Exam 2
Valuations and accounting policies
Explanations of the valuation methods used or the basic assumptions made concerning inventory valuations, depreciation methods, investments in subsidiaries, etc.
T/F The future value of a deferred annuity is normally greater than the future value of an annuity not deferred.
False Because there is no accumulation or investment on which interest may accrue, the future value of a deferred annuity is the same as the future value of an annuity not deferred
t/f Available-for-sale investments are debt securities that the enterprise has the positive intent and ability to hold to maturity
False Held-to-maturity investments are debt securities that the enterprise has the positive intent and ability to hold to maturity. Trading investments are securities bought and held primarily for sale in the near term to generate income on short-term price differences. Available-for-sale investments are securities not classified as held-to maturity or trading securities.
major classifications used in the balance sheet
assets, liabilities, and equity
Working capital
current assets - current liabilities represents the net amount of a company's relatively liquid resources
Available-for-sale securities
securities that are not classified as held-to-maturity or trading securities
Balance Sheet
users can gain a considerable amount of information related to liquidity, solvency and financial flexibility.
A long-term bond produces two cash flows
(1) periodic interest payments during the life of the bond, and (2) the principal (face value) paid at maturity
The information to prepare the statement of cash flows comes from three sources
(a) comparative balance sheets (b) the current income statement (c) selected transaction data
Limitations of the Balance Sheet
1. Most assets and liabilities are reported at historical cost. 2. Use of judgments and estimates. 3. Many items of financial value are omitted.
Techniques of Disclosure
1. Parenthetical Explanations 2. Notes 3. Cross-Reference and Contra Items 4. Supporting Schedules 5. Terminology
Single-sum problems generally fall into one of two categories
1. consists of problems that require the computation of the unknown future value of a known single sum of money that is invested now for a certain number of periods at a certain interest rate 2. consists of problems that require the computation of the unknown present value of a known single sum of money in the future that is discounted for a certain number of periods at a certain interest rate
cash
A company's most liquid asset; includes money in change funds, petty cash, undeposited receipts such as currency, checks, bank drafts, and money orders, and funds immediately available in bank accounts.
Statement of Cash Flows
A financial statement that provides financial information about the cash receipts and cash payments of a business for a specific period of time.
contingency
A possible future event that must be prepared for or guarded against; possibility as an existing situation involving uncertainty as to possible gain (gain contingency) or loss (loss contingency) that will ultimately be resolved when one or more future events occur or fail to occur
What amount should Spencer Forman have in his 6% bank account today before withdrawal if he needs $3,000 each year for three years with the first withdrawal to be made today and each subsequent withdrawal at one-year intervals? (He is to have exactly a zero balance in his bank account after the third withdrawal.) A. $3,000 + ($3,000 × 0.94340) + ($3,000 × 0.89000) B. ($3,000/0.83962) × 3 C. ($3,000 × 0.94340) + ($3,000 × 0.89000) + ($3,000 × 0.83962) D. ($3,000/0.94340) × 3
A. $3,000 + ($3,000 × 0.94340) + ($3,000 × 0.89000) The requirement is to find the amount Spencer Forman should have in his bank account today (present value) if he desires to withdraw $3,000 each year for 3 years with the first $3,000 withdrawal occurring today. Normally the present value of an annuity due table for 1 could be used for this problem; however, such an answer was not provided in the choices given. Instead, the present value of this future series of withdrawals can be calculated by using the present value of 1 table and summing the present value of $3,000 to be received now ($3,000) and, the present value of $3,000 to be received 1 period from now ($3,000 × 0.94340) and the present value of $3,000 to be received 2 periods from now ($3,000 × 0.89000). This series of withdrawals follows the pattern of an annuity due; that is, the withdrawals of the amounts take place at the beginning of an interest period. Consequently the first withdrawal does not earn interest. Answer (C) is incorrect because it describes an ordinary annuity situation where the withdrawals are made at the end of the interest period; that is, the first withdrawal would have had to be made one interest period from now
Which of the following transactions would best use the present value of an annuity due of 1 table. A. Diamond Bar, Inc. rents a truck for 5 years with annual rental payments of $20,000 to be made at the beginning of each year. B. Michener Co. rents a warehouse for 7 years with annual rental payments of $120,000 to be made at the end of each year. C. Durant, Inc. borrows $20,000 and has agreed to pay back the principal plus interest in three years. D. Babbitt, Inc. wants to deposit a lump sum to accumulate $50,000 for the construction of a new parking lot in 4 years.
