ACC-358-Chapter-8-finaical reporting

ACC-358-Chapter-8-finaical reporting 17) Loan provisions that are specifically designed to restrict dividend payments to shareholders are called: A) debt covenants. B) debt obligations. C) stock covenants. D) stock agreements - A) debt covenants. 18) A lender may be protected from deterioration of the borrower's creditworthiness if the commercial lending agreement requires the borrower to maintain a: A) specified return on equity. B) specified earnings per share (EPS). C) fixed charge ratio above a certain level. D) fixed charge ratio below a certain level - C) fixed charge ratio above a certain level. 19) A borrower that violates one or more loan covenants but makes all interest and principal payments timely: A) is in payment default. B) is in trigger default. C) is in technical default. D) is not in default. - C) is in technical default. 20) Which of the following is not a purpose served by debt covenants? A) Preservation of repayment capacity B) Protection against credit damaging events C) Triggers and signals D) Guarantee of no default by the creditor - D) Guarantee of no default by the creditor 21) When one party to a business relationship can make decisions that benefit him or her but harm another other party in the relationship: A) a lawsuit is automatically filed. B) a contract arises. C) a conflict of interest arises. D) a contingent liability arises - C) a conflict of interest arises. 22) Potential conflicts of interest permeate: A) few business relationships. B) only relationships between investors and managers. C) only relationships between borrowers and lenders. D) many business relationships. - D) many business relationships. 23) Contract terms: A) confer the rights and obligations of the borrower. B) depend on data in financial statements that are issued before the contract is executed. C) cannot be designed to eliminate or reduce conflicting incentives. D) do not use financial accounting numbers to monitor compliance with contract terms. - A) confer the rights and obligations of the borrower. 24) A typical rate formula for a public utility includes: A) revenue, operating costs, and taxes. B) operating costs, depreciation, and taxes. C) advertising, depreciation, and taxes. D) operating costs, bad debt provisions, and depreciation. - B) operating costs, depreciation, and taxes. 25) When agents do not act in the best interest of their principals, the cost is borne by which of the following? A) Only the principal. B) Only the agent. C) Both the principal and agent. D) There is no cost of an agent not acting on behalf of their principal. - C) Both the principal and agent. 26) When conflicts of interest exist, lenders generally take all of the following actions at the creation of a contract except: A) impose higher interest rates to reflect greater default risk. B) ensure that affirmative covenants are in the contract. C) accept the risk and set up a reserve for potential future issues. D) ensure that negative covenants are in the contract. - C) accept the risk and set up a reserve for potential future issues. 27) A covenant that specifies a required minimum level of net worth and working capital is a/an: A) compliance covenant. B) financial covenant. C) implicit covenant. D) negative covenant - B) financial covenant. 28) Affirmative covenants generally would not include which of the following stipulations? A) The lender has the right to inspect business assets and business contracts. B) Limits on the borrower's total indebtedness. C) The borrower must maintain insurance on business properties. D) Specific financial covenants and reporting requirements. - B) Limits on the borrower's total indebtedness. 29) Many loan agreements have financial covenants that rely on: A) floating GAAP. B) fixed GAAP. C) flexible GAAP. D) regulatory accounting procedures (RAP). - B) fixed GAAP. 30) What purpose is served by including covenants that place strict limits on new borrowing, prohibit stock repurchases and dividends without prior lender approval, or ensure that cash generated both from ongoing operations and from asset sales will not be diverted away from servicing debt? Version 1 7 A) Signal B) Protection against credit-damaging events C) Preservation of repayment capital D) Trigger - C) Preservation of repayment capital 31) Which of the following is not an example of a negative covenant provision? A) Limits on capital expenditures. B) Limits on the borrower's total indebtedness. C) Limits the use of the loan to an agreed-upon purpose. D) Restricts the payment of cash dividends. - C) Limits the use of the loan to an agreed-upon purpose. 32) Based on a comprehensive survey of U.S. companies, the most common financial performance measure used in annual and long-term incentive plans for senior executives is: A) return on equity. B) economic value added. C) return on capital. D) net income or revenues. - D) net income or revenues. 33) Which of the following situations does not lead to default of a loan contract? A) Impairment of capital B) Failure to abide by a covenant C) Paying interest and principal when due D) Failure to pay other debts when due - C) Paying interest and principal when due 34) Debt covenants benefit: Version 1 8 A) lenders. B) borrowers. C) both lenders and borrowers. D) neither borrowers nor lenders, but are required by the SEC as a condition of issuing debt securities. - C) both lenders and borrowers. 