Basic Accounting

What is the high level calculation for a balance sheet?

Assets = Liabilities + Stockholders' Equity The balance sheet equation must balance. Total assets include current and long-lived assets. Total liabilities include both current and long-term liabilities. Total liabilities combined with stockholders' equity must equal total assets.

How do you calculate SE?

Assets minus liabilities equal stockholders' equity.

Asset

Assets represent the amount of resources owned by an entity, the probable future economic benefits obtained or controlled by the entity as a result of past transactions or events.

Current Assets

Assets that are likely to be converted into cash or used to benefit the entity within one year. Current assets include cash, accounts receivable, and merchandise inventory.

Long Term Assets

It could be stocks or bonds the company plans to hold for a long time. Property, plant and equipment, often called PP&E, includes all types of physical assets, such as machines, factories, buildings, office equipment, computers, vehicles, fixtures and land. These are sometimes called fixed assets or capital assets. These are long-term assets since they are held by the company typically for several years and are not intended for sale. PP&E also includes leasehold improvements, which are modifications a company makes to a property it is leasing from another entity. Might also include intangible assets, such as goodwill, patents and copyrights. These are not physical assets, nor do they have set values. But they are worth something, often a great deal, to the company and thus are included as assets. Research and development can also be categorized as a long-term asset.

What is paid-in capital?

Paid-in capital includes common stock at par value and additional paid-in capital.

If assets equal liabilities plus stockholders' equity, when assets equal $320,000 and liabilities equal $117,000, what is the amount of stockholders' equity?

Stockholders' equity equals $203,000 ($320,000 - $117,000).

Stockholders' Equity (SE)

Stockholders' equity is the stockholders' ownership in the assets of an entity that remain after deducting the liabilities. Stockholders' equity is often referred to as net assets.

What is the DuPont Model and how is it calculated? How is it different from the ROI calculation?

The DuPont model is an expansion of the basic ROI calculation. The margin (net income divided by sales) and turnover (sales divided by average total assets) are calculated separately and then margin is multiplied by turnover to arrive at ROI. The developers of the model reasoned that profitability from sales and utilization of assets to generate sales revenue were both important factors to be considered when evaluating profitability. Margin emphasizes that from every dollar of sales revenue, some amount must work its way to net income. Turnover relates to the efficiency with which the firm's assets are used in the revenue-generating process. A rule of thumb useful for putting ROI in perspective is that average ROI, based on net income, for most American merchandising and manufacturing companies is between eight percent and twelve percent.

What do income statement captions include?

The income statement captions include net sales (sales minus returns), cost of goods sold (the cost of merchandise removed from inventory and sold to customers), and gross profit (net sales minus cost of goods sold). Selling, general, and administrative expenses (also known as operating expenses) are deducted from gross profit to arrive at income from operations (an important measure of the firm's activities). Interest expense (the cost of borrowing funds) and income tax expense (which is calculated after all other items have been reported) are deducted from income from operations to arrive at net income. Net income per share of common stock outstanding (which is net income earned divided by the average number of shares of the entity's common stock outstanding) is often referred to as earnings per share or EPS.

Balance Sheet

A listing of an organization's assets, liabilities, and equity at a point in time

Where do Earnings per share of common stock outstanding land on the income statement and why?

Earnings per share of common stock outstanding is reported as a separate item at the bottom of the income statement because of its significance in evaluating the market value of a share of common stock.

Given that assets equal liabilities plus stockholders' equity, suppose that total assets increase by $10,000 and total liabilities decrease by $3,000 during the year, what is the amount of stockholders' equity at the end of the year?

First, solve for the change in stockholders' equity during the year. If assets increased by $10,000 and liabilities decreased by $3,000, then stockholders' equity must have increased by $13,000 ($10,000 + $3,000). Next, combine (1) the assets, $320,000 plus $10,000 increase for a total of $330,000, (2) combine the liabilities, $117,000 less $3,000 decrease for a total of $114,000, and (3) combine the stockholders' equity, $203,000 plus $13,000 for a total of $216,000.

Where are income taxes shown and why?

Income taxes are shown after all the other income statement items have been reported, because income taxes (often captioned as income tax expense or provision for income taxes) are a function of the firm's income before taxes.

Liabilities

Liabilities are those amounts owed to other entities, the probable future sacrifices of the entity's economic benefits arising from present obligations to transfer assets or provide services to other entities in the future as a result of past transactions or events.

Long Term Liabilities

Liabilities that will not be repaid within one year of the balance sheet date. Examples are bonds payable, long-term loans, capital leases, pension liabilities, post-retirement healthcare liabilities, deferred compensation, deferred revenues, deferred income taxes, and derivative liabilities.

How is liquidity measured?

Liquidity is measured in three principal ways: working capital, current ratio, and acid-test ratio.

