AFM101 Chapter Notes - Chapter 3: Gross Margin, Gross Profit, Interest Expense

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lilacmouse857

7 Jun 2018

School

University of Waterloo

Department

Accounting & Financial Management

Course

AFM101

Professor

Donna Psutka

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AFM 101 - Chapter 3 Notes

HOW DO THE BUSINESS ACTIVITIES AFFECT THE STATEMENT OF EARNINGS?

The Operating Cycle

• Operating (cash-to-cash) Cycle: the time it takes for a company to pay cash to suppliers, sell

goods and services to customers, and collect cash from customers

o Begins when a company receives goods to sell, pay for them, and sells to customers

o Ends when customers pay cash to the company

o Short-term financing may be used so that businesses can pay suppliers and employees

before they receive cash from customers

• Shortening the operating cycle means higher net earnings and faster growth

• Periodicity Assumption: means that the long life of a company can be reported in shorter

periods

o To help measure net earnings for a specific period of time

o Two types of issues arise in reporting periodic net earnings to users:

▪ Recognition issues: When should the effects of operating activities be

recognized (recorded)

▪ Measurement issues: What amounts should be recognized?

Elements of the Statement of Earnings

• Includes three major sections:

o 1) Results of continuing operations

o 2) Results of discontinued operations → (Net earnings = sum of 1+2)

o 3) Earnings per share

• Continuing Operations: presents results of continuing operations

• Operating Revenues:

o Revenues: increases in assets or settlements of liabilities from ongoing operations

▪ Assets (usually cash or trade receivables) increase when revenues are earned

▪ Deferred Revenue is created when a company receives cash in advance for a for

a promise to receive goods or services in the future → a liability account is

earned

• Operating Expenses:

o Expenses: decreases in assets (or increase in liabilities) to generate revenues during the

period

▪ Different from expenditures which is any outflow of cash for any purpose

▪ Expenses only occur when an asset is used to generate revenue or when an

amount is incurred to generate revenues during a period (ex. Electricity)

o Ex. Sun-Rpe’s priar operatig epeses ilude:

▪ Cost of sales (aka cost of goods sold)

• = inventories used to produce and package the squeezed fruits and

become an expense

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Related Questions

a. What is the difference between aâ firm's cash cycle and its operatingâ cycle? Select all that apply

A firm's cash cycle is the average length of time from when a firm pays cash for its inventory to when it receives cash from the sale of that inventory? (or the end product that the firm produced with the? inventory).

B. If a firm were to pay cash for its? inventory, rather than buying the inventory on? credit, the cash cycle and the operating cycle of the firm would be identical. In most? cases, however, firms buy their inventory on? credit, so the cash cycle is longer than the operating cycle of the firm.

C. firm's operating cycle is calculated as the average number of days between the purchase of the initial inventory and the sale of the end product plus the average number of days it takes the? firm's customers to pay for the inventory they purchase.

D. A firm's operating cycle is the average length of time between when a firm purchases its inventory and when the firm receives cash from the sale of the inventory. E. The cash cycle is calculated as the average number of days between the purchase of the initial inventory and the sale of the end product plus the average number of days it takes the? firm's customers to pay cash for the inventory they purchase minus the average number of days the firm takes to pay its suppliers for the inventory. F. If a firm were to pay cash for its? inventory, rather than buying the inventory on? credit, the cash cycle and the operating cycle of the firm would be identical. In most? cases, however, firms buy their inventory on? credit, so the cash cycle is shorter than the operating cycle of the firm.

amethystwater-buffalo366

Ravenna Company is a merchandiser that uses the indirect methodto prepare the operating activities section of its statement ofcash flows. Its balance sheet for this year is as follows:

	Ending Balance		Beginning Balance
Cash	$	52,800	$	62,700
Accounts receivable		45,100		48,400
Inventory		60,500		55,000

Total current assets		158,400		166,100

Property, plant, and equipment		165,000		154,000
Less accumulated depreciation		55,000		38,500

Net property, plant, and equipment		110,000		115,500

Total assets	$	268,400	$	281,600

Accounts payable	$	35,200	$	62,700
Income taxes payable		27,500		30,900
Bonds payable		66,000		55,000
Common stock		77,000		66,000
Retained earnings		62,700		67,000

Total liabilities and stockholdersâ equity	$	268,400	$	281,600

During the year, Ravenna paid a $6,600 cash dividend and it solda piece of equipment for $3,300 that had originally cost $6,600 andhad accumulated depreciation of $4,400. The company did not retireany bonds or repurchase any of its own common stock during theyear.

1.	What is the amount of the net increase or decrease in cash andcash equivalents that would be shown on the companyâs statement ofcash flows?
3.	How much depreciation would the company add to net income on itsstatement of cash flows?
5-a.	What is the amount and direction (+ or â) of the accountsreceivable adjustment to net income in the operating activitiessection of the statement of cash flows?

5-b.

What does this adjustment represent?

	Cash collected from customers < Credit sales
	Cash collected from customers > Credit sales
	Cash payments > Cash collected

7-a.

What is the combined amount and direction (+ or â) of theinventory and accounts payable adjustments to net income in theoperating activities section of the statement of cash flows?

7-b.

What does this amount represent?

	Cash paid to suppliers > Purchases
	Cash paid to suppliers < Cost of goods sold
	Cash paid to suppliers > Cost of goods sold

1. A creditor is reviewing Hoffman Electronicsâ statements ofretained earnings for the last 3 years. The creditor is trying todetermine whether a substantial loan should be given to HoffmanElectronics. Which question will most likely be answered byreviewing the statement of retained earnings?

a. Does Hoffman Electronics make risky investments that impedethe cash flow of the firm?

b. What was the ending permanent account balance for HoffmanElectronics last quarter?

c. What assets owned by Hoffman Electronics are valuable enoughto cover debt repayment?

d. Does Hoffman Electronics have enough earnings to pay bothdividends and debts?

2. True or false. By reviewing a companyâs statement of retainedearnings over multiple reporting periods, an investor can evaluatethe companyâs future growth potential based on net incomechanges.

3. A creditor would most likely be interested in reviewing afirmâs statement of retained earnings to determine if the firm

a. exhibits liquidity.

b.can repay its debt obligations.

c.makes risky investments.

d.has sufficient receivables.

4. On statement of cash flow, the repayment of loans iscategorized as a cash flow from ____activities.

a. operating

b. financing

5."Fill in the blank" question: select the correct answer.

In a statement of cash flows, cash inflows that result fromproviding goods to customers are included in the section calledâcash flows from_______ activities.

a. investing

b. operating

c. sales

d. investing

6. Creditors want to know whether Photon, Inc. uses itsavailable cash to purchase new equipment. Which section of thestatement of cash flows would provide this information?

a.Cash flows from operating activities

b.Cash flows from sales activities

c.Cash flows from financing activities

d.Cash flows from investing activities

7. Creditors are examining the statement of cash flows forPhoton, Inc. Which of the following questions can be answered byreviewing the statement of cash flows?

a. What is the average net income of Photon?

b.What type of assets does Photon possess?

c.Does Photon reset its temporary accounts?

d.Does Photon pay its bills when they are due?

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AFM101 Chapter Notes - Chapter 3: Gross Margin, Gross Profit, Interest Expense

AFM101 Full Course Notes

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