Chapter 14 The Role of Accountants and Accounting Information 1. The controller is a company's chief accounting officer. Answer: True Explanation: A controller oversees the current financial state of a company. 2. A firm's financial accounting system is only concerned with external users of information. Answer: True Explanation: Financial accounting gives information to external parties on a company's financial state. 3. An audit examines whether a firm's financial statement conforms to generally accepted accounting principles. Answer: True Explanation: An audit examines a company's accounting information system to determine whether financial reports reliably represent its operations; independent auditors who do not work for the company must ensure that clients' accounting systems follow generally accepted accounting principles (GAAP). 4. An asset is defined as any economic resource expected to benefit a firm or an individual who owns it. Answer: True Explanation: Assets are counted as among the financial credits to a firm. 5. Current assets refers to all assets that are able to be liquidated in a short amount of time. Answer: True Explanation: Current assets includes cash on hand and all assets that can be quickly converted into cash. 6. The primary goal for the standard practices and principles in accountant reporting is to ensure external users that the information is accurate and has meaning. Answer: True Explanation: Reporting of accounts must convey information that outsiders will be able to use to determine the financial state of the company. 7. Activity ratios allow investors to compare the relative efficiencies of similar companies. Answer: True Explanation: Activity ratios show the company's sales as related to inventory. 8. The purpose of ethics in accounting is to maintain public confidence in business institutions, financial markets, and the products and services of the accounting profession. Answer: True Explanation: Ethical accounting practices provide accuracy and transparency so that useful and dependable information is given. 9. The International Accounting Standards Board is the prominent international organization for global accounting standards. Answer: True Explanation: U.S. companies are making their accounting practices more in line with the International Accounting Standards Board. 10. Bookkeeping is a comprehensive system for collecting, analyzing, and communicating financial information. Answer: False Explanation: Accounting is a comprehensive system for collecting, analyzing, and communicating financial information. 11. Due to current concerns over accounting fraud, certified public accountants are now licensed by the Securities and Exchange Commission. Answer: False Explanation: Certified public accountants are licensed by a state after passing an exam prepared by the American Institute of Certified Public Accountants. 12. In order to increase the quality of current accountants, the CPA Vision Project has re-asserted the ability to use and calculate large amounts of numerical data as a primary competency for accountants. Answer: False Explanation: The core competencies in accounting identified in the CPA Vision Project go beyond the ability to crunch numbers; they include certain communications skills, along with skills in critical thinking and leadership. 13. Joe has good reason to suspect that his investments in XYZ Manufacturing are being fraudulently recorded and used by the accountants of that company. In order to start a legal investigation, he needs to go to the American Institute of Certified Public Accountants. Answer: False Explanation: The Securities and Exchange Commission is the U.S. government agency that legally enforces accounting and auditing rules and procedures. 14. Owners' equity is net worth minus liabilities. Answer: False Explanation: Owners' equity is the amount of invested ownership in a company that the owners have. 15. If a company's assets exceed its liabilities, owners' equity is negative. Answer: False Explanation: If a company's assets exceed its liabilities, owners' equity is positive; this is based on the accounting equation. 16. Assets are categorized by the capacity in which they benefit the company. Answer: True Explanation: There are three kinds of assets—current, fixed, and intangible. 17. The most liquid asset for a firm are marketable securities that can be sold very quickly. Answer: False Explanation: Cash is the most liquid asset. 18. Retained earnings are net profits minus dividend payments to stockholders. Answer: True Explanation: Retained earnings accumulate when profits, which can be distributed to stockholders, are kept instead for the company's use. 19. The accountant to a local bakery would classify the buying of a new oven as "Cash flows from investing" on her statement of cash flows. Answer: True Explanation: A new oven is an investment in capital for doing business. 20. A reasonable assessment of the future financial stability of a company is the percentage of intangible assets with respect to all assets of the company. Answer: True Explanation: A company with sound finances must have intangible assets to invest in future business. 21. Revenues are reported when a sale is made. Answer: False Explanation: Although a firm earns revenues continuously as it makes sales, earnings are not reported until the earnings cycle is completed. The end of the earnings cycle determines the timing for revenue recognition in a firm's financial statements. 22. Revenue from the earnings of a particular transaction is able to be reported as soon as the product or service is delivered. Answer: False Explanation: It is able to be reported only after the money has been collected—or is collectible. 23. The most commonly used liquidity ratio is found by calculating current assets to current liabilities. Answer: True Explanation: This ratio measures a company's ability to meet current obligations; the ratio is determined by dividing current assets by current liabilities. 24. A long-term ratio of 2:3 indicates that the company has more equity than debt by a half. Answer: False Explanation: This ratio indicates that the company has more debt than equity by half. 25. It is currently very common that a CPA who is hired to audit a firm's finances will also be hired to help design a more efficient financial information system. Answer: False Explanation: This is illegal under the Sarbanes-Oxley Act of 2002. 26. A key component of the Sarbanes-Oxley Act of 2002 was increased government oversight over the certification examinations given by the accounting professional organizations such as the Institute of Management Accountants. Answer: False Explanation: More or less, the professional organizations were left alone by this act. 27. A company with a very high amount of liabilities will always find it more difficult to secure loans than a company with a very low amount of liabilities. Answer: False Explanation: Securing of loans is a function of net worth, not necessarily the amount of liabilities. Net worth may be high in spite of high liabilities. 28. The percentage of liabilities in a company's assets plus the percentage of owners' equity in its assets is always equal to 100. Answer: True Explanation: By definition, assets equals liabilities plus owners' equity. 29. Major projects such as corporate mergers or buyouts can adversely affect the long-term solvency ratio of a company. Answer: True Explanation: Corporate mergers of buyouts imply that significant debt has been taken on by a company. 