Domain 4 Formula

Accounts with a beginning balance and an ending balance relationship

Accounts with a beginning balance and an ending balance, such as inventory accounts, will have the following relationship: Beginning Account Balance + Account Additions in Period = Ending Account Balance + Account Deductions in Period.

Straight Line - Annual Depreciation

Annual Depreciation = (Cost - Salvage Value)/Estimated Useful Life

Book value

Book value = Cost - Accumulated Depreciation

Company A has 50,000 common shares and 10,000 preferred shares outstanding at the start of the year on January 1. The preferred shares are entitled to a $2 per share annual cash dividend, payable on December 31. The company had net income of $150,000 for the year. On April 1, the company issued 15,000 additional common shares for cash. When calculating earnings per share for Company A, the number of shares outstanding to use in the denominator is 50,000. 60,000. 61,250. 65,000.

CORRECT: 61,250.

Dividends Declare

Dividends Declared = Net Income - Increase in Retained Earnings

Weighted Average Method of Calculating Equivalent Units Formula

EQUIVALENT UNITS OF PRODUCTIONS = UNITS TRANSFERRED TO NEXT DEPARTMENT OR FINISHED GOODS + EQUIVALENT UNITS IN ENDING WORK-IN-PROGRESS INVENTORY

Net Profit

NET PROFITS are calculated by subtracting interest and taxes from operating profits.

Operating Profit

Operating profit is net sales less cost of goods sold and operating expenses (also called selling, general, and administrative expenses).

Debt ratio

Total Liabilities/Total Assets REARRANGE ASSETS - LIABILITIES = EQUITY IF NECCESSARY

Contribution Margin Formula

contribution margin = total revenues - total variable costs

Gross Profit

gross profit/net sales

Net Profit Margin

net profit/net sales

Earnings from earnings per share formula

(Net Income - Preferred Dividends)/Weighted Average Number of Common Shares Outstanding

Earnings per share formula

(Net Income - Preferred Dividends)/Weighted Average Number of Common Shares Outstanding

Gross Profit Margin Formula

-Gross profit equals net sales minus the cost of goods sold (net sales - cost of goods sold). It is the money remaining from sales revenues after deductions for the direct costs of sales. -Gross profit margin is the proportion of net sales minus cost of goods sold to net sales.

Net Working Capital

-Net working capital measures the relationship of short-term debt to short-term assets by simply subtracting liabilities from assets. -A larger number indicates a greater ability to pay current debts—greater liquidity, in other words. -Because it is not really a ratio, it is expressed as a monetary amount rather than a number or percentage.

Internal Rate of Return (IRR)

-The internal rate of return (IRR), or project yield, is the rate of return promised by an investment project over its useful life. -The IRR is the discount rate that will result in the net present value of a project being equal to zero. -We want to knoe the rate of return that equates the cash inflows with the cash outflows -Once the IRR for a project is computed, it is compared with the firm's required rate of return. ---If the IRR is greater than the required rate, the project is acceptable. ---If the IRR is equal to the required rate, managers decide whether to accept or reject it. ---If the IRR is less than the organization's required rate of return, the project is rejected.

Equivalent Units Formula

-To calculate equivalent units, the number of units that are partially complete is multiplied by the estimated percentage that are complete overall: EQUIVALENT UNITS = NUMBER OF PARTIALLY COMPLETED UNITS X PERCENTAGE COMPLETION

Receivables collection period or average days' accounts receivable formula

365/Average A/R Turnover Ratio -Length of time required to convert account receivable to cash. -Should be compared with company's credit terms to detect issues with collection.

A company's accounts receivable turnover rate decreased from 7.3 to 4.3 over the last three years. What is the most likely cause for the decrease?

A more liberal credit policy With a liberal credit policy, customers would be taking longer to pay (365/4.3 compared to 365/7.3). The other options would either have the opposite effect or no impact.

Cash Conversion Cycle

A/R Collection Period + Inventory Processing Period - A/P Payment Period = Cash Conversion Cycle A/R Collection Period + Inventory Processing Period - A/P Payment Period = Cash Conversion Cycle, or the number of days a company has cash invested in its operating cycle. Therefore, Inventory Processing Period = Cash Conversion Cycle - A/R Collection Period + A/P Payment Period = 50 - 20 + 30 = 60 days.

