ACCT 575 Adv Finc Statement Analysis

1.
Question : (TCO C) Which of the following is not an example of a red flag used to evaluate
earnings quality?
Student Answer:

Qualified audit report

Net income this year is higher then net income last year

Poor financial performance

Frequent or unexplained changes in accounting policies
Instructor Explanation: Chapter 2
Points Received: 3 of 3
Comments:

Question 2. Question : (TCO C) Which of the following statements about directors of a company is
true?
Student Answer:

Directors are elected by management of a company.

Directors only get paid if the company increases its profitability that year.

Directors are shareholders' representatives.

All directors of a company are senior managers in that company.
Comments:

Question 3. Question : (TCO C) Which of the following is an auditor most likely to consider when
planning the scope of an audit?
Student Answer:

Client's system of internal controls

Changes in the company's fortunes

Risks specific to the client's industry

Fees authorized by the audit committee of the board of directors
Comments:

Question 4. Question : (TCO C) Which of the following is not considered part of GAAP?
Student Answer:

Statement of Financial Accounting Standards

International Accounting Standards

Accounting Research Bulletins

Accounting Principles Board Opinions
Comments:

Question 5. Question : (TCO C) The two secondary qualities of accounting information that make it
useful for decision making are _________.
Student Answer:

consistency and comparability

relevance and reliability

materiality and comparability

full disclosure and relevance
Comments:

Question 6. Question : (TCO E) Economic pension cost is the net cost arising from:
Student Answer:

changes in gross economic position for the period.

changes in net economic position for the period.

changes in gross profit position for the period.

None of the above
Comments:

Question 7. Question : (TCO E) When analyzing post retirement benefits one should evaluate the
actuarial assumptions and their effect on the:
Student Answer:

stock prices.

cash requirement.

balance sheet statements.

financial statements.
Comments:

Question 8. Question : (TCO E) Treasury stock is:
Student Answer:

investments in government securities.

retained earnings that have been appropriated to make equity investments.

a company's own stock that it has repurchased.

assets held for safekeeping in company's vaults.
Comments:

Question 9. Question : (TCO E) Which of the following is not a component of pension expense?
Student Answer:

Service cost

Interest cost

Actual return on plan assets

Expected return on plan assets
Comments:

Question 10. Question : (TCO E) Investing in equity is considered to involve more risk than investing in:
Student Answer:

stocks.

bonds.

cash.

gold.
Comments:

Question 11. Question : (TCO F) The use of LIFO rather than FIFO for inventory costing under normal
economic conditions results in:
Student Answer:

lower net income.

higher total assets.

higher retained earnings.

All of the above
Comments:

Question 12. Question : (TCO F) If management underestimates the allowance for non collectible
accounts, this will cause net income for the period to be _________.
Student Answer:

understated

level

overstated

None of the above
Comments:

Question 13. Question : (TCO F) If a company factors its accounts receivables, this will have the effect
of making:
Student Answer:

its cash cycle appear longer.

its cash cycle appear even.

its cash cycle appear shorter.

its cash cycle appear exact.
Comments:

Question 14. Question : (TCO F) Which of the following is incorrect with respect to recognized goodwill
on the balance sheet?
Student Answer:

It should not be amortized over 30 years.

It arises when another company is purchased or internally generated.

It should be written down if the future benefits no longer exist.

It may be negative.
Comments:

Question 15. Question : (TCO F) LIFO provides a better match of _________ on the income statement.
Student Answer:

revenues

liabilities

assets

none of the above
Comments:

Question 16. Question : (TCO G) Differences in taxable income and pretax accounting income that will
not be offset by corresponding differences or turn around in future periods are
called:
Student Answer:

timing differences.

circular differences.

permanent differences.

reverse differences.
Comments:

Question 17. Question : (TCO G) For an item to be considered extraordinary it should be:
Student Answer:

unusual in nature.

infrequent in occurence.

