Chapter 14 Financial Statement Analysis
Chapter 14 Financial Statement Analysis True / False Questions
1. Vertical Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of o f time. True False
2. The uic! ratio is especially useful in evaluatin" the liuidity of a company with fast movin" inventories. True False
#. $eductin" the cost of "oods sold from net income "ives us operatin" income. True False
4. The "ross profit rate is "ross profit e%pressed as a percenta"e of net sales. True False
&. The "ross profit rate usually is lowest on fast movin" merchandise and hi"hest on specialty and novelty products True False
'. (hen an income statement does not show "ross profit or operatin" income it is called a consolidated statement. True False
). *+, - return on euity - is measured by dividin" net income by avera"e number of shares outstandin". True False
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Chapter 14 Financial Statement Analysis
. The yield rate on stoc! is measured by dividin" dividends per share by mar!et price per share. True False
/. The trend in ratios is usually more useful than loo!in" at a sin"le year0s ratio. True False
1. The acid test ratio includes mar!etable securities but does not include accounts receivable. True False
11. Comparative financial statements show side-by-side financial data for two or more companies. True False
12. The uality of earnin"s tends to be hi"her for a company compan y that uses strai"ht-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. True False
1#. f total current assets are 314 at the end of 5ear 5ear 1 increase by 3& 3& by the end of 5ear 5ear 2 and increase by 3& in 5ear 5ear # the percenta"e increase over the precedin" year is less in 5ear # than in 5ear 2. True False
14. (or!in" (or!in" capital is the e%cess of current assets over current liabilities. True False
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Chapter 14 Financial Statement Analysis
. The yield rate on stoc! is measured by dividin" dividends per share by mar!et price per share. True False
/. The trend in ratios is usually more useful than loo!in" at a sin"le year0s ratio. True False
1. The acid test ratio includes mar!etable securities but does not include accounts receivable. True False
11. Comparative financial statements show side-by-side financial data for two or more companies. True False
12. The uality of earnin"s tends to be hi"her for a company compan y that uses strai"ht-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. True False
1#. f total current assets are 314 at the end of 5ear 5ear 1 increase by 3& 3& by the end of 5ear 5ear 2 and increase by 3& in 5ear 5ear # the percenta"e increase over the precedin" year is less in 5ear # than in 5ear 2. True False
14. (or!in" (or!in" capital is the e%cess of current assets over current liabilities. True False
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Chapter 14 Financial Statement Analysis
1&. A company0s liuidity refers to its ability to remain profitable. True False
1'. nventory is an e%ample of a uic! asset. True False
1). Current assets are those assets that can be converted into cash within a year and never lon"er. True False
1. The debt ratio is computed by dividin" total liabilities by current assets. True False
1/. The lower the current ratio the more liuid the company appears. True False
2. The owners of a corporation are not personally responsible for the debts of the business. True False
21. A sin"le-step and multiple-step income statement are different in form and in the amount of net income reported. True False
22. A company whose sales are "rowin" at less than the rate of inflation may actually be sellin" less merchandise every year. True False
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Chapter 14 Financial Statement Analysis
2#. A company cannot be increasin" its mar!et share if its net sales are declinin". True False
24. 6et income stated as a percenta"e of sales is one means of evaluatin" a company0s ability to control its e%penses. True False
2&. A company whose future earnin"s are e%pected to rise substantially is li!ely to have a hi"her price7earnin"s ratio than a company whose future earnin"s are e%pected to decline. True False
2'. From a creditor0s point of view the lower the debt ratio8 the safer the c reditors0 position. True False
2). The price7earnin"s ratio is calculated by dividin" earnin"s per share by the current mar!et price of a share of the company0s stoc!. True False
2. f the return on total assets ratio is substantially below the co st of borrowin" common stoc!holders will benefit from a hi"h debt ratio. True False
2/. The return on euity ratio may be either hi"her or lower than the return on assets ratio. True False
#. The current ratio may be less than eual to or "reater than the uic! ratio. True False
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Chapter 14 Financial Statement Analysis
#1. The inventory turnover rate indicates how uic!ly inventory sells. True False
#2. n a sin"le-step income statement all revenue items are listed then all e%pense items are combined and deducted from total revenue. True False
##. n a classified balance sheet assets are subdivided into current assets plant and euipment and other assets while liabilities are all classified as current. True False
#4. The more pessimistic investors0 e%pectations re"ardin" a company0s future p erformance the lower the price7earnin"s ratio is li!ely to be. True False
#&. A company should carry the amount of wor!in" capital necessary to conduct operations not necessarily ma%imi9e its wor!in" capital. True False
Multiple Choice Questions
#'. n order for investors and creditors to decide whether to invest in a company or loan a company funds they may A. Analy9e financial statements. :. Focus on corporate "overnance. C. :oth of the above. $. 6either of the above.
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Chapter 14 Financial Statement Analysis
#). A comparative financial statement A. ;laces the balance sheet the income statement and the statement of cash flows side by side in order to compare the results. :. ;laces two or more years of a financial statement side by side in order to compare results. C. ;laces the financial statements of two or more companies side by side in order to compare results. $. ;laces the dollar amounts ne%t to the percenta"e amounts of a "iven year for the income statement.
#. The chan"es in financial statement items from a base year to followin" years are called< A. =oney chan"es :. Trend percenta"es C. Component percenta"es $. *atios
#/. The measurement of the relative si9e of each item included in a total is called< A. =oney chan"es :. Trend percenta"es C. Component percenta"es $. *atios
4. +ne number e%pressed as a percenta"e of another is called< A. =oney chan"es :. Trend percenta"es C. Component percenta"es $. *atios
41. The e%cess of current assets over current liabilities is called< A. Current ratio :. (or!in" capital C. $ebt ratio $. >uic! ratio
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Chapter 14 Financial Statement Analysis
42. >uic! assets include which of the followin"? A. Cash mar!etable securities and receivables. :. Cash mar!etable securities and inventories. C. Cash inventories and receivables. $. =ar!et securities receivables and inventories.
4#. The ratio which measures total liabilities as a percenta"e of total assets is called< A. Current ratio :. (or!in" capital C. $ebt ratio $. >uic! ratio
44. The price7earnin"s ratio is measured by dividin" A. :oo! value by earnin"s per share. :. ;ar value by earnin"s per share. C. =ar!et value by earnin"s per share. $. =ar!et value by total net income.
4&. The principle factors affectin" the uality of wor!in" cap ital are< A. The nature of the current assets. :. The len"th of time to convert current assets into cash. C. :oth A and :. $. 6either A nor :.
4'. All of the followin" ratios are considered measures of profitability e%cept< A. ,arnin"s per share :. @ross profit rate C. ;rice earnin"s ratio $. *eturn on assets
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Chapter 14 Financial Statement Analysis
4). All of the followin" ratios are considered measures of liuidity e%cept< A. >uic! ratio :. $ebt ratio C. Current ratio $. *eceivables turnover rate
4. The term classified financial statements refers< A. To the financial statements of all companies wor!in" on "overnment proects. :. +nly to the financial statements of defense contractors wor!in" on secret proects. C. To financial statements prepared for use by mana"ement but not for distribution outside of the or"ani9ation. $. To financial statements in which items with certain characteristics are placed to"ether in a "roup in an effort to develop useful subtotals.
4/. Comparative financial statements compare the company0s current statements with< A. Those of prior periods. :. Those of other companies in the same industry. C. Those of the company0s principal competitor. $. The bud"eted level of performance for the period.
&. (hich of the followin" is not a measure of short-term liuidity? A. >uic! ratio. :. (or!in" capital. C. Current ratio. $. $ebt ratio.
&1. The current ratio will be BBBBBBBBBBBBBBB the uic! ratio. A. ess than. :. @reater than or eual to. C. The same as. $. Always different than.
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Chapter 14 Financial Statement Analysis
&2. (hich of the followin" is not a measure of lon"-term credit ris!? A. >uic! ratio. :. $ebt ratio. C. nterest covera"e ratio. $. Trend in net cash provided by operatin" activities.
. A hi"h uality of earnin"s is indicated by< A. ,arnin"s derived lar"ely from newly introduced products. :. $eclaration of both cash and stoc! dividends. C. Dse of the FF+ method of inventory durin" sustained inflation. $. A history of increasin" earnin"s and conservative accountin" methods.
&4. n evaluatin" the uality of a company0s earnin"s which of the followin" factors is least important? A. The accountin" methods used by mana"ement. :. The trend of the company0s earnin"s over a period of years. C. The dollar amount of earnin"s per share. $. The stability and sources of the company0s earnin"s.
&&. The measures most often used in evaluatin" solvency--the current ratio uic! ratio and amount of wor!in" capital are developed from amounts appearin" in the< A. :alance sheet. :. ncome statement. C. Statement of retained earnin"s. $. Statement of cash flows.
&'. (hich of the followin" is not a measure of profitability? A. ,;S. :. *+. C. *+,. $. 6*.
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Chapter 14 Financial Statement Analysis
&). (hich American industry would tend to have the "reatest debt ratio? A. Auto. :. *etail clothin". C. =anufacturin". $. :an!in".
&. The current ratio< A. s computed by dividin" current assets by current liabilities. :. s computed by subtractin" current liabilities from current assets. C. *emains unchan"ed throu"hout the operatin" cycle. $. s a measure of short-term profitability.
&/. Component percenta"es indicate the relative si9e of each item included in a total. (hich of the followin" statements is true? A. ncome statement items are e%pressed as a percenta"e of net income and balance sheet items as a percenta"e of total assets. :. ncome statement items are e%pressed as a percenta"e of sales and balance sheet items as a percenta"e of total assets. C. ncome statement items are e%pressed as a percenta"e of net income and balance sheet items as a percenta"e of net worth. $. :oth income statement and balance sheet items are e%pressed as a percenta"e of net worth.