Current Liabilities

Represent amounts borrowed that will be repaid within one year of the balance sheet date. Current liabilities include short-term debt, accounts payable, and other accrued liabilities.

What are retained earnings?

Retained earnings include the net income or loss reported by the entity since its inception less any dividends that have been distributed to owners.

What is the acid test ratio and how do you calculate it?

The acid-test ratio, also called quick ratio, is calculated by dividing quick assets by current liabilities. Quick assets are Cash (including temporary cash investments) and Accounts Receivable. This ratio provides information about an almost worst-case situation-the firm's ability to meet its current obligations even if none of the inventory can be sold. As a rule of thumb, an acid-test ratio of one is considered indicative of adequate liquidity.

In what 3 categories are the inflows and outflows of cash separated?

The inflows and outflows of cash are separated into three distinct categories: 1) operating activities; 2) investing activities; and 3) financing activities.

What are the captions in the statement of stockholders' equity?

The statement of changes in stockholders' equity reports paid-in capital, the total amount owners have invested in the entity, which includes common stock, the number of shares of authorized, issued, and outstanding (outstanding means the shares still held by the stockholders). The retained earnings account reports the cumulative net income of the entity that has been retained for use in the business minus the dividends, which are distributions of earnings to owners. This statement reflects the changes that have occurred over a period of time with stockholders' equity. Each shareholder is considered an "owner" of the organization and therefore has the most interest in this financial statement.

How do you calculate return on equity?

To calculate return on equity, net income is divided by average stockholders' equity. Owners are interested in expressing the profits of the firm as a rate of return on the amount of stockholders' equity. As a rule of thumb, average ROE for most American merchandising and manufacturing companies has historically ranged from ten percent to fifteen percent.

How do you calculate the current ratio?

To calculate the current ratio, divide current assets by current liabilities. This ratio measures the ability of the company to pay current debts as they become due. As a rule of thumb, a current ratio of two is considered indicative of adequate liquidity.

What is working capital and how to you measure it?

Working capital is calculated by subtracting current liabilities from current assets. Working capital is the excess of a firm's current assets over its current liabilities.

Statement of Cash Flows

details the inflows and outflows of cash during a period of time, which is typically one year

Income Statement

net income (or net loss) for the period of time under consideration.

Statement of Changes in Stockholders Equity

reports the details of stockholders' equity and explains the changes that occurred in paid-in capital and retained earnings during the year. This statement provides the details of the balances reported in the stockholders' equity section of the balance sheet.

How do you calculate the Income Statement?

reports the revenues that result from the entity's operating activities and deducts the costs and expenses incurred in generating the revenues to arrive at net income, which represents the profit or loss for the period

Name 3 other names the Income Statement can be called

statement of earnings, profit and loss statement, or statement of operations

What are the captions in a statement of cash flows?

The statement of cash flows includes three captions (referred to as activities). The first caption, cash flows from operating activities, begins with net income from the income statement, then 1) adds back depreciation expense because it is subtracted to arrive at net income but does not require the use of cash, 2) deducts an increase in accounts receivable because it reflects sales revenues that are included in net income but not yet received in cash, 3) deducts an increase in merchandise inventory because cash was spent to acquire the increase in inventory, and 4) adds an increase in current liabilities because cash has not yet been paid for the products and services that have been received during the current fiscal period. The caption, cash flows from investing activities, shows the cash sources and uses related to long-lived assets. The caption, cash flows from financing activities, shows the cash sources and uses related to transactions with creditors and stockholders. The statement of cash flows is another supplementary statement. As an asset, the ending cash balance is reported on the balance sheet. This statement recaps the sources of cash and how cash was used throughout a period of time - typically one year. One key number to watch on this statement is whether the cash flows from operating activities are generating positive or negative results. Over time an organization should have a positive cash inflow from operating activities. If an organization consistently generates a negative cash inflow from operating activities, it is an indicator of trouble. Cash is mandatory to continue operations. When cash flow from operating activities is consistently negative, it translates to financing activities. Consistent borrowing to fund day-to-day operations will ultimately cause an organization to go bankrupt.

What is the rate of return and how do you calculate?

To calculate the rate of return ratio, the amount of return on an investment is divided by the amount of the investment. The rate of return ratio provides the return on a given investment alternative. All other things being equal, the higher the rate of return, the more profitable the alternative. The rate of return calculation is derived from the interest calculation. Interest equals Principal times Rate times Time. Higher rates of return are associated with greater risk.

What is the return on investment and how is it calculated?

To calculate the return on investment (ROI) ratio, divide net income by the average total assets. This ratio describes the rate of return management was able to earn on the assets that it had available during the year. An informed judgment about the firm's profitability requires relating net income to the assets used to generate that net income.