Test Bank Financial Statement Analysis Mutiple Choice Ch18

CHAPTER 18

FINANCIAL STATEMENT ANALYSIS

CHAPTER STUDY OBJECTIVES

1. Identify the need for, and tools of, financial statement analysis. Users of financial statements make comparisons in order to evaluate a company’s past, current, and future performance and position. There are two commonly used bases of comparison: intracompany (within a company) and intercompany (between companies). The tools of financial analysis include horizontal, vertical, and ratio analysis.

2. Explain and apply horizontal analysis. Horizontal analysis is a technique for evaluating a series of data, such as line items in a company’s financial statements, by expressing them as percentage increases or decreases over two or more periods of time. The trend percent is calculated by dividing the amount for the specific period under analysis by a base-period amount multiplied by 100%. This percentage calculation normally covers multiple periods. The horizontal percentage change for a period is calculated by dividing the dollar amount of the change between the specific period under analysis and the prior period by the prior-period amount. This percentage calculation normally covers two periods only.

3. Explain and apply vertical analysis. Vertical analysis is a technique for evaluating data within one period by expressing each item in a financial statement as a percentage of a relevant total (base amount) in the same financial statement. The vertical percentage is calculated by dividing the financial statement amount under analysis by the base amount multiplied by 100% for that particular financial statement, which is usually total assets for the balance sheet and revenues or net sales for the income statement.

4. Identify and use ratios to analyze liquidity. Liquidity ratios include the current ratio, acid-test ratio, receivables turnover, collection period, inventory turnover, days sales in inventory, and operating cycle. The formula, purpose, and desired result for each liquidity ratio are presented in Illustration 18-12.

5. Identify and use ratios to analyze solvency. Solvency ratios include debt to total assets, interest coverage, and free cash flow. The formula, purpose, and desired result for each solvency ratio are presented in Illustration 18-15.

6. Identify and use ratios to analyze profitability. Profitability ratios include the gross profit margin, profit margin, asset turnover, return on assets, return on equity, earnings per share, price-earnings, and payout ratios. The formula, purpose, and desired result for each profitability ratio are presented in Illustration 18-18.

7. Recognize the limitations of financial statement analysis. The usefulness of analytical tools can be limited by (1) the use of alternative accounting policies, (2) significant amounts of other comprehensive income, (3) the quality of the information provided, and (4) economic factors.

TRUE-FALSE STATEMENTS

1. The objective to financial reporting is to provide capital providers useful information for decision making.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

2. A borrower’s liquidity is very important in evaluating the safety of a long-term loan.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

3. A long-term lender would look at the company’s solvency to determine a company’s ability to survive a long period of time.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

4. Investors will want to assess the probability of receiving a dividend and the growth potential of the share price of the company.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

5. When a company is compared on an intracompany basis, the company will compare its ratios with other companies in the same industry.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

6. Industry averages are used to compare companies within the same industry.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

7. Non-financial information may include a discussion of a company’s mission, goals, objectives, and its market position.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

8. Meaningful analysis of financial statements will include either horizontal or vertical analysis, but NOT both.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

9. Vertical analysis evaluates financial statement data over different periods of time.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

10. Horizontal analysis will measure the percentage change over two or more periods.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

11. An intercompany comparative analysis involves comparing an item or financial relationship of one company with the same item or relationship in one or more competing companies.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

12. If the base-year revenue is $ 8,606 and the increase between the past year and the current year is 515, then the revenue increased by 6%.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

13. In a horizontal analysis, if an item has a small value in the base year and a large value in the next year, the percentage change will NOT be meaningful.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

14. In a horizontal analysis, if there is a negative amount in the base year and a positive amount in the next year, then no percentage change can be calculated.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

15. If a company has sales of $ 110,000 in 2020 and $ 154,000 in 2021, the percentage increase in sales from 2020 to 2021 is 40%.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

16. Horizontal analysis evaluates financial statements by expressing each item in a financial statement as a percentage of the base amount.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

17. Horizontal analysis is also known as common size analysis.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

18. The vertical percentage formula divides the analysis amount by the base amount.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

