Lecture Notes Review: Financial Statements and Concepts

These flashcards cover key concepts and questions from the lecture on financial statements and accounting principles.

What is one of the four basic financial statements that is NOT included? A) Income Statement; B) Balance Sheet; C) Statement of Cash Flows; D) Audit report

D) Audit report. The four basic financial statements are the Income Statement, Balance Sheet, Statement of Cash Flows, and Statement of Stockholders' Equity. An audit report is an independent opinion on these statements, not one of the statements themselves.

According to the audit report, who holds primary responsibility for a company's financial statements? A) External auditors; B) The company's management; C) The Board of Directors; D) Stockholders

B) The company's management. Management is responsible for the preparation and fair presentation of the financial statements in accordance with GAAP, including the design and implementation of internal controls.

Which organization creates U.S. GAAP? A) Securities and Exchange Commission (SEC); B) Internal Revenue Service (IRS); C) Financial Accounting Standards Board (FASB); D) Governmental Accounting Standards Board (GASB)

C) Financial Accounting Standards Board (FASB). GAAP (Generally Accepted Accounting Principles) are the common set of accounting principles, standards, and procedures that companies must follow when compiling their financial statements. The FASB is the authoritative body that sets these standards in the U.S.

Which statement about retained earnings is false? A) Retained earnings represents accumulated profits not distributed as dividends; B) Retained earnings is increased by net income and decreased by dividends; C) Retained earnings is an asset on the balance sheet; D) Retained earnings is a component of stockholders' equity

C) Retained earnings is an asset on the balance sheet. Retained earnings is an equity account on the balance sheet, representing the cumulative net income of a company that has been retained for reinvestment in the business rather than being paid out as dividends. Assets are economic resources owned by the company.

Which of the following is NOT one of the four required items in the heading of a financial statement? A) The financial statement preparer's name; B) The title of the financial statement; C) The unit of measure; D) The auditor's opinion

D) The auditor's opinion. The four required items in the heading of a financial statement are: 1) The name of the entity; 2) The title of the financial statement; 3) The specific date or period of time covered; and 4) The unit of measure (e.g., in thousands of dollars).

What is the primary purpose of the statement of cash flows? A) To report assets, liabilities, and equity at a point in time; B) To report revenues and expenses over a period; C) To separate cash inflows and outflows into operating, investing, and financing categories; D) To show changes in stockholders' equity

C) To separate cash inflows and outflows into operating, investing, and financing categories. Operating activities relate to the primary business operations, investing activities involve buying and selling long-term assets, and financing activities relate to debt and equity transactions.

Which of the following is NOT a typical note in an annual report? A) A note discussing accounting policies; B) A note detailing segments of the business; C) A note describing contingencies; D) A note describing the auditor's opinion of the management's past and future financial planning

D) A note describing the auditor's opinion of the management's past and future financial planning. Notes to financial statements provide additional details that help users understand the financial statements, such as significant accounting policies, contingencies, and segment information. The auditor's opinion is presented in the separate audit report and does not comment on management's future financial planning.

What is another common name for the income statement? A) Balance Sheet; B) Statement of Cash Flows; C) Statement of Operations; D) Statement of Financial Position

C) Statement of Operations. The income statement, also known as the statement of operations, reports a company's financial performance (revenues, expenses, gains, and losses) over a specific accounting period, resulting in net income or loss.

The balance sheet represents the amount of assets, liabilities, and stockholders' equity: A) Over a period of time; B) At a specific point in time; C) From operating activities only; D) For future projections only

B) At a specific point in time. The balance sheet provides a 'snapshot' of a company's financial position (assets, liabilities, and equity) on a particular date, unlike the income statement or statement of cash flows which cover a period of time.

Which of the following is true regarding changes in GAAP? A) Changes in GAAP only affect auditors; B) Changes in GAAP only affect stockholders; C) Changes in GAAP can affect the interests of managers and stockholders; D) Changes in GAAP are rare and insignificant

C) Changes in GAAP can affect the interests of managers and stockholders. New accounting standards can alter how a company's financial performance or position is reported, which in turn can influence management's compensation, debt covenants, and stockholders' perception of the company's value and future prospects.