35) Which one of the following is not a broad function served by debt covenants? A) Debt covenants usually preclude the borrower from being a merger target. B) Debt covenants serve as both signals and triggers, thereby assuring a steady flow of information from borrower to lender. C) Debt covenants are designed to preserve the borrower's repayment capacity. D) Debt covenants offer the lender some protection against credit-damaging events affecting the borrower. - A) Debt covenants usually preclude the borrower from being a merger target. 36) A financial covenant would stipulate all of the following except: A) financial statements must be prepared in accordance with GAAP. B) specific levels of performance to be met. C) which accounting methods are to be used. D) conditions that must be met. - D) conditions that must be met. 37) In the event of a default, lenders may do all of the following except: A) modify the contract terms. B) take immediate full control of the creditor. C) initiate bankruptcy proceedings. D) seize the collateral - B) take immediate full control of the creditor. 38) In using financial statements to monitor compliance with debt covenants: Version 1 9 A) mandatory changes in accounting principles can be ignored in all cases. B) many loan agreements have financial covenants that rely on the accounting rules in place when the loan is first granted. C) the lender is in default if not enforcing the borrower's compliance with the most recent accounting principles. D) the lender must renegotiate the covenants if a new accounting principle harms the borrower's compliance. - B) many loan agreements have financial covenants that rely on the accounting rules in place when the loan is first granted. 39) A lender's requirement for a borrower to maintain a certain level of fixed charge coverage: A) directly enhances the borrower's ability to pay dividends. B) indirectly enhances the borrower's ability to pay dividends. C) directly limits the borrower's ability to pay dividends. D) indirectly limits the borrower's ability to pay dividends. - D) indirectly limits the borrower's ability to pay dividends. 40) Covenants that place direct restrictions on managerial decisions are called: A) affirmative restrictions. B) affirmative covenants. C) negative restrictions. D) negative covenants - D) negative covenants 41) Which one of the following is an example of a negative covenant? A) Compliance with laws. B) Maintenance of insurance. C) Limit on capital expenditures. D) Rights of inspection. - C) Limit on capital expenditures. 42) Which of the following is not an example of an affirmative covenant? Version 1 10 A) Allowing the lender to inspect business assets and business contracts. B) Limiting new business ventures. C) Complying with laws. D) Providing periodic, audited financial statements. - B) Limiting new business ventures. 43) A requirement that a company maintain a fixed-charge coverage ratio: A) cannot limit the company's ability to pay dividends. B) is an example of a negative covenant. C) is an example of an affirmative covenant. D) cannot limit the company's ability to spend replacement capital - C) is an example of an affirmative covenant. 44) The section of a loan agreement that describes circumstances in which the creditor obtains additional rights is called the: A) events of compliance section. B) certificate of compliance section. C) events of termination section. D) events of default section. - D) events of default section. 45) The failure of a company to pay other debts, such as payables or other loans, when due is called: A) routine default. B) non-default. C) cross default. D) compliance default. - C) cross default. 46) Which statement below best describes a technical default? Version 1 11 A) The borrower violates one or more loan covenants but has made all interest and principal payments. B) The borrower has not violated any covenants but has missed both an interest and principal payment. C) The borrower violates one or more loan covenants but has made all principal payments. D) The borrower violates one or more loan covenants but has made all interest payments. - A) The borrower violates one or more loan covenants but has made all interest and principal payments. 47) According to the SEC, any breach of a loan covenant that existed at the balance sheet date that has not subsequently been cured should: A) be recorded as an adjustment to the financial statements. B) be disclosed in the notes to the financial statements. C) be disclosed in the audit report. D) not be disclosed. - B) be disclosed in the notes to the financial statements. 48) When a debt covenant is violated, the related debt must be classified as current if it is: A) probable that the borrower will not be able to cure the default within the next twelve months. B) probable that the borrower will not be able to cure the default within the next fifteen months. C) probable that the borrower will be able to cure the default in the next twelve months. D) probable that the borrower will be able to cure the default in the next fifteen months. - A) probable that the borrower will not be able to cure the default within the next twelve months. 49) Company A's interest ratio has fallen below the level required by its lender. The lender may not take which action? Version 1 12 A) Gain representation on the company's board of directors. B) Replace the CEO of the company. C) Demand repayment of the loan. D) Veto payment of a dividend. - B) Replace the CEO of the company. 50) Which accounting choice would not be used to reduce the likelihood of a technical default? A) Bad debt provisions B) When to sell assets C) Inventory valuation method D) Management compensation plans - C) Inventory valuation method 51) When a borrower is unable to make a scheduled interest payment, the type of default that occurs is a: A) technical default. B) covenant default. C) payment default. D) transitory default. - C) payment default. 