Unit 7 - Financial Reporting

SSS Corporation's total assets amount to $780,000, of which $260,000 represents current assets. Total liabilities equal $370,000, of which $200,000 is considered long-term or other liabilities. What is SSS Corporation's shareholders' equity? A) $410,000 B) $1,150,000 C) $980,000 D) $170,000

A) $410,000 Total assets minus total liabilities equals shareholders' equity ($780,000 − $370,000 = $410,000). LO 7.a

Which of the following statements about balance sheets are true? I Balance sheets provide a snapshot of a company's financial position on a given date. II Balance sheets represent the relationship between a company's assets, liabilities, and stockholders' equity. IV Balance sheets provide a record of a company's earnings over a given period. A) I and II B) II and III C) I and III D) I, II, and III

A) I and II A balance sheet shows a company's assets, liabilities, and stockholders' equity on a specific date. The financial statement that reflects a company's operating activities and earnings over a period of time is the income statement. LO 7.a

What is the balance sheet equation? A) Assets = net worth B) Assets = liabilities + shareholders' equity C) Assets = shareholders' equity − liabilities D) Assets = liabilities − shareholders' equity

B) Assets = liabilities + shareholders' equity Total assets equal total liabilities plus total shareholders' equity. LO 7.a

When a company recognizes a sale only when payment is made, it is using which form of accounting? A) Audited B) Cash C) Double entry D) Accrual

B) 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. LO 7.c

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) 13F. B) 10-K. C) 8-K. D) 10-Q.

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. LO 7.e

When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) net value of fixed assets. B) earnings per share. C) cash flow from operations. D) cash flow from investments.

C) cash flow from operations. Cash flow from operations is computed by adding the year's depreciation deduction to the net income. LO 7.d

An analyst is reviewing the financial statements of Penta, Ltd. Over the period shown, Penta has sales of $5 million, a net profit of $1.5 million, annual bond interest charges of $500,000, and total assets of $2 million. Penta's net profit margin is A) 35%. B) 20%. C) 25%. D) 30%.

D) 30%. Profit margin = net profit ÷ sales = $1.5 million ÷ $5 million = 30%. Profit margin is based on operating costs. Because interest on bonds is a fixed expense, it is not included in the computation. As is often the case, there is more information supplied than needed. LO 7.c

KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? I Tax rate II Cash dividend III Interest charged on bank loans A) I and II B) I only C) II only D) I and III

D) I and III Higher taxes mean less net income. Interest charged on loans is an expense item; increasing it lowers operating income. Dividends are paid out of retained earnings and have no effect on the net income the company reports. LO 7.c

A stock analyst viewing a corporation's income statement would not be able to determine the company's A) expenses. B) income. C) revenues. D) cash on hand.

D) cash on hand. The income statement reflects the firm's revenues (sales), expenses, and income. Assets, such as cash, are found on the balance sheet. LO 7.c

An analyst reviewing a company's financial statements would examine the footnotes to A) discover any pending legal action against the company. B) identify the authors of quoted information. C) compute the net worth. D) determine the average age of the receivables.

A) discover any pending legal action against the company. Footnotes to the financial statements are used to convey off-book information such as pending lawsuits. LO 7.c

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 payable. B) accounts receivable. C) taxes payable. D) outstanding principal balance on long-term debt.

B) accounts receivable. Accounts receivable are assets; all the other listings represent liabilities of the company. LO 7.a

All of the following are considered to be components of cash flow except A) operating activities. B) banking activities. C) investing activities. D) financing activities.

B) banking activities. There is no such term as banking activities in the context of cash flow. Cash flow is generated through financing (issuing stock or bonds), investing (profits from investments), and operations of the entity (the most significant of all). LO 7.d

If a client has 100 shares of XYZ publicly traded stock and it undergoes a split, afterward the client will have A) a greater role in the daily management of the company. B) no effective change in the value of the ownership share. C) a proportionately increased interest in XYZ company. D) a proportionately decreased interest in XYZ company.