Both 1 and 2

None of the above
Comments:

Question 18. Question : (TCO G) Which of the following measures of accounting income is typically
reported in an income statement?
Student Answer:

Net income

Comprehensive income

Continuing income

All of the above
Comments:

Question 19. Question : (TCO G) Which of the following statements is correct?
Student Answer:

Tax loss carrybacks result in deferred tax assets.

Tax loss carryforwards result in deferred tax assets.

The tax valuation account is used to adjust deferred tax liabilities.

All of the above
Comments:

Question 20. Question : (TCO G) Under GAAP, comprehensive income:
Student Answer:

may be reported in addition to net income.

must be reported in addition to net income.

may be reported instead of net income.

must be reported instead of net income.
Comments:

1. Question : (TCO F) Analysts maintain that two of the most important ratios are
inventory turnover and accounts receivable turnover.
1. You are analyzing XYZ Company, a tractor manufacturer. You notice
that inventory turnover this year is significantly lower than prior years.
Provide two explanations that would be consistent with this observation.
Explain whether these would be a good sign or if these would be a
concern to you and what the effect might be on next period's financial
results.
2. You are analyzing XYZ Company, a tractor manufacturer. You notice
that accounts receivable turnover this year is significantly lower than prior
years. Provide two explanations that would be consistent with this
observation. Explain whether these would be a good sign of if these
would be of concern to you and what the effect might be on next period's
financial results.
Student Answer:

[1.]One of the reasons why inventory turnover has declined in the years is
because maybe the product is just not selling. Other competitors like Wal-Mart or
Target may sell the same product for cheaper. A great example of what I'm
talking about is "pajama jeans." Pajama Jeans are a product that I saw on
television that are made of a soft material, but they actually look like jeans. The
pajama jeans website are selling their product for $40.00 (for example). Target is
selling the same product for $35.00, while Wal-Mart is selling the exact same
brand name product for $20. Most consumers are going to go with the cheaper
buy for the same product, in order to save money. One of the reasons the product
may not be selling at the XYZ Company, is because maybe the product is
overpriced. The product could very well meet a lot of people's point of pain, but
the company must also consider how much money they are willing to sell the
product for. One thing the XYZ Company may want to do is to sell two products
for the price of one to kinda sweeten the deal (an "incentive" of some kind for the
customers). By making the product more of a package deal, that involves a two
for one set package, XYZ Company could profit more off of it's own product,
and collect even more money than they had expected in order to pay everyone
involved in making the product to keep the company in business. Another reason
why the sells for the product are low is due to how the product was manufactured
(or made). If the product is defective, and the company has had more reported
returns on the product item, than actually sell that keep the revenue growing (or
forever increasing), then this could be a problem that needs to be fixed
immediately so that customers will want to purchase the product or more than on
of the same product from the XYZ Company, and keep it (meaning not returns on
the items to the stores they originally were sold at). The effects of the products
being over priced, and defective, can make the revenues for the XYZ Company
decrease tremendously, unless the company does more research on the items in
order to make their product better so that people will actually buy and keep their
items they bought from the XYZ Company. [2.] From what I gather after reading
the second scenario, the XYZ Company is in debt due to customers not paying
the company back the monies that they owe them. As a result of this happening,
the "accounts receivable" so low to the point where bill can not be paid in order
for the company to continue running with it's daily operations. One way the
company can prevent from losing monies is to create a supply and demand for
the product by making LESS of the product. Maybe the company can sell certain
product items only during the Christmas holiday season. For example, I
remember traveling to Wal-Mart to buy a Hillshire Farms Beef Summer Sausage
in May of 2014. When I went find the product in the store, I saw that the product
has disappeared. I asked the sales associates at Wal-mart to help me find one
"Hillshire Farms Beef Summer Sausage," and then I was told by the manager of
the store that the "Hillshire Farms Beef Summer Sausages" are only for sale
during the fall and winter seasons, and they would not receive any more of the
"Hillshire Farms Beef Summer Sausages" until November, somewhere close to
the Thanksgiving holidays. I was sadden that I could not buy my "Hillshire
Farms Beef Summer Sausage," but I understood that their was a supply and
demand for the particular product around the holiday season (near the end of the
year). My point is if XYZ Company only makes a certain amount of product once
a year, then the demand for the product will be much higher. The bigger the
demand, the more people will be more eager to pay good cash money for the
product that they want. Another solution for the XYZ Company not to lose
money is the change the selling method. In other words, make the customers pay
cash for the items only, and sell the product at one place such as a massive mass
merchant (Wal-Mart) or sell the items at the small local mom and pop businesses.
Make a contract with the retailers that cash only is to be excepted for the items,
only for a limited time within the year. These are just a couple of solutions that
could help the company stay in business without losing anymore of it's financial
assets (MONIES).
Instructor Explanation: A. A decrease in inventory turnover means that an average inventory is being held
for a longer period of time before it is sold.
This may indicate:
obsolete inventory. This is a matter of concern.
planned increase in purchasing in anticipation of increased demand
for goods. This is a good sign.
less demand than expected in prior period. This is a matter of
concern.
B. An increase in accounts receivable relative to sales can be due to the
following reasons:
more sales made on credit.
o change in credit policy.
o failure by employees to follow credit policy
customers are paying less quickly.
o general recession
o poorer quality merchandise
o poorer job by credit department
Change to a more aggresive revenue recognition procedures. A
cause of concern.
Change in allowance for uncollected accounts receivable.
Change in allowance for returns

