Financial Management: Core Concepts , 2/E Brooks Solutions manual and test bank

Financial Management: Core Concepts , 2/E Brooks Solutions manual and test bank

Financial Management: Core Concepts, 2e (Brooks)

Chapter 2 Financial Statements

2.1 Financial Statements

1) The purpose of studying financial statements is ________.

A) to mechanically build portfolio analysis

B) to understand those portions of the statements that have relevance for financial decision making

C) to primarily investigate all portions of the statements that have relevance for dividend policy

D) to mechanically learn how to read and understand footnotes

Answer: B

Comment: Accounting and finance view the numbers in DIFFERENT WAYS.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

2) Which of the statements below is FALSE?

A) The purpose of studying financial statements is to understand those portions of the statements that have relevance for financial decision making.

B) We need to understand how to interpret and use the information presented in financial statements to form a picture of the financial profile of the firm.

C) Accounting, it has been said, looks back to where a company has been — somewhat like looking through a rear view mirror.

D) Accounting and finance view the numbers in the same way.

Answer: D

Comment: Accounting and finance view the numbers in DIFFERENT WAYS.

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3) Understanding the sources and uses of cash in the recent past will enable a manager to ________ the cash flow for a potential project of the firm.

A) determine with perfect precision

B) forecast with perfect precision

C) predict more accurately

D) know today

Answer: C

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

4) The fundamental starting point of all the accounting statements is the ________.

A) accounting identity

B) computing identity

C) investing identity

D) financing identity

Answer: A

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5) Which of the statements below is TRUE?

A) Accounting Identity is: Assets ≡ Liabilities - Owners' Equity.

B) Accounting Identity is: Assets ≡ Liabilities + Owners' Equity.

C) Accounting Identity is: Assets ≡ Owners' Equity - Liabilities.

D) Accounting Identity is: Liabilities ≡ Assets + Owners' Equity.

Answer: B

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Topic: 2.1 Financial Statements

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6) There are four primary financial statements that are used to measure the performance of a firm. Which of the choices below are included among these four?

A) The balance statement and income statement

B) The income sheet and statement of retained earnings

C) The statement of cash flow and statement of balance

D) The balance sheet and statement of cash flow

Answer: D

Comment: There are four primary financial statements that are used to measure the performance of a firm: the income statement, the balance sheet, the statement of retained earnings, and the statement of cash flow (also know as sources and uses of cash). Together, these four financial statements contain much of the essential historical information about the performance and management choices of a firm.

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Topic: 2.1 Financial Statements

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7) It is important to remember that the fundamental ________ of accounting is the debit and credit recording activity where debits always equal credits.

A) effect

B) end product

C) outcome

D) identity

Answer: D

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

8) It is important to remember that the fundamental identity of accounting is the debit and credit recording activity where debits ________ equal credits.

A) never

B) seldom

C) sometimes

D) always

Answer: D

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Topic: 2.1 Financial Statements

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9) Which of the statements below is FALSE?

A) The income statement summaries and categorizes a company's revenues and expenses for that period.

B) Typically, income statements are prepared quarterly and annually for distribution outside the company, but usually monthly for internal managers.

C) The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes (EBIT).

D) The balance sheet reports the performance of the firm over the past period. It summarizes and categorizes a company's revenues and expenses for that period.

Answer: D

Comment: The income statement reports the performance of the firm over the past period. It summarizes and categorizes a company’s revenues and expenses for that period.

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Topic: 2.1 Financial Statements

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10) Which of the below statements is FALSE?

A) Typically, income statements are prepared quarterly and annually for distribution outside the company, but usually semi-annually for internal managers.

B) Typically, income statements are prepared quarterly and annually for distribution outside the company.

C) The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes (EBIT).

D) The income statement reports the performance of the firm over the past period. It summaries and categorizes a company's revenues and expenses for that period.

Answer: A

Comment: Typically, income statements are prepared quarterly and annually for distribution outside the company, but usually MONTHLY for internal managers.

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11) The income statement begins with revenue and subtracts various operating expenses until arriving at ________.

