Accounting Quiz 2

A company purchased bonds issued by another corporation. The company expects to hold the bonds for more than one year. On its classified balance sheet, the company should report the bonds as

a long-term investment. Solution:Classified balance sheets partition a company's assets into four categories: (i) current assets (e.g., cash, accounts receivable, inventory), (ii) long-term investments (e.g., investments in other companies' stocks and bonds expected to be held more than one year and assets [such as land and buildings] not currently being used in its operating activities), (iii) property, plant, and equipment (e.g., buildings, land, equipment, accumulated depreciation)), and (iv) intangibles (e.g., goodwill, patents, copyrights, trademarks)

A short-term creditor is primarily interested in the __________ of the borrower.

liquidity Solution:Financial accounting ratios are commonly categorized into three categories, including profitability ratios, liquidity ratios, and solvency ratios. Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash.

The current ratio is important in evaluating a company's

liquidity Solution:Financial accounting ratios are commonly categorized into three categories, including profitability ratios, liquidity ratios, and solvency ratios. Liquidity ratios measure the short-term ability of the company to pay its maturing obligations and to meet unexpected needs for cash. An example of a liquidity ratio is the current ratio.

he following ratios are available for Alpha Inc. and Omega Inc. Alpha Inc. Omega Inc. Current ratio 1.2 1.5Earnings per share $1/share $1.5/share Compared to Omega Inc., Alpha Inc. has

lower liquidity The current ratio is computed as current assets divided by current liabilities. The current ratio measures liquidity. Higher current ratios mean the company is more liquid (i.e., better able to pay is short-term liabilities), and lower current ratios mean the company is less liquid. Warning: Do not compare earnings per share (EPS) of one company to the EPS of a different company. Comparisons of EPS of one company to EPS of another company are usually misleading.

What is measured by current assets minus current liabilities?

working capital Solution:By definition, working capital is the difference between current assets and current liabilities. It is a measure of liquidity.

At the end of the year, a company had retained earnings of $2,840,000. During the year, the company reported the following: Issued common stock, $108,000 Declared and paid dividends, $43,000 Net income, $402,000. How much was the retained earnings balance at the beginning of the same year?

$2,481,000 Solution:Ending retained earnings equals beginning retained earnings plus net income minus dividends.$2,840,000 = X + $402,000 - $43,000Solve for X: Beginning retained earnings = $2,481,000.

What group is considered to be the primary accounting standard-setting body in the United States?

Financial Accounting Standards Board Solution: The Financial Accounting Standards Board (FASB)is the primary accounting standard-setting body in the U.S. The Securities Exchange Commission has authority to make accounting rules, but it largely delegates accounting rule-making to the FASB.

Which of the following describes a company's ability to pay its obligations that are expected to become due within the next year or operating cycle whichever is longer?

Liquidity Solution:Liquidity is the ability to pay short-term obligations. Notice that the question asks about obligations being paid within a very short period of time. Solvency refers to an ability to pay obligations over a long period of time such as more than one year.

Which of the following would increase a company's current ratio?

Negotiate with a creditor to reclassify a note payable in 3 months into a note payable due in 2 years. Solution:Current ratio = current assets divided by current liabilitiesChanging a current liability (e.g., a note due in 3 months) into a long-term liability (i.e., a note payable due in 2 years) lowers total current liabilities. This increases the current ratio.

Which of the following does not affect the company's current ratio?

Paying the next month's rent one month in advance. Solution:Current ratio = current assets divided by current liabilitiesPaying next month's rent one month in advance decreases cash and increase prepaid rent. Both cash and prepaid rent are current assets. Increasing one and decreasing the other does not affect total current assets or the current ratio.

Which of the following is a financial ratio classification that measures the ability of the company to survive over a long period of time?

Solvency ratios There are three well-known financial ratio classifications including (i) profitability ratios, (ii) liquidity ratios, and (iii) solvency ratios. Profitability ratios measure the income or operating success of a company for a given period of time. Liquidity ratios measure short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios measure the ability of the company to survive over a long period of time.

Which financial statement is used by most corporations to compute year-end retained earnings?

