Unit 7

KPT, Inc., is preparing to report its net income for the past year. An increase in which of the following causes a decrease in the reported net income? 1. Tax rate 2. Cash dividend 3. Interest charged on bank loans A) II only B) I and III C) I and II D) I only

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

Looking at the balance sheet, a corporation builds its capital structure with all of the following except A) long-term debt. B) capital stock. C) cash. D) retained earnings.

C) cash. A corporation's capital structure consists of its long-term debt plus shareholders' equity. Included in shareholders' equity are the equity capital (stock) and the retained earnings.

An IAR is doing some research on a company. When viewing the corporation's financial statements, prepaid expenses would most likely be found as A) a fixed asset on the balance sheet. B) an expense on the income statement. C) a current liability on the balance sheet. D) a current asset on the balance sheet.

D) a current asset on the balance sheet. Prepaid expenses, such as rent, insurance, and postage, are considered current assets and are shown as such, sometimes under the listing "other assets." The amounts paid for those expenses will not appear on the income statement until the specific item is actually used. For example, if a company pays its property insurance premiums six months in advance, it isn't until the next premium is paid that the prepaid expense comes off the balance sheet and is reflected as an actual expense.

Components of a company's net worth would include all of these except A) fixed assets. B) inventory. C) goodwill. D) operating income.

D) operating income. Net worth is all of the company's assets minus its liabilities as found on the balance sheet. Operating income is found on the income statement and is neither an asset nor a liability

A client asks her investment adviser representative what footnotes to the financial statements are for. The best reply would be that footnotes A) serve as a bibliography indicating where additional information may be obtained. B) are used to explain how the various ratios are computed because companies recognize that many shareholders do not have a financial background. C) contain a detailed history of the enterprise and its products or services. D) contain information that doesn't have a place in the main body of the financial statements.

D) contain information that doesn't have a place in the main body of the financial statements. There are many important financial details that cannot be properly placed in either the balance sheet or the income statement. Examples of these are method of accounting used, collateral securing debt, pension liabilities, and many others. Footnotes are an integral part of the financial statements and are usually found with this notation: "The accompanying footnotes to the financial statements are an integral part of these statements."

If a corporation issues mortgage bonds, all of the following would be affected except A) total assets. B) working capital. C) total liabilities. D) shareholders' equity.

D) shareholders' equity. When issued, the corporation receives the net proceeds in cash, increasing current assets (and thus total assets). Simultaneously, the corporation's long-term liabilities increase, reflecting the debt (and thus total liabilities). Working capital increases because of the increase in current assets. Shareholders' equity, or net worth, is only affected by the sale of new equity securities or by any profit or loss generated by the corporation.

Which items change when a company pays a cash dividend? 1. Working capital 2. Total assets 3. Total liabilities 4. Shareholders' equity A) II, III, and IV B) I, II, and III C) I and IV D) II and III

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