Chapter 11 - Corporations and their Financial Statements (Done)

Question 1

What are the significant differences between a sole proprietorship and a partnership?

Answer 1

Sole Proprietorship:
- Ownership: Owned by a single individual.
- Control: The owner has full control over all decisions.
- Liability: The owner has unlimited personal liability for debts and obligations.
- Taxation: Income is taxed as personal income of the owner.
- Continuity: Business ceases to exist if the owner dies or withdraws.

Partnership:
- Ownership: Owned by two or more individuals.
- Control: Control is shared among partners, often outlined in a partnership agreement.
- Liability: Partners have unlimited personal liability, but this is shared among partners.
- Taxation: Income is divided among partners and taxed as their personal income.
- Continuity: The partnership can continue if a partner leaves, depending on the partnership agreement.

Question 2

What is a corporation?

Answer 2

A corporation is a legal entity that is separate from its owners, meaning it can own property, incur debt, sue, and be sued. Corporations are created by a group of shareholders who have ownership of the corporation, represented by their shares. The corporation’s operations are overseen by a board of directors elected by the shareholders.

Question 3

Can you list and explain six advantages to incorporation?

Answer 3

• Limited Liability: Shareholders’ personal assets are protected from the corporation’s debts and liabilities.
• Perpetual Existence: The corporation continues to exist even if the shareholders or directors change.
• Raising Capital: Easier to raise capital through the sale of shares.
• Transferability of Ownership: Shares can be easily transferred to others.
• Credibility: Incorporated businesses may have more credibility with customers, suppliers, and investors.
• Tax Benefits: Potential tax advantages, such as income splitting and lower tax rates on retained earnings.

Question 4

Can you list and explain four disadvantages to incorporation?

Answer 4

• Cost: Incorporation can be expensive due to legal fees and ongoing compliance costs.
• Complexity: More complex to set up and manage due to regulatory requirements.
• Double Taxation: In some jurisdictions, profits can be taxed at both the corporate level and again as shareholder dividends.
• Disclosure Requirements: Corporations are required to disclose financial and operational information, which can be time-consuming and reduce privacy.

Question 5

Can you compare the fundamental differences between a private and a public corporation?

Answer 5

Private Corporation:
- Shares: Shares are not offered to the public and are held by a small group of investors.
- Disclosure: Less stringent disclosure and reporting requirements.
- Regulation: Subject to less regulatory scrutiny.
- Ownership: Typically, ownership is more concentrated among founders and initial investors.

Public Corporation:
- Shares: Shares are offered to the public through a stock exchange.
- Disclosure: Must comply with strict disclosure and reporting requirements to regulators and the public.
- Regulation: Subject to more regulatory oversight.
- Ownership: Ownership is distributed among many public shareholders, and shares are more liquid.

Question 6

What provisions would a corporation’s by-laws deal with?

Answer 6

• Board of Directors: Composition, election, and powers.
• Meetings: Procedures for shareholder and board meetings.
• Officers: Roles and responsibilities of corporate officers.
• Shares: Issuance, transfer, and repurchase of shares.
• Dividends: Policies on declaring and paying dividends.
• Amendments: Procedures for amending by-laws.

Question 7

Can you summarize what voting by proxy is, and the role it plays in forming the direction of a corporation?

Answer 7

• Definition: A proxy vote is a vote that is cast by one person on behalf of another.
• Role: Shareholders who cannot attend meetings can assign their voting rights to a proxy, usually someone who aligns with their views on corporate governance. This ensures their vote influences corporate decisions even if they are not present.

Question 8

What is the difference between shares registered in street form versus shares registered in the name of the true beneficial owner?

Answer 8

• Street Form: Shares are registered in the name of a brokerage firm or other nominee, not the actual owner. This facilitates easier trading.
• True Beneficial Owner: Shares are registered directly in the name of the shareholder, who is the actual owner, giving them direct ownership rights and communication from the corporation.

Question 9

What is the purpose of a voting trust? How does it work?

Answer 9

• Purpose: To consolidate voting power, typically to maintain control or achieve specific objectives.
• How it Works: Shareholders transfer their shares to a trustee, who then votes on behalf of the shareholders as per the agreement. Shareholders retain beneficial ownership but cede voting rights to the trustee.

Question 10

What responsibilities would the director of a corporation have?

