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CPA FAR Exam > CPA FAR Ratios + Ch 1 > Flashcards

CPA FAR Ratios + Ch 1 Flashcards

1
Q

Liquidity

A

ability to pay ST obligations as they become due

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2
Q

Working capital

A

the extent to which current assets exceed current liabilities measuring the ability of a firm to meet ST obligations as they become due
WC = CA - CL
an absolute value not a ratio
not good if it is a negative value

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3
Q

Debt covenants

A

loans often have debt covenants where the borrower agrees to maintain a current ratio of at least 2:1 or the lender can call the loan due immediately (for noncompliance) even if current with payments

often liquidity ratios are important for debt covenants

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4
Q

ratio analysis

A

development of quantitative relationships between various elements of a firm’s financial statements
enables comparison of firms of different sizes

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5
Q

Quick ratio or acid test

A

Quick ratio =
cash and cash equivalents + ST securities + net receivables /
current liabilities
ST securities = marketable securities

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6
Q

operational and efficiency ratios

A

measure the efficiency of operations
sales or COGS in numerator
Ex asset turnover, inventory turnover, rec’v turnover

profitability ratios = measure operational results (net income in numerator)

leverage/equity ratios = measure the magnitude of debt in the capital structure of the company

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7
Q

profitability ratios

A

profitability ratios = measure operational results (net income in numerator)
Ex ROI, ROE, ROA

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8
Q

leverage/equity ratios

A

leverage/equity ratios = measure the magnitude of debt in the capital structure of the company

more asset financed by debt = more risk but greater potential for return

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9
Q

Which of the following types of ratios measures the firm’s ability to meet obligations as they become due?
-Liquidity
-operational
-efficiency
-profitability

A

Liquidity measures the ability of the firm to pay its obligations as they become due (short term/current)

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10
Q

Working capital can be defined as the extent to which __

A

current assets exceed current liabilities

it is an absolute value and measures the firm’s ability to meet short term obligations as they become due

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11
Q

If current assets are 90 and current liabilities are 100, which is correct?
1. working capital is negative
2. current ratio is less than 1:1

A

Both!
WC = -10
0.90 of current assets to meet $1.00 of current obligations
WC or current ratio = 0.9:1

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12
Q

Is high current ratio always good?

A

not always, it does not tell the whole story
Why is it so high?
quick ratio is better indication of liquidity using the most liquid assets for the firm
Quick ratio or acid test = not all CA used, only those most liquid = usually the results are lower vs current ratio
Not as liquid current assets (not in quick ratio) = prepaid expenses, inventory

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13
Q

Which of the following is correct Re: acid test ratio (quick ratio)?
1. uses the most liquid assets to measure ability to meet maturing obligations
2. is a variation of current or WC ratio

A

Both!

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14
Q

Which of the following is correct Re: acid test ratio (quick ratio)?
1. includes cash, receivables and inventory in the numerator
2. expected to be higher than firm’s current ratio

A

Neither!
No inventory
should be lower vs current ratio

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15
Q

Common size balance sheet

A

you can use common size B/S to compare two companies of different sizes by using total assets as the base (denominator)

compares each item on B/S to the total asset value

size becomes irrelevant with this approach

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16
Q

current ratio: true or false
1. an increase in current assets increases the current ratio assuming no change in current liabilities
2. a decrease in current liabilities increases the current ratio assuming no change in current assets

A

Both are true!

Current ratio = WC ratio = CA/CL

numerator up/denominator same = increases ratio
numerator same/denominator up= increases ratio

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17
Q

Which of the following ratios measures the quantitative relationship between highly liquid assets and current liabilities in terms of the “number of times” that cash and assets that can quickly be converted to cash can cover current liabilties?

A

quick ratio or acid test ratio =
Cash/cash equiv + mkt securities + net receivables /
current liabilities

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18
Q

If a company has a drop in inventory from beg of the year to end of year b/c $20,000 loss write down due to obsolescence, which is correct?

A

True= current ratio will decrease due to inventory loss write down

quick ratio will not be impacted as inventory is excluded!