A. Diamond Bar, Inc. rents a truck for 5 years with annual rental payments of $20,000 to be made at the beginning of each year. The present value of annuity due of 1 table involves equal periodic rents which become due at the beginning of regular periodic intervals. Therefore a lease which requires the initial rental payment to be made upon signing the lease would be the correct answer. Answer (B) is incorrect because it would use the present value of an ordinary annuity of 1 table because the rental payments are due at the end of the regular periodic intervals. Answer (C) is incorrect because it involves the future amount of a single sum. Answer (D) is incorrect because it involves the present value of a single sum
On June 1, 2020, Walsh Company sold some equipment to Fischer Company. The two companies entered into an installment sales contract at a rate of 8%. The contract required 8 equal annual payments with the first payment due on June 1, 2020. What type of compound interest table is appropriate for this situation? A. Present value of an annuity due of 1 table. B. Present value of an ordinary annuity of 1 table. C. Future value of an ordinary annuity of 1 table. D. Future value of 1 table.
A. Present value of an annuity due of 1 table. The present value of an annuity due of 1 table would be the appropriate table for this situation. The present value of an annuity due involves the present value of equal future annual payments due at the beginning of the annual period. Answer (B) is incorrect because it concerns the present value of equal future annual payments due at the end of the annual period (ordinary annuity). Answers (C) and (D) are incorrect because they involve accumulations of an annuity and of a single amount, respectively, into some future value
If $1,240 cash and a $4,760 note are given in exchange for a delivery truck to be used in a business: A. assets and liabilities will change by the same amount. B. owners' equity will be increased. C. assets will increase and liabilities decrease. D. assets and liabilities will increase but by different amounts
A. assets and liabilities will change by the same amount. This transaction causes assets to increase by $4,760. The asset account truck increases by $6,000 (the purchase price), but assets also decrease by $1,240 due to the cash payment. Liabilities increase by $4,760 as a result of the issuance of the note.
Solvency refers to: A. the ability of an enterprise to pay its debts as they mature. B. the amount of time that is expected to elapse until an asset is realized. C. the amount of time that is expected to elapse until a liability has to be paid. D. the amount of time that is expected to elapse until an asset is converted into cash.
A. the ability of an enterprise to pay its debts as they mature. Solvency refers to the ability of an enterprise to pay its debts as they mature. Alternatives (B), (C) and (D) are all part of the definition of liquidity
One of the main reasons for separating liabilities into current and longterm is: A. to provide decision makers with information regarding currently maturing debts. B. to separate large and small debts. C. to separate capital into its component parts. D. to separate total equity into its two basic parts
A. to provide decision makers with information regarding currently maturing debts. Alternative (B) is incorrect because dividing liabilities between current and long-term has nothing to do with the amount of the debt. Alternative (C) is incorrect because the term "capital" is not a correct term to use in describing debt. Alternative (D) is incorrect because total equity includes six components, none of which are liabilities
Of the following items, the one which should be classified as a current asset is A. trade installment receivables normally collectible in 20 months. B. a deposit on equipment ordered, delivery of which will be made within 7 months. C. cash designated for the redemption of callable bonds. D. cash surrender value of a life insurance policy of which the company is a beneficiary
A. trade installment receivables normally collectible in 20 months. A current asset is either cash, something that will be converted into cash or consumed in one year or the operating cycle, whichever is longer. If installment sales are a normal part of operations, they may be classified as current assets because they will be converted into cash within the company's normal operating cycle. Answer (B) is incorrect because the cash deposit is a part of the cost of the machinery ordered and should be classified as a noncurrent asset. Answer (C) is incorrect because cash that is restricted for an indefinite period of time should be classified as a noncurrent asset. Answer (D) is incorrect because a life insurance policy is not likely to be canceled in the near future; therefore, its cash surrender value would be most appropriately reported in the long-term investment section of the balance sheet.
simple interest
principal x rate x time
Outline of Balance Sheet
Assets - Current Assets - Long-Term Liabilities - Property, Plant, and equipment - Intangible Assets Liabilities & Stockholders' Equity - Current Liabilities - Long-Term debt - Stockholders' Equity
Sharon Walsh has developed and patented a computer chip that allows telecommunications in race cars to become more efficient. She agrees to sell the patent to Pensca for five annual payments of $50,000 each. The payments are to begin three years from today. Given an annual rate of 6%, what is the present value of the five payments? A. $176,839 B. $187,450 C. $210,618 D. $218,820
B. $187,450
The payment of cash dividends to the common shareholders would be reported on a company's statement of cash flows under the classification of A. Operating Activities. B. Financing Activities. C. Investing Activities. D. Significant Transactions
B. Financing Activities Financing activities involve liability and owners' equity items. They include (1) obtaining capital from owners and providing them with a return on (and a return of) their investment and (b) borrowing money from creditors and repaying the amounts borrowed
Which of the following is not a current asset? A. Prepaid property taxes that relate to the next operating period. B. The cash surrender value of a life insurance policy carried by a corporation on its president. C. Marketable securities purchased as a temporary investment of cash. D. Installment notes receivable due over 15 months in accordance with normal trade practices
B. The cash surrender value of a life insurance policy carried by a corporation on its president. Generally, the rule is that if an asset is to be turned into cash, sold, or consumed either in one year or the operating cycle, whichever is longer, it is classified as current. The cash surrender value of a life insurance policy is not expected to be turned into cash, etc. within a year or the operating cycle. This item is normally shown in the long-term investments section of the balance sheet.
