Deck 9: Financial Statement Analysis

Question 1

An analysis procedure that uses percentages to compare each of the parts of an individual statement to a key dollar amount from the financial statements is:

A) Ratio analysis.
B) Contribution analysis.
C) Horizontal analysis.
D) Vertical analysis.

Answer 1

D
Explanation: Horizontal analysis compares items over many time periods; vertical analysis compares many items within the same time period.

Question 2

Which of the following statements regarding ratio analysis is incorrect?

A) Ratio analysis is a specific form of horizontal analysis.
B) There are many different ratios available for evaluating a firm's performance.
C) Some ratios involve an account from the balance sheet and one from the income statement.
D) Ratio analysis involves making comparisons between different accounts in the same set of financial statements.

Answer 2

A
Explanation: Horizontal analysis, also called trend analysis, refers to studying the behavior of individual financial statement items over several accounting periods. These periods may be several quarters within the same fiscal year or they may be several different years. Ratio analysis involves studying various relationships between different items reported in a set of financial statements.

Question 3

Common methods of financial statement analysis include all of the following except:

A) Incremental analysis.
B) Horizontal analysis.
C) Vertical analysis.
D) Ratio analysis.

Answer 3

A

Question 4

Which of the following statements regarding the information disclosed in financial statements is incorrect?

A) The costs of providing all possible information about a firm would be prohibitively high for the business.
B) Some information disclosed in financial statements may be irrelevant to some users.
C) Financial statements should be detailed enough to answer any financial-related question an investor might have.
D) When too much information is presented users may suffer from information overload.

Question 5

Which of the following statements regarding the analysis of absolute amounts of various accounts reported on the financial statements is incorrect?

A) Financial statement users with expertise in particular industries can look at absolute amounts and assess a company's performance in a certain area.
B) To correctly evaluate an absolute amount, the analyst must consider its relative importance.
C) Economic statistics such as the gross national product are built upon totals of absolute amounts reported by businesses.
D) Using absolute amounts eliminates the problem of varying materiality levels.

Question 6

All of the following are considered to be measures of a company's short-term debt-paying ability except:

A) Current ratio.
B) Earnings per share.
C) Inventory turnover.
D) Average collection period.

Question 7

Milton Company has total current assets of $46,000, including inventory of $10,000, and current liabilities of $20,000. The company's current ratio is:

A) 0.4.
B) 1.8.
C) 2.8.
D) 2.3.

Question 8

Factor(s) involved in communicating useful information is (are):

A) Attributes of the users.
B) Purpose for which the information will be used.
C) Process by which the information is analyzed.
D) All of these answers are correct.

Question 9

Financial ratios can be used to assess which of the following aspects of a firm's performance?

A) Liquidity
B) Solvency
C) Profitability
D) All of these answers are correct.

Question 10

Which of the following is an (are) objective(s) of ratio analysis?

A) Assessing past performance.
B) Assessing the prospects for future performance.
C) Analyzing how a company finances its operations.
D) All of these answers are correct.

Question 11

The study of an individual financial statement item over several accounting periods is called:

A) Horizontal analysis.
B) Vertical analysis.
C) Ratio analysis.
D) Time and motion analysis.

Question 12

Financial statement analysis involves forms of comparison including:

A) Comparing changes in the same item over a number of periods.
B) Comparing key relationships within the same year.
C) Comparing key items to industry averages.
D) All of these answers are correct.

Question 13

Darden Company has cash of $40,000, accounts receivable of $60,000, inventory of $32,000, and equipment of $100,000. Assuming current liabilities of $48,000, this company's working capital is:

A) $12,000.
B) $52,000.
C) $144,000.
D) $84,000.

Question 14

Rialto Company collected $5,000 on account. What impact will this transaction have on the firm's current ratio?

A) No impact
B) Increase it
C) Decrease it
D) Not enough information is provided to answer the question.

Question 15

Knoell Company paid its sales employees $15,000 in sales commissions. What impact will this transaction have on the firm's working capital?

