Deck 13: Financial Statement Analysis

Question 1

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.

Answer 1

False

Question 2

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.

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

An example of horizontal analysis is the increase in cost of goods sold by 29% from 2016 to 2017.

Question 7

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.

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

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

Question 13

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.

Question 14

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.

Question 15

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

Question 16

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.

Question 17

The most liquid of all assets is cash.

Question 18

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.

Question 19

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

Question 20

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.

Question 21

The income number used in the rate of return on assets is income after interest expense is added back.

Question 22

The concept of leverage refers to the practice of using borrowed funds and amounts received from preferred stockholders in an attempt to earn an overall return that is higher than the cost of these funds.

Question 23

One measure of a company's overall long-term financial health is the debt-to-equity ratio.

Question 24

Because net income is on an after-tax basis, interest in the return on assets ratio must be placed on a before-tax basis.

Question 25

A company with a capital structure that shifts more toward debt financing will appear to be in a stronger position to pay interest and any principal amount that may be maturing by using its cash flows generated by operating activities.

Question 26

The selection of a particular inventory valuation method has a significant effect on certain key ratios.

Question 27

The number of days' sales in inventory is the same as a company's accounting cycle.

Question 28

Solvency is concerned with the ability of a company to pay next year's debts as they come due.

Question 29

The return on sales ratio is a variation of the profit margin ratio.

Question 30

A high P/E ratio always indicates that a stock is overpriced by the market.

Question 31

Discontinued operations and extraordinary items are two components of the income statement that are reported after income from operations or are reported separately because of their unique nature.

Question 32

If a company must pay more for the amounts provided by creditors and preferred stockholders than it can earn overall, as indicated by the return on assets, there will be favorable leverage.

Question 33

Kingston Company's accounts receivable turned over nine times during the year.This translates into strict adherence of the company's net/30 credit terms by Kingston's customers.

Question 34

Various organizations publish summaries of selected ratios organized by industry for a sample of U.S.companies.

Question 35

The denominator of a return ratio will be some measure of the company's income for the period.

Question 36

Because discontinued segments of a business will not be part of the company's future operations, discontinued operations are disclosed separately on the income statement.

Question 37

Analysts trying to make investment decisions may very well ignore discontinued operations, and extraordinary items.

Question 38

Solvency is the company's ability to pay its current debts when they become due.

Question 39

The definition of a conglomerate is a company that operates in one industry and uses different inventory valuation techniques.

Question 40

Since inflation is an important consideration in analyzing financial statements, the FASB requires the submission of all financial statements in an inflation-adjusted format to the SEC.

Question 41

Following are selected data from the financial statements of Mother Nature Supplies: $\begin{array} { r r }& \underline { \mathbf { 2 0 1 7 } } & \underline { \mathbf { 2 0 1 6 } } \\ \text {Accounts receivable}&\$ 60,000 & \$ 38,000 \\\text {Merchandise inventory}& 12,000 & 16,000 \\ \text {Total assets}&450,000 & 380,000 \\ \text {Net sales}&380,000 & 270,000 \\ \text {Cost of goods sold}&160,000 & 210,000 \end{array}$

-Refer to the data for Mother Nature Supplies. ?
Which of the following would result from a vertical analysis of its income statement?

A) Accounts receivable increased $22,000 or 57.9% during 2017.
B) Gross profit is 57.9% of net sales for 2017.
C) Cost of goods sold increased $50,000 or 23.8% during 2017.
D) Net sales increased $110,000 or 28.9% during 2017.

Question 42

To review the current market price of the stock, one should review the

A) balance sheet.
B) income statement.
C) statement of cash flows.
D) none of these; it is not on the financial statements.

Question 43

Following are selected data from the financial statements of Mother Nature Supplies: $\begin{array} { r r }& \underline { \mathbf { 2 0 1 7 } } & \underline { \mathbf { 2 0 1 6 } } \\ \text {Accounts receivable}&\$ 60,000 & \$ 38,000 \\\text {Merchandise inventory}& 12,000 & 16,000 \\ \text {Total assets}&450,000 & 380,000 \\ \text {Net sales}&380,000 & 270,000 \\ \text {Cost of goods sold}&160,000 & 210,000 \end{array}$

-Refer to the data for Mother Nature Supplies. ?
Which of the following would result from a horizontal analysis of its balance sheet?

