations. SALES, SERVICES, INTEREST, and other revenues.
Revenues
Value of resources consumed in generating revenues. The amount of assets consumed through normal operations
Expenses
PROBABLE future economic benefit
Assets
POSSIBLE future economic benefit
Expenses
Bad debt expense
Sell on credit to increase sales, cost of selling on credit is not paying.
Keeps 3 books. 1. Financial reporting, 2. income tax reporting, 3. Internal managerial accounting system.
Income tax expenses
Decrease in the recorded amount of an asset bc it has declined in value.
Impairment losses
Impairment losses and estimated severance costs.
Restructuring charge
“the line” is income from continuing operations. Reported “net of taxes”
Below the line items
Market related gains and losses that are NOT included on the income statement
OIC: Other comprehensive income
Always at the bottom of the income statement. Net income/outstanding number of shares of stock
EPS: Earnings per share
EPS Basic
Net income/shares outstanding
EPS Diluted
Net income/actual and potential shares
Single Step=All revenue-All expenses=net income
Format of income statement
Cost of goods sold
Gross profit
Highlights important measures, same net outcome.
Multiple step format
Income from discontinued operations and extraordinary items
below the line items
point of sale
Revenue is recognized at the:
Sales forecast
Pro Forma
generating a realistic and reliable sales forecast
What is the most difficult part of creating a pro forma?
Forecasting cash receipts
What is the first step in developing a cash budget?
Allows a company to anticipate financing needs
What is the benefit of a cash budget for a company
Operating. Investing. Financing.
O.I.F.
Provides info that is not apparent by looking at the balance sheet or income statement
Statement of cash flows
When net income does not give an accurate reflection of a companies performance
Operating cash flow is particularly useful when
Reports cash inflow and outflow during the period with an emphasis on the amount of cash GENERATED BY OPERATIONS
Purpose of statement of cash flows
More retained earnings
More revenue=
Less retained earnings
More expenses=
Less retained earnings
More dividends=
The amount of assets consumed or liabilities created through doing business. Expenses = decrease $
Expenses
Amount of cash generated or liabilities satisfied through doing business. Revenues = increase $
Revenues
an operating cost. Ex: Collection on account, paid for investors, paid investor on debt, paid miscellaneous expense, paid income tax…these are operating, NOT financial as one would assume
By definition, anything that is an expense is…
Six steps. 1. Compute change in cash balance. 2. Convert income statement form accrual to cash. 3. Analyze changes in long term assets, INVESTING. 4. Analyze phage in debt and equity, FINANCING. 5. Reconcile to the computed change cash, then prepare a Formal statement of cash flows. 6. Disclose non cash items.
Deductive reasoning is a how many step process? what are the steps?
Yes, because it is a non cash item
If you deduct $(500.00) due to depreciation of an item o the income statement, do you add that $500.00 back?
Increase in cash
Decrease in accounts receivable=increase or decrease in cash?
Increase in cash
Decrease in investing= increase or decrease in cash?
Decrease in cash
decrease in accounts payable= increase or decrease in cash
Increase in cash, because you kept your cash, you didn’t pay your interest.
Increase in interest payable=increase or decrease in cash
Increase in cash, bc you didn’t pay, you kept your cash
Increase in income tax payable=decrease or increase in cash?
Start with net income and show the adjustments
Cash flow indirect method=
Show the line by line cash flows
Cash flow direct method=
SUBTRACT (uses cash)
If current assets are up you
ADD (preserves cash)
If current assets are down you
ADD
If current liabilities are up you
Subtract
if current liabilities are down you
You subtract, this uses cash
If inventory goes up…
You add, saves cash
If accounts payable goes up…
Increase in net income and decrease in dividends
What causes retained earnings to change
Beginning retained earnings + net income – dividends= ending retained earnings
Retained earnings equation
Cash paid for interest and cash paid for interest in taxes
What requires a disclosure?
Misappropriation of assets (stealing) and fraudulent financial reporting (lying)
What are the two types of fraud?
Unintentional error, disagreement in judgment and or fraud
Inaccurate financial reports can result from:
PCAOB, it increased auditor rules, made senior executives take personal responsibility and sign reports, enhance financial disclosures, increase penalty for white collar crime.
The sarbane-oxley act created? What did this do?
The strategic choice of accounting estimates and judgments in orders to meet pre determined financial statement targets
Earnings management:
To meet internal targets, meet external expectations, income smoothing, and window dressing for an initial public offering (IPO) or a loan
Managers manage earnings to
Registration statment, form 10-k, 10-Q, and 8k
Required filings for when auditors audit
Summary data, outside company for ppl who are making occasional decisions
Financial accounting
Detailed, for inside company, making daily decisions, it is a COMPETITIVE Tool. 1. Plan. 2. Control. 3. Evaluate.