A) No impact
B) Increase it
C) Decrease it
D) Not enough information is provided to answer the question.

Question 16

Select the correct statement regarding vertical analysis.

A) Vertical analysis of the income statement involves showing each item as a percentage of sales.
B) Vertical analysis of the balance sheet involves showing each asset as a percentage of total assets.
C) Vertical analysis examines two or more items from the financial statements of one accounting period.
D) All of these answers are correct.

Question 17

Current financial reporting standards assume that users of accounting information:

A) Have an expert's understanding of economic and financial events and conditions.
B) Have a reasonably informed knowledge of business.
C) Have widely differing levels of knowledge about business, and that financial reporting must meet these differing needs.
D) Have only minimal knowledge of business.

Question 18

Which of the following statements regarding the quick ratio is incorrect?

A) The quick ratio is also known as the acid-test ratio.
B) The quick ratio ignores some current assets that are less liquid than others.
C) The quick ratio is a conservative variation of the current ratio.
D) The quick ratio equals quick assets divided by total liabilities.

Question 19

Working capital is defined as:

A) Current assets divided by current liabilities.
B) Total assets minus total liabilities.
C) Current assets less current liabilities.
D) Current liabilities divided by total liabilities.

Question 20

Which of the following statements regarding horizontal analysis is incorrect?

A) Percentage analysis involves establishing the relationship of one amount to another.
B) A horizontal analysis of cost of goods sold on the income statement includes dividing net income by total revenue.
C) Percentage analysis attempts to eliminate the materiality problem of comparing firms of different sizes.
D) In doing horizontal analysis, an account is expressed as a percentage of the previous balance of the same account.

Question 21

Which of the following statements regarding the return on equity (ROE) measure is incorrect?

A) ROE is used to measure the profitability of the firm in relation to the amount invested by stockholders.
B) ROE equals net income divided by average total stockholders' equity.
C) ROE is affected by a company's use of leverage.
D) A company's ROE is lower than its return on investment because ROE does not consider that part of the business that is financed by debt.

Question 22

You are considering an investment in Apple stock and wish to assess the firm's short-term debt-paying ability. All of the following ratios are used to assess liquidity except:

A) Debt to equity ratio.
B) Inventory turnover.
C) Quick ratio.
D) Accounts receivable turnover.

Question 23

The Poole Company reported the following income for Year 2: What is the company's net margin? (Round your answers to the nearest whole percent.)

A) 73%
B) 40%
C) 18%
D) 27%

Question 24

The following balance sheet information was provided by Western Company: Assuming Year 2 net credit sales totaled $270,000, what were the company's average days to collect receivables? (Use 365 days in a year. Do not round intermediate calculations.)

A) 18.25 days
B) 47.31 days
C) 16.22 days
D) 20.28 days

Question 25

Which of the following statements regarding net margin is incorrect?

A) Net margin refers to the average amount of each sales dollar remaining after all expenses are subtracted.
B) Net margin may be calculated in several ways.
C) The amount of net margin is affected by a company's choices of accounting principles.
D) The smaller the net margin the better.

Question 26

The following balance sheet information is provided for Apex Company for Year 2: What is the company's working capital?

A) $20,300
B) $4,900
C) $22,900
D) $24,500

Question 27

The following balance sheet information is provided for Santana Company for Year 2: What is the company's debt to equity ratio? (Round your answers to the nearest whole percent.)

A) 42%
B) 130%
C) 43%
D) 77%

Question 28

The following balance sheet information was provided by O'Connor Company: Assuming that net credit sales for Year 2 totaled $270,000, what is the company's most recent accounts receivable turnover?

A) 18 times
B) 20 times
C) 22.5 times
D) 7.7 times

Question 29

The following balance sheet information is provided for Patton Company: Assuming Year 2 cost of goods sold is $730,000, what are the company's average days to sell inventory? (Use 365 days in a year. Do not round intermediate calculations.)

A) 17.5 days
B) 18.25 days
C) 19 days
D) 20.86 days

Question 30

Alpha Company provided the following balance sheet for Year 2: What is the company's plant assets to long-term liabilities ratio?

