Review of accounting
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Review of Accounting. 2. Chapter Outline. Income Statement Price-earnings Ratio Balance Sheet Statement of Cash Flows Tax-free Investments (Deprecation). Basic Financial Statements. Income Statement Balance Sheet Statement of Cash Flows. Income Statement.

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Review of Accounting

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Review of accounting

Review of Accounting

2


Chapter outline

Chapter Outline

  • Income Statement

  • Price-earnings Ratio

  • Balance Sheet

  • Statement of Cash Flows

  • Tax-free Investments (Deprecation)


Basic financial statements

Basic Financial Statements

  • Income Statement

  • Balance Sheet

  • Statement of Cash Flows


Income statement

Income Statement

  • Device to measure the profitability of a firm over a period of time

    • It covers a defined period of time

    • It is presented in a stair-step or progressive fashion to examine profit or loss after each type of expense item is deducted


Income statement cont d

Income Statement (cont’d)

Sales – Cost of Goods Sold (COGS)

= Gross Profit (GP)

GP – Expenses = Earnings Before Interest and Taxes (EBIT) or Operating Income (OI)

EBIT – Interest = Earnings Before Taxes (EBT)

EBT – Taxes = Earnings After Taxes (EAT) or Net Income (NI)


Return to capital

Return to Capital

  • Three primary sources of capital:

    • Bondholders

    • Preferred stockholders

    • Common stockholders

  • Earnings per share

    • Interpreted in terms of number of outstanding shares

    • May be paid out in dividends or retained by company for subsequent reinvestment


Price earnings p e ratio

Price-Earnings (P/E) Ratio

  • Multiplier applied to earnings per share to determine current value of common stock

  • Some factors that influence P/E:

    • Earnings and sales growth of the firm

    • Risk (volatility in performance)

    • Debt-equity structure of the firm

    • Dividend payment policy

    • Quality of management


Price earnings p e ratio cont d

Price-Earnings (P/E) Ratio (cont’d)

  • Allows comparison of the relative market value of many companies based on $1 of earnings per share

    • Indicates expectations about the future of a company

  • Price-earnings ratios can be confusing


Price earnings ratios for selected us companies

Price-earnings Ratios for Selected US Companies


Balance sheet

Balance Sheet

  • Indicates what the firm owns and how these assets are financed in the form of liabilities or ownership interest

    • Delineates the firm’s holdings and obligations

    • Items are stated on an original cost basis rather than at current market value


Balance sheet items

Balance Sheet Items

  • Liquidity: Asset accounts are listed in order of liquidity

    • Current assets

      • Items that can be converted to cash within 12 months

    • Marketable securities

      • Temporary investments of excess cash

    • Accounts receivable

      • Allowance for bad debts to determine their anticipated collection value

    • Inventory

      • Includes raw materials, goods in progress, or finished goods


Balance sheet items cont d

Balance Sheet Items (cont’d)

  • Prepaid expenses

    • Represent future expense items that are already paid for

  • Investments

    • Long-term commitment of funds

    • Includes stocks, bonds, or investments in other companies

  • Plant and equipment

    • Carried at original cost minus accumulated depreciation

    • Accumulated depreciation

      • Sum of past and present depreciation charges on currently owned assets


Balance sheet items cont d1

Balance Sheet Items (cont’d)

  • Depreciation expense is the current year’s charge

  • Total assets: Financed through liabilities or stockholders’ equity

  • Short-term obligations

    • Accounts payable

    • Notes payable

    • Accrued expense


  • Stockholder s equity

    Stockholder’s Equity

    • Represents total contribution and ownership interest of preferred and common stockholders

      • Preferred stock

      • Common stock

      • Capital paid in excess of par

      • Retained earnings


    Concept of net worth

    Concept of Net Worth

    Net worth/book value = Stockholders’ equity – preferred stock component

    • Market value is of primary concern to the:

      • Financial manager

      • Security analyst

      • Stockholders


    Concepts behind the statement of cash flows

    Concepts Behind the Statement of Cash Flows


    Depreciation and funds flow

    Depreciation and Funds Flow

    • Depreciation

      • Attempt to allocate the initial cost of an asset over its useful life

    • Charging of depreciation does not directly influence the movement of funds


    Comparison of accounting and cash flows

    Comparison of Accounting and Cash Flows


    Income tax considerations

    Income Tax Considerations

    • Corporate tax rates

      • Progressive: the top rate is 40% including state and foreign taxes if applicable. The lower bracket is 15–20%

    • Cost of a tax-deductible expense


    Depreciation as a tax shield

    Depreciation as a Tax Shield

    • Not a new source of fund

    • Provides tax shield benefits measurable as depreciation times the tax rate

      Corporation ACorporation B

      Earnings before depreciation and taxes……$400,000$400,000

      Depreciation……………………………………… 100,000 0

      _________ _________

      Earnings before taxed………………………… 300,000 400,000

      Taxes (40%)……………………………………… 120,000 160,000

      _________ _________

      Earnings after taxes…………………………… 180,000 240,000

      +Depreciation charged without cash outlay… 100,000 0

      _________ _________

      Cash flow………………………………………… $280,000 $240,000

      Difference…………………………………………$40,000


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