Ch. 3-301
An asset that is generally not expected to be converted to cash or consumed within one year or the operating cycle is:
Building
Ratio analysis
Financial statement items are converted to ratios for evaluating the performance and risk of a company
ratio analysis
Financial statement items are converted to ratios for evaluating the performance and risk of a company.
Comparative financial statements
Financial statements that are accompanied by the corresponding financial statement of the preceding year, and often the previous two years
comparative financial statements definition
Financial statements that are accompanied by the corresponding financial statement of the preceding year, and often the previous two years.
Restricted cash example
These restrictions could include future plans to repay debt, purchase equipment, or make investments.
Inventory for a wholesale or retail company consists of
finished goods for sale to customers.
Unearned revenue represents cash received from a customer for goods or services to be provided in a(n) _________
future period
Cash restrictions include
future plans to repay debt, purchase equipment, or make investments.
Deferred revenues definition
sometimes called unearned revenues, represent cash received from a customer for goods or services to be provided in a future period
On January 1 of the current year, Lafferty signs a contract to rent a building for $1,000 per month for the next three years. On that date, Lafferty pays $36,000 for rent. On January 1 when payment is made, what is the amount of the prepaid rent that should be classified as a current asset?
$12,000
On January 1 of the current year, Lafferty signs a contract to rent a building for $1,000 per month for the next three years. On that date, Lafferty pays $36,000 for rent. On January 1 when payment is made, what is the amount of the prepaid rent that should be classified as a noncurrent asset?
$24,000
Long-term liabilities are obligations that are
(a) due to be settled or (b) have a contractual right by the borrowing company to be settled in more than one year (or operating cycle, if longer) after the balance sheet date. Examples are long-term notes, bonds, pension obligations, and lease obligations.
Management's discussion and analysis provides a biased but informed perspective of a company's
(a) operations, (b) liquidity, and (c) capital resources.
long term assets include
1. Investments 2. Property, plant, and equipment 3. Intangible assets 4. Other long-term assets
Rent collected in advance is:
A liability account in the balance sheet.
What is an unqualified opinion for an auditor?
An auditor issues an unqualified (or "clean") opinion when the auditor has undertaken professional care to ensure that the financial statements are presented in conformity with generally accepted accounting principles (GAAP)
An accrued liability represents which of the following?
An expense that has been incurred but will be paid in a future period.
operational risk definition
Another aspect of risk is operational risk, which relates more to how adept a company is at withstanding various events and circumstances that might impair its ability to earn profits.
Bear Corp. has $100,000 cash in the bank restricted to repay a note payable that matures in 2 years. How should this $100,000 be reported?
As restricted cash in the long-term section of the balance sheet.
What does an auditor do?
Auditors examine financial statements and the internal control procedures designed to support the content of those statements. Their role is to attest to the fairness of the financial statements based on that examination.
Cash equivalents would not include:
Cash not available for current operations.
Management's Report on Internal Control Over Financial Reporting:
Contains personal certification of the financial statements by the company's executives.
Disclosure notes would not include:
Data to adjust the financial statements so that they are not misleading.
what is a disclaimer for an auditor?
Disclaimer when the auditor is not able to gather sufficient information that financial statements are in conformity with GAAP
Horizontal analysis
Each item in a financial statement is expressed as a percentage of that same item in the financial statements of another year (base amount). For example, comparing inventory this year to inventory last year would provide the percentage change in inventory
horizontal analysis definition
Each item in a financial statement is expressed as a percentage of that same item in the financial statements of another year (base amount). For example, comparing inventory this year to inventory last year would provide the percentage change in inventory.
Vertical analysis
Each item in the financial statements is expressed as a percentage of an appropriate corresponding total, or base amount, but within the same year. For example, cash, receivables, and inventory in the current year can be restated as a percentage of total assets in the current year
vertical analysis
Each item in the financial statements is expressed as a percentage of an appropriate corresponding total, or base amount, but within the same year. For example, cash, receivables, and inventory in the current year can be restated as a percentage of total assets in the current year.
prepaid expenses example
Examples are supplies, prepaid rent, and prepaid insurance. These assets are not converted to cash, like receivables collected and inventory sold, but they instead are consumed in the future.
cash equivalent examples
Examples include certain negotiable items such as commercial paper, money market funds, and U.S. treasury bills. These items are listed as cash equivalents because they are highly liquid investments that can be quickly converted into cash with little risk of loss.
