Unit 3: Accounting

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1.Accounting involves both the recording and the interpreting of financial events


Assign the following functions of accounting to the type of accountant that performs them

2.Budget preparation
3.Information for investors outside the firm 4.Measurement of production costs
5.Reports for stakeholders

a.Financial accountants
b.Managerial accountants

2. (b) managerial accountants
3. (a) financial accountants
4. (b) managerial accounts
5. (a) financial accounts

As a Certified Public Accountant (CPA), you would be working primarily in the area of

a. Audits
b. Financial accounting
c. Managerial accounting d.Tax accounting
e.All of the above

b. Financial accounting

How does the purpose of managerial accounting differ from the purpose of financial accounting?

It assists with the internal management decisions for the firm

The accounting equation states that

Assets = Liabilities + Owners Equity

The balance sheet, the statement of cash flows, and the ___________ are three key financial statements prepared by accountants.

income statement

The ____________ is an accounting statement that reports the financial condition of a firm at a specific point in time.

balance sheet

The "bottom line" of an income statement is the net worth of the firm


The balance sheet is composed of the following types of accounts:

a. assets, liabilities, and owner's equity

13. Assets = Liabilities + Owner's Equity
14. Refers to how fast an asset could be converted into cash
15. Reports the financial condition of a firm in a specific point in time
16. Reports the profit or loss for the firm over a specified time period
17. Represents what the company owns and owes as of a specific date

b.Balance sheet
c.Income statement

13. (b) balance sheet
14. (a) liquidity
15. (b) balance sheet
16. (c) income sheet
17. (b) balance sheet

The income statement fundamentally compares

Revenue and expenses

What is an example of current assets?

a. cash

Debts that are due in one year or less are classified on the balance sheet as:

current liabilities

Which of the following items is found on an income statement?

a. Current assets
b. Cost of goods sold c. Cash flow from investments
d. Owner's equity
e. Return on investment

b. cost of goods sold

Revenue - minus cost of goods sold =

Gross profit

Company resources that are purchased with the intention that they will convert to cash within one year are:

current assets

Rent, depreciation, and salaries are examples of

operating expenses

_________ is the systematic write-off of the value of a tangible asset over its useful life.


Depreciation is a systematic write-off of the cost of a tangible asset that affects taxes on ____________.

the income statement

FIFO and LIFO are two common methods used to compute the depreciation of tangible assets


Which of the following is INCORRECT?
a. Gross Profit - Interest Expenses = Net Profit before Interest and Taxes
b. Liabilities + Stockholder's Equity = Assets
c. Net Profit Before Interest and Taxes - Interest - Taxes = Net Profit after Taxes
d. Sales - Cost of Goods Sold = Gross Profit

a. gross profit-interest expenses = net profit before interest and taxes

Which of the following is NOT a current asset?

a.Accounts payable
b.Accounts receivable
c. Cash
d. Inventories

a. accounts payable

Accounting is an exact science

b. false

a. Financial ratios that measure a firm's ability to pay its short-term debts. b. Financial ratios that measure a firm's effective use of resources.
c. Financial ratios that measure a firm's ability to use its assets to their highest potential.
d. Financial ratios that reflect the degree to which a firm relies on borrowed funds.

a. liquidity
b. profitability
c. efficiency
d. leverage

_________ measures the speed of inventory moving through the firm and becoming sales.

c. inventory turnover ratio

Match each of the following ratios with kind of financial ratio it represents

7.Debt/equity ratio
8.Inventory turnover ratio
9.Quick ratio
10. Return on equity ratio 11. Return on sales ratio

6. liquidity
7. leverage
8. efficiency
9. liquidity
10. profitability
11. profitability

A company's current ratio is a better indicator of its ability to pay off short-term debt obligations than its acid-test ratio


The acid-test ratio is the best method to determine a firm's long term ability to pay off its debts a. True


Which of the following financial ratios is better the lower it is?

