Financial Reporting & Analysis

Selected items from the financial statements of three plumbing fixture manufacturers appear in the following table. All three firms use straight-line depreciation for financial reporting. Based only on these data, which firm is most likely to require significant capital expenditures sooner than the others?

Sammco has PP&E with the highest average age and lowest remaining useful life, and therefore appears more likely to need new equipment in the near future than the other firms.

When comparing two firms, an analyst should most appropriately adjust the financial statements when they include significant:

property, plant, and equipment, if one of the firms uses accelerated depreciation and the other uses straight-line depreciation. Depreciation methods are an example of a difference that may require an analyst to adjust financial statements to make them comparable. Acquisition goodwill is treated the same way under IFRS and U.S. GAAP: it is not amortized but is tested for impairment at least annually. Securities held for trading are reported at fair value with unrealized gains and losses reported on the income statement.

As a result of a recent acquisition, Lombard, Inc., has placed the following items on their balance sheet as of the beginning of their fiscal year: Goodwill$30 millionPatent$10 millionExpires in 10 years.Trademark$15 millionExpires in 15 years, renewable at minimal cost. If Lombard amortizes intangible assets using the straight line method, the amortization expense on these assets for the fiscal year will be:

$1 million Goodwill has an indefinite life and is not amortized. A trademark or other intangible asset that has an expiration date but is renewable at minimal cost is treated as having an indefinite life and is not amortized. The patent has a finite life and its cost will be amortized at the rate of $1 million each year over ten years under the straight-line method.

An analyst gathered the following data about a company: Net sales$4,000Dividends declared170Cost of goods sold2,000Inventory increased by100Accounts payable increased by300Cash expenses for other inputs500Long-term debt principal replayment250Cash tax payments200Purchase of new equipment300 The company's cash flow from operations, based on these data only, is:

$1500

An analyst gathered the following data about a company: Collections from customers are $5,000. Depreciation is $800. Cash expenses (including taxes) are $2,000. Tax rate = 30%. Net cash increased by $1,000. If inventory increases over the period by $800, cash flow from operations equals:

$3,000

A firm has undertaken a contract with an estimated total cost of $200 million at a price of $220 million. At the end of the first reporting period, the firm has devoted resources of $70 million to the project. The customer has been billed for $80 million and made payments of $60 million. As a result of these transactions, the firm should report revenue from this project of:

$77 Million Using the percentage of total costs incurred to date as an estimate of the portion of the performance obligations completed, revenue should be (70/200) × $220 million = $77 million. recognize revenue only when it is highly probable they will not have to reverse it. For example, a firm may need to recognize a liability for a refund obligation (and an offsetting asset for the right to returned goods) if revenue from a sale cannot be estimated reliably

On January 2, a company acquires some state-of-the-art production equipment at a net cost of $14 million. For financial reporting purposes, the firm will depreciate the equipment over a 7-year life using straight-line depreciation and a zero salvage value; for tax reporting purposes, however, the firm will use straight-line depreciation over a 3-year life. Given a tax rate of 35%, by how much will the company's deferred tax liability increase in the first year of the equipment's life?

$931,700

How to calculate the net increase in common shares from potential exercise of stock options or warrants when the exercise price is less than the average market price is:

(( AMP - EP ) / AMP ) * N AMP = Average market price EP = exercise price n = number of common shares that the options and warrants can be converted intoterm-14

An analyst gathers the following data about a company: The company had 1 million shares of common stock outstanding for the entire year. The company's beginning stock price was $50, its ending price was $70, and its average price was $60. The company had 100,000 warrants outstanding for the entire year. Each warrant allows the holder to buy one share of common stock at $50 per share. How many shares of common stock should the company use in computing its diluted earnings per share?

