Practice exam with the 11th edition of Financial Accounting by Needles & Powers

How to use financial statements for business accounting? - ExamTests 1

Questions

Question 1

How is a business defined?

Question 2

What are the 2 major goals for all businesses?

Question 3

Which are the four major financial statements?

Question 4

What is the correlation between financial analysis, financial statement and performance measures?

Question 5

What is the accounting equation?

Question 6

Which are the 3 forms of business? And explain them briefly.

Answer indication

Question 1

A business is an economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners.

Question 2

Major goals:

1. The need to earn enough income to attract and hold investment capital is the goal of profitability.
2. In addition, business must meet the goal of liquidity: having enough cash available to pays debts when they are due.

Question 3

The four major statements:

1. The income statement focuses on the company’s profitability. It summarizes the revenue earned and expenses incurred by a business over a period of time. This will give the net income.
2. The statement of retained earnings shows the changes in retained earnings over a period of time. It is the difference between the old and the new net income, less the dividends paid to stockholders.
3. The balance sheet is used to show the financial position of a business on a certain date. Usually a balance sheet is made at the end of a month or year. On the left side of the balance sheet are the assets, on the right side the liabilities and the stockholder’s equity. Both sides of the balance sheet must be equal.
4. The statement of cash flows is directed toward the company’s liquidity goal. The outcome of the cash flows statement should be equal to the amount of cash on the balance sheet.

Question 4

Financial analysis is based on a financial statement. The outcome depends on the quality of Performance measures.

Question 5

Assets = Liabilities + Stockholder's equity

Question 6

Three forms of businesses:

1. Sole proprietorship, one person is the owner and responsible for everything.
2. Partnership, two or more owners who share responsibility.
3. Corporations, business units chartered by the state and which is legally separate from its owners, the stockholders.

How to analyze business transactions? - ExamTests 2

Questions

Question 1

How is a business defined?

Question 2

What are the 2 major goals for all businesses?

Question 3

Which are the four major financial statements?

Question 4

What is the correlation between financial analysis, financial statement and performance measures?

Question 5

What is the accounting equation?

Question 6

Which are the 3 forms of business? And explain them briefly.

Answer indication

Question 1

A business is an economic unit that aims to sell goods and services to customers at prices that will provide an adequate return to its owners.

Question 2

Major goals:

1. The need to earn enough income to attract and hold investment capital is the goal of profitability.
2. In addition, business must meet the goal of liquidity: having enough cash available to pays debts when they are due.

Question 3

The four major statements:

1. The income statement focuses on the company’s profitability. It summarizes the revenue earned and expenses incurred by a business over a period of time. This will give the net income.
2. The statement of retained earnings shows the changes in retained earnings over a period of time. It is the difference between the old and the new net income, less the dividends paid to stockholders.
3. The balance sheet is used to show the financial position of a business on a certain date. Usually a balance sheet is made at the end of a month or year. On the left side of the balance sheet are the assets, on the right side the liabilities and the stockholder’s equity. Both sides of the balance sheet must be equal.
4. The statement of cash flows is directed toward the company’s liquidity goal. The outcome of the cash flows statement should be equal to the amount of cash on the balance sheet.

Question 4

Financial analysis is based on a financial statement. The outcome depends on the quality of Performance measures.

Question 5

Assets = Liabilities + Stockholder's equity

Question 6

Three forms of businesses:

1. Sole proprietorship, one person is the owner and responsible for everything.
2. Partnership, two or more owners who share responsibility.
3. Corporations, business units chartered by the state and which is legally separate from its owners, the stockholders.

How to measure business income? - ExamTests 3

Questions

Question 1

Which assumptions are made when measuring income?

Question 2

Which four types of adjustments can be made to adjust entries? If necessary, explain.

Question 3

What are closing entries?

Question 4

What must be done to close the accounts?

Question 5

Which conditions must be satisfied before a revenue is recognized?

Answer indication

Question 1

Continuity: the company is a going concern that continues to operate indefinitely so will not go bankrupt. Periodicity: it is useful to estimate the business's net income in terms of accounting periods. Matching rule: revenues must be assigned to the accounting period in which the goods are sold or services performed. Expenses must be assigned to the periods in which they are used to produce revenue.

