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Question 1 Assume US GAAP to answer this question. In 2017, $2 million in wages were earned and no cash wages were paid. In 2018, $8 million in wages were earned and $7 million in cash wages were paid. Cash wages were used to first pay wages earned in 2017 with the remainder used to pay wages earned in 2018. Any earned but unpaid wages will be paid during the first quarter of 2019. Using only the information provided, which of the following statements is most accurate? Liabilities increased by $1.0 million in 2018 Liabilities increased by $3.0 million in 2018 Assets decreased by $5.0 million in 2018 Retained earnings decreased by $10.0 million in 2018 Retained earnings decreased by $7.0 million in 2018 Your answer is correct. Since wages were earned in 2017 but not yet paid, the opening balance sheet in 2018 would have an accrued wages liability of $2.0. These were paid in 2018, reversing the liability. However, since there is only $5.0 million in cash ($7.0 less the $2.0 million used to pay 2017 wages) available to pay wages earned in 2018, that leaves $3.0 million in earned wages unpaid, raising the accrued wages liability to $3.0 million. The net impact to the liability is $1.0 million (-$2.0 + $3 million). The only asset impacted is cash, which decreases by $7.0 million, while retained earnings decreases by $8.0 million, since wages are expensed when they are earned, not when they are paid. See Lesson: Payable, Accrued Expenses, Deferred Revenue & Debt Question 2 A company issued its CEO 100,000 shares of restricted stock in the beginning of 2018 that are restricted for two years. The current share price is $10. Based on the information provided, which of the following statements is true? An unearned compensation liability in the amount of $1 million is created at the grant date An unearned compensation asset in the amount of $1 million is created at the grant date Stockholders' equity increases by $1 million at the grant date An unearned compensation contra equity account in the amount of $500,000 is recognized at the grant date Stockholders' equity is unchanged at the grant date Your answer is correct. The entire value of restricted stock issued at grant date is recognized as an equity account and is immediately offset by a contra equity account in the same amount so there is no change to stockholders’ equity at the grant date. This contra equity account is reversed over the service period. In this case, a $1 million contra equity account is created and reduced by $500,000 over the next two years, with an offsetting reduction in retained earnings. See Lesson: Stock Based Compensation Accounting: Journal Entries Question 3 A company issued its CEO 100,000 stock options in the beginning of 2018 that will vest equally over 2 years. Assume the following: The share price at grant date is $10 per share The option exercise price is $10 per share The fair value of each option at grant date is $5 per share No options are exercised until after year 2 Based only on the information provided, which of the following statements is true? Stockholders' equity increases by $1,000,000 at the grant date Stockholders' equity increases by $500,000 at the grant date Stockholders' equity increases by $250,000 at the grant date Stockholders' equity decreases by $250,000 at the end of year 1 Stockholders' equity does not change at the end of year 1 Your answer is correct. No journal entries occur at the grant date. Stock options are expensed as they vest with a corresponding entry in "APIC – Stock options" account. Since both accounts are part of stockholders’ equity, there is no change to stockholders’ equity. No asset or liabilities are recognized on the grant date. See Lesson: Stock Based Compensation Accounting: Journal Entries Question 4 A company recorded the following activities in 2018: $5 million in capital expenditures were made in 2018 $4 million in depreciation expense was recognized in 2018 $3 million in affiliate income recognized on the income statement from a 25% investment in an affiliate $1 million of insurance proceeds were received in cash due to hurricane damage on the company’s corporate headquarters Based only on the information provided, calculate the impact of the activities described above on the company’s 2018 operating income and cash flows (ignore taxes). Operating income decreased by $1.0 million. Cash flows decreased by $4.0 million. Operating income decreased by $5.0 million. Cash flows increased by $6.0 million. Operating income decreased by $4.0 million. Cash flows decreased by $4.0 million. Operating income decreased by $6.0 million. Cash flows decreased by $1.0 million. Operating income decreased by $6.0 million. Cash flows decreased by $3.0 million. Your answer is correct. Only the $4.0 million in depreciation expense