Testing the Financial Literacy and Expertise of Audit Committee Members

This article in the CPA Journal (see link below) covers a very worthy topic: how much financial literacy should audit committee members have, and how should you measure it. Can you answer all these questions correctly?

1. Retained earnings on the balance sheet is an account usually referring to:
a. Cash and other liquid assets generated by income with which the firm
can pay dividends
b. Net assets (assets minus liabilities) generated by income that the firm can distribute its dividends
c. Part of the firm’s owners’ claims to net assets of the firm
d. None of the above
e. More than one of the above

2. If a firm uses the indirect method for the statement of cash flows (SCF),
which of the following is true? (indicate all that apply)
a. The SCF lists cash receipts from customers.
b. The SCF shows cash spent for acquiring other firms in the financing section of the statement.
c. The SCF shows stock issued to acquire other firms.
d. The SCF shows the change in accounts receivable.

3. Which of the following is true of the accounting for derivatives? (indicate all that apply)
a. Derivatives always appear at fair value (market value) on the balance
sheet.
b. The accounting for derivatives under U.S. GAAP can induce volatility into
earnings.
c. By definition in U.S. GAAP, accounting derivatives are instruments that
require large cash investments at inception.
d. Derivatives can never be assets for accounting purposes.

4. The accounting for inventories in the United States can be based on either LIFO or FIFO. Which of the following statements describes LIFO and FIFO accounting under U.S. GAAP? (indicate all that apply)
a. LIFO inventory accounting always results in lower financial statement
income.
b. LIFO inventory accounting always reduces income taxes paid for a given
period.
c. A given firm must use either LIFO or FIFO for all its inventories; it is not
legal under tax law to use LIFO for some inventories and FIFO for other
inventories.
d. A firm that uses LIFO must display the difference between costs of beginning and ending inventories as reported and the costs of inventories that would have been reported had the firm been using FIFO (or current cost).

How about these questions?

1. Retained earnings on the balance sheet is an account usually referring to:
a. Cash and other liquid assets generated by income with which the firm
can pay dividends
b. Net assets (assets minus liabilities) generated by income that the firm can distribute its dividends
c. Part of the firm’s owners’ claims to net assets of the firm
d. None of the above
e. More than one of the above

2. If a firm uses the indirect method for the statement of cash flows (SCF),
which of the following is true? (indicate all that apply)
a. The SCF lists cash receipts from customers.
b. The SCF shows cash spent for acquiring other firms in the financing section of the statement.
c. The SCF shows stock issued to acquire other firms.
d. The SCF shows the change in accounts receivable.
3. Which of the following is true of the accounting for derivatives? (indicate all that apply)
a. Derivatives always appear at fair value (market value) on the balance
sheet.
b. The accounting for derivatives under U.S. GAAP can induce volatility into
earnings.
c. By definition in U.S. GAAP, accounting derivatives are instruments that
require large cash investments at inception.
d. Derivatives can never be assets for accounting purposes.
4. The accounting for inventories in the United States can be based on either LIFO or FIFO. Which of the following statements describes LIFO and FIFO accounting under U.S. GAAP? (indicate all that apply)
a. LIFO inventory accounting always results in lower financial statement
income.
b. LIFO inventory accounting always reduces income taxes paid for a given
period.
c. A given firm must use either LIFO or FIFO for all its inventories; it is not
legal under tax law to use LIFO for some inventories and FIFO for other
inventories.
d. A firm that uses LIFO must display the difference between costs of beginning and ending inventories as reported and the costs of inventories that would have been reported had the firm been using FIFO (or current cost).

Financial Statements and Accounting Literature

1. The balance sheet
a. Is a financial snapshot, taken at a point in time, of the assets the company owns and the claims against those assets.
b. Records the flow of financial resources over time.
c. Reports the operating results of a company for a period of time.
d. Is prepared by the auditors.
e. Both a and d are correct.

2. Financial statements to be filed with the SEC should be prepared
a. Following the IRS code
b. As the company’s financing agreements dictate or prescribe
c. Following generally accepted accounting principles (GAAP)
d. Using the practices followed by others in the industry
e. All of the above

Disclosure Rules
1. Which of the following financial information is not covered by the independent auditor’s report?
a. Earnings announcements
b. Pro forma earnings releases
c. The footnotes to the financial statements
d. MD&A
e. All of the above

Form and Content of SEC Filings
1. Which of the following is true about the Form 10-K?
a. Contains the annual financial statements of the company
b. Contains an audit report on the included financial statements
c. Is subject to SEC review
d. All of the above are true

Internal Controls
1. Who is responsible for the design and effectiveness of the company’s internal controls?
a. Management
b. Internal audit
c. External audit
d. The audit committee
e. All of the above

Or, these?

1. Who is responsible for the proper preparation and presentation of the financial statements?
a. Board of Directors
b. Management
c. External auditor
d. Audit Committee

2. Which of the following is NOT typically included among “current assets” on the balance sheet?
a. Accounts receivable
b. Fixed assets
c. Inventory
d. Prepaid expenses
e. All of the above are typically included.

3. Cash flow per share is defined by GAAP as:
a Net income plus depreciation divided by shares outstanding
b. Cash flow from operations on the cash flow statement divided by shares
outstanding
c. The change in cash in the balance sheet divided by the shares outstanding
d. There is no GAAP definition. Analysts/companies devise one to suit their
own purposes.

4. The audit committee of a public company should be composed of:
a. The CFO, CEO, and at least three outside directors
b. At least three independent directors, all financially literate, and at least
one financial expert
c. The CFO, the CEO, and the Chairman of the Board

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The Board Director Training Institute (BDTI) is a "public interest" nonprofit in Japan dedicated to training about directorship, corporate governance, and related management techniques. It is certified by the Japanese government to conduct these activities as a regulated nonprofit. Read a summary about BDTI here, and see a menu of its services for both corporations and investors here.

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