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Chapter 14 Financial Statement Analysis True/False

1. Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of time. Answer: False Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement

2. The quick ratio is especially useful in evaluating the liquidity of a company with fast moving inventories. Answer: False Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

3. Deducting the cost of goods sold from net income gives us operating income. Answer: False Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

4. The gross profit rate is gross profit expressed as a percentage of net sales. Answer: True Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement 5. The gross profit rate usually is lowest on fast moving merchandise and highest on specialty and novelty products Answer: True Learning Objective: 5 AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis

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6. When an income statement does not show gross profit or operating income it is called a consolidated statement. Answer: False Learning Objective: 1, 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

7. ROE - return on equity - is measured by dividing net income by average number of shares outstanding. Answer: False Learning Objective: 5, 7 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

8. The yield rate on stock is measured by dividing dividends per share by market price per share. Answer: True Learning Objective: 5, 7 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

9. The trend in ratios is usually more useful than looking at a single year’s ratio. Answer: True Learning Objective: 7 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement

10. The acid test ratio includes marketable securities but does not include accounts receivable. Answer: False Learning Objective: 7 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

11. Comparative financial statements show side-by-side financial data for two or more companies. Answer: False Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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12. The quality of earnings tends to be higher for a company that uses straight-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. Answer: False Learning Objective: 2 AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement

13. If total current assets are $130,000 at the end of Year 1, increase by $40,000 by the end of Year 2, and increase by $40,000 in Year 3, the percentage increase over the preceding year is less in Year 3 than in Year 2. Answer: True Learning Objective: 4 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement

14. Working capital is the excess of current assets over current liabilities. Answer: True Learning Objective: 2 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

15. A company's liquidity refers to its ability to remain profitable. Answer: False Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

16. Inventory is an example of a quick asset. Answer: False Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

17. Current assets are those assets that can be converted into cash within a year and never longer. Answer: False Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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18. The debt ratio is computed by dividing total liabilities by current assets. Answer: False Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

19. The lower the current ratio, the more liquid the company appears. Answer: False Learning Objective: 4 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Risk Analysis

20. The owners of a corporation are not personally responsible for the debts of the business. Answer: True Learning Objective:4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

21. A single-step and multiple-step income statement differ in form and in the amount of net income reported. Answer: False Learning Objective:5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

22. A company whose sales are growing at less than the rate of inflation may actually be selling less merchandise every year. Answer: True Learning Objective: 6 AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis

23. A company cannot be increasing its market share if its net sales are declining. Answer: False Learning Objective: 6 AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis

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24. Net income stated as a percentage of sales is one means of evaluating a company's ability to control its expenses. Answer: True Learning Objective: 6 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

25. A company whose future earnings are expected to rise substantially is likely to have a higher p/e ratio than a company whose future earnings are expected to decline. Answer: True Learning Objective: 5 AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement

26. From a creditor's point of view, the lower the debt ratio, the safer the creditors’ position. Answer: True Learning Objective: 4 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement

27. The price/earnings ratio is calculated by dividing EPS by the current market price of a share of the company's stock. Answer: False Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement

28. If the return on total assets is substantially below the cost of borrowing, common stockholders will benefit from a high debt ratio. Answer: False Learning Objective: 4 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Risk Analysis

29. The return on equity may be either higher or lower than the return on assets. Answer: True Learning Objective: 5 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Measurement

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30. The current ratio may be less than, equal to, or greater than the quick ratio. Answer: False Learning Objective: 4 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Measurement

31. The inventory turnover rate indicates how quickly inventory sells. Answer: True Learning Objective: 7 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Risk Analysis

32. In a single-step income statement, all revenue items are listed then all expense items are combined and deducted from total revenue Answer: True Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

33. In a classified balance sheet assets are subdivided into current assets, plant and equipment and other assets while liabilities are all classified as current. Answer: False Learning Objective: 3, 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