1,016,667 Step 1:Determine the number of common shares created if the warrants are exercised = 100,000.Step 2:Calculate the cash inflow if the warrants are exercised: (100,000)($50 per share) = $5,000,000.Step 3:Calculate the number of shares that can be purchased with these funds using the average market price ($60 per share): 5,000,000 / 60 = 83,333 shares.Step 4:Calculate the net increase in common shares outstanding from the exercise of the warrants: 100,000 − 83,333 = 16,667.Step 5:Add the net increase in common shares from the exercise of the warrants to the number of common shares outstanding for the entire year: 1,000,000 + 16,667 = 1,016,667.

A company has 1,000,000 warrants outstanding at the beginning of the year, each convertible into one share of stock with an exercise price of $50. No new warrants were issued during the year. The average stock price during the period was $60, and the year-end stock price was $45. What adjustment for these warrants should be made, under the treasury stock method, to the number of shares used to calculate diluted earnings per share (EPS)?

166,667 Diluted EPS uses average price. Since the average price is greater than the exercise price, the warrants are dilutive.

Which of the following statements about the calculation of earnings per share (EPS) is least accurate? A)Shares issued after a stock split must be adjusted for the split. B)Options outstanding may have no effect on diluted EPS. C)Reacquired shares are excluded from the computation from the date of reacquisition.

A Shares issued post-split need not be adjusted for the split as they are already "new" shares. Options with an exercise price greater than the average share price do not affect diluted EPS.

Which costs are least likely to be reported as an expense in the current accounting period?

Costs of producing inventory Inventory costs are expensed when items are sold under the matching principle. As an extreme example, if no sales are made, no costs of inventory production are expensed for the period. Period costs are expensed during the period. Under the accrual method, interest accrued during the period is expensed, regardless of whether it has been paid during the period.

Direct vs indirect method

Direct method: - gives more information - Can find the following components (Cash collected from customers, cash used in the production of goods, cash operating expenses, cash paid for interest, taxes -*A common "trick" in direct method questions is to provide information on depreciation expense along with other operating cash flow components. - Investing cash flows (CFI) are calculated by examining the change in the gross asset accounts that result from investing activities, such as property, plant, and equipment, intangible assets, and investment securities. Related accumulated depreciation or amortization accounts are ignored since they do not represent cash expenses - calculating the cash flow from an asset that has been sold, it is necessary to consider any gain or loss from the sale Indirect Method: -adjustment to net income on an indirect statement of cash flows is to subtract gains on the disposal of assets. Proceeds from the sale of fixed assets are an investing cash flow. Since gains are a portion of such proceeds, we need to subtract them from net income in calculating CFO under the indirect method. -we also need to adjust net income for change in balance sheet accounts. If, for example, accounts receivable went up during the period, we know that sales during the period were greater than the cash collected from customers.

Greene Company discloses that its net income for the most recent period was reduced by a writedown of inventory to net realizable value. What effect is the inventory writedown most likely to have on Greene's net income in future periods?

Increase In future periods, lower-valued inventory will result in lower cost of sales and higher net income.

According to the IASB Conceptual Framework for Financial Reporting, what are the two fundamental qualitative characteristics of financial statements?

Relevance and faithful representation. The IASB Conceptual Framework for Financial Reporting describes the two fundamental qualitative characteristics of financial statements as relevance and faithful representation. The Conceptual Framework lists timeliness, comparability, verifiability, and understandability as characteristics that enhance relevance and faithful representation.

Compared to reporting in a country where life insurance payments on key employees are deductible for tax, a company that makes such payments and reports in a country in which they are not tax deductible would report:

a higher effective tax rate In the case where insurance premiums paid are not tax deductible, taxes would be higher so the effective tax rate (tax expense / pretax income) would be higher. Expenses on the income statement that are not deductible for tax and will not reverse are permanent differences and will not affect deferred tax items.

Open market sales of securities by a country's central bank will most likely result in:

appreciation of the domestic currency. Central bank sales of securities reduce excess reserves in the banking system, causing interbank lending rates and other short-term interest rates to increase. If the monetary policy transmission mechanism operates normally, long-term interest rates should also increase, the domestic currency should appreciate, and economic growth and inflation should decrease.

