IA2 - Chapter 24 Study Guide

Devers company has 120,000 shares of common stock outstanding on December 31, 2014, selling at a current market price of $56 per share. If the price-earnings ratio at December 31, 2014 is 14, what amount of net income did Devers Company earn in 2014?

480,000 HOW: $56 / (NI / 120,000) = 14 NI / 120,000 = 4 NI = 480,000

Rosseto Company reports the following information about its sales and accounts receivable for 2014: Sales Net Cash Sales $164,000 Net Credit Sales 451,000 Total Sales $615,000 Accounts Receivable Balance 1/1/14 $86,000 Balance 12/31/14 78,000 What is Rosseto Company's receivables turnover ratio

5.5 HOW: 86,000 + 78,000 = 164,000 /2 = 82,000 451,000 / 82,000 = 5.5

Notes related to the claims of equity holders are quite rare, as this kind of information is presented in the equity section of the balance sheet directly opposite the class of security to which the information applies. T/F

FALSE - It is quite common to have equity notes related to contracts and senior securities outstanding that might affect the various claims of the residual equity holders. These notes are important and are by no means rare.

Companies are required to issue a summary annual report which contains a condensed financial presentation in a more readable format than that of the traditional annual report. T/F

FALSE - Summary annual reports are not required. However, some companies have experimented with their issuance.

The SEC has a safe harbor rule which allows companies to report fraudulent information as long as its done in good faith. T/F

FALSE - The SEC does NOT have a safe harbor rule concerning fraudulent information. The SEC does however, have a safe harbor rule concerning financial forecasts and projections.

Accounting policies of a given entity are normally the specific accounting principles recommended by the industry in which the entity operates. T/F

FALSE - The accounting policies of a given entity are the specific accounting principles and methods currently employed & considered appropriate to present fairly the financial statements of the enterprise. An entity is required by GAAP to include a note in its financial statements that provides information about the significant accounting policies it has adopted.

Segment information that is required to be reported must be prepared on the same accounting basis as that is used in the enterprise's consolidated financial statements. T/F

FALSE - The accounting principles to be used for segment disclosure need not be the same as the principles used to prepare the consolidated statements

Normally, the information disclosed in notes to financial statements is less relevant to an understanding of the financial statement than the information presented in the body of the financial statements. T/F

FALSE - The information in the notes to financial statements and the information in the body of the financial statements are equally relevant. The notes provide a means of amplifying on the data presented in the body of the financial statements. Because of the complexity of economic events reflected in the financial statements, notes are a necessary part of full disclosure in financial reporting

The price earnings ratio is computed by dividing the market price of a share of common stock by the net income for the period. T/F

FALSE - The price earnings ratio is computed by dividing the market price of the stock by its earnings per share.

According to GAAP, when a company issues a quarterly income statement, that statement should represent approximately one-fourth of the total net income for the year in which the quarter exists. T/F

FALSE - The profession has not taken a definite position on the most appropriate method to use in recognizing revenues and expenses during an interim period. Entities currently use both the discrete and integral viewpoint in the preparation of interim financial statements. Because of the vague nature of the standards for interim financial reports, it is difficult to characterize the relationship of interim financial reports and annual financial reports

A particular segment is NOT significant enough to disclose unless its revenues exceed 10% of the revenues earned by the other segments being reported. T/F

FALSE - There are three quantitative tests that determine whether a segment is significant enough to disclose. To be disclosed, a segment must meet either a revenue test, a profit test or an asset test. The revenue test requires the segment's revenue to be 10% or more of the combined revenue of all the enterprises industry segments.

When an auditor examines the financial statements of a business enterprise for the purpose of expressing an opinion thereon, he or she attempts to determine whether the statements are an accurate representation of the entity's financial position and results of operations. T/F

FALSE - This statement is made false by the use of the word ACCURATE. An auditor expresses an opinion on whether the financial statements "present fairly" the financial position and results of operation. In the auditing literature the term "presents fairy" has a specific meaning

Vertical analysis is the proportionate change over a period of time. T/F

FALSE - Vertical analysis is the proportional expression of each item on a financial statement in a given period to a base figure. Horizontal Analysis indicates the proportionate change over a period of time.

An executory contract refers to a contract entered into by an enterprise that must be fulfilled by an executive of the company. T/F

FALSE - when two parties commit themselves t osome undertaking on the basis of a signed contract but neither party has yet performed, the contract is executory

When should an average amount be used for the numerator or denominator?

For a balance sheet item when a ratio consists of an income statement item and a balance sheet item.

