26. Understanding the Balance Sheet (Sch, CFA)

At the beginning of the year, Company P purchased 1,000 shares of Company S for $80 per share. During the year, Company S paid a dividend of $4 per share. At the end of the year, Company S's share price was $75. 1. What amount should Company P report on its balance sheet at year-end if the investment in Company S is considered a trading security, and what amount should be reported if the investment is considered an available-for-sale security? Trading=======Available-for-sale A. $75,000=====$75,000 B. $75,000=====$80,000 C. $80,000=====$80,000 2. What amount of investment income should Company P recognize in its income statement if the investment in Company S is considered trading, and what amount should be recognized if the investment is considered available-for-sale? Trading=======Available-for-sale A. ($1,000)=====($1,000) B. ($1,000)=====$4,000 C. ($5,000)=====$4,000

1. A Both trading securities and available-for-sale securities are reported on the balance sheet at their fair values. At year-end, the fair value is $75,000 [$75 per share x 1,000 shares]. 2. B A loss of $1,000 is recognized if the securities are considered trading securities ($4 dividend x $1,000 shares) - ($5 unrealized loss x 1,000 shares). Income is $4,000 if the investment in Company S is considered available-for-sale [$4 dividend x $1,000].

A vertical common-size balance sheet expresses each category of the balance sheet as a percentage of: A. assets. B. equity. C. revenue.

A Each category of the balance sheet is expressed as a percentage of total assets.

Which of the following inventory valuation methods is required by the accounting standard-setting bodies? A. Lower of cost or net realizable value. B. Weighted average cost. C. First-in, first-out.

A Inventories are required to be valued at the lower of cost or net realizable value (or "market" under US GAAP) FIFO and average cost are two of the inventory cost flow assumptions among which a firm has a choice.

Century Company Balance Sheet (in millions) ========================20X7======20X6 Current assets============$340======$280 Noncurrent assets=========$660======$630 Total assets==============$1,000=====$910 Current liabilities==========$170======$110 Noncurrent liabilities=======$50=======$50 Total liabilities============$220======$160 Equity===================$780=======$750 Total liabilities and equity===$1.000======$910 Century's balance sheet presentation is known as a(n)? A. classified balance sheet. B. liquidity-based balance sheet. C. account form balance sheet.

A A classified balance sheet groups together similar items (e.g., current and noncurrent assets and liabilities) to arrive at significant subtotals.

Miller Corporation has 160,000 shares of common stock authorized. There are 92,000 shares issued and 84,000 shares outstanding. How many shares of treasury stock does Miller own? A. 8,000. B. 68,000. C. 76,000.

A The difference between the issued shares and the outstanding shares is the treasury shares.

Equity equals: A. Assets- Liabilities. B. Liabilities- Assets. C. Assets + Liabilities.

A is correct Assets = Liabilities + Equity' and, therefore. Assets- Liabilities = Equity

Distinguishing between current and non-current items on the balance sheet and presenting a subtotal for current assets and liabilities is referred to as: A. a classified balance sheet. B. an unclassified balance sheet C. a liquidity-based balance sheet

A is correct. A classified balance sheet is one that classifies assets and liabilities as current or non-current and provides a subtotal for current assets and current liabilities. A liquidity-based balance sheet broadly' presents assets and liabilities in order of liquidity

Debt due within one year is considered: A. current. B. preferred. C. convertible.

A is correct. Current liabilities are those liabilities, including debt, due within one year. Preferred refers to a class of stock. Convertible refers to a feature of bonds (or preferred stock) allowing the holder to convert the instrument into common stock.

For financial assets classified as held to maturity, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through retained earnings. C. They are a component of accumulated other comprehensive income

A is correct. Financial assets classified as held to maturity are measured at amortised cost. Gains and losses are recognized only when realized.

The initial measurement of goodwill is most likely affected by: A. an acquisition's purchase price. B. the acquired company's book value. C. the fair value of the acquirer's assets and liabilities

A is correct. Initially, goodwill is measured as the difference between the purchase price paid for an acquisition and the fair value of the acquired, not acquiring, company's net assets (identifiable assets less liabilities).

The most stringent test of a company's liquidity is its: A. cash ratio. B. quick ratio. C. current ratio.

A is correct. The cash ratio determines how much of a company's near-term obligations can be settled with existing amounts of cash and marketable securities.