Management accounting
Proprietary (secret), strategic and capital budgeting
Long run planning
Production and process prioritizing, operational budget (profit planning)
Short run planning
Measuring ACTUAL performance. Assess importance of VARIANCE (differences )
Controlling
Analyze results, provide feedback, reward performance, identify problems
Evaluating
Capital budgeting
Determining the best use of financial resources is:
Aspects of management accounting that deal with issues as what additional major resources (PPE) are needed to meet a companies long run goals
Capital Budgeting
Preparing operational budgets
Short run planning involves:
“Break even analysis”
Cost Volume profit analysis (CVP)
Costs that increase the more you make sell
Variable costs
Costs that stay the same the more you make or sell
Fixed costs
Incurred INSIDE the production facility, ex: rent, product to make the inventory, direct labor, manufacturing overhead.
Product cost (material)
Incurred OUTSIDE the productive facility, ex:marketing cost, CEO payroll, interest.
Period cost
Direct and indirect costs, differential and sunk costs, out of pocket and opportunity cost
Decision making includes what kind of costs
Provides/establishes professional standards for accountants INSIDE a company. Requires CMA certification
Institute of management accountants (IMA)
It is also a competitive tool just like good management accounting
Product costing
Focused on overhead only (not materials or labor), trying to find better ways to assign overhead
Activity based costing (ABC)
- Identify overhead cost. 2. Analyze individual overhead costs in terms of cost activities COST POOLS. 3. Identify measurable cost drivers (numerical # such as gallons). 4. Assign overhead. 5. Use the ABC date to make decisions
5 steps in the activity based costing (ABC)
ACTIVITIES consume overhead costs
ABC system assumes that:
PRODUCTS consume overhead costs
Traditional product costing systems assume that:
Operating, producing, servicing, keeping factory open
Things that cause overhead cost=
Is an activity that affects a particular cost. It is a numerical measure that reflects the amount of an overhead cost caused by a particular activity.
Cost Driver:
cost drivers
A More accurate allocation of manufacturing overhead and product costing can take place when costs are assigned on the basis of:
No cost driver should be selected, the cost should be treated as common cost
If a cost activity has no production related cost drivers =
Motivates correct behavior and reflects economic reality
Good management accounting ABC=
It would consume the highest amount of overhead cost per unit
A low volume unique product would consume low or high overhead costs?
How much is needed to be sold to break even
Cost Volume Profit Analysis (C-V-P) most fundamental question is?
Controlling decisions, evaluating decisions, and planning
CVP is useful to managers in
PLANNING
CVP is primarily useful in:
Mixed and variable costs, sales, revenue, and the # of product sold
C-V-P key factors
Fixed and variable components. The mixed costs must be separated into their fixed and variable costs in order to do the CVP
Mixed costs:
- Invoice by invoice, detail categorization. 2. Scattergraph method, a visual approach. 3. high-low method, a computational approach.
3 approaches to do the CVP:
Regression line=straight line that best fits amon all of the data points
On the scattergraph (which is a historical method/approach) what does regression line mean?
Slope of total cost line
Scattergraph variable cost/hr=
The y-intercept for the total cost line
Scattergraph fixed cost=
rise/run ($/hr) Increase in cost, increase in activity.
Slope=
Total cost
Variable cost + fixed cost =
Fixed cost. on the graph, fixed cost is located at the horizontal point (x-axis) of zero units, and the vertical axis (y-axis) start of the line.
Total cost – variable =
both high and low and scattergraph.
Common method of analyzing mixed costs
Constant
Fixed cost increased, decreased, or is constant as the number of units sold increases?
Decrease (cost less to make mass amounts)
Fixed costs increase or decrease as the number of units increase?
Will provide a profit if fixed costs are lowered. It contributes to making the fixed costs
Contribution margin
contribution margin
Sales-variable costs
Contribution margin-total fixed cost
net income=
Shows total profit (not total revenue and cost) y-axis= money, x-axis= level of actions. Profit is plotted at 2 points.
Profit graph
Stepped costs
Costs that would not be graphed on a straight line=
Proportion of sales revenue represented by each of a companies products
Sales Mix
contribution margin
Change in sales mix can affect profit because not all products have the same…
contribution margin ratios
Managers should put greater emphasis on the sales of a product with higher…
Increase advertising of the product
A multi product firm can do what to promote a high contribution margin of a product?
the more money a company looses
The higher the operating leverage…
Decreases fixed cost and increases variable costs
conservative cost structure=
Fixed and variable costs
Operating leverage=
Have larger losses below the breakeven point
A Company with high operating leverage will
A measure of rise
Operating leverage is=
Accounts receivable
Money owed to the company for goods and services (this will be a subtraction -, b/c people owe it to you, but you do not have it).
Accounts payable
Money the company owes to pay its creditors. (this will be an addition +, b/c you owe this amount, but still have it)
asset (capital equipment).
