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Working capital is?
net short-term investment needed to carry out day to day activities
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Compute working capital:
current assets - current liabilities
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Creditors are focused on what?
Liquidity
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Investors are focused on what?
Earnings capability
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Currently what is working capital an indication of?
indication of liquity and degree of protection to short term creditors. Also a basis to predict future cash flows.
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The liquidity focus is in conflict with?
Going concern assumption.
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PP&E represent a major source of?
Future service potential, indication of physical resources available to the firm
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Major objective of PP&E accounting?
accounting and reporting to investors on stewardship
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With PP&E what costs are capitalized?
intial cost, all costs necessary to acquire and prepare for intended use
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Why is cost the prefered valuation for PPE
it is reliable and verifiable, arms-length transactions
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What does capitlization imply?
Future service potential.
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Depreciation is a form of?
Cost allocation
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When to capitalize expenditures?
Prolongs life or increases efficiency
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When to expense expenditures?
Ordinary and necessary
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Asset retirement obligation?
the liability associated with the ultimate disposal of a long-term asset
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Historic cost is?
More reliable but less relevent
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Equity securities are?
ownership interests, right to acquire or dispose of an ownership interest
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Debt securities are?
investment in debt of another enterprise
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Uncertainty with R&D?
whether present costs will result in future benefits and when those benefit will occur (if they do).
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R&D decreases the usesfulness of?
The finacial statements, because the matching concept is not followed. Reality is distorted.
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Why is it important to seperate long-term and current liabilities?
Implications of working capital, risks associated with long-term debt, finacial flexability
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Difference between liabilities and equities?
Liabilities are creditor claims, equity is owner interest
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Both liabilities and equity provide what?
resource/capital, used to acquire assets, both groups have claims to the firm's assets.
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Under the entity theory?
liabilities and equity are the same, both receive a return from income of the firm (dividends/interest)
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Proprietary theory?
Equity is the residual amount, assets- liabilities = equity
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Liabilites are?
Arise from a past transaction, represent a current obligation, and are a future transfer of benefit.
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Under SFAC No. 6 what is equity?
Residual interest
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SFAC No. 6's definition of equity is similar to what theory of equity?
Proprietary theory.
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Measure liability?
At present value of future cash flows, transaction approach
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Effective interest method?
results in a stable interest rate each period, discloses the liability balance as equal to the present value of future cash flows discounted
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Straight line interest method
Easier to calculate, stable interest cost per perioed, but not realistic.
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Contingency is a?
Prossible future event
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Loss contingecnices are recognized if?
probable, can be reasonably estimated, otherwise disclosed
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Permanent differences
An item is only included in book income or taxable income, but will never be in both
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Temporary differences
Item is included in both book income and taxable income at some point, but is not recognized in the same period for each purpose.
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Deferred tax assets
Book income is less than taxable income
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Deferred tax liability
Book income is greater than taxable income
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Asset/liability method
deferred amount reported on the balance sheet at the estimated future rate when reversal will happen. Balance sheet focused, increased predictive value
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Intraperiod
allocating tax among components, users are able to see the effect of tax down to the component level. Discourages users from using pretax measures of performance.
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Advantages of leasing
less costly, off-balance sheet treatment, management compensation ignores leasing, debt covennants, tax advatages,
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Capital lease characteristics
Transfers ownership by the end of the lease term, bargain purchase option, lease term >= 75% of economic life, present value of min payments >= 90% of FMV
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Methods of determining pension benefits:
Defined contribution plan, defined benefit plan
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Defined contribution plan?
employer promises to contribute a certain sum into the plan each period. Risk lies with employee.
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Defined benefit plan
the amount of pension benefits to be received in the future are defined by the terms of the plan. Risk lies with the employer
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Cost approach
estimates the total retirement benefits to be paid in the future, determines equal annual payment that wil be necessary to fund those benefits
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Benefit approach
determines the amount of benefits earned by the employee service to date and then estimates the present value of these benefits
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View of pensions?
A means of promoting efficiency (defined benefit), or a form of supplemental benefits (defined contribution)
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Means of promoting efficiency (Pensions)
Costs associated with the plan and not the employee
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Supplemental benefits (Pensions)
Costs related to specific employees
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Components of annual pension cost
Service cost, interest cost, actual return on plan assets, prior service costs, transition amount
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Issues with working capital?
inconsistencies in measurement of components, difference of opinion regarding what should be included, lack of precision in defining elements.
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SFAS No. 87 Minimum liability
ABO - fair value of plan assets, conservative, but contrary to conceptual framework
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SFAS No. 158 liability
PBO - fair value of plan assets. Critics argue overstates liability, but matches
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Capital structure is?
the mix of debt and equity
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Proprietary theory of equity
Assets, belong to owners, flow through to owners
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Entity theory of equity
Entity is a separate legal entity
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Noncompensatory stock options
Not designed as compensation, no expense
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Compensatory stock options
Designed as compensation, expense
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Stock options are what to holders?
Incentive that influences the holder to try to increase profits, help firm avoid taxes and expenses
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Pooling method negatives
accounting is distorted, assets undervalued, income overstated
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Entity theory of consolidation
purpose of finacial statements is to provide information to all shareholders
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Parent company theory of consolidation
purpose of consolidated statements is to provide information for parent company stockholders
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Noncontrolling interest equity?
SFAC 6, says is equity, residual interest
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