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19
Q

times interest earned ratio

A

another measure of liquidity/solvency

measure of a firm’s ability to meet interest expense given current level of earnings

times interest earned ratio =
Net income + interest expense + income tax expense / interest exp

Answers can current earnings cover the firm’s interest cost for the period; this is important to lenders or creditors

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20
Q

Company A is applying for a loan. The bank is concerned the company will not have sufficient earnings to pay interest costs on the amount borrowed.
Calc times interest earned ratio for Company A: Net income = 2,000, interest exp = $100, and income tax exp = 400

A

2,000 + 100 + 400 / 100 = 25 = times interest cost can be covered

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21
Q

activity ratios

A

are more operational
they measure efficiency
Ex asset turnover, receivable turnover, inventory turnover

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22
Q

“Return on” ratios

A

tend to have net income in the numerator
measure profitability
ROA, ROI, ROE

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23
Q

ROA return on assets

A

return on assets = net income/ total assets

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24
Q

ROE return on equity

A

return on equity = net income/total equity

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25
Q

Return on sales

A

return on sales = net income / net sales
return on sales = profit margin

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26
Q

Turnover ratios = operational ratios

A

they measure efficiency
inventory turnover, AR turnover
sales or COGS are numerator

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27
Q

inventory turnover

A

how many times per year the company turns over its inventory
inventory turnover = COGS/average inventory

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28
Q

AR turnover

A

how may times per year a company turns over its AR
net credit sales/ average receivables
higher= more times collected = lower collection period

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29
Q

operating cycle

A

is the time it takes to convert inventory into sales (rec’v) and those rec’v into cash
operating cycle = rec’v collection period + inventory collection period
AR collection and inventory conversion = lower is better

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30
Q

receivable collection period

A

receivable collection period = 365/AR turnover

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31
Q

inventory conversion period

A

receivable collection period = 365/inventory turnover

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32
Q

With regard to ratio analysis, the “operating cycle” includes which of the following:
1. period of time from the purchase of inventory to the sale
2. period of time from date of credit sale to the collection of cash from the receivable

A

Both
operating cycle = purchase of inventory =>sale =>final collection of cash from receivables
operating cycle = # days sales in inventory + # days sales in receivables

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33
Q

days sales in inventory

A

days sales in inventory= average number of days before an item of inventory is sold

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34
Q

days sales in receivables

A

days sales in receivables= average # days to collect a receivable

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35
Q

days sales in inventory + # days sales in receivables equals

A

operating cycle = # days sales in inventory + # days sales in receivables

operating cycle = purchase of inventory =>sale =>final collection of cash from receivables

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36
Q

net operating cycle = cash conversion cycle =

A

days to sell + # days to collect less # days to pay vendor

operating cycle less payables deferral period

of days to create cash from the core business

higher is better

cash conversion cycle =
inventory conversion period + rec’v collection - AP deferral period

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37
Q

payables deferral period =

A

average # of days to pay the vendor
payables deferral period = 365/payables turnover
higher is better

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38
Q

payables turnover =

A

payables turnover = COGS/average AP

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39
Q

of days..

lower or higher??

A

days to collet = lower is better

days to sell = lower is better
# days to pay vendor = higher is better (defer)

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40
Q

a decrease in operating cycle implies that

A

time to convert inventory into sales (rec’v) and rec’v into cash has decreased

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41
Q

cash conversion cycle is equal to..

A

does NOT include the cash discount period

42
Q

decrease in both the inventory conversion period and the receivable collection period would indicate that …

A

inventory is being converted faster into sales and cash is being collected faster from rec’v

43
Q

the cash conversion cycle or net operating cycle would improve if there was an increase in which of the following?

A

increase in payables deferral

companies would want to decrease rec’v collection period and inventory conversion period

44
Q

the cash conversion cycle or net operating cycle would deteriorate if there was an increase in which of the following?

A

inventory conversion period and receivables collection

a company would prefer it take less time to convert inventory into sales and rec’v into cash

45
Q

evaluate ST liquidity?

A

quick ratio or acid test

current ratio

46
Q

average collection period determines?

A

liquidity = if take too long to collect = hard to meet current obligations

47
Q

How is cash conversion cycle improving?

A

decrease in inventory conversion and decrease AR collection period

48
Q

what ratio uses average inventory?

A

inventory turnover ratio

49
Q

what ratio uses average AR?

A

receivables turnover ratio = net credit sales/average AR

50
Q

Which of the following would increase the quick ratio assuming ratio begins over 1?
collecting AR faster rate
paying existing AP
selling obsolete inventory at a loss

A

paying existing AP = increases quick ratio
selling obsolete inventory at a loss = increases cash and quick ratio

51
Q

if most of our current assets are tied up in inventory or prepaid expenses..

