Financial Accounting Final Exam Practice: Comprehensive Study Notes

Stockholders' Equity

Common and Preferred Stock

Stockholders' equity represents the owners' claim on the assets of a corporation after liabilities are settled. It is primarily composed of common stock, preferred stock, additional paid-in capital, and retained earnings.

• Common Stock: Represents ownership in a corporation, with voting rights and residual claim on assets.

• Preferred Stock: Has priority over common stock in dividend payments and asset distribution, often with a fixed dividend rate.

• Treasury Stock: Shares repurchased by the company, reducing total stockholders' equity.

• Authorized, Issued, and Outstanding Shares:

  • Authorized: Maximum shares a corporation can issue as specified in its charter.

  • Issued: Shares that have been sold to investors.

  • Outstanding: Issued shares currently held by shareholders (excluding treasury shares).

Example: If a company has 100,000 authorized shares, 53,000 issued shares, and 49,000 outstanding shares, the number of treasury shares is 4,000 (53,000 issued - 49,000 outstanding).

Dividends

Dividends are distributions of earnings to shareholders, typically in cash or additional shares.

• Cash Dividends: Paid out of retained earnings; require sufficient cash and retained earnings.

• Stock Dividends: Distribution of additional shares to shareholders, increasing the number of shares but not total equity value.

• Cumulative Preferred Dividends: Unpaid dividends accumulate and must be paid before common dividends.

Journal Entry Example for Cash Dividend:

• On declaration: Debit Retained Earnings, Credit Dividends Payable

• On payment: Debit Dividends Payable, Credit Cash

Long-Term Liabilities

Bonds Payable

Bonds are long-term debt instruments issued by corporations to raise capital. They have a face value, stated interest rate, and maturity date.

• Face Value: The principal amount repaid at maturity.

• Stated Interest Rate: The rate used to calculate periodic interest payments.

• Market Rate: The rate investors demand for similar risk bonds.

• Premium and Discount:

  • Premium: Bonds sold above face value when stated rate > market rate.

  • Discount: Bonds sold below face value when stated rate < market rate.

Example: A $100,000 bond with a 6% stated rate, market rate 8%, will sell at a discount.

Annual Interest Payment Formula:

• $\text{Interest Payment} = \text{Face Value} \times \text{Stated Rate}$

Bond Price Calculation: Present value of future cash flows (interest and principal) discounted at the market rate.

Amortization of Premiums and Discounts

Premiums and discounts are amortized over the life of the bond, affecting interest expense each period.

• Premium Amortization: Reduces interest expense below cash paid.

• Discount Amortization: Increases interest expense above cash paid.

Statement of Cash Flows

Classification of Cash Flows

The statement of cash flows categorizes cash transactions into operating, investing, and financing activities.

• Operating Activities: Cash flows from core business operations (e.g., receipts from customers, payments to suppliers).

• Investing Activities: Cash flows from buying/selling long-term assets (e.g., equipment, investments).

• Financing Activities: Cash flows from transactions with owners and creditors (e.g., issuing stock, borrowing, paying dividends).

Indirect Method: Adjusts net income for non-cash items and changes in working capital to calculate cash from operating activities.

Examples of Cash Flow Classification

• Operating: Receipt from customers, payment to suppliers.

• Investing: Purchase of equipment, sale of land.

• Financing: Issuance of stock, payment of dividends, borrowing cash.

Time Value of Money

Present Value and Future Value Concepts

The time value of money recognizes that a dollar today is worth more than a dollar in the future due to its earning potential.

• Present Value (PV): The current value of future cash flows discounted at the appropriate rate.

• Future Value (FV): The value of a current sum after earning interest over time.

Present Value of an Ordinary Annuity Formula:

• $PV = PMT \times \left[ \frac{1 - (1 + r)^{-n}}{r} \right]$

Example: To find the lump sum needed today to fund $10,000 in 10 years at 6% interest, use the present value formula.

Financial Statement Analysis

Key Ratios and Concepts

Financial statement analysis involves evaluating a company's performance using ratios and trends.

• Return on Equity (ROE): Measures profitability relative to equity.

• Debt to Equity Ratio: Indicates financial leverage.

• Earnings Per Share (EPS): Net income divided by weighted average shares outstanding.

GAAP vs IFRS

Comparison of Standards

Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) are two major accounting frameworks.

• GAAP: Used primarily in the United States; rules-based.

• IFRS: Used internationally; principles-based.

• Key Differences: Treatment of inventory, revenue recognition, and financial statement presentation.

HTML Table Example: Stockholders' Equity Components

Component	Description
Common Stock	Basic ownership, voting rights
Preferred Stock	Priority in dividends, fixed rate
Treasury Stock	Repurchased shares, reduces equity
Retained Earnings	Accumulated profits not distributed
Additional Paid-in Capital	Amounts paid above par value

Additional info:

• Some questions referenced journal entries, which require understanding of double-entry accounting.

• Bond pricing and amortization require present value calculations using time value of money concepts.

• Cash flow classification is essential for understanding the statement of cash flows.