Chapter 2 Quiz

At the end of the year, Red Company had retained earnings of $2,184,000. During the year, the company issued stock for $98,000 and paid dividends of $34,000. Net income for the year was $402,000. How much was the retained earnings balance at the beginning of the same year? - $1,816,000 - $1,914,000 - $2,253,000 - $2,552,000 - $2,454,000

$1,816,000 Solution: Ending retained earnings equals beginning retained earnings plus net income minus dividends. $2,184,000 = X + $402,000 - $34,000 Solve for X: Beginning retained earnings = $1,816,000. Chapter 2, Learning objective 2

Bombay Corporation had $24,000 of cash at the beginning of the year and it had cash receipts of $21,000 during the year. At the end of the year, Bombay Company had $33,000 of cash. What was Bombay Corporation's cash disbursements for the year? - $24,000 - $45,000 - $22,000 - $30,000 - $12,000

$12,000 Solution: The ending balance equals beginning cash minus cash disbursements plus cash receipts $33,000 = $24,000 + $21,000 - X Solve for X: Cash disbursements = $12,000. Chapter 2, Learning Objective 5, Pool 4

For a given company, total assets are $150,000, current liabilities are $10,000, long-term liabilities are $20,000, common stock is $50,000, and retained earnings is $70,000. How much is total stockholders' equity? - $150,000 - $120,000 - $70,000 - $140,000 - $110,000

$120,000 Solution: Stockholders' equity equals common stock plus retained earnings. Common stock of $50,000 plus retained earnings of $70,000 equals $120,000 in stockholders' equity. Assets equals liabilities plus stockholders' equity. $150,000 = $10,000 + $20,000 + X Solving for X: Stockholders' equity = $120,000 Chapter 2, Learning objective 1

At the end of the year, Green Company had retained earnings of $2,640,000. During the year, the company issued stock for $120,000 and paid dividends of $25,000. Net income for the year was $412,000. How much was the retained earnings balance at the beginning of the same year? - $1,816,000 - $1,943,000 - $2,376,000 - $2,253,000 - $2,481,000

$2,253,000 Solution: Ending retained earnings equals beginning retained earnings plus net income minus dividends. $2,640,000 = X + $412,000 - $25,000 Solve for X: Beginning retained earnings = $2,253,000. Chapter 2, Learning objective 3

Net income is $200,000, preferred dividends are $20,000, and average common shares outstanding are 50,000. How much is earnings per share? - $0.28 - $0.25 - $4.00 - $4.40 - $3.60

$3.60 Solution: Earnings per share is calculated by dividing earnings (i.e., net income) available to common stockholders ($200,000 - $20,000) by the average number of common shares outstanding (50,000) = $3.60/share. Earnings per share equals net income earned on each share of common stock. Earnings per share equals net income minus preferred dividends divided by the average number of shares outstanding. Earnings per share = ($200,000 - 20,000)/50,000 shares = $3.60/share. Chapter 2, Learning objective 2

Which of these measures is an evaluation of a company's ability to pay current liabilities? - Both earnings per share and current ratio - Earnings per share - Working capital - Both the current ratio and working capital - Current ratio

Both the current ratio and working capital Solution: The current ratio measures liquidity as current assets divided by current liabilities. Higher current ratios indicate higher liquidity. Working capital measures liquidity as current assets minus current liabilities. Higher working capital indicates higher liquidity. Chapter 2, Learning objective 4

In what order are current assets listed on a classified balance sheet? - By liquidity - By their size measured in dollars - By importance - Alphabetically - By longevity

By liquidity Solution: Current assets are listed in order of liquidity which is the order of how quickly they are expected to be converted into cash. Chapter 2, Learning objective 1

Which of the following is an indicator of profitability? - Current ratio - Debt to total assets ratio - Working capital - All of these - Earnings per share

Earnings per share Solution: The earnings per share ratio is a measure of profitability. The others are measures of solvency or liquidity. Chapter 2, Learning objective 2

What are the accounting rules that have substantial authoritative support and are recognized as a general guide for financial reporting purposes in the U. S.? - Generally accepted auditing principles - General accounting principles - Generally accepted accounting principles - Generally accepted accounting standards

Generally accepted accounting principles Solution: Learning objective 6 Generally accepted accounting principles, or "GAAP" have substantial authoritative support, and are recognized as a general guide for financial reporting purposes.