B) 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. LO 7.b

Under SEC rules, Form 8-K must be filed A) within 15 business days of the event. B) within 4 business days of the event. C) promptly. D) within 10 business days of the event.

B) 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. LO 7.e

A corporation ends its accounting year on September 30. It would be correct to state that it uses A) an accounting year. B) an alternative year. C) a fiscal year. D) a nine-month year.

C) 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. LO 7.c

Many businesses choose to use a date other than December 31 to close out their financial year for accounting purposes. When this is done, it is said that the entity is reporting on A) an alternative-year basis. B) a fiscal-year basis. C) a nontraditional basis. D) a calendar-year basis.

B) a fiscal-year basis. Fiscal-year accounting uses a date other than December 31 as its year-end. LO 7.c

The issuance of a long-term debt instrument, such as a bond, by a company would have an immediate effect on which of the following balance sheet items? I Total assets II Total liabilities III Working capital IV Shareholders' equity A) II, III, and IV B) I, III, and IV C) I, II, and IV D) I, II, and III

D) I, II, and III The cash received from the sale of the bonds is a current asset of the company and, as such, would increase assets and working capital on the balance sheet. The bonds are debt of the company and would increase the liabilities of the company. Shareholders' equity is only affected by gains, losses, new invested capital, and the declaration of cash distributions (dividends) to shareholders. LO 7.c

A term used to describe the results of subtracting a corporation's liabilities from its assets is A) owners' equity. B) retained earnings. C) net income. D) operating income.

A) owners' equity. There are several terms used on the exam to express the results of the balance sheet formula. In most cases, it will be shown as assets minus liabilities equals net worth. Net worth can also be expressed as owners' equity or shareholders' equity. Income has nothing to do with assets and liabilities, and retained earnings is a component of owners' equity. LO 7.a

Net income A) represents the amount of money remaining after all expenses, including taxes. B) reflects the operating profits of a firm only. C) is paid out in cash to stockholders in addition to any declared dividends. D) must be paid out in dividends.

A) 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. LO 7.c

Which of the following would have the effect of increasing a company's cash flow? A) Increasing inventory B) Issuance of a bond C) Extending credit to good customers D) Reducing sales

B) 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. LO 7.d

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 significant long-term debt. C) is in arrears on its cumulative preferred stock dividends. D) has issued employee stock options.

B) 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. LO 7.b

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) Form 10-K. B) the balance sheet. C) the annual report. D) the investor's brochure.

C) 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. LO 7.e

Which of the following equations correctly shows the relationship between the items on a company's balance sheet? A) Assets = liabilities + stockholders' equity B) Assets = liabilities − net worth C) Assets = stockholders' equity − liabilities D) Assets + liabilities = net worth

A) 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. LO 7.a

When cash flow of a business is negative, all of the following are true except A) the company might not be agile enough to respond to new opportunities. B) the company might have a hard time figuring out how to cover expenses it hasn't budgeted for. C) the company may struggle to pay its bills. D) the company will probably increase its dividend.

D) the company will probably increase its dividend. The basic definition of negative cash flow is when a business does not have enough cash on hand to pay its immediate outstanding bills. It certainly would not be the time to increase its dividend. In fact, the dividend might be cut or even eliminated. Negative cash flow may also lead to the company being unable to take advantage of a business opportunity and meeting emergencies. LO 7.d

All of the following appear on a corporation's balance sheet as fixed assets except A) real estate. B) inventory. C) computer equipment. D) furniture.

B) 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. LO 7.a

One of the best sources of financial information is found in the reports required to be filed with the SEC by publicly traded companies. The easiest way to access this information is by A) using EDGAR. B) making an appointment to meet with the company's CFO. C) visiting the SEC's offices. D) writing a letter to the company.

A) using EDGAR. EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval. It is the easiest (and surely the fastest) way to obtain all of the financial information filed by reporting companies. It is available at SEC.gov. LO 7.e

When reviewing a corporation's financial statements, shareholders' equity is computed by A) multiplying the current market price per share times the number of outstanding shares. B) subtracting total liabilities from total assets. C) adding together retained earnings, preferred and common stock, and long-term debts. D) subtracting current liabilities from current assets.