30. Unethical accounting methods fortunately have only affected public confidence in the company found to have committed accounting violations. Answer: False Explanation: The practice of unethical accounting methods can hurt public opinion of all businesses. 31. In general, the accounting standards from the IASB and from the U.S. GAAP align nearly perfectly. Answer: False Explanation: These are different accounting standards; a company can align itself only with one or the other. 32. Ethical behavior requires that a CPA give precedence to public trust in the profession over the directions of her or his employer. Answer: True Explanation: The ethical responsibility of a CPA is to generate information that is accurate and useful to any outside party. 33. Which of the following terms refers to the comprehensive system for collecting, analyzing, and communicating financial information? A) bookkeeping B) accounting C) controlling D) auditing E) budgeting Answer: B Explanation: B) Accounting is the practice of making financial information useful to internal and external parties. 34. Which of the following terms refers to the recording of financial transactions? A) bookkeeping B) accounting C) controlling D) budgeting E) auditing Answer: A Explanation: A) Bookkeeping is the accurate recording of transactions, which accountants use to generate useful information. 35. Which of the following terms refers to the examination of a company's accounting system to determine whether its financial reports fairly represent its operations? A) company-wide analysis B) forensic accounting C) portfolio analysis D) audit E) preliminary investigation Answer: D Explanation: D) An audit is an examination by an external party to ensure that a company's financial reports are faithful and accurate. 36. Which of the following terms refers to any economic resource that is expected to benefit a firm or individual who owns it? A) asset B) liability C) equity D) account E) deposit Answer: A Explanation: A) An asset counts as something of value for accounting purposes. 37. Which of the following terms refers to the amount of money that owners would receive if they sold all of a company's assets and paid all of its liabilities? A) asset B) owners' equity C) inventory D) liability E) credit Answer: B Explanation: B) Owners' equity is that value that represents the financial stake in a company by the owners. 38. Which of the following refers to the financial statement detailing a firm's assets, liabilities, and owners' equity? A) income statement B) statement of cash flows C) balance sheet D) expense report E) annual budget Answer: C Explanation: C) A balance sheet uses the accounting equation to show the current value of a company. 39. Which of the following describes assets such as land, building, and equipment? A) liquid assets B) fixed assets C) intangible assets D) current assets E) limited assets Answer: B Explanation: B) Fixed assets are tangible things of value. 40. Which of the following best describes depreciation? A) the process of the decreasing value of fixed assets due to use B) the process of deducting operating expenses from the value of fixed assets C) the process of reducing the value of fixed assets equally over time D) the process of distributing the cost of liabilities equally over time E) the process of distributing the cost of intangible assets equally over time Answer: C Explanation: C) Depreciation is the natural reduction of value of certain assets over time. 41. Which of the following describes assets such as patents and trademarks? A) liquid assets B) fixed assets C) intangible assets D) current assets E) limited assets Answer: C Explanation: C) Intangible assets are nonphysical items that still have monetary value attached to them. 42. Which of the following terms refers to the amount paid for an existing business beyond the value of its other assets? A) goodwill B) excess compensation C) licensing D) asset promotion E) liability deduction Answer: A Explanation: A) Goodwill is the intangible value of the expectation that a company will continue to do business wisely. 43. Which of the following terms refers to the difference between operating income and income taxes ? A) gross revenue B) net income C) gross profit D) cash flow E) leverage Answer: B Explanation: B) Net income is operating income minus taxes. 44. Which of the following ratios measures a firm's ability to meet its current debt obligations? A) short-term solvency ratio B) long-term solvency ratio C) profitability ratio D) activity ratio E) equity ratio Answer: A Explanation: A) The short-term solvency ratio is calculated by dividing current assets by current liabilities. 45. Which of the following ratios measures a firm's potential earnings? A) short-term solvency ratio B) long-term solvency ratio C) profitability ratio D) activity ratio E) equity ratio Answer: C Explanation: C) This ratio is calculated by dividing net income by the number of common shares of stock. 46. ABC Company has a net income of $5 million. ABC's number of outstanding shares of stock is 3,870,000 shares. What is the company's earnings per share? A) $1.29 B) $.77 C) $1.25 D) $.80 E) $18.75 Answer: A Explanation: A) Earnings per share = Net Income/Number of Common Shares Outstanding; therefore, in this scenario, $5,000,000/3,870,000 = $1.29. 47. Which of the following ratios evaluates management's use of resources? A) short-term solvency ratio B) long-term solvency ratio C) activity ratio D) profitability ratio E) equity ratio Answer: C Explanation: C) The activity ratio is used to compare relative efficiencies between similar companies. 48. Which are the two major fields of accounting? A) managerial and forensic B) financial and managerial C) bookkeeping and advisory D) corporate and individual E) public and private Answer: B Explanation: B) The two fields of accounting can be classified according to the users they serve; it is convenient and accurate to classify users as those outside the company and those inside the company. 49. Bennequin Accounting has been hired by XYZ Manufacturing to help plan its merger with ABC Distribution. Which of the following terms best describes the capacity for which Bennequin has been hired? A) regulatory accounting B) corporate bookkeeping C) company auditing D) fraud investigation E) management advisory Answer: E Explanation: E) In this capacity, private accountants help management make decisions. 50. Which of the following statements is true? A) As common practice, a union representative for the workers at a firm receives information from the firm's financial accounting system. B) As common practice, a union representative for the workers at a firm receives information from the firm's managerial accounting system. C) As common practice, a union representative for the workers at a firm receives information from both the firm's managerial accounting system and its financial accounting system. D) As common practice, a union representative for the workers at a firm receives information from the firm's forensic accounting system. E) As common practice, a union representative for the workers at a firm does not receive any information from the firm's accounting system. Answer: A Explanation: A) The financial accounting system is concerned with external users, such as unions. 51. Which of the following statements is true? A) As common practice, a sales representative for a firm receives information from the firm's financial accounting system. B) As common practice, a sales representative for a firm receives information from the firm's managerial accounting system. C) As common practice, a sales representative for a firm receives information from both the firm's managerial accounting system and its financial accounting system. D) As common practice, a sales representative for a firm receives information from the firm's revenue accounting system. E) As common practice, a sales representative for a firm does not receive any information from the firm's accounting system. Answer: B Explanation: B) The managerial accounting system is concerned with internal users. 