Fin 405 Exam 1

An example of an intangible asset is: a. A patent b. Land c. Investment in another company d. Raw material inventory

ANS: A Other intangible assets are brand names, trademarks, licenses, and goodwill (arises when a business buys another business, and the other business has assets that aren't separately identifiable. So, the amount that you paid for that company above and beyond its net market value. In a privately held company, goodwill has no predetermined value prior to acquisition).

Which of the following assets appears on the balance sheet at Historical cost? a. Equipment b. Notes Payable c. Investments in Marketable Securities d. Accounts Payable

ANS: A Page 81. Historical cost, adjusted for expensing the used portion (for equipment, this is depreciation).

Academic research has found that market rates of return on common stock are the most highly correlated with: a. net income. b. cash flow from operations. c. EBITDA. d. cash flow from investing activities.

ANS: A Remember the graph of this from Chapter 1 (Exhibit 1.14). The findings are summarized in Chapter 3 on page 135. Firms with positive net income have stock returns that are 35.6% higher than firms with negative net income. Firms with positive operating cash flows have stock returns that are 15% higher than firms with negative cash flows. So, while both net income and operating cash flows are positively correlated with stock returns, net income has a higher correlation.

The following steps make up the steps in financial statement analysis: 1. Identify the strategies the firm pursues to gain and sustain a competitive advantage. 2. Analyze the current profitability and risk of the firm using information in the financial statements. 3. Value the firm. 4. Identify the economic characteristics and competitive dynamics of the industry in which a particular firm participates. 5. Assess the quality of the firm's financial statements and, if necessary, adjust them for such desirable characteristics as sustainability or comparability. 6. Prepare forecasted financial statements. Which of the following is the proper order for these interrelated sequential steps? a. 4,1,5,2,6,3 b. 1,2,3,4,5,6 c. 4,6,2,5,1,3 d. 1,4,2,5,3,6

ANS: A This is important, i.e., this question or a question like it will definitely be on the test. This sets out the whole roadmap for this course. We are currently done with Step 3.

Tinker Company reported sales revenue of $500,000 and total expenses of $450,000 (including depreciation) for the year ended December 31, 2020. During 2020, accounts receivable decreased by $5,000, merchandise inventory increased by $4,000, accounts payable increased by $6,000, and depreciation expense of $10,000 was recorded. Assuming no other data is needed and using the indirect method, the net cash inflow from operating activities for 2020 was: a. $60,000 b. $67,000 c. $44,000 d. $51,000

ANS: B $500,000 - $450,000 + $5,000 - $4,000 + $6,000 + $10,000 = $67,000

Which of the following economic characteristics is consistent with a grocery store chain? a. Minimal competition b. Extensive competition c. High net income to sales d. Differentiated product

ANS: B Choose the best answer. D may be applicable to certain high-end stores like Whole Foods, but not generally.

Adophus, Inc.'s 2020 income statement reported total revenues of $850,000 and total expenses (including $40,000 depreciation) of $720,000. The 2020 balance sheet reported the following: accounts receivable beginning balance of $50,000 and ending balance of $40,000; accounts payable beginning balance of $22,000 and ending balance of $28,000. Therefore, based only on this information and using the indirect method, the 2020 net cash inflow from operating activities was: a. $126,000 b. $186,000 c. $166,000 d. $174,000

ANS: B Generally, you start with net income (which is just revenues minus expenses). Then, add back depreciation. Next, either add back a decrease in AR or subtract an increase in AR (in this case, since AR decreased over the year, you would add back whatever that amount is). Finally, either subtract an increase in AP or add back a decrease in AP (in this case, since AP increased over the year, you would subtract that amount out). Specifically, for Adophus, Inc.: $850,000 - $720,000 + $40,000 + $10,000 (which is $50K - $40K) + $6,000 (which is -$22K + $28K) = $186,000

One rationale for the statement of cash flows is to: a. ensure that the cash account balances at year-end. b. reconcile differences between net income and cash receipts and disbursements. c. calculate the company's free cash flow. d. examine the cash effects of income from discontinued operations, extraordinary items and changes in accounting principles.

ANS: B Net income is calculated based on accrual accounting. Because the measurement of net income isn't dependent on the timing of cash inflows and outflows, there will be discrepancies between a company's cash flows and its net income. The statement of cash flows reconciles these differences.

