Financial Statement Analysis Chapter 6

During July 2012, Ralston Company decides to dispose of one of its subsidiaries, which qualifies for accounting as a discontinued operation. At the July 2012 measurement date, Ralston Company estimates that it will report net losses of $1,500,000 dollars from the measurement date until the disposal date, which is expected to be in April 2013. In addition, Ralston estimates that it will lose $300,000 on the sale of the segment. How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)? a. $1,500,000 loss b. $0 c. $1,800,000 loss d. $300,000 loss

$1,800,000 loss

During July 2013, Ralston Company decides to dispose of one of its subsidiaries, which qualifies for accounting as a discontinued operation. At the July 2013 measurement date, Ralston Company estimates that it will report net income of $300,0000 dollars from the measurement date until the disposal date, which is expected to be in April 2014. In addition, Ralston estimates that it will lose 100,000 on the sale of the segment. How much gain or loss on discontinued operations will Ralston report in its 2012 income statement (net of income taxes)? a. $200,000 gain b. $0 c. $100,000 loss d. $300,000 loss

$200,000 gain

Many times a financial analyst may decide to make adjustments to the financial statements in order to make the statements more useful. Which of the following would not require an adjustment to the financial statement? a. A company signs a new contract with a customer. b. A delivery company incurs a loss from disposition of used delivery trucks. c. A company changes the useful life of its equipment from 5 years to 8 years. d. A company incurs a charge related restructuring its operations.

A company signs a new contract with a customer.

Warranties payable and Notes payable are considered which of the following? a. Accounting Liabilities b. Assets c. Stockholders' Equity d. Other Financial Assets

Accounting Liabilities

Which of the following are characteristics of an extraordinary item? a. Unusual in nature b. Infrequent in occurrence c. Material in amount d. All of the above

All of the above

Users of financial statements should consider which of the following when evaluating the quality of accounting information? a. Economic faithfulness of accounting measurements and classifications. b. Reliability of the measurements. c. Reasonableness of the estimates made in applying GAAP or IFRS. d. All of these should be considered.

All of these should be considered

Which one of the following is an example of sustainable earnings? a. A gain from corporate restructuring. b. A loss from debt retirement. c. A settlement paid by the company for a class action suit. d. Earnings from repeat customers.

Earnings from repeat customers.

The Orbus Company has a 30,000 unrealized gain and a 10,000 unrealized loss. Where would Orbus Company report these transactions? a. Only in non-current assets and liabilities b. In stockholders' equity c. Other comprehensive income d. On the balance sheet as a current asset

Other comprehensive income

Examples of poor earnings quality that hinder the forecasting of expected future earnings include all of the following except: a. Earnings dominated by a substantial one-time gain from the sale of real estate tangential to the firm's operations. b. Reporting a large expense from a warehouse fire that was not covered by insurance. c. A local government corrects a processing error and a firm receives an unexpected rebate on property taxes previously paid. d. The company adds equipment that reduces carbon emissions in response to EPA requirements and increases production efficiency.

The company adds equipment that reduces carbon emissions in response to EPA requirements and increases production efficiency.

All of the following are the general principles underlying the valuation of liabilities except: a. Liabilities requiring future cash payments appear at the present value of the required future cash flows discounted at an interest rate that reflects the uncertainty that the firm will be able to make the cash payments. b. The fair value of a liability cannot differ from the amount appearing on the balance sheet, particularly for long-term debt. c. Liabilities representing cash advances from customers appear at the amount of the cash advance. d. Liabilities requiring the future delivery of goods or services appear at the estimated cost of those goods and services.

The fair value of a liability cannot differ from the amount appearing on the balance sheet, particularly for long-term debt.

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings is sustainable? a. The firm recognizes an unexpected gain b. The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates. c. The firm recognizes additional expenses this period due to pre-opening costs associated with new stores. d. The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

All of the following are criteria that financial reporting requires before recognizing an obligation as a liability except: a. The transaction or event that gave rise to the obligation has already occurred. b. The firm has a present obligation and little or no discretion to avoid the transfer. c. The firm must know the precise amount of the obligation before recording it. d. The obligation involves a probable future sacrifice of economic benefits—a future transfer of cash, goods, or services, the forgoing of a future cash receipt; or the transfer of equity shares—at a specified or determinable date. The firm can measure with reasonable precision the cash-equivalent value of the resources needed to satisfy the obligation.;

The firm must know the precise amount of the obligation before recording it.

Which of the following items is consistent with earnings being informative about current performance but not informative about future earnings? a. The firm recognizes an unexpected gain b. The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates. c. The firm recognizes additional expenses this period due to pre-opening costs associated with new stores. d. The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.

Which of the following items is consistent with earnings not being informative about current performance but are informative about future earnings? a. The firm recognizes an unexpected gain b. The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates. c. The firm recognizes additional expenses this period due to pre-opening costs associated with new stores. d. The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.

Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings are not sustainable? a. The firm recognizes an unexpected gain b. The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates. c. The firm recognizes additional expenses this period due to pre-opening costs associated with new stores. d. The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.

The firm recognizes an unexpected gain

In a restructuring it is possible that managers may use the opportunity to write down assets that do not even relate directly to the restructuring action. Why might a manager decide to write down an asset that is not included in the restructuring action? a. The manager is practicing conservatism. b. The write down relieves future periods of depreciation expense, which increases cash flows. c. Normally the stock market reacts positively to restructuring and the greater the amount the better. d. The write down relieves future periods of depreciation expense, which increases earnings.