A) earning after taxes

B) net income

C) taxable income

D) EBIT

Answer: D

Comment: The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes (EBIT). Next, interest expense is subtracted to find the taxable income for the period. Then the appropriate taxes are calculated and subtracted. We finally arrive at the net income, the so-called bottom line of the income statement.

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

12) The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes. Next, interest expense is subtracted to find the ________ for the period.

A) EBIT

B) after-tax income

C) net income

D) taxable income

Answer: D

Comment: The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes (EBIT). Next, interest expense is subtracted to find the taxable income for the period. Then the appropriate taxes are calculated and subtracted. We finally arrive at the net income, the so-called bottom line of the income statement.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

13) The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes. Next, interest expense is subtracted to find the taxable income for the period. Then the appropriate taxes are calculated and subtracted. We finally arrive at the ________ , the so-called bottom line of the income statement.

A) after-tax income

B) before-tax income

C) net income

D) EBIT

Answer: C

Comment: The income statement begins with revenue and subtracts various operating expenses until arriving at Earnings Before Interest and Taxes (EBIT). Next, interest expense is subtracted to find the taxable income for the period. Then the appropriate taxes are calculated and subtracted. We finally arrive at the net income, the so-called bottom line of the income statement.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

14) Net income is ________.

A) not cash flow

B) the cash flow from the operations of the company during the period

C) the increase or decrease in cash flow for the period

D) earnings before interest and taxes

Answer: A

Comment: Net income is not cash flow. Net income is the ACCOUNTING PROFIT from the operations of the company during the period. Cash flow is the increase or decrease in CASH for the period.

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15) Net income is ________.

A) the accounting profit from the operations of the company during the period

B) cash flow

C) the accounting profit from the non-operating assets of the company during the period

D) always the dividends paid shareholders

Answer: A

Comment: Net income is not cash flow. Net income is the accounting profits from the OPERATIONS of the company during the period. Cash flow is the increase or decrease in cash for the period.

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16) Cash flow is ________.

A) the increase but not decrease in cash for the period

B) the decrease but not increase in cash for the period

C) the increase or decrease in cash for the period

D) the net income for the period

Answer: C

Comment: Net income is the accounting profits from the operations of the company during the period and thus would not typically be the cash flow (except by coincidence). Cash flow can be positive or negative and thus is the increase or decrease in cash for the period.

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17) One of the key components to making financial decisions is to ________.

A) understand the timing and amount of dividends

B) understand the timing and amount of cash flow

C) understand the timing of EBIT

D) understand the amount of net income

Answer: B

Comment: One of the key components to making financial decisions is to understand the timing and amount of cash flow. Dividends, EBIT, and net income are not synonomous with the firm's cash flow for any particular period.

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Topic: 2.1 Financial Statements

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18) Which of the statements below is FALSE?

A) The textbook uses the framework of the income statement to find the operating income of the company (an accounting measure) and then makes adjustments to find the true cash flow from operations.

B) In accrual-based accounting, revenue is recorded at the time of sale if the revenue has been received in cash.

C) Three fundamental issues separate net income and cash flow: accrual-based accounting, non-cash expense items, and interest expense.

D) Generally Accepted Accounting Principles (GAAP) in the United States allow the use of accrual accounting to record revenue.

Answer: B

Comment: In accrual based accounting, revenue is recorded at the time of sale WHETHER OR NOT the revenue has been received in cash.

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Topic: 2.1 Financial Statements

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19) Three fundamental issues separate net income and cash flow. Which of the answers below is NOT one of these three fundamental issues?

A) Accrual accounting

B) Non-cash accounting

C) Non-cash expense items

D) Interest expense

Answer: B

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Topic: 2.1 Financial Statements

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20) Which of the following statements is true?

A) The finance manager uses the framework of the income statement to find the operating income of the company (an accounting measure), which is also the true cash flow from operations.

B) In accrual-based accounting, revenue is recorded at the time of sale if the revenue has been received in cash.

