Deck 4: Analyzing Investing Activities

Question 1

Which of the following would rarely be classified as a current asset?

A) Prepaid insurance
B) Goodwill
C) Marketable Securities
D) Work-in-progress

Answer 1

B

Question 2

For Control Furniture Co.,
LIFO Reserve in Year 2006 $91 million
LIFO Reserve in Year 2005$82 million
Tax Rate is 35%.
To restate Year 2006 LIFO inventories to a FIFO basis, we use the following analytical entry: $$\begin{array} { | l | l | r | r | } \hline \text { A) } & \text { Inventories } & 91 & \\\hline & \text { Deferred Tax Payable } & & 31.85 \\\hline & \text { Retained Earnings } & & 59.15 \\\hline \text { B) } & \text { Inventories } & 91 & \\\hline & \text { Deferred Tax Payable } & & 35.65 \\\hline & \text { Retained Earnings } & & 55.35 \\\hline \text { C) } & \text { Inventories } & 91 & \\\hline & \text { Deferred Tax Payable } & & 38.96 \\\hline & \text { Retained Earnings } & & 52.04 \\\hline \text { D) } & \text { Inventories } & 91 & \\\hline & \text { Deferred Tax Payable } & & 32.85 \\\hline & \text { Retained Earnings } & & 58.15 \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Answer 2

Option C

Question 3

The use of LIFO rather than FIFO for inventory costing under normal economic conditions results in:
I) lower net income.
II) higher total assets.
III) gher retained earnings.
IV) unchanged retained earnings.

A) II and III
B) I, II and IV
C) I only
D) I and IV

Answer 3

C

Question 4

Which of the following would not be classified as a current asset?

A) Inventory
B) Accounts payable
C) Accounts receivable
D) Prepaid expenses

Question 5

Which of the following is not considered an intangible asset?

A) Goodwill
B) Customer lists
C) Prepaid advertising expenses
D) Memberships

Question 6

Which of the following is incorrect with respect to recognized goodwill on the balance sheet?

A) It should not be amortized over 30 years.
B) It arises when another company is purchased or when internally generated.
C) It should be written-down if the future benefits no longer exist.
D) It may be negative.

Question 7

The following information can be found in ABC Co.'s financial statements.
$$\begin{array} { | l | r | r | } \hline & \underline { 2006 } & \underline { 2005 } \\\hline \text { Finished Goods } & \$ 251,690 & \$ 195,360 \\\hline \begin{array} { l } \text { Work in Process and } \\\text { purchased parts }\end{array} & 245,123 & 17,377 \\\hline \text { Raw Materials } & 136,568 & 106,789 \\\hline & 633,381 & 488,581 \\\hline \begin{array} { l } \text { Less excess of current } \\\text { cost over stated LIFO } \\\text { value }\end{array} &\underline { 62,951 } & \underline { 71,186 } \\\hline & \$ 570,430 & \$ 417,395\\\hline & &\\\hline \text { Retained earnings }&\$3,526,000 & \$ 3,159,000 \\\hline\end{array}$$ Assume a tax rate of 35%. Inventories valued using the LIFO method represented approximately 80% of consolidated inventories.

-What will be the value of inventory for 2006 if ABC used FIFO valuation?

A) 633,485
B) 570,430
C) 633,381
D) 488,581

Question 8

The inventory costing method used by a company (LIFO, FIFO, etc.) will affect: $$\begin{array} { | c | c | c | } \hline & \text { Asset Turnover } & \text { Debt/Equity Ratio } \\\hline \text { A) } & \text { Yes } & \text { Yes } \\\hline \text { B) } & \text { Yes } & \text { No } \\\hline \text { C) } & \text { No } & \text { No } \\\hline \text { D) } & \text { No } & \text { Yes } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 9

Analysis of a company's assets will help evaluate its:
I) liquidity.
II) solvency.
III) operational capacity.
IV financing ability.

A) I, II, III and IV
B) 1, II and IV
C) II, III and IV
D) I, II and III

Question 10

The following information can be found in ABC Co.'s financial statements.
$$\begin{array} { | l | r | r | } \hline & \underline { 2006 } & \underline { 2005 } \\\hline \text { Finished Goods } & \$ 251,690 & \$ 195,360 \\\hline \begin{array} { l } \text { Work in Process and } \\\text { purchased parts }\end{array} & 245,123 & 17,377 \\\hline \text { Raw Materials } & 136,568 & 106,789 \\\hline & 633,381 & 488,581 \\\hline \begin{array} { l } \text { Less excess of current } \\\text { cost over stated LIFO } \\\text { value }\end{array} &\underline { 62,951 } & \underline { 71,186 } \\\hline & \$ 570,430 & \$ 417,395\\\hline & &\\\hline \text { Retained earnings }&\$3,526,000 & \$ 3,159,000 \\\hline\end{array}$$ Assume a tax rate of 35%. Inventories valued using the LIFO method represented approximately 80% of consolidated inventories.

