Quiz 1 (Midterm) Phillips, Libby & Libby. Fundamental of Financial Accounting.

McGraw-Hill, 6th edition with

ConnectPlus access (online homework module).
Corporations: separate legal entity. Owners of a corporation are the stockholders and not personally liable for debts of the
corporation
Three Business Activities: Financing Activities: get loans and money; Investing Activities: take the money and invest it in land,
buildings, infrastructure, etc; Operating Activities: open the business, sell the goods
Accounting system: recording, summarizing, analysing, and reporting the results of a business’s activities
● Financial Reports: money, have to be consistent and follow set of rules because they are seen by outsiders (stockholders,
bankers, SEC, etc) - evaluate the company for external users
● Managerial Reports: info gathered to run the company (how many people visited the park, how many people will visit, what
is weather report, what happens when it rains, etc) - run the company for internal users
Assets = Liabilities + Stockholders’ equity (resources owned by the company = liabilities to creditors + resources owed to
stockholders) => A=L+SE
● Assets: economic resources presently controlled by the company that have measurable value and are expected to benefit the
company by producing cash inflows or reducing cash outflows in the future (ex: cash, supplies, furniture, equipment)
● If you did not pay for an asset you can’t record it
● Liabilities: measurable amounts that the company owes to creditors (notes payable, accounts payable)
● Stockholders’ Equity: owners’ claims to the business resources
● Common stock: equity paid in by stockholders; Retained earnings: equity earned by the company
Revenues - Expenses = Net Income
● Revenues: sales of goods or services to customers, measured at the amount the business charges the customer
● Expenses: costs of doing business necessary to earn revenues, including wages to employees, advertising, insurance, utilities,
and supplies used in the office
Dividends: distributions of a company’s earnings to its stockholders as a return on their investment
● Common stock: equity paid in by stockholders; Retained earnings: equity earned by the company
Four Basic Financial Statements: must be done in this order; footnotes on financial statements help financial statement users
understand how the amounts were derived and what other info may affect their decisions
● Income statement: reports the amount of revenues less expenses for a period of time (Total Revenues - Total Expenses = Net
Income)
● Statement of Retained Earnings reports the way that net income and the distribution of dividends affected the financial
position of the company during the period (Net Income - Dividends = Retained Earnings)
● Balance sheet: not for a period of time, it is a snapshot as of that moment (usually at end of fiscal year); Reports: what a
business owns (assets), what it owes (liabilities), and what is left over for the owners of the company’s stock (stockholders’
equity) - (assets = liabilities + Stockholders’ Equity)
● Assets are listed in the order of liquidation - the order of which things will be converted to cash
● Liabilities are listed in the order which you have to pay off first
● Retailers like to have their fiscal year end the closest Saturday to Jan 31st
● Statement of Cash Flow: summaries how a business’s operating, investing, and financing activities caused its cash balance to
change over a particular period of time (cash flows from operating activities, used in investing activities, and from financing
activities = change in cash)
Generally Accepted Accounting Principles (GAAP): The rules for how we do accounting
● Set of standards that are generally accepted and universally practices
● Major sources include: FASB standards, interpretations, and staff positions;
APB opinions; AICPA accounting research bulletins
Three organizations involved in standard setting:
● SEC: securities and exchange commission; Securities Act of 1933: list everything about company, what you do to go public
with IPO; Securities Act of 1934: governance after the IP; Requires companies to adhere to GAAP; SEC oversight and
