Principles Of Accounting II Assignment 4

BBA 2301, Principles of Accounting II 1

Course Learning Outcomes for Unit IV Upon completion of this unit, students should be able to:

1. Prepare corporate financial statements. 1.1 Describe methods of completing the statement of cash flow (SCF).

2. Interpret financial statements.

2.1 Identify corporate investment account content. 2.2 Explain cash flow statement content.

Course/Unit Learning Outcomes

Learning Activity

1.1

Unit Lesson Chapter 16, pp. 16-1 to 16-18 Chapter 17, pp. 17-1 to 17-33 Video: 27. How to Read a Cash Flow Statement Unit IV Scholarly Activity

2.1

Unit Lesson Chapter 16, pp. 16-1 to 16-18 Chapter 17, pp. 17-1 to 17-33 Video: Long Term Investments on the Balance Sheet Unit IV Scholarly Activity

2.2

Unit Lesson Chapter 16, pp. 16-1 to 16-18 Chapter 17, pp. 17-1 to 17-33 Video: Long Term Investments on the Balance Sheet Unit IV Scholarly Activity

Required Unit Resources Chapter 16: Investments, pp. 16-1 to 16-18 Chapter 17: Statement of Cash Flows, pp. 17-1 to 17-33 In order to access the following resources, click the links below. For the video resources below, transcripts and closed captioning are available upon accessing the videos. Perfect Stock Alert. (2012, October 2). Long term investments on the balance sheet [Video]. Cielo24.

https://c24.page/yt7egpgbnp2eyej2b7cte9kuqk Pysh, P. (2012, June 28). 27. How to read a cash flow statement [Video]. Cielo24.

https://c24.page/95s8mr2j7ggtycchv38gcp8fd4

UNIT IV STUDY GUIDE

Accounting: Investing and Cash Flow

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Unit Lesson

Introduction This unit focuses on investments by the firm and the fourth required external financial statement, which is often referred to as the statement of cash flows (SCF). Today, there are mixed views on the corporation. While some see significant benefit from this entity and its ability to scale, others view such large organizations as dangerous to the markets and society. Upon concluding this unit, regardless of your opinion, you should be well prepared to participate in a meaningful conversation about corporations. Consider the questions below as you read, study, and respond to this unit.

1. As the chief financial officer (CFO), what investments would you consider? 2. What form of the SCF would you prepare and submit?

Why do corporations invest?

It may surprise you to learn that corporations can and do invest in securities, but what would you do with any excess cash? Investments should generate income above the company’s main business operations and may even be a start toward the acquisition of another company. Corporations go through a cycle from their initial formation, product and

service development, promotion, and sales and service. At different times, the firm will have cash that should not just sit in a cash account. So, what are the choices? Through your readings and work on this in prior units, what should come to mind immediately are equity and debt. Much will depend on the firm’s cash needs forecast. Do they have a relatively short window before major cash needs arise (less than a year), or do they forecast a few years before major capital expenditures or some other cash requirement?

Debt Investments As with any security, the firm can buy a bond, hold it, receive the stated interest payments, and then sell it before maturity (or not). As with any bond, its value above or below par will depend on the coupon rate and the market rate at the time of purchase or sale.

Stock Investments You may recall from Unit III that stock (equity) represents ownership share in a company. Stock investments are accounted for differently, depending on the percentage of ownership you have in the company. Is it minor (less than 20%); significant but not controlling (between 20% and 50%); or controlling more than 50%? In the latter case, where the ownership is greater than 50%, you might consider the company you have invested into as a subsidiary and the firm as the parent. You can understand that owning more than half of a company provides effective control over the company’s management.

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Reporting Investments Just as with our personal investments, a corporation’s debt and stock securities will vary in value over the time of the investment. There are three types of holdings, which are listed below.

 trading securities,

 available-for-sale securities, and

 held-to-maturity securities. The labels tell the story. A trading security is one purchased for the short-term; available-for-sale means that it is the firm’s intent to sell the securities at some unknown time in the future; and held-to-maturity means exactly as the name implies. Read more about financial reporting for trading securities on pages 16-11 through 16-14 in the textbook.

Gains and Losses Again, similar to the requirement that federal taxes be filed each year by individuals and households, corporations must do the same. The difference between individually filed returns and corporate filed returns is that corporations must report both realized and unrealized gains or losses, whereas individuals only report realized gains and losses. The value at the end of a reporting period will usually be the first item under long- lived assets on the balance sheet. Investment gains or losses for the period will be on the income statement as other. As noted in prior units, using the most recent financial statements for a company you have an interest in is a great way to understand accounting. You will see the firm’s investments quantified in the balance sheet and the income statement. You will see an explanation as to how the firm valued them in the notes to the financial statements. These immediately follow the statements in the 10-K. As an entity separate from the owners, the firm may invest short-term (anything less than 12 months) or long- term (anything longer than 12 months), depending on their cash situation and strategic alternatives. Strategic alternatives would include other uses for the firm’s money as defined in the long-range plan for capital investments.

Cash Flows In order to support the daily operations of a business and prepare for its future, the firm must have cash. Cash is used to pay bills, invest in needed capital equipment, and maintain a financial equilibrium. Cash comes from successful operations, the sale of investments, and capital infusions from equity or debt stakeholders. The first lists uses of cash, such as paying bills, and the second lists sources of cash. As individuals and family units, consider the uses and sources of cash. Just as with corporations, the use and source of cash varies with our life cycle. Consider the three categories in the cash flow statement, which are listed below.

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 Operating is the result of our day-to-day activities. In a new business, the activity level may be low, resulting in lower revenues to offset expenses. The result will be negative for a period—hopefully, a brief period. As the firm grows, revenues increase, and expenses as a proportion of revenues will decrease, resulting in positive operating cash flow.