52) A study examining how incentives arising out of debt contracts affect managers' accounting choices found that the most common violations of accounting-based covenants occurred with: A) net worth and working capital restrictions. B) mergers and acquisitions restrictions. C) leveraged buyout restrictions. D) debt restructures. - A) net worth and working capital restrictions. 53) Discretionary accounting accruals are: A) cash financial statement adjustments, which accrue revenue or expenses. B) noncash financial statement adjustments, which accrue revenue or expenses. C) cash financial statement adjustments, which accrue only revenue. D) noncash financial statement adjustments, which accrue only expenses - B) noncash financial statement adjustments, which accrue revenue or expenses. 54) A study of discretionary accounting accruals found that abnormal accruals in the year prior to reporting covenant violations: A) significantly decreased the company's current ratio but significantly increased the company's reported earnings. B) significantly decreased the company's net worth. C) significantly increased reported earnings and increased working capital. D) significantly increased reported earnings and decreased working capital. - C) significantly increased reported earnings and increased working capital. 55) Studies seem to suggest that management tends to make accounting changes and/or manipulate discretionary accruals to: A) enhance technical defaults. B) eliminate debt covenants. C) violate debt covenants. D) avoid violation of debt covenants. - D) avoid violation of debt covenants. 56) Potential conflicts of interest between shareholders and managers may be overcome if managers are given incentives which cause them to behave as if they were: A) creditors. B) owners. C) debtors. D) vendors. Version 1 14 - B) owners. 57) Firms must provide detailed disclosure of three broad executive pay categories. Which of the following is not one of these categories? A) Retirement and other postemployment compensation B) Costs incurred by the corporation for executive travel, entertainment, and other "expense account" items C) Compensation for the last fiscal year and the two preceding years D) Holdings of equity-related interests that relate to compensation - B) Costs incurred by the corporation for executive travel, entertainment, and other "expense account" items 58) Information about a company's executive compensation practices can be found in a company's: A) annual report. B) form 10-K. C) proxy statement. D) form 10-Q. - C) proxy statement. 59) A decrease in market-wide interest rates will result in a/an: A) increase in the cost of equity capital. B) decrease in the cost of equity capital. C) increase in the cost of debt. D) decrease in the demand for fixed-rate bond investments. - B) decrease in the cost of equity capital. 60) Compensation incentives that motivate and reward executives for three to seven years of growth and prosperity are called: A) base salaries. B) short-term incentives. C) long-term incentives. D) executive compensation packages. - C) long-term incentives. 61) Which of the following is not an accurate statement regarding the compensation committee? A) It selects the performance metrics used. B) It may adjust a calculated award up or down at its discretion. C) It is comprised of both internal and external directors. D) It selects the annual or multiyear performance goals. - C) It is comprised of both internal and external directors. 62) Stock options: A) have value only if the market price of the stock declines. B) have value only if the market price of the stock rises. C) are taxed at ordinary rates. D) do not qualify for favorable tax treatment. - B) have value only if the market price of the stock rises. 63) An award of stock that is not transferable or subject to forfeiture for a period of years is called: A) phantom stock. B) treasury stock. C) restricted stock. D) preferred stock. - C) restricted stock. 64) Most executive compensation plans link bonus awards to one or more: A) non-accounting based performance measures. B) accounting-based performance measures. C) marketing-based performance measures. D) management-based performance measures - B) accounting-based performance measures. 65) The widespread use of accounting-based incentives for executive compensation is controversial for which one of the following reasons? A) earnings growth does not automatically increase shareholder value. B) accounting-based incentive plans can encourage managers to adopt a long-term business focus. C) executives cannot use their discretion over the accounting policies. D) managers do not have accounting flexibility - A) earnings growth does not automatically increase shareholder value. 66) Several studies show that incoming CEOs have an incentive to: A) increase earnings in the year of the executive change as well as in years subsequent to the change. B) decrease earnings in the year of executive change and increase earnings in the next year. C) decrease earnings for a few years after taking over to establish a low "bonus baseline." D) take actions that will make his/her predecessor look incompetent thus validating the board's decision to change CEOs. - B) decrease earnings in the year of executive change and increase earnings in the next 67) Which statement best describes stock options? A) Stock options are not an expense on the company's profit and loss statement. B) Stock options obligate the holder to purchase shares at a stated price. C) Stock options give the holder the right to purchase shares at a stated price. D) Stock options have been replaced by restricted stock. - C) Stock options give the holder the right to purchase shares at a stated price. 