Accounting Rate of Return

ARR = Increase in Expected Average Annual Operating Income/Initial Required Investment

EQUITY

ASSETS - LIABILITIES = EQUITY

Activity Method Depreciation Formula

Activity depreciation per period = (depreciable base x units in period)/Total Estimated Units in Service Life

A company purchases a machine on January 1, Year 1, for $1,000,000. (Note that all amounts are in U.S. dollars.) The machine has an estimated useful life of nine years and a salvage value of $100,000. The company uses straight-line depreciation. On December 31, Year 4, the machine is sold for $535,000.What should be recorded on the disposal of this machine?

Annual Depreciation = (Cost - Salvage Value)/Estimated Useful Life = ($1,000,000 - $100,000)/9 years = $100,000 per year Book value on December 31, Year 4 = Cost - Accumulated Depreciation = $1,000,000 - $400,000 = $600,000 Loss on Disposal = Book Value - Proceeds = $600,000 - $535,000 = $65,000 loss

On a statement of shareholders' equity, which would be included in the calculation of the ending balance for retained earnings?

Beginning Balance of Retained Earnings + Net Income (Period Revenues - Period Expenses) - Dividends = Ending Balance of Retained Earnings. The excess of par value of funds received from stock is additional paid-in capital and is not included in retained earnings.

Barnaby has a current ratio of 2 and a quick ratio of 0.8 and a positive cash balance. If he purchases inventory on credit what is the effect on these ratios? Select one: A. Current ratio - decrease; Quick ratio - decrease B. Current ratio - decrease; Quick ratio - increase C. Current ratio - increase; Quick ratio - decrease D. Current ratio - increase; Quick ratio - increase

CORRECT : A. Current ratio - decrease; Quick ratio - decrease RATIONALE: If inventory is purchased on credit, then both current assets and current liabilities will increase by the same amount. For example: at start of period, current assets are £500K (including stock of £300K) and current liabilities £250K. So, current ratio stands at 2 and quick ratio at 0.8. Inventory purchased on credit = £100K So, current assets become £600K (including stock of £400K) and current liabilities £350K. The correct answer is: Current ratio - decrease;Quick ratio - decrease

A new machine has an initial cost of $300,000, an estimated useful life of 2,000 hours over a three-year period, and an estimated salvage value of $70,000. Usage rates are estimated as 500 hours in the first year, 700 hours in the second year, and 800 hours in the third year. Depreciation expense in year two under the activity method of depreciation will be $57,500. $75,000. CORRECT: $80,500. $105,000.

CORRECT: $80,500. Depreciation expense in year two is calculated as follows: [(Cost - Salvage) x (Estimated Hours of Use in Year Two)]/Total Estimated Hours of Use = [($300,000 - $70,000) x (700 hours)]/2,000 hours = $80,500.

The following are some of the assets held on a company's statement of financial position at the end the year: Motor car net book value £10,000 (original cost £10,000, depreciation policy 20% straight line, residual value £0) Machinery net book value £25,000 (depreciation policy 10% reducing balance) Land net book value £80,000 (depreciation policy 15% reducing balance) What would the total depreciation be in Year 2? A.£16,500 B.£14,700 C.£14,450 D.£14,050

CORRECT: C.£14,450 RATIONALE: The total depreciation is the sum of each of the component's depreciation amounts. The car depreciates through 20% straight line policy i.e. 20% of £10,000 each year. So Year 2 depreciation for the car is £2,000. The machinery depreciates through 10% reducing balance policy. So Year 1 reduced balance value from 10% depreciation is £25,000 - (£25,000 x 10%)=£22,500 and so Year 2 depreciation for the machinery is (£22,500 x 10%) = £2,250. The land depreciates through 15% reducing balance policy. So Year 1 reduced balance value from 15% depreciation is £80,000 - (£80,000 x 15%) = £68,000 and so Year 2 depreciation for the land is (£68,000 x 15%) = £10,200. Total deprciation is £2,000 + £2,250 + £10,200 = £14,450.

An auditor performs an analytical review of division operations and notes the following: Current ratio: increasing Quick ratio: decreasing Number of days' sales in inventory: increasing Sales: constant Current liabilities: constant From this, the auditor can conclude which of the following? The company has produced less product this year than last year. Products are selling faster, but there are periods with no sales. Cash or accounts receivable have decreased. The gross margin has decreased.

