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1) Under current GAAP a stock dividend declaration and distribution will not reduce either total assets or total owners’ equity. 2) The activities comprising the operating cycle are generally consistent across firms. Answer: FALSE 3) The earnings conservatism ratio comparisons […]

1) When companies following IFRS write-up an asset to its current fair value, an owners’ equity account entitled “revaluation surplus” is credited and disclosed as a separate line item. 2) IFRS requires the use of direct costing for inventories. Answer: […]

1) A benchmark comparison is an analytic tool similar in approach to time-series analysis. 2) A variable interest entity must be consolidated into the financial statements of the sponsoring entity if the sponsoring entity has either a controlling or a […]

1) GAAP states that if it is impractical to determine the cumulative effect of applying a change in accounting principle to prior periodssuch as when a firm adopts the LIFO inventory accounting methodthe new accounting principle is to be applied […]

1) Annual amortization of discount on bonds payable (bond discount) increases as a bond matures. 2) The comparability of earnings per share across firms is influenced by the relative amount of capital raised by the various firms and by the […]

1) Generally accepted accounting principles do not allow variable costing to be used in external financial statements because absorption costing makes it easier for financial statement users to interpret year-to-year changes in reported income. 2) The starting point for developing […]

1) In applying the discounted free cash flow valuation model, the discount rate used is the average cost of capital. 2) Special purpose entities generally stay on the balance sheet under both IFRS and current U.S. GAAP. Answer: TRUE 3) […]

1) When analyzing a company’s risk of bankruptcy using Altman’s Z-score, a high Z-score indicates low risk of default. 2) Changes in accounting principles and changes in the reporting entity are reported under the prospective approach. Answer: FALSE 3) Under […]

1) The proprietary view of a firm stresses the importance of owners’ equity and differentiates between capital provided by owners and creditors. 2) Lower profitability means higher default risk. Answer: TRUE 3) A primary concern of auditors and analysts is […]

1) Income statements prepared in accordance with GAAP differentiate between income components that are believed to be sustainable and those that are transitory. 2) Under the cash basis, expenses are recognized when the costs expire or assets are used. Answer: […]

1) The cohesiveness principle set forth in the FASB’s exposure draft on financial statement presentation means that firms should present information in their financial statements so that the relationship between items across financial statements is clear and that the statements […]

1) The use of the lower of cost or market method to value inventory for reporting purposes employs the accounting principle of matching. 2) Days payable outstanding helps analysts understand the company’s pattern of cash receipts from customers. Answer: FALSE […]

1) All companies should be expected to produce positive operating cash flows every year. 2) Debt covenants help guard against conflicts of interest between creditors and bank regulators. Answer: FALSE 3) Under IFRS the two additional lessor criteria provided under […]

1) Companies occasionally adopt “aggressive” revenue recognition practices which then generate significant returns in later periods. 2) Much of the information needed for assessing the quality and value-relevance of a company’s reported accounting numbers cannot be found in the company’s […]

1) An unexplained increase in fixed asset sales may indicate that management needs to raise cash quickly. 2) According to the full disclosure principle, companies create a competitive advantage when they report: Details about the company’s strategies, plans and tactics. […]

1) The amount available to finance planned expansion of operating capacity, reduce debt, pay dividends, or repurchase stock is distributable (or free) cash flow. 2) Because financial disclosures are regulated, owners and managers have little economic incentive to supply the […]

1) Extended time of completion of the project and accurate measurement of its progress towards completion are the only attributes necessary for the appropriate utilization of the percentage-of-completion method of revenue recognition. 2) Temporary differences that will cause taxable income […]

1) An impairment loss increases both assets and net income. 2) Loan covenants are one reason lessees prefer operating lease treatment. Answer: TRUE 3) When the market rate of interest is below the nominal rate, a bond sells at stated […]

1) A major factor underlying the rise of IFRS is that companies needing to seek global sources of capital are at a disadvantage when they only produce financial statements based on the commercial and tax law approach. 2) A lender […]

1) While analysts may forecast only a single financial statement item, such forecasts may prove highly unreliable. 2) A significant difference between income from operations and net cash flows from operating activities is a signal that reported income might have […]

1) Aging assets and inflation tend to complicate financial statement analysis by overstating return on assets. 2) A comprehensive risk analysis involves evaluating and summarizing the various individual risks associated with a loan. Answer: TRUE 3) In the United States, […]

1) When the risk of non-collection of installment payments is high or when there is no reasonable basis for estimating the proportion of installment accounts receivable likely to prove uncollectible, U.S. GAAP permits the use of the installment sales method. […]

1) Reported accrual accounting income for a period always provides an accurate picture of underlying economic performance. 2) Companies judged to be high credit risks may be subject to loan covenants. Answer: TRUE 3) For accounting purposes, “fair value” is […]

1) An increase in accounts payable of $6,000 for the year increases cash flow from operating activities by $6,000. 2) The sale of fixed assets represents an investing activity. Answer: TRUE 3) A corporation that incurs a net operating loss […]

