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Module 1
Financial Accounting for MBAs
Learning Objectives coverage by question
LO1 Identify and
discuss the
users and
suppliers of
financial
statement
information.
LO2 Identify and
explain the four
financial
statements, and
define the
accounting
equation.
LO3 Explain and
apply the basics
of profitability
analysis.
LO4 Describe
business
analysis within
the context of a
competitive
environment.
LO5 Describe
the accounting
principles and
regulations that
frame financial
statements.
True/
False
Multiple
Choice
Exercises
Problems
Essay
Questions
1-4
1-2
1-2
5-10
3-19
1-8
2-5
11-13
20-25
9-10
6-7
14
26-27
15
28-30
9-10
True/False
Topic: Users of Financial Statement Information
LO: 1
1. Shareholders demand financial information primarily to assess profitability and risk whereas
bankers demand information primarily to assess cash flows to repay loan interest and principle.
Answer: True
Rationale: While both shareholders and bankers are interested in all the information companys
provide, shareholders care about more about a companys profitability and bankers care more about
solvency and creditworthiness.
Topic: Publicly available financial reports
LO: 1
2. Publicly traded companies are required to provide quarterly financial reports directly to the public.
Answer: False
Rationale: Companies provide electronic versions of quarterly financial statements to the SEC that
posts them to the internet for the public to access them.
Topic: Users of Financial Statement Information
LO: 1
3. Publicly traded companies provide financial information primarily to satisfy the SEC and the tax
authorities (that is, the Internal Revenue Service).
Answer: False
Rationale: Demand for information extends to many users, the regulators such as the SEC and the
IRS are only one class of users.
Topic: SEC filings
LO: 1
4. Publicly traded companies must provide to the Securities Exchange Commission annual audited
financial statements (10K reports) and quarterly audited financial statements (10Q reports).
Answer: False
Rationale: Quarterly reports do not need to be audited.
Topic: Balance Sheet
LO: 2
5. If a company reports retained earnings of $175.3 million on its balance sheet, it must also report
$175.3 million in cash.
Answer: False
Rationale: The accounting equation requires total assets to equal total liabilities plus stockholders
equity. That does not imply, however, that liability and equity accounts relate directly to specific
assets.
Multiple Choice
Topic: Users of Financial Statement Information
LO: 1
1. Which of the following groups would likely not be interested in the financial statements of a large
public company such as Berkshire Hathaway?
a. Shareholders
b. Employees
c. Competitors
d. Taxing agencies
e. None of the above
Answer: e
Rationale: All of these parties would use the financial statements, albeit in different ways and for
different purposes.
Topic: Users of Financial Statement Information
LO: 1
2. The SEC adopted Regulation FD, to curb public companies practice of:
a. Routinely filing extensions for annual reports (Form 10-k)
b. Selectively disclosing information
c. Reporting pro forma (non-GAAP) numbers
d. Hiring auditors for non-audit services such as consulting engagements
e. None of the above
Answer: b
Rationale: Reg FD reads as follows: Whenever an issuer discloses any material nonpublic
information regarding that issuer, the issuer shall make public disclosure of that information . . .
simultaneously, in the case of an intentional disclosure; and . . . promptly, in the case of a nonintentional disclosure.
Topic: Components of the Balance Sheet
LO: 2
3. A list of assets, liabilities and equity can be found on which of the following?
a. Balance Sheet
b. Income Statement
c. Statement of Assets and Liabilities
d. Statement of Cash Flows
e. Statement of Stockholders Equity
Answer: a
Rationale: A balance sheet lists amounts for assets, liabilities and equity at a point in time.
$15,226
14,204
1022
(77)
$ 1,602
What did Goodyear report for Retained earnings at December 31, 2008?
a. $1,679 million
b. $1,525 million
c. $1,022 million
d. $945 million
e. There is not enough information to determine the answer.
Answer: e
Rationale: To determine the balance in retained earnings at the end of the year we must also know
the amount of dividends (if any) paid by the company during the year.
Topic: Balance Sheet Numerical calculations required
LO: 2
8. American Airlines 2007 balance sheet reported the following (in millions)
Total Assets
Total Liabilities
Contributed Capital
$25,385
23,941
$ 4,422
What was American Airlines Total liabilities and Stockholders Equity at December 31, 2007?
a. $25,385 million
b. $23,941 million
c. $28,363 million
d. $4,422 million
e. There is not enough information to determine the answer.