Comments: Good job.

Question 2. Question : (TCO E) Compare the effects of operating leases as compared to
capitalized leases in the first year of a lease on the following items listed.
Explain your answer.
1. Earnings Before Interest and Taxes (EBIT)
2. Net Income
3. Cash flow from Operations
Student Within the first year for operating leases (cars, boats, things that you can operate
Answer: while RENTING), everything has to be paid up front. Net Income is
EVERYTHING after all of the bills are paid (operating leases). Cash flow from
Operations is everyday money that comes into the business, and out of the
business. The earnings earned prior to getting any taxes for the stuff you are
RENTING, must also be paid for as well (EBIT). With Capitalized Leases, one
must realize that they must count the cash that you have before you pay your
taxes. Remember: EBIT involves the earnings earned prior to getting any taxes for
the stuff you are RENTING, must also be paid for as well. Net Income is the cash
you pay for all of your utilities, and the stuff that you are RENTING (building you
may be renting for a business, or a home that looks really nice BUT you are
RENTING to own{for example}, or just plain renting [and not owning at all]
MUST ALL BE PAID for too). Cash flow from operations is the monies that you
would use to pay all your RENT, bills, and employees (for those that own a
business) that work for you (due to the fact that there's no such thing as a free
lunch, everything cost money) MUST ALL BE PAID in order to prevent any
financial drama with the monies one earns on a daily basis. *Capital Leases are
for RENTING Real estate (homes, businesses, buildings), and the operating leases
are for cars, boats, and other physical items one can RENT & operate.
Instructor
Explanati
on:
EBIT
Operating leases deduct total rental expense in arriving at EBIT
Capitalized leases deduct only depreciation expense in arriving at EBIT (the other deduction is
interest which is not included in EBIT)
Therefore, EBIT will be higher under capitalized leases
Net Income
Operating leases deduct total rental expense in arriving at net income
Capitalized leases deduct only depreciation expense and interest expense in arriving at NI.
In first year, depreciation + interest expense > rental expense, therefore, NI is lower for
capitalized lease
Cash flow from Operations
Operating leases: all rental expense is deducted in arriving at CFO
Capitalized leases:
Interest expense XXX interest expense deduction is included in CFO.
Decrease in liability XXX decrease in liability is in CFF
Cash XXX
Note: depreciation is not a factor (and is not a cash flow)
CFO is higher for capitalized leases.
Comments: Good job.