Question 2

Four types:

1. Allocating recorded costs: companies pay some expenses in advance, this is called prepaid expenses.
2. Recognizing unrecorded expenses: accrued expenses are used. Not recording expenses when they are made.
3. Allocating recorded, unearned revenues.
4. Recognizing unrecorded, earned revenues (accrued revenues)

Question 3

Closing entries are journal entries made at the end of an accounting period. They clear the accounts of their balance and they summarize a period’s revenue and expenses.

Question 4

To do this, the balances of the revenue and expense accounts are transferred to the Income Summary account; another temporary account. It is only used for closing entries and does not appear in financial statements.

Question 5

Conditions:

• Persuasive evidence of an arrangement exists.
• Delivery of the product or service has occurred.
• The seller’s price to the buyer is fixed or determinable.
• Collectability is reasonably assured.

How do Financial Reporting and Analysis work? - ExamTests 4

Questions

Question 1

Which financial ratios can be used to see if a company has reached its objectives? And how are these ratios are measured?

Question 2

What are the steps of the multistep income statement?

Question 3

Which are the 5 accounting conventions? Explain.

Answer indication

Question 1

Financial ratios:

• Profit margin = Net income/ revenue
• Asset turnover ratio = Revenue / Average total assets
• Cash flow yield ratio = Cash flows from operating activities / Net income
• Debt to equity ratio = Total liabilities / Total equity
• Return to assets ratio = net income / average total assets
• Cash return on assets = Cash flows from operating activities / Average total assets
• Return on equity ratio = Net income/ average total equity

Question 2

Steps of the multistep income statement:

1. Net sales
2. Cost of goods sold
3. Gross margin
4. Operating expenses
5. Income from operations
6. Other revenues and expenses
7. Income before income taxes
8. Income taxes
9. Net income
10. Earnings per share

Question 3

Five accounting conventions:

1. Comparability and consistency: The information in a financial statement must be provided in such a way that anyone who reads it can recognize similarities, differences, and trends over time.
2. Materiality: Refers to the relative importance of an item or event. An item is material if there is a reasonable expectation that knowing about it would influence the decisions of users of the statements.
3. Conservatism: When accounts are uncertain about a judgment or estimate that they must make they look to the conservatism convention. This means that when an accountant has to choose between two equally acceptable procedures, they should choose the one that is least likely to overstate assets and income.
4. Full disclosure (Transparency): It is required that financial statements present all information that is relevant to the users of the statements.
5. Cost-benefit: The benefits to be gained from providing accounting information should be greater than the costs of providing it.

What are the Operating Cycle and Merchandising Operations? - ExamTests 5

Questions

Question 1

Which seven control activities can be used by a company?

Question 2

What are the five interrelated components that are needed for a system of internal control to be effective?

Question 3

Which special terms are available for explaining whether the seller or the buyer pays (part of) the freight charges? Explain.

Question 4

What are the two basic inventory systems that are used for the items in the merchandise inventory ? Explain.

Question 5

What are the 4 stages of the operating cycle?

Answer indication

Question 1

Seven control activities:

1. having managers authorize certain transactions,
2. recording all transactions to establish accountability for assets,
3. using well-designed documents to ensure proper recording of transactions,
4. Instituting physical controls (controls that limit access to assets).
5. Periodic independent verification: means that someone other than the one responsible for the accounting records must periodically check the records and assets,
6. separation of duties: means that authorizing transactions, handling assets or keeping records of assets must not be done by one person.
7. using sound personnel practices like bonding, which is carefully checking an employee's background and insuring the company against theft by that person

Question 2

Five components:

1. Control environment, which means personnel should be qualified to handle responsibilities
2. Risk assessment, this involves identifying areas in which risks of loss of assets or inaccuracies in accounting records are high.
3. Information and communication, which involves identifying areas in which risks of loss of assets are high. In these risk areas adequate controls can me implemented
4. Control activities
5. Monitoring, which includes the management’s regular assessment of the quality of internal control.

