Unit 7
Balance sheets contain A) the net worth of the firm at the end of the reporting period. B) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half. C) no reference to the accounting methods used to construct the balance sheet. D) gross revenues for the year.
Answer: A) The balance sheet provides a snapshot view of the financial condition of the firm at the end of the reporting period. It does not provide information on the flow of expenses, revenues, and cash during the reporting period. Gross revenues are reflected on the income statement, not on the balance sheet. The balance sheet provides a description of the assets, liabilities, and owner's equity at the end of the reporting period. References to accounting methods used are contained in the footnotes of the balance sheet. LO 7.a
A company has filed for an initial public offering for its $10 par common stock. The IPO is priced at $35 per share. Where on the balance sheet is the extra $25 recorded? A. capital surplus B. retained earnings C. distributed dividends D. paid-in earnings
Answer: A) Capital surplus is the amount of premium paid by the shareholders above par value. It may also be called paid-in capital or paid-in surplus, but not paid-in earnings.
Current liabilities on a company's balance sheet would include A) accounts payable. B) accounts receivable. C) mortgage payable. D) prepaid rent.
Answer: A) Current liabilities are those that are expected to be paid within a normal operating cycle and would include accounts payable. A mortgage payable is a liability, but it is a long-term debt and would be included in fixed or long-term liabilities. Accounts receivable and prepaid expenses are current assets. LO 7.a
On a balance sheet, dividends payable would fall under the category of A) current liabilities. B) assets. C) stockholders' equity. D) fixed liabilities.
Answer: A) Dividends payable are dividends that have been declared but have not yet paid out. They are a type of current liability—that is, an obligation that will come due within one year from the date on the balance sheet. LO 7.a
Issuance of which of the following would most likely increase the leverage in a company's capital structure? A) Bonds B) Common stock C) Preferred stock D) Warrants
Answer: A) 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. LO 7.b
Which of the following acts requires publicly traded corporations to issue annual reports? A) Securities Exchange Act of 1934 B) Securities Act of 1933 C) Trust Indenture Act of 1939 D) Investment Company Act of 1940
Answer: A) The Securities Exchange Act of 1934 mandates that public issuers file annual and quarterly reports with the SEC. LO 7.e
Potential litigation for patent infringement would appear on a corporation's A. balance sheet as a deferred asset B. footnotes C. income statement as an expense D. statement of potential litigation
Answer: B) The footnotes to the financial statements carry information such as potential legal actions, accounting methods used, and off book debt.
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.
Answer: C) 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. LO 7.a
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 payable. B) outstanding principal balance on long-term debt. C) taxes payable. D) accounts receivable.
Answer: D) Accounts receivable are assets; all the other listings represent liabilities of the company. LO 7.a
If a publicly traded corporation was going to sell a wholly owned subsidiary, the information would be made available through the filing of Form A) 13F. B) 10-K. C) 8-K. D) 10-Q.
Answer: c) Form 8-K is filed with the SEC within four business days of any one of a number of significant actions, including the sale of a significant asset such as a wholly owned subsidiary. LO 7.e
What is the term given to the item, typically found at the bottom of a corporation's balance sheet, that describes such things as significant accounting policies, commitments made by the company, and potential liabilities and potential losses? A) Contingency statement B) Footnotes C) Offline items D) Resource material
Answer: B) Footnotes to the balance sheet, describing unusual items, are typically found at the bottom of the statement. LO 7.c
SSS Corporation's total assets amount to $780,000, of which $260,000 represents current assets. Total liabilities equal $370,000, of which $200,000 is considered long-term or other liabilities. What is SSS Corporation's shareholders' equity? A) $980,000 B) $410,000 C) $1,150,000 D) $170,000
Answer: B)_ Total assets minus total liabilities equals shareholders' equity ($780,000 − $370,000 = $410,000). LO 7.a
Federal securities laws require publicly traded companies to disclose certain information on a regular basis. Which of these forms must be submitted quarterly? A) Form 10-Q B) Form 8-K C) Form 10-K D) Form PF
Answer: A) Domestic companies must submit quarterly reports on Form 10-Q (Q for quarterly) and annual reports on Form 10-K. Form 8-K is used to report certain events, and Form PF is for private fund investment advisers. LO 7.e
Publicly traded corporations are subject to an annual audit of their financial records. Those audits must comply with GAAP (generally accepted accounting principles). When preparing to recommend a stock to a customer, you would most likely want to see that the auditor gave A) a certified opinion. B) an unqualified opinion. C) a comprehensive opinion. D) a qualified opinion.
