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Flashcards in Chapter 13 Powerpoint Deck (58):

Authorized shares

The board of directors can issue this amount of shares

The maximum amount that can be issued


Issued shares

Shares that are owned by the company (Treasury Stock) and owned by the stockholders


Outstanding Shares

Shares that are owned by the stockholders only


Sustainable Income notes

Income that is the most likely level of income to be obtained in the future

Determined by removing irregular items from net income (net of income taxes)


Irregular Items include:

Discontinued Operations

Extraordinary Items


Discontinued Operations

A disposal of a significant component of a business

ex. Elimination of a Major class of Customers

*The income statement should recognize a gain (or loss) from discontinued operations, net of tax


Extraordinary items:

Extraordinary items should be recognized when meet two conditions:

1. Unusual in Nature

2. Infrequent in Occurrence

*The company must consider the environment in which it operates

**These amounts are reported net of income taxes on a seperate section of the income statement, below discontinued operations


Unusual in Nature

The item should be abnormal and only incidentally related to the customary activities of the entity


Infrequent in Occurrence

The event or transaction should not be reasonably expected to recur in the foreseeable future


Effects of major natural casualties, if rare in the area

Yes - extraordinary 


Write-down of inventories or write-off of receivables

No - not extraordinary


Expropriation (takeover) of property by a foreign government

Yes- extraordinary


Losses attributable to labor strikes

No - not extraordinary


Gains or losses from sales of property, plant, or equipment

No - not extraordinary


Significant damage resulting from a hurricane in Florida

No - not extraordinary


Significant loss in derivative instruments due to unexpected financial collapse

No - not extraordinary


Changes in Accounting Principle

Users expect financial statements to be prepared on a basis consistent with the preceding period

When management can show that the new principle is preferable to the old principle, accounting rules permit a change

It is important that most changes in principle are reported retroactively

- this treatment improves comparability


A change in accounting principle occurs when:

The principle used in the current period is different from te one used in the previous period

ex. Change in Inventory Costing Methods - FIFO vs. LIFO


We know that most revenues, expenses, gains, and losses are included in net income. However, _____________________

certain gains and losses are not

ex. Unrealized Gain / Loss on an AFS Security


Comprehensive income includes _____________________

all changes in stockholders' equity except:

- Changes resulting from Stockholder Investments

- Changes resulting from distributions to Stockholders

*This measure provides a more comprehensive measure


Three types of comparisons to improve the decision usefulness of financial information:

1. Intracompany Basis - Historical Trend Analysis

2. Intercompany Basis - Direct Comparison to Competitor

3. Industry Averages - Relative Position within Industry


Three basic tools to highglight significance in financial statement data

1. Horizontal Analysis - Trend Analysis

2. Common-Size Analysis

3. Ratio Analysis


Horizontal Analysis

A technique for evalutaing a sries of financial statement data over a period of time to determine increase or decrease

*commonly applied to the balance sheet and income statement

**expressed in dollar amounts and percent change

e. 2006 current assets = $10; 2007 current assets= $15

Percent = 50%


Vertical Analysis

A "common-size analysis"

A technique that expresses each financial statement item as a percent of a base amount

Commonly applied to the balance sheet and income statement

ex. Current assets = 25%, Property assets = 25%, Other assets = 50%, Total assets = 100%



Measures short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash



Measures the ability of the company to survive over a long period of time



Measures the income or operating success of a company for a given period of time


Woring capital

Current assets - Current liabilties


Current Ratio

Current assets

Current liabilities


 Current cash debt coverage ratio

Cash provided by operations

Average current liabilties


Inventory turnover ratio

Cost of goods sold

Average Inventory


Days in inventory

365 days

Inventory turnover ratio


Receivables turnover ratio

Net credit sales

Average net receivables


Average collection period

365 days

Receivables turnover ratio


Debt to total assets ratio

Total Assets

Total Liabilities


Cash debt coverage ratio

Cash provided by operations

Average total liabilities


Times interest earned ratio

Net income + Interest expense + Tax expense

Interest expense


Free cash flow

Casy provided by operations - Capital expenditures - Cash dividends


Solvency ratios

Debt to total assets ratio

Cash debt coverage ratio

Times interest earned ratio

Free cash flow


Liquidity ratio

Working capital

Current ratio

Current cash debt coverage ratio

Inventory turnover ratio

Days in inventory

Receivables turnover ratio

Average collection period


Earnings per share

Net income - Preferred stock dividends

Average common shares outstanding


Price-earings ratio

Stock price per share

Earnings per share


Gross profit rate

Gross profit

Net sales


Profit margin ratio

Net income

Net sales


Return on assets ratio

Net income

Average total assets


Asset turnover ratio

Net sales

Average total assets


Payout ratio

Cash dividends declared on common stock

Net income


Return on common stockholders' equity ratio

Net income - Preferred stock dividends

Average common stockholders' equity


Profit Margin x Asset turnover ratio = 

Return on assets ratio


Profitability ratios

Earnings per share

Price-earnings ratio

Gross profit rate

Profit margin ratio

Return on assets ratio

Asset turnover ratio

Payout ratio

Return on common stockholders' equity


Quality of Earnings

A company that has a high quality of earnings provides full and transparent information that will not confuse or mislead users

*It is increasingly important because of recent accounting scandals involving earnings management


Issues relating to quality of earnings:

1. Alternative accounting methods

2. Pro Forma Income

3. Improper Recognition (Channel Stuffing)


Explain why the municipalities may be reluctant to disclose the additonal pension obligations on their balance sheets?

These municipalities may be reluctant to disclose these additional obligations, as this could potentially lead to credit rating downgrades, thus making it more difficult for the municipality to borrow funds in the future.  Also, additional debt would make the balance sheet look worse and could spark a negative reaction from taxpayers.


2. Although currently allowable by US GAAP for government organizations, what qualitative accounting characteristic do government organizations violate by not including information on pension obligations in their financial statements and why?

Transparency or Faithful Representation. Both emphasize giving a clear, concise, and balanced view of a company’s financial situation to its shareholders. The stakeholders in this situation are not only debt holders, but also taxpayers. Government organizations do not provide their stakeholders a clear image of their financial position.


3. If government organizations are required to recognize these additional obligations, what is the effect on the balance sheet?  Name 2 financial ratios that would be affected.  Would these ratios be better or worse?

Disclosing the additional obligations would add more debt to the balance sheet. 

Each of the following ratios would look worse as a result of disclosing additional obligations:

Solvency: Debt to Total Assets Ratio (Total Liabilities/Total Assets); Cash Debt Coverage Ratio (Cash Provided by Operations/Average Total Liabilities)


4. As an investor considering investing in municipal bonds, how would the exclusion or inclusion affect your decision to invest?

Exclusion: Need to estimate pension obligation and the municipality’s ability to make pension payments as they come due, then assess the risk that the municipality may not be able to repay debts from bonds as they come due

Inclusion: Increases relevance of reported financial information.  Increases faithful representation.  Provides more information about pension obligation and the government’s ability to make pension payments as they come due, which reduces the risk that your estimation of the pension obligation is not accurate.  Then more likely to invest, or require a lower rate of return on investment, than if obligation is excluded.


5. How would recognition of pension obligations better align the actions of state and local government officials with the interests of taxpayers?

Provides more and better information to the public about the performance of government officials.  Creates incentive for government officials to better fund pension plans to improve the funded status of plans in financial statements.