enforcement authority - made stricter with Sarbanes-Oxley Act
● AICPA: American Institute of Certified Public Accountants; National professional organization
● Established the following: Committee on accounting procedures; Accounting principles board
● FASB: financial accounting standards board; Missions is to establish and improve standards of financial accounting and
reporting; smaller than APB, full-time, autonomy, independence, broader representation
● Financial accounting foundation: select members of FASB, funds their activities, general oversight; Financial
accounting standards board: mission to establish and improve standards of financial accounting and reporting;
Financial accounting standards advisory council: consult on major policy issues
International Accounting Standards: US: GAAP issued by FASB; International financial reporting standards (IFRS) issue by IASB
Horizontal Analysis: conducted to help financial statement users recognize important financial changes that unfold over time; can
only compare to own company, not other companies; = (New-old)/(old) *100 for percent change
● Computation: usually calculated in terms of year-to-year dollar and percentage changes
● Year-to-year % = change this year/prior year’s total x 100
Vertical Analysis: focus on important relationships between items on the same financial statement; can look at other companies for
comparison or compare to itself; income statement sales = 100%; balance sheet total assets = 100%
Ratio Analysis: conducted to understand relationships among various items reported in one or more of the financial statements; it is
essential to understand that no analysis is complete unless it leads to an interpretation that helps financial statement users understand
and evaluate a company’s financial results; Compares amount for one or more line items to the amounts for other line items in the
same year
● Profitability ratios: examine a company's ability to generate income; Net profit margin, gross profit percentage, fixed asset
turnover, ROE, EPS, Price/Earning ratio
● Net profit margin - slowly improving economy helped boost the profits as shown by increase in a net profit margin;
● Gross profit - indicates how much profit was made on each dollar of sales after deducting COGS
● Fixed Asset Turnover - indicates how much revenue the company generates in sales for each dollar invested in
fixed assets
● ROE – compare amt of net income to avg stockholder’s equity; reports net amount earned during period as % of
each dollar contributed by common stockholders and retained in the business
● Earnings per share - shows amount of earning generated for each share of outstanding common stock
● Price/Earnings Ratio – shows relationship between EPS and market price of one share
● Common Liquidity ratios: receivables turnover, days to collect, inventory turnover (use cost of sales, not sales), days to
sell, current ratio
● Receivables turnover – low level means they collect majority of sales in cash immediately
● Days to collect
● Inventory turnover - indicates how frequently inventory is bought and sold
● Days to sell - indicates how many days it takes to sell a good
● Current ratio - measures the company’s ability to pay its current liabilities
● Solvency ratios: examine a company’s ability to pay interest and repay debt when due
● Debt-to assets – indicates proportion of total assets that creditors finance
● Times interest earned – indicates how many times company interest expense was covered by operating results
Factors that commonly contribute to the going-concern problems (assuming that business will be here tomorrow, not a
liquidating business)
● Revealed by financial analysis: declining sales, declining gross profit, significant one-time expenses, fluctuating net income,
insufficient current assets, excessive reliance on debt financing, Negative operating cash flows
● Revealed by other analysis: loss of key supplier, insufficient product innovation, significant barriers to expansion, loss of key
personnel without replacement, unfavorable long-term commitments, inadequate maintenance of long-lived assets, loss of a
key franchise, license, or patent
Quick Ratio:
= cash+accts rec+mark
sec / current liabilities

