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Flashcards in Stock Rights & R.E, Deck (17):
1

In September year 1, West Corp. made a dividend distribution of one right for each of its 120,000 shares of outstanding common stock.
Each right was exercisable for the purchase of one-hundredth of a share of West's $50 variable-rate preferred stock at an exercise price of $80 per share. On March 20, year 5, none of the rights had been exercised, and West redeemed them by paying each stockholder $0.10 per right.

As a result of this redemption, West's stockholders' equity was reduced by

A. $120
B. $2,400
C. $12,000
D. $36,000

C. $12,000

.1*120,000= Amt Equity was reduced

2

A retained earnings appropriation can be used to
A. Absorb a fire loss when a company is self-insured.
B. Provide for a contingent loss that is probable and reasonable.
C. Smooth periodic income.
D. Restrict earnings available for dividends.

D. Restrict earnings available for dividends.

The purpose of appropriations is to restrict dividends and communicate that restriction to users of the financial statements. It is merely a partitioning of retained earnings into two parts: (1) available for dividends, and (2) unavailable.

A firm need not record an appropriation in order to restrict dividends. However, it helps alert stockholders to the possibility that dividends may be curtailed, and informs them of the reason for that curtailment.

3

At December 31, 20x4, Eagle Corp. reported $1.75m of appropriated retained earnings for the construction of a new office building, which was completed in 20x5 at a total cost of $1.5mn.
In 20x5, Eagle appropriated $1.2mn of retained earnings for the construction of a new plant. Also, $2mn cash was restricted for the retirement of bonds due in 20x6.

In its 20x5 balance sheet, Eagle should report what amount of appropriated retained earnings?

A. $1.2mn
B. $1.45mn
C. $2.95mn
D. $3.2mn

A. $1.2mn

The first appropriation of $1.75mn was removed (returned to unappropriated retained earnings) when the office building was completed. Appropriations no longer needed are returned to unappropriated status. Therefore, only the new appropriation is needed at the end of 20x5.
The amount of unrestricted cash is reported separately and does not affect the appropriation amount. An appropriation of retained earnings is primarily a device for communicating the intention of management to restrict dividends, so that cash will be conserved for the specified purpose. The actual restriction of cash makes that amount of cash unavailable for normal operating use. Restricted cash is an investment account. It is not part of the cash account.

4

Redwood Co.'s financial statements had the following information at year end:
Cash $ 60,000
Accounts receivable 180,000
Allowance for uncollectible accounts 8,000
Inventory 240,000
Short-term marketable securities 90,000
Prepaid rent 18,000
Current liabilities 400,000
Long-term debt 220,000
What was Redwood's quick ratio?

A. 0.81 to 1
B. 0.83 to 1
C. 0.94 to 1
D. 1.46 to 1

A. 0.81 to 1

Prepaid Expenses aren't considered here as an asset

The quick ratio is the quotient of very liquid current assets to total current liabilities. Inventories and prepaids are not included in the numerator because they are not considered sufficiently liquid. As such, it is a more stringent test of liquidity than the current ratio. In this case, the quick ratio consists of: cash + net AR + marketable securities divided by current liabilities: ($60,000 + $180,000 - $8,000 + $90,000)/$400,000) = .805. The closest answer is 0.81 to 1

5

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 Quick ratio
No effect No effect
Increase Increase
No effect Increase
Increase No effect

Current ratio Quick ratio
No effect No effect

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.

6

The following information was taken from Baxter Department Store's financial statements:
Inventory on January 1 $ 100,000
Inventory on December 31 300,000
Net sales 2,000,000
Net purchases 700,000
What was Baxter's inventory turnover for the year ending December 31?

A. 2.5
B. 3.5
C. 5
D. 10

A. 2.5

Inventory turnover is the ratio of cost of goods (CGS) sold to average inventory.

First, calculate CGS = beginning inventory $100,000 + purchases $700,000 - ending inventory $300,000 = $500,000.
Then, average inventory = (beginning inventory + ending inventory)/2 = ($100,000 + $300,000)/2 = $200,000.

Turnover = $500,000/$200,000 = 2.5.

7

On December 30, 2005, Vida Co. had cash of $200,000, a current ratio of 1.5:1 and a quick ratio of .5:1. On December 31, 2005, all cash was used to reduce accounts payable.
How did these cash payments affect the ratios?

Current ratio Quick ratio
Increased Decreased
Increased No effect
Decreased Increased
Decreased No effect

Current ratio Quick ratio
Increased Decreased

The numerator and denominator of both ratios are reduced by $200,000 as a result of the transaction. Cash is included in both current and quick assets (current assets that are highly liquid), the numerators of the two ratios. Accounts payable is a part of current liabilities, which is the denominator of both ratios.