19. In a vertical analysis of the balance sheet, all items are expressed as a percentage of total assets.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

20. In a vertical analysis of a merchandising company, all items on the income statement are expressed as a percentage of net sales.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

21. A vertical analysis can compare companies of differing sizes.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

22. A vertical analysis of a servicing company will have all items on the income statement expressed as a percentage of revenue.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

23. The term “vertical analysis” means that we view financial statement data from up to down (or down to up) across more than one period.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

24. Ratio analysis expresses the relationship among selected items of financial statement data.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

25. The three categories used to measure a company are ratios, which analyze a company’s liquidity, profitability, and permanency.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

26. Solvency ratios are used to measure a company’s short-term ability to pay its maturing obligations and to meet unexpected needs for cash.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

27. Profitability ratios measure a company’s ability to survive over a long period of time.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

28. Current ratio is total assets divided by total liabilities.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

29. If the current assets are $ 841,000 and the current liabilities are $ 541,000 then the current ratio of the company is 1.55:1.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

30. A current ratio of 2:1 means that for every $ 1 of current assets, the company has $ 2 of current liabilities.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

31. If a company has an acid-test ratio significantly higher than the current ratio, it means that the company has a significant amount of inventory.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

32. The receivables turnover is used to assess the liquidity of the accounts receivable.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

33. A higher receivable turnover than last year means that the company is collecting their receivable slower this year than last year.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

34. The collection period for accounts receivable is calculated by dividing 365 days by the receivables turnover.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

35. The inventory turnover measures the average number of times that the inventory is sold during the period.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

36. Generally, the faster inventory is sold, the more cash there is tied up in inventory and the higher chance there is of inventory becoming obsolete.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

37. Debt to total assets is a ratio which measures a company’s solvency.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

38. The higher the percentage of total debt to total assets, the greater the risk that the company will be unable to meet its maturing obligations.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

39. From a lender’s point of view, a high ratio of debt to total assets is desirable.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

40. The interest coverage ratio gives an indication of a company’s ability to make its interest payments as they come due.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

41. Free cash flow is the amount of excess cash a company generates after paying to maintain its current physical plant.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

42. Free cash flow refers to the amount of excess cash it generates after paying to maintain its current productive capacity.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

43. Profitability ratios measure a company’s operating success for a specific period of time.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

44. Gross profit margin is the profit of a company divided by its net sales.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

45. Asset turnover measures how efficiently a company uses its sales to generate assets.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

46. Return on asset ratio is calculated as profit divided by average total assets.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

47. Earnings per share is a measure of the profit earned on each preferred share.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

48. Earnings per share is only expressed in terms of the common shares, NOT the preferred shares.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

49. A company can NEVER have negative earnings per share.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

50. The payout ratio measures the percentage of profit distributed as cash dividends.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

51. Most companies with stable earnings have a low payout ratio.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

52. Investors who are interested in purchasing company shares for the income potential will be interested in a company with a high payout ratio.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

53. Investors who are interested in purchasing a company’s shares for growth potential will be interested in companies with a low payout ratio.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

54. A company’s financial information can best be analyzed by ignoring the external information that may affect the company.

Difficulty: Medium

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

55. A strong corporate governance process, including an active board of directors and audit committee, is essential to ensuring the quality of information.

Difficulty: Easy

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

MULTIPLE CHOICE QUESTIONS

56. Which of the following is NOT commonly used as a tool of analysis?

a) productive capacity analysis

b) vertical analysis

c) horizontal analysis

d) ratio analysis

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

57. Which one of the following is NOT a characteristic generally evaluated in analyzing financial statements?

a) liquidity

b) profitability

c) marketability

d) solvency

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

58. In analyzing the financial statements of a company, a single item on the financial statements

a) should be reported in bold-faced type.

b) is more meaningful if compared to other financial information.

c) is significant only if it is large.

d) should be accompanied by a footnote.