Which SEC form may be the best place to start learning about the economics of an industry and the particular strategy a firm has selected for competing in the industry? a. Form 8-K b. Form 10-K c. Form MD&A d. Form FSAP

ANS: B Page 47 "Sources of Financial Statement Information." 8-K is about notifying investors of important upcoming and current events. MD&A is about operating performance, financial position, and liquidity. It is included in the 10-K.

When preparing the statement of cash flows using the indirect method, the sale of marketable securities would appear as: a. a use of cash in the investing activities section b. a source of cash in the investing activities section c. a use of cash in the financing activities section d. a source of cash in the financing activities section

ANS: B Remember, this is one of the exceptions. Even though marketable securities are short-term, they still go in the investing activities section. See Exhibit 3.12 "Worksheet for Preparation of Statement of Cash Flows" on page 153.

The traditional accounting model delays the recognition of value changes of assets and liabilities until what event occurs? a. A change in value. b. A market transaction. c. A balance sheet date. d. Cash is received or cash is paid.

ANS: B See Approach 1 on page 89. Delay recognition until when the value changes are realized in a market transaction.

A company in the growth phase of its product life cycle will normally have which of the following patterns of cash flows? a. Negative cash flows from operations, negative cash flows from investing and positive cash flows from financing. b. Negative or positive cash flows from operations, negative cash flows from investing and positive cash flows from financing. c. Positive cash flows from operations, positive cash flows from investing and positive cash flows from financing. d. Negative or positive cash flows from operations, negative cash flows from investing and negative cash flows from financing.

ANS: B See page 130, "A Firm's Life Cycle: Cash Flows".

The expense incurred by issuing stock options should be: a. classified as a financing activity. b. added back to net income in the operating activities section. c. subtracted from net income in the operating activities section. d. does not appear in the statement of cash flows.

ANS: B See page 140, "Other Noncash Components of Income Adjustments: Stock-based compensation."

Which of the following is the correct formula for calculating cash collections from customers? a. sales for the period plus accounts receivable at the beginning of the period b. sales for the period plus accounts receivable at the beginning of the period minus accounts receivable at the end of the period c. sales for the period plus accounts receivable at the end of the period d. sales for the period plus accounts receivable at the end of the period minus accounts receivable at the beginning of the period

ANS: B See page 152, "Classifying Changes in Balance Sheet Accounts: 1. Accounts Receivable." Cash collected from customers equals sales MINUS the change in A/R, which is the same thing that Option B is saying.

The net amount a firm would receive if it sold an asset or the net amount it would pay to settle a liability is referred to as: a. current replacement cost b. net realizable value c. current cost d. acquisition cost

ANS: B See page 84 "Net Realizable Value." Current replacement cost is the amount a firm would have to pay now to acquire or produce an asset it currently already holds.

When net income is high relative to operating cash flows, we describe the firm as having recorded: a. income-decreasing accruals. b. income-increasing accruals. c. income-neutral accruals. d. abnormal accruals.

ANS: B Specifically, in this case the firm probably had increases in A/R and inventories that were greater than its increases in its current operating liabilities (i.e. A/P).

If a firm is growing and expanding its accounts receivable and inventories faster than its current operating liabilities, its cash flow from operations will normally be: a. greater than net income b. less than net income c. greater than the change in working capital from operations d. greater than the change in cash

ANS: B Start out with NI. Any increase in CA is a subtraction, and any increase in CL is an addition. If CA is growing at a faster rate than CL, then the minuses are growing faster than the pluses, thus cash flow from operations would be lower than NI(for most companies, it's usually the other way around—operating cash flows tend to be greater than net income).

Firms with short operating cycles will experience less of a lag between the creation and delivery of their products and the collection of cash from customers because: a. their cash flow from operations will be much greater than their working capital from operations. b. their cash flow from operations will not differ much from their working capital from operations. c. their cash flow from operations will be much less than their working capital from operations. d. there will be no relation between their cash flow from operations and working capital from operations.

ANS: B They collect cash from CA and pay out cash from CL more quickly than firms with long operating cycles.

