FIN Ch. 2
U.S. public companies are required to file their annual financial statements with the U.S. Securities and Exchange Commission on which form?
10-K
What role does Generally Accepted Accounting Principles (GAAP) play in the accounting process?
All firms quoted on a U.S. exchange are required to use GAAP in their financial reporting process. This standardization process makes it easier to adjust and/or compare the financial figures across different firms.
What is a firmʹs net income?
All of the above - the difference between the sales and other income generated by a firm, and all costs, taxes, and expenses incurred by the firm in a given period - the last or bottom line of the income statement - a measure of the firmʹs profitability over a given period
What role do external auditors play in a firmʹs financial reporting process?
As the name implies, external auditors act as third party monitors to a firmʹs financial reporting process.
Which of the following balance sheet equations is INCORRECT?
Assets - Current liabilities = Long-term liabilities
Company A has current assets of $42 billion and current liabilities of $41 billion. Company B has current assets of $2.7 billion and current liabilities of $1.8 billion. Which of the following statements is correct, based on this information?
Company A is less likely than Company B to have sufficient working capital to meet its short-term needs.
State the names of some of the firms discussed in the chapter that had inaccurate reporting in their financial statements.
Examples of some firms that had practiced inaccurate reporting are Enron and WorldCom.
T/F. Financial statements are optional accounting reports issued periodically by a firm which present information on the past performance of the firm, a summary of the firmʹs assets and the financing of those assets, and a prediction of the firmʹs future performance.
False
T/F. In the United States, publicly traded companies can choose whether or not they wish to release periodic financial statements.
False
T/F. International Financial Reporting Standards are taking root throughout the world. However, it is unlikely that the U.S. will report according to IFRS before the second half of the twenty -first century.
False
T/F. The balance sheet shows the assets, liabilities, and stockholdersʹ equity of a firm over a given length of time.
False
T/F. The management of public companies is not legally required to disclose any off-balance sheet transactions.
False
T/F. Use of Generally Accepted Accounting Principles (GAAP) and auditors have eliminated the danger of inadvertent or deliberate fraud in financial statements.
False
A public company has a book value of $128 million. They have 20 million shares outstanding, with a market price of $4 per share. Which of the following statements is true regarding this company?
Investors believe the companyʹs assets are not likely to be profitable since its market value is worth less than its book value.
Which of the following is a way that the operating activity section of the statement of cash flows adjusts Net Income from the balance sheet?
It adds all non-cash entries related to a firmʹs operating activities.
Which of the following is NOT a reason that the income statement does not accurately indicate how much cash a firm has earned?
It includes cash inflows from services rendered.
What is the main reason that it is necessary for public companies to follow the rules and format set out in the Generally Accepted Accounting Principles (GAAP) when creating financial statements?
It makes it easier to compare the financial results of different firms
What are the requirements of section 404 of SOX?
It requires that senior management and the boards of public companies attest to the effectiveness and validity of their financial control process.
A manufacturer of plastic bottles for the medical trade purchases a new compression blow molder for its bottle production plant. How will the cost to the company of this piece of equipment be recorded?
It will be depreciated over time on the income statement and subtracted as a capital expenditure on the statement of cash flows.
Allen Company bought a new copy machine to be depreciated straight line for three years for use by sales personnel. Where would this purchase be reflected on the Statement of Cash Flows?
It would be an addition to property, plant and equipment so it would be an investing activity.
According to the text, did Enron and WorldCom follow Generally Accepted Accounting Principles (GAAP) in their financial reporting process?
Many of the problems of Enron and WorldCom were kept hidden from boards and shareholders, until it was too late. People felt that the accounting statements of these companies, while often remaining true to the letter of GAAP, did not present an accurate picture of the financial health of the company.
What is the need for the notes to the financial statements when a firmʹs operations are already documented in the financial statements?
Not all actions of the firm can be directly converted to an entry on the financial statements. For example, the firm may be involved in off balance sheet transactions, which have to be reported through notes to the financial statements.
Which of the following is the main lesson that analysts and investors should take from the cases of Enron and WorldCom?
Readers of even fraudulent financial statements can spot signs of a firmʹs financial health, if those statements are read fully and with care.
Why must care be taken when comparing a firmʹs share price to its operating income?
Share price is a quantity related to equity holders, while operating income is an amount that is related to the whole firm.
A small company has current assets of $112,000 and current liabilities of $117,000. Which of the following statements about that company is most likely to be true?
Since net working capital is negative, the company will not have enough funds to meet its obligations
What will be the effect on the balance sheet if a firm buys a new processing plant through a new loan?
The Assets side will increase under Net property, plant, and equipment with the net effect of the new processing plant, while the Liabilities side will correspondingly show the new debt that was incurred in paying for the plant.
Which of the following best describes why the left and right sides of a balance sheet are equal?
The assets must equal liabilities plus stockholdersʹ equity because stockholdersʹ equity is the difference between the assets and the liabilities.
How does a firm select the date for preparation of its balance sheet?
The balance sheet is prepared on the fiscal closing date for the accounts of a firm that may or may not coincide with the calendar year-end of December 31st.
Which of the following statements regarding the balance sheet is INCORRECT?