A) 2.5
B) 4.5
C) 1.7
D) None of these answers is correct.

Question 31

Solvency ratios are used to assess a company's:

A) Long-term debt paying ability.
B) Profitability.
C) Short-term debt paying ability.
D) Efficiency in use of its assets.

Question 32

You are considering an investment in IBM stock and wish to assess the firm's long-term debt-paying ability and its use of debt financing. All of the following ratios can be used to assess solvency except:

A) Number of times interest is earned.
B) Debt to assets ratio.
C) Debt to equity ratio.
D) Net margin.

Question 33

The following balance sheet information is provided for Duke Company for Year 2: What is the company's current ratio?

A) 1.16
B) 1.31
C) 2.53
D) 3.79

Question 34

The following partial balance sheet is provided for Groome Company: What is the company's quick (acid-test) ratio?

A) 49%
B) 16%
C) 33%
D) Cannot be determined with the information given.

Question 35

The following balance sheet information is provided for Greene Company for Year 2: What is the company's quick (acid-test) ratio?

A) 0.7
B) 1.4
C) 1.3
D) 3.8

Question 36

The Martin Company reported net income of $15,000 on gross sales of $80,000. The company has average total assets of $135,000, of which $102,000 is property, plant and equipment. What is the company's return on investment? (Round your final answer to 1 decimal place.)

A) 18.8%
B) 11.1%
C) 14.7%
D) 12.5%

Question 37

The Fortune Company reported the following income for Year 2: What is the company's number of times interest is earned ratio?

A) 7 times
B) 6 times
C) 4 times
D) None of these answers is correct.

Question 38

The following balance sheet information is provided for Gaynor Company: Assuming Year 2 cost of goods sold is $153,300, what is the company's inventory turnover?

A) 4.0 times
B) 4.4 times
C) 4.2 times
D) None of these answers is correct.

Question 39

You are considering an investment in Frontier Airlines stock and wish to assess the firm's earnings performance. All of the following ratios can be used to assess profitability except:

A) Average days to collect receivables.
B) Asset turnover.
C) Return on investment.
D) Net margin.

Question 40

The Miller Company reported gross sales of $850,000, sales returns and allowances of $15,000 and sales discounts of $5,000. The company has average total assets of $500,000, of which $250,000 is property, plant, and equipment. What is the company's asset turnover ratio?

A) 3.32 times
B) 1.67 times
C) 1.66 times
D) 1.70 times

Question 41

You are considering an investment in Facebook stock and wish to assess the company's position in the stock market. All of the following ratios can be used except:

A) Dividend yield.
B) Earnings per share.
C) Working capital.
D) Price-earnings ratio.

Question 42

Benson Company received cash of $1,000,000 from issuing common stock at par value. As a result of this transaction, the company's debt to equity ratio will:

A) Decrease.
B) Increase.
C) Remain the same.
D) Cannot be determined.

Question 43

Which of the following is a potential limitation of financial statement analysis?

A) Lack of comparability of firms in different industries
B) The impact of changing economic conditions
C) The impact of having more than one acceptable alternative accounting principle for accounting for a given transaction or economic event
D) All of these answers are correct.

Question 44

The Phibbs Company paid total cash dividends of $200,000 on 25,000 outstanding common shares. On the most recent trading day, the common shares sold at $80. What is this company's dividend yield?

A) 25%
B) 6.4%
C) 16.9%
D) 10%

Question 45

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant collected $5,200 of accounts receivable. As a result of this transaction, Gant's working capital will:

A) Increase.
B) Decrease.
C) Remain the same.
D) Cannot be determined.

Question 46

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant purchased merchandise on account for $4,000. Which of the following statements is correct?

A) Gant's current ratio will decrease.
B) Gant's quick ratio will increase.
C) Gant's working capital will increase.
D) Gant's quick ratio will increase and its current ratio will decrease.

Question 47

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2 Gant paid $3,600 on accounts payable. Which of the following statements is incorrect?

