C14 Financial Forecasting 2.10 Topic 2

2.10 Topic 2 Review


Assessment Section 1
1
1/1
TellAll reports retained earnings of $1,122 and $1,402 for 20X1 and 20X2,
respectively. Additionally, the firm paid dividends of $200 and $225 in 20X1 and
20X2, respectively. What was TellAll’s net income for 20X2?

 $55
 $280
 Correct


$505

 $1,225

New RE = Old RE + NI – Div

$1,402 = $1,122 + NI – $225

NI = $505

2
1/1
Which of the following represent potential uses of net income under the accrual
accounting system?

 Retain within the firm and use for research/development
 Pay dividends and use for research/development
 Pay dividends and make charitable contributions
 Correct


Retain within the firm and pay dividends

There are only two things a company can do with its net income: (1) pay it out as
dividends to shareholders, or (2) retain it within the firm.

3
1/1
BackJack reports retained earnings of $15,225 for 20X2. The firm paid dividends
of $4,000 and $2,025 in 20X1 and 20X2, respectively. Additionally, the firm

, reported net income of $8,000 and $5,000 in 20X1 and 20X2, respectively. What
were BackJack’s reported retained earnings for 20X1?

 $2,975
 $4,075
 Correct


$12,250

 $18,200

For this problem, we need to remember that the retained earnings on the
balance sheet are the sum of the historical retained earnings from the past
income statements. The New RE on the balance sheet will equal the prior RE
from the balance sheet the period before (Old RE) plus the new RE from the
income statement. Recall that we can compute the new retained earnings from
the income statement as Net Income (NI) minus the dividends paid (Div). This is
because the firm can do two things with its net income: either pay it out as
dividends or plow it back into the firm as RE. The equation for this logic is New
RE = Old RE + (NI – Div). If we solve for Old RE by subtracting (NI – Div) from both
sides of the equation, we get New RE – (NI – Div) = Old RE. Substituting in the
numbers from the problem statement gives $15,225 – $5,000 + $2,025 =
$12,250. Notice here that the minus sign in front of the (NI – Div) gets distributed
in and equals (– NI + Div).

4
1/1
What are the two things a company can do with net income?

 Purchase assets or pay off long-term debt
 Fund research and development or pay wages
 Invest in marketable securities or buy back shares
 Correct


Pay dividends or retain within the firm

Net income can be either distributed to shareholders as dividends or retained
within the company for future use.

5
1/1
How is the new Retained Earnings (RE) on the balance sheet calculated?

 Net Income – Old RE + Dividends