input
stringlengths 3
64
| output
stringlengths 40
3.16k
| Instruction
stringclasses 1
value |
|---|---|---|
Working Capital | Working capital is defined as current assets minus current liabilities. Therefore, a company with current assets of $43,000 and current liabilities of $38,000 has working capital of $5,000. | This is a cheet sheet Question |
Current Assets | Current assets are a company’s resources that are expected to be converted to cash within one year of the balance sheet’s date. (However, in industries having operating cycles that are longer than one year, the current assets are the resources that are expected to be converted to cash within the operating cycle.) Current assets are usually listed in the general ledger and on the balance sheet in the order in which they normally turn into cash. This is referred to as their order of liquidity. The typical order is shown here: • Cash (currency, checking account balances, money received but not yet deposited, petty cash) • Cash equivalents • Temporary investments • Accounts receivable • Inventory • Supplies • Prepaid expenses | This is a cheet sheet Question |
Current Liabilities | Current liabilities are the company’s obligations that will come due for payment within one year of the balance sheet’s date. (In industries with operating cycles that are longer than one year, the current liabilities are the obligations that will come due within the operating cycle.) Current liabilities are not listed in the order in which they need to be paid. However, it is common to see the current liabilities presented on the balance sheet in the following order: For personal use by the original purchaser only. Copyright © AccountingCoach®.com. • Short-term notes payable • Accounts payable • Accrued wages and other payroll related expenses • Other accrued expenses/liabilities (utilities, repairs, interest, etc.) • Customer deposits • Deferred revenues • Others If a current liability is assured of being replaced with a long-term liability, it should be reported as a long-term liability. | This is a cheet sheet Question |
Operating Cycle | If a company sells goods (products, component parts, etc.) its operating cycle is the time it takes for a company’s money to purchase the inventory items and for the money from their sale to return to the company’s checking account. To illustrate, assume a company purchases goods for inventory and it takes the company 120 days to sell the inventory to customers who are given trade credit terms. Next, assume that the company collects the customers’ money 45 days after the sale. This company’s operating cycle is 165 days as shown here: Since the operating cycle of 165 days is less than one year, a current asset for this company will be a resource that is expected to turn to cash within one year of the date shown in the heading of the balance sheet. A current liability will be an obligation that is due within one year of the balance sheet’s date (unless there is assurance that the liability will be replaced with a long-term liability). For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Liquidity | Liquidity refers to a company’s ability to pay its bills as they come due. In accounting terms, we might say that liquidity is a company’s ability to convert its current assets to cash before the current liabilities must be paid. Current assets are reported on a company’s balance sheet in their order of liquidity. Since cash is the most liquid asset, it will appear first followed by the current assets that can be quickly turned into cash: cash equivalents, temporary investments, and accounts receivable. The remaining current assets will follow in this order: inventory, supplies, and prepaid expenses. If a company has most of its current assets in inventory, the company may have a large amount of working capital but may not have the liquidity necessary to pay its current liabilities when they come due. In contrast, another company with a small amount of working capital with little inventory may have the liquidity it needs. (This can occur if a company sells high-demand products through its online website and the customers pay with credit cards when ordering.) Thus, the speed at which a company’s current assets can be converted to cash is as important as the amount of working capital. A company’s liquidity is also influenced by the credit terms granted by its suppliers. For example, one company may have to pay cash when it receives goods from its suppliers, while another company is permitted to pay 30 or 60 days after receiving the goods. If a company is permitted to pay its suppliers by using its business credit card, it will mean the company’s cash payment can be delayed for 27 to 57 days. With accrual accounting, credit terms and paying with a business credit card will help the company’s liquidity but will not increase the amount of working capital. Lastly, but perhaps most importantly, a company’s liquidity is affected by the profitability of its business operations. If a company has operating profits because its revenues are greater than its expenses, the company’s working capital and liquidity is more likely to increase. (If the company has operating losses, the company’s liquidity is more likely to decrease.) Operating profits also make it easier for a company to obtain money from long-term lenders or investors in order to increase the company’s working capital and liquidity. On the other hand, operating losses make it difficult to obtain such financing. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Working Capital Ratios | In addition to calculating the amount of working capital (current assets minus current liabilities), there are two financial ratios directly associated with working capital and liquidity: • Current ratio (sometimes referred to as the working capital ratio) • Quick ratio (also known as the acid-test ratio) The current ratio is the total amount of current assets divided by the total amount of current liabilities. The quick ratio is the amount of “quick” assets divided by the total amount of current liabilities. The quick assets are cash, temporary investments, and accounts receivable. To illustrate the calculations, assume a company has the following current assets: Current assets Cash $ 24,000 Temporary investments 6,000 Accounts receivable 100,000 Inventory 198,000 Supplies 8,000 Prepaid expenses 4,000 Total current assets $ 340,000 Also assume that the total amount of the company’s current liabilities is $200,000. Based on our assumptions, the company has the following metrics: Working capital = $140,000 ($340,000 minus $200,000) Current ratio = 1.7 to 1 ($340,000 divided by $200,000) Quick ratio = 0.65 to 1 ($130,000* divided by $200,000) *The quick assets consist of cash, temporary investments, and accounts receivable For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Accounts Receivable | Accounts receivable result from selling goods (or providing services) and allowing the customers to pay at a later date (perhaps in 10, 30, or 60 days). At the time of the sale, the seller transfers ownership of the goods to the customer and in turn becomes one of the customer’s unsecured creditors until the money is collected. This means the seller is at risk for a potential loss if the customer fails to pay. Therefore, it is imperative that the seller be certain that potential and current customers are credit worthy before shipping goods on credit. To avoid the risk of such a loss, the seller could require some of its potential and current customers to pay when the goods are delivered or to pay with a business credit card at the time of delivery. | This is a cheet sheet Question |
Accounts Receivable Ratios | There are two ratios/metrics that are calculated for reviewing a company’s success in collecting its accounts receivable: • Accounts receivable turnover ratio (or receivables turnover ratio) • Average collection period (or days’ sales in accounts receivable) The accounts receivable turnover ratio is calculated by dividing a company’s net credit sales for a year by the average balance in accounts receivable during the year. Outside of your own company, the financial information may not be available. Here are some examples: • A company may not distribute its financial statements to outsiders • Only total sales are reported. Credit sales are not listed seperately. • Sales took place throughout the year, but the amount of inventory is the amount at the final moment of the accounting year • The inventory at the final moment of the year may be much smaller than the inventory throughout the year To calculate the accounts receivable turnover ratio and the average collection period, let’s assume that in the most recent year all of a company’s sales were credit sales in the amount of $2,000,000 For personal use by the original purchaser only. Copyright © AccountingCoach®.com. and its accounts receivable had an average balance throughout the year of $250,000. Given these assumptions, the company will have: Accounts receivable turnover ratio = $2,000,000 of net credit sales divided by the average accounts receivable balance of $250,000 = 8 times. Average collection period = 360 or 365 days divided by the accounts receivable turnover ratio of 8 times = 45 or 45.6 days. | This is a cheet sheet Question |