C) Three fundamental issues separate net income and cash flow: accrual accounting, noncash expense items, and interest expense.

D) Generally accepting accounting principles (GAAP) in the United States do not allow the use of accrual accounting to record revenue.

Answer: C

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

21) In finance, we separate operating decisions from financing decisions and thus exclude ________ as a part of operating income from the income statement.

A) cash flow

B) dividends

C) interest expense

D) earnings

Answer: C

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

22) Which of the following statements is FALSE?

A) The income statement is put together at a specific point in time (end of a business quarter, or business year) and so the sale could be in one period and the cash received in another period.

B) The income statement contains the set of expenses associated with the products or services sold during the current operating period, with those expenses not associated with current cash flow labeled as non-cash expense items.

C) Depreciation is a current expense of a cash outflow in the current period.

D) Companies depreciate fixed assets (such as office furniture, equipment, machinery, and buildings) over an assigned time period, but the initial cash outlay for the fixed asset typically occurs at the time the asset is acquired by the firm.

Answer: C

Comment: Depreciation is a current expense of a cash outflow in A PREVIOUS period.

Diff: 2

Topic: 2.1 Financial Statements

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23) To find operating cash flow for the business for the year, add depreciation expense to EBIT and then ________.

A) subtract the interest expenses

B) add the taxes

C) subtract the taxes

D) add interest expenses

Answer: C

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

24) Which of the statements below is FALSE?

A) The cash account is much like your individual checkbook, because it tells you how much money you currently have for paying bills or spending on new items.

B) Current assets are accounts that will normally be turned into cash over the course of the operating or business cycle of the firm, and current liabilities are the accounts that will come due for payment over the operating or business cycle.

C) The long-term capital asset accounts of the balance sheet represent the capital investment of the company and reflect assets that the company owns and that provide the basis for producing goods and services for sale.

D) The Plant, Property and Equipment account is straightforward in its description, yet it cannot tell you the accumulated depreciation.

Answer: D

Comment: The Plant, Property and Equipment account is straightforward in its description, yet it really contains two pieces: the original value (purchase price) of the equipment and the accumulated depreciation.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

25) Which of the statements below is FALSE?

A) The cash account is much like your individual checkbook, because it tells you how much money you currently have for paying bills or spending on new items.

B) Long-term assets are accounts that will normally be turned into cash over the course of the operating or business cycle of the firm, and current liabilities are the accounts that will come due for payment over the operating or business cycle.

C) The long-term capital asset accounts of the balance sheet represent the capital investment of the company and reflect assets that the company owns and that provide the basis for producing goods and services for sale.

D) The Plant, Property and Equipment account is straightforward in its description, yet it really contains two pieces: the original value (purchase price) of the equipment and the accumulated depreciation.

Answer: B

Comment: CURRENT ASSETS are accounts that will normally be turned into cash over the course of the operating or business cycle of the firm, and current liabilities are the accounts that will come due for payment over the operating or business cycle.

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AACSB : 3 Analytic Skills

26) Debts to be paid more than one year from now are claims against the firm's assets: in other words, they are long-term liabilities. These claims are from ________ who have provided capital to the firm but whose entire repayment is not due during the coming year or operating cycle.

A) banks and bondholders

B) banks and stockholders

C) stockholders and bondholders

D) all long-term lenders

Answer: A

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

27) Which of the statements below is TRUE?

A) The ownership accounts or owners' equity section of the balance sheet reflects the owners' stake in the firm.

B) The ownership accounts or owners' equity section of the balance sheet is made up of common stock but not retained earnings.

C) The retained earnings amount on the balance sheet really reflect retained earnings and other stockholder equity, but not treasury stock.

D) The Statement of Retained Earnings is used to show the distribution of the interest paid for the past period.

Answer: A

Comment: The ownership accounts or owners’ equity section of the balance sheet is made up of common stock AND RETAINED EARNINGS.

The retained earnings amount on the balance sheet really reflects retained earnings, other stockholder equity, AND TREASURY STOCK.

The Statement of Retained Earnings is really the fourth financial statement and is used to show the distribution of the NET INCOME for the past period.