Question 3

Special terms:

• FOB shipping point: means that the seller places the merchandise 'free on board' at the point of origin and the buyer bears the shipping costs.
• FOB destination: seller bears the transportation costs to the place where the merchandise is delivered.
• Freight-in: when the buyer pays the whole transportation expense.
• Freight-out expense or Delivery expense: When the seller pays the whole transportation charge.

Question 4

Two basic inventory systems:

• Perpetual inventory system. In this system continuous records are kept of the quantity and, usually, the cost of individual items as they are bought and sold.
• Periodic inventory system. In this system the inventory not yet sold, or on hand, is counted periodically.

Question 5

4 stages:

1. Purchase of merchandise inventory for cash or on credit
2. Payment for purchases made on credit
3. Sales of merchandise inventory for cash or on credit
4. Collection of cash from credit sales

What do inventories consist of? - ExamTests 6

Questions

Question 1

Inventory can be measured with four different methods. What are these methods? Explain.

Question 2

How can inventory be estimated? Name the two methods that can be used and explain them.

Answer indication

Question 1

Four Methods:

1. Specific identification method, which identifies the cost for each item in ending inventory.
2. Average-cost method. With this method inventory is priced at the average cost of goods available for sale during the accounting period.
3. First-in, first-out (FIFO) method assumes that the costs of the first item acquired should be assigned to the first items sold. Cost of ending inventory reflects costs of the latest items sold.
4. Last-in, first-out (LIFO) method assumes that the costs of the last item purchased should be assigned to the first item sold, cost of ending inventory reflects costs of the earliest purchased items.

Question 2

Two methods:

• Retail method: is used in retail merchandising. It uses the ratio of cost to retail price. At retail means the amount of the inventory at the marked selling prices of the inventory items. The value of goods available for sale at cost is divided by the value of goods available for sale at retail. (this gives the ratio of cost to retail price) The ending inventory at retail is determined by subtracting the net sales during the period from the goods available for sale at retail. This amount is multiplied by the ratio. This gives the estimated cost of ending inventory.
• Gross profit method: assumes that the ratio of gross margin remains stable from year to year. The cost of goods available for sale should be established in the usual way. The cost of goods sold should be calculated by deducting the estimated gross margin of 30 percent from sales. Then, deduct the estimated cost of goods sold from the goods available for sale to get the estimated cost of ending inventory.

What do cash and receivables include? - ExamTests 7

Questions

Question 1

Which 5 key issues must management address in dealing with cash and receivables? Explain.

Question 2

In which ways can cash be controlled? Name three different options.

Question 3

Which methods can be used in order to deal with uncollectible accounts?

Answer indication

Question 1

Five key issues:

1. Managing cash needs. Management must consider the need for short-term investing and borrowing during seasonal cycles.
2. Setting credit policies that balance the need for sales with the ability to collect.
3. Evaluating the level of accounts receivable. There are two common measures that are often used to measure the effect of the credit policies of a company. These two measures are:
   • receivable turnover: net sales / average net accounts receivable
   • average days’ sales uncollected: days in a year / receivable turnover
4. Financing receivables. There are three methods for this.
   • Factoring: The sale or transfer of accounts receivable to an entity called a factor. Can be done with resource: the seller is liable to the factor if a receivable can not be collected. Without resource:factor bears any losses from unpaid accounts
   • Securization: the company groups its receivables in batches and sells them at a discount to companies and investors.
   • Discounting: This is the selling of promissory notes held as notes receivable.
5. Understanding the importance of ethics in estimating credit losses.

Question 2

Cash control options:

• Imprest system: the petty cash fund is commonly used here, which is established at a fixed amount. A receipt documents each cash payment made from the fund.
• Banking services: very safe. Electronic funds transfer (EFT) is used for business transactions that do not involve actual cash.
• Bank reconciliation: the process of accounting for the difference between the balance on the company’s bank statement and the balance on its Cash account.

Question 3

Methods:

• The direct charge-off method, which will help to recognize the uncollectible accounts as a loss.
• The allowance method, which matches the losses from bad debts against the sales they help to produce.

What are the time value of money and current liabilities? - ExamTests 8

Questions

Question 1

For what purpose are payables turnover and days' payable used and how do we compute them?

Question 2

We distinguish between two major types of liabilities. What are those two?

Question 3

What is a contingent liability, and how do we determine it?