impacts operating income. Capital expenditures are not recognized on the income statement. Affiliate income and insurance proceeds are recognized below operating income. Capex reduces cash flows, offset by the $1 million insurance proceeds. Depreciation is non-cash and the investment income is an accrual – its cash impact is not provided. See Lessons: All lessons in "Accounting Crash Course" Chapters 2 (The Income Statement) and 6 (The Cash Flow Statement). Question 5 A company reported gross profit of $20 million in 2018. In addition, it recorded the following activities: Sales and marketing expenses were $5 million. Interest income was $2 million. Sold equipment for $5 million that had a net book value of $9 million. $3 million in preferred stock issuance. Company’s tax rate is 40%. Calculate the company’s net income. $5.4 million $6.0 million $6.8 million $7.2 million $7.8 million Your answer is correct. Gross profit 20.0 Selling and marketing expenses (5.0) Interest income 2.0 Loss on sale (4.0) Pretax income 13.0 Tax rate 40% Net income 7.80 Loss on sale is calculated as the sale price less the net book value. See Lesson: Net Income, EPS & Dividends Question 6 The next two questions use the following data from TGX Global, a heavy equipment manufacturer (this information will be repeated on the next question): TGX Global sells excavators, with an average sale price of $500,000 per excavator. TGX received new orders for 90 excavators in 2018. TGX produced & delivered 120 excavators in 2018: 50 excavators were ordered in 2017 and the rest (70 excavators) were ordered in 2018. TGX received payment for 110 excavators. TGX began selling 1-year maintenance services contracts for $50,000 per excavator in 2018, which begin after the excavator is delivered. Contracts were sold on 50% of all excavator orders made in 2018 (no contracts were sold on orders placed in 2017). Assume all excavators delivered in 2018 are delivered at year end, calculate TGX’s 2018 revenue based on the transactions described above. $45.0 million $55.0 million $60.0 million $61.0 million $66.0 million Your answer is correct. According to the revenue recognition principle, a company cannot record revenue until that order is shipped to a customer (or a service has been provided) and collection from that customer is reasonably assured. 120 excavators were shipped and delivered in 2018 at a price of $500,000 each, which implies $60.0 million of revenue. The maintenance agreement cannot be recognized as revenue until the service is provided, since excavators were delivered at year end, no revenue from the service agreement can be recognized in 2018. See Lesson: Basic Accounting Principles Question 7 This question uses the same TGX Global data as the previous question, repeated below: TGX Global sells excavators, with an average sale price of $500,000 per excavator. TGX received new orders for 90 excavators in 2018. TGX produced & delivered 120 excavators in 2018: 50 excavators were ordered in 2017 and the rest (70 excavators) were ordered in 2018. TGX received payment for 110 excavators. TGX began selling 1-year maintenance services contracts for $50,000 per excavator in 2018, which begin after the excavator is delivered. Contracts were sold on 50% of all excavator orders made in 2018 (no contracts were sold on orders placed in 2017). Assume now that instead of the revenue recognized in the previous question, TGX recognized $50 million in revenue for 100 excavators (and assume no maintenance contract revenue was recognized). In addition, the following occurred in 2018: TGX recognized $2 million in shipping and delivery costs for its excavators. TGX recognized $6 million in direct labor expenses. TGX recognized $3 million in commissions paid to its salespeople for selling the excavators. TGX purchased $60 million in raw materials in 2018, of which $50 million was in cash. Raw materials required to assemble each excavator cost $300,000 per excavator. Calculate TGX’s 2018 gross profit based on the transactions described above. $(15.0 million) $9.0 million $12.0 million $14.0 million $18.0 million Your answer is correct. Gross profit is revenue less cost of goods sold. Cost of Goods sold represents a company's direct cost to manufacture or procure goods and services. According to the matching principle, costs associated with the production of the book should be recorded in (matched to) the same period as the revenue from the book’s sale. Revenue from 100 excavators was recognized and the corresponding cost of $300,000 each or $30 million should be matched. In addition, shipping, delivery and direct labor costs are included in the direct production of the excavator and should thus be included in COGS. Sales, marketing and general expenses are not included in COGS. See Lesson: COGS & Gross Profit Question 8 Fairview Corporation recorded the following in 2018: After-tax net income was $20 million in 2018. The actual share count at the beginning of the year was 10.0 million. Fairview repurchased 2 million shares at $12/share in the middle of 2018. Fairview issued preferred dividends of $3 million and common dividends of $2 million. Fairview issued 4 million stock options in 2018 that begin to vest in 2019. Calculate 2018 basic earnings per share (EPS). 