Exam 4 Review

Patterson Co.'s Depreciation Expense is $56,000 and the beginning and ending Accumulated Depreciation balances are $420,000 and $434,000, respectively. What is the cash paid for depreciation?

$0 When initially recording depreciation, we increase Depreciation Expense (with a debit) and increase Accumulated Depreciation (with a credit). Notice that depreciation does not involve cash.

Snowberry Corporation had a net increase in Retained Earnings of $182,000 for the year. The corporation also paid $56,000 of cash dividends that had been declared in the previous year. This year, the corporation declared $50,400 of dividends but has not paid them as of year-end. Given this information, the net income for the current year must have been:

$232,400

Harlow Industries reported net income of $56,000 for the current year. During the year, Inventory decreased by $19,600, Accounts Payable decreased by $22,400, Depreciation Expense was $28,000, and Accounts Receivable increased by $18,200. If the indirect method is used, what is the net cash provided by operating activities?

$63,000

A company bought $250,000 of equipment with an expected life of ten years and no residual value. After six years the company sold the equipment for $94,000. If the company uses straight-line depreciation and the indirect method is used to determine cash flows from operating activities, which of the following reflects how the sale of the equipment would be reported in the statement of cash flows?

$94,000 is recorded as a cash inflow from investing activities and $6,000 is added to convert net income to net cash flow provided by operating activities

Sunnyside Co.'s comparative balance sheet indicated that the Equipment account increased by $112,000. Upon further investigation of the account changes, it is determined that Sunnyside purchased equipment totaling $196,000 for the year. It also sold equipment with an original cost of $84,000 for $22,400 cash. Assuming these are the only transactions affecting the investing activities, Sunnyside will report net cash flows provided by (used in) investing activities of:

($173,600).

Strawbale, Inc. purchases a $600,000 building, paying $400,000 in cash and signing a $200,000 promissory note. What will be reported on the statement of cash flows as a result of this transaction?

A $400,000 cash outflow from investing activities and a $200,000 noncash transaction

Which of the following statements about liquidity and solvency ratios is correct

Both liquidity ratios and solvency ratios measure a company's ability to meet its financial obligations. Liquidity ratios relate to the company's short-term survival, in particular, the company's ability to use current assets to repay liabilities as they become due. Solvency ratios relate to the company's long-run survival, in particular, the company's ability to repay lenders when debt matures and to make the required interest payments prior to the date of maturity.

Which of the following ratios is used to evaluate solvency?

Debt-to-assets Solvency ratios measure the company's ability to survive long enough to repay lenders when debt matures and to make the required interest payments prior to the date of maturity. Debt-to-assets is a solvency ratio. EPS and fixed asset turnover are profitability ratios. The current ratio is a liquidity ratio.

If the debt-to-assets ratio is 0.73, it means that 73% of the company's financing has been provided by stockholders' equity.

False A debt-to-assets ratio of 0.73 indicates that creditors contributed 73% of the company's financing, while stockholders provided only 27% (or 100% − 73%).

Maya Company's purchase of 100 shares of Labrador Inc. common stock would be reported as a financing activity on its statement of cash flows.

False A purchase of another company's common stock is an investment in that company's securities. The purchase of investments in securities is an investing activity.

A stock dividend increases the market price of the company's stock.

False A stock dividend, which results in additional shares of stock issued, will result in a market reaction which will lower the market price per share

When preparing the operating activities section of the statement of cash flows using the indirect method, a decrease in accounts receivable is subtracted from net income.

False Accounts Receivable increases when sales are made on account and it decreases when cash is collected from customers. An overall decrease in this account, then, implies that cash collections were more than sales on account. To convert from the lower sales number that is included in net income to the higher cash collected from customers, we add the decrease in Accounts Receivable to convert net income to cash flows from operating activities.

Dividends in arrears are reported as current liabilities on the balance sheet

False Dividends are not liabilities until they are declared by the board of directors.

Unpaid dividends on cumulative preferred stock are called dividends payable.

False Dividends payable represent dividends which have been declared by the board of directors but have not yet been paid. Dividends in arrears represent the cumulative unpaid dividends on cumulative preferred stock. These dividends must be paid before any common dividends can be paid.

If earnings per share (EPS) increases, it must mean that the company's net income has increased.

False Earnings per share = (Net income − preferred dividends) ÷ Average number of common shares outstandingAn increase in EPS could result from an increase in net income, a decrease in preferred dividends, or a decrease in the average number of shares outstanding.

Horizontal analysis is the comparison of each financial statement amount to another amount on the same financial statement.

False Horizontal analysis involves comparing results across time, often expressing changes in account balances as a percentage of prior year balances. Vertical (common size) analysis involves expressing each financial statement amount as a percentage of another amount on the same financial statement.

A company with a high inventory turnover requires a larger investment in inventory than another company of similar sales with a lower inventory turnover

False Inventory turnover = Cost of goods sold ÷ Average inventoryA higher inventory turnover suggests a smaller investment in inventory is required.