The balance sheet reports liabilities on the left-hand side.
What will be the effect on the income statement if a firm buys a new processing plant through a new loan?
The effect on the income statement will be in the form of a depreciation expense for the first year on the new processing plant.
Which of the following is the LEAST likely explanation for a firmʹs high ROE?
The firm is growing.
How does a firm select the dates for preparation of its income statement?
The income statement is prepared on the fiscal closing date for the accounts of a firm that may or may not coincide with the calendar year-end of December 31st. Typically the income statement spans the flow between two adjacent balance sheets.
Which of the following statements regarding the income statement is INCORRECT?
The income statement shows the cash flows and expenses at a given point in time.
How can we cross check the statement of cash flows?
The last item in the statement of cash flows should equal the difference in cash balances between two adjacent balance sheets.
What will be the effect on the statement of cash flows if a firm buys a new processing plant through a new loan?
The new loan entry should show as a cash inflow for the firm, while the payment for the new processing plant will be entered as a cash outflow.
One way Enron manipulated its financial statements was to sell assets at inflated prices to other firms, while giving a promise to buy back those assets at a later date. The incoming cash was recorded as revenue, but the promise to buy back the assets was not disclosed. Which of the following is one of the ways that such a transaction is deceptive?
The off-balance sheet promises to repurchase assets should have been disclosed in management discussion and analysis (MD&A) or notes to the financial statement.
A printing company prints a brochure for a client and then bills them for this service. At the time the printing companyʹs financial disclosure statements are prepared, the client has not yet paid the bill for this service. How will this transaction be recorded?
The sale will be added to Net Income on the income statement but deducted from Net Income on the statement of cash flows.
T/F. A firmʹs statement of cash flows uses the balance sheet and the income statement to determine the amount of cash a firm has generated and how it has used that cash during a given period.
True
T/F. In general, a successful firm will have a market-to-book ratio that is substantially greater than 1.
True
T/F. Price-earnings ratios tend to be high for fast-growing firms
True
T/F. Stockholdersʹ equity is the difference between a firmʹs assets and liabilities, as shown on the balance sheet.
True
T/F. The income statement reports the firmʹs revenues and expenses, and it computes the firmʹs bottom line of net income, or earnings.
True
The exchanges in which of the following countries or regions do NOT accept the International Financial Reporting Standards set out by the International Accounting Standards Board?
United States
What is the main problem in using a balance sheet to provide an accurate assessment of the value of a companyʹs equity?
Valuable assets such as the companyʹs reputation, the quality of its work force, and the strength of its management are not captured on the balance sheet.
Which of the following firms would be expected to have a high ROE?
a grocery store chain that has very high turnover, selling many multiples of its assets per year
Which of the following firms would be expected to have a high ROE based on that firmʹs high profitability?
a medical supply company that provides very precise instruments at a high price to large medical establishments such as hospitals
A company that produces drugs is preparing a balance sheet. Which of the following would be most likely to be considered a long-term asset on this balance sheet?
a patent for a drug held by the company
A software company acquires a smaller company in order to acquire the patents that it holds. Where will the cost of this acquisition be recorded on the statement of cash flows?
as an outflow under investment activities
The third party who checks annual financial statements to ensure that they are prepared according to Generally Accepted Accounting Principles (GAAP) and verifies that the information reported is reliable is the ________.
auditor
Which of the following is NOT one of the ways that the Sarbanes-Ox
by forcing companies to audit financial statements they release
WorldCom classified $3.85 billion in operating expenses as long-term investments. How would this make WorldComʹs financial statements more attractive to investors?
by raising its reported earnings
The major components of stockholdersʹ equity are ________.
common stock, paid-in surplus, and retained earnings
Which of the following is NOT considered to be an operating expense on the income statement?
corporate taxes
Cash is a ________.
current asset
Accounts payable is a ________.
current liability
Which ratio would you use to measure the financial health of a firm by assessing that firmʹs leverage?
debt-equity or equity multiplier ratio
Which of the following is NOT an operating expense?
interest expense
A 30-year mortgage loan is a ________.
long term liability
A delivery company is creating a balance sheet. Which of the following would most likely be considered a short-term liability on this balance sheet?
revenue received for the delivery of items that have not yet been delivered
Which of the following is NOT a financial statement that every public company is required to produce?
statement of sources and uses of cash
A firm whose primary business is in a line of regional grocery stores would be most likely to have to include which of the following facts, if true, in the firmʹs management discussion and analysis (MD&A)?
that the company has lost a class action suit brought against the firm by its employees and is expected to have to pay a large amount of damages
Which of the following amounts would be included on the right side of a balance sheet?
the amount of deferred tax liability held by the company
What is a firmʹs gross profit?
the difference between sales revenues and the costs
Which of the following is NOT one of the financial statements that must be produced by a public company?
the statement of activities
The notes to the financial statements would LEAST likely be used for which of the following purposes?
to disclose the financial implications of any off-balance sheet transactions
Which of the following best describes why a firm produces financial statements?
to provide a means for interested outside parties such as creditors to obtain information about a firm, with an overview of the short- and long-term financial condition of a business
Gross profit is calculated as ________.
total sales - cost of sales