An investor concerned whether a company can meet its near-term obligations is most likely to calculate the: A. current ratio. B. return on total capital. C. financial leverage ratio.

A is correct. The current ratio provides a comparison of assets that can be turned into cash relatively quickly and liabilities that must be paid within one year. The other ratios are more suited to longer-term concerns.

SF Corporation has created employee goodwill by reorganizing its retirement benefit package. An independent management consultant estimated the value of the goodwill at $2 million. In addition, SF recently purchased a patent that was developed by a competitor. The patent has an estimated useful life of five years. Should SF report the goodwill and patent on its balance sheet? Goodwill====Patent A. Yes========No B. No========Yes C. No========No

B Goodwill developed internally is expensed as incurred. The purchased patent is reported on the balance sheet.

At the beginning of the year, Parent Company purchased all 500,000 shares of Sub Incorporated for $15 per share. Just before the acquisition date, Sub's balance sheet reported net assets of$6 million. Parent determined the fair value of Sub's property and equipment was $1 million higher than reported by Sub. What amount of goodwill should Parent report as a result of its acquisition of Sub? A. $0. B. $500,000. C. $1,500,000.

B Purchase price of $7,500,000 [$15 per share x 500,000 shares] - fair value of net assets of $7,000,000 [$6,000,000 book value + $1,000,000 increase in property and equipment] = goodwill of $500,000.

Investment in Beta Company, at fair value====$150,000 Deferred taxes==========================$86,000 Common stock, $1 par value==============$550,000 Preferred stock, $100 par value============$175,000 Retained earnings=======================$893,000 Accumulated other comprehensive income====$46,000 The investment in Beta Company had an original cost of $120,000. Assuming the investment in Beta is classified as available-for-sale, Alpha's total owners' equity at year-end is closest to: A. $1,618,000. B. $1,664,000. C. $1,714,000.

B Total stockholders' equity consists of common stock of $550,000, preferred stock of $175,000, retained earnings of $893,000, and accumulated other comprehensive income of $46,000, for a total of $1,664,000. The $30,000 unrealized gain from the investment in Beta is already included in accumulated other comprehensive income.

Resources controlled by a company as a result of past events are: A. equity. B. assets. C. liabilities.

B is correct Assets are resources controlled by a company as a result of past events.

Which of the following would an analyst most likely be able to determine from a common-size analysis of a company's balance sheet over several periods? A. An increase or decrease in sales. B. An increase or decrease in financial leverage. C. A more efficient or less efficient use of assets.

B is correct. Common-size analysis (as presented in the reading) provides information about composition of the balance sheet and changes over time. As a result, it can provide information about an increase or decrease in a company's financial leverage.

For financial assets classified as trading securities, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through income into retained earnings. C. They are a component of accumulated other comprehensive income.

B is correct. For financial assets classified as trading securities, unrealized gains and losses are reported on the income statement and flow to shareholders' equity as part of retained earnings.

All of the following are current assets except: A. cash. B. goodwill. C. inventories.

B is correct. Goodwill is a long-term asset, and the others are all current assets.

When a company buys shares of its own stock to be held in treasury, it records a reduction in: A. both assets and liabilities. B. both assets and shareholders' equity. C. assets and an increase in shareholders' equity'.

B is correct. Share repurchases reduce the company's cash (an asset). Shareholders' equity is reduced because there are fewer shares outstanding and treasury stock is an offset to owners' equity.

Money received from customers for products to be delivered in the future is recorded as: A- revenue and an asset. B. an asset and a liability. C. revenue and a liability.

B is correct. The cash received from customers represents an asset. The obligation to provide a product in the future is a liability called "unearned income" or "unearned revenue." As the product is delivered, revenue will be recognized and the liability will be reduced.

The non-controlling (minority') interest in consolidated subsidiaries is presented on the balance sheet: A. as a long-term liability. B. separately, but as a part of shareholders' equity. C. as a mezzanine item between liabilities and shareholders' equity.

B is correct. The non-controlling interest in consolidated subsidiaries is shown separately as part of shareholders' equity.

Using the information presented in Exhibit 4, the quick ratio for SAP Group at 31 December 2009 is closest to: A. 1.01. B. 1.44. C. 1.54.

B is correct. The quick ratio ([Cash + Marketable securities + Receivables] / Current liabilities) is 1.44 (J= 1,884 + 486 + 2,546] / 3,416). Given the placement of other financial assets between cash and receivables, it is reasonable to assume these are highly liquid and are probably marketable securities.