A) Accounts receivable increased $22,000 or 57.9% during 2017.
B) Accounts receivable is five times larger than Merchandise inventory in 2017.
C) Accounts receivable is 13.3% of total assets for 2017.
D) Merchandise inventory is 2.7% of total assets for 2017.

Question 44

Following are selected data from the financial statements of Mother Nature Supplies: $\begin{array} { r r }& \underline { \mathbf { 2 0 1 7 } } & \underline { \mathbf { 2 0 1 6 } } \\ \text {Accounts receivable}&\$ 60,000 & \$ 38,000 \\\text {Merchandise inventory}& 12,000 & 16,000 \\ \text {Total assets}&450,000 & 380,000 \\ \text {Net sales}&380,000 & 270,000 \\ \text {Cost of goods sold}&160,000 & 210,000 \end{array}$

-Refer to the data for Mother Nature Supplies. ?
Which of the following results would be found through a vertical analysis of the balance sheet or the income statement of Mother Nature Supplies?

A) Accounts receivable increased $22,000 during 2017.
B) Total assets increased $70,000 during 2017.
C) Cost of goods sold increased $50,000 or 23.8% during 2017.
D) Gross profit is 57.9% of net sales for 2017.

Question 45

Horizontal analysis is analysis

A) of dollar changes and percentage changes over two or more years.
B) in which all items are presented as a percentage of one selected item on a financial statement.
C) in which a statistic is calculated for the relationship between two items on a single financial statement or for two items on different financial statements
D) of all ratios that increased or decreased over past accounting periods.

Question 46

Trend analysis is analysis

A) of dollar changes and percentage changes over several years.
B) in which all items are presented as a percentage of one selected item on a financial statement.
C) in which a statistic is calculated for the relationship between two items on a single financial statement or for two items on different financial statements.
D) of all ratios that increased or decreased over past accounting periods.

Question 47

The dollar change and percentage change in the accounts receivable account from 2016 to 2017 is calculated for Allison Corporation.This is an example of

A) horizontal analysis
B) vertical analysis
C) profitability analysis
D) solvency assessment

Question 48

Which of the following statements is true regarding valuation amounts on the balance sheet?

A) Stockholders' equity reflects the amount the stockholders would receive upon liquidation.
B) Assets are recorded at current cost.
C) Stockholders' equity reflects the current market value of the stock
D) There are a variety of assumptions used in determining amounts reported on the balance sheet.

Question 49

What is the minimum number of years for which publicly traded companies must include the following statements in their annual report filed with the SEC? ​

Question 50

Which of the following is least useful in evaluating a company's financial statements?

A) Comparison of the company's current period data with accounting data from 5 years ago
B) Comparison with other companies in the same industry
C) Comparison with government economic data for the economy as a whole.
D) Comparison of the company's current period data with that of the last year

Question 51

Which of the following considerations is most important for a stockholder when evaluating whether to purchase stock in a company?

A) Will earnings per share be distributed to stockholders?
B) Will the company earn a fair return on the amount invested by the stockholders?
C) Will the key ratios be reported on the balance sheet?
D) Will cash flows from operations exceed the amount of net income for the period?

Question 52

A financial analyst is comparing two companies.Which of the following would cause major problems in the evaluation process?

A) One company has a fiscal year that ends on October 31, while the other company has a fiscal year that ends on August 31.
B) One company reported nonoperating activities, while the other company did not.
C) The companies operate in different industries.
D) Inflation has been low for the past several years.

Question 53

Which of the following statements is true regarding horizontal analysis?

A) Horizontal analysis can only be used with balance sheet accounts.
B) Horizontal analysis can only be used with income statement accounts.
C) Horizontal analysis can only be used with retained earnings accounts.
D) Time series analysis is an advanced statistical technique for horizontal analysis.

Question 54

Since almost all debts require payment with quick assets, the quick ratio is more useful than the cash flow from operations to current liabilities ratio.

Question 55

A banker is analyzing a company which operates in the petroleum industry.Which of the following might be a major consideration in determining whether the company should receive a loan?

A) The petroleum industry suffers from political pressures concerning the selling price of its products.
B) Inflation has been high for several years in a row.
C) All companies in the petroleum industry use the same accounting principles.
D) The company has a large amount of interest payments related to many outstanding loans.

