Deck 13: Financial Analysis: The Big Picture

Question 1

One objective of the income statement is to separate the results of continuing operations from those of discontinued operations.

Answer 1

True

Question 2

Comprehensive income includes all revenues, expenses, gains, losses, and dividends.

Answer 2

False

Question 3

In horizontal analysis, the base year is the most current year being examined.

Answer 3

False

Question 4

If a company has sales of $130 in 2014 and $182 in 2013, the percentage decrease in sales from 2013 to 2014 is 40%.

Question 5

Analysts are interested in sustainable income, which is equal to the past year's net income.

Question 6

Another name for horizontal analysis is trend analysis.

Question 7

Comprehensive income includes all changes in stockholders' equity during a period except those resulting from investments by stockholders and distributions to stockholders.

Question 8

An event or transaction should be classified as an extraordinary item if it is unusual in nature or if it occurs infrequently.

Question 9

When the disposal of a significant segment occurs, the income statement should report both income from continuing operations and income (loss) from discontinued operations.

Question 10

In horizontal analysis, if an item has a negative amount in the base year, and a positive amount in the following year, no percentage change for that item can be computed.

Question 11

The loss on disposal of a significant component of a business is disclosed in the statement of retained earnings.

Question 12

Intracompany comparisons of the same financial statement items are often useful to detect changes in financial relationships and significant trends.

Question 13

Common size analysis expresses each item in a financial statement as a percent of a base amount.

Question 14

Vertical analysis is a technique for evaluating a series of financial statement data over a period of time to determine the increase (decrease) that has taken place.

Question 15

A primary purpose of vertical analysis is to observe trends over a three-year period.

Question 16

Horizontal analysis is a technique for evaluating a financial statement item in the current year with other items in the current year.

Question 17

Companies report most changes in accounting principle currently.

Question 18

Comparisons of company data with industry averages provide information about a company's relative position within the industry.

Question 19

Horizontal, vertical, and circular analyses are the basic tools of financial statement analysis.

Question 20

A change in accounting principle occurs when the principle used in the current year is different from the one used by competitors in the current year.

Question 21

Liquidity ratios measure the ability of the enterprise to survive over a long period of time.

Question 22

Using vertical analysis of the income statement, a company's net income as a percentage of net sales is 15%; therefore, the cost of goods sold as a percentage of sales must be 85%.

Question 23

In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.

Question 24

From a creditor's point of view, the higher the debt to assets ratio, the lower the risk that the company may be unable to pay its obligations.

Question 25

The return on assets will be greater than the rate of return on common stockholders' equity if the company has been successful in trading on the equity at a gain.

Question 26

A solvency ratio measures the income or operating success of an enterprise for a given period of time.

Question 27

In a common size balance sheet, total assets are represented by 100%.

Question 28

The current ratio is a measure of all the ratios calculated for the current year.

Question 29

In a common size income statement, each item is expressed as a percentage of net income.

Question 30

The current ratio is one of the most utilized measures of profitability.

Question 31

Accounts receivable turnover is useful in assessing the profitability of receivables.

Question 32

Vertical analysis is useful in making comparisons of companies of different sizes.

Question 33

In the vertical analysis of an income statement, each item is generally stated as a percentage of net income.

Question 34

Profitability ratios are frequently used as a basis for evaluating management's operating effectiveness.

Question 35

A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current liabilities.

Question 36

Leverage and return on equity are closely related.

Question 37

Inventory turnover measures the number of times on average the inventory was sold during the period.

Question 38

In a common size income statement, net sales are represented by 100%.

Question 39

Both profit margin and asset turnover affect a company's return on assets.

Question 40

Inventory turnover is a measure of liquidity that focuses on efficient use of inventory.

Question 41

The discontinued operations section of the income statement refers to

A) discontinuance of a product line.
B) the income or loss on products that have been completed and sold.
C) obsolete equipment and discontinued inventory items.
D) the disposal of a significant component of a business.

Question 42

When a change in depreciation method occurs

A) prior years' financial statements should be changed to reflect the newly adopted method.
B) the change should be reported in current and future years.
C) the cumulative effect of the change should be reflected on the income statement as of the beginning of the next year.
D) the cumulative effect of the change in accounting principle should be classified as an extraordinary item on the income statement.

Question 43

Sophie's Dog Supplies has income before taxes of $550,000 and an extraordinary loss of $170,000. If the income tax rate is 30% on all items, the income statement should show income before irregular items and an extraordinary loss, respectively, of

A) $550,000 and ($170,000).
B) $385,000 and ($86,700).
C) $385,000 and ($119,000).
D) $165,000 and ($51,000).

Question 44

Using borrowed money to increase the rate of return on common stockholders' equity is called "trading on the equity."