Which of the following would most likely result in a current liability? A. Possible warranty claims. B. Future operating lease payments. C. Estimated income taxes for the current year.

C Estimated income taxes for the current year are likely reported as a current liability. To recognize the warranty expense, it must be probable, not just possible. Future operating lease payments are not reported on the balance sheet.

How should the proceeds received from the advance sale of tickets to a sporting event be treated by the seller, assuming the tickets are nonrefundable? A. Unearned revenue is recognized to the extent that costs have been incurred. B. Revenue is recognized to the extent that costs have been incurred. C. Revenue is deferred until the sporting event is held.

C The ticket revenue should not be recognized until it is earned. Even though the tickets are nonrefundable, the seller is still obligated to hold the event.

Which of the following is most likely an essential characteristic of an asset? A. An asset is tangible. B. An asset is obtained at a cost. C. An asset provides future benefits.

C An asset is a future economic benefit obtained or controlled as a result of past transactions. Some assets are intangible (e.g., goodwill), and others may be donated.

Which of the following statements about analyzing the balance sheet is most accurate? A. The value of the firm's reputation is reported on the balance sheet at amortized cost. B. Shareholders' equity is equal to the intrinsic value of the firm. C. The balance sheet can be used to measure the firm's capital structure.

C The balance sheet lists the firm's assets, liabilities, and equity. The capital structure is measured by the mix of debt and equity used to finance the business.

Which of the following ratios are used to measure a firm's liquidity and solvency? Liquidity==================Solvency A. Current ratio============Quick ratio B. Debt-to-equity ratio ======Financial leverage ratio C. Cash ratio==============Total debt ratio

C The current ratio, quick ratio, and cash ratio measure liquidity. Debt-to-equity, the total debt ratio, and the financial leverage ratio measure solvency

Accrued expenses (accrued liabilities) are: A. expenses that have been paid. B. created w hen another liability is reduced. C. expenses that have been reported on the income statement but not yet paid.

C is correct. Accrued liabilities are expenses that have been reported on a company's income statement but have not yet been paid.

For financial assets classified as available for sale, how are unrealized gains and losses reflected in shareholders' equity? A. They are not recognized. B. They flow through retained earnings. C. They are a component of accumulated other comprehensive income.

C is correct. For financial assets classified as available for sale, unrealized gains and losses are not recorded on the income statement and instead are part of other comprehensive income. Accumulated other comprehensive income is a component of Shareholders' equity

Defining total asset turnover as revenue divided by average total assets, all else equal, impairment write-downs of long-lived assets owned by a company will likely result in an increase for that company most in: A. the debt-to-equity ratio but not the total asset turnover. B. the total asset turnover but not the debt-to-equity ratio. C. both the debt-to-equity ratio and the total asset turnover.

C is correct. Impairment write-downs reduce equity in the denominator of the debt-to-equity ratio but do not affect debt, so the debt-to-equity ratio is expected to increase. Impairment write-downs reduce total assets but do not affect revenue. Thus, total asset turnover is expected to increase.

When a company pays its rent in advance, its balance sheet will reflect a reduction in: A. assets and liabilities. B. assets and shareholders' equity. C. one category of assets and an increase in another.

C is correct. Paying rent in advance will reduce cash and increase prepaid expenses, both of which are assets.

An investor worried about a company's long-term solvency would most likely examine its: A. current ratio. B. return on equity. C. debt-to-equity ratio.

C is correct. The debt-to-equity ratio, a solvency ratio, is an indicator of financial risk.

Using the information presented in Exhibit 12, the financial leverage ratio for SAP Group at 31 December 2009 is closest to: A. 0.08. B. 0.58. C. 1.58

C is correct. The financial leverage ratio (Total assets Total equity) is 1.58 (= 13,374 + 8,491).

The item "retained earnings" is a component of: A. assets. B. liabilities. C. shareholders' equity

C is correct. The item "retained earnings" is a component of shareholders' equity.

The carrying value of inventories reflects: A. their historical cost. B. their current value. C. the lower of historical cost or net realizable value.

C is correct. Under IFRS, inventories are carried at historical cost, unless net realizable value of the inventory is less. Under US GAAP, inventories are carried at the lower ofcost or market.