If a publicly traded company is maximizing its perceived value, what might it understate on its balance sheet to potentially mislead stakeholders? A) Common Stock; B) Bonds Payable; C) Retained Earnings; D) Accounts Payable

C) Retained Earnings. Retained Earnings represents the cumulative profits that a company has kept for reinvestment rather than distributing them as dividends. While generally higher retained earnings indicate a stronger financial position, a company seeking to mislead or manage perceptions might manipulate this figure to influence opinions about its dividend policy, growth potential, or capital structure, though understating it typically would decrease perceived equity value.

Which of the following is NOT considered an asset? A) Cash; B) Accounts Receivable; C) Additional Paid-in Capital; D) Inventory

C) Additional Paid-in Capital. An asset is an economic resource expected to provide future economic benefits. Additional Paid-in Capital (also known as Capital in Excess of Par Value) is an equity account that represents the amount of cash or other assets shareholders contributed above the par value of common stock, and it is not an asset itself.

Which concept is best described as having at least two effects on the basic accounting equation? A) The periodicity concept; B) The revenue recognition principle; C) The matching principle; D) The dual-effects concept

D) The dual-effects concept. Also known as double-entry accounting, this concept states that every transaction affects at least two accounts in the accounting equation (Assets = Liabilities + Stockholders' Equity) to keep the equation in balance. For example, if cash (an asset) increases, another asset might decrease, or a liability or equity account might increase.

How are assets typically listed on the balance sheet? A) From least liquid to most liquid; B) Alphabetically; C) From largest dollar amount to smallest; D) From most liquid to least liquid

D) From most liquid to least liquid. Liquidity refers to how quickly an asset can be converted into cash without significant loss in value. Therefore, on the balance sheet, current assets like Cash and Accounts Receivable are listed before less liquid long-term assets like Property, Plant, and Equipment.

Given a Cash beginning balance of 21,000, with 100,000 in debits and 110,000 in credits, what is the ending balance of Cash? A) 11,000 debit balance; B) 11,000 credit balance; C) 31,000 debit balance; D) 31,000 credit balance

A) 11,000 debit balance. Cash is an asset and has a normal debit balance. The calculation is: Beginning Balance 21,000 (debit) + Debits 100,000 - Credits 110,000 = Ending Balance 11,000 (debit).

Which of the following statements regarding the balance sheet is true? A) All assets, including internally generated goodwill, are reported; B) Certain internally generated assets are not reported on a company's balance sheet; C) The balance sheet reports performance over a period; D) The balance sheet only includes tangible assets

B) Certain internally generated assets are not reported on a company's balance sheet. For example, internally generated goodwill, brand names, and patents developed internally are generally not recognized as assets on the balance sheet because their costs are expensed as incurred, and their fair value is difficult to measure reliably without an external transaction.

If The Gap, Inc. has a current ratio of 1.41, what does this generally suggest about its financial health? A) It has poor profitability; B) It has excessive debt; C) It suggests that The Gap has sufficient liquidity; D) It reflects strong long-term growth

C) It suggests that The Gap has sufficient liquidity. The current ratio (Current Assets / Current Liabilities) measures a company's ability to meet its short-term obligations. A ratio of 1.41 means the company has 1.41 times more current assets than current liabilities, indicating a healthy capacity to cover its short-term debts.

Which of the following is NOT typically classified as a financing activity on the statement of cash flows? A) Issuing new stock; B) Paying dividends; C) When the company lends money; D) Repaying a loan

C) When the company lends money. Financing activities relate to transactions involving debt and equity capital (getting cash from owners/creditors, repaying creditors, or returning cash to owners). Lending money to another entity is considered an investing activity because it involves the purchase or sale of investments.

If 250,000 in operating expenses are incurred and 150,000 is paid in cash, how does this accounting event impact the financial statements? A) Decrease stockholders' equity by 250,000; decrease assets by 150,000; increase liabilities by 100,000; B) Decrease stockholders' equity by 150,000; decrease assets by 150,000; C) Decrease assets by 250,000; increase liabilities by 100,000; D) Decrease stockholders' equity by 100,000; decrease assets by 150,000; increase liabilities by 50,000

A) Decrease stockholders' equity by 250,000; decrease assets by 150,000; increase liabilities by 100,000. Incurring 250,000 of expense decreases Stockholders' Equity by 250,000. Paying 150,000 in cash decreases Assets (Cash) by 150,000. The remaining 100,000 expense not yet paid increases Liabilities (e.g., Accounts Payable or Accrued Expenses Payable) by 100,000. The accounting equation remains balanced: (Assets - 150,000) = (Liabilities + 100,000) + (Equity - 250,000) .