A) Gant's quick ratio will increase and its current ratio will decrease.
B) Gant's quick ratio will increase.
C) Gant's working capital will remain the same.
D) Gant's current ratio will increase.

Question 48

Which of the following statements is generally incorrect from an investor's perspective?

A) A 1:1 current ratio is generally preferred over a 1.5:1 current ratio.
B) A 20-day average collection period for accounts receivable is generally preferred over a 30-day average collection period.
C) A 5% dividend yield is generally preferred over a 3% dividend yield.
D) A 10% net margin is generally preferred over an 8% net margin.

Question 49

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant sold inventory on account. Which of the following statements is incorrect?

A) Gant's current ratio will increase.
B) Gant's quick ratio will increase.
C) Gant's working capital will increase.
D) None of these answers is correct.

Question 50

Accrual accounting requires the use of many estimates, including:

A) Uncollectible accounts expense.
B) Warranty costs.
C) Assets' useful lives.
D) All of these answers are correct.

Question 51

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant recorded cost of goods sold of $4,100. As a result of this transaction, Gant's quick ratio will:

A) Decrease.
B) Increase.
C) Remain the same.
D) Cannot be determined.

Question 52

The Dennis Company reported net income of $50,000 on sales of $300,000. The company has average total assets of $500,000 and average total liabilities of $100,000. What is the company's return on equity ratio?

A) 10.0%
B) 16.7%
C) 12.5%
D) 50.0%

Question 53

The accounting concept or principle that is perhaps the greatest single culprit in distorting the results of financial statement analysis is the:

A) Matching principle.
B) Conservatism concept.
C) Historical cost principle.
D) Time value of money concept.

Question 54

The Abel Company provided the following information from its financial records: What is the amount of the company's earnings per share?

A) $0.82
B) $1.00
C) $0.90
D) $0.75

Question 55

Benson Company declared and paid a cash dividend totaling $500,000 on its common stock. As a result of this transaction, the company's debt to assets ratio will:

A) Decrease.
B) Increase.
C) Remain the same.
D) Cannot be determined.

Question 56

The Bernard Company provided the following information from its financial records: What is the company's book value per share?

A) $0.50
B) $5.50
C) $6.67
D) $1.67

Question 57

The Crestar Company reported net income of $112,000 on 20,000 average outstanding common shares. Preferred dividends total $12,000. On the most recent trading day, the preferred shares sold at $50 and the common shares sold at $95. What is this company's current price-earnings ratio?

A) 19
B) 17
C) 20
D) None of these answers is correct.

Question 58

The return on investment measure is also referred to as:

A) Net margin.
B) Return on equity.
C) Return on debt.
D) Return on assets.

Question 59

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant issued common stock at par value for $10,000 cash. Which of the following statement is correct?

A) Gant's current ratio will decrease.
B) Gant's current ratio will increase.
C) Gant's quick ratio will decrease.
D) Gant's working capital will decrease.

Question 60

As of December 31, Year 1, Gant Corporation had a current ratio of 1.29, quick ratio of 1.05, and working capital of $18,000. The company uses a perpetual inventory system and sells merchandise for more than it cost. On January 1, Year 2, Gant paid $250 for transportation cost on merchandise it had received. Which of the following statements is incorrect?

A) Grove's current ratio will remain the same
B) Grove's quick ratio will increase
C) Grove's working capital will remain the same
D) Grove's quick ratio will increase and its current ratio will remain the same.

Question 61

Which ratios measure a company's long-term debt paying ability and its financing structure?

A) Solvency
B) Liquidity
C) Profitability
D) None of these answers is correct.

Question 62

Lilly's Corporation has working capital of $620,000, and Harmon Corporation has working capital of $840,000. Which of the following statements is incorrect?

A) Since working capital is an absolute amount, other factors such as size of the company and materiality will help to determine liquidity of these two companies.
B) Since Harmon's working capital exceeds Lilly's working capital, it is safe to conclude that Harmon is more liquid than Lilly.
C) If Lilly Corporation is smaller than Harmon or has lower current liabilities; Lilly could be more liquid than Harmon.
D) None of these answers is correct.

