Ch8 Exam Questions Analysis And Interpretation Of Financial

Testbank

to accompany

Accounting: business reporting for decision making

7th edition

by

Birt et al.

Not for distribution. Instructors may assign selected questions in their LMS.

© John Wiley & Sons Australia, Ltd 2020

Chapter 8: Analysis and interpretation of financial statements

Learning objectives

1. Explain why different user groups require financial statements to be analysed and interpreted

Q1, Q2, Q51

2. Describe the nature and purpose of financial analysis

Q3, Q4, Q5, Q52

3. Apply the analytical methods of horizontal, trend, vertical and ratio analysis

Q6, Q7, Q8, Q9, Q10, Q11, Q12, Q53, Q54

4. Define, calculate and interpret the ratios that measure profitability

Q13, Q14, Q15, Q16, Q17, Q55, Q56

5. Define, calculate and interpret the ratios that measure asset efficiency

Q18, Q19, Q20, Q21, Q22, Q23, Q24, Q57, Q58

6. Define, calculate and interpret the ratios that measure liquidity

Q25, Q26, Q27, Q28, Q29, Q30, Q31, Q32, Q59, Q60

7. Define, calculate and interpret the ratios that measure capital structure

Q33, Q34, Q35, Q36, Q37, Q38, Q61, Q62

8. Define, calculate and interpret the ratios that measure market performance

Q39, Q40, Q41, Q42, Q43, Q44, Q45, Q63

9. Explain the interrelationships between ratios and use ratio analysis to discuss the financial performance and position of an entity

Q46, Q47, Q48, Q64

10. Discuss the limitations of ratio analysis

Q49, Q50, Q65

Multiple-choice questions

1. Blinds Pty is seeking a loan from a financial institution. Which of the following factors would the financial institution be most interested in?

a. Blinds Pty’s ability to generate cash flows.

b. Blinds Pty’s ability to generate profits.

c. Blinds Pty’s ability to pay its employees.

d. Blinds Pty’s ability to pay its suppliers.

Learning objective 8.1 ~ Explain why different user groups require financial statements to be analysed and interpreted

1. What is financial analysis useful for?

a. Decision making

b. Evaluating the performance of an entity

c. Evaluating the financial health of an entity

d. All of the options are correct

Learning objective 8.1 ~ Explain why different user groups require financial statements to be analysed and interpreted

1. How can financial analysis be categorised?

a. As ratio analysis

b. As trend analysis

c. As vertical and horizontal analysis

d. All of the options are correct

Learning objective 8.2 ~ Describe the nature and purpose of financial analysis

1. Relying on absolute values in an entity’s financial statements to predict future risks is not meaningful because:

a. an increase in the profit figure does not necessarily indicate an increase in the profitability of the entity.

b. an increase in non-current liabilities does not necessarily mean the entity has become more reliable on external funding.

c. an increase in current liabilities does not necessarily mean the entity is having liquidity problems.

d. all of the statements are correct.

Learning objective 8.2 ~ Describe the nature and purpose of financial analysis

1. If an entity has increased its profit from $25 000 last year to $40 000 this year, have they become more profitable?

a. Yes

b. No

c. Maybe

d. Same both years

Learning objective 8.2 ~ Describe the nature and purpose of financial analysis

1. Which of the options below is an appropriate benchmark for the comparison of ratios in financial analysis?

a. Economic industry sector

b. Changes over time

c. Industry averages

d. All of the options are appropriate benchmarks

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. Horizontal analysis:

a. compares numbers reported on the financial statements in the current period with those from the previous period.

b. determines the profitability of an entity.

c. requires a minimum of 3 years of data to provide meaningful analysis.

d. compares numbers reported on a financial statement to others on the same statement.

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. Use the data below to perform a trend analysis (assume that year 1 is the base year). What is the value assigned to sales revenue for year 2?

a. 86

b. 100

c. 116

d. 135

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. In a vertical analysis of a statement of profit or loss, what would the 100% figure be assigned to?

a. Expenses

b. Net profit

c. Sales

d. Gross profit

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. What is the anchor point for accounts payable in a vertical analysis?

a. Total current liabilities

b. Total liabilities

c. Total equity

d. Total assets

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. With ratio analysis, when an item on the statement of cash flows is compared to a statement of financial position item:

a. the statement of financial position item should first be calculated as an average amount for the year.

b. the ending balance of the statement of financial position item should be used.

c. the beginning balance of the statement of financial position item should be used.

d. a meaningful comparison of items between these statements cannot be made.

