Chapter 3: Understanding Financial Statements

6) Gross profit is calculated as: A) total sales - cost of sales - selling, general, and administrative expenses - depreciation and amortization. B) total sales - cost of sales - selling, general, and administrative expenses. C) total sales - cost of sales. D) None of the above

C

9) Which of the following will decrease total equity? An increase in: A) common stock material. B) net income. C) dividends paid. D) interest expense.

C

15) A firm reports the following income statement items: sales of $60,550,000; income tax of $1,744,000; operating expenses of $10,115,000; cost of goods sold $34,025,000; and interest expense of $750,000. What is the amount of the firm's EBIT? A) $18,154,000 B) $14,935,000 C) $16,410,000 D) $7,775,000

C C) EBIT = Sales - COGS - Operating Expenses = $60,550,000 - $34,025,000 - $10,115,000 = $16,410,000.

19) What is Regency's 2012 cash flow from operating activities? A) $7.4 million B) $6.1 million C) $9.4 million D) $9.7 million *look at graph #19 from TABLE 3.3 (pg22)

C C) Operating CF = NI + Depreciation -increase in A/R, - increase in Inventory + increase in A/P = $10.6 + $3.6 - ($55.5 - $39.6) - ($45.9 - $42.9) + ($87.6 - $73.5) = $9.4 million.

22) Ajax enterprises, Inc. has the following income statement items: sales of $48,250,000; operating expenses of $10,225,000; cost of goods sold of $32,025,000; and interest expense of $650,000. If the firm's income tax rate is 34%, what is the amount of the firm's income tax liability? A) $1,665,000 B) $2,040,000 C) $1,819,000 D) $1,385,000

C C) Tax liability = EBT * Tax rate = (Sales - COGS - Operating Expenses - Interest Expense)*Tax rate = ($48,250,000 - $32,025,000 - $10,225,000 - $650,000) * .34 = $1,819,000.

16) A firm reports the following balance sheet items; total current liabilities of $535,000; total assets of $2,500,000; net working capital of $115,000; and long-term debt of $200,000. What is the amount of the firm's current assets? A) $1,315,000 B) $1,965,000 C) $650,000 D) $735,00

C Explanation: C) C/A = NWC + C/L = $115,000 + $535,000 = $650,000

8) Which of the following is NOT a use of cash from investing activities? A) Proceeds from the sale of a business B) Investment in fixed assets C) Payment of dividends D) Both A and C

D

8) Which of the following is NOT considered a fixed asset? A) Land B) Equipment C) Buildings D) Patents

D

27) Why is the examination of the balance sheet and income statement only not an adequate evaluation of a firm? What else should be done?

The most obvious part missing is an examination of the statement of cash flows. Understanding cash flow statements helps identify the extent to which cash was generate from operating activities, how much cash was invested, and how much cash was used to finance the activities with which the firm was involved.

33) If a firm reports $25 million of retained earnings on its balance sheet, could the board of directors declare a $25 million cash dividend without any concerns? Explain why or why not.

The retained earnings on a firm's balance sheet represents the accumulation of net income over time that was not paid out as dividends. When realized, the R/E were not necessarily a cash flow thus we cannot assume cash is equal to the R/E figure. Further, the R/E are a source of internal funding used to finance existing assets. Thus, paying out R/E as dividends would almost certainly cause concerns.

4) Free cash flow will increase with a decrease in: A) tax rate. B) depreciation expense. C) accruals. D) Both A and C.

A

1) Which of the following items is included in the calculation of net operating working capital which determines free cash flow? A) Accounts payable B) Dividend payments C) Fixed assets D) Interest expense

A

10) Which of the following balance sheet equations is NOT CORRECT? A) Assets - Current Liabilities = Long-Term Liabilities B) Assets - liabilities = Shareholders' Equity C) Assets = Liabilities + Shareholders' Equity D) Assets - Current Liabilities = Long-Term Liabilities + Shareholders' Equity

A

10) Which of the following is NOT a source of cash from financing activities? A) Repayment of long-term debt B) Proceeds from issuance of common stock C) Proceeds for long-term borrowing D) Both A and C

A

12) Who owns the retained earnings of a public firm? A) Common stockholders B) Bondholders C) Management D) The IRS

A

14) A firm reports the following income statement items: sales of $60,550,000; income tax of $1,744,000; operating expenses of $10,115,000; cost of goods sold $34,025,000; and interest expense of $750,000. What is the amount of the firm's income before tax? A) $15,660,000 B) $16,410,000 C) $13,916,000 $14,666,000

A

14) The statement of financial position is also known as the: A) balance sheet B) statement of stockholders' equity. C) income statement. D) statement of cash flows.

