BUSN 70, Chapter 14

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Accounting
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The recording, measurement and interpretation of financial information
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Certified Public Accountant (CPA)
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An individual who has been state certified to provide accounting services ranging from the preparation of financial records and the filing of tax returns to complex audits of corporate financial records -Most CPAs are self-employed or members of large public accounting firms
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Sarbanes-Oxley Act
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required firms to be more rigorous in their accounting and reporting practices -After the accounting scandals of Enron and Worldcom in the early 2000’s, Congress passed this
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Dodd Frank Act
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strengthens the oversight of financial institutions -During the latest financial crisis, banks developed questionable lending practices, leading to this
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Forensic accounting
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-fit for legal review -Involves analyzing financial documents in search of fraudulent entries or financial misconduct, in other words “cooked books”
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Private Accountants
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Employed by large corporations, government agencies, and other organizations to prepare and analyze their financial statements -Deeply involved in most of the important financial decisions of the organization
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Certified Management Accountants (CMAs)
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Private accountants who, after rigorous examination, are certified by the National Association of Accountants and who have some managerial responsibility
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Bookkeeping
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-much narrower and more mechanical than accounting; limited to routine recording of business transactions -obtain and record the information used by accountants; requires less training
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Accountants
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have more training allowing them to understand, interpret and analyze financial information
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Managerial Accounting
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The internal use of accounting statements by managers in planning and directing the organization’s activities
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Cash Flow
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The movement of money through an organization over a daily, weekly, monthly or yearly basis -Perhaps management’s single greatest concern is:
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Budget
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An internal financial plan that forecasts expenses and income over a set period of time -Managerial accountants help prepare this -The principal value of budgets lies in the breakdown of cash inflows and outflows
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accounting statements
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-Managers use accounting statements to report to outsiders -Used for filing income taxes, obtaining credit and reporting results to stockholders
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Audited financial statements
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are those signed off on by a certified public accountant
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The Accounting Equation
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Assets = Liabilities + Owner’s Equity
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Assets
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A firm’s economic resources, or items of value that it owns, such as cash, inventory, land, equipment, buildings, and other tangible and intangible things
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Short term assets
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anything that can be turned into cash after a year, always at the top of financial statement, wall street pays attention to this
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Long term assets
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asset that will take longer than a year to liquidate it into cash, like land
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Liabilities
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Debts that a firm owes to others Not all debt is bad to a company -Interest you pay on a debt is a write off
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Owners’ Equity
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Equals assets minus liabilities and reflects historical values
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Double-Entry Bookkeeping
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A system of recording and classifying business transactions that maintains the balance of the accounting equation
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Balance
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To keep the accounting equation in balance, each transaction must be recorded in two separate accounts
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Classification
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All business transactions are classified as either assets, liabilities, or owner’s equity
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Break Down
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Most organizations further break down these accounts, such as assets may be broken down into cash, inventory and equipment
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Accounting Cycle
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The four-step procedure of an accounting system: 1)examining source documents, 2)recording transactions in an accounting journal, 3) posting recorded transactions 4) preparing financial statements
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Journal
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A time-ordered list of account transactions
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Ledger
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A book or computer file with separate sections for each account
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Income Statement
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A financial report that shows an organization’s profitability over a period of time – month, quarter, or year -Indicates a firm’s profitability or income (the bottom line), derived by subtracting expenses from revenues -Other names include profit and loss (P) statement or operating statement
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Revenue
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The total amount of money received from the sale of goods or services, as well as from related business activities -Total dollar amount of products sold; includes rental-lease income and interest income -Nonbusiness entities obtain revenues through donations and grants
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Cost of Goods Sold
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The amount of money a firm spent to buy or produce the products it sold during the period to which the income statement applies -The cost of producing the goods and services, including labor, raw materials and other expenses associated with production
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Cost of Goods Equation
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Cost of Goods Sold = Beginning Inventory + Interim Purchases – Ending Inventory
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Gross Income (or Profit)
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Revenues minus the cost of goods sold required to generate the revenues
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Expenses
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Always referred to as a percentage -The costs incurred in the day-to-day operations of an organization
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Common expense accounts
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1) Selling, general, and administrative expenses (includes depreciation) 2) Research, development and engineering expenses 3) Interest expenses
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Depreciation
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The process of spreading the costs of long-lived assets such as buildings and equipment over the total number of accounting periods in which they are expected to be used
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Net Income
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The total profit (or loss) after all expenses, including taxes, have been deducted from revenue; also called net earnings -Most companies present the current year’s results along with the previous two years’ income statements -The portion of net income the business does not keep is what it pays out as dividends to shareholders
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Shares outstanding
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can be classified as either primary (primary EPS) or fully diluted (diluted EPS).
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EPS
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net income divided by the number of shares outstanding
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Primary EPS
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is calculated using the number of shares that have been issued and held by investors. These are the shares that are currently in the market and can be traded.
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Diluted EPS
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entails a complex calculation that determines how many shares would be outstanding if all exercisable warrants, options, etc. were converted into shares at a point in time, generally the end of a quarter.
