Unit 7
Differences between balance sheet and income statement items
Balance Sheet Income Statement Current liabilities Revenues Net worth Cost of goods sold (COGS) Retained earnings Net income Cash Interest paid
Federal securities laws require publicly traded companies to disclose certain information on a regular basis. Which of these forms must be submitted quarterly? A) Form 10-Q B) Form PF C) Form 10-K D) Form 8-K
A) Form 10-Q Domestic companies must submit quarterly reports on Form 10-Q (Q for quarterly) and annual reports on Form 10-K. Form 8-K is used to report certain events, and Form PF is for private fund investment advisers.
Which of the following is not affected by the issuance of a bond? A) Shareholders' equity B) Total liabilities C) Working capital D) Assets
A) Shareholders' equity When bonds are issued, cash is received (thus increasing current assets) and long-term debt increases (increasing total liabilities). Because there is no corresponding increase in current liabilities, working capital increases. There is no effect on shareholders' equity because the increased liability is offset by the asset (cash) received.
Those investors wishing to examine a document that would probably give them the most information about a corporation's current and planned operations would seek out A) the annual report. B) Form 10-K. C) the balance sheet. D) the investor's brochure.
A) the annual report. The annual report to shareholders contains not only a complete financial report of the prior year's operations but also a statement from key personnel dealing with the company's future plans. Form 10-K does not include discussion of future business plans—it is a report of what happened over the previous fiscal year.
The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is A) reported as a separate line item on the balance sheet. B) the net change in the cash position of the firm for the reporting period. C) an integral part of the footnotes to the balance sheet required by generally accepted accounting principles. D) reported as cash income on the income statement.
B) the net change in the cash position of the firm for the reporting period. The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is the net change in the cash position of the firm for the reporting period. The sum total, or the net change in cash, is not reported on either the balance sheet or the income statement. It is the sum total of the entries on the statement of cash flows, which is a separate financial statement.
When a company recognizes a sale only when payment is made, it is using which form of accounting? A) Double entry B) Accrual C) Audited D) Cash
D) Cash Cash and accrual are the two major forms of accounting. In the cash method, sales and expenses are recognized when the money changes hands. With accrual accounting, the date of the transaction is used.
What is the balance sheet equation? A) Assets = liabilities + shareholders' equity B) Assets = liabilities − shareholders' equity C) Assets = net worth D) Assets = shareholders' equity − liabilities
A) Assets = liabilities + shareholders' equity Total assets equal total liabilities plus total shareholders' equity.
A fundamental analyst is reviewing a company's financial statements. When attempting to determine their debt exposure, all of the following would be included except A) accounts receivable. B) accounts payable. C) outstanding principal balance on long-term debt. D) taxes payable.
A) accounts receivable. Accounts receivable are assets; all the other listings represent liabilities of the company.
A corporation ends its accounting year on September 30. It would be correct to state that it uses A) an alternative year. B) a fiscal year. C) an accounting year. D) a nine-month year.
B) a fiscal year. Fiscal-year accounting is the term used to describe whenever an entity ends its accounting year on a date other than December 31.
In order to be in compliance with SEC reporting rules, a company will typically file a Form 10-Q how many times during its fiscal year? A) One time B) Four times C) Three times D) Two times
C) Three times Form 10-Q is used for quarterly financial reporting. However, even though there are four quarters in an accounting year, only three forms are filed. This is because the Form 10-K, the annual report, takes the place of the fourth quarterly report.
Under SEC rules, Form 8-K must be filed A) within 10 business days of the event. B) promptly. C) within 4 business days of the event. D) within 15 business days of the event.
C) within 4 business days of the event. Form 8-K is used to report newsworthy events to the SEC. The reporting time limit is four business days.