34. The more pessimistic investors’ expectations regarding a company’s future performance the lower the p/e ratio is likely to be. Answer: True Learning Objective: 5 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement

35. A company should carry the amount of working capital necessary to conduct operations not necessarily maximize it’s working capital. Answer: True Learning Objective: 4 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Measurement

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Multiple Choice

36. In order for investors and creditors to decide whether to invest in a company or loan a company funds they may A) Analyze financial statements B) Focus on corporate governance C) Both of the above D) Neither of the above. Answer: C Learning Objective: 8 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

37. A comparative financial statement A) Places the balance sheet, the income statement and the statement of cash flows side by side in order to compare the results. B) Places two or more years of a financial statement side by side in order to compare results C) Places the financial statements of two or more companies side by side in order to compare results. D) Places the dollar amounts next to the percentage amounts of a given year for the income statement. Answer: B Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

38. The changes in financial statement items from a base year to following years are called: A) Money changes B) Trend percentages C) Component percentages D) Ratios Answer: B Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement

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39. The measurement of the relative size of each item included in a total is called: A) Money changes B) Trend percentages C) Component percentages D) Ratios Answer: C Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

40. One number expressed as a percentage of another is called: A) Money changes B) Trend percentages C) Component percentages D) Ratios Answer: D Learning Objective: 1, 7 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

41. The excess of current assets over current liabilities is called: A) Current ratio B) Working capital C) Debt ratio D) Quick ratio Answer: B Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

42. Quick assets include A) Cash, marketable securities and receivables B) Cash, marketable securities and inventories C) Cash, inventories and receivables D) Market securities, receivables and inventories. Answer: A Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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43. The ratio which measures total liabilities as a percentage of total assets is called: A) Current ratio B) Working capital C) Debt ratio D) Quick ratio Answer: C Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

44. The price/earnings ratio is measured by dividing A) Book value by earnings per share B) Par value by earnings per share C) Market value by earnings per share D) Market value by total net income Answer: C Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

45. The principle factors affecting the quality of working capital are: A) The nature of the current assets B) The length of time to convert current assets into cash C) Both A and B D) Neither A nor B Answer: C Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

46. All of the following ratios are considered measures of profitability except: A) Earnings per share B) Gross profit rate C) Price earnings ratio D) Return on assets Answer: C Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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47. All of the following ratios are considered measures of liquidity except: A) Quick ratio B) Debt ratio C) Current ratio D) Receivables turnover rate Answer: B Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

48. The term classified financial statements refers: A) To the financial statements of all companies working on government projects. B) Only to the financial statements of defense contractors working on secret projects. C) To financial statements prepared for use by management, but not for distribution outside of the organization. D) To financial statements in which items with certain characteristics are placed together in a group in an effort to develop useful subtotals. Answer: D Learning Objective: 1, 3 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

49. Comparative financial statements compare the company's current statements with: A) Those of prior periods. B) Those of other companies in the same industry. C) Those of the company's principal competitor. D) The budgeted level of performance for the period. Answer: A Learning Objective: 1 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

50. Which of the following is not a measure of short-term liquidity? A) Quick ratio. B) Working capital. C) Current ratio. D) Debt ratio. Answer: D Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

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51. The current ratio will be _______________ the quick ratio. A) Less than. B) Greater than or equal to. C) The same as. D) Always different than. Answer: B Learning Objective: 4 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement

52. Which of the following is not a measure of long-term credit risk? A) Quick ratio. B) Debt ratio. C) Interest coverage ratio. D) Trend in net cash provided by operating activities. Answer: A Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

53. A high quality of earnings is indicated by: A) Earnings derived largely from newly introduced products. B) Declaration of both cash and stock dividends. C) Use of the FIFO method of inventory during sustained inflation. D) A history of increasing earnings and conservative accounting methods. Answer: D Learning Objective: 2 AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Risk Analysis

