Exam 2

Question 1

What is Appropriated Retained Earnings

Answer 1

A retained earnings account that is restricted for a specific use, usually to comply with contractual requirements, board of directors’ policy, or current necessity.

Question 2

Capital maintenance approach

Answer 2

The most common alternative to the transaction approach in which a company determines income for the period based on the change in equity, after adjusting for capital contributions (e.g., investments by owners) or distributions (e.g., dividends).

Question 3

What are Changes in accounting estimates

Answer 3

Adjustments or changes that companies must make because financial circumstances did not turn out as expected. Companies account for changes in accounting estimates in the period of change if they affect only that period, or in the period of change and future periods if the change affects both. They do not carry back such changes to prior years. Changes in accounting estimates are not considered errors.

Question 4

What are Changes in accounting principle

Answer 4

Adjustments or changes that results when a company adopts a different accounting principle. A company recognizes a change in accounting principle by making a retrospective adjustment to the financial statements.

Question 5

Comprehensive income

Answer 5

Income measure that includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. Comprehensive income includes all revenues and gains, expenses and losses reported in net income, and all gains and losses that bypass net income but affect stockholders’ equity. These latter amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.

Question 6

What is other comprehensive income.

Answer 6

Measure of the amounts of all gains and losses in a period that bypass the income statement but affect stockholders’ equity. These amounts arise from such items as unrealized gains or losses on certain investments and unrealized gains and losses on certain hedging transactions.

Question 7

What are the two ways Discontinued Operation happen

Answer 7

Occurs for a company when two things happen: (1) a company eliminates the results of operations and cash flows of a component from its ongoing operations, and (2) there is no significant continuing involvement in that component after the disposal transaction. Companies report a discontinued operation (in a separate income statement category), indicating the gain or loss from disposal of a business. In addition, companies report separately from continuing operations the results of operations of a component that has been, or will be, disposed of.

Question 8

What is Earning Management

Answer 8

The planned timing of revenues, expenses, gains, and losses to smooth out bumps in earnings.

Question 9

Accounting Policies

Answer 9

The specific principles, bases, conventions, rules, and practices applied by a company in preparing and presenting financial information.

Question 10

Accounts receivable turnover

Answer 10

An activity ratio that measures the number of times, on average, a company collects receivables during a period. Computed by dividing net sales by average net accounts receivable outstanding during the year. Barring significant seasonal factors, average receivables outstanding can be computed from the beginning and ending balances of net trade receivables.

Question 11

Accumulated other comprehensive income

Answer 11

The aggregate amount of the other comprehensive income items, such as unrealized gains and losses on certain investments.

Question 12

Activity ratios

Answer 12

Measures of how effectively a company is using its assets. Common activity ratios are accounts receivables turnover, inventory turnover, and asset turnover.

Question 13

Additional paid-in capital

Answer 13

The excess of amounts paid in over the par or stated value.

Question 14

Adjunct account

Answer 14

An account that increases either an asset, liability, or owners’ equity account. An example is Premium on Bonds Payable, which, when added to the Bonds Payable account, describes the total bond liability of the company

Question 15

Asset turnover

Answer 15

Activity ratio that measures how efficiently a company uses its assets to generate sales. Computed as net sales divided by average total assets for the period. The resulting number is the dollars of sales produced by each dollar invested in assets.

Question 16

Available-for-sale

Answer 16

Debt securities not classified as held-to-maturity or trading securities. Companies report available-for-sale securities at fair value, but do not report changes in fair value as part of net income until after they sell the security. Interest on available-for-sale securities is recorded when earned. Unrealized holding gains and losses on available-for-sale securities are recognized as other comprehensive income and as a separate component of stockholders’ equity.

Question 17

Balance sheet

Answer 17

Financial statement that shows the financial condition of a company at the end of a period by reporting its assets, liabilities, and owners’ equity.

Question 18

Book value per share

Answer 18

The amount each share of stock would receive if a company were liquidated, based on the amounts reported on the balance sheet. Computed as common stockholders’ equity divided by the outstanding shares. If the valuations on the balance sheet do not approximate fair value, the book value per share figure loses its relevance.

Question 19

Capital stock

Answer 19

The total par or stated value of the shares issued. Companies must disclose the par value per share and the authorized, issued, and outstanding share amounts for common and preferred stock.