b. debt/equity

If a firm has a debt to owners' equity ratio of .54 (or 54%) we can conclude that:

b. Its total liabilities are less than its owners equity (ratio = liabilities/equity)

The top managers of Highbrow Bookstores want to indicate to the firm's shareholders how effectively they have managed the company in their behalf. Perhaps the most meaningful way to do this would be by reporting strong:

b. profitability ratios

Bob Stewart plans to visit his financial planner today to discuss investment strategy. As a young, "20 something" accountant, he knows he can afford to invest in a few riskier investments. Which of the following ratios will be an important measure of profitability for Bob?

d. return on equity

Match the following financial ratios with the arguments you'd expect stakeholders (including shareholders) to level against high levels of each.

44. Debt-equity ratio
45. Inventory turnover ratio
46. Quick ratio
47. Return on equity
48. Return on sales

a. Not enough reinvestment onto the business;
b. Over-leveraged financial structure;
c. The firm may be foregoing potential new customers;
d. There is an excessive chance of stock outs, disruptions, and unsatisfied customers;
e.Too much liquidity belongs to the shareholders, not to the firm.

44. b
45. d
46. e
47. a
48. c

When return on sales increases, return on equity must

d. dont know

Other things equal, when return on sales decreases we can expect return on equity to

a. decrease

__________ refers to the process that identifies variances by comparing actual revenues and expenses to projected revenues and expenses.

b. Financial control

Financial management is more important for a large firm than for a small firm


Financial managers spend the majority of their time

a.Managing the short-term financial needs of the firm.
b.Obtaining long-term financing to fund the firm's capital expenditures.


The duties and responsibilities of a financial manager are virtually identical to the duties and responsibilities of an accountant


Which of the following is not a responsibility of financial management?

a.Advising top management;
b.Buying merchandise on credit and collecting overdue payment from customers;
c. Cash flow control;
d. Production scheduling; e.Tax management and budgeting.

d. production scheduling

The purpose of liquidity ratios is to indicate the degree to which a firm relies on borrowed funds in its operations


If a company applies for bankruptcy protection, it is likely that it confronted ___________ problems

a. liquidity

The first step in financial planning is to develop a budget to better control costs


In order to assist in revenue realization, a(n) ________ allocates resources throughout the firm.

c. budget

Match the budgets with their definitions
10. Allocation of funds required to operate a business at a projected level of revenue;
11. Borrowing, debt repayment, operation expenses, and short-term investment opportunity schedule;
12. Firm's spending plans for long-lasting assets such as property, buildings, and equipment.

a. Capital budget
b. Cash budget
c. Operating (master) budget

10. operating (master) budget
11. cash budget
12. capital budget

Match the following situations with the appropriate financial tool. 13. Akiko realizes the importance of developing a ________ for her interior design business. Akiko
understands the importance of appropriately allocating resources in order to achieve the goals of
her firm.
14. As a finance manager at AllSports Communication, Charlie worries about the firm's borrowing
requirements for the upcoming year. He knows the benefit of estimating AllSports' expenses and short-term investment expectations. Facing these concerns, a(n) ________ would provide Charlie with valuable information by providing a good estimation of whether the firm will need to do short-term borrowing.
15. As a management consultant, Lamont knows that regardless of how good his firm's product might be, the business has little chance of success without a(n) __________ .
16. Carolina Financial Services is considering the purchase and installation of an expensive computer network. This is the type of expenditure that would be included in a(n) _________ .

a. Budget
b. Capital budget
c. Cash budget
d. Financial plan
e. Master budget

13. a. budget
14. c. cash budget
15. d. financial plan
16. b. capital budget

The most widely used source of short term funding is

trade credit

The rationale behind offering customers credit is:

e. permitting customers to pay with credit cards or on credit makes it easier for them to buy, and it also attracts new customers

Financial managers generally oppose credit sales because of the impact on cash flows


