Financial Reporting

A is correct. The fundamental accounting equation is Assets = Liabilities + Shareholders' Equity. This equation must always balance and forms the basis of the balance sheet. Assets represent what the company owns, liabilities represent what it owes, and shareholders' equity represents the residual ownership interest.

B (Assets = Shareholders' Equity - Liabilities) incorrectly subtracts liabilities instead of adding them. C (Assets + Liabilities = Shareholders' Equity) incorrectly places liabilities on the wrong side of the equation. D (Assets + Shareholders' Equity = Liabilities) reverses the entire relationship and would suggest liabilities equal the sum of assets and equity.

D is correct. Current assets are assets expected to convert to cash within one year. Accounts receivable expected to be collected in 8 months clearly meets this definition, making it a current asset along with cash, marketable securities, inventory, and prepaid expenses.

A (A patent) is incorrect because patents are intangible assets, not current assets, regardless of how long ago they were acquired. B (Manufacturing equipment) is incorrect because equipment is classified as property, plant, and equipment (PPE), a non-current fixed asset. C (A building planned for sale) is incorrect because buildings are fixed assets; even if management intends to sell it soon, real property typically remains classified as a non-current asset unless specifically held for sale as part of normal business operations.

B is correct. Treasury stock represents shares that a company has repurchased from shareholders. Treasury stock is a contra-equity account that reduces total shareholders' equity. When a company buys back its shares, it pays cash and reduces equity by the amount paid, effectively returning capital to shareholders.

A (equity increases) is incorrect because it reverses the actual effect. Repurchasing shares reduces equity, not increases it. C (equity unchanged) is incorrect because the cash paid reduces assets and equity decreases by the same amount. D (equity increases by par value) is both directionally wrong and uses the wrong value basis. The repurchase price, not par value, determines the equity reduction.

B is correct. Operating income (also called EBIT, or Earnings Before Interest and Taxes) is calculated as Gross Profit minus Operating Expenses. Operating expenses include selling, general & administrative expenses (SG&A) and research & development (R&D). This measures profit from core business operations before financing costs and taxes.

A (Revenue - COGS) is incorrect because this calculates gross profit, not operating income. Gross profit is the starting point before subtracting operating expenses. C (Net Income + Income Taxes) is incorrect because this calculates earnings before taxes (EBT), not operating income. Operating income is before both interest and taxes. D (Revenue - Interest Expense) is incorrect because it skips both COGS and operating expenses, and incorrectly includes interest expense which comes after operating income.

D is correct. EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is calculated by taking EBIT and adding back depreciation and amortization. In this case: $500,000 (EBIT) + $75,000 (depreciation) + $25,000 (amortization) = $600,000. EBITDA serves as a proxy for cash flow from operations by removing non-cash expenses.

A ($400,000) is incorrect because it subtracts both depreciation and amortization from EBIT rather than adding them back. B ($500,000) is incorrect because it simply restates EBIT without adding back the non-cash expenses. C ($575,000) is incorrect because it only adds back depreciation ($75,000) but fails to include amortization ($25,000).

B is correct. Using the indirect method, depreciation expense is a non-cash expense that reduced net income but did not involve an actual cash outflow. Therefore, it must be added back to net income in the operating activities section to reconcile net income to cash flow from operations. This is one of the most important adjustments in cash flow analysis.

A (subtracted from net income) is incorrect because it goes in the wrong direction. Depreciation already reduced net income, so adding it back reverses that non-cash deduction. C (cash outflow in investing) is incorrect because depreciation is not a cash flow at all; the cash outflow occurred when the asset was originally purchased. D (excluded entirely) is incorrect because depreciation must be adjusted for to properly reconcile accrual-basis net income to cash flow.

C is correct. Dividends paid to shareholders appear in the financing activities section because they represent distributions to the company's capital providers (equity holders). Financing activities include transactions related to debt and equity financing, such as issuing or repaying debt, issuing or repurchasing stock, and paying dividends.

A (purchase of equipment) is incorrect because capital expenditures appear in the investing activities section, which covers purchases and sales of long-term assets. B (collection of A/R) is incorrect because it appears in the operating activities section as part of day-to-day business operations. D (sale of inventory) is incorrect because revenue-generating activities are part of operating activities, not financing activities.

C is correct. The current ratio is calculated as Current Assets ÷ Current Liabilities. In this case: $800,000 ÷ $400,000 = 2.0. A current ratio of 2.0 means the company has $2 of current assets for every $1 of current liabilities, indicating strong short-term liquidity. A ratio of 2:1 is generally considered healthy.

A (0.5) is incorrect because it inverts the formula, dividing current liabilities by current assets ($400,000 ÷ $800,000). B (1.0) is incorrect because it would require current assets and liabilities to be equal, not the actual values given. D (4.0) is incorrect because it incorrectly multiplies the ratio by 2 or miscalculates the division.

A is correct. The quick ratio (also called the acid-test ratio) is calculated as (Current Assets - Inventory) ÷ Current Liabilities. The key difference from the current ratio is that it excludes inventory from current assets because inventory is the least liquid current asset and may not convert to cash quickly in a crisis. A quick ratio of 1:1 is generally considered healthy.

B (includes long-term assets) is incorrect because the quick ratio only uses current assets (minus inventory), never long-term assets. C (uses only cash) is incorrect because this describes the cash ratio, not the quick ratio. The quick ratio includes cash, marketable securities, and accounts receivable. D (subtracts A/P from current liabilities) is incorrect because the quick ratio uses all current liabilities in the denominator without adjustment.

D is correct. Under accrual accounting, revenue is recognized when it is earned, which occurs when goods are delivered or services are performed, not when cash is received. This is a fundamental principle of accrual accounting that contrasts with cash-basis accounting. The matching principle requires that revenues be matched with the expenses incurred to generate them in the same accounting period.

A (when cash is received) is incorrect because this describes cash-basis accounting, not accrual accounting. Many companies deliver goods on credit and recognize revenue before receiving payment. B (when invoice is mailed) is incorrect because invoicing is an administrative step; revenue recognition depends on performance (delivery/completion), not billing. C (when customer places order) is incorrect because placing an order creates a contract obligation but revenue isn't earned until performance occurs.