Week 10 - Reading Questions A.docx
- 1. Week 10 Questions/Answers Questions by Article: SEC: Beginner’s Guide to Financial Statements (Part 1) In your own words, describe the “shareholder equity” category on the balance sheet.How is it calculated? Considering the basic accounting equation where assets equal the liabilities added with shareholder’s equity, we can derive that the shareholder’s equity equals the sellable assets of the company less the total pending liabilities payable to other associations. This can be much explained as the total value of the company, which at time of liquidation could be sold and distributed to all the shareholders after all its dues are paid off. This also gives a state of financial health of the company which helps investors and general shareholders to buy the direct shares of the company. In another language, it could also be stated as the total investment made by the investors at the start of the business with the retained earnings over time. Formula: Shareholders’ Equity = Total Assets – Total Liabilities OR Shareholders’ Equity = Share Capital + Retained Earnings – Treasury Stock What is the difference between “current” and “non-current” liabilities? What about “current” and “non-current” assets? Current liabilities are obligations of the company which must be paid off within a year, like vendor credits, post delivery payments, utility payments, short term loan (1 year). Non-Current liabilities are obligations whose settlement goes beyond 1 year period. This is accrued towards daily operations and for long term effect in the company, like purchasing of fixed assets. Some examples are bank loans, bonds, pensions, and gratuity. Current assets are expected incoming cash, which could be redeemed to the company within a year. Such can be converted to cash to fund the ongoing and day to day operations. Some of the relevant examples are inventory, accounts receivable, short-term investments and even the cash in hand. Non-current assets are tangible and non-tangible benefits or things that the company possesses, which in times of liquidity could be converted to cash to pay off all the liabilities and shareholders. Some examples could be building, equipments, vehicles, land, patents, trademarks etc. What is earnings per share? How is it calculated? Earnings per share or EPS is the company’s net profit divided by the total outstanding shares given by the company. This gives a general sense to any shareholder or potential
- 2. buyer about the general corporate value which they could benefit from. A high EPS may be considered as a good metric for investors meaning the high profits of the company, thereby being paid off as dividends or increasing the total value of the assets through retained earnings. Formula: Earnings per Share = (Net Income − Preferred Dividends) // End-of Period Common Shares Outstanding This can be explained as net income less the preferred dividends as that is immediately paid off to the investors. The remaining is dividedby the period outstanding shares as there could be changes in the total outstanding due to stock splits, treasury buyoff etc. Explain the author’s comparison of the income statement with a flight of stairs. The author has compared the income statement to the flight of stairs, considering each step-down as a deduction in value from the top of the stair (total revenue). The top of the stair is considered as the total gross revenue from the sale of the product/goods. Even some sale of assets or interest accrued from investing is considered as part of the revenue, specifies as gains. Coming to the next steps, we reach to the gross profit stair once the cost of goods sold is deducted. In such manner there are many deductions like SG&A, R&D, Taxes, Interest paid, depreciation which step down each point to a new stair name as gross profit, earnings before interest, tax, depreciation and amortization, earnings before tax, earnings after tax, net earnings. In your own words, define “depreciation” as found on the income statement. Depreciation is the process of spreading the cost of decreasing value of the assets like wear and tear of machinery, tools, buildings etc. across multiple periods on an average or weighted basis. Such cost of using the asset goes on till the asset is sold off or discarded. It is considered as a non-cash expense in the income statement and for that reason, the same is added back in the cash flow statement. Only the depreciation expense is considered in the income statement whereas the accumulated depreciation is considered in the balance sheet. There are multiple ways to find the depreciation like straight line method, diminishing balance, unit production etc. ---X---