Test 2 Multiple Choice Questions Flashcards
Goodwill is:
a. Amortized over the greater of its estimated life or 40 years.
b. Only recorded by the seller of a business.
c. The excess of the purchase price of a business over the fair value of all net identifiable assets.
d. None of these answer choices are correct.
c. The excess of the purchase price of a business over the fair value of all net identifiable assets.
When recording depreciation using the Double-Declining Balance method of depreciation, which financial statements are impacted?
I. Income Statement
II. Cash Flow Statement (using indirect method)
III. Balance Sheet
a. I only
b. III only
c. I and III
d. I, II, and III
e. None of the above
d. I, II, and III
- Nike’s portfolio of Trading Securities, originally purchased at $100 million, now has a market value of $150 million. How will this impact Nike’s financial statements?
a. $50 million gain in other comprehensive income
b. $50 million loss in other comprehensive income
c. $50 million gain in net income
d. $50 million loss in net income
e. Not recognized
c. $50 million gain in net income
Which of the following may cause a temporary difference between taxable and pretax accounting income?
a. Expenses related to political contributions.
b. Double declining balance used for depreciating equipment.
c. Income from municipal bonds.
d. Life insurance proceeds received due to the death of an executive.
b. Double declining balance used for depreciating equipment.
- LIFO layers are created every year that sales are greater than purchases.
a. TRUE
b. FALSE
b. FALSE
- Purchases > sales
- Lifo LIQUIDATION occurs when sales > purchases
During a period of inflation, which of the following inventory costing methods will result in the highest COGS?
a. LIFO
b. FIFO
c. Average
d. They will produce the same COGS
LIFO
________ inventory costing method is used to derive a lower income tax expense when prices are rising.
a. FIFO.
b. LIFO.
c. Weighted Average.
d. Specific Identification
LIFO
List two reasons why a lender would include a tight debt covenant in a contract.
- Early warning of financial distress
- Protects from default
Which of the following would NOT be included when finding DILUTED earnings per share?
a. Convertible bonds that cause an increase in EPS
b. Options issued that are considered to be “in the money”
c. Convertible bonds 1 year away from maturity
d. Convertible preferred stock that is backed by secure collateral
a. Convertible bonds that cause an increase in EPS
- Has an “antidilutive” effect, so is not included
How would a $2,000 restructuring charge that hasn’t been paid in cash impact the financial statements, with a tax rate of 20% and income subject to tax of $14,000?
a. The restructuring expense would be recorded on the balance sheet as an Income Tax Payable of $2,400.
b. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Asset of $400.
c. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Liability of $400.
d. Restructuring charges do not impact the balance sheet, they are only recorded on the income statement as an expense.
b. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Asset of $400.
- Restructuring charges have been incurred but not paid
- So, FI < TI = DTA
- Which of the following fixed assets are NOT depreciated?
a. Buildings
b. Land
c. Land Improvements
d. Equipment
b. Land
Which of the following statements is CORRECT regarding Book-Tax Differences?
a. If straight-line is used for book depreciation and MACRS (double declining balance) is used for tax depreciation, this results in a deferred tax liability.
b. Permanent differences create deferred tax assets by decreasing or increasing the effective tax rate.
c. Income from municipal bonds and premiums paid for life insurance policies of key executives are all examples of income that is never taxed.
d. When financial income is greater than taxable income it is a deferred tax asset.
a. If straight-line is used for book depreciation and MACRS (double declining balance) is used for tax depreciation, this results in a deferred tax liability.
- What is a main reason for purchasing trading securities?
a. To take advantage of short-term price changes
b. To avoid risk and make safe investments
c. Trading securities are known for their guaranteed huge returns
d. Trading securities are the cheapest investments
a. To take advantage of short-term price changes
Which of the following answer choices is NOT true about the amortization and impairment of intangible assets?
a. If the useful life of the intangible asset is determinable, we amortize the cost over the lesser of the useful life or legal life.
b. Goodwill and intangibles with indefinite useful lives are always amortized on a 10-year basis
c. If sum of future cash flows is greater than the book value for assets with a definite useful life, the asset is not impaired
d. We check for impairment on
b. Goodwill and intangibles with indefinite useful lives are always amortized on a 10-year basis
Which of the following would cause a DECREASE in EPS?