One of the benefits of the statement of cash flows is that it helps users evaluate financial flexibility. Which of the following explanations is a description of financial flexibility? A. The nearness to cash of assets and liabilities. B. The firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities. C. The firm's ability to pay its debts as they mature. D. The firm's ability to invest in a number of projects with different objectives and costs.
B. The firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities. Financial flexibility refers to a firm's ability to respond and adapt to financial adversity and unexpected needs and opportunities. Alternative "D" is an indication of flexibility, but does not take into account adversity and unexpected needs. The nearness to cash of assets and liabilities is a firm's liquidity, and the firm's ability to pay its debts refers to solvency
Prepaid expenses are included in the current assets section of the balance sheet because A. they will be converted into cash within one year or the operating cycle, whichever is longer. B. if they had not been already paid they would require the use of cash during the next year or operating cycle. C. they were already included in operating expenses on the income statement in the year cash was expended. D. they reflect payments that were made in a prior period that will not be charged to expense in the current period.
B. if they had not been already paid they would require the use of cash during the next year or operating cycle. Prepaid expenses are expenditures already made for benefits to be received within one year or the operating cycle, whichever is longer. The cash has already been expended, but its inclusion on the income statement will not occur until the benefit has been received by the company.
The primary purpose of the balance sheet is to reflect A. the firm's potential for growth in stock values in the stock market. B. items of value, debts, and net worth. C. the value of items owned by the firm. D. the status of the firm's assets in case of forced liquidation of the firm
B. items of value, debts, and net worth. The primary purpose of the balance sheet is to reflect items of value, debts, and net worth. The three classes of items that appear on the balance sheet are assets (items of value measured by historical costs or net realizable values), liabilities (debts and obligations of the firm which represent creditor claims to the assets of the firm), and owners' equity (the net worth of the owners as represented by their claims to the firm's assets). The balance sheet reflects these items as of a particular date
One criticism not normally aimed at a balance sheet prepared using current accounting and reporting standards is: A. failure to reflect current value information. B. the extensive use of separate classifications. C. an extensive use of estimates. D. failure to include items of financial value that cannot be recorded objectively
B. the extensive use of separate classifications. The balance sheet is criticized for its failure to reflect current value (A), the extensive use of estimates in its preparation (C), and its failure to include items of financial value that cannot be measured objectively (D). The balance sheet is rarely, if ever, criticized for its division of items into separate classifications
If J.J. Morse put $1,000 in a 12% savings account today, what amount of cash would be available 3 years from now? A. $1,000 × .71178 B. $1,000 × .71178 × 3 C. $1,000/.71178 D. ($1,000/.89286) × 3
C. $1,000/.71178
Bob Geimer plans on going on vacation to Asia in four years. The trip will cost $4,000. He proposes to finance the trip by investing a sum of money now at 9% compound interest. How much should Bob invest now in order to obtain his goal of $4,000? A. $2,474.67 B. $2,654.35 C. $2,833.72 D. $3,088.72
C. $2,833.72 This problem involves the present value of a single sum. Using Table 6-2 for 9% at 4 periods, the value of .70843 is multiplied by $4,000 to obtain the amount of $2,833.72.
Jeanie Pearson plans to buy a golf course in 10 years. Because of cash flow problems, Jeanie is able to budget deposits of $900,000 that are expected to earn 10% annually only at the end of the seventh, eighth, ninth, and tenth periods. What future amount will Jeanie accumulate at the end of the tenth year? A. $3,600,000 B. $3,960,000 C. $4,176,900 D. $6,902,631
C. $4,176,900
Which of the following would not be considered a basic source of information useful in preparing a statement of cash flows? A. Selected transaction data. B. Comparative balance sheets. C. An analysis of sales by territory. D. The current income statement
C. An analysis of sales by territory A statement of cash flows deals with gross inflows and outflows of cash. An analysis of sales by territory would generate no information about the cash flow from the sales.
