Unit 7: Financial Reporting

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) $410,000 B) $170,000 C) $1,150,000 D) $980,000

A) $410,000 Total assets minus total liabilities equals shareholders' equity ($780,000 − $370,000 = $410,000).

What is the purpose of the Securities Exchange Act of 1934? A) It regulates the persons involved in the secondary market. B) It provides policies relating to unethical business practices. C) It provides requirements relating to new issues. D) It provides standards among the states.

A) It regulates the persons involved in the secondary market. 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.

If, during a given year, a company has net income of $1 million and pays out dividends of $800,000, its retained earnings will A) decrease by $200,000. B) decrease by $1 million. C) increase by $1 million. D) increase by $200,000.

D) increase by $200,000. Retained earnings represent the net income a company has retained and not paid out in dividends. If a company has net income of $1 million and pays out only $800,000 in dividends, its retained earnings will increase by $200,000.

An analyst wishing to check on the most recent financial performance of an SEC-registered issuer would probably examine the A) Schedule 13D B) Form 10-K C) Form 10-Q D) Form 8-K

C) Form 10-Q Financial reporting is done on Forms 10-K and 10-Q; the former on an annual, the latter, quarterly. Therefore, unless it is shortly after the end of the company's fiscal year, the most recent information is going to be on the Form 10-Q. For test-taking skill purposes, note that the question uses the term, probably. With 3 Form 10-Qs filed each year and only 1 Form 10-K, the "probability" is higher that the Form 10-Q will be the most recent one available. The moral of this story is that you don't look for exceptions unless that is what the question is aiming for.

Which of the following best describe the balance sheet formula? Assets minus liabilities equals net worth. Sales minus expenses equals operating income. Liabilities plus equity equals assets. Dividends plus retained earnings equals net income. A) II and IV B) I and IV C) I and III D) II and III

C) I and III A balance sheet basically lists what is owned (assets) and what is owed (liabilities). The difference between these two is the net worth or equity. Sales, expenses, and dividends are all found on the income statement.

The owners' equity portion of a corporation's balance sheet would contain all of the following except A) paid-in capital. B) preferred stock. C) net income. D) Treasury stock.

C) 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 reacquired 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 owners' 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.

Issuance of which of the following would most likely increase the leverage in a company's capital structure? A) Common stock B) Warrants C) Bonds D) Preferred stock

C) 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.

All of the following appear on a corporation's balance sheet as fixed assets except A) real estate. B) furniture. C) computer equipment. D) inventory.

D) inventory. Inventory is considered a current asset, not a fixed asset, because the company expects to convert its inventory into cash within a short period. The other choices are fixed assets and cannot be liquidated easily.

All of the following corporate actions would have the effect of increasing the firm's net worth except A) purchasing some of the corporation's outstanding bonds at a discount. B) issuing common stock. C) issuing convertible preferred stock. D) issuing convertible debentures.

D) issuing convertible debentures. Issuing a debt security, such as a debenture, will bring in cash (an asset) but will be offset by an equal amount: the debt. Therefore, the net worth will remain the same. Issuing any equity security, preferred or common, increases the owners' equity (net worth), while being able to pay off a debt at a discount means that the current asset (cash) went down less than the long-term liability (the bond) resulting in an increase to net worth.

A term used to describe the results of subtracting a corporation's liabilities from its assets is A) retained earnings. B) net income. C) operating income. D) owners' equity.

D) owners' equity. 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.

Under SEC rules, Form 8-K must be filed A) within 10 business days of the event B) within 4 business days of the event C) promptly D) within 15 business days of the event

B) within 4 business days of the event

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) Retiring outstanding bonds B) Retaining earnings C) Amortizing goodwill D) Depreciation on assets used in the business

A) Retiring outstanding bonds 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.

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) the annual report. B) the investor's brochure. C) the balance sheet. D) Form 10-K.

A) the annual report. 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.

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) $10 million B) $9 million C) $3 million D) $7 million

B) $9 million The ending retained earnings = beginning retained earnings + net income - dividend. That means $7 million + $3 million - $1 million = $9 million.

The SEC requires that reporting companies (those registered with the SEC) file certain information within specified time limits. Which of the following reports carries the shortest time limit? A) Annual report B) Form 8-K C) Form 10-Q D) Form 10-K

B) Form 8-K Form 8-K is used to report newsworthy events to the SEC, thereby making them available to the public. These reports must be filed within four business days of the event. Form 10-Q is a quarterly report and, depending on the size of the company, is filed within 40 to 45 days of the end of the quarter. Form 10-K is the annual report, and once again, the filing time depends on the size of the company and ranges from 60 to 90 days after the end of the fiscal year. The annual report is technically Form 10-K, although most major corporations publish an additional expanded document with pretty pictures and other information about the company.

Which of the following acts requires publicly traded corporations to issue annual reports? A) Trust Indenture Act of 1939 B) Securities Exchange Act of 1934 C) Securities Act of 1933 D) Investment Company Act of 1940

B) Securities Exchange Act of 1934 The Securities Exchange Act of 1934 mandates that public issuers file annual and quarterly reports with the SEC.