'. Eow would a company0s wor!in" capital be affected if a substantial amount of accounts payable were paid in cash? A. t would be unaffected. :. t would fall. C. t would increase. $. The chan"e would depend on the relationship between the payables liuidated and current liabilities.
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Chapter 14 Financial Statement Analysis
'1. Current assets are those assets that can be converted into cash within< A. +ne year and never lon"er. :. +ne year or the operatin" cycle whichever is lon"er. C. +ne year or the operatin" cycle whichever is shorter. $. =ana"ement0s discretion.
'2. The current ratio is calculated by< A. $ividin" current assets by total assets. :. $ividin" current assets by total liabilities. C. $ividin" current assets by stoc!holders0 euity. $. $ividin" current assets by current liabilities.
'#. The uic! ratio< A. s computed by dividin" current assets by current liabilities. :. s always hi"her than the current ratio. C. Cannot be hi"her than the current ratio. $. =ay be hi"her or lower than the current ratio.
'4. Short-term creditors are most li!ely to use the uic! ratio instead of the current ratio in evaluatin" the solvency of a company with lar"e slow-movin"< A. ;lant and euipment. :. *eceivables. C. nventories. $. ,mployees.
'&. (hich of the followin" is considered a uic! asset? A. Accounts receivable. :. nventory. C. Automobiles. $. ;repaid e%penses.
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Chapter 14 Financial Statement Analysis
''. (hich of the followin" transactions would cause a chan"e in the amount of a company0s wor!in" capital? A. Collection of an account receivable. :. ;ayment of an account payable. C. :orrowin" cash over a '-day period. $. Sellin" merchandise at a price above its cost.
'). The debt ratio indicates the percenta"e of< A. Total assets financed by lon"-term mort"a"es. :. *evenue consumed by interest e%pense. C. Total assets financed by creditors. $. Total liabilities classified as current.
'. The debt ratio is used primarily as a measure of< A. Short-term liuidity. :. Creditors0 lon"-term ris!. C. ;rofitability. $. *eturn on nvestment.
'/. @enerally spea!in" which appears to be a desirable current ratio? A. 2 to 1. :. 1 to 2. C. 2 to 1. $. 1 to 2.
). All of the followin" captions or subtotals are typical o f a multiple-step income statement e%cept for< A. 6et sales. :. @ross profit. C. Total costs and e%penses. $. +peratin" income.
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Chapter 14 Financial Statement Analysis
)1. (hen comparin" the current ratio to the uic! ratio< A. The current ratio will always be "reater :. The uic! ratio will always be "reater C. The uic! ratio is sometimes "reater and sometimes less than the current ratio $. They always will be the same
)2. The "ross profit rate represents< A. Total sales revenue. :. The percenta"e chan"e in net sales from the prior period. C. The percenta"e of sales revenue remainin" after providin" for the cost of the merchandise sold. $. 6et income stated as a percenta"e of total sales revenue.
)#. A risin" "ross profit rate most stron"ly su""ests< A. An increase in physical sales volume. :. Stron" consumer demand for the company0s products. C. ntense competition. $. ncreased short-term solvency.
)4. +peratin" income e%cludes each of the followin" e%cept< A. nterest e%pense. :. ncome ta%es. C. $epreciation. $. ;repaid e%penses.
)&. Assume that net sales are increasin" faster than the rate of inflation and that the company0s "ross profit rate is risin". +f the followin" the most lo"ical conclusion is that< A. The company0s cost of purchasin" merchandise is risin" rapidly. :. +peratin" e%penses are fallin". C. $emand for the company0s products is very stron". $. The company has achieved an increase in sales volume by reducin" its sales prices.
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Chapter 14 Financial Statement Analysis
)'. n calculatin" earnin"s per share the denominator of the euation includes< A. +nly common stoc! outstandin". :. Common stoc! plus preferred stoc!. C. Common stoc! less preferred stoc!. $. The total shares of authori9ed common stoc!.
)). +n common si9e income statements each component in the income statement is represented as a percenta"e of< A. 6et income. :. Sales. C. Total assets. $. ;rofit.
). n a multiple-step income statement interest e%pense usually is no t classified as an operatin" e%pense because interest char"es< A. $o not contribute to the production of revenue. :. Stem from the manner in which assets are financed not the manner in which they are used in business operations. C. *elate directly to the cost of "oods sold. $. The statement is incorrect. nterest usually is classified as an operatin" e%pense.
)/. n a multiple-step income statement income ta%es are not classified as operatin" e%penses because< A. ncome ta%es do not contribute to the production of revenue. :. ncome ta%es stem from the manner in which assets are financed not the manner in which they are used in business operations. C. 6ot all forms of business or"ani9ation are subect to income ta%es. $. The statement is incorrect8 income ta%es are classified as operatin" e%penses.
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Chapter 14 Financial Statement Analysis
. Traditionally stoc! of financially sound companies with stable earnin"s usually have a price7earnin"s ratio of< A. /. :. 12. C. 174. $. #.
1. *eturn on euity computations are used in evaluatin"< A. iuidity. :. ;rofitability. C. @ross profit. $. (hether a ratio is improvin" or deterioratin" over time.
2. The financial ratio intended to measure the effectiveness with which mana"ement has utili9ed the resources of the business re"ardless of how these resources are financed is< A. @ross profit rate. :. Current ratio. C. *eturn on assets. $. *eturn on euity.
#. The return on assets ratio usually is computed as< A. 6et sales divided by avera"e total assets. :. @ross profit divided by avera"e total assets. C. +peratin" income divided by avera"e total assets. $. 6et income divided by avera"e total assets.
4. f a company has a current ratio of 2 to 1 and purchases inventory on credit what will this do to its current ratio? A. ncrease the current ratio. :. $ecrease the current ratio. C. $oes not chan"e the current ratio. $. Cannot be determined.
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Chapter 14 Financial Statement Analysis
&. The return on euity ratio usually is computed as< A. 6et income divided by avera"e total assets. :. +peratin" income divided by avera"e total stoc!holders0 euity. C. @ross profit divided by avera"e total stoc!holders0 euity. $. 6one of the above answers is correct.
'. The measurement that best reflects investors0 e%pectations about future earnin"s is< A. ,arnin"s per share. :. *eturn on assets. C. The price7earnin"s ratio. $. *eturn on euity.
). The interest covera"e ratio is computed by dividin"< A. +peratin" income by annual interest e%pense. :. 6et income by annual interest e%pense. C. Carryin" value of bonds by cash interest payments. $. ,arnin"s per share by the prime interest rate.
. Amal"amated Corporation0s net income was 324 in 2/ and 3 in 21. (hat percenta"e increase in net income must Amal"amated achieve in 211 to offset the decline in profits in 21? A. )&. :. #. C. ##.##. $. .
/. f a retail store has a current ratio of 2.& and current assets of 31/& the amount of wor!in" capital is< A. 3). :. 3#. C. 3##. $. 311).
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Chapter 14 Financial Statement Analysis
/. The ;la9a Company has wor!in" capital of 3&4 and a current ratio of # to 1. The amount of current assets is< A. 34&. :. 3&4. C. 31. $. 32).
/1. $urin" the years 2/ throu"h 211 ;owers nc. reported the followin" amounts of net income Gdollars in thousandsH<
*elative to the prior year the percenta"e chan"e in net income< A. (as the same in 21 and 211. :. (as lar"er in 211 than in 21. C. (as smaller in 211 than in 21. $. Cannot be determined without !nowin" how many shares of stoc! were outstandin".
Shown below are selected data from the balance sheet of Compros a small electronics store Gdollar amounts are in thousandsH<
/2. *efer to the above data. (hat is the uic! ratio? A. 1.& to 1. :. .) to 1. C. .4& to 1. $. Some other amount.
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Chapter 14 Financial Statement Analysis
/#. *efer to the above data. (hat is the current ratio? A. &. to 1. :. 1.& to 1. C. .) to 1. $. Some other amount.
/4. *efer to the above data. (hat is wor!in" capital amounts to< A. 322&. :. 3#. C. 31&. $. Some other amount.
/&. *efer to the above data. (hat is Compro0s debt ratio? A. )&. :. 2&. C. '. $. Some other amount.
Shown below are selected data from the balance sheet of :ill0s Auto ;arts a retail store Gdollar amounts are in thousandsH<
/'. *efer to the above data. (hat is the uic! ratio? A. &. :. 1.& to 1. C. 2. $. Some other amount.
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Chapter 14 Financial Statement Analysis
/). *efer to the above data. (hat is the current ratio? A. 1.2 to 1. :. ess than 2 to 1 but not 1.2 to 1. C. 2.' to 1. $. =ore than 2 to 1 but not 2.' to 1.
/. *efer to the above data. (or!in" capital amounts to< A. 3&' :. 3 C. 32) $. Some other amount.
//. *efer to the above data. :ill0s debt ratio is< A. 22. :. 2). C. &). $. Some other amount.
Shown below are selected data from the financial statements of Supreme Co. $ollar amounts are in millions Ge%cept for the per share dataH.
;er share data Gthese amounts stated in actual dollars not millionsH< Supreme reported earnin"s per share for the year of 34 and paid cash dividends of 31 per share. At year end the (all Street Iournal listed Supreme0s capital stoc! as tradin" at 3 per share.
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Chapter 14 Financial Statement Analysis
1. *efer to the above data. Supreme0s "ross profit rate was< A. 42./. :. &).). C. 2.. $. Some other amount.
11. *efer to the above data. (hat was Supreme0s operatin" income? Gin millionsH< A. 3)1. :. 3#/. C. 32). $. Some other amount.
