ACC 210 Exam 4
Adjustments to net income in calculating operating cash flows include:
Changes in current assets and current liabilities Noncash items Nonoperating items
What accounts result in adjustments to net income under the indirect method of preparing the statement of cash flows if their balances change during the year?
Inventory Accounts payable Accounts receivable
What statement best describes the purpose of a statement of cash flows for a corporation?
Its purpose is to summarize the company's cash inflows and cash outflows for the year.
(15) Rachel's Recordings reported net income of $200,000. Beginning balances in Accounts Receivable and Accounts Payable were $15,000 and $20,000, respectively. Ending balances in these accounts were $12,000 and $22,000, respectively. Assuming that all relevant information has been presented, Rachel's net cash flows from operating activities would be:
Net Income = $200,000 A/R decrease = 3,000 A/P increase = 2,000 Cash flows from operations = $205,000 The correct answer is: $205,000
cash flow to sales
Net cash flows from operating activities divided by sales revenue; measures the operating cash flow generated per dollar of sales
asset turnover
Net sales divided by average total assets, which measures the sales per dollar of assets invested
When a company purchases Treasury Stock:
One stockholders' equity account increases and one asset account decreases The journal entry is: Treasury Stock 1,000 Cash 1,000
(11) Issued stock refers to the number of shares:
Outstanding plus treasury shares.
From smallest to largest, which is the correct order in terms of number of shares involved?
Outstanding, Issued, Authorized
What transaction would generally result in an investing cash inflow?
Receive cash from the sale of land Cash flows resulting from the sale of a long-term asset (e.g., land) will be classified as investing activities. Recall that dividend receipts are classified as operasting activities.
True or False: Dividends return earnings made by the corporation to its stockholders.
True
True or False: If the Red Company has a debt to equity ratio of 2.3 while the Blue Company has a debt to equity ratio of 1.9, one could say that Red Company is more financially leveraged than Blue Company.
True
True or False: Interest expense related to bonds is tax-deductible whereas dividends paid to stockholders are not tax-deductible.
True
True or false: When pricing a bond, the present value of the interest payments is added to the present value of the maturity value of the bond.
True
When using the direct method, when is cash received from customers greater than sales revenue on the income statement when accounts receivable decreases?
When there are more collections of accounts receivable than sales on account during the year.
(16) When treasury stock is acquired, what is the effect on total stockholders' equity?
When treasury stock is purchased both stockholders' equity and assets will decline by the cost of the treasury stock. Here's the journal entry (amount assumed): Treasury Stock 200,000 Cash 200,000 Recall the Treasury Stock is a contra-stockholders' equity account. The correct answer is: Decrease
Milton Corp. retired its bonds early which resulted in a loss of $80,000. In the journal entry to record the retirement, how should the loss be recorded, and what will be the effect of the loss on the company's net income?
a "Loss" account should be. debited and the loss will cause the company's net income to decrease
callable
a bond feature that allows the borrower to repay the bonds before their scheduled maturity date at a specified call price more common than a conversion feature
premium
a bond's issue price is above the face amount debit cash, credit. bonds payable and premium
discount
a bond's issue price is below the face amount debit cash and discount (contra liability), credit bonds payable
Net cash flows from operating activities include all revenue and expense activities reported on:
a cash basis
treasury stock
a company's own issued stock that it has purchased
lease
a contractual arrangement by which the lessor (owner) provided the lessee (user) the right to use an asset for a specified period of time
accumulated deficit
a debit balance in retained earnings (loss > income)
statement of cash flows
a financial statement that measures activities involving cash receipts and cash payments over an interval of time
bond
a formal debt instrument issued by a company to borrow money. the issuing co (borrower) is obligated to pay back to the investor (lender) 1. a stated amount, referred to as the principal/face amount, at a specified maturity date 2. periodic interest payments over the life of the bond
stock split
a large stock dividend that includes a reduction in the par or stated value per share
Periodic payments on installment notes typically include:
a portion that reflects interest. a portion that reduces the outstanding loan balance.
Dividends account
a temporary stockholders' equity account that is closed into Retained Earnings at the end of each period
As the default risk of a bond increases:
investors can increase their rate of return over the life of the bond by paying a lower price at the issue date
carrying value at maturity equals face amount when:
issued at face amount, at a discount, or at a premium always!