Rapidly growing companies often buy increasing amounts of merchandise from suppliers on credit, and then sell the goods to their customers on credit. These companies sometimes have difficulty repaying their suppliers when customers who buy on credit don't pay on time. Firms that experience this difficulty need to do a better job of:

e. managing cash flows

Which of the following presents an effective technique to improve cash management?

a. Slow down both the payment and collections of cash
b. Speed up both collections and payments of cash
c. Speed up cash collections and slow down cash payments
d. Speed up cash payments and slow down cash collections

c. speed up cash collections and slow down on cash payments

The best way for a firm to avoid serious cash flow problems is to sustain a rapid growth in sale


The costs to a retailer of accepting credit cards are generally greater than the benefits provided


Lancer Wholesale Company wants to improve cash flow. Which of the following strategies would be most likely to help Lancer achieve this objective?

a. Accepting IOUs from customers who buy in large quantities b. Offering cash discounts to buyers who pay their accounts promptly c. Offering extended payment plans to qualified buyers d. Relaxing its credit policy for new customers e. All of the above.

b. offering cash discounts to buyers who pay their accounts promptly

Maryland Nursery offers customers credit terms of 3/15 net 30. This gives customers a:

three percent discount if they pay in 15 days

The owner of a Mountain Cycle Shop worries that cash flows may be insufficient to pay his current operating expenses. While he anticipates a surplus of cash inflows as warm weather approaches, he needs to borrow funds now to meet his immediate obligations. He can best resolve his cash flow concerns by obtaining short term financing.


Some suppliers hesitate to offer trade credit to firms with a poor credit history. In these cases, the supplier may insist that the customer sign a(n):

promissory note

Selling accounts receivable to obtain short-term funds is called:

c. factoring

_________ offers financially stable corporations a technique to raise short-term funds by issuing unsecured promissory notes to the general public with the promise of repayment within 270 days.

commercial paper

Commercial paper is a common source of short-term financing for small and medium sized businesses


Organizations can avoid financial difficulties by marketing products that generate a significant rate of growth in sales revenue


As we saw in class, WalMart sports an inventory turnover ratio of about nine. This means that WalMart turns its inventory

a. every forty days

Match the following inventory management problems with their expected inventory turnover ratio:

34. Obsolete merchandise resulting in unsold goods 35. Poor buying practices resulting in unsold goods 36. Potential for lost sales because of lack of inventory

34. low inventory turnover
35. low inventory turnover
36. higher turnover ratio

We would expect the inventory turnover ratio for a ski shop to be _______ than the turnover for a convenience store.


An extremely high inventory turnover ratio may represent lost sales due to holding inadequate stocks of merchandise


Assuming equal levels of sales for all three retailers, you'd expect Amazon.com inventory turnover to be ________ that of Borders or Barnes & Noble.

e. Much higher than

Assuming equal levels of sales for all three retailers, you'd expect Amazon.com acid ratio to be ______ that of Borders or Barnes & Noble.

c. about equal to

Scott Drilling Contractors recently issues a corporate bond on which it expects to pay interest for the next twenty years. Scott would record this as a __________ on its balance sheet.

b. Long-term liability

Kunpeng Airlines is a recent start-up commuter airline that flies between eight regional cities on the coastal region of China. Although it has attracted numerous investors who see value in the company's service, it does not pay dividends. Last year, the firm claimed profits of $4,800,000, which will be used to purchase an additional commuter plane. The Balance Sheet accounts that will show this affect are:

a. Accounts payable and accounts receivable accounts;
b. Long-term liabilities and fixed asset accounts; c. Retained earnings and accounts receivable accounts;
d. Retained earnings and fixed assets accounts;
e. None of the above.

d. Retained earnings and fixed assest accounts

The need for operating funds:

b. increases when a firm introduces new products or enters a new market

The concept "time value of money" indicates:

a. A dollar received today is worth more than a dollar received a year from today

Acquiring funds through borrowing represents:

a. debt financing

Ifa firm sells shares of stock, it is financing with ________.