12. *efer to the above data. Supreme0s return on assets was< A. 1. :. '.)&. C. 1&. $. Some other percenta"e.
1#. *efer to the above data. Supreme0s return on euity was< A. 11. :. 2&. C. ).&. $. 1'.#.
14. *efer to the above data. Supreme0s price7earnin"s ratio at year end was< A. 2&. :. 22. C. 1. $. Some other amount.
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Chapter 14 Financial Statement Analysis
Shown below are selected data from the financial statements of 6oble Computers. G$ollar amounts are in millions e%cept for the per share data.H
;er share data Gthese amounts stated in actual dollars not millionsH< 6oble reported earnin"s per share for the year of 3' and paid cash dividends of 32. per share. At year end the (all Street Iournal listed 6oble0s capital stoc! a s tradin" at 31 per share.
1&. *efer to the above data. 6oble0s price7earnin"s ratio at year end was< A. .). :. 1#.&. C. 1). $. Some other amount.
1'. *efer to the above data. 6oble0s "ross profit rate was< A. 1. :. 4'. C. &. $. Some other amount.
1). *efer to the above data. 6oble0s operatin" income was< A. 31'1. :. 3')& C. 3/#&. $. Some other amount.
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Chapter 14 Financial Statement Analysis
1. *efer to the above data. 6oble0s return on assets was< A. 2.' :. 21. C. 2'. $. Some other amount.
1/. *efer to the above data. 6oble0s return on euity was< A. 1. :. 1#. C. 21. $. Some other amount.
@iven below are comparative balance sheets and an income statement for Claret Corporation
All sales were made on account. Cash dividends declared durin" the year totaled 3114/2
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Chapter 14 Financial Statement Analysis
11. *efer to the above data. Claret Corporation0s accounts receivable turnover for 2/ is< A. 4.' times. :. 2./ times. C. &.4 times. $. ' days.
111. *efer to the above data. Claret Corporation0s inventory turnover for 2/ is< A. '.' times. :. #./ times. C. 4.1 times. $. /4 days.
112. *efer to the above data. Claret Corporation0s "ross profit rate for 2/ is< A. '.1. :. #/./. C. ##. $. '.
11#. *efer to the above data. Claret Corporation0s return on assets for 2/ rounded to the nearest tenth of a percent is< A. /./. :. 4.1. C. &./. $. 1'./.
114. *efer to the above data. Claret Corporation0s return on common stoc!holders0 euity for 2/ rounded to the nearest tenth of a percent is< A. &./. :. '.&. C. 14.4. $. /.4.
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Chapter 14 Financial Statement Analysis
11&. n an attempt to standardi9e financial practices worldwide two areas of particular interest to the nternational Accountin" Standards Committee are< A. Capitali9in" and e%pensin" :. Se"ments and consolidations C. ;ensions and eases $. ;artnerships and corporation
11'. An or"ani9ation that provides ratin"s of corporate "overnance services is< A. S,C :. SS C. *S $. :=
Essay Questions
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Chapter 14 Financial Statement Analysis
11). Accountin" terminolo"y isted below are ei"ht technical accountin" terms introduced in this chapter<
,ach of the followin" statements may Gor may notH describe one of these technical terms. For each statement indicate the term described or answer J6oneJ if the statement does not correctly describe any of the terms. GaH The percenta"e of total assets financed by creditors. GbH A measure of the effectiveness with which mana"ement utili9es a company0s resources re"ardless of how those resources are financed. GcH A company0s percenta"e share of total dollar sales within its industry. GdH Current assets less current liabilities. GeH A measure reflectin" investors e%pectations of future profitability. GfH A measure of short-term solvency often used when a company has lar"e inventories that cannot be uic!ly converted into cash. G"H A ratio that helps individual stoc!holders relate the net income of a lar"e corporation to their euity investment.
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Chapter 14 Financial Statement Analysis
11. Current ratio and wor!in" capital The balance sheet of *ed =issile Company contained the followin" items amon" others<
GaH From the above information compute< G1H Current assets< 3BBBBBBB G2H Current liabilities< 3BBBBBB G#H The current ratio< BBBBBB to 1 G4H (or!in" capital< 3BBBBBB GbH Assume that *ed =issile Company pays the note payable of 31'# thus reducin" cash to 31). Compute the followin" after the completion of this transaction< G1H The current ratio< BBBBBB to 1 G2H (or!in" capital< 3BBBBBB
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Chapter 14 Financial Statement Analysis
11/. =easures of solvency and credit ris! Shown below are selected items appearin" in a recent balance sheet of @rant ;roducts. G$ollar amounts are in thousands.H
GaH Compute the followin"< G1H Total uic! assets 3BBBBBBBBBBBB G2H Total current assets 3BBBBBBBBBBBB G#H Total current liabilities 3BBBBBBBBBBBB G4H >uic! ratio BBBBBB to 1 G&H Current ratio BBBBBB to 1 GbH *esearch indicates an industry avera"e uic! ratio is 1.# to 1 and a current ratio of 2.# to 1. :ased upon this information does @rant ;roducts appear more or less solvent than the avera"e company in its industry? ,%plain briefly.
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Chapter 14 Financial Statement Analysis
12. =ultiple-step income statement Shown below is a recent income statement for ;haeton nc.<
;repare an income statement for the year in a multiple-step format. GDse the "rid provided below.H
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Chapter 14 Financial Statement Analysis
121. *eturn on investment Shown below are selected data from a recent annual report of >uality Service. G$ollar amounts are in millions.H
Compute for the year<
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Chapter 14 Financial Statement Analysis
122. Computation of profitability ratios Shown below are selected data from a recent annual report of Tall +a!s Co. G$ollar amounts are in thousands.H
Compute for the year the company0s<
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Chapter 14 Financial Statement Analysis
12#. ;rofitability measures Shown below is a recent income statement for :-$ ,lectric.
Assume that comparative balance sheets for :-$ ,lectric indicate avera"e total assets for the year of 32& and avera"e total euity of 32&. Compute the followin"<
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Chapter 14 Financial Statement Analysis
124. ;ercenta"e chan"es Selected information from the financial statements of ;erfectly :a!ed Ca!e Co. appears below<
GaH Compute the percenta"e chan"e in each of the above items from 21 to 211. Dse a K or to indicate increase or decrease.
GbH Compute net income as a percenta"e of net sales in each year. G*ound to the nearest onetenth of 1H
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Chapter 14 Financial Statement Analysis
12&. ;ercenta"e chan"es8 p7e ratios and investors0 e%pectations Shown below are @amma nc.0s earnin"s per share for a four-year period alon" with the pershare mar!et price of the company0s stoc! at each year-end. The earnin"s in 211 were the hi"hest in the company0s history.
GaH Compute the percenta"e chan"e in earnin"s per share in 2/ 21 and 211. G;lace your answers in the spaces provided above.H GbH Compute the p7e ratio of stoc! at the end of each of the four years. G;lace your answers in the spaces provided above.H GcH (hat does the p7e ratio at the end of 211 indicate about investors0 e%pectations of earnin"s per share for the comin" year? ,%plain your reasonin".
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Chapter 14 Financial Statement Analysis
12'. ,ffects of events on financial measurements ndicate the probable effects of each of the followin" strate"ies or events upon the financial measurements of indsay Corp. listed below. Dse the code letters L ncrease $ L $ecrease and 6, L 6o ,ffect.
14-#4
Chapter 14 Financial Statement Analysis
12). Financial ratios Shown below are some !ey fi"ures from the balance sheets of =inuteman @as Company for two successive years<
$ividends of 3/' were declared and paid in 21. Compute the followin"<
14-#&
Chapter 14 Financial Statement Analysis
12. Financial ratios @iven below are comparative balance sheets and an income statement for the ,%cellent Corporation<
All sales were made on account. Cash dividends declared durin" the year totaled 3&&&. Compute the followin"<
14-#'
Chapter 14 Financial Statement Analysis
12/. ,ffects of transactions upon analytical measurements $etermine the immediate effect of each of the transactions described be low on the ratio listed beside each transaction. n the blan! space to the left of each statement you are to indicate the effect by writin" the appropriate code letter. The code letters are as follows< L increase the ratio $ L decrease the ratio and 6, L no effect on this ratio.
14-#)
Chapter 14 Financial Statement Analysis
1#. Dse and interpretation of financial measurements Shown below are various financial measurements for two companies which are similar in si9e and sell similar products<
nstructions< 5ou are to enter code letters in the spaces provided in the two ri"ht-hand columns. n the first column indicate which of the followin" three "roups probably would be most interested in the specified financial measurement. dentify one "roup usin" the followin" code letters< STC L indicatin" short-term creditors TC L indicatin" lon"-term creditors and S L indicatin" stoc!holders. n the second column enter an M or a 5 to indicate whether your Jmost interested "roupJ would prefer the measurement results reported by Co. M or Co. 5. Consider each financial measurement independently of the others.
1#1. ,valuatin" the adeuacy of net income Assume that $elta Corp. earns net income of 31 in the current year. dentify two important factors that investors should consider in evaluatin" the reasonableness of this do llar amount. ,%plain what investors may learn from each of these considerations.
14-#
Chapter 14 Financial Statement Analysis
1#2. *+< (hat and why? n "eneral terms what do all J*+J ratios measure? (hy are such computations useful?
1##. ncome statement classifications Simon Eardware and @arfun!el Foods are sole proprietorships with similar amounts of total assets. Also both businesses earn similar amounts of revenue incur similar amounts of operatin" e%penses and report similar net incomes. Eowever Simon has a hi"her cost of "oods sold while @arfun!el Foods has hi"her interest e%pense. ndicate which of these companies has the hi"her GaH "ross profit rate and GbH return on assets. n each case e%plain the reasons for each answer.