CORRECT: Cash or accounts receivable have decreased.The gross margin has decreased. RATIONALE: The only way the quick ratio could be decreasing while the current ratio is increasing is if cash or accounts receivable have decreased. Sales are constant, but days' sales in inventory has increased. Therefore, production or raw materials would have increased. No information is given regarding the gross margin.

Sales in Y2 were £30,000 more than they were in Y1. This represented a 20% increase on Y1. What was the level of sales for Y2? A.£90,000 B.£120,000 C.£150,000 CORRECT: D.£180,000

CORRECT: D.£180,000 RATIONALE: The Y1 sales figures can be calculated as £30,000/20%, which comes to £150,000. Year 2 sales are £150,000 plus £30,000, which is £180,000.

An organization makes significant investments in plant, property, and equipment (PPE). Which of the following ratios would be best for determining the effectiveness of these investments? CORRECT Fixed assets turnover Operating leverage Market-to-book-value ratio Total asset turnover

CORRECT: Fixed assets turnover RATIONALE: Fixed assets turnover is net sales divided by average net fixed assets. It is the proportion of sales to fixed assets (PPE). The higher the number, the more efficiently fixed assets are being used. Fixed assets turnover might be used to measure the effectiveness of significant investments in PPE.

Just before the end of the period, an organization's current ratio changes from 1.33 to 1.5 while at the same time its debt to equity ratio changes from 0.3 to 0.2 . (The latter ratio uses total liabilities as the numerator.) Which of the following would be a possible reason for this change? Managers took out a short-term loan to increase cash balances. The organization finalized a new account and recognized a large new account receivable. The organization received payment on a large account receivable, reducing receivables and increasing cash.

CORRECT: Managers paid off some current liabilities using current assets.

Which is the most significant risk listed for a manufacturer with a high operating leverage ratio? The organization's assets may not be efficiently utilized. The organization may not have the liquidity to pay its debts. Activist shareholders may want the organization to take on more risk to increase profit potential. Sales revenue may fail to exceed fixed costs.

CORRECT: Sales revenue may fail to exceed fixed costs.

A firm has an operating leverage ratio of 0.65 and a financial leverage index of 1.25. If the firm posts a loss, shareholders will experience a loss that is 25% greater than it would be if the firm had no debt. a loss that is 65% less than it would be if the firm had no debt. a loss that is no greater and no less than it would be if the firm had no debt. a loss that is 25% less than it would be if the firm had no debt.

CORRECT: a loss that is 25% greater than it would be if the firm had no debt. RATIONALE: Financial leverage, or trading on equity, is the use of fixed interest in the form of debt or preferred equity stock with the expectation of earning a greater return than the cost of the fixed interest. Shareholders prefer a higher degree of financial leverage, because, if the organization is profitable, the use of the alternate source of funds multiplies their equity investment. However, when the organization is not profitable, their loss is equally magnified. A financial leverage index of 1 would indicate that the return on common equity is the same as the return on assets, meaning that the firm has no debt. Therefore, the profit or loss for a shareholder would be magnified by 25% compared to a situation in which the same firm had no debt.

An auditor decides to perform inventory turnover analyses for both raw materials and finished goods inventories. The analyses would be potentially useful in identifying potential problems in accounts payable activities. identifying a need for higher amounts of inventory. identifying areas for setting new safety stock policies. identifying products for which management has not been attuned to changes in market demand.

CORRECT: identifying products for which management has not been attuned to changes in market demand. RATIONALE: Turnover analysis is a useful form of analytical review because it can identify slow-selling inventory (e.g., inventory that is becoming obsolete) and thus areas of excess inventory. The need for higher amounts of inventory or areas for safety stock policies would be better measured using analysis of stockouts.

INVESTMENT VALUATION RATIOS: Dividend payout ratio

Cash dividends per share/Earnings per share Proportion of a company's earnings paid out as dividends. The higher the dividend payout ratio, the sooner retained earnings are exhausted and the company must seek more costly outside equity financing. This drives up the marginal cost of capital. The price/earnings ratio is computed by dividing price per share by earnings per share, so a company with a higher dividend payout ratio would have a lower price/earnings ratio.

Cash Flow from Operations

Cash flow from operations on the statement of cash flows can be calculated as follows: Net Income + Depreciation Add-Back +/- (Increase)/Decrease in Inventory +/- (Increase)/Decrease in Accounts Receivable +/- Increase/(Decrease) in Accounts Payable

INVESTMENT VALUATION RATIOS: Book value per common share

Common Shareholders' Equity/Outstanding Common Shares Shareholders' portion of all assets as stated on the statement of financial position if liquidated. But it can be misleading if asset values as reported differ materially from their fair market value.