Inventory | If a company sells goods (products, component parts, etc.), it is common for inventory to be its largest current asset. Having sufficient inventory is necessary to serve and retain customers, but too much inventory can result in excessive expenses (including potential losses if any of the goods become obsolete). Slow-moving inventory may also cause a liquidity problem since the company’s cash is now sitting in the warehouse as inventory. The inventory needs to be sold for the company to have the cash to pay its current liabilities. | This is a cheet sheet Question |
Inventory Ratios | The following ratios are often computed to see how a company has managed its inventory: • Inventory turnover ratio • Days’ sales in inventory The inventory turnover ratio is best calculated by using the following amounts from the most recent year: the cost of goods sold divided by the average balance in inventory. The cost of goods sold is used because typically the inventories are recorded and reported at cost (not at selling prices). The average inventory amounts during the year are known to people within a company, but outsiders may know only the amount as of the final moment of the accounting year. Since U.S. companies often end their accounting years when their business activity is slowest, the inventory cost reported on their balance sheets may be less than the average of the inventory amounts throughout the year. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. To illustrate the inventory ratios, we will assume that a company’s cost of goods sold for the most recent year was $1,440,000 and that the average amount of inventory throughout the same year was $480,000. Given these assumptions, the company will have: Inventory turnover ratio = the cost of goods sold of $1,440,000 divided by the average inventory of $480,000 = 3 times. Days’ sales in inventory = 360 or 365 days divided by the inventory turnover ratio which was 3 times = 120 or 121.7 days. These metrics are averages because sales do not occur evenly throughout the year. In addition, some inventory items may turn over quickly while some items are rarely sold. | This is a cheet sheet Question |
Financial Ratios in General | When financial ratios are calculated using the amounts reported on a company’s financial statements, the ratios reflect the transactions that occurred perhaps a year ago. It is possible that today the demand for some products has changed, new competitors entered the market, economic conditions changed, etc. Financial ratios allow a company to track the trend of its own ratios over several years. It could also be helpful when comparing one company’s financial ratios to those of another company within the same industry. However, the ratios may be of no value when they are compared to the ratios of companies in different industries. Within a company, the financial ratios based on the prior year’s summarized amounts are less valuable than current, detailed information. For example, the accounts receivable turnover ratio based on last year’s amounts is less valuable/relevant than an aging of today’s accounts receivable. Similarly, an inventory turnover ratio based on last year’s summarized amounts is less valuable than a report comparing the current quantities of every inventory item on hand with the quantity sold in the recent past. This report will expose the inventory items not turning over. | This is a cheet sheet Question |
Cash Flow Statement | Since liquidity depends on a company having the cash to pay its obligations when they come due, insights can be gained from reading a company’s statement of cash flows (SCF or cash flow statement). While the SCF may be difficult to prepare, you can read and understand it with a little coaching. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. The SCF organizes a company’s main cash inflows and cash outflows into three major sections: 1. Cash flows from operating activities which typically begins with net income (based on the accrual method of accounting) and then lists the adjustments necessary to arrive at the cash from its business operations. The adjustments include the adding back of noncash expenses such as depreciation, and the changes in the working capital accounts (except for short-term loans which are included as part of financing activities). 2. Cash flows from investing activities which includes the purchase and/or sale of long-term assets. 3. Cash flows from financing activities which includes borrowing and/or repaying of short- term and long-term debt, issuing and/or repurchasing of capital stock, declaring of dividends to stockholders, and draws made by an owner. | This is a cheet sheet Question |
Cash flows from operating activities | We will focus on the first section of the SCF, cash flows from operating activities, which shows the adjustments made to convert the working capital accounts (except for short-term loans payable). The adjustments involve the changes in the balances at the end of the year minus the balances from one year earlier. Let’s clarify this with some examples using hypothetical amounts: • If the balance in accounts receivable was $50,000 at the end of the year and was $38,000 one year earlier, the accounts receivables increased by $12,000. An increase in accounts receivable is not good for the company’s liquidity since less was collected than was sold. Since this increase in accounts receivables is unfavorable or negative for the company’s cash balance and its liquidity, the $12,000 will be reported in parentheses: (12,000). • If the balance in inventory was $250,000 at the end of the year and was $270,000 one year earlier, the inventory had decreased by $20,000. A decrease in inventory indicates that for the year the company did not have to buy $20,000 of the goods that it had sold. This is good for a company’s liquidity. Since a decrease of $20,000 in inventory is favorable or positive for the company’s cash balance and its liquidity, the decrease in inventory will be reported on the SCF as a positive amount: 20,000. • If accounts payable had a balance of $60,000 at the end of the current year and was $53,000 one year earlier, it indicates that accounts payable increased by $7,000 during the year. An increase in accounts payable is good for the company’s cash balance and liquidity since less cash was paid out. Since the increase in accounts payable (or other current liabilities) is favorable or positive for the company’s cash balance and liquidity, the increase in accounts payable will be reported on the SCF as a positive amount: 7,000. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. From these three examples, you should remember the following when reading the SCF: • An amount in parentheses is not good, is unfavorable, is negative for a company’s cash balance and liquidity • A positive amount is good, is favorable, is positive for a company’s cash balance and its liquidity | This is a cheet sheet Question |
Operating Cash Flow Ratio | A financial ratio for assessing a company’s working capital and liquidity that is based on the statement of cash flows is: Operating cash flow ratio = net cash flows from operating activities divided by the average amount of current liabilities throughout the year Since the net cash provided by operating activities is likely the amount from the SCF of a recent year, it needs to be divided by the average amount of current liabilities throughout the same year. (Using only the amount of current liabilities at the final instant of one or two accounting years may not be representative of the amounts during the year.) To illustrate this ratio, let’s assume that a company’s SCF for the recent year reported net cash provided by operating activities of $200,000. For the same year it was determined that the average amount of current liabilities during the year was $300,000. Inserting those amounts into the formula, we have: Operating cash flow ratio = net cash provided by operating activities divided by average current liabilities = $200,000 divided by $300,000 = 67%, or 0.67:1, or 0.67 to 1 | This is a cheet sheet Question |
Reasons Why Liquidity Will Decrease | Below is a list of reasons why a company’s liquidity may decrease. The list is organized according to the three sections of the statement of cash flows. Since these items decrease the company’s liquidity, they can be thought of as being unfavorable or as having a negative effect on the company’s liquidity. They are also reported in parentheses on the statement of cash flows. Operating activities Net loss from the business operations Accounts receivable increased For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Inventory increased Prepaid expenses increased Accounts payable decreased Investing activities Capital expenditures (purchase of equipment, etc.) Purchase of long-term investments Financing activities Repayment of short-term and long-term borrowings Declaring dividends on capital stock Purchase of treasury stock Draws by an owner | This is a cheet sheet Question |