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. Which of the following categories of ratios is only relevant to a listed company?

a. Profitability ratios

b. Liquidity ratios

c. Market performance ratios

d. Efficiency ratios

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. How is the profit margin ratio calculated?

a. By dividing gross profit (loss) by sales revenue

b. By dividing profit (loss) by sales revenue

c. By dividing profit (loss) by net assets

d. By dividing profit (loss) by shareholders’ equity

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. What is the profitability ratio that measures an entity’s ability to generate a profit from its asset investments?

a. Return on assets

b. Profit margin

c. Return on equity

d. Gross profit margin

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. From the information provided below, how would you calculate the entity’s return on assets (rounded to the nearest whole number)?

a. 21%

b. 18%

c. 15%

d. 13%

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. If an entity’s selling and distribution expenses to sales ratio increases from 2.5% in one year to 3.8% the following year, this indicates that:

a. the entity has become more efficient in controlling its selling and distribution expenses over the period.

b. the entity has become less efficient in controlling its selling and distribution expenses over the period.

c. selling and distribution expenses are a lower percentage of sales.

d. the entity’s profitability has decreased.

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. Calculate the cash flow to sales ratio using the following data.

a. 3.46%

b. 7.74%

c. 9.46%

d. 12.92%

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. What does the days debtors ratio indicate?

a. The average length of time it takes an entity to collect its accounts receivable

b. The average length of time it takes an entity to pay its account payable

c. An entity’s efficiency in paying back its borrowings

d. An entity’s efficiency in raising capital

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Which of the following statements regarding days inventory is incorrect?

a. Days inventory is much higher for a supermarket than a clothing retailer.

b. Days inventory is a measure of the average length of time it takes to sell inventory.

c. Days inventory is a measure of the efficiency of an entity at selling inventory.

d. All of the above options are incorrect.

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Chemist Pty’s beginning balance of inventory is $16 000; the ending balance is $30 000; credit sales for the period are $420 000; and cost of sales are $380 000. Calculate Chemist Pty’s days inventory.

a. 22 days

b. 20 days

c. 29 days

d. 26 days

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Which of the following does not measure asset efficiency?

a. Asset turnover ratio

b. Return on assets

c. Days inventory

d. Times debtors turnover

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. What does a high times debtors turnover indicate?

a. Customers are taking longer to pay their accounts

b. The entity’s credit sales have decreased

c. A small percentage of the entity’s sales are on credit

d. The entity is more efficient in collecting monies owing from customers

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Carpets Pty’s days debtors ratio has changed from 32 days to 38 days. What does this indicate?

a. The time Carpets Pty takes to sell inventory is increasing.

b. Carpets Pty is becoming more efficient at collecting money from trade debtors.

c. The time Carpets Pty takes to collect money from trade debtors is increasing.

d. The time Carpets Pty takes to pay suppliers of inventory is increasing.

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Assuming an entity sells inventory only on credit terms, use the following information to calculate the length of the entity’s activity cycle and cash cycle.

Days inventory is 60 days.

Days debtors is 35 days.

Days creditors is 30 days.

a. Activity cycle is 95 days; cash cycle is 65 days.

b. Activity cycle is 65 days; cash cycle is 95 days.

c. Activity cycle is 65 days; cash cycle is 30 days.

d. Activity cycle is 95 days; cash cycle is 30 days.

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency.

1. The current ratio is also known by another name. What is it?

a. Cash flow ratio

b. Quick ratio

c. Working capital ratio

d. Acid-test ratio

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. The quick ratio is used to determine an entity’s:

a. liquidity.

b. profitability.

c. efficiency.

d. performance.

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Liquidity ratios measure the ability of an entity to:

a. remain a going concern.

b. meet its short-term obligations and unexpected cash needs.

c. generate profit.

d. all of the options are correct.

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Which of the following statements is correct?

a. Low liquidity ratios are undesirable.

b. High liquidity ratios may indicate excessive investments in unproductive current assets.

c. Low liquidity ratios can indicate liquidity problems.

d. All of the above statements are correct.

