ACCT 2001 Study Guide - Final Guide: International Financial Reporting Standards, Cash Cash, Retained Earnings

QUESTION 1 The knowledge of financial accounting can assist people with decisions such as whether to extend credit to a business. True False 0.2 points Saved QUESTION 2 Employees of a company would not have a reason to use the information provided by financial accounting. True False 0.2 points Saved

QUESTION 3 Financial accounting should be used for assessing the financial health of large organizations only. True False 0.2 points Saved

QUESTION 4 Financial accounting can be helpful for a job candidate who is assessing the financial future of a potential employer. True False 0.2 points Saved QUESTION 5 Lenders might use the information produced by financial accounting when making loan decisions. True False 0.2 points Saved

QUESTION 6 Credit analysts prefer not to use information provided by financial accounting, as it is not accurate. True False 0.2 points Saved

QUESTION 7 Financial accounting is helpful to investment advisors. True False 0.2 points Saved

QUESTION 8 Financial accounting is more useful than managerial accounting. True False 0.2 points Saved

QUESTION 9 The decision to buy or rent equipment is an example of a decision aided by managerial accounting. True False 0.2 points Saved

QUESTION 10 Which of the following statements is true of financial accounting? A. It is used by external parties to make investment decisions. B. It is used to make lease or purchase decisions. C. Managerial accounting is another name for financial accounting, D. It is primarily used to make internal decisions of a business. E. The effectiveness of advertising can be judged using financial accounting. 0.2 points Saved QUESTION 11 The charge for using money over time, often associated with long-term loans, is known as: A. interest. B. principal. C. distribution charge. D. cash dividend. E. preferred dividend. 0.2 points Saved QUESTION 12 Which of the following is a common feature of financial and managerial accounting? A. Both have same objectives B. Both are prepared according to U.S. GAAP C. Both are reported at year end in the annual report D. Both are analyzed by external users while making investment decisions E. Both are used by the management in making decisions 0.2 points Saved

QUESTION 13 Dividends are required to be paid to stockholders on an annual basis. True False 0.2 points Saved

QUESTION 14 An individual who owns one or more shares of stock in a corporation is an owner of that corporation. True False 0.2 points Saved

QUESTION 15 Corporations do not exist as separate legal entities apart from their owners. True False 0.2 points Save Answer

QUESTION 16 It is very difficult to buy or sell ownership shares of a corporation in a stock exchange. True False 0.2 points Saved

QUESTION 17 Stock markets match up investors who wish to buy shares with those who wish to sell them. True False 0.2 points Saved

QUESTION 18 Legal process by which owners of an organization apply to a state government to have it identified as an entity legally separate from its owners is called: A. stocking. B. filling. C. attributing. D. registration. E. incorporation. 0.2 points Saved

QUESTION 19 An advantage of ownership in a sole proprietorship over ownership in a corporation is: A. tax benefits. B. having a board of directors. C. the ability to raise capital through issuance of stock. D. separation of owner and business as legal entities. E. limited liability for debts. 0.2 points Saved

QUESTION 20 Who hires the management of a corporation? A. Stockholders B. Board of directors C. Creditors D. Government E. SEC 0.2 points Saved QUESTION 21 Inventory refers to the: A. excess amount paid for an asset over its fair value. B. intangible assets of a business. C. merchandise bought or manufactured for the purpose of selling. D. amount of net income reinvested by company for future operations. E. revenue generated from investment. 0.2 points Saved QUESTION 22 Investors use financial information to predict whether a: A. company will recruit more employees. B. company's stock price will increase C. company has invested in buildings. D. company will pay salaries. E. company's bond price will increase. 0.2 points Saved

QUESTION 23 Financial accounting can be compared to a portrait. True False 0.2 points Saved

QUESTION 24 Financial statements provide the form and structure for the conveyance of financial information that will create a likeness of the reporting organization. True False 0.2 points Saved

QUESTION 25 The information reported in financial statements must be exact for an investor to make any decision. True False 0.2 points Saved

1 of 50

Investments in debt securities, such as bonds, may be classifiedas either current or long-term assets.

