WSP ACCOUNTING Technicals| EXAM QUESTIONS
WITH ANSWERS VERIFIED 100% CORRECT|
If you have a balance sheet and must choose between the income statement or cash
flow statement, which would you pick? - ✔✔Assuming that I would be given both the
beginning and end of period balance sheets, I would choose the income statement since
I could reconcile the cash flow statement using the balance sheet's year-over-year
changes along with the income statement.
Which is more important, the income statement or the cash flow statement? -
✔✔The income statement and cash flow statement are both necessary, and any in-
depth analysis would require using both. However, the cash flow statement is arguably
more important because it reconciles net income, the accrual-based bottom line on the
income statement, to what is actually occurring to cash.
This means the actual movement of cash during the period is reflected on the cash flow
statement. Thus, the cash flow statement brings attention to liquidity-related issues and
investments and financing activities that don't show up on the accrual-based income
statement.
If you had to pick between either the income statement or cash flow statement to
analyze a company, which would you pick? - ✔✔In most cases, the cash flow
statement would be chosen since the cash flow statement reflects a company's true
liquidity and is not prone to the same discretionary accounting conventions used in
accrual accounting. Whether you're an equity investor or lender, a company's ability to
generate sufficient free cash flow to reinvest into its operations and meet its debt
obligations comes first. At the end of the day, "cash is king."
Although one factor that could switch the answer is the company's profitability. For an
unprofitable company, the income statement can be used to value the company based
on a revenue multiple. The cash flow statement becomes less useful for valuation
,purposes if the company's net income, cash from operations, and free cash flow are all
negative.
Why is the income statement insufficient to assess the liquidity of a company? -
✔✔The income statement can be misleading in the portrayal of a company's health
from a liquidity and solvency standpoint.
For example, a company can consistently show positive net income yet struggle to
collect sales made on credit. The company's inability to retrieve payments from
customers would not be reflected on its income statement.
Financial reporting under accrual accounting is also imperfect in the sense that it often
relies on management discretion. This "wiggle room" for managerial discretion in
reporting decisions increases the risk of earnings management and the misleading
depiction of a company's actual operational performance.
The solution to the shortcomings of the income statement is the cash flow statement,
which reconciles net income based on the real cash inflows/(outflows) to understand
the true cash impact from operations, investing, and financing activities during the
period.
What are some discretionary management decisions that could inflate earnings? -
✔✔Using excess useful life assumptions for new capital expenditures to reduce the
annual depreciation
Switching from LIFO to FIFO if inventory costs are expected to increase, resulting in
higher net income
Refusing to write-down impaired assets to avoid the impairment loss, which would
reduce net income
,Changing policies for costs to be capitalized rather than expensed (e.g., capitalized
software costs)
Repurchasing shares to decrease its share count and artificially increase earnings per
share ("EPS")
Deferral of capex or R&D to the next period to show more profitability and cash flow in
the current period
More aggressive revenue recognition policies in which the obligations of the buyer
become less stringent
Tell me about the revenue recognition and matching principle used in accrual
accounting. - ✔✔Revenue Recognition Principle: Revenue is recorded in the same
period the good or service was delivered (and therefore "earned"), whether or not cash
was collected from the customer.
Matching Principle: The expenses associated with the production/delivery of a good or
service must be recorded in the same period as when the revenue was earned.
How does accrual accounting differ from cash-basis accounting? - ✔✔Accrual
Accounting: For accrual accounting, revenue recognition is based on when it's earned
and the expenses associated with that revenue are incurred in the same period.
Cash-Basis Accounting: Under cash-basis accounting, revenues and expenses are
recognized once cash is received or spent, regardless of whether the product or service
was delivered to the customer.
, What is the difference between cost of goods sold and operating expenses? -
✔✔Cost of Goods Sold: COGS represents the direct costs associated with the
production of the goods sold or the delivery of services to generate revenue. Examples
include direct material and labor costs.
Operating Expenses: Operating expenses such as SG&A and R&D are not directly
associated with the production of goods or services offered. Often called indirect costs,
examples include rent, payroll, wages, commissions, meal and travel expenses,
advertising, and marketing expenses.
When do you capitalize vs. expense items under accrual accounting? - ✔✔The factor
that determines whether an item gets capitalized as an asset or gets expensed in the
period incurred is its useful life (i.e., estimated timing of benefits).
Capitalized: Expenditures on fixed and intangible assets expected to benefit the firm for
more than one year need to be capitalized and expensed over time. For example, PP&E
such as a building can provide benefits for 15+ years and is therefore depreciated over
its useful life.
Expensed: In contrast, when the benefits received are short-term, the related expenses
should be incurred in the same period. For example, inventory cycles out fairly quickly
within a year and employee wages should be expensed when the employee's services
were provided.
If depreciation is a non-cash expense, how does it affect net income? - ✔✔While
depreciation is treated as non-cash and an add-back on the cash flow statement, the
expense is taxdeductible and reduces the tax burden. The actual cash outflow for the
initial purchase of PP&E has already occurred, so the annual depreciation is the non-
cash allocation of the initial outlay at purchase.