68) Managers believe it is important to meet earnings benchmarks. When a number of executives were asked-within the parameters of GAAP-which choices your company might make to hit an earnings target, the most popular choice was to: Version 1 17 A) decrease discretionary spending. B) alter accrual assumptions (such as allowances). C) postpone taking an accounting charge. D) draw down on reserves previously set aside. - A) decrease discretionary spending. 69) A clawback provision in an employment contract: A) requires managers to become more conservative in their business decision-making. B) requires managers to respond to compensation committee requests for information. C) requires managers to return bonuses received in the event of a financial statement restatement. D) requires managers to refrain from making discretionary accruals - C) requires managers to return bonuses received in the event of a financial statement 70) With respect to executive pay, which of the following is not correct? A) The proportion of pay "at risk" falls off steeply for executives on lower rungs of the corporate ladder. B) Top executive bonus opportuni•ties have a maximum payout of 200%. C) Most executive compensation packages involve a base salary, an annual incentive, and a long-term incentive. D) Long-term incentives are designed to counterbalance the inherently short-term orientation of other incentives. - B) Top executive bonus opportuni•ties have a maximum payout of 200%. 71) Research has shown that research and development expenditures during the years immediately prior to a CEO's retirement tend to: A) increase by a large amount. B) increase by a small amount. C) decline. D) show no change - C) decline. 72) Compensation plans should: A) not link incentive plans to financial performance. B) not be based on long-term business goals. C) align shareholders' incentives with the objectives of managers. D) align managers' incentives with the objectives of shareholders. - D) align managers' incentives with the objectives of shareholders. 73) Long-term incentive components of executive compensation plans should include stock options: A) to enhance the short-term focus of executives. B) to mitigate the short-term focus of executives. C) to mitigate the long-term focus of executives. D) to encourage better performance by low-level staff. - B) to mitigate the short-term focus of executives. 74) With respect to executive compensation, which statement is not valid? A) Compensation packages are designed to minimize conflicts of interest. B) Stock returns are the best way to align managers' and owners' interests since management's actions control the share price in both the short and long term. C) Executive compensation components are generally linked to stock returns and/or financial performance measures. D) Use of accounting earnings should not be used due to its reliance on valuations that involve subjectivity and judgments. - B) Stock returns are the best way to align managers' and owners' interests since management's actions control the share price in both the short and long term. 75) A compensation committee should be comprised of: A) the CEO and the CFO of the company. B) the CEO of the company and the outside attorney. C) members of the Board of Directors who are also officers of the company. D) members of the Board of Directors who are outside (non-management) directors. - D) members of the Board of Directors who are outside (non-management) directors. 76) Regulatory accounting principles are important to those outside the regulatory agencies because: A) GAAP may allow reporting for assets and liabilities consistent with the way in which regulators establish rates. B) GAAP does not allow reporting for assets and liabilities consistent with the way in which regulators establish rates. C) regulatory accounting principles are not compatible with GAAP. D) the SEC requires them. - A) GAAP may allow reporting for assets and liabilities consistent with the way in which regulators establish rates. 77) Banks that fail to comply with regulations, including the failure to maintain an adequate capital adequacy ratio, face: A) higher costs. B) lower costs. C) mergers and expansion of services. D) incarceration of officers. - A) higher costs. 78) The use of a bank manager's discretion in the timing and amount of loan loss provisions and loan charge-offs can falsely understate the losses and: A) decrease net income. B) decrease bank obligations. C) improve the bank's debt adequacy ratio. D) improve the bank's capital adequacy ratio. - D) improve the bank's capital adequacy ratio. 79) In the banking industry, the ratio of investor capital/gross assets, as defined by RAP, is the: Version 1 20 A) capital asset ratio. B) capital adequacy ratio. C) gross asset ratio. D) indirect capital ratio. - B) capital adequacy ratio. 80) A bank's estimated bad debt expense associated with its loan receivables is the: A) loan loss provision. B) loan charge-offs. C) allowance for loans. D) accumulated loan loss - A) loan loss provision. 