Difficulty: Medium

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

59. Short-term creditors are usually most interested in evaluating

a) solvency.

b) liquidity.

c) marketability.

d) profitability.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

60. Long-term creditors are usually most interested in evaluating

a) liquidity and solvency.

b) solvency and marketability.

c) liquidity and profitability.

d) profitability and solvency.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

61. Shareholders are most interested in evaluating

a) liquidity and solvency.

b) profitability and solvency.

c) liquidity and profitability.

d) marketability and solvency.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

62. A shareholder is interested in the ability of a firm to

a) pay consistent dividends.

b) appreciate in share price.

c) survive over a long period.

d) all of these

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

63. Comparisons of financial data made within a company are called

a) intracompany comparisons.

b) interior comparisons.

c) intercompany comparisons.

d) intramural comparisons.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

64. Intercompany comparisons are useful for understanding a company’s

a) short-term goals.

b) ability to repay debt.

c) competitive position.

d) changes in financial relationships.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

65. Comparison with industry averages for diversified companies has

a) less relevance than intracompany and intercompany comparisons.

b) more relevance than intracompany and intercompany comparisons.

c) the best results for investors.

d) the same amount of relevance as intracompany and intercompany comparisons.

Difficulty: Medium

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

66. An intracompany comparative analysis is the process of

a) comparing an item or financial relationship within a company in the current year with one or more prior years.

b) comparing an item or financial relationship within a company to the internally prepared master budget in order to highlight variances.

c) comparing an item or financial relationship of one company with historical data compiled by one or more competing companies.

d) comparing an item or financial relationship of one company with the same item or relationship in one or more competing companies.

Difficulty: Easy

Learning Objective: Identify the need for, and tools of, financial statement analysis.

Section Reference: Basics of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

67. Horizontal analysis is used mainly in

a) linear analysis.

b) intercompany analysis.

c) common size analysis.

d) intracompany analysis.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

68. Horizontal analysis is also known as

a) linear analysis.

b) vertical analysis.

c) trend analysis.

d) common size analysis.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

69. Horizontal analysis is a technique for evaluating a series of financial statement data over a period of time

a) that has been arranged from the highest number to the lowest number.

b) that has been arranged from the lowest number to the highest number.

c) to determine which items are in error.

d) to determine the amount and/or percentage increase or decrease that has taken place.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

70. Horizontal analysis is a technique for evaluating financial statement data

a) within a period of time.

b) over a period of time.

c) on a certain date.

d) as it may appear in the future.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

71. Assume the following sales data for a company:
2022 $ 1,000,000
2021 900,000
2020 750,000
2019 500,000
If 2019 is the base year, what is the percentage increase in sales from 2019 to 2021?

a) 100%

b) 180%

c) 80%

d) 55.5%

Difficulty: Medium

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

72. Horizontal analysis is appropriately performed

a) only on the income statement.

b) only on the balance sheet.

c) only on the statement of retained earnings.

d) on all three of these statements.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

73. Under which of the following scenarios may a percentage change be calculated?

a) The trend of the balances is decreasing but all balances are positive.

b) There is no balance in the base year.

c) There is a negative balance in the base year and a negative balance in the subsequent year.

d) There is a negative balance in the base year and a positive balance in the subsequent year.

Difficulty: Medium

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

74. When horizontal analysis is used to measure the percentage change between any two periods of time, this is known as

a) horizontal percentage of the base-period amount.

b) horizontal analysis period amount.

c) horizontal base period amount.

d) horizontal percentage change for period.

Difficulty: Easy

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

75. Lovely Things Boutique reported revenue of $ 500,000 in 2021 and $ 446,500 in 2020. The horizontal percentage change from 2020 to 2021 is

a) 9%.

b) 10%.

c) 11%.

d) 12%.

Difficulty: Medium

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

76. Software Inc. reported revenue of $ 500,000 in 2022, $ 446,500 in 2021, and $ 458,000 in 2020. The trend percentage for 2022 revenue using 2020 as the base period is

a) 91.6%.

b) 109.2%.

c) 112.0%.

d) 97.5%.

Difficulty: Medium

Learning Objective: Explain and apply horizontal analysis.