Answer: a
Rationale: Assets = Liabilities + Stockholders Equity. Assets = $25,385 so this is the total of liabilities
and equity combined.
$5,672.6
2,490.9
$2,189.7
$1,140.7
$1,186.5
$1,523.8
$10,560
$ 6,102
$ 4,458
$3,498
$1,307
$19,488
$16,139
$ 3,426
What did Goodyear report for Net income for the year ending December 31, 2008?
a. $77 million
b. $(77) million
c. $3,349 million
d. $16,062 million
e. There is not enough information to determine the answer.
Answer: b
Rationale: Sales Cost of sales Other expenses = Net income.
$19,488 $16,139 $3,426 = $(77).
Topic: Income Statement Numerical calculations required
LO: 2
14. E. I. du Pont reported the following on its 2007 income statement (in millions)
Sales revenue
Gross profit
Total expenses
$29,378
7,813
$26,390
What did E. I. du Pont report for Cost of goods sold during 2007?
a. $18,577 million
b. $21,565 million
c. $37,191 million
d. $2,988 million
e. None of the above
Answer: b
Rationale: Sales Cost of goods sold = Gross profit. $29,378 Cost of goods sold = $7,813.
Therefore, Cost of goods sold = $21,565.
2008
$10,067.5
503.9
$ 315.5
2007
$8,738.9
1,053.9
$ 672.6
What amount of revenues did Starbucks report for the year ending September 30, 2008?
a. $10,383.0
b. $9,411.5
c. $10,571.4
d. $9,752.0
e. None of the above.
Answer: a
Rationale: Revenues Total expenses = Net earnings. Revenues $10,067.5 = $315.5. Therefore,
Revenues were $10,383.0.
Topic: Income Statement Numerical calculations required (More challenging, requires calculation of
negative growth rate.)
LO: 2
16. On September 30, 2008 Starbucks Corporation reported, on its Form 10-K, the following (in
millions):
Operating income
Net earnings
2008
$ 503.9
$ 315.5
2007
$1,053.9
$ 672.6
Topic: Income Statement Numerical calculations required (More challenging requires calculation
of Gross profit and ratios for two years.)
LO: 2
17. In its 2007 annual report, Caterpillar, Inc. reported the following (in millions):
Sales
Cost of goods sold
2007
$44,958
$32,626
2006
$41,517
$29,549
As a percentage of Sales, did Caterpillars Gross profit increase or decrease during 2007?
a. Gross profit increased from 27% to 29%
b. Gross profit decreased from 29% to 27%
c. Gross profit increased from 71% to 73%
d. Gross profit decreased from 73% to 71%
e. There is not enough information to answer the question.
Answer: b
Rationale: Sales = Cost of goods sold = Gross profit. In 2006, gross profit to sales was 29%. This
ratio decreased to 27% in 2007.
Topic: Statement of Cash Flow Numerical calculations required
LO: 2
18. The Goodyear Tire & Rubber Companys December 31, 2008 financial statements reported the
following (in millions)
Cash December 31, 2008
Cash from operating activities
Cash from investing activities
Cash from financing activities
$ 1,894
(745)
(1,136)
$ 312
What did Goodyear report for Cash on its December 31, 2007 balance sheet?
a. $1,894 million
b. $3,463 million
c. $325 million
d. $1,973 million
e. none of the above
Answer: b
Rationale: Cash, beginning of year + Cash from operating activities + Cash from investing activities +
Cash from financing activities = Cash at end of year
Cash, beginning of year $745 $1,136 + $312 = $1,894. Cash, beginning of year = $3,463
$ 5,354
3,313
15,814
$(2,549)
What did Procter & Gamble report for Cash from financing activities for the year ended June 30,
2008?
a. $(21,932) million
b. $15,306 million
c. $(15,306) million
d. $(13,265) million
e. $13,265 million
Answer: c
Rationale: Cash, beginning of year + Cash from operating activities + Cash from investing activities +
Cash from financing activities = Cash at end of year
$5,454 + $15,814 $2,549 + Cash from financing = $3,313. Cash from financing = $(15,306)
Topic: Return on Assets
LO: 3
20. A companys return on assets (ROA) can be disaggregated to reveal which of the following
(select all that apply):
a. Financial leverage
b. Profit Margin
c. Sales growth
d. Asset growth
e. Asset turnover
Answer: b and e
Rationale: ROA can be disaggregated into profit margin and asset turnover. Financial leverage and
sales growth are not components of this ratio. Asset growth affects the calculation via the
denominator, but cant be disaggregated directly.
