Question 1

The income statement shows the difference between a firm's income and its costs--i.e., its profits--during a specified period of time. However, not all reported income comes in the form or cash, and reported costs likewise may not correctly reflect cash outlays. Therefore, there may be a substantial difference between a firm's reported profits and its actual cash flow for the same period.

Accepted Answer

The income statement shows profits and expenses, but not all profits are in cash and not all expenses are cash outlays. Therefore, there may be a difference between reported profits and actual cash flow.

Question 2

The primary reason the annual report is important in finance is that it is used by investors when they form expectations about the firm's future earnings and dividends, and the riskiness of those cash flows.

Accepted Answer

The annual report contains important financial information that investors use to make informed decisions about investing in the company. It includes financial statements, management discussions and analysis, and other relevant information that help investors assess the company's financial health, growth prospects, and risk profile. As such, the annual report is a critical tool for investors in determining the value of a company's stock or bonds.

Question 3

Net operating profit after taxes (NOPAT) is the amount of net income a company would generate from its operations if it had no interest income or interest expense.

Accepted Answer

NOPAT is a measure of a company's profitability that takes into account its operating income and tax expenses, while excluding any interest income or interest expense. This allows for a more accurate reflection of the company's operational efficiency and profitability, without the impact of its financing activities.

Question 4

The annual report contains four basic financial statements: the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

Accepted Answer

The four basic financial statements included in the annual report are the income statement, balance sheet, statement of cash flows, and statement of stockholders' equity.

Question 5

The balance sheet is a financial statement that measures the flow of funds into and out of various accounts over time, while the income statement measures the firm's financial position at a point in time.

Accepted Answer

The opposite is true - the balance sheet measures the firm's financial position at a point in time, while the income statement measures the flow of funds into and out of various accounts over time.

Question 6

The current cash flow from existing assets is highly relevant to the investor. However, since the value of the firm depends primarily upon its growth opportunities, profit projections from those opportunities are the only relevant future flows with which investors are concerned.

Accepted Answer

While growth opportunities and their profit projections are crucial, investors also consider the current cash flow from existing assets as it reflects the firm's present health and ability to generate revenue, which is fundamental for sustaining operations and funding future growth.

Question 7

The interest and dividends paid by a corporation are considered to be deductible operating expenses, hence they decrease the firm's tax liability.

Accepted Answer

Interest paid by a corporation can be considered a deductible expense, which can decrease the firm's tax liability, but dividends paid are not deductible and do not affect the corporation's taxes.

Question 8

Its retained earnings is the actual cash that the firm has generated through operations less the cash that has been paid out to stockholders as dividends. Retained earnings are kept in cash or near cash accounts and, thus, these cash accounts, when added together, will always be equal to the firm's total retained earnings.

Accepted Answer

Retained earnings represent the cumulative amount of net income earned by a company that is retained by the company rather than distributed to its shareholders as dividends. Retained earnings are not necessarily held in cash or near-cash accounts; they can be reinvested in the business, such as in equipment, inventory, or other assets.

Question 9

The retained earnings account on the balance sheet does not represent cash. Rather, it represents part of stockholders' claims against the firm's existing assets. This implies that retained earnings are in fact stockholders' reinvested earnings.

Accepted Answer

Retained earnings represent the portion of a company's profit that is not paid out as dividends and is instead reinvested back into the business. It is a part of the stockholders' equity section of the balance sheet, which represents the claims that the company's owners have against its assets. Therefore, retained earnings are indeed the stockholders' reinvested earnings, not cash.

Question 10

In accounting, emphasis is placed on determining net income in accordance with generally accepted accounting principles. In finance, the primary emphasis is also on net income because that is what investors use to value the firm. However, a secondary financial consideration is cash flow, because cash is needed to operate the business.

Accepted Answer

The answer of In accounting, emphasis is placed on determining...

Question 11

Interest paid by a corporation is a tax deduction for the paying corporation, but dividends paid are not deductible. This treatment, other things held constant, tends to encourage the use of debt financing by corporations.

Accepted Answer

Since interest payments are tax deductible, while dividend payments are not, this creates an advantage for debt financing over equity financing. As a result, corporations may be incentivized to use debt financing to take advantage of the tax benefit.

Question 12

Assets other than cash are expected to produce cash over time, but the amount of cash they eventually produce could be higher or lower than the values at which these assets are carried on the books.

Accepted Answer

This statement is true. Examples of assets other than cash that are expected to produce cash over time include inventory, property, plant and equipment, and investments in securities. The eventual amount of cash produced by these assets could be affected by factors such as market changes, obsolescence, and depreciation. Therefore, their carrying values on the books may not necessarily reflect their true market value or cash producing potential in the future.

Question 13

On the balance sheet, total assets must always equal total liabilities and equity.

Accepted Answer

This is the fundamental principle of accounting known as the accounting equation. Total assets represent the resources a company owns, while total liabilities and equity represent the sources of financing for those assets. Therefore, by definition, the two sides of the balance sheet must always be equal.

Question 14

Total net operating capital is equal to net fixed assets.

Accepted Answer

Total net operating capital includes both net fixed assets and working capital (current assets minus current liabilities).

Question 15

Net operating working capital is equal to operating current assets minus operating current liabilities.

Accepted Answer

Net operating working capital is calculated by subtracting operating current liabilities from operating current assets.

Question 16

If the tax laws were changed so that $0.50 out of every $1.00 of interest paid by a corporation was allowed as a tax-deductible expense, this would probably encourage companies to use more debt financing than they presently do, other things held constant.

Accepted Answer

The answer of If the tax laws were changed so...

Question 17

Consider the balance sheet of Wilkes Industries as shown below. Because Wilkes has $800,000 of retained earnings, the company would be able to pay cash to buy an asset with a cost of $200,000.

Accepted Answer

The answer of Consider the balance sheet of Wilkes Industries...

Question 18

The time dimension is important in financial statement analysis. The balance sheet shows the firm's financial position at a given point in time, the income statement shows results over a period of time, and the statement of cash flows reflects changes in the firm's accounts over that period of time.

Accepted Answer

The time dimension is indeed important in financial statement analysis as the balance sheet shows a snapshot of the firm's financial position at a particular point in time, the income statement shows the results of the firm's operations over a period of time, and the statement of cash flows shows the changes in the firm's accounts over that same period of time.

Question 19

The fact that 70% of the dividends received by a corporation is excluded from its taxable income encourages firms to use more debt financing than they would in the absence of this tax law provision.

Accepted Answer

The exclusion of 70% of dividends from taxable income encourages firms to invest in equity rather than debt, as it makes dividend income more attractive and tax-efficient compared to interest income from debt.

Question 20

To estimate the cash flow from operations, depreciation must be added back to net income because it is a non-cash charge that has been deducted from revenue.

Accepted Answer

Depreciation is a non-cash expense that is subtracted from revenue to calculate net income. However, it does not involve an outflow of cash, so it needs to be added back to net income to estimate the cash flow from operations.

Quiz 2: Financial Statements, Cash Flow, and Taxes