Net income is equal to: a. Assets minus Liabilities b. Revenues and Gains minus Expenses and Losses c. Shareholders' Equity minus Assets d. Revenues and Assets minus Expenses and Liabilities

ANS: B This is at the top of page 28 (Income Statement—Measuring Performance).

Shareholders' equity consists of what three components: a. Assets, liabilities, and contributed capital. b. Contributed capital, accumulated other comprehensive income, and retained earnings. c. Liabilities, contributed capital, and retained earnings. d. Liabilities, contributed capital, and accumulated other comprehensive income.

ANS: B Towards the bottom of page 105 "Framework for Analyzing the Effects of Transactions on the Financial Statements," "Overview of the Analytical Framework."

Which of the following is an adjustment that would need to be made to net income when calculating cash flows from operations under the indirect method? a. subtract amortization expense b. subtract gain on sale of subsidiary c. add an increase in accounts receivable d. add a decrease in accounts payable

ANS: B You would add back amortization. You would subtract an increase in AR. You would add an increase in AP, thus you would subtract a decrease in AP. A gain on the sale of a subsidiary would be a noncash gain and would thus have to be subtracted, so B is the right answer.

Outback Corp. recorded sales of $1,300,000 in 2020, in addition the company's accounts receivable balance grew from $120,000 at the beginning of 2020 to $165,000 at the end of 2020. How much cash did Outback collect from customers in 2020? a. $1,300,000 b. $1,345,000 c. $1,255,000 d. $1,135,000

ANS: C Just use the formula from the previous question. Start out with the $1.3M in sales, and then from that you SUBTRACT the increase in AR. $1,300,000 + $120,000 - $165,000 = $1,255,000.

Current assets are defined as: a. Cash and cash equivalents. b. All assets expected to be quickly used by the firm. c. Cash and other assets that the firm expects to sell or consume during the normal operating cycle of a business, usually one year. d. Cash and other assets that the firm expects maintain for a period including the normal operating cycle of a business, usually one year.

ANS: C Option C is straight from the book, top of page 24. Important to note "collect, sell, or consume."

Which of the following valuation methods reflects current values? a. acquisition cost b. present value of cash flows using historical interest rates c. net realizable value d. adjusted acquisition cost

ANS: C Options A and D are obviously historical. So is B (initial present value is used for A and L with payment schedules in excess of one year. Mainly for monetary A and L). Net realizable value is the net amount a firm would receive if it sold an asset (the key word here is "selling," as this means that the current prevailing market conditions are being reflected). It's a hybrid, but it does reflect current value with historical value providing a benchmark.

The accrual basis of accounting recognizes: a. Revenue when cash is received from customers b. Expenses when paid c. Revenue when all or a substantial portion is performed d. Revenue when contracts are signed

ANS: C Page 29. "It has completed all or substantially all of the revenue-generating process by delivering products or services to companies." D is too early and A is too late in the game. Expenses can be recognized at the time of sale (as cost of goods sold) or in the period during which the company consumes the resources in question (i.e., depreciation). So again, B is too late in the game.

When preparing the statement of cash flows using the indirect method, the payment of dividends would appear as: a. a decrease in the operating activities section b. an increase in the operating activities section c. a use of cash in the financing activities section d. a source of cash in the financing activities section

ANS: C See page 156, "Classifying Changes in Balance Sheet Accounts: 18. Retained Earnings". "Net income is an operating activity, and dividends are a financing activity." Also see Exhibit 3.12 "Worksheet for Preparation of Statement of Cash Flows" on page 153.

The third step in financial statement analysis is to assess the quality of the firm's financial statements. Which of the following is a question an analyst should ask when performing this step? a. Are industry sales growing rapidly or slowly? b. Do earnings include revenues that appear mismatched with the business model employed by the firm? c. Does the industry include a large number of firms selling similar products? d. What is the company's degree of geographical diversification?

B

Accounts payable represent: a. Amounts which are owed to the company by its customers resulting from credit sales. b. Amounts which are owed by the company to its suppliers for past purchases. c. Amounts which are due to stockholders. d. Amounts which have been borrowed to finance operations.

B. amounts which are owed by the company to its suppliers for past purchases

When attempting to identify the economic characteristics of the industry in which a particular firm participates an analyst might ask which of the following questions? a. Has the firm diversified across several geographic markets? b. Does technological change play an important role in the firm maintaining a competitive advantage? c. Has the firm recognized revenues at the proper time? d. Has the firm structured transactions to make it look more profitable than economic conditions suggest?