When a company purchases equipment, it exchanges one asset (cash) for another…
Means that the company is running its operations efficiently and responsibly managing its investing and financing activities. Also may reflect that the management is getting lazy about investing in the company.
Cash flow statement shows a net increase in cash:
May be concurrent with a major investment in the companies future growth. May indicate problems with the companies operating, investing or financing activities.
Cash flow statement shows a net decrease in cash:
They go in the equity section of the balance sheet. IT IS WHAT YOU OWN.
What section do retained earnings go on the balance sheet?
Revenue and expenses. Revenue=sales (cash coming in through operations). Expenses=Cash spent to generate sales. Revenue-Expenses=Profit.
Income statement are transactions regarding?
Owners equity section on balance sheet
What section does profit (rev-expenses=profit) go in on the balance sheet?
Sales, cost of sales, gross profit (sales-cost of sales), expenses, profit.
Income statement structure=
Retained earnings, paid in capital, preferred stock, common stock
Shareholders equity=
Dividends (money given to share holders-distributions of equity into hands of shareholders)
What reduces retained earnings?
Companies raise money through the sale of debt (bonds or acquiring bank loans) and equity (stock). Companies pay off debt and distribute dividends to shareholders which decreases cash.
The financing activities in statement of cash flows (includes investing, operating, and financing) what are some ways that increase cash? What decreases cash?
Indirect method. The Direct method is organized into the 3 activities. (operating, investing, financing). Both methods start and end with the same numbers. (Most companies use indirect method).
In calculating statement of cash flows, does the indirect or direct method use the balance sheet to arrive at the change in cash?
income (money) coming in. Disbursement is money going out
Receipts =
Assets up=Cash down. Liabilities up=Cash up
On the statement of cash flows, if Assets go up, cash goes?
If Liabilities go up, cash goes?
It is a subtraction from net income on the cash flow statement. If the change is a decrease, it is an addition to net income.
If the change of an asset on the balance sheet from last year to this year increases:
It is an addition from net income on the cash flow statement. If the change is a decrease, it is a subtraction to net income on the cash flow statement.
If the change of a liability the balance sheet form last year to this year increases:
Subtract the increase
Account: Current Asset. Direction of change: Increase. Necessary adjustment:…
Add the decrease
Account: Current Asset. Direction of change: Decrease. Necessary adjustment:…
Add the increase
Account: current liability. Direction of change: increase. Necessary adjustment:…
Subtract the decrease
Account: Current Liability. Direction of change: decrease. Necessary adjustment:…
Process of determining the cost of a particular object by accumulating many individual costs into a single total cost.
Cost accumulation
Object for which managers need to know the cost; can be products, processes, departments, services, activities, and so on.
Cost Object :
Any factor, usually some measure of activity, that causes cost to be incurrent. Examples are labor hours, machine hours, or some other measure of activity who’s change causes corresponding changes in the cost object.
Cost Driver:
Support multiple objects but cannot be directly traced to any specific object.
Common Cost:
Costs tha can be influenced by a mangers decisions and actions
Controllable costs:
Dividing a total cost into parts and assigning the parts to designated cost object.
Cost Allocation:
Yes, indirect costs (overhead) are lumped together. ex: direct labor, direct materials.
Does traditional costing include both direct and indirect components?
Activity cost pools.
Activity Based Costing ABC utilizes direct costs like traditional costing, but breaks down the overhead costs into pieces called:
YES, used as a planning tool for a manufacturing facility or a product line. it begins on a unit basis, and when volume is applied, describes profitability potential.
Is C-V-P a planning tool?
Total fixed cost = Contribution margin. When the contribution margin is lower than fixed cost you’re loosing money. When the contribution margin is higher than fixed cost you’re making money. When contribution margin is the same as the fixed cost you break even-which is the goal of CVP.
in C-V-P break even point is when what equals what?
The difference between total sales an variable costs; the portion of sales revenue available to cover fixed costs and provide profit.
Contribution Margin:
The extent to which fixed costs replace variable costs as part of a companies cost structure; the higher the proportion of fixed costs to variable costs, the faster income increases or decreases with change in sales volume.
Operating Leverage:
Range of activity over which the definitions of fixed and variable costs are valid
Relevant range:
Accounts payable, accounts receivable, and inventory
Typical cash budgeting accounts that are allocated:
Determining the best use of financial resources is an aspect of:
Capital Budgeting
Providing information for planning, controlling, and evaluating is a function of:
Manegement Accounting
The process of making decisions about future operations is called:
Planning
The aspect of management accounting that deals with such issues as what additional major resources (e.g., plant and equipment) are needed to meet a company’s long-run goals is called:
Capital Budgeting
Short-run planning involves which one of the following processes?
