Financial Statements

Question 1

the four basic financial statements required by GAP are

Answer 1

balance sheet, income sheet, statement of cash flow, statement of owners equity

Question 2

Financial statements report on a company’s

Answer 2

income, cash flow and equity

Question 3

The balance sheet reports a

Answer 3

point-in-time snapshot of the assets, liabilities and equity of the entity.

Question 4

An income statement reports on a company’s

Answer 4

expenses and profits to show whether the company made or lost money.

Question 5

The cash flow statement reports

Answer 5

the flow of cash in and out of the business, dividing cash into operating, investing and financing activities.

Question 6

A statement of changes in equity explains

Answer 6

the changes of the company’s equity throughout the reporting period, including profits or losses, dividends paid and issue or redemption of stock.

Question 7

Owners and managers use financial statements to

Answer 7

make important long-term business decisions. For example: whether or not to continue or discontinue part of its business, to make or purchase certain materials, or to acquire or rent/lease certain equipment in the production of its goods.

Question 8

Prospective investors use financial statements to

Answer 8

perform financial analysis, which is a key component in making investment decisions.

Question 9

A lending institution will examine the financial health of a person or organization and use the financial statement to

Answer 9

decide whether or not to lend funds.

Question 10

Financial analysis (also referred to as financial statement analysis) refers to

Answer 10

Financial analysis (also referred to as financial statement analysis) refers to

Question 11

Other individuals and entities use financial statements too. For example:

Answer 11

Prospective investors use financial statements to perform financial analysis, which is a key component in making investment decisions.
A lending institution will examine the financial health of a person or organization and use the financial statement to decide whether or not to lend funds.
Philanthropies may use financial statements of a non-profit as a component in determining where to donate funds.
Government entities (tax authorities) need financial statements to ascertain the propriety and accuracy of taxes and other duties declared and paid by a company.
Vendors who extend credit may use financial statements to assess the creditworthiness of the business.
Employees also may use reports in making collective bargaining agreements.

Question 12

The income statement, or profit and loss statement (P&L), reports

Answer 12

a company’s revenue, expenses, and net income over a period of time.

Question 13

The income statement consists of

Answer 13

revenues and expenses along with the resulting net income or loss over a period of time due to earning activities. The income statement shows investors and management if the firm made money during the period reported.

Question 14

The operating section of an income statement includes

Answer 14

revenue and expenses. Revenue consists of cash inflows or other enhancements of assets of an entity, and expenses consist of cash outflows or other using-up of assets or incurring of liabilities.

Question 15

The non-operating section includes

Answer 15

revenues and gains from non-primary business activities, items that are either unusual or infrequent, finance costs like interest expense, and income tax expense.

Question 16

The “bottom line” of an income statement is

Answer 16

the net income that is calculated after subtracting the expenses from revenue. It is important to investors – also on a per share basis (as earnings per share, EPS)–as it represents the profit for the accounting period attributable to the shareholders.

Question 17

Income statement:

Answer 17

a calculation which shows the profit or loss of an accounting unit during a specific period of time, providing a summary of how the profit or loss is calculated from gross revenue and expenses.

Question 18

Gross profit:

Answer 18

the difference between net sales and the cost of goods sold.

Question 19

Net income:

Answer 19

gross profit minus operating expenses and taxes. Net earnings and net profit are also known as “net income.”

Question 20

Income bond:

Answer 20

a debt instrument where coupon payments are only made if the issuer can afford it.

Question 21

Statement of cash flows:

Answer 21

a financial document that shows how changes in balance sheet accounts and income affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities.

Question 22

The income statement is a financial statement that is used to

Answer 22

help determine the past financial performance of the enterprise, predict future performance, and assess the capability of generating future cash flows. It is also known as the profit and loss statement (P&L), statement of operations, or statement of earnings.

Question 23

Items that create temporary differences due to the recording requirements of GAAP include

Answer 23

rent or other revenue collected in advance, estimated expenses, and deferred tax liabilities and assets.

Question 24

Also there are events, usually one-time events, which create “permanent differences,” such as

Answer 24

GAAP recognizing as an expense an item that the IRS will not allow to be deducted.

Question 25

The four basic principles of GAAP can affect items on the income statement. These principles include

Answer 25

the historical cost principle, revenue recognition principle, matching principle, and full disclosure principle.

Question 26

The historical cost principle:

Answer 26

It requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.

Question 27

The revenue recognition principle:

Answer 27

It requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received.

Question 28

The matching principle:

Answer 28

This governs the matching of expenses and revenues, where expenses are recognized, not when the work is performed or when a product is produced, but when the work or the product actually makes its contribution to revenue.