The times interest earned ratio includes which of the following in its computation? Income Before Taxes and Interest Interest Charges Total Debt

Income Before taxes and interest - Numerator Interest Charges - Denominator Total Debt - Not included

The management discussion and analysis (MD&A) section of the annual report should focus attention on which of the following financial aspects of an enterprise's business? Liquidity Capital Resources Results of Operations

Liquidity - YES Capital Resources - YES Results of operations - YES

If the financial statements examined by an auditor lead the auditor to issue an opinion that contains an exception that is NOT of sufficient magnitude to invalidate the statement as a while, the opinion is said to be:

Qualified

In presenting segment information, which of the following items must be reconciled to the entity's consolidated financial statements? Revenues Operating profit (loss) Identifiable assets

Revenues - NO Operating Profit (Loss) Yes Identifiable Assets - Yes

An industry segment is regarded as significant and therefore identified as a reportable segment if it satisfies one or more quantitative tests that deal with segment revenues, income or assets. In addition to these quantitative tests the FASB believes entities should not report too many segments so as to overwhelm users with detailed information that may not be useful. The FASB also requires that:

Segment results equal or exceed 75% of the combined sales to unaffiliated customers for the entire enterprise

The disclosure of accounting policies is important to financial statement readers in determining:

Whether accounting policies are consistently applied from year to year

Management discussion & analysis

a part of an entity's annual report that covers three aspects of the business, liquidity, capital resources and results of operations

interim financial reporting

a report used to provide information on the profitability of a company for less than a one-year period

Auditors report

a report useful to investors that indicates amount other things, the accounting basis used by an entity to prepare its financial statements

Fraudulent financial reporting

intentional or reckless conduct, whether by act or omission, that results in materially misleading financial statements.

The accounting profession indicates that

the same accounting principles used for the annual report should be employed for interim reports

Nick Baker company earns a 7.4% return on assets. If net income amounts to $275,000, total average assets must be:

$3,716,216 ROA = NI / Average Total Assets 275,000 / .074 = $3716216

financial forecast

information based on a company's assumptions reflecting conditions it expects to exist in the future and the course of action it expects to take

Social responsibility disclosures

information related to environmental and ecological issues addressed by the firm

Information from Hardy Company's balance sheet is as Follows: Current Assets Cash $150,000 Marketable Securities 200,000 Accounts receivable 300,000 Inventories 350,000 Prepaid Expenses 20,000 Total Current Assets $1,020,000 Current Liabilities Notes Payable $50,000 Accounts Payable 450,000 Accrued Expenses 100,000 Income Taxes Payable 200,000 Total Current Liabilities $800,000 What is the acid test ratio

.8125 to 1 HOW: (150,000 + 200,000 + 300,000) / 800,000

Vrany Company's income statement included the following information related to its gross profit on sales. Sales $2,560,000 Beginning Inventory $826,000 Purchases 1,250,000 2,076,000 Less Ending Inventory (904,000) Cost of Goods Sold 1,172,000 Gross Profit $1,388,000 Vrany Company's Inventory Turnover is:

1.355 HOW: Cost of Goods sold / Average inventory $1,172,000 / [(826,000 + 904,000)/2] = 1,172,000 / 865,000 = 1.355

Presented below is information related to Riley, Inc.: December 31 2014 2015 Common Stock $500,000 $600,000 Preferred Stock 400,000 400,000 Retained Earnings (Includes Net income for current year) 150,000 200,000 Net Income for Current Year 40,000 130,000 What is Riley's rate of return on common stock equity for 2015 if a $20,000 dividend was given to the preferred shareholders during 2015?

20% WHY: NI = 130,000 Preferred Dividends = 20,000 130,000 - 20,000 = 110,000 / AVG Stock Equity Average Stock Equity = (500,000 + 600,000) / 2 = 550,000 110,000 / 550,000 = 20%

Reporting of Segment information

information related to revenue and profit breakdowns by divisional lines

Accounting Policy Disclosure

information related to the accounting methods used in the preparation of year end financial statements

Which of the following best characterizes the difference between a financial forecast and a financial projection?

A forecast attempts to provide information on what is expected to happen whereas a projection may provide information on what is not necessarily expected to happen.

How are net sales used in the computation of each of the following ratios? Asset Turnover Profit Margin on Sales

Asset Turnover - Numerator Profit Margin on Sales - Denominator

Which of the following should be disclosed in a Summary of Significant Accounting Policies? A. The aggregate amount of maturities and sinking fund requirements for all long-term borrowings B. Inventory method followed C. The existence of outstanding stock options D. Possible tax assessments.