Section Reference: Horizontal Analysis

CPA: Financial Reporting

AACSB: Analytic

77. Vertical analysis is a technique that expresses each item within a financial statement

a) in dollars and cents.

b) in terms of a percentage of the item in the previous year.

c) in terms of a percent of a base amount.

d) starting with the highest value down to the lowest value.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

78. Vertical analysis is also known as

a) perpendicular analysis.

b) common size analysis.

c) trend analysis.

d) straight-line analysis.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

79. In performing a vertical analysis, the base for prepaid expenses is

a) total current assets.

b) total assets.

c) total liabilities and shareholders’ equity.

d) prepaid expenses.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

80. In performing a vertical analysis for a merchandising company, the base for sales on the income statement is

a) net sales.

b) total revenues.

c) profit.

d) cost of goods available for sale.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

81. In performing a vertical analysis for a merchandising company, the base for sales returns and allowances is

a) sales.

b) cost of goods sold.

c) net sales.

d) total revenues.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

82. In performing a vertical analysis for a service company, the base for salaries expense is

a) total selling expenses.

b) revenues.

c) total revenues.

d) total expenses.

Difficulty: Easy

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

83. In performing a vertical analysis, a 10% increase in net sales combined with an 8% increase in total expenses will cause profit to

a) increase by 10%.

b) decrease by 10%.

c) increase by 2%.

d) decrease by 2%.

Difficulty: Medium

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

84. Stella Ltd. has provided you with the following selected information from 2020 and 2021:

Using a vertical trend analysis with net sales as a base, which of the following most accurately depicts the information stated above?

a) Profit as a percentage of net sales decreased by 6.7 percentage points.

b) Cost of goods sold as a percentage of net sales decreased by 5 percentage points.

c) Profit as a percentage of net sales did not change significantly from 2020.

d) Cost of goods sold as a percentage of net sales remained consistent from 2020.

Difficulty: Medium

Learning Objective: Explain and apply vertical analysis.

Section Reference: Vertical Analysis

CPA: Financial Reporting

AACSB: Analytic

85. A ratio calculated in the analysis of financial statements

a) expresses a mathematical relationship between two numbers.

b) shows the percentage increase from one year to another.

c) restates all items on a financial statement in terms of dollars of the same purchasing power.

d) is meaningful only if the numerator is greater than the denominator.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

86. A liquidity ratio measures the

a) operating success of a company over a period of time.

b) ability of a company to survive over a long period of time.

c) short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash.

d) number of times interest is earned or “covered”.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

87. The current ratio is

a) calculated by dividing current liabilities by current assets.

b) used to evaluate a company's liquidity and short-term debt-paying ability.

c) used to evaluate a company's solvency and long-term debt-paying ability.

d) calculated by subtracting current liabilities from current assets.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

88. Winter Clothing Store had a balance in the Accounts Receivable account of $ 780,000 at the beginning of the year and a balance of $ 820,000 at the end of the year. Net credit sales during the year amounted to $ 5,840,000. The collection period of the receivables was

a) 30 days.

b) 365 days.

c) 100 days.

d) 50 days.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

89. The Custom Kitchen Cabinets Store had net credit sales of $ 3,900,000 and cost of goods sold of $ 3,000,000 for the year. The Accounts Receivable balances at the beginning and end of the year were $ 600,000 and $ 700,000, respectively. The receivables turnover ratio was

a) 5.6 times.

b) 6.5 times.

c) 4.6 times.

d) 6 times.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

90. The Clock Store had net credit sales of $ 7,500,000 and cost of goods sold of $ 4,500,000 for the year. The average inventory for the year amounted to $ 1,500,000. The inventory turnover ratio for the year is

a) 5 times.

b) 7.5 times.

c) 3 times.

d) 1.67 times.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

91. Gummybear Ltd had net credit sales of $ 7,500,000 and cost of goods sold of $ 4,500,000 for the year. The average inventory for the year amounted to $ 1,500,000. The days sales in inventory during the year was

a) 73 days.

b) 49 days.

c) 122 days.

d) 219 days.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

92. Which one of the following would NOT be considered a liquidity ratio?

a) current ratio

b) inventory turnover ratio

c) receivables turnover ratio

d) return on assets ratio

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

93. A weakness of the current ratio is

a) the difficulty of the calculation.

b) that it doesn't take into account the composition of the current assets.

