Chapter 4 Homework

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Chapter 4 – Implementing accounting analysis Question 4.1 The first task in an accounting analysis is to: A. Determine how assets were measured. B. Make adjustments for any contingent liabilities. C. Determine what accounts may require adjusting. D. Recast the financial statements into a common format . Answer D Question 4.2 In which of the following ways might financial statements differ between firms and across the same firm over time? A. Terminology used when describing accounts. B. Classification of assets and liabilities. C. The format of the financial statements. D. All of these choices. Answer D Question 4.3 When using the worksheet approach which of the following accounts would not be a column? A. Assets. B. Liabilities. C. Equity. D. Expenses. Answer D Question 4.4 Financial statements may require adjusting because: A. Management have objectively set out the financial statements. B. The accounting standards reflect the underlying economics of the firm. C. There is too much management bias in the financial statements . D. The firm has used the same accounting choices within GAAP as it did in previous financial statements. Answer C Question 4.5 When writing down the value of an asset, which of the following accounts could potentially change in value? A. Asset. B. Liabilities. C. Equity.

D. Liabilities and equity. E. All of these choices. Answer E Question 4.6 When removing a deferred tax liability from a financial statement how would the relevant columns in an accounting worksheet change? A. A decrease in assets and a decrease in liabilities. B. An increase in assets and a decrease in liabilities. C. An increase in equity and a decrease in liabilities. D. A decrease in equity and an increase liabilities. Answer C Question 4.7 The accounting requirement to measure inventories at net realisable value (NRV) will likely result in assets that are not: A. Overvalued. B. Undervalued. C. Overvalued or undervalued assets depending on local tax requirements. D. All of these choices. Answer A Question 4.8 An issue that can arise when reporting liabilities is: A. The amount of the obligation is certain. B. There is little ambiguity as to whether an obligation has been incurred. C. A commitment may depend on an uncertain future event. D. All of these choices. Answer C Question 4.9 Recognising an accrual that increases income in one financial reporting period can result in which of the following occurring in later periods? A. Either a further increase in accruals or a decrease in accruals. B. A decrease in accruals. C. A further increase in accruals. D. None of these choices. Answer A Question 4.10 Managers have incentives to: A. Increase earnings. B. Decrease earnings.

C. Increase assets and liabilities. D. Decrease assets and liabilities. E. All of these choices . Answer E Question 4.11 Analysts may prefer to a remove deferred tax from the financial statements as: A. Deferred tax does not represent an amount that is owed from or to tax authorities. B. Analysts only require after-tax profit numbers. C. There are minor differences between tax accounting and GAAP accounting. D. Tax rates vary too much across jurisdictions and industries. Answer A Question 4.12 In what situation would management be most likely to distort the financial report? A. When earnings are higher than the level required to achieve their bonus. B. When they have just met an analyst’s forecast. C. When they have just enough assets to meet a financial covenant. D. All of these choices. Answer A Question 4.13 Which of the following should be removed from the financial statements? A. Items that are unique to the business and do not impact business value on a continuing basis . B. Items that are not unique to the business and impact business value on a continuing basis. C. Items that are unique to the business and impact business value on a continuing basis. D. Items that are not unique to the business and do impact business value on a continuing basis. Answer A Question 4.14 An analyst should make a full adjustment and not a partial adjustment because: A. Partial adjustments can potentially ignore the impact on the income statement. B. Partial adjustments can potentially ignore the impact on the balance sheet. C. Partial adjustments can potentially ignore the impact on accounting ratios. D. All of these choices. Answer D

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Question 4.15 You notice that a firm has listed a helicopter in a fixed asset account. This helicopter is only used recreationally by one of the directors of the firm. Using the worksheet approach, what should you do? A. Decrease the asset account by the value of the helicopter and adjust it against another asset account. B. Make no adjustment. C. Decrease the asset account by the value of the helicopter and adjust it against an equity account. D. Decrease the asset account by the value of the helicopter and adjust it against a liability account. Answer C Question 4.16 Consider the following worksheet with information extracted from a financial statement: 2018 Assets Liabilities Equity Reported ($) 500 000 100 000 400 000 An analyst makes an adjustment that decreases goodwill by $100 000 and equity (profit) by $100 000. This goodwill was acquired on consolidation, hence there are no tax adjustments. Using the worksheet approach, what would be the change in the debt to assets ratio? A. An increase of 10%. B. An increase of 5%. C. A decrease of 5% D. A decrease of 10%. Answer B: Adjusted Assets = $500,000 - $100,000 = $400,000 Liabilities = $100,000 (unchanged) Initial debt to assets ratio = Liabilities / Assets = $100,000 / $500,000 = 0.2 or 20% Adjusted debt to assets ratio = Liabilities / Adjusted Assets = $100,000 / $400,000 = 0.25 or 25% Change in debt to assets ratio = 0.25 - 0.20 = 0.05 or 5% Question 4.17 Consider the following worksheet with information extracted from a financial statement: 2018 Assets Liabilities Equity Reported ($) 500 000 200 000 300 000 An analyst makes an adjustment for goodwill that decreases assets by $100 000 and decreases equity (profit) by $100 000. This decrease in equity has reduced profit to $50 000. Using the worksheet approach, what would be the reported return on assets? A. 30% B. 12.5% C. 37.5%