1.25 1.67 1.89 2.22 2.25 Your answer is correct. Net income must be reduced by preferred dividends in the basic EPS calculation. Unvested shares do not get included in the basic share count, only the diluted. The share count is a weighted average. Since shares were repurchased midyear, the average is 10x50% + 8x50% = 9.0 weighted average shares. Net income 20.0 Preferred dividends (3.0) Net income to common 17.0 Basic Shares - BOP 10.0 Basic Shares - EOP 8.0 Basic Shares - Weighted Average 9.0 Basic EPS 1.89 See Lessons: Net Income, EPS & Dividends Financial Statement Analysis Question 9 Dynamic Resources reported the following information for year ending June 30, 2016 (values in millions): Plant, Property & Equipment, gross $3,000 Accumulated Depreciation 1,400 Plant, Property & Equipment, net 1,600 Salvage Value 200 The company also reported the following transactions on the first day of fiscal 2017: Sale of asset with gross PP&E of $600 million for $500 million and useful life of 3 years and no salvage value. Recorded a gain on sale of $300 million. Write off of asset with gross PP&E of $400 million. Asset was purchased 3 years ago with original useful life of 4 years and salvage value of $200 million. Purchase of new equipment for $1,400 million with useful life of 8 years and no salvage value. Assuming the remaining useful life of other equipment is 10 years on a straight-line basis, what is the net PP&E as of June 30, 2017? $2,125 million $2,260 million $2,300 million $2,435 million Your answer is correct. First calculate the PP&E balance on the first day of FY2017. The asset was sold for $500 million and a gain of $300 million was recognized, which implies a net PP&E value of $200 million. The write off is for gross PP&E of $400 million that has been depreciated at $50 million (($400-200)/4) for 3 years, which implies a net PP&E value of $250 million. Starting with $1,600 million of net PP&E, subtracting $200 million for the sale and $250 million for the write down leaves $1,150 million of other equipment with no salvage value (due to the write down). $1,400 of new equipment is purchased, which increases net PP&E to $2,550 million. After one year, the other equipment is depreciated by $115 million reflecting remaining useful life of 10 years and the new equipment is depreciated by $175 million reflecting a useful life of 8 years. Net PP&E for FY2017 is $2,550 – 115 – 175 = $2,260 million. See Lesson: Depreciation Question 10 Information about the assets of TAP Holdings is provided below: TAP purchased land on January 1, 2013 for $250 million. As of January 1, 2018, the fair value was estimated to be $290 million. TAP purchased a trademark on January 1, 2016 for $150 million. As of January 1, 2018, the fair value was estimated to be $80 million. TAP acquired a company on Jun 5, 2016 and recognized $880 million in goodwill as a result. A $140 million goodwill impairment was recognized at year end 2017. Assume a useful life of 5 years and the straight-line method for any depreciable or amortizable assets above. What is the total value of these assets reported on TAP’s balance sheet as of January 1, 2018? $1,070 million $890 million $1,170 million $1,140 million Your answer is correct. GAAP financial statements report companies’ resources at an initial historical cost (unless written down). GAAP requires that firms only show measurable activities, such as the value of acquired intangible assets. The current reported value of the land would be the lower historical cost of $250. The current reported value of the trademark would be written down to the lower fair value of $80. Goodwill would also be reported at the lower fair value of $740. The total value of the assets would be $250 + $80 + $740 = $1,070. Land, trademarks and goodwill are considered are generally considered to have indefinite useful lives and not depreciated or amortized. See Lessons: Basic Accounting Principles Intangible Assets & Goodwill Question 11 For the next 3 questions, use the financials of Acme Corporation. Based solely on the information provided in the financials, how much cash did Acme generate from revenue for the nine months ending September 30, 2017? $851.7 million $892.1 million $939.4 million $979.8 million Your answer is correct. Accounts receivable increased by $87.7 million, implying that the company did not collect that amount in cash. Deferred revenue increased by $40.4 million, which