Module 2 Critical Thinking Assignment: Understanding Financial Statements, Cash Flows and Taxes *Complete the problems in an Excel spreadsheet. Be sure to show your work to receive credit; no hard keys. Problem 2-1: Preparing Financial Statements Information below is for Warner Manufacturing, Inc. for the year ended December 31, 20×1 except where beginning of year numbers indicated. All amounts in SAR unless otherwise stated. Using the information below: 1. Prepare an income statement with the proper title 2. Prepare end of year balance sheet with the proper title 3. Calculate net working capital 4. Calculate the debt ratio *Complete the problems in an Excel spreadsheet. Be sure to show your work to receive credit; no hard keys. DATA Depreciation expense Cash Long-Term Debt Net Sales Accounts payable Marketing and general and administrative expenses Buildings and Equipment Notes payable Accounts receivable Interest expense Accrued expenses Common Stock Cost of Goods sold Inventory Taxes Accumulated Depreciation Prepaid expenses Taxes payable Retained earnings 66,000 220,000 330,000 615,000 102,000 79,000 895,000 7,5000 156,000 4,750 7,900 289,000 297,000 99,300 67,300 26,3000 14,500 55,000 262,900 Problem 2-2 Preparing Statement of Cash Flows Given the following information, prepare a statement of cash flows. DATA Increase in accounts receivable Increase in inventories Operating Income Interest Expense Increase in accounts payable Dividends Increase in common stock Increase in net fixed assets Depreciation Expense Income taxes Beginning cash Assume all amounts are in 000’s SAR. 30 30 95 30 25 15 20 23 12 17 20 Chapter 3 Understanding Financial Statements and Cash Flows Learning Objectives • Compute a company’s profits as reflected by its income statement. • Determine a firm’s financial position at a point in time based on its balance sheet. • Measure a company’s cash flows. • Explain the difference between GAAP and IRFS. 3-2 © 2017 Pearson Education, Inc. All rights reserved. Learning Objectives • Compute taxable income and income taxes owed. • Describe the limitations of financial statements. • Calculate a firm’s free cash flows and financing cash flows. 3-3 © 2017 Pearson Education, Inc. All rights reserved. THE INCOME STATEMENT 3-4 © 2017 Pearson Education, Inc. All rights reserved. The Income Statement • It is also known as Profit/Loss Statement • It measures the results of firm’s operation over a specific period. • The bottom line of the income statement shows the firm’s profit or loss for a period. Sales – Expenses = Profits 3-5 © 2017 Pearson Education, Inc. All rights reserved. Income Statement Terms Revenue (Sales) – Money derived from selling the company’s product or service Cost of Goods Sold (COGS) – The cost of producing or acquiring the goods or services to be sold Operating Expenses – Expenses related to marketing and distributing the product or service, general administrative expenses and depreciation expense Financing Costs – The interest paid to creditors Tax Expenses – Amount of taxes owed, based upon taxable income 3-6 © 2017 Pearson Education, Inc. All rights reserved. 3-7 © 2017 Pearson Education, Inc. All rights reserved. Common-Sized Income Statement • Common-sized income statement restates the income statement items as a percentage of sales. • Common-sized income statement makes it easier to compare trends over time and across firms in the industry. • See Table 3.1 3-8 © 2017 Pearson Education, Inc. All rights reserved. 3-9 © 2017 Pearson Education, Inc. All rights reserved. Profit-to-Sales Analysis from Common-Sized Income Statement See Table 3.1 • Gross profit margin (or percentage of sales going towards gross profit) is 61.1% • Operating profit margin (or percentage of sales going towards operating profit) is 21.1% • Net profit margin (or percentage of sales going towards net profit) is 15.4% 3-10 © 2017 Pearson Education, Inc. All rights reserved. THE BALANCE SHEET 3-11 © 2017 Pearson Education, Inc. All rights reserved. The Balance Sheet • The balance sheet provides a snapshot of a firm’s financial position at a particular date. • It includes three main items: assets, liabilities, and owner-supplied capital (shareholders’ equity). – Assets (A) are resources owned by the firm. – Liabilities (L) and owner’s equity (E) indicate how those resources are financed: A=L+E • The transactions in balance sheet are recorded at cost price, so the book value of a firm may be very different from its current market value. 3-12 © 2017 Pearson Education, Inc. All rights reserved. 3-13 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet Terms: Assets Current assets comprise assets that are relatively liquid, or expected to be converted into cash within 12 months. Current assets typically include: – Cash – Accounts Receivable (payments due from customers who buy on credit) – Inventory (raw materials, work in process, and finished goods held for eventual sale) – Other assets (ex.: Prepaid expenses are items paid for in advance) 3-14 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet Terms: Assets Long-Term Assets: Fixed Assets and Other Assets • Fixed Assets – Include assets that will be used for more than one year. Fixed assets typically include: • Machinery and equipment, buildings, land • Other Assets – Assets that are neither current assets nor fixed assets. They may include long-term investments and intangible assets such as patents, copyrights, and goodwill. 3-15 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet Terms: Liabilities Debt (Liabilities) – Money that has been borrowed from a creditor and must be repaid at some predetermined date. – Debt could be current (must be repaid within twelve months) or long-term (repayment time exceeds one year). 