1#4. mprovin" the current ratio Carter Corporation financed construction of a new addition to its facilities with a lar"e lon"term note payable. As a condition of obtainin" the loan Carter a"reed to maintain a current ratio at year-end of at least 1.) to 1. f Carter fails to maintain this ratio the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches Carter is concerned about the ma"nitude of its current ratio. Su""est some actions that the company mi"ht ta!e to increase the ma"nitude of the current ratio.
14-#/
Chapter 14 Financial Statement Analysis
1#&. :elow is a number of ratios. =atch the computation to one of the ratios. f there is no match fill in JnoneJ
Ga.H 6et income - preferred dividends divided by avera"e number of common shares outstandin". Gb.H 6et sales divided by avera"e accounts receivable Gc.H +peratin" income divided by avera"e total assets Gd.H Current assets divided by current liabilities Ge.H Annual dividend divided by current stoc! price Gf.H Current assets minus current liabilities G".H Total liabilities divided by total assets Gh.H 6et income divided by avera"e total euity Gi.H Common stoc!holder0s euity divided by shares of common stoc! outstandin". G.H Current stoc! price divided by earnin"s per share
14-4
Chapter 14 Financial Statement Analysis
1#'. The followin" information is available for the @rant Company for 21<
*euired< (hat are earnin"s per share for the current year? (hat is the ;7, ratio? (hat is the boo! value per share of common stoc!? (hat is the dividend yield on common stoc!? (hat is the net profit ratio? (hat is the return on euity?
14-41
Chapter 14 Financial Statement Analysis
Chapter 14 Financial Statement Analysis Answer Ney
True / False Questions
1. Vertical analysis compares the results of financial information with a business in the same industry for a number of consecutive periods of time. FALSE
AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement earning !"#ective: $
2. The uic! ratio is especially useful in evaluatin" the liuidity of a company with fast movin" inventories. FALSE
AACSB: Reflective Thinking AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: &
#. $eductin" the cost of "oods sold from net income "ives us operatin" income. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-42
Chapter 14 Financial Statement Analysis
4. The "ross profit rate is "ross profit e%pressed as a percenta"e of net sales. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
&. The "ross profit rate usually is lowest on fast movin" merchandise and hi"hest on specialty and novelty products TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
'. (hen an income statement does not show "ross profit or operatin" income it is called a consolidated statement. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ earning !"#ective: '
). *+, - return on euity - is measured by dividin" net income by avera"e number of shares outstandin". FALSE
AACSB: Reflective Thinking AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
14-4#
Chapter 14 Financial Statement Analysis
. The yield rate on stoc! is measured by dividin" dividends per share by mar!et price per share. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
/. The trend in ratios is usually more useful than loo!in" at a sin"le year0s ratio. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: (
1. The acid test ratio includes mar!etable securities but does not include accounts receivable. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: (
11. Comparative financial statements show side-by-side financial data for two or more companies. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $
14-44
Chapter 14 Financial Statement Analysis
12. The uality of earnin"s tends to be hi"her for a company that uses strai"ht-line depreciation and defers costs whenever possible than for a company which uses accelerated depreciation and defers costs only when necessary. FALSE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: )
1#. f total current assets are 314 at the end of 5ear 1 increase by 3& by the end of 5ear 2 and increase by 3& in 5ear # the percenta"e increase over the precedin" year is less in 5ear # than in 5ear 2. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
14. (or!in" capital is the e%cess of current assets over current liabilities. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: )
1&. A company0s liuidity refers to its ability to remain profitable. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
14-4&
Chapter 14 Financial Statement Analysis
1'. nventory is an e%ample of a uic! asset. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
1). Current assets are those assets that can be converted into cash within a year and never lon"er. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
1. The debt ratio is computed by dividin" total liabilities by current assets. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
1/. The lower the current ratio the more liuid the company appears. FALSE
AACSB: Analytic AICPA BB: Res%urce Management AICPA FN: Risk Analysis earning !"#ective: &
14-4'
Chapter 14 Financial Statement Analysis
2. The owners of a corporation are not personally responsible for the debts of the business. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
21. A sin"le-step and multiple-step income statement are different in form and in the amount of net income reported. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
22. A company whose sales are "rowin" at less than the rate of inflation may actually be sellin" less merchandise every year. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: *
2#. A company cannot be increasin" its mar!et share if its net sales are declinin". FALSE
AACSB: Analytic AICPA BB: Marketing AICPA FN: Measurement earning !"#ective: *
14-4)
Chapter 14 Financial Statement Analysis
24. 6et income stated as a percenta"e of sales is one means of evaluatin" a company0s ability to control its e%penses. TRUE
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2&. A company whose future earnin"s are e%pected to rise substantially is li!ely to have a hi"her price7earnin"s ratio than a company whose future earnin"s are e%pected to decline. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
2'. From a creditor0s point of view the lower the debt ratio8 the safer the c reditors0 position. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
2). The price7earnin"s ratio is calculated by dividin" earnin"s per share by the current mar!et price of a share of the company0s stoc!. FALSE
AACSB: Reflective Thinking AICPA BB: Industry AICPA FN: Measurement earning !"#ective: '
14-4
Chapter 14 Financial Statement Analysis
2. f the return on total assets ratio is substantially below the co st of borrowin" common stoc!holders will benefit from a hi"h debt ratio. FALSE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
2/. The return on euity ratio may be either hi"her or lower than the return on assets ratio. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
#. The current ratio may be less than eual to or "reater than the uic! ratio. FALSE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
#1. The inventory turnover rate indicates how uic!ly inventory sells. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: (
14-4/
Chapter 14 Financial Statement Analysis
#2. n a sin"le-step income statement all revenue items are listed then all e%pense items are combined and deducted from total revenue. TRUE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
##. n a classified balance sheet assets are subdivided into current assets plant and euipment and other assets while liabilities are all classified as current. FALSE
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: + earning !"#ective: &
#4. The more pessimistic investors0 e%pectations re"ardin" a company0s future p erformance the lower the price7earnin"s ratio is li!ely to be. TRUE
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
#&. A company should carry the amount of wor!in" capital necessary to conduct operations not necessarily ma%imi9e its wor!in" capital. TRUE
AACSB: Analytic AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: &
Multiple Choice Questions
14-&
Chapter 14 Financial Statement Analysis
#'. n order for investors and creditors to decide whether to invest in a company or loan a company funds they may A. Analy9e financial statements. :. Focus on corporate "overnance. C. :oth of the above. $. 6either of the above.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ,
#). A comparative financial statement A. ;laces the balance sheet the income statement and the statement of cash flows side by side in order to compare the results. . ;laces two or more years of a financial statement side by side in order to compare results. C. ;laces the financial statements of two or more companies side by side in order to compare results. $. ;laces the dollar amounts ne%t to the percenta"e amounts of a "iven year for the income statement.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $
#. The chan"es in financial statement items from a base year to followin" years are called< A. =oney chan"es . Trend percenta"es C. Component percenta"es $. *atios
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $
14-&1
Chapter 14 Financial Statement Analysis
#/. The measurement of the relative si9e of each item included in a total is called< A. =oney chan"es :. Trend percenta"es C. Component percenta"es $. *atios
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $
4. +ne number e%pressed as a percenta"e of another is called< A. =oney chan"es :. Trend percenta"es C. Component percenta"es !. *atios
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ earning !"#ective: (
41. The e%cess of current assets over current liabilities is called< A. Current ratio . (or!in" capital C. $ebt ratio $. >uic! ratio
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14-&2
Chapter 14 Financial Statement Analysis
42. >uic! assets include which of the followin"? A. Cash mar!etable securities and receivables. :. Cash mar!etable securities and inventories. C. Cash inventories and receivables. $. =ar!et securities receivables and inventories.
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4#. The ratio which measures total liabilities as a percenta"e of total assets is called< A. Current ratio :. (or!in" capital C. $ebt ratio $. >uic! ratio
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
44. The price7earnin"s ratio is measured by dividin" A. :oo! value by earnin"s per share. :. ;ar value by earnin"s per share. C. =ar!et value by earnin"s per share. $. =ar!et value by total net income.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-
Chapter 14 Financial Statement Analysis
4&. The principle factors affectin" the uality of wor!in" cap ital are< A. The nature of the current assets. :. The len"th of time to convert current assets into cash. C. :oth A and :. $. 6either A nor :.
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4'. All of the followin" ratios are considered measures of profitability e%cept< A. ,arnin"s per share :. @ross profit rate C. ;rice earnin"s ratio $. *eturn on assets
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4). All of the followin" ratios are considered measures of liuidity e%cept< A. >uic! ratio . $ebt ratio C. Current ratio $. *eceivables turnover rate
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14-&4
Chapter 14 Financial Statement Analysis
4. The term classified financial statements refers< A. To the financial statements of all companies wor!in" on "overnment proects. :. +nly to the financial statements of defense contractors wor!in" on secret proects. C. To financial statements prepared for use by mana"ement but not for distribution outside of the or"ani9ation. !. To financial statements in which items with certain characteristics are placed to"ether in a "roup in an effort to develop useful subtotals.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ earning !"#ective: +
4/. Comparative financial statements compare the company0s current statements with< A. Those of prior periods. :. Those of other companies in the same industry. C. Those of the company0s principal competitor. $. The bud"eted level of performance for the period.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $
&. (hich of the followin" is not a measure of short-term liuidity? A. >uic! ratio. :. (or!in" capital. C. Current ratio. !. $ebt ratio.
