ACCT 2101 Fall 2024 Annotated Study Guide PDF

**ACCT 2101, Fall 2024** **Annotated Study Guide for Final Exam** ***General Information*:** The exam is worth 125 points and consists of 30 equally weighted multiple choice questions. You will have 75 minutes to complete the exam. **Topic 8 -- Liabilities** Understand the classification of curr...

**ACCT 2101, Fall 2024** **Annotated Study Guide for Final Exam** ***General Information*:** The exam is worth 125 points and consists of 30 equally weighted multiple choice questions. You will have 75 minutes to complete the exam. **Topic 8 -- Liabilities** Understand the classification of current and long-term liabilities - Current liabilities are obligations the company owes that are due within one year of the balance sheet date. - Long-term liabilities are non-current obligations; this entails all obligations due after one year from the company's balance sheet. - Why do we separate current from long-term liabilities? ***Risk***. If a company does not have sufficient assets (e.g., cash) to cover the obligations due in the next year, the business may not survive. This is ***liquidity*** -- having sufficient assets on hand to cover current obligations. Sorting current from long-term liabilities makes it easier for stakeholders to assess liquidity. The ***current ratio*** (i.e., current assets ÷ current liabilities) allows stakeholders to assess liquidity. Calculate and prepare the entry for interest on notes payable - Interest Expense = Note Face Amount ***x*** Interest Rate ***x*** Time Note is Outstanding - Example 1: A company purchases goods by issuing a 2-month note of \$40,000 with an interest rate of 9% on March 1. The journal entry on April 30 would be: +-----------------------+-----------------------+-----------------------+ | Note Payable | 40,000 | | | | | | | Interest Expense | 600 | | +=======================+=======================+=======================+ | Cash | | 40,600 | +-----------------------+-----------------------+-----------------------+ where Interest Expense = \$40,000 *x* 0.09 *x* 2/12. Cash of \$40,600 is required to pay the note face amount (\$40,000) and the accrued interest (\$600). - Example 2: A company purchases goods by issuing a 2-month note of \$40,000 with an interest rate of 9% on December 1 of Year 1. If the company's year-end is December 31, the Year 1 year-end adjusting journal entry related to this note would be: Interest Expense 300 ------------------ ----- ----- Interest Payable 300 where Interest Ex\[ense = \$40,000 x 0.09 x (1 / 12). We accrue the interest payable to recognize the obligation the company will have to pay interest on the note in the next month (January of Year 2). The entry to record the payment +-----------------------+-----------------------+-----------------------+ | Note Payable | 40,600 | | | | | | | Interest Expense | 300 | | | | | | | Interest Payable | 300 | | +=======================+=======================+=======================+ | Cash | | 40,600 | +-----------------------+-----------------------+-----------------------+ Know how to account for the issuance of bonds at par (face) value, and how to calculate bond interest expense. - Bonds are debt instruments that allow companies to raise large sums of capital. When bonds are "*issued*", this means the bond is being **sold** to investors who will hold the bond. - When bonds are issued at *par value*, or *face value*, this means that the interest rate paid by the bonds (i.e., the **contract** rate) is the same as the **market** rate on the bond issuance date. - When bonds are issued, you *debit* Cash and *credit* Bonds Payable: Cash 500,000 --------------- --------- --------- Bonds Payable 500,000 - Bonds typically pay interest semiannually (i.e., twice per year). As an example, suppose the \$500,000 worth of bonds above pay interest of 8% semiannually on June 30 and December 31 of each year; the journal entry to record the interest payment would be: +-----------------------+-----------------------+-----------------------+ | Bond Interest Expense | 20,000 | | +=======================+=======================+=======================+ | Cash | | 20,000 | | | | | | *Semiannual interest | | | | = 500,000 x 8% x | | | | (1/2)* | | | +-----------------------+-----------------------+-----------------------+ - General bond accounting example: **Cosmo Corporation issues 12%, 10-year bonds with a par value of \$450,000 that pay interest semiannually.