Question 4

In which ways can we determine future value?

Answer indication

Question 1

We use payables turnover and days' payable to measure liquidity.

• Payables turnover = (Cost of goods sold ± Change in Merchandise inventory) / Average accounts payable
• Days’ Payable = 365 days / Payables Turnover

Question 2

Types of liabilities:

• Definitely determinable liabilities, which are liabilities like accounts payable and dividends payable. The exact dollar amount of these liabilities can be known.
• Estimated liabilities are liabilities whose exact dollar amount is not known until a later date, like income taxes payable.

Question 3

We call a potential, but not an existing liability a contingent liability. There are 2 conditions in order to determine if a contingent liability should be entered:

• The liability must be probable
• The liability can be reasonably estimated

Question 4

Interest:

• Simple interest: interest cost for one or more periods if we assume that the amount on which the interest is computed stays the same from period to period.
• Compound interest: the interest cost for two or more periods if we assume that after each period, the interest of that period is added to the amount on which interest is computed in future periods.

What are the long term assets? - ExamTests 9

Questions

Question 1

What are the characteristics of long-term assets?

Question 2

Which 2 kinds of expenditure are there?

Question 3

Which methods do we have to determine depreciation?

Answer indication

Question 1

Charactaristics of long-term assets:

• They have a useful life of more than one year
• They are used in the operation of a business
• They are not intended for resale to customers

Question 2

Two types:

• A capital expenditure is an expenditure for the purchase or expansion of a long-term asset. They are recorded in the asset accounts.
• Revenue expenditure is related to the repair and maintenance of a long-term asset. They are recorded in an expense account because their benefits are realized in the current period.

Question 3

Different methods:

• Straight-line method: In this method depreciation cost is spread evenly over the estimated useful life of the asset.
• Production method: This method is also called the units of production method and assumes that depreciation is the result of use and that time plays no role in the depreciation process.
• Declining balance method: this is an accelerated method and also most commonly used. A fixed rate is applied to the carrying value of a tangible long-term asset. If the straight-line is used twice, it becomes the double-declining-balance method.

What are long term liabilities? - ExamTests 10

Questions

Question 1

Which ratios do we use to determine how much long-term debt a company should carry?

Question 2

How can a company obtain plant or long-term assets?

Question 3

What is a bond?

Question 4

Which two interest rates are relevant for bonds?

Answer indication

Question 1

The debt to equity ratio = Total liabilities / Total Stockholders' equity;
or the interest coverage ratio = (Income before income taxes + interest expense) / Interest expense

Question 2

Obtaining long-term assets:

• By borrowing money and buying the asset
• By renting the asset on a short-term lease. Such an agreement is called an operating lease. An operating lease is a lease that is short term in relation to the useful life of the asset, and the risk of ownership remains with the lessor.
• By obtaining the asset on a long-term lease. A long-term lease can be treated as a capital lease when it meets the following conditions: The duration of the long-term lease is about the same as its useful life, the lease cannot be canceled and the lessee has the option to buy the asset at a nominal price at the end of the lease.

Question 3

A bond is a security, usually long term, representing money that a corporation or other entity borrows from the investing public.

Question 4

Two interest rates:

• the face interest rate: the fixed rate of interest paid to bondholders based on the value of the bonds.
• the market interest rate: the rate of interest paid in the market on the bonds of similar risk.

What is contributed capital? - ExamTests 11

Questions

Question 1

Which components does the stockholders' equity contain?

Question 2

Which kinds of stocks can a corporation issue?

Question 3

Explain the statement of stockholders' equity and retained earnings.

Answer indication

Question 1

Components:

• contributed capital, which is the stockholders' investments in the corporation
• retained earnings
• Treasury stock: Shares of the corporation own stock that it has bought back on the open market.
• it can also include other comprehensive income or loss, which includes a variety of items, such as the effect of foreign exchange adjustment and unrealized gains and losses.

Question 2

Kinds of stock:

• Common stock which is the basic form of stock that a corporation issues. This is the company’s residual equity. This means that in case of liquidation, all claims to the company from preferred stockholders and creditors rank ahead of common stockholders.
• Preferred stock, which gives its owners preferences over common stockholders. Preferences related to things such as receiving dividends and claims to assets if the corporation is liquidated.

