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Textbook Chapter 5-12 Summaries - Midterm or Final Review material Detailed summary of important topics covered in MGT220. Excellent for review before final exams or if you haven't had time to read the textbook. Done in Dec 2009.

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University of Toronto Mississauga
Feng Chen

Zoya Zareen, Dec 09 MGT220 Final Exam Revision Notes Ch 5 : Financial Position of Cash Flows Statement of Cash Flows: To access the firms ability to generate cash and cash equivalents To access the firms cash requirements It shows: Where the cash came from What is was used for What was the change in the cash flow balance Cash divided into 3 main categories: Operating activities main revenue-producing activities Cash Inflows: When operating cash receipts > cash expenditures Cash Outflows: When operating cash expenditures > cash receipts Investing activities changes in long term assets and investments Cash Inflows: Sale of property, plant and equipment Sale of debt or equity securities of other entities Collection of loans to other entities Cash Outflows: Purchase of property, plant and equipment Purchase of debt or equity securities of other entities Loans to other entities Financing activities changes in equity and non-operating liabilities Cash Inflows: Issuance of equity securities Issuance of debt (bonds and notes) Cash Outflows: Payment of dividends Redemption of debt Reacquisition of capital stock The indirect method: Reconciles net income to cash flows and affects only the operating activities section of the cash flow statement Steps for operating activities (indirect method): Begin with net income from the income statement Amortization is a non cash expense that reduces net income -> add amortization 1 Gains and losses from sale of capital assets are reported as part of net income and the proceeds are reported in the investing activities section -> gains are subtracted from net income and losses are added to net income Increases in current assets (other than cash) are subtracted from net income Decreases in current assets are added to net income Increases in current liabilities (other than dividends payable) are added to net income Decreases in current liabilities are subtracted from net income Add deferred income tax Usefulness of the statement of cash flows: Provides creditors with useful info such as: Companys ability to generate net cash from operating activities Net cash flow trends or patterns from operating activities Major reasons for positive or negative net cash from operating activities Whether the cash flows are renewable or sustainable Measures financial liquidity: Current Cash Debt Coverage Ratio: Net Cash provided by Operating Activities Average Current Liabilities Ratio indicates whether the company can pay off its current liabilities from its operations. Ratio near 1:1 is good. However, the higher, the better. Measures financial flexibility: Cash Debt Coverage Ratio: Net Cash provided by Operating Activities Average Total Liabilities Ratio indicates the companys ability to repay its liabilities from net cash provided by operating activities, without having to liquidate the assets employed in its operations. The higher, the better. Free Cash Flow: Net cash from operations less capital expenditures and dividends Indicates discretionary cash flow (cash left to invest or expand) to make additional investments, to retire its debt or to add to its liquidity Answers questions such as: o Is the company able to pay its dividends without the help of external financing? o If business operations decline, will the company be able to maintain its needed capital investment? o What is the free cash flow that can be used for additional investments, retirement of dent, purchases of treasury stock or additions to liquidity? Additional Notes: 2 Operating cycle: time it takes for a firm to purchase raw materials, manufacture merchandise, sell it and receive cash. (8-9 months on average) Cash trap: Today, firms like to hold more cash due to uncertainty following bad economic times. Decision-making individuals are more risk-averse. Principal payments on notes and bonds are a financing activity. Interest payments on notes and bonds are an operating activity. Ch 6: Revenue Recognition Revenue is realized when goods and services are exchanged for cash or claims to cash (receivables). Revenue is recognized when: Performance is achieved (risk and rewards transferred, measurability reasonably assured) Collectibility is reasonably assured Revenue is NOT recognized in the following cases: Buyback agreements - not recognized unless the rights and risks have been passed on to the buyer Bill and hold transactions (sold inventory but not delivered yet) Sale made on a trial and evaluation basis not recognized unless evaluation period lapses or customer accepts Percentage-of-completion: Used when performance requires many events Continuous earnings process Can be used if transaction is measurable The amount of revenues, cost and gross profit recognized on long-term contracts depends upon the percentage of work done Can use input measures costs incurred or labour hours worked Can use output measures storeys of a building completed etc Cost-to-cost Basis- the percentage of completion method is measured by comparing costs incurred to date with the most recent estimate of the total costs to complete the contract. Steps: 1. Percent complete = costs incurred to date Most recent estimated total costs 2. Revenue to be recognized to date = percent complete x estimated total revenue 3. Current period revenue = revenue to be recognized to date revenue recognized in . . previous periods 4. Gross Profit = current period revenue current costs 3 Construction in process is an inventory (asset) account Billings on Construction in Progress is a contra-inventory (contra-asset) account to A/R Materials, Cash, Payables is an expense/liability account Percentage-of-Completion Method: Cost-to-Cost Basis 2007 2008 2009 A Contract price A A A B Opening costs 0 a a+b C Costs incurred during the year a b c D Costs incurred to date a a+b a+b+c E Estimated future costs to complete d e f F Estimated total costs to complete a+d a+b+e a+b+c+f G Percent complete F / D F / D F / D H Estimated total gross profit A - F A - F A - F I Revenue to date A x G = g A x G = h A x G = i J Revenue during the year g h - g i - h K Gross profit to date H x G = j H x G = k H x G = l L Gross profit(loss) for the year j k j l - k Journal Entries: To record cost of construction: Construction in Process est costs during year Material, Cash, Payables est costs during year To record progress billings: Accounts Receivable progress billings during year Billings on Construction in Progress progress billings during year To record collections: Cash cash collected during year Accounts Receivable cash collected during year To recognize revenue and gross profit Construction expense est costs during year Construction in process (profit) current year GP Revenue from long term contract revenue to date OR Construction expense est costs during year Construction in process (loss) current year GP(abs value) Revenue from long term contract revenue to date To record completion of contract (recorded only on completion date) 4
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