3-16 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet Terms: Liabilities Short-Term Debt (Current Liabilities) – Accounts payable (Credit extended by suppliers to a firm when it purchases inventories) – Accrued expenses (Short-term liabilities incurred in the firm’s operations but not yet paid for) – Short-term notes (Borrowings from a bank or lending institution due and payable within 12 months) Long-Term Debt – Borrowings from banks and other sources for more than one year 3-17 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet Terms: Equity • Equity: Shareholder’s investment in the firm in the form of preferred stock and common stock. Preferred stockholders enjoy preference with regard to payment of dividend and seniority at settlement of bankruptcy claims. • Treasury Stock: Stock that have been repurchased by the company. • Retained Earnings: Cumulative total of all the net income over the life of the firm, less common stock dividends that have been paid out over the years. Note that retained earnings are not equal to hard cash! 3-18 © 2017 Pearson Education, Inc. All rights reserved. Balance Sheet: A = L + E • ASSETS (A) – Current Assets – Fixed Assets Total Assets • LIABILITIES (L) – Current Liabilities – Long-Term Liabilities Total Liabilities • OWNER’S EQUITY (E) – Preferred Stock – Common Stock – Retained Earnings Total Owner’s Equity Total Liabilities + Equity 3-19 © 2017 Pearson Education, Inc. All rights reserved. 3-20 © 2017 Pearson Education, Inc. All rights reserved. Table 3-2 • Total assets exceeded $90 billion (1/3 current assets, 2/3 long-term assets) • 1/4 of assets were held in cash • Small accounts receivable and inventory • 1/3 of assets are intangible • Nearly 2/3 of financing came from debt (debt ratio = 67%) 3-21 © 2017 Pearson Education, Inc. All rights reserved. Debt Ratio – Debt ratio is the percentage of assets that are financed by debt. – Debt ratio is an indication of “financial risk.” Generally, the higher the ratio, the more risky the firm is, as firms have to pay interest on debt regardless of the earnings or cash flow situation. 3-22 © 2017 Pearson Education, Inc. All rights reserved. Net Working Capital Net Working Capital = Current assets – current liabilities – The larger the net working capital, the better the firm’s ability to repay its debt. – Net working capital can be positive or zero or negative. It is generally positive. – An increase in net working capital may not always be good news. For example, if the level of inventory goes up, current assets will increase and thus net working capital will also increase. However, increasing inventory level may well be a sign of inability to sell. 3-23 © 2017 Pearson Education, Inc. All rights reserved. MEASURING CASH FLOWS 3-24 © 2017 Pearson Education, Inc. All rights reserved. Measuring Cash Flows • Profits in the financial statements are calculated on “accrual basis” rather than “cash basis” (see next slide for accrual basis accounting). • Thus, profits are not equal to cash. 3-25 © 2017 Pearson Education, Inc. All rights reserved. Accrual Basis Accounting • Accrual basis is the principle of recording revenues when earned and expenses when incurred, rather than when cash is received or paid. – Thus, sales revenue recorded in the income statement includes both cash and credit sales. Similarly, inventory purchases may not be entirely paid for in cash as suppliers may extend credit for some of the purchases. • Treatment of long-term assets: Asset acquisitions (that will last more than one year, such as equipment) are not recorded as an expense but are written off every year as depreciation expense. 3-26 © 2017 Pearson Education, Inc. All rights reserved. 3-27 © 2017 Pearson Education, Inc. All rights reserved. 3-28 © 2017 Pearson Education, Inc. All rights reserved. 3-29 © 2017 Pearson Education, Inc. All rights reserved. Three Sources of Cash Flows • Cash flows from Operations (ex. Sales revenue, labor expenses) • Cash flows from Investments (ex. Purchase of new equipment) • Cash flows from Financing (ex. Borrowing funds, payment of dividends) 3-30 © 2017 Pearson Education, Inc. All rights reserved. Three Sources of Cash Flows (cont.) • If we know the cash flows from operations, investments, and financing, we can understand the firm’s cash flow position better, that is, how cash was generated and how it was used. 3-31 © 2017 Pearson Education, Inc. All rights reserved. Income Statement Conversion: From Accrual to Cash Basis Cash Flow from Operations: Five Steps 1. Add back depreciation. 2. Subtract (add) any increase (decrease) in accounts receivable. 3. Subtract (add) any increase (decrease) in inventory. 4. Subtract (add) any increase (decrease) in other current assets. 5. Add (subtract) any increase (decrease) in accounts payable 6. Add (subtract) any increase (decrease) in other accrued expenses. 3-32 © 2017 Pearson Education, Inc. All rights reserved. 3-33 © 2017 Pearson Education, Inc. All rights reserved. Coca-Cola(cash flow from operations) 3-34 © 2017 Pearson Education, Inc. All rights reserved. Cash Flow from Investing in Long-Term Assets • Long-term assets include fixed assets and other long-term assets. A firm may be engaged in acquisition and sale of such assets leading to cash flows. • Coca-Cola example: 3-35 © 2017 Pearson Education, Inc. All rights reserved. Cash Flows from Financing the Business 3-36 © 2017 Pearson Education, Inc. All rights reserved. Financing the Business Illustrated: Coca-Cola 3-37 © 2017 Pearson Education, Inc. All rights reserved. 