ACCT 712 Final Exam 1. Net cash will be different from a company’s net income because of the changes in working capital (inventories, receivables, etc. ) which is derived in the operating flows on a cash flow statement. By taking net income and making adjustments to reflect the changes, net cash flow from operating section will show how cash was generated. Another main reason is the translation process from accrual accounting to cash accounting because for example revenue reported on a accrual basis may not have been collected but on the cash flow statement and changes in cash is accounted for.
For the operating section of the cash flow (CF) statement a positive sign will show high quality and identifies that the cash is flowing is available to pay operating expenses. For the investing section of the CF statement a negative sign will usually show investing of capital expenditures, investments, acquisitions. For a growing company a negative investing flow is preferred to show grow potential. Lastly, the financing section of the CF statement should show a positive to be evidence in the ability to pay debts or other flows.
A growing company would show negative cash low due to the start up of taking out debt to finance capital within a growing company. Investing and financing sections for a growing company will likely show a negative due to the growth potential and start up of limited cash flows available. Sale proceeds from a sale of accounts receivable will result in a gain on sale affecting the balance sheet, income statement, CF statement. 2. Intrinsic value method – is the difference between the market price and the preset strike price at any point in time. It represents the amount realized by the option holder, if exercised.
Also known as the true value of a company’s stock. Fair value method – total compensation expense is computed based on the fair value of the options expected to vest on the date the options are granted to the employees. Estimation is done by using an option-pricing model such as the Black- Scholes to estimate fair value. From a investor’s perspective, the fair value method is preferred because of reporting more transparency to investors as well as restoring market confidence in financial reporting. This method requires expensing all stock options by allocation when the service is performed.
In addition, by valuing at fair value, it appears consistent and comparable to the end user of a financial statement. From an company’s perspective, the intrinsic value is favored over the fair value method because when employees are granted the stock options, it is reported as compensation expense. But due to the intrinsic value method, most employee stock plan option at the measurement date is zero because the option is set equal to the market price at the date that the options are granted. Thus, showing no compensation expense and only a foot note disclosure.
In my opinion, I prefer the ntrinsic value method because accounting is based on present values that are realized not assumptions or estimates of values by using an option-pricing model. 3. arrangement Step2: Do the continuing cash flows result from a migration or a continuation of activities? No, the royalty agreement does not provide for a migration or a continuation of activities. The revenue-producing activities and cost generating activities of the component before the disposal transaction were the manufacturing and sale of medical devices.
No continuance of those activities after the disposal ransaction; therefore, the cash flows associated with the royalty fee are indirect cash flows. Accordingly, Step 3, “an evaluation of the significance of the continuing cash flows, is not necessary. Step 4: Is there significant continuing involvement in the operations of the disposed component? No ability to significantly influence is based on the insignificance of the royalty agreement to the overall operations of the disposed component.
Also, the ongoing entity is involved in the operations of the disposed component is limited to the ability to receive Just a royalty for five years. Lastly, no rights by the agreement enable the ongoing entity to exert significant influence over the disposed component. Thus, the continuing cash flows are indirect cash flows and the ongoing entity will not have any significant continuing involvement in the operations of the disposed component, this will be classified as a discontinued operation. . FASB is looking to make changes to lease accounting that would affect almost every organization. Lessees would be required to recognize in their balance sheets an asset representing the right to use the leased property over the estimated lease erm and a liability to make estimated future lease payments for each lease under this proposed capital lease method. This would ultimately eliminate the accounting and reporting of leases classified as operating leases.
This impact could face timing recognition issues for example study analysis of financial data reveals that the proposal would depress company profits, economic growth and financial stability because it does not accurately reflect the economics of the lease transaction. 5. The three motivations for earnings management: 1) Compensation – compensation is the driving force in management especially alary bonuses, whether pay is linked to performance, or controlling operating results compensation is very important to be profitable in a large part to motivation manipulation.
For example, a more high-powered compensation is necessary to incentivize effort when earnings management is possible. 2) Covenant violation- by violating covenants this can cause interest rate to increase. Managers that violated covenants can avoid default by making income- increasing accounts choices. Such actions may improve the firm’s bargaining positions in cases of renegotiations. As a result, this usually leads to higher cost of orrowing or new restrictive covenants. ) Provide window dressing for IPO – This relates to market incentives to manage earnings when there is a connection between reported earnings and the company’s market value. Managers can use accounting discretion to increase earnings in the periods affecting an initial public offerings or a seasoned equity offerings to build also decline following offerings. The difference between “real” earnings management and accounting earnings management is real earnings management involves discretionary spending, manipulation of production, selling of assets, stock options, or repurchase stock.
Accounting earnings management is the way “real” earnings is accounted for within classifications, for example discretionary accruals or management buyouts. Earnings management is not necessarily “bad” from the shareholders’ perspective because by allowing managers to manipulate earnings figures mangers can meet a pre-specified target. But abusive earnings management would be considered “bad” due to the excessive income smoothing. Different methods used by managers can be very complex and confusing, which makes it very difficult for shareholders to pick up on accounting frauds before they happen.