Question 56

Following are selected data from the financial statements of Mother Nature Supplies: $\begin{array} { r r }& \underline { \mathbf { 2 0 1 7 } } & \underline { \mathbf { 2 0 1 6 } } \\ \text {Accounts receivable}&\$ 60,000 & \$ 38,000 \\\text {Merchandise inventory}& 12,000 & 16,000 \\ \text {Total assets}&450,000 & 380,000 \\ \text {Net sales}&380,000 & 270,000 \\ \text {Cost of goods sold}&160,000 & 210,000 \end{array}$

-Refer to the data for Mother Nature Supplies. ?
Which of the following would result from a horizontal analysis of its income statement?

A) Cost of goods sold is 45.5% of net sales for 2017.
B) Gross profit is 42.1% of net sales for 2017.
C) Cost of goods sold decreased $50,000 or 23.8% during 2017.
D) Accounts receivable total 13.3% of total assets for 2017.

Question 57

Following are selected data from the financial statements of Mother Nature Supplies: $\begin{array} { r r }& \underline { \mathbf { 2 0 1 7 } } & \underline { \mathbf { 2 0 1 6 } } \\ \text {Accounts receivable}&\$ 60,000 & \$ 38,000 \\\text {Merchandise inventory}& 12,000 & 16,000 \\ \text {Total assets}&450,000 & 380,000 \\ \text {Net sales}&380,000 & 270,000 \\ \text {Cost of goods sold}&160,000 & 210,000 \end{array}$

-Refer to the data for Mother Nature Supplies. ?
Which of the following would not result from a vertical analysis of its balance sheet?

A) Accounts receivable increased $22,000 or 36.7% during 2017.
B) Accounts receivable is five times larger than Merchandise inventory in 2017.
C) Accounts receivable is 13.3% of total assets for 2017.
D) Merchandise inventory is 2.7% of total assets for 2017.

Question 58

The calculations for some profitability ratios are the same as the calculations for common-size analysis of the income statement.Which of the following profitability ratios would also be determined through a common-size analysis of the income statement?

A) gross profit ratio
B) debt-to-equity ratio
C) acid-test ratio
D) earnings per share

Question 59

Which of the following statements is true regarding vertical analysis?

A) Common-size financial statements can be used to compare businesses of different sizes.
B) Vertical analysis can only be used with balance sheet accounts.
C) Vertical analysis can only be used with income statement accounts.
D) Vertical analysis can only be used with retained earnings accounts.

Question 60

Which of the following is the most serious limitation to financial statement analysis of publicly traded companies?

A) Some companies do not use GAAP.
B) Inflation can distort comparisons between years.
C) Some companies report nonoperating items such as extraordinary gains and losses, while others do not.
D) Different industries use different account names.

Question 61

Below is financial data for Fawnsworth Industries' current year. $\begin{array}{lr}\text { Net sales on account during year } & \$ 500,000 \\\text { Cost of merchandise sold during year } & 300,000 \\\text { Accounts receivable, beginning of year } & 45,000 \\\text { Accounts receivable, end of year } & 35,000 \\\text { Inventory, beginning of year } & 90,000 \\\text { Inventory, end of year } & 110,000\end{array}$

-Refer to the data for Fawnsworth Industries. Based on this information, what is Fawnsworth's number of days' sales in inventory (assuming a 360 day year)?

A) 132 days
B) 216 days
C) 1,091 days
D) 120 days

Question 62

Use the selected data from Pinecrest Company's financial statements to answer the following question. $$\begin{array} { l r r } & \underline { 2017 } & \underline { 2016 } \\\text { Cash } & \$ 22,000 & \$ 14,000 \\\text { Accounts receivable } & 42,000 & 16,000 \\\text { Merchandise inventory } & 22,000 & 83,000 \\\text { Prepaid expenses }& \underline { 23,000 } & \underline { 18,000 } \\\text { Total current assets } & \underline { \mathbf { \$ 1 0 9 , 0 0 0 } } & \underline { \mathbf { \$ 1 3 1 , 0 0 0 } } \\\\\text { Total current liabilities } & \$ 65,000 & \$ 72,000 \\\text { Net credit sales } & 221,000 & 326,000 \\\text { Cost of goods sold } & 168,000 & 299,000 \\\text { Net cash flow from operating activities } & 16,000 & 29,000\end{array}$$ ?
?

-Refer to the data for Pinecrest Company. The current ratio for 2017 is

A) 0.60 to 1
B) 0.99 to 1
C) 1.34 to 1
D) 1.68 to 1

Question 63

If Tommy's Subs Company has a current ratio of 2.5 and current assets of $195,000, the amount of working capital is:

A) $117,000
B) $330,000
C) $380,000
D) $78,000

Question 64

Which of the following is a measure of the time that it takes to convert current assets into cash?