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2 of 50

Marketable securities that are held until the due date of thesecurities are

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3 of 50

Which of the following business types is most common as measuredby the amount of business transacted?

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4 of 50

Depreciation is based upon cost, useful life, and salvagevalue.

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5 of 50

Because depreciation is not cash-based, it is NOT reported inthe direct method of the statement of cash flows.

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6 of 50

A company has a petty cash fund of $200. At the end of themonth, $6.41 remains in the fund along with $190.96 in variousreceipts. The journal entry to replenish the fund would show adebit(s) to

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7 of 50

A 12-month, 8% note dated August 1, 2013 for $5,000 would haveaccrued interest payable on December 31, 2013 of $166.67.

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8 of 50

Warranty expense must be estimated and matched to revenues.

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9 of 50

Upgrading the RAM on a computer would be an example of a(n)

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10 of 50

The formula for the quick ratio is quick assets divided bynoncurrent assets.

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11 of 50

Which of the following are considered to be legal entities thatexist separate and distinct from their owners?

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12 of 50

Patents and copyrights can be seen, held, or touched.

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13 of 50

Which of the following would be considered part of the cost ofmachinery and equipment?

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14 of 50

The business or person that signs the note and promises to paythe required amount is called the payee.

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15 of 50

Conley Company has a petty cash fund of $300. At the end of themonth, $42.38 remains in the fund along with $260.75 in variousreceipts. The journal entry to replenish the fund would bedebit

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16 of 50

Neither land nor land improvements are depreciated.

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17 of 50

Using a 365-day year, the maturity value of a 180-day note for$2,700 at 9% annual interest is (rounded to the nearest cent)

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18 of 50

On January 1, Bestway, Inc. signed a $175,000, 8%, 30-yearmortgage that requires semiannual payments of $7,735 on June 30 andDecember 31 of each year. The journal entry to record the secondsemiannual payment would be (round interest calculation to thenearest dollar) to

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19 of 50

Allied Industries purchased a piece of equipment for $65,000with an estimated salvage value of $15,000 on January 1. Itsestimated life is five years. To the nearest dollar, what is theequipment's depreciation using double-declining-balance for yeartwo?

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20 of 50

Payroll is also called employee compensation and can consist ofmany parts.

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21 of 50

The number of shares of stock that a corporation is given theright to sell is called

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22 of 50

Which of the following would NOT be considered part of the costof machinery and equipment?

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23 of 50

Equipment costing $118,000 has accumulated depreciation of$92,000. The equipment is a trade-in for new equipment costing$187,000. If the trade-in value received for the old equipment is$30,000, the journal entry to record this transaction is to

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24 of 50

Liberty Company has declared a $40,000 cash dividend toshareholders. The company has 5,000 shares of $20-par, 6% preferredstock and 10,000 shares of $15-par common stock. The preferredstock is cumulative. How much will be distributed to the preferredand common stockholders on the date of payment if the preferredstock is $12,000 in arrears?

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25 of 50

In accounting, what is the meaning of capitalized?

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26 of 50

Interest is an expense to the debtor and income to thecreditor.

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27 of 50

Cash consists of anything that a bank will take as adeposit.

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28 of 50

The cost of long-term assets must be allocated to an expense asthe asset is used up.

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29 of 50

The process of acquiring merchandise from a supplier begins withthe

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30 of 50

Appleway Corporation purchases a machine for $125,000. It has anestimated salvage value of $10,000 and is expected to produce50,000 units in its lifetime. During the first year of operation,it produced 14,500 units. To the nearest dollar, the depreciationfor the first year under the units of production method will be

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31 of 50

Book value is depreciable cost minus accumulateddepreciation.

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32 of 50

The records of Inland Equipment showed a net loss of $30,000,depreciation expense of $25,000, and an increase in supplies onhand of $5,000. The amount of net cash flow from operatingactivities using the indirect method is

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33 of 50

Retained earnings represent internally generated capital.