B. does technological change play an important role in the firm maintaining a competitive edge

Present value is most likely to be used as a valuation basis for a. inventory. b. long-term debt. c. property, plant, and equipment. d. accounts receivable.

B. long term debt

Normally, cash flows from operations will peak during which phase of the product life cycle? a. Introduction b. Growth c. Maturity d. Decline

C

The cash basis method of accounting can be best described as: a. The recording of transactions and adjustments so that debits equal credits. b. The method that equates assets with liabilities and owners' equity. c. The method that recognizes revenue when money is received and expenses when money is paid. d. The method that matches incurred expenses with related revenues when they are earned.

C

Which of the following would not inhibit new entrants into a market? a. Existing technological expertise. b. Large required capital investment. c. Lack of rivalry among current participants. d. Existing patented technology.

C

Which of the following activities is an operating activity? a. Payment of dividends. b. Issuing common stock. c. Collections of accounts receivable. d. Investing in equity securities of other companies.

C. collections of accounts receivable

Which of the following economic characteristics is consistent with a commercial bank? a. Low profit margin on fee-based financial services, such as merger consulting. b. Low barriers to entry. c. Low profit margin on lending activities. d. High levels of research and development.

C. low profit margin on lending activities

Relevant asset valuations refer to all of the following except: a. they are timely. b. they have the capacity to affect a user's decisions, based on the information. c. they incorporate all available information. d. they are always subjective.

D

Which of the following is a question an analyst would ask when assessing the quality of a firm's financial statements? a. Are the company's products designed to meet a specific market segment? b. Has the firm integrated forward into retailing to final consumers? c. Is the firm diversified across several geographical markets? d. Do earnings include nonrecurring gains or losses?

D. Remember, we want the information contained in the financial statements to be a complete and faithful representation of firm's economic performance, financial position, and risk. Thus, nonrecurring gains or losses should be evaluated differently than recurring ones.

Why is the operating activities section of the statement of cash flows often believed to be the most important part of the statement? a. Because it shows the dividends that have been paid to stockholders. b. Because shows the net increase or decrease in cash during the period. c. Because it gives the most information about how operations have been financed. d. Because it indicates a company's ability to generate cash from sales to meet current cash payments for goods or service

D. because it indicates a company's ability to generate cash from sales to meet current cash payments for goods and services

What is the principal activity of security analysts? a. To apply IFRS adjustments. b. To assign credit ratings. c. To assess the need for audits. d. To value firms.

D. to value firms

Nonmonetary assets include assets that are ? , such as inventories, and assets that are ?, such as brand names.

Tangible , intangible

Under the ? basis of accounting, a firm recognizes revenue when it performs all or a substantial portion, of the services it expects to perform and receives either cash or a receivable.

accrual

Which of the following statements about the mixed attribute model is true? a. Relevance receives the primary emphasis. b. Representational faithfulness receives the primary emphasis. c. Obtaining an optimal mix of relevance and representational faithfulness is the primary objective. d. None of these statements are true.

c. Obtaining an optimal mix of relevance and representational faithfulness is the primary objective.

Recognize changes in economic value on the balance sheet and income statement when they occur, even though they are not yet realized in a market transaction.

fair value accounting on the income statement

Normally, intense rivalries have a tendency to reduce

profitability

Most financial statement analysis aims to assess a firm's

profitability and risk

he main components that make up the stockholder's equity section of the balance sheet are

retained earnings and common stock

sets forth the sequence of activities involved in the creation, manufacture and distribution of its products and services.

value chain

Which of the following is not an expense of a business? a. Dividends b. Salaries c. Advertising d. Depreciation

A. dividends

Which financial statement for a business would you look at to determine the company's earnings performance during an accounting period? a. Income statement. b. The Management Assessment. c. Balance sheet. d. Statement of cash flows.

A. income statement

Which forces typically represent horizontal competition in a value chain? a. Substitutes and potential entry. b. Potential entry and buyer power. c. Buyer power and supplier power. d. Rivalry among existing firms and supplier power.

