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Review of Accounting Chapter 4 Feb 3 rd , 2010
Learning Objectives: <ul><li>Use of the balance sheet, the income statement, and the statement of cash flows by managers. ...
The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balanc...
The Firm’s Financial Statements <ul><li>Balance Sheet ( as of a point in time ) </li></ul>Current Liabilities A/P Payroll ...
<ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
<ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
Assets  =  Liabilities  +  Owner’s Equity <ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balanc...
The Firm’s Financial Statements Revenues  -  Expenses  =  Net Income Sales <ul><li>Income Statement ( covers a period of t...
The Firm’s Financial Statements Retained Earnings Revenues  -  Expenses  =  Net Income <ul><li>Income Statement  </li></ul...
<ul><li>Income Statement </li></ul>ACME CORPORATION
Ethical Considerations - Income <ul><li>Rite Aid investigated by the SEC </li></ul><ul><li>$500 million restatement of ear...
The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balanc...
Statement of Cash Flows <ul><li>Reconciles net income and change in cash </li></ul><ul><li>Broken down into 3 sections: </...
How balance sheet changes affect cash flow <ul><li>Decision Table: </li></ul><ul><li>Asset increases (-)  Use of cash </li...
The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>Cash Inflow  -  Cash Outflow  =  Change in Cash ...
The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>Cash Inflow  -  Cash Outflow  =  Change in Cash ...
The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>+Sale of stock -Buy back stock +Issue of LT debt...
Statement of Cash Flows <ul><li>Summary </li></ul><ul><li>Cash flow from operations 9,294 </li></ul><ul><li>-/+ cash flow ...
Statement of Cash flow - Acme <ul><li>Figure 4-4, page 58 (77) </li></ul><ul><li>Statement of cash flow </li></ul><ul><li>...
Ethical Considerations - Enron <ul><li>Failure of  management  team for errors on financial statements and hidden debt  </...
Depreciation <ul><li>Accounting depreciation is the allocation of an asset’s initial cost over time. </li></ul><ul><li>Boo...
Calculation of Depreciation <ul><li>Straight line depreciation –used per books </li></ul><ul><ul><li>Depreciable basis div...
Example of Straight Line Depreciation <ul><li>Total depreciable basis =$10,000 </li></ul><ul><li>Accounting life = 3 years...
Federal Income Taxation <ul><li>Tax Computation </li></ul>2002 Corporate Tax Rates Taxable Income Tax Rate $0 - $50,000 15...
Tax Calculation Example <ul><li>Taxable income = $1,000,000 </li></ul><ul><li>$  50,000 x .15 = $  7,500 </li></ul><ul><li...
Federal Income Taxation <ul><li>Used in computing after tax cash flow for calculation of value of business decisions </li>...
End of Chapter 4 <ul><li>Taxes – Ugh! </li></ul>
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Review of Accounting Chapter 4

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Review of Accounting Chapter 4

  1. 1. Review of Accounting Chapter 4 Feb 3 rd , 2010
  2. 2. Learning Objectives: <ul><li>Use of the balance sheet, the income statement, and the statement of cash flows by managers. </li></ul><ul><li>Calculation of depreciation. </li></ul><ul><li>How depreciation affects cash flow. </li></ul><ul><li>Calculation of marginal and average tax rates. How taxes affect cash flow. </li></ul>
  3. 3. The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balance sheet </li></ul></ul><ul><ul><li>Income statement </li></ul></ul><ul><ul><li>Statement of cash flows </li></ul></ul><ul><ul><li>Statement of Retained Earnings </li></ul></ul><ul><ul><li>Accompanying notes </li></ul></ul>
  4. 4. The Firm’s Financial Statements <ul><li>Balance Sheet ( as of a point in time ) </li></ul>Current Liabilities A/P Payroll S-T Debt Long Term Liabilities L-T Bank Debt Bonds Mortgages Assets = Liabilities + Owners’ Equity Current Assets Cash A/R Inventory Fixed Assets Land Buildings Equipment Less: Accum. Dep. Owners’ Equity Preferred Stock Common Stock Capital in Excess of Par Retained Earnings
  5. 5. <ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
  6. 6. <ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
  7. 7. Assets = Liabilities + Owner’s Equity <ul><li>Balance Sheet </li></ul>ACME CORPORATION Year Ended December 31
  8. 8. The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balance sheet </li></ul></ul><ul><ul><li>Income statement </li></ul></ul><ul><ul><li>Statement of cash flows </li></ul></ul><ul><ul><li>Accompanying notes </li></ul></ul>
  9. 9. The Firm’s Financial Statements Revenues - Expenses = Net Income Sales <ul><li>Income Statement ( covers a period of time ) </li></ul>Cost of Materials Direct labor Manufacturing overhead, including Depreciation Marketing Exp Research & Development Administrative Exp Taxes Interest Exp.