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Going Ltd has the following statement of financial position figures. What is the current ratio?
   

a. 3:1

b. 1.67:1

c. 2:1

d. 3.75:1

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Logan Pty Ltd has a current ratio of 2:1 with total current liabilities of $30 000. If Logan Pty Ltd’s inventory is $7500, what is the quick ratio?

a. 2.25:1

b. 2.67:1

c. 1.75:1

d. 1.6:1

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Pink Skies Ltd has a quick ratio of 1.5:1 with total current liabilities of $50 000 and inventory of $25 000. Calculate total current assets.

a. $25 000

b. $50 000

c. $75 000

d. $100 000

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. ‘Net cash flows from operating activities divided by current liabilities’ is the formula for the:

a. quick ratio.

b. cash flow ratio.

c. operating ratio.

d. debt coverage ratio.

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. Which of the following measures long-term solvency?

a. Debt ratio

b. Debt to equity ratio

c. Equity ratio

d. All the options listed measure long-term solvency

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Which of the following statements is not true?

a. If the equity ratio is less than 50% then the entity is more reliant on debt funding than equity funding.

b. The sum of the debt ratio and the equity ratio does not have to equal 100%.

c. The debt ratio indicates how many dollars of debt exist per dollar of assets.

d. If the debt to equity ratio is more than 100%, the entity is more reliant on debt funding than equity funding.

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Capital structure ratios are also known by another name. What is it?

a. Efficiency ratios

b. Profitability ratios

c. Gearing ratios

d. Liquidity ratios

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Soap Trading Pty Ltd has the following statement of financial position figures. Calculate the debt ratio.
   

a. 43.75%

b. 66.67%

c. 31.82%

d. 50%

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Paper Pty Ltd has the following statement of financial position figures. Calculate the debt to equity ratio.
   

a. 80.0%

b. 58.3%

c. 36.8%

d. 23.1%

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Which of the following statements regarding the interest coverage ratio is not true?

a. The interest coverage ratio is also referred to as times interest earned.

b. The interest coverage ratio will be less than one if EBIT is greater than net finance costs.

c. The interest coverage ratio is calculated as earnings before interest and tax divided by net finance costs.

d. The interest coverage ratio indicates the level of comfort the entity has in meeting interest commitments from earnings.

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Which of these is a market performance ratio?

a. Earnings per share

b. Dividends per share

c. Price earnings ratio

d. All of these options are market performance ratios

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. Which of the following statements concerning net tangible asset backing (NTAB) per share is not true?

a. It determines the cash available per share if the company liquidates.

b. The difference between NTAB and the market share price is an indication of the market’s assessment of the entity’s future growth prospects.

c. It expresses the book value of an entity’s tangible assets per ordinary share issued.

d. Intangible assets are excluded from the calculation.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. If the market share price is $20 and the earnings per share is calculated to be $2.50, the price earnings ratio is:

a. 4 times.

b. 5 times.

c. 8 times.

d. 12.5 times.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. The dividend payout ratio represents:

a. the proportion of the current period’s profits that are distributed to shareholders.

b. the amount of dividends that have been paid as a proportion of the number of shares issued.

c. the earnings available to be paid out per share.

d. the amount of dividends paid out as a proportion of the operating cash flows.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. Which of the following statements relating to operating cash flow per share (CFPS) is correct?

a. It reflects the net cash flows from operating activities available to pay dividends and fund future investments.

b. The difference between the earnings per share and the CFPS shows no differences between cash and accrual accounting.

c. The CFPS reflects the current market value of the entity’s shares.

d. All of the above options are correct.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. Which of the following statements concerning price earnings ratio (PER) is true?

a. PER is calculated as current market price divided by dividends per share.

b. PER is calculated as total shareholders’ equity divided by earnings per share.

c. PERs are commonly between 10 and 15 times for industrial companies.

d. PER is not affected by a change in the share price.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. Profit available to ordinary shareholders divided by the weighted number of ordinary shares is the calculation for:

a. net tangible asset backing (NTAB) per share.

b. dividend per share.

c. operating cash flow per share.

d. earnings per share.