3-38 © 2017 Pearson Education, Inc. All rights reserved. 3-39 © 2017 Pearson Education, Inc. All rights reserved. Suggestions for Computing Cash Flows • Consider one section at a time. • You need only 2 items from the income statement: net income and depreciation expense. • Consider change for all items in the balance sheet, except: ignore accumulated depreciation and net fixed assets; ignore change in retained earnings. 3-40 © 2017 Pearson Education, Inc. All rights reserved. GAAP AND IFRS 3-41 © 2017 Pearson Education, Inc. All rights reserved. GAAP and IFRS • U.S. follows GAAP (Generally Accepted Accounting Principles) – a set of standards, conventions and rules established by FASB. • Most other countries follow IFRS (International Financial Reporting Standards) – a set of broad and general principles established by IASB. • IFRS is simpler but allows more leeway for accounting malpractice. 3-42 © 2017 Pearson Education, Inc. All rights reserved. INCOME TAXES AND FINANCE 3-43 © 2017 Pearson Education, Inc. All rights reserved. Income Taxes and Finance Computing Taxable Income for Corporation • Gross Income – Dollar sales from a product or service less cost of production or acquisition • Taxable Income – Gross income less tax deductible expenses, plus interest income received and dividend income received – Tax Deductible Expenses: Include operating expenses (marketing, depreciation, administrative expenses) and interest expense. Dividends paid are not deductible. 3-44 © 2017 Pearson Education, Inc. All rights reserved. 3-45 © 2017 Pearson Education, Inc. All rights reserved. 3-46 © 2017 Pearson Education, Inc. All rights reserved. THE LIMITATIONS OF FINANCIAL STATEMENTS AND ACCOUNTING MALPRACTICE 3-47 © 2017 Pearson Education, Inc. All rights reserved. Accounting Malpractice and Limitations of Financial Statements • Since accounting rules give managers discretionary powers, it is possible that two firms with similar financial performance may report different results. • There have been several cases of accounting malpractice where rules have been broken! 3-48 © 2017 Pearson Education, Inc. All rights reserved. Key Terms • • • • • • • • • • • • • • • 3-49 Accounts payable Accounts receivable Accrual basis accounting Accounting book value Accrued expenses Accumulated depreciation Additional paid-in-capital Average tax rate Balance sheet Capital gains Cash Cash basis accounting Common size financial statements Common stock Common stock holders © 2017 Pearson Education, Inc. All rights reserved. • • • • • • • • • • • • • • • • Cost of goods sold Current assets Current debt Debt Debt ratio Depreciation expense Dividends per share Earnings before taxes Earnings per share Equity Financing cash flows Fixed costs Fixed assets Free cash flows GAAP Gross fixed assets Key Terms (cont.) • • • • • • • • • • • • • • 3-50 Gross profit Gross profit margin IFRS Income statement Inventories Liquidity Long-term debt Marginal tax rate Mortgage Net fixed assets Net income Net profit margin Net working capital Operating expenses © 2017 Pearson Education, Inc. All rights reserved. • • • • • • • • • • • • • Operating income Paid-in capital Par value Preferred stockholders Profit margins Retained earnings Semi-variable costs Short-term notes (debt) Statement of cash flows Taxable income Trade credit Treasury stock Variable costs Required • • • Chapter 3 in Foundations of Finance – Understanding Financial Statements and Cash Flows Boolaky, P. K., Omoteso, K., Ibrahim, M. U., & Adelopo, I. (2018). The development of accounting practices and the adoption of IFRS in selected MENA countries. Journal of Accounting in Emerging Economies, 8(3), 327-351. Oraby, S. A. (2017). IFRS and accounting information relevance: The case of Saudi Arabia. Journal of Business & Economic Policy, 4 (1), 145-155. Retrieved from http://jbepnet.com/journals/Vol_4_No_1_March_2017/16.pdf Recommended • • Chapter 3 PowerPoint slides in Foundations of Finance Understanding Financial Statements and Cash Flows IFRS. (2017). IFRS application around the world jurisdictional profile: Saudi Arabia. Retrieved from https://www.ifrs.org//media/feature/around-the-world/jurisdiction-profiles/saudi-arabia-ifrsprofile.pdf For Your Success This module has two primary sections. The first section focuses on the content of financial statements and the role each statement plays in monitoring the financial performance of organizations. The second section follows with a discussion of the differences between the Generally Accepted Accounting Principles (GAAP) used in the United States and International Financial Reporting Standards (IFRS) being adopted in Saudi Arabia. Make sure to read all of the required readings this week and complete the Check Your Understanding activity. Your first Critical Thinking Assignment is due this week. Review the assignment early in the week and contact your instructor if you have any questions or concerns. As you begin to prepare your assignment, think about how these concepts could be applied to the real world. You will also have a quiz to complete pertaining to Modules 1 and 2. Finance Principles for this module • Principle 1: Cash Flow Is What Matters—We are concerned with the money in hand, not accounting profit. • Principle 5: Conflicts of Interest Cause Agency Problems—Conflicts of interest between owners and managers can create challenges for optimal efficiency and value creation in organizations. Learning Outcomes 1. Analyze financial statements. 2. Calculate cash flows and corporate taxes. 3. Identify the accounting principles used to prepare financial statements.