AACSB: Reflective Thinking AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: &
14-&&
Chapter 14 Financial Statement Analysis
&1. The current ratio will be BBBBBBBBBBBBBBB the uic! ratio. A. ess than. . @reater than or eual to. C. The same as. $. Always different than.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
&2. (hich of the followin" is not a measure of lon"-term credit ris!? A. >uic! ratio. :. $ebt ratio. C. nterest covera"e ratio. $. Trend in net cash provided by operatin" activities.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
. A hi"h uality of earnin"s is indicated by< A. ,arnin"s derived lar"ely from newly introduced products. :. $eclaration of both cash and stoc! dividends. C. Dse of the FF+ method of inventory durin" sustained inflation. !. A history of increasin" earnin"s and conservative accountin" methods.
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14-&'
Chapter 14 Financial Statement Analysis
&4. n evaluatin" the uality of a company0s earnin"s which of the followin" factors is least important? A. The accountin" methods used by mana"ement. :. The trend of the company0s earnin"s over a period of years. C. The dollar amount of earnin"s per share. $. The stability and sources of the company0s earnin"s.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Risk Analysis earning !"#ective: )
&&. The measures most often used in evaluatin" solvency--the current ratio uic! ratio and amount of wor!in" capital are developed from amounts appearin" in the< A. :alance sheet. :. ncome statement. C. Statement of retained earnin"s. $. Statement of cash flows.
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&'. (hich of the followin" is not a measure of profitability? A. ,;S. :. *+. C. *+,. !. 6*.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-&)
Chapter 14 Financial Statement Analysis
&). (hich American industry would tend to have the "reatest debt ratio? A. Auto. :. *etail clothin". C. =anufacturin". !. :an!in".
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: &
&. The current ratio< A. s computed by dividin" current assets by current liabilities. :. s computed by subtractin" current liabilities from current assets. C. *emains unchan"ed throu"hout the operatin" cycle. $. s a measure of short-term profitability.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
&/. Component percenta"es indicate the relative si9e of each item included in a total. (hich of the followin" statements is true? A. ncome statement items are e%pressed as a percenta"e of net income and balance sheet items as a percenta"e of total assets. . ncome statement items are e%pressed as a percenta"e of sales and balance sheet items as a percenta"e of total assets. C. ncome statement items are e%pressed as a percenta"e of net income and balance sheet items as a percenta"e of net worth. $. :oth income statement and balance sheet items are e%pressed as a percenta"e of net worth.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: *
14-&
Chapter 14 Financial Statement Analysis
'. Eow would a company0s wor!in" capital be affected if a substantial amount of accounts payable were paid in cash? A. t would be unaffected. :. t would fall. C. t would increase. $. The chan"e would depend on the relationship between the payables liuidated and current liabilities.
AACSB: Analytic AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: &
'1. Current assets are those assets that can be converted into cash within< A. +ne year and never lon"er. . +ne year or the operatin" cycle whichever is lon"er. C. +ne year or the operatin" cycle whichever is shorter. $. =ana"ement0s discretion.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
'2. The current ratio is calculated by< A. $ividin" current assets by total assets. :. $ividin" current assets by total liabilities. C. $ividin" current assets by stoc!holders0 euity. !. $ividin" current assets by current liabilities.
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14-&/
Chapter 14 Financial Statement Analysis
'#. The uic! ratio< A. s computed by dividin" current assets by current liabilities. :. s always hi"her than the current ratio. C. Cannot be hi"her than the current ratio. $. =ay be hi"her or lower than the current ratio.
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'4. Short-term creditors are most li!ely to use the uic! ratio instead of the current ratio in evaluatin" the solvency of a company with lar"e slow-movin"< A. ;lant and euipment. :. *eceivables. C. nventories. $. ,mployees.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
'&. (hich of the followin" is considered a uic! asset? A. Accounts receivable. :. nventory. C. Automobiles. $. ;repaid e%penses.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
14-'
Chapter 14 Financial Statement Analysis
''. (hich of the followin" transactions would cause a chan"e in the amount of a company0s wor!in" capital? A. Collection of an account receivable. :. ;ayment of an account payable. C. :orrowin" cash over a '-day period. !. Sellin" merchandise at a price above its cost.
AACSB: Reflective Thinking AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: &
'). The debt ratio indicates the percenta"e of< A. Total assets financed by lon"-term mort"a"es. :. *evenue consumed by interest e%pense. C. Total assets financed by creditors. $. Total liabilities classified as current.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
'. The debt ratio is used primarily as a measure of< A. Short-term liuidity. . Creditors0 lon"-term ris!. C. ;rofitability. $. *eturn on nvestment.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
14-'1
Chapter 14 Financial Statement Analysis
'/. @enerally spea!in" which appears to be a desirable current ratio? A. 2 to 1. :. 1 to 2. C. 2 to 1. $. 1 to 2.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
). All of the followin" captions or subtotals are typical o f a multiple-step income statement e%cept for< A. 6et sales. :. @ross profit. C. Total costs and e%penses. $. +peratin" income.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
)1. (hen comparin" the current ratio to the uic! ratio< A. The current ratio will always be "reater :. The uic! ratio will always be "reater C. The uic! ratio is sometimes "reater and sometimes less than the current ratio $. They always will be the same
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
14-'2
Chapter 14 Financial Statement Analysis
)2. The "ross profit rate represents< A. Total sales revenue. :. The percenta"e chan"e in net sales from the prior period. C. The percenta"e of sales revenue remainin" after providin" for the cost of the merchandise sold. $. 6et income stated as a percenta"e of total sales revenue.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
)#. A risin" "ross profit rate most stron"ly su""ests< A. An increase in physical sales volume. . Stron" consumer demand for the company0s products. C. ntense competition. $. ncreased short-term solvency.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
)4. +peratin" income e%cludes each of the followin" e%cept< A. nterest e%pense. :. ncome ta%es. C. $epreciation. $. ;repaid e%penses.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-'#
Chapter 14 Financial Statement Analysis
)&. Assume that net sales are increasin" faster than the rate of inflation and that the company0s "ross profit rate is risin". +f the followin" the most lo"ical conclusion is that< A. The company0s cost of purchasin" merchandise is risin" rapidly. :. +peratin" e%penses are fallin". C. $emand for the company0s products is very stron". $. The company has achieved an increase in sales volume by reducin" its sales prices.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: *
)'. n calculatin" earnin"s per share the denominator of the euation includes< A. +nly common stoc! outstandin". :. Common stoc! plus preferred stoc!. C. Common stoc! less preferred stoc!. $. The total shares of authori9ed common stoc!.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
)). +n common si9e income statements each component in the income statement is represented as a percenta"e of< A. 6et income. . Sales. C. Total assets. $. ;rofit.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ earning !"#ective: *
14-'4
Chapter 14 Financial Statement Analysis
). n a multiple-step income statement interest e%pense usually is no t classified as an operatin" e%pense because interest char"es< A. $o not contribute to the production of revenue. . Stem from the manner in which assets are financed not the manner in which they are used in business operations. C. *elate directly to the cost of "oods sold. $. The statement is incorrect. nterest usually is classified as an operatin" e%pense.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
)/. n a multiple-step income statement income ta%es are not classified as operatin" e%penses because< A. ncome ta%es do not contribute to the production of revenue. :. ncome ta%es stem from the manner in which assets are financed not the manner in which they are used in business operations. C. 6ot all forms of business or"ani9ation are subect to income ta%es. $. The statement is incorrect8 income ta%es are classified as operatin" e%penses.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
. Traditionally stoc! of financially sound companies with stable earnin"s usually have a price7earnin"s ratio of< A. /. . 12. C. 174. $. #.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
14-'&
Chapter 14 Financial Statement Analysis
1. *eturn on euity computations are used in evaluatin"< A. iuidity. . ;rofitability. C. @ross profit. $. (hether a ratio is improvin" or deterioratin" over time.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
2. The financial ratio intended to measure the effectiveness with which mana"ement has utili9ed the resources of the business re"ardless of how these resources are financed is< A. @ross profit rate. :. Current ratio. C. *eturn on assets. $. *eturn on euity.
AACSB: Reflective Thinking AICPA BB: Res%urce Management AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
#. The return on assets ratio usually is computed as< A. 6et sales divided by avera"e total assets. :. @ross profit divided by avera"e total assets. C. +peratin" income divided by avera"e total assets. $. 6et income divided by avera"e total assets.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
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Chapter 14 Financial Statement Analysis
4. f a company has a current ratio of 2 to 1 and purchases inventory on credit what will this do to its current ratio? A. ncrease the current ratio. . $ecrease the current ratio. C. $oes not chan"e the current ratio. $. Cannot be determined.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
&. The return on euity ratio usually is computed as< A. 6et income divided by avera"e total assets. :. +peratin" income divided by avera"e total stoc!holders0 euity. C. @ross profit divided by avera"e total stoc!holders0 euity. !. 6one of the above answers is correct.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
'. The measurement that best reflects investors0 e%pectations about future earnin"s is< A. ,arnin"s per share. :. *eturn on assets. C. The price7earnin"s ratio. $. *eturn on euity.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-')
Chapter 14 Financial Statement Analysis
). The interest covera"e ratio is computed by dividin"< A. +peratin" income by annual interest e%pense. :. 6et income by annual interest e%pense. C. Carryin" value of bonds by cash interest payments. $. ,arnin"s per share by the prime interest rate.