Which accounting assumption assumes that an enterprise will continue in operation long enough to carry out its existing objectives and commitments? - Economic entity assumption - Periodicity assumption - Full disclosure principle - Going concern assumption - Monetary unit assumption

Going concern assumption Solution: The going concern assumption states that the business will remain in operation for the foreseeable future. Chapter 2, Learning objective 7

How does a company compute its free cash flow? - Net cash provided by its operating activities plus (i) its expenditures on property, plant, and equipment and (ii) its dividends paid. - Net cash flow from all activities plus (i) its expenditures on property, plant, and equipment and (ii) its dividends paid. - None of these - Net cash provided by its operating activities minus (i) expenditures on property, plant, and equipment and (ii) its dividends paid. - Net cash flow from all activities minus (i) its expenditures on property, plant, and equipment and (ii) its dividends paid.

Net cash provided by its operating activities minus (i) expenditures on property, plant, and equipment and (ii) its dividends paid. Solution: Free cash flow is computed as the company's net cash provided by its operating activities minus (i) its expenditures on property, plant, and equipment and (ii) its dividends paid. Chapter 2, Learning objective 5, Pool 1

Which of the following is not classified as a current asset? - Cash - Inventory - Patents - Prepaid expenses - Accounts receivable

Patents Solution: Since patents have lives as long as 20 years, they are not usually classified as current assets. Chapter 2, Learning objective 1

Which of the following is a financial ratio classification that measures the ability of the company to survive over a long period of time? - Liquidity ratios - Analysis ratios - Profitability ratios - Solvency ratios - Financial ratios

Solvency ratios Solution: There are three well-known financial ratio classifications including (i) profitability ratios, (ii) liquidity ratios, and (iii) solvency ratios. Profitability ratios measure the income or operating success of a company for a given period of time. Liquidity ratios measure short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios measure the ability of the company to survive over a long period of time. Chapter 2, Learning objective 2

Which financial statement is used by most corporations instead of the retained earnings statement? - Statement of sources and uses - Statement of cash flows - Balance sheet - None of these - Statement of stockholders' equity

Statement of stockholders' equity Solution: Most companies use a statement of stockholders' equity instead of the retained earnings statement because the statement of stockholders' equity reports the changes in all of the stockholders' accounts. A statement of retained earnings reports only the changes in retained earnings. Chapter 2, Learning objective 3

Jose Inc. reports the following balances and amounts. The following information is presented in random order (amounts are in dollars). Accounts payable, 125,000 Accounts receivable, 140,000 Accumulated depreciation—Equipment, 60,000 Cash, 100,000 Equipment, 400,000 Intangible assets, 20,000 Inventory, 200,000 Long-term investments, 80,000 Long-term liabilities, 200,000 Notes payable (short-term), 56,000 Prepaid insurance, 2,000 Salaries and wages payable, 8,000 Short-term investments, 80,000 Stockholders' equity, 493,000 How much is its working capital? - $333,000 - $331,000 - $389,000 - $341,000 - $322,000

$333,000 Solution: Working capital is current assets minus current liabilities. Current assets = $140,000 + 100,000 + 200,000 + 2,000 + 80,000 = $522,000 Current liabilities = $125,000 + 56,000 + 8,000 = $189,000 Working capital = $522,000 - $189,000 = $333,000 Chapter 2, Learning objective 4

Riverview Inc. reports the following balances and amounts. The following information is presented in random order. Accounts payable, $60,000 Cash provided by operations, 150,000 Accounts receivable, 25,000 Net income, 50,000 Average common shares, 12,000 Salaries and wages payable, 45,000 Average current liabilities, 220,000 Stockholders' equity, 200,000 Average total assets, 500,000 Current assets, 200,000 Average total liabilities, 320,000 Current liabilities, 150,000 Dividends paid to preferred shareholders, 2,000 How much is earnings per share? - $1.80 - $1.20 - $4.00 - $2.33 - $1.50