 Investing is using cash to build our business—acquiring equipment, adding to our physical structure, and possibly acquiring another firm. Again, in the early stages of a firm, investing cash flow will probably be negative. As the business grows, the equipment becomes more productive; we reach our desired scale, and we may even sell some unneeded items. Cash flow will be neutral or positive.

 Financing may be needed during startup, as the firm will need cash. A couple of ways to get it is from investors (e.g., sell stock) or to borrow funds. As the firm matures, it may obtain (source) more cash through the financing activities and, at some point, pay back (use) its funds in the form of dividends to stockholders and loan repayment to lenders.

SCF

To record the sources and uses of cash, a SCF—alternatively referred to as a cash flow statement—is prepared. Our textbook outlines the types of inflows (sources) and outflows (uses) on page 17-4. There are three sources used to prepare the statement; these are comparative balance sheets, current income statement, and additional information. There are three steps used in preparing the statement of cash flows (for which you will incorporate the data from the comparative balance sheets, current income statement, and additional information sources). These steps include determining the net cash, analyzing changes in noncurrent asset and liability accounts, and comparing the net change in cash on the SCF with the change in the cash account. The illustration below outlines this three-step process in more detail.

Preparing the Statement of Cash Flow – Indirect Method

While there are two methods in use to prepare the statement, the indirect method is the one commonly used. The preparation steps are detailed in the textbook on pages 17-8 through 17-16. The good news is that we already have all of the necessary information. It is in the income statement and the balance sheet. What the SCF does for us is consolidate all of the cash activity, and SCF supports decision-making in regard to the short-term and long-term needs for cash.

Preparing the SCF – Direct Method The direct method is the one recommended by the Financial Accounting Standards Board (FASB), but its use is not required. The steps to preparation and presentation are outlined in the textbook on pages 17-19

(Weygandt et al., 2018)

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through 17-25. Using the income statement as its primary source, the presentation focuses on major classes of operating cash receipts and cash payments. The net change in cash from operating activities and from all three categories together is identical.

Analyzing the SCF As with every other financial statement, there are a couple of specific metrics one can use to evaluate performance. From the SCF, the prime metric used is free cash flow (FCF). To supplement the textbook, one of the suggested unit resources (i.e., The Ultimate Cash Flow Guide [EBITDA, CF, FCF, FCFE, FCFF]) outlines the measures and calculations. Concisely, it is the net cash provided by operating activities minus capital expenditures and cash dividends, if any. If we are going to invest (or work for) a corporation, we should know how it is performing from a financial point of view. After you have completed this course, you can do the analysis yourself! All of the data necessary, with the exception of the current market price of a share, are in the company’s 10-K. The free report is available for all corporations on the U.S. Securities and Exchange Commission (SEC), Yahoo, Google, and Bloomberg websites and on the firm’s website as well. There are a variety of metrics used to evaluate corporate financial performance. You will explore them further in this unit as you complete the assignment.

Conclusion Can you now answer the two questions posed at the beginning of this lesson? Go back, and check!

Reference Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2018). Accounting principles (13th ed.). Wiley.

https://online.vitalsource.com/#/books/9781119411017

Suggested Unit Resources In order to access the following resources, click the links below. For the video resources below, transcripts and closed captioning are available upon accessing the videos. The differences of earnings before interest, taxes, depreciation, and amortization (EBITDA); cash flow (CF); free cash flow (FCF); free cash flow to equity (FCFE); and free cash flow to the firm (FCFF) are discussed in the following video. Corporate Finance Institute. (2018, August 8). The ultimate cash flow guide (EBITDA, CF, FCF, FCFE, FCFF)

[Video]. Cielo24. https://c24.page/9zbsbjv7rys53mt6yctn8mfbr6 The video below will explain how to read a cash flow statement using the actual numbers from Tesla between 2016 and 2018. The Finance Storyteller. (2019, February 28). Cash flow statement tutorial Tesla 2016 to 2018 [Video].

Cielo24. https://c24.page/6pfhpyd4wtzqdjwffuzdg4vhwn The following video explains why trading securities are reported at fair value on the balance sheet, and the video also provides examples of journal entries. WallStreetMojo. (2019, July 9). Trading securities in balance sheet | Example | Journal entries [Video].

Cielo24. https://c24.page/43a75pjfxm75fad96pgd23aa5m

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Learning Activities (Nongraded) Nongraded Learning Activities are provided to aid students in their course of study. You do not have to submit them. If you have questions, contact your instructor for further guidance and information. This is an opportunity for you to express your thoughts about the material you are studying by writing about it. Conceptual thinking is a great way to study because it gives you a chance to process what you have learned, and it increases your ability to remember it. In order to practice what you have learned, please attempt the exercises and problems below, which can be found in your textbook. Chapter 16:

 Brief Exercises (BE16.1), page 16-24

 Brief Exercises (BE16.2), page 16-24

 Brief Exercises (BE16.8), page 16-24

 Exercises (E16.5), page 16-26

 Exercises (E16.8), page 16-26

 Problems: Set A (P16.1A), page 16-28 Chapter 17:

 Brief Exercises (BE17.1), page 17-42

 Brief Exercises (BE17.6), page 17-42

 Brief Exercises (BE17.10), page 17-43

 Exercises (E17.1), page 17-45

 Exercises (E17.8), page 17-47

 Problems: Set A (P17.3A), page 17-51 If you have any questions or do not understand a concept, contact your professor for clarification. Completing these practice exercises and problems will give you practice, which will be helpful as you complete the assignment for this unit.