54. In evaluating the quality of a company's earnings, which of the following factors is least important? A) The accounting methods used by management. B) The trend of the company's earnings over a period of years. C) The dollar amount of earnings per share. D) The stability and sources of the company's earnings. Answer: C Learning Objective: 2 AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Risk Analysis

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55. The measures most often used in evaluating solvency--the current ratio, quick ratio, and amount of working capital are developed from amounts appearing in the: A) Balance sheet. B) Income statement. C) Statement of retained earnings. D) Statement of cash flows. Answer: A Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

56. Which of the following is not a measure of profitability? A) EPS. B) ROI. C) ROE. D) NLR. Answer: D Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

57. Which American industry would tend to have the greatest debt ratio? A) Auto. B) Retail clothing. C) Manufacturing. D) Banking. Answer: D Learning Objective: 4 AACSB: Analytic AICPA BB: Industry AICPA FN: Risk Analysis

58. The current ratio: A) Is computed by dividing current assets by current liabilities. B) Is computed by subtracting current liabilities from current assets. C) Remains unchanged throughout the operating cycle. D) Is a measure of short-term profitability. Answer: A Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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59. Component percentages indicate the relative size of each item included in a total. Which of the following statements is true? A) Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of total assets. B) Income statement items are expressed as a percentage of sales and balance sheet items as a percentage of total assets. C) Income statement items are expressed as a percentage of net income and balance sheet items as a percentage of net worth. D) Both income statement and balance sheet items are expressed as a percentage of net worth. Answer: B Learning Objective: 6 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

60. How would a company's working capital be affected if a substantial amount of accounts payable were paid in cash? A) It would be unaffected. B) It would fall. C) It would increase. D) The change would depend on the relationship between the payables liquidated and current liabilities. Answer: A Learning Objective: 4 AACSB: Analytic AICPA BB: Resource Management AICPA FN: Risk Analysis

61. Current assets are those assets that can be converted into cash within: A) One year and never longer. B) One year or the operating cycle, whichever is longer. C) One year or the operating cycle, whichever is shorter. D) Management's discretion. Answer: B Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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62. The current ratio is calculated by: A) Dividing current assets by total assets. B) Dividing current assets by total liabilities. C) Dividing current assets by stockholders' equity. D) Dividing current assets by current liabilities. Answer: D Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

63. The quick ratio: A) Is computed by dividing current assets by current liabilities. B) Is always higher than the current ratio. C) Cannot be higher than the current ratio. D) May be higher or lower than the current ratio. Answer: C Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

64. Short-term creditors are most likely to use the quick ratio instead of the current ratio in evaluating the solvency of a company with large, slow-moving: A) Plant and equipment. B) Receivables. C) Inventories. D) Employees. Answer: C Learning Objective: 4 AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement

65. Which of the following is considered a quick asset? A) Accounts receivable. B) Inventory. C) Automobiles. D) Prepaid expenses. Answer: A Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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66. Which of the following transactions would cause a change in the amount of a company's working capital? A) Collection of an account receivable. B) Payment of an account payable. C) Borrowing cash over a 60-day period. D) Selling merchandise at a price above its cost. Answer: D Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Resource Management AICPA FN: Measurement

67. The debt ratio indicates the percentage of: A) Total assets financed by long-term mortgages. B) Revenue consumed by interest expense. C) Total assets financed by creditors. D) Total liabilities classified as current. Answer: C Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

68. The debt ratio is used primarily as a measure of: A) Short-term liquidity. B) Creditors' long-term risk. C) Profitability. D) ROI. Answer: B Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

69. Generally speaking, which appears to be a desirable current ratio? A) 20 to 1. B) 1 to 20. C) 2 to 1. D) 1 to 2. Answer: C Learning Objective: 4 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

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70. All of the following captions or subtotals are typical of a multiple-step income statement except for: A) Net sales. B) Gross profit. C) Total costs and expenses. D) Operating income. Answer: C Learning Objective: 5 AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement

71. When compa...