When a law firm receives a 2,000 retainer for services to be performed in the future, what is the correct journal entry? A) Debit Cash, 2,000; Credit Service Revenue, 2,000; B) Debit Accounts Receivable, 2,000; Credit Unearned Revenue, 2,000; C) Debit Cash, 2,000; Credit Unearned Revenue, 2,000; D) Debit Unearned Revenue, 2,000; Credit Cash, 2,000

C) Debit Cash, 2,000; Credit Unearned Revenue, 2,000. Receiving cash for services not yet performed increases the asset Cash (debit) and creates a liability, Unearned Revenue (credit), representing the obligation to provide services in the future. Revenue is only recognized when the services are actually delivered.

Which scenario is a likely explanation for an increasing net profit margin in a retail chain? A) Cost of goods sold increased faster than sales; B) A successful advertising campaign increased sales companywide with no increases in operating expenses; C) Interest expense increased significantly; D) Income tax rates increased

B) A successful advertising campaign increased sales companywide with no increases in operating expenses. Net profit margin (Net Income / Sales) measures how much profit a company makes for every dollar of sales. If sales increase significantly without a proportional increase in expenses, net income will rise, leading to a higher profit margin.

Cash payments for salaries are typically reported in which section of the statement of cash flows? A) Investing section; B) Financing section; C) Operating section; D) Non-cash activities section

C) Operating section. Operating activities include the cash effects of transactions that create revenues and expenses, representing the normal day-to-day business operations. Payments for salaries are a direct cost of running the business and are therefore classified as operating cash outflows.

What effect does failure to make an adjusting entry for accrued salaries payable have? A) An overstatement of expenses and liabilities, and an understatement of stockholders' equity; B) An understatement of expenses and liabilities, and an overstatement of stockholders' equity; C) An understatement of expenses, liabilities, and stockholders' equity; D) No effect, as it balances out in the next period

B) An understatement of expenses and liabilities, and an overstatement of stockholders' equity. Accrued salaries payable represent salaries earned by employees but not yet paid or recorded. Failure to record this adjusting entry means expenses are too low (understated), liabilities are too low (understated), and consequently, net income and stockholders' equity (through retained earnings) are too high (overstated).

What is the primary purpose of an adjusted trial balance? A) To list all accounts and their balances before any adjustments; B) To show the ending account balances after adjusting journal entries have been posted; C) To summarize all transactions for a period; D) To prepare the statement of cash flows

B) To show the ending account balances after adjusting journal entries have been posted. The adjusted trial balance is prepared after all adjusting entries have been made and posted. It ensures that total debits still equal total credits, and serves as the primary source for preparing the financial statements.

Which part of the adjusting entry for supplies at year-end for Donna Company involves a 5,400 amount in relation to Supplies Expense? A) Debit to Supplies Expense for 5,400; B) Credit to Supplies Expense for 5,400; C) Debit to Supplies for 5,400; D) Credit to Cash for 5,400

B) Credit to Supplies Expense for 5,400. This entry would be correct if the company initially recorded all purchases of supplies directly to the Supplies Expense account. At year-end, if a physical count reveals 5,400 of supplies still on hand (an asset), then an adjusting entry is needed to recognize this remaining asset, thereby reducing the expense and increasing the asset. The entry would be: Debit Supplies (asset) for 5,400; Credit Supplies Expense for 5,400.

Which ratio is explicitly required to be reported on financial statements according to GAAP? A) Current ratio; B) Debt-to-equity ratio; C) Earnings per share ratio; D) Net profit margin

C) Earnings per share ratio. The Earnings Per Share (EPS) ratio, which measures the net income earned per share of common stock outstanding, is a very important indicator for investors and is specifically required by GAAP to be reported on the face of the income statement for publicly traded companies.

What happens to the total asset turnover ratio when a company acquires several large buildings? A) The ratio will increase; B) The ratio will decrease; C) The ratio will remain unchanged; D) The ratio will become negative

B) The ratio will decrease. The total asset turnover ratio (Sales / Average Total Assets) measures how efficiently a company uses its assets to generate sales. Acquiring large buildings significantly increases total assets (the denominator), which, assuming sales do not immediately increase proportionally, will cause the ratio to decrease.