a. Increase in Net Income
b. The purchase of common stock to keep in treasury
c. Having unrealized losses in available-for-sale debt securities
d. Re-issuing treasury stocks to the public
d. Re-issuing treasury stocks to the public
What differentiates Pretax Financial Income from Financial Income Subject to Tax?
a. Permanent Book-Tax differences
b. Temporary Book-Tax differences
c. Financial Income Subject to Tax is synonymous with Pretax Financial Income
d. None of the Above
a. Permanent Book-Tax differences
During periods when costs are rising and inventory quantities are stable, cost of goods sold will be:
A. Higher under FIFO than LIFO.
B. Higher under FIFO than average cost.
C. Lower under average cost than LIFO.
D. Lower under LIFO than FIFO.
C. Lower under average cost than LIFO.
Which type of income is used to calculate taxes on the income statement?
Financial income subject to to tax
During periods when costs are rising and inventory quantities are stable, ending inventory will be:
A. Higher under LIFO than FIFO.
B. Lower under average cost than LIFO.
C. Higher under average cost than FIFO.
D. Higher under FIFO than LIFO.
D. Higher under FIFO than LIFO.
A company determines its costs using the LIFO inventory flow assumption. In a period of rising prices, how would their choice of inventory flow assumption affect their income tax expense?
a. Higher income tax expense due to higher reported costs.
b. Higher income tax expense due to a higher reported earnings before taxes.
c. Lower income tax expense due to higher reported costs.
d. Lower income tax expense due to lower reported costs.
c. Lower income tax expense due to higher reported costs.
Which of the following is a reason why the specific identification method may be considered ideal for assigning costs to inventory and cost of goods sold?
A. The potential for manipulation of net income is reduced.
B. There is no arbitrary allocation of costs.
C. The cost flow matches the physical flow.
D. Able to use on all types of inventory
C. The cost flow matches the physical flow.
Assuming no beginning inventory, what can be said about the trend of inventory prices if cost of goods
sold computed when inventory is valued using the FIFO method exceeds cost of goods sold when
inventory is valued using the LIFO method?
A. Prices decreased.
B. Prices remained unchanged.
C. Prices increased.
D. Price trend cannot be determined from information give
A. Prices decreased.
During periods when costs are rising and inventory quantities are stable, cost of goods sold will be:
A. Higher under FIFO than LIFO.
B. Higher under FIFO than average cost.
C. Lower under average cost than LIFO.
D. Lower under LIFO than FIFO.
C. Lower under average cost than LIFO.
An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending
inventory valuation is:
A.FIFO.
B. LIFO.
C. Weighted Average.
D. None of the above.
A.FIFO.
During periods when costs are rising and inventory quantities are stable, ending inventory will be:
A. Higher under LIFO than FIFO.
B. Lower under average cost than LIFO.
C. Higher under average cost than FIFO.
D. Higher under FIFO than LIFO.
D. Higher under FIFO than LIFO.
The Reid Co. acquired a piece of land to construct a new factory paying $100,000. Reid
demolished the old building at a cost of $20,000, and sold scrapped material salvaged from the
old building for $5,000. The architect’s fees for the factory were $25,000 and the contractor
received $300,000 for construction of the factory building.
1.What is the recorded cost of the land?
2.What is the recorded cost of the building?
Land = 100,000 + 20,000 - 5,000 = 115,000
Building = 25,000 + 300,000 = 325,000
Assuming no beginning inventory, what can be said about the trend of inventory prices if cost of goods sold computed when inventory is valued using the FIFO method exceeds cost of goods sold when inventory is valued using the LIFO method?
A. Prices decreased.
B. Prices remained unchanged.
C. Prices increased.
D. Price trend cannot be determined from information given.
A. Prices decreased.
Staley Enterprises purchased a machine for $260,000. The seller paid $900 freight to deliver the
machine. Staley used $4,600 of staff mechanics’ time to install the machine and employee
training cost on the new machine totaled $7,000. Staley also paid $2,000 for the annual insurance
premium relating to operating the machine. The state charged a 5% sales tax on the invoice price.
What is the capitalized cost of the machine?
260,000 * 1.05 + 4,600 + 7,000 = 284,600
An inventory pricing procedure in which the oldest costs incurred rarely have an effect on the ending
inventory valuation is:
A. FIFO.
B. LIFO.
C. Weighted Average.
D. None of the above.
A. FIFO.
How to calculate DDB?