c) that it is rarely used by sophisticated analysts.

d) that it can be expressed as a percentage, as a rate, or as a proportion.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

94. A supplier to a company would be most interested in the

a) asset turnover.

b) profit margin.

c) current ratio.

d) earnings per share.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

95. Which one of the following ratios would NOT likely be used by a short-term creditor in evaluating whether to sell on credit to a company?

a) acid-test ratio

b) days sales in inventory

c) asset turnover

d) receivables turnover

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

96. The ratios that are used to determine a company's short-term debt-paying ability are

a) asset turnover, interest coverage, current ratio, and receivables turnover.

b) interest coverage, inventory turnover, current ratio, and receivables turnover.

c) interest coverage, current ratio, and inventory turnover.

d) current ratio, receivables turnover, and inventory turnover.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

97. Now We See You Security Corporation had $ 250,000 of current assets and $ 90,000 of current liabilities before borrowing $ 60,000 from the bank with a 3-month note payable. What effect did the borrowing transaction have on Now We See You Security's current ratio?

a) The ratio remained unchanged.

b) The change in the current ratio cannot be determined.

c) The ratio decreased.

d) The ratio increased.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

98. If a company has a current ratio of 1.2:1, what respective effects will the borrowing of cash by short-term debt and collection of accounts receivable have on the ratio?
Short-term Borrowing Collection of Receivables

a) increase no effect

b) increase increase

c) decrease no effect

d) decrease decrease

Difficulty: Hard

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

99. A company has a receivables turnover ratio of 10. The average gross receivables during the period are $ 400,000. What is the amount of net credit sales for the period?

a) $ 40,000

b) $ 4,000,000

c) $ 480,000

d) cannot be determined from the information given

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

100. If the average collection period is 50 days, what is the receivables turnover?

a) 6.64 times

b) 7.30 times

c) 3.65 times

d) none of these

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

101. A general rule to use in assessing the collection period is that

a) it should not exceed 30 days.

b) it can be any length as long as the customer continues to buy merchandise.

c) it should not greatly exceed the discount period.

d) it should not greatly exceed the credit term period.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

102. An increase in the inventory turnover indicates

a) the company is selling its inventory more frequently.

b) the company’s cost of goods sold has decreased.

c) the company’s average inventory has increased.

d) the company’s profitability has improved.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

103. A company has an average inventory on hand of $ 60,000 and the average days to sell inventory is 29.2 days. What is the cost of goods sold?

a) $ 750,000

b) $ 1,752,000

c) $ 739,726

d) $ 876,000

Difficulty: Hard

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

104. A successful grocery store would probably have

a) a low inventory turnover.

b) a high inventory turnover.

c) zero profit margin.

d) low volume.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

105. An aircraft company would most likely have

a) a high inventory turnover.

b) low profit margin.

c) high volume.

d) a low inventory turnover.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

106. Net sales are $ 1,500,000, beginning total assets are $ 700,000, and the asset turnover is 3.0. What is the ending total asset balance?

a) $ 500,000

b) $ 300,000

c) $ 700,000

d) $ 400,000

Difficulty: Hard

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

107. Selected financial ratios for Birdnest Incorporated are as follows:
2021 2020 2019
Current ratio 2.50:1 2.0:1 1.75:1
Accounts receivable turnover 7 times 12 times 18 times
Inventory turnover 9 times 9.1 times 8.9 times

Based upon an analysis of the above information, which of the following statements most accurately describes Birdnests financial results for 2021?

a) The company is selling more inventory.

b) The company is taking longer to collect its accounts receivable.

c) The company’s current ratio deteriorated.

d) The company’s liquidity improved.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

108. Selected financial ratios for Front Room Decorating Incorporated are as follows:
2021 2020 2019
Current ratio 2.50:1 2.0:1 1.75:1
Accounts receivable turnover 7 times 12 times 18 times
Inventory turnover 9 times 9.1 times 8.9 times
Front Room’s current ratio increased in 2021. From an analysis of the above numbers, the most likely cause for the increase is

a) the company’s cash has increased.

b) the company’s inventory has increased.

c) the company’s accounts receivable have increased.