Reasons Why Liquidity Will Increase | The following are reasons why a company’s cash and liquidity could increase. The list is also arranged according to the three sections of the statement of cash flows. Since these items are increasing the company’s liquidity, they can be thought of as being favorable or having a positive effect on the company’s liquidity. The amounts for these items will appear on the statement of cash flows as positive amounts. Operating activities Net income from the business operations Accounts receivable decreased Inventory decreased Prepaid expenses decreased Accounts payable increased Investing activities Proceeds from the sale of assets used in the business Proceeds from the sale of long-term investments Financing activities Short-term and long-term borrowings Proceeds from issuing shares of common and preferred stock Proceeds from sale of treasury stock Additional investments by an owner To learn more about the statement of cash flows see our separate topic Cash Flow Statement. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Stockholders’ Equity | A business corporation’s owners are referred to as stockholders or shareholders because they hold stock certificates which provide evidence of their share of ownership in the corporation. Hence, the balance sheet of a business corporation will report the following: Assets = Liabilities + Stockholders’ Equity Stockholders’ equity (along with corporation’s liabilities) can be viewed as: • Sources of a corporation’s assets, and/or • Claims against the corporation’s assets. (However, the liabilities (creditor’s claims) come ahead of the stockholders’ claims.) The stockholders’ equity section of the balance sheet consist of the following components: • Paid-in capital (or contributed capital) • Retained earnings • Accumulated other comprehensive income • Treasury stock (however, this is a deduction/negative amount) The changes which occurred during an accounting year are reported in the annual statement of stockholders’ equity, which is one of the five required external financial statements. | This is a cheet sheet Question |
Paid-in Capital or Contributed Capital | Paid-in capital or contributed capital is the first component listed in the stockholders’ equity section of the balance sheet. It includes the amounts that the corporation received from investors when the corporation issued its shares of capital stock. (Capital stock is used to describe both common and preferred stock.) All corporations issue common stock, but a few will also issue preferred stock. If preferred stock is issued, the amounts received will be reported separately from the amounts received for its common stock. If any of the shares of stock have par values or stated values, those amounts are listed separately. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Common Stock Common stock is the capital stock that is issued by all U.S. business corporations. (Relatively few corporations issue preferred stock in addition to the common stock.) The holders of common stock: • Elect the corporation’s directors • Vote on significant issues such as its acquisition by another corporation • Receive dividends if declared by the board of directors Depending on state laws, each share of common stock could have a par value, a stated value, or neither. If the shares have a par or stated value, that amount is reported separate from the amount in excess of the par or stated value. When approved by a corporation’s board of directors, the common stockholders will receive cash dividends based on the number of shares of common stock owned. | This is a cheet sheet Question |
Preferred Stock | In addition to common stock, a few corporations also issue preferred stock. These shares have a preferential treatment as far as dividends and liquidation. This means that stockholders of the preferred shares of stock must receive their dividends before the corporation can pay a dividend on its common stock. The dividend for the preferred stock is based on its stated dividend rate and the par value of the preferred stock. For example, each share of 6% preferred stock with a par value of $100 must be paid its $6 per year dividend before the common stockholders will receive any dividend. (Only participating preferred stock will receive more than the stated dividend.) When the stock is cumulative preferred, any past omitted preferred dividends plus the preferred stock’s current dividend must be paid before a dividend can be given to the common stockholders. Any past omitted dividend on the cumulative preferred stock is known as a dividend in arrears and it must be disclosed in the notes to the financial statements. | This is a cheet sheet Question |
Par Value or Stated Value | The par value or stated value of shares of stock is a legal amount (based on state laws) that must be recorded and reported separately from the amounts received in excess of the par or stated value. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. The par value of a corporation’s preferred stock (if any is issued) will determine the dividends for the preferred stockholders. For example, a 6% $100 par value preferred stock will receive a $6 per year dividend. However, the shares of common stock often have no par value or a very small par value. | This is a cheet sheet Question |
Retained Earnings | Generally, retained earnings are the cumulative amounts of the corporation’s earnings or net income since the corporation began minus the cumulative amounts of dividends that the corporation declared since the corporation began. The amount of retained earnings is reported separately in the stockholders’ equity section of the balance sheet and must be a positive amount (a credit balance) in order for the corporation to declare and pay dividends to its stockholders. For successful corporations the amount of retained earnings is often many times the amount of its paid- in capital. | This is a cheet sheet Question |
Accumulated Other Comprehensive Income | Accumulated other comprehensive income is a separate line within the stockholders’ equity section of the balance sheet. While retained earnings reports the cumulative amounts of earnings or net income, accumulated other comprehensive income reports the cumulative amount of the other comprehensive income or loss. (Other comprehensive income involves gains or losses on hedging transactions, foreign currency translation adjustments, and a few others.) | This is a cheet sheet Question |
Treasury Stock | Treasury stock is usually the amount that a corporation has paid to repurchase some of its own shares of stock (and has not reissued or retired the shares). The corporation’s cost is debited to the general ledger account Treasury Stock. This debit balance will appear as a subtraction near the end of the stockholders’ equity section of the balance sheet. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Cash Dividend | A cash dividend is a distribution of cash by a corporation to its stockholders. The dividend amount will reduce the balance in the account Retained Earnings (as well as reduce the corporation’s cash). In order for a corporation’s board of directors to declare a cash dividend, the Retained Earnings must have a positive, credit balance. | This is a cheet sheet Question |
Stock Dividend | A stock dividend is a distribution of additional shares of a corporation’s own shares of stock to its existing stockholders. For instance, if a corporation declares a 5% common stock dividend and the corporation has 100,000 shares of common stock outstanding, the corporation will be issuing and distributing 5,000 additional shares of common stock. After the stock dividend there will be 105,000 shares outstanding (instead of 100,000) but the total amount of the corporation’s assets, liabilities, and stockholders’ equity do not change. The journal entry to record the declaration of a stock dividend will usually debit Retained Earnings for the market value of the new shares and will credit the paid-in capital accounts for the same total amount. | This is a cheet sheet Question |
Stock Split | A stock split reduces the market value per share of common stock by increasing the number of shares outstanding. If the market value of a share of common stock was $60 before a 2-for-1 stock split, the market value per share of common stock should be approximately $30 after the stock split. If the corporation had 300,000 shares of $10 par value common stock outstanding and it declares a 2-for-1 stock split, the corporation will have 600,000 shares of $5 par value common stock after the stock split. No journal entry is necessary since the total amounts of the stockholders’ equity are unchanged. A memo is entered to indicate the stock split and to note the new total number of common shares and the new par value per share. | This is a cheet sheet Question |