Take SL Rate and double it
- straight line rate is cost of equipment (not including SV) / years
What are the 2 indefinite-life intangibles?
- Goodwill
- Trademarks
If a company simply disposes an asset worth 7,000 on the books, how does that impact the INCOME STATEMENT?
Loss on disposal of 7,000
The Reid Co. acquired a piece of land to construct a new factory paying $100,000. Reid
demolished the old building at a cost of $20,000, and sold scrapped material salvaged from the
old building for $5,000. The architect’s fees for the factory were $25,000 and the contractor
received $300,000 for construction of the factory building.
What is the recorded cost of the land?
What is the recorded cost of the building?
What is the recorded cost of the land?
100,000 (cost) + 20,000 (demolition) – 5,000 (salvage) = 115,000
What is the recorded cost of the building?
25,000 (architect) + 300,000 (contractor) = $325,000
How does depreciation impact the 3 statements?
B/S - reduces PPE value and RE
I/S - depreciation expense
CF - is added back to net income
Staley Enterprises purchased a machine for $260,000. The seller paid $900 freight to deliver the
machine. Staley used $4,600 of staff mechanics’ time to install the machine and employee
training cost on the new machine totaled $7,000. Staley also paid $2,000 for the annual insurance
premium relating to operating the machine. The state charged a 5% sales tax on the invoice price.
What is the capitalized cost of the machine?
260,000 x 1.05 + 4,600 + 7,000 = 284,600
Amortizable intangible assets include all of the following except
a. goodwill.
b. patents.
c. copyrights
a. goodwill.
How to calculate straight line rate? Then how to get DDB?
Price (without SV) / years
Multiply this x 2
Which characteristic is not possessed by intangible assets?
a. Physical existence.
b. Long-lived.
c. Result in future benefits.
d. Expensed over current and/or future years.
a. Physical existence.
How to calculate total OCI for two years?
Take Fair Value - Cost and compare from year 2 to year 1
Which of the following costs incurred internally to create an intangible asset is generally
expensed?
a. Research and development costs.
b. Filing costs.
c. Legal costs.
d. All of these answer choices are correct
a. Research and development costs.
For an EQUITY METHOD calculation, say you earn 100 in net income and 300 in dividends (both after adjustments) from a company. What goes on YOUR income statement?
Just the 100 net income
For the equity method, let’s say a company you’re invested in pays you dividends of 300 and has net income (after equity method adjustment) of 1000. What amount will appear on YOUR income statement?
Just the net income, after adjustment, of 1000
For an INSIGNIFICANT CONTROL equity calculation, say you earn 100 in net income and 300 in dividends (both after adjustments) from a company. What goes on YOUR income statement?
Just the dividends of 300 (and any gain/loss on the investment)
For an equity portfolio of trading securities, say the unrealized gain is 5,000. How much goes on OCI?
None, it is reported on Net Income
OCI is for available for sale debt securities
The investment category for which the investor’s “positive intent and ability to hold to the end date”
is important is:
a. Securities reported under the equity method.
b. Trading securities.
c. Securities classified as held to maturity.
d. Available for sale debt securities.
c. Securities classified as held to maturity.
Which of the following investment securities held by Zoogle Inc. are not reported at fair value in its
balance sheet?
a. Common stock held by a company that management intends to hold for several years.
b. Debt securities held to maturity.
c. Preferred stock held as trading securities.
d. All of these answer choices are reported at fair value
b. Debt securities held to maturity.
The income statement reports changes in fair value for which type of securities?
a. Securities reported under the equity method
b. Equity securities that represent less than 20% ownership
c. Held to maturity securities
d. Available for sale debt securities
b. Equity securities that represent less than 20% ownership
Holding gains and losses on trading securities are included in earnings because:
a. They measure the success or failure of taking advantage of short-term price changes.
b. The IRS mandates the inclusion.
c. The SEC mandates the inclusion.
d. They measure the book value of the securities in the balance sheet date.
a. They measure the success or failure of taking advantage of short-term price changes.
