Deck 13: Financial Statement Analysis Available Online in the Connect Library

Question 1

Jones Company's current ratio is higher than the average for its industry, while its quick ratio is below the industry average. One possible interpretation for these results is that Jones carries more inventory than most companies in its industry.

Answer 1

True
Explanation: Inventory is not included in the quick ratio numerator, but it is included in the numerator for current ratio. Since the denominator, current liabilities, doesn't change the difference in these ratios could be due to a large amount of inventory.

Question 2

The accounting profession assumes that financial statement users have a reasonable knowledge of business.

Answer 2

True
Explanation: Current reporting standards target users that have a reasonably informed knowledge of business, though that level of sophistication is difficult to define.

Question 3

In terms of solvency, the smaller the number of times interest is earned, the better.

Answer 3

False
Explanation: The number of times interest is earned ratio is: Earnings before interest and taxes (EBIT)/interest expense. This ratio measures the burden a company's interest payments represent. Users often consider times interest is earned along with the debt ratios when evaluating financial risk. Dividing EBIT by interest expense indicates how many times the company could have made its interest payments. The more times it could be paid, the bigger the company's safety net.

Question 4

Financial ratio analysis is a form of horizontal analysis in that comparisons are made between different accounts in the same set of financial statements.

Question 5

Liquidity ratios are used to analyze the long-term debt-paying ability and the composition of the financing structure of the firm.

Question 6

The most frequently quoted measure of earnings performance is the stockholders' equity ratio.

Question 7

A company has an obligation to provide highly detailed information on its financial statements.

Question 8

Vertical analysis involves comparing amounts in the financial statements for a single period, but an analyst may usefully compare vertical analysis results for two or more periods.

Question 9

A vertical analysis uses percentages to compare each of the parts of an individual statement to the whole. For example, on an income statement each item would be shown as a percentage of net sales.

Question 10

The only requirement involved in communicating useful information is that the information be accurate.

Question 11

A banker may perform a financial ratio analysis to assess a firm's ability to repay debt in a timely manner.

Question 12

While horizontal analysis examines one item over many time periods, vertical analysis examines many items in the same interval of time.

Question 13

Financial analysis typically involves some form of comparison such as changes in the same item over a number of years.

Question 14

The debt to equity ratio can be used to asses a firm's solvency.

Question 15

The quick ratio although similar to the current ratio is more conservative.

Question 16

When debt is used to finance purchase of assets, the term or time span of the debt should be similar to the lifespan of the assets.

Question 17

Working capital is current assets divided by current liabilities.

Question 18

Profitability ratios attempt to assess the company's ability to generate earnings.

Question 19

The drawback of studying absolute amounts reported in financial statements is the problem of differing materiality levels.

Question 20

The current ratio is one of the most common measures of liquidity.

Question 21

Select the incorrect statement regarding the information disclosed in financial statements.

A)Financial statements should be detailed enough to answer any financial-related question an investor might have.
B)Some information disclosed in financial statements may be irrelevant to some users.
C)The costs of providing all possible information about a firm would be prohibitively high for the business.
D)When too much information is presented users may suffer from information overloaD.Financial statements can provide only highly summarized economic information. The costs to a company of providing excessively detailed information would be prohibitive. In addition, too much detail leads to information overload, the problem of having so much data that important information becomes obscured by trivial information.

Question 22

Which of the following is a factor involved in communicating useful information?

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 the other answers are correct.

Question 23

Select the incorrect statement regarding the quick ratio:

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

Question 24

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

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

Question 25

Jones Company has cash of $20,000, accounts receivable of $30,000, inventory of $16,000, and equipment of $50,000. Assuming current liabilities of $24,000, this company's working capital is:

A)$6,000.
B)$26,000.
C)$42,000.
D)$72,000.

Question 26

Select the incorrect statement regarding horizontal analysis.

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

Question 27

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 the other answers are correct.

Question 28

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 the other answers are correct.

Question 29

Select the incorrect statement regarding the analysis of absolute amounts of various accounts reported on the financial statements.

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

Question 30

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 the other answers are correct.

Question 31

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

A)Current ratio.
B)Inventory turnover.
C)Earnings per share.
D)Average collection perioD.Liquidity ratios indicate a firm's short-term ability to pay its current obligations. Liquidity ratios include: working capital, current ratio, acid test (quick) ratio, accounts receivable turnover, average days to collect ratio, inventory turnover and average days to sell inventory. Earnings per share is a stock market ratio.

Question 32

Working capital is defined as:

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

Question 33

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

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

Question 34

Current financial reporting standards assume that users of accounting information:

A)Have a reasonably informed knowledge of business.
B)Have an expert's understanding of economic and financial events and conditions
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 35

Roanoke Company collected $500 on account. What impact will this transaction have on the firm's current ratio?

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

Question 36

Select the incorrect statement regarding ratio analysis.

A)Ratio analysis involves making comparisons between different accounts in the same set of financial statements.
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 is a specific form of horizontal analysis.

Question 37

A limitation of financial statement analysis stems from the discretion of management to choose accounting procedures that cast the best light on the firm's performance.

Question 38

Which of the following is an objective 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 the other answers are correct.

Question 39

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)Vertical analysis.
C)Horizontal analysis.
D)Contribution analysis.

Question 40

Keller Company paid its sales employees $1,200 in sales commissions. What impact will this transaction have on working capital?

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

Question 41

You are considering an investment in General Motors 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)Net margin.
C)Debt to equity ratio.
D)Debt to assets ratio.

Question 42

You are considering an investment in Microsoft 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)Quick ratio.
B)Inventory turnover.
C)Debt to equity ratio.
D)Accounts receivable turnover.