$4.00 Solution: Earnings per share equals net income earned on each share of common stock. Earnings per share equals net income minus preferred dividends divided by the average number of shares outstanding. This company has no preferred dividends. Earnings per share = ($50,000 - 2,000)/12,000 shares = $4.00/share. Chapter 2, Learning objective 2

Pilgrim Corporation reports the following on its financial statements: Cash paid for new equipment, $35,000 Cash collected from customers, $120,000 Paid a note payable, $10,000 Cash collected in exchange for issuing additional shares of Pilgrim stock to stockholders, $15,000 Cash dividends paid, $5,000 The company reports $75,000 of net income for the year and it has $80,000 of cash at year-end. What is the company's free cash flow? - $15,000 - $45,000 - $80,000 - $35,000 - $5,000

$80,000 Solution: Free cash flow is computed by subtracting capital expenditures and cash dividends from cash provided by operations. The company has only one cash inflow or outflow from operating activities (i.e., cash collected from customers) and it has only one capital expenditure (cash paid for new equipment). Free cash flow = $120,000 - $35,000 - $5,000 = $80,000. The payment of the note payable is not an operating activity cash flow. It is a financing activity cash flow, and it is neither a capital expenditure nor a payment of a dividend so it is not used to compute free cash flow. Similarly, the cash collected from stockholders who paid for additional shares of stock is a financing activity inflow for the company, but it does not affect free cash flow. Chapter 2, Learning objective 5, Pool 2

The net cash inflow from operating activities is $200,000; cash received from issuing stock is $150,000; cash paid for capital expenditures is $90,000; cash paid for bonds held as an investment is $50,000; and cash paid for dividends is $20,000. How much is free cash flow? - $40,000 - $110,000 - $180,000 - $90,000

$90,000 Solution: Free cash flow is cash provided by operating activities minus cash paid for capital expenditures and dividends paid. Free cash flow = $200,000 - $90,000 -$20,000 = $90,000. Chapter 2, Learning objective 5

Earnings per share is computed by dividing - net income by the average common shares outstanding. - net income by the ending common shares outstanding. - net income less preferred stock dividends by the ending common shares outstanding. - net income less preferred stock dividends by the average common shares outstanding. - None of these

-net income less preferred stock dividends by the average common shares outstanding. Solution: Earnings per share is determined by dividing net income less preferred stock dividends by the average common shares outstanding. It represents the amount a company earned for each common share of stock outstanding. Chapter 2, Learning objective 1

A company purchased a tract of land on which it expects to build a factory in approximately five years. During the five years before construction, the land will be idle. In what classification should the land be reported? - An intangible asset - Property, plant, and equipment - A long-term investment - Land expense

A long-term investment Solution: Land or a building which is currently not used in operation is considered to be a long-term investment. Land being used in a business would be listed among property, plant, and equipment. Only land described as sitting idle or held as an investment should be classified as an investment. Otherwise, classify it as property, plant, and equipment. Chapter 2, Learning objective 1

A ratio summarizes the relation between selected items. Financial statement analysis (i.e., ratio analysis) focuses on the relation between certain financial statement data, such as earnings and the number of shares of common stock (i.e., earnings per share or EPS). A ratio by itself is not particularly useful. Rather, ratios tend to be compared to standards. Which of the following is a comparison facilitated by ratios when conducting a financial statement analysis (i.e., ratio analysis)? - Intracompany comparisons such as comparing two years' ratios for the same company. - None of these. - All of these. - Intercompany comparisons such as comparing a company's ratio to the ratio of a competitor in the same industry. - Industry-average comparisons such as comparing a company's ratio to an industry average.

All of these Solution: Ratios facilitate comparisons and they are frequently used to assess a company's performance. Comparisons include (i) intracompany comparisons (i.e., comparing one company to itself across time), (ii) industry-average comparisons, and (iii) intercompany comparisons (i.e., comparing one company to another company). Chapter 2, Learning objective 2

What is the primary criterion by which accounting information can be judged? - Comparability - Predictive value - Usefulness for decision making - Consistency

Usefulness for decision making Solution: Learning objective 7 Information provided must be useful to enable users to make decisions. Consistency, or the use of the same accounting principles from period to period by the same firm, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Predictive value, or the ability of information to help in predicting future results, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Comparability, or the use of the same accounting principles by two firms in the same period, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged.