Accumulated Other Comprehensive Income in the shareholders’ equity section of the balance sheet reflects changes in the fair value of securities for which type of securities?
a. Available for sale debt securities
b. Trading securities
c. Consolidated securities
d. Held to maturity securities
a. Available for sale debt securities
Which ONE of the following statements BEST describes a CONSOLIDATED balance sheet?
a. A balance sheet that includes the assets and liabilities of both the parent company and all of the subsidiaries controlled by the parent company
b. A balance sheet that includes the goodwill of both the parent company and all of the smaller
companies purchased by the parent company
c. A balance sheet that includes not only the assets and liabilities of the parent company but
also the retained earnings of the parent company
d. A balance sheet that reports both the replacement cost and the fair value of all property,
plant, and equipment of the parent company
e. A balance sheet that reports both the interest-bearing and the non-interest-bearing liabilities
of the parent company
a. A balance sheet that includes the assets and liabilities of both the parent company and all of the subsidiaries controlled by the parent company
Fill in the blanks:
Which of the following statements accurately fills in the blanks with the most appropriate terms?
The ________ investments are carried at ___________ on the balance sheet; with unrealized
holding gains and losses reported in _________
What does a debt ratio of 35% mean?
You borrowed 35% to buy your assets
Butte Mountain Inc repurchased bonds by exercising a call provision for $825,000. The bonds have a face value of $800,000 and an unamortized premium of $20,000.
Determine the amount of any gain or loss on the repurchase.
Loss
Purchase price of 800,000 + unamortized premium of 20,000 = 820,000
820 - 825 = loss of 5,000
How is a discount/premium on bonds payable accounted for on the balance sheet?
As a contra-account to bonds payable
A bond issue with a face amount of $900,000 bears interest at the rate of 8%. The current market rate of
interest is 10%. These bonds will sell at a price that is:
a. More than $900,000.
b. The answer cannot be determined.
c. Equal to $900,000
d. Less than $900,000
d. Less than $900,000
A bond issue on June 1, Year 6, has interest payment dates of April 1 and October 1. Bond interest
expense for the year ended December 31, Year 6, is for a period of:
a. 3 months.
b. 4 months.
c. 6 months.
d. 7 months.
d. 7 months.
For a bond issue that sells for more than its face value, the market rate of interest is
a. Equal to the rate stated on the bond.
b. Dependent on the rate stated on the bond.
c. Higher than the rate stated on the bond.
d. Less than the rate stated on the bond.
d. Less than the rate stated on the bond.
Which of the following is a reason that a lender would desire a loan contract that includes a debt
covenant?
I. To protect themselves from borrower default.
II. To lower the interest rate.
III. To lower the risk.
a. I, III
b. II, III
c. I, II
d. I, II, III
a. I, III
Permanent book/tax differences is/are:
a. differences in book/tax income that will be reversed in following years.
b. used to determine book income but never used to determine taxable income.
c. depreciation expenses, warranty expenses, and unrealized gains on corporate stock held for
investment.
d. income/loss that is recorded for book purposes which is not recorded for tax purposes until the next year
b. used to determine book income but never used to determine taxable income.
Company X reports pre-tax financial income of $45,000 which includes interest revenues of
$500 from a municipal bond. What is the amount of financial income subject to tax?
Muni bond interest not included in taxable income
So, 45000 - 500 = 44,500
For tax questions, how to calculate net income?
Pre tax financial income - Total income tax expense
For tax questions, how to calculate effective tax rate?
Total income tax expense / pre tax financial income
When doing journal entries for stock options, what is the journal entry during the vesting years?
Debit Com Exp
Credit PIC
How to calculate compensation expense for stock options?
use the fair value price
When doing journal entries for stock options, what is the journal entry for the exercising of the stock options?
Debit cash (using strike price)
debit PIC (using FV price)
Credit common stock
Total stockholders’ equity represents
a. a claim to specific assets contributed by the owners.
b. the maximum amount that can be borrowed by a company.
c. a claim against a portion of the total assets of a company.
d. only the amount of earnings that have been retained in the business.
c. a claim against a portion of the total assets of a company.
Stockholders’ equity is generally classified into three major categories:
a. contributed capital, appropriated capital, and retained earnings.
b. appropriated capital, retained earnings, and accumulated other comprehensive income.
c. retained earnings, unappropriated capital, and earned capital.
d. earned capital, contributed capital, and accumulated other comprehensive income.
d. earned capital, contributed capital, and accumulated other comprehensive income.
