ACCT 208 CH 2
the stockholders' net claim on total assets; it has 2 components: common stock and retained earnings
Stockholders' equity
identify the assumption or principle that has been violated: Reported at its fair value of $260,000 merchandise inventory with a cost of $208,000.
Historical cost principle
_______ ratios measure the ability of a company to survive over a long period of time.
Solvency
Reports all changes in stockholders' equity accounts including: • Issuance of common stock • Retirement of common stock • Changes in retained earnings
Statement of Stockholders' Equity
Examples of Property, plant, and equipment assets
include land, buildings, machinery, delivery equipment, and furniture and fixtures
Indicate the proper balance sheet classification for the following account: patent
intangible asset
issues standards (IFRS) that have been adopted by many countries outside the US
international accounting standards board (IASB)
examples of long-term investments
investments of stocks and bonds of other corporations
What property, plant, and equipment assets is not depreciated?
land
Indicate the proper balance sheet classification for the following account: building
property, plant, and equipment
Expresses the mathematical relationship between one quantity and another
ratio
A tool that can be used to analyze financial statements and make more meaningful evaluations; Expresses the relationship among selected items
ratio analysis
Information that makes a difference in a decision
relevance
For information to be _____, it should have predictive and confirmatory value.
relevant
If information has the ability to make a difference in a decision scenario, it is _______. • Provides a basis for forecasts • Confirms or corrects prior expectations • Is timely
relevant
Information is free of error and bias
reliability
If information can be depended on, it is ________. • Is verifiable • Is a faithful representation • Is neutral • Comparability
reliable
oversees US financial markets and standard-setting
securities and exchange commission (SEC)
The ability of the enterprise to survive over a long period of time
solvency
provides financial information on sources and uses of a company's cash
statement of cash flows
Free cash flow fails to take into account that a company must...
• Invest in new property, plant, and equipment to maintain its current level of operations and • Maintain dividends at current levels to satisfy investors
the statement of cash flows presents information about cash inflows and outflows from what 3 things?
• Operating activities • Investing activities • Financing activities
earnings retained for use in the business
Retained earnings
Describes the events that caused changes and retained earnings for the period
Retained earnings statement
At December 31, 2014, Shorts Company had retained earnings of $2,184,000. During 2014, the company issued stock for $98,000, and paid dividends of $34,000. Net income for 2014 was $402,000. How much was the retained earnings balance at the beginning of 2014?
$1,816,000
Current liabilities are $10,000, long-term liabilities are $20,000, common stock is $50,000, and retained earnings totals $70,000. How much is total stockholders' equity?
$120,000
For what purpose might a company use free cash flow?
-Pay additional dividends -Pay off debts -Acquire property, plant, and equipment
The business will remain in operation for the foreseeable future
Going concern
A company purchased a tract of land on which it expects to build a production plant on in approximately five years. During the five years before construction, the land will be idle. In what classification should the land be reported?
A long-term investment
How to find retained earnings?
Add net income and subtract dividends from beginning balance of retained earnings to arrive at ending balance of retained earnings
investments of assets by stockholders in the company
Common stock
Different companies use similar accounting principles
Comparability
Allows the accountant to choose the accounting method that will be the least likely to overstate assets and income; Requires that companies write down inventory to market value if it is below cost; Requires that when the market value of inventory exceeds costs, the inventory is not increased but instead it is kept at cost
Conservatism
When preparing financial statements, a company should choose the accounting method that will be least likely to overstate assets or income
Conservatism
Company uses the same accounting methods from year to year
Consistency
______ means using the same accounting principles and methods from year to year within a company.
Consistency
2 types of constraints
Constraints
Companies should record assets at cost
Cost
Which of the following are constraints that allow a company to modify generally accepted accounting principles without jeopardizing the usefulness of the financial statements? -Relevance and faithful representation -Consistency and comparability -Timeliness and neutrality -Cost constraint
Cost constraint
Dictates that assets be recorded at their cost
Cost principle
Assets that are expected to be converted to cash or used in the business within a short period of time, usually one year
Current assets
Obligations that are supposed to be paid within the coming year
Current liabilities
equation for current ratio
Current ratio = current assets / current liabilities
Measures the percentage of assets financed by creditors
Debt to Total Assets Ratio
Debt to Total Assets Ratio
Debt to total assets ratio = total liabilities / total assets
Assumes business will be in existence for the foreseeable future; Allows use of capitalizing cost when recording assets
Going concern assumption
Every economic entity can be separately identified and accounted for
Economic entity assumption
identify the assumption or principle that has been violated: The president of Garcia Co., Sal Garcia, purchased a truck for personal use and charged it to his expense account.
Economic entity assumption
T/F Current assets are economic resources that are expected to be converted to cash or used up by the business within one year or the normal operating cycle, whichever is shorter.
False
T/F Substantial authoritative support for GAAP usually comes from two standards-setting bodies: the FASB and the IRS.