Preparing operational budgets
The only kind of costs that do NOT involve any outlay of cash are:
Opportunity costs
When calculating manufacturing overhead you add:
Indirect materials, indirect labor, factory utilities bill, depreciation of equipment, and taxes. You do not add direct materials or labor, delivery expenses or advertising costs.
Future costs that change as a result of a decision are
Differential costs
What is NOT reported on a financial statement?
Opportunity costs
Costs that are directly traceable to a unit of business or segment being analyzed are called:
Direct costs
The top accountant in most large organizations is usually called the:
Controller
The three Management functions are:
Planning, Controlling, and Evaluating
Long run planning includes:
Capital budgeting and strategic planning
Short run planning includes
Production and process prioritizing, operational budgeting (profit planning)
Uniform across companies (generally accepted accounting principles)
Restricted to financial data
Data often made public
Used primarily by investors and creditors in deciding whether to provide capital to the company
Financial Accounting
Unique competitive tool
Both financial and nonfinancial data
Usually kept secret within the company
Used for internal planning, control, and evaluation
Management Accounting
Costs are all costs incurred that are not closely associated with a specific product or service are? Example are the presidents salary, advertising, and office costs.
Period costs
Costs closely associated with the products or services offered are called? Costs associated with products or services offered. Examples are cost of product, wages of product workers, salary of store manager, and rent on store location.
Product costs:
Direct materials
Direct labor
Manufacturing overhead
Direct materials, direct labor, and manufacturing overhead.
Product costs:
A cost incurred as part of the production process. Operationally, these are the costs incurred in the factory. These costs are first reported as an asset (inventory) and then as an expense (cost of goods sold) when the product is sold.
A cost incurred outside the factory or production facility. These costs are reported as an expense in the period in which they are incurred.
Period costs:
A cost that changes directly with changes in the level of sales or production. Examples are materials costs and sales commissions.
Variable costs
A cost that doesn’t change based on changes in the level of sales or production. Examples are building rent and executive salaries.
Fixed costs
The cost of the primary raw materials used in production. In producing french fries, the direct materials cost is the cost of the potatoes.
Direct materials
The cost of the wages of the workers who are assembling the direct materials into the finished product. In producing an automobile, the direct labor cost is the compensation cost of the auto workers on the assembly line.
Direct labor:
All factory costs that are not direct materials or direct labor. Examples are factory supervisor salaries, factory building depreciation, and miscellaneous indirect materials such as glue or screws.
Manufacturing overhead:
The costs that are created by a particular product or segment that is being analyzed. If a product or segment is dropped, the direct costs created by that product or segment will disappear.
Direct costs:
The costs that are assigned to a particular product or segment but that are not actually caused by that product or segment. If a product or segment is dropped, the indirect costs assigned to that product or segment will remain
Indirect costs:
A future cost that can be changed by a decision made now. An example is monthly rent for an apartment.
Differenital costs:
A past cost that cannot be changed by any decision made now. An example would be last month’s paid rent.
Sunk Costs:
Costs that involve the outlay of cash or the use of some other asset (like equipment).
Out of pocket costs:
The benefits not received because of actions NOT taken. For example, the opportunity cost of going to a basketball game is the increased points that you could have received on the next day’s accounting exam if you had spent that time studying.
Opportunity costs:
Guidance on ethical professional practice to help professionals involved in management accounting processes.
The Institute of Management Accountants (IMA) provides:
The recording of the day-to-day financial activities of a company and the organization of that information into summary reports used to evaluate the company’s financial status.
Accounting is:
The three primary financial statements: the balance sheet, the income statement, and the statement of cash flows.
The focus on accounting is:
lenders, investors, company management, suppliers, customers, employees, competitors, government agencies, politicians, and the press.
Among the users of financial accounting information are
FASB
The practice of accounting involves adherence to duplicate the system throughout the United States. established accounting rules as well as the use of judgment. U.S. accounting rules are established by the:
SEC, the AICPA, the PCAOB, the IRS, and the IASB.
In addition to the FASB, other important accounting-related organizations are the
The three factors are the rapid advance in information technology, the international integration of worldwide business, and the increased scrutiny associated with the large corporate accounting scandals.
Three factors have combined to make right now a time of significant change in accounting.
A system for providing quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions.
Definition of accounting:
Communicating economic information about organizations, Measuring economic information about organizations, Accumulating economic information about organizations.
Functions of accounting:
Businesses use accounting systems to
Analyze transactions ,Handle routine bookkeeping tasks, Evaluate the performance and health of the business.
Which financial statement reports a company’s resources, obligations, and owner’s equity?
Balance sheet
Which financial statement reports the excess of a company’s revenues over its expenses?
Income statement
Which financial statement reports the amount of cash collected and paid out by a company?
Statement of cash flows
According to U.S. law, companies selling stock to the public must provide potential investors with?