52. Due to investor disgruntlement, Howard Industries needs to provide a complete review of its financial records in order to confirm that they have been conforming with generally accepted accounting principles. Which of the following processes does Howard Industries need to start? A) company-wide analysis B) company-wide audit C) portfolio analysis D) preliminary investigation E) fraud investigation Answer: B Explanation: B) An audit examines a company's accounting information system to determine whether financial reports reliably represent its operations. 53. Which of the following refers to the rules and procedures governing the content and form of financial reports? A) national bookkeeping standards B) core competencies for accounting C) accounting and financial rules D) national guidelines of accounting principles E) generally accepted accounting principles Answer: E Explanation: E) GAAP is formulated by the Financial Accounting Standards Board (FASB) of the AICPA and should be used to determine whether a firm has controls to prevent errors and fraud. 54. Jose is a recent college graduate who has been hired for an entry-level professional position in the accounting department of a large corporation. Which of the following terms best describes Jose's capacity as an accountant? A) public accountant B) private accountant C) forensic accountant D) advisory accountant E) management accountant Answer: B Explanation: B) Private accountants are hired by individual businesses to perform day-to-day activities. 55. Which of the following describes a liability? A) the potential profit from selling a firm's assets and settling all of its debts B) a debt owed by a firm to an outside organization or individual C) any economic resource expected to benefit a firm or an individual who owns it D) any economic deficit expected to cost a firm or an individual who owns it E) the amount of money originally invested in a business by its owners Answer: B Explanation: B) All debts owed to others are liabilities. 56. Which of the following statements best describes the difference between current and long-term liabilities? A) Current liabilities are debts that need to be paid immediately, whereas long-term liabilities do not. B) Current liabilities are those which will cost less in debt interest than long-term liabilities. C) Current liabilities are debts that are settled sooner than long-term debts. D) Current liabilities are debts on tangible assets, whereas long-term liabilities are debts on intangible assets. E) Current liabilities are debts on current assets, whereas long-term liabilities are debts on fixed and intangible assets. Answer: C Explanation: C) Current liabilities include accounts payable: unpaid bills to suppliers for materials as well as wages and taxes that must be paid in the coming year. Long-term liabilities are debts that are not due for at least a year. 57. A company's owners invested $10,000 total into the company, which made a profit of $3,500 last year. Its total liabilities are currently at $7,000. What is the value of the total assets of this company? A) $3,000 B) $3,500 C) $6,500 D) $13,500 E) $27,500 Answer: C Explanation: C) 6500 = (10,000 + 3500) - 7000 58. A company has an assets-to-liabilities ratio of 3:2 and total assets worth $6 million. What is its owners' equity? A) $1 million B) $2 million C) $3 million D) $9 million E) $12 million Answer: B Explanation: B) assets/(assets - owners' equity) = 3/2 59. How much profit does a company which has a total of $5 million invested by its owners and $4 million in liabilities need to make in order to have an assets-to-liabilities ratio of 2:1? A) $2 million B) $3 million C) $5 million D) $7 million E) $8 million Answer: D Explanation: D) (profits + investment - liabilities)/liabilities = 2 60. What distinguishes the two most commonly used categories of owners' equity? A) the amount of equity within each type of asset—current versus fixed and intangible B) the financial form of the equity—cash investments versus stock and bond investments C) the source of the equity—investments versus earnings D) the use of the equity—invested versus saved E) the age of the equity—older investments and earnings versus newer investments and earnings Answer: C Explanation: C) Paid-in capital is additional money invested by owners; retained earnings are net profits kept by a firm rather than paid out as dividend payments to stockholders. 61. What are the major categories within an income statement? A) operating costs and profits, investing costs and profits, and financing costs and profits B) current revenue, long-term revenue, and net revenue C) revenue, sales, and income D) assets, liabilities, and owners' equity E) revenues, cost of revenues, operating expenses, and net income Answer: E Explanation: E) An income statement shows the financial results that occurred during a period of time, such as a month or a quarter or a year. 62. Which of the following is the difference between revenues and the cost of revenues? A) net income B) gross profit C) accounts payable D) interest expense E) cash flow Answer: B Explanation: B) Managers are often interested in gross profit, a preliminary profit figure that considers revenues and cost of revenues from the income statement. 63. Which of the following best illustrates cash flow from operations? A) the revenue from selling bread at a local bakery B) the revenue from selling stocks by an insurance company C) the revenue from new investors in a software start-up D) the revenue from selling obsolescent trucks by a delivery company E) the revenue from issuing stock by a financial management firm Answer: A Explanation: A) This figure represents how much of the year's cash balance results from the firm's main line of business. 64. Which of the following documents would most likely come from a planning strategy meeting? A) income statement B) flow of cash statement C) balance sheet D) budget E) statement of projected earnings Answer: D Explanation: D) A budget is the most important internal financial statement. 65. A company brings in $3.25 million in revenue and has a revenue cost of $1 million. Which of the following statements is true? A) In order to have a net income of more than $1.5 million, the operating expenses and income taxes need to be less than $0.25 million. B) In order to have a net income of more than $1.5 million, the operating expenses and income taxes need to be less than $0.75 million. C) In order to have a net income of more than $1.5 million, the operating expenses and income taxes need to be less than $1.75 million. D) In order to have a net income of more than $1.5 million, the operating expenses and income taxes need to be less than $2.25 million. E) In order to have a net income of more than $1.5 million, the operating expenses and income taxes need to be less than $2.75. Answer: B Explanation: B) operating expenses + taxes = net - gross profit 66. A company ended the year with $4.5 million in cash. During this year, it had earned $2.4 million in operating and financing activities. Which of the following statements is necessarily true? A) The company started the year with less than $2.1 million. B) The company started the year with more than $2.1 million. C) The company started the year with $2.1 million minus the amount of investing activities during the year. D) The company started the year with $2.1 million plus the amount of investing activities during the year. E) The company started the year with $4.5 million in cash. Answer: D Explanation: D) net cash flow = start + revenue - all costs 67. Which of the following terms refers to the formal recording and reporting of revenues in financial statements? A) full disclosure B) revenue recognition C) compliance D) ethical practice E) materiality Answer: B Explanation: B) Revenue recognition is the formal recording and reporting of revenues at the appropriate time; although a firm earns revenues continuously as it makes sales, earnings are not reported until the earnings cycle is completed. 