A. substitutes and potential entry

All of the following are firms that may experience a long lag between the expenditures of cash and the receipt of cash from customers, except: a. restaurants b. wineries c. construction companies d. aerospace manufacturers

A

All of the following can be used to describe reliability of accounting information except: a. biased. b. credible. c. verifiable. d. supported by source documents.

A

Current replacement cost represents: a. the amount a firm would have to pay currently to acquire an asset it now holds b. the amount a firm would have to pay currently to acquire an asset it does not now hold c. the amount a firm would have to pay in the future to acquire an asset it now holds d. the amount a firm would have to pay to purchase a comparably depreciated version of the asset it now holds

A

There are three valuation methods that reflect historical values: acquisition cost, adjusted acquisition cost, and present value of cash flows using historical interest rates. For each of three methods discuss what the valuation represents and provide an example of a balance sheet item that is valued using the method. In addition, for each of the three methods valuation methods explain its advantages and disadvantages

ANS: 1. Acquisition cost is the amount paid initially to acquire the asset, examples include prepayments, land, and intangibles with indefinite lives. The advantage is simplicity and reliability, the disadvantage is lack of relevance. 2. Adjusted acquisition cost is the amount paid initially to acquire an asset, minusaccumulated depreciation and amortization. Examples include equipment and intangible assets with limited lives. The advantage is simplicity and reliability, the disadvantage is lack of relevance and subjectivity due to not being able to observe the actual consumption of the asset. 3. Present value of cash flows using historical interest rates is an item in which cash receipts or cash payments will occur over time. These future cash flows are then discounted at the interest rate in effect at the time of the initial transaction. Balance sheet examples include notes receivable and notes payable. The advantage is simplicity and reliability, the disadvantage is subjectivity due to not updating the interest rate as time elapses. Exhibit 2.4 on page has a brief summary. More detail on pages 80-82.

The calculation of cash flow from operations under the indirect method involves two types of adjustments. Discuss each type of adjustment and provide an example of each type of adjustment.

ANS: 1. Adjusting revenues and expenses for changes in non-working capital accounts, for example depreciation, amortization, and deferred income tax. 2. Adjusting revenues and expenses for changes in operating working capital accounts, for example accounts receivable, inventories, and accounts payable.

What three financial statements are prepared by business firms and what information does each provide?

ANS: 1. Balance sheet--Point in time reporting of assets, liabilities and stockholders' equity. 2. Income statement--Measurement of operating performance for a period of time. 3. Statement of cash flows--The net cash flows for a period of time from the three business activities: operating, investing and financing.

What are the six interconnected activities related to financial statement analysis?

ANS: 1. Identify the economic characteristics of the industry in which a firm participates. 2. Identify the strategies that a particular firm pursues to gain and sustain a competitive advantage. 3. Assess the quality of a firm's financial statements and, if necessary, adjust them for such desirable characteristics such as sustainability or comparability. 4. Analyze the current profitability and risk of the firm using information in the financial statements. 5. Prepare forecasted financial statements. 6. Value the particular firm.

Many people view the balance sheet as being a representation of a firm's economic position. What are some issues that reduce the quality of this representation?

ANS: 1. Many valuable resources of a firm that generate cash flows, such as a patent or a brand name, will only appear as assets if acquired, not when they are internally developed. 2. Nonmonetary assets appear at acquisition cost, even though their current market values might exceed acquisition cost. 3. Certain rights to use resources and commitments to make future payments may not appear as assets and liabilities. For instance, for Starbucks, the legal right to use leased spaces isn't an asset, nor are obligations to make future lease payments considered to be liabilities. Same thing for airlines and aircraft that they lease. 4. Noncurrent liabilities appear at the present value of expected cash flows discounted at an interest rate determined when the liability arose, not at the current rate. (all on page 26)

What are three activities reported in the statement of cash flows and what information does each activity provide?

ANS: 1. Operating activities - Provides information on cash generated and used by a firm in its normal activities of selling goods and providing services. 2. Investing activities - Provides information about the firm's use of cash in the acquisition of long-lived productive assets and cash provided by the disposal of long-lived productive assets. In addition, cash provided and used by investment in debt and equity securities are included in this category. 3. Financing activities - Provides information about cash provided and used by short- and long-term borrowing and from issuing or repurchasing capital stock. In addition, cash used for dividends is reported in this category.