A

14) Which of the following is NOT a reason why cash flow may not equal net income? A) Amortization is added in when calculating income. B) Changes in inventory will change cash flows but not income. C) Capital expenditures are not recorded on the income statement. D) Depreciation is deducted when calculating net income.

A

16) Which of the following adjustments to net income is NOT correct if you want to calculate cash flow from financing activities? A) Add dividends paid B) Add any increase in long-term borrowing C) Add proceeds from sale of stock D) Add any increase in short-term borrowing

A

17) A firm reports the following balance sheet items: total current liabilities of $535,000; total assets of $2,500,000; fixed and other assets of $1,850,000; and long-term debt of $200,000. What is the amount of the firm's net working capital? A) $115,000 B) $450,000 C) $335,000 D) $1,315,000

A

19) Which of the following statements regarding the income statement is INCORRECT? A) The income statement shows the retained earnings and expenses at a given point in time. B) The income statement shows the flow of earnings and expenses generated by the firm between two dates. C) The last or "bottom" line of the income statement shows the firm's net income. D) The first line of an income statement lists the revenues from the sales of products or services.

A

24) All of the following statements are true EXCEPT: A) under current accounting rules, plant and equipment appear on a company's balance sheet valued at replacement value. B) plant and equipment are generally reported net of depreciation. C) depreciation reflects the reduction in the value of fixed assets over time. D) land is assume to remain useful indefinitely.

A

26) Lakeview Industries had sales of $40 million and net income of $2 million in 2012. Lakeview paid a dividend of $1.5 million. Assuming that their beginning balance for retained earnings was $4 million, calculate their ending balance for retained earnings. A) $4.5 million B) $2.5 million C) $3 million D) $4 million *look at table 3.3 (pg 7) Regency Corporation Consolidated Balance Sheet As of December 31, 2011 + 2012

A

27) What is Regency's net working capital in 2012 and 2011? A) $27 million; $12 million B) $315 million; $276 million C) $39 million; $27 million D) None of the above

A

3) Which of the following describes a balance sheet? A) Reports the amount and composition of assets and liabilities at a specified point in time? B) Reports cash receipts and cash disbursements for a specific accounting period. C) Reports the amount and composition of assets and liabilities at a specific accounting period. D) Reports revenues and expenses for a specific accounting period.

A

3) Which of the following is NOT included as a tax-deductible expense? A) Dividend expenses B) Marketing expenses C) Depreciation expenses D) Cost of goods sold

A

6) The change between a firm's beginning cash balance and ending cash balance would equal A) cash flow from operations + cash flow from investing activities + cash flow from financing activities. B) the change in current assets minus the change in current liabilities. C) net income plus new borrowing minus asset purchases. D) total assets minus total liabilities minus total stockholders' equity.

A

7) Which of the following is NOT a section on the cash flow statement? A) Income-generating activities B) Investing activities C) Operating activities D) Financing activities

A

8) Which of the following best represents the stream of income that is available to stockholders? A) Net profit after tax B) Earnings before interest, taxes, and dividends C) Gross profit D) Operating profit

A

9) Which of the following is NOT a use of cash from investing activities? A) Proceeds from the sale of a business B) Investment in fixed assets C) Payment for business acquired D) Investment in land

A

5) Which of the following represents a source of cash? A) A decrease in accounts payable B) A decrease in accounts receivable C) Payment of dividends D) An increase in inventories

B

1) Which of the basic financial statements attempts to measure the earnings of the firm's operations over a given time period? A) Balance sheet B) Income statement C) Cash flow statement D) None of the above

B

11) Cost of sales is calculated by: A) adding the cost of inventory on hand at the start of the period minus the cost of any purchases of materials during the year and then subtract the cost of ending inventory. B) adding the cost of the inventory at the start of the period plus the cost of any purchases of materials during the year and then subtract the cost of the ending inventory. C) adding the cost of the inventory on hand at the start of the period plus the cost of any purchases of materials during the year and then add the cost of the ending inventory. D) adding the cost of the inventory on hand at the end of the period plus the cost of any purchases of materials during the year and then subtract the costs of the beginning inventory.

