Chapter 3 Accounting Analysis

Question 1

Ownership of Proprietorship and Partnership are generally _____.

Answer 1

Private

Question 2

Corporations which are larger firms with diverse ownership that can be bought or sold in an open market are generally ________.

Answer 2

Public

Question 3

What are the 3 reasons publicly traded corps. have to file financial reports?

Answer 3

1. Monitoring 2. Contracting - example is bank contract for a loan, employee contract for bonus incentive 3. Valuation

Question 4

TRUE OR FALSE? Because corporate managers have superior knowledge of their firms’ business, they are entrusted with making appropriate accounting estimates.

Answer 4

TRUE

Question 5

Financial statements are __________ responsibility (not auditors)

Answer 5

management’s

Question 6

TRUE OR FALSE? It is optimal to allow managers some discretion in applying accounting standards (e.g., allowance for doubtful accounts). Incentives exist for managers to distort accounting numbers positively (e.g., contracts, reputation)

Answer 6

TRUE

Question 7

The ____ is a regulatory agency commissioned by Congress to monitor and enforce legal behavior in the U.S. capital markets.

Answer 7

SEC

Question 8

What are the 2 financial reports that the SEC mandates that all publicly-traded firms file?.

Answer 8

10-Q: Quarterly report (filed at the end of each of the first 3 fiscal quarters) 10-K: Annual report (filed at the end of the last fiscal quarter)

Question 9

The ____ has legal authority to enact civil or criminal penalties for lack of compliance or suspicion of fraud.

Answer 9

SEC

Question 10

FASB = Financial Accounting Standards Board (private, non-profit) purpose is to establish and improve ____

Answer 10

GAAP

Question 11

IFRS = International Financial Reporting Standards; they developed ____

Answer 11

GAAP

Question 12

IASB developed the IFRS, which is the international accounting framework within which to properly organize and report financial information.

Answer 12

IFRS (International Financial Reporting Standards)

Question 13

TRUE OR FALSE: Uniform accounting standards MAXIMIZE manager’s ability to manipulate financial statement information

Answer 13

FALSE, it minimizes a manager’s ability to manipulate

Question 14

The Securities and Exchange Commission (SEC) U.S. government agency that _____ rules for financial statements by public companies.

Answer 14

enforces

Question 15

The Financial Accounting Standards Board (FASB) is the private sector body given the responsible for developing detailed rules for ____ within U.S.; they ____ the rules.

Answer 15

GAAP set

Question 16

Head Financial Accountant is usually called the _____

Answer 16

controller

Question 17

An auditor is an independent agent hired by the firm. They typically work for a ____ firm.

Answer 17

CPA

Question 18

Accounting is all about ____. (what Prof. Tang kept saying in class)

Answer 18

Timing

Question 19

Cash basis of accounting: Method of accounting where income is calculated by recording revenues when cash is _____ and expenses when expenditures _____.

Answer 19

received occur

Question 20

____ basis of accounting: Method of accounting where income is calculated by recording revenues when benefits are earned and expenses when resources are given up to produce the revenues (expenses are matched to revenues). – What GAAP requires

Answer 20

accrual

Question 21

What is a downside to CASH BASIS ACCOUNTING? Financial statements reflect when cash comes into and out of a company, but not necessarily when business transactions take ____ between the company, customers, and suppliers.

Answer 21

place

Question 22

What 4 criteria must by met under ACCRUAL BASIS for revenue to be posted or recognized? (remember DPPC)

Answer 22

1. The company has delivered its goods/services to the customer.
2. The price is fixed or determinable.
3. There is persuasive evidence of an arrangement for customer payment (written orders)
4. Collection of cash (or other benefits) is reasonably assured, though there may still be some uncertainty (uncollectible accounts, warranties). The degree of uncollectability should be estimated with reasonable reliability.

Question 23

Goal of accrual accounting is to report inflows of assets (e.g., cash or A/R) when they are ____, and net them against outflows of assets ____ to generate them.

Answer 23

earned

used

Question 24

The ______principle recognizes costs and/or assets used as expenses in the period in which they produce revenue. (Cost of the hat is not recognized until it actually sold)

Answer 24

matching

Question 25

When are expenses recognized in accrual accounting?

Answer 25

• When the associated revenue is recognized.
• Matched to the timing of revenue.
• Reported in the income statement in the same period as the revenue they gave rise to.
• The revenue could be zero.