Question 45

All of the following statements regarding changes in accounting principles are true except which of the following?

A) Most changes in accounting principles are only reported in current periods when the principle change takes place.
B) Changes in accounting principles are allowed when new principles are preferable to old ones.
C) Most changes in accounting principles are retroactively reported.
D) Consistency is one of the biggest concerns when a change in accounting principle is undertaken.

Question 46

Which one of the following would be classified as an extraordinary item?

A) Expropriation of property by a foreign government
B) Losses attributed to a labor strike
C) Write-down of inventories
D) Gains or losses from sales of equipment

Question 47

Improper recognition of income is not one of the factors affecting the quality of earnings.

Question 48

If a company has an extraordinary gain of $20,000 and a 32% tax rate, what is the effect on net income?

A) Increase of $20,000.
B) Increase of $13,600.
C) Increase of $6,400.
D) No effect.

Question 49

An extraordinary item must meet which of the following two criteria?

A) Foreseeable and material
B) Infrequent and unusual
C) Substantial and measurable
D) Unusual and measurable

Question 50

Which of the following is the best definition of sustainable income?

A) Sustainable income is a measure of solvency that does not include capital expenditure.
B) Sustainable income is the same as net income.
C) Sustainable income is income that is unusual in nature and infrequent in occurrence.
D) Sustainable income is the most likely level of income to be obtained in the future.

Question 51

Alternative accounting methods affect the quality of earnings.

Question 52

Indian River Groves in central Florida lost about 10% of its strawberries (or $750,000) due to frost. Based on this information, how will Indian River Groves most likely report this loss?

A) As an extraordinary item net of taxes.
B) Below discontinued operations.
C) As a pretax ordinary loss prior to income before income taxes.
D) As a discontinued operation net of taxes.

Question 53

When preparing an income statement, which of the following is the proper order for income statement components?

A) Comprehensive income, Other comprehensive income items, irregular items, Net income
B) Net income, irregular items, Comprehensive income, Other comprehensive income items
C) Irregular items, Net income, Other comprehensive income items, Comprehensive income
D) Irregular items, Net income, Comprehensive income, Other comprehensive income items

Question 54

Because pro forma earnings are based on specific rules, these amounts are highly reliable.

Question 55

All of the following are reported on the income statement net of tax except

A) irregular items.
B) other comprehensive income items.
C) income from operations.
D) extraordinary items.

Question 56

The order of presentation of items that may appear on the income statement is

A) Extraordinary items, Discontinued operations, Income before income taxes.
B) Discontinued operations, Extraordinary items, Income before income taxes.
C) Income before income taxes, Discontinued operations, Extraordinary items.
D) Income before income taxes, Extraordinary items, Discontinued operations.

Question 57

An income statement would not include

A) other revenue and gains.
B) extraordinary items.
C) discontinued operations.
D) dividends paid.

Question 58

Declining profitability and liquidity ratios are indications that a company may not survive.

Question 59

Which of the following income statement figures would probably be the best indicator of a company's future performance?

A) Total revenues
B) Income from operations
C) Net income
D) Gross profit

Question 60

If an item meets one (but not both) of the criteria for an extraordinary item, it

A) only needs to be disclosed in the footnotes of the financial statements.
B) may be treated as sales revenue (if it is a gain) and as an operating expense (if it is a loss).
C) is reported as an "other revenue or gain" or "other expense and loss," net of tax.
D) is reported at its gross amount as an "other revenue or gain" or "other expense or loss."

Question 61

Which of the following would not be considered a change in accounting principle?

A) Changing the estimated percentage used in calculating bad debt expense
B) Changing the inventory costing method used from FIFO to LIFO
C) Changing from straight-line depreciation to double-declining balance depreciation
D) Changing from the cost method of accounting for investments to the equity method

Question 62

Which of the following statements is true with respect to financial statement reporting for all cases when a company changes from one acceptable accounting method to another?

A) Comparability across periods is impaired
B) Only a footnote is required to report the change
C) Changes in both depreciation methods and inventory methods are reported retroactively.
D) Management must indicate that the accounting method change is preferable to the old method.

Question 63

Extraordinary items are reported on the income statement immediately

A) below income from continuing operations.
B) after comprehensive income.
C) below income before taxes.
D) after discontinued operations.

Question 64

Patchett Company reported income before taxes of $800,000 and an extraordinary loss of $200,000. Assume that the company's tax rate is 25%. What amounts will be reported on the income statement for income before irregular items and extraordinary items, respectively?

A) $600,000 and $200,000
B) $600,000 and $150,000
C) $600,000 and $200,000
D) $600,000 and $150,000

Question 65

Lupton Inc. disposes of an unprofitable segment of its business. The operation of the segment suffered a $160,000 loss in the year of disposal. The loss on disposal of the segment was $80,000. If the tax rate is 30%, and income before income taxes was $1,300,000,

A) the income tax expense on the income before discontinued operations is $318,000.
B) the income from continuing operations is $910,000.
C) net income is $1,060,000.
D) the losses from discontinued operations are reported net of income taxes at $240,000.