An analyst reviewing a company's financial statements would examine the footnotes to A) determine the average age of the receivables B) discover any pending legal action against the company C) compute the net worth D) identify the authors of quoted information

B) discover any pending legal action against the company Footnotes to the financial statements are used to convey "off-book" information such as pending lawsuits.

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

B) 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.

Which items would change if a company declared a cash dividend? Working capital Total assets Total liabilities Shareholders' equity A) I only B) I, II, III, and IV C) I, III, and IV D) I and IV

C) I, III, and IV 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.

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 sale of XYZ Lathe Manufacturing bonds B) The purchase of a new building to store inventory C) Payment of cash dividends D) The purchase of a new computer-driven lathe

C) Payment of cash dividends 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.

Debts that will come due more than one year after the date on the balance sheet are known as A) current liabilities. B) accounts payable. C) fixed (or long-term) liabilities. D) deferred charges.

C) fixed (or long-term) liabilities. Debts that will come due more than one year after the date on the balance sheet are known as fixed (or long-term) liabilities. Current liabilities are debts that may come due within one year from the date on the balance sheet.

Which of the following statements about balance sheets are true? Balance sheets provide a snapshot of a company's financial position on a given date. Balance sheets represent the relationship between a company's assets, liabilities, and stockholders' equity. Balance sheets provide a record of a company's earnings over a given period. A) I, II, and III B) I and III C) II and III D) I and II

D) I and II 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.

When cash flow of a business is negative, all of the following are true except A) the company might have a hard time figuring out how to cover expenses it hasn't budgeted for. B) the company might not be agile enough to respond to new opportunities. C) the company may struggle to pay its bills. D) the company will probably increase its dividend.

D) the company will probably increase its dividend. 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.

One of the components of a cash flow statement is cash flow from investing activities. Included would be A) transactions and events involving the purchase and sale of land, buildings, and equipment. B) cash receipts (money coming in) from items such as interest and dividends. C) cash proceeds from issuing stocks or bonds. D) payments to retire bonds and the payment of dividends.

A) transactions and events involving the purchase and sale of land, buildings, and equipment. 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.

When an analyst adds back the current year's depreciation to the net income, she is computing the company's A) earnings per share B) cash flow from operations C) cash flow from investments D) net value of fixed assets

B) cash flow from operations Cash flow from operations is computed by adding the year's depreciation deduction to the net income.

Balance sheets contain A) the amount of cash and cash equivalents expended during the first half of the fiscal year as opposed to the second half. B) the net worth of the firm at the end of the reporting period. C) no reference to the accounting methods used to construct the balance sheet. D) gross revenues for the year.

B) the net worth of the firm at the end of the reporting period. 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.

A commentator on a cable news show mentions that the capital structure of the Lowveh Corporation is highly leveraged. This means that the company A) has issued employee stock options. B) has very little default risk. C) has significant long-term debt. D) is in arrears on its cumulative preferred stock dividends.

C) has significant long-term debt. When describing a corporation's capital structure, leverage refers to the amount of long-term debt capital. Highly leveraged means the debt capital is generally more than 50% of the total capital and increases rather than decreases the default risk. Employee stock options and preferred stock dividends have nothing to do with leverage.

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

C) 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.

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? Tax rate Cash dividend Interest charged on bank loans A) I and III B) I only C) II only D) I and II

A) 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.

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.

A) relocation of a wholly owned subsidiary. 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.

An analyst wishing to view a good consolidated indicator of a business's cash inflow and outflow would most likely ask look at A) the statement of cash flows B) the consolidated income statement C) the working capital D) the current ratio

A) the statement of cash flows Cash flow is the money (cash) that flows into and out of a business. It consolidates the flow of money from operating activities, investing activities, and financing activities. Working capital and current ratio are indicators of current liquidity and in the income statement only reflect income and expenses. Items such as the cash received from the issuance of securities (stocks or bonds) or a loan from a bank do not appear.

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

A) II, III, and IV 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).

When a company recognizes a sale only when payment is made, it is using which form of accounting? A) Cash B) Audited C) Accrual D) Double entry

A) Cash Cash and accrual are the two major forms of accounting. In the cash method, sales and expenses are recognized when the money changes hands. With accrual accounting, it is the date of the transaction that is used.

Which of the following is not affected by the issuance of a bond? A) Working capital B) Assets C) Shareholders' equity D) Total liabilities

C) Shareholders' equity When bonds are issued, cash is received (thus increasing current assets) and long-term debt increases (increasing total liabilities). Because there is no corresponding increase in current liabilities, working capital increases. There is no effect on shareholders' equity because the increased liability is offset by the asset (cash) received.

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) a change in top management. C) a change in the external CPA firm engaged to perform the annual audit. D) acquisition of a major asset.

A) relocation of a wholly owned subsidiary. 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.