Chapter 4 Review of Accounting

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Shows the firm's assets, liabilities, and equity at a given point in time.

Balance Sheet

Are assets that are expected to provide a benefit to the firm for more than one year.

Fixed Assets

Contains audited financial statements submitted annually to the SEC for distribution to the public.

10K Report

The tax rate that applies to the next dollar of taxable income earned changes as the level of taxable income changes.

Marginal Tax Rate

Specifies the percent of the cost of assets that will be charged each year as depreciation expense during the asset's life as dictated by the Tax Reform Act of 1986.

MACRS

In addition to the income statement, many firms prepare a short _____________ that records dividend and retained earnings information.

Statement of Retained Earnings

Cash, Accounts Payable, and Inventory are considered either __________ or _________.

Current Assets or Liabilities

What statement measures a firm's profitability over a period of time?

Income Statement

What is the formula for EPS?

Earnings available to common stockholders ÷ number of shares of common stock outstanding

Current assets minus current liabilities = ________.

Net Working Capital

What is the formula for calculating the effective tax rate?

Effective tax rate paid ÷ EBT

Finish the following statement: The matching principle says that ________________________.

Expenses should be matched to the revenues they help to generate.

True or False: Net profit is equivalent to net cash flow at the end of an accounting period.

False

The stated value printed on the stock certificate is called the _______________.

Par Value

Finish the following statement: Depreciation basis is equal to _______________.

The cost of the asset plus any set up or delivery cost that may be incurred.

What is the difference between capital in excess of par and common stock?

The common stock reflects the par value printed on the stock certificate times the number of shares issued which is usually very low. Capital in excess of par is the total of the original market price per share value for each stock sold minus the par value.

Explain the difference between a prepaid expense and an accrued expense; why is one considered an asset and one a liability?

A prepaid expense represents future expenses expected but that have been paid in advance. The benefit is owed to the company and is considered an asset. Accrued expenses are business expenses that have not been paid yet and are owed by the company and are considered liabilities.

Retained earnings includes net income before any dividends are deducted. Comment on this statement.

Retained earnings represent the accumulation of earnings after dividends have been paid out that have been retained for reinvestment in the firm. Dividends paid out by definition are not retained.

You have a net income of $76,000; taxes are paid at a rate of 40%; common stock dividends paid are $40,000; and shares of stock outstanding are 50,000. Calculate the EPS.

EPS: $76,000/50,000 shares = $1.52

Cash at the end of 2005 was $100,000 and cash at the end of 2006 was $105,000. Your cash flow statement shows a net cash position of zero. Is this possible? Explain.

No, this is not possible. The statement of cash flows shows the changes in the cash position; thus the change in the actual cash account should be equal to the change in cash position as reflected on the cash-flow statement.

The following information corresponds to Flynn Corporation's 2006 operations.
COGS $400,000
S&A Expenses 50,000
Depreciation 400,000
Sales 1,000,000
Interest Expense 10,000
Tax Rate 35%
Calculate the following income statement items:
a. Gross Profit
b. EBIT
c. EBT
d. Taxes
e. Net Income

a. GP = $600,000
b. EBIT = $150,000
c. EBT = $140,000
d. Taxes = $ 49,000
e. Net Profit = $ 91,000

The following information corresponds to AREO Corporation's 2006 operations.
Sales $13,000,000
Net Income 400,000
Interest Expense 100,000
Preferred Dividends 200,000
Common Stock Dividends 300,000
Beginning Retained Earnings 900,000
Calculate Ending Retained Earnings:

Beginning retained earnings plus net income minus dividends = ending retained earnings:
900,000 + 400,000 - 200,000 - 300,000 = $800,000

Calculate earnings per share for the following:
Net income 600,000
Interest expense 40,000
Preferred dividends paid 25,000
Common dividends paid 125,000
Preferred shares outstanding 100,000
Common shares outstanding 450,000

EPS = ($600,000 - 25,000) ÷ 450,000 = $1.28

Hibbert Inc. had retained earnings at the end of 2005 of $3,500,000. 2006 earnings available to commons stockholders was $500,000 and retained earnings for the end of 2006 was $3,700,000. What was the amount paid in dividends to common stockholders in 2006?

$3,500,000 + 500,000 - 3,700,000 = $300,000

Wilmot Manufacturing bought new equipment in 2006 for $500,000 (total cost). The equipment falls into the MACRS seven-year class. What would be the depreciation taken on this equipment in year 3 using MACRS rules?

$400,000 x 17.5% = $87,500

Brother Mel's Bar-B-Q Restaurant has $80,000 in assets and $20,000 in liabilities. What is the equity of this firm?

$80,000 assets - $20,000 liabilities = $60,000 equity

Cantwell Corporation has sales revenue of $2 million. Cost of goods sold is $1,500,000.What is Cantwell Corporation's gross profit?

Gross profit = $2,000,000 sales revenue -$1,500,000 cost of goods sold = $500,000

Adams Computer Store had accumulated depreciation of $75,000 at the end of 2009,and at the end of 2008 this figure was $60,000. Earnings before interest and taxes for 2009 were 850,000. Assuming that no assets were sold in 2009, what was the amount of
depreciation expense for 2009?

$75,000 end-of-2009 accumulated depreciation - $60,000 end-of-2005 accumulated depreciation = $15,000 2009 depreciation expense

Shattuck Corporation had operating income (EBIT) of $2,500,000 in 2009, depreciation expense of $500,000, and dividends paid of $400,000. What is Shattuck's operating cash flow (EBITDA) for 2009?

$2,500,000 EBIT + $500,000 = $3,000,000 cash flow from operations (Dividend payments are not operating cash flows; they are financial cash flows)

Bubba's Sporting Goods Company had retained earnings of $3 million at the end of 2008. During 2009, the company had net income of $500,000 and of this paid out $100,000 in dividends. What is the retained earnings figure for the end of 2009?

