If a firm recognizes expenses before that dictated by accrual accounting, which of the following best describes the effects on income, total assets and retained earnings?Income Total assets Retained earnings
Answer(s): A
Total assets Retained earnings Understated Understated Overstated Understated Understated Overstated Overstated OverstatedIf expenses are recognized before they should be, then income gets understated since you subtract more from the revenues than you should. Hence, retained earnings get understated, leading to an understatement of total equity. Since assets equal liabilities plus equity and liabilities have not been affected, the understatement of equity leads to an understatement of assets.
Which of the following is/are TRUE under GAAP?
Answer(s): D
Use the basic equation, Assets = Liabilities + Total Equity.II is false since you need "Total equity" comprises of common stock as well as other forms of equity like preferred issues. IV is false since the borrowing increases only the liabilities while the cash increases only the assets, leaving equity unchanged.
A firm has just experienced a LIFO liquidation under inflation. Which of the following could be true?
The LIFO Reserve is defined as the difference between the values of the inventory under FIFO and under LIFO. A decrease in this reserve is referred to as LIFO liquidation. Under the usual case of rising prices, this occurs when units sold exceed units purchased, leading to a "dipping" into the LIFO layers. Since some of the goods sold were purchased at lower prices in previous periods as accounted for by LIFO, COGS gets understated compared to the case where the firm purchases the sold goods in the current period instead of dipping into the LIFO layers. Hence, the firm's income is overstated, leading to higher taxes paid.
Firms A and B have simple capital structure with the same number of common stock outstanding. A finances its operations relying on debt financing while B prefers issuing preferred equity. If both the firms had the same net income last year, Firm A will have a:
For a simple capital structure, EPS = (Net Income - Preferred stock dividends)/weighted # of common shares Since both the firms have the same net income and common shares outstanding, Firm B will show a lower EPS due to the payment of preferred stock dividends.
The peaks and valleys of the business cycle tend to be magnified using which inventory method?
Answer(s): B
Businesses tend to increase selling prices as costs rise, regardless of the fact that inventories may have been purchased before the price rise. The reverse effect occurs in periods of price decreases.
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