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Why we prefer diluted EPS
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it is a more conservative number that calculates EPS as if all possible shares were issued and outstanding. The number of diluted shares can change as share prices fluctuate (as options fall into/out of the money), but generally the Street assumes the number is fixed as stated
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Companies report both primary and diluted EPS
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and the focus is generally on diluted EPS, but investors should not assume this is always the case. Sometimes, diluted and primary EPS are the same because the company does not have any “in-the-money” options, warrants or convertible bonds outstanding. Companies can discuss either, so investors need to be sure which is being used
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Balance Sheet
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A “snapshot” of an organization’s financial position at a given moment -Shows assets and the funding used to pay for these assets, such as bank debt or owners’ equity -Takes its name from its reliance on the accounting equation: assets must equal liabilities plus owners’ equity -The balance sheet is an accumulation of all financial transactions since the company’s founding
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liquidity
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how fast they can be turned into cash
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Current Assets
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Assets used or converted into cash within the course of a calendar year Cash, temporary investments, accounts receivable and inventory
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Accounts Receivable
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Money owed a company by its clients or customers who have promised to pay for the products at a later date
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Current Liabilities
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A firm’s financial obligation to short-term creditors, which must be repaid within one year
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Accounts Payable
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The amount a company owes to suppliers for goods and services purchased with credit
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Accrued Expenses
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An account representing all unpaid financial obligations incurred by the organization
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Owners’ Equity
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-Owners’ equity includes the owners’ contributions along with income retained to finance growth and development -Owners’ equity differs dramatically from company to company as some corporations sell stock to investors, who then become the owners -Some companies have several kinds of stock, each with a different claim on the organization -Each type of stock is represented by a separate owners’ equity account, called contributed capital
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Statement of Cash Flows
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Explains how the company’s cash changed from the beginning of the accounting period to the end -flows takes the cash balance from one year’s balance sheet and compares it with the next while providing detail about how the firm used the cash
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Cash From Operating Activities
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Calculated by combining the changes in the revenue, expense, current assets and current liability accounts
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Cash From Investing Activities
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Calculated from changes in the long-term or fixed asset accounts
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Cash From Financing Activities
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Calculated from changes in the long-term liability accounts and the contributed capital accounts in owners’ equity
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Goodwill
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The excess of the purchase price over the fair market value of an asset. Accountants record this as a ‘write off’ in the financial report. -The market sets the price of what a business is worth. In mergers and acquisitions, goodwill arises when more was paid for the business than you’d expect from just looking at the value of its assets and liabilities. This difference can have a number of reasons, including a happy workforce, customer loyalty, a good location, and so on.
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Ratio Analysis
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Calculations that measure an organization’s financial health -Brings the complex information from the income statement and balance sheet into sharper focus -A ratio is simply a number divided by another resulting in a number showing a relationship between the two -Whether these numbers are good or bad depends on their relation to other numbers, such as ratios of prior performance or the performance of “peers”
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Profitability Ratios
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-Ratios measuring the amount of operating income or net income an organization is able to generate relative to its assets, owners’ equity, and sales -Common profitability ratios include profit margin, return on assets and return on equity
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Profit Margin
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Net income divided by sales
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Return on Assets
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Net income divided by assets
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Return on Equity
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Net income divided by owners’ equity; also called return on investment (ROI)
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Asset Utilization Ratios
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Ratios that measure how well a firm uses its assets to generate each $1 of sales -Managers use asset utilization ratios to pinpoint areas of inefficiency in their operations -These ratios – receivables turnover, inventory turnover, and total asset turnover – relate balance sheet assets to sales, which are found on the income statement
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Receivables Turnover
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Sales divided by accounts receivable
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Inventory Turnover
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Sales divided by total inventory
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Total Asset Turnover
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Sales divided by total assets
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Liquidity Ratios
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Ratios that measure the speed with which a company can turn its assets into cash to meet short-term debt -High liquidity ratios may satisfy a creditor’s need for safety, but may indicate the company is not using its current assets efficiently -Liquidity ratios are best examined in conjunction with asset utilization ratios because high turnover ratios imply cash is flowing through very quickly
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Current Ratio
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Current assets divided by current liabilities
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Quick Ratio (Acid Test)
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A stringent measure of liquidity that eliminates inventory
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Debt Utilization Ratios
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Ratios that measure how much debt an organization is using relative to other sources of capital, such as owners’ equity -Debt financing is riskier than equity as it demands a monthly payment regardless of profitability -Recessions affect heavily indebted firms far more than those financed through equity -Most companies tend to keep debt-to-asset levels below 50 percent
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Debt to Total Assets Ratio
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A ratio indicating how much of the firm is financed by debt and how much by owners’ equity
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Times Interest Earned Ratio
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Operating income divided by interest expense
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Per Share Data
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Data used by investors to compare the performance of one company with another on a equal, per share basis
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Earnings Per Share
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Net income or profit divided by the number of stock shares outstanding
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Dividends Per Share
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The actual cash received for each share owned

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