Topic: Return on Equity
LO: 3
21. The ratio of net income to equity is also known as:
a. Total net equity ratio
b. Profit margin
c. Return on equity
d. Net income ratio
e. None of the above
Answer: b
Rationale: The ratio of net income to equity is called ROE, return on equity and measures how
profitable the company was given the shareholders investment.
Topic: Return on Assets Numerical calculations required (More challenging because Average
assets are not provided, must be calculated.)
LO: 3
25. On December 31, 2008 Harley-Davidson Inc. reported, on its Form 10-K, the following (in
millions):
Total assets
Total sales
Net income
2008
$7,829
5,594
$ 655
2007
$5,657
5,727
$ 934
Exercises
Topic: Financial Accounting Vocabulary
LO: 2
1. Match the item on the left to a numbered item on the right to complete each sentence.
a. Resources that a company owns or controls are
called ____________________.
b. The difference between a companys assets and
its equity is equal to ___________.
c. Net income divided by average assets is known
as ____________________.
d. Sales, cost of goods sold and all other expenses
are necessary to calculate a companys
__________________.
Answer: a. 3.
b. 1.
c. 2.
1. liabilities
2. return on assets
3. assets
4. income statement
5. net income
d. 5.
1. income statement
2. balance sheet
3. statement of cash flows
4. statement of shareholders equity
5. financial statements
Answer: a. 2.
b. 1.
c. 4.
d. 3.
7,953,912
?
2,706,705
?
236,238
Answer:
Whole Foods
Income Statement
For Year Ended September 28, 2008
Sales
Cost of goods sold and occupancy costs
Gross profit
Operating expenses
Operating income
7,953,912
5,247,207
2,706,705
2,470,467
236,238
?
67,425
16,078
?
$12,075
Answer:
Procter & Gamble
Income Statement
For Year Ended June 30, 2008
Sales
Expenses
Earnings before income taxes
Income taxes
Net earnings
$83,503
67,425
16,078
4,003
$12,075
$ 325,760
(365,054)
69,828
?
?
$ 30,534
Answer:
Whole Foods
Statement of Cash Flows
For Year Ended September 28, 2008
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by financing activities
Net change in cash
Cash at beginning of year
Cash at end of year
$ 325,760
(365,054)
69,828
30,534
0
$ 30,534
Cash
Non-cash assets
Total assets
Whole Foods
Balance Sheet
September 28, 2008
$ 30,534
Current liabilities
?
Long-term liabilities
Stockholders equity
$3,380,736
Total liabilities and equity
$ 666,177
?
1,506,024
$
?
Whole Foods
Balance Sheet
September 28, 2008
$ 30,534
Current liabilities
3,350,202
Long-term liabilities
Stockholders equity
$3,380,736
Total liabilities and equity
$ 666,177
1,208,535
1,506,024
$3,380,736
Answer:
Cash
Non-cash assets
Total assets
Cash
Non-cash assets
Total assets
?
43,540
69,494
143,992
30,958
43,540
69,494
143,992
Answer:
Cash
Non-cash assets
Total assets
2008
2007
?
?
85,300
439,422
?
182,740
121,802
410,198
2006
486,299
203,828
?
?
2008
410,198
114,524
85,300
439,422
2007
349,260
182,740
121,802
410,198
2006
486,299
203,828
340,867
349,260
2008
141,003
12,075
?
2007
136,854
?
7.6%
2008
141,003
12,075
8.6%
2007
136,854
10,340
7.6%
Answer:
($ millions)
Average assets
Net earnings
Return on assets
2008
3,296,959
7,953,912
114,524
?
?
?
Answer:
($ thousands)
Average assets
Sales
Net income
Return on assets
Profit margin
Asset turnover
2008
3,296,959
7,953,912
114,524
3.47%
1.44%
2.41%
Problems
Topic: Other Financial Information
LO: 1
1. In addition to the four financial statements, list three sources of financial information available to
external stakeholders?
Answer:
Management Discussion and Analysis (MD&A)
Managements report on internal controls
Annual corporate report
Auditors report and opinion
Notes to financial statements
Proxy statements
Various regulatory filings for SEC and IRS, etc.