Declaration Date | The declaration date is the date that the board of directors declares a dividend to the corporation’s stockholders. The declaration date is used to record a credit to the liability account Dividends Payable and a debit to the account Retained Earnings (or the temporary account Dividends). For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Payroll Accounting | Payroll accounting involves the recording of a company’s: • Gross wages, salaries, commissions, bonuses, overtime premium, sick pay, holiday pay, and vacation pay that are earned by the employees • Payroll taxes which include 1) the taxes that are withheld from the employees’ pay, 2) payroll taxes that are paid solely by the employer, and 3) the payroll taxes that are withheld from the employees’ gross pay and also paid by the employer • Payments to employees for their net pay (the amount remaining after withholdings for taxes and other amounts are deducted from each employee’s gross pay) • Remittance of withholdings and the employer’s payroll obligations to governments and others • Costs of fringe benefits provided by the employer (medical insurance, dental insurance, life insurance, disability insurance, and retirement plans) • Workers’ compensation insurance, which covers medical claims and lost wages when an employee cannot work because of a work-related injury | This is a cheet sheet Question |
Wages or Gross Wages | Wages or gross wages usually refers to the pay earned by hourly-paid employees. These employees are paid hourly rates of pay for the number of hours worked. If these employees have a work week that begins on Sunday and ends on Saturday, their pay date is typically the Thursday or Friday following the work week. This allows the employer a few days to prepare the hourly-paid employees’ paychecks. (The term gross wages emphasizes that the amounts are before withholdings for taxes and other deductions.) For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Salaries or Gross Salaries | Salaries or gross salaries refers to the pay earned by employees who are paid a fixed or constant amount for each pay period. For example, an office manager that is compensated with an annual salary of $52,000 will have a monthly salary of $4,333; a semi-monthly salary of $2,167; a biweekly salary of $2,000; or a weekly salary of $1,000. Since the paychecks reflect a constant amount, the paychecks of salaried employees often cover the work period up to and including the date of the paychecks. (The term gross salaries emphasizes that the amounts are before any withholdings for taxes and other deductions.) | This is a cheet sheet Question |
Semi-monthly | Semi-monthly means two times per month. For instance, a salaried employee might be paid on the 15th day of the month and the last day of the month. An employee with an annual salary of $52,000 would have a gross salary of $2,167 for each of the 24 semi-monthly pay periods in the year. | This is a cheet sheet Question |
Bi-weekly | Bi-weekly means every two weeks (such as every other Friday). In most years, there will be 26 bi- weekly pay periods. An employee with an annual salary of $52,000 would have a gross salary of $2,000 for each of the 26 bi-weekly pay periods in a year. | This is a cheet sheet Question |
Overtime | Generally, overtime refers to an employee’s hours that exceed 40 hours in a work week. The hours in excess of 40 hours per week must be compensated for unless the employee is exempt from overtime pay. Merely classifying a low-paid employee as salaried does not eliminate the need to pay overtime pay. As a result, a salaried employee with an annual salary of $20,000 must receive additional compensation for the hours worked that are in excess of 40 hours in a work week. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Overtime Premium | Overtime premium is the additional amount per hour that is paid to employees for the overtime hours. To illustrate, let’s assume that a company pays “time-and-a-half” for hours worked that are greater than 40 hours during the work week. If an employee earns $9 an hour (the straight-time hourly rate), the overtime premium is $4.50 per hour (half of $9.00). Therefore for every hour worked that is in excess of 40 hours in a work week, the employee will be paid $13.50 instead of the straight-time rate of $9 per hour. | This is a cheet sheet Question |
Exempt Employee | An exempt employee refers to an employee who is not entitled to receive overtime pay when working more than 40 hours in a work week. For example, a company’s vice president of sales earning $125,000 per year is an exempt employee because the person earns a high salary and the person can control the number of hours worked. (On the other hand, a clerk earning an annual salary of $20,000 is a nonexempt employee because the person’s salary is low and the person is unlikely to be able to control the number of hours that are worked.) | This is a cheet sheet Question |
Payroll Withholdings | Payroll withholdings refers to the amounts deducted from an employee’s gross wages, salaries, etc. Examples of payroll withholdings include the employee’s portion of the Social Security and Medicare taxes, personal income taxes, medical insurance contributions, retirement plan contributions, garnishments, etc. | This is a cheet sheet Question |
Net Pay | Net pay is the employee’s gross pay minus the withholdings. Net pay is also known as an employee’s take-home pay or the amount that an employee clears on their paycheck. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Social Security Taxes | Social Security taxes are paid by both the employee and the employer. Usually the rate for each has been 6.2% of the employee’s gross pay. In other words, if an employee earns $100,000 in a year, the employee will have $6,200 of withholding for Social Security tax, and the employer will also incur an expense of $6,200. This means the employer is required to remit $12,400 during the year. For the year 2024, there is a ceiling on the wages, salaries, etc. of $168,600 per employee that are subject to the Social Security tax. (Current rates and ceiling amounts are available at irs.gov.) The combination on the Social Security tax and the Medicare tax is known as FICA. | This is a cheet sheet Question |
Medicare Taxes | Medicare taxes are also paid by both the employee and the employer. The basic rate for each is 1.45% of the employee’s gross pay (with no annual ceiling). If an employee earns $100,000 in a year, the employee will have $1,450 of withholding for the Medicare tax, and the employer will also incur an expense of $1,450. This means the employer is required to remit $2,900 during the year. The combination of the Medicare tax and the Social Security tax is known as FICA. There is also an Additional Medicare Tax of 0.9% that applies to highly-paid employees. | This is a cheet sheet Question |
FICA | FICA is the acronym for Federal Insurance Contributions Act. FICA refers to the combination of the Social Security tax and the Medicare tax. | This is a cheet sheet Question |
Employer’s Tax Guide | Employer’s Tax Guide (also known as IRS Publication 15 or Circular E) is a guide to U.S. payroll taxes. It is published annually by the Internal Revenue Service and it can be downloaded from irs.gov at no cost. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
State Unemployment Tax | State unemployment tax is a tax paid by the employer. However, the amount of the tax is calculated by multiplying the company’s state unemployment tax rate times each of its employee’s annual wages, salaries, etc. up to a ceiling amount which varies from state to state. The unemployment benefit payments to employees are funded by this tax. | This is a cheet sheet Question |
Federal Unemployment Tax | Federal unemployment tax is a tax paid by the employer. However, the amount of the tax is calculated by multiplying 0.6% (rate depends on credits allowed) times each employee’s annual wages, salaries, etc. up to a ceiling amount of $7,000. | This is a cheet sheet Question |
Worker Compensation Insurance | Depending on the number of employees, companies must provide worker compensation insurance to 1) pay the medical costs for work-related injuries or illnesses, and 2) provide compensation to the employee until the worker is able to return to work. | This is a cheet sheet Question |
Compensated Absences | Compensated absences is a term used by accountants for the paid holidays, paid sick days, paid vacations, etc. provided to employees. For example, a company’s vacation plan may require the company to 1) record and report the vacation expense in the accounting period when the vacation days are earned, and 2) record and report a liability for the amount of vacation days that employees have earned but have not yet taken. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Postretirement Benefits Other Than Pensions | Postretirement benefits other than pensions is a term that is used by accountants to describe the medical, dental, and vision benefits that are provided to retirees. The amounts owed for such commitments must be expensed during the years when the employee earns the benefits. The amount is also recorded as a liability (which will be reduced when the retiree receives the benefits). | This is a cheet sheet Question |
