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 of cash, and reported costs likewise may not be consistent with 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 statement is true. Reported income and costs on an income statement may not reflect actual cash inflows and outflows, creating a difference between reported profits and actual cash flow.

Question 2

Consider the following balance sheet, for Games Inc. Because Games has $800,000 of retained earnings, we know that the company would be able to pay cash to buy an asset with a cost of $200,000. $$\begin{array} { l r l r } 
\text { Cash } & \$ 50,000 & \text { Accounts payable } & \$ 100,000 \
\text { Inventory } & 200,000 & \text { Accruals } & \underline{100,000} \
\text { Accounts receivable } & \underline{250,000} & \text { Total CL } & \underline{\$ 200,000} \
\text { Total CA } & \$ \underline{500,000} & \text { Long-term debt } & 200,000 \
\text { Net fixed assets } & \$ 900,000 & \text { Common stock } & 200,000 \
& & \text { Retained earnings } & 800,000 \
\text { Total assets } & \$ 1,400,000 & \text { Total L \& E } & \$ 1,400,000 \
\hline
\end{array}$$

Accepted Answer

Retained earnings are not cash; they represent cumulative profits not distributed as dividends. The company only has $50,000 in cash, not enough to buy a $200,000 asset.

Question 3

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 provides important financial and operational information that helps investors make informed decisions. Investors use this information to assess the financial health of the company, as well as its growth potential and risk profile. This information is critical in shaping investor expectations about future earnings and dividends, and the level of risk associated with those cash flows.

Question 4

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 amounts at which the assets are carried on the books.

Accepted Answer

Assets such as property, plant and equipment, and investments are valued on the balance sheet based on historical cost or fair market value. However, their ultimate cash-generating potential may be impacted by factors such as changes in market conditions, obsolescence, or changes in demand. Therefore, the actual amount of cash they eventually produce may differ from their book value.

Question 5

Net operating working capital is equal to current assets minus the difference between current liabilities and notes payable. This definition assumes that the firm has no "excess" cash.

Accepted Answer

The formula for calculating net operating working capital is correct, and it assumes that all cash held by the firm is necessary for its operations, so there is no "excess" cash.

Question 6

Companies typically provide four basic financial statements: the fixed income statement, the current income statement, the balance sheet, and the cash flow statement.

Accepted Answer

The correct statement is that companies typically provide four basic financial statements: the income statement, the balance sheet, the cash flow statement, and the statement of changes in equity. The fixed income statement is not a common financial statement.

Question 7

The value of any asset is the present value of the cash flows the asset is expected to provide. The cash flows a business is able to provide to its investors is its free cash flow. This is the reason that FCF is so important in finance.

Accepted Answer

The statement correctly explains the importance of free cash flow in determining the value of an asset or a business.

Question 8

Free cash flow (FCF) is, essentially, the cash flow that is available for interest and dividends after the company has made the investments in current and fixed assets that are necessary to sustain ongoing operations.

Accepted Answer

Free cash flow (FCF) is the cash flow available for interest and dividends after necessary investments in current and fixed assets for ongoing operations have been made.

Question 9

If a firm is reporting its income in accordance with generally accepted accounting principles, then its net income as reported on the income statement should be equal to its free cash flow.

Accepted Answer

Net income as reported on the income statement includes non-cash expenses such as depreciation and amortization, which do not affect the firm's free cash flow. Free cash flow is calculated as operating cash flow minus capital expenditures.

Question 10

If we were describing the income statement and the balance sheet, it would be correct to say that the income statement is more like a video while the balance sheet is more like a snapshot.

Accepted Answer

The income statement shows a company's financial performance over a specific period of time, like a video that captures a certain period of action. In contrast, the balance sheet shows a company's financial position at a specific moment in time, like a snapshot.

Question 11

The amount shown on the December 31, 2013, balance sheet as "retained earnings" is equal to the firm's net income for 2013 minus any dividends it paid.

Accepted Answer

Retained earnings on the balance sheet include the cumulative net income minus dividends over the life of the company, not just for the year 2013.

Question 12

EBIT stands for earnings before interest and taxes, and it is often called "operating income."

Accepted Answer

EBIT stands for earnings before interest and taxes and is used to measure a company's operating income. This metric excludes non-operating expenses such as interest charges and taxes, providing a clearer picture of a company's profitability from its core operations.

Question 13

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

Accepted Answer

This statement is true. The four basic financial statements included in an annual report are the income statement, balance sheet, cash flow statement, and statement of stockholders' equity.

Question 14

Typically, the statement of stockholders' equity starts with total stockholders' equity at the beginning of the year, adds net income, subtracts dividends paid, and ends up with total stockholders' equity at the end of the year. Over time, a profitable company will have earnings in excess of the dividends it pays out, and will result in a substantial amount of retained earnings shown on the balance sheet.

Accepted Answer

This statement accurately describes the typical format of a stockholders' equity statement and explains how a profitable company can accumulate retained earnings over time.

Question 15

The fact that 70% of the interest income received by corporations is excluded from its taxable income encourages firms to finance with more debt than they would in the absence of this tax law provision.

Accepted Answer

The answer of The fact that 70% of the interest...

Question 16

Assume that two firms are both following generally accepted accounting principles. Both firms commenced operations two years ago with $1 million of identical fixed assets, and neither firm sold any of those assets or purchased any new fixed assets. The two firms would be required to report the same amount of net fixed assets on their balance sheets as those statements are presented to investors.

Accepted Answer

The answer of Assume that two firms are both following...

Question 17

Both interest and dividends paid by a corporation are deductible operating expenses, hence they decrease the firm's taxes.

Accepted Answer

The answer of Both interest and dividends paid by a...

Question 18

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

Accepted Answer

This is the fundamental accounting equation, also known as the balance sheet equation. It must always hold true for the balance sheet to be accurate and in balance.

Question 19

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

Question 20

EBITDA stands for earnings before interest, taxes, debt, and assets.

Accepted Answer

EBITDA stands for earnings before interest, taxes, depreciation, and amortization.

Quiz 3: Financial Statements, Cash Flow, and Taxes