Question 1

When using a company's current earnings to estimate future earnings performance,investors normally should exclude discontinued operations.

Accepted Answer

Discontinued operations are considered nonrecurring and are excluded from estimates of future earnings performance.

Question 2

Conservative accounting practices are those that result in reporting lower income,lower assets,and higher liabilities.

Accepted Answer

Conservative accounting practices aim to minimize the possibility of overstating financial results by adopting measures that report lower income, lower assets, and higher liabilities. This ensures more accurate and reliable financial reporting.

Question 3

We report discontinued items separately,net of taxes,near the bottom of the income statement.

Accepted Answer

The statement is true - discontinued items are reported separately, net of taxes, towards the bottom of the income statement.

Question 4

We report any profits or losses on discontinued operations in the current year,separately from profits and losses on the portion of the business that will continue.

Accepted Answer

This statement is true. Discontinued operations are reported separately from continuing operations in order to provide a clear picture of the company's performance moving forward. This allows investors and stakeholders to better understand the financial impact of any changes in the business.

Question 5

The price-earnings (PE)ratio compares a company's share price with its earnings per share.

Accepted Answer

The statement is true.

Question 6

The acid-test ratio is always smaller than the current ratio.

Accepted Answer

The acid-test ratio, also known as the quick ratio, only includes the most liquid assets (cash, marketable securities, and accounts receivable) in its calculation, while the current ratio includes all current assets. Since the acid-test ratio is a more conservative measure of liquidity, it is always smaller than the current ratio.

Question 7

Growth stocks have high expectations of future earnings growth,and therefore,usually trade at higher PE ratios.

Accepted Answer

Growth stocks typically have higher expected earnings growth, leading investors to pay a premium in the form of higher PE ratios for the stock.

Question 8

Profit margin measures the income earned on each dollar of sales,and is calculated by dividing net income by net sales.

Accepted Answer

This is a correct definition of profit margin.

Question 9

The location where a loss is reported in the income statement does not really matter as long as the loss is reported.The location of a loss in the income statement does matter as investors attempt to determine if the loss is recurring or a one-time occurrence.

Accepted Answer

The location of a loss in the income statement does matter because it helps investors and analysts determine if the loss is a one-time event or part of the company's regular operations, affecting their assessment of the company's financial health and future performance.

Question 10

We use the times interest earned ratio to compare interest payments with a company's income available to pay those charges.

Accepted Answer

The statement is true. The times interest earned ratio measures a company's ability to meet its interest payments with its income. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense. A higher ratio indicates that the company has more earnings available to cover its interest charges, while a lower ratio may suggest that the company may struggle to meet its interest payments.

Question 11

Other things being equal,the higher the debt to equity ratio,the higher the risk of bankruptcy.

Accepted Answer

This is because a higher debt to equity ratio indicates that a company is relying more heavily on borrowing to finance its operations, which means it has a higher level of financial leverage. This increases the risk of bankruptcy because if the company is unable to make its debt payments, it may be forced to file for bankruptcy.

Question 12

Return on equity is calculated by dividing the stock return by average stockholders' equity.Return on equity is calculated by dividing net income by average stockholders' equity.

Accepted Answer

Return on equity is calculated by dividing net income by average stockholders' equity, not the stock return by average stockholders' equity.

Question 13

Value stocks have lower share prices in relationship to their fundamental ratios,and therefore,trade at lower PE ratios.

Accepted Answer

Value stocks are typically priced lower in relation to their fundamental ratios, such as price-to-earnings ratio (PE ratio), compared to growth stocks. This is because value stocks are perceived to have lower growth potential and therefore may not command a higher valuation.

Question 14

A discontinued operation is the sale or disposal of any long-term asset.A discontinued operation is the sale or disposal of a significant component of a business.

Accepted Answer

A discontinued operation refers specifically to the sale or disposal of a significant component of a business, not just any long-term asset.

Question 15

Asset turnover measures sales volume in relation to the investment in assets,and is calculated as net sales divided by average total assets.

Accepted Answer

Asset turnover is indeed calculated as net sales divided by average total assets.

Question 16

The gross profit ratio is calculated as gross profit divided by net sales.

Accepted Answer

The gross profit ratio is calculated by dividing gross profit by net sales.

Question 17

We calculate the times interest earned ratio by dividing net income by interest expense.We calculate the times interest earned ratio by dividing net income before interest expense and income taxes by interest expense.

Accepted Answer

The correct formula for calculating the times interest earned (TIE) ratio is dividing EBIT (earnings before interest and taxes) by interest expense.

Question 18

Return on assets is calculated as net income divided by ending total assets.Return on assets is calculated as net income divided by average total assets.

Accepted Answer

Return on assets is calculated as net income divided by average total assets to account for fluctuations in the amount of assets throughout the year instead of only at the end of the year.

Question 19

A low current ratio indicates that a company has sufficient current assets to pay current liabilities as they become due.A high current ratio indicates that a company has sufficient current assets to pay current liabilities as they become due.

Accepted Answer

A low current ratio actually indicates that a company may have difficulty paying its current liabilities as they become due, while a high current ratio indicates that a company has a larger cushion of current assets to cover its current liabilities.

Question 20

Conservative accounting practices are those that result in reporting higher income,higher assets,and lower liabilities.Conservative accounting practices are those that result in reporting lower income,lower assets,and higher liabilities.

Accepted Answer

Conservative accounting practices are those that result in reporting lower income, lower assets, and higher liabilities as they take a cautious approach towards recognizing revenue and assets and are more likely to recognize expenses and liabilities early.

Quiz 12: Financial Statement Analysis