-What will be the retained earnings for 2005 if ABC used FIFO valuation?

A) 3,205,271
B) 3,566,918
C) 3,893,000
D) 4,096,430

Question 11

An asset is considered to be liquid if:

A) it is readily converted into a current asset.
B) it is an intangible asset.
C) it is readily converted into cash.
D) it is part of retained earnings.

Question 12

Which of the following steps are required to adjust LIFO to FIFO?

A) Inventory needs to be calculated as reported LIFO inventory plus LIFO reserve.
B) Increase deferred tax payable by LIFO reserve times Tax rate.
C) Retained earnings need to be calculated as reported retained earnings plus LIFO reserve times (1 - Tax rate).
D) All of the above.

Question 13

Target Inc. has 30M shares outstanding and trades at $50 per share. Target has net identifiable assets with a book value of $1,000M and a fair value of $1,200M. Acquirer Corporation purchases all of Target Inc. stock for $60 per share. How much will Acquirer record as goodwill upon acquiring Target?

A) 300M
B) 500M
C) 600M
D) 800M

Question 14

The following information can be found in ABC Co.'s financial statements.
$$\begin{array} { | l | r | r | } \hline & \underline { 2006 } & \underline { 2005 } \\\hline \text { Finished Goods } & \$ 251,690 & \$ 195,360 \\\hline \begin{array} { l } \text { Work in Process and } \\\text { purchased parts }\end{array} & 245,123 & 17,377 \\\hline \text { Raw Materials } & 136,568 & 106,789 \\\hline & 633,381 & 488,581 \\\hline \begin{array} { l } \text { Less excess of current } \\\text { cost over stated LIFO } \\\text { value }\end{array} &\underline { 62,951 } & \underline { 71,186 } \\\hline & \$ 570,430 & \$ 417,395\\\hline & &\\\hline \text { Retained earnings }&\$3,526,000 & \$ 3,159,000 \\\hline\end{array}$$ Assume a tax rate of 35%. Inventories valued using the LIFO method represented approximately 80% of consolidated inventories.

-What will be the retained earnings for 2006 if ABC used FIFO valuation?

A) 3,205,271
B) 3,566,918
C) 3,893,000
D) 4,096,430

Question 15

Which of the following is not a common characteristic of a company choosing to use LIFO rather than FIFO?

A) Larger inventory balances
B) Higher variability in inventory balances
C) Greater expected tax savings
D) Larger in size

Question 16

Which of the following is not an effect of capitalization?

A) Capitalization usually reduces net income.
B) Capitalization usually yields a smoother net income.
C) Capitalization usually decreases the volatility of the return on investment.
D) Capitalization usually increases net income.

Question 17

Companies are supposed to write-down value of assets if a permanent impairment of value or loss of utility occurs. If a company writes down its assets this year the effect on: $$\begin{array} { | l | c | c | } \hline & \text { This year's ROA } & \text { Next year's ROA } \\\hline \text { A) } & \text { Increased } & \text { No change } \\\hline \text { B) } & \text { Decreased } & \text { No change } \\\hline \text { C) } & \text { Decreased } & \text { Decreased } \\\hline \text { D) } & \text { Decreased } & \text { Increased } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 18

A write-down in asset value is:

A) a very rare occurrence.
B) not allowed under GAAP.
C) results in a direct debit to stockholders' equity.
D) required if an asset is deemed to have permanent impairment of value.

Question 19

Financial Statements of ABC Corp. indicates that ending inventory levels in 2005 and 2006 were $200,000 and $350,000 respectively. Cost of Goods sold for 2005 and 2006 were $1,900,000 and $2,200,000 respectively. Purchases in 2006 were:

A) $1,950,000
B) $2,150,000
C) $2,350,000
D) $1,850,000

Question 20

One advantage of LIFO over FIFO under normal conditions is that:

A) it reports higher retained earnings.
B) it results in higher cash flows.
C) it results in higher current ratios.
D) it results in higher gross margins.