68. Which of the following are the three categories on a company's cash flow statement? A) operating activities, purchase activities, taxes B) profit inflow, debt outflow, taxes C) profitable activities, deficit activities, taxes D) operating activities, investing activities, taxes E) operating activities, investing activities, financing activities Answer: E Explanation: E) Those are the three main figures by which net cash flow is calculated. 69. Financial statements that do not include interpretation and explanation by management are in violation of which GAAP principle? A) principle of sincerity B) principle of continuity C) principle of full disclosure D) principle of regularity E) principle of prudence Answer: C Explanation: C) Because they know about events inside the company, the people in management prepare additional information to explain certain events or transactions or to disclose the circumstances behind certain results. 70. A large company specializing in bread baking has made its annual balance sheet available to its investors. Profits were slightly lower than expected this year. Which of the following items does NOT need to be included in this statement in order to fulfill the principle of full disclosure? A) The current rise of local micro-bakeries has not affected and probably will not affect the revenue of the company. B) The company is contemplating a merger with another major baking company. C) Much of the loss of profits can be explained by the sudden rise in the price of wheat during the past year. D) A baking start-up company founded by some former executives of the company looks like it will be a major competitor in the upcoming years. E) The company and the union for its workers were able to halt a labor strike by negotiating increased health benefits for its workers, causing a slight increase in operating costs. Answer: B Explanation: B) Since this would be a company secret at this point and not directly affect costs or revenues from the previous year, this would be unnecessary (and probably unwise) to reveal. 71. A company ends the year with a banker's ratio of 5.3. How much current liabilities does it have if its current asset total is $15.3 million? A) $3.1 million B) $5.1 million C) $10.1 million D) $10.2 million E) $15.1 million Answer: A Explanation: A) current assets/current liabilities = 5.3 72. A company ends the year with a net income of $7.5 million and an earnings per share value of $1.50. What is the number of common shares outstanding for this company? A) 3 million B) 4.5 million C) 5 million D) 6.5 million E) 11.25 million Answer: C Explanation: C) 1.5 = net income/# of shares 73. A local bakery is suddenly inundated with many more orders for wedding cakes than it has the physical capacity to make. Rather than turn away customers, the owner decides to rent another kitchen across town to fulfill all of the orders. But she needs to borrow money to pay for the rent and additional workers, the additional cost of which will be paid by the profits from the additional cakes. Which of the following ratios will be most affected by this decision? A) the bakery's short-term solvency ratio B) the bakery's long-term solvency ratio C) the bakery's profitability ratio D) the bakery's activity ratio E) the bakery's equity ratio Answer: A Explanation: A) Since this involves a short-term loan with no additional assets, this ratio will temporarily go down. 74. Which of the following bodies formulates the generally accepted accounting principles ? A) Accounting Disclosure Board B) Financial Accounting Standards Board C) Association of Certified Fraud Examiners D) Securities and Exchange Commission E) American Institute of Certified Public Accountants Answer: B Explanation: B) GAAPs are formulated by the Financial Accounting Standards Board (FASB) of the AICPA and should be used to determine whether a firm has controls to prevent errors and fraud. 75. Which of the following bodies enforces accounting and auditing rules and procedures? A) Accounting Disclosure Board B) Financial Accounting Standards Board C) Association of Certified Fraud Examiners D) Securities and Exchange Commission E) American Institute of Certified Public Accountants Answer: D Explanation: D) The Securities and Exchange Commission, a government regulatory agency, requires firms to file such disclosures so that potential investors have valid information about their financial status. 76. Which of the following statements is true? A) Forensic accounting is mostly used as a tool for government regulation and investigation. B) Forensic accounting is mostly used as a tool for intracompany investigations. C) Forensic accounting is rarely used to investigate the misuse of government funds. D) Forensic accounting is often used to investigate the misuse of government funds. E) Forensic accounting is mostly used as a tool for local police enforcement. Answer: D Explanation: D) Forensic accountants may be called upon for both investigative accounting and litigation support in crimes against companies, crimes by companies, and civil disagreements. 77. Which of the following BEST describes a certified fraud examiner? A) a specialized managerial accountant concerned with issues of fraud B) a specialized certified public accountant concerned with issues of fraud C) a specialized forensic accountant concerned with issues of fraud D) an accounting agent for the Securities and Exchange Commission concerned with issues of fraud E) an accounting agent provided by the Sarbanes-Oxley Act of 2002 concerned with issues of fraud Answer: C Explanation: C) The CFE's activities focus specifically on fraud-related issues: fraud detection, evaluating accounting systems for weaknesses and fraud risks, investigating white collar crime on behalf of law enforcement agencies, evaluating internal organizational controls for fraud prevention, and expert witnessing. 78. Which of the following areas of the Certified Fraud Examiner (CFE) exam includes theories of fraud prevention? A) criminology and ethics B) financial transactions C) fraud investigation D) fraud litigation E) legal elements of fraud Answer: A Explanation: A) The criminology and ethics section includes theories of fraud prevention and ethical situations. 79. Which of the following inequalities is always true? A) liabilities + assets < assets + owners' equity B) liabilities < assets - owners' equity C) assets < owners' equity + liabilities D) owners' equity < assets - liabilities E) assets < owners' equity - liabilities Answer: E Explanation: E) Since assets = owners' equity + liabilities, this is always true. 80. Bennequin Manufacturing was a highly profitable firm five years ago but has since been severely declining in net revenue, even though the amount of business has held steady. Marlena has been hired as the new Chief Executive Officer to help turn things around for the company. She would like to understand what happened financially to the company in the past five years in order to start coming up with possible solutions. Which of the following documents would be most useful for her? A) income statements from the past five years B) debt statements from the past five years C) statements of cash flows from the past five years D) budgets from the past five years E) balance sheets from the past five years Answer: E Explanation: E) All of these might be helpful. But, since balance sheets give a detailed accounting of the financial condition at a particular time, by comparing several in a row Marlena might be able to pinpoint more accurately what is causing Bennequin's problems. 