Answer: B) An unqualified, or clean, opinion is the best type of report a business can get. The term qualified means that the auditor has some reservations about the information contained in the financial statements. LO 7.c
What is the balance sheet equation? A) Assets = liabilities − shareholders' equity B) Assets = shareholders' equity − liabilities C) Assets = net worth D) Assets = liabilities + shareholders' equity
Answer: D) Total assets equal total liabilities plus total shareholders' equity. LO 7.a
Due to changes in customer preferences, a manufacturing company has decided to discontinue the operations of one of its subsidiaries. An explanation of this decision would most likely be found in the company's A) balance sheet. B) footnotes to the financial statements. C) income statement. D) tax return.
Answer: B) Footnotes are used to explain extraordinary items such as the sale of a subsidiary. LO 7.c
If a corporation issues mortgage bonds, all of the following would be affected except A) working capital. B) shareholders' equity. C) total liabilities. D) total assets.
Answer: B) 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. LO 7.b
ABC Manufacturing Company is in the business of making high-quality machine tools. Which of the following would be included in ABC's cash flow from financing activities? A) Payment of cash dividends B) The sale of XYZ Lathe Manufacturing bonds C) The purchase of a new computer-driven lathe D) The purchase of a new building to store inventory
Answer: A) All financing activities deal with the flow of cash to or from the business owners. Who do dividends go to? The company's shareholders, and that is why they are included in financing activities. The other choices are part of cash flow from investing activities. This is a perfect example of the need to read every word in the question and answer choices. Payment of cash dividends is a financing activity while receipt of cash dividends is considered an operating activity. LO 7.d
When a corporation's accounting year ends on a date other than Dec 31st, the company is using A. a fiscal year B. a non calendar year C. a Gregorian year D. a lunar year
Answer: A) Fiscal year accounting refers to any entity ending its account year on a date other than Dec 31st. The largest user of a fiscal year is the U.S. government. For accounting purposes, the fiscal year begins on Oct 1 and ends Sept 30th.
A member of the LMP Corporation's board of directors has just resigned after a dispute with the board chair. This would be reported to the public on A. Form 8-K B. Form 10-K C. Form 10-Q D. Form D
Answer: A) Form 8-K is used to report newsworthy events to the SEC, thereby making them available to the public . Resignation of a board member over a dispute is considered newsworthy.
A corporation calls in $5 million of its outstanding 6% bonds. The call price is 103. The effect of the balance sheet is all of the following except: A. current assets decrease B. current liabilities decrease C. long-term liabilities decrease D. owners equity decreases
Answer: B) There is no change to current liabilities. Cash is used to pay for the called bonds. That reduces current assets. Those bonds, a long-term liability, are no longer on the books, so the long-term liabilities decrease. Because the company had to pay $5,150,000 to eliminate $5 million in debt, the net worth drops by an extra $150,000.
Components of a company's net worth would include all of these except A) fixed assets. B) operating income. C) inventory. D) goodwill.
Answer: B) 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. LO 7.a
An analyst is reviewing the financial statements of Penta, Ltd. Over the period shown, Penta has sales of $5 million, a net profit of $1.5 million, annual bond interest charges of $500,000, and total assets of $2 million. Penta's net profit margin is A) 35%. B) 20%. C) 25%. D) 30%
Answer: D) Profit margin = net profit ÷ sales = $1.5 million ÷ $5 million = 30%. Profit margin is based on operating costs. Because interest on bonds is a fixed expense, it is not included in the computation. As is often the case, there is more information supplied than needed. LO 7.c
Due to changes in customer preferences, a manufacturing company has decided to discontinue the operations of one of its subsidiaries. An explanation of this decision would most likely be found in the company's A) income statement. B) footnotes to the financial statements. C) tax return. D) balance sheet.
