ACC 290 Week 4 Complete Work

Week 4Resource: Ch. 5 and 6 of Financial Accounting
Complete Chapter 5: Brief Exercises BE5-1, BE5-3, BE5-4, BE5-7 and Chapter 6: Brief Exercises BE6-1, BE6-2 and BE6-3
Resource: Chapter 5 and Chapter 6 of Financial Accounting
Complete Chapter 5: Problem P5-7A and Chapter 6: Problem P6-3A
·         Why are companies required to prepare a statement of cash flows? Why is the statement of cash flows divided into three sections? What does each section tell you about the operations of a company?
Companies are required to prepare a statement of cash flows because it contains vital information for the external user. External users consist of investors, creditors, unions, analysts and the consumer. The statement of cash flows helps the external user make educated decisions about the financial state of the company. The cash flow statement focuses on the amount of cash a company has produced so it’s a good prediction of the ability of the company to continue its operations and promote future expansion. The cash flow statement is divided into three sections because there are different categories that a company can generate cash. These are cash flows from operations, financing and investing. Cash flows from operating activities portray the influx and outflow of cash related to everyday core business. Cash flow from investing activities is associated with the buying and selling of non-current assets and cash flow from financing activities is concerned with funding the company, such as issuing stock or paying dividends.
·         What are some common ratios used to analyze financial information? Which are the most important? What are some examples of how ratios are used in the decisionmaking process?

There are four main categories of ratios: Liquidity ratios, Risk analysis ratios, Operating performance ratios, and value ratios. Liquidity ratios measure a company’s ability to commit to short-term commitments while risk analysis ratios determine a company’s ability to meet its debt obligations. Operating performance ratios assess the effectiveness of the company’s resource management while value ratios measure the value of the company’s shares to investors. All ratios are important, but depending on one’s role in the company, one category may be more significant than another. For example, as a creditor of the company, you may be moreconcerned with its risk analysis ratios, whereas as an investor, value ratios may be more meaningful.
A basic example of the use of ratios is to calculate a liquidity ratio called the Current ratio to determine whether a company has the ability to pay off current liabilities. Current ratio is calculated by dividing current asset by current liabilities. If the ratio is less than 1, it would mean that the current assets the company holds is not enough to pay off the current liabilities the company has, and therefore, the liquidity of the company may pose as a concern to the analyst. However, one key thing to note is that one ratio of one company alone may be meaningless. Only when that ratio is compared with the industry average, or the company’s ratio from previous years, will it reflect the company’s well-being.
·         Two popular methods of financial statement analysis are horizontal analysis and vertical analysis.  What are the differences between these two methods?
There are many methods of analyzing financial statements. Of these, two particular methods for measuring the company’s financial 
standings are the horizontal and vertical analysis. Horizontal analysis focuses on the performance of the company during a specific 
time period. Two different balance sheets are compared for changes in financial data, such as growth, decay and changes in the amount 
of debt. Vertical analysis only utilizes one balance sheet to compare diverse categories on it. This is useful for comparisons with the
company’s balance sheet/income statement and other company’s balance sheets/income statements.
·         What are the differences between the direct and indirect presentation of cash flows? Why does the Financial Accounting Standards Board allow both methods? Which do you prefer? Why?
The differences between the direct and indirect presentation of cash flows lies in the amount of cash produced by operating activities. There is no difference present for the investing and financing portions. Both are FASB approved and arrive at the same results. The Financial Accounting Standards Board allows the use of both methods because both adequately show the cash inflows and outflows from each activity and produce the same net cash.
Cash flows from the direct method are calculated cash flows from scratch. The indirect method starts with net income and then makes adjustments for non-cash items, like depreciation, and changes in balance sheet items, like inventory, A/R, A/P. I personally prefer the direct method, although it is rarely used. It shows the detail of all receipts and payments and it is easy to understand.
·         Why must preferred stock dividends be subtracted from net income in computing earnings per share? Why is common stock usually not issued at a price that is less than par value?
Preferred stocks have priority claims upon dividends. Preferred stock dividends must be subtracted from net income in computing earnings per share as part of the GAAP requirements in order to calculate the income available to common shareholders. The denominator in the earnings per share calculation is the weighted average number of common shares. Also, an adjustment for cumulative preferred stock is made, regardless of whether it has been declared in that period. In some cases, preferred stock dividends are paid in shares as opposed to cash.
Usually, common stocks are not issued at a price that is less than par value because if a common stock has a par value then it cannot be offered at less than its par value as delegated by most states. Most common stocks do not have par value.
·         What three conditions must exist before a cash dividend is paid? Contract the effects of a cash dividend and a stock dividend on a corporation’s balance sheet.

Three prerequisites that must be met in order for a cash dividend to be paid are:
1)   The board of directors declares dividends before they are paid
2)  Sufficient amount of cash is on hand
3)  Large enough balance in retained earnings
A stock dividend has no effect upon the total amount of stockholder’s equity, while only affecting the individual balances in retained earnings and contributed capital accounts on the balance sheet. Cash dividends decrease retained earnings as well as stockholder’s equity while having no effect upon the contributed capital accounts.
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