the company collected but did not book as sales. Therefore, cash collection was $939.4 million – $87.7 million + $40.4 million = $892.1 million. See Lessons: Cash, Receivables & Prepaid Expenses Payable, Accrued Expenses, Deferred Revenue & Debt Question 12 For the next 2 questions, use the financials of Acme Corporation. Note the industry average ratios below: A/R days (based on average balances) = 57 days A/P days (based on average balances) = 23 days Current ratio (based on ending balance) = 1.8x Based on Acme’s A/R days, A/P days and Current ratios for the nine months ending September 30, 2017, which of the following conclusions is most accurate? Assume 273 days in the nine months ending September 30, 2017 and 365 days in the year. Compared to the industry average: Acme has more favorable collection terms but less favorable payment terms with vendors. Acme has more favorable collection terms and more favorable payment terms with vendors. Acme has less favorable collection terms and less favorable payment terms with vendors. Acme has less favorable payment terms with vendors and a less favorable current ratio. Acme has less favorable collection terms and less favorable current ratio. Your answer is incorrect. The activity ratios are calculated below: Activity ratios Acme Industry A/R Days = Average A/R / YTD Revenue * 273 77 days57 days A/P Days = Average A/P / YTD COGS * 273 2 days 23 days Current Ratio = Current Assets / Current Liabilities 2.0x 1.8x Lower A/R days is favorable because if you collect very fast from customers, you immediately get cash. Higher inventory turnover is advantageous because it means you do not need large amounts of cash for inventory requirements until a sale is actually made. Higher A/P days is favorable because a company can take longer to pay vendors and longer credit terms provide more flexibility. The current ratio gauges the ability of a company to cover short term financing needs. A current ratio 1 is good. It implies that there are more liquid assets than short term liabilities, reflecting a healthier level of liquidity. See Lesson: Financial Statement Analysis Question 13 To answer this question, use the financials of Acme Corporation. In Acme’s earnings press release, the company discloses the following items for the nine months ending September 30, 2017 (amounts in $000s): Amortization expense related to acquired intangible assets of $29,919. One-time gain on sale of equipment of $771. Adjusted Net Income is defined as Net Income adjusted for one-time, unusual or non-recurring items as well as the accounting effects of acquisitions. Assume the tax rate on unusual items is the same as the effective rate during the period. Based on this disclosure and the provided financials above, what is Adjusted Net Income for the nine months ending September 30, 2017? $238,599 $238,827 $259,895 $268,518 Your answer is correct. Reported Net Income is $239,370. Add back amortization expense of $29,919, subtract gain of $771 and subtract tax effect of $8,623 (calculated as ($29,929 – 771) * effective rate of 29.6% calculated from income statement) for Adjusted Net Income of $259,895. See Lesson: All lessons in Accounting Crash Course, Advanced Topics, Chapter 1: GAAP vs Non-GAAP Question 14 If Dodge Logistics decided to change its leases currently classified as capital leases to operating leases, which of the following statements would most likely be true? Dodge is expecting to take title at the end of the lease. Interest expense will be higher going forward as a result of the change. Dodge has the option of a bargain purchase during the lease. Operating income will be lower as a result of the change. Your answer is incorrect. If any of the following criteria are met, a lease must be treated as a capital lease: title transfer at lease end, bargain purchase option, lease 75% of asset’s life, PV of lease payments is 90% of FV. For capital leases, a liability is recognized on the B/S with the corresponding asset as PP&E, and interest expense and amortization recognized on the I/S. For operating leases, no asset or liability is recognized on the balance sheet, and lease payments are expensed on the I/S. All else equal, operating income would be higher under a capital lease as operating income only captures the amortization expense and not the interest expense, whereas the operating lease captures the entire rent expense as an operating expense. See Lesson: Operating & Capital Leases Question 15 McDowell Corporation spends the same amount on capital expenditures each year. All capital expenditures have an estimated useful life of 10 years. Over time, which of the following is most likely true? Capital expenditures and depreciation expense converge PP&E steadily increases to perpetuity PP&E approaches zero Capital expenditures depreciation expense Your answer is correct.