$3,000,000 end-of-2008 retained earnings + $500,000 net income -
$100,000 dividends paid = $3,400,000 end-of-2009 retained earnings

Ron's In-Line Skating Corporation had retained earnings at the end of 2009 of $120,000. At the end of 2008, this figure was $90,000. If the company paid $5,000 in dividends to common stockholders during 2009, what was the amount of earnings available to common stockholders?

Beginning retained earnings + net income - dividends paid = ending retained earnings
Therefore:
Net income = ending retained earnings - beginning retained earnings + dividends paid.
So, for Ron's In-Line Skating Corporation:
Net income = $120,000 - $90,000 + $5,000 = $35,000

Hayes Company recently bought a new
computer system. The total cost, including setup, was $8,000. If this is five-year assetclass equipment, what would be the amount of depreciation taken on this system in year 2 using MACRS rules?

$8,000 depreciation basis × .32 (second-year MACRS depreciation
percentage for a five-year class asset) = $2,560 year - depreciation expense

If Burns Corporation has taxable income of $800,000, how much federal income taxes are owed?

($50,000 × .15) + ($25,000 × .25) + ($25,000 × .34) + ($235,000 × .39) + ($465,000 × .34) = $272,000 federal income taxes owed.
Note: $50,000 + $25,000 + $25,000 + $235,000 + $465,000 = $800,000 taxable income

If Badeusz Quarry Corporation has taxable income of $4 million, what is the average tax rate for this company?

($50,000 × .15) + ($25,000 × .25) + ($25,000 × .34) + ($235,000 × .39) + ($3,665,000 × .34) = $1,360,000 taxes owed; $1,360,000 ÷ $4 million = .34 = 34% average tax rate.
Note: $50,000 + $25,000 + $25,000 + $235,000 + $3,665,000 = $4 million taxable income

If Parmenter Corporation has taxable income of $20 million, what is the marginal tax rate for this company?

Taxable income over $18,333,333 is taxed at a 35% rate. Therefore the marginal tax rate at $20 million in taxable income is 35%.

Why do total assets equal the sum of total liabilities and equity? Explain.

Assets are the items of value a business owns. Liabilities are claims on the business by non-owners, and equity is the owners' claim on the business. The sum of the liabilities and equity is the total capital contributed to the business, which, by definition, equals the total value of the assets.

What are the time dimensions of the income statement, the balance sheet, and the statement of cash flows? Hint: Are they videos or still pictures? Explain.

The income statement is like a video: It measures a firm's profitability over a period of time (which can be a week, a month, a year, or any other time period).
The balance sheet is like a still photograph. The balance sheet shows the firm's assets, liabilities, and equity at a given point in time.
This cash flow statement like the income statement, can be compared to a video: It shows how cash flows into and out of a company over a given period of time.

Define depreciation expense as it appears on the income statement.

Accounting depreciation is the allocation of an asset's initial cost over time. Depreciation expense on an income statement is the amount of the asset=s initial cost allocated to the period covered by the income statement.

How does depreciation affect cash flow?

Depreciation expense is not a cash flow. Depreciation as an expense category affects cash flow, however, because it is tax-deductible. Depreciation expense lowers a company's taxable income and, therefore its income tax liability. In this way depreciation reduces cash outflows.

What are retained earnings?

Retained earnings represents the sum of all the earnings available to common stockholders of a business during its entire history, minus the sum of all the common stock dividends which it has ever paid. Those earnings that were not paid out were, by definition, retained.

Why are retained earnings important?

Retained earnings are important because they represent amounts reinvested in a company on behalf of the company's owners instead of being paid out in the form of dividends.

Explain how earnings available to common stockholders and common stock dividends paid from the current income statement affect the balance sheet item retained earnings.

The change in the retained earnings account from one balance sheet to the next equals net income less preferred stock dividends (which is the amount of earnings available to common stockholders) less common stock dividends.

What is accumulated depreciation?

Depreciation is the allocation of an asset's initial cost over time. Accumulated depreciation is the total of all the depreciation expense that has been recognized to date.

What are the three major sections of the statement of cash flows?

Cash flows from Operations
Cash flows from investing activities
Cash flows from financing activities
Net change in cash balance
Cash balance at beginning of period
Cash balance at end of period

How do financial managers calculate the average tax rate?

Average tax rates are calculated by dividing tax dollars paid by earnings before taxes (EBT).

Why do financial managers calculate the marginal tax rate?

Financial managers use marginal tax rates to estimate the future after-tax cash flows from investments. Since they are interested in how much of the next dollar earned from new investments will have to be paid in taxes, they use the marginal tax rate (rather than the average tax rate) to calculate the tax liability.

What items belong on the income statement?

Interest Expense, Preferred Stock Dividends Paid, Sales, Cost of Goods Sold, Operating Income, Depreciation Expense, Net Income

What items belong on the balance sheet?

Plant and Equipment, Notes Payable, Common Stock, Accounts Receivable, Accrued Expenses, Preferred Stock, Long-Term Debt, Cash, Capital in Excess of Par, Marketable Securities, Accounts Payable, Prepaid Expenses, Inventory, Retained Earnings

What items belong in the current asset section of the blance sheet?

Cash, Accounts Receivable, Marketable Securities, Prepaid Expenses, Inventory

What item belongs in the fixed asset section of the balance sheet?

Plant and Equipment

What items belong in the current liabilities section of the balance sheet?

Notes Payable, Accrued Expenses, Accounts Payable

What items belong in the equity section of the balance sheet?

Common Stock, Preferred Stock, Capital in Excess of Par, Retained Earnings

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