B. Inventory method followed

If a business entity entered into certain related party transactions it would be required to disclose all of the following information EXCEPT: A. The nature of the relationship between the parties to the transactions B. the nature of any future transactions planned between the parties and the terms involved C. The dollar amount of the transactions for each of the periods for which an income statement is presented. D. Amounts due from or to related parties as of the date of each balance sheet presented.

B. The nature of any future transactions planned between the parties and the terms involved

Note Information

information that is an integral part of the financial statements that serves as a means of amplifying or explaining the items presented in the main body of the statements

Which of the following questions would an analyst be LEAST likely to find addressed by the notes of the financial statements? A. What method of depreciation is used on plant assets? B. What type of inventory method is being used to account for inventory? C. How many separate bank accounts does the company maintain? D. What restrictions are required by the new bond issue?

C. - How many separate bank accounts does the company maintain?

Ratio analysis provides only a single snapshot, the analysis being for one given point or a period in time. When an investment analyst wishes to concentrate on a given item to determine whether it appears to be growing or diminishing year by year and the proportion of such change to related items, they should use:

Comparative analysis

Opportunities for fraudulent reporting are present in circumstances when the fraud is easy to commit and when detection is difficult. An opportunity for fraud would LEAST likely arise from the following situation: A. Unusual or complex transactions B. The absence of a Board of Directors or an audit committee C. Ineffective internal audit staffs D. Strong internal controls

D. Strong internal controls

Durdil company has a current ratio of 2:1. If current assets and current liabilities are both increased by $10,000, the current ratio will:

Decrease

The full disclosure principle, as adopted by the accounting profession, is best described by which of the following?

Disclosure of any financial facts significant enough to influence the judgement of an informed reader

Which of the following describes UNINTENTIONAL mistakes? ERRORS IRREGULARITIES

Errors - Yes Irregularities - No

Interim financial reports prepared by a business enterprise normally include a complete set of financial statements for a period of less than one year. T/F

FALSE - Interim financial reports normally show summarized information on revenues, expenses, assets, liabilities, and shareholders equity The profession encourages but does not require companies to publish a balance sheet and a statement of cash flows.

A careful reading of the notes to the financial statements provides information as to off balance sheet commitments, future financing needs, and the quality of a company's earnings. T/F

TRUE

An adverse opinion is an indication that the financial statements do NOT present fairly the financial position and results of operations. T/F

TRUE

An auditor is a professional who conducts an independent examination of the accounting data presented by the business enterprise for the purpose of expressing an opinion thereon. T/F

TRUE

For purposes of computing earnings per share and making the disclosures required by GAAP, each interim period should stand alone, that is, all applicable tests should be made for that single period. T/F

TRUE

In situations where the calculations of net income includes a significant amount of estimated items, profitability rations lose some of their credibility. T/F

TRUE

Management is required to highlight favorable or unfavorable trends and to identify significant events and uncertainties that affect the enterprise's liquidity, capital resources and results of operations. T/F

TRUE

Notes are an integral part of the financial statements of a business enterprise. T/F

TRUE

One limitation of ratios is that they are based on historical cost, which can lead to distortions in measuring performance. T/F

TRUE

Rate of return on assets is computed by using as a numerator net income and as a denominator average total assets. T/F

TRUE

The relevance of conclusions drawn from an analysis of financial rations is enhanced when the ratios are computed from comparative financial statements. T/F

TRUE

The required approach to handing extraordinary items in interim financial reports is to charge or credit the loss or gain in the interim period that it occurs instead of attempting some arbitrary multiple-period allocation. T/F

TRUE

When consolidated financial statements are presented by a business enterprise, that enterprise is required to disclose the principles of consolidation in the notes to its financial statements. T/F

TRUE

When gain or loss contingencies exist, an enterprise will generally disclose them in notes to the balance sheet. T/F

TRUE

When the percentage analysis is used in connection with an income statement, the items shown on the income statement are normally expressed as a percentage of net sales. T/F

TRUE

Perhaps the most severe criticism aimed at ratio analysis is:

The difficult problem of achieving comparability among firms in a given industry

The standard unqualified opinion issued at the conclusion of an audit by the independent public accountant contains how many paragraphs?

Three

In the first week of June 2014, Travis Company incurred advertising expenses at a cost of $300,000. These advertising costs will benefit operations for the second half of the calendar year. How should these expenses be reflected in Travis's quarterly income statements?

Three Months Ended 3/31/14 6/30/14 9/30/14 12/31/14 0 0 150,000 150,000

The publication of profit projections by a business enterprise is:

encouraged by the SEC, which has issued a safe harbor rule to protect entities that present this kind of information

financial projection

financial information based on a company's assumptions reflecting conditions it expects would exist in the future given one or more hypothetical assumptions