Question 3

The statement of stockholders' equity summarizes the changes in the components of the stockholders’ equity section in the balance sheet. The retained earnings of a company are the part of the stockholders’ equity that represent stockholders’ claims to assets arising from the earnings of the business. A restriction on retained earnings means that dividends can be declared only to the extent of the unrestricted retained earnings.

What is the statement of cash flows? - ExamTests 12

Questions

Question 1

What does the statement of cash flows show?

Question 2

What are cash equivalents?

Question 3

Which ratios can be used to analyze the cash flows?

Question 4

What must be done with the figures of the income statement and how do we do this?

Answer indication

Question 1

The statement of cash flows shows how a company’s operating, investing, and financing activities have affected cash during an accounting period. On the statement of cash flows, cash includes both cash and cash equivalents.

Question 2

Short-term, highly liquid investments that can be quickly converted into cash. Cash equivalents include money market accounts, commercial paper and U.S. treasury bills.

Question 3

Ratios:

• Cash flow yield = Net cash flows from operating activities / Net income. A cash flow yield of 1.9 means that the company is generating 90% more cash flow than net income.
• Cash flows to sales = Net cash flows from operating activities / Net sales. A cash flows to sales of 0.09 means that the company generates 9% of net cash from sales.
• Cash flow to assets = Net cash flows from operating activities / Average total assets

Question 4

The figures of an income statement must be converted form an accrual basis to a cash basis, there are 2 methods to accomplish this:

1. The direct method converts each item from the accrual basis to the cash basis.
2. The indirect method lists only those adjustments necessary to convert net income to cash flows from operations.

What are financial performant measurements? - ExamTests 13

Questions

Question 1

Which two groups are interested in measuring the financial performance of a company?

Question 2

What are the three most common used comparison standards related to analyzing financial statements?

Question 3

What are the tools than can be used to determine financial performance considering the relationship between numbers and their change from one period to another? Explain the tools.

Answer indication

Question 1

Two groups:

1. The top managers of the company
2. Creditors, investors and customers who have cooperative agreements with the company.

Question 2

The three most common used comparison standards are (1) rule-of-thumb measures, (2) past performance and (3) industry norms.

Question 3

Different tools:

• With horizontal analysis changes from previous year to the current year are computed in both money amounts and percentages.
• Trend analysis is a variant of horizontal analysis. With this analysis one calculates the percentage changes for several successive years instead of just for two years.
• Vertical analysis shows how different components of a financial statement relate to a total figure in the statement. The total figure contains 100 percent and the each component's percentage of the total is computed. This results in a financial statement that is expressed entirely in terms of percentages. This is called a common-size statement.
• Financial ratio analysis identifies key relationships between the components of the financial statements.

What do investments consist of? - ExamTests 14

Questions

Question 1

In what categories can short-term and long-term investments be further classified? Explain.

Question 2

What is the equity method and what are its main features?

Question 3

How does the purchase method work?

Question 4

What is the cost-adjusted-to-market method and when is it necessary to use this method?

Answer indication

Question 1

Categories:

• Trading securities: debt or equity securities that are bought and held principally with the purpose to sell them in the near term.
• Held-to-maturity securities: debt securities that the management intends to hold until their maturity date.
• Available-for-sale securities: debt or equity securities that do not meet the criteria for either trading or held-to-maturity securities.

Question 2

The equity method to account for the stock investment presumes that an investment of 20 percent or more is nor a passive investment and that the investor should therefore share proportionally in the success or failure of the company. The main features of the equity method are:

• The original purchase of the stock is recorded at cost.
• The investor's share of the company's period net income is recorded as an increase in the investment account with a corresponding credit to an income account.
• When a cash dividend is paid to the investor, the asset account Cash is increased and the investment account is decreased.

Question 3

The purchase method for preparing the consolidated financial statements combines the similar accounts from the separate statements of the parent company and the subsidiaries.

Question 4

For the accounting of long-term available-for-sale securities the cost-adjusted-to-market method is required. With this method the securities are initially recorder at cost and are thereafter adjusted periodically for changes om market value by using an allowance account.