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. Amal"amated Corporation0s net income was 324 in 2/ and 3 in 21. (hat percenta"e increase in net income must Amal"amated achieve in 211 to offset the decline in profits in 21? A. )&. . #. C. ##.##. $. . 32473 L # or #
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/. f a retail store has a current ratio of 2.& and current assets of 31/& the amount of wor!in" capital is< A. 3). :. 3#. C. 3##. !. 311). 31/& - G31/&72.&H L 311)
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: &
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Chapter 14 Financial Statement Analysis
/. The ;la9a Company has wor!in" capital of 3&4 and a current ratio of # to 1. The amount of current assets is< A. 34&. :. 3&4. C. 31. $. 32). #C - C L 3&4< C L 32)8 CA L 31
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/1. $urin" the years 2/ throu"h 211 ;owers nc. reported the followin" amounts of net income Gdollars in thousandsH<
*elative to the prior year the percenta"e chan"e in net income< A. (as the same in 21 and 211. :. (as lar"er in 211 than in 21. C. (as smaller in 211 than in 21. $. Cannot be determined without !nowin" how many shares of stoc! were outstandin". 271& L 1# while #712 L 2&
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14-'/
Chapter 14 Financial Statement Analysis
Shown below are selected data from the balance sheet of Compros a small electronics store Gdollar amounts are in thousandsH<
/2. *efer to the above data. (hat is the uic! ratio? A. 1.& to 1. . .) to 1. C. .4& to 1. $. Some other amount. G3)& K 31#&H73# L .)
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
/#. *efer to the above data. (hat is the current ratio? A. &. to 1. . 1.& to 1. C. .) to 1. $. Some other amount. G3)& K 31#& K 324H73# L 1.&
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14-)
Chapter 14 Financial Statement Analysis
/4. *efer to the above data. (hat is wor!in" capital amounts to< A. 322&. :. 3#. C. 31&. $. Some other amount. 34& - 3# L 31&
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
/&. *efer to the above data. (hat is Compro0s debt ratio? A. )&. :. 2&. C. '. $. Some other amount. 3')&73/ L )&
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
Shown below are selected data from the balance sheet of :ill0s Auto ;arts a retail store Gdollar amounts are in thousandsH<
14-)1
Chapter 14 Financial Statement Analysis
/'. *efer to the above data. (hat is the uic! ratio? A. &. . 1.& to 1. C. 2. $. Some other amount. G31# K 3#)H73#4 L 1.4)
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
/). *efer to the above data. (hat is the current ratio? A. 1.2 to 1. :. ess than 2 to 1 but not 1.2 to 1. C. 2.' to 1. $. =ore than 2 to 1 but not 2.' to 1. G31# K 3#) K 34H 73#4 L 2.'&
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/. *efer to the above data. (or!in" capital amounts to< A. 3&' :. 3 C. 32) $. Some other amount. G31# K 3#) K 34H - 3#4 L 3&'
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
14-)2
Chapter 14 Financial Statement Analysis
//. *efer to the above data. :ill0s debt ratio is< A. 22. :. 2). C. &). !. Some other amount. G3#4 K 32H7312' L 4/
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
Shown below are selected data from the financial statements of Supreme Co. $ollar amounts are in millions Ge%cept for the per share dataH.
;er share data Gthese amounts stated in actual dollars not millionsH< Supreme reported earnin"s per share for the year of 34 and paid cash dividends of 31 per share. At year end the (all Street Iournal listed Supreme0s capital stoc! as tradin" at 3 per share.
14-)#
Chapter 14 Financial Statement Analysis
1. *efer to the above data. Supreme0s "ross profit rate was< A. 42./. . &).). C. 2.. $. Some other amount. 312# - 3&2 L 3)18 3)17312# L &).)
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11. *efer to the above data. (hat was Supreme0s operatin" income? Gin millionsH< A. 3)1. :. 3#/. C. 32). $. Some other amount. 312# - 3&2 - 344 L 32)
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14-)4
Chapter 14 Financial Statement Analysis
12. *efer to the above data. Supreme0s return on assets was< A. 1. . '.)&. C. 1&. $. Some other percenta"e. 32#734 L .'
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
1#. *efer to the above data. Supreme0s return on euity was< A. 11. :. 2&. C. ).&. !. 1'.#. 3#/7324 L 1'.#
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
14-)&
Chapter 14 Financial Statement Analysis
14. *efer to the above data. Supreme0s price7earnin"s ratio at year end was< A. 2&. . 22. C. 1. $. Some other amount. 3734 L 22
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
Shown below are selected data from the financial statements of 6oble Computers. G$ollar amounts are in millions e%cept for the per share data.H
;er share data Gthese amounts stated in actual dollars not millionsH< 6oble reported earnin"s per share for the year of 3' and paid cash dividends of 32. per share. At year end the (all Street Iournal listed 6oble0s capital stoc! a s tradin" at 31 per share.
14-)'
Chapter 14 Financial Statement Analysis
1&. *efer to the above data. 6oble0s price7earnin"s ratio at year end was< A. .). . 1#.&. C. 1). $. Some other amount. 3173' L 1#.&
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
1'. *efer to the above data. 6oble0s "ross profit rate was< A. 1. . 4'. C. &. $. Some other amount. G3#& - 31/H73#& L 4'
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
14-))
Chapter 14 Financial Statement Analysis
1). *efer to the above data. 6oble0s operatin" income was< A. 31'1. :. 3')& C. 3/#&. $. Some other amount. 3#& - 31/ - 3')& L 3/#&
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
1. *efer to the above data. 6oble0s return on assets was< A. 2.' . 21. C. 2'. $. Some other amount. 3/#&7344 L 21
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
14-)
Chapter 14 Financial Statement Analysis
1/. *efer to the above data. 6oble0s return on euity was< A. 1. :. 1#. C. 21. $. Some other amount. 311&73&4 L 21
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
@iven below are comparative balance sheets and an income statement for Claret Corporation
All sales were made on account. Cash dividends declared durin" the year totaled 3114/2
14-)/
Chapter 14 Financial Statement Analysis
11. *efer to the above data. Claret Corporation0s accounts receivable turnover for 2/ is< A. 4.' times. :. 2./ times. C. &.4 times. $. ' days. 3227 OG34' K 3#))H72P L &.4
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: (
111. *efer to the above data. Claret Corporation0s inventory turnover for 2/ is< A. '.' times. . #./ times. C. 4.1 times. $. /4 days. 1#)&47OG#2& K #'4H72P L #.//
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: (
112. *efer to the above data. Claret Corporation0s "ross profit rate for 2/ is< A. '.1. . #/./. C. ##. $. '. 3/12'7322 L #/./
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
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Chapter 14 Financial Statement Analysis
11#. *efer to the above data. Claret Corporation0s return on assets for 2/ rounded to the nearest tenth of a percent is< A. /./. :. 4.1. C. &./. $. 1'./. 31&#/27OGG31&21 K 31&'H72HP L /./
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: * earning !"#ective: (
114. *efer to the above data. Claret Corporation0s return on common stoc!holders0 euity for 2/ rounded to the nearest tenth of a percent is< A. &./. :. '.&. C. 14.4. $. /.4. 3'2/27OG314 K 31/2H72P L &./
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14-1
Chapter 14 Financial Statement Analysis
11&. n an attempt to standardi9e financial practices worldwide two areas of particular interest to the nternational Accountin" Standards Committee are< A. Capitali9in" and e%pensin" . Se"ments and consolidations C. ;ensions and eases $. ;artnerships and corporation
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: +
11'. An or"ani9ation that provides ratin"s of corporate "overnance services is< A. S,C . SS C. *S $. :=
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Essay Questions
14-2
Chapter 14 Financial Statement Analysis
11). Accountin" terminolo"y isted below are ei"ht technical accountin" terms introduced in this chapter<
,ach of the followin" statements may Gor may notH describe one of these technical terms. For each statement indicate the term described or answer J6oneJ if the statement does not correctly describe any of the terms. GaH The percenta"e of total assets financed by creditors. GbH A measure of the effectiveness with which mana"ement utili9es a company0s resources re"ardless of how those resources are financed. GcH A company0s percenta"e share of total dollar sales within its industry. GdH Current assets less current liabilities. GeH A measure reflectin" investors e%pectations of future profitability. GfH A measure of short-term solvency often used when a company has lar"e inventories that cannot be uic!ly converted into cash. G"H A ratio that helps individual stoc!holders relate the net income of a lar"e corporation to their euity investment. GaH $ebt ratio GbH *eturn on assets GcH =ar!et share GdH (or!in" capital GeH ;rice7earnin"s ratio GfH >uic! ratio G"H ,arnin"s per share
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ . ,
14-#
Chapter 14 Financial Statement Analysis
11. Current ratio and wor!in" capital The balance sheet of *ed =issile Company contained the followin" items amon" others<
GaH From the above information compute< G1H Current assets< 3BBBBBBB G2H Current liabilities< 3BBBBBB G#H The current ratio< BBBBBB to 1 G4H (or!in" capital< 3BBBBBB GbH Assume that *ed =issile Company pays the note payable of 31'# thus reducin" cash to 31). Compute the followin" after the completion of this transaction< G1H The current ratio< BBBBBB to 1 G2H (or!in" capital< 3BBBBBB
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Chapter 14 Financial Statement Analysis
11/. =easures of solvency and credit ris! Shown below are selected items appearin" in a recent balance sheet of @rant ;roducts. G$ollar amounts are in thousands.H
GaH Compute the followin"< G1H Total uic! assets 3BBBBBBBBBBBB G2H Total current assets 3BBBBBBBBBBBB G#H Total current liabilities 3BBBBBBBBBBBB G4H >uic! ratio BBBBBB to 1 G&H Current ratio BBBBBB to 1 GbH *esearch indicates an industry avera"e uic! ratio is 1.# to 1 and a current ratio of 2.# to 1. :ased upon this information does @rant ;roducts appear more or less solvent than the avera"e company in its industry? ,%plain briefly.
Gb.H @rant ;roducts0 current ratio and uic! ratio both are below the industry avera"es. This means that @rant ;roducts has less liuid assets in relation to its current liabilities and therefore appears less solvent than the avera"e company in the industry.