1) Contract terms can be designed to eliminate or reduce conflicting incentives that arise in business relationships. ⊚ true ⊚ false - true 2) Contracts include financial reporting information and create incentives for earnings management. True ⊚ false - True 3) Debt covenants help guard against conflicts of interest between creditors and bank regulators. ⊚ true ⊚ false - false 4) Some debt covenants preserve repayment capacity by preventing mergers and acquisitions unless the debt is first repaid. ⊚ true ⊚ false - false 5) Negative covenants tend to be less significant than affirmative covenants because they place direct restrictions on the actions lenders can take. ⊚ true ⊚ false - false 6) Managers wishing to avoid loan covenant violations may resort to making accounting changes that increase reported earnings. ⊚ true - true 7) Potential conflicts of interest between managers and owners can be overcome if compensation packages are tied to improvement in firm value. ⊚ true ⊚ false - true 8) Most compensation packages involve a base salary, an annual incentive, and a short-term incentive. ⊚ true ⊚ false - ⊚ false 9) When restricted stock is granted as executive compensation, the recipient must and exercising voting rights until the restriction period ends. ⊚ true ⊚ false - false 10) Research shows that managers sometimes use accounting flexibility to evade contract constraints in order to gain bonus benefits. ⊚ true ⊚ false - ⊚ true 12) Banks and other financial institutions are required by federal and state regulatory agencies to meet minimum lending requirements. Version 1 3 ⊚ true ⊚ false - false 11) A factor that can affect managers' incentives for short-term focus on performance is that a compensation committee oversees incentive plans and can intervene when circumstances warrant modification of the scheduled incentive award. ⊚ true ⊚ false - true 13) Under RAP, loan charge-offs decrease bank capital and also reduce bank net income. ⊚ true ⊚ false - false 14) Many managers believe that meeting earnings benchmarks helps to build credibility with investors. ⊚ true ⊚ false - true 16) Increasingly, information on social issues is included in required financial reporting in the U.S. ⊚ true ⊚ false - true 15) A difference of one penny between reported EPS and analysts' expectations of EPS matters a lot to investors. ⊚ true ⊚ false - true 82) In the utilities industry, image advertising and customer safety advertising are: A) both paid for by customers. B) both paid for by shareholders. C) both treated as operating expenses under RAP. D) both treated as operating expenses under GAAP. - D) both treated as operating expenses under GAAP. 83) Rate regulation provides incentives for public utility managers to: Version 1 21 A) artificially decrease the asset base. B) artificially increase the asset base. C) artificially decrease operating expenses. D) artificially decrease taxes - B) artificially increase the asset base. 84) IRS regulations govern the: A) computation of net income for GAAP. B) computation of net income for tax purposes. C) computation of gross profit for GAAP. D) computation of net income for the SEC. - B) computation of net income for tax purposes. 85) Regulatory Accounting Principles (RAP) can be used: A) to set the prices customers may be charged. B) as a basis for supervisory action. C) as a source of statistical information. D) to determine the amount of dividend to be paid - D) to determine the amount of dividend to be paid. 86) Which of the following does not properly represent the relation of tax and GAAP accounting? A) Companies using FIFO for financial statements prefer FIFO for tax purposes because FIFO results in a lower taxable income. B) GAAP and tax depreciation expense will rarely be equal. C) If LIFO is used for inventory valuation for taxes, LIFO must also be used for GAAP financial reporting. D) The accounting methods used for tax are permitted to differ from GAAP rules. - A) Companies using FIFO for financial statements prefer FIFO for tax purposes because FIFO results in a lower taxable income. 88) Which of the following did not contribute to the 2008 financial meltdown? A) the packaging/bundling of traditional mortgages to be sold as investments. B) the speculative bubble related to housing demand drove up prices which proved to be unsustainable. C) an increase in traditional 30 year mortgages. D) the issuance of high-risk/subprime mortgage loans - C) an increase in traditional 30 year mortgages. 87) Which of the following statements does not reflect the provisions of ASU 2016-01 related to fair value measurement? Version 1 22 A) It requires minority-passive equity investments (generally less than 20% ownership) to be measured at fair value with changes in fair value recognized in net income, unless there is no readily determinable fair value. B) It simplifies the impairment assessment of equity investments that do not have readily determin•able fair values. C) It requires an entity applying the fair value option to its own liabilities to recognize in net income the change in fair value attributable to the entity's creditworthiness. D) It requires an entity applying the fair value option to its own liabilities to recognize in other comprehensive income (not net income) the change in fair value attributable to the entity's creditworthiness. - C) It requires an entity applying the fair value option to its own liabilities to recognize in net income the change in fair value attributable to the entity's creditworthiness. 89) Banking regulators have a powerful weapon to encourage compliance with minimum capital guidelines as they can compel a noncomplying bank to do any or all of the following except: A) require the bank to increase the number of outside directors on its board. B) require the bank to submit a plan describing how and when its capital will be increased. C) subject the bank to more frequent examinations by the regulator. D) deny a request to merge, open new branches, or expand services - A) require the bank to increase the number of outside directors on its board.