A

WC may not be the best indicator/measure of liquidity

52
Q

complex capital structure

A

when the company has securities that can potentially be converted to common stock

when the company has securities that can potentially dilute EPS

both basic and diluted must be reported

53
Q

Basic EPS ignores potentially dilutive securities

A

Basic EPS=
Net income less preferred dividends /
WACSO

54
Q

objective of diluted EPS

A

to measure performance of an entity over the reporting period while giving effect to all potentially dilutive common shares outstanding during the period

55
Q

potentially dilutive securities

A

convertible securities (convertible preferred stock, convertible bonds)
warrants and other options
contracts that may be settled in cash or stock
contingent shares

must test to confirm if dilutive

56
Q

diluted EPS

A

Income avail to common shareholder + interest on dilutive securities/ WACSO

57
Q

income available to common shareholder

A

net income less preferred dividends

58
Q

dilutive if

A

average price > strike/exercise price

options or warrants that are “in the money”

the dilutive effects of options and warrants and their equivalents is applied using the treasury stock method

59
Q

strike price

A

price at which a share (underlying security) can be bought or sold in options trading

60
Q

treasury stock method

A

the dilutive effects of options and warrants and their equivalents is applied using the treasury stock method

this method assumes that the proceeds from the exercise of stock options, warrants and their equiv will be used by the company to repurchase treasury shares at FMV

61
Q

is higher or lower EPS better?

A

higher is better and very important to investors

62
Q

antidilutive

A

average price < exercise price

options or warrants that are “out of the money”

63
Q

dilution from convertible securities: convertible bonds

A

add to numerator: interest expense net of tax

add to denominator: # bonds * # common stock per bond

64
Q

dilution from convertible securities: antidilution

A

do not include the results if antidilutive (increased EPS/decreased loss per share

include results if dilutive (lowered EPS and increased loss/share)

tests should be based on income from cont ops and start with options and warrants

65
Q

dilution from convertible securities: convertible preferred stock

A

adjust numerator as dividends do not affect net income

add to denominator # shares assoc with assumed conversion

antidilution rules apply

66
Q

dilution from contracts that may be settled in cash or stock

A

presumed that: settled in common stock and resulting shares included in diluted EPS if effect is more dilutive

67
Q

dilution from contingent shares

A

contingent issuable shares:
do not require cash consideration
depend on some future event or certain conditions being met

contingent shares that are dilutive are included in calc of basic EPS if conditions for issuance met

68
Q

stockholders’ equity

A

owners’ claim to net assets of the corp

assets less liabilities = residual interest

generally last major section of B/S

69
Q

capital stock (legal capital)

A

amount of capital that must be retained by the corp for the protection of creditors

par/stated value of both preferred and common stock is legal capital and referred to as capital stock

three categories: authorized, issued and outstanding

70
Q

capital stock (legal capital): authorized

A

corp charter contains amounts of each class of stock that they may legally issue = authorized

71
Q

capital stock (legal capital): issued

A

when part or all of the authorized capital stock is issued = issued capital stock

72
Q

capital stock (legal capital): outstanding

A

because a corp may own issued capital stock in the form of treasury stock (stock buybacks), the amount of issued capital stock in the hands of shareholders is called outstanding capital stock

shares issued less shares repurchased = shares outstanding

73
Q

capital stock (legal capital): common stock

A

common shareholders have the right to vote and the right to share in earnings of the corp

common shareholders have the right to share in assets upon liquidation after claims of creditors and preferred shareholders have been satisfied

order: creditors=> preferred shareholders=> common shareholders

74
Q

capital stock (legal capital): preferred stock

A

equity security with preferences and features not assoc with common stock

may include dividend preference (cumulative or noncumulative and participating or nonparticipating)

assumes less risk vs common stock (preference relating to liquidation)

usually does not have voting rights

75
Q

capital stock (legal capital): cumulative preferred stock

A

cumulative feature: all or part of the preferred dividend not paid in any year accumulates and must be paid in the future before dividends can be paid to common shareholders

accumulated amount = dividends in arrears (preference to get caught up)

amount of dividends in arrears is not a legal liability = must be disclosed in total and on a per share basis (footnotes and parenthetically on B/S)

76
Q

capital stock (legal capital): participating preferred stock

A

the participating feature provides that preferred shareholders share/participate with common shareholders in dividends in excess of a specific amount

it may be full or partial participation

77
Q

capital stock (legal capital): preferred stock preference in liquidation

A

may include preference to assets upon liquidation

liquidation preference = significantly greater than par/stated value and must be disclosed

disclosure of liq preference must be in equity section of B/S not in notes to financial statements