1) When a LIFO firm liquidates old LIFO layers, the net income number under LIFO can be seriously distorted because the older costs in the LIFO layers that are liquidated are matched against sales dollars that are stated at higher […]

1) Intra-entity receivables and payables for an 80%-owned subsidiary are eliminated to the extent of ownership (i.e., 80% of balance is eliminated). 2) GAAP does not require the cost flow assumption to conform to the actual physical flow of the […]

1) Securitizations have always been carefully designed to enable the transferor to consolidate the special purpose entity. 2) Predicting loan default and bankruptcy are relatively easy tasks if financial ratios are carefully analyzed. Answer: FALSE 3) GAAP requires the cost […]

1) Under IFRS, acquired intangibles are always carried at amortized cost even when an active market is available for the intangible. 2) Firms are required to disclose executive retirement and other postemployment compensation, generally for the ten most highly paid […]

1) If a long-lived asset’s remaining expected future value falls below its net book value, the asset is considered to be an impaired asset. 2) A company is considering offering for sale one of two bond issues. The two bond […]

1) A revenue included in the determination of book income this year but not included in taxable income until next year is an example of a timing difference. 2) “Triggers” enable the lender to decide whether it might be appropriate […]

1) Companies with ROEs that consistently exceed the industry average generally will have shares that sell for book value. 2) A product warranty provided with the sale of an item of merchandise gives rise to a non-monetary liability. Answer: TRUE […]

1) Once the deferred income tax allowance is established, it can be either increased or decreased in future years. 2) For tax purposes lessees prefer operating leases. Answer: FALSE 3) A firm generates a return that exceeds the cost of […]

1) Lenders monitor financial statement data to ascertain whether borrowers are adhering to, or violating, loan covenants. 2) Seasonal lines of credit are used by companies with seasonal sales cycles and provide the cash needed to support increases in current […]

1) Book income tax expense could equal current taxes payable to the IRS plus the increase in deferred tax liabilities minus the increase in deferred tax assets. 2) For firms using the straight-line depreciation method, dividing average net property, plant, […]

1) A convertible bond’s net-of-tax interest expense is added back to net income when determining diluted earnings per share only if the bond is known to be dilutive. 2) Subsequent events are required to be disclosed if they are material […]

1) The IASB and the FASB jointly issued an Exposure Draft entitled “Financial Statement Presentation” that would require firms to use the indirect method of reporting cash flows from operating activities. 2) Accrual accounting is often based upon subjective judgments […]

1) The SEC permits Internet resellers (i.e., those that act as agents or brokers in a transaction) to report revenue on either a “gross” or “net” basis. 2) GAAP states that if it is impractical to determine the cumulative effect […]

1) When a company restates its financial statements due to some accounting irregularity, shareholder lawsuits are often filed against the company and its management. 2) If a lessee mistakenly treats a capital lease as an operating lease, both assets and […]

1) Under absorption costing all production costs are inventoried. 2) Executory costs paid by the lessee associated with a capital lease are recorded as a component of the lease liability. Answer: FALSE 3) Because equity funds are not really “free,” […]

1) Depreciation is not intended to track the asset’s declining market value. 2) Broadly defined, the term “analyst” includes anyone who uses financial statements to make decisions as part of their job. Answer: TRUE 3) To preclude firms from engaging […]

1) There is no need for an analyst to develop plausible predictions about future economic conditions in the target company’s industry as these are readily available from the U.S. Commerce Department. 2) Research indicates that investors treat R&D expenditures as […]

1) Accrual accounting can produce large discrepancies between the firm’s reported profit performance and the amount of cash generated from operations. 2) “Unbiased” means that, on average, the market’s earnings expectations will be correct. Answer: TRUE 3) Aggregated information is […]

1) The same interest rate is used to compute service cost, interest cost, and return on plan assets. 2) GAAP frequently requires financial statement users to accept a compromise that favors reliability over faithful representation. Answer: TRUE 3) Errors discovered […]

1) Analysts combine information about the company’s current earnings, its business strategy, and the industry’s competitive dynamics to forecast future free cash flows. 2) Lenders are willing to restructure a customer’s loan to help the customer resolve present financial difficulties […]

1) Contract terms can be designed to eliminate or reduce conflicting incentives that arise in business relationships. 2) The quick ratio measures the most immediate liquidity of a company. Answer: TRUE 3) In the United Kingdom and Germany (and some […]

1) Lenders have several courses of action available when a borrower is in default. 2) There is more than one commonly used debt ratio. Answer: TRUE 3) A deferred tax asset can be fully recognized without adjustment if management believes […]

1) One way to value a piece of manufacturing equipment is to just add up the net future operating cash inflows the equipment is expected to generate over its life. 2) Under the temporal method, foreign translation gains and losses […]

1) Income tax expense when interperiod tax allocation is used creates a more stable effective tax rate over time relative to using tax payments as income tax expense. 2) Analyzing the disclosures pertaining to deferred income taxes can provide relevant […]