Which of the following tables would show the largest value for an interest rate of 10% for 8 periods? A. Future value of 1 table. B. Present value of 1 table. C. Future value of an ordinary annuity of 1 table. D. Present value of an ordinary annuity of 1 table
C. Future value of an ordinary annuity of 1 table The future value of an ordinary annuity of 1 table would show the largest value for an interest rate of 10% for 8 periods. Answer (A) is incorrect because the future value of 1 table only calculates the future value of a single sum whereas the future value of an ordinary annuity of 1 table calculates the future value of a stream of payments. Answer (B) is incorrect because the present value of 1 table includes values of less than 1 whereas the future value of an ordinary annuity of 1 table includes values greater than 1. Answer (D) is incorrect because the present value of an ordinary annuity of 1 table calculates a stream of payments back to the present whereas the future value of an ordinary annuity of 1 table calculates a stream of payments forward to the future; thus the future amount is greater than the present amount because it is earning more interest
How are the following items handled in computing the total stockholders' equity section of the balance sheet? Treasury Stock Additional Paid-in Capital A. Added Added B. Added Subtracted C. Subtracted Added D. Subtracted Subtracted
C. Subtracted Added Treasury stock (the company's own stock reacquired and not canceled) is shown as a reduction of stockholders' equity, while additional paid-in capital is added to the stockholders' equity section of the balance sheet.
The statement of cash flows provides answers to all of the following questions EXCEPT: A. Where did the cash come from during the period? B. What was the cash used for during the period? C. What is the impact of inflation on the cash balance at the end of the year? D. What was the change in the cash balance during the period?
C. What is the impact of inflation on the cash balance at the end of the year? The statement of cash flows does not adjust the cash balance for the effects of inflation or deflation during the period. Such an amount can be determined by the use of certain indices, but this is not a function of the statement of cash flows
A characteristic of all assets and liabilities comprising working capital is that they are A. monetary. B. marketable. C. current. D. cash equivalents
C. current A characteristic of all assets and liabilities comprising working capital is that they are current. The accounting profession defines working capital as the excess of current assets over current liabilities. Answers (A), (B), and (D) are incorrect because not all working capital assets and liabilities are monetary (e.g., inventory), marketable (e.g., federal income taxes payable), or cash equivalents (e.g., prepaid expenses)
The balance sheet contributes to financial reporting by providing a basis for all of the following except A. computing rates of return. B. evaluating the capital structure of the enterprise. C. determining the increase in cash due to operations. D. assessing the liquidity and financial flexibility of the enterprise.
C. determining the increase in cash due to operations. The balance sheet provides a basis for computing rates of return based on asset growth. The balance sheet also includes information used in evaluating capital structure (equity section) and assessing the liquidity and financial flexibility (assets and liabilities) of the enterprise. However, to determine the increase in cash due to operations one should refer to the statement of cash flows.
If a company converted a short-term note payable into a long-term note payable, this transaction would A. increase both working capital and net income. B. decrease only working capital. C. increase only working capital. D. decrease both working capital and owners' equity
C. increase only working capital Conversion of a short-term note payable (current liability) into a long-term note payable (noncurrent liability) would increase working capital. Working capital is the difference between current assets and current liabilities. Conversion of the short term note payable reduces current liabilities and does not affect current assets. Answers (A) and (D) are incorrect because there is no effect on net income or owners' equity.
For accounting purposes the "operating cycle concept" A. has become obsolete. B. affects the income statement but not the balance sheet. C. permits some assets to be classified as current even though they are more than one year removed from becoming cash. D. causes the distinction between current and noncurrent items to depend on whether they will affect cash within one year
C. permits some assets to be classified as current even though they are more than one year removed from becoming cash. The operating cycle concept is used as a basis for classifying current items. The operating cycle of a firm is the length of time elapsed from the time cash is expended for such items as inventory to the time it converts the inventory back to cash. When the operating cycle is longer than 12 months, the longer period should be used. Therefore, the operating cycle concept does allow some assets to be classified as current even though their conversion into cash will not take place within one year
A liability to be paid next year would not be included in the current liability section of the balance sheet if the debt is expected to be refinanced through another long-term issue, or A. the operating cycle is less than one year. B. the liability will be paid with cash that the company earns during the next year. C. when the debt is retired out of noncurrent assets. D. the liability is a nonoperating debt instrument due within the next year
C. when the debt is retired out of noncurrent assets. When the operating cycle is less than one year and/or the debt will be paid with cash (alternatives A & B) the item is properly classified as a current liability. Also, operating or nonoperating debt due within the next year can be a current liability. However, when the debt is retired out of noncurrent assets it should not be classified as current even if it meets the operating cycle/one year criteria.
Investing Activities
Cash flow activities that include (a) cash transactions that involve the purchase or disposal of investments and property, plant, and equipment using cash and (b) lending money and collecting the loans.
"Present value of 1" table
Contains the amount that must be deposited now at a specified rate of interest to amount to 1 at the end of a specified number of periods
"Future value of an ordinary annuity of 1" table
Contains the amount to which periodic rents of 1 will accumulate if the rents are invested at the END of each period at a specified rate of interest and are continued for a specified number of periods. (This table may also be used as a basis for converting to the amount of an annuity due of 1.)