Allison O'Toole sells high end accessories at her resort boutique in Destin, FL. During the past ten years, Allison's business has performed quite well. Even when she made the decision to expand her store by purchasing the building next door, she financed this event by reinvesting her profits. Up until now, Allison has:

a. burned through a sizable quantity of capital. b. leveraged her financing.
c. successfully found equity financing through the sale of stock.
d. utilized a significant amount of debt financing. e. utilized equity to finance large capital expenditures.

e. utilize equity to finance large capital expenditures

______________ refers to the strategy of using borrowed funds to increase the rate of return for stockholders.

c. leverage

Retained earnings represent a source of equity financing

a. True

The interest paid for debt financing is a tax-deductible expense for the firm


Analysts worry about Starbuck's Notes Payable/Short Term Debt. In the short term (less than a year) do you believe that there is reason to worry?

a. Yes b. No c. There is insufficient data to answer this question

c. There is insufficient data to answer this question

On the basis of your estimate of Starbucks debt/equity ratio, is it likely that Starbucks will be able to borrow money to finance its Notes Payable/Short Term Debt item? (For comparison, the ratio for McDonald's is 1.12)

a. yes

A firm that takes too much debt could experience problems repaying its lenders or meeting promises made to stockholders


Equity financing represents money acquired from the operations of the firm or through the sale of ownership in the company


Companies raising funds must choose either debt or equity sources, but not both


Which of the following represents a capital expenditure?

a. Paying for media advertising
b. Paying salaries to employees
c. Purchasing a building to be used for office space
d. Purchasing raw materials to be used in the production of a firm's product
e. Purchasing utilities such as electricity and water.

c. purchasing a building to be used for office space

To maximize the benefits of using financial leverage, a firm should

a. Avoid securing funds through long-term debt financing
b. Limit their investments to projects with minimum risk levels c. Strive to minimize their cost of capital
d. b. and c.
e. All of the above

c. strive to minimize their cost of capital

Stockholders of a company in a risky market environment would expect lower return on equity ratio than stockholders in a less risky market


Generally, a high _________ ratio could lead investors and creditors to view the company as being very risky

Debt to owner's equity

A firm must pay dividends to its shareholders when it is profitable


Effective managers strive to minimize their firm's cost of capital


When given a choice, businesses prefer to obtain long-term financing through retained earnings or by borrowing from a lending institution


The relationship between debt and equity is called:


Which of the following best characterizes the dilemma of financial management?
a. Assets need to be kept at the same level as liabilities and owner's equity
b. Pursuing profitable growth opportunities may jeopardize the survival of a business
c. Survival, growth and profits are supported by the exact same strategies
d. The overriding goal of a business is to make profits
e. The overriding goal of a financial manager is to maintain a conservative financial and
cash flow strategy

b. Pursuing profitable growth opportunities may jeopardize the survival of a business

Generally, a high ___________ ratio could lead investors and creditors to view the company as being very risky.

b. debt to owner's equity

he primary purpose of retained earnings is to a. pay off federal taxes
b. pay out to shareholders later as dividends
c. reinvest into the company and its operations
d. save in the company's bank account

c. reinvest into the company and its operations

On an article in "The Economist" (February 26th, 2011), the CEO of IKEA, Mikael Ohlsson, is quoted as follows: "IKEA is more competitive as a privately owned company. Instead of sweating to meet the quarterly targets the stockmarket demand, it can concentrate on long term growth." On the basis of the above, you'd expect IKEA's return on equity to be ______ that of a similar, publicly traded corporation.

b. lower than

Refer to the previous question. IKEA is likely to prefer _____ as their sources of long term financing.

c. Retained earnings

The overall objective of financial planning is to

d. optimize the firms profitability

The fundamental challenge of effective financial management is to have sufficient _____ on hand without compromising the firm's ______ potential.

c. cash, investment

Which of the following represents a capital expenditure?