Typical classifications of long-term assets are as follows:
Investments Property, plant, and equipment Intangible assets Other long-term assets
What is the operating cycle for a typical merchandising or manufacturing company look like?
It refers to the period of time from the initial outlay of cash for the purchase of inventory until the time the company collects cash from a customer from the sale of inventory.
2 reasons why book value does not equal market value
Land and building are measured by historical costs rather than the amount for which the land could be sold Aspects of a company are valuable resources (trained employees, experienced management team, loyal customer relationships, product knowledge) but not recorded as assets on balance sheet
liquidity definition
Liquidity most often refers to the ability of a company to convert its assets to cash to pay its current liabilities.
long term solvency definition
Long-term solvency refers to an assessment of whether a company will be able to pay all its liabilities, which includes long-term liabilities as well. Other things being equal, the risk that a company will not be able to pay its debt increases as its liabilities, relative to equity, increase.
An analysis provided by the company's management is included in the
Management Discussion and Analysis.
two primary reasons that a company's book value in the balance sheet does not equal its market value are:
Many assets, like land and buildings, are measured at their historical costs rather than amounts for which the assets could be sold Many aspects of a company may represent valuable resources (such as trained employees, experienced management team, loyal customer relationships, and product knowledge). These items, however, are not recorded as assets in the balance sheet and therefore have zero book value.
what does market value represent?
Market value represents the price at which something could be sold in a given market.
Which of the following items are considered cash equivalents? (Select all that apply.)
Money market funds that are quickly converted to cash. Commercial paper due in 1 month. U.S. Treasury bills due in 2 months.
Which of the following are examples of prepaid expenses? (Select all that apply.)
Prepaid insurance. Rent paid in advance.
numerator includes for acid test ratio (quick assets)
The numerator consists of (unrestricted) cash, short-term investments, and accounts receivable, which are referred to as the "quick assets.
Liquidity refers to:
The readiness of an asset to be converted to cash.
How are current liabilities satisfied? (Select all that apply.)
The use of current assets. The creation of other current liabilities.
Which of the following describe long-term liabilities? (Select all that apply.)
They do not require the creation of current liabilities for payment. They do not require the use of current assets.
default risk definition
This is the risk that a company won't be able to pay its obligations when they come due
the 4 basic auditor report types are
Unqualified Unqualified with an explanatory or emphasis paragraph Qualified Adverse or disclaimer
Current assets include cash and all other assets expected to become cash or be consumed:
Within one year or one operating cycle, whichever is longer.
working capital definition
Working capital, the difference between current assets and current liabilities, is a popular measure of a company's ability to satisfy its short-term obligations
times interest earned ratio definition
a way to gauge the ability of a company to satisfy its fixed debt obligations by comparing interest charges with the income available to pay those charges.
__________ _____________ result from the sale of goods or services on credit. (Enter one word per blank.)
accounts receivable
An expense that has been incurred but not yet paid results is a(n)
accrued liability
The full-disclosure principle requires that financial statements provide
all material relevant information concerning the reporting entity
current assets include
cash and other assets that are reasonably expected to be converted to cash or consumed within one year from the balance sheet date, or within the normal operating cycle of the business if that's longer than one year.
Disclosure notes must include
certain specific notes such as a summary of significant accounting policies, descriptions of subsequent events, and related third-party transactions
look at...
ch 3 liquidity order
the balance sheet presents
an organized list of assets, liabilities and equity at a point in time
cash equivalents
are defined as short-term investments that have a maturity date no longer than three months from the date of purchase.
book value equals
assets minus liabilities as shown in the balance sheet
The financial statement that displays a firm's financial position on a particular date is the
balance sheet
The financial statement that provides information about liquidity and long-term solvency is the
balance sheet
Which of the following items is classified as cash?
bank drafts
A company's assets minus its liabilities shown on the balance sheet is referred to as its ______ value.
book
elements of current assets
cash cash equivalents short-term investments accounts receivable inventories prepaid expenses
Current assets include which of the following? (Select all that apply.)
cash short term investments
The two classifications used for assets and liabilities on the balance sheet are ______ and ______.