According to the full disclosure principle, financial reports should present detailed information about every transaction.

False Simply put, according to the full disclosure principle, financial reports should present all information that is needed to properly interpret the results of the company's business activities. This doesn't mean that every single transaction needs to be explained in detail, but rather that adequate information needs to be presented to allow financial statement users to fairly interpret reports about the company's income, financial position, and cash flows.

Liquidity measures the ability of a company to meet its long-term financial obligations.

False Solvency measures a company's ability to meet its long-term financial obligations. Liquidity relates to the company's short-term survival, in particular, the company's ability to use current assets to repay liabilities as they become due.

When preparing the operating activities section of the statement of cash flows using the direct method, net income must be adjusted for gains or losses realized when property, plant, and equipment is sold.

False The direct method converts revenues to cash inflows and expenses to cash outflows. Since a gain is a noncash revenue and a loss is a nonc

The higher the times interest earned ratio, the greater the risk of nonpayment of interest.

False The higher the times interest earned ratio, the better able the company is to meet its interest obligations.

The par value of stock indicates what the stock is worth.

False The par value insignificant value per share of capital stock specified in the charter. Par value is a legal concept and is not related in any way to the market value of the company's stock.

Corporations are governed by federal law.

False To protect everyone's rights, the creation and oversight of corporations are tightly regulated by law. Corporations are created by submitting an application to a state government (not the federal government).

Vertical analysis is the comparison of a company's financial information over time.

False Vertical (common size) analysis involves expressing each financial statement amount as a percentage of another amount on the same financial statement.

When a company reissues (or sells) shares of its treasury stock at an amount different than its cost, it reports a gain or a loss on the sale.

False When a company reissues shares previously reported as treasury stock, it does not report a gain or loss on sale, even if it issues the shares for more or less than they cost when the company reacquired them. GAAP does not permit a corporation to report income or losses from investments in its own stock because transactions with the owners are not considered profit-making activities.

A stock split increases total stockholders' equity.

False A stock split does not require a journal entry, so total stockholders' equity does not change. A stock split involves a change in the par value per share and a proportionate change in the number of shares authorized; the total par value across all shares does not chan

A company that pays no dividends is always a poor investment.

False Investors acquire common stock because they expect a return on their investment. This return can come in two forms: dividends and increases in stock price. Some investors prefer to buy stocks that pay little or no dividends (called a growth investment) because companies that reinvest the majority of their earnings tend to increase their future earnings potential, along with their stock price.

Which of the following is a liquidity ratio?

Inventory turnover Liquidity ratios measure the company's ability to use current assets to pay its current obligations as they become due. Inventory turnover is a liquidity ratio. Price/Earnings and net profit margin are profitability ratios. Times interest earned is a solvency ratio.

Which of the following statements about the statement of cash flows is not correct?

It measures profitability. The income statement (rather than the statement of cash flows) measures profitability.

Scots Glenn Manufacturing took out $532,000 of new debt this year and repaid $800,000 of older debt in the same year. The company also issued stock for $353,600 cash and paid dividends of $79,200 for the year. The company's financing cash flows appearing the statement of cash flows will show:

Net cash provided by financing activities of $6,400.

Which of the following is a profitability measure?

Net income ÷ Revenues Net profit margin ratio, which is a profitability measure, is calculated as net income divided by revenues.

Gains or losses from discontinued operations are reported on a separate line on the income statement net of income tax effects.

True A gain or loss from discontinued operations, net of tax, is reported on the income statement on a separate line below the income tax expense and income from continuing operations lines.

All other things being equal, the higher the return on equity ratio, the better the financial performance of the company.

True A higher return on equity ratio means that stockholders are likely to enjoy greater returns.

When preparing the operating activities section of the statement of cash flows using the indirect method, an increase in Income Taxes Payable is added to net income.

True An increase in Income Taxes Payable indicates that more Income Tax Expense was accrued than paid. Consequently, when the indirect method is used, this difference (representing less cash paid) must be added to net income to calculate cash flows from operating activities.

Benchmarks are useful when evaluating a company's performance.

True Benchmarks are help when interpreting a company's financial ratios. These benchmarks may be the company's own results for prior years, the results of competitors, or an average for the industry.

The payment of salaries and wages would be reported as an operating activity on the statement of cash flows.

True Cash flows from operating activities are the cash inflows and outflows related directly to the revenues and expenses reported on the income statement. Operating activities involve day-to-day business activities with customers, suppliers, employees, landlords, and others.

The payment of interest on bonds is classified as a cash outflow from operating activities on the statement of cash flows.

True GAAP requires the payment of interest to be classified as cash inflows from operating activities because it enters into the determination of net income.

The general goal of horizontal analyses is to identify significant trends.

True Horizontal analyses compare individual financial statement line items horizontally (from one period to the next), with the general goal of identifying significant sustained changes (trends).