b. purchasing a building to be used for office space

Businesses ought to match their long-term capital needs to:

a. the firm's debt to equity ratio.
b. the ratio of long-term vs. short-term capital available.
c. the relative cost of their financing options.
d. their long-term goals and objectives.
e. trade credit discounts.

d. their long-term goals and objectives

The CFO of a well known satellite radio company was trying to work his magic today as he solicited another telecommunications/entertainment company to invest in his company in order to prevent bankruptcy. Having refinanced the company less than a year ago, the satellite radio finance manager had a $75 million note coming due today. The current financing arrangement represents:

d. short term debt financing (within a year)

While _________ provide a buyer with collateral, _________ are backed only by the reputation issuer.

a. Debentures, retained earnings
b. Debentures, secured bonds
c. Equity shares, debentures
d. Secured bonds, debentures
e. Secured bonds, equity shares

d. Secured bonds, debentures

Which of the following will determine the broad rate of interest a firm will have to offer on its bonds?
a. The general level of market interest rates
b. The intensity of competition the firm faces with new products
c. The relative strength of the dollar versus other currencies
d. All of the above
e. None of the above.

a. The general level of market interest rates

Lottadoe and Bigbux are two companies that are identical in every respect except that Lottadoe uses only equity financing while Bigbux relies heavily on debt financing. Over the past year, the firms had identical net incomes before interest and taxes were taken into account. If this net income was very high,

a. Bigbux would report a higher return on equity than Lottadoe.
b. Bigbux would report a lower return on equity than Lottadoe.
c. Bigbux would report higher dividends than Lottadoe.
d. Lottadoe would pay less in taxes than Bigbux.
e. Lottadoe would report a lower net income after taxes than Bigbux.

a. Bigbux would report a higher return on equity than Lottadoe

Lottadoe and Bigbux are two companies that are identical in every respect except that Lottadoe uses only equity financing while Bigbux relies heavily on debt financing. Over the past year, the firms had identical net incomes before interest and taxes were taken into account. If the firms faced a rough year with a very low earnings,

a. Bigbux would be able to skip its interest payments if paying them would cause its net income to be negative.
b. Bigbux would report a higher net taxable income than Lottadoe.
c. Bigbux would, of necessity, go bankrupt.
d. Lottadoe would be required to pay a higher dividend than Bigbux, thus reducing retained
e. Lottadoe would report a higher return on equity than Bigbux.

e.Lottadoe would report a higher return on equity than Bigbux.

Match the following definitions with their concepts.
1. Certificate issued to an investor that has loaned money to a corporation or government.
2. Form of company ownership that gives priority claim in the payment of dividends, as well as assets, if the business is liquidated. However, these investors do not have voting rights.
3. The most basic form of company ownership that includes voting rights and dividends, if and,when the firm elects to pay dividends.

1. Bond
2. Preferred stock
3. Common Stock

Match the following bond-related terms with their meaning

a. Date in which principal is due
b. Interest
c. Principal

a. Maturity
b. Coupon
c. Face Value

Bondholders are considered creditors of a firm


Bonds, like stocks, trade daily on major security exchanges


U.S. Government bonds are considered safe investments


With everything else held constant, secured bonds likely pay investors a _________ interest rate than debenture bonds

a. Higher and more volatile
b. Higher but less volatile
c. Lower and less volatile
d. Lower but more volatile

c. Lower and less volatile

A convertible bond allows the bondholder to exchange the bond for

a. Preferred stock
b. Common stock
c. Collateral
d. All of the above
e. None of the above

b. common stock

As creditors of a firm, bond holders enjoy voting privileges for the board of directors' elections


Unlike stocks, bond market prices remain stable over the life of the bond


As interest rates fall, bond prices


Bonds perceived as high risk typically pay __________ interest rates.

a. Higher

Which of the following securities provides the owner the right to vote for the corporate board of directors?