** - How much money does the company get in exchange for issuing the bonds? **\$450,000**. - How long will investors hold the bonds? **10 years**. - How much interest will investors receive annually? **12%**. - When does the company have to pay back the \$450,000 face amount to investors? **10 years from issue date**. - How much cash will the company have to pay for each bond interest payment? **\$27,000 (\$450,000 x 0.12 x ½)**. - How much cash will the company have to pay each year? \$54,000 (\$27,000 + \$27,000). Understand when a bond would be issued at a discount or premium, rather than at par value. - A bond's contract rate is fixed, whereas the market rate fluctuates. As a result, when a bond is going through the various regulatory and legal processes prior to issuance, the market rate will likely differ from the bond's originally determined contract rate. - If the **market** rate does not equal the bond's **contract** rate, the bond will not be issued at par. Instead, it will be issued at a discount or a premium. - If the bond's **contract rate** is **[greater than] the market rate**, the bond will be issued at a **premium**. - If the bond's **contract rate** is **[less than] the market rate**, the bond will be issued at a **discount**. - You do not need to know how to do the accounting for the bond premium or discount; this is the topic of an advanced accounting class. Just understand the concepts above. Be able to compute the Times-Interest Earned Ratio: - Calculated as: *Income before Interest Expense and Income Tax* ÷ *Interest Expense* - Interpretation: measures the ability of a company to meet its interest obligations with operating income. **Topic 9 -- Equity** Understand the journal entry to record the issuance of common stock and calculate total shares issued. - Stock is usually issued at a price that is greater than the stock's par value. In this case, the amount greater than par is included in an account called ***Paid-in Capital in Excess of Par Value*** +-----------------------+-----------------------+-----------------------+ | Cash | XXX | | +=======================+=======================+=======================+ | Common Stock, \$X Par | | XXX | | Value | | | | | | XXX | | Paid-in Capital in | | | | Excess of Par | | | +-----------------------+-----------------------+-----------------------+ - If the stock is sold at par value, then the entry is simply: Cash XXX ----------------------------- ----- ----- Common Stock, \$X Par Value XXX - Shares ***authorized*** is the total \# of shares that the company can issue per the company's charter; shares ***issued*** is the total \# of shares that have been issued to shareholders to date; shares ***outstanding*** is the total \# of shares that have been issued historically, minus the \# of shares held in treasury. - Treasury stock is a contra equity account. When a company buys back stock, it debits ***Treasury Stock*** and credits ***Cash***. Understand dividend declaration date, record date, and payment date. - When the board of directors announces a dividend, it commits to pay shareholders a dividend on a specified future date; this is called the **[declaration date]**; on this date, the company debits ***Dividend*** and credits ***Dividends Payable***. - On the **[record date]**, the company identifies all shareholders of record who will be legally entitled to receive the dividend; there is no accounting entry recorded on this date. - The dividend **[payment date]** is the date the dividends are actually paid to investors; on this date, the company debits ***Dividends Payable*** and credits ***Cash***. - As such, the liability for a dividend is recognized when the board announces (declares) the dividend; and the cash outflow (credit) is recorded when the dividend is actually paid. Understand stock dividends - In a stock dividend, the company distributes additional shares of stock to stockholders; stockholders do not contribute more cash to the company in a stock dividend. In these transactions, the number of shares issued and outstanding increase. - A ***small stock dividend*** is a distribution of 25% or less of previously outstanding shares. It is recorded by capitalizing retained earnings for an amount equal to the ***market value*** of the shares. The entry includes a debit to Retained Earnings equal to *Dividend % x Shares Outstanding x Market Value of Stock*; a credit to Common Stock equal to *Dividend % x Shares Outstanding x Par Value of Stock*; and a credit to Paid-in Capital in Excess of Par equal to *Dividend % x Shares Outstanding x (Market Value of Stock -- Par Value of Stock)* - A ***large stock dividend*** is a distribution of more than 25% of previously outstanding shares. It is recorded by capitalizing retained earnings for an amount equal to the ***par value*** or ***stated value*** of the shares. - Importantly, in a small or large stock dividend, the total equity as reported on the balance sheet does not change; rather, the amount included in retained earnings, common stock (par), and paid-in capital in excess of par changes. - ***Stock splits*** closely relate to large stock dividends, but the accounting treatment differs. - Results in a reduction in the par or stated value per share. - *Retained Earnings*, *Common Stock*, and *Paid-in Capital in Excess of Par* accounts do not change. However, the \# of shares outstanding will increase, and the par value per share will decrease in inverse proportion to the split (e.g., in a 2-for-1 split, \$10 par value stock would split into two units of shares, each with a par value of \$5). - Because a stock split does not affect any of the stockholders' equity accounts, no journal entries are required. - Balance Sheet example presentation before and after a stock split: A screenshot of a financial statement Description automatically generated Basic Earnings Per Share = (Net Income -- Preferred Dividends) ÷ Weighted Average \# of Common Shares Outstanding **Topic 10 -- FSA** Understand horizontal analysis - This analysis