When a member of the board of directors of a publicly traded company resigns due to a disagreement over an operational matter, A) Form 8-K must be filed with the SEC within four business days of the event. B) Form 10-K must be filed with the SEC within four business days of the event. C) the administrator must be notified no later than the close of the business day following the event. D) FINRA must be notified promptly
A) Form 8-K must be filed with the SEC within four business days of the event. Form 8-K is used to report significant events of importance to investors. Examples would be the resignation of a member of the board because of an operational dispute, liquidation of a significant asset, filing for bankruptcy, or a change in management control. When any of these occur, Form 8-K must be filed with the SEC no later than four business days after the event. Form 10-K is the company's annual filing, and that is due—depending on the size of the company—60 to 90 days after the end of the fiscal year. LO 7.e
Which of the following would have the effect of increasing a company's cash flow? A) Issuance of a bond B) Increasing inventory C) Extending credit to good customers D) Reducing sales
A) Issuance of a bond One of the ways to increase cash flow is through financing. When a company issues a bond, it receives cash but does not have to pay the money back until maturity—a number of years in the future. Extending credit means waiting a longer period to receive the cash from sales. Increasing inventory means spending money for raw material and waiting for it to be sold. The company would want to increase sales to bring in more cash, not decrease them.
On a balance sheet, dividends payable would fall under the category of A) current liabilities. B) fixed liabilities. C) stockholders' equity. D) assets.
A) current liabilities. Dividends payable are dividends that have been declared but have not yet paid out. They are a type of current liability—that is, an obligation that will come due within one year from the date on the balance sheet.
All of the following appear on a corporation's balance sheet as fixed assets except A) inventory. B) furniture. C) computer equipment. D) real estate.
A) inventory. Inventory is considered a current asset, not a fixed asset, because the company expects to convert its inventory into cash within a short period. The other choices are fixed assets, and the company does not expect to turn them into cash (sell them) during the normal business cycle.
An analyst wishing to view a good consolidated indicator of a business's cash inflow and outflow would most likely ask to look at A) the statement of cash flows. B) the working capital. C) the current ratio. D) the consolidated income statement.
A) the statement of cash flows. Cash flow is the money (cash) that flows into and out of a business. It consolidates the flow of money from operating activities, investing activities, and financing activities. Working capital and current ratio are indicators of current liquidity and in the income statement reflect only income and expenses. Items such as the cash received from the issuance of securities (stocks or bonds) or a loan from a bank do not appear.
One of the components of a cash flow statement is cash flow from investing activities. Included would be A) transactions and events involving the purchase and sale of land, buildings, and equipment. B) cash proceeds from issuing stocks or bonds. C) payments to retire bonds and the payment of dividends. D) cash receipts (money coming in) from items such as interest and dividends.
A) transactions and events involving the purchase and sale of land, buildings, and equipment. Investing activities include transactions and events involving the purchase and sale of securities, land, buildings, equipment, and other assets not generally held for resale as a product of the business. The proceeds from issuing securities (stocks or bonds) is a financing activity, as is using funds to retire bonds and/or pay dividends. Cash receipts are included in cash flow from operating activities, even when generated through investments such as interest or dividends.
An analyst is viewing financial statements of Diderot Clothing Stores (DCS), a chain of high-fashion women's apparel. DCS had $7 million as its beginning-of-year retained earnings and it made post-tax profits of $3 million. The board of directors decides to pay a dividend of $1 million. Once paid, what will be the ending retained earnings? A) $3 million B) $9 million C) $7 million D) $10 million
B) $9 million The ending retained earnings = beginning retained earnings + net income - dividend. That means $7 million + $3 million - $1 million = $9 million.
Which of the following equations correctly shows the relationship between the items on a company's balance sheet? A) Assets + liabilities = net worth B) Assets = liabilities + stockholders' equity C) Assets = liabilities − net worth D) Assets = stockholders' equity − liabilities
B) Assets = liabilities + stockholders' equity The stockholders' equity, sometimes referred to as net worth, equals the difference between the company's assets and its liabilities (assets − liabilities = stockholders' equity). This formula is often restated as assets = liabilities + stockholders' equity.
An analyst wishing to check on the most recent financial performance of an SEC-registered issuer would probably examine the A) Form 10-K. B) Form 10-Q. C) Schedule 13D. D) Form 8-K.
B) Form 10-Q. Financial reporting is done on Forms 10-K and 10-Q: the former annually and the latter quarterly. Therefore, unless it is shortly after the end of the company's fiscal year, the most recent information is going to be on Form 10-Q. For test-taking purposes, note that the question uses the term probably. With three Form 10-Qs filed each year and only one Form 10-K filed yearly, the probability is higher that Form 10-Q will be the most recent one available. The moral of this story is that you don't look for exceptions unless that is what the question is aiming for.