Accrued Wages | Accrued wages refers to the amounts that a company owes its employees for hours worked that have not yet been recorded in the general ledger accounts. For example, hourly-paid employees often have a work week of Sunday through Saturday and are paid on the following Thursday. On any given day, the company will have a liability and an expense for hours worked that have not yet been entered in the company’s general ledger accounts. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Inventory | Inventory is usually the most significant current asset of a retailer or manufacturer. Generally, inventory is reported on the balance sheet at its cost (or lower). When the items in inventory are sold, their costs will move from inventory to the cost of goods sold on the income statement. Inventory is important for a company’s profitability and survival. For instance, if a retailer or manufacturer does not have sufficient inventory of requested items, the result can be lost sales and lost customers. If a company has too much inventory, the company may encounter a cash flow problem and/or losses due to obsolescence. Inventory also means some accounting complexities due to the changing costs of the items in inventory. | This is a cheet sheet Question |
Cost of Goods Sold | For a retailer or manufacturer the cost of goods sold is likely to be its most significant expense on its income statement. When the costs of its items in inventory are continuously increasing (perhaps from inflation or scarcity), a decision must be made as to which of the costs in inventory should become the cost of goods sold. For instance, should the oldest (or first costs) be moved out of inventory, thereby leaving the most recent costs in inventory? Or, should an average cost be used? U.S. companies may decide that the most recent costs will be moved out of inventory, thereby leaving the oldest costs in inventory. The decision involves the flowing of costs (which can be different from the physical flow of the goods being removed from the warehouse). | This is a cheet sheet Question |
Cost Flow Assumptions | When the costs of the items in inventory are changing, a cost flow assumption must be made. If a company elects to first flow the oldest costs to the cost of goods sold, they are choosing the cost flow assumption known as first-in, first-out (FIFO). This means the most recent costs of items remain in inventory. In the U.S. a company may instead choose to use the last-in, first-out (LIFO) cost flow assumption. This means that the most recent costs will be the first costs moved from inventory to become the cost of goods sold. Under this assumption, the oldest costs will remain in inventory. The LIFO cost flow assumption can be used even if the goods that are removed from inventory are the oldest units. This is why it is a cost flow assumption. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Another option is to use an average cost of the items purchased in the current period along with the costs in inventory from the prior accounting period. The average cost per item is then used to determine both 1) the cost of the items remaining in inventory, and 2) the cost of goods sold. It is important to understand that these are cost flow assumptions and that the physical goods may flow differently. With continuous inflation, LIFO (compared to FIFO) will result in lower gross profits, lower net income, and lower taxable income. Hence, since 1960 many profitable U.S. corporations have elected the LIFO cost flow assumption. | This is a cheet sheet Question |
Inventory Systems | For the recording of inventory transactions in the general ledger, there are two main types of inventory systems: • periodic • perpetual When combined with a cost flow assumption, some of the many options for computing the cost of inventory and the cost of goods sold are: • periodic FIFO • periodic LIFO • periodic weighted-average cost • perpetual FIFO • perpetual LIFO • perpetual moving average • specific identification • others (such as a retailer’s dollar-value retail LIFO system) As the list indicates, the calculation of inventory and the cost of goods sold amounts can vary from company to company. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Periodic Inventory System | Under the periodic inventory system, the general ledger account Inventory will NOT be updated with each transaction. (Neither the cost of goods purchased nor the cost of goods sold are recorded in the inventory account.) Instead, the cost of the inventory items purchased will be recorded in a temporary account entitled Purchases. Then at the end of the accounting year, the Inventory account balance will be adjusted so that its balance is equal to the cost of the inventory items that are actually on hand. In other words, during the accounting year the balance in the Inventory account will be dormant and will show only the ending balance from the previous accounting year. | This is a cheet sheet Question |
Perpetual Inventory System | Under the perpetual inventory system, the general ledger account Inventory will be increased with the cost of each purchase of goods and decreased with the cost of each sale of goods. In other words, the balance in the Inventory account will be perpetually changing. In the perpetual system there will be a general ledger account Cost of Goods Sold that will be debited at the time of each sale for the cost of the goods that are sold. | This is a cheet sheet Question |
Estimating Ending Inventory | There are occasions when a company needs to estimate the cost of its inventory. Two examples are: • Filing an insurance claim for the inventory that was destroyed by a fire, tornado, etc. • Calculating the estimated cost of its ending inventory for its monthly balance sheets and the related cost of goods for the income statements Two common methods for estimating the cost of a company’s inventory are: • Gross profit method • Retail method For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Gross Profit Method of Estimating Ending Inventory | The gross profit method allows you to estimate the amount of ending inventory by using the following information: sales, purchases, and gross profit percentage since the last physical inventory was taken. For example, if the company had sales of $100,000 and its gross profit was 30% the cost of goods sold must have been 70% of sales. If the prior physical inventory had a cost of $25,000 and purchases were $60,000, the resulting costs of the goods available would be $85,000. The goods available of $85,000 minus the cost of goods sold of $70,000 means that the estimated amount of ending inventory is $15,000. It is easier to understand when the information is arranged as follows: | This is a cheet sheet Question |
Retail Method of Estimating Ending Inventory | The retail method can be used when a company has records showing both the cost and the retail prices of the merchandise. Since there are many variations of the retail method including the FIFO average cost method and the dollar-value retail LIFO method, it is best to study this topic from an intermediate accounting book. In order to apply the various retail methods you must understand the terms such as additional markups, markup cancellations, markdowns, returns, etc. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Income Statement | The income statement is also known as the statement of income, statement of operations, statement of earnings, profit and loss statement, and P&L. It reports a corporation’s revenues, expenses, gains, losses, and the resulting net income that occurred during the period of time shown in the heading of the income statement. The period of time (or time interval) could be a year, quarter, five months, one month, 52 weeks, 4 weeks, etc. If the corporation’s shares of common stock are publicly traded, the earnings per share of common stock must also appear on the face of the income statement. As with all of the external financial statements, the notes to the financial statements are to be referenced on the face of the income statement, and should be distributed with the financial statements. | This is a cheet sheet Question |