Assignment Question(s):(5 Marks)

Q1-

A company wants to implement good internal control. What are the policies and procedures you can suggest to minimize human frauds and errors? (1Mark)

Q2-

Assume that you have a company. And the management team estimates that 3% of sales will be uncollectible.

Give any amount of sales and prepare the journal entry using the percent of sales method. (1Mark)

Q3-

A company that uses a perpetual inventory system made the following cash purchases and sales.There was no beginning inventory.

A. Prepare general journal entries to record the March 16 sale using the

B. What is the cost of goods sold and the gross margin for each method? (2Marks)

Q4. What is the bank reconciliation? why is it important for companies to prepare bank reconciliation periodically? (1Mark)

College of Administration and Finance Sciences Assignment (3) Deadline: Saturday 27/11/2021 @ 23:59 Course Name: Auditing Principles and Procedures Student’s Name: Course Code: ACCT401 Student’s ID Number: Semester: 1st CRN: Academic Year: 1443 H For Instructor’s Use only Instructor’s Name: Students’ Grade: /5 Level of Marks: High/Middle/Low Instructions – PLEASE READ THEM CAREFULLY • The Assignment must be submitted on Blackboard (WORD format only) via allocated folder. • Assignments submitted through email will not be accepted. • Students are advised to make their work clear and well presented, marks may be reduced for poor presentation. This includes filling your information on the cover page. • Students must mention question number clearly in their answer. • Late submission will NOT be accepted. • Avoid plagiarism, the work should be in your own words, copying from students or other resources without proper referencing will result in ZERO marks. No exceptions. • All answers must be typed using Times New Roman (size 12, double-spaced) font. No pictures containing text will be accepted and will be considered plagiarism. • Submissions without this cover page will NOT be accepted. College of Administration and Finance Sciences Assignment Question(s): (Marks 5) IMPORTANT NOTE: Answer in your own words, DO NOT COPY from slides, fellow student, or internet source without proper citation. Q1. Why bank reconciliation is important to the audit? Your answer should explain in detail what types of bank reconciliation uses the auditor should consider when auditing cash, and you should also list some of the items found on the reconciliation (2 Marks). Q2. Define the term “contingent liability” and discuss the criteria used to classify these events or conditions. Provide some examples of contingent liabilities (1Marks). Q3. The following four situations require a modification to the standard unqualified/unmodified audit report. Identify the modification required for each. (2 Marks). a. Opinion based in part on the report of another auditor. b. Going concern. c. Lack of consistency. d. Additional emphasis.

Based on the overview, developed after finishing chapter one (The context of healthcare Financial Management)

Discuss does Health Information Technology Reduce the healthcare Costs?

Some analysts have suggested that the adoption of electronic medical records (EHR) by hospitals could eventually reduce annual healthcare expenditures by one third or more. Others have been far less sanguine about such projections, arguing that adopting such information technologies may in fact increase costs. State if you agree or disagree with reasons.