sld02 review of acctg

C H

A P

T E

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Review of Accounting

McGraw-Hill Ryerson McGraw-Hill Ryerson Limited 2000

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McGraw-Hill Ryerson Limited 2000

Foundations of FinancialManagement CANADIAN

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KRAMER CORPORATIONIncome Statement

For the Year Ended December 31, 1999

1. Sales . . . . . . . . . . . . . . . . . $2,000,000 2. Cost of goods sold . . . . . . . . . . . 1,500,000 3. Gross Profits . . . . . . . . . . . . . 500,000 4. Selling and administrative expense . . . . 220,000 5. Amortization expense . . . . . . . . . . 50,000 6. Operating profit (EBIT)* . . . . . . . . 230,000 7. Interest expense . . . . . . . . . . . . 20,000 8. Earnings before taxes (EBT) . . . . . . . 210,000 9. Taxes . . . . . . . . . . . . . . . . . 99,50010. Earnings after taxes (EAT) . . . . . . . . 110,50011. Preferred stock dividends . . . . . . . . 10,50012. Earnings available to common shareholders. $ 100,00013. Shares outstanding . . . . . . . . . . . 100,00014. Earnings per share . . . . . . . . . . . $1.00*Earnings before interest and taxes.

PPT 2-1

Table 2-1

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Abitibi . . . . . Forest Products 3.7 21.1 BCE . . . . . . Telecommunications 7.8 11.2 14.9 24.8Bank of Montreal . Banking 3.9 8.8 8.6 13.8Imasco . . . . . Tobacco Products 7.4 13.8 11.0 20.4Loblaw . . . . Grocery Chain 6.2 18.5 18.1 41.8Molson . . . . . Brewery 9.1 13.5 22.2 6.4Open Text . . . . Tech. Software 443.8Pan Canadian . . Petroleum 10.3 143.4 23.3 29.2 TSE 300 Index 8.6 110.2 13.2 24.6

Dec. Sept. Nov. Mar.Corporation Industry 1981 1992 1995 1999

PPT 2-2

Table 2-3Price-earnings ratios for selected Canadian companies

Note: No P/E ratios are reported on negative earnings.

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KRAMER CORPORATIONStatement of Financial Position (Balance Sheet)

December 31, 1999

AssetsCurrent assets:

Cash . . . . . . . . . . . $ 40,000Marketable securities . . . . . . 10,000Accounts receivable . . . . . . $ 220,000

Less: Allowance for bad debts . . 20,000 200,000Inventory . . . . . . . . . 180,000Prepaid expenses . . . . . . . 20,000

Total current assets . . . . . 450,000

Other assets:Investments . . . . . . . . . 50,000

Capital assets:Plant and equipment, original cost. . . 1,100,000

Less: Accumulated amortization . 600,000Net plant and equipment . . . . . 500,000

Total assets . . . . . . . . . . $1,000,000

PPT 2-3

Table 2-4a

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Liabilities and Shareholders Equity

Current liabilities:Accounts payable . . . . . . . . . . $ 80,000Notes payable (bank indebtedness) . . . . . . 100,000Accrued expenses . . . . . . . . . . 30,000

Total current liabilities . . . . . . . 210,000

Long-term liabilities:Bonds payable, 2007 . . . . . . . . . 90,000

Total liabilities . . . . . . . . . 300,000

Shareholders equity:Preferred stock, 500 shares . . . . . . . 50,000Common stock, 100,000 shares . . . . . . 350,000Retained earnings . . . . . . . . . . 300,000

Total shareholders equity . . . . . 700,000

Total liabilities and shareholders equity . . . . $1,000,000

PPT 2-3

Table 2-4b

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Abitibi . . . . . . . . $12.15 $15.66 .78Bank of Montreal . . . . 64.50 32.32 2.00BCE . . . . . . . . . 62.05 18.70 3.32Imasco . . . . . . . . 33.25 8.56 3.88Loblaw . . . . . . . . 39.75 6.94 5.73Molson . . . . . . . . 21.60 16.60 1.30PanCanadian . . . . . . 17.20 10.79 1.59Open Text . . . . . . . 32.40 4.62 7.01Rogers Comm. . . . . . 27.20 (6.14) Stelco . . . . . . . . . 8.50 13.47 0.63

Ratio ofMarket Value Book Value Market Value

Corporation per Share per Share to Book Value

PPT 2-4

Table 2-5Comparison of market value to book value per share, March, 1999

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Figure 2-1Illustration of concepts behind the statement of cash flows

