Unit 7 | Financial Reporting Flashcards
As a result of corporate transactions, a company’s assets remain the same, and its owners’ equity decreases. Which of the following statements is true?
A. Prepaid expenses decrease.
B. Total liabilities increase.
C. Accrued expenses decrease.
D. Net worth increases.
B. Sometimes, questions are best answered by analyzing the question before we even look at the answer choices. We are told in the question that assets have remained the same, but somehow, the net worth (owners’ equity) has gone down. If the balance sheet formula is Assets - Liabilities = Net Worth, then somehow the liabilities must have increased. That seems to make choice B a straightforward answer, but let’s check the others to be sure. Prepaid expenses are an asset—it can’t be choice A because we know assets haven’t changed. Choice D is so simple that students sometimes choose it because they think there is a “trick” somewhere. There is no trick here—if owners’ equity goes down, that is the net worth, so we can’t choose “net worth increases. Finally, accrued expenses are a liability, so if they decrease, net worth goes up, not down. If you take these questions step by step, they tend to be very logical.
Which of the following corporate actions will lead to an increase in a company’s owners’ equity?
A. Issuing $10 million of 6% $100 par preferred stock
B. Issuing $10 million of 4% debentures
C. Payment of a cash dividend to common shareholders
D. Redemption of outstanding debt securities at a price over par value
A. Stock represents equity in a corporation; issuing additional stock is a straightforward method of increasing net worth (owners’ equity). Issuing a debt security brings in cash, offset by the new debt. Payment of a cash dividend reduces cash on hand but reduces the declared dividend’s current liability by an equal amount. Eliminating debt is good but, when done so at a price above the par value results, decreases owners’ equity.
Potential litigation for patent infringement would appear on a corporation’s
A. balance sheet as a deferred asset.
B. footnotes.
C. income statement as an expense.
D. statement of potential litigation.
B. The footnotes to the financial statements carry information such as potential legal actions, accounting methods used, and off-book debt.
A company has filed for an initial public offering for its $10 par common stock. The IPO is priced at $35 per share. Where on the balance sheet is the extra $25 per share recorded?
A. Capital surplus
B. Retained earnings
C. Distributed dividends
D. Paid-in earnings
A | Capital surplus is the premium paid by shareholders above par value. It may also be called paid-in capital or surplus, but it is not paid-in earnings.
LO 7.a
A corporation calls in $5 million of its outstanding 6% bonds. The call price is 103. The effect on the balance sheet is all of the following except
A. current assets decrease.
B. current liabilities decrease.
C. long-term liabilities decrease.
D. owners’ equity decreases.
B | There is no change to current liabilities. Cash is used to pay for the called bonds. That reduces current assets. Those bonds, a long-term liability, are no longer on the books, so the long-term liabilities decrease. Because the company had to pay $5,150,000 to eliminate $5 million in debt, the net worth was lowered by $150,000.
LO 7.6
When a corporation’s accounting year ends on a date other than December 31, the company is using
A. a fiscal year.
B. a non-calendar year.
C. a Gregorian year.
D. a lunar year.
A | Fiscal year accounting refers to any entity ending its accounting year on a date other than December 31. The largest user of a fiscal year is the U.S. government. For accounting purposes, the government’s year begins on October 1 and ends on September 30.
LO 7.c