The number of shares outstanding equals the number of shares
issued minus the number of shares in treasury
outstanding stock
issued shares that currently are held by investors; does not include treasury shares
Because depreciation expense is deducted from net income:
it is added back to that amount in calculating operating cash flows
In order to assess a company's financial risk, investors and creditors frequently consider and analyze the company's:
long-term debt
A common reason for redeeming a bond prior to its maturity date is that:
market rates decreased
We record small, large stock dividends at the:
market value, par value
cash return on assets
net cash flows from operating activities divided by average total assets; measures the operating cash flow generated per dollar of assets = cash flow to sales * asset turnover = (op. cash flows/net sales) * (net sales/avg. total assets)
When using the indirect method to prepare the operating activities section of the statement of cash flows, the first amount listed is
net income
earnings per share
net income available to common shareholders divided by average shares of common stock outstanding
return on equity
net income divided by average stockholders' equity measured the income generated per dollar of equity
When accounts receivable decrease:
net sales are less than cash receipts from customers.
recording bonds retired before maturity
no gain or loss is recorded record a gain or loss on early extinguishment equal to difference between price paid to repurchase bonds and bonds' carrying value
primary sources of long-term debt
notes, leases, and bonds
equity financing
obtaining investment from stockholders (stockholders' equity)
cumulative
preferred stock shares receive priority for future dividends, if dividends are not declared in a given year
venture capital firms
provide additional financing, often in the millions, for a percentage ownership in the company
amortization schedule
provides a table format detailing the cash payment each period, the portions of each cash payment that represents interest and the change in carrying value, and balance of the carrying value
times interest earned ratio
ratio that compares interest expense with income available to pay those charges = (net income + interest expense + tax expense) / interest expense.
redeemable
shares can be returned to the corporation at a fixed price
issued stock
shares sold to investors; includes treasury shares
noncash activities
significant investing and financing activities that do not affect cash ex: purchase of long-term assets by issuing debt/stock, conversion of bonds payable into common stock, exchange of long-term assets, depreciation and amortization expense
bonds issued at: -discount -face amount -premium
stated rate is: -less than market rate -equal to market rate -greater than market rate
preferred stock
stock with preference over common stock in the payment of dividends and the distribution of assets
growth stocks
stocks that tend to have higher price earnings ratios and are expected to have higher future earnings
value stocks
stocks that tend to have lower price-earnings ratios and are priced low in relation to current earnings
Interest expense incurred when borrowing money is ___, whereas dividends paid to stockholders are ___.
tax-deductible, not tax deductible
Losses on the sale of long-term land decrease net income, meaning:
the amount of the loss is added back to net income in calculating operating cash flows
paid-in capital
the amount stockerholders have invested in the company
The total number of shares a corporation may sell or issue is known as:
the authorized number of shares
In a statement of cash flows, the sum of cash inflows and outflows is equal to
the change in cash balance
payment date
the date of the actual distribution of dividends
record date
the date on which a company looks at its records to determine who the stockholders of the company are
declaration date
the date the board of directors announces the next dividend to be paid
property dividend
the distribution of a noncash asset to stockholders
initial public offering
the first time a corporation issues stock to the public
early extinguishment of debt
the issuer retires debt before its scheduled maturity date
par value
the legal capital assigned per share of stock par value has no relationship to the market value of the common stock
stated value
the legal capital assigned per share to no-par stock
The market rate determines:
the present values of the face value and interest payments
Assuming a company has net income for the year, the end of year dollar balance in the "Total Stockholders' Equity" column of the statement of stockholders' equity should exactly match which of the following:
the total stockholders' equity balance on the balance sheet
reasons for a company to buy back stock
to boost underpriced stock, to distribute surplus cash without paying dividends, to boost earnings per share, to satisfy employee stock ownership plans
operating activities
transactions involving revenue and expense activities
investing activities
transactions involving the purchase and sale of long-term assets and current investments
financing activities
transactions with lenders, such as borrowing money and repaying debt, and with stockholders, such as issuing stock, paying dividends, and purchasing treasury stock
Repurchased shares which a company has bought back from stockholders with the intention of reissuing at a later date are known as:
treasury shares
Dividends are not paid on:
treasury shares Dividends are paid only on shares outstanding
dividends in arrears
unpaid dividends on cumulative preferred stock
angel investors
wealthy individuals in the business community willing to risk investment funds on a promising business. venture
Tar Heel, Inc. retires a $15 million (face value) bond issue when the carrying value of the bonds is $13 million, but the market value of the bonds is $16 million. The entry to record the retirement will include:
A loss of $3 million We retire bonds with a carrying value of $13 million by paying $16 million. That's a loss on retirement of $3 million
For cash dividends, what is the correct order chronologically (which comes first, then next, and then next)?