Answer: B) Footnotes are used to explain extraordinary items such as the sale of a subsidiary. LO 7.c
A publicly traded corporation keeps its books on a calendar-year basis. An investor wanting the most up-to-date financial information in late August would view the company's A. June 30th form 8-K B. June 30th form 10-Q c. Dec 31st form 10-K D. July 31st form 10-Q
Answer: B) Form 10-Q is prepared every quarter. Because this company operates on a calendar year, those quarters end in March, June, September, and December. In August, the most recent would be from June 30th form 10-Q.
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 current liability on the balance sheet. B) a fixed asset on the balance sheet. C) an expense on the income statement. D) a current asset on the balance sheet.
Answer: D) 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. LO 7.a
When a member of the board of directors of a publicly traded company resigns due to a disagreement over an operational matter, A) Form 10-K must be filed with the SEC within four business days of the event. B) the administrator must be notified no later than the close of the business day following the event. C) FINRA must be notified promptly. D) Form 8-K must be filed with the SEC within four business days of the event.
Answer: D) Form 8-K is used to report significant events of importance to investors. Examples would be the resignation of a member of the board because of an operational dispute, liquidation of a significant asset, filing for bankruptcy, or a change in management control. When any of these occur, Form 8-K must be filed with the SEC no later than four business days after the event. Form 10-K is the company's annual filing, and that is due—depending on the size of the company—60 to 90 days after the end of the fiscal year. LO 7.e
Dividends received on investments held by a corporation are part of cash flow from which activities? A. financing B. investing C. operating d. sales
Answer: c) Even though one would think this would be part of investing activities, the accounting industry puts them into operating activities.
LMN Manufacturing Company, listed on the NYSE, is an SEC reporting company. Each of the following would require the filing of Form 8-K except A) relocation of a wholly owned subsidiary. B) acquisition of a major asset. C) a change in the external CPA firm engaged to perform the annual audit. D) a change in top management.
Answer: A) Form 8-K is used to report significant events that could affect the price of the company's stock. The SEC does not consider relocation of a subsidiary to be of significant magnitude. LO 7.e
A term used to describe the results of subtracting a corporation's liabilities from its assets is A) net income. B) operating income. C) owners' equity. D) retained earnings.
Answer: C) There are several terms used on the exam to express the results of the balance sheet formula. In most cases, it will be shown as assets minus liabilities equals net worth. Net worth can also be expressed as owners' equity or shareholders' equity. Income has nothing to do with assets and liabilities, and retained earnings is a component of owners' equity. LO 7.a
What is the purpose of the Securities Exchange Act of 1934? A) It provides requirements relating to new issues. B) It provides policies relating to unethical business practices. C) It provides standards among the states. D) It regulates the persons involved in the secondary market.
Answer: D) The Securities Exchange Act of 1934 was designed to regulate securities transactions, securities markets, and securities firms that trade in the secondary market. The Securities Act of 1933 was designed to provide regulation in the new issue market. Unethical business practices are covered in NASAA's Statements of Policy on Unethical Business Practices. The Uniform Securities Act provides a model for the states. LO 7.e
Which of the following corporate actions will lead to an increase in a company's owner's equity? A. issuing $10 million of 6% $100 par preferred stock b. Issuing $10 million of 4% debentures C. payment of a cash dividend to common share holders D. redemption of outstanding debt securities at a price in excess of par value
Answer: A) Stock represents equity in a corporation; issuing additional stock is a straightforward method of increasing net worth (owners equity). Issuing a debt security brings in cash, but that is offset by the new debt. payment of a cash dividend reduces cash on hand but reduces the declared dividend current liability by an equal amount. Eliminating debt is good, but when done so at a price in excess of the par value results, is a decrease to owners equity.
