Week One – Accounting Principles
- Please explain the following accounting concepts and give an example of how they relate to accounting information: Materiality, Consistency, and Full Disclosure.
Materiality principle. Accountants follow the materiality principle, which states that the requirements of any accounting principle may be ignored when there is no effect on the users of financial information. Certainly, tracking individual paper clips or pieces of paper is immaterial and excessively burdensome to any company’s accounting department. Although there is no definitive measure of materiality, the accountant’s judgment on such matters must be sound. For example, several thousand dollars may not be material to an entity such as Microsoft, but that same figure is quite material to a small, family-owned business.
To be useful, financial information must be relevant, reliable, and prepared in a consistent manner. Consistent information is prepared using the same methods each accounting period, which allows meaningful comparisons to be made between different accounting periods and between the financial statements of different companies that use the same methods.
Full disclosure principle. Financial statements
normally provide information about a company’s past performance. However, pending lawsuits, incomplete transactions, or other conditions may have imminent and significant effects on the company’s financial status. The full disclosure principle requires that financial statements include disclosure of such information. Examples are footnotes supplement financial statements to convey this information and to describe the policies the company uses to record and report business transactions.
- What would happen if all of the steps of the accounting cycle were not completed in a specific accounting period? What would be the impact on the company’s balance sheet and net income if a company did not set up a necessary receivable at the end of the accounting period?
Step one of the accounting cycle is to analyze transactions and determine how those transactions affect the accounting equation. Accountants analyze transactions using debits and credits. The second step is record the effects of transactions using journal entries Journal entries are the accountant’s way of recording the debit and credit effects of both simple and complex business transactions. The third step is summarizing the resulting journal entries through posting and prepares a trial balance. Once journal entries are made, their effects must be sorted and copied, or posted, to the individual accounts. The fourth step is to prepare the report. Accounting is designed to accumulate
and report in summary form the results of a company’s transactions, thereby transforming the financial data into useful information for decision making.
Some economic activities, such as the growth in the amount of interest a company owes, happen gradually. Without special adjustments, the accounting records would not reflect the impact of these gradual activities. Adjusting entries must be made at the end of each accounting period to ensure that all balance sheet and income statement items are stated at the correct amount.
All businesses, periodically issue their financial statements so that users can make sound economic decisions. Current owners, investors, and bankers, and need up-to-date reports in order to compare and judge a company’s financial position and operating results on a continuing, timely basis. They need to know the financial position of a company (from the balance sheet), the relative success or failure of current operations (from the income statement), and the nature and extent of cash flows (from the statement of cash flows). Delays would be in violation of reporting guidelines and may carry substantial costs.
Week Two – Principles of Financial Statement Preparation
- What at the primary financial statements and how do the statements tie together?
Primary financial statements are income statement, balance sheet, and cash flow statements. The income statements’ revenue and expense illustrate
the changes in assets and liabilities on the balance sheet. Cash assets and cash and cash equivalents on a balance sheet are reflected on the statements of cash flows. Also, the statements of cash flows present additional data on cash assets displayed on the balance sheet.
Managers use a few significant ratios to summarize the firm’s leverage, liquidity, efficiency, and profitability. They may also combine accounting data with other data to measure the esteem in which investors hold the company or the efficiency with which the firm uses its resources.
- What is the basic accounting equation? How is equilibrium maintained if overall liabilities decrease (what has to happen to assets or equity)?
Assets – Liabilities = Equity. This equation is the basis for the most basic of accounting reports, the suitably named balance sheet. A balance sheet reports what a business have possession of (assets), what is in debt (liabilities) and what the remainder is for the owners (equity) as of a definite date. This equation should be in balance.
Week Three – Financial Statement Analysis
- What types of ratios would a credit analyst at a bank tend to focus on when deciding whether to give a company a loan (name a specific ratio)? What ratios would a financial manager focus on in order to manage a company (name at least two specific ratios)?
I would use debt ratio by comparing the amount of liabilities with the amount of assets
indicates the extent to which a company has borrowed money to leverage the owners’ investments and increase the size of the company. As a frequently used measure of leverage, debt ratio computes the total liabilities divided by total assets. A perceptive interpretation of the debt ratio is that it represents the proportion of borrowed funds used to acquire the company’s assets.