Question 20

Cash debt coverage

Answer 20

Measure of solvency that indicates a company’s ability to repay its liabilities from cash generated from operations (without having to liquidate productive assets). Computed as the ratio of net cash provided by operating activities to total debt, as represented by average total liabilities

Question 21

Contingency

Answer 21

Material events with an uncertain future outcome. The uncertainty can involve a possible gain (gain contingency) or possible loss (loss contingency) that will ultimately be resolved when one or more future events occur or fail to occur. Typical gain contingencies are tax operating loss carryforwards or company litigation against another party. Typical loss contingencies relate to litigation, environmental issues, possible tax assessments, or government investigations.

Question 22

Contra account

Answer 22

An account that reduces either an asset, liability, or owners’ equity account. Examples include Accumulated Depreciation—Equipment and Discount on Bonds Payable. Use of contra accounts enables readers of financial statements to see the original cost of the asset, liability, or owners’ equity account as well as the changes in the account to date.

Question 23

Coverage ratios

Answer 23

Measures of the degree of protection for long-term creditors and investors. Common coverage ratios are debt to assets ratio, times interest earned, cash debt coverage, and book value per share.

Question 24

Current assets

Answer 24

Cash and other assets a company expects to convert into cash, sell, or consume either in one year or in the operating cycle, whichever is longer. Companies present current assets in the balance sheet in order of liquidity.

Question 25

Current cash debt coverage

Answer 25

Measure of liquidity that indicates a company’s ability to pay its short-term debts. Computed as net cash provided by operating activities divided by average current liabilities.

Question 26

Current Liabilities

Answer 26

The obligations that a company reasonably expects to liquidate either through the use of current assets or the creation of other current liabilities. This concept includes payables resulting from the acquisition of goods and services, (2) collections received in advance for the delivery of goods or performance of services, and (3) other liabilities whose liquidation will take place within the operating cycle.

Question 27

Current ratio

Answer 27

Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available current assets and to meet unexpected needs for cash. Computed as total current assets divided by total current liabilities.

Question 28

Debt to assets ratio

Answer 28

Coverage ratio that measures the percentage of the total assets provided by creditors. Computed as total liabilities divided by total assets. The higher the percentage of total liabilities to total assets, the greater the risk that the company may be unable to meet its maturing obligations.

Question 29

Earning per share

Answer 29

A distilled and important income figure, calculated as net income minus preferred dividends (income available to common stockholders), divided by the weighted average of common shares outstanding. Companies must disclose earnings per share on the face of the income statement.

Question 30

Financial instruments

Answer 30

Assets consisting of cash, accounts receivable, an ownership interest, or a contractual right to receive or obligation to deliver cash or another financial instrument.

Question 31

Financing activities

Answer 31

Cash flow activities that include (1) obtaining cash from issuing debt and repaying the amounts borrowed, and (2) obtaining cash from stockholders and paying them dividends.

Question 32

Free cash flow

Answer 32

Measure of the cash remaining from operating activities after adjusting for capital expenditures and cash dividends paid. Some analysts prefer free cash flow to the measure of net cash provided by operating activities because free cash flow takes into account the outflows needed to maintain current operations.

Question 33

Held-to-maturity

Answer 33

Debt securities that a company has the positive intent and ability to hold to maturity.

Question 34

Income statement

Answer 34

Financial statement that measures the results of operations during a particular period and presents those results in terms of net income or net loss.

Question 35

Intangible assets

Answer 35

Assets that lack physical substance and that are not financial instruments. Intangible assets derive their value from the rights and privileges granted to the company using them. They are normally classified as long-term assets. Companies write off (amortize) limited-life intangible assets over their useful lives and they periodically assess indefinite-life intangibles for impairment.

Question 36

Intraperiod tax allocation

Answer 36

Reporting of items (e.g., discontinued operations) within an accounting period on the income statement or statement of retained earnings net of tax. Such allocation relates the income tax expense of the fiscal period to the specific items that give rise to the amount of the tax provision. It helps financial statement users better understand the impact of income taxes on the various components of net income, and it discourages statement readers from using pretax measures of performance when evaluating financial results.

Question 37

Inventory turnover

Answer 37

The number of times on average a company sells its inventory during the period. Computed as the cost of goods sold divided by the average inventory on hand during the period. Analysts compute average inventory from beginning and ending inventory balances.