Question 63

Which type of approach should be used when evaluating corporate results using horizontal analysis?

A) Study of absolute amounts.
B) Percentages.
C) Trends.
D) All of these answers are correct.

Question 64

In vertical analysis, each item is expressed as a percentage of:

A) Total assets on the balance sheet.
B) Total cash on the balance sheet.
C) Total current assets on the balance sheet.
D) None of these answers is correct.

Question 65

Assume that you are considering purchasing some of a company's long-term bonds as an investment. Which of the company's financial statement ratios would you probably be most interested in?

A) Debt to assets ratio
B) Debt to equity
C) Plant assets to long-term liabilities
D) All of these answers are correct.

Question 66

Long-term creditors are usually most interested in evaluating:

A) Liquidity.
B) Managerial effectiveness.
C) Solvency.
D) Profitability.

Question 67

Which of the following statement is correct regarding the quick ratio?

A) The numerator for the quick ratio is current assets minus inventory minus accounts receivable.
B) The numerator for the quick ratio is current assets.
C) The quick ratio is also called the working capital ratio.
D) The quick ratio is a more conservative variation of the current ratio.

Question 68

If the company purchased a $60,000 piece of equipment by paying $30,000 and having the rest financed with a short-term note from the bank, then immediately after this transaction what is the expected impact on the components of the current ratio?

A) Current assets decrease and current liabilities increase by the same amount.
B) Current liabilities decrease.
C) Current assets and current liabilities decrease by the same amount.
D) Current assets increase.

Question 69

Horizontal analysis is also known as:

A) Liquidity analysis.
B) Trend analysis.
C) Revenue analysis.
D) Variance analysis.

Question 70

Benson Company received cash of $5,000,000 by issuing 20-year bonds payable. As a result of this transaction, the company's current ratio will:

A) Remain the same.
B) Increase.
C) Decrease.
D) Cannot be determined.

Question 71

Net income divided by sales is the formula for which of these analytical measures?

A) Return on assets
B) Return on equity
C) Earnings per share
D) Net margin

Question 72

Two ratios that provide insight on the relationship between credit sales and receivables are:

A) Current ratio and inventory turnover ratio.
B) Accounts receivable turnover and average days to collect receivables.
C) Average days to collect receivables and asset turnover.
D) Accounts receivable turnover and current ratio.

Question 73

The study of an individual item or account over several periods in the same financial year or over many years is known as:

A) Liquidity analysis
B) Ratio analysis
C) Vertical analysis
D) Horizontal analysis

Question 74

Short-term creditors are usually most interested in assessing:

A) Liquidity.
B) Solvency.
C) Managerial effectiveness.
D) Profitability.

Question 75

Earnings before interest and taxes divided by interest expense is the formula for which of these analytical measures?

A) Debt to assets ratio
B) Earnings per share
C) Return on investment
D) Number of times interest is earned

Question 76

Which ratio measures how effectively a company is using assets to generate revenue?

A) Net margin
B) Plant assets to long-term liabilities
C) Asset turnover
D) Inventory turnover

Question 77

Cost of goods sold divided by average inventory is the formula for which of these analytical measures?

A) Number of day's sales in inventory
B) Return on investment
C) Inventory turnover
D) Debt to assets ratio

Question 78

Which ratio would you use to examine a company's ability to pay its debts in the short term?

A) Earnings per share
B) Acid-test ratio
C) Debt to assets ratio
D) Return on equity

Question 79

In vertical analysis, each item is expressed as a percentage of:

A) Total expenses on the income statement.
B) Net income on the income statement.
C) Sales on the income statement.
D) None of these answers is correct.

Question 80

Starwood Corporation has current assets of $200,000, total current liabilities of $750,000 net credit sales of $1,300,000, beginning accounts receivable of $65,000 and ending accounts receivable of $69,000. What is Starwood's accounts receivable turnover?

A) 21.8 times
B) 19.4 times
C) 22.4 times
D) 5.8 times