Answer 10

• Strategic Direction: Setting and overseeing the strategic direction of the corporation.
• Fiduciary Duty: Acting in the best interests of the corporation and its shareholders.
• Oversight: Monitoring and overseeing the corporation’s management and operations.
• Compliance: Ensuring the corporation complies with laws and regulations.
• Financial Performance: Reviewing and approving financial statements and major transactions.

Question 11

How would you explain what a company officer is?

Answer 11

A company officer is an individual appointed by the board of directors to manage day-to-day operations. Common officers include the CEO, CFO, and COO. They execute the board’s directives and policies, and are responsible for the overall administration and performance of the company.

Question 12

How would you arrange total assets, total equity, and total liability into the fundamental accounting equation?

Answer 12

Assets = Liabilities + Equity

Question 13

Can you list examples of noncurrent assets that would show in a statement of financial position?

Answer 13

• Property, Plant, and Equipment (PPE): Buildings, machinery, and equipment.
• Intangible Assets: Patents, trademarks, and goodwill.
• Long-term Investments: Stocks and bonds held for more than one year.
• Deferred Tax Assets: Taxes recoverable in future periods.

Question 14

Can you compare the straight-line method of depreciation to the declining-balance method?

Answer 14

Straight-Line Method:
- Depreciation expense is the same each year.
- Simpler and more common for assets that wear out evenly over time.

Declining-Balance Method:
- Depreciation expense decreases over time.
- More appropriate for assets that lose value quickly, like technology.

Question 15

What are some examples of intangible assets?

Answer 15

• Patents: Exclusive rights to inventions.
• Trademarks: Brand names and logos.
• Copyrights: Rights to literary and artistic works.
• Goodwill: Value from reputation, customer relationships, etc.

Question 16

What does an investment in associates mean?

Answer 16

An investment in associates refers to a situation where a company holds a significant, but not controlling, interest (typically 20-50%) in another company, allowing it to exert significant influence over the associate’s operations and policies.

Question 17

What are some examples of current assets?

Answer 17

• Cash and Cash Equivalents: Readily available funds.
• Accounts Receivable: Money owed by customers.
• Inventory: Goods available for sale.
• Prepaid Expenses: Payments made in advance for services or goods.

Question 18

Can you compare the weighted average method of inventory valuation with the first-in-first-out method?

Answer 18

Weighted Average Method:
- Calculation: Costs of goods available for sale are averaged and applied to ending inventory and cost of goods sold.
- Use: Smooths out price fluctuations over the period.

First-In-First-Out (FIFO) Method:
- Calculation: The earliest goods purchased are the first to be sold.
- Use: Often aligns with the actual physical flow of goods and is beneficial when prices are rising, as it reports higher profits.

Question 19

What are the basic items that form a company’s equity?

Answer 19

• Common Stock: Shares issued to investors.
• Preferred Stock: Shares with preferential rights over common stock.
• Retained Earnings: Profits retained in the company.
• Additional Paid-In Capital: Excess amount paid by investors over the par value of shares.

Question 20

How would you explain what retained earnings are?

Answer 20

Retained earnings are the cumulative amount of net income that a company has retained, rather than distributed to shareholders as dividends. They are used to reinvest in the business, pay off debt, or save for future use.

Question 21

What is the difference between long-term debt and short-term debt?

Answer 21

Long-Term Debt:
- Maturity: Due in more than one year.
- Examples: Bonds, mortgages, and long-term loans.
- Purpose: Often used for significant investments or capital projects.

Short-Term Debt:
- Maturity: Due within one year.
- Examples: Short-term loans, credit lines, and accounts payable.
- Purpose: Used for immediate financing needs and working capital management.

Question 22

What is the purpose of the income statement?

Answer 22

The income statement, also known as the profit and loss statement, shows a company’s revenues, expenses, and profits or losses over a specific period. Its main purposes are:

• Performance Measurement: Evaluates how well the company is doing financially.
• Decision Making: Helps management, investors, and creditors make informed decisions.
• Trend Analysis: Allows comparison of financial performance over time.
• Expense Management: Breaks down costs to identify areas for improvement.
• Tax Calculation: Basis for determining taxable income.
• Stakeholder Communication: Provides transparency to shareholders and other stakeholders.

It includes key components like revenues, expenses, and net income, giving a clear picture of the company’s profitability.

Question 23

How do revenue and cost of sales relate to each other?