Question 21

LIFO liquidation occurs when:

A) a firm changes from LIFO to another inventory method.
B) a firm experiences an increase in cost of raw materials.
C) the LIFO reserves decline in value.
D) the quantity of goods sold is greater than the quantity produced.

Question 22

Prepaid expenses are usually classified as current assets.

Question 23

With respect to LIFO, which of the following is incorrect?

A) If a company uses LIFO for tax purposes it must use it for GAAP purposes.
B) If the LIFO reserve increases in a given year, the LIFO COGS is higher than it would have been if FIFO had been used for that year.
C) LIFO results in better matching on the income statement than FIFO.
D) LIFO results in inventory levels on the balance sheet that are closer to current cost than FIFO.

Question 24

A firm has a current ratio greater than 1.0. If the firm's ending inventory is understated by $3,000 and beginning inventory is overstated by $5,000, the firm's net income (before taxes) and current ratio will be: $$\begin{array} { | l | l | l | } \hline & { \text { Net Income } } & \text { Current Ratio } \\\hline \text { A) } & \text { understated by } \$ 2,000 & \text { too low } \\\hline \text { B) } & \text { overstated by } \$ 2,000 & \text { too low } \\\hline \text { C) } & \text { understated by } \$ 8,000 & \text { too low } \\\hline \text { D) } & \text { understated by } \$ 8,000 & \text { too high } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 25

If a LIFO liquidation occurs during a period of rising prices, which of the following statements about the effects on a firm's financial statements, all other things equal, is generally true?
I) Cost of goods sold increases.
II) Gross profit margin increases.
III) Taxes decrease.
IV) Net income increases.

A) I only
B) II only
C) I and III only
D) II and IV only

Question 26

Goodwill is:

A) the excess of the purchase price of net assets over the book value of net assets.
B) the excess of the appraised value of net assets over the book value of net assets.
C) the excess of the purchase price of net assets over the fair value of net assets.
D) the excess of the appraised value of net assets over the fair value of net assets.

Question 27

A firm has a current ratio greater than 1.0. During the course of the year the firm sells $60M of accounts receivable with limited recourse. If it had not sold the receivables it would have to have taken out a short-term loan. The effect of selling the receivables is: $$\begin{array} { | l | c | c | } \hline & \text { Accounts Receivable Turnover } & \text { Current Ratio } \\\hline \text { A) } & \text { higher } & \text { lower } \\\hline \text { B) } & \text { higher } & \text { higher } \\\hline \text { C) } & \text { lower } & \text { lower } \\\hline \text { D) } & \text { lower } & \text { higher } \\\hline\end{array}$$

A) Option A
B) Option B
C) Option C
D) Option D

Question 28

Look Good Corporation has current assets of $1.1M and current liabilities of $1M. It is close to year-end and it would like to increase its current ratio. Which of the following will achieve this?

A) Encourage customers to pay their bills more quickly.
B) Increase short-term borrowings by $0.1M.
C) Sold building for $0.2M in cash.
D) Liquidate some of its trading marketable securities.

Question 29

A Corporation wants to increase its current ratio from its present level of 1.2 before it ends the fiscal year. The action having the desired effect is:

A) delaying the next payroll.
B) writing down impaired assets.
C) selling furniture for cash.
D) selling current marketable securities at cash for their book value.

Question 30

Which of the following statements about inventories is true?

A) U.S. generally accepted accounting principles (GAAP) require the use of lower-of-cost or market-valuation basis for inventories.
B) Last-in, last-out (LIFO) inventory accounting makes management of income more difficult than first-in, first-out (FIFO) accounting.
C) During inflation, LIFO inventory accounting tends to overstate the current ratio.
D) FIFO inventory balances generally contain old and outdated costs that have little or no relationship to current costs.

Question 31

Depreciation is based on the principle of:

A) allocation.
B) appropriation.
C) estimation.
D) approbation.