Cash inflows (1) Cash outflows

Generation of Expenditure of fundsfunds in normal in normal operationsoperations

(2)Sale of plant Purchase of plant

and equipment and equipmentLiquidation of Long-term investment

long-terminvestment

(3)Sale of bonds, Retirement or

common stock, repurchase ofpreferred stock, bonds, common stock,and other preferred stock, andsecurities other securities

Payment of cash dividends

Cash flows fromoperating activities

Cash flows frominvesting activities

Cash flows fromfinancing activities

Add items 1, 2, and3 together to arrive atnet increase(decrease) in cash

PPT 2-5

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Figure 2-2 / Steps in computing cash provided by operatingactivities using the indirect method

Net income

Amortization and other non-cash items

Increase in current assets

Decrease in current assets

Increase in current liabilities

Decrease in current liabilities

equals

Cash provided by (used in) operating activities

+

+

+

PPT 2-6

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KRAMER CORPORATIONComparative Balance Sheets

AssetsCurrent assets:

Cash . . . . . . . . . . $ 30,000 $ 40,000Marketable securities . . . . . 10,000 10,000Accounts receivable (net) . . . . 170,000 200,000Inventory . . . . . . . . 160,000 180,000Prepaid expenses . . . . . . . 30,000 20,000

Total current assets . . . . . 400,000 450,000

Investments (long term) . . . . . 20,000 50,000Plant and equipment . . . . . . 1,000,000 1,100,000

Less: Accumulated amortization . . 550,000 600,000Net plant and equipment . . . . . 450,000 500,000Total assets . . . . . . . . . $ 870,000 $ 1 ,000,000

Year-End Year-End1998 1999

PPT 2-7

Table 2-6a

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KRAMER CORPORATIONComparative Balance Sheets

Liabilities and Shareholders Equity

Current liabilities:Accounts payable . . . . . . . . $ 45,000 $ 80,000Notes payable . . . . . . . . 100,000 100,000Accrued expenses . . . . . . . . 35,000 30,000

Total current liabilities . . . 180,000 210,000Long-term liabilities:

Bonds payable, 2007 . . . . . . . . 40,000 90,000Total liabilities . . . . . 220,000 300,000

Shareholders equity:Preferred stock, . . . . . . . . 50,000 50,000Common stock, . . . . . . . . . 350,000 50,000Retained earnings . . . . . . . . 250,000 300,000

Total shareholders equity . . 650,000 700,000

Total liabilities and shareholders equity . . $ 870,000 $ 1,000,000

Year-End Year-End1998 1999

PPT 2-7

Table 2-6b

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Table 2-7Cash flows from operating activities

Operating Activities

Net income (earnings aftertaxes) (Table 2-1) . . . . . $110,500

Add items not requiring an outlay of cash:

Amortization (Table 2-1) . . . . . . . . . . . . . $50,000

Cash flow from operations . . . . . . . . . . . . . . $160,500

Changes in non-cash working capital:

Increase in accounts receivable (Table 2-6) . . . . (30,000)

Increase in inventory (Table 2-6) . . . . . . . . . (20,000)

Decrease in prepaid expenses (Table 2-6) . . . . . . 10,000

Increase in accounts payable (Table 2-6) . . . . . . 35,000

Decrease in accrued expenses (Table 2-6). . . . . . (5,000)

Net change in non-cash working capital . . . . . . . . 10,000

Cash provided by (used in) operating activities. . . . $150,500

PPT 2-8

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KRAMER CORPORATIONStatement of Cash Flows

For the Year Ended December 31, 1999

Operating Activities

Net income (earnings aftertaxes) . . . . . . . . . $ 110,500

Add items not requiring an outlay of cash:

Amortization . . . . . . . . . . . $ 50,000

Cash flow from operations 160,500

Changes in non-cash working capital

Increase in accounts receivable . . . . . . . . . (30,000)

Increase in inventory . . . . . . . . . . . . (20,000

Decrease in prepaid expenses . . . . . . . . . 10,000

Increase in accounts payable . . . . . . . . . . 35,000

Decrease in accrued expenses . . . . . . . . . (5,000)

Net change in non-cash working capital . . . . . . 10,000

Cash provided by (used in) operating activities . . . . $ 150,500

PPT 2-9

Table 2-10a

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Investing Activities:

Increase in investments (long-term securities) . . . ($ 30,000)

Increase in plant and equipment . . . . . . . . . (100,000)

Cash used in investing activities . . . . . . . . . . ($130,000)

Financing Activities:

Increase in bonds payable . . . . . . . . . . . . 50,000

Preferred stock dividends paid . . . . . . . . . . (10,500)

Common stock dividends paid . . . . . . . . . . (50,000)

Cash used in financing activities . . . . . . . . . (10,500)

