Chapter 5

Question 1

Balance sheet

Answer 1

The balance sheet reports assets, liabilities, and stockholders’ equity of a business enterprise at a point in time.

Question 2

Liquidity

Answer 2

The degree to which an asset or security can be quickly bought or sold in the market at a price reflecting its intrinsic value. In short: the ease of converting it to cash

Question 3

Solvency

Answer 3

The company’s ability to meet its long-term debt and financial obligations

Question 4

Limitations of the Balance sheet (3)

Answer 4

• Most assets/liabilities are reported at historical cost
• Lots of elements reported in the balance sheet are estimates
• The balance sheet necessarily omits many items that are of financial value but that a company can’t record objectively

Question 5

Current assets

Answer 5

Current assets are assets that company expects to convert to cash or consume within a year or in the operating cycle, whichever is longer

Question 6

Trading securities (short-term investments)

Answer 6

Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences. Companies should report trading securities as current assets. Reported at fair value

Question 7

Available-for-sale

Answer 7

Debt securities not classified as held-to-maturity or trading securities. Companies should classify available-for-securities as current or non-current assets depending on the mgmt’s intent. Reported at fair value

Question 8

held-to-maturity

Answer 8

Debt securities that a company has the intent and ability to hold to maturity. Can be classified as current or non-current. Held-to-maturity securities are reported at amortized cost

Question 9

free cash flow

Answer 9

Free cash flow is the amount of discretionary cash flow a company has. In other words, FCF is cash left over after a company pays for its operating expenses and capital expenditures.

Companies can use this cash flow to purchase additional investments, retire its debt, purchase treasury stock etc.

Question 10

contra account

Answer 10

Contra account reduces assets, liabilities or owner’s equity account

Question 11

adjunct account

Answer 11

Adjunct account increases liability account. The most common example of an adjunct account is the unamortized bond premium account, which is used when a business sells bonds at a premium.

Question 12

Significant non cash activities

Answer 12

1. Issuance of common stock to purchase assets
2. Conversion of bonds into common stock
3. Issuance of debt to purchase assets
4. Exchanges of long lived assets

Question 13

Operating activities

Answer 13

Cash effects of transactions that enter in the determination of net income

Question 14

Investing Activities

Answer 14

Involves the making and collecting loans and acquiring/disposing of investments, PP&E, and intangibles

Question 15

Financing activities

Answer 15

Involve obtaining capital form owners and distributing capital to owners and borrowing money from creditors