review questions chapter 3

Topics: Financial ratio, Financial ratios, Generally Accepted Accounting Principles Pages: 6 (1636 words) Published: November 12, 2014
Group: 5Vi Number: 1550633 Name: Estefania Gutierrez Sanmiguel Team: 4 Review Questions Chapter 3

1 What roles do GAAP, the FASB, and the PCAOB play in the financial reporting activities of public companies? 2 Describe the purpose of each of the four major financial statements. The purposes of each of the 4 major financial statements are: Income Statement—the purpose of the income statement is to provide a financial summary of the firm’s operating results during a specified time period. It includes both the sales for the firm and the costs incurred in generating those sales. Other expenses, such as taxes, are also included on this statement. Balance Sheet—the purpose of the balance sheet is to present a summary of the assets owned by the firm, the liabilities owed by the firm, and the net financial position of the owners as of a given point in time. The assets are often referred to as investments and the liabilities and owners equity as financing. Statement of Retained Earnings—this statement reconciles the net income earned during the year, and any cash dividends paid, with the change in retained earnings during the year.

Statement of Cash Flows—this statement provides a summary of the cash inflows and the cash outflows experienced by the firm during the period of concern. The inflows and outflows are grouped into the cash flow areas of operations, investment, and financing.

3 Why are the notes to the financial statements important to professional securities analysts
The notes to the financial statements are important because they provide detailed information not directly available in the financial statements. The footnotes provide information on accounting policies, procedures, calculation, and transactions underlying entries in the financial statements.

4 How is the current rate (translation) method used to consolidate a firm’s an foreign and domestic financial statements?
Financial Accounting Standards Board Statement No. 52 describes the rules for consolidating a company’s foreign and domestic financial statements. It requires U.S.-based companies to translate foreign-currency-denominated assets and liabilities into U.S. dollars using the current rate (translation) method. This method uses the exchange rate prevailing on the date the fiscal year ends (the current rate). Income statement items can be translated using either the current rate or an average exchange rate for the period covered by the statement. Equity accounts are converted at the exchange rate on the date of the investment. In the retained earnings account any gains and losses from currency fluctuations are stated separately in an equity reserve accountthe cumulative translation adjustment accountand not realized until the parent company sells or closes the foreign operations.

5 With regard to financial ratio analysis, how do the viewpoints held by the firm’s present and prospective shareholders, creditors, and management differ?
Current and prospective shareholders place primary emphasis on the firm’s current and future level of risk and return as measures of profitability, while creditors are more concerned with short-term liquidity measures of debt. Stockholders are, therefore, most interested in income statement measures, and creditors are most concerned with balance sheet measures. Management is concerned with all ratio measures, since they recognize that stockholders and creditors must see good ratios in order to keep the stock price up and raise new funds.

6 What is the difference between cross-sectional and time-series ratio analysis? What is benchmarking?
Cross-sectional comparisons are made by comparing similar ratios for firms within the same industry, or to an industry average, as of some point in time. Time-series comparisons are made by comparing similar ratios for a firm measured at various points in time. Benchmarking is the term used to describe this cross-sectional comparison with...
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