False
Requires all circumstances and events that would make a difference to financial statement users to be disclosed
Full disclosure principle
Are the agreed-upon accounting rules which most US companies use in preparing financial statements
Generally accepted accounting principles
What are the accounting rules that have substantial authoritative support and are recognized as a general guide for financial reporting purposes in the U. S.?
Generally accepted accounting principles
Rights, privileges, and competitive advantages that result from assets that have no physical substance; Non-current assets
Intangible assets
Which one of the following does not affect retained earnings? -Issuance of common stock -Dividends -Net income -Net loss
Issuance of common stock
If a company has the ability to pay obligations that are expected to become due within the next year or operating cycle whichever is longer, what is the term that describes this measure?
Liquidity
Short-term creditors such as bankers and suppliers are most interested in a company's _________ ratios.
Liquidity
The ability to pay short-term obligations as they come due
Liquidity
_______ ratios measure short-term ability to the company to pay its maturing obligations and to meet unexpected needs for cash.
Liquidity
Assets not used in the operations of the business that can be converted to cash in more than one year
Long-term investments
Obligations expected to be paid after one year
Long-term liabilities
Relates to financial statement item's impact on a company's overall financial condition and operations; An item is material if it **can influence the decision of an investor or creditor**; Companies do not have to follow GAAP for small amounts
Materiality
Only transaction data that can be expressed in money is included in accounting records
Monetary unit
Include in the accounting records only those things that can be expressed in terms of money
Monetary unit assumption
Cash inflows and cash outflows associated with the primary operations of the business; Intended to indicate the cash-generating capability of a company
Operating activities
identify the assumption or principle that has been violated: Garcia Co. wanted to make its 2014 income look better, so it added 2 more weeks to the year (a 54-week year). Previous years were 52 weeks.
Periodicity assumption
________ ratios measure the income or operating success of a company for a given period of time.
Profitability
frequently used as a test of managements effectiveness; Creditors and investors are interested in evaluating this
Profitability
Measure the income or operating success of an enterprise for a given period of time
Profitability ratios
Assets with relatively long useful lives that are used in the business
Property, plant, and equipment
determines auditing standards and reviews auditing firms
Public Company Accounting Oversight Board (PCAOB)
The economic life of a business can be divided into artificial time periods
Time period
Allows the life of the business to be divided into artificial time periods. These periods can be months, quarters, semi-annual periods, or annual periods as required by the business to evaluate its operations
Time period assumption
T/F GAAP is a set of rules and practices established by accounting standard-setting bodies to serve as a general guide for financial reporting purposes.
True
Measure of short-term ability to pay obligations; Excess of current assets over current liabilities
Working capital
equation for working capital
Working capital = current assets - current liabilities
Common examples of Current liabilities
accounts payable, wages payable, bank loans payable, interest payable, taxes payable, and current maturities of long-term bank loans payable
Some intangible assets are _______, and charged to the income statement as an expense, to indicate their contribution to the revenue-producing process for the period
amortized
examples of Long-term liabilities
bonds payable, mortgages payable, long-term notes payable, lease liabilities, and obligations under employee pension plans
Examples of current assets
cash, short-term investments, receivables, inventories and prepaid expenses
a company's most liquid asset
cash
Indicate the proper balance sheet classification for the following account: inventories
current asset
Indicate the proper balance sheet classification for the following account: accounts payable
current liability
Measure of short-term ability to pay obligations; More dependable indicator of liquidity than working capital
current ratio
Most property, plant, and equipment assets are _______, and charged to the income statement as an _______, to indicate their contribution to the revenue-producing process for the period.
depreciated; expense
Measures the net income earned on each share of common stock
earnings per share
formula for earnings per share
earnings per share= net income - preferred stock dividends / average common shares outstanding
______ means that information accurately depicts what really happened.
faithful representation
the primary standard-setting body in US
financial accounting standards board (FASB)
Examples of intangible assets
franchises, patents, copyrights, and trademarks or trade names
measurement to provide additional insight regarding a company's cash generating ability
free cash flow
equation of free cash flow
free cash flow= cash provided by operations-capital expenditures-cash dividends
An analysis of the relationship between a company's assets and liabilities provides information about what?
liquidity and solvency
How are current assets listed on the balance sheet?
listed in the order in which the company expects to convert them into cash (order of liquidity)
Indicate the proper balance sheet classification for the following account: bonds payable
long-term liability
A company can change to a new method of accounting if management can justify that the new method results in terms of
more meaningful financial information.
A classified balance sheet generally contains the following standard 7 classifications:
o Current assets o Long-term investments o Property, plant, and equipment o Intangible assets o Current liabilities o Long-term liabilities o Stockholders' equity
To develop accounting standards, the FASB relies on what key assumptions and principles?
o Monetary unit assumption o Economic entity assumption o Time period assumption o Going concern assumption o Cost principle o Full disclosure principle
In order to be useful, financial information should possess what qualitative characteristics?
o Relevance o Reliability o Comparability o Consistency
A classified balance sheet helps users evaluate:
o The company's ability to pay its debt o The claims of short-term and long-term creditors