Question 32

Below is selected information taken from the balance sheet of Huy Corporation as of 12/31/06.
$$\begin{array}{l}\begin{array} {| l | l| l |} &12/31/05&12/31/06\\\hline \text {Land}&\$ 100,000&\$ 100,000 \\\hline \text {Machines}&80,000&70,000\\\hline \text {Gross P,P\&E}&180,000&170,000\\\hline \text {Accumulated depreciation}&\$ 25,000&\$ 10,000\\\hline \text {Net P,P\&E}&\$ 155,000&\$ 160,000\\\hline \text {Depreciation expense}&&\$ 5,000\\\end{array}\end{array}$$

-The average depreciable life of Huy's depreciable assets as of 2006 is:

A) 2 years
B) 7 years
C) 14 years
D) 34 years

Question 33

The following information can be found in Manufacturer Company's financial statements.
$$\begin{array} { | l | c | c | } \hline & \underline { 2006 } & \underline { 2005 } \\\hline \text { COGS } & \$ 2,500,000 & \$ 2,000,000 \\\hline \text { Inventory } & \$ 180,000 & \$ 140,000 \\\hline \text { Net Income } & \$ 125,000 & \$ 100,000 \\\hline \text { Retained } & \$ 500,000 & \$ 400,000 \\\text { Earnings } & & \\\hline \text { LIFO Reserve } & \$ 40,000 & \$ 30,000 \\\hline \text { Tax Rate } & 40 \% & 40 \% \\\hline\end{array}$$

-If Manufacturer used FIFO its Net Income for fiscal 2006 would be:

A) $ 165,000
B) $ 149,000
C) $ 135,000
D) $ 131,000

Question 34

The following information can be found in Manufacturer Company's financial statements.
$$\begin{array} { | l | c | c | } \hline & \underline { 2006 } & \underline { 2005 } \\\hline \text { COGS } & \$ 2,500,000 & \$ 2,000,000 \\\hline \text { Inventory } & \$ 180,000 & \$ 140,000 \\\hline \text { Net Income } & \$ 125,000 & \$ 100,000 \\\hline \text { Retained } & \$ 500,000 & \$ 400,000 \\\text { Earnings } & & \\\hline \text { LIFO Reserve } & \$ 40,000 & \$ 30,000 \\\hline \text { Tax Rate } & 40 \% & 40 \% \\\hline\end{array}$$

-If Manufacturer used FIFO its retained earnings as of the end of fiscal 2006 would be:

A) $ 540,000
B) $ 440,000
C) $ 524,000
D) $ 506,000

Question 35

Which of the following is not an analysis issue arising with impairment?

A) Evaluating the appropriateness of the amount of the impairment.
B) Evaluating the appropriateness of the timing of the impairment.
C) Analyzing the effect of the impairment on asset.
D) Analyzing the effect of the impairment on income.

Question 36

Under current US GAAP, goodwill is:
I) amortized over a period not to exceed 40 years.
II) tested annually for impairment.
III) exclusive of separately identifiable intangible assets.
IV) recorded only upon purchase of another entity.

A) I, II, III and IV
B) II, III and IV
C) I, II and III
D) II and IV

Question 37

Solvency refers to the ability of a company to meet its short-term obligations.

Question 38

During fiscal 2006, Huy sold fully depreciated assets that originally cost $20,000 for $4,000. In 2006, they purchased assets that cost:

A) $5,000
B) $6,000
C) $10,000
D) $30,000

Question 39

Securitization through the use of a properly structured SPE may result in the following benefits to the company:
I) Remove receivables from the balance sheet.
II) Remove debt from the balance sheet.
III) Lower financing costs.
IV) Recognize gains on the sale of assets to the SPE.

A) I, II, III and IV
B) I, II and III
C) I and IV
D) II and III
True / False Questions

Question 40

Below is selected information taken from the balance sheet of Huy Corporation as of 12/31/06.
$$\begin{array}{l}\begin{array} {| l | l| l |} &12/31/05&12/31/06\\\hline \text {Land}&\$ 100,000&\$ 100,000 \\\hline \text {Machines}&80,000&70,000\\\hline \text {Gross P,P\&E}&180,000&170,000\\\hline \text {Accumulated depreciation}&\$ 25,000&\$ 10,000\\\hline \text {Net P,P\&E}&\$ 155,000&\$ 160,000\\\hline \text {Depreciation expense}&&\$ 5,000\\\end{array}\end{array}$$

-The average age of Huy's depreciable assets as of 2006 is:

A) 2 years
B) 7 years
C) 14 years
D) 34 years

Question 41

When the discounted amount of expected cash flows from an asset is greater than the asset's book value, the asset is deemed to be impaired.

Question 42

Gains and losses from the sale of plant, property and equipment should be included in cost of goods sold as in reality they reflect the cost of producing goods for sale.

Question 43

If a company factors its accounts receivables, this will have the effect of making its cash cycle appear shorter.