Question 3. Question : (TCO C) One step in assessing the quality of earnings is to look for red
flags. An example of a red flag is a change in auditors. A parting of the
ways with auditors may be because of disagreements over accounting
matters. This will be filed in an 8-K report. List five other red flags the
astute analyst might look for, describe why it is a red flag, and identify
where the analyst might find this information.
Student Answer:

Possible red flags: [1] Decrease in inventory turnover - calculated from financial
statements. This may show evidence of obsolete or unsalable goods. [2]Change
in auditors. A parting of the ways with auditors may be because of disagreements
over accounting matters. This will be filed in an 8-K report.[3]Qualified audit
report.[4] Frequent changes in accounting principles-this may be an attempt at
earnings management and information can be found in auditor's letter and
footnotes. [5] Reported net income is consistently higher than operating cash
flow. Unless the business grows rapidly for extended periods of time, that can
show other examples of inflated earnings. [6] Reported net income is consistently
higher than income that is taxed. [7] Poor monetary performance. Desperate
businesses are prone to desperate means and their managements are subject to
temptation. [8] Frequent one-time charges and big baths. These may indicate
significant underlying problems. [9] Significant or maybe frequent changes in
corporate management. Departures of officers and directors may be indicative of
important corporate issues. The proxy, press releases, company publications & 8-
K filings may contain this information. [10] Use of financing mechanisms. Off
balance sheet financing such as operating leases, securitization of assets of assets,
special purpose entities, etc. may be proper but can also be used to excess or to
cover cash shortfalls. [11] Related party transactions and relationships. Unusual
transactions between management and the company indicate conflicts of interest,
potential for abuses and self dealing, often prefacing financial difficulties for the
company. Similarly, a board of directors with few independent directors is less
likely to protect the interests of outside shareholders. The proxy statement is a
particularly good place to catch these disclosures. [12] Incomprehensible
disclosures. Some disclosures are so convoluted that it can be so impossible to
make heads or tails out of them. Increasingly, companies take pains to clearly
explain complex situations so that the reader may take some comfort. [13] Last
minute transactions. Transactions that take place at the end of the reporting
period may be used to make up for the poor results that would otherwise have
been handled and achieved.
Instructor Explanation: Decrease in inventory turnover - calculated from financial statements. This
may indicate obsolete or unsaleable goods.
Significant increase in accounts receivable without commensurate growth in
sales (that is, accounts receivable turnover decreases). Qualified audit
report
Change in accounting principle or estimate - this may be an attempt at
earnings management and information can be found in auditor's letter and
footnotes
Reported net income is consistently higher than operating cash flow. Unless
the company is growing fast for long periods this may indicate inflated
earnings.
Reported net income is consistently higher than taxable income. Taxable
income is not reported but we can infer whether it is higher or lower and by
how much from the size of the deferred taxes. Consistently large deferred
tax liabilities could be a signal.
Poor financial performance. Desperate companies are prone to desperate
means and their managements are subject to temptation.
Frequent one-time charges and big baths. These may indicate significant
underlying problems.
Significant and/or frequent changes in corporate management. Departures
of officers and directors may be indicative of important corporate issues. The
proxy, press releases, business publications and possibly 8-K filings may
contain this information.
Use of financing mechanisms. Off balance sheet financings such as
operating leases, securitization of assets, special purpose entities, etc. may
be proper but can also be used to excess or to cover cash
shortfalls. Footnotes and the MD&A should describe these situations.
Related party transactions and relationships. Unusual transactions (if
disclosed) between management and the company (such as Adelphia
Communications' guarantee of loans to the controlling Rigas family and
Worldcom's extension of loans to its CEO Bernie Ebbers) indicate conflicts of
interest, potential for abuses and self dealing, often prefacing financial
difficulties for the company. Similarly, a board of directors with few
independent directors is less likely to protect the interests of outside
shareholders. The proxy is a particularly good place to catch these
disclosures
Comments: Good job.