Which of the following is not a characteristic of relevance? - Materiality - Confirmatory value - All of these are characteristics of relevance. - Predictive value - Verifiability

Verifiability Solution: Verifiability refers to the process or capability of being able to prove or verify that the data is free from error. This is one of the enhancing qualities of useful information. Materiality is an element of relevance. An item is material when its size make it likely to influence the decision of an investor or creditor. Confirmatory value is an element of relevance, i.e. it confirms or corrects prior expectations. Predictive value means that the information can help provide accurate expectations about the future and it is an element of relevance. Chapter 2, Learning objective 7

The principle that indicates that assets should be reported at the price received to sell an asset is the - historical cost principle. - full disclosure principle. - fair value principle. - consistency principle. - cost-benefit principle.

fair value principle Solution: The fair value principle indicates that assets and liabilities should be reported at their fair values. The fair value of an asset is the price received to sell the asset. The fair value of a liability is the amount needed to settle or pay the liability. Chapter 2, Learning objective 7

Accounting information is relevant to business decisions because it - is neutral in its representations. - has predictive value. - is prepared on an annual basis. - has been verified by external audit. - is complete

has predictive value Solution: To be useful for decision-making, accounting information needs to possess certain fundamental qualities: (i) relevance and (ii) faithful representation. Information is considered to be relevant if it provides information that has predictive value, that is, it helps provide accurate expectations about he future, and has confirmatory value (i.e., it confirms or corrects prior expectations). Materiality is another aspect of relevance. An item of information is material if its size makes it likely to influence decision-making. Faithful representation means information accurately depicts what actually happened. To provide a faithful representation, information must be complete (i.e., nothing important omitted), neutral (i.e., the information s not biased toward one position of another), and free from error. In addition to qualities of useful information, there are several enhancing qualities of useful information. These include comparability, consistency, verifiability, timeliness, and understandability. Chapter 2, Learning objective 7

The following ratios are available for Rock Inc. and Pebble Inc. Rock Inc. Pebble Inc. Current Ratio 1.8 2.1 Compared to Rock Inc., Pebble Inc. has - higher liquidity. - higher solvency. - lower profitability. - lower solvency. - lower liquidity. Current Ratio: Rock (1.8), Pebble (2.1)

higher liquidity Solution: The current ratio is computed as current assets divided by current liabilities. The current ratio measures liquidity. Higher current ratios mean the company is more liquid (i.e., better able to pay is short-term liabilities), and lower current ratios mean the company is less liquid. Chapter 2, Learning objective 4 Solution: The current ratio is computed as current assets divided by current liabilities. The current ratio measures liquidity. Higher current ratios mean the company is more liquid (i.e., better able to pay is short-term liabilities), and lower current ratios mean the company is less liquid. Chapter 2, Learning objective 4

Issuing new shares of common stock will - increase common stock. - increase retained earnings. - decrease common stock - increase liabilities. - decrease retained earnings

increase common stock. Solution: The issuance of common stock increases the common stock account; it does not affect retained earnings. Chapter 2, Learning objective 3

Materiality is important to relevance. An item is considered to be material if - it is verifiable. - the cost of reporting the item is greater than its benefits. - it is related to a tangible asset. - it doesn't costs a lot of money. - its size is likely to influence the decision of an investor or creditor

its size is likely to influence the decision of an investor or creditor Solution: Materiality is an aspect of relevance. An item of information is material if its size makes it likely to influence decision-making. Chapter 2, Learning objective 7

A company can change to a new method of accounting if management can justify that the new method results in a higher net income. a lower net income for tax purposes. more meaningful financial information. less likelihood of clerical errors.

more meaningful financial information. Solution: Learning objective 7 Management can justify a new method of accounting if the financial information is more meaningful. The manipulation of financial accounting information to increase net income is usually not ethical. The manipulation of financial accounting information to lower net income for tax planning is usually not ethical. The consistency of clerical errors indicates a requirement for training and education within the company.