Question 38

Investing activities

Answer 38

Cash flow activities that include (1) purchasing and disposing of investments and productive long-lived assets using cash, and (2) lending money and collecting the loans.

Question 39

Liquidity ratios

Answer 39

Measures of a company’s short-run ability to pay its maturing obligations. Common liquidity ratios are the current ratio, the quick or acid-test ratio, and current cash debt coverage.

Question 40

Long-term investments

Answer 40

Investments that companies expect to hold for many years. Examples are (1) investments in securities, such as bonds or common stock; (2) investments in tangible fixed assets not currently used in operations, such as land held for speculation; (3) investments set aside in special funds, such as a pension fund; and (4) investments in nonconsolidated subsidiaries. Companies usually present long-term investments on the balance sheet just below current assets.

Question 41

Long-term liabilities

Answer 41

Obligations that a company expects to pay at some date beyond the normal operating cycle. Examples are bonds payable, notes payable, deferred income tax amounts, lease obligations, and pension obligations. Also referred to as long-term debt. Companies provide a great deal of supplementary disclosure for long-term liabilities because they often are subject to covenants and restrictions for the protection of lenders.

Question 42

Multiple-step income statement

Answer 42

Income statement format that separates operating transactions from nonoperating transactions, and matches costs and expenses with related revenues. It highlights certain intermediate components of income that analysts use to compute ratios for assessing the performance of the company.

Question 43

Operating activities

Answer 43

Cash flow activities include the cash effects of transactions that create revenues and expenses, and thus enter into the determination of net income.

Question 44

Owners’ equity (stockholders’ equity)

Answer 44

The ownership claim on a company’s total assets. The owners’ equity section of the corporate balance sheet consists of capital stock, additional paid-in capital, and retained earnings. The ownership accounts (stockholders’ equity) in a corporation differ considerably from ownership accounts in a partnership or proprietorship. Partners show separately their permanent capital accounts and the balance in their temporary accounts (drawing accounts). Proprietors ordinarily use a single capital account that handles all of the owner’s equity transactions.

Question 45

Payout ratio

Answer 45

Profitability ratio that measures the percentage of earnings a company distributes to common stockholders in the form of cash dividends. Computed as cash dividends paid to common stockholders divided by net income available to common stockholders (net income minus preferred dividends).

Question 46

Price-earnings ratio

Answer 46

Profitability ratio the measures the market price per share to earnings. Computed as market price per share divided by earnings per share.

Question 47

Prior period adjustments

Answer 47

Corrections of accounting errors made in previous accounting periods. Companies correct such errors by making proper entries in the accounts and reporting the corrections in the financial statements (as an adjustment to the beginning balance of retained earnings) in the year in which they are discovered. If a company prepares comparative financial statements, it should restate the prior statements for the effects of the error.

Question 48

Profit margin on sales

Answer 48

Profitability ratio that measures the company’s use of its assets to produce net income. Also called return on sales. Computed as net income divided by net sales. This measure indicates the percentage of each dollar of sales that results in net income. By relating the profit margin on sales to the asset turnover for the period, we can find out how profitably the company used assets during that period of time.

Question 49

Profitability ratios

Answer 49

Measures of the degree of success or failure of a given company or division for a given period of time. Common profitability ratios are profit margin on sales, return on assets, return on common stockholders’ equity, earnings per share, the price-earnings ratio, and the payout ratio.

Question 50

Property, plant, and equipment

Answer 50

Assets of a durable nature used in the regular operations of the business. These assets consist of physical property (such as land, buildings, machinery) and wasting resources (timberland, minerals). With the exception of land, a company either depreciates (e.g., buildings) or depletes (e.g., oil reserves) these assets.

Question 51

Quick (acid-test) ratio

Answer 51

Liquidity ratio that measures the ability of a company to meet its maturing obligations with its available assets and to meet unexpected needs for cash. Computed as cash plus short-term investments plus net accounts receivable divided by current liabilities. A variation of the current ratio, the quick ratio (also referred to as the acid-test ratio) eliminates inventories and prepaid expenses from the amount of current assets, to provide a more conservative liquidity measure.

Question 52

Ratio analysis

Answer 52

An evaluation of the relationship among selected financial statement data, expressed in terms of either a percentage, a rate, or a simple proportion.

Question 53

Report form

Answer 53

Presentation in a classified balance sheet that lists liabilities and stockholders’ equity directly below assets on the same page.