Question 4. Question : (TCO G) For each of these nonrecurring items, give an example and
indicate (match with) the appropriate accounting treatment.
1. Change in accounting estimate
2. Change in accounting principle
3. Discontinued operation
4. Special items
5. Comprehensive income items
6. Change in reporting entity
7. SEC Enforcement Releases

A. Shown net as a separate line item between net income and
comprehensive income, no restatement.
B. Income statement line items adjusted as appropriate, gross or net,
prior years restated.
C. Gross amount is part of its regular income or expense line item in
income from continuing operations, prior years restated.
D. Gross amount is part of its regular income or expense line item in
income from continuing operations, no restatement.
E. Shown gross as a separate line item in income from continuing
operations, no restatement.
F. Shown net as a separate line item between income from continuing
operations and net income, prior years restated.
G. Shown cumulative net as a separate line item between income from
continuing operations and net income, no restatement.
Student Answer:

1. Change in accounting estimate G. Shown cumulative net as a separate line
item between income from continuing operations and net income, no restatement.
2. Change in accounting principle D. Gross amount is part of its regular income
or expense line item in income from continuing operations, no restatement. 3.
Discontinued operation F. Shown net as a separate line item between income
from continuing operations and net income, prior years restated. 4. Special items
E. Shown gross as a separate line item in income from continuing operations, no
restatement. 5. Comprehensive income items C. Gross amount is part of its
regular income or expense line item in income from continuing operations, prior
years restated. 6. Change in reporting entity A. Shown net as a separate line item
between net income and comprehensive income, no restatement. 7. SEC
Enforcement Releases B. Income statement line items adjusted as appropriate,
gross or net, prior years restated.
Instructor Explanation: 1. Change in Accounting Estimate
D. Gross amount is part of its regular income or expense line item in
income from continuing operations, no restatement.
Change in depreciable lives
2. Change in Accounting Principle
G. Shown cumulative net as a separate line item between income
from continuing operations and net income, no restatement.
Change in depreciation method, change in revenue recognition
methodology
3. Discontinued Operation
F. Shown net as a separate line item between income from
continuing operations and net income, prior years restated.
Operating income/loss from discontinued operations, gain/loss on
disposal of discontinued operations.
4. Special Items
E. Shown gross as a separate line item in income from continuing
operations, no restatement.
Impairment of long-lived assets, restructuring charges.
5. Comprehensive income items
A. Shown net as a separate line item between net income and
comprehensive income, no restatement.
Unrealized holding gain/loss on marketable securities, foriegn
currency translation adjustment.
6. Change in Reporting Activity
C.Gross amount is part of its regular income or expense line item in
income from continuing operations, prior years restated.
Consolidation of subsidiary.
7. SEC Enforcement Releases
B. Income statement line items adjusted as appropriate, gross or net,
prior years restated.
Overly aggresive accounting practices.


Comments: 1. Change in Accounting Estimate D. Gross amount is part of its regular
income or expense line item in income from continuing operations, no
restatement. Change in depreciable lives 2. Change in Accounting Principle G.
Shown cumulative net as a separate line item between income from continuing
operations and net income, no restatement. Change in depreciation method,
change in revenue recognition methodology 3. Discontinued Operation F.
Shown net as a separate line item between income from continuing operations
and net income, prior years restated. Operating income/loss from discontinued
operations, gain/loss on disposal of discontinued operations. 4. Special Items E.
Shown gross as a separate line item in income from continuing operations, no
restatement. Impairment of long-lived assets, restructuring charges. 5.
Comprehensive income items A. Shown net as a separate line item between net
income and comprehensive income, no restatement. Unrealized holding
gain/loss on marketable securities, foriegn currency translation adjustment. 6.
Change in Reporting Activity C.Gross amount is part of its regular income or
expense line item in income from continuing operations, prior years restated.
Consolidation of subsidiary. 7. SEC Enforcement Releases B. Income
statement line items adjusted as appropriate, gross or net, prior years restated.
Overly aggressive accounting practices.

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