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34 of 50

A company issues 15,000 shares of its $25 par common stock for$29 per share. The amount to be debited to Cash is

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35 of 50

On September 1, 2012, Juno Corp. lent $2,400 to Bill Askins on asix-month 8% promissory note. The journal entry to record the notefor Juno Corp. would be to:

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36 of 50

Separation of duties is essential for internal control over cashreceipts and cash payments.

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37 of 50

Which of the following would indicate poor internal control overaccounts receivable?

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38 of 50

Limited liability means that the stockholders of a corporationshare a personal liability for all debts of the corporation.

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39 of 50

Accumulated depletion is a(n)

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40 of 50

Allied Industries reported net income of $52,000, depreciationexpenses of $13,000, a gain on a land sale of $3,000, and adecrease in accounts receivable of $1,500. Under the indirectmethod, net cash flows from operations is

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41 of 50

The portion of stockholders' equity that can be used fordividends is referred to as legal capital.

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42 of 50

Franklin Industries had total assets of $560,000; totalliabilities of $250,000; and total stockholders' equity of$310,000. Franklin Industries debt ratio is

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43 of 50

Financial analysis is used to predict the future of abusiness.

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44 of 50

Online banking should NOT be used to reconcile the bankaccount.

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45 of 50

Costs of testing machinery or equipment before they are usedwould be included in the price of the machinery or theequipment.

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46 of 50

There are two methods for accounting for uncollectiblereceivables.

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47 of 50

Assets that are NOT expected to provide benefits for a number ofaccounting periods are called

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48 of 50

The allowance method of accounting for bad debts is required byGAAP because of the materiality principle.

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49 of 50

A stock dividend affects total stockholders' equity.

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50 of 50

Realized gains and losses only occur when the security is soldfor more or less than the original cost.

Problem

The Enron Fraud Enron Corporation began as a small natural gas distributor and over the course of 15 years grew to become the seventh largest company in the United States. Soon after the federal deregulation of natural gas pipelines in 1985, Enron was born by the merging of Houston Natural Gas and Inter North, a Nebraska pipeline company. Initially, Enron was merely involved in the distribution of gas, but it later became a market leader in facilitating the buying and selling of futures of natural gas, electricity, broadband, and other products. However, Enron’s continuous growth eventually came to an end as a complicated financial statement fraud and multiple scandals sent Enron on a downward spiral to bankruptcy.

During the 1980s, several major national energy corporations began lobbying Washington to deregulate the energy business. Their claim was that the extra competition resulting from a deregulated market would benefit both businesses and consumers. Consequently, the national government began to lift controls on who was allowed to produce energy and how it was marketed and sold. But, as competition in the energy market increased, gas and energy prices began to fluctuate greatly. Over time, Enron incurred massive debts and no longer had exclusive rights to its pipelines. It needed some new and innovative business strategies.

Kenneth Lay, chairman and CEO, hired the consulting firm McKinsey & Company to assist in developing a new plan to help Enron get back on its feet. Jeff Skilling, a young McKinsey consultant who had a background in banking and asset and liability management, was assigned to work with Enron. He recommended that Enron create a “gas bank” to buy and sell gas. Skilling, who later became chief executive at Enron, recognized that Enron could capitalize on the fluctuating gas prices by acting as a middleman and creating a futures market for buyers and sellers of gas; it would buy and sell gas to be used tomorrow at a stable price today.

Although brilliantly successful in theory, Skilling’s gas bank idea faced a major problem. The natural gas producers who agreed to supply Enron’s gas bank desperately needed cash and required cash as payment for their products. But Enron also had insufficient cash levels. Therefore, management decided to team up with banks and other financial institutions, establishing partnerships that would provide the cash needed to complete the transactions with Enron’s suppliers. Under the direction of Andrew Fastow, a newly hired financial genius, Enron also created several special purpose entities (SPEs), which served as the vehicles through which money was funneled from the banks to the gas suppliers, thus keeping these transactions off Enron’s books. As Enron’s business became more and more complicated, its vulnerability to fraud and eventual disaster also grew. Initially, the newly formed partnerships and SPEs worked to Enron’s advantage. But, in the end, it was the creation of these SPEs that culminated in Enron’s death.

