MBUS 629 Exam #1 Topics List Chapter 1 Understand the context in which financial statements are produced.

. o Why financial statements are produced. Used as an analytical tool As a management report card An early warning signal As a basis for prediction As a measure of accountability o Have a broad understanding of how the basic business activities of financing, investing, and operations are reflected in the specific financial statements. Planning: R&D Forecasts Management Discussion &Analysis no statement makes this possible Financing Sell Stock Borrow Money Pay Dividend Buyback Stock Liabilities & Stockholder Equity Investing Buildings Production capacity Assets (Balance Sheet) Operating Sales Pay wages, taxes, utilities R&D CGS Collecting A/R Income Statement o Understand why there is managerial discretion in the production of financial statements. Information asymmetry Financial statements are demanded because of their value as a source of information about the companys performance, financial condition, and stewardship of its resources Contract efficiency Supply of financial statement info is guided by the costs of producing and disseminating it and the benefits it will provide to the company Disclosure Benefits: Market forces owners & managers have an economic incentive to supply the amount & type of financial info that will enable them to raise capital at the lowest cost Convey benefits of firms, but not at zero cost Disclosure Costs: Info collecting, processing & dissemination Competitive disadvantage costs Litigation costs Political costs Understand the responsibilities of the analyst, given the discretion and competing incentives that managers face to report truthfully.

Help investors assess the value of a firms debt and equity securities, creditors assess the companys ability to both meet its debt payments and to abide by loan terms, financial advisors and securities analysts to do their job of providing info and advice to investors and creditors, and auditors both to recognize potential reporting abuses and to choose audit procedures to detect them

Chapter 2 Understand the difference between cash-basis and accrual-basis financial statements. Cash basis only use cash, NO A/R; Revenues & expenses are recorded in the period in which the cash is received or paid; measurement base is time; reports reality of cash flows Cash basis distortion distorts view of operating performance on a year-by-year basis Accrual basis - revenues are recorded in the period when they are earned and become measurable; reports the reality of economic value added (or performance) during an accounting period Key Issue = Timing of income recognition: WHEN Revenue recognition Expense Matching

o Understand the revenue recognition principle and what it means for accrual accounting. Revenues are recorded in the period in which they are earned and become measurable Criteria for Revenue Recognition o o Condition 1: Critical Event Condition 2: Measurable

o Understand the matching principle and what it means for accrual accounting. Requires that related revenues & expenses be recognized in the same accounting period Expenses are the expired costs or assets used up in producing those revenues, and they are recorded in the same accounting period in which the revenues are recognized using the matching principle

o Understand Accruals and Deferrals Accrual recognized in Net Income even though NO cash has changed hands Revenue A/R, N/R Expense Wages, Interest, Taxes, Utilities, Salaries Payable Deferral Not initially recognized in Net Income even though cash HAS changed hands Revenue Unearned Revenue, Deferred Revenue Expense Supplies, Inventory, Prepaids, Equipment, Buildings, Machinery, Cars & Trucks Example: Cash Vs. Accrual Income Measurement Measurement of Profit Performance: Revenues & Expenses Net Asset valuation & income determination are inextricably intertwined Ex: Magazine CE in earning subscription revenue is actually providing the product to the customers In MOST instances the time of sale turns out to be the earliest moment at which both Conditions 1 & 2 are satisfied, which is why revenue is most frequently recognized at the time of sale of the product or service Installment-sales method

Production phase Revenue Recognition Specific customer must be Idd & an exchange price agreed on; most cases require formal contract signed Significant portion of the services to be performed has been performed, & expected cost of future services can be reliably estimated An assessment of the customers credit standing permits a reasonably accurate estimate of the amount of cash that will be collected

Completion of Production (Natural resources; Agricultural Products) Product is immediately saleable at quoted market prices Units are homogeneous No significant uncertainty exists regarding the costs of distributing the product

Know how to convert accrual based revenues and expenses in to cash received and cash paid.

Compute Cash inflows from customers using sales revenue from the income statement and changes in A/R and Unearned Revenue Subtract Add Add Subtract INC A/R DEC A/R INC U/Rev DEC U/Rev Non-cash revenue Cash receipt w/prior revenues Cash receipt w/future revenues Non-cash revenue

Compute cash paid for _______ using ________ expense and changes in _______ payable and prepaid _________. Subtract Add Add Subtract INC ____ Payable DEC ____ Payable INC in Prepaid ______ DEC in Prepaid _______ Non-cash expense Cash payment for prior expense Cash payment for future expense Non-cash expense

Understand how the Income Statement and Statement of Shareholders Equity are embedded in the Balance Sheet. A = L + PIC + Beg R/E + (Rev Exp) Div () = Income Statement Be familiar with the format of a multiple-step Income Statement.
Kritek Com pany Income Statement 31-Dec-12 Sales Revenues Sales Revenue Sales Deposits (Unearned Revenue) Total Sales Revenue Less: Sales Discounts $ Net Sales Cost of Goods Sold Gross Profit/Margin Operating Expenses Salaries & Wages Office Salaries Advertising Depreciaiton of store Utilities Expense Rent Expense Insurance Expense 7K - 1.2K Freight-out Total Expenses Income fromOperations Other Revenues & Gains Interest Revenue Other Expenses & Losses Interest Expense Income before Income Taxes Income Tax Expense (@25% ) Net Income $ 720,000 $ 12,000 $ 708,000 11,300 $ 11,300 $ 696,700 $ 460,000 $ 236,700