81. Which of the following scenarios would most likely occur with a company that has reported disappointing earnings recently but still looks to be financially stable for quite some time? A) high long-term solvency ratio but low profitability ratio B) high short-term solvency ratio but low profitability ratio C) high long-term solvency ratio but low activity ratio D) high short-term solvency ratio but low activity ratio E) high long-term solvency ratio but low short-term solvency ratio Answer: A Explanation: A) Many of these situations may apply, but this one is the most certain. 82. With fixed assets of $4 billion and current assets of $1.7 billion, Realm Company has long-term liabilities of $2 billion and current liabilities of $0.34 billion. What is Realm's current ratio? A) 0.85 B) 2 C) 2.44 D) 5 E) 11.76 Answer: D Explanation: D) The current ratio = current assets/current liabilities; in this scenario, $1.7/.34 = 5. 83. Which organization provides guidelines for ethical conduct for the accounting profession? A) AICPA B) SEC C) GAAP D) FASB E) CMA Answer: A Explanation: A) The code of professional conduct for public accountants in the United States is maintained and enforced by the AICPA (American Institute of Certified Public Accountants). 84. Which of the following statements BEST describes the need for global accounting standards? A) The complexity of the global market increases the risk of unethical accounting behavior by allowing accountants to choose which national GAAP standards are best for their clients. B) The rise of the global market increases the risk of money laundering and offshore accounting. C) The rise of the global market increases the risk of fraudulent business transactions across borders. D) The rise of the global market increases the risk of international dumping and profit-skimming. E) The rise of the global market increases the risk of the creation of dummy companies and accounts for the purpose of dumping toxic assets. Answer: A Explanation: A) All of these statements are true, but this one is the only one that is best addressed by an international code of conduct. 85. Which of the following is NOT an unethical or illegal accounting action? A) hiding expenses B) underreporting liabilities C) overestimating depreciation value of equipment D) inflating revenues E) maximizing the value of a company's intangible assets Answer: E Explanation: E) This is not illegal nor unethical as long as it is done legitimately. 86. Give three examples of management advisory services. Answer: Management advisory services include production scheduling, computer feasibility studies, and accounting information system design. Explanation: As consultants, accounting firms provide a range of management advisory services. The staffs of the largest CPA firms include engineers, architects, mathematicians, and psychologists, all of whom are available for consulting. 87. For what types of organizations do forensic accountants work? Answer: Forensic accountants may be called on by law enforcement agencies, insurance companies, law firms, and business firms. Explanation: Forensic accountants may be called upon for both investigative accounting and litigation support in crimes against companies, crimes by companies, and civil disagreements. 88. What is the accounting equation? Answer: assets = liabilities + owners' equity Explanation: The accounting equation underlies all record-keeping procedures and is the most basic tool of accounting. 89. What is a leveraged buyout? Answer: In a leveraged buyout, a firm takes on sometimes huge debt to buy out other companies. Explanation: If owning the purchased company generates profits above the cost of borrowing the purchase price, leveraging often makes sense. Unfortunately, many buyouts have caused problems because profits fell short of expected levels or because rising interest rates increased payments on the buyer's debt. 90. Identify the potential users of accounting information. Answer: The potential users of accounting information include business managers, employees, unions, investors, creditors, tax authorities, and government regulatory agencies. Explanation: Users of accounting information have varied needs. Business managers, for example, use accounting information to develop goals and plans, set budgets, and evaluate future prospects, whereas tax authorities use it to plan for tax inflows, determine the tax liabilities of individual and businesses, and ensure that correct amounts are paid on time. 91. What two sources of capital make up owners' equity? Answer: Owners' equity includes the amount that the owners originally invested and any profits earned by and reinvested in the company. Explanation: Owners' equity is the amount of money that owners would receive if they sold all of a company's assets and paid all of its liabilities. 92. What are the six ethics-related areas enforced by the American Institute of Certified Public Accountants? Answer: These areas include responsibilities; the public interest; integrity; objectivity and independence; due care; and scope and nature of services. Explanation: Accountants must comply with these six ethics-related areas in order to maintain certification with the AICPA. Mary Ann has always loved to cook and is interested in starting a catering business. Being aware of the failure rate of new businesses, she is considering buying an existing catering business that is up for sale. The current owners claim that the business is highly profitable, but Mary Ann has her doubts. She wonders why the owners would be so interested in selling the business if it is such a money maker. Furthermore, the price that they are asking seems high to Mary Ann. Without any formal training in accounting, Mary Ann asks a friend, Rolanda, for advice. 93. Rolanda suggests that Mary Ann may benefit from the services of a noncertified public accountant. What types of services could be provided? Answer: Noncertified public accountants assist with income tax preparation, payroll accounting, and financial-planning services. Explanation: Noncertified accountants often put together financial statements that are used in the firm for internal purposes, based on information provided by management. These statements may include a notification that auditing methods were not used in their preparation. 94. The auditor's report has come back and Mary Ann is reviewing the financial statements. The current balance sheet shows that the business has more liabilities than assets. Why would this explain the need to sell the business? Answer: The current owners face a negative owners' equity, which means that they might not be able to settle any debts that are due soon. Thus, they would not be able to stay in business for very long. Explanation: The type of liabilities and assets could be a factor. For example, the assets may not be very liquid, and the liabilities may be current (debts that must be paid within one year) or long-term (debts that are not due for at least a year). 