Question 54

Reserve

Answer 54

An appropriation of retained earnings. Also called appropriated earnings.

Question 55

Retained earnings

Answer 55

The company’s accumulated, undistributed earnings, which may be divided into (1) unappropriated (the amount usually available for dividend distributions) and (2) restricted (the amount restricted by bond indentures or other loan agreements).

Question 56

Return on assets

Answer 56

The return a company achieves through use of its assets. Computed as net income divided by average total assets. ROA indicates the amount of net income generated by each dollar invested in assets. By relating the profit margin on sales to the asset turnover for the period, analysts can find out how profitably the company used assets during that period of time.

Question 57

Return on common stockholders’ equity

Answer 57

Profitability ratio that indicates how many dollars of net income the company earned for each dollar invested by the common stockholders. Also called return on equity (ROE). Computed as net income less preferred dividends divided by average common stockholders’ equity.

Question 58

Revenue recognition

Answer 58

The recording of the transfer of goods or services to customers in an amount that reflects the consideration that the company receives, or expects to receive, in exchange for those goods or services.

Question 59

Single-step income statement

Answer 59

Income statement format that consists of just two groupings: revenues and expenses. Expenses are deducted from revenues to arrive at net income or loss. Companies that use the single-step income statement in financial reporting typically do so because of its simplicity.

Question 60

Statement of cash flows

Answer 60

A basic financial statement that provides information about cash receipts, cash payments, and the net change in cash resulting from the operating, investing, and financing activities of a company during the period, in a format that reconciles the beginning and ending cash balances.

Question 61

Statement of comprehensive income (comprehensive income statement)

Answer 61

Part of a two statement approach for reporting the components of other comprehensive income; this statement reports other comprehensive income separate from its income statement.

Question 62

Statement of stockholders’ equity

Answer 62

One of the basic financial statements, which reports the changes in each stockholders’ equity account and in total stockholders’ equity during the year. It typically shows balances at the beginning of the period, additions and deductions, and balances at the end of the period. Companies disclose changes in the separate accounts either in separate statements or in the basic financial statements or notes thereto.

Question 63

Times interest earned

Answer 63

Solvency ratio that indicates the company’s ability to meet interest payments as they come due. Computed as the sum of net income, interest expense, and income tax expense divided by interest expense.

Question 64

Trading

Answer 64

Debt securities bought and held primarily for sale in the near term to generate income on short-term price differences.

Question 65

Transactional approach

Answer 65

Method of income measurement that focuses on the income-related activities-revenue, expense, gain, and loss transactions-that have occurred during the period.

Question 66

Treasury stock

Answer 66

The cost of shares repurchases by the company, which results in a reduction of stockholders’ equity.

Question 67

Working capital

Answer 67

The cost of shares repurchases by the company, which results in a reduction of stockholders’ equity.

Question 68

How is the Multiple-step income statement organized?

Answer 68

Sales:
Sales revenue (right)
Less: Sales discounts (left)
Sales return and allowances (left)
Net Sales (right)
Cost of goods sold (right)
Gross Profit (right)
Operating expenses (left)
Selling expenses (left)
General and administrative expenses (left)
Income from Operations (right)
Other revenues and gains
Dividend revenue (left)
Gain on sale of equipment (left)
Other expenses and losses
Interest on bond and notes (left)
Loss on flood (left)
Income before Income Tax (right)
Income tax (right)
Net income (right)
Earnings per common share (right)

Question 69

How do you find earnings per share (EPS)?

Answer 69

EPS= [(Net Income- Preferred Dividends)/ Weighted-Average Number of Common Shares Outstanding]

Question 70

Single-step income statement format?

Answer 70

Revenues:
Net Sales
Dividend revenue
Gain on sale of equipment
Total revenues
Expenses:
Cost of goods sold
Selling expenses
Administrative expenses
Interest expense on bonds and notes
Loss on flood
Income tax
Total expenses
Net income
Earning per common share

Question 71

What are the 5 steps of revenue recognition?

Answer 71

1. Identify the contracts
2. Identify Performance Obligations
3. Determined the transaction price
4. Allocate the transaction price
5. Recognize the revenue

Question 72

What is the difference between a revenue and a gain?

Answer 72

Revenues result from transactions related to central operations, whereas gains result from transactions related to peripheral operations.