"Present value of an annuity due of 1" table
Contains the amounts that must be deposited now at a specified rate of interest to permit withdrawals of 1 at the beginning of regular periodic intervals for the specified number of periods
"Present value of an ordinary annuity of 1" table
Contains the amounts that must be deposited now at a specified rate of interest to permit withdrawals of 1 at the end of regular periodic intervals for the specified number of periods
"Future value of 1" table
Contains the amounts to which 1 will accumulate if deposited now at a specified rate and left for a specified number of periods
What amount should be deposited in a bank today at an interest rate of 10% to grow to $2,000 four years from today? A. $2,000/0.68301 B. $2,000 × 0.90909 × 3 C. ($2,000 × 0.90909) + ($2,000 × 0.82645) + ($2,000 × 0.75132) + ($2,000 × 0.68301) D. $2,000 × 0.68301
D. $2,000 × 0.68301 The amount to be deposited today (present value) to grow to $2,000 (future value) four years from now if the bank pays 10% annual compound interest can be calculated by multiplying the desired future value ($2,000) by the present value factor for 4 periods at 10% per period (0.68301). The correct answer is $2,000 × 0.68301.
Kimberly Nelson, a computer programmer, wishes to create her own retirement fund. Kimberly deposits $4,000 today in a fixed rate savings account that earns 5% interest. She plans to deposit $4,000 every year for the next 24 years (total of 25 deposits). How much cash will she have accumulated in her retirement account when she retires in 25 years? A. $186,908 B. $190,908 C. $194,908 D. $200,454
D. $200,454
Which of the following items should never be included in the current section of the balance sheet? A. Receivable from a customer outstanding for more than a year. B. Deferred income taxes resulting from interperiod tax allocation. C. Three-year premium for fire insurance on plant and equipment. D. A pension fund
D. A pension fund A pension fund is an investment made by a company for the retirement benefits of its employees. These funds will not be converted to cash for use in the business nor will they be used to liquidate current liabilities. The other three alternatives (A, B, and C) include items that, although somewhat unusual, could be classified as current.
Of the following statements, which best illustrates the fact that the formal distinction made between current and noncurrent assets is somewhat arbitrary? A. Cash in a checking account is a current asset, while cash in a savings account is more permanent and is normally classified as noncurrent. B. Inventory that may be sold next year, or in the subsequent year as demand dictates may be classified as current or noncurrent. C. Accounts receivable due in less than one year or the operating cycle are classified as current assets, while accounts receivable due in longer than one year or the operating cycle are classified as noncurrent. D. An amount equal to the current depreciation charge on buildings should be placed in the current assets section at the beginning of the year, because it will be consumed in the next operating cycle.
D. An amount equal to the current depreciation charge on buildings should be placed in the current assets section at the beginning of the year, because it will be consumed in the next operating cycle. Cash is a current asset whether it is in a checking or savings account. Inventory is a current asset at the time the balance sheet is prepared even though it may not all be sold in the subsequent year, as it is held for sale in the normal course of business. The accounts receivable that are not collectible in the coming year should be classified as a noncurrent asset. However, while the theoretical treatment of next year's depreciation should be shown as a current asset, common practice is to ignore the formal distinction in this case
How would the two items shown below be handled in arriving at cash provided by operations in the statement of cash flows? Increase in Increase in Accounts Receivable Accounts Payable A. Add to net income ; Add to net income B. Deduct from net income ; Deduct from net income C. Add to net income ; Deduct from net income D. Deduct from net income ; Add to net income
D. Deduct from net income ; Add to net income To arrive at cash provided by operation, the increase in accounts receivable must be deducted from net income, and the increase in accounts payable must be added back to net income
Which of the following balance sheet classifications would normally require the greatest amount of supplementary disclosure? A. Current assets. B. Current liabilities. C. Plant assets. D. Long-term liabilities
D. Long-term liabilities Long-term liabilities normally require the greatest amount of supplementary disclosure. This is because the terms of all long-term liability agreements, including maturity date or dates, rate of interest, nature of obligation, and any security pledged to support the debt, should be disclosed. The other classifications do require supplementary disclosure, but rarely is it as extensive as that required for long-term liabilities
Which of the following reflects proper use of the term "reserve" in the preparation of financial statements? A. The term used to describe amounts deducted from assets, such as "reserve for depreciation." B. The initial term used in connection with an estimated liability, such as "estimated reserve for product warranty." C. The term used to describe the setting aside of funds for the subsequent payment of an existing liability, such as "reserve for bonds payable." D. The term used to describe an appropriation of retained earnings in the stockholders' equity section of the balance sheet.
