Financial Management Chapter 2

Front 1

What is the main measure of the profitability of a company?

Back 1

Net Income.
Net Income = Sales - Expenses

Front 2

What does stock prices generally reflect?

Back 2

Stock prices generally reflect the investor's expectations about company's income.
Some times rumours also effect company's stock prices.

Front 3

What time frame a net income of a company is generally based upon?

Back 3

Generally a net income is either based on a fiscal year of interim period.

Front 4

Define income?

Back 4

Excess of revenues over expenses.
Synonyms to income are earnings and profits.

Front 5

Define Retained Earning?

Back 5

The total cumulative owner's equity generated by income or profit is called retained earnings or retained income.

Retained Earning = Revenue - Expense.

Front 6

Describe Accrual Basis?

Back 6

The accrual basis recognizes the impact of transactions in the financial statements for the time periods when revenues and expenses occur.
That is accountant record revenue as a company earns it, and they record expenses as the company incurs them, not necessarily when cash changes hand.

Front 7

Describe Cash Basis?

Back 7

Cash Basis recognizes the impact of transactions in the financial statements when a company recieves or pays cash

Front 8

What are the differences between Cash and Accrual Basis?

Back 8

Cash Basis:
1-It ignore the activities that increases and decreases Assets.
2-No matter how a company seems to be doing can still go bankrupt if it doesnot manage cash properly.
Accrual Basis:
1-For the calculation of income over a period of time the accrual basis is the current basis of income measurement and is the best basis of measuring economic performance.
2-The Accrual basis has the advantage of presenting a more complete summary of entity's value producing activities.
3-It recognizes the revenue as it is earned and matches cost to revenues.

Front 9

Describe recognition of revenue?

Back 9

This is a test for determining whether to record revenues in the financial statement of a given period.

Front 10

What are the criteria for the recognition of the revenue?

Back 10

1- They must be earned. A company earns its revenue when it delivers goods or services to the customer.
2-They must be realized. A company realizes revenues when it recieves cash or claims to the cash in exchange to goods or services.

Front 11

Describe Claims to cash?

Back 11

Credit or someother promise to pay.

Front 12

Describe Matching?

Back 12

The process of recognizing and recording revenue in the same period with their related revenue is calle matching.

Front 13

How many types of expenses are their in an accounting period?

Back 13

Two types:
1-Those linked with the revenues earned that period.
2-Those linked with the time period itself.

Front 14

What expenses are directly linked with revenues?

Back 14

Product costs.

Front 15

When do we recognize product costs?

Back 15

During matching of expenses to the revenues.

Front 16

Describe period costs?

Back 16

Their are some expenses which are used to support a company's operations for a given period, for example Rent and Many other administrative expenses, they are called period costs.
We record period costs as the expense in the period in which the company incurs them.
Suppose a firm pays annual rent of 12000 on january 1, because we hav not yet used the rental service yet. Each month we reduce the prepaid rent account by 1000$ and increase the rent expense by 1000$, recognizing the using up of the prepaid rent asset and matching the rent expense with the revenue recorded in each month that we use.

Front 17

Describe Depreciation?

Back 17

Systematic allocation of the acquisition cost of long-lived or fixed assets to the expense accounts of particular periods that benefits from the used of that assets. These assets are the tangible physical assets, such as buildings, equipments, furniture, fixture, owned by the entity.
Land is not subject to depreciation because it does not deteriorate overtime.
The same matching concept which appliest to prepaid rent also applies to Depreciation.
Usually its a two step process.
1-Acquisition of fixed assets (which involve deduction of the Assets expense account)
2-Expiration of fixed assets (which involve deduction of stock holders equity expense accounts)

Front 18

What is the difference between prepaid rent/expense and depreciation?

Back 18

The sole difference between depreciation and prepaid rent is the length of time taken before the asset losses its usefulness.
Buildings, equipment and furniture remains useful for many years, prepaid rent and other prepaid expenses usually expire within a year.
They both usually effects retained earnings (usually the expense accounts which are the deductions from stock holders equity).

Front 19

What is the difference between inventory cost and rent?

Back 19

Inventory costs are the product costs that accountants match to the revenue they produce.
Rent is a period cost that accountants match with the period it benefits.

Front 20

Describe the recognition of Inventory, Equipment and rental cost?

Back 20

For inventory we record the expense when the company sells the item and recognize the revenue.
For equipment we split the total cost of long lived assets into smaller pieces and recognize one piece of that total cost as an expense in each of the periods that benefits from the use of the equipment.
For rent we recognize the period in which it applies.

Front 21

What are the similarities between Income Statement and Balance Sheet?

Back 21

Income statement is just a way of explaining the changes between one balance sheet to another.
The Balance sheet equation shows revenue and expense items as subparts of owner's equity.
The Income statement simply collects all the changes in owner's equity for accounting period and combines them in one place.

Front 22

What is the expanded Balance Sheet Equation?

Back 22

Assets = Liability + StockHolder's equity
Stock Holder's Equity = Paid in Capital + Retained Earnings.
Retained Earnings =Cumulative Revenue - Cumulative Expense

Front 23

What are Revenue and Expense Accounts?

Back 23

Revenue and Expense accounts are nothing more than subdivisions of stockholder's equity(temporary stock holder's equity accounts)
Their purpose is to summarize the volume of sales and the various expenses so we can measure income.

Front 24

What is the important feature of Balance Sheet equation?

Back 24

It is universal.
No one has ever conceived a transaction, no matter how simple or complex that we cannot analyze via the balance sheet equation.

Front 25

Define Income Statement?

