Flashcards in FAR 7 - General-Purpose FS 3 - Notes to FS Deck (26):
The summary of significant accounting policies should disclose the
A. Pro forma effect of retroactive application of an accounting change.
B. Basis of profit recognition on long-term construction contracts.
C. Adequacy of pension plan assets in relation to vested benefits.
D. Future minimum lease payments in the aggregate and for each of the five succeeding fiscal years.
B. The summary of significant accounting policies conveys information regarding the important accounting methods and policies chosen by the firm, when a choice is available.
Knowledge of the methods is critical to an understanding of the amounts disclosed in the financial statements. The method of accounting for long-term contracts may be the percentage of completion or completed contract method. Disclosure of this method assists the user in understanding the meaning of reported revenue and gross profit.
The other answer alternatives give data on specific accounts or the result of applying specific accounting principles. They do not indicate what choices the firm has made for accounting and reporting.
Which of the following should be disclosed in a summary of significant accounting policies?
I. Management's intention to maintain or vary the dividend payout ratio.
II. Criteria for determining which investments are treated as cash equivalents.
III. Composition of the sales order backlog by segment.
Only II. is an accounting policy. Accounting policies include the choice of accounting methods made by the firm, the principles and methods specific to an industry, and any unusual or innovative applications of GAAP.
I. and III. are data regarding specific accounts or statements of management intention. They are not descriptions of methods of measurement or recognition used by the firm disclosed for the purpose of assisting users in understanding the amounts reported in the financial statements.
Which of the following should be disclosed in a summary of significant accounting policies?
A. Basis of profit recognition on long-term construction contracts.
B. Future minimum lease payments in the aggregate and for each of the five succeeding fiscal years.
C. Depreciation expense.
D. Composition of sales by segment.
A. GAAP allows many choices. In the long-term construction contracts area, GAAP allows both the completed contract and percentage of completion methods. The result of applying each method significantly affects both the Income Statement and Balance Sheet.
Where in its financial statements should a company disclose information about its concentration of credit risks?
A. No disclosure is required.
B. The notes to the financial statements.
C. Supplementary information to the financial statements.
D. Management's report to shareholders.
B. GAAP requires disclosure of all significant concentrations of credit risk from receivables and other financial instruments in the notes. A concentration of credit risk occurs when receivables from different sources reflect common economic risks (for example, a group of receivables from several firms within the same industry).
Brad Corp. has unconditional purchase obligations associated with product financing arrangements. These obligations are reported as liabilities on Brad's balance sheet, with the related assets also recognized.
In the notes to Brad's financial statements, the aggregate amount of payments for these obligations should be disclosed for each of how many years following the date of the latest balance sheet?
C. The payments for the five years following the balance sheet date must be disclosed.
This question requires memorization of a relatively obscure piece of information. However, there are other cases for which data must be disclosed for the five years following the balance sheet date. Few, if any disclosures are required for a full ten years after the balance sheet date.
Which type of material related-party transactions require disclosure?
A. Only those not reported in the body of the financial statements.
B. Only those that receive accounting recognition.
C. Those that contain possible illegal acts.
D. All those other than compensation arrangements, expense allowances, and other similar items in the ordinary course of business.
D. Material related party transactions must be disclosed unless they are ordinary business transactions, such as payment of employees and other routine transactions.
T/F: Companies must disclose the future maturities on their borrowing for five years following the balance sheet date.
T/F: U.S. and International GAAP require disclosure of the amount of dividends proposed or declared before the statements were authorized for issue.
Companies are required to provide the following info related to capital structure:
1. Rights and privileges of outstanding securities
2. Number of shares issued during the annual fiscal period and any subsequent interim period
3. Liquidation preference of preferred stock
4. If there is a considerable excess of par value or stated value of preferred stock, this info should be disclosed in the equity section of BS
5. Other preferred stock disclosures
6. Redeemable preferred stock
On December 30, 2004, Solomon Co. had a current ratio greater than 1:1 and a quick ratio less than 1:1.
On December 31, 2004, all cash was used to reduce accounts payable. How did these cash payments affect the ratios?
Current Ratio = Increase
Quick Ratio = Decrease
Cash is both a current and a quick asset (an asset immediately available to pay debts). Accounts payable is a current liability. Thus, the numerator and denominator of both ratios have decreased.
The current ratio was greater than 1.0 before the transaction. Therefore, the denominator decreased a greater percentage than the numerator causing the ratio to increase.