95. Rolanda suggests that, even with the negative owners' equity, this business might still be worth buying. What other indicators within the auditor's report should they consider for this decision? Answer: It needs to be determined whether the catering business is actually viable, i.e., it has the potential of turning a profit. To this purpose, they should look at the income statement, in particular the gross profit, just to see if there is a history of enough regular business to offset any liabilities. If this is very low, then Mary should look elsewhere. If it's very high, then she might be able to turn the company around under her leadership. Explanation: Gross profit is a preliminary, quick-to-calculate profit figure that considers just two pieces of data—revenues and cost of revenues (the direct costs of getting those revenues)—from the income statement. To calculate gross profit, subtract cost of revenues from revenues obtained by selling the firm's products. 96. The auditor has also found annual budgets for the company from the past few years. How can Mary Ann benefit from these? Answer: In particular, she can evaluate the actual monthly performance of the business in comparison to the current owners' expectations. This might help her decide whether the current financial problems were caused by a nonviable business or by bad management. Explanation: For planning, controlling, and decision making, the most important internal financial statement is the budget—a detailed report on estimated receipts and expenditures for a future period of time. Although that period is usually one year, some companies also prepare three- or five-year budgets, especially when considering major capital expenditures. 97. Mary Ann begins to express some doubts to the sellers after a close examination of the financial statements and auditor's report. The sellers claim that they have a number of contracts that are in the works but that are not reflected in the financial statements. According to GAAP, how are these transactions supposed to be recognized in the financial statements? Answer: There are two conditions that must exist for revenue to be recognized. First, the sale must be complete and the product must have been delivered. Second, the sale price to the customer must have been collected or be collectible. Explanation: The reporting of revenue inflows, and the timing of other transactions, must abide by accounting principles that govern financial statements. Revenue recognition, for example, is the formal recording and reporting of revenues at the appropriate time. 98. The auditor has expressed concerns about the company's ability to pay its bills as they are due. What type of financial ratio might provide insight into this concern? Answer: The auditor has probably evaluated the firm's current ratio. The current ratio is the most commonly used liquidity ratio and is calculated by dividing current liabilities into current assets, both of which are found on the balance sheet. The current ratio is often referred to as the "banker's ratio" because it concerns a firm's creditworthiness. Explanation: The current ratio measures a firm's ability to generate cash to meet current obligations through the normal, orderly process of selling inventories and collecting revenues from customers. Julie, a recent college graduate, is interested in business and is considering pursuing a career in accounting. Her parents are supportive, with her mother recommending that Julie become a public accountant and her father recommending that she become a private accountant. 99. Which of the following, if true, supports the mother's position? A) Julie has said that she wants to work for one of the accounting services firms like Ernst & Young. B) The demand for government accountants is expected to grow in the near future. C) Two other recent grads in Julie's class chose to pursue public accounting. D) A recent survey showed that about 45 percent of new accountants chose public accounting. E) Julie has said that she wants to work as an in-house accountant for a large public interest group like Sierra Club or Greenpeace. Answer: A Explanation: A) Public accountants work as individual practitioners or they may join an accounting firm, such as Deloitte Touche Tohmatsu or Ernst & Young. Many government accountants are private accountants so Choice B would tend to support the father's position. Choice C presents too small of a sample to be representative of a trend, or to be relevant to Julie's situation. It's not clear how Choice D would affect Julie's particular situation, even if we knew what portion of the remaining 55 percent chose private accounting versus government accounting. Choice E would be a reason for Julie to pursue private accounting, as private accountants work for a single for-profit or nonprofit organization. 100. Which of the following, if true, supports the father's position? A) Julie has said she wants to work for one of the accounting firms like Ernst & Young. B) The demand for external auditors is expected to grow in the near future. C) Many accountants flooded the job market when the Arthur Andersen firm effectively went out of business in 2002. D) Accountants for nonprofits are more concerned with efficiency than with profit. E) Julie has said that she wants to work as an in-house accountant for a large public interest group like Sierra Club or Greenpeace. Answer: E Explanation: E) Private accountants work as salaried staff members for single organizations, whether for-profit companies or nonprofits like Sierra Club and Greenpeace. Choice A would be a reason for Julie to pursue public accounting. External auditors are public accountants so Choice B would tend to support the mother's position. Choice C: As one of the then Big Five, Arthur Andersen employed public accountants, and in any case more than a decade has passed since its demise. Choice D does not address a distinction between public and private accountants, since either could work for a nonprofit group. 101. Which of the following, if true, would support the position that Julie should consider a specialty field in accounting? A) Julie wants to eventually pursue an MBA degree. B) Colleges have different policies on whether specialty accounting courses are required. C) Julie is interested in financial crimes. D) Julie is interested in helping a nonprofit organization. E) Julie wants to work directly for a private company. Answer: C Explanation: C) This suggests that Julie should go into forensic accounting, which is an accounting specialty. Choices A and B are not directly relevant to whether Julie should pursue an accounting specialty. Choices D and E suggest that Julie should become a public or private accountant but do not suggest specializing in a particular field. Aardvark is a small pest-control business that has 30 employees. The company started business within the past year, and needs to make a decision on how best to make sure its finances are managed well as the company continues to grow its customer base and its business. 102. Which of the following, if true, would NOT strengthen the case that Aardvark needs to hire a full-time controller? A) The company needs its cash flow to be continuously monitored. B) The company needs to determine how to market its products so as to reach the largest number of customers. C) The company needs to have its excess funds invested in high-growth opportunities. D) The company needs to have financial goals mapped out for it. E) The company needs to have good sources of funding identified. Answer: B Explanation: B) This would not be the role of a controller, but of a marketing manager. A controller would keep track of and help plan the expenditures and revenues of the company, as mentioned in Choices A, C, D, and E, but not determine how best to reach potential customers. 