Question 1

Inventories and prepaid assets are excluded from the numerator used to compute the quick ratio.

Accepted Answer

The quick ratio (also called the acid-test ratio) excludes inventories and prepaid assets from the numerator, as they are not considered easily convertible into cash. Therefore, only cash, cash equivalents, and accounts receivable are included in the numerator.

Question 2

If two companies in the same industry use different methods to value inventory,this makes comparisons more difficult but not impossible.

Accepted Answer

While different inventory valuation methods can make comparisons more challenging, it is still possible to make meaningful comparisons with some additional analysis and adjustments.

Question 3

Ratios that focus on cash are more useful than those that focus on income in the evaluation of the liquidity of a company.

Accepted Answer

Ratios that focus on cash, such as the cash ratio and the quick ratio, provide a better indication of a company's ability to meet its short-term obligations. Income-based ratios, such as the current ratio and the working capital ratio, do not take into account the timing of cash flows and may provide a misleading picture of a company's liquidity. Therefore, ratios that focus on cash are more useful in evaluating a company's liquidity.

Question 4

Three measures of liquidity are working capital,the acid-test ratio,and the debt-to-equity ratio.

Accepted Answer

The debt-to-equity ratio is a measure of financial leverage, not liquidity. Working capital and the acid-test ratio are measures of liquidity.

Question 5

Vertical analysis is a comparison of financial statement items for a single company over a period of time.

Accepted Answer

Vertical analysis is a method of financial statement analysis in which each entry for each of the three major categories of accounts (assets, liabilities, and equities) in a balance sheet is represented as a proportion of the total account. It analyzes the relative size of different items on a single financial statement (e.g., a balance sheet or income statement) at a point in time, not over a period of time.

Question 6

Apple Company had terms of net 60 days for customers.The number of days' sales in accounts receivable for Apple was 42 days.Apple is efficient in the collection of its receivables.

Accepted Answer

The number of days' sales in accounts receivable for Apple (42 days) is less than the terms of net 60 days for customers, which indicates that Apple is collecting its receivables efficiently.

Question 7

The profit margin ratio reflects the amount of income for each dollar of sales.

Accepted Answer

The profit margin ratio is calculated by dividing net income by total revenue, which reflects the amount of income generated from each dollar of sales. Therefore, the statement is true.

Question 8

The amount of working capital is more meaningful to users than the current ratio because it provides information on the composition of the current accounts.

Accepted Answer

The current ratio provides a measure of a company's ability to cover its short-term obligations with its short-term assets, which is a critical piece of information for users. The amount of working capital (current assets minus current liabilities) does not provide information on the composition of the current accounts; it only provides a net figure.

Question 9

Common-size financial statements exclude the dollar amount as a relevant variable in the analysis,which makes comparison of one period with the next more meaningful.

Accepted Answer

Common-size financial statements express each line item as a percentage of a base amount, usually total assets or total revenue. By eliminating the dollar amount, the focus shifts to each line item's proportionate representation in the financial statement, making it easier to compare and analyze different periods or companies.

Question 10

All line items in common-size comparative income statements are stated as a percentage of net income.

Accepted Answer

All line items in common-size comparative income statements are stated as a percentage of sales or revenue, not net income.

Question 11

Inventory is more liquid than accounts receivable because receivables must be collected and some customers may not be willing to pay,while inventory need only be sold in a retail store.

Accepted Answer

This statement is false. Inventory may also become unsellable or depreciate in value over time, making it less liquid than accounts receivable in some cases. Additionally, there are avenues for collecting overdue receivables, such as collections agencies or legal action, which can make them more liquid than unsellable or obsolete inventory.

Question 12

Comparing one company with another in the same industry should cause no problems since companies in the same industry are required to use the same GAAP.

Accepted Answer

While companies in the same industry do follow the same general set of GAAP principles, individual companies can still interpret and apply those principles differently, resulting in differences in financial statements. Additionally, companies may use alternative GAAP frameworks like IFRS (International Financial Reporting Standards) or industry-specific frameworks like GASB (Governmental Accounting Standards Board) that could further complicate comparisons.

Question 13

An increase in a company's revenue and expense accounts will automatically cause an increase in net income for the period.

Accepted Answer

An increase in revenue without a corresponding increase in expenses will result in an increase in net income. However, an increase in expenses without a corresponding increase in revenue will result in a decrease in net income. Therefore, it is not always true that an increase in both revenue and expenses will lead to an increase in net income. It depends on the magnitude of the changes in each account.

Question 14

The acid-test ratio is a stricter test of a company's ability to pay its current debts as they are due than the current ratio is.

Accepted Answer

The acid-test ratio only takes into account a company's most liquid assets (cash, marketable securities, and accounts receivable) compared to its current liabilities, whereas the current ratio includes all current assets. Because the acid-test ratio is a more conservative measure of liquidity, it is considered to be a stricter test of a company's ability to pay its current debts.

Question 15

The analysis of common-size statements is called horizontal analysis.

Accepted Answer

The analysis of common-size statements is referred to as vertical analysis, whereas horizontal analysis compares financial information over multiple periods.

Question 16

An example of horizontal analysis is the increase in cost of goods sold by 29% from 2017 to 2018.

Accepted Answer

The given statement shows a comparison of the cost of goods sold between two years, 2017 and 2018. This is an example of horizontal analysis as it analyzes the change or increase/decrease in financial numbers over time periods.

Question 17

The base,or benchmark,on which all items on the income statement are compared is net sales.

Accepted Answer

Net sales is typically used as the starting point or benchmark for calculating other items on the income statement, such as cost of goods sold, gross profit, operating expenses, and net income. This is because net sales represents the total amount of revenue earned by a company from its primary operations, before deducting any expenses or other costs. Therefore, all other items on the income statement are typically expressed as a percentage or ratio of net sales, making it a key metric for analyzing a company's financial performance.

Question 18

Spring Market has an inventory turnover ratio of 15 times.Fall Market has a turnover of 14 times.Fall is more effective in managing inventory.

Accepted Answer

The higher the inventory turnover ratio, the more effective the company is in managing its inventory. In this case, Spring Market has a higher turnover ratio (15 times) than Fall Market (14 times), so Spring Market is more effective in managing its inventory.

Question 19

The FASB requires a separate note in the financial statements to show the effects of inflation so that investors are able to compare statements more accurately.

Accepted Answer

The FASB does not require a separate note to show the effects of inflation in financial statements. However, companies may choose to include such information voluntarily.

Question 20

The most liquid of all assets is cash.

Accepted Answer

Cash is considered the most liquid asset because it can be easily and quickly converted into other forms of asset or used for transactions.

Quiz 13: Financial Statement Analysis