A fundamental analyst would be interested in funds available for use in the business. Doing which of the following would have the greatest impact on future cash flow? A) Amortizing goodwill B) Retiring outstanding bonds C) Depreciation on assets used in the business D) Retaining earnings
B) Retiring outstanding bonds The retirement of outstanding bonds means that there will be no future interest payments made. Because a major component of cash flow is a company's net income, this reduced expense would lead to increased income resulting in higher cash flow.
Debts that will come due more than one year after the date on the balance sheet are known as A) deferred charges. B) fixed (or long-term) liabilities. C) accounts payable. D) current liabilities.
B) fixed (or long-term) liabilities. Debts that will come due more than one year after the date on the balance sheet are known as fixed (or long-term) liabilities. Current liabilities are debts that may come due within one year from the date on the balance sheet.
Net income A) reflects the operating profits of a firm only. B) represents the amount of money remaining after all expenses, including taxes. C) is paid out in cash to stockholders in addition to any declared dividends. D) must be paid out in dividends.
B) represents the amount of money remaining after all expenses, including taxes. Net income is not a cash item that is paid out to stockholders. Dividends, both preferred and common, are generally cash distributions paid out from net income. Net income after taxes can reflect all sources of income in addition to the operating income generated by business activities. Net income also reflects investment income, as well as operating income. Net income may be paid out in the form of dividends; however, most firms retain a portion of net income in order to reinvest the funds in the business.
When reviewing a corporation's financial statements, shareholders' equity is computed by A) subtracting current liabilities from current assets. B) subtracting total liabilities from total assets. C) adding together retained earnings, preferred and common stock, and long-term debts. D) multiplying the current market price per share times the number of outstanding shares.
B) subtracting total liabilities from total assets. Shareholders' equity is the corporation's net worth, sometimes called owners' equity. It is computed by subtracting the total liabilities from the total assets. Current assets minus current liabilities is the working capital. Taking all of the equity capital, including retained earnings, and adding the long-term debt to that is the company's total capitalization, and the market price per share times the number of outstanding shares is the company's market capitalization.
If a publicly traded corporation was going to sell a wholly owned subsidiary, the information would be made available through the filing of Form A) 10-Q. B) 13F. C) 8-K. D) 10-K.
C) 8-K. Form 8-K is filed with the SEC within four business days of any one of a number of significant actions, including the sale of a significant asset such as a wholly owned subsidiary.
What is the term given to the item, typically found at the bottom of a corporation's balance sheet, that describes such things as significant accounting policies, commitments made by the company, and potential liabilities and potential losses? A) Resource material B) Offline items C) Footnotes D) Contingency statement
C) Footnotes Footnotes to the balance sheet, describing unusual items, are typically found at the bottom of the statement.
The SEC requires that reporting companies (those registered with the SEC) file certain information within specified time limits. Which of the following reports carries the shortest time limit? A) Form 10-K B) Form 10-Q C) Form 8-K D) Annual report
C) Form 8-K Form 8-K is used to report newsworthy events to the SEC, thereby making them available to the public. These reports must be filed within four business days of the event. Form 10-Q is a quarterly report and, depending on the size of the company, is filed within 40 to 45 days of the end of the quarter. Form 10-K is the annual report, and once again, the filing time depends on the size of the company and ranges from 60 to 90 days after the end of the fiscal year. The annual report is technically Form 10-K, although most major corporations publish an additional expanded document with pretty pictures and other information about the company.
Which of the following acts requires publicly traded corporations to issue annual reports? A) Securities Act of 1933 B) Investment Company Act of 1940 C) Securities Exchange Act of 1934 D) Trust Indenture Act of 1939
C) Securities Exchange Act of 1934 The Securities Exchange Act of 1934 mandates that public issuers file annual and quarterly reports with the SEC.
When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) earnings per share. B) net value of fixed assets. C) cash flow from investments. D) cash flow from operations.
C) cash flow from investments. Cash flow from operations is computed by adding the year's depreciation deduction to the net income.