What is the standard order for the sections of the statement of cash flows? A) Investing, Operating, Financing; B) Financing, Investing, Operating; C) Operating, Investing, Financing; D) Operating, Financing, Investing

C) Operating, Investing, Financing. This is the standard presentation order for the three major sections on the statement of cash flows, providing a logical flow from core business activities to long-term asset changes and then to capital structure changes.

If the balance of prepaid expenses has increased, what should be done in the statement of cash flows? A) The change should be added to net income; B) The change should be subtracted from net income; C) The change is ignored; D) The change is reported in the investing section

B) The change should be subtracted from net income. When using the indirect method for operating cash flows, an increase in a prepaid expense account means that more cash was paid out during the period than the expense recognized on the income statement. To convert net income to cash flow, this non-cash expense adjustment needs to be subtracted from net income.

What is the cash flow from operating activities if net income is 10,000, depreciation is 2,000, accounts receivable increases by 800, inventory decreases by 100, and accounts payable increases by 500? A) 10,800; B) 11,800; C) 12,400; D) 13,400

B) 11,800. Using the indirect method: Net Income (10,000) + Depreciation (non-cash expense, add back 2,000) - Increase in Accounts Receivable (cash used, subtract 800) + Decrease in Inventory (cash provided, add 100) + Increase in Accounts Payable (cash saved, add 500) = Cash Flow from Operations (11,800).

What would NOT appear in the investing section of the statement of cash flows? A) Purchase of land; B) Sale of equipment; C) Purchase of inventory; D) Purchase of another company's bonds

C) Purchase of inventory. Investing activities involve the cash flows from buying and selling long-term assets or investment securities. Purchasing inventory is part of a company's normal operating cycle and is therefore classified under operating activities.

Which transaction causes accounts payable turnover to increase? A) Purchasing more merchandise on credit; B) Payment of cash to a supplier for merchandise previously purchased on credit; C) Returning merchandise to a supplier; D) Issuing a promissory note to a supplier in exchange for an existing account payable

B) Payment of cash to a supplier for merchandise previously purchased on credit. Accounts payable turnover (Cost of Goods Sold / Average Accounts Payable) measures how quickly a company pays its suppliers. Paying off accounts payable (decreasing the denominator) makes the turnover ratio higher, indicating more frequent payment to suppliers.

How is working capital calculated? A) Total assets minus total liabilities; B) Current assets minus current liabilities; C) Current assets divided by current liabilities; D) Sales minus cost of goods sold

B) Current assets minus current liabilities. Working capital is a measure of a company's short-term liquidity, indicating its ability to cover its short-term liabilities with its short-term assets. A positive working capital generally suggests good short-term financial health.

What is the present value of an annuity for 10,000 per year for 10 years at 8 percent? A) 67,101; B) 80,000; C) 100,000; D) 144,930

A) 67,101. This is calculated by multiplying the annual payment (10,000) by the present value of an ordinary annuity factor for 10 periods at 8 percent. The factor can be found in a present value of an ordinary annuity table or calculated as [1 - (1 + i)^{-n}] / i where i = 0.08 and n = 10
. The factor is approximately 6.7101.

How much interest does Phoebe Company owe for borrowing 100,000 at 8 percent annual interest for three months? A) 200; B) 800; C) 2,000; D) 8,000

C) 2,000. Interest is calculated as Principal x Rate x Time. For three months, the time factor is 3/12. So, $100,000 \times 0.08 \times (3/12) = $2,000$$.

What does Raija need to calculate the present value of his gift? A) The anticipated interest rate and the present value table for annuities; B) The historical inflation rate and current tax rates; C) The opportunity cost and the future value interest factor; D) The nominal rate and the effective rate

A) The anticipated interest rate and the present value table for annuities. To calculate the present value (the current worth of a future amount), Raija needs the future amount of the gift, the number of periods, and a discount rate (anticipated interest rate or required rate of return) to find the appropriate present value factor from a table or formula.