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

28) The basic accounting identity that assets equal liabilities plus owners' equity usually, but not always, holds.

Answer: FALSE

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29) Equity on the balance sheet refers to what the owners receive after liabilities have been satisfied.

Answer: TRUE

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30) In double-entry bookkeeping, every time an economic transaction is recorded, equal debit and credit amounts must be recorded.

Answer: TRUE

Comment: .

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Topic: 2.1 Financial Statements

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31) Debts to be paid more than one year from now are considered short-term liabilities.

Answer: FALSE

Comment: Debts to be paid more than one year from now are considered long-term liabilities.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

32) EBIT (earnings before interest and taxes) is obtained by adding together revenue and operating expenses.

Answer: FALSE

Comment: EBIT is obtained by subtracting various operating expenses from revenue.

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33) Net income is not cash flow.

Answer: TRUE

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34) Explain the three main areas of the balance sheet.

Answer: The three main areas of the balance sheet are assets, liabilities, and owners' equity. Assets include items of economic value owned by the company--they can be physical (like buildings), financial (like accounts receivable), or intellectual (like patents). Assets also include cash itself. Liabilities are the amounts of mone that the company owes to others, such as payroll to employees, taxes to government, borrowed money to banks, and bills for materials or services to creditors. Owners' equity is what is left over from the assets after all liabilities have been settled.

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35) From the finance perspective, there are five principal line accounts of particular interest on the balance sheet: the cash account, the working capital accounts, long-term capital assets accounts, long-term debt accounts, and ownership accounts. Briefly explain each.

Answer: The cash account indicates how much money the company currently has on hand for paying bills and spending on new items. The working capital accounts are the current assets and current liabilities of the company; current assets are those accounts that will be turned into cash over the course of the operating cycle, and current liabilities are accounts that will come due for payment over the course of the operating cycle. Current assets minus current liabilities gives us the net working capital of the company. Long-term capital assets accounts indicate the capital investment of the company in items like land, buildings, and machinery. Long-term debt accounts are those debts to be paid in more than one year. Ownership accounts show the amount of capital contributed by owners (common stock) and retained earnings (earnings of the company that are reinvested in the core business or used to pay off debt).

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36) Why is an understanding of cash flow so important in the study of finance?

Answer: A firm may show robust accounting profits, yet still get into serious financial trouble or even go bankrupt. It is only cash flows that allow accurate and insightful financial analysis, which is the foundations of a firm's long-run planning and value maximization.

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AACSB : 3 Analytic Skills

2.2 Cash Flow Identity and the Statement of Cash Flows

1) Which of the statements below is FALSE?

A) The cash that the firm generates from its operating decisions (use of its assets) is used to either pay creditors or the owners of the company.

B) Cash flow from assets shows the success or failure of the operating decisions.

C) Cash flow to owners shows cash paid to owners plus any new borrowing from owners.

D) Cash flow to creditors shows a portion of how the firm is financing the operations.

Answer: C

Comment: Cash flow to owners COMPLETES the overview of financing and examines any additional contributions by the owners and the return of capital to the owners.

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AACSB : 3 Analytic Skills

2) Which one of the answers below is NOT one of the three components of the "Cash Flow from Assets"?

A) Operating Cash Flow

B) Net Capital Spending

C) Noncash expenses

D) Change in Net Working Capital

Answer: C

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Topic: 2.1 Financial Statements

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3) Which of the following identities is TRUE?

A) Operating Cash Flow = EBIT + Depreciation - Taxes

B) Net Capital Spending = Ending Net Fixed Assets - Depreciation

C) Change in Net Working Capital (NWC) = Current Assets - Current Liabilities

D) Cash Flow from Assets = Operating Cash Flow + Net Capital Spending

Answer: A

Comment: Net Capital Spending = Ending Net Fixed Assets - Beginning Net Fixed Assets + Depreciation

Change in Net Working Capital (NWC) = Ending NWC - Beginning NWC

Cash Flow from Assets = Operating Cash Flow - Net Capital Spending - Change in NWC

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

4) Which of the following identities is TRUE?