The quick ratio was less than 1.0 before the transaction. Therefore, the numerator decreased a greater percentage than the denominator causing the ratio to decrease.
Assuming constant inventory quantities, which of the following inventory-costing methods will produce a lower inventory turnover ratio in an inflationary economy?
A. FIFO (first in, first out).
B. LIFO (last in, first out).
C. Moving average.
D. Weighted average.
Inventory turnover ratio is Cost of Goods Sold/Average Inventory. Therefore, to produce the lowest inventory turnover ratio, we need the highest value of ending inventory. The method that produces the highest value of ending inventory in an inflationary economy (prices are rising) is FIFO.
What effect would the sale of a company's trading securities at their carrying amounts for cash have on each of the following ratios?
Current Ratio = No effect
Quick Ratio = No effect
The current ratio equals current assets divided by current liabilities. The quick ratio equals quick assets divided by current liabilities. Quick assets include cash, cash equivalents, trading securities, accounts receivable and other current assets readily convertible to cash. Quick assets exclude inventories and prepaids.
Trading securities are included in both current assets and quick assets because they are, by definition, immediately marketable. The sale of trading securities at book value has no effect on current assets or quick assets because the cash received equals the reduction in the trading securities account. Thus, neither ratio is affected by such a sale.
T/F: If the cost of goods sold increases while average inventory remains constant, there has been a more efficient use of inventory.
T/F: The accounts receivable turnover ratio shows the relationship between total sales and average accounts receivable on the books.
Measures the # of times that AR turns over during a period. Indicates the quality of credit policies and the efficiency of collection procedures.
AR turnover = (net) credit sales / avg. (net) AR
T/F: If the working capital ratio is more or less than 1.00, equal changes in the current assets and current liabilities will change the working capital ratio.
WCR = Current Assets / Current Liabilities
T/F: The defensive-interval ratio is a measure of how long available cash and other highly liquid assets could support normal cash requirements.
Securities Defensive-interval ratios = (cash + (net) AR + Marketable Securities) / Avg. Daily cash expenditures
T/F: In computing the interest earned ratio, interest expense and income tax expense have to be added back to net income.
Measures the ability of current earnings to cover interest payments for a period.
Times Interest Earned Ratio = (NI + Interest Exp. + Income Tax) / Interest Exp.
T/F: The price-earnings ratio is computed only for common stock.
Measures the price of a share of CS relative to its latest earnings per share (EPS). Indicates a measure of how the market values the stock, especially when compared with other stocks.
Price-earnings ratio = market price for a CS / EPS
Accounts Receivable Turnover =
(Net) Credit Sales / Average (Net) Accounts Receivable (e.g. (Beginning + Ending)/2)
Measures the number of times that accounts receivable turnover (are incurred and collected) during a period. Indicates the quality of credit policies (and the resulting receivables) and the efficiency of collection procedures.
Number of Days' Sales in Average Receivables =
(300 or 360 or 365 (or other measure of business days in a year)) / Accounts Receivable Turnover (computed above)
Measures the average number of days required to collect receivables; it is a measure of the average age or receivables.
Inventory Turnover =
Cost of Goods Sold / Average Inventory (e.g. (Beginning + Ending)/2)
Measures the number of times that inventory turns over (is acquired and sold or used) during a period. Indicates over or under stocking of inventory or obsolete inventory.
Number of Days' Supply in Inventory =
(300 or 360 or 365 (or other measure of business days in a year)) / Inventory Turnover (computed first)
Measures the number of days inventory is held before it is sold or used. Indicates the efficiency of general inventory management.
Operating Number of Cycle = Days in Operating =
Number of Days' Sale in A/R + Length Cycle Number of Days' Supply in Inventory
Measures the average length of time to invest cash in inventory, convert the inventory to receivables, and collect the receivables; it measures the time to go from cash back to cash.
Acid Test Ratio - aka Quick Ratio =
(Cash + (net) AR + Marketable Securities) / Current Liabilities
Measures the quantitative relationship between highly liquid assets and current liabilities in terms of the "# of times" that cash and assets that can be converted quickly to cash cover current liabilities
Times Preferred Dividend Earned Ratio =
NI / Annual preferred dividend obligation
Measures the ability of current earnings to cover preferred dividends for a period.
Profit Margin (on sales) =
NI / (Net) Sales
Measures the net profitability on sales (revenue)