103. Which of the following questions would be LEAST relevant to a controller as he or she develops a financial forecast for Aardvark? A) What are the future plans of the company? B) What is the current state of the local economy? C) What is the future state of the local economy likely to be? D) What subcontractors should the company use? E) What is the company's competition likely to do? Answer: D Explanation: D) Which subcontractors to hire is a choice that would be up to those who deal directly in whatever business the company subcontracts to other companies, and not directly the province of financial forecasting. The company's future plans (Choice A), the state of the local economy (Choices B and C), and the company's competition (Choice E), however, are fully relevant to developing a financial forecast. 104. Which of the following, if true, would NOT strengthen the case for Aardvark's closely monitoring its cash flow? A) The company needs to make sure it is not spending too much. B) The company needs to make sure it is generating enough revenue. C) The company needs to make sure its employees perform well. D) The company needs to make sure it can always pay its bills. E) The company needs to make sure it can make capital expenditures. Answer: C Explanation: C) Employee performance is an important factor in the success of a service company like Aardvark, but how the company monitors that does not relate directly to cash flow. The careful management of cash flow is important for other reasons, such as controlling company spending (Choice A), making sure it makes enough money and does not go into debt too quickly or deeply (Choice B), and preserving cash on hand to pay bills (Choice D) or invest in capital (Choice E). Streeter & Sons is a regional service company that has been in business for a few years, but has not employed a controller or anyone else full-time to keep track of its financial state. The company needs to take a good look at its financial state to determine whether it needs to make any changes in its practices, in order to prevent possible financial meltdown. 105. Which of the following questions would a balance sheet NOT be able to help answer about the current state of Streeter & Sons? A) Is it a good time for the business to grow? B) Can the company survive a season of low revenues? C) Does the company have too many employees? D) Can the company take on more debt? E) What is the value of the company's assets? Answer: C Explanation: C) Although employees who have provided labor but not yet been paid represent a liability, salaries are considered not on the balance sheet but as operating expenses on the income statement. In any case, salary expenses may or may not indicate whether a company has too many employees. A balance sheet gives information about the level of a company's assets (Choice E) versus liabilities. This information can indicate whether the company has resources to grow (Choice A), can survive low revenues (Choice B), or has too much debt (Choice D). 106. Which of the following, if true, would strengthen the case that Streeter & Sons will be able to meet its current financial obligations? A) The company has high levels of accounts payable. B) The company's liabilities exceed its assets. C) The company currently has a negative cash flow. D) The company needs to expand its number of customers. E) The company has more assets than it has liabilities. Answer: E Explanation: E) If Streeter & Sons has more assets than liabilities, this would be an indicator that it does not have too much debt and can therefore meet its financial obligations. If it has large current liabilities (Choice A), if its liabilities exceed its assets (Choice B), or if the company has a negative cash flow (Choice C), it's less likely it would be in a good position to meet its current obligations. Needing to expand its customer base (Choice D) would be an indication that Streeter & Sons is not generating enough revenue, and thus also would weaken the case that it is able to meet its financial obligations. 107. Which of the following, if true, would strengthen the case that Streeter & Sons has too much debt? A) The company has grown only slowly since its beginning. B) The company's customer base has steadily increased in the last few years. C) The company is outcompeting other similar companies in the area. D) The company's current liabilities are higher than its current and fixed assets. E) The company has built up a substantial amount of owners' equity. Answer: D Explanation: D) If what the company must pay within the next year is greater than both the assets it can convert into cash within a year and its relatively permanent assets, this suggests that the company may have too much debt. How quickly the company has grown (Choice A) may be due to any number of factors not related to debt, but it's certainly possible that it has grown slowly because it has refrained from borrowing large sums of money to promote rapid growth. Likewise, if its customer base has been steadily increasing (Choice B) or the company has been outcompeting its rivals (Choice C), this may be due to any number of factors but it suggests that there's revenue available to meet liabilities. Choice E: A high level of owners' equity also suggests that the company can meet its liabilities. 108. Which of the following, if true, would strengthen the case that Streeter & Sons is profitable? A) The company's sales revenue is low relative to its cost of goods sold. B) The company's cost of goods sold is low relative to its sales revenue. C) The company has had the same number of customers for some time. D) The company has had the same owners over its lifetime. E) The company's selling expenses are high relative to its administrative expenses. Answer: B Explanation: B) If the company's cost of goods sold is low relative to its sales revenue, this makes it likely that the company is profitable. By the same token, low sales revenue relative to the cost of goods sold (Choice A) would decrease the probability that it is profitable. Maintaining the same number of customers (Choice C) and having the same owners over time (Choice D) may or may not affect whether the company is profitable. It's not clear what effect on net income would result from the relationship of the company's selling expenses to its administrative expenses (Choice E), lacking data on sales revenue and cost of goods sold. 109. Which of the following, if true, would weaken the case that more than one type of financial statement should be examined in order to determine a company's financial health? A) Nowadays many companies burnish their balance sheet by claiming inflated figures for goodwill. B) An income statement from one year may be radically different from the one for the previous year. C) It can be difficult for auditors to independently verify certain figures in income statements. D) The management by data trend has led companies to consider as imperative detailed and accurate financial statements. E) In times of recession, companies often reduce their accounting and financial management staffs. Answer: D Explanation: D) In general it is certainly beneficial to consider a company's balance sheet, income statement, and statement of cash flows. If the management by data trend is resulting in more complete and reliable individual statements, however, this would tend to weaken the claim that multiple statements must be considered. Reasons not to rely exclusively on a single statement include possibly misleading balance sheets (Choice A) and income statements (Choices B and C). Companies that lay off accounting and financial staff during difficult economic times (Choice E) may as a result have fewer resources available to produce complete and accurate financial statements. 