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. LO 7.a

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) Contingency statement C) Footnotes D) Offline items

C) Footnotes Footnotes to the balance sheet, describing unusual items, are typically found at the bottom of the statement. LO 7.c

Which of the following would have the effect of increasing a company's cash flow? A) Reducing sales B) Issuance of a bond C) Increasing inventory D) Extending credit to good customers

B) 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. LO 7.d

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 working capital. B) the consolidated income statement. C) the statement of cash flows. D) the current ratio.

C) 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. LO 7.d

An analyst wishing to check on the most recent financial performance of an SEC-registered issuer would probably examine the A) Form 10-Q. B) Form 10-K. C) Form 8-K. D) Schedule 13D.

A) 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. LO 7.e

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) Three times C) Four times D) Two times

B) 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. LO 7.e

All of the following corporate actions would have the effect of increasing the firm's net worth except A) issuing common stock. B) issuing convertible debentures. C) purchasing some of the corporation's outstanding bonds at a discount. D) issuing convertible preferred stock.

B) 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. LO 7.b

An analyst who wants to examine a firm's financing transactions during the most recent period is most likely to evaluate the firm's statement of A) comprehensive income. B) financial position. C) cash flows. D) changes in equity.

C) cash flows. The statement of cash flows describes a firm's inflows and outflows of cash during a reporting period from operating, investing, and financing activities. Financing transactions such as issuance of debt or stock are shown on the statement of cash flows. The statement of financial position (balance sheet) presents the firm's assets, liabilities, and equity at a point in time. The statement of comprehensive income (income statement) does not directly reflect a firm's financing transactions. Cash raised is not included in a firm's revenues and dividends paid and debt principal repaid are not included in its expenses. LO 7.d

A profitable company reports net income of $10 million. A cash dividend of $7 million is declared. From an accounting standpoint, the other $3 million will be credited to which balance sheet account? A) Dividends payable B) Working capital C) Capital surplus D) Retained earnings

D) Retained earnings Retained earnings are increased to the extent that company profits (net income) are undistributed—in essence, retained. Capital surplus comes from original investors purchasing stock at a price in excess of stated or par value. Working capital is not a balance sheet account; it is a computation. When the dividend is declared, it becomes a current liability (dividends payable), but this question is asking for the portion of the income that is not going to be paid out. LO 7.b

Which items change when a company pays a cash dividend? I Working capital II Total assets III Total liabilities IV Shareholders' equity A) II, III, and IV B) I, II, and III C) II and III D) I and IV

C) II and III From an accounting standpoint, once a corporation declares a cash dividend, it becomes a current liability on the company's balance sheet. When that dividend is paid, cash—a current asset—is decreased by the amount of the dividend. Payment of the dividend removes it from the balance sheet as a current liability. Therefore, there is no change to the company's working capital (current assets minus current liabilities) because they are both reduced by the same amount. The total assets (of which cash is one) and the total liabilities (of which the dividend payable is one) both decrease. Because assets and liabilities are changed by an identical amount, there is no change to shareholders' equity (net worth). LO 7.b

An analyst comparing revenues with expenses is most likely analyzing A) capitalization. B) working capital. C) cash flow. D) liquidity.

C) cash flow. The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis would involve examining the balance sheet's current assets and current liability entries, not the income statement. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet. LO 7.d

One of the components of a cash flow statement is cash flow from investing activities. Included would be A) cash proceeds from issuing stocks or bonds. B) payments to retire bonds and the payment of dividends. C) transactions and events involving the purchase and sale of land, buildings, and equipment. D) cash receipts (money coming in) from items such as interest and dividends.

C) 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. LO 7.d

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 8-K B) Annual report C) Form 10-Q D) Form 10-K

A) 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. LO 7.e

The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is A) an integral part of the footnotes to the balance sheet required by generally accepted accounting principles. B) the net change in the cash position of the firm for the reporting period. C) reported as cash income on the income statement. D) 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. 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. LO 7.d

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 the following: 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." LO 7.c