A) accounts receivable turnover ratio
B) cash to cash operating cycle
C) number of days' sales in inventory
D) working capital

Question 65

Use the selected data from Pinecrest Company's financial statements to answer the following question. $$\begin{array} { l r r } & \underline { 2017 } & \underline { 2016 } \\\text { Cash } & \$ 22,000 & \$ 14,000 \\\text { Accounts receivable } & 42,000 & 16,000 \\\text { Merchandise inventory } & 22,000 & 83,000 \\\text { Prepaid expenses }& \underline { 23,000 } & \underline { 18,000 } \\\text { Total current assets } & \underline { \mathbf { \$ 1 0 9 , 0 0 0 } } & \underline { \mathbf { \$ 1 3 1 , 0 0 0 } } \\\\\text { Total current liabilities } & \$ 65,000 & \$ 72,000 \\\text { Net credit sales } & 221,000 & 326,000 \\\text { Cost of goods sold } & 168,000 & 299,000 \\\text { Net cash flow from operating activities } & 16,000 & 29,000\end{array}$$ ?
?

-Refer to the data for Pinecrest Company. ?
Competitors in Pinecrest Company's industry have an average inventory turnover of 20.8 times.Its inventory turnover for 2017

A) indicates that the company has too little inventory on hand at the end of 2017.
B) indicates that the company is pricing its products too low.
C) is equal to the number of days' sales in the company's inventory.
D) indicates that the market may be reacting to problems in the sales department by reducing demand for the company's products.

Question 66

If Mussel Company has working capital of $540,000 and a current ratio of 3 to 1, the amount of current assets is:

A) $540,000
B) $810,000
C) $270,000
D) $405,000

Question 67

Which of the following is considered a liquidity analysis tool?

A) gross profit ratio
B) acid-test ratio
C) dividend yield ratio
D) return on assets ratio

Question 68

In a vertical analysis of the income statement, the 100% amount is

A) Net income
B) Gross profit
C) Operating income
D) Net sales

Question 69

Use the selected data from Pinecrest Company's financial statements to answer the following question. $$\begin{array} { l r r } & \underline { 2017 } & \underline { 2016 } \\\text { Cash } & \$ 22,000 & \$ 14,000 \\\text { Accounts receivable } & 42,000 & 16,000 \\\text { Merchandise inventory } & 22,000 & 83,000 \\\text { Prepaid expenses }& \underline { 23,000 } & \underline { 18,000 } \\\text { Total current assets } & \underline { \mathbf { \$ 1 0 9 , 0 0 0 } } & \underline { \mathbf { \$ 1 3 1 , 0 0 0 } } \\\\\text { Total current liabilities } & \$ 65,000 & \$ 72,000 \\\text { Net credit sales } & 221,000 & 326,000 \\\text { Cost of goods sold } & 168,000 & 299,000 \\\text { Net cash flow from operating activities } & 16,000 & 29,000\end{array}$$ ?
?

-Refer to the data for Pinecrest Company. ?
The amount of working capital at the end of 2017 is

A) $36,000
B) $44,000
C) $99,000
D) $174,000

Question 70

Use the selected data from Pinecrest Company's financial statements to answer the following question. $$\begin{array} { l r r } & \underline { 2017 } & \underline { 2016 } \\\text { Cash } & \$ 22,000 & \$ 14,000 \\\text { Accounts receivable } & 42,000 & 16,000 \\\text { Merchandise inventory } & 22,000 & 83,000 \\\text { Prepaid expenses }& \underline { 23,000 } & \underline { 18,000 } \\\text { Total current assets } & \underline { \mathbf { \$ 1 0 9 , 0 0 0 } } & \underline { \mathbf { \$ 1 3 1 , 0 0 0 } } \\\\\text { Total current liabilities } & \$ 65,000 & \$ 72,000 \\\text { Net credit sales } & 221,000 & 326,000 \\\text { Cost of goods sold } & 168,000 & 299,000 \\\text { Net cash flow from operating activities } & 16,000 & 29,000\end{array}$$ ?
?

-Refer to the data for Pinecrest Company. ?
Which of the following statements is true?

A) Net income must be at least $36,000 for 2017.
B) Net income must be less than $36,000 for 2017.
C) Cash flows from operating activities is twice as large as net income for 2017.
D) The amount of net income for 2017 cannot be determined based on the data provided.