A client asks her investment adviser representative what footnotes to the financial statements are for. The best reply would be that footnotes A) contain a detailed history of the enterprise and its products or services. B) are used to explain how the various ratios are computed because companies recognize that many shareholders do not have a financial background. C) contain information that doesn't have a place in the main body of the financial statements. D) serve as a bibliography indicating where additional information may be obtained.
C) contain information that doesn't have a place in the main body of the financial statements. There are many important financial details that cannot be properly placed in either the balance sheet or the income statement. Examples of these are method of accounting used, collateral securing debt, pension liabilities, and many others. Footnotes are an integral part of the financial statements and are usually found with this notation: "The accompanying footnotes to the financial statements are an integral part of these statements."
A commentator on a cable news show mentions that the capital structure of the Lowveh Corporation is highly leveraged. This means that the company A) has very little default risk. B) has issued employee stock options. C) has significant long-term debt. D) is in arrears on its cumulative preferred stock dividends.
C) has significant long-term debt. When describing a corporation's capital structure, leverage refers to the amount of long-term debt capital. Highly leveraged means the debt capital is generally more than 50% of the total capital and increases rather than decreases the default risk. Employee stock options and preferred stock dividends have nothing to do with leverage.
All of the following corporate actions would have the effect of increasing the firm's net worth except A) issuing common stock. B) purchasing some of the corporation's outstanding bonds at a discount. C) issuing convertible debentures. D) issuing convertible preferred stock.
C) issuing convertible debentures. Issuing a debt security, such as a debenture, will bring in cash (an asset) but will be offset by an equal amount: the debt. Therefore, the net worth will remain the same. Issuing any equity security, preferred or common, increases the owners' equity (net worth). Being able to pay off a debt at a discount means that the current asset (cash) went down less than the long-term liability (the bond), resulting in an increase to net worth.
Which items would change if a company declared a cash dividend? I. Working capital II. Total assets III. Total liabilities IV. Shareholders' equity A) I only B) I, II, III, and IV C) I and IV D) I, III, and IV
D) I, III, and IV The key word is declared. Liabilities increase when a dividend is declared, and total assets decrease when it is paid. A declared dividend (but not yet paid) would increase current liabilities (and would therefore decrease working capital). It would increase total liabilities (this is a pending obligation) and reduce shareholders' equity because retained earnings would be decreased by the dividend. Total assets would not be affected until the dividend is actually paid.
Publicly traded corporations are generally required to have an annual independent audit of their financial records. What is the highest opinion offered under GAAP? A) Qualified opinion B) Disclaimer of opinion C) Adverse opinion D) Unqualified opinion
D) Unqualified opinion An unqualified or "clean" opinion is the best type of report a business can get. The term qualified means that the auditor has some reservations about the information contained in the financial statements. An adverse opinion means the auditor is not willing to vouch for the accuracy of the information. Note: This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback.
An IAR is doing some research on a company. When viewing the corporation's financial statements, prepaid expenses would most likely be found as A) an expense on the income statement. B) a fixed asset on the balance sheet. C) a current liability on the balance sheet. D) D) a current asset on the balance sheet.
D) a current asset on the balance sheet. Prepaid expenses, such as rent, insurance, and postage, are considered current assets and are shown as such, sometimes under the listing "other assets." The amounts paid for those expenses will not appear on the income statement until the specific item is actually used. For example, if a company pays its property insurance premiums six months in advance, it isn't until the next premium is paid that the prepaid expense comes off the balance sheet and is reflected as an actual expense.
If a client has 100 shares of XYZ publicly traded stock and it undergoes a split, afterward the client will have A) a proportionately increased interest in XYZ company. B) a proportionately decreased interest in XYZ company. C) a greater role in the daily management of the company. D) no effective change in the value of the ownership share.
D) no effective change in the value of the ownership share. When a stock splits, the number of shares each stockholder holds increases. However, the value of each share decreases proportionately. The client experiences no effective change in the value of the ownership share.
If a corporation issues mortgage bonds, all of the following would be affected except A) total liabilities. B) working capital. C) total assets. D) shareholders' equity.
D) shareholders' equity. When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase, reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholders' equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation.
