ACG2021 Chapter 02

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

Trademarks Solution: Trademarks like the Nike swoosh package design are intangible assets. The trademark makes it easier for customers to recognize Nike swoosh products. Chapter 2, Learning objective 1

The three most common financial ratio classifications used by businesses include

profitability ratios, liquidity ratios, and solvency ratios. Solution: The three financial ratio classifications include (i) profitability ratios, (ii) liquidity ratios, and (iii) solvency ratios. Chapter 2, Learning objective 2

Bombay Corporation had $24,000 of cash at the beginning of the year and it had cash receipts of $21,000 during the year. At the end of the year, Bombay Company had $33,000 of cash. What was Bombay Corporation's cash disbusements for the year?

$12,000 Solution: The ending balance equals beginning cash minus cash disbursements plus cash receipts $33,000 = $24,000 + $21,000 - X Solve for X: Cash disbursements = $12,000. Chapter 2, Learning Objective 5, Pool 4

At the end of the year, Green Company had retained earnings of $2,640,000. During the year, the company issued stock for $120,000 and paid dividends of $25,000. Net income for the year was $412,000. How much was the retained earnings balance at the beginning of the same year?

$2,253,000 Solution: Ending retained earnings = beginning retained earnings + net income - dividends. $2,640,000 = X + $412,000 - $25,000 Solve for X: Beginning retained earnings = $2,253,000. Chapter 2, Learning objective 3

Which one of the following does not affect retained earnings?

Issuance of common stock Solution: Net income causes an increase in retained earnings, while a net losses and dividends cause decreases. Issuances of common stock have no impact on retained earnings. Chapter 2, Learning objective 3

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. Chapter 2, Learning objective 2

Which of the following is a financial ratio classification that measures short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash?

Liquidity ratios Solution: 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. Chapter 2, Learning objective 2

How does a company compute its free cash flow?

Net cash provided by its operating activities minus (i) expenditures on property, plant, and equipment and (ii) its dividends paid. Solution: Free cash flow is computed as the company's net cash provided by its operating activities minus (i) its expenditures on property, plant, and equipment and (ii) its dividends paid. Chapter 2, Learning objective 5, Pool 1

For a given company, total assets are $160,000, current liabilities are $10,000, long-term liabilities are $40,000, common stock is $50,000, and retained earnings is $60,000. How much is total stockholders' equity?

$110,000 Solution: Stockholders' equity equals common stock plus retained earnings. Common stock of $50,000 plus retained earnings of $60,000 equals $110,000 in stockholders' equity. Assets equals liabilities plus stockholders' equity. $160,000 = $10,000 + $40,000 + X Solving for X: Stockholders' equity = $110,000 Chapter 2, Learning objective 1

Bombay Corporation had $24,000 of cash at the beginning of the year and it had cash receipts of $21,000 during the year. At the end of the year, Bombay Company had $33,000 of cash. What was Bombay Corporation's cash disbusements for the year?

$12,000 Solution: The ending balance equals beginning cash minus cash disbursements plus cash receipts $33,000 = $24,000 + $21,000 - X Solve for X: Cash disbursements = $12,000. Chapter 2, Learning Objective 5, Pool 4

Riverview Inc. reports the following balances and amounts. The following information is presented in random order. Accounts payable, $50,000 Cash provided by operations, 100,000 Accounts receivable, 35,000 Net income, 40,000 Average common shares, 15,000 Salaries and wages payable, 40,000 Average current liabilities, 225,000 Stockholders' equity, 200,000 Average total assets, 600,000 Current assets, 300,000 Average total liabilities, 320,000 Current liabilities, 250,000 Dividends paid to preferred shareholders, 5,000 How much is earnings per share?

$2.33 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 = ($40,000 - 5,000)/15,000 shares = $2.33/share. Chapter 2, Learning objective 2

Stonebrook Corporation reported net income of $32,000, net sales of $500,000, and average shares outstanding of 12,000. There were $2,000 of preferred stock dividends. How much was its earnings per share?

$2.50 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 = ($32,000 - $2,000)/12,000 shares = $2.50/share. Chapter 2, Learning objective 2

Jose Inc. reports the following balances and amounts. The following information is presented in random order (amounts are in dollars). Accounts payable, 125,000 Accounts receivable, 140,000 Accumulated depreciation—Equipment, 60,000 Cash, 100,000 Equipment, 400,000 Intangible assets, 20,000 Inventory, 200,000 Long-term investments, 80,000 Long-term liabilities, 200,000 Notes payable (short-term), 56,000 Prepaid insurance, 2,000 Salaries and wages payable, 8,000 Short-term investments, 80,000 Stockholders' equity, 493,000 How much is its working capital?