Declaration date, Record date, Payment date
True or False: The main reason a company declares a stock split is to raise the market price per share of its stock.
False
A $500,000 bond issue was sold for $490,000. Therefore, the bonds:
Sold at a discount because the market interest rate was higher than the coupon (stated) rate Bonds sell at a discount to their face value when their coupon or stated rate of interest is less than the rate the market demands on the date of issue
ABC Company is in the process of issuing bonds. The bonds have a stated interest rate of 6%, which is 2% above the current market rate. What effect will the two interest rates have on the bond issue price?
The issue price will be above the bond's face value.
unsecured bonds
bonds that are not supported by specific assets pledged as collateral
secured bonds
bonds that are supported by specific assets pledged as collateral
debt financing
borrowing money from creditors (liabilities)
annuity
cash payments of equal amounts over equal time periods
A frequent reason for a stock split is to
cause the market price per share to decline.
Gains and losses on the sale of long-term assets represent
common nonoperating items needing adjustment under the indirect method.
no-par value stock
common stock that has not been assigned a par value
The best way to apply the direct method is to:
convert each revenue and expense item to its cash basis amount
features of preferred stock
convertible, redeemable, and/or cumulative
recording a lease:
creates an asset (the right to use) and a liability (obligation to make payments) for the lessee (user)
company recording a bond issuance
debit cash, credit bonds payable issued at face amount
In the statement of cash flows, net income must be adjusted:
from accrual basis to cash basis inflows
three primary categories of cash flows
from operating, investing, and financing activities
installment payment
includes both an amount that represents interest and an amount that represents a reduction of the outstanding balance
retained earnings has a:
normal credit balance
organization chart
traces the line of authority within the corporation
(8) Velociraptor retires a $20 million bond issue when the carrying value of the bonds is $18 million, but the market value of the bonds is $15 million. The entry to record the retirement will include:
$18 million liability retired for $15 million = $3 million gain The correct answer is: A credit of $3 million to a gain account.
Camp Seagull obtains a $85,000, 6%, six-year loan for a new camp bus on January 1, 2020. If the monthly payment is $1,408.70 by how much will the carrying value decrease when the first payment is made on January 31, 2020?
$85,000 x .06 x 1/12 = $425 interest in first month. The principal reduction would be $1,408.70 - $425 = $983.70
stated interest rate
the rate specified in the bond contract used to calculate the cash payments for interest
default risk
the risk that a co will be unable to pay the bond's face amount or interest payments as they become due
price-earnings ratio
the stock price divided by earnings per share so that both stock price and earnings are expressed on a per share basis
market interest rate
an implied rate based on the price investors are willing to pay to purchase a bond in return for the right to receive the face amount at maturity and periodic interest payments over the remaining life of the bond
sinking fund
an investment fund used to set aside money to be used to pay debts as they come due
We can find a firm's investing activities by:
analyzing changes in long-term asset accounts from the balance sheet
With respect to installment notes where the installment payment stays the same over time, as time goes by, the interest portion of each installment payment should:
be decreasing
indirect method
begins with net income and then lists adjustments to net income in order to arrive at operating cash flows
capital structure
the mixture of liabilities and stockholders' equity in a business
What required to be included in a corporation's articles of incorporation (also known as its corporate charter)?
the nature of the corporation's primary business activities, the types of shares to be issued, information regarding its board of directors
The number of shares outstanding equals
the number of shares issued minus the number of shares in treasury
additional paid-in capital
the portion of the cash proceeds from issuing stock above par value
(20) When a company issues 25,000 shares of $1 par value common stock for $10 per share, the journal entry for this issuance would include:
A credit to Additional Paid-in Capital for $225,000 Cash 250,000 Common Stock 25,000 APIC 225,000
What are the fundamental rights possessed by common stockholders?
- The right to vote on important corporate matters including the selection of the board of directors - The right to receive a distribution in the event of liquidation, once creditors and preferred shareholders have been satisfied - The right to receive dividends, if declared
What are common reasons for why a particular company would buy back its own stock?
- To raise the market price of its stock - To distribute excess cash to existing stockholders without paying them a dividend. - To increase earnings per share., To satisfy employee stock ownership plans.
steps in preparing the statement of cash flows
1. Calculate net cash flows from operating activities (use info from income statement, changes in current assets/liabilities). 2. Determine the net cash flows from investing activities (changes in long-term assets from balance sheet). 3. Determine the net cash flows from financing activities (changes in long-term liabilities and SE from balance sheet). 4. Combine the three and make sure that the total equals the amount of change in cash reported in the balance sheet from last year to this year.