Treasury shares are shares:
a. held as an investment by the treasurer of the corporation.
b. held as an investment of the corporation.
c. issued and outstanding.
d. issued but not outstanding
d. issued but not outstanding
The compensation associated with restricted stock under a stock award plan is:
a. The book value of an unrestricted share of the same stock times the number of shares
represented by the restricted stock.
b. Allocated to expense over the service period which usually is the vesting period.
c. The estimated fair value of a share of similar stock times the number of shares
represented by the restricted stock.
d. The book value of a share of similar stock times the number of shares represented by the
restricted stock
b. Allocated to expense over the service period which usually is the vesting period.
The compensation associated with a stock option plan is the number of shares granted by the
option multiplied by:
a. The strike price at the grant date.
b. The market price at the grant date.
c. The expected market price at the exercise date.
d. The Black-Scholes value per share at the grant date.
d. The Black-Scholes value per share at the grant date.
A treasury stock reissuance may have an impact on retained earnings if the company
reacquired the shares at a higher price than they reissued them.
a. True
b. False
a. True
Diluted EPS is calculated for companies with complex capital structures only.
True
False
True
An investor company must consolidate its financial statements with an investee company if it owns more than ______ of the voting stock of the investee company, and the portion not owned by the parent company is reflected as _______ on the balance sheet.
a. 50%, non-controlling interest
b. 50%, non-consolidated interest
c. 50%, controlling interest
d. 50%, consolidated interest
a. 50%, non-controlling interest
If Apple Corporation owns 65% of Bee Inc., how much of Bee’s revenue will be reported on Apple’s Income statement in total revenues?
a. 0%
b. 65%
c. 50%
d. 100%
d. 100%
Prepaid Insurance will result in:
a. Permanent differences
b. Deferred tax liabilities
c. Deferred tax assets
d. None of the items listed
b. Deferred tax liabilities
3 deferred tax liabilities
- Prepaid expenses
- Depreciation differences (when tax uses DDB)
- Goodwill
Estimated Bad Debt Expenses recorded at the end of the year result in:
a. Deferred Tax Liabilities
b. Permanent differences
c. None of the items listed
d. Deferred Tax Assets
d. Deferred Tax Assets
A company must pay dividends in cash at the time they are declared.
a. True
b. False
b. False
Which of the following is NOT a reason for why a company might repurchase its own stock (Treasury Stock)?
a. To display doubt in the stock and that it is currently overvalued by the market.
b. To provide shares for incentive compensation and employee savings plans.
c. To remove some shares from the open market to protect against a hostile takeover.
d. To improve per share earnings by reducing the number of shares outstanding.
a. To display doubt in the stock and that it is currently overvalued by the market.
The total par value of the common and preferred stock, along with the associated amounts of paid-in capital in excess of par, constitute a corporation’s contributed capital (including subtracting treasury stock).
a. True
b. False
a. True
If a trading security that originally cost 300 is sold for 310, how much investment related income is reported on the income statement?
10
How would a $2,000 restructuring charge that hasn’t been paid in cash impact the financial statements, with a tax rate of 20% and income subject to tax of $14,000?
a. The restructuring expense would be recorded on the balance sheet as an Income Tax Payable of $2,400.
b. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Asset of $400.
c. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Liability of $400.
d. Restructuring charges do not impact the balance sheet, they are only recorded on the income statement as an expense.
b. The restructuring charges would be recorded on the balance sheet as a Deferred Tax Asset of $400.
-
Impairment testing is performed in the same way for indefinite-life intangibles and limited-life intangibles.
A. True
B. False
B. False
- Impairment testing for definites use depreciation, which indefinites do not have
When a bond sells at a premium, interest expense will be:
A. none of these answer choices are correct.
B. greater than the bond interest payment.
C. less than the bond interest payment.
D. equal to the bond interest payment
C. less than the bond interest payment.
Deferred tax expense is the:
A. amount of income taxes payable for the period.
B. increase in a deferred tax liability.
C. increase in a deferred tax asset.
D. decrease in a deferred tax liabilit
B. increase in a deferred tax liability.
A deferred tax liability represents the…
A. decrease in taxes payable in future years as a result of taxable temporary differences.
B. increase in taxes saved in future years as a result of deductible temporary differences.
C. decrease in taxes saved in future years as a result of deductible temporary differences.
D. increase in taxes payable in future years as a result of taxable temporary difference
D. increase in taxes payable in future years as a result of taxable temporary differenc
How to calculate Days’ Sales in Inventory?
