Chapter 1 Problems Flashcards

1
Q

What do Board of directors use financial statement data for?

A

to decide whether to declare a dividend to shareholders

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2
Q

What do Bondholders use financial statement data for?

A

To decide whether to buy (or sell) the bonds of a given company

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3
Q

What do Corporate employees use financial statement data for?

A

to decide whether to seek a raise or look for employment elsewhere

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4
Q

What do Corporate executives use financial statement data for?

A

to decide whether to give a bonus to employees

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5
Q

What do Customers use financial statement data for?

A

To help decide whether to buy a company’s products

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6
Q

What do Investment advisors use financial statement data for?

A

To decide whether to recommend the purchase of a company’s shares to clients

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7
Q

What do labor unions use financial statement data for?

A

To decide whether to seek a pay increase for union members

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8
Q

What do loan officers/credit analysts use financial statement data for?

A

To decide whether a company merits a new or continuing loan

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9
Q

What do shareholders use financial statement data for?

A

To decide whether to buy, sell, or hold their existing shares in a company

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10
Q

What do suppliers use financial statement data for?

A

To decide whether to extend credit to a company

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11
Q

What is GAAP and how does it make markets more efficient?

A

GAAP is like rules to baseball, determining winners and losers. It makes markets more efficient by estimating future performance based on past performance.

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12
Q

Why is corporate governance important to shareholders

A

Board of Directors- creates stock option or bonus plans for executives
Executives (with board’s approval) issue or increase a cash dividend
Executives (with board’s & shareholder’s approval) execute merger or acquisition

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13
Q

Discuss the relationship between investment risk and expected rate of return. Why is accounting useful in evaluating risk/return trade off?

A

an investor can expect higher return with higher risk, accounting helps investors make predictions about future investment outcomes.

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14
Q

What are impediments of global GAAP.

A

Legal issues= government sets acct legislation
cultural issues= openness & footnotes are seen as good in GB and bad in SK
social issues= Italys acct standards based on family run businesses

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15
Q

Should GAAP allow increasing value of real estate asset if value exceeds original purchase price?

A

GB does- adds to asset & shareholder’s equity (revaluation reserve), US allows write-up for long-lived investments marked “available for sale”

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16
Q

What industries are impacted by Human Assets not recorded on balance sheets?

A

Customer services centric- Service industry (American Airlines), Tech companies (Microsoft) & Pharmaceuticals (Pfizer)

17
Q

Identify 5 Key Performance Indicators for Amazon that are present and not present.

A

Present- Net income, revenues, cash flows from operations, ROE, long-term debt-to-equity
Absent- forecasted revenues, future demand for purchases, pro-forma income, pro-forma cash flow & future tax policy

18
Q

What does Amazon’s audit report tell you about their financial statements?

A

It was unqualified or “clean” but states they changed their accounting measurements, limiting utility of prior financial data

19
Q

Discuss the information vs contracting role of accounting.

A
information= investors informed of risk/return trade off
contracting= managers are held accountable, behavior control
20
Q

Describe an Income Statement

A

A financial statement describing the operating performance of a business for a given period of time.
Rev-Exp=NI

21
Q

Describe a Balance Sheet

A

A financial statement describing the financial health or condition of a business as of a specific date (snapshot)
A + L = SE

22
Q

Describe a Statement of Shareholder’s Equity

A

A financial statement describing the change in shareholder’s contributed capital to a business for a given period of time.
=SE from BS & IS

23
Q

Describe a Statement of Cash Flow

A

A financial statement summarizing the cash inflows and outflows of a business
Investing, Financing & Operating Activities from Balance Sheet

24
Q

How are the four financial statements connected?

A

Income State: Rev - Exp = NI
Balance S: A & SE (NI) from Income state
State of SE: SE from Income State & Balance S
State of Cash Flows: Investing Activ (BS’s A), Financing Activ (BS’s L& SE), Operating Activ (BS’ SE)

25
Q

Why are debt covenants established?

A

American Air: Agency problem between shareholders & creditors- if American airlines doesn’t agree, they may not be extended or refinance loan contracts
Titanium Metals Corp: agency problem between shareholdders & lenders, TIMET had to agree if they wanted a loan

26
Q

When do shareholders and managers disagree?

A

Managers want more income for less work

solution: managers may be given salary-plus-bonus tied to net income & cash flow

27
Q

When to shareholders and debt holders disagree?

A

Shareholders want more dividend payouts

solution: debtholders lend money for operational growth but restrict dividends tied to net income

28
Q

Why would an audit firm give a “clean opinion” if a firm’s “going concern” is doubtful?

A

Auditor assumes the merger would make the firm stronger

29
Q

Is the Sarbanes-Oxley Act Effective?

A

No, corporate executives control auditors, S-O puts minimal constraints on auditors, S-O does not restrict sufficient non-audit work

30
Q

Should the Sarbanes-Oxley Act be revised?

A

Yes- it is unfair to foreign and small firms, fails at providing sufficient guidance

31
Q

Does rule-based GAAP lead to unethical managerial behavior?

A

No- rules do not make people ethical, they cannot be legislated

32
Q

What are some inconsistencies in the preparation of basic financial statements?

A

Historical cost concept (assets valued at their acquisition cost)

33
Q

How does going concern, relevance and faithful representation influence historical cost as reporting method?

A

Ex: method of using depreciation of PPE, expected useful lives of those assets and salvage value. Auditors must feel comfortable of the estimates