D. None of these choices. Answer A: ROA = Net profit Totalassets = 100,000 + 50,000 500,000 *100% = 30% Question 4.18 An analyst makes an adjustment to the goodwill in a firm’s financial statements. This results in a decrease of assets and a decrease in equity. Using the worksheet approach, which of the following financial ratios will be affected? A. Debt to assets. B. Return on assets. C. Both debt to assets and return on assets will be affected. D. None of these choices. Answer C Question 4.19 You have identified that a firm has omitted a provision for potential damages related to an oil spill on the basis that payments will not be required. However, you believe these payments will be required and paid in instalments over the coming two years. Using the worksheet approach and assuming a corporate tax rate of 30%, which of the following is unlikely to be adjusted? A. Deferred tax liability. B. Current liabilities. C. Non-current liabilities. D. Equity (profit). E. None of these choices. Answer A Question 4.20 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Reported ($) 500 000 100 000 400 000 You believe the firm has omitted a provision pertaining to a lawsuit. You assess this provision is valued at $50 000 and that it will be paid in the next six months. Using the worksheet approach and assuming a corporate tax rate of 30 per cent, what would be the change to the total value of the liability account? A. An increase of $35 000 B. A decrease of $65 000 C. An increase of $65 000 D. A decrease of $35 000 Answer A: Tax effect = Omitted provision × Corporate tax rate = $50,000 × 0.30 = $15,000 Change in total liabilities = Omitted provision - Tax effect = $50,000 - $15,000 = $35,000

Question 4.21 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Reported ($) 500 000 100 000 400 000 You believe the firm has omitted a provision pertaining to a lawsuit. You assess this provision is valued at $30 000 and that it will be paid in the next six months. Using the worksheet approach and assuming a corporate tax rate of 30 per cent, what would be the adjusted debt to assets ratio? A. 15.8% B. 24.2% C. 27.8% D. 12.2% Answer B: Tax effect = Provision × Tax rate = $30,000 × 0.30 = $9,000 Adjusted Liabilities = $100,000 + $30,000 - $9,000 = $121,000 Adjusted debt to assets ratio = Adjusted Liabilities / Assets = $121,000 / $500,000 = 0.242 or 24.2% Question 4.22 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Reported ($) 900 000 200 000 700 000 You identify that a firm has incorrectly recognised revenue on $200 000 worth of goods in the form of receivables. You decide to reverse this sale and the associated inventory which has a value of $120 000. Using the worksheet approach, what would be the adjusted change in the value of the asset account? A. An increase of $80 000 B. A decrease of $80 000 C. An increase of $320 000 D. A decrease of $320 000 Answer B: Adjusted Assets = Initial Assets - Reversal of revenue + Value of inventory = $900,000 - $200,000 + $120,000 = $820,000 Adjusted change in the value of the asset = Adjusted Assets – Initial Assets = $820,000 - $900,000 = - $80,000 Question 4.23 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Reported ($) 400 000 100 000 300 000

