Chapter 1 Problems Flashcards
What do Board of directors use financial statement data for?
to decide whether to declare a dividend to shareholders
What do Bondholders use financial statement data for?
To decide whether to buy (or sell) the bonds of a given company
What do Corporate employees use financial statement data for?
to decide whether to seek a raise or look for employment elsewhere
What do Corporate executives use financial statement data for?
to decide whether to give a bonus to employees
What do Customers use financial statement data for?
To help decide whether to buy a company’s products
What do Investment advisors use financial statement data for?
To decide whether to recommend the purchase of a company’s shares to clients
What do labor unions use financial statement data for?
To decide whether to seek a pay increase for union members
What do loan officers/credit analysts use financial statement data for?
To decide whether a company merits a new or continuing loan
What do shareholders use financial statement data for?
To decide whether to buy, sell, or hold their existing shares in a company
What do suppliers use financial statement data for?
To decide whether to extend credit to a company
What is GAAP and how does it make markets more efficient?
GAAP is like rules to baseball, determining winners and losers. It makes markets more efficient by estimating future performance based on past performance.
Why is corporate governance important to shareholders
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
Discuss the relationship between investment risk and expected rate of return. Why is accounting useful in evaluating risk/return trade off?
an investor can expect higher return with higher risk, accounting helps investors make predictions about future investment outcomes.
What are impediments of global GAAP.
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
Should GAAP allow increasing value of real estate asset if value exceeds original purchase price?
GB does- adds to asset & shareholder’s equity (revaluation reserve), US allows write-up for long-lived investments marked “available for sale”
What industries are impacted by Human Assets not recorded on balance sheets?
Customer services centric- Service industry (American Airlines), Tech companies (Microsoft) & Pharmaceuticals (Pfizer)
Identify 5 Key Performance Indicators for Amazon that are present and not present.
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
What does Amazon’s audit report tell you about their financial statements?
It was unqualified or “clean” but states they changed their accounting measurements, limiting utility of prior financial data
Discuss the information vs contracting role of accounting.
information= investors informed of risk/return trade off contracting= managers are held accountable, behavior control
Describe an Income Statement
A financial statement describing the operating performance of a business for a given period of time.
Rev-Exp=NI
Describe a Balance Sheet
A financial statement describing the financial health or condition of a business as of a specific date (snapshot)
A + L = SE
Describe a Statement of Shareholder’s Equity
A financial statement describing the change in shareholder’s contributed capital to a business for a given period of time.
=SE from BS & IS
Describe a Statement of Cash Flow
A financial statement summarizing the cash inflows and outflows of a business
Investing, Financing & Operating Activities from Balance Sheet
How are the four financial statements connected?
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)
Why are debt covenants established?
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
When do shareholders and managers disagree?
Managers want more income for less work
solution: managers may be given salary-plus-bonus tied to net income & cash flow
When to shareholders and debt holders disagree?
Shareholders want more dividend payouts
solution: debtholders lend money for operational growth but restrict dividends tied to net income
Why would an audit firm give a “clean opinion” if a firm’s “going concern” is doubtful?
Auditor assumes the merger would make the firm stronger
Is the Sarbanes-Oxley Act Effective?
No, corporate executives control auditors, S-O puts minimal constraints on auditors, S-O does not restrict sufficient non-audit work
Should the Sarbanes-Oxley Act be revised?
Yes- it is unfair to foreign and small firms, fails at providing sufficient guidance
Does rule-based GAAP lead to unethical managerial behavior?
No- rules do not make people ethical, they cannot be legislated
What are some inconsistencies in the preparation of basic financial statements?
Historical cost concept (assets valued at their acquisition cost)
How does going concern, relevance and faithful representation influence historical cost as reporting method?
Ex: method of using depreciation of PPE, expected useful lives of those assets and salvage value. Auditors must feel comfortable of the estimates