Net increase (decrease) in cash and cash equivalents during the year 10,000

Cash and cash equivalents, beginning of year . . . . 30,000

Cash and cash equivalents, end of year . . . . . . . $ 40,000

PPT 2-9

Table 2-10b

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(A) (B)

Accounting Flows Cash Flows

Earnings before amortization and taxes (EBAT) . . $1,000 $1,000

Amortization . . . . . . . . . . . . 100 100

Earnings before taxes (EBT) . . . . . . . 900 900

Taxes . . . . . . . . . . . . . . 400 400

Earnings aftertaxes (EAT) . . . . . . . . $ 500 500

Purchase of equipment . . . . . . . . . -500

Amortization charged without cash outlay . . . +100

Cash flow . . . . . . . . . . . . $ 100

Year 1

PPT 2-10

Table 2-11aComparison of accounting and cash flows

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PPT 2-10

Table 2-11bComparison of accounting and cash flows

(A) (B)

Accounting Flows Cash Flows

Earnings before amortization and taxes (EBAT) . . $1,000 $1,000

Amortization . . . . . . . . . . . 100 100

Earnings before taxes (EBT) . . . . . . . 900 900

Taxes . . . . . . . . . . . . . 400 400

Earnings aftertaxes (EAT) . . . . . . . $ 500 500

Amortization charged without cash outlay . . . +100

Cash flow . . . . . . . . . . . . $ 600

Year 2

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Chapter 2 - Outline LT 2-1

Income Statement (I/S)

P/E Ratio

Balance Sheet (B/S)

Statement of Cash Flows (CFs)

Income Tax considerations

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Income Statement LT 2-2

An Income Statement shows profitability for aperiod (ex.; 1 year). Can be prepared in steps:

(1) Sales - Cost of Goods Sold (COGS) = Gross Profit (GP)

(2) GP - Operating Expenses = Earnings Before Interest andTaxes (EBIT) or Operating Income (OI)

(3) EBIT - Interest = Earnings Before Taxes (EBT)

(4) EBT - Taxes = Earnings Aftertaxes (EAT) or Net Income(NI)

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P/E Ratio LT 2-3

P/E Ratio = Price/Earnings Ratio

P/E Ratio = Market Price of Stock / Earnings pershare (EPS)

Way of measuring desirability of a stock. Ifmarket expects better than average returns fromcompany, its P/E ratio will be higher

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Balance Sheet LT 2-4

A Balance Sheet (B/S) shows what a firmowns and how it is financed at a point in

time (ex.; December 31)

Remember the ALOE!

Assets = Liabilities + Owners Equity

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Statement of Cash Flows LT 2-5

The Statement of Cash Flows (CFs) measures theflow of cash into and out of a firm

CF from operating activities PLUS

CF from financing activities PLUS

CF from investing activities EQUALS

Net increase (decrease) in cash

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Income Tax Considerations LT 2-6

Income taxes affect financial decisions

For instance, corporate taxes vary by province, bytype of business and by size of business

Cash flows aftertax are most relevant for decision-making

Aftertax investment income paid to shareholdersor other individuals varies depending upon theform of the income

Expenses deductible from taxable income providea tax shield (tax savings)

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Tax Treatment of Interest,Dividends, and Capital Gains LT 2-7

Interest Dividend Capital Gain

Monies received . . . . $1,000.00 $1,000.00 $1,000.00

Gross -up (dividends by 25%) . . . 250.00

Taxable capital gain (75% of capital gain) . . . 750.00

$1,000.00 $1,250.00 $750.00Taxable income . . . .

Federal tax (29%) . . . . . 290.00 362.50 217.50

Dividend tax credit166.70 (13 1/3% of grossed-up income)

Federal tax payable . . . ..

290.00 195.80 217.50

Provincial tax payable (50%) . 145.00 97.90 108.75

435.00 293.70 326.25Total income tax payable

$565.00 $706.30 $673.75Aftertax income . . . .

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Amortization (Capital Cost allowance)as a Tax Shield LT 2-8

Corporation A Corporation B Earnings beforeamortization and taxes . $400,000 $400,000

Amortization (capital costallowance) . . . . . . 100,000 0

Earnings before taxes . 300,000 400,000

Taxes (40%) . . . . . 120,000 160,000

Earnings aftertaxes . . 180,000 240,000

+ amortization chargedwithout cash outlay . . . 100,000 0

Cash flow . . . . . . . 280,000 240,000

Difference - $40,000

sld02 review of acctg

Documents

total liabilities

total assets

total shareholders equity

total current liabilities

total current assets

negative earnings

earnings available

common shareholders