current and non current
A temporary investment or short-term marketable security should be reported in which section of the balance sheet?
current asset
Red Onion Restaurant would classify a six-month prepaid insurance policy as:
current asset
Inventories held for sale in the normal course of business are classified in the balance sheet as
current assets
working capital formula
current assets - current liabilities
current ratio
current assets divided by current liabilities
current ratio formula
current assets/current liabilities
A ______ is satisfied within 1 year or the current operating cycle, whichever is longer.
current liability
A ratio used to measure liquidity is the
current ratio
2 common measures of liquidity are
current ratio and acid-test ratio or quick ratio
2 common solvency ratios are
debt to equity ratio and times interest earned ratio
Which type of risk is the risk of a company not being able to pay its obligations when they come due?
default risk
What account is affected when a customer pays in advance for services to be performed in the future?
deferred revenue
Look at...
exercise 3-2 snippit
All illegal acts should be disclosed in the notes to the financial statements.
false
Intangible assets usually are reported in the balance sheet as current assets.
false
Subsequent events are significant developments that take place after a firm's year-end, and after the financial statements are issued or available to be issued.
false
True or false: Investments are assets used directly in the operations of the business.
false
Inventories include which of the following items? (Select all that apply.)
goods in production goods directly consumed in production finished goods
Accounts receivable usually are due ___ and are classified as ____
in 30 to 60 days, current assets
current assets definition
include cash and other assets that are reasonably expected to be converted to cash or consumed within one year from the balance sheet date, or within the normal operating cycle of the business if that's longer than one year.
debt to equity ratio definition
indicates the extent of reliance on creditors, rather than owners, in providing resources
Ownership of an exclusive right to something such as a product, a process, or a name is called what?
intangible asset
Land held for speculation, noncurrent receivables, and cash set aside for future plant expansion are all examples of
investment
investments include
investments in equity and debt securities of other corporations land held for speculation long-term receivables cash set aside for special purposes
short term investment
investments not classified as cash equivalents that the company has the ability and intent to sell within one year (or operating cycle, if longer) are reported as short-term investments.
equity definition
is the residual interest in the assets of an entity that remains after deducting liabilities. Stated another way, equity equals total assets minus total liabilities.
Other limitations of balance sheet are
items on balance sheet heavily rely on estimates and judgments concerning: the amount of receivables able to be collected the amount of warranty costs they will incur for products sold the useful life of a long term asset amount used to calculate employee pension obligation
On the balance sheet, current assets are listed in the order of their what?
liquidity
look at...
list a & b snippit
Nontrade receivables result from
loans or advances by the company to individuals and other entities.
When assets are expected to be converted to cash or consumed in more than one year (or operating cycle, if longer), they are reported as
long-term (or noncurrent) assets
Any receivable, regardless of the source, not expected to be collected within one year (or operating cycle, if longer) is classified as a
long-term investment.
book value will not directly measure
market value
Liquidity definition
most often refers to the ability of a company to convert its assets to cash to pay its current liabilities
The ability to pay its long-term debts as they become due is referred to as ______ of the company.
solvency
times interest earned ratio
net income + interest expense + income tax/interest expense
times interest earned ratio
net income + interest expense + tax expense / interest expense
Any receivable not expected to be collected within one year or the operating cycle, whichever is longer, is classified as a
non current asset
Which of the following items are included in investments? (Select all that apply.)
note receivable due in 5 years cash reserved to purchase land
When receivables are supported by a formal agreement or note that specifies payment terms they are called
notes receivable
Balance sheets often include a catch-all classification of noncurrent assets called
other long term assets
Assets do not include:
paid-in capital
Shareholders' equity for a corporation arises primarily from
paid-in capital retained earnings
assets definition
probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events. Simply, these are the economic resources of a company.
liabilities definition
probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events. Simply, these are the obligations of a company.
tangible long term assets include
property, plant, and equipment.
acid test ratio
quick assets/current liabilities
acid-test ratio or quick ratio formula
quick assets/current liabilities
A manufacturing firm will use which of the following accounts to record inventory? (Select all that apply.)
raw material finished goods work in process
current maturities of long term debt
refer to the portion of long-term notes, loans, mortgages, and bonds payable that is payable within the next year (or operating cycle, if longer)
Classifying items on the balance sheet as current and noncurrent assists financial statement users in assessing what aspects about a company?
solvency and liquidity
Long-term solvency
refers to an assessment of whether a company will be able to pay all its liabilities, which includes long-term liabilities as well.