WITH ANSWERS VERIFIED 100% CORRECT|
If you have a balance sheet and must choose between the income statement or cash
flow statement, which would you pick? - ✔✔Assuming that I would be given both the
beginning and end of period balance sheets, I would choose the income statement since
I could reconcile the cash flow statement using the balance sheet's year-over-year
changes along with the income statement.
Which is more important, the income statement or the cash flow statement? -
✔✔The income statement and cash flow statement are both necessary, and any in-
depth analysis would require using both. However, the cash flow statement is arguably
more important because it reconciles net income, the accrual-based bottom line on the
income statement, to what is actually occurring to cash.
This means the actual movement of cash during the period is reflected on the cash flow
statement. Thus, the cash flow statement brings attention to liquidity-related issues and
investments and financing activities that don't show up on the accrual-based income
statement.
If you had to pick between either the income statement or cash flow statement to
analyze a company, which would you pick? - ✔✔In most cases, the cash flow
statement would be chosen since the cash flow statement reflects a company's true
liquidity and is not prone to the same discretionary accounting conventions used in
accrual accounting. Whether you're an equity investor or lender, a company's ability to
generate sufficient free cash flow to reinvest into its operations and meet its debt
obligations comes first. At the end of the day, "cash is king."
Although one factor that could switch the answer is the company's profitability. For an
unprofitable company, the income statement can be used to value the company based
on a revenue multiple. The cash flow statement becomes less useful for valuation
,purposes if the company's net income, cash from operations, and free cash flow are all
negative.
Why is the income statement insufficient to assess the liquidity of a company? -
✔✔The income statement can be misleading in the portrayal of a company's health
from a liquidity and solvency standpoint.
For example, a company can consistently show positive net income yet struggle to
collect sales made on credit. The company's inability to retrieve payments from
customers would not be reflected on its income statement.
Financial reporting under accrual accounting is also imperfect in the sense that it often
relies on management discretion. This "wiggle room" for managerial discretion in
reporting decisions increases the risk of earnings management and the misleading
depiction of a company's actual operational performance.
The solution to the shortcomings of the income statement is the cash flow statement,
which reconciles net income based on the real cash inflows/(outflows) to understand
the true cash impact from operations, investing, and financing activities during the
period.
What are some discretionary management decisions that could inflate earnings? -
✔✔Using excess useful life assumptions for new capital expenditures to reduce the
annual depreciation
Switching from LIFO to FIFO if inventory costs are expected to increase, resulting in
higher net income
Refusing to write-down impaired assets to avoid the impairment loss, which would
reduce net income
,Changing policies for costs to be capitalized rather than expensed (e.g., capitalized
software costs)
Repurchasing shares to decrease its share count and artificially increase earnings per
share ("EPS")
Deferral of capex or R&D to the next period to show more profitability and cash flow in
the current period
More aggressive revenue recognition policies in which the obligations of the buyer
become less stringent
Tell me about the revenue recognition and matching principle used in accrual
accounting. - ✔✔Revenue Recognition Principle: Revenue is recorded in the same
period the good or service was delivered (and therefore "earned"), whether or not cash
was collected from the customer.
Matching Principle: The expenses associated with the production/delivery of a good or
service must be recorded in the same period as when the revenue was earned.
How does accrual accounting differ from cash-basis accounting? - ✔✔Accrual
Accounting: For accrual accounting, revenue recognition is based on when it's earned
and the expenses associated with that revenue are incurred in the same period.
Cash-Basis Accounting: Under cash-basis accounting, revenues and expenses are
recognized once cash is received or spent, regardless of whether the product or service
was delivered to the customer.
, What is the difference between cost of goods sold and operating expenses? -
✔✔Cost of Goods Sold: COGS represents the direct costs associated with the
production of the goods sold or the delivery of services to generate revenue. Examples
include direct material and labor costs.
Operating Expenses: Operating expenses such as SG&A and R&D are not directly
associated with the production of goods or services offered. Often called indirect costs,
examples include rent, payroll, wages, commissions, meal and travel expenses,
advertising, and marketing expenses.
When do you capitalize vs. expense items under accrual accounting? - ✔✔The factor
that determines whether an item gets capitalized as an asset or gets expensed in the
period incurred is its useful life (i.e., estimated timing of benefits).
Capitalized: Expenditures on fixed and intangible assets expected to benefit the firm for
more than one year need to be capitalized and expensed over time. For example, PP&E
such as a building can provide benefits for 15+ years and is therefore depreciated over
its useful life.
Expensed: In contrast, when the benefits received are short-term, the related expenses
should be incurred in the same period. For example, inventory cycles out fairly quickly
within a year and employee wages should be expensed when the employee's services
were provided.
If depreciation is a non-cash expense, how does it affect net income? - ✔✔While
depreciation is treated as non-cash and an add-back on the cash flow statement, the
expense is taxdeductible and reduces the tax burden. The actual cash outflow for the
initial purchase of PP&E has already occurred, so the annual depreciation is the non-
cash allocation of the initial outlay at purchase.