Using the indirect method, we start with net income and adjust this number for:
1. revenue and expense items that do not affect cash 2. gains and losses that do not affect operating cash flows 3. changes in current assets and liabilities
What is a reason that a corporation would prefer to issue stock instead of bonds?
The risk of going bankrupt is less.
Changes to current assets and current liabilities require adjustment of net income under the indirect method because
related cash may be higher or lower than the accrued amount included in net income
term bonds
require payment of the full principal amount at a single maturity date issuing co usually sets money aside in a "sinking fund"
private placement
sale of debt securities directly to a single investor
authorized stock
shares available to sell, as stated in the company's articles of incorporation
convertible
shares can be exchanged for common stock
What is the effect on cash when a company records depreciation expense for the year?
Cash does not change
A corporation declares and distributes a 20% stock dividend at a time when there are 10,000 shares outstanding (before the dividend). The common stock has a par value of $1/share and a market value of $10/share. What will be the debit made to retained earnings to record this stock dividend?
$20,000 This is a small stock dividend (less than 25%) so the charge to retained earnings will be for the market value of the shares distributed. 10,000 shares x 20% = 2,000 shares x $10/share = $20,000.
(25) Clothing Emporium was organized on January 1, 2021. The firm was authorized to issue 100,000 shares of $5 par value common stock. During 2021, Clothing Emporium had the following transactions relating to stockholders' equity: Issued 30,000 shares of common stock at $7 per share. Issued 20,000 shares of common stock at $8 per share. Reported a net income of $100,000. Paid dividends of $50,000. What is total paid-in capital at the end of 2021?
$370,000 30,000 sh x $7.sh = $210,000 20,000 sh x $8/sh = $160,000 Total paid-in capital = $210,000 + $160,000 = $370,000
return on assets
= net income / average total assets
issue price of a bond
= present value of the bond's face amount plus the present value of its periodic interest payments
debt to equity ratio
= total liabilities / stockholder's equity
For bonds issued at a discount or at a premium to face value, in each successive entry to recognize interest expense
Both the discount and the premium amortizations will be higher The entry to record interest expense if the bonds were issued at a discount is: Interest Expense Discount on B/P Cash Since the cash payment is constant and interest expense increases (for discount bonds) then the amortization amount must also increase to preserve the balance The entry to record interest expense for premium bonds is: Interest Expense Premium on B/P Cash Since the cash credit is constant and interest expense decreases (for premium bonds) then the premium amortization must increase to preserve the balance period to period
(18) When bonds are issued at a discount, what happens to the carrying value and interest expense over the life of the bonds?
Carrying value increases to face value over time for bonds sold at a discount. As CV increases, interest expense will increase since it is calculated as CV x market rate x 6/12.
A corporation has cumulative preferred stock outstanding with an annual dividend of $18,000. If no dividends were paid in the two prior years, and a $50,000 dividend is declared this year, how much goes to common stockholders?
Dividends in arrears = $36,000 ($18,000 x 2 prior years). The current year dividend of $18,000 must also be paid so $54,000 is owed to preferred shareholders. This would mean the entire $50,000 goes to preferred shareholders (with $4,000 in arrears). This leaves $-0- for the common stockholders.
True or False: If a company reports net income on its income statement, it should always report positive as opposed to negative cash flows from operating activities on its statement of cash flows.
False
True or False: When a company borrows money to finance the purchase of an asset to use in its business, one of their likely goals is to earn a rate of return on that asset which is lower than the interest rate on the loan borrowing.
False
True or False: The higher a company's times interest earned ratio, the less likely it is that the company can make its interest payments as they become due.
False
True or False: When stock is issued for more than its par value, the excess is considered to be revenue and should be reported on the income statement.
False
When bonds are issued at a premium and the effective interest method is used for amortization of the premium, at each subsequent interest payment date, the cash paid is:
Greater than the interest expense recognized The journal entry to record interest expense for bonds issued at a premium will always look like this: Interest Expense Premium on Bonds Payable Cash Therefore, the cash credit will always be greater than the debit to interest expense since there is also a debit made to the premium on B/P account
(17) Bakerson, Inc. issued a five-year corporate bond with a face value of $300,000 and a 5% coupon rate for $290,000. What effect would the bond issuance have on Bakerson's fundamental accounting equation?
Increase assets and liabilities.
(21) Camp Wesley obtains an $85,000, 8%, six-year loan for a new camp bus on January 1, 2019. If the monthly payment is $1,490.33, by how much will the carrying value of the note payable decrease when the first payment is made on January 31, 2019?