Question 71

You want to know whether selling and administrative expenses were reasonable for the past year, based on the level of sales.The best analysis for obtaining this information is:

A) trend analysis
B) vertical analysis
C) horizontal analysis
D) liquidity analysis

Question 72

Below is financial data for Fawnsworth Industries' current year. $\begin{array}{lr}\text { Net sales on account during year } & \$ 500,000 \\\text { Cost of merchandise sold during year } & 300,000 \\\text { Accounts receivable, beginning of year } & 45,000 \\\text { Accounts receivable, end of year } & 35,000 \\\text { Inventory, beginning of year } & 90,000 \\\text { Inventory, end of year } & 110,000\end{array}$

-Refer to the data for Fawnsworth Industries. Based on this information, what is Fawnsworth's number of days' sales in receivables (assuming a 360 day year)?

A) 32.4 days
B) 36.0 days
C) 28.8 days
D) 25.2 days

Question 73

Below is financial data for Fawnsworth Industries' current year. $\begin{array}{lr}\text { Net sales on account during year } & \$ 500,000 \\\text { Cost of merchandise sold during year } & 300,000 \\\text { Accounts receivable, beginning of year } & 45,000 \\\text { Accounts receivable, end of year } & 35,000 \\\text { Inventory, beginning of year } & 90,000 \\\text { Inventory, end of year } & 110,000\end{array}$

-Refer to the data for Fawnsworth Industries. Based on this information, what is Fawnsworth's inventory turnover ratio for the current period?

A) 1.67 times
B) 2.73 times
C) 0.33 times
D) 3.00 times

Question 74

Which of the following ratios is least useful in evaluating a company's ability to pay its current debts as they become due?

A) current ratio
B) debt-to-equity ratio
C) debt service coverage ratio
D) acid-test ratio

Question 75

Below is financial data for Fawnsworth Industries' current year. $\begin{array}{lr}\text { Net sales on account during year } & \$ 500,000 \\\text { Cost of merchandise sold during year } & 300,000 \\\text { Accounts receivable, beginning of year } & 45,000 \\\text { Accounts receivable, end of year } & 35,000 \\\text { Inventory, beginning of year } & 90,000 \\\text { Inventory, end of year } & 110,000\end{array}$

-Refer to the data for Fawnsworth Industries. Based on this information, what is the accounts receivable turnover for the current period?

A) 10.0 times
B) 12.5 times
C) 11.1 times
D) 14.3 times

Question 76

​Starship Inc.'s gross profit ratio decreased from 36.5% in 2016 to 28.6% in 2017.What is the trend in this change?

A) An upward trend
B) A downward trend
C) It depends on whether net sales increased or decreased during the period
D) Trends cannot be determined without the dollar amount of the increase provided

Question 77

In a vertical analysis of the balance sheet, the 100% amount is

A) Current assets
B) Working capital
C) Total assets
D) Total stockholders' equity

Question 78

What numerators are used in the computation of the following ratios? ​

Question 79

Which of the following is a total dollar measure of liquidity?

A) accounts receivable turnover ratio
B) cash to cash operating cycle
C) number of days' sales in inventory
D) working capital

Question 80

Use the selected data from Pinecrest Company's financial statements to answer the following question. $$\begin{array} { l r r } & \underline { 2017 } & \underline { 2016 } \\\text { Cash } & \$ 22,000 & \$ 14,000 \\\text { Accounts receivable } & 42,000 & 16,000 \\\text { Merchandise inventory } & 22,000 & 83,000 \\\text { Prepaid expenses }& \underline { 23,000 } & \underline { 18,000 } \\\text { Total current assets } & \underline { \mathbf { \$ 1 0 9 , 0 0 0 } } & \underline { \mathbf { \$ 1 3 1 , 0 0 0 } } \\\\\text { Total current liabilities } & \$ 65,000 & \$ 72,000 \\\text { Net credit sales } & 221,000 & 326,000 \\\text { Cost of goods sold } & 168,000 & 299,000 \\\text { Net cash flow from operating activities } & 16,000 & 29,000\end{array}$$ ?
?

-Refer to the data for Pinecrest Company. ?
Which of the following statements is true?

A) The current ratio increased from 2016 to 2017.
B) The acid-test ratio decreased from 2016 to 2017.
C) The amount of working capital decreased from 2016 to 2017.
D) Assuming extreme conditions do not exist, the company appears to be in a worse position to pay its current debts at the end of 2017 compared to 2016.