365 / (COGS / Avg Inventory)
Unrealized gains are based off of …. …
Realized gains are based off …
Fair value
Cost
Under the equity method, how is income reported on the income statement?
As “equity method income”
What inventory method to use and why during inflation?
- Fifo
- You want lower COGS to get higher net income, so don’t want to use newest, more expensive, inventory
Main incentive to use LIFO
Tax savings
3 downsides to LIFO
- LIFO Layers
- LIFO Liquidation
- Higher COGs –> lower net income
What can LIFO layers result in over time?
Significant difference better market value of inventory and the value of inventory on your B/S (lower)
How to calculate LIFO reserve?
FIFO - LIFO
What is LIFO liquidation?
When old layers of inventory need to be used to satisfy sales
What can LIFO liquidation lead to?
Lower COGS, higher net income, but higher taxes (which is the main benefit of LIFO)
How to calculate inventory turnover
COGS / Average Inventory
How would FIFO affect inventory turnover and days in inventory?
Fifo = lower COGS
Lower COGS = lower inventory turnover
Lower inventory turnover = higher days in inventory
How to calculate NRV of inventory?
Cost of inventory - completion - transportation - disposal
How is inventory using LIFO recorded?
Lower of historical cost or market
Tangible assets are … and then … over time
capitalized ; expensed
What is the acquisition cost of an asset?
All costs incurred to bring an asset into use
When to capitalize vs expense cost AFTER acquisition
- Expense if costs MAINTAIN given level of service
- Capitalize if costs IMPROVE given level of service
Suppose that 9 years ago Imtel purchased an asset of $10,000. The current book value is $1,000 and they decide to scrap it because it’s useful life is over and it isn’t worth anything.
How should this disposal impact the…
Balance sheet effect?
Income statement effect?
Cash flow effect?
Balance Sheet
- Assets (ppe) decrease 1,000
- Equity decreases by 1,000 (loss on disposal)
Income Statement
- Loss of 1,000
Cash Flow
- No effect (Not a cash transaction)
Suppose that 9 years ago Imtel purchased an asset of $10,000. The current book value is $1,000 and they decide to sell it for $600.
How should this sale impact the CASH FLOW statement?
Increase to investing section of 600
Journal entry for impairment loss
Debit impairment loss (expense)
Credit PPE
When using DDB, what does the last year have to have?
A depreciation amount so that the book value = salvage value
4 types of intangibles
- Rights
- Relationships
- Information
- People
Intangible assets are only recognized if they are …
purchased
Internally-generated intangibles are … the balance sheet.
Purchased intangibles are … the balance sheet.
Off ; on
2 exceptions to internally-generated intangibles not being expensed
R&D - if it creates technological feasibility
Legal fees - added on to price
Purchased intangibles are capitalized as an …
asset
How to calculate goodwill?
Purchase price - FVA
Will the goodwill balance ever change?
Only if it is impaired, so it will go down.
Can never go up
What is the test called for limited life intangibles?
Recoverability test
These are all goals of what type of investment?
- Influence their decisions (investing in a suppliers)
- Control their decisions
- Quick growth
- Foothold in a new market, industry, geographic location
- Acquire particular expertise, skill, product
- Eliminate competition
In other companies
How are held to maturity debt early redemption reported?
On I/S
How are 50% + equity investments valued?
Using consolidation
Part not owned under “non-controlling interests” on B/S
The equity method basically captures a … … of the change in the investee’s … …. during the year.
proportionate share ; retained earnings
Equity Method: The investor reports its investment in the investee in a single investment account on the … …
balance sheet
How does the equity method impact the financial statements?
Balance sheet: ending investment amount reported in RE
Income Statement: proportionate net income reported in Income
Cash flow: initial investment as cash outflow in investment section
True/False: Unrealized gains and losses on equity method investments are ignored.
True
Which of the following investment securities held by Zoogle Inc. are not reported at fair value in its balance sheet?
a. Common stock held by a company that management intends to hold for several years.
b. Debt securities held to maturity.
c. Preferred stock held as trading securities.
d. All of these answer choices are reported at fair value
b. Debt securities held to maturity.
Why would companies need debt/credit for operating needs?