Price-earnings ratio is a measure of growth potential, earnings stability, and management capabilities; computed by dividing market value of a company by net income and current ratio, a measure of the liquidity of a business; equal to current assets divided by current liabilities.
- How can operating leverage be used to increase a company’s profitability?
A measurement of the degree to which a firm or project incurs a combination of fixed and variable costs. A company that makes few sales is highly leveraged. A business that makes many sales is less leveraged. As the volume of sales in a business increase, each new sale contributes less to fixed costs and more to profitability.
Week Four – Managerial Accounting
- Why is good working capital management important? What are some working capital strategies used in your organization (or an organization you’ve worked for in the past)?
A measure of a company’s efficiency and short-term financial health; a company’s working capital an d calculated as Working capital = Current Assets – Current Liabilities
Positive working capital means that the company is able to pay off its short-term liabilities, whereas negative working capital means that a company is unable to meet its short-term liabilities out of its current assets (cash, accounts receivable, and inventory). Working capital also is referred to as net working capital.
Ongoing improvements include Online Paying and Collection (OPAC OPAC – Online Public Access Catalog ), which was implemented at all DFAS locations, with authorization from the Department of the Treasury where needed. The implementation resulted in a 50 percent reduction in manual billings produced by GSA for the FTS area. The reduction in manual billings and the use of OPAC decreased the GSA accounts receivables from $192.4 million in July 2000 to $103.3 million in September 2001. Delinquent Department of Defense (DoD) bills were reduced by 44 percent, which increased GSA’S working capital fund and increased GSA’S ability to reimburse its vendors. Along with this increase in electronic commerce, the chargeback percentage of OPAC transactions decreased from 22 percent in January 2001 to 3 percent by July 2001.
- How is a car loan an example of the time value of money? Under what circumstances should an individual take out a loan versus pay all cash?
Time value of money (TVM) is the process of calculating the value of an asset in the past, present or future. It is based on the premise that the original
principal will increase in value over time by interest. This means that a dollar invested today is going to be worth more tomorrow. Principal is the amount of money borrowed today. You buy a car today for $10,000 of which you borrow $8,000.00 from the bank and pay $2,000.00 of your own money: the $8,000.00 is the principal of the car loan. The $2000.00 is the principal.
You should never pay cash for a car. Instead of using your savings for the purchase of a car this will decrease your assets and increase your liabilities, wait until your assets generate monthly cash-flow and then purchase a car. That way the cash-flow from your assets will finance your liabilities. Also, your payment remains fixed and you will be paying with deflated dollars over time, assuming you stretch it out. This is why businesses never pay cash for anything, because they understand the economics.
Week Five – Principles of Finance
- What is the difference between stocks and bonds? Which represents more risk to the company? Why?
Stocks are EQUITY. They represent shares of ownership in a Corporation. A Stockholder is actually one of many owners of a Publicly Owned Corporation. If a Corporation dissolves for any reason owners of Common Stock (the main type of stock issued) receive the value of the sold assets of the Corporation AFTER everyone else is paid, including the IRS, Employees, Bonds, Accounts Payable, etc.
Bonds are DEBT. They are sold by
the Corporation in order to raise money for various purposes for use by the company. Bonds offer an interest rate to the Bondholder for the period of time that the Bondholder owns the bonds.
Since bonds do not represent ownership, the bondholder could lose their investment if the Corporation dissolves, but are paid BEFORE owners of stock. Bonds are not risky as they have a set payment schedule so there are no surprises. There is no such guarantee with stocks.
- Does a company receive money when its stock is traded in the secondary market? How does the company affect the price of its stock? Why is a company concerned about its stock price in the secondary market?
No, a company does not receive money when its stock is traded in the market. The company only receives funds in the initial public offering. The company affects the price of its stock by its financial management and performance (increasing revenues, net income, issuing dividends, making strategic investments, reducing debt, etc.), and by keeping the market informed about its accomplishments. The company is concerned about its stock price in the secondary market because it affects the company’s ability to issue more stock in the future (if needed to grow), the company’s ability to borrow in the future, the net worth of shareholders, the value of stock options (if provided as compensation to key employees), and the company’s ability to make acquisitions of other companie