Financial statements
The emphasis in financial accounting is on which external user groups?
Investors and creditors
The primary internal group that uses accounting information is
Management
The FASB
It seeks consistency for its proposed standards, It is not a government agency, It consists of seven full-time members, It has no legal power to enforce the standards it sets. Is the current standard-setting board for accounting in the private sector.
Standards established by the International Accounting Standards Board are referred to as the
International financial reporting standards
Which organizations has specific legal authority to establish accounting standards for publicly held companies?
The SEC
What NOT a service typically provided by large public accounting firms?
Making management decision. What is typical is :Redesigning operating procedures, Performing audits, Establishing accounting systems.
Reasons for the integration of worldwide accounting standards?
the need to evaluate investments across the world, the integration of the global economy, the increased efficiency of financial markets.
True or false? The International Accounting Standards Board (IASB) is charged with developing worldwide accounting practices?
TRUE
Increased federal oversight of the audit process resulted from the passage of the following act of Congress:
SOX
For a corporation, owners’ equity is called:
Stockholders equity
Stockholders can invest in a corporation in two ways. First, they can directly invest cash or other assets as paid-in capital. Second, they can allow the corporation to keep a portion of the profits for reinvestment in the business; these profits are called?
Retained Earnings
Revenues are the amount of assets generated in the normal course of business; expenses are the amount of assets consumed in doing business. An income statement also reports gains and losses that result from activities outside a company’s normal business operations. An additional number reported in the income statement is?
Earnings per share, which is the amount of net income divided by the number of shares of stock outstanding.
Financial statement notes are of four general types:
a summary of accounting policies, additional information about summary totals in the statements, disclosure of important information not in the statements, and supplemental disclosure required by the FASB or SEC
Relevant information is information that is:
provided on a timely basis and can be used to assess the past and to project the future for decision making.
Makes financial statement information more useful because it allows a company’s financial statements to be analyzed in light of the company’s own performance in prior years or other companies’ performance.
Comparability:
Is the practice of recognizing all losses but not recognizing gains until they are certain. As a practical matter, accounting conservatism is a counterbalance to the naturally optimistic estimates made by management.
Conservatism:
Refers to the concept that weighs whether a certain dollar amount is large enough to make a difference to anyone. For small amounts, convenient accounting often is preferred over elaborate, theoretically correct treatment.
Materiality:
Is the idea that the three primary financial statements are interrelated
Articulation:
Analysis of financial statement numbers can be used to diagnose existing problems and
To forecast how a company will perform in the future.
Common-size financial statements allows
Comparison of financial statements across years and between companies and are prepared by dividing all financial statement numbers by sales for the year.
The DuPont framework
decomposes return on equity into its profitability, efficiency, and leverage components.
Cash flow ratios are frequently overlooked because
traditional analysis models are based on the balance sheet and the income statement.
Analysis of financial statements can be misleading if statements are not
comparable or if statements exclude significant information. In addition, analysis of historical data may distract one’s attention from relevant current information.
External users of financial statements use financial statement analysis for
investing decisions
Financial statement analysis is greatly enhanced when financial ratios are compared wit
Past values and values of other firms in the same industry
Which ratio is calculated using only balance sheet numbers?
current ratio
The ability a company has to pay its debts in the short run is its
Liquidity
Stock holders equity includes
Common stock, Paid in capital, and retained earnings
A common-size balance sheet is often prepared using total ?
assets to standardize each amount instead of using total sales, in which case the asset percentages are a good indication of the company’s asset mix.
Which generally is the most useful in analyzing companies of different sizes?
Common sized financial statements
In a common-size balance sheet, using the percent of sales method, each item on the balance sheet is typically expressed as a percentage of
Sales revenue
In a common-size income statement, each item on the statement is expressed as a percentage of
Revenue
The Dupont framework include what 3 things
Efficiency, profitability, and leverage
Which cash flow ratio reflects the extent to which accrual accounting adjustments and assumptions have been included in net income?
Cash flow to net income
The particular analytical measures chosen to analyze a company may be influenced by:
Industry type, Diversity of business operations, or capital structure. NOT Product quality or service effectiveness.
Benchmarking problems that arises when analyzing financial statements
Reported financial statement numbers may actually be a measurement of different things,
Companies that are being compared may be conglomerates,
Not all companies use the same accounting practices.
Return on sales. It is interpreted as the number of pennies in profit generated from each dollar of sales.
Profitability
Asset turnover. It is the number of dollars in sales generated by each dollar of assets.
Efficiency
Assets-to-equity ratio. It is the number of dollars of assets a company is able to acquire using each dollar invested by stockholders.
Leverage
A company’s asset mix is:
the proportion of total assets in each asset category and is largely determined by the industry in which the company operates. Financing mix is the result of management decisions.