An analyst comparing revenues with expenses is most likely analyzing A) cash flow. B) liquidity. C) working capital. D) capitalization.
Answer: A) The analyst is most likely measuring the income statement for cash flow (money coming in against money going out). Working capital analysis would involve examining the balance sheet's current assets and current liability entries, not the income statement. Capitalization analysis involves examination of long-term debt and stock issues. Liquidity analysis involves examining current assets and liabilities from the balance sheet. LO 7.d
Which items would change if a company declared a cash dividend? I. Working capital II. Total assets III. Total liabilities IV. Shareholders' equity A) I, III, and IV B) I only C) I, II, III, and IV D) I and IV
Answer: A) The key word is declared. Liabilities increase when a dividend is declared, and total assets decrease when it is paid. A declared dividend (but not yet paid) would increase current liabilities (and would therefore decrease working capital). It would increase total liabilities (this is a pending obligation) and reduce shareholders' equity because retained earnings would be decreased by the dividend. Total assets would not be affected until the dividend is actually paid. LO 7.a
As a result of corporate transactions, a company's assets remain the same and its equity decreases. Which of the following statements is TRUE? A. prepaid expenses decrease B. total liabilities increase C. accrued expenses decrease D. Net worth increases
Answer: B) Sometimes questions are best answered by analyzing the question before we even look at the answer choices. We are told in the question that assets have remained the same, but somehow the net worth (owners equity) has gone down. If the balance sheet formula is Assets - minus liabilities = Net worth, then somehow the liabilities must have increased. That seems to make choice B a straightforward answer, let's just check the others to be sure. Prepaid expenses are an assets haven't changed. Choice D is so simple that it seems sometimes students think it is a trick. No trick here- if owner's equity goes down, that is the net worth, so we can't choose net worth increases. Finally, accrued expenses are a liability, so if they decrease, net worth goes up, not down. Taking the question step by step tends to be logical.
Which of the following statements about balance sheets are true? I. Balance sheets provide a snapshot of a company's financial position on a given date. II. Balance sheets represent the relationship between a company's assets, liabilities, and stockholders' equity. III. Balance sheets provide a record of a company's earnings over a given period. A) I and III B) I and II C) I, II, and III D) II and III
Answer: B) A balance sheet shows a company's assets, liabilities, and stockholders' equity on a specific date. The financial statement that reflects a company's operating activities and earnings over a period of time is the income statement. LO 7.a
Current assets on a corporate balance sheet would include which of these? I. Accounts payable II. Accrued wages III. Cash IV. Inventory A) I and III B) III and IV C) I and II D) II and IV
Answer: B) Cash is the most obvious current asset. The general definition of current asset is one that is expected to be turned into cash within the year. One would certainly hope that to be true of inventory. Accounts payable and accrued wages are liabilities—obligations that must be paid on a current basis. LO 7.a
One of the components of a cash flow statement is cash flow from investing activities. Included would be A) cash proceeds from issuing stocks or bonds. B) transactions and events involving the purchase and sale of land, buildings, and equipment. C) payments to retire bonds and the payment of dividends. D) cash receipts (money coming in) from items such as interest and dividends.
Answer: B) Investing activities include transactions and events involving the purchase and sale of securities, land, buildings, equipment, and other assets not generally held for resale as a product of the business. The proceeds from issuing securities (stocks or bonds) is a financing activity, as is using funds to retire bonds and/or pay dividends. Cash receipts are included in cash flow from operating activities, even when generated through investments such as interest or dividends. LO 7.d
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 will be the ending retained earnings? A) $7 million B) $9 million C) $3 million D) $10 million
Answer: B) The ending retained earnings = beginning retained earnings + net income - dividend. That means $7 million + $3 million - $1 million = $9 million. LO 7.c
A fundamental analyst would be interested in funds available for use in the business. Doing which of the following would have the greatest impact on future cash flow? A) Depreciation on assets used in the business B) Retiring outstanding bonds C) Retaining earnings D) Amortizing goodwill
Answer: B) The retirement of outstanding bonds means that there will be no future interest payments made. Because a major component of cash flow is a company's net income, this reduced expense would lead to increased income resulting in higher cash flow. LO 7.d
The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is A) reported as cash income on the income statement. B) the net change in the cash position of the firm for the reporting period. C) reported as a separate line item on the balance sheet. D) an integral part of the footnotes to the balance sheet required by generally accepted accounting principles.