Statement of stockholders' equity Solution:Companies use a statement of stockholders' equity to show beginning retained earnings and the amount it increases by net income and decreases by dividends resulting in ending retained earnings.

A corporation reports the following balances and amountsAccounts payable, $35,000Cash provided by operations, $90,000Accounts receivable, $37,500Net income, $36,000Average number of common shares, 20,000Salaries and wages payable, $8,000Average current liabilities, $110,000Stockholders' equity, $240,000Average total assets, $600,000Current assets, $300,000Average total liabilities, $320,000Current liabilities, $120,000Dividends paid to preferred shareholders, $10,000 Determine its earnings per share?

$1.30 Solution:Earnings per share equals net income earned on each share of common stock. Earnings per share equals net income minus preferred dividends divided by the average number of shares outstanding. This company has no preferred dividends.Earnings per share = ($36,000 - 10,000)/20,000 shares = $1.30/share.

A corporation reported net sales of $360,000, net income of $20,000, average stockholders' equity of $1,000,000, and average common shares outstanding of 10,000. It paid $4,000 of dividends to preferred stockholders. How much was its earnings per share?

$1.60 Solution:Earnings per share equals net income earned on each share of common stock. Earnings per share equals net income minus preferred dividends divided by the average number of shares outstanding. This company has no preferred dividends.Earnings per share = ($20,000 - $4,000)/10,000 shares = $1.60/share.

The following information is available for a certain corporation: (in millions) Year 2022 2021 Common dividends 0 0 Preferred dividends 25 10 Net income 500 480 Shares outstanding at the end of the year 200 180 Shares outstanding at the beginning of the year 180 170 Based on this information, what is the company's earnings per share (rounded to two decimals) for 2022?

$2.50 Solution:Average common shares outstanding = (Beginning common shares outstanding + ending common shares outstanding)/2Average common shares outstanding = (180 shares + 200 shares)/2 = 190 sharesEarnings per share = (Net income - preferred dividends)/average common shares outstandingEarnings per share = ($500 - $25)/190 shares = $2.50 per share

Based on the following data (in dollars), what is the working capital? Accounts payable$ 64,000Notes payable (due in 6 months) 56,000Accounts receivable 114,000Notes payable (due in 2 years) 200,000Cash 60,000Patents 100,000Equipment 300,000Prepaid insurance 2,000Inventory 138,000Short-term investments 80,000Investments in bonds 160,000

$274,000 Solution:Working capital = current assets - current liabilitiesCurrent assets = cash and assets expected to be converted into cash or consumed in one year or operating cycle, whichever is longer.Current assets = Cash + Accounts receivable + inventory + short-term investments + prepaid insuranceCurrent assets = 60,000 + 114,000 + 138,000 + 80,000 + 2,000 = 394,000Current liabilities = liabilities to be paid in one year or operating cycle, whichever is longer.Current liabilities = Accounts payable + Notes payable (short-term)Current liabilities = 64,000 + 56,000 = 120,000Working capital = 394,000 - 120,000 = 274,000

A company has liabilities of $2,300,000, common stock of $550,000, and retained earnings of $1,250,000. It has assets of

$4,100,000. Solution:The basic accounting equation is: Assets = Liabilities + EquityThis equation must always balance, meaning total assets must equal total liabilities plus total stockholders' equity.Equity equals paid-in capital (i.e., common stock) plus retained earnings.Equity = 550,000 + 1,250,000 = 1,800,000Fill-in assets and equity into the accounting equation and solve for liabilities.Assets = Liabilities + Equity = 2,300,000 + 1,800,000 Assets = $4,100,000

A corporation reports the following on its financial statements. Cash paid for new equipment, $30,000 Cash collected from customers, $100,000 Paid a note payable, $5,000 Cash collected in exchange for issuing additional shares of Pilgrim stock to stockholders, $15,000 Cash dividends paid, $25,000The company reports $75,000 of net income for the year and it has $90,000 of cash at year-end. What is the company's free cash flow?