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You identify that a firm has incorrectly recognised revenue on $50 000 worth of goods in the form of receivables. You decide to reverse this sale and the associated inventory which has a value of $40 000. Using the worksheet approach and assuming a corporate tax rate of 30 per cent, what would be the adjusted debt to assets ratio? A. 32.6% B. 24.9% C. 18.2% D. 26.41% Answer C 2020 Assets Liabilities Equity Reported ($) 400 000 100 000 300 000 Receivables/revenue -50 000 Inventories/COGS 40 000 Deferred tax (- 50,000+40,000)*30%=3,000 Adjusted 390 000 97 000 300 000 Debt to Assets = Adjusted Liabilities / Adjusted Assets = $97,000 / $390,000 ≈ 24.9% Question 4.24 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Revenue Expenses Other Reported ($) 400 000 50 000 100 000 -50 000 300 000 You identify that a firm has incorrectly recognised revenue on $10 000 worth of goods in the form of receivables. You decide to reverse this sale and the associated inventory which has a value of $5 000. Using the worksheet approach and assuming no tax implications, what would be the adjusted return on assets ratio? A. 11.1% B. 8.6% C. 11.4% D. 8.9% Answer C: 2020 Assets Liabilities Equity Revenue Expenses Other Reported 400 000 50 000 100 000 -50 000 300 000 Receivables/revenue -10 000 -10 000 Inventories/COGS 5 000 5 000 Adjusted 395 000 50 000 90 000 -45 000 300 000 Return on Assets (ROA) = Adjusted Net Income / Adjusted Assets = ($90,000-$45,000)/ $395,000 ≈ 11.4%

Question 4.25 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Revenue Expenses Other Reported 700 000 450 000 300 000 -250 000 200 000 You identify that a firm has incorrectly recognised revenue on $70 000 worth of goods in the form of receivables. You decide to reverse this sale and the associated inventory which has a value of $50 000. Using the worksheet approach and assuming no tax implications, what would be the adjusted return on sales ratio? A. 13% B. 10% C. 16.7% D. 43.5% Answer A 2020 Assets Liabilities Equity Revenue Expenses Other Reported 700 000 450 000 300 000 -250 000 200 000 Receivables/revenue -70 000 -70 000 Inventories/COGS 50 000 50 000 Adjusted 680 000 450 000 230 000 -200 000 200 000 Return on Sales (ROS) = Adjusted Net Income / Adjusted Revenue = ($230,000-$200,000) / $230,000 ≈ 13% Question 4.26 List three reasons why managers could be motivated to distort financial reporting. ANSWER: ▪ Increase profits in order to fulfill analyst estimates, or standards. ▪ Enhance assets or income in order to comply with debt arrangements or financial covenants. ▪ Increase income in order to get higher bonuses. ▪ When the company is getting ready to launch a public stock offering. Question 4.27 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Revenue Expenses Other Reported 900 000 670 000 150 000 -120 000 200 000 You identify that a firm has incorrectly recognised revenue on $40 000 worth of goods in the form of receivables. You decide to reverse this sale and the associated inventory which has a value of $25 000. Using the worksheet approach and assuming a corporate tax rate of 30%, complete the worksheet and calculate both the reported and adjusted:  Return on sales.  Return on assets.

 Debt to assets. ANSWER: 2020 Assets Liabilities Equity Revenue Expenses Other Reported 900 000 670 000 150 000 -120 000 200 000 Receivables/revenue -40 000 -40 000 Inventories/COGS 25 000 25 000 Deferred tax -19 500 19 500 Adjusted 885 000 650 500 110 000 -75 500 200 000  Net Income = Revenue + Expenses = $150,000 - $120,000 = $30,000 Ratios Reported Adjusted Return on sales 20% 31.4% Return on assets 3.33% 3.9% Debt to assets 74.4% 73.5% Reported Ratios:  Return on Sales (ROS) = Net Income / Revenue = $30,000 / $150,000 = 20%  Return on Assets (ROA) = Net Income / Total Assets = $30,000 / $900,000 = 3.33%  Debt to Assets = Total Liabilities / Total Assets = $670,000 / $900,000 = 74.44% Adjusted Ratios:  Return on Sales (ROS) = Adjusted Net Income / Adjusted Revenue = (110,000-75,500) / $110,000 ≈ 31.4%  Return on Assets (ROA) = Adjusted Net Income / Adjusted Assets = $34,500/ $885,000 ≈ 3.9%  Debt to Assets = Adjusted Liabilities / Adjusted Assets = $650,500 / $885,000 ≈ 73.5% Question 4.28 Consider the following worksheet with information extracted from a financial statement: 2020 Assets Liabilities Equity Capitalised Other Profit Other Reported ($) 20 000 50 000 25 000 15 000 30 000 You have identified the firm has capitalised $15 000 of expenses on a building in 2020 when all of their competitors choose to recognise these expenses straight into the income statement. Unwind these expenses, assuming they were to be depreciated over the next 10 years using the straight-line method, and complete the worksheet for 2020. ANSWER: 2020 Assets Liabilities Equity Capitalised Other Profit Other Reported 20 000 50 000 25 000 15 000 30 000 Capitalisation -13 500 -13 500 Deferred tax -4 050 4 050

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