Answer: B) The total of the cash from operations, investing, and financing, as reported on the statement of cash flows, is the net change in the cash position of the firm for the reporting period. The sum total, or the net change in cash, is not reported on either the balance sheet or the income statement. It is the sum total of the entries on the statement of cash flows, which is a separate financial statement. LO 7.d
If a corporation issues mortgage bonds, all of the following would be affected except A) working capital. B) shareholders' equity. C) total assets. D) total liabilities.
Answer: B) 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. LO 7.b
ABC Manufacturing Company is in the business of making high-quality machine tools. Which of the following would be included in ABC's cash flow from financing activities? A) The purchase of a new computer-driven lathe B) The sale of XYZ Lathe Manufacturing bonds C) Payment of cash dividends D) The purchase of a new building to store inventory
Answer: C) All financing activities deal with the flow of cash to or from the business owners. Who do dividends go to? The company's shareholders, and that is why they are included in financing activities. The other choices are part of cash flow from investing activities. This is a perfect example of the need to read every word in the question and answer choices. Payment of cash dividends is a financing activity while receipt of cash dividends is considered an operating activity. LO 7.d
Publicly traded corporations are generally required to have an annual independent audit of their financial records. What is the highest opinion offered under GAAP? A) Adverse opinion B) Disclaimer of opinion C) Unqualified opinion D) Qualified opinion
Answer: C) An unqualified or "clean" opinion is the best type of report a business can get. The term qualified means that the auditor has some reservations about the information contained in the financial statements. An adverse opinion means the auditor is not willing to vouch for the accuracy of the information. Note: This question deals with material not covered in your LEM, but it relates to recent rule changes and/or student feedback. LO 7.c
One of the best sources of financial information is found in the reports required to be filed with the SEC by publicly traded companies. The easiest way to access this information is by A) visiting the SEC's offices. B) writing a letter to the company. C) using EDGAR. D) making an appointment to meet with the company's CFO
Answer: C) EDGAR stands for Electronic Data Gathering, Analysis, and Retrieval. It is the easiest (and surely the fastest) way to obtain all of the financial information filed by reporting companies. It is available at SEC.gov. LO 7.e
Those investors wishing to examine a document that would probably give them the most information about a corporation's current and planned operations would seek out A) Form 10-K. B) the balance sheet. C) the annual report. D) the investor's brochure.
Answer: C) The annual report to shareholders contains not only a complete financial report of the prior year's operations but also a statement from key personnel dealing with the company's future plans. Form 10-K does not include discussion of future business plans—it is a report of what happened over the previous fiscal year. LO 7.e
When cash flow of a business is negative, all of the following are true except A) the company may struggle to pay its bills. B) the company might have a hard time figuring out how to cover expenses it hasn't budgeted for. C) the company will probably increase its dividend. D) the company might not be agile enough to respond to new opportunities.
Answer: C) The basic definition of negative cash flow is when a business does not have enough cash on hand to pay its immediate outstanding bills. It certainly would not be the time to increase its dividend. In fact, the dividend might be cut or even eliminated. Negative cash flow may also lead to the company being unable to take advantage of a business opportunity and meeting emergencies. LO 7.d
All the following are measurements of cash flow except: A. cash flow from financing activities B. cash flow from investing activities C. cash flow from operating activities D. cash flow from sales activities
Answer: D) Although sales (revenues) are critical components of cash flow, there are no measurements using that term. Sales (revenues) are included in cash flow from operating activities.
Which items change when a company pays a cash dividend? I. Working capital II. Total assets III. Total liabilities IV. Shareholders' equity A) II, III, and IV B) I, II, and III C) I and IV D) II and III
Answer: D) 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). LO 7.b