Within just a few years of instituting its gas bank and the complicated financing system, Enron grew rapidly, controlling a large part of the U.S. energy market. At one point, it controlled as much as a quarter of all of the nation’s gas business. It also began expanding to create markets for other types of products, including electricity, crude oil, coal, plastics, weather derivatives, and broadband. In addition, Enron continued to expand its trading business and with the introduction of EnronOnline in the late 1990s, it became one of the largest trading companies on Wall Street, at one time generating 90 percent of its income through trades. Enron soon had more contracts than any of its competitors and, with market dominance, could predict future prices with great accuracy, thereby guaranteeing superior profits.

To continue enhanced growth and dominance, Enron began hiring the “best and brightest” traders. But Enron was just as quick in firing its employees as it was in hiring new ones. Management created the Performance Review Committee (PRC), which became known as the harshest employee ranking system in the country. Its method of evaluating employee performance was nicknamed “rank and yank” by Enron employees. Every six months, employees were ranked on a scale of 1 to 5. Those ranked in the lowest category (1) were immediately “yanked” (fired) from their position and replaced by new recruits. Surprisingly, during each employee review, management required that at least 15 percent of all the employees ranked were given a 1 and therefore yanked from their position and income. The employees ranked with a 2 or 3 were also given notice that they were liable to be released in the near future. These ruthless performance reviews created fierce internal competition between fellowemployees who faced a strict ultimatum—performor be replaced. Furthermore, it created a work environment where employees were unable to express opinions or valid concerns for fear of a low-ranking score by their superiors.

With so much pressure to succeed and maintain its position as the global energy market leader, Enron began to jeopardize its integrity by committing fraud. The SPEs, which originally were used for good business purposes, were now used illegally to hide bad investments, poor-performing assets, and debt; to manipulate cash flows; and eventually, to report over $1 billion of false income. The following examples illustrate how specific SPEs were used fraudulently.

Chewco In 1993, Enron and the California Public Employees’ Retirement System (CalPERS) formed a 50/50 partnership called Joint Energy Development Investments Limited (JEDI). In 1997, Enron’s Andrew Fastow established the Chewco SPE, which was designed to repurchase CalPERS’ share of equity in JEDI at a large profit. However, Chewco crossed the bounds of legality in two ways.

First, it broke the 3 percent equity rule, which allowed corporations such as Enron to “not consolidate” if outsiders contributed even 3 percent of the capital, but the other 97 percent could come from the company. When Chewco bought out JEDI, however, half of the $ 11.4 million that bought the 3 percent equity involved cash collateral provided by Enron, meaning that only 1.5 percent was owned by outsiders. Therefore, the debts and losses incurred at Chewco were not listed where they belonged, on Enron’s financial reports, but remained only on Chewco’s separate financial records.

Second, since Fastow was an Enron officer, he was, therefore, unauthorized to personally run Chewco without direct approval from Enron’s board of directors and public disclosure with the SEC. In an effort to secretly bypass these restrictions, Fastow appointed one of his subordinates, Michael Kopper, to run Chewco under Fastow’s close supervision and influence. Fastow continually applied pressure to Kopper to prevent Enron from getting the best possible deals from Chewco and therefore giving Kopper huge profits.

Chewco was eventually forced to consolidate its financial statements with Enron. By doing so, however, it caused large losses on Enron’s balance sheet and other financial statements. The Chewco SPE accounted for 80 percent (approximately $400 million) of all of Enron’s SPE restatements. Moreover, Chewco set the stage for Fastow as he continued to expand his personal profiting SPE empire.