B

13) A firm reports the following income statement items: sales of $60,550,000; income tax of $1,744,000; operating expenses of $10,115,000; cost of goods sold $34,025,000; and interest expense of $750,000. What is the amount of the firm's gross profit? A) $23,910,000 B) $26,525,000 C) $15,660,000 D) $16,410,000

B

15) Which of the following adjustments to net income is NOT correct if you want to calculate cash flow from operating activities? A) Add increases in accounts payable B) Add increases in accounts receivable C) Add back depreciation D) Depreciation is deducted when calculating net income

B

16) Which of the following best represents operating income? A) Income after financing activities B) Earnings before interest and taxes C) Income from capital gains D) Income from discontinued operations

B

18) A consolidated balance sheet refers to: A) a balance sheet of a large firm that has numerous subsidiaries, each with its own balance sheet that have been combining into one all-encompassing balance sheet. B) a balance sheet of a large firm that has combined the balance sheets fo all wholly owned and some partially owned subsidiaries into one separate balance sheet. C) a balance sheet of a large firm that has combined the balance sheet of all partially owned subsidiaries into one separate balance sheet. D) All of the above.

B

18) Which statement is NOT correct about cash flow statements? A) They examine the cash inflows and cash outflows generated by operating activities, investing activities, and financing activities. B) They examine the cash inflows and cash outflows generated by operating activities, budgeting activities, and financing activities. C) They reconcile any changes in cash balances between two periods. D) They reflect the firm's ongoing investment in fixed assets.

B

19) Which is NOT an example of current assets? A) Marketable securities B) Intangible assets C) Prepaid expenses D) Trade receivables

B

2) Which of the basic financial statements is used to explain changes in the owner's equity that are NOT explained by the income statement? A) Balance sheet B) Statement of shareholders' equity C) Income statement D) Cash flow statement

B

20) The firm's revenues and expenses over a period of time are reported on the firm's: A) income statement or statement of financial position. B) income statement or statement of financial performance. C) balance sheet or statement of financial performance. D) balance sheet or statement of financial position.

B

2011 2012 Dividends paid $400 $700 Accounts payable 300 500 Long-term debt 2,300 2,000 Common stock 2,200 3,000 Retained earnings 6,150 6,350 23) Based on the selected financial information for Coffeeberry Coffeehouse, calculate net income for 2012. A) $100 B) $900 C) $500 D) $300

B

21) Which is NOT an example of current liabilities? A) Notes payable B) Accounts receivable C) Current portion of long-term debt D) Taxes payable

B

21) Which of the basic financial statements is best used to answer the question, "How profitable is the business?" A) Balance sheet B) Income statement C) Statement of shareholders' equity D) Accounts receivable aging schedule

B

23) All of the following statements are true EXCEPT: A) retained earnings is common stock minus paid in capital. B) retained earnings are generated when a firm has excess cash. C) retained earnings are the accumulated profits not paid out in dividends. D) All of the above.

B

3) Which of the following is NOT included in the calculation of free cash flows? A) Operating income B) Interest expense C) Depreciation D) Net operating working capital

B

5) Which of the following statements regarding the income statement is NOT CORRECT? A) The income statement shows the flow of earnings and expenses generated by the firm between two dates. B) The income statement shows the earnings and expenses at a given point in time. C) The last or"bottom" line of the income statement shows the firm's net income. D) The first line of an income statement lists the revenues from the sales of products or services.