Question 66

Shambhala Spice Company has experienced a $60,000 loss due to tornado damage to their inventory. Tornados have never before occurred in this area. Assuming that the company's tax rate is 30%, what amount will be reported for this loss on the income statement?

A) $60,000
B) $42,000
C) $18,000
D) $36,000

Question 67

Which of the following would not be considered an example of a discontinued operation?

A) Shifting production processes within an operation
B) Elimination of a major class of customers
C) Elimination of an entire activity
D) Disposal of a significant component of a business

Question 68

Which of the following items appears on the income statement before income before irregular items?

A) Other comprehensive income.
B) Extraordinary items.
C) Income tax expense.
D) Discontinued operations.

Question 69

Which of the following items should be classified as an extraordinary item on an income statement?

A) Gain on the sale of property, plant or equipment
B) Loss due to expropriation of property by a foreign government
C) Loss due to discontinued operations
D) Excess of the selling price over the cost of treasury stock

Question 70

The disposal of a significant component of a business is called

A) a change in accounting principle.
B) an extraordinary item.
C) an other expense.
D) discontinued operations.

Question 71

Which of the following is not an irregular item on the income statement?

A) Discontinued operations
B) Extraordinary items
C) Other revenues and expenses
D) Loss on disposal of a significant component of a business

Question 72

The Holiday House had severe damage done to its Christmas inventory due to an escaped circus monkey rampaging through the store. The inventory loss was $150,000 before applicable taxes of $30,000. The Holiday House should record the loss as a(n)

A) $150,000 loss in other expenses and losses.
B) $180,000 extraordinary loss.
C) $120,000 extraordinary loss.
D) $180,000 extraordinary loss.

Question 73

Jack's by the Tracks. has the following partial balance sheet: JACK'S BY THE TRACKS.
Balance Sheet (partial) $\begin{array}{lr}\text { Stockholders' Equity. }\\\text { Common Stock } & \$ 6,000,000 \\\text { Retained Earnings } & 2,000,000 \\\text { Total Paid-in capital and retained earnings } & 8,000,000 \\\text { Add: Unrealized gain on available-for-sale securities } & 800,000\\\text { Total Stockholders' Equity. }&\$8,800,000\end{array}$ What effect will the unrealized gain on available for sales securities have on comprehensive income?

A) No effect on comprehensive income.
B) Increase of $800,000 in comprehensive income.
C) Increase of $8,800,000 in comprehensive income.
D) Decrease of $800,000 in comprehensive income.

Question 74

Dandy Candy Company sold its licorice division resulting in a loss of $60,000. Assuming a tax rate of 25%, the loss on this disposal will be reported on the income statement at what amount?

A) $75,000
B) $15,000
C) $60,000
D) $45,000

Question 75

In reporting discontinued operations, the income statement should show in a special section
1) gains on the disposal of a discontinued component.
2) losses on the disposal of a discontinued component.

A) 1 only.
B) 2 only.
C) neither 1 nor 2.
D) both 1 and 2.

Question 76

Reardon Inc. has an investment in trading securities of $120,000. This investment experienced an unrealized loss of $6,000 during the current year. Assuming a 35% tax rate, the effect of this loss on comprehensive income will be

A) no effect.
B) $120,000 increase.
C) $42,000 decrease.
D) $78,000 decrease.

Question 77

Comprehensive income would not include

A) dividends declared.
B) unrealized gains on available-for-sale securities.
C) discontinued operations.
D) extraordinary gains and losses.

Question 78

R. Stone Corporation has income before taxes of $780,000 and an extraordinary gain of $200,000. If the income tax rate is 25% on all items, the income statement should show income before irregular items and extraordinary items, respectively, of

A) $635,000 and $200,000.
B) $635,000 and $150,000.
C) $585,000 and $200,000.
D) $585,000 and $150,000.

Question 79

Which of the following would be considered an "Other Comprehensive Income" item?

A) Net income
B) Gain on disposal of discontinued operations
C) Extraordinary loss related to flood
D) Unrealized loss on available-for-sale securities

Question 80

Stellar, Inc. decided on January 1 to discontinue its telescope manufacturing division. On July 1, the division's assets with a book value of $840,000 are sold for $600,000. Operating income from January 1 to June 30 for the division amounted to $130,000. Ignoring income taxes, what total amount should be reported on Stellar's income statement for the current year under the caption, Discontinued Operations?

A) $130,000
B) $110,000 loss
C) $240,000 loss
D) $370,000