Question 44

One advantage of FIFO over LIFO is that it minimizes the distortion caused by inflation on net income.

Question 45

Software development costs are treated the same way as research and development costs under GAAP (Generally Accepted Accounting Principles).

Question 46

Under GAAP, the choice of inventory costing method (LIFO, FIFO, etc.) must be determined by the physical flow of the goods.

Question 47

An increasing accounts receivables balance is always a good sign as it means the company has more current assets and is more liquid.

Question 48

The LIFO Conformity rule states that if a company uses LIFO for tax purposes it must also use it for financial reporting purposes.

Question 49

If a company contracts to purchase goods or services in advance this is called a Purchase commitment, and if the contract is non-cancelable the company must recognize an asset and liability equal to the present value of the future cash payment at the time the contract is signed.

Question 50

Accounts receivable are usually not classified as a current asset.

Question 51

All plant, property and equipment must be depreciated over a period not to exceed forty years.

Question 52

Forming a special purpose entity (SPE) is a common way companies securitize receivables.

Question 53

If management underestimates the allowance for non-collectible accounts, this will cause net income for the period to be overstated.

Question 54

In a period of rising prices, using FIFO would produce a lower cost of goods sold than using LIFO.

Question 55

The cost of software developed for internal use should be capitalized only after it has reached technological feasibility.

Question 56

Capitalization of interest costs results in higher reported net income in the period of capitalization and lower net income in future periods.

Question 57

The cash operating cycle is the amount of days between making a sale and collecting money from customers.

Question 58

LIFO provides a better match of current expenses to revenues on the income statement, while FIFO provides a better ending inventory figure by more closely reflecting current costs.

Question 59

Changes in inventory levels have been shown to be useful in predicting future sales and earnings.

Question 60

Depreciation is a method for matching costs of long-lived assets to revenues generated from their use.

Question 61

If the write-off is occurring because of an industrywide downturn or market crash, it is useful to compare the percentages of the write-off with those taken by other companies in the industry.

Question 62

Below are selected numbers extracted from Harnischfeger's Year X2 financial statements (numbers are in thousands).
Inventories valued using the LIFO method represented approximately 56% and 80% of consolidated inventories at October 31, X2 and X1, respectively.
a. Calculate for Year X2:
i) the gross margin percentage
ii) the current ratio
iii) inventory turnover
iv) Estimate the following numbers if Harnischfeger used FIFO for all inventories:
v) the gross margin
vi) the current ratio
vii) nventory turnover
b. Compare your answers in part a) and b) and comment.

Question 63

Analysts maintain that two of the most important ratios are Inventory turnover and Accounts receivable turnover.
a. You are analyzing ABC Company, a computer manufacturer. You notice that inventory turnover this year is significantly lower than prior years. Provide three explanations that would be consistent with this observation. Explain whether these would be of concern to you and what the effect might be on next period's financial results.
b. You are analyzing ABC Company, a computer manufacturer. You notice that accounts receivable turnover this year is significantly lower than prior years. Provide three explanations that would be consistent with this observation. Explain whether these would be of concern to you.

Question 64

Depreciation is a valuation exercise.
Essay Questions

Question 65

Indicate which of the following items would be classified as assets on the balance sheets.

Question 66

You are comparing the financial statements of two companies, Ready PLC and Marlet Inc., which operate in the same industry but different countries. Ready, Inc. is a British company and prepares its financial statements using British accounting rules. Marlet is a U.S company and prepares its statements using U.S. GAAP.
The following differences in accounting methods are noted:
You want to restate the financial statements of Marlet in order to make them comparable with Ready PLC. Identify the adjustments you would make, and the effect on the financial statements.

Question 67

Below is selected information taken from the balance sheet of LongLi Corporation as of 12/31/06.
From the operating section of the statement of cash flows, you determine that the depreciation expense for the year was $2,000 and loss on sales of assets was $5,000. The investing section reveals that the company purchased equipment for $14,000 and sold equipment for $2,000.
In the footnotes to the financial statements, the company states:
At the beginning of 2006, we determined that the useful life of our assets was higher than originally believed. Accordingly we have increased the useful life from 10 years to 15 years in 2006.
a. What was the gross book value of the equipment that was sold?
b. What was the net book value of the equipment that was sold?
c. With respect to the change in the useful lives of the assets:
i. What is the effect on 2005's financial statements?
ii. What is the effect on 2006's financial statements?