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. An entity’s profit margin is affected by which of the following ratios?

a. Gross profit margin and expense ratios

b. Inventory and debtors days ratios

c. Gross profit margin and return on assets

d. Debt and equity ratios

Learning objective 8.9 ~ Explain the interrelationships between ratios and use ratio analysis to discuss the financial performance and position of an entity

1. Explaining why the ROE (return on equity) ratio has changed requires an examination of the:

a. asset efficiency ratios and debt ratios.

b. profitability ratios and the market performance ratios.

c. return on assets and financial risk.

d. profitability ratios and the asset efficiency ratios.

Learning objective 8.9 ~ Explain the interrelationships between ratios and use ratio analysis to discuss the financial performance and position of an entity

1. Using financial analysis to assist users in answering the ‘why’ questions requires a thorough understanding of:

a. ratio measurements only.

b. preparation of the financial statements only.

c. all ratio measurements and how they interrelate.

d. only some of the ratio measurements.

Learning objective 8.9 ~ Explain the interrelationships between ratios and use ratio analysis to discuss the financial performance and position of an entity

1. A problem with many of the financial ratio calculations is that:

a. asset, liability and equity numbers obtained from the statement of financial position reflect a point in time and may not be representative of the financial position at other times of the year.

b. all of these options describes a problem with the calculation of financial ratios.

c. numbers in the financial statements may be aggregated with inadequate disclosure in the notes.

d. entities being compared may use different accounting policy choices and estimations.

Learning objective 8.10 ~ Discuss the limitations of ratio analysis

1. Limitations of ratio analysis can be caused by:

a. purchasing expensive machinery at the end of the financial year.

b. estimations of employee benefits.

c. different depreciation methods adopted by entities in the same industry.

d. all of the options listed.

Learning objective 8.10 ~ Discuss the limitations of ratio analysis

Fill in the blanks

1. _________________ analysis involves reviewing the industry in which an entity operates.

a. Fundamental

Learning objective 8.1 ~ Explain why different user groups require financial statements to be analysed and interpreted

1. _________________ analysis assists users in their decision making by expressing an entity’s financial performance and position in relative terms.

a. Financial

Learning objective 8.2 ~ Describe the nature and purpose of financial analysis

1. Expressing each item in a financial statement as a percentage of a base amount is known as _____________ analysis.

a. vertical

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. ____________________ analysis is a technique for evaluating a series of financial statement data over a period of time.

a. Trend

Learning objective 8.3 ~ Apply the analytical methods of horizontal, trend, vertical and ratio analysis

1. The gross profit margin is calculated as gross profit divided by _____________ _____________.

a. sales revenue

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. Return on equity measures the profit generated compared to the _____________ investment.

a. owner’s

Learning objective 8.4 ~ Define, calculate and interpret the ratios that measure profitability

1. The ______________ turnover ratio measures the effectiveness of an entity in generating sales revenue.

a. asset

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. Average inventory divided by cost of sales equals the ______________ inventory ratio.

a. days

Learning objective 8.5 ~ Define, calculate and interpret the ratios that measure asset efficiency

1. ____________________ is excluded from the quick ratio as it is the asset that takes the longest to convert to cash.

a. Inventory

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. It is argued that the cash flow ratio is a better measure of ________ than the current ratio as it uses cash flows generated over the whole reporting period rather than at a particular point in time.

a. liquidity

Learning objective 8.6 ~ Define, calculate and interpret the ratios that measure liquidity

1. If the ____________________ ratio is less than 50%, the entity relies more on debt funding than equity funding.

a. equity

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. ________ before interest and tax divided by net finance costs equals times interest earned.

a. Earnings

Learning objective 8.7 ~ Define, calculate and interpret the ratios that measure capital structure

1. Companies are required to ____________________ their earnings per share at the bottom of their statement of profit or loss.

a. disclose

Learning objective 8.8 ~ Define, calculate and interpret the ratios that measure market performance

1. Ratios can be impacted by the accounting policy choices and ___________ made by an entity.

a. estimations

Learning objective 8.9 ~ Explain the interrelationships between ratios and use ratio analysis to discuss the financial performance and position of an entity

1. The information provided by financial statements alone is not enough to form predictions about an entity’s financial ___________.

a. health

Learning objective 8.10 ~ Discuss the limitations of ratio analysis