chapter 7 and 8 ACCT

1. What does a bond's coupon rate represent?

A bond's coupon rate, also known as the contract rate, is simply the interest rate per the loan agreement. It is always expressed an annual interest rate, even if interest is paid monthly.

1. What are dividends?

Dividends are distributions of earnings to shareholders. The most common form is a cash dividend, in which the shareholders receive a certain amount of cash based on the number of shares they each own. A company is not required to pay dividends but often does to incentivize investors to purchase its stock. When a dividend is declared, retained earnings is decreased.

1. How does straight-line depreciation compare to double declining?

Double declining depreciation accelerates the depreciation expense, meaning the company records more depreciation expense in the earlier years of the asset's useful life. Straight-line depreciation evenly depreciates the asset.

1. How is the gain or loss on the sale of a fixed asset calculated?

The gain or loss is calculated as the difference between the sales price of an asset and its carrying value (book value). Gain/(Loss) = Sales Price - (Cost - Acc Dep)

1. How is interest calculated?

The interest rate is always stated as the rate of interest for an entire year. So, if the note is for less than a year or if the note begins or ends in the middle of the year, the interest should be prorated. First, calculate the total interest amount for 12 months (the annual interest expense). This is equal to the amount of the loan (the face value) times the interest rate. Then, if the interest needs to be prorated for less than one year, divide the annual interest expense by 12 months and then multiply by the applicable number of months.

1. How is the Book Value (also known as Net Book Value and Carrying Value) calculated?

The original cost of the asset (what it was originally purchased for) minus the accumulated depreciation (the cumulative depreciation expense). This represents the net amount on the company's balance sheet.

1. What is a stock's par value (what does this represent)?

The par value is the monetary value assigned to each share - not the price of the share itself. This is a formality that is required to be decided on when a company incorporates. The par value has no impact on what the shares sell for on the open market. Typically par values are very low ($0.01).

1. What are the characteristics of a depletable natural resource?

They are: Naturally occurring; Removed from its land source for sale; and Removed and sold over more than one year

1. What is the different between fixed assets and intangible assets?

A fixed asset is a physical item that is used in the business. It is something that we can touch and feel. Examples include buildings, equipment, furniture, land (note, land is not depreciated though). Intangible assets are things that the company uses or that provide value to the company over a number of years but that are not physical things we can touch. They are generally acquired through innovative, creative activities or from purchasing the rights from another company. Examples include patents, copyrights, trademarks, and goodwill. *Note, there will be no amortization calculations on the exam.

1. How is depreciation expense calculated?

Annual depreciation expense equals the cost of the asset minus the residual value divided by the number of years in the asset's useful life. The residual value represents what the company expects to receive for the asset after its useful life is completed. When an asset is purchased or sold/disposed of during the year, be sure to prorate that year's depreciation expense for the number of months in the year (do not worry about the # of days in a month).

1. What a company issues a note, does this mean it is borrowing money or giving someone money?

Borrowing. The company is issuing a request for a loan.

1. What are the three different dividend dates and what is recorded on each date?

Date of Declaration - when the board of directors declares a dividend (as in, when it formally authorizes a dividend). On this date, the company decreases retained earnings and increases dividends payable to represent the amount it now owes its shareholders. Date of Record - the date that the company compiles its list of shareholders. Anyone owning a share of the company on this date will receive the dividend. The company does not record anything on this date. Date of Payment - when the company actually pays the dividend to the shareholders. On this date, the company decreases cash because it now finally paying the shareholders. It also decreases dividends payable because it no longer owes this amount to the shareholders (since it paid it).

1. What does a company record at the end of a note's term? What type of activity is this on the statement of cash flows?

Decrease cash for the amount of the loan (paying it back to the lender). Decrease notes payable for the amount of the loan (the face value, not the maturity value). If the company is also paying interest on the last day of the loan, the company would also record the above from #6. This is a financing activity, just like it was when we first received the loan.

1. What does a company record when it pays interest? What type of activity is this on the statement of cash flows?

Decrease cash for the interest paid. Decrease retained earnings for the interest expense (the amount paid). The interest expense is recorded on the income statement. This is an operating activity, not a financing activity.

1. What is depletion?

Depletion is similar to depreciation, except that it is applicable to natural resources. It represents our "using up" of the resource to then sell the resource. For example, if a company has large amounts of timber that it sells to customers, the company will record depletion as it cuts down the trees. *Note, there will be no depletion calculations on the exam.

1. How is depreciation recorded?

Depreciation expense is recorded on the income statement, which in turn decreases retained earnings. Accumulated depreciation (a contra asset) is increased. The fixed asset account itself (e.g. Equipment) is not impacted, but the overall carrying value of the asset decreases.

1. What does a company record when it sells a fixed asset?

First, it needs to record any depreciation expense not yet recorded as of the sale date. (If the asset is sold on March 31 but depreciation expense was last recorded on Dec 31, the company should record 3 months of depreciation expense.) Then: An increase in cash for whatever they are selling the asset for. Decrease the asset by its original cost (the balance should go to $0) Decrease the asset's accumulated depreciation by the current balance (the balance should go to $0). Note, when we say decrease acc dep, we're bringing it closer to zero. Even though we show a negative balance on our framework, we're still viewing this account as building up a balance as we record depreciation expense and then removing this balance when the asset is sold or disposed of. Increase Retained Earnings for any gain (if applicable) or Decrease Retained Earnings for any loss (if applicable)

1. What is the different between gross pay and net pay for an employee?

Gross pay is the total salary or wages for an employee. For example, a company has hired a sales clerk and agreed on a wage of $10 per hour. Net pay is the actual amount of money the employee is paid. Various deductions such as income taxes, payroll taxes, insurance, retirement contributions, etc. are subtracted from the gross pay to calculate the net pay. Using the same example as above, if the sales clerk works 40 hours per week, she will not actually receive $400 that week. The amount of her paycheck will be closer to $250, due to the various deduction that have been taken out of her gross pay.