The total amount invested to acquire an ownership interest in a corporation is called
Common stock and preferred stock
Which of the following types of accounts show how resources came into a firm?
Liabilities and owners equity
What is generally considered to be a liability?
Notes payable
Long term asset:
Land. Short term: Accounts receivable, accounts payable, inventory
Current assets are:
Accounts receivable, inventory, cash. NOT Equipment
Current assets usually are listed on a balance sheet in
Decreasing order if liquidity
This is sometimes done in place of recognition when the effects of an event cannot be quantified with any degree of certainty.
Disclosure
The process of valuation involves computing numbers that are both
Relevant and reliable
The process of determining the dollar value to assign to an item that is to be recognized in the financial statements is called
Valuation
Reporting the details of a transaction in the notes to the financial statements is called
Disclosure
The process of formally recording an item in the accounting records so that it will be reflected in the financial statements is called
Recognition
The process of formally recording an item in the accounting records so that it will be reflected in the financial statements is called
Increase in building and decrease in cash
When an investor pays cash into a business to become a part owner, the effect on the accounting equation for the business will be to
Increase in cash and increase in paid in capital
When a company rents a warehouse by paying for the first six month’s rent in advance, the effect on the accounting equation on the day of payment would be to
Increase in prepaid rend and decrease in cash
When a company buys a warehouse by using a mortgage with a local bank, the effect on the accounting equation for the company will be to
Increase in buildings and increase in mortgage payable
When a company purchases equipment on credit, the effect on the accounting equation will be to
Increase equipment and increase liability
A company’s asset mix is strongly influence by
the companies industry
Financing mix is a measure of:
The degree to which a company finances assets using liabilities or owners’ equity
The concept that income is defined as the excess of net assets at the end of an accounting period over the net assets at the beginning of the accounting period, excluding effect of transactions with owners is called –
Financial capital maintenance
The proper order on an income statement for the various measures of income is –
gross profit, operating income, income from continuing operations, net income, comprehensive income
A measure of a company’s performance that includes all items that are expected to continue into the future is
income from continuing operations
A measure of a company’s performance that is intended to summarize in one number the overall economic performance of a company in a given period is –
Net income
When a company determines to get out of a specific line of business
Revenues and expenses from that line of business are excluded from the company’s recurring revenues and expenses when preparing an income statement.
Under the general rule of revenue recognition, revenue is recognized when
the earnings process is complete, and a valid promise of payment has been received.
When revenue and expense items are arranged to highlight important profit relationships, the resulting income statement format is called a –
Multiple step income statement
True or false:With a single-step income statement all revenues are grouped together, all expenses are grouped together, and net income is computed as the difference between the two.
True
Which principles best describes the rationale for matching administrative and selling expenses with revenues of the current period?
Immediate recognition
Which of the following is NOT an acceptable basis for the recognition of expenses?
Cash Disbursement. What are acceptable: Immediate recognition, Direct matching, Systematic and rational allocation
Which of the following categories of expenses is subject to immediate recognition on the income statement?
The salary of the company president
Most forecasting exercises begin with a forecast of
Sales
If a company anticipates a 40% increase in sales volume, then it is most likely that the company will need about a 40% increase in
Accounts payable
The statement of cash flows provides information that is not readily apparent by looking at just…
he balance sheet and the income statement. Operating cash flow is particularly useful in selected cases when net income does not give an accurate reflection of a company’s performance.
Cash flows are partitioned into three categories —
operating, investing, and financing. In normal circumstances, a company has positive cash from operations and negative cash from investing activities. Whether cash from financing activities is positive or negative typically depends on how fast a company is growing.
When detailed cash flow information is not available, a statement of cash flows can be prepared using:
knowledge of how the three primary financial statements articulate. Operating cash flow can be reported using either the direct or the indirect method.
Purposes of the statement of cash flows?
It highlights changes in managerial strategy regarding investments and finances.
It provides investors with information about the investing and financing activities of an entity.
It provides information about an entity’s cash receipts and payments over a period of time. It does NOT measure profitability.
Significant noncash financing transactions
Should not be disclosed in the body of a statement of cash flows but should appear elsewhere
Those transactions and events that enter into the determination of net income are reported under which section of the statement of cash flows?
Operatig activities
What would be reported as a financing activity on a statement of cash flows?
Purchase of treasury stock
What would be reported as an investing activity on a statement of cash flows?
Extending loans to other entities, Sale of a building, Collection of a long-term note receivable.
Amounts borrowed would NOT be reported as an investing activity.
Calculating operating activities:
Add Accounts receivable, payments for salary/wages, interest revenue, subtract payments for inventory.
Which of the following would be deducted from net income on a statement of cash flows prepared using the indirect method?
A gain from the sale of equipment
Operating.
For purposes of preparing a cash flow statement, operating activities are those activities that enter into the calculation of net income. Net cash provided by operating activities is the “bottom line” of the cash flow statement.