Topic: Constructing Financial Statements
LO: 2
2. In its September 28, 2008 annual report, Starbucks Corporation reports the following items.
($ millions)
Cash flows from operations
Total revenues
Shareholders equity
Cash flows from financing
Total liabilities
Cash, ending year
Expenses
Noncash assets
Cash flows from investing
Net earnings
Cash, beginning year
2008
1,258.7
10,383.0
2,490.9
(183.6)
3,181.7
269.8
10,067.5
5,402.8
(1,086.6)
315.5
281.3
a. Prepare the balance sheet for Starbucks for September 28, 2008.
b. Prepare the income statement for Starbucks for the year ended September 28, 2008.
c. Prepare the statement of cash flows for Starbucks for the year ended September 28, 2008.
Answer:
a.
Cash
Non-cash assets
Total assets
Starbucks Corporation
Balance Sheet
September 28, 2008
$ 269.8
Total liabilities
5,402.8
Shareholders equity
$5,672.6
Total liabilities and equity
$3,181.7
2,490.9
$5,672.6
b.
Starbucks Corporation
Income Statement
For Year Ended September 28, 2008
Total revenues
$10,383.0
Expenses
10,067.5
Net earnings
$ 315.5
Cambridge Business Publishers, 2010
1-22
c.
Starbucks Corporation
Statement of Cash Flows
For Year Ended September 28, 2008
Cash flows from operations
$1,258.7
Cash flows from investing
(1,086.6)
Cash flows from financing
(183.6)
Net change in cash
(11.5)
Cash, beginning year
281.3
Cash at end of year
$ 269.8
Topic: Constructing Financial Statements
LO: 2
3. In its December 31, 2007 annual report, Mattel Inc. reports the following items.
($ thousands)
Net cash flows from operating activities
Net sales
Stockholders equity
Net cash flows from financing activities
Total assets
Cash, ending year
Expenses
Noncash assets
Net cash flows from investing activities
Net income
Cash, beginning year
2007
560,532
5,970,090
2,306,742
(579,646)
4,805,455
901,148
5,370,097
3,904,307
(285,290)
599,993
1,205,552
a. Prepare the balance sheet for Mattel Inc. for December 31, 2007.
b. Prepare the income statement for Mattel Inc. for the year ended December 31, 2007.
c. Prepare the statement of cash flows for Mattel Inc. for the year ended December 31, 2007.
Answer:
a.
Mattel Inc.
Balance Sheet
December 31, 2007
$ 901,148
Total liabilities
3,904,307
Stockholders equity
$4,805,455
Total liabilities and equity
Cash
Non-cash assets
Total assets
b.
Mattel Inc.
Income Statement
For Year Ended December 31, 2007
Net sales
Expenses
Net income
$5,970,090
5,370,097
$ 599,993
$2,498,713
2,306,742
$4,805,455
c.
Mattel Inc.
Statement of Cash Flows
For Year Ended December 31, 2007
Net cash flows from operating activities
$ 560,532
Net cash flows from investing activities
(285,290)
Net cash flows from financing activities
(579,646)
Net change in cash
(304,404)
Cash, beginning year
1,205,552
Cash at end of year
$ 901,148
2007
1,652,140
(996,981)
(1,571,511)
599,993
2,054,676
274,677
21,931
Prepare the Statement of stockholders equity for Mattel Inc. for the year ended December 31, 2007.
Answer:
Mattel Inc.
Statement of Stockholders Equity
For Year Ended December 31, 2007
Contributed capital, beginning of year
$2,054,676
Stock issued during 2007
21,931
Contributed capital, beginning of year
$2,076,607
Treasury stock, beginning of year
Stock repurchased during 2007
Treasury stock, end of year
Retained earnings, beginning of year
Net income for 2007
Dividends during 2007
Treasury stock, end of year
$(996,981)
(574,530)
$(1,571,511)
$1,652,140
599,993
(274,677)
$1,977,456
11,023
178
16,772
14,308
4,953
Answer:
a. Return on Assets = Net income / Average assets
= $178 / [0.5*($16,772 + $14,308)]
= 1.1%
Return on assets measures profitability of a companyspecifically, how well a company has
employed its average assets in generating net income
b. Profit Margin = Net Income / Sales
= $178/ $11,023
= 1.6%
Profit Margin is an income to sales ratio that reflects the profitability of sales of a company.