a. Bonds
b. Callable bonds
c. Commercial paper d. Common stock
e. Preferred stock

d. common stock

Which of the following sources of long-term financing has liquidity consequences?

a. Bonds
b. Retained earnings
c. Stock
d. Venture capital
e. All of the above

a. bonds

Dividends on preferred stock are:

a. always greater than dividends on common stock.
b. guaranteed, except in the event of bankruptcy.
c. normally fixed, if and when dividends are paid.
d. not subject to double taxation.
e. paid after common stockholders receive their dividends.

c. normally fixed, if and when dividends are paid

The proceeds from a secondary market sale of securities go to the corporation whose security is being traded


A share of preferred stock currently sells for $120. It offers the investor a dividend of 8%, with a par value of $100. If dividends are paid, preferred stockholders would receive a dividend of $9.60

b. False

If the stock price of a publicly traded company declines, it is likely that it is confronting ____________ problems

b. profitability

A firm must pay dividends to its shareholders when it is profitable


Like bonds, equity financing must be repaid


When is it easiest to raise equity capital?

a. Excellent performance, bull market
b. Excellent performance, bear market
c. Poor performance, bull market
d. Poor performance, bear market

a. excellent performance, bull market

When is a company most likely to need to raise capital?

a. Excellent performance, bull market
b. Excellent performance, bear market
c. Poor performance, bull market
d. Poor performance, bear market

d. poor performance, bear market

Private investors benefit from securities markets primarily by:

a. analyzing information about publicly traded companies.
b. having a place to buy and sell stocks and bonds.
c. obtaining the capital they need to finance their operations.
d. participating in the primary markets of investment bankers.
e. securing memberships on various stock exchanges.

b. having a place to buy and sell stocks and bonds

An organization whose members can buy and sell securities for companies and investors is known as a:

d. stock exchange

A company's stock does not have to be listed on one of the major stock exchanges in order to trade. It can be traded on _____________.

Over-the-counter markets

Which of the following would be classified as an institutional investor?

a. Commodity brokers
b. Federal Reserve banks
c. OTC markets
d. Pension funds e
. Stock exchanges

d. pension funds

Before a corporation's stock can be sold on a major stock exchange, the firm must provide detailed financial information to the Securities and Exchange Commission


When a shareholder of a publicly traded corporation sells her stock, the corporation receives the proceeds of the sale


The stock of companies that fail to meet a stock exchange's minimum requirements can be delisted


Molly Manufacturing plans to issue $75 million of common stock. The firm will likely rely on the advice and assistance of a(n):
a. Commercial bank.
b. Federal Reserve Bank.
c. Investment banker. d. Mutual fund.
e. Universal bank.

c. Investment banker

How do investment bankers generate revenue for their firms?

a. They buy, at a discount, the entire issue of a new security and then sell the issue toinvestors at full price.

The higher the risk of a particular investment, the greater the expected rate of return required by investors


Which of the following is the most important measure for equity investment valuation?

a. Growth
b. Returns
c. Risk
d. All of the above
e. None of the above

d. all of the above

The more diversified a stock portfolio, the __________ risky it is.

b. less

Which of the following is NOT a reasonable investment strategy?
a. Buy stocks with high P/E ratios
b. Buy for the long term
c. Diversify
d. Be a contrarian
e. Consider the tradeoffs between returns, growth and risk

a. Buy stocks with a high P/E ratio

Put the following investments in order from riskiest to least risky. Which of following lists begin with the least risky investment and ends with the most risky? Least risky = 1; most risky = 5

1) Bonds 2) Mutual Funds 3) ETFs 4) Preferred Stock 5) Common Stock

Which of the following statements is FALSE?

a. Corporations receive money each time their securities are traded
b. Securities markets benefit businesses and private investors
c. Securities markets help companies raise long term debt and equity financing
d. Securities markets serve as a place to buy and sell stocks, bonds, and mutual funds
e. Securities markets represent the financial marketplaces for stocks and bonds

a. Corporations receive money each time their securities are traded

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