Answer 23

Revenue is the total amount of income generated from the sale of goods or services. The cost of sales (also known as the cost of goods sold) is the direct costs attributable to the production of the goods sold by the company. The difference between revenue and cost of sales gives the gross profit.

Question 24

What is the purpose of the statement of changes in equity?

Answer 24

The statement of changes in equity shows how a company’s equity has changed over a specific period. Its main purposes are:

• Tracking Equity Changes: Shows changes in share capital, retained earnings, and reserves.
• Understanding Retained Earnings: Details how profits and dividends affect retained earnings.
• Analyzing Equity Transactions: Reports share issuances, buybacks, and other equity movements.
• Assessing Company Policies: Reflects policies on profit reinvestment and dividend distribution.
• Ensuring Transparency: Provides a clear view of equity changes to investors and stakeholders.

It includes the opening balance, net income or loss, dividends, share transactions, and the closing balance, offering a comprehensive view of equity-related activities.

Question 25

What is the purpose of the statement of cash flows?

Answer 25

The statement of cash flows shows a company’s cash inflows and outflows over a specific period. Its main purposes are:

• Assessing Liquidity: Shows the company’s ability to generate cash to meet obligations.
• Evaluating Cash Flow Activities: Breaks down cash flows into operating, investing, and financing activities.
• Understanding Operational Efficiency: Highlights cash from core business operations.
• Supporting Decision Making: Provides information for management, investors, and creditors.
• Ensuring Financial Transparency: Shows actual cash movements for greater transparency.

It includes cash flows from:

• Operating Activities: Cash from daily business operations.
• Investing Activities: Cash from buying/selling long-term assets.
• Financing Activities: Cash from borrowing, repaying debts, and issuing shares.

This statement helps stakeholders understand the company’s financial health and cash management.

Question 26

What are the four general categories that form the structure of the statement of cash flows?

Answer 26

• Operating Activities: Cash flows from the core business operations.
• Investing Activities: Cash flows from the purchase and sale of long-term assets and investments.
• Financing Activities: Cash flows from transactions with the company’s owners and creditors.
• Net Increase/Decrease in Cash: The net effect of the cash flows from operating, investing, and financing activities on the company’s cash position.

Question 27

What is the purpose of the annual report?

Answer 27

The annual report provides a comprehensive overview of a company’s financial performance and operations over the past year. It includes financial statements, management’s discussion and analysis, and other relevant information, helping investors, analysts, and stakeholders make informed decisions.

Question 28

What is the significance of the auditor’s report?

Answer 28

The auditor’s report provides an independent assessment of the accuracy and fairness of a company’s financial statements. It adds credibility to the financial information presented and helps stakeholders trust the reported financial position and performance.

Question 29

Can you highlight the differences between right of withdrawal from right of rescission?

Answer 29

Right of Withdrawal:
- Timing: Typically exercised before a contract is completed.
- Purpose: Allows a party to back out of an agreement without penalty.

Right of Rescission:
- Timing: Exercised after a contract is completed.
- Purpose: Allows a party to cancel the contract and return the parties to their pre-contractual position, usually due to misrepresentation, fraud, or other breaches.

Question 30

What is a takeover bid?

Answer 30

A takeover bid is an offer made by an individual, company, or group to acquire a controlling interest in another company, often by purchasing its shares at a premium over the market price. The goal is to gain control of the target company’s operations and assets.

Question 31

How would you describe the rules of early warning disclosure?

Answer 31

Early warning disclosure rules require investors to notify the relevant regulatory authorities and the public when they acquire a significant ownership stake in a company, typically 5% or more of the company’s shares. This ensures transparency and allows other investors to be aware of potential changes in control or significant shifts in ownership.

Question 32

What is insider trading?

Answer 32

Insider trading involves buying or selling a company’s securities based on material, non-public information about the company. This practice is illegal and unethical because it gives the insider an unfair advantage and violates principles of market fairness and transparency.

Question 33

Can you list and describe the different definitions of an insider?

Answer 33

• Corporate Insiders: Officers, directors, and employees with access to confidential information.
• Beneficial Owners: Individuals or entities owning more than 10% of a company’s shares.
• Temporary Insiders: Lawyers, consultants, investment bankers, and other professionals who gain access to non-public information while providing services to the company.
• Affiliated Insiders: Family members or associates of corporate insiders who might receive material non-public information.