D. The term used to describe an appropriation of retained earnings in the stockholders' equity section of the balance sheet. The profession has recommended that the word "reserve" be used only to describe an appropriation of retained earnings. The term had been used to describe a number of items in the financial statements which has resulted in a great deal of confusion.
trading
Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences. reported as current assets
t/f Intangible assets lack physical substance and may include financial instruments such as contractual rights to receive cash.
False Intangible assets lack physical substance and are not financial instruments. They include patents, copyrights, trademarks and tradenames, and goodwill.
T/F The major difference between compound interest and simple interest lies in the fact that compound interest is computed twice each year, whereas simple interest is computed only once
False Simple interest is the term used to describe interest that is computed on the amount of the principal only. Compound interest is the term used to describe interest that is compounded on principal and on any interest earned that has not been paid or withdrawn
t/f The stockholders' equity accounts used by a corporation are the same as those used in accounting for a partnership or proprietorship
False A partnership or proprietorship uses individual capital accounts for each owner in the owners' equity section of the balance sheet. A corporation's owners' equity section shows capital stock accounts representing ownership and a retained earnings account that reflects undistributed earnings of the corporation.
T/F An annuity requires that periodic rents always be the same even though the interval between the rents may vary
False An annuity requires that (a) the periodic payments or receipts (called rents) always be the same, (b) the interval between such rents always be the same, and (c) the interest be compounded once each interval.
t/f Determination of cash flows from operating activities requires predicting the amount of cash the entity will collect from customers who purchase the entity's product on account
False Cash flow from operating activities refers to the amount of cash inflow and cash outflow which result from the activities an entity enters into for the purpose of generating net income. Because an income statement is prepared on an accrual basis, it includes revenues earned and expenses incurred in earning revenues without regard for the receipt or payment of cash. To compute cash flow from operating activities you must add to or deduct from net income those items in the income statement which did not generate or require the use of cash.
t/f Current assets include only assets expected to be sold within one year or the operating cycle, whichever is longer
False Current assets are cash and other assets that are expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, whichever is longer
T/F The ordinary annuity table may be used to compute the periodic rents when the desired future value and the present value of the annuity are not known
False If the desired future value or present value of an annuity are not known, the periodic rents cannot be computed.
T/F In the formula for compound interest, the number of periods refers to the number of months an obligation will be outstanding
False In the formula for compound interest the number of periods refers to the number of times interest is compounded. Interest is generally expressed in terms of an annual rate; however, in many business circumstances, the compounding period is less than a year (daily, monthly, quarterly, semiannually, etc.). In such circumstances the annual interest rate must be converted to correspond to the length of the period. This is done by dividing the annual rate by the number of compounding periods per year
T/F If interest is compounded quarterly and the annual interest rate is 8%, the compounding period interest rate is 4%
False In this case the compounding interest rate is 2% rather than 4%. This is computed by dividing the annual rate (8%) by the number of compounding periods per year (4)
t/f Securities classified as available-for-sale should be reported at cost
False Securities classified as available-for-sale should be reported at fair value. Securities classified as held-to-maturity are reported at cost
t/f The balance sheet reflects a corporation's results of operations for a specified period of time
False The balance sheet reflects a corporation's financial position for a point in time. This accounts for the heading on a balance sheet, which states "December 31, 20×1," rather than "For the year ended December 31, 20×1
t/f The current cash debt coverage ratio provides information on financial flexibility and the company's ability to repay its liabilities from net cash provided by operating activities
False The current cash debt coverage ratio helps users assess liquidity. The cash debt coverage ratio provides information on financial flexibility and the company's ability to repay its liabilities from net cash provided by operating activities.
T/F The number of rents exceeds the number of discount periods under the present value of an ordinary annuity
False The present value of an ordinary annuity is the present value of a series of rents equal to the number of discount periods
t/f The sale of 12,000 shares of its common stock by Xerax Company for $22,000 cash would be classified an investing activity due to the increased investment by company shareholders
False When an entity sells its stock for cash it is considered to have entered into a transaction designed to aid in financing the entity's operation. Thus, this transaction would be classified as a financing activity on Xerax Company's statement of cash flows. Investing activities refer to those activities designed to utilize cash to acquire debt and equity investments of other companies (bonds and stocks) as well as property, plant, and equipment
Contingencies
Material events that have an uncertain future
Basic Format of Statement of Cash Flows
Statement of Cash Flows Cash flows from operating activities $XXX Cash flows from investing activities XXX Cash flows from financing activities XXX ---------------------------------------------------- Net increase (decrease) in cash XXX Cash at beginning of year XXX ----------------------------------------------------- Cash at end of year $XXX
Number of Time Periods
The number of compounding periods (a period may be equal to or less than a year)
Future Value (FV)
The value at a future date of a given sum or sums invested assuming compound interest
T/F An annuity is classified as an ordinary annuity if the rents occur at the end of the period; it is classified as an annuity due if the rents occur at the beginning of the period
True
T/F Periodic interest earnings under an ordinary annuity will always be lower by one period's interest than the interest earned by an annuity due
True
T/F Present value is the amount that must be invested now to produce a known future amount
True
T/F Present value techniques can be used in valuing receivables and payables that carry no stated interest rate
True
T/F The amount of interest on a $1,000, 6%, 6-month note is the same as the amount of interest on a $1,000, 3%, 1-year note.