A) Operating Cash Flow = EBIT - Depreciation + Taxes

B) Net Capital Spending = Ending Net Fixed Assets - Depreciation

C) Net Working Capital (NWC) = Current Assets - Current Liabilities

D) Cash Flow from Assets = Operating Cash Flow - Net Capital Spending

Answer: C

Comment: Operating Cash Flow = EBIT + Depreciation - Taxes

Net Capital Spending = Ending Net Fixed Assets - Beginning Net Fixed Assets + Depreciation

Cash Flow from Assets = Operating Cash Flow - Net Capital Spending - Change in NWC

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

5) Which of the following identities is FALSE?

A) Cash Flow to Creditors = Interest Expense - Net New Borrowing from Creditors

B) Net New Borrowing = Ending Long-term Liabilities - Beginning Long-Term Liabilities

C) Cash Flow to Owners = Dividends + Net New Borrowing from Owners

D) Net New Borrowing from Owners = Change in Equity

Answer: C

Comment: Cash Flow to Owners = Dividends - Net New Borrowing from Owners

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

6) Which of the following identities is FALSE?

A) Change in Equity = Paid-in-Surplus - Net New Borrowing from Creditors

B) Net New Borrowing = Ending Long-term Liabilities - Beginning Long-Term Liabilities

C) Cash Flow to Owners = Dividends - Net New Borrowing from Owners

D) Net New Borrowing from Owners = Change in Equity

Answer: A

Comment: Change in Equity = Ending Common Stock and Paid-in-Surplus - Beginning Common Stock and Paid-in-Surplus

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

7) Cash and Equivalents are $1,561, Short-Term Investments are $1,052, Accounts Receivables are $3,616, Accounts Payable is $5,173, Short-Term Debt is $288, Inventories are $1,816, Other Current Liabilities are $1,401, and Other Current Assets are $707. What are the Total Current Assets?

A) $8,752

B) $6,936

C) $6,862

D) $5,136

Answer: A

Comment: Total Current Assets = Cash and Equivalents + Short-Term Investments + Accounts Receivables + Inventories + Other Current Assets = $1,561 + $1,052 + $3,616 + $1,816 + $707 = $8,752.

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Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

8) Cash and Equivalents are $1,561; Short-Term Investments are $1,052; Accounts Receivables are $3,616; Accounts Payable are $5,173; Short-Term Debt is $288; Inventories are $1,816; Other Current Liabilities are $1,401; and Other Current Assets are $707. What is the amount of Total Current Liabilities?

A) $8,752

B) $6,974

C) $6,862

D) $6,574

Answer: C

Comment: Total Current Liabilities = Accounts Payable + Short-Term Debt + Other Current Liabilities = $5,173 + $288 + $1,401 = $6,862.

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills

Hmwrk Questions: * Taken from "Prepping for Exams" questions at the end of the chapter.

9) Net Working Capital for 2007 is $3,597 and Net Working Capital for 2008 is $1,890. What is the change in Net Working Capital?

A) $1,707

B) -$1,707

C) -$1,727

D) -$2,527

Answer: B

Comment: Change in Net Working Capital is $1,890 - $3,597 = -$1,707

Diff: 2

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AACSB : 3 Analytic Skills

10) Which of the statements below is FALSE?

A) Understanding the underpinnings of the accounting identity and the relationship across the primary financial statements provides a springboard for projecting cash flow for future periods for both the company in general and for individual projects within a company.

B) The right hand side of the balance sheet represents all the claims to the assets of the company, with these claims representing two types of lenders: creditors and owners.

C) Change in net working capital looks at both long-term assets and long-term liabilities.

D) Cash flow from assets examines the success or failure of the operating decisions, while cash flow to creditors examines a portion of how the firm is financing the operations.

Answer: C

Comment: Change in net working capital looks at both current assets and current liabilities.

Diff: 2

Topic: 2.1 Financial Statements

AACSB : 3 Analytic Skills