ASSET MANAGEMENT RATIOS: Average inventory turnover

Cost of Goods Sold/Average Inventory -Average inventory turnover is the proportion of goods sold to goods in inventory. -It indicates how efficiently a company converts inventory into sales. -If relatively high, inventory is efficiently managed, while a declining ratio could show an inventory build-up due to poor demand or obsolescence. -Too high a ratio could mean lost sales due to stockouts.

Cost of Goods Sold Formula

Cost of goods sold equals opening inventory plus purchases minus closing inventory.

Current Ratio

Current Assets/Current Liabilities Lowering current ratios over time shows declining liquidity but, if too high, could show that the firm has too much invested in low-yield short-term assets.

Earnings per Share

Earnings per Share = (Net Income - Preferred Dividends)/Weighted Number of Common Shares Outstanding = ($120,000 - $5,000)/1,500 shares = $76.67 per share. Earnings per share indicates the income earned by each share of common stock. The numerator is earnings available to common shareholders; the denominator is the weighted average number of common shares outstanding over the accounting period. Earnings per share uses the weighted average number of outstanding shares for the year, which is calculated as follows: (Number of Months/12) x (50,000) + (Number of Months/12) x (65,000) (1/4) (50,000) + (3/4) (65,000) = 61,250 Shares

Weighted average number of outstanding shares for the year

Earnings per share uses the weighted average number of outstanding shares for the year, which is calculated as follows: (Number of Months/12) x (50,000) + (Number of Months/12) x (65,000) (1/4) (50,000) + (3/4) (65,000) = 61,250 Shares

If a high PERCENTAGE of a firm's total costs is fixed, the firm's operating leverage will be

High In business terminology, a high degree of operating leverage, other things held constant, means that a relatively small change in sales will result in a large change in operating income. Therefore, if a high percentage of a firm's total cost is fixed, the firm is said to have a high degree of operating leverage. The higher the operating leverage, the greater the impact of changes in price and variable costs, up or down. Higher operating leverage means higher risk, because fixed charges must be met regardless of sales levels.

Loss on Disposal

Loss on Disposal = Book Value - Proceeds = $600,000 - $535,000 = $65,000 loss

Price/earnings ratio

Market Price of Stock/Earnings per Share Proportion of a share's price to its earnings. A higher number is better; a declining trend may indicate poor growth potential. A company with a higher dividend payout ratio would have a lower price/earnings ratio.

Average A/R turnover formula

Net Credit Sales/Average A/R or rearranged receivables collection period formula Accounts Receivable Turnover Ratio = 365/Receivables Collection Period -Average A/R turnover is the number of times accounts receivable are collected each year. -Average A/R is calculated by finding the average between the current and prior years' A/R. -Increasing A/R turnover indicates effective credit extension and collection processes.

ASSET MANAGEMENT RATIOS: Fixed assets turnover

Net Sales/Average Net Fixed Assets -Fixed asset turnover measures how efficiently a company uses its fixed assets (property, plant, equipment) to generate sales. -The higher the number, the more efficiently fixed assets are being used (or, possibly, there is a need to replace older assets). -Might be used to measure the effectiveness of significant investments in PP&E. -Net sales is sales minus sales discounts, returns, and allowances

Operating Profit Margin Fromula

Operating profit is net sales less cost of goods sold and operating expenses (also called selling, general, and administrative expenses). operating profit/net sales

Payback Period Formula

PAYBACK PERIOD = Original Investment/Annual Cash Flow

ROI RATIOS: Return on assets (ROA)

Return on Assets = Net Income/Average Total Assets. To calculate average total assets, sum the prior year and current year total assets and divide by 2: (U.S. $300 million + U.S. $320 million)/2 = U.S. $310 million. Return on Assets = U.S. $50 million/U.S. $310 million = 0.1613 or 16.1%. Last year's net income is not needed to answer the question.