Generally Accepted Accounting Principles | In the U.S., an income statement that is distributed to someone outside of the corporation must comply with generally accepted accounting principles (referred to as GAAP or US GAAP). US GAAP includes basic underlying concepts such as the cost principle and matching principle to some very complex accounting standards developed by the Financial Accounting Standards Board (FASB). As a result of US GAAP, a corporation’s income statement will be prepared using the accrual method of accounting (as opposed to the cash method). Under the accrual method, revenues will be included on the income statement in the period in which they are earned (which often occurs before the receipt of cash). The accrual method also means that expenses will appear on the income statement when they best match the revenues or when a cost expires or is used up (instead of when the cash is paid out). Double-entry accounting, debits and credits, and the accounting equation result in a connection betwee the income statement and the balance sheet. For example, the net income from the income statement increases the retained earnings reported on the balance sheet. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Components or Elements of the Income | Statement 1. Revenues • Operating revenues such as the sale of goods and fees earned from providing services • Nonoperating revenues (or other income) earned from peripheral activities. An example is interest income that is earned by a retailer when it invests its idle cash. 2. Expenses • Operating expenses such as the cost of goods sold, selling and administrative expenses • Nonoperating expenses (or other expenses) which were incurred but were outside of the corporation’s main activities. An example is the interest expense incurred by a retailer. 3. Gains • An example is the Gain on Sale of a Plant Asset which resulted from selling a plant asset for more than the asset’s book value. 4. Losses • An example is the Loss on Sale of a Plant Asset which resulted from selling a plant asset for less than the asset’s book value. The net result (or combination) of these components is a corporation’s net income or net earnings. | This is a cheet sheet Question |
Format of Income Statement | Accounting textbooks often present two types of income statement formats: • Multiple-step. This format has more than one subtraction before displaying the company’s net income. The following is a condensed version of a multiple-step income statement: For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Income Statement | For the Year Ended December 31, 2023 • Single-step. This format has only one subtraction before displaying the company’s net income. In other words, all revenues (operating and nonoperating) minus all expenses (operating and nonoperating) equals net income. The following is a condensed version of the single-step income statement: XYZ Corporation Income Statement For the Year Ended December 31, 2023 For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Cost of Goods Sold | The cost of goods sold or cost of sales is likely the largest expense on the income statement of a retailer or manufacturer. Since the amount is very significant it is important that the proper costs are matched with the sales revenues. On the internal financial statements of a retailer, the cost of goods sold (COGS) might be presented in one of two ways: 1. The COGS could be calculated as the cost of the beginning inventory plus the cost of its net purchases minus the cost of the ending inventory: | This is a cheet sheet Question |
Gross Profit | Gross profit is the remainder of a company’s net sales minus its cost of goods sold. Gross profit is often expressed as a dollar amount and as a percentage of net sales. The gross profit is also known as gross margin. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Selling, General and Administrative (SG&A) Expenses | Selling, general and administrative (SG&A) expenses are a company’s operating expenses (along with the cost of goods sold). SG&A expenses are not considered to be product costs and therefore are not inventoriable costs. Rather, SG&A expenses are considered to be expenses of the accounting period. | This is a cheet sheet Question |
Inventory Cost Flow Assumptions | When inventory items are purchased at different unit costs during the year, a company must elect a cost flow assumption. In the U.S. the options are 1) first costs in are the first costs out (first-in, first-out or FIFO), 2) last costs in are first costs out (last-in, first-out or LIFO), 3) average costs, 4) specific identification, and others. The inventory systems could be periodic or perpetual. Hence, the combination of the cost flow assumptions and the system used can result in differing amounts for the cost of goods sold, gross profit, net income, taxable income, and income tax expense being reported on the income statement. | This is a cheet sheet Question |
Notes to the Income Statement | In addition to the amounts appearing on the face of the income statement, there needs to be a reference such as “See notes to the financial statements.” or “The accompanying notes are an integral part of the financial statements.” The notes to the financial statements are important because a corporation’s net income is dependent on the accounting policies regarding inventory, depreciation, revenue recognition, and more. There may also be some potential losses that are looming, but have not yet been finalized. Hence, the notes will disclose this and other important information pertinent to the income statement and the other financial statements. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Improving Profits | Improving profits or reducing operating losses is likely to require some decisions and some action. Both the decisions and the actions involve the future and may involve: • expanding a product line • eliminating a product line • increasing selling prices • reducing selling prices • reducing advertising expenses • increasing advertising expenses • closing a facility or outlet • adding a facility or outlet • many other possibilities Unfortunately, the amounts that are readily available (such as the amounts in the general ledger accounts) are amounts from the past transactions. To make the best decisions, management needs the future amounts. Obviously, the future has not yet occurred, therefore getting the approximate future amounts will be a challenge. | This is a cheet sheet Question |
Past Amounts Are Not Relevant | The enormous number of transactions that a company has experienced can be found in the company’s accounting records. However, those transactions are from the past. As a result, they are not relevant for today’s decisions or future decisions. Management accounting textbooks describe these past historical transactions as sunk or irrelevant as far as decision making. Even though the past amounts are irrelevant for today’s decisions they may help the management accountant to understand how costs behave, which costs to examine, etc. Some past costs could also have an impact on income tax payments or income tax savings that will occur due to a decision regarding the future. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Future Amounts That Will Be the Same Are Not Relevant | In making a decision between two alternatives, the costs and/or revenues that will be the same under both alternatives are not relevant and therefore can be omitted from the analysis. For example, if the management’s total compensation will be the same whether or not the company expands into ten additional states, the management’s compensation is irrelevant to the decision of whether to expand or not. Therefore, the management’s compensation can be excluded from the analysis. Only Future Amounts That Will Differ Among | This is a cheet sheet Question |
Alternatives Are Relevant | In order to make the best decisions, management accountants must work to identify, predict and estimate the relevant future amounts. However, only the future costs and future revenues that will be different will be relevant. | This is a cheet sheet Question |
Accountants Must Be Careful | Accountants might be the most knowledgeable about a company’s past costs and past revenues. However, when it comes to decision making, management will need information on the future costs and future revenues. Accountants must realize that their familiarity with numbers does not necessarily translate into an ability to predict the future. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Future Value of a Single Amount | The future value of a single amount is also known as the future value of 1. The amount is a single, one-time deposit made at time period 0, which is also the beginning of period 1. It is assumed that the interest earned is added at the end of each time period. | This is a cheet sheet Question |
Compounding of Interest | In the future value of a single amount, it is assumed that the interest added at the end of a time period will earn interest in the next time period. When the amount of interest earns interest, it is known as the compounding of interest. A single deposit that remains invested for many years at a high rate of interest will result in a very large amount. Example 1. Assume that someone inherits $100,000 and the amount is deposited in an investment that is not taxed until the money is withdrawn. Also assume the money is never withdrawn and the investment earns a consistent 10% per year compounded annually. The following table illustrates how the single deposit of $100,000 will grow as a result of the compounding at 10% per year. (The amounts are approximate due to rounding.) * The interest earned during a one-year period is 10% of the future value at the start of that year, (which is also the ending balance of the previous year). For example, the interest earned in Year 4 is $13,310 (10% of $133,100 the balance at the end of Year 3). In year 40, the interest earned during that year single year is $411,448 (10% of $4,114,479 which is the balance at the end of Year 39 which is not shown). | This is a cheet sheet Question |