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 the other answers are correct.

Question 44

Select the incorrect statement regarding net margin.

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 smaller the net margin the better.
D)The amount of net margin is affected by a company's choices of accounting principles.

Question 45

The Phillips Company paid total cash dividends of $100,000 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)3.2%
C)5%
D)16.9%

Question 46

The Crestar Company reported net income of $100,000 on 20,000 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 $80. What is this company's current price-earnings ratio? (rounded)

A)16
B)18
C)20
D)None of the other answers are correct.

Question 47

The return on investment measure is also referred to as:

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

Question 48

The following balance sheet information is provided for Paris Company: Assuming 2012 cost of goods sold is $365,000, what is the company's average days to sell inventory?

A)25 days
B)15 days
C)100 days
D)None of the other answers are correct.

Question 49

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

A)1.68 times
B)1.72 times
C)0.59 times
D)1.7 times

Question 50

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

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

Question 51

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

A)$1.67
B)$6.67
C)$5.42
D)$1.58

Question 52

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

Question 53

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

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

Question 54

The Monticello Company reported net income of $14,400 on gross sales of $80,000. The company has total average assets of $115,200, of which $100,000 is property, plant and equipment. What is the company's return on investment?

A)69.4%
B)18.0%
C)14.5%
D)12.5%

Question 55

Solvency ratios are used to assess a company's:

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

Question 56

Select the incorrect statement regarding the return on equity (ROE) measure.

A)ROE is used to measure the profitability of the firm in relation to the amount invested by stockholders.
B)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.
C)ROE is affected by a company's use of leverage.
D)ROE equals net income divided by total stockholders' equity.

Question 57

Morton Company has total current assets of $45,000, including inventory of $10,000, and current liabilities of $21,000. The company's current ratio is:

A)0.4.
B)1.7.
C)2.1.
D)2.6.

Question 58

Accrual accounting requires the use of many estimates, including:

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

Question 59

Which of the following statements is generally incorrect?

A)A 2:1 current ratio is generally preferred over a 1:1 current ratio.
B)A 30-day average collection period for accounts receivable is generally preferred over a 20-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 60

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

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

Question 61

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

A)The numerator for the quick ratio is current assets.
B)The numerator for the quick ratio is current assets minus inventory minus-prepaid expenses.
C)The quick ratio is also called the working capital ratio.
D)The quick ratio is a less conservative variation of the current ratio.

Question 62

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

A)Increase.
B)Decrease.
C)Remain the same.
D)Cannot be determineD.The transaction will increase assets (cash) and increase stockholders' equity (common stock). The debt to equity ratio is total debt/total stockholders' equity. The increase in cash will not affect the ratio, but the increase in common stock will cause the ratio to go down.

Question 63

As of December 31, 2012, Grove 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, 2012, Grove collected $5,200 of accounts receivable. As a result of this transaction, Grove's working capital will:

A)Increase.
B)Remain the same.
C)Decrease.
D)Cannot be determineD.The transaction will increase one current asset (cash) and decrease another current asset (accounts receivable). Current assets do not change; therefore working capital will not change.

Question 64

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

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

Question 65

As of December 31, 2012, Grove 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, 2012, Grove purchased merchandise on account for $4,000. Which of the following statements is true?

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

Question 66

Barrett 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)Increase.
B)Decrease.
C)Remain the same.
D)Cannot be determineD.The transaction will decrease stockholders' equity (retained earnings) and decrease an asset (cash). The debt to asset ratio is total debt/total assets. The reduction in stockholders' equity does not affect the ratio, but the decrease in assets causes an increase in the ratio.

Question 67

As of December 31, 2012, Grove 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, 2012 Grove issued common stock for $10,000 cash. Which of the following statement is true?

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

Question 68

As of December 31, 2012, Grove 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, 2012 Grove sold inventory on account for $6,000 and recorded cost of goods sold of $4,100. Which of the following statement is incorrect?

A)Grove's current ratio will decrease.
B)Grove's quick ratio will increase.
C)Grove's working capital will decrease.
D)A and C are both incorrect statements

Question 69

Short-term creditors are usually most interested in assessing:

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

Question 70

Long-term creditors are usually most interested in evaluating:

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

Question 71

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

Question 72

The study of an individual item or account over several accounting periods, such as months, quarters or years is known as:

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

Question 73

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

A)Remain the same.
B)Decrease.
C)Increase.
D)Cannot be determineD.The transaction will increase current assets (cash) and increase long-term liabilities (bonds payable). The current ratio is current assets/current liabilities. The ratio will not be affected by the increase in long-term liabilities, but the increase in current assets will cause the ratio to increase.

Question 74

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

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

Question 75

Horizontal analysis is also known as:

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

Question 76

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

A)Since Lilly's working capital exceeds Harmon's working capital, it is safe to conclude that Lilly is more liquid than Harmon.
B)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.
C)If Harmon Corporation is smaller than Lilly or has lower current liabilities; Harmon could be more liquid than Lilly.
D)None of the other answers are correct.

Question 77

As of December 31, 2012, Grove 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, 2012, Grove paid $250 for transportation costs on merchandise it had received. Which of the following statements is incorrect?

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

Question 78

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

A)Net sales on the income statement.
B)Net income on the income statement.
C)Total expenses on the income statement.
D)None of the other answers are correct.

Question 79

As of December 31, 2012, Grove 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, 2012, Grove paid $3,600 on accounts payable. Which of the following statements is incorrect?

A)Grove's current ratio will increase.
B)Grove's quick ratio will increase.
C)Grove's working capital will not change.
D)Grove's quick ratio will increase and its current ratio will decrease.

Question 80

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 the other answers are correct.