A liability for dividends is recorded on the declaration date.

True On the declaration date, the company's board of directors formally approves the dividend, thereby creating a legal liability for the corporation.

The lower the receivables turnover, the slower accounts receivable are being collected.

True Receivable turnover = Net sales ÷ Average net receivableThe lower the receivables turnover, the slower accounts receivable are being collected.

Depreciation Expense is not reported on the statement of cash flows when prepared using the direct method.

True The direct method converts revenues to cash inflows and expenses to cash outflows. Since depreciation is a noncash expense, it would not appear in the operating activities section of the statement of cash flows prepared using the direct method.

The fixed asset turnover ratio is a profitability ratio.

True The fixed asset turnover ratio indicates how much revenue the company generates for each dollar invested in fixed assets.

The going-concern assumption is also known as the continuity assumption.

True The going-concern (also called the continuity) assumption means that a business is assumed to be capable of continuing its operations long enough to meet its obligations

The statement of cash flows explains the difference between the beginning and ending balances of cash and cash equivalents.

True The statement of cash flows shows each major type of business activity that caused a company's cash and cash equivalents to increase or decrease during the accounting period.

The reporting of financing activities is identical under the indirect and direct methods for the statement of cash flows on the statement of cash flows.

True The two alternative methods (the indirect and direct methods) may be used when presenting the operating activities section of the statement of cash flows; these methods do not affect the reporting of investing or financing activities.

Trend data can be measured in dollar amounts or percentages

True Trend data show changes over time. These changes can be measured in dollars or in percentages.

Special items, such as gains or losses relating to changes in the value of certain balance sheet accounts, are reported below the net income line on the income statement.

True While most gains and losses are included in the computation of net income, some (such as gains or losses relating to changes in the value of certain balance sheet accounts) are excluded from net income and included only in comprehensive income

A major advantage of debt financing is that interest expense is tax deductible.

True Interest on debt is tax deductible; whereas, dividends on stock are not tax deductible.

Issuing stock to obtain financing is called equity financing.

True The two main ways that corporations finance their operations are by issuing stock (equity financing), or by borrowing (debt financing).

Treasury stock is a corporation's own stock that has been issued and subsequently repurchased by the corporation.

True Treasury Stock reports shares that were previously issued to and owned by stockholders but have been reacquired and are now held by the corporation.

When the indirect method is used, if accounts payable increases during the accounting period, the change in accounts payable is:

added to net income. Accounts Payable increases when purchases are made on account and it decreases when cash is paid on account. An overall increase in this account, then, implies that cash paid on account was less than purchases on account. To convert from the higher credit purchases number to the lower amount of cash paid to creditors, we add the increase in Accounts Payable to net income to calculate cash flows from operating activities.

Advantages of the corporate form include all of the following except

legal liability of its owners is unlimited. Creditors have no legal claim on the personal assets of stockholders like they do on the personal assets belonging to owners of sole proprietorships and partnerships. In other words, the corporate form limits the legal liability of its owners.

The rights of current stockholders to purchase additional shares of newly issued stock in order to maintain the same percentage ownership is called:

preemptive rights. Preemptive rights mean that, to retain their ownership percentages, existing stockholders may be given the first chance to buy newly issued stock before it is offered to others.

Holders of common stock receive certain benefits, such as a residual claim, which is the:

right to share in any remaining assets after creditors have been paid off, should the company cease operations. Residual claim means that, if the company ceases operations, stockholders share in any assets remaining after creditors have been paid.

Corporations can raise large amounts of money because:

shares of stock can be purchased in small amounts, so even small investors can participate. The law recognizes a corporation as a separate legal entity. Ownership in a corporation can be easily transferred, and a corporation can raise large amounts of money because investors can easily participate in the ownership of a corporation.

The creation and oversight of all corporations are regulated by

state laws. Corporate law is dictated by the state in which the corporation is established. Corporate law varies from state to state. More than half of the largest corporations in America are incorporated in Delaware because it has some of the most favorable laws for establishing corporations.

When the indirect method is used, if a prepaid expense account increases during the accounting period, the change in the prepaid expense account is:

subtracted from net income. Cash prepayments increase the balance in prepaid expense accounts, and recording of expenses decreases the balance in prepaid expense accounts. An increase in a prepaid expense account means that cash prepayments this period were greater than expenses. To convert from the higher cash payments number to the lower expense payment number included in net income, we subtract the increase in the prepaid expense accounts from net income to calculate cash flows from operating activities.

A corporation does not have a legal obligation to pay dividends.

true Dividends are not an obligation of the corporation and become a liability only when the board of directors formally declares a dividend.

The price-earnings ratio reveals information about the stock market's expectations for a company's future growth in earnings.

true The Price/Earnings (P/E) ratio measures how many times more than the current year's earnings investors are willing to pay for a company's common stock. A higher number means investors anticipate an improvement in the company's future results.