Interest due on first payment = $85,000 x .08 x 1/12 = $566.67 So principal reduction = $1,490.33 - $566.67 = $923.66 The correct answer is: $923.66
Quark Corp. issues bonds on January 1, 2020 with a face value of $100,000, a coupon (stated) rate of 8%, and they mature in ten years. The market rate is 10% on January 1, 2020. The bonds sell for $87,538 and pay interest semi-annually on 6/30 and 12/31 each year. What is the amount of interest expense recognized by Quark on June 30, 2020?
Interest expense = carrying value x market rate x time Interest expense = $87,538 x .10 x 6/12 = $4,377
A type of corporation which avoids double taxation is a
S corporation
Durham Corp.'s is a local service-oriented company. All of its sales are on account. If Durham's "Accounts Receivable" balances on 1/1/X6 and 12/31/X6 were $40,000 and $48,000, respectively, what can we determine about the dollar amount of sales on account relative to the dollar amount of cash collections on account for the year?
Sales on account were higher than cash collections on account.
Which of the following statements is correct concerning a decrease in accounts payable?
Since the cash payments were more than the credit purchases, the decrease must be added to purchases to calculate cash payments to suppliers.
(12) Arrow Printers paid $2,000 interest on short-term notes payable, $10,000 interest on long-term bonds, and $6,000 in dividends on its common stock. Arrow would report cash outflows from activities, as follows:
The $12,000 interest paid would be classified as an operating activity. The $6,000 dividend payment is a financing activity. The correct answer is: Operating, $12,000; Financing, $6,000.
(22) The Surf's Up issues 1,000 shares of 6%, $100 par value preferred stock at the beginning of 2020. All remaining shares are common stock. The company was not able to pay dividends in 2020, but plans to pay dividends of $18,000 in 2021. Assuming the preferred stock is cumulative, how much of the $18,000 dividend will be paid to preferred stockholders and how much will be paid to common stockholders in 2021?
The preferred dividend is $6 per share (6% x $100 par value). Since there are 1,000 preferred shares the annual dividend is $6,000. If omitted in 2020 and the preferred stock is cumulative then the company must pay both the 2020 and 2021 dividends to the preferred shareholders ($12,000 in all) and the remaining $6,000 will go to the common shareholders. The correct answer is: $12,000 to preferred stockholders and $6,000 to common stockholders.
authorized shares
The total number of shares that a company may sell
Earnings per share (EPS) is best applied when comparing a company to itself over time rather than to a different company.
True
In some states, corporations are not required to have a par value associated with their common stock.
True
stock dividends
additional shares of a company's own stock given to stockholders
direct method
adjusts the items in the income statement to directly show the cash inflows and outflows from operations, such as. cash received from customers and cash paid for inventory, salaries, rent, interest, and taxes.
corporation
an entity that is legally separate from its owners
serial bonds
bonds that require payment of the principal amount of the bond over a series of maturity dates
Preferred stock tends to have attributes of:
both bonds and common stock.
journal entry for common stock issues
debit cash, credit common stock
when a company issues par value stock,
debit cash, credit common stock and additional paid-in capital
journal entry for preferred stock issue
debit cash, credit preferred stock and additional paid-in capital
journal entry for reselling stock
debit cash, credit treasury stock and additional paid-in capital (or debit additional paid-in capital is selling price is less than market price)
payment date journal entry
debit dividends payable, credit cash
declaration date journal entry
debit dividends, credit dividends payable
recording an interest payment on a bond
debit interest expense, credit cash and discount
stock split/ stock dividend journal entry
debit stock dividends, credit common stock (does not change change total assets, liabilities, or stockholders' equity)
journal entry for purchasing shares
debit treasury stock, credit cash
When a company borrows funds from creditors, it is considered a form of:
debt financing
Stock dividends have the following effects on stockholders' equity
decrease in retained earnings increase in common stock no change to total stockholders' equity
A stock split:
decreases par value of shares
articles of incorporation
describes the nature of the firm's business activities, the shares to be issued, and the composition of the initial board of directors
Operating activity cash flows exclude:
dividends paid
dividend yield
dividends per share divided by the stock price
Investors who acquire preferred stock:
do not have voting rights. have preference as to dividends.
retained earnings
earnings not distributed as dividends to stockholders over the life of the company
We can find a firm's financing activities by:
examining changes in long-term liabilities and stockholders' equity accounts from the balance sheet
From the corporation's perspective, the issuance of its stock is an example of which type of business activity?
financing
The balance of retained earnings:
increases with net income and decreases with dividends declared