Accrued liabilities definition
represent obligations created when expenses have been incurred but amounts owed will not be paid until a subsequent reporting period
market price can be calculated by
share price X the # of shares outstanding
Which of the following items are required disclosures in the notes to financial statements? (Select all that apply.)
significant accounting policies description of subsequent events related third-party transactions
A subsequent event is a
significant development that occurs after a company's fiscal year-end but before the financial statements are issued or available to be issued
balance sheet is sometimes referred to
statement of financial position
Which of the following are characteristics of plant, property, and equipment? (Select all that apply.)
tangible used long-term in production
financial flexibility
the ability of a company to alter cash flows in order to take advantage of unexpected investment opportunities and needs.
Solvency also provides information about financial flexibility which is
the ability of a company to alter cash flows in order to take advantage of unexpected investment opportunities and needs. For example, the higher the percentage of a company's liabilities to its equity, the more difficult it typically will be to borrow additional funds either to take advantage of a promising investment opportunity or to meet an obligation
capital structure definition
the mixture of liabilities and shareholders' equity in a company
When related-party transactions occur, companies must disclose
the nature of the relationship, provide a description of the transactions, and report the dollar amounts of transactions and any amounts due from or to related parties
In addition, receivables are typically reported ____
the net amount expected to be collected
intangible assets represent
the ownership of an exclusive right to something such as a product, a process, or a name, that can be a valuable resource in generating future revenues. Patents, copyrights, franchises, and trademarks are examples.
market value represents
the price at which something could be sold in a given market
Current liabilities are those obligations that are expected to be satisfied through
the use of current assets or the creation of other current liabilities
Assets are classified as long-term if:
they are expected to be converted to cash or consumed in more than one operating cycle
debt to equity ratio
total liabilities/share holders equity
Debt to Equity Ratio
total liabilities/stockholders equity
The net amount is calculated as
total receivables less an allowance for the estimate of uncollectible accounts.
Accounts receivable often are referred to as
trade receivables because they arise in the course of a company's normal trade
related party transaction
transactions with owners, management, families of owners or management, affiliated companies, and other parties that can significantly influence or be influenced by the company.
A payment on account has no effect on working capital but will increase the current ratio if it is already greater than 1.0.
true
All current assets are either cash or assets that will be converted into cash or consumed within 12 months or the operating cycle, whichever is longer.
true
Current liabilities are those obligations that are expected to be satisfied through the use of current assets or the creation of other current liabilities.
true
Management acknowledges responsibility and certifies accuracy of financial statements.
true
Prepaid expenses are classified as current assets if the services purchased are expected to expire within 12 months or the operating cycle, whichever is longer.
true
Restricted cash is classified as a current asset if it is expected to be used within one year from the balance sheet date. Otherwise, restricted cash is classified as a long-term asset.
true
The balance of net receivables represents the amount expected to be collected.
true
The criteria for determining which items comprise cash equivalents often is disclosed in the summary of significant accounting policies.
true
The most common current liabilities are accounts payable, notes payable (short-term borrowings), deferred revenues, accrued liabilities, and the currently maturing portion of long-term debt
true
The proxy statement contains disclosures on compensation to directors and executives.
true
True or false: The operating cycle for most firms is 1 year or less.
true
Which of the following are accrued liabilities? (Select all that apply.)
warranty liabilities salaries payable interest payable
prepaid expense arises
when a company incurs a cost of acquiring an asset in one period that won't be expensed until a future period.
What is a qualified opinion for an auditor?
when either the audit process has been limited (scope limitation) or there has been a departure from GAAP, but neither is of sufficient seriousness to invalidate the financial statements as a whole.
what is an adverse opinion for an auditor?
when the auditor has specific knowledge that financial statements or disclosures are seriously misstated or misleading. Adverse opinions are rare because auditors usually are able to persuade management to rectify problems to avoid this undesirable report.
A liability is classified as current if it is due
within 1 year or the current operating cycle, whichever is longer.