Question 29

The full disclosure principle:

Answer 29

This suggests that the amount and kinds of information disclosed should be decided based on a trade-off analysis, since a larger amount of information costs more to prepare and use. GAAP reporting also suggests that income statements should present financial figures that are objective, material, consistent, and conservative.

Question 30

Noncash items should be added back in when

Answer 30

analyzing income statements to determine cash flow because they do not contribute to the inflow or outflow of cash like other gains and expenses eventually do.

Question 31

Depreciation:

Answer 31

the measurement of the decline in value of assets. Not to be confused with impairment, which is the measurement of the unplanned, extraordinary decline in value of assets.

Question 32

Amortization:

Answer 32

the distribution of the cost of an intangible asset, such as an intellectual property right, over the projected useful life of the asset.

Question 33

Obsolescence:

Answer 33

the state of being obsolete—no longer in use; gone into disuse; disused or neglected.

Question 34

A balance sheet is

Answer 34

a financial statement that summarizes a company’s assets, liabilities and shareholders’ equity at a specific point in time.

Question 35

A standard company balance sheet has three parts:

Answer 35

assets, liabilities and ownership equity.

Question 36

In financial accounting, a liability is defined as

Answer 36

an obligation of an entity arising from past transactions or events, the settlement of which may result in the transfer or use of assets, provision of services or other yielding of economic benefits in the future.

Question 37

The types of accounts and their description that comprise the owner’s equity depend on the nature of the entity and may include:

Answer 37

Common stock, preferred stock, capital surplus, retained earnings, treasury stock, stock options and reserve.

Question 38

Preferred Stock:

Answer 38

stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock. It also has priority to common stock in liquidation.

Question 39

Net working capital is calculated as

Answer 39

current assets minus current liabilities.

Question 40

Current assets and current liabilities include three accounts which are of special importance:

Answer 40

accounts receivable, accounts payable and inventories.

Question 41

The goal of working capital management is to

Answer 41

ensure that the firm is able to continue its operations and that it has sufficient cash flow. The management of working capital involves managing inventories, accounts receivable and payable, and cash.

Question 42

Operating liquidity:

Answer 42

the ability of a company or individual to quickly convert assets to cash for the purpose of paying operating expenses.

Question 43

Operating cash flows refers to

Answer 43

the cash a company generates from the revenues it brings in, excluding costs associated with long-term investment on capital items or investment in securities (these are investing or financing activities).

Question 44

IFRS:

Answer 44

International Financial Reporting Standards. The major accounting standards system used outside of the United States.

Question 45

GAAP:

Answer 45

Generally Accepted Accounting Principles refer to the standard framework of guidelines, conventions, and rules accountants are expected to follow in recording, summarizing, and preparing financial statements in any given jurisdiction.

Question 46

Significant cash outflows are

Answer 46

salaries paid to employees and purchases of supplies.

Question 47

Investing activity:

Answer 47

An activity that causes changes in non-current assets or involves a return on investment.

Question 48

Merger:

Answer 48

The legal union of two or more corporations into a single entity, typically assets and liabilities being assumed by the buying party.

Question 49

Purchase return:

Answer 49

merchandise given back to the seller from the buyer after the sale in return for a refund.

Question 50

Investing activities:

Answer 50

actions where money is put into something with the expectation of gain, usually over a longer term.

Question 51

The three types of cash flow are cash from

Answer 51

operations, investing, and financing.

Question 52

Cash flows from operating activities are essential to helping analysts assess the company’s ability to

Answer 52

meet ongoing funding requirements, contribute to long-term projects and pay a dividend.

Question 53

Which answer best defines financial statements in general?

Answer 53

A collection of reports that describes a company’s financial activities to a third party

Question 54

Which answer gives the best example of a factor that can be determined through an analysis of a company’s financial statements?

Answer 54

The company’s profitability, The accuracy of the company’s tax returns, The company’s creditworthiness

Question 55

Which answer does not describe a step in constructing a multi-step income statement?

Answer 55

Add all revenues, then subtract all expenses.

Question 56

Which answer is not one of the four basic GAAP principles?

Answer 56

Revenue should be recorded when realized or realizable and when cash is received. Under the accrual basis of accounting (as opposed to the cash basis of accounting), revenues are recognized as soon as a product has been sold or a service has been performed, regardless of when the cash is actually received.

Question 57

Which answer best summarizes why there may be a difference between a company’s pretax income and taxable income?

Answer 57

Pretax income is based on revenue recognition; taxable income is based on the company’s cash flow.