$45,000 Solution:Free cash flow is computed by subtracting capital expenditures and cash dividends from cash provided by operations. The company has only one cash inflow or outflow from operating activities (i.e., cash collected from customers) and it has only one capital expenditure (cash paid for new equipment).Free cash flow = $100,000 - $30,000 - $25,000 = $45,000.The payment of the note payable is not an operating activity cash flow. It is a financing activity cash flow, and it is neither a capital expenditure nor a payment of a dividend so it is not used to compute free cash flow. Similarly, the cash collected from stockholders who paid for additional shares of stock is a financing activity inflow for the company, but it does not affect free cash flow.

A corporation has current assets of $3,750,000, current liabilities of $2,050,000, total assets of $10,000,000 and total liabilities of $6,000,000. If it pays $500,000 of its accounts payable what will the current ratio be? (rounded)

2.10 Solution: Current ratio equals current assets divided by current liabilities. Accounts payable is a current liability. Paying accounts payable reduces cash (i.e., current assets) and reduces accounts payable (i.e., current liabilities). Current ratio = ($3,750,000 − $500,000) ÷ ($2,050,000 − $500,000) Current ratio = 2.0967 (i.e., 2.10 to 1 or 2.10:1)

A company has current assets of $1,600,000 and total assets of $9,000,000. It has current liabilities of $750,000 and total liabilities of $6,000,000. If it issues $100,000 of common stock what will its current ratio be? (rounded)

2.27 Solution:Current ratio = current assets divided by current liabilities.Issuing common stock to shareholders increases the corporation's cash (i.e., current assets) and increases its stockholders' equity. It does not affect current liabilities.Current ratio = (1,600,000 + 100,000)/750,000Current ratio = 2.2666 (i.e., 2.2666 to 1)2

What is the total dollar amount of current assets reported on the classified balance for the following company? Accounts payable$ 60,000Inventory 140,000Accounts receivable 80,000Land 190,000Accumulated depreciation 40,000Prepaid insurance 30,000Buildings 230,000Retained earnings 150,000Cash 90,000Trademarks 140,000Common stock 650,000

340,000 Solution: Current assets include accounts receivable, cash, inventory, prepaid insurance = 80,000 + 90,000 + 140,000 + 30,000 = 340,000

Which of the following is typically not a current liability?

Bonds Payable (due in 10 years) Solution:On a classified balance sheet liabilities are partitioned into two subcategories, including (i) current liabilities and (ii) long-term liabilities. Current liabilities are obligations that the company is to pay within the next year or operating cycle, whichever is longer. Current maturities of long-term debt due in 10 months so they are classified as a current liability.

Which of the following statements is true?#1. The Financial Accounting Standards Board is the organization that makes many of the accounting standards or rules in the United States.#2. Generally Accepted Accounting Principles are rules and practices that are recognized as a general guide for financial reporting purposes in the United States.

Both statements are true Solution:The Securities Exchange Commission (SEC) is the agency of the U.S. government that oversees U.S. financial markets and accounting standard-setting bodies. The Financial Accounting Standards Board (FASB) is the primary accounting standard-setting body in the U.S. Generally Accepted Accounting Principles (GAAP) is the set of accounting standards (i.e., rules) that have authoritative support for determining the content of financial statements, including assets, liabilities, equity, revenues, and expenses.

A corporation used four different accounting methods to compute depreciation in four consecutive years. Which of the following qualities of useful information has the company most likely violated?

Consistency Solution: To be useful for decision-making, accounting information needs to possess certain fundamental qualities: (i) relevance and (ii) faithful representation. Information is considered to be relevant if it provides information that has predictive value, that is, it helps provide accurate expectations about he future, and has confirmatory value (i.e., it confirms or corrects prior expectations). Materiality is another aspect of relevance. An item of information is material if its size makes it likely to influence decision-making. Faithful representation means information accurately depicts what actually happened. To provide a faithful representation, information must be complete (i.e., nothing important omitted), neutral (i.e., the information s not biased toward one position of another), and free from error. In addition to qualities of useful information, there are several enhancing qualities of useful information. These include comparability, consistency, verifiability, timeliness, and understandability. Consistency means that a company uses the same accounting principles and methods from year to year.