Under U.S. GAAP, land owned by the firm is most likely to be reported on the balance sheet at:

historical cost Unless impairment has been recognized, land is reported at historical cost and is not subject to depreciation. Increases in value are not reflected in balance sheet values under U.S. GAAP.

Peri, Inc. has entered into a long-term contract to build a warehouse that includes a bonus payment of 10% of the contract value, to be paid if the building is completed by a specific date. In determining the revenue to recognize, the firm should calculate the proportion of the performance obligations fulfilled to date, and multiply that by the contract value

including the bonus only if they are certain they will receive it. Revenue recognition standards require that firm conclude that they will not have to reverse any cumulative revenue recognized, as they would have to if the bonus is not received. If nonreversal is only probable, they should not include the bonus in calculating revenue.

A company has a cash conversion cycle of 70 days. If the company's payables turnover decreases from 11 to 10 and days of sales outstanding increase by 5, the company's cash conversion cycle will:

increase by approximately 2 days.

A low inventory turnover ratio in a period of declining revenue growth is most likely an indication that a firm may have:

obsolete inventory. Low inventory turnover and declining revenue growth may be signs that a firm has obsolete or slow-moving inventory. High turnover and low revenue growth may indicate too little inventory, while high turnover and high revenue growth may indicate efficient inventory management.

Which of the following is most likely presented on a common-size balance sheet or common-size income statement?

operating profit margin Operating profit margin can be read directly from a common-size income statement. Asset turnover and return on equity mix balance sheet and income statement items.

Normal Corp. has a current ratio above 1 and a quick ratio less than 1. Which of the following actions will increase the current ratio and decrease the quick ratio? Normal Corp.:

pays off accounts payable from cash. Paying off accounts payable from cash lowers current assets and current liabilities by the same amount. Because the current ratio started off above 1, the current ratio will increase. Because the quick ratio started off less than 1, it will decrease further. The other choices are incorrect. Buying fixed assets on credit decreases both ratios because the denominator increases, with no change to the numerator. Using cash to purchase inventory would result in no change in the current ratio but would decrease the quick ratio by decreasing the numerator.

While motivation and opportunity both can lead to low quality of financial reporting, a third important contributing factor is:

rationalization of the actions. A mindset that allows rationalization is the third important condition underlying low-quality financial reporting. Poor financial controls are an example of opportunity and pressure to meet earnings expectations is a possible motivation.

Financial reporting quality

refers to the characteristics of a firm's financial statements. The primary criterion for judging financial reporting quality is adherence to generally accepted accounting principles (GAAP) in the jurisdiction in which the firm operates. However, given that GAAP provide choices of methods, estimates, and specific treatment of many items, compliance with GAAP by itself does not necessarily result in financial reporting of the highest quality. quality of earnings is, in many respects, a separate issue. The quality of reported earnings (not the quality of earnings reports) can be judged based on the sustainability of the earnings as well as on their level.

In accounting for a defined benefit pension plan, the amount reported as "prior service cost" refers to:

the present value of the increase in future pension benefits from a change in the terms of the pension plan. *key word - "increase" in future pension benefits

A firm uses the first-in first-out (FIFO) cost flow assumption. Compared to gross profit with a periodic inventory system, the firm's gross profit with a perpetual inventory system would be:

the same For a firm using FIFO, gross profit is the same whether the firm uses a periodic or perpetual inventory system. For a firm using LIFO or average cost, gross profit can be different depending on the choice of inventory system.

A permanent difference between pretax and taxable income is least likely to arise when a firm:

uses the installment sales method for financial reporting. The installment sales method of revenue recognition does not result in permanent differences between pretax and taxable income. Premium payments on life insurance of key employees is an expense on the financial statements, but is not deducted on tax returns. Tax exempt interest is recognized as revenue on the financial statements. These items result in permanent differences between pretax income and taxable income.