$333,000 Solution: Working capital is current assets minus current liabilities. Current assets = $140,000 + 100,000 + 200,000 + 2,000 + 80,000 = $522,000 Current liabilities = $125,000 + 56,000 + 8,000 = $189,000 Working capital = $522,000 - $189,000 = $333,000 Chapter 2, Learning objective 4

Pilgrim 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, $25,000 The 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. Chapter 2, Learning objective 5, Pool 2

The net cash inflow from operating activities is $200,000; cash received from issuing stock is $150,000; cash paid for capital expenditures is $90,000; cash paid for bonds held as an investment is $50,000; and cash paid for dividends is $20,000. How much is free cash flow?

$90,000 Solution: Free cash flow is cash provided by operating activities minus cash paid for capital expenditures and dividends paid. Free cash flow = $200,000 - $90,000 -$20,000 = $90,000. Chapter 2, Learning objective 5

Clawson Corporation has current assets of $3,010,000 and current liabilities of 2,150,000. If Clawson Corporation pays $200,000 of its accounts payable what will its new current ratio be?

1.44 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 = ($3,010,000 - $200,000) / ($2,150,000 - $200,000) Current ratio = 1.44 (i.e., 1.44 to 1 or 1.44:1) Chapter 2, Learning objective 4

Clawson Corporation has current assets of $3,150,000 and current liabilities of 2,250,000. If Clawson Corporation pays $500,000 of its accounts payable what will its new current ratio be?

1.51 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 = ($3,150,000 − $500,000) ÷ ($2,250,000 − $500,000) Current ratio = 1.514 (i.e., 1.51 to 1 or 1.51:1) Chapter 2, Learning objective 4

In what order are current assets listed on a classified balance sheet?

By liquidity Solution: Current assets are listed in order of liquidity which is the order of how quickly they are expected to be converted into cash. Chapter 2, Learning objective 1

Which of the following are constraints that allow a company to modify generally accepted accounting principles without jeopardizing the usefulness of the financial statements?

Cost constraint Solution: The cost constraint states that the cost that companies incur to provide information should be weighed against the benefit that financial statement users will gain from having the information available. Consistency and comparability must be maintained to comply with GAAP. These features allow comparisons from year-to-year and within the industry. Relevance and faithful representation must be maintained to comply with GAAP. These factors insure the financial information is factual, neutral, and timely for the decision makers. Timeliness and neutrality must be maintained for GAAP. These features preclude expired information or biased information from being provided to decision makers. Chapter 2, Learning objective 7

Dividing net income minus preferred stock dividends by the average of common shares outstanding produces the following:

Earnings per share Solution: Earnings per share is determined by dividing net income less preferred stock dividends by the average common shares outstanding. It represents the amount a company earned for each common share of stock outstanding. Chapter 2, Learning objective 1

What are the accounting rules that have substantial authoritative support and are recognized as a general guide for financial reporting purposes in the U. S.?

Generally accepted accounting principles Solution: Learning objective 6 Generally accepted accounting principles, or "GAAP" have substantial authoritative support, and are recognized as a general guide for financial reporting purposes.

What is the primary criterion by which accounting information can be judged?

Usefulness for decision making Solution: Learning objective 7 Information provided must be useful to enable users to make decisions. Consistency, or the use of the same accounting principles from period to period by the same firm, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Predictive value, or the ability of information to help in predicting future results, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Comparability, or the use of the same accounting principles by two firms in the same period, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged.

Which of the following is not a characteristic of relevance?

Verifiability Solution: Verifiability refers to the process or capability of being able to prove or verify that the data is free from error. This is one of the enhancing qualities of useful information. Materiality is an element of relevance. An item is material when its size make it likely to influence the decision of an investor or creditor. Confirmatory value is an element of relevance, i.e. it confirms or corrects prior expectations. Predictive value means that the information can help provide accurate expectations about the future and it is an element of relevance. Chapter 2, Learning objective 7

Accounting information has relevance is it would make a difference in a business decision. Characteristics associated with relevant accounting information include

being material and having predictive value. 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. Chapter 2, Learning objective 7

Faithful representation means that information accurately depicts what really happened. Characteristics associated with faithfully representative accounting information include being

complete, neutral, and 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. Chapter 2, Learning objective 7

The accounting concept that indicates that assets and liabilities should be reported at the price received to sell the asset or settle the liability 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. Chapter 2, Learning objective 7

Accounting information should be neutral in order to enhance

faithful representation. 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. Chapter 2, Learning objective 7

The concept that a business has a reasonable expectation of remaining in business for the foreseeable future is called the

going concern assumption. Solution The going concern assumption states that the business will remain in operation for the foreseeable future. Chapter 2, Learning objective 7

The following ratios are available for Rock Inc. and Pebble Inc. Rock Inc. Pebble Inc. Current Ratio 1.8 1.6 Compared to Rock Inc., Pebble Inc. has

lower liquidity. Solution: 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. Chapter 2, Learning objective 4