The write down relieves future periods of depreciation expense, which increases earnings.

Which of the following is not considered a motive to manage earnings? a. To create optimal manager compensation payments b. To create optimal job security for senior management c. To create optimal measures of assets and liabilities for balance sheet purposes d. To manage reported earnings in order to reduce industry-specific actions

To create optimal measures of assets and liabilities for balance sheet purposes

When evaluating the quality of accounting information, an analyst should consider all of the following except: a. reliability of the measurements made b. adequacy of disclosures c. comparability of estimates d. economic faithfulness of the measurements made

comparability of estimates

Accounting information should provide a fair and complete representation about a number of a firm's characteristics. Which of the following is not one of those characteristics? a. risk b. position c. performance d. conservatism

conservatism

The best measure of a firm's sustainable income is: a. net income. b. income from continuing operations. c. income before extraordinary items. d. income before extraordinary item and change in accounting principle.

income from continuing operations.

One definition of earnings management is that it occurs when managers use: a. judgment in financial reporting to alter financial reports to mislead stakeholder. b. an accounting method that is inconsistent with other industry members. c. more conservative accounting estimates than other companies. d. pro forma accounting results as opposed to GAAP results.

judgment in financial reporting to alter financial reports to mislead stakeholder.

On the income statement, income from discontinued operations is shown: a. as an accounting principle change. b. without any income tax effect. c. as a separate section of income from continuing operations. d. net of taxes after income from continuing operations.

net of taxes after income from continuing operations.

Which of the following does not describe an extraordinary gain or loss? a. infrequent in occurrence b. peripheral to the company's core business c. unusual in nature d. material in amount

peripheral to the company's core business

How is a disposal of a segment of the business reported? a. separately stated item on the income statement b. balance sheet c. statement of cash flows d. statement of retained earnings

separately stated item on the income statement

When a company makes a change in an estimate that it has used in its financial statements, it should account for the change by: a. retroactively restating all prior financial statements b. treat the change as a cumulative effect change in accounting estimate c. spread the effect of the change over the current and future periods d. companies are not allowed to make changes to estimates

spread the effect of the change over the current and future periods

Firm's choices and estimates within U.S. GAAP should be determined by: a. how the industry operates. b. the firm's underlying economic circumstances. c. SEC interpretations regarding specific choices. d. the firm's auditor.

the firm's underlying economic circumstances.

Income or loss from discontinued operations would best be regarded by an analyst as: a. sustainable earnings. b. impairments. c. transitory earnings. d. permanent earnings.

transitory earnings.

Under new accounting standards passed in 2006 firms must report changes in accounting principle in the current and prior years as if the new accounting principle had been applied all along. The rationale for this change was: a. using the same accounting principle in current and prior periods enhances the information content of reported earnings in forecasting future earnings. b. conservatism. c. comparability. d. materiality.

using the same accounting principle in current and prior periods enhances the information content of reported earnings in forecasting future earnings.

All of the following are typically recognized as accounting liabilities except: a. Obligations with Fixed Payment Dates and Amounts b. Obligations under Mutually Unexecuted Contracts c. Obligations Arising from Advances from Customers on Unexecuted Contracts and Agreements d. Obligations with Fixed Payment Amounts but Estimated Payment Dates

Obligations under Mutually Unexecuted Contracts

All of the following are true regarding a high quality balance sheet except: a. It should portray the economic resources that can be reasonably expected to generate future economic benefits. b. It should provide a complete and fair portrayal of all of the firm's obligations at a point in time, including the present value of long-term liabilities for future payments. c. It should minimize measurement error and bias. d. It should be optimistic in terms of accounting numbers.

It should be optimistic in terms of accounting numbers.

All of the following are typically recognized as accounting liabilities except: a. Bonds Payable b. Rental Fees Received in Advance c. Loan Guarantees d. Taxes Payable

Loan Guarantees

The assessment of earnings quality is best accomplished through the use of which one of the following? a. Balance sheet and cash flow statement. b. Single-step financial statements. c. Single-step income statement, balance sheet, and cash flow statement. d. Multi-step income statement, balance sheet, and cash flow statement.

Multi-step income statement, balance sheet, and cash flow statement.

Firms' choices and estimates within U.S. GAAP or IFRS should be determined by all of the following except: a. firms' underlying economic circumstances. b. conditions in the company's industry. c. the company's competitive strategy. d. accelerated management efforts to meet earnings projections.

accelerated management efforts to meet earnings projections.

As transitory components become a more important part of a firm's reported earnings, the reported earnings: a. are more quality enhanced. b. become a more reliable indicator of sustainable cash flows. c. are a less reliable indicator of sustainable cash flows. d. are a more reliable indicator of fundamental value.

are a less reliable indicator of sustainable cash flows.

Earnings that are high quality would: a. be informative about current performance and provide information about the long-run sustainability of profits. b. be informative about past performance and provide information about the long-run sustainability of profits. c. be informative about current performance and provide information about the long-run sustainability of assets. d. be informative about past performance and provide information about the long-run sustainability of assets and liabilities.

be informative about current performance and provide information about the long-run sustainability of profits.