1) Revenues are earned when the seller substantially completes performance required by an agreement. 2) Stock valuation involves estimating the worth of a company, one of its operating units, or its ownership shares. Answer: FALSE 3) The indirect method for […]

1) The IASB and FASB are working on a joint convergence project on fair value measurement and disclosure and are in general agreement on what fair value means and how to measure it. 2) Under IFRS, past service cost related […]

1) Covenants restricting the use of funds for dividend payments, share repurchases, capital expenditures, and other business purposes are included so the creditor has greater assurance that cash will be available to make principal and interest payments when due. 2) […]

1) Financial statement users can see whether debt financing is being used to enhance shareholders’ returns by comparing ROA and ROCE. 2) Inventory carrying cost includes storage costs. Answer: TRUE 3) Foreign companies registered with the SEC that use IFRS […]

1) Changes in the fair value of all derivatives other than hedges must be recognized in income when they occur. 2) Analysts must always be vigilant about the possibility that accounting distortions are present and complicate the interpretation of financial […]

1) Because covenant compliance can be jeopardized by mandated changes in accounting principles, many loan agreements have financial covenants that rely on the accounting rules in place when the loan is first granted. 2) Costs matched with the passage of […]

1) Financial reporting assists statement users to forecast future cash flows by providing an income statement format that segregates components of income. 2) Research indicates that fewer firms report slightly negative earnings than slightly positive earnings, suggesting that managers of […]

1) Long-lived assets are operating assets that are expected to yield their economic benefits over a period longer than one year. 2) Companies are required to disclose the dollar amount of pension retirement benefits they expect to pay in each […]

1) For companies having monetary assets denominated in foreign currency units, these assets are converted into dollars at the historical rate of exchange that was in effect at the time of the foreign currency inflow. 2) An increase in cash […]

1) It is possible to estimate the amount of inventory holding gain (or loss) that is embedded in a company’s FIFO earnings number. 2) When receivables growth exceeds sales growth, this could be an indication of aggressive revenue recognition policies. […]

1) Firms facing asset retirement obligations must estimate the expected present value of the outflows that will occur when the assets are eventually retired. 2) Inventory carrying cost includes transportation costs paid by the seller. Answer: FALSE 3) GAAP requires […]

1) The sale is itself the sole criterion for recognizing revenue. 2) Asset turnover is defined as sales divided by total assets. Answer: FALSE 3) The accounting standards codification was created by the IASB to harmonize U.S. and international GAAP. […]

1) Companies frequently disclose the effects of absorption costing on reported net income. 2) Accounting standard-setting in the U.S. is a technical process and thus little affected by political considerations. Answer: FALSE 3) A sale should not be recognized as […]

1) Managers in lessee companies prefer that leases be treated as capital leases. 2) High quality financial statements help credit analysts see what is really going on at a company; low quality statements mask true performance and financial condition. Answer: […]

1) A lender can effectively convert a fixed-rate debt into a floating-rate debt by using an interest rate swap. 2) IFRS rules allow firms to classify dividends paid as a component of cash flows from operating activities in order to […]

1) Under the direct approach to cash flow statement preparation, net cash flows from operations is arrived at by adjusting earnings for the differences between accrual-basis revenues and expenses and cash inflows and outflows during the period. 2) When firms […]

1) Absorption costing makes it difficult for financial statement users to interpret year-to-year changes in reported income when inventory levels change between one year and the next. 2) The quick ratio does not include inventory in the denominator because few […]

1) Stock shares classified as trading securities are typically purchased by the investor to generate profits on holding gains. 2) An unrealized loss for an equity securities investment classified as trading securities does not reduce net income. Answer: FALSE 3) […]

1) Using total sales instead of credit sales in the accounts receivable turnover calculation can produce misleading results and is a problem primarily for companies that have a material amount of cash sales. 2) Large amounts of high interest debt […]

1) Under IFRS, an indicator that could lead to a lease being classified as a finance lease is if the lessee cancels the lease, the lessor’s losses will be borne by the lessee. 2) Higher marginal income tax rates create […]

1) Net accounts receivable is carried on the balance sheet at expected net realizable value, not at original historical cost. 2) The FASB addressed simultaneous financing and investing activities by requiring they be ignored. Answer: FALSE 3) Contracts often contain […]

1) Interest must be imputed when the stated rate is lower than the prevailing borrowing rate at the time of the transaction. 2) All economic events and activities that affect a company are reflected in a company’s financial statements. Answer: […]

1) Companies can smooth reported income by strategically timing the recognition of revenue and expenses to dampen the normal ups and downs of business activity. 2) GAAP requires that all exchange transactions be recorded at the fair value of the […]

1) For a firm using the indirect method, an increase in a deferred tax liability should be added back to net income to arrive at cash flow from operating activities. 2) A $3,000 increase in total owners’ equity occurs if […]

1) U.S. tax laws encourage companies to overfund their pension plans. 2) Authoritative guidance on bundled (multiple-element) software sales transactions states that if a software sales arrangement includes multiple, distinct elements, the revenue from the arrangement should be allocated to […]