Returns on X:
= net income / avg of x

X days outstanding:
= 365 / X Ratio
 Quiz 2 (Final)

Capital Structure: debt (funds from creditors) and equity (funds from owners); assets – liabilities = equity
● Two primary sources of equity include contributed capital and retained earning account
● Debt is riskier because legal obligations, bankruptcy, and can force sale of assets
● Long term liabilities are older than a year, current liabilities (to be paid with current assets) are 1 year or less
● Secured debt: creditors often require borrower to pledge assets as security for long term liabilities
● Small debts filled from single sources; large debts filled from issuing bonds to public
Corporate Capital: influence of state corporate law, use of capital stock or share system, development of variety of owner interests
● State law: articles of incorporation, charter, some states better to incorporate (DE), account for stockholder’s equity by law
● Each Stock/Share has right to share proportionately in: profit & loss, management/vote, assets upon liquidation, preemptive
right to new stock;
● Common stock bears ultimate risks of loss, receives benefits of success, not guaranteed dividends or assets on dissolution
● Preferred stock is created by contract when stockholder’s sacrifice certain rights in return for other rights or privileges
● Issuance of stock: shares authorized, shares offered for sale, shares issued; accounting problems: par value stock, no-par
stock, stock issued with other securities, stock issued in noncash transactions, cost of issuing stock
● Par value: low par values help avoid contingent liability; preferred or common stock and additional paid-in capital
● No-Par Stock: avoid contingent liability and confusion over recording par value vs. fair market value; some states tax high
● Non-Cash Stock: companies should record stock issued for services or property other than cash at fair value of stock or fair
value of noncash consideration received
● Cost of issuing: underwriting, accounting/legal fees, printing, taxes – report as reduction of amount paid-in
● Preferred Stock: dividends, assets in liquidation, convert to common stock, corp can call them back, non-voting
● Reacquisition: purchase treasury stock; cost v. par method
Dividends: cash (date of declaration, record, payment, year end), property/in kind, liquidating – all reduce total stockholder’s equity
● Stock dividends: given to stockholders, used when management wants to capitalize part of earnings, usually <20% of stocks
● Stock splits: double the stocks, price reduces but usually goes back up; no entry recorded; dec value, inc shares
Time Value of Money: Total I = p*ir*n (not compound); Compound do p*ir*n every year and the p changes - “$ today = worth more
than $ promised in future”
● PV: notes, leases, pensions, settlements, shared compensation, business combos
● Tables give you the compound interest rate: FVF = (1+i)n ; PVF = (1/((1+ir)n))
● If it is more than once per year, multiply the periods and divide the interest rate
● Single sum: you have an unknown PV or FV, but know the IR and N; FV = PV(FVF); PV = FV(PVF)
● Annuity: periodic payments of same amount; same-length intervals; compounding interest once at interval (ex: rent)
o Ordinary: at the end of period, Annuity Due: at beginning of period
o R(FVF-OA); FVF-OA = ((1+i)n – 1)/(i) ; can find FVF-OA using table
● If you are beginning at the start of year but ending at the end, to get the correct FVF-OA multiple the number from the table
by 1+IR (ex: IR = 5%, multiply by 1.05)

Annuity Find this value and then multiply by Periodic Rent (R) Single Sum Future Value/Present Value

Capital Structure Classifications: long term debt (bonds, notes, mortgages, pensions, leases)
Low Cost/Low Risk: senior secured debt (bank debt); senior unsecured debt (bonds, notes, etc); Senior subordinated debt (high yield);
subordinated debt; preferred stock; common stock: High Cost/High Risk
Bonds: cash interest payments over life, repayment upon maturity; principal (par value/maturity value), coupon rate (stated rate);
issuing bonds (bond indenture, promise to pay, certificate, interest payments, used); selling price based on supply/demand, risk,
market, and economy; **zero coupon bonds do not pay periodic cash interest
● Unsecured (debenture) bonds: No assets are pledged as a guarantee of repayment at maturity.
● Secured bonds: Specific assets are pledged as a guarantee of repayment at maturity.
● Callable bonds: Bond issuer is allowed to retire the bonds early.
● Convertible bonds: Bondholder is allowed to convert the bond into shares of the issuer's common stock.
Advantages of bonds: Stockholders maintain control because bonds are debt, not equity.; Interest expense is tax deductible.; The
return to shareholders can be positive if money is borrowed at a low interest rate and invested to earn a higher rate.
Disadvantages of bonds: Risk of bankruptcy exists because the interest and debt must be paid back as scheduled or else creditors will
force legal action.; Negative impact on cash flows exists because interest and principal must be repaid at a specified time in the future.
Numbers for Calculations: coupon rate: rate written in contract/indenture; market rate or yield: acceptable return based on risk
Calculate Bonds Issued at Discount
Step 1: Compute interest expense (Bonds Payable Book Value × Market Interest Rate per Period)
Step 2: Compute cash owed for interest (Bond Face Value × Coupon Rate per Period)
Step 3: Compute amortization amount (Interest Expense − Cash Owed for Interest)