To cushion cyclical operating needs (as a buffer)
How debt shows up on 3 financial statements
BS: current liabilities and long term liabilities
IS: interest expense
CF: cash paid for interest impact operating section, cash received from borrowing and paid on principal impacts financing section
Bonds sold to the public are different from bank loans in a 3 ways:
- have a market price
- risk and maturity determine issue price
- have a longer maturity
How to calculate carrying value of bond
Face value -/+ Unamortized Discount/Premium
What method is used to calculate the carrying value of a bond?
The Effective Interest Method
Premiums … interest expense, whereas discounts …. interest expense
decrease ; increase
When do you get a gain from buying back debt? When do you get a loss
Gain: Purchase Price < CV
Loss: Purchase price > CV
Give two reasons why companies issue bonds that can be converted into equity and why an investor would purchase a bond with an equity feature.
Company: they don’t have to come up with cash to repay bonds when it matures. Can also command a higher price for the bonds because they are convertible
Investor: ownership, take advantage of stock appreciation
Two types of credit risk
Short-term liquidity risk
Long-term solvency risk
Utah Corp took out a 5% note for $500,000 on January 1, 20X4. The principal is to be paid back in installmentsof $100,000 at the end of each year for the next 5 years.
How will this note be reflected on the balance sheet at December 31, 20X4?
What is interest expense for the year ended 20X4? 20X5?
a. $100,000 will be included in Current Liabilities, $400,000 will be included in Long-term Liabilities
b. $500,000 x 5% = 25,000$400,000 x 5% = 20,000
Goal of financial reporting (3)
predictive value, comparability, faithful representation
What are permanent differences?
The financial accounting number will never factor into taxes
Permanent differences increase/decrease the … … … by increasing or decreasing …. … … … … …
effective tax rate
pretax financial income subject to tax
Examples of permanent differences: income that is NEVER taxed (3) - are subtracted from income
- Income from municipal bonds
- Life insurance proceeds on the death of a key executive
- A portion of dividends received from other companies → to eliminate double taxation (since dividends are already post-tax)
Expenses that are NEVER deducted for tax purposes (4)
- Political contributions
- Disallowed meals and entertainment
- Premiums paid for life insurance policies of key executives
- Payments and fines due to violations of the law.
5 common DTAs
- Unearned revenue (cash advances
- Bad debt expense
- Stock comp expense
- Warranty expense
- Loss carryforwards
3 common DTLs
- Depreciation
- Prepaid expenses
- Goodwill
When is effective tax rate higher?
When financial income subject to tax is LOWER than pretax financial income
Journal Entry for DTA
Debit Income Tax Expense
Debit Deferred Tax Asset
Credit Income Tax Payable
What is it called when you do not take advantage of deferred tax assets?
Valuation allowance
3 major components of equity
- Contributed capital
- Earned capital
- Accumulated other comprehensive income (loss)
4 primary equity transactions
- Issue stock
- Repurchase stock
- Issue dividends
- Close out net income
4 Types of Share-Based Plans (and what each does)
- Stock award plans (firm gives employees shares)
- Stock option plans (firm gives employees option to purchase shares)
- Share purchase plans (employees can buy shares directly from company and avoid broker)
- Stock appreciation rights (firm pays cash bonuses to employees equal to appreciation of stock)
What is the impact on the financial statements of the restricted stock awards on the grant date?
No impact
The compensation associated with a stock option plan is the number of shares granted by the option multiplied by:
a. The strike price at the grant date.
b. The market price at the grant date.
c. The expected market price at the exercise date.
d. The Black-Scholes value per share at the grant date
d. The Black-Scholes value per share at the grant date
Basic EPS Equation
(net income - preferred dividends) / weighted average common shares outstanding
Do stock dividends/splits change overall SE?
No, just shares outstanding (but overall value remains the same)
When do you subtract out preferred dividends with non-cumulative preferred stock?
Only if they have been DECLARED
Simple vs Complex Capital Structures
Simple = only common shares, no dilution
Complex = securities could dilute shares
2 ways that Basic EPS can be diluted
- Convertibles
- Options, warrants, and other dilutive securities
4 steps to the treasury stock method:
- Determine new shares from hypothetical exercise of ALL options
- Determine the cash proceeds (# of options x strike price)
- Determine number of shares that could be bought back (cash proceeeds / avg market price)
- Increase denominator by difference between total number of shares from hypothetical and number of shares from repurchases