B

5) Which of the following would NOT be included as an asset on a corporate balance sheet? A) Accounts receivable B) Preferred stock C) Inventory D) Buildings

B

7) Which of the following is NOT be included as equity in a corporate balance sheet? A) Paid in capital B) Cash C) Common stock D) Retained earnings

B

9) Which of the following best represents operating income? A) Income after investment activities B) Earnings before interest and taxes C) income from discontinued operations D) Income from capital gains

B

22) All of the following statements are true EXCEPT: A) deferred income taxes can be thought of as a liability. B) deferred income taxes arise because firms are allowed to keep two sets of financial statements; one for shareholders and one for the IRS. C) deferred income taxes arise because firms are allowed to keep two sets of financial statements; one for the shareholders and one for internal management. D) deferred income taxes are also referred to as deferred tax liabilities.

C

31) Explain how depreciation generates actual cash flows for the firm.

Because depreciation is a non cash expense, it generates cash flows for the firm by reducing the amount of taxable income without actually incurring a cash expense.

11) Which of the following statements regarding the balance sheet is NOT correct? A) The balance sheet provides a snapshot of the firm's financial position at a given point in time. B) The balance sheet lists the firm's assets, liabilities, and equity. C) The balance sheet reports liabilities on the left side. D) The balance sheet reports stockholders' equity on the right side.

C

12) Earnings before interest and taxes: A) is the same as EBITDA. B) refers to the gross profit minus operating expenses minus interest. C) refers to gross profit minus operating expenses. D) Both A and C.

C

12) Which of the following statements regarding net income transferred to retained earnings is correct? A) Net income = net income transferred to retained earnings - dividends B) Net income transferred to retained earnings = net income + dividends C) Net income = net income transferred to retain earnings + dividends D) Net income transferred to retain earnings - net income = dividends

C

13) Stock that is repurchased by the issuing company is called: A) paid in capital. B) retained capital. C) treasury stock. D) par value stock.

C

17) Which of the following adjustments net income is NOT correct if you want to calculate cash flow from operating activities? A) Add back depreciation B) Add increases in accounts payable C) Add increases in accounts receivable D) Deduct increases in inventory

C

18) The following statements are all true EXCEPT: A) dividends are paid from net income. B) dividends represent a use of cash and do not have to be paid if a firm has a net loss. C) dividends are paid to a firm's stockholders, both preferred and common stockholders, are tax deductible to the paying company. preferred stockholders, who are primarily investors seeking current income, usually receive dividends.

C

2) The type of financing (whether with debt or equity) does not affect which stream of income? A) Net profit after tax but before dividends. B) Net working capital C) Operating income D) Income before tax

C

20) Net value of property and equipment is calculated as: A) total property and equipment minus long-term debt minus depreciation and amortization. B) total property and equipment minus selling, general and administrative expenses minus depreciation and amortization. C) total property and equipment minus depreciation and amortization. D) None of the above.

C

1) What is sales revenue, less cost of goods sold and operating expenses, called for income statement purposes? A) Net profit before taxes B) Retained earnings C) Net income available to preferred shareholders D) EBIT

D

10) All of the following statements are true EXCEPT: A) net revenues come mainly from the firm's business operations in the form of sales of products and services. B) net revenue can also come from other non core business sources, such as from interest earned on marketable securities. C) net revenues are after deducting returns, allowances for damages, cash discounts, etc. D) net revenues are after deducting selling and administrative expenses.

D

11) Which of the following is NOT a use of cash from financing activities? A) Repayment of long-term debt B) Proceeds from issuance of common stock C) Proceeds for long-term borrowing D) Both B and C

D

13) To determine the cash flow from operating activities, certain adjustments must be made which include A) Add back depreciation, amortization, and stock-based compensation expenses. B) Adjust for any changes in operating assets and liabilities. C) Add or subtract any changes in deferred income taxes. D) All of the above.