True
T/F The growth in principal is the same under both compound and simple interest if only one compounding period is involved
True
T/F The present value of an ordinary annuity is the present value of series of rents to be made at equal intervals in the future
True
T/F The valuation of a sum as of an earlier date involves a determination of present value; the valuation of a sum as of a later date involves a determination of a future value
True
t/f Companies often include insurance and other prepayments for 2 or 3 years in current assets even though part of the advance payment applies to periods beyond one year or the current operating cycle
True
t/f Contracts and negotiations of significance, in addition to contingencies, are disclosed in footnotes to the financial statements
True
t/f Current liabilities are the obligations that are reasonably expected to be liquidated either by creation of other current liabilities or through the use of current assets
True
t/f If cash is restricted for purposes other than the liquidation of current obligations, it should not be classified as a current asset
True
t/f Individual balance sheet items should be separately reported and classified in sufficient detail to permit users to assess the amounts, timing, and uncertainty of future cash flows.
True
t/f It is recommended that there be a disclosure for all significant accounting principles and methods that involve selection from among alternatives or those that are peculiar to a given industry
True
t/f Long-term liabilities are obligations that are not reasonably expected to be liquidated within one year or the normal operating cycle, whichever is longer
True
t/f Notes are commonly used to disclose the existence and amount of any preferred stock dividends in arrears
True
t/f Proper presentation of inventories for a manufacturing concern includes disclosure of the basis of valuation, the method of pricing, and the stage of completion
True
t/f The primary purpose of the statement of cash flows is to provide relevant information about the cash receipts and cash payments of an enterprise during a period
True
t/f The three general classes of items included in the balance sheet are assets, liabilities, and equity
True
t/f The use of an other-asset section varies widely in practice. It should be restricted to unusual items that are different from assets included elsewhere
True
t/f To arrive at cash provided by operations, an increase in accounts receivable must be deducted from net income, and an increase in accounts payable must be added back to net income
True
t/f Trading securities are reported at fair value in the current asset section
True
t/f The profession has recommended that the word "reserve" be used only to describe an appropriation of retained earnings
True
Present Value of an Annuity
a sum of money invested today at compound interest that will provide for a series of equal withdrawals for a specified number of future periods
Preparation of the statement of cash flows involves the following steps
a. Determine the net cash provided by (or used in) operating activities. b. Determine the net cash provided by (or used in) investing and financing activities. c. Determine the change (increase or decrease) in cash during the period. d. Reconcile the change in cash with the beginning and the ending cash balances.
Long-term investments
a. Investments in securities, such as stock, bonds, or long-term notes. b. Investments in tangible fixed assets not currently used in operations. c. Investments set aside in special funds (sinking, pension, plant expansion, etc.) and cash surrender value of life insurance. d. Investments in nonconsolidated subsidiaries or affiliated companies. They are shown in the balance sheet below current assets in a separate section called Investments
Long term liabilities generally fall into one of the three following categories:
a. Obligations arising from specific financing situations, such as the issuance of bonds, long-term lease obligations, and long-term notes payable. b. Obligations arising from the ordinary operations of the enterprise such as pensions and deferred income taxes. c. Obligations that are dependent upon the occurrence or non-occurrence of one or more future events to confirm the amount payable such as warranties and other contingencies.