Rule of 72 | The rule of 72 is a quick way to approximate either: • the number of years needed for an amount to double, or • the interest rate needed in order for an amount to double For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Example 2. To illustrate how to approximate the number of years needed for an amount to double using the rule of 72, assume that an amount (or deposit) will earn 10% per year with the interest compounded at the end of each year. To determine the approximate number of years needed for the amount to double, divide 72 by the interest rate to be earned. Since 72 divided by 10 (the annual interest rate) = 7.2 years, a single amount compounded annually at 10% will double in 7.2 years. In the table from Example 1, you will see that at the end of 7 years the future value is $194,872. This is nearly double the initial deposit of $100,000. At 7.2 years, the amount will be extremely close to $200,000 or double the $100,000 deposit. Example 3. To illustrate how to approximate the interest rate needed for an amount to double in 7 years, divide 72 by 7 years. The result is a required interest rate of 10.3%. | This is a cheet sheet Question |
Future Value of 1 Tables | In a classroom setting, future value of 1 (FV of 1) table which displays the future value factors is often used for instruction purposes. For instance, if you looked at an FV of 1 table, under the column with the heading of 10% and selected the row where the number of periods is 7, you would see the factor “1.94872”. This tells you that if $1 is invested at 10% and the interest is compounded annually for 7 annual periods, the $1 will grow to $1.95. Therefore, if you invest $100,000 at 10% interest for 7 years, it will grow to a future value of $194,872 ($100,000 X 1.94872). Note that this is the same as the amount we have in the table above. | This is a cheet sheet Question |
Frequency of Compounded Interest | If the compounding of interest is done quarterly (instead of annually) for 7 years, the annual rate of 10% would be restated to be 2.5% per quarterly period; and the 7 annual periods will be restated to be 28 quarterly periods. The more frequent the compounding, the greater will be the future value. | This is a cheet sheet Question |
Calculators | Instead of using a future value table or the rule of 72, it will be more precise and faster to use an online financial calculator. Electronic handheld financial calculators are also available. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Annual Financial Statements | The financial statements that are to be included as a complete set when a U.S. corporation distributes them to people outside* of the corporation are: *Examples of people outside of the corporation that are likely to receive these external, general- purpose financial statements include investors, lenders, government agencies, etc. **Note that the balance sheet reports amounts as of the final moment of the accounting period. For example, the balance sheet’s heading might indicate “December 31, 2023. This means that the amounts are as of midnight on December 31. Examples of the headings of the other four financial statements include “For the Year Ended December 31, 2023”, “For the Six Months Ended June 30, 2023”, For the 13 Weeks Ended…”, etc. | This is a cheet sheet Question |
Notes to Financial Statements | For the financial statements to be complete, they must be accompanied with notes to the financial statements. The notes are usually referenced at the bottom of each of the financial statements with wording such as “See notes to the financial statements.” or “The accompanying notes are an integral part of the financial statements.” For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Generally Accepted Accounting Principles | The external financial statements must be in compliance with generally accepted accounting principles, which are commonly referred to as GAAP or US GAAP. GAAP includes basic underlying principles, official accounting standards issued by the Financial Accounting Standards Board (FASB), and industry-specific requirements. U.S. corporations whose stock is publicly-traded are also required to file financial reports to the U.S. Securities and Exchange Commission (SEC). Generally, US GAAP requires that a U.S. corporation’s financial statements be based on the accrual method (or accrual basis) of accounting. The accrual method means that 1) revenues and a related receivable will be reported when they are earned and collection is assured, and 2) expenses and a related payable will be reported when an expense or loss has occurred. In short, the accrual method of accounting will result in financial statements that will be more complete and useful. The financial statements are interconnected and should always be in balance because of the accounting equation and double-entry accounting system. | This is a cheet sheet Question |
Accounting Periods | Often U.S. corporations have accounting years that end on December 31 (referred to as calendar years). However, many U.S. corporations have fiscal years which end on other dates, such as June 30, September 30, etc. In addition, some U.S. corporations have 52/53-week years which end on the Saturday nearest to January 31 or some other day of the week. Those corporations’ interim financial statements will include four 13-week periods instead of four 3-month quarters. | This is a cheet sheet Question |
Income Statement | The income statement reports a corporation’s revenues, expenses, gains, losses, and the resulting net income for the period of time specified in its heading. The period of time or time interval could be a year, quarter, week, 26 weeks, etc. If the corporation’s shares of stock are publicly traded, the earnings per share of common stock (EPS) must also be reported on the face of the income statement. A positive net income reported on the income statement will cause the corporation’s retained earnings (part of the balance sheet section, stockholders’ equity) to increase. A net loss will cause retained earnings to decrease. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. There are a few items that will increase stockholders’ equity but will not be reported on the income statement. These items are part of other comprehensive income, which is reported on the statement of comprehensive income. | This is a cheet sheet Question |
Statement of Comprehensive Income | The statement of comprehensive income reports the amount of a corporation’s comprehensive income (or loss), which consists of the following: • The corporation’s net income (the details of which are reported on the income statement) • Items that are classified as other comprehensive income for the period of time indicated in the heading. Some of the items that are considered to be other comprehensive income include: • Unrealized gains or losses on derivatives used in hedging • Unrealized gains or losses on pension and postretirement liabilities • Foreign currency adjustments. The total of the other comprehensive income will cause the corporation’s accumulated other comprehensive income (a component of the balance sheet section, stockholders’ equity) to change. NOTE: Net income increases retained earnings, but other comprehensive income increases accumulated other comprehensive income. | This is a cheet sheet Question |
Balance Sheet | The balance sheet reports a corporation’s assets, liabilities, and stockholders’ equity as of a moment in time. (The other financial statements report amounts for a period of time.) The balance sheet reports amounts as of the final moment of the day shown in the heading of the balance sheet, which is typically the final moment of the accounting period. At all times the amount of the corporation’s assets should be equal to the amount of liabilities plus stockholders’ equity. In other words, the balance sheet reflects the accounting equation: assets = liabilities + stockholders’ equity. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. Assets are resources such as cash, inventory, investments, buildings, equipment, and prepaid or deferred expenses. Liabilities are obligations such as accounts payable, loans payable, accrued expenses payable (wages, interest, utilities), deferred revenues, and bonds payable. Stockholders’ equity includes paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock. Because of the cost principle, some valuable assets will not be reported (trade names, management) and some assets may be more valuable than the reported amounts based on cost. As a result, the amount of stockholders’ equity should not be interpreted to be the corporation’s market value. | This is a cheet sheet Question |
Statement of Stockholders’ Equity | The statement of stockholders’ equity reports the changes that occurred during the accounting year to the corporation’s paid-in capital, retained earnings, accumulated other comprehensive income, and treasury stock. | This is a cheet sheet Question |