  10. 10. The Firm’s Financial Statements Retained Earnings Revenues - Expenses = Net Income <ul><li>Income Statement </li></ul>Dividends Note: Dividends are paid out of retained earnings, not net income
  11. 11. <ul><li>Income Statement </li></ul>ACME CORPORATION
  12. 12. Ethical Considerations - Income <ul><li>Rite Aid investigated by the SEC </li></ul><ul><li>$500 million restatement of earnings </li></ul><ul><li>KPMG resigned as auditor because they were unable to rely on management’s representations </li></ul><ul><li>Stock fell by 86%! </li></ul><ul><li>Firm (investors!) lost $11.2 billion in market value </li></ul><ul><li>See page 53 (72) for details </li></ul>
  13. 13. The Firm’s Financial Statements <ul><li>Annual report includes: </li></ul>Link to Annual Report Gallery <ul><ul><li>Balance sheet </li></ul></ul><ul><ul><li>Income statement </li></ul></ul><ul><ul><li>Statement of cash flows </li></ul></ul><ul><ul><li>Accompanying notes </li></ul></ul>
  14. 14. Statement of Cash Flows <ul><li>Reconciles net income and change in cash </li></ul><ul><li>Broken down into 3 sections: </li></ul><ul><li>Cash flow from operations </li></ul><ul><li>Cash flow used for investing </li></ul><ul><li>Cash flow from/for financing </li></ul><ul><li>The total of these 3 = change in cash </li></ul><ul><li>Balance Sheet current year cash balance minus prior year cash balance = change in cash </li></ul>
  15. 15. How balance sheet changes affect cash flow <ul><li>Decision Table: </li></ul><ul><li>Asset increases (-) Use of cash </li></ul><ul><li>Asset decreases (+) Source of cash </li></ul><ul><li>Liability increases (+) Source of cash </li></ul><ul><li>Liability decreases (-) Use of cash </li></ul>
  16. 16. The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>Cash Inflow - Cash Outflow = Change in Cash Net Income +Depreciation & amortization (non-cash expenses) -Increase/+Decrease in Current Assets (+/- cash) +Increase/-Decrease in Current Liabilities (+/- cash) = cash from operations (can be + or -), but usually a source of cash (+) (EBITDA) See Fig 4-4, page 58 (77) From Operations:
  17. 17. The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>Cash Inflow - Cash Outflow = Change in Cash +Sale of Fixed Assets - Purchase of fixed assets +Sale of Securities -Purchase of Securities +Sale of other LT assets -Purchase of other LT assets = cash used for investing (usually a use of cash) See Fig 4-4, page 58 (77) From Investing:
  18. 18. The Firm’s Financial Statements <ul><li>Statement of Cash Flows </li></ul>+Sale of stock -Buy back stock +Issue of LT debt -Repay LT debt or notes payable -Pay dividends = cash received from or used for Financing See Fig 4-4, page 58 (77) Cash Inflow - Cash Outflow = Change in Cash From Financing:
  19. 19. Statement of Cash Flows <ul><li>Summary </li></ul><ul><li>Cash flow from operations 9,294 </li></ul><ul><li>-/+ cash flow from investing -14,000 </li></ul><ul><li>+/- cash flow from financing 5,706 </li></ul><ul><li>= change in cash 1,000 </li></ul>
  20. 20. Statement of Cash flow - Acme <ul><li>Figure 4-4, page 58 (77) </li></ul><ul><li>Statement of cash flow </li></ul><ul><li>Figure 4-5, page 59 (78) </li></ul><ul><li>Statement of changes on balance sheet </li></ul><ul><li>Compare, trace change column on balance sheet to cash flow statement </li></ul>