Discuss operating, investing, and financing cash flows in relation to the various stages of the product life cycle.

ANS: 1. Operating cash flows begin negative in the introduction phase and start becoming positive in the growth phase. Operating cash flows reach their peak in the maturity phase and start to decrease at the end of the maturity phase and into the decline phase. 2. Investing cash flows begin negative in the introduction phase and stay negative in the growth phase. Investing cash flows become positive in the maturity phase and start to decrease at the end of the maturity phase and into the decline phase. 3. Financing cash flows are positive in the introduction and growth phase. Financing cash flows start to decrease at the end of the maturity phase and continue to decrease in the decline phase.

What is an industry's value chain?

ANS: An industry's value chain is the sequence of activities involved in the creation, manufacture and distribution of its products and services.

Firms use acquisition cost valuations and adjusted acquisition cost valuations for which of the following types of assets? a. Assets that do not have fixed amounts of future cash flows. b. Assets that have fixed amounts of future cash flows. c. Assets with certain future economic benefits. d. monetary

ANS: A If the asset had fixed future cash flows, you would use present value method

Which of the following would not appear as a liability on the balance sheet? a. A labor contract b. A note due to a bank c. Salary due employees at year-end d. Accounts payable

ANS: A Liabilities are obligations to make payments of cash, goods, or services in a reasonably predictable amount at a reasonably predictable future time. Option A isn't applicable because the firm hasn't received anything yet. You would recognize the liability for future wages once the employee has actually provided the services.

Fizzzle Inc. sold a piece of equipment during the period for $230,000 and recorded a gain of $45,000 on the sale. How should this gain be treated when preparing the operating activities section of the statement of cash flows using the indirect method? a. A sale of equipment is an investing activity; the transaction will not affect the operating activities section. b. The gain is added back to net income in the operating activities section. c. The gain is subtracted from net income in the operating activities section. d. The entire sales price is subtracted from net income in the operating activities section.

ANS: C The adjustment that needs to be made here is just the gain/loss on disposition of asset. In this case, there was a gain, so the gain needs to be subtracted out from net income in the operating activities section (the gain will be reflected as a positive amount in the investing activities section, so you don't want to double count it. See page 140, "Other Noncash Components of Income Adjustments: Gains and losses" as well as page 154, "Classifying Changes in Balance Sheet Accounts: 6. Property, Plant, and Equipment").

The second step in financial statement analysis is to identify the company strategy. Which of the following is a question an analyst should ask when performing a strategy analysis? a. Are industry sales growing rapidly or slowly? b. Do earnings include revenues that appear mismatched with the business model employed by the firm? c. Does the industry include a large number of firms selling similar products? d. What is the company's degree of geographical diversification?

ANS: D A is relevant to step 1 (industry analysis). B is more about accounting quality analysis, which is step 3. C is also relevant to step 1. Only D is relevant to step 2 (other aspects are nature of product or service, degree of integration in value chain, anddegree of the firm's industry diversification (is the firm operating in a single industry or across multiple industries?)).

Which of the following is not considered to be a liability? a. Wages payable. b. Accounts payable. c. Notes payable. d. Cost of goods sold.

ANS: D COGS is an expense found in the income statement.

Which financial statement would you look at to determine whether a company will be able to pay for the goods when payment is due in 30 days? a. Statement of cash flows. b. Statement of stockholders' equity. c. Income statement. d. Balance sheet.

ANS: D Compare its current assets to its current liabilities. Is its current ratio higher than 1?

When a firm attempting to create unique products or services for particular market niches, in order to achieve relatively high profit margins, this is best known as: a. A quality strategy b. A low-cost leadership strategy c. A vertical integration strategy d. A product differentiation strategy

ANS: D Page 17. "Framework for Strategy Analysis". Low-cost leadership would be the opposite, where you'd have nondifferentiated products at a low price. The lower profit margin would be made up for by higher sales volume and market share.

U.S. GAAP, IFRS, and other major accounting standards are best characterized as: a. historical accounting models. b. current value accounting models. c. acquisition cost accounting models. d. mixed attribute accounting models.

ANS: D Starting on page 76. MAAM is a compromise between relevance and representational faithfulness.