D

15) Which of the following is best represents the income stream that is available to common stockholders? A) Earnings before interest and taxes B) Gross profit C) Operating profit D) Net profit after tax and after preferred dividend payments

D

17) Which of the following would be included in the calculation of net operating working capital? A) Accounts payable B) Accruals C) Short-term notes payable D) Both A and B E) All of the above

D

2) Which of the following does NOT represent cash outflows to the firm? A) Taxes B) Interest payments C) Dividends D) Depreciation

D

25) Which of the following would be included in the calculation of net operating working capital? A) Accounts payable? B) Accruals C) Short-term notes payable D) Both A and B

D

4) Which of the following is NOT included as operating income? A) Cost of goods sold B) Sales C) Operating expenses D) Taxes

D

4) Which of the following is the least liquid current asset? A) Accruals B) Accounts receivable C) Marketable securities D) Inventory

D

6) Which of the following would NOT be included as a liability in a corporate balance sheet? A) Accruals B) Notes payable C) Accounts payable D) Depreciation

D

7) The statement of financial performance is known as the: A) statement of cash flows. B) statement of stockholders' equity. C) balance sheet. D) income statement.

D

26) What is free cash flow? Why is it important in the acquisition of a firm particularly a highly leveraged firm?

Essentially, free cash flow are the funds available to pay all claimants on a firm. How much is available to meet the needs of creditors, and various equity holders. One definition of FCF = (EBIT) * (1-t) + depreciation + amortization - changes in capital expenditures - changes in NWC.

20) Cash flows from assets will always be less than cash flows from financing due to dividends.

F

22) Reducing a firm's debt will increase its cash flow.

F

23) Cash flows from assets will always be less than cash flows from financing due to dividends.

F

24) A firm's balance sheet provides a representation of the current market value of the company.

F

26) The income statement represents a snapshot of account balances at one point in time.

F

27) An income statement reports a firm's profit relative to its total investment in plant and equipment.

F

28) On an accrual basis income statement, revenues and expenses always match the firm's cash flow.

F

28) Total equity on the balance sheet increases as the amount of dividends paid increases.

F

30) Dividends paid to a firm's stockholders, both preferred and common stockholders, are taxdeductible to the paying company.

F

30) Under current accounting rules, plant and equipment appear on a firm's balance sheet valued at its replacement value

F

33) What changes in the balance sheet accounts would constitute sources of funds? What changes would be considered uses of funds?

Increases in liabilities and equity would be considered sources of funds. For example, increases in debt, A/P, N/P, R/E or equity. Uses of funds are increases in assets, such as increases in A/R, inventory, land, buildings, and equipment. At the same time, a reduction in assets could also be considered a sources of funds while a decrease in liabilities and equity would be uses of funds.

25) How might inflation restrict the usefulness of the balance sheet as normally presented?

Inflation may significantly change the market value of assets and liabilities and be representative of actual values nor replacement costs.

31) Who reads financial statements? List five internal and external readers of financial statements and provide an example of the type of information that they might be interested in and discuss why.

Internal readers could be the CEO, financial managers, marketing managers, operations manager, and human resource managers. External readers include regulators, stock holders, bond holders, customers, suppliers, and possible employees to name a few.

32) Why does the preferred stockholders' equity section of the balance sheet change only when new shares are sold or repurchased, whereas the common stockholders' equity section changes from year to year regardless of whether new shares are bought or sold?

Preferred stock is a fixed perpetuity. Common equity consists of the paid in capital plus changes in retained earnings. The portion of net income not paid as dividends to common stock holders becomes additions to retained earnings for the firm. Because this money belongs to the shareholders but is being retained by the firm and reinvested, it is considered an addition to the equity provided by common shareholders.

32) What checks are there on the accuracy of financial statements?

Regulatory agencies and public audits of firms are our best outside-the-firm checks on the accuracy of financial statements. Further, in a market where financial statements cannot be trusted, investors will pay less for firms that have less than trustworthy financial statements.

21) In a growing business, negative cash flow from investing activities is normal.

T

24) Beginning cash balance + cash flow from operations + cash flow from investing activities + cash flow from financing activities = ending cash balance.

T

25) Balance sheets and income statements connect through the retained earnings account.

T

29) A balance sheet is a statement of the financial position of the firm on a given date, including its asset holdings, liabilities, and equity.

T

29) Corporate income statements are usually compiled on an accrual, rather than cash, basis.

T