78
Q

APIC additional paid in capital

A

APIC = # shares * (contributed capital less par value)

contributed capital in excess of par/stated value

can arise from other types of transactions

may be aggregated and shown as one amount on B/S

Ex
sales of treasury stock at gain
liquidating dividends
conversion of bonds
small stock dividends

79
Q

retained earnings

A

REGL=> net income=> retained earnings=> equity

accumulated earnings/losses throughout the life of a company less dividends

does not include treasury stock or AOCI

if negative balance = deficit

80
Q

retained earnings formula

A

Net income/loss
+/- dividends declared (cash, stock, property)
+/- prior period adjustments
+/- accounting changes reported retrospectively
= retained earnings

Beginning RE
+/- current year changes in RE
= ending RE

81
Q

AOCI accumulated other comprehensive income

A

Beg AOCI
+/- current year OCI gain loss and reclassification
= ending AOCI

AOCI= PUFI

82
Q

PUFI

A

pension adjustments
unrealized gains/losses AFS securities, hedges
foreign current translation adjustments
investment specific risk

83
Q

treasury stock

A

stock buybacks = lower SE
contra equity account

reacquired but not retired stock

Not entitled to rights of common shareholders= no voting rights and no dividends

84
Q

cost method for treasury stock accounting

A

most commonly used

gain or loss calc upon reissue

85
Q

legal (or par/stated value) method

A

gain or loss calc immediately upon repurchase

only used about 5% of the time

86
Q

Both methods of accounting for treasury stock

A

difference = timing of recognition of gain or loss

both= the gains or losses are recorded as direct adjustment to SE and are not used in determination of net income

both= shares held as treasury stock are not considered shares outstanding

87
Q

Accounting for stock issues: nonemployees

A

this is a source of capital and financing inflow

If par value exists: stock may be issues at par/stated, above par/stated or below par/stated

often stock subscriptions are sold before stock is actually issued

88
Q

stock subscriptions

A

often stock subscriptions are sold before stock is actually issued

often, corps sell capital stock via subscription= this means a contractual agreement to sell a specific # of shares at an agreed upon price on credit

upon full payment= stock certificate issued

89
Q

journal entry: stock sold

A

DR cash (# shares * exercise price)
CR common stock (# shares * par)
CR APIC- common stock

90
Q

stock rights

A

provides existing shareholder with opportunity to buy additional shares (usually below mkt price on date of grant)

issuance of stock rights= requires memorandum entry only

itis poss that the rights may subsequently be redeemed by the company causing a decrease in SE in amount of redemption price

91
Q

distribution to shareholders

A

pro rata distribution of earnings to shareholders (cash, stock, property) = not on I/S

based on shares of a particular class of stock usually representing a distribution of earnings

cash = most common

preferred stock = usually a fixed dividend in $ or %

92
Q

are dividends legally required?

A

no, for both common and preferred

93
Q

dividends: date of declaration

A

date the board approves the dividend (binding action)

a liability is created (dividends payable) and RE is reduced (debited)

94
Q

dividends: date of record

A

date the board specifies the names of shareholders to receive dividends (no accounts impacted)

95
Q

dividends: date of payment

A

the date on which the dividend is actually disbursed by the corp

96
Q

liquidating dividends

A

when dividends to shareholders exceed RE

reduce paid in capital
DR retained earnings
DR paid in capital
DR common or preferred stock
CR cash

97
Q

stock dividends

A

no cash out
no dividend income to owner
reduces cost basis per share

distribute additional shares of company’s own stock to shareholders

small stock dividend= reduce RE by FMV
large stock dividend= reduce RE by par

98
Q

stock splits

A

does not affect RE or total SE

before split:
common stock 10,000 shares @ $10/par = $100,000

after split:
common stock 20,000 shares @ $5.00/par = $100,000

99
Q

reverse stock splits

A

reducing the # shares outstanding an increasing the par/stated value proportionately

reduce outstanding shares= recall outstanding stock certs and issue new certs

100
Q

statement of changes stockholders’ equity

A

what changed? what happened in RE?

details of changes in primary equity components
Ex
capital transactions and distributions to shareholders
reconciliation of RE
reconciliation of carrying amount of each class of equity capital, paid in capital and AOCI

CPA FAR Exam (25 decks)

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