What organization issues the majority of generally accepted accounting standards in the United States?

Financial Accounting Standards Board Solution:The Financial Accounting Standards Board (FASB) is the primary accounting standard-setting body in the U.S. Generally Accepted Accounting Principles (GAAP) is the set of accounting standards (i.e., rules) that have authoritative support for determining the content of financial statements, including assets, liabilities, equity, revenues, and expenses.

Which of the following is an example of an intangible asset?

Goodwill Solution:Examples of intangible assets include goodwill, patents, copyrights, and trademarks or trade names.

A ratio summarizes the relation between selected items. Financial statement analysis (i.e., ratio analysis) focuses on the relation between certain financial statement data, such as earnings and the number of shares of common stock (i.e., earnings per share or EPS). A ratio by itself is not particularly useful. Rather, ratios tend to be compared to standards. Which of the following is a comparison facilitated by ratios when conducting a financial statement analysis (i.e., ratio analysis)?

Intracompany comparisons such as comparing two years' ratios for the same company. Industry-average comparisons such as comparing a company's ratio to an industry average. Intercompany comparisons such as comparing a company's ratio to the ratio of a competitor in the same industry. Solution:Ratios facilitate comparisons and they are frequently used to assess a company's performance. Comparisons include (i) intracompany comparisons (i.e., comparing one company to itself across time), (ii) industry-average comparisons, and (iii) intercompany comparisons (i.e., comparing one company to another company).

Which of the following would not be reported among property, plant, and equipment on a classified balance sheet?

Inventory Solution:Classified balance sheets partition a company's assets into four categories: (i) current assets (e.g., inventory), (ii) long-term investments, (iii) property, plant, and equipment (e.g., buildings, land, equipment, and accumulated depreciation which is the total amount of depreciation that the company has expensed so far on its property, plant and equipment), and (iv) intangibles. If land or other real estate is held for investment or sits idle, the account name should reflect it (e.g., Land held for investment, Investment in real estate).

Which of the following requires that only those things that can be expressed in money are included in the accounting records?

The monetary unit assumption Solution The monetary unit assumption requires that only those things that can be expressed in money are included in the accounting records. This means that certain important information needed by investors, creditors, and managers, such as customer satisfaction, is not reported in the financial statements.

The principle that indicates that assets should be reported at the price received to sell an asset is the

fair value principle Solution: The fair value principle indicates that assets and liabilities should be reported at their fair values. The fair value of an asset is the price received to sell the asset. The fair value of a liability is the amount needed to settle or pay the liability.

The primary objective of financial reporting is to provide financial information that is useful. According to the FASB, useful information should possess certain fundamental qualities. One such quality is faithful representation. Which of the following is a characteristic of faithful representation?

free from error Solution: To be useful for decision-making, accounting information needs to possess certain fundamental qualities: (i) relevance and (ii) faithful representation. Information is considered to be relevant if it provides information that has predictive value, that is, it helps provide accurate expectations about he future, and has confirmatory value (i.e., it confirms or corrects prior expectations). Materiality is another aspect of relevance. An item of information is material if its size makes it likely to influence decision-making. Faithful representation means information accurately depicts what actually happened. To provide a faithful representation, information must be complete (i.e., nothing important omitted), neutral (i.e., the information s not biased toward one position of another), and free from error. In addition to qualities of useful information, there are several enhancing qualities of useful information. These include comparability, consistency, verifiability, timeliness, and understandability.

Issuing new shares of common stock will

increase common stock Solution:The issuance of common stock increases the common stock account; it does not affect retained earnings.

Materiality is a characteristic or aspect of relevance. An item is considered to be material if

its size is likely to influence the decision of an investor or creditor. Solution: Materiality is an aspect of relevance. An item of information is material if its size makes it likely to influence decision-making.

The assumption the life of a business can be divided into artificial time periods for financial reporting purposes is known as the

periodicity assumption. Solution To develop accounting standards, the FASB relies on some key assumptions. These include the monetary unit assumption, economic entity assumption, periodicity assumption, and the going concern assumption.