14-&
Chapter 14 Financial Statement Analysis AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: (
12. =ultiple-step income statement Shown below is a recent income statement for ;haeton nc.<
;repare an income statement for the year in a multiple-step format. GDse the "rid provided below.H
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Chapter 14 Financial Statement Analysis
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-)
Chapter 14 Financial Statement Analysis
121. *eturn on investment Shown below are selected data from a recent annual report of >uality Service. G$ollar amounts are in millions.H
Compute for the year<
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14-
Chapter 14 Financial Statement Analysis
122. Computation of profitability ratios Shown below are selected data from a recent annual report of Tall +a!s Co. G$ollar amounts are in thousands.H
Compute for the year the company0s<
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14-/
Chapter 14 Financial Statement Analysis
12#. ;rofitability measures Shown below is a recent income statement for :-$ ,lectric.
Assume that comparative balance sheets for :-$ ,lectric indicate avera"e total assets for the year of 32& and avera"e total euity of 32&. Compute the followin"<
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14-/
Chapter 14 Financial Statement Analysis
124. ;ercenta"e chan"es Selected information from the financial statements of ;erfectly :a!ed Ca!e Co. appears below<
GaH Compute the percenta"e chan"e in each of the above items from 21 to 211. Dse a K or to indicate increase or decrease.
GbH Compute net income as a percenta"e of net sales in each year. G*ound to the nearest onetenth of 1H
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: $ earning !"#ective: (
14-/1
Chapter 14 Financial Statement Analysis
12&. ;ercenta"e chan"es8 p7e ratios and investors0 e%pectations Shown below are @amma nc.0s earnin"s per share for a four-year period alon" with the pershare mar!et price of the company0s stoc! at each year-end. The earnin"s in 211 were the hi"hest in the company0s history.
GaH Compute the percenta"e chan"e in earnin"s per share in 2/ 21 and 211. G;lace your answers in the spaces provided above.H GbH Compute the p7e ratio of stoc! at the end of each of the four years. G;lace your answers in the spaces provided above.H GcH (hat does the p7e ratio at the end of 211 indicate about investors0 e%pectations of earnin"s per share for the comin" year? ,%plain your reasonin".
GcH The p7e ratio of .& is low by historical standards indicatin" that investors do not e%pect the rapid earnin"s "rowth of recent years to continue. The sharp declines in stoc! price and price7earnin"s ratio occurrin" durin" @amma0s Jrecord yearJ su""est that investors may be e%pectin" earnin"s to decline from current levels. The current price7earnin"s ratio of .& is even less than that at the end of 2 which was preceded by a decline in earnin"s per share.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: $ earning !"#ective: ' earning !"#ective: ,
14-/2
Chapter 14 Financial Statement Analysis
12'. ,ffects of events on financial measurements ndicate the probable effects of each of the followin" strate"ies or events upon the financial measurements of indsay Corp. listed below. Dse the code letters L ncrease $ L $ecrease and 6, L 6o ,ffect.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ,
14-/#
Chapter 14 Financial Statement Analysis
12). Financial ratios Shown below are some !ey fi"ures from the balance sheets of =inuteman @as Company for two successive years<
$ividends of 3/' were declared and paid in 21. Compute the followin"<
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: & earning !"#ective: ' earning !"#ective: (
14-/4
Chapter 14 Financial Statement Analysis
12. Financial ratios @iven below are comparative balance sheets and an income statement for the ,%cellent Corporation<
All sales were made on account. Cash dividends declared durin" the year totaled 3&&&. Compute the followin"<
14-/&
Chapter 14 Financial Statement Analysis
AACSB: Analytic AICPA BB: Industry AICPA FN: Measurement earning !"#ective: $ earning !"#ective: & earning !"#ective: ' earning !"#ective: (
14-/'
Chapter 14 Financial Statement Analysis
12/. ,ffects of transactions upon analytical measurements $etermine the immediate effect of each of the transactions described be low on the ratio listed beside each transaction. n the blan! space to the left of each statement you are to indicate the effect by writin" the appropriate code letter. The code letters are as follows< L increase the ratio $ L decrease the ratio and 6, L no effect on this ratio.
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14-/)
Chapter 14 Financial Statement Analysis
1#. Dse and interpretation of financial measurements Shown below are various financial measurements for two companies which are similar in si9e and sell similar products<
nstructions< 5ou are to enter code letters in the spaces provided in the two ri"ht-hand columns. n the first column indicate which of the followin" three "roups probably would be most interested in the specified financial measurement. dentify one "roup usin" the followin" code letters< STC L indicatin" short-term creditors TC L indicatin" lon"-term creditors and S L indicatin" stoc!holders. n the second column enter an M or a 5 to indicate whether your Jmost interested "roupJ would prefer the measurement results reported by Co. M or Co. 5. Consider each financial measurement independently of the others.
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ( earning !"#ective: ,
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Chapter 14 Financial Statement Analysis
1#1. ,valuatin" the adeuacy of net income Assume that $elta Corp. earns net income of 31 in the current year. dentify two important factors that investors should consider in evaluatin" the reasonableness of this do llar amount. ,%plain what investors may learn from each of these considerations. Students are to identify two important factors to be considered in the evaluation of a company0s earnin"s and to e%plain what investors may learn from these considerations. =ost students identify two of the followin" factors< -The resources invested in the effort to "enerate the company0s earnin"s Gi.e. si9e of the companyH. This consideration indicates the efficiency with which economic resources are employed. -The earnin"s of the company in prior periods. The trend in earnin"s indicates whether performance is improvin" or deterioratin". -The earnin"s of comparable companies Gin si9e as well as in the nature of operationsH. This comparison provides an indication of the company0s ability to compete.
AACSB: Reflective Thinking AICPA BB: Critical Thinking AICPA FN: /ecisi%n Making earning !"#ective: *
1#2. *+< (hat and why? n "eneral terms what do all J*+J ratios measure? (hy are such computations useful? J*+J ratios measure an investor0s JreturnJ as a percenta"e of the avera"e amount of the reuired investment. Such computations provide investors with a basis for comparin" the profitability of alternative investment opportunities.
AACSB: C%mmunicati%ns AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: '
14-//
Chapter 14 Financial Statement Analysis
1##. ncome statement classifications Simon Eardware and @arfun!el Foods are sole proprietorships with similar amounts of total assets. Also both businesses earn similar amounts of revenue incur similar amounts of operatin" e%penses and report similar net incomes. Eowever Simon has a hi"her cost of "oods sold while @arfun!el Foods has hi"her interest e%pense. ndicate which of these companies has the hi"her GaH "ross profit rate and GbH return on assets. n each case e%plain the reasons for each answer. GaH :oth companies earn similar amounts of revenue but Simon Eardware has the hi"her cost of "oods sold. Therefore @arfun!el Foods must have the hi"her total "ross profit and also the hi"her "ross profit rate. GbH @arfun!el Foods has the hi"her return on assets. *eturn on assets usually is computed by e%pressin" operatin" income as a percenta"e of avera"e total assets. As both companies have similar amounts of total assets the company with the hi"her operatin" income will have the hi"her return on assets. @arfun!el Foods probably has the hi"her operatin" income. As both companies earn similar amounts of revenue and net income their total costs and e%penses also must be similar. Simon however has a hi"her cost of "oods sold which is deducted in arrivin" at operatin" income. @arfun!el Foods has hi"her interest e%pense but interest is deducted after the determination of operatin" income. Therefore @arfun!el Foods probably has the hi"her operatin" income of the two businesses. 6ote to instructor< ncome ta%es is another Jnon-operatin" itemJ which may cause two businesses with similar net incomes to have different levels of operatin" income. Eowever both Simon Eardware and @arfun!el Foods are or"ani9ed as sole proprietorships and therefore do not include income ta%es e%pense in their income statements.
AACSB: C%mmunicati%ns AICPA BB: Critical Thinking AICPA FN: Re-%rting earning !"#ective: * earning !"#ective: ,
14-1
Chapter 14 Financial Statement Analysis
1#4. mprovin" the current ratio Carter Corporation financed construction of a new addition to its facilities with a lar"e lon"term note payable. As a condition of obtainin" the loan Carter a"reed to maintain a current ratio at year-end of at least 1.) to 1. f Carter fails to maintain this ratio the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches Carter is concerned about the ma"nitude of its current ratio. Su""est some actions that the company mi"ht ta!e to increase the ma"nitude of the current ratio. ;ayin" any current liabilities will increase the current ratio. The company co uld also consider postponin" until after year-end any routine transactions that would reduce current assets such as the acuisition of euipment or scheduled maintenance and repair e%penditures. The sale of e%istin" inventory Gor any other current assetH for a price above cost would also cause the current ratio to increase.