CVP Model

The CVP model is: PROFIT = TOTAL REVENUE - TOTAL COST or, equivalently, since total costs include both variable- and fixed-cost elements: REVENUES = FIXED COSTS + VARIABLE COSTS + PROFIT -Replacing revenues with the quantity of units sold times the unit selling price and replacing variable cost with unit variable cost times the quantity of units sold, the CVP model is: UNIT SELLING PRICE x QUANTITY SOLD = FIXED COSTS + UNIT VARIABLE COST x QUANTITY SOLD + PROFIT The symbolic form of the model is: USP x Q = FC + UVC x Q + OP Where: USP is the unit selling price. Q is the quantity sold. FC is the total fixed cost. UVC is the unit variable cost. OP is the operating profit (profits not including unusual or nonrecurring items and income taxes)

Depreciable Based

The depreciable base is the asset's original cost less its salvage value.

FIFO Calculating Equivant Units Formula

The formula for computing the equivalent units of production under FIFO is more complex than under the weighted average method: EQUIVALENT UNITS OF PRODUCTIONS = EQUIVALENT UNITS TO COMPLETE BEGINNING INVENTORY + UNITS STARTED AND COMPLETED DURING THE PERIOD + EQUIVALENT UNITS IN ENDING WORK-IN-PROGRESS INVENTORY

How to calculate accounts receiveable turnover ratio using receivables collection period calculation?

The receivables collection period calculation can be rearranged to solve for the A/R turnover ratio: Receivables Collection Period = 365/Accounts Receivable Turnover Ratio, rearranged as: Accounts Receivable Turnover Ratio = 365/Receivables Collection Period = 365/17.36 = 21.03 times.

ACCELERATED DEPRECIATION METHODS: Sum-of-the-Years'-Digits Method

The sum-of-the-years'-digits method starts with the depreciable base and reduces it by a fraction based on the number of remaining years of service. Note that the depreciable base used for calculating the depreciation fraction is kept constant and the book value starts at original cost and ends at salvage value. Under the sum-of-the-years'-digits method, the portion of depreciable cost to expense in any given year is calculated as the number of years of estimated life remaining as of the beginning of the year divided by the sum of the years of estimated useful life. Therefore, the portion to expense in the third year of an asset with a four-year estimated useful life = 2/[1 + 2 + 3 + 4] = 2/10 = 20%.

Breakeven Point Formula - Contribution Margin Method

breakeven point = total fixed costs/unit contribution margin = (600,000 + 567,840 + 352,800)/33 = $1,520,640/33 = 46,080 units. OR Contribution Margin per Unit = 0.2 (CM%) x 100 (Selling Price) = $20 Break-Even Units = 40,000 (Fixed Expenses)/20 (CM per Unit) = 2,000 Units

LIQUIDITY/SHORT-TERM DEBT RATIOS: Cash ratio

cash and marketable securities/current liabilities -Proportion of cash or easily convertible securities to liabilities at one point in time. -A more conservative measure of liquidity used to determine if an organization can pay its obligations over the short term. -However, firms can use other sources than cash to pay current liabilities.

Quick ratio (acid test ratio)

cash, cash equivalents, and receivables/current liabilities Like the current ratio, but eliminates inventory, the least liquid of current assets and therefore the least available for cash to reduce current debts. It is the proportion of most liquid sources of funding (cash, cash equivalents, receivables) to liabilities. Since inventory is excluded, stable current ratio but declining quick ratio could indicate temporary or permanent increase in inventory.

LEVERAGE RATIOS: Operating leverage

fixed costs/total costs Proportion of fixed costs required to produce goods or services. The higher the operating leverage, the greater the impact of changes in price and variable costs, up or down. Higher operating leverage means higher risk, because fixed charges must be met regardless of sales levels.

LEVERAGE RATIOS: Financial leverage index

return on common equity/return on assets If the return on assets is lower than the return on common equity, the organization is trading on the equity at a gain, a greater return than the interest related to their fixed cost debts. Shareholders prefer a higher degree of financial leverage, because, if the organization is profitable, the use of the alternate source of funds multiplies their equity investment. However, when the organization is not profitable, their loss is equally magnified. A financial leverage index of 1 would indicate that the return on common equity is the same as the return on assets, meaning that the firm has no debt.

DEBT MANAGEMENT RATIOS: Debt to equity ratio

total liabilities/total equity Measures an organization's proportion of liabilities to equity. A reasonable ratio of debt to equity varies among industries, with capital-intensive organizations generally carrying more debt in relation to owners' equity. Under 100% is desirable.

Unit Contribution Margin Formula

unit contribution margin = contribution margin/number of units