82500 23000 13000 7500 9500 14500 5800 14,000 169800 66,900

5300

4000 $ 68,200 $17,050.00 $ 51,150

Be able to identify potentially non-recurring items listed on an Income Statement. o Unusual or Infrequent Items o Extraordinary Items o Discontinued Operations o Accounting Changes o Prior Period Adjustments Understand the reporting and calculation of Earnings per Share (EPS) Operating Performance EPS = Income Available to Common Shareholders (less preferred dividends) / Weighted Avg. Common Shares outstanding Diluted EPS = convert all debt / preferred shares into Common Shares ALWAYS less than EPS Understand the concept and reporting of Comprehensive Income. Comprehensive income is the change in equity during the period arising from transactions with nonshareholders Unrealized gains / losses on available-for-sale marketable securities Unrealized gains / losses on foreign currency translations Unrealized losses on recognition of minimum pension obligations NI + Other Comprehensive Income = Total Comprehensive Income

Chapter 3 Understand what is meant by Earnings Management and generally how it is accomplished in an accrual accounting environment. Using the estimates inherent in accrual accounting to move revenues/expenses to different periods Borrowing revenue from the future Delaying expenses to future periods o Expand Depreciation / Amortization Schedule Big Bath expense treatment accelerating expenses in bad years o Front load expenses o Makes future income look better Cookie Jar reserves o Over-estimate liabilities doubtful accounts that get reversed in bad years Chapter 4 Understand how various asset, liability, and equity accounts are classified and measured on a typical Balance Sheet. o Know how to explain adjustments to Net Income in the Operating section of a Statement of Cash Flows. o Adjust for THREE areas ADD back Depreciation / Amortization (non-cash expense) SUBTRACT gains / ADD losses from sale of Long-Term Assets Undo in NI as it is in Investing Activities ADJUST for changes in operating assets & liabilities Understand the accrual and deferral information that is presented in the operating section of the Statement of Cash Flows.

Operational Cash Flow Adjustments / Adjustments on SCF Subtract INC A/R Non-cash revenue Add DEC A/R Cash receipt not reflected in NI

Accounts A/R; N/R Accrurals Accts; Wages; Interest; Taxes, Utilities Payable

Add INC Payable Non-cash expense Subtract DEC Payable Use of cash not reflected in NI

Add INC U/Rev Subtract DEC U/Rev

Cash receipt not reflected in NI Non-cash revenue

Unearned Rev; Deferred Rev ST Prepaid Assets; Inventory

D eferrals

o Understand the details of why Net Income is different from operating cash flows for a particular period. o Income Statement is prepared on the accrual basis of accounting and not all operating transactions are cash transactions o Changes in case are also a result of capital transactions from investments o Some changes in cash are related to changes in liabilities and owners transactions

Subtract INC Prepaid Use of cash not reflected in NI Add DEC Prepaid Non-cash expense

Chapter 5 Know how to construct and analyze common-sized income statements and balance sheets. Time-series analysis IDs trends over time for a biz unit Cross-sectional analysis similarities/differences across companies at same point in time Benchmark comparison uses predetermined standard Common-size statements & ratio analysis provide the easiest comparison methods of two companies of relatively different sizes. Trend statements provide a clear indication of growth and decline for one company. Ratio analysis indicates changes in the composition of the financial statement elements for one company or differences in the financial statement elements between two companies Know how to calculate and analyze the following ratios: 1. ROCE and its 3-factor decomposition. Net Income Available to Common Shares (Less Preferred Dividends) / Avg. Common Shareholders Equity (Less Preferred Shares) 3-Factors o ROA = NOPAT / Avg. Assets o Common Earnings Leverage = NI Avail. To Common / NOPAT o Financial Structure Leverage = Avg. Assets / Avg. CSE 2. ROA and its two components. Net Op Profit After Taxes (NOPAT or EBI)/ Avg. Total Assets Op profit margin = NOPAT / Sales Asset Turnover = Sales / Avg. Total Assets Understand the relationship between ROA and ROCE. ROCE examines how the assets are financed ROCE look at the profitable use of assets (ROA), the % of the earnings that belong to the common shareholders (Common Earnings Leverage), and the degree to which the company uses common shareholders investments to finance the assets. Know when a firms debt financing is adding to or subtracting from the return to common shareholders (i.e. is the firms leverage helping or hurting the return to common shareholders). o Adding ROCE > ROA o Subtracting ROA > ROCE 3. Current Ratio = Current Assets / Current Liabilities 4. Quick Ratio = Current Assets Inventory / Current Liabilities QR = Cash + Marketable Securities + A/R / Current Liabilities 5. Long-Term Debt-to-Assets Ratio 6. Long-Term Debt-to-Equity Ratio 7. Interest Coverage

8.

Operating Cycle/Cash Conversion Cycle Components: Inventory Turnover / Avg. # of days Inventory INV Turnover = CGS / Avg. INV Days INV Held / Outstanding = 365 / INV Turnover Receivables Turnover / Avg. # of days Receivables Outstanding A/R Turnover = Net Sales / Avg. A/R Days A/R Outstanding = 365 / A/R Turnover Payables Turnover / Avg. # of days Payables Outstanding A/P Turnover = INV Purchases / Avg. A/P o INV Purchases = CGS + (End)INV (Beg)INV Days A/P Outstanding = 365 / A/P Turnover Cash Conversion Cycle Days spread in Cash Flows = Days A/R + Days INV Days Payable o Positive Spread firm must cover this mismatch of cash flows through other financing means or with other operating cash inflows