The three most common financial ratio classifications used by businesses include - earnings ratios, liquidity ratios, and issue ratios. - profitability ratios, index ratios, and solvency ratios. - profitability ratios, liquidity ratios, and solvency ratios. - profitability ratios, index ratios, and solvency ratios. - profitability ratios, index ratios, and solvency ratios.

profitability ratios, liquidity ratios, and solvency ratios Solution: The three financial ratio classifications include (i) profitability ratios, (ii) liquidity ratios, and (iii) solvency ratios. Chapter 2, Learning objective 2

The periodicity assumption states - every economic entity can be separately identified and accounted for. - the business will use the same accounting procedures and methods in each period. - the life of a business can be divided into artificial time periods for financial reporting purposes. - the business will remain in operation for at least one more period. - only those things that can be expressed in monetary terms are included in the accounting records.

the life of a business can be divided into artificial time periods for financial reporting purposes. Solution: The periodicity assumption states that the life of a business can be divided into artificial time periods (such as a calendar or fiscal year or a quarter or a month) and that useful reports covering those periods can be prepared for the business. Chapter 2, Learning objective 7

The notion that the life of a business can be divided into artificial time periods for financial reporting purposes is known as - the economic entity assumption. - the historical cost principle. - the periodicity assumption. - the going concern assumption. - the monetary unit assumption.

the periodicity assumption. Solution: The periodicity assumption states that the life of a business can be divided into artificial time periods (such as a calendar or fiscal year or a quarter or a month) and that useful reports covering those periods can be prepared for the business. Chapter 2, Learning objective 7

Clawson Corporation has current assets of $3,010,000 and current liabilities of 2,150,000. If Clawson Corporation pays $200,000 of its accounts payable what will its new current ratio be? - 1.51 - 1.40 - 1.54 - 1.48 - 1.44

1.44 Solution: Current ratio equals current assets divided by current liabilities. Accounts payable is a current liability. Paying accounts payable reduces cash (i.e., current assets) and reduces accounts payable (i.e., current liabilities). Current ratio = ($3,010,000 - $200,000) / ($2,150,000 - $200,000) Current ratio = 1.44 (i.e., 1.44 to 1 or 1.44:1) Chapter 2, Learning objective 4

In what order are the following accounts and their balances listed on a classified balance sheet? - Inventories, equipment, cash, and accounts receivable. - Accounts receivable, cash, equipment, inventories. - Inventories, cash, accounts receivable, equipment. - Cash, inventories, accounts receivable, equipment. - Cash, accounts receivable, inventories, equipment.

Cash, accounts receivable, inventories, equipment. Solution: These accounts are current assets. Current assets are listed in order of their liquidity. Liquidity is the ability of an amount to be converted into cash. Cash is always listed first; it is the most liquid. Accounts receivable are very liquid; most accounts receivable will be collected within 30 days. Inventory is probably sold (or exchanged into cash) in a couple days, weeks, or months but that varies by company and industry. Equipment is property, plant, and equipment rather than a current asset. Equipment is probably not sold (or converted into cash) for several years. Chapter 2, Learning objective 1

A company using the same accounting principles and the same accounting methods from one year to the next year is an application or example of - consistency. - materiality. - verifiability. - full disclosure. - timeliness.

Consistency Solution: Consistency means that a company uses the same accounting principles and methods from year to year. Chapter 2, Learning objective 2

Which of the following are constraints that allow a company to modify generally accepted accounting principles without jeopardizing the usefulness of the financial statements? - Relevance and faithful representation - Consistency and comparability - Cost constraint - Timeliness and neutrality - Calendar constraint

Cost constraint Solution: The cost constraint states that the cost that companies incur to provide information should be weighed against the benefit that financial statement users will gain from having the information available. Consistency and comparability must be maintained to comply with GAAP. These features allow comparisons from year-to-year and within the industry. Relevance and faithful representation must be maintained to comply with GAAP. These factors insure the financial information is factual, neutral, and timely for the decision makers. Timeliness and neutrality must be maintained for GAAP. These features preclude expired information or biased information from being provided to decision makers. Chapter 2, Learning objective 7