Question 27

______method for bad debt accounting

• GAAP requires companies to estimate the amount of credit sales that they believe are uncollectible in the period those credit sales are made.
• Ensures accounts receivable (asset) is not overstated.
• Ensures bad debt expense is matched against revenue for the period.

This happens when A/R cannot be collected in full.

Answer 27

Allowance

Question 28

Under ______ method, there is a contra asset account set up to keep track of the estimated bad debt: this account is called ___ for _____ accounts

Answer 28

allowance

allowance

doubtful - Allowance for Doubtful Accounts (AFDA).

Question 29

Bad Debt Expense is reported on ______ statement among the ______ expenses (matching principle).

Answer 29

income

operating

Question 30

Sources of accounting distortion in accrual-based accounting:

• _____ errors (e.g., allowance for doubtful accounts)
• Noise from accounting _____ (e.g., expensing R&D, GAAP)
• _____ management (i.e., intentional, can be manipulated)

Answer 30

estimation

rules

earnings

Question 31

What are some of the reasons or incentives of EARNINGS MANAGEMENT occurs?

Answer 31

• Compensation
• Debt covenants
• Competitive consideration
• Reputation
• Tax considerations
• Stakeholder consideration
• Big bath (blame previous management for bad earnings)
• Corporate control contests (can be used to keep competitors away)
• Regulatory consideration
• Income smoothing (can be used to mask volatility.)
• Capital Market consideration

Question 32

Earning management can be both legal and ____.

Answer 32

illegal

Question 33

What are some of the forms of Earnings management?

Answer 33

1) Changing accounting estimates and policies that determine accounting numbers
2) Income shifting
3) Classificatory earnings management

Question 34

Earnings management by distorting different accounts

Answer 34

assets

liabilities

equity

Question 35

Common causes for asset distortions

Answer 35

• Improper write-down and impairment of assets
• Improper depreciation and amortization
• Improper capitalization of expenses

Question 36

•Distortions may generally arise from ambiguities about:

Answer 36

• Whether an obligation has been incurred
• The proper measurement of an obligation

Question 37

Since Assets = Liabilities + Equity, distortions in assets and/or liabilities lead to distortions in _______.

Answer 37

equity

Question 38

All publicly listed companies are required to have their annual financial statements audited by an independent public _____ (quarterly reports are reviewed, but not audited)

Answer 38

accountant

audited

Question 39

____ requires external auditors to report to or be overseen by a company’s audit committee

Answer 39

SOX or Sarbanes Oxley

Question 40

Name the big 4

Answer 40

Deloitte

KPMG

Ernt and Young

Price Waterhouse Coopers

Question 41

TRUE OR FALSE

An audit report is a written opinion of an auditor regarding an entity’s financial statements.

Answer 41

TRUE

Question 42

An ____report is published in an annual report

Answer 42

audit

Question 43

____(or clean) opinions (GOOD) are issued when

• Financial statements conform to GAAP
• Statements represent the entity’s financial accounts fairly

Answer 43

UNQUALIFIED

Question 44

______ opinion or an adverse report (NOT GOOD) are issued when

• There are limits on audit scope
• Financial statements are materially misstated but such misstatement does not have pervasive effect on the financial statement These may indicate a firm’s aggressive attitude or a tendency to “opinion shop.”

Answer 44

QUALIFIED

Question 45

______ opinion is issued when

•Financial statements are materially misstated and such misstatements have pervasive effect on the financial statement

Answer 45

ADVERSE

Question 46

______ of opinion is issued when auditors choose not to render one. This is issued in either of the following cases

• When the auditor is not independent or when there is conflicts of interest
• When the auditee has going concern issues

Answer 46

DISCLAIMER

Question 47

TRUE OR FALSE

The quality of financial analysis, and the inferences drawn, depends on the quality of the underlying accounting information

Answer 47

true

Question 48

Accounting analysis is the process of

• evaluating the extent to which a company’s accounting numbers reflect economic reality
• identifying and assessing accounting _____in a company’s financial statements

Answer 48

reality

distortions

Question 49

______ analysis is an essential step in analyzing corporate financial reports.

Answer 49

accounting

Question 50

Research suggests _______ management is not so pervasive as to make earnings data unreliable.

Answer 50

earnings

Question 51

What are the 6 steps in performing accounting analysis?

1) Indentify accounting __________
2) Assess Accounting ______
3) Evaluate Accounting ______
4) Evaluate the quality of ________
5) Identify potential ____flags
6) undo accounting _______

Answer 51

1. policies
2. flexibility
3. Strategy
   4) disclosure
   5) red
   6) distortions