LJM 1 & 2 The LJM SPEs (LJM1 and LJM2) were two organizations sponsored by Enron that also participated heavily in fraudulent deal making. LJM1 and its successor, LJM2, were similar to the Chewco SPE in that they also broke the two important rules set forth by the SEC. First, although less than 3 percent of the SPE equity was owned by outside investors, LJM’s books were kept separate from Enron’s. An error in judgment by Arthur Andersen allowed LJM’s financial statements to go unconsolidated. Furthermore, Fastow (now CFO at Enron) was appointed to personally oversee all operations at LJM. Without the governing controls in place, fraud became inevitable.

LJM1 was first created by Fastow as a result of a deal Enron had made with a high-speed Internet service provider called Rhythms Net Connections. In March 1998, Enron purchased $10 million worth of shares in Rhythms and agreed to hold the shares until the end of 1999, when it was authorized to sell those shares. Rhythms released its first IPO in April 1999, and Enron’s share of Rhythms stock immediately jumped to a net worth of $300 million.

Fearing that the value of the stock might drop again before it could be sold, Enron searched for an investor from whom it would purchase a put option (i.e., insurance against a falling stock price). However, because Enron had such a large share and because Rhythms was such a risky company, Enron could not find an investor at the price Enron was seeking. So, with the approval of the board of directors and a waiver of Enron’s code of conduct, Fastow created LJM1, which used Enron stock as its capital to sell the Rhythms stock put options to Enron. In effect, Enron was insuring itself against a plummeting Rhythms stock price. But, since Enron was basically insuring itself and paying Fastow and his subordinates millions of dollars to run the deal, Enron really had no insurance. With all of its actions independent of Enron’s financial records, LJM1 was able to provide a hedge against a profitable investment.

LJM2 was the sequel to LJM1 and is infamous for its involvement in four major deals known as the Raptors. The Raptors were deals made between Enron and LJM2 that enabled Enron to hide losses from Enron’s unprofitable investments. In total, LJM2 hid approximately $1.1 billion worth of losses from Enron’s balance sheet.

LJM1 and LJM2 were used by Enron to alter its actual financial statements and by Fastow for personal profits. Enron’s books took a hard hit when LJM finally consolidated its financial statements, a $100 million SPE restatement. In the end, Fastow pocketed millions of dollars from his involvement with the LJM SPEs.

Through complicated accounting schemes, Enron was able to fool the public for a time into thinking that its profits were continually growing. The energy giant cooked its books by hiding significant liabilities and losses from bad investments and poor assets, by not recognizing declines in the value of its aging assets, by reporting over $1 billion of false income, and by manipulating its cash flows, often during fourth quarters. However, as soon as the public became aware of Enron’s fraudulent acts, both investors and the company suffered. As investor confidence in Enron dropped because of its fraudulent deal making, so did Enron’s stock price. In just one year, Enron stock plummeted from a high of about $95 per share to below $1 per share. The decrease in equity made it impossible for Enron to cover its expenses and liabilities, and it was forced to declare bankruptcy on December 2, 2001. Enron had been reduced from a company claiming almost $62 billion worth of assets to nearly nothing.

Questions

1. What important internal controls were ignored when LJM1 was created?

2. How might Enron’s harsh Performance Review Committee have aided company executives in committing the fraud?

3. The fraud at Enron is one of many major financial statement frauds that have occurred in recent years (Qwest, Global Crossing, WorldCom, etc.). What are some factors that could explain why the falsifying of financial statements is occurring so frequently? List four factors.

4. Suppose you are a certified fraud examiner but enjoy investing in the stock market as an additional source of income. On research of Enron’s stock, you notice that although its stock has a history of strong growth and a seemingly promising future, Enron’s financial reports are unclear and, frankly, confusing. In fact, you can’t even explain how Enron is making money. Could this lack of clarity in its financial reporting serve as a red flag in alerting you to the possibility of fraud at Enron? Why or why not?

5. How could the auditor, Arthur Andersen in this case, have performed Enron’s audits and not caught the fraud? Is it possible for a financial statement auditor to perform an audit in compliance with generally accepted auditing standards (GAAS) and not catch major financial statement fraud? How would GAAS auditing need to change to guarantee that all frauds are caught?