The current ratio exceeds 1.00 before the transaction. Reducing the numerator and denominator the same amount causes the denominator to fall a greater percentage than the numerator. Thus, the ratio increases. Example: if the ratio were $900,000/$600,000 before the transaction; after the transaction, the ratio is $700,000/$400,000, a higher ratio. The quick ratio is less than 1.00 before the transaction. Thus, the ratio decreases. Example: if the ratio were $300,000/$600,000 before the transaction, after the transaction the ratio is $100,000/$400,000, a lower ratio.

8

Tod Corp. wrote off $100,000 of obsolete inventory on December 31, 2005. The effect of this write-off was to decrease
A. Both the current and acid-test ratios.
B. Only the current ratio.
C. Only the acid-test ratio.
D. Neither the current nor the acid-test ratios.

B. Only the current ratio.

Inventory is a current asset but not a quick asset (assets that are readily converted to cash). The current ratio is current assets/current liabilities. Thus, the current ratio is reduced.
The quick ratio is quick assets/current liabilities. Thus, the quick ratio is unaffected.

9

How is the average inventory used in the calculation of each of the following?
Acid test (quick ratio) Inventory turnover rate
Numerator Numerator
Numerator Denominator
Not used Denominator
Not used Numerator

Acid test (quick ratio) Inventory turnover rate

Not used Denominator

* DO NOT INCLUDE OTHER ASSETS NUMBERS IN QUICK RATIO

10

Zenk Co. wrote off obsolete inventory of $100,000 during 2005. What was the effect of this write-off on Zenk's ratio analysis?
A. Decrease in current ratio but not in quick ratio.
B. Decrease in quick ratio but not in current ratio.
C. Increase in current ratio but not in quick ratio.
D. Increase in quick ratio but not in current ratio

A. Decrease in current ratio but not in quick ratio.

The write-off of inventory reduces current assets but not quick assets.
Quick assets are those current assets, which are considered very liquid and which can be turned into cash relatively quickly. Inventory is not a quick asset. The denominator of the current and quick ratios is the same: current liabilities. The denominator of neither ratio is affected by this write-off. Only current assets decrease; thus the current ratio decreases but the quick ratio is unaffected.

11

On December 31, 2005, Northpark Co. collected a receivable due from a major customer.
Which of the following ratios would be increased by this transaction?
A. Inventory turnover ratio.
B. Receivable turnover ratio.
C. Current ratio.
D. Quick ratio.

B. Receivable turnover ratio.

Accounts receivable turnover = credit sales/average accounts receivable.
Collection of a receivable reduces the denominator and thus increases the ratio.

12

The following computations were made from Clay Co.'s 2005 books:

Number of days' sales in inventory 61
Number of days' sales in trade accounts receivable 33
What was the number of days in Clay's 2005 operating cycle?

A. 33
B. 47
C. 61
D. 94

D. 94

13

North Bank is analyzing Belle Corp.'s financial statements for a possible extension of credit. Belle's quick ratio is significantly better than the industry average.
Which of the following factors should North consider as a possible limitation of using this ratio when evaluating Belle's creditworthiness?

A. Fluctuating market prices of short-term investments may adversely affect the ratio.
B. Increasing market prices for Belle's inventory may adversely affect the ratio.
C. Belle may need to sell its available-for-sale investments to meet its current obligations.
D. Belle may need to liquidate its inventory to meet its long-term obligations.

Fluctuating market prices of short-term investments may adversely affect the ratio.


Since the quick ratio includes short-term investments (marketable securities) in the numerator and since short-term investments are reported at fair market value, fluctuating market prices may adversely affect the ratio (if the market price decreases).

14

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.

A.
FIFO (first in, first out).

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.

15

At December 31, 2005, the following information was provided by the Kerr Corp. pension plan administrator:
Fair value of plan assets $3.45mn
Accumulated benefit obligation $4.3mn
Projected benefit obligation $5.7mn

What is the amount of the pension liability that should be shown on Kerr's December 31, 2005 balance sheet?
A. $5.7mn
B. $2.25mn
C. $1.4mn
D. $850,000

B. $2.25mn

FV- Projected BO

16

How should plan investments be reported in a defined benefit plan's financial statements?

A.
At actuarial present value.

B.
At cost.

C.
At net realizable value.

D.
At fair value.

D.
At fair value

Fair value represents the most representationally faithful amount to be applied to pension obligation. Fair value is the current amount available for payment of pension benefits.

17

The funded status of a defined benefit pension plan for a company should be reported in
A. The income statement.
B. The statement of cash flows.
C. The statement of financial position.
D. The notes to the financial statements only.

C. The statement of financial position.
Funded status is the difference between projected benefit obligation and plan assets at fair value. Neither of these amounts is reported in the balance sheet (they appear in the notes only), but their difference is reported in the balance sheet as the reported pension liability for defined benefit plans. It is the amount the plan is "behind" in terms of having assets available for payment of benefits.