Short-Term Investments
all equity securities are recorded at fair value with changes reported in net income Companies group investments in debt securities into 3 separate portfolio for valuation & reporting purposes; held to maturity, trading, available for sale Any anticipated loss due to uncollectible, the amount and nature of any non-trade receivables, and any receivables designated as collateral should be clearly identified
deferred annuity
an annuity in which two or more periods must pass, after it has been arranged, before the rents will begin
If rents occur at the beginning of each time period, it is an
annuity due
Property, plant, and equipment (PP&E)
are properties of a durable nature that are used in the regular operations of the enterprise. Ex include land, buildings, machinery, furniture, tools, and wasting resources. With the exception of land, these assets are either depreciable or depletable
accounting policies
are the specific principles, bases, conventions, rules, and practices applied by a company in preparing and presenting financial information
current assets
cash and other assets expected to be converted into cash, sold, or consumed either in one year or in the operating cycle, whichever is longer exceptions involve prepaid expenses, investments in common stock, and the subsequent years' depreciation of fixed assets are presented in the balance sheet in the order of their liquidity and normally include cash, short-term investments, receivables, inventories, and prepaid expenses
current cash debt coverage ratio Financial Liquidity
cash provided by operations/average current liabilities
cash debt coverage ratio Financial Flexibility
cash provided by operations/average total liabilities
"Other Assets"
classification in the balance sheet after Property, Plant, and Equipment This section includes a wide variety of items that do not appear to fall clearly into one of the other classifications. Some of the more common items included in this section are: deferred income taxes, noncurrent receivables, property held for sale, assets in special funds, and restricted cash
"summary of significant accounting policies"
conveys valuable information about the company's choices from among various alternative accounting methods
Held-to-maturity securities
debt securities that are expected to be held until they mature, which means until they become payable
to convert the annual interest rate to the compounding period interest rate
divide the annual interest rate by the number of compounding periods in a year the number of periods over which interest will be compounded is calculated by multiplying the number of years involved by the number of compounding periods in a year
t/f Liquidity is the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities
false Liquidity describes the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid. Financial flexibility is the ability of an enterprise to take effective actions to alter the amounts and timing of cash flows so it can respond to unexpected needs and opportunities
owners' (stockholders') equity section
includes information related to capital stock, additional paid-in capital, retained earnings, accumulated other comprehensive income, treasury stock, and noncontrolling interest. Preparation of the owners' equity section should be approached with caution because of the various restrictions imposed by state corporation laws, liability agreements, and voluntary actions of the board of directors
Limited-life
intangible assets are amortized over their useful lives
Indefinite-life
intangibles (such as goodwill) are not amortized but, instead, are assessed (at least annually) for impairment
Financing activities
involve liability and owners' equity items and include (1) obtaining capital from owners and providing them with return on (and return of) their investment and (2) borrowing money from creditors and repaying the amounts borrowed
Operating Activities
involve the cash effects of transactions that enter into the determination of net income
annuity
is a series of equal periodic payments or receipts called rents requires that the rents be paid or received at equal time intervals, and that compound interest be applied
Interest
is the payment for the use of money
Coumpound interest
is the process of computing interest on the principal plus any interest previously earned.
Future Value of an Annuity
is the sum (future value) of all the rents (payments or receipts) plus the accumulated compound interest on them
intangible assets
lack physical substance; however, their benefit lies in the rights they convey to the holder. Ex: patents, copyrights, franchises, goodwill, trademarks, trade names, and secret processes
Current Liabilities
liabilities due within a short time, usually within a year EX: notes and accounts payable, advances received from customers, current maturities of long-term debt, taxes payable, and accrued liabilities Obligations due to be paid during the next year may be excluded from the current liability section if the item is expected to be refinanced through long-term debt or the item will be paid out of noncurrent assets
Level 3 of the fair value hierarchy
measures (least reliable) are based on unobservable inputs, such as a company's own data or assumptions must provide significant additional disclosure related to Level 3 measurements
Level 2 of the fair value hierarchy
measures (less reliable) are based on market-based inputs other than those included in Level 1, such as those based on market prices for similar assets or liabilities
Level 1 of the fair value hierarchy
measures (the most reliable) are based on observable inputs, such as market price for identical assets or liabilities.
Free cash flow
net cash provided by operating activities - (Capital Expenditures + Dividends) the amount of discretionary cash flow a company has for purchasing additional investments, retiring its debt, purchasing treasury stock, or simply adding to its liquidity
Long-term liabilities
obligations that a company expects to pay after one year Examples include bonds payable, notes payable, lease obligations, and pension obligations
If the rents occur at the end of each time period, the annuity is known as an
ordinary annuity
Liquidity
related to the amount of time that is expected to elapse until an asset is realized or otherwise converted into cash or until a liability has to be paid
Solvency
the ability of an enterprise to pay its debts as they mature.
Financial flexibility
the ability of an enterprise to take effective action to alter the amounts and timing of cash flow so that it can respond to unexpected needs and opportunities
Present Value
the amount that must be invested now to produce a known future value EX: What amount must be invested today at 6% interest compounded annually to accumulate $5,000 at the end of 10 years? In this question the present value method is used to determine the initial dollar amount to be invested. The present value method can also be used to determine the number of years or the interest rate when the other facts are known
For a proper presentation of inventories
the basis of valuation (i.e., lower of cost or market) and the method of pricing (FIFO or LIFO) should be disclosed
Additional paid-in capital
the excess of amounts paid in over the par or stated value
If the annuity is an annuity due
the initial sum of money is invested at the beginning of the first period and withdrawals are made at the beginning of each period starting with the first period
If the annuity is an ordinary annuity,
the initial sum of money is invested at the beginning of the first period and withdrawals are made at the end of each period
Rate of Interest
the percent that is the basis for interest earned or paid
future value of a deferred annuity
the same as the amount of an annuity not deferred because there is no accumulation or investment on which interest may accrue