Which statement is true regarding bonds when sold at a discount? A) The stated interest rate is higher than the market rate; B) Annual cash interest payments decrease over the life of the bonds; C) Annual interest expense increases over the life of the bonds; D) The bond will be redeemed at less than face value

C) Annual interest expense increases over the life of the bonds. When bonds are sold at a discount, it means their stated (coupon) interest rate is lower than the market interest rate. The discount is amortized over the life of the bond, increasing the recognized interest expense each period (under the effective-interest method), even though the cash interest payments remain constant.

What is the advantage of issuing bonds compared to issuing stocks? A) Bonds do not have to be repaid; B) Interest expense is tax-deductible; C) Bondholders have voting rights; D) Bonds do not dilute ownership interest

B) Interest expense is tax-deductible. A significant advantage of issuing bonds (debt financing) over issuing stock (equity financing) is that the interest paid on bonds is a tax-deductible expense for the issuing company, which reduces its taxable income and thus its income tax liability. Dividends paid to stockholders are not tax-deductible.

What is the value investors will pay for a bond with a face value of 100,000 at an 8 percent coupon rate when the market rate is 10 percent? (Assume a 10-year maturity and annual payments.) A) 100,000; B) 87,711; C) 113,420; D) 92,000

B) 87,711. The bond will sell at a discount because the market interest rate (10\%) is higher than its coupon rate (8\%), meaning investors demand a higher return. The value is the present value of its future cash flows (annual interest payments and the face value at maturity), discounted at the market rate. Present Value = (Interest \, Payment \times PVOA{n,i}) + (Face \, Value \times PVF{n,i}) = (8,000 \times 6.14457) + (100,000 \times 0.38554) = 49,156.56 + 38,554 = 87,710.56 (rounded to 87,711).

What does the debt-to-equity ratio calculation exclude? A) Notes Payable; B) Bonds Payable; C) Unearned Revenue; D) Mortgages Payable

C) Unearned Revenue. The debt-to-equity ratio (Total \, Liabilities / Total \, Stockholders' \, Equity) measures a company's financial leverage. Unearned Revenue, while a liability, is typically a short-term operating liability (resulting from receiving cash before earning revenue) and is often excluded from the 'debt' component in certain interpretations of this ratio, especially when focusing on long-term, interest-bearing debt.

What is the correct order for the three sections of the statement of cash flows? A) Investing, Operating, Financing; B) Operating, Investing, Financing; C) Financing, Operating, Investing; D) Operating, Financing, Investing

B) Operating, Investing, Financing. This is the universally accepted standard order for presenting the cash flow activities, providing clarity by first showing cash from primary business operations, then changes in long-term assets, and finally changes in debt and equity.

Under the direct method, which of the following describes how total cash inflow is calculated in the operating section of the statement of cash flows? A) Includes cash collections from customer accounts receivable, cash received from customers, and cash received in advance; B) Starts with net income and adjusts for non-cash items and changes in working capital accounts; C) Only includes cash received from the sale of inventory; D) Focuses on cash received from issuing stock or bonds

A) Includes cash collections from customer accounts receivable, cash received from customers, and cash received in advance. In the direct method of preparing the statement of cash flows, cash inflows from operating activities are explicitly reported from sources such as cash collected from customers (both for current sales and from accounts receivable), cash received from interest and dividends, and cash received from advance payments for services.

If accounts payable increases, what impact does it have on net income when computing cash flows from operations? A) It's added to net income; B) It's subtracted from net income; C) It has no effect; D) It's reported in the investing section

A) It's added to net income. When using the indirect method to calculate cash flows from operations, an increase in Accounts Payable means the company incurred expenses on credit but has not yet paid cash for them. This creates a cash savings compared to the expense reported on the income statement, so the increase is added back to net income.

How do you calculate net cash inflow from financing activities if common stock issued is 18,000 and dividends paid are 4,000? A) 22,000; B) 14,000; C) 4,000; D) (14,000)

B) 14,000. Net cash inflow from financing activities is calculated by taking cash inflows from financing (like issuing common stock) and subtracting cash outflows for financing (like paying dividends). So, 18,000 (cash from stock issuance) - 4,000 (cash paid for dividends) = 14,000.

The total change in cash reported at the bottom of the statement of cash flows should reconcile with which of the following? A) The beginning cash balance on the balance sheet; B) The ending cash balance on the balance sheet; C) The net income for the period; D) The difference in cash when comparing the current and prior period balance sheets.

D) The