Statement of Cash Flows | The statement of cash flows (SCF or cash flow statement) reports a corporation’s significant cash inflows and cash outflows that caused the corporation’s cash and cash equivalents to change. The cash flow information is important because the income statement reflects the accrual method of accounting (not the cash method). The cash flows are presented in one of the three sections of the SCF: • Operating activities • Investing activities • Financing activities In addition, the following supplementary information must be disclosed: interest paid, income taxes paid, and significant noncash transactions such as the exchange of shares of common stock for land. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Notes to Financial Statements | The notes to the financial statements are considered to be an integral part of the financial statements and are referenced at the bottom of each financial statement. The first of the notes lists the corporation’s significant accounting policies. Large corporations could have 30 or more pages of notes in order to comply with the full disclosure principle. | This is a cheet sheet Question |
Comparative Financial Statements | In order for the financial statements to be more useful, corporations prepare comparative financial statements. This means that in addition to the amounts for the current year, the statements will also have columns containing the amounts from one or two of the earlier years. These earlier amounts give the readers a frame of reference when reviewing the most recent amounts. | This is a cheet sheet Question |
Audited Financial Statements | Some financial statements must be audited. For example, corporations with common stock that is traded on a stock exchange must have their financial statements audited by a registered CPA firm. Other corporations may have a lender or investor that requires that the financial statements be audited. The CPA firm that performs the audit will issue an audit report to describe what to expect from the audit. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Financial Ratios Including Limitations | Financial ratios are one component of financial analysis. Financial ratios are often calculated by using amounts from previously issued annual financial statements. In that case the resulting ratios are history and may not be indicative of the present and future situation. It is also wise to consider the financial ratios to be averages. For example, the sales are unlikely to have occured evenly throughout the year. Therefore, the resulting number of days’ sales in inventory may be 100, but it is an average of some months of 120 days and some months of 80 days. The turnover ratios and the “return on” ratios usually involve an annual income statement amount and a balance sheet amount. However, the balance sheet amount is valid only for the final moment of the accounting year and may not be indicative of the amounts within the accounting year. This is especially true when a corporation ends its accounting year at the low point of its business activity. To overcome this situation, it is best to use the average balance sheet amounts for the 12 months during the year. (Merely averaging the two lowest points of the year will not solve the problem.) It is also important to realize that companies within the same industry may apply accounting principles differently. Some companies may be conservative in their accounting, while another may be the complete opposite. For example, Company C values its inventory using LIFO and uses very short useful lives for depreciating its plant assets. Its competitor Company L values its inventory using FIFO and uses very long useful lives for depreciating its plant assets. In periods of inflation, the financial statements and financial ratios of these companies will have differences due to the way accounting principles are applied. Of course within a company where the accounting rules are consistantly applied, the current financial ratios can be compared with confidence to its financial ratios from the past and to those budgeted for the current year and future years. | This is a cheet sheet Question |
Working Capital | Working capital is actually an amount (rather than a ratio) which is an indicator of a company’s ability to meet its obligations. It is calculated as follows: current assets minus current liabilities. For example, if a business has $280,000 of current assets and $260,000 of current liabilities, its working capital is $20,000. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Current Ratio | The current ratio is also an indicator of a company’s ability to pay its current obligations. The calculation is: current assets divided by current liabilities. If a company has current assets of $300,000 and current liabilities of $150,000 the company’s current ratio is 2:1 [($300,000/$150,000):1]. | This is a cheet sheet Question |
Acid-Test Ratio or Quick Ratio | The acid-test ratio is also known as the quick ratio. It is a more conservative indicator of a company’s ability to pay its current obligations (than the current ratio) since inventory is excluded from the calculation. In other words, the calculation is: [cash + marketable securities + accounts receivable] divided by current liabilities. If a company had current assets of $300,000 (of which $180,000 was inventory) and current liabilities of $150,000, the acid-test ratio will be approximately 0.8:1 [$120,000/$150,000]. | This is a cheet sheet Question |
Receivables Turnover Ratio | The receivables turnover ratio is an indicator of how fast a company’s accounts receivable are (or were) collected. The calculation is: credit sales for a year divided by the average balance in accounts receivable during the same year. If credit sales for the year were $800,000 and the average amount of accounts receivable throughout the year was $100,000 the company’s receivables turnover ratio will be 8 times [$800,000/$100,000]. Of course, if only the two low end-of-the-year receivable amounts are averaged, the resulting ratio will be much different from the average based on the average throughout the year. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Average Collection Period or Days’ Sales in Receivables | The average collection period tells how many days (on average) it takes to collect a company’s accounts receivable. The calculation is: 360 or 365 days divided by the receivables turnover ratio. Using the information in our previous calculation, the receivables turnover ratio was 8. Therefore, the average collection period was 45 days [360 days/8]. A logical next step is to compare the average collection period to past ratios and also to the credit terms offered to customers. | This is a cheet sheet Question |
Inventory Turnover Ratio | The inventory turnover ratio indicates how many times a company’s inventory turns over in a year. The calculation is: cost of goods sold for a year divided by the average inventory during the same year. Since a company records inventory at cost, it is logical to use the cost of goods sold from the income statement. If the cost of goods sold for the year was $600,000 and the average cost of inventory during the year was $200,000 the company’s inventory turnover ratio is 3 times [$600,000/$200,000]. Again, if the average inventory is based on the two lowest points of the year, this turnover ratio will be greater than an average based on amounts throughout the year. | This is a cheet sheet Question |
Days’ Sales in Inventory or Days to Sell | The days’ sales in inventory indicates how many days of sales are in inventory. The calculation is: 360 or 365 days divided by the inventory turnover ratio. If the inventory turnover ratio is 3, the days’ sales in inventory will be 120 days [360 days/3]. | This is a cheet sheet Question |
Free Cash Flow | The calculation of free cash flow is: net cash flow from operating activities minus the necessary capital expenditures. (Sometimes a company’s dividend payments are deducted along with the capital expenditures.) If a corporation had cash from operating activities of $200,000 and necessary capital expenditures of $60,000 the amount of free cash flow was $140,000. For personal use by the original purchaser only. Copyright © AccountingCoach®.com. | This is a cheet sheet Question |
Times Interest Earned | Times interest earned indicates a company’s ability to pay the interest on its debt. The calculation is: income before interest expense and income tax expense divided by interest expense. If a company’s net income was $100,000 after interest expense of $40,000 and income tax expense of $20,000 the times interest earned is 4 times [$160,000/$40,000]. Gross Profit or Gross Margin (in dollars) Gross profit is the remainder of net sales minus cost of goods sold. Gross profit is the amount prior to deducting a company’s selling, general and administrative expenses and adding or subtracting the nonoperating items. If net sales (gross sales minus sales returns and allowances and sales discounts) were $800,000 and the cost of goods sold was $600,000 the gross profit was $200,000. Gross Profit Percentage or Gross Margin as a | This is a cheet sheet Question |
Percentage | The gross profit percentage is the dollars of gross profit divided by the dollars of net sales. If the gross profit was $200,000 and the net sales were $800,000 the gross profit percentage or gross margin was 25%. | This is a cheet sheet Question |