The primary investing activities are the purchase and sale of land, buildings, and equipment.
investing
Financing. Financing activities involve the receipt of cash from, and the repayment of cash to, owners and creditors.
Financing
the purchase of long-term assets in exchange for the issuance of debt or stock.
Non-cash investing and financing transactions include
If a company does NOT record accrued wages expense at the end of the year, how does this affect the year-end financial statements?
Overstates owners equity
Which one of the following errors causes net income to be overstated?
Failure to record depreciation expense
If the total amount for Rent Expense is inadvertently posted to Prepaid Rent at the end of the year, what will be the effect on the year-end financial statements?
Revenues will be correctly stated
If the total amount for Insurance Expense is inadvertently posted to Prepaid Insurance at the end of the year, what will be the effect on the year-end financial statements?
Owners equity will be overstated
To provide accurate accounting records and financial statements. To safeguard assets and records.
To effectively and efficiently run their operations, without duplication of effort or waste. To follow management policies.To comply with the Foreign Corrupt Practices and Sarbanes-Oxley acts, which require companies to maintain proper record-keeping systems and controls.
Most companies have the following five concerns in mind when they are designing internal controls
Most companies think of their assets as including their:
financial assets (such as cash or property), their employees, their confidential information, and their reputation and image.
A company’s internal control structure can be divided into five basic categories
The control environment
Risk assessment
Control activities
Information and communication
Monitoring
Authorizing and approving the execution of transactions; for example, approving the sale of a building or land.
Authorization.
Recording the transactions in the accounting records.
Record keeping.
Having physical possession of or control over the assets involved in transactions, including operational responsibility; for example, having the key to the safe in which cash or investment securities are kept or, more generally, having control over the production function
Custody of assets.
Which are the three functions that should be performed by separate departments or individuals?
Authorization, record keeping, and custody of assets
What the major safeguards in the financial reporting process?
External auditors, Internal auditors, Internal controls.
NOT Earnings management
What are considered components of a company’s control environment
Management’s philosophy and operating style
The organizational structure
The audit committee
Earnings management through deceptive accounting is best exemplified by
Changing the interest rate used in accounting for leases without describing the change in the notes to the financial statements.
items of the earnings management continuum is in the correct order
strategic matching, change in methods or estimates with full disclosure, change in methods or estimates with little or no disclosures, non-GAAP accounting, fictitious transactions
Recording as an asset expenditures that have no future economic benefit is an example o
Non GAAP accounting
Fraud is
Both the deceptive concealment of transactions and the creation of fictitious transactions
Constraints on auditors
Constraints on company management
Independent oversight of auditors
SOX
PCAOB
Conduct inspections of accounting firms, Register all public accounting firms that provide audits for public companies, Establish standards relating to the preparation of audit reports for public companies. Does NOT Enforce compliance with the Foreign Corrupt Practices Act.
According to Sarbanes-Oxley, which services is an accounting firm permitted to provide to its audit client?
Opinions about the reliability of internal controls
What does Sarbanes-Oxley NOT require management to do?
Make loans to executive officers and directors
What does Sarbanes-Oxley require management to do?
Develop and enforce an officer code of ethics, Support a much stronger board and audit committee in each public company, Prepare a statement to accompany the audit report
The Public Company Accounting Oversight Board
Conducts inspections of accounting firms
Which audit processes is used primarily by external auditors and not by internal auditors?
confirmation. Internal auditors use: interviewing, sampling, and observation
What activities would internal auditors NOT typically perform in a large company?
Prepare the primary financial statements. It would typically perform: Detect fraud, Assist with increasing the efficiency of operations, Evaluate internal controls.
What are incentives that influences auditors to remain independent and to provide fair and reliable financial information?
Auditors have a reputation to protect.
Management would be taking a large legal risk if they interfere with the auditors.
External auditors are taking a large legal risk if they allow their independence and integrity to be compromised
Which statement best describes the role of external auditors when auditing a large public company?
Examine the organization’s accounting for a sample of business transactions to provide reasonable assurance that the financial statements are presented fairly
When does the Securities and Exchange Commission (SEC) typically require a company to submit a registration statement to the SEC for approval?
When the company issues new debt or stock securities to the public
The effects that the Securities Exchange Act of 1934 had on accountants?
Accountants must audit all 10-K reports, Accountants’ work is subject to approval by the SEC.
Unintentional mistakes that can enter the accounting system at the transaction and journal entry stage or when journal entries are posted to accounts.
