Chapter 2 Flashcards
classified balance sheet
- companies often group similar assets and similar liabilities together using standard classifications and sections.
- This is useful because items within the groups have similar economic characteristics.
- The groupings help users determine:
(1) whether the company has enough assets to pay its debts and (2) what claims by short-and long-term creditors exist on the company’s total assets.
current assets
- Assets that are expected to be converted to cash or used up in the business within one year or one operating cycle whichever is longer.
- Examples of current assets: cash, short-term investments (which include short-term U.S. government securities), receivables (accounts receivable, notes receivable, and interest receivable), inventories (sold within a year hopefully), and prepaid expenses (rent, supplies, insurance, and advertising).
- On the balance sheet, current assets are listed in the order in which they are expected to be converted into cash (order of liquidity). (Liquidity how quickly an asset can be converted to cash)
- Some companies use a period longer than one year to classify assets and liabilities as current because they have an operating cycle longer than one year. The operating cycle of a company is the average time required to go from cash to cash in producing revenue-buy inventory, sell it, and collect the cash from the customers.
Long-term investments
- Assets that can be converted into cash, but whose conversion is not expected within one year.
- These include long-term assets not currently used in the company’s operations (i.e., land, buildings, etc.) and investments in stocks and bonds of other corporations.
- Normally seen with relatively mature companies with a smaller amount of debt and a lot of cash
Property, Plant, and Equipment
- Assets with relatively long useful lives.
- Assets currently used in operating the business.
- Sometimes called fixed assets or plant assets.
- Examples include land, buildings, machinery, equipment, and furniture and fixtures.
- Record these assets at cost and depreciate them (except land) over their useful lives. The full purchase price is not expensed in the year of purchase because the assets will be used for more than one accounting period.
- ex: if a company bought a building at 100,000 and now it costs 1,000,000, the balance sheet will still maintain that it is worth 100,000
depreciation
the practice of allocating the cost of assets to a number of years
-ex: I bought a building for $1,000,000 (considered an asset, not an expense). The expense of big assets are spread out across the life of the asset. In this case, if the building has a 20 year life (1,000,000/20 = 50,000 depreciation expense each year)
depreciation expense
the amount of the allocation for one accounting period
accumulated depreciation
the total amount of depreciation that has been expensed since the asset was placed in service.
-Accumulated depreciation = contra asset because it shows up in the asset section, but unlike all the other assets that are added up there, this asset is subtracted
intangible assets
- Noncurrent assets.
- Assets that have no physical substance, but is a resource to the company.
- Examples are goodwill (occurs when one company buys another entire company and they pay more for it then the assets are worth; ex: customer base, eliminate competition, labor base), patents (big in the technology and pharmaceutical industry), copyrights (music and written word), and trademarks or trade names.
current liabilities
- Obligations that are to be paid within the coming year or operating cycle whichever is longer.
- Common examples are notes payable, accounts payable, wages payable, bank loans payable, interest payable, taxes payable, and current maturities of long-term obligations.
- Within the current liabilities section, companies usually list notes payable first, followed by accounts payable, and then the remaining items in the order of their magnitude.
long-term liabilities
- obligations expected to be paid after one year.
- Liabilities in this category include bonds payable, mortgages payable, long-term notes payable (can be both short/long terms- depends on timing), lease liabilities, and pension liabilities.
- Many companies report long-term debt maturing after one year as a single amount in the balance sheet and show the details of the debt in notes that accompany the financial statements.
stockholder’s equity
consists of two parts: common stock and retained earnings
common stock
investments of assets into the business by stockholders
retained earnings
income retained for use in the business
ratio analysis
expresses the relationship among selected items of financial statement data
ratio
expresses the mathematical relatinoship between one quuantity and another
-shed light on company performance
intracompany comparisons
covers two years for the same company
industry-average comparisons
based on average ratios for particular industries
intercompany comparisons
based on comparisons with competitor in the same industry
profitability ratio
measure the operating success of a company for a given period of time; tests management’s effectiveness
earnings per share
- Is a profitability ratio that measures the net income earned on each share of common stock.
- Is computed by dividing (net income less preferred dividends) by the average number of common shares outstanding during the year.
- By comparing earnings per share of a single company over time, one can evaluate its relative earnings performance on a per share basis.
- Comparisons of earnings per share across companies are not meaningful because of the wide variations in numbers of shares of outstanding stock among companies.
- use an income statement
retained earnings statement vs statement of stockholder’s equity
RES: Describes the events that caused changes in the retained earnings account for the period. (Add net income to and subtract dividends from the beginning balance of retained earnings to arrive at the ending balance of retained earnings.)
SSE: reports ALL CHANGES in stockholders’ equity accounts (ie capital stock issued or retired)
liquidity
ability to pay obligations expected to come due within the next year or operating cycle
two measure of liquidity
working capital
current ratio
working capital
- Measure of short-term ability to pay obligations
- Excess of current assets over current liabilities
- Positive working capital (Current Assets > Current Liabilities) indicates the likelihood for paying liabilities is favorable.
- Negative working capital (Current Liabilities > Current Assets) indicates that a company might not be able to pay short-term creditors and may be forced into bankruptcy.
- liquidity ratio