Southwest Airlines has a profit margin of only 1.6% meaning the company records 1.6 cents of net
income (after paying taxes) for every dollar of sales. This is very low the airline industry is
performing poorly in 2008.
Asset Turnover = Sales / Average Assets
= $11,023/ [0.5*($16,772 + $14,308)]
= 0.71
Asset turnover reflects the effectiveness in generating sales from assets. Southwest Airlines asset
turnover ratio of 0.71, means that the company generates $0.71 in sales for every $1.00 of assets.
Net income
Sales
Average assets
Average stockholders equity
Whole Foods
Market
115
7,954
3,297
1,482
The Kroger
Co.
1,181
70,235
21,757
4,919
Answer:
a. Return on Assets = Net income / Average assets
Whole Foods = $115 / $3,297 = 3.5%
Kroger = $1,181 / $21,757 = 5.4%
Return on equity = Net income / Average stockholders equity
Whole Foods: = 115 / $1,482 = 7.8%
Kroger = $1,181 / $4,919 = 24%
Kroger appears to be more profitable ROA and ROE are both higher. This is surprising because
Whole Foods is a premium grocery store. Perhaps the recent economic downturn in 2007 is causing
high-end food buyers to substitute some purchases for more mainstream groceries such as those
sold at Kroger.
b. Profit margin = Net income / Sales
Whole Foods = $115 / $7,954 = 1.4%
Kroger = $1,181 / $70,235 = 1.7%
Asset turnover = Sales / Average assets
Whole Foods = $7,954 / $3,297 = 2.4
Kroger = $70,235 / $21,757 = 3.2
Kroger has a higher return on assets because its profit margin is higher and its turnover is higher.
Thus Kroger is more profitable and more efficient.
Essay Questions
Topic: Costs and Benefits of Disclosure
LO: 1
1. Explain the benefits and costs associated with a company's disclosure of information.
Answer:
Supplying information benefits a company by helping it to compete in capital, labor, input, and output
markets. A companys performance hinges on successful business activities and the markets
awareness of that success. Economic incentives exist for those companies that disclose reliable
accounting information, especially when the company discloses good news about products,
processes, management, etc. Direct costs associated with the disclosure of information pertain to its
preparation and dissemination. More significant are other costs including competitive disadvantage,
litigation potential, and political costs. Managers must weigh these costs and benefits to determine
how much information to voluntarily disclose.
Topic: Demand for Financial Accounting Information
LO: 1
2. List three users of financial accounting information and explain how each user might use financial
information.
Answer:
Managers and employees Managers and employees demand financial information on the
financial condition, profitability and prospects of their companies for their own well-being and future
earnings potential. They also demand comparative financial information on competing companies
and other business opportunities. This permits them to conduct comparative analyses to benchmark
company performance and condition.
Creditors and suppliers Creditors and other lenders demand financial accounting information to
help decide loan terms, dollar amounts, interest rates and collateral. Suppliers similarly demand
financial information to establish credit sales terms and to determine their long-term commitment to
supply-chain relations. Both creditors and suppliers use financial information to continuously monitor
and adjust their contracts and commitments with a debtor company.
Shareholders and directors Shareholders and directors demand financial accounting
information to assess the profitability and risks of companies. Shareholders look for information
useful in their investment decisions. Both directors and shareholders use accounting information to
evaluate manager performance Managers similarly use such information to request further
compensation and managerial power from directors. Outside directors are crucial to determining who
runs the company, and these directors use accounting information to evaluate manager performance.
Customers and Sales Staffs Customers and sales staffs demand accounting information to
assess the ability of the company to provide products or services as agreed and to assess the
companys staying power and reliability. Customers and sales staffs also wish to estimate the
companys profitability to assess fairness of returns on mutual transactions.
Regulators and Tax Agencies Regulators and tax agencies demand accounting information for
tax policies, antitrust assessments, public protection, price setting, import-export analyses and
various other uses. Timely and reliable information is crucial to effective regulatory policy. Moreover,
accounting information is often central to social and economic policy.
Voters and their Representatives Voters and their representatives to national, state and local
governments demand accounting information for policy decisions. The decisions can involve
economic, social, taxation and other initiatives. Voters and their representatives also use accounting
information to monitor government spending. Contributors to nonprofit organizations also demand
accounting information to assess the impact of their donations.