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14-11
Chapter 14 Financial Statement Analysis
1#&. :elow is a number of ratios. =atch the computation to one of the ratios. f there is no match fill in JnoneJ
Ga.H 6et income - preferred dividends divided by avera"e number of common shares outstandin". Gb.H 6et sales divided by avera"e accounts receivable Gc.H +peratin" income divided by avera"e total assets Gd.H Current assets divided by current liabilities Ge.H Annual dividend divided by current stoc! price Gf.H Current assets minus current liabilities G".H Total liabilities divided by total assets Gh.H 6et income divided by avera"e total euity Gi.H Common stoc!holder0s euity divided by shares of common stoc! outstandin". G.H Current stoc! price divided by earnin"s per share Ga.H ,arnin"s per share Gb.H A7* turnover rate Gc.H *eturn on assets Gd.H Current ratio Ge.H none s7b dividend yield Gf.H (or!in" capital G".H $ebt ratio Gh.H *eturn on euity GiH none s7b boo! value per share G.H ;rice7earnin"s ratio
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14-12
Chapter 14 Financial Statement Analysis
1#'. The followin" information is available for the @rant Company for 21<
*euired< (hat are earnin"s per share for the current year? (hat is the ;7, ratio? (hat is the boo! value per share of common stoc!? (hat is the dividend yield on common stoc!? (hat is the net profit ratio? (hat is the return on euity? ,arnin"s per share 3' - 3217& L 311./' ;rice7,arnin"s ratio 3#27311./' L 32.' :oo! value G31' - 3#H7 & L 32.' $ividend yield 31.73#2 L &.'# 6et profit rate 3'7312 L & *eturn on euity 3'731' L #)&
AACSB: Analytic AICPA BB: Critical Thinking AICPA FN: Measurement earning !"#ective: ' earning !"#ective: (
14-1#
Chapter 14 Financial Statement Analysis
Chapter 14 Financial Statement Analysis C"A#TER 14
$AME
1&'M($UTE QU() A
SECT(*$
%
ndicate the best answer to each uestion in the space provided. 1
The uic! ratio is considered more useful than the current ratio for< ,valuatin" the profitability of a business that sells inventory very uic!ly such as a a restaurant. ,valuatin" the solvency of a business that turns inventory into cash very slowly + such as a shipbuilder. ,valuatin" lon"-term credit ris!. c ,valuatin" investorsQ e%pectations concernin" future earnin"s. ,
-
The debt ratio is a measure of< 6et cash flows relatin" to financin" activities. a on"-term credit ris!. + Short-term solvency. c ;rofitability independent of the manner in which assets are financed. ,
n the lon"-run it is most important for a business to "enerate an inflow of cash from its< +peratin" activities. a Stoc!holders. + nvestin" activities. c Creditors. ,
4
*eturn on assets measures the efficiency with which mana"ement< @enerates earnin"s from the assets under its control re"ardless of how these a assets are financed. @enerates earnin"s from the assets under its control "ivin" consideration to any + costs of financin" these assets. @enerates cash from the assets under its control re"ardless of accrual-based c measures of profitability. Converts its current assets into cash. ,
A transaction that will increase the uic! ratio but cause the current ratio to decline is< Short-term borrowin". a nvestin" cash in plant assets. + Sale of inventory at a price below cost. c Collection of an account receivable. ,
14-14
Chapter 14 Financial Statement Analysis
C"A#TER 14
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SECT(*$
%
Shown below are data ta!en from a recent annual report of Falcon Co. G$ollar amounts in millions.H e0innin0 En, o 2ear o 2ear alance sheet ,ata3 Current assets............................................................. Total assets................................................................. Current liabilities........................................................ Total liabilities............................................................ Total stoc!holdersQ euity...........................................
31#4 31 3#)/ 3&4' 31
(ncome statement ,ata3 6et sales..................................................................... @ross profit................................................................. +peratin" income....................................................... 6et income.................................................................
4112 3122 3#1 34)) 4121)
32)&/ 312'4 3&)4 3421
. :ased upon the above information indicate the best answer in the space provided. 1
The current ratio at year-end Grounded to the nearest tenthH is< 2.# to 1. #.& to 1. a c .' to 1. Some other answer. + ,
-
The amount of wor!in" capital at the be"innin" of the year Gin millionsH was< 3)& 34)/. a c 311/#. Some other answer. + ,
The "ross profit rate for the year Grounded to the nearest 1 percentH was< 4'. '/. a c &4. Some other answer + ,
4
The return on avera"e total assets durin" the year Grounded to the nearest percentH was< 24. )/. a c #4. Some other answer. + ,
The return on avera"e total stoc!holdersQ euity durin" the year Grounded to the nearest 1 percentH was< &. #. a c 41. Some other answer. + ,
14-1&
Chapter 14 Financial Statement Analysis
C"A#TER 14
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SECT(*$
%
Shown below are data ta!en from a recent annual report of Topa9 nc . G$ollar amounts in millions.H e0innin0 En, o 2ear o 2ear alance sheet ,ata3 Current assets............................................................. Total assets................................................................. Current liabilities........................................................ Total liabilities............................................................ Total stoc!holdersQ euity...........................................
3 '2& 31& 32)& 3& 3&)&
3) 312 31)& 3' 3)2&
(ncome statement ,ata3 6et sales..................................................................... @ross profit................................................................. +peratin" income....................................................... 6et income.................................................................
31/ 3/ 34& 3#
(nstructions Compute the followin"< a Current ratio at year-end Ground to nearest tenthH.. .. ... ..
BBBBBBBB to 1
.
+
c
,
e
(or!in" capital at the be"innin" of the year Gin millionsH
3BBBBBBBBBBBB
@ross profit rate for the year Ground to the nearest 1 percentH
BBBBBB
*eturn on avera"e total assets for the year Ground to the nearest 1 percentH
BBBBBB
*eturn on avera"e total euity for the year Ground to the nearest 1 percentH
BBBBBB
14-1'
Chapter 14 Financial Statement Analysis
C"A#TER 14
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@iven below are comparative balance sheets and an income statement for the Copper Corporation<
Cash
Copper Corporation :alance Sheets R Current 5ear $ec. #1 Ian. 1 3 #1' 3 2'/
Copper Corporation ncome Statement for the Current 5ear Sales 3/#'
Accounts receivable
2&2
21'
Cost of "oods sold
G&1&H
nventory
1)#
1)
@ross profit on sales
3421
,uipment GnetH
12/
1&2
+peratin" e%penses
G##2H
3&&'
3&)2/
+peratin" income
31#&
314)
nterest e%pense and income ta%es
1
14
/ #42'
/ #21/
3&&'
3&)2/
Accounts payable $ividends payable Capital stoc! 3/ par *etained earnin"s
All sales were made on account. Compute the followin"<
6et income
3 / G#/H 3 &.
Cash dividends declared durin" the year totaled 32/#.
a
Avera"e accounts receivable turnover
times
+
:oo! value per share at the end of the current year
3BBBBBBBBBBBBBB
c
,arnin"s per share of capital stoc!
3BBBBBBBBBBBBBB
,
*eturn on assets
e
*eturn on common stoc!holdersQ euity is computed by dividin" 3 BBBBBBBBBBBB by 3BBBBBBBBBBBBBB
14-1)
Chapter 14 Financial Statement Analysis
C"A#TER 14 SELF'TEST QUEST(*$S FR*M TET**5
Choose the best answer for each of the followin" uestions and insert the identifyin" letter in the space provided. 1
(hich of the followin" usually is least important as a measure of short-term liuidity? >uic! ratio. a $ebt ratio. + Current ratio. c Cash flow from operatin" activities. ,
-
n each of the last five years the net sales of ;la9a Co. have increased at about half the rate of inflation but net income has increased at appro%imately twice the rate of inflation. $urin" this period the companyQs total assets liabilities and euity have remained almost unchan"ed8 dividends are appro%imately eual to net income. These relationships su""est Gindicate all correct answersH< =ana"ement is successfully controllin" costs and e%penses. a The company is sellin" more merchandise every year. + The annual return on assets has been increasin". c Financin" activities are li!ely to result in a net use of cash. ,
From the viewpoint of a stoc!holder which of the followin" relationships do you consider of the least si"nificance? The return on assets consistently is hi"her than the industry avera"e. a The return on euity has increased in each of the past five years. + 6et income is "reater than the amount of wor!in" capital. c The return on assets is "reater than the rate of interest bein" paid to creditors. ,
4
The followin" data are available from the annual report of Fri%all =otors< Current assets...................... 3 4 Avera"e total assets............. 2 Avera"e total euity.............
Current liabilities.............. 3# +peratin" income.............. 24 6et income.......................
(hich of the followin" statements are correct? G=ore than one statement may be correct.H The return on euity e%ceeds the return on assets. a The current ratio is .'2& to 1. + (or!in" capital is 312. c 6one of the above answers are correct. ,
14-1
Chapter 14 Financial Statement Analysis
Eart CorporationQs net income was 34 in 24 and 31' in 2&. (hat percenta"e increase in net income must Eart achieve in 2' to offset the decline in profits in 2&? '. 1&. '. '). a + c ,
6
f a companyQs current ratio declined in a year durin" which its uic! ratio improved which of the followin" is the most li!ely e%planation? nventory is increasin". a nventory is declinin". + *eceivables are bein" collected more rapidly than in the past. c *eceivables are bein" collected more slowly than in the past. ,
7
n financial statement analysis the most difficult of the followin" items to predict is whether< The company will be liuid in si% months. a The companyQs mar!et share is increasin" or declinin". + ;rofits will increase in the comin" year. c The mar!et price of capital stoc! will rise or fall over the ne%t two months. ,
14-1/
Chapter 14 Financial Statement Analysis
S*LUT(*$S T* C"A#TER 14 1&'M($UTE QU())ES QU() A : 1 : A A 4 C
QU() C 1 $ G31#4 - #)/ L 3''2H A : 4 C
QU() C a
Current ratio at year-end 3) ÷ 31)& L 4
4 to 1
+
(or!in" capital at the be"innin" of the year Gin millionsH 3'2& - 32)& L 3#&
3#&
c
@ross profit rate 3/ ÷ 31/ L 4).4
,
*eturn on avera"e total assets 34& ÷ OG31& K 312H ÷ 2P L 4
e
*eturn on avera"e total stoc!holdersQ euity 3# ÷ OG3&)& K 3)2&H ÷ 2P L 4'.2
4).4
4
QU() ! a + c , e
Accounts receivable turnover G3/#' ÷ 32#4H L 4 times :oo! value per share at the end of the current year L G34#2' ÷ 1 sharesH L 34#.2' ,arnin"s per share of capital stoc! G3& ÷ 1 sharesH L 3&. *eturn on assets G3/ ÷O G3&&' K 3&)2/H72P L 1& *eturn on common stoc!holdersQ euity is computed by dividin" 3& by 34222&. OG34#2' K 3411/H ÷ 2P
.
14-11
4'.2