Errors
Intentional misrepresentations in the financial statements
Fraud
Differences in opinion about what numbers should be reported in the financial statements based on different estimates
Disagreements in judgment
The three basic internal control structure categories are
The control environment
The accounting systems
The control procedures
The five types of control procedures are
Segregation of duties
Procedures for authorizations
Documents and records
Physical safeguards
Independent checks
Reasons for earnings management
- Pressure to meet internal earnings targets
- Pressure to meet external expectations
- Smoothing income
- Preparing to apply for a loan or to offer stock to the public
Techniques of earnings management
- Careful timing of transactions
- Changing accounting methods or estimates with full disclosure
- Changing accounting methods or estimates withOUT adequate disclosure
- Non-GAAP accounting
- Fictitious transactions
Public Company Accounting Oversight
register all public accounting firms.
Board (PCAOB)
- Establish auditing standards.
- Inspect public accounting firms.
Constraints on auditors
- Auditors are prohibited from providing nonaudit services to audit clients.
- Audit partners must rotate every five years.
- Auditors must report to the audit committee of the board of directors.
Constraints on management
- The CEO and the CFO must personally certify the reliability of the financial statements.
- Companies must have a code of ethics.
- Loans to company executives are prohibited.
- Audit committees must be strengthened.
Internal auditors
- Evaluate internal controls
- Monitor operating results
- Ensure compliance with laws and company policy
- Detect fraud
External auditors
Gather evidence to be able to certify the fairness of the financial statements through:
- Interviews
- Observation
- Sampling
- Confirmation
- Analytical procedures
The SEC adds credibility to financial statements by
Requiring independent audits
Requiring independent audits
Reviewing financial statements itself
Sanctioning firms that violate its standards
Good management accounting is motivated by:
Management desire to improve
Management accounting
Unique competitive tool, Both financial and non financial data, Data usually kept secret within the company,Used for internal planning, control, and evaluation
Financial accounting
Uniform across companies (generally accepted accounting principles), Restricted to financial data, data is made public,Used primarily by investors and creditors in deciding whether to provide capital to the company.
The allocation of which of the following can cause the greatest errors when computing product costs?
Manufacturing overhead
ABC assume that:
Activities that consume overhead cost
Traditional product costing systems (e.g. job order costing and process costing) usually assume that:
Products consume overhead costs.
5 steps of ABC system
Identify overhead cost activities, analyze individual overhead costs in terms of those cost activities, identify measurable cost drivers, assign overhead, and use the cost data to make decisions
Machine depreciation.
A unit-level item associated with the overhead cost activity “operating the ice cream production process.”
Building depreciation.
A facility support item associated with the overhead cost activity “keeping the factory open.”
Building insurance.
Building insurance. A facility support item associated with the overhead cost activity “keeping the factory open.
Security guards.
Security guards. A facility support item associated with the overhead cost activity “keeping the factory open.”
Unit—
activities that take place each time a unit of product is produced. Examples:• Machine maintenance
- Machine depreciation
- Electricity and other energy cost
Batch
activities that take place in order to support a batch or production run, regardless of the size of the batch. Examples:• Inspections
- Machine setups
- Movement of and accounting for materials
Product line—
activities that take place in order to support a product line, regardless of the number of batches or individual units actually produced. Examples:• Engineering product design
- Storage in special warehouses
- Managment by a special supervisor of all activities associated with a particular product line
- Ordering, purchasing, and receiving materials unique to a particular product line
Facility support—
activities necessary to have a production facility in place. However, these activities are not related to any particular line of products or services. Examples: Property taxes
- Factory insurance
- Security
- Landscaping
- General accounting
- General factory administration
The total cost identified as being generated by a specific overhead cost activity is called the
COST POOL
If activity-based costing is used, property taxes would be classified as a:
Facility support activity
If activity-based costing is used, assembly would be classified as a:
Unit level activity
Tracing overhead costs to activities involves dividing overhead costs into:
Cost pool
A more accurate allocation of manufacturing overhead and product costing can take place when costs are assigned on the basis of:
Cost drivers
The first three steps in implementing an ABC system are:
Identify the key cost activities.
Analyze each overhead cost in terms of these activities in order to compute the cost pools.
Specify numerical cost drivers that can be used to assign the overhead costs to production.
To then assign overhead costs to production, the necessary steps are:
Gather the overhead cost and numerical cost driver data.
Compute the amount of overhead cost per cost driver event.
Use these data to assign overhead to production
If the fixed costs relative to a specific product increase while the variable costs and sales price remain constant, the break-even point will:
Increase
A company’s break-even point would change if there were an increase in:
Total fixed costs due to a plant addition
Total contribution margin will increase in a two-product firm if total units sold remain the same and:
More products with the highest contribution margin are sold
Operating leverage is
a measure of risk
Operating leverage deals primarily with the relationship between:
Fixed costs and variable costs
Maintaining low fixed costs and high variable costs rather than high fixed costs and low variable costs:
Conservative cost structure
As compared to a company with a low operating leverage, a company with a high operating leverage will:
Have a larger loss below the breakeven point