allows stakeholders to observes changes in financial performance **[across time]**, such as revenue growth, change in assets, increases/decreases in COGS, or other profit/expense trends. - This can be done by looking at the dollar changes between periods (2025 figures subtract 2024 figures) or the percent changes between periods:  - Trend analysis is horizontal analysis done over multiple accounting periods, where some base year in the past is used to assess changes in accounts period by period. For example, in the below data, performance in 2017-2020 is benchmarked relative to 2016 as the base year: A close-up of a chart Description automatically generated Understand vertical analysis - This is a process of converting the income statement and balance sheet into ***common-size financial statements***. This means converting all numbers reported into percents. - Income statement: calculate each number as a percent of ***Total** **Revenue*** in the same year - Balance sheet: calculate each number as a percent of ***Total** **Assets*** in the same year - Example:  A table with numbers and text Description automatically generated Understand the DuPont framework to calculate Return on Equity:   - Net Profit Margin: shows operational profitability; higher margins indicate effective cost control and pricing strategies. - Asset turnover: shows operational efficiency; higher ratio indicates the company is generating more revenue per one unit of assets. - Equity Multiplier (Leverage): reflects the degree to which assets are financed by debt; a higher multiplier implies greater reliance on debt, which can increase returns (and risk). - Not included above is the ***Return on Assets*** ratio; this is calculated using ***Net Income ÷ Total Assets***; this ratio indicates how efficiently a company uses its assets to generate net income; the closely related ***ROE*** formula indicates how efficiently a company uses its equity to generate income. **Topic 11 -- Cash Flow** Understand purpose of the statement of cash flows: - Reconcile how cash changed from one period to the next. - See sources of income. - See how management chose to spend cash. Cash flow life stages: 1. Start-up stage: a. Companies in initial phase of development; focus is on product development and market entry b. ***Cash from Operating Activity***: likely to be negative because of start-up expenses and little to no revenue. c. ***Cash from Investing Activity***: likely to be negative because of heavy investment in tech, infrastructure, and R&D. d. ***Cash from Financing Activity***: likely to be very positive, as the company raises funds mainly through issuing equity. 2. Growth stage: e. Rapid revenue and market expansion f. ***Cash from Operating Activity***: trending toward being positive, but still likely negative due to operational expenditures to sustain growth. g. ***Cash from Investing Activity***: likely negative, may trend toward positive; company continues to invest heavily in growth opportunities. h. ***Cash from Financing Activity***: likely to remain positive, additional sources of financing cash may come by issuing debt as the company has a proven track record and is credit worthy. 3. Maturity stage: i. Stable revenue and positive earnings. j. ***Cash from Operating Activity***: typically positive as net income is backed by strong net operating cash inflow. k. ***Cash from Investing Activity***: likely to oscillate between positive and negative, as company will sell off and buy new plant, property, and equipment; likely to be negative if company engages in M&A activity to eliminate competition and grow through corporate expansion. l. ***Cash from Financing Activity***: often negative as company has sufficient cash to return capital to shareholders and retire debt balances, or buy back stock. 4. Decline stage. m. Revenue starts to decrease year over year, and company struggles to stay profitable. n. ***Cash from Operating Activity***: begins to decrease relative to prior years, and may turn negative if revenues do not exceed operating costs. o. ***Cash from Investing Activity***: likely positive if out of desperation management starts to sell off assets for capital. p. ***Cash from Financing Activity***: negative if the company continues to pay dividends and retire debt; may be positive though if the company needs cash and the needed levels of cash cannot come from operating activities. Distinguish among operating, investing, and financing activities - *Operating* activities involve transactions that impact the balance **of current assets** and **current liabilities**; also includes interest paid and interest received, as well as dividends received from investment. - *Investing* activities involve transactions that impact **long-term assets** (i.e., intangible assets and PP&E) - *Financing* activities involve transactions that impact **long-term liabilities** (e.g., notes payable, bonds payable), and **equity** (common stock, preferred stock, and treasury stock). Be able to compute net cash provided by operating activities using the indirect method see practice problems and classes done in class. Calculate net cash provided (used) by investing and financing activities see practice problems and classes done in class.