Fiancial Reporting-Unit 9
An analyst is viewing financial statements of Diderot Clothing Stores (DCS), a chain of high-fashion women's apparel. DCS had $7 million as its beginning-of-year retained earnings and it made post-tax profits of $3 million. The board of directors decides to pay a dividend of $1 million. Once paid, what would be the ending retained earnings? A) $9 million B) $10 million C) $7 million D) $3 million
A) $9 million The ending retained earnings = beginning retained earnings + net income - dividend. That means $7 million + $3 million - $1 million = $9 million.
Which of the following would appear as assets on a corporation's balance sheet? I. Prepaid expenses II. Deferred tax credits III. Notes payable IV. Notes receivable A) I and IV B) I, II, and IV C) I and III D) II and III
A) I and IV Prepaid expenses, such as advertising, rent, or insurance, are listed as assets on the balance sheet. All receivables are assets, while payables are liabilities. Under current accounting practice, deferred tax credits are treated as a liability.
Due to changes in market rates, a corporation is able to purchase some of its outstanding 20-year bonds at a discount. Which of the following is CORRECT? I. Working capital is increased. II. Working capital is reduced. III. Net worth is increased. IV. Net worth is reduced. A) II and III B) II and IV C) I and IV D) I and III
A) II and III Even though the bonds are purchased for less than par value, working capital is reduced because the company is using a current asset—cash—to pay off a long-term liability. However, the fact that it is reducing its debt for less than the amount shown on the books will result in an increase to net worth.
A fundamental analyst is reviewing a company's financial statements. When attempting to determine their debt exposure, all of the following would be included EXCEPT A) accounts receivable B) taxes payable C) outstanding principal balance on long-term debt D) accounts payable
A) accounts receivable Accounts receivable are assets; all the other listings represent liabilities of the company.
Issuance of which of the following would most likely increase the leverage in a company's capital structure? A) Warrants B) Bonds C) Common stock D) Preferred stock
B) Bonds Leverage is the use of borrowed money. This is reflected in a company's debt-to-equity ratio. Of these choices, the only one that is borrowed money is the bonds.
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? I. Tax rate II. Cash dividend III. Interest charged on bank loans A) I and II B) I and III C) II only 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.
Which of the following acts requires publicly traded corporations to issue annual reports? A) Investment Company Act of 1940 B) Securities Exchange Act of 1934 C) Trust Indenture Act of 1939 D) Securities Act of 1933
B) Securities Exchange Act of 1934 The Securities Exchange Act of 1934 mandates that public issuers file annual and quarterly reports with the SEC.
Which items change when a company pays a cash dividend? I. Working capital II. Total assets III. Total liabilities IV. Shareholders' equity A) I, II, and III B) II, III, and IV C) II and III D) I and IV
C) 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).
The issuance of a long-term debt instrument, such as a bond, by a company would have an immediate effect on which of the following balance sheet items? I. Total assets II. Total liabilities III. Working capital IV. Shareholders' equity A) I, III, and IV B) II, III, and IV C) I, II, and IV D) I, II, and III
D) I, II, and III The cash received from the sale of the bonds is a current asset of the company, and as such would increase assets and working capital on the balance sheet. The bonds are debt of the company and would increase the liabilities of the company. Shareholders' equity is only affected by gains, losses, new invested capital, and the declaration of cash distributions (dividends) to shareholders.
When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) cash flow from investments. B) earnings per share. C) net value of fixed assets. D) cash flow from operations.
D) cash flow from operations. Cash flow from operations is computed by adding the year's depreciation deduction to the net income.
The owners' equity portion of a corporation's balance sheet would contain all of the following except A) preferred stock. B) paid-in capital. C) Treasury stock. D) net income.
D) net income. Net income is only found on the income statement. The other three are part of stockholders' equity (net worth). Treasury stock is company stock that has been issued to the public and then re-acquired by the issuer (the company). It appears as a negative number so it reduces the net worth (owners' equity). Note, even though the Treasury stock reduces the owner's equity, the question is asking for the items you would see in the owners' equity section on the balance sheet and, if it exists, it would appear there as a deduction.