  21. 21. Ethical Considerations - Enron <ul><li>Failure of management team for errors on financial statements and hidden debt </li></ul><ul><li>Failure of analysts and debt rating agencies to forewarn investors </li></ul><ul><li>Investment bankers and attorneys who created the special purpose entities </li></ul><ul><li>Failure of audit firm due to conflict of interest – audit versus consulting </li></ul><ul><li>Retirement plan administrators who put employee contributions into Enron stock </li></ul><ul><li>(See page 61 (80) for details) </li></ul>
  22. 22. Depreciation <ul><li>Accounting depreciation is the allocation of an asset’s initial cost over time. </li></ul><ul><li>Book value is Asset Cost minus Depreciation </li></ul><ul><li>Book Value does not equal Market Value </li></ul><ul><li>Allowable depreciation expense is determined by accounting rules. </li></ul><ul><li>Depreciation is a non-cash expense </li></ul>
  23. 23. Calculation of Depreciation <ul><li>Straight line depreciation –used per books </li></ul><ul><ul><li>Depreciable basis divided by accounting life with equal amounts of depreciation allocated to each time period. </li></ul></ul><ul><li>Depreciable basis </li></ul><ul><ul><li>Total amount to be depreciated over the accounting life of the asset. </li></ul></ul><ul><ul><li>Equal to cost of the asset plus any installation, setup and delivery costs incurred. </li></ul></ul>
  24. 24. Example of Straight Line Depreciation <ul><li>Total depreciable basis =$10,000 </li></ul><ul><li>Accounting life = 3 years </li></ul><ul><li>Year Percent Basis Amount </li></ul><ul><li>1 33.33 $10,000 $3,333 </li></ul><ul><li>2 33.33 $3,333 </li></ul><ul><li>3 33.34 $3,334 </li></ul>
  25. 25. Federal Income Taxation <ul><li>Tax Computation </li></ul>2002 Corporate Tax Rates Taxable Income Tax Rate $0 - $50,000 15% $50,001 - $75,000 25% $75,001 - $100,000 34% $100,001-$335,000 39% $335,001-$10,000,000 34% $10,000,001-$15,000,000 35% $15,000,001-$18,333,333 38% Over $18,333,333 35
  26. 26. Tax Calculation Example <ul><li>Taxable income = $1,000,000 </li></ul><ul><li>$ 50,000 x .15 = $ 7,500 </li></ul><ul><li>$ 25,000 x .25 = $ 6,250 </li></ul><ul><li>$ 25,000 x .34 = $ 8,500 </li></ul><ul><li>$ 235,000 x .39 = $ 91,650 </li></ul><ul><li>$ 665,000 x .34 = $226,100 </li></ul><ul><li>$1,000,000 Tax $340,000 </li></ul><ul><li>Note: 34% of $1,000,000 = ? </li></ul>
  27. 27. Federal Income Taxation <ul><li>Used in computing after tax cash flow for calculation of value of business decisions </li></ul>Marginal tax rate = tax rate on next dollar earned = 15 % on income from 0 – 50,000 = 39% on income from $100,000 to $335,000 Above $335,000, to $10,000,000 marginal rate = 34%, Above $18,333,333, marginal rate = 35% <ul><li>Marginal Tax Rate </li></ul>2002 Corporate Tax Rates Taxable Income Tax Rate $0 - $50,000 15% $50,001 - $75,000 25% $75,001 - $100,000 34% $100,001-$335,000 39% $335,001-$10,000,000 34%
  28. 28. End of Chapter 4 <ul><li>Taxes – Ugh! </li></ul>

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