110. Which of the following, if true, would strengthen the case that an income statement would show Streeter & Sons where its problems lie? A) The company does not have enough shareholders. B) The company's expenses are too high. C) The company's owners' equity is too low. D) The company needs to hire more service specialists. E) The company has few intangible assets. Answer: B Explanation: B) If the company's expenses are too high, this will show up on an income statement. Choices A and D are not directly relevant to the information on an income statement. Choices C and E do not show up on an income statement. Kershner: Our income statement should be looking good this year. We've been doing excellent business this year, so we have a lot of gross sales. The company should be in good shape. Michaels: It remains to be seen how our income statement will look overall. In spite of strong sales revenue, the overall income statement might not be as good as we might hope. 111. Which of the following does Kershner assume? A) High revenues equate to a healthy income statement. B) Many factors must be taken into account to calculate the income statement. C) The company's revenue next year will be as good as this year's. D) Operating expenses have been relatively high this year. E) Gross profit is much lower than gross sales. Answer: A Explanation: A) Kershner assumes from the fact of strong revenues that a good income statement will result. Kershner does not assume Choices B, D, and E. If he did, his outlook for the company would not be so optimistic. He does not mention Choice C, which in any case is not relevant to this year's income statement. 112. Which of the following does Michaels assume? A) Revenues this year were not as high as last year's. B) Revenues are not as high as Kershner thinks they are. C) Selling expenses exceeded administrative expenses this year. D) Other factors must be taken into account to arrive at an income statement. E) Income taxes will be high this year. Answer: D Explanation: D) Michaels cautions that other factors in addition to revenue must be taken into account to arrive at a full and accurate income statement. Choice A: revenues from last year are not relevant to this year's income statement. Michaels does not dispute Kershner's statement of high revenues, Choice B. Although Choices C and E are factors that would impact the income statement, Michaels does not assume anything specifically about them. 113. Which of the following, if true, would strengthen Kershner's argument? A) The total operating expenses were high in the current year. B) The company's rent went up 30 percent from the previous year. C) The cost of goods sold was low compared to gross sales. D) The company is a small one compared to its competitors. E) The company has a solid core of fixed assets. Answer: C Explanation: C) This means that gross profit will be relatively high, which makes it more likely that the company will have a positive income statement. Choice A would weaken Kershner's argument, since it suggests that net income will be lower than he suggests. Choice B would tend to weaken Kershner's argument since rent is an operating expense. Choices D and E are statements that do not directly impact the company's income statement. 114. Which of the following, if true, would strengthen Michaels's argument? A) The company's gross sales went up from the previous year. B) Total operating expenses were high in the current year. C) The company has only one part-time accountant. D) There were few sales returns in the current year. E) Offshoring allowed the company to trim administrative salaries by 25 percent. Answer: B Explanation: B) This means that revenues will be offset by significant expenses, which makes it more likely that the income statement will not be as good as Kershner is suggesting. Choices A and D suggest that sales revenue is relatively high, which does not strengthen Michaels's argument that the income statement will not be as good as Kershner suggests. Choice C is not directly relevant to how the income statement will look overall. Choice E, showing a reduction in expenses, would tend to weaken Michaels's argument that the income statement might be disappointing. 115. Which of the following points out a flaw in Kershner's reasoning? A) Kershner is not accounting for all of the possible sources of revenue for the company. B) Kershner is not including owners' equity as part of sales revenue. C) Income statements are not as important as balance sheets in determining a company's fiscal health. D) Many employees are not happy with the direction the company is headed. E) Kershner is not accounting for the contribution that expenses will make to the income statement. Answer: E Explanation: E) Expenses must be subtracted from revenues to arrive at a complete income statement. Choice A: There is no reason to think that the company has additional sources of revenue not accounted for by gross sales. Choice B: Kershner is right not to include owners' equity as part of sales revenue. Choice C: Kershner doesn't make this claim. Choice D is not directly relevant to the company's income statement. At the end of the fiscal year for Santos Industrial Machinery, management raised concerns about the company's financial performance. The company's accountants have been asked to analyze the current financial state of the company by using ratio analysis. 116. Santos needs to assess its debt situation with respect to the value of the company. Which of the following, if true, would most strengthen the case that Santos's debt is manageable? A) Santos has a high profitability ratio. B) Santos has a high inventory turnover ratio. C) Santos has a low inventory turnover ratio. D) Santos has a high debt to owners' equity ratio. E) Santos has a low debt to owners' equity ratio. Answer: E Explanation: E) The debt to owners' equity ratio is low if the firm's liabilities are low compared to the owners' equity, which would indicate that its debt is low. If the debt to owners' equity ratio is high, on the other hand (Choice D), it would indicate that Santos's debt is high. Profitability ratio (Choice A) is a measure of how well Santos is doing business, and does not pertain directly to its debt. Inventory turnover ratio (Choices B and C) does not pertain to debt. 117. Santos's executives are most interested in seeing the company's short-term solvency ratios. Based on this information, what question do they most likely want to have answered? A) Can the company pay its immediate debts without obtaining further loans? B) Does the company have enough inventory to meet sales demands? C) How much inventory on hand does Santos have? D) How much bonds payable debt is Santos carrying? E) Is the company selling products at an appropriate price? Answer: A Explanation: A) Short-term solvency ratios indicate generally whether Santos has the assets necessary to pay its immediate debts on time. They don't, however, tell how much long-term debt, such as bonds payable, Santos may have (Choice D). They don't directly relate to inventory on hand (Choices B and C) or product pricing (Choice E). Test Bank for Business Essentials US Edition Ronald J. Ebert, Ricky W. Griffin 9780133034028, 9780273766599, 9780136070764
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