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Lecture

CHAPTER 3 ACCOUNTING AND FINANCE.docx

3 Pages
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Department
Finance
Course Code
FINE 2000
Professor
H A M D I D R I S S

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CHAPTER 3 ACCOUNTING AND FINANCE 3.1 The Balance Sheet  Financial statement that shows the value of the firm’s assets and liabilities at a particular time  Current Assets: Some assets can be turned into cash more easily= liquid assets (put most liquid at top of the list and works down)  Long term Assets: first group known as tangible assets/ fixed capital assets (property, plant and equipment) and second group known as intangible (patents, copyrights), investments in associated companies (ownership interest in some other businesses) >> reluctant to show intangible assets on the balance sheet except for Goodwill (when acquire another company and pay more than fair value for the assets acquired) Book Values and Market Values  Items in balance sheet are valued according to generally accepted accounting principles (GAAP). This states that assets must be shown in the balance sheet at their historical cost adjusted for depreciation.  Book values: backward looking measures of value  Difference between book and market value vary depending on the asset>> fixed asset the difference could be large and difference is likely to be largest with shareholders equity. The book value of equity measures the cash that shareholders have contributed in the past plus the cash that the company has retained and reinvested in the business on their behalf. But this often bares little resemblance to the total market value that investors place on the shares ** often find that shares fo stock sell for more than the value shown in the company’s books 3.2 The Income statement  How profitable the firm has been during the past year  EBITDA- earnings before interest, taxes, depreciation and amortization  EBIT- total earnings before interest and taxes Profits vs. Cash Flow  Important to distinguish between profits and cash flows. Here are three reasons why profits and cash are not the same 1. When preparing the income statement under accrual accounting take into account non cash transactions. Furthermore, rather than deducting the cost of the capital expenditure n the year it is purchased, the accountants make an annual charge for depreciation, thus the cost of capital expenditure is spread over its forecast life. “When calculating profits, accountants do not deduct the expenditure on new equipment that year, even though cash is paid out However, they do deduct depreciation on assets previously purchased, even though no cash is currently paid out. For this reason, depreciation is classified as a non-cash expense 2. Recognize revenue at the time of sale rather than when the cash is received. Therefore, although the cash is not received the sale is recognized in the revenue of a given period 3. Matching cost of producing the goods with the revenues from the sale. The accountant gathers all expenses that are associated with a sale and deducts them from the revenues to calculate profit, even though the expenses may have occurred in an earlier period. 3.3 The Statement of Cash Flows  Financial statement that shows the firm’s cash receipts and cash payments over a period of time  Firm’s cash flow can be quite different form its net income which can arise for a number of reasons 1. Income statement does not recognize capital expenditures as expenses in the year that the capital goods are paid for. Instead, it spread those expenses over time in the form of an annual deduction for depreciation 2. Income statement uses the accrual method of accounting, revenues and expenses are recognized as they are incurred rather t
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