1. What does a company record when it issues a note? What type of activity is this on the statement of cash flows?

Increase cash for the amount of money received (which will be the face value). Increase Notes Payable (or Bonds Payable if it's a bond) for the face value of the note (the amount of the loan), not the maturity value. This is a financing activity.

1. What do we record when common stock is issued?

Increase cash for the total amount received for the shares issued. This dollar amount will either be provided in the problem or the problem will say "# of shares were issued for $X per share", which case you would multiply the two numbers to calculated the total dollar amount. Increase Common Stock for the total par value issued (# of shares x the par value per share) Increase Paid-In Capital in Excess of Par for the excess of the total amount issued over the par value. This would equal the total cash increase minus the common stock increase. You should see that total equity increases by the same amount as the cash received.

1. If a fixed asset is disposed of (I.e. given away with $0 in return) after the last day of its useful life, will the company record a gain, loss, or neither?

Neither. It will record no gain or loss. It will simply remove the asset from its books. Going off the same logic as stated above, there is no more depreciation expense remaining. Since we're disposing of it after its useful life is over, we have fully used up what we expected to from the asset. Its book value on disposal date is $0 and we're getting $0 in return. Thus, no gain or loss. Note, the above assume the asset has no residual value. Technically, if the company estimated a residual value and then disposed of the asset rather than selling it, it would record a loss for that residual value. The residual value represents what the company estimated it would receive for the asset at the end of its useful life. So it the company then just disposed of the asset rather than selling it for that amount, it would need to record that loss.

1. If a fixed asset is sold for less than what it was originally purchased for, will it always record a loss?

No, not always. When calculating the gain/loss, we compare the sales price to the book value - not the original cost. The book value represents our current value of the asset, after depreciating the asset for any number of years. For an example, an asset was purchased for $100,000 and has a 5 year useful life. No residual value. Four years later, it was sold for $50,000. Even though the sales price is less than the original cost, the company will still record a gain of $30,000. Gain = $50,000 - ($100,000 - $80,000 Acc Dep) = $30,000

1. Is depreciating an asset considered a cash flow that must be reported on the statement of cash flows?

No. Depreciation expense does NOT affect the cash account, and thus is not reported on the statement of cash flows as a cash flow activity.

1. What are each of the four main types of intangible assets and label whether it is amortized or not?

Patent: (amortized) Exclusive right to benefit from an innovation Copyright: (amortized) Exclusive right to publish and sell a literary, artistic, or musical composition Trademark: (not amortized) Name, term, or symbol used to identify a business and its products Goodwill: (not amortized) Created from purchasing another company. Represents the potential earnings potential of that company due to favorable factors, such as location, product quality, reputation, and managerial skill

1. What is a contingent liability?

Potential liabilities that may arise from past transactions if certain events occur in the future. For example, a company is being sued by a former customer after the customer was injured on the company's property. The case has not yet gone to court. The company might record a contingent liability for the estimated payout it thinks it will need to pay. Companies should record contingent liabilities if the payment is probable and estimable.

1. What is the difference between shares authorized, issued, and outstanding?

Shares authorized is the number of shares a company is legally authorized to sell, per its articles of incorporation it filed when it was first formed. Shares issued is the number of shares owned by either the company or a shareholder. (Basically the number of shares actually out there owned.) Shares outstanding is the portion of shares issued that are owned by an outside party, as in someone other than the company itself. Shares outstanding is equal to shares issued minus the treasury stock (shares owned by the company itself).

1. What is the different between the face value and maturity value of a note or bond?

The face value is the actual amount of the loan. The maturity value is the total amount the borrower will end up paying over the life of the loan (the amount of the original loan plus all the interest paid over the life of the loan).

1. When a company purchases its own stock, which of the above is impacted? What kind of stock do we call this repurchased stock?

This is called treasury stock. The number of shares outstanding is decreased when this happens. The number of shares issued and authorized is not impacted. Treasury stock is a contra equity account. As in, as the company buys its own shares and increases Treasury Stock, the total equity balance decreases. It essentially like when a company buys its own stock, rather than taking it out of the common stock account, we instead record it to the treasury stock account so that we can keep track of how many shares the company owns.

1. If a fixed asset is sold for more than its book value, will the company record a gain or loss?

Yes, a gain. If a company sells an asset for more than its current balance on the balance sheet (its book value), the company will record a gain. Note, if the sales price is less than the book value, the company will record a loss.

1. If a fixed asset is disposed of (I.e. given away with $0 in return) before it is fully depreciated, will it always record a loss?

Yes, the loss will equal the remaining depreciation that has not yet been recorded. This represents the use of the asset that we expected to get out it that we did not. Using the same numbers as above, except the company disposed of the asset rather than selling it. The loss will equal $20,000, which is equal to the book value, which is equal to the remaining depreciation. (Loss) = $0 - ($100,000 - $80,000) Note, the above assume the asset has no residual value. Technically, if the company estimated a residual value and then disposed of the asset rather than selling it, it would also include the residual value in the loss. The residual value represents what the company estimated it would receive for the asset at the end of its useful life. So if the company then just disposed of the asset rather than selling it for that amount, it would need to record that loss.