Back 25

An Income statement (Statement of earnings or operating statement) is a report of all revenues and expenses pertaining to a specific time period.

Front 26

Define Net Income?

Back 26

Net Income = Revenue - Expense

Front 27

What does the income statement shows?

Back 27

The income statement shows how the entity's operations for the period have increased net assets (assets less liabilities) through revenues and decreased net assets throughs expenses.

Front 28

Define Net Income?

Back 28

Net income measures the amount by which the increase in newly acquired assets (revenues) exceeds the cost of using other assets(expenses).

Front 29

Describe Net Loss?

Back 29

when expense exceeds the revenue.

Front 30

What is the relationship between Retained Earning and net income?

Back 30

Retained earnings increases with the amount of net income (which is revenue - expense)

Front 31

What is the relationship between Retained Earning and net loss?

Back 31

Retained earnings decrease with the amount of net income (which is revenue - expense)

Front 32

Describe Cash Dividends?

Back 32

Distribution of cash to the stock holders in the retained earnings account.
Corporations usually pays out cash dividends to the stock holders to provide a return on the stock holder's investment in the corporation.
Although cash dividends decrease the retained earnings we do not deduct them from revenues because dividends are not directly linked to the generation of revenue or the costs of operating activities.

Front 33

Define Declaration Date, Record Date and Payment Date?

Back 33

Declaration Date: The date on which board of directors announces declares/announces its intention to pay a dividend.
Record Date: The date on which this announcement is recorded.
Payment Date: the date on which the actual payment takes place.

Front 34

What is an equivalent of negative retained earnings?

Back 34

Accumulated Deficit.

Front 35

How do we determine the net income under accrual accounting?

Back 35

To determine the net income under accrual accounting, we susbstract expenses from the revenues(expenses are linked with revenues via matching).
Sales and expenses are not equivalent to cash inflows and outflows.

Front 36

Describe Retained Earnings and will it effect divident or wage policies of a firm?

Back 36

Retained earning is not cash, its a stockholder's equity account that represents the accumulated increase in the profitable operations.
The level of retained earnings does not lead to a specific wage or dividend policy for the firm.

Front 37

Does balance sheet represent current values?

Back 37

No

Front 38

Describe Entity?

Back 38

An Accounting entity is an organization or a section of an organization that stands apart from other organizations and individuals as a separate economic unit.

Front 39

Describe Reliability concept?

Back 39

Reliability is a quality of information that assures decision makers that infomation captures the conditions or events it purports to represent. Reliable data require convincing evidence that can be verified by independent auditors.
The death of an executive may have considerably more economic or financial significance than embezzlement, but the monetary effect is hard to meaure in any reliable way thus accountants will record the embezellement event as compare to the death of a higher executive.

Front 40

Describe the going concern convention?

Back 40

It is an assumption that ordinarily an entity persists indefinitely.
A company will use its existing resources such as plant assets, to fulfill its general needs rather than sell them in tomorrow's real estate or equipment markets.

Front 41

What is the opposite of the going concern?

Back 41

Immediate Liquidation assumption, whereby all items on a balance sheet are valued at the amounts appropriate if the entity were to be liquidated in piecemeal fashion within a few days or months.

Front 42

Describe Materiality Convention?

Back 42

The materiality convention asserts that an item should be included in a financial statement if its omission or misstreatment would tend to mislead the reader of the financial statements under consideration.

Front 43

Describe Cost Benefit criterion?

Back 43

A system should be changed when the expected additional benefits of the change exceed its expected additional costs.

Front 44

What are benefits of cost benefit criterion?

Back 44

It safeguards the cost effectiveness of its standard by
1-ensuring a standard does not impose costs on the many for the benefit of a few.
2-seeking alternative ways of handling an issue that are less costly and only slightly less efficient.

Front 45

Describe Stable Monetary Unit?

Back 45

It is simply the one that is not expected to change in value significantly over time.
That is a 2005 dollar has about the same value as a 2000 dollar.

Front 46

What are the four popular financial ratios?

Back 46

1-Earnings Per Share
2-Price Earnings Ratio
3-Dividend-Yield Ratio
4-Dividend-Payout Ratio

Front 47

Describe EPS (EPS ratio)?

Back 47

Net income divided by the average number of common shares outstanding during the period.
EPS Data must appear on the income statement of publicly held corporations.
This is the only ratio which is required in the body of financial ratio.
It tells the investors how much of a period's net income belongs to each share of common stock.

Front 48

What is Price-Earnings(P-E ratio)?

Back 48

P-E Ratio = Market price per share/ Earnings per share of common stock.
This ratio tells us that investors expectation of a company's earning's growth.

Front 49

What is the dividend yield ratio?

Back 49

Dividend-Yield Ratio =common dividend per share/ current market price of the stock.

Front 50

What is Dividend-payout ratio?

Back 50

Dividend-payout ratio = Common Dividends per share/ Earnings per share

Front 51

What are the aspects of decision usefulness?

Back 51

1-Relevance(whether the information makes a difference to the decision makers)
2-Reliability

Front 52

Define verifiability?

Back 52

A quality of information meaning that it can be checked to ensure it is correct.

Front 53

Define validity?

Back 53

A correpsondence between the accounting numbers and the objects or events those numbers purport to represent.

Front 54

Define Neutrality?

Back 54

A quality of information that is objective and free from bias.

Front 55

Define Comparibility?

Back 55

Conformity across companies with respect to policies and procedures.

Front 56

Define consistency?

Back 56

Conformity from period to period with unchanging policies and procedures.