d) the company borrowed on its line of credit to repay some current liabilities.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

109. Selected financial ratios for Big Comfy Couch Incorporated are as follows:
2021 2020 2019
Current ratio 2.50:1 2.0:1 1.75:1
Accounts receivable turnover 7 times 12 times 18 times
Inventory turnover 9 times 9.1 times 8.9 times
When assessing the above ratios on an overall basis, most analysts would conclude that the company’s liquidity

a) improved.

b) declined.

c) remained unchanged.

d) cannot be determined from the information provided.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

110. Liquidity ratios measure

a) a company’s cash flow.

b) a company’s solvency.

c) a company’s ability to meet its maturing obligations.

d) a company’s general financial performance.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

111. In general, the faster the receivable turnover, the better and more reliable the ______ is.

a) collection period

b) current ratio

c) inventory ratio

d) days sales in inventory

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

112. Inventory turnover measures the average number of times that the inventory is sold during the year. Its purpose is to measure the ______ of the inventory.

a) liquidity

b) validity

c) solvency

d) profitability

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

113. Sheldon Shoes Ltd. has provided you with the following selected information from 2020 and 2021:

Which of the following best interprets Sheldon Shoe’s acid-test ratio analysis?

a) Acid-test ratio has improved compared to prior year, increasing from 0.9 to 1.1.

b) Acid-test ratio has weakened compared to prior year, decreasing from 0.8 to 0.6.

c) Acid-test ratio has weakened compared to prior year, decreasing from 1.1 to 0.9.

d) Acid-test ratio has improved compared to prior year, increasing from 0.6 to 1.8.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze liquidity.

Section Reference: Ratio Analysis

CPA: Financial Reporting

AACSB: Analytic

114. Stargate Limited reported the following on its income statement:
Profit before income taxes $ 560,000
Income tax expense 140,000
Profit $ 420,000
An analysis of the income statement revealed that interest expense was $ 40,000. Stargate’s interest coverage ratio was

a) 15 times.

b) 14 times.

c) 10.5 times.

d) 11.5 times.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

115. The debt to total assets ratio measures

a) the company's profitability.

b) whether interest can be paid on debt in the current year.

c) the proportion of interest paid relative to dividends paid.

d) the percentage of the total assets financed by creditors.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

116. A company can increase its free cash flow by all of the following EXCEPT

a) receiving increased dividend income.

b) increasing spending on property, plant, and equipment.

c) speeding up the collection of accounts receivable.

d) decreasing payments to suppliers.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

117. An increase in the debt to total assets ratio indicates that the company is

a) financing a greater portion of its assets with debt.

b) likely to have significant growth in the future.

c) having trouble meeting its debt payments.

d) increasing the amount of equity invested in the business.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

118. Solvency ratios measure

a) a company’s cash flow.

b) a company’s liquidity.

c) a company’s ability to survive over the long term.

d) a company’s general financial performance.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

119. The higher the percentage of total debt to total assets, the greater the risk

a) that the company will be able to pay all its debt.

b) that the company will purchase more assets.

c) that the company will be able to obtain financing.

d) that the company may be unable to meet its maturing obligations.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

120. From a lender’s point of view,

a) a low ratio of debt to total assets is desirable.

b) a high ratio of debt to total assets is desirable.

c) a low ratio of debt to current assets is desirable.

d) a high ratio of non-current liabilities to current liabilities is desirable.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

121. BBQ Incorporated has provided you with the following selected information from 2020 and 2021:

Which of the following best interprets BBQ’s interest coverage ratio?

a) Interest coverage ratio has improved compared to prior year, increasing from 6.5 to 8.7.

b) Interest coverage ratio has improved compared to prior year, increasing from 4.4 to 5.6.

c) Interest coverage ratio has weakened compared to prior year, decreasing from 3.8 to 2.7.

d) Interest coverage ratio has weakened compared to prior year, decreasing from 5.2 to 4.8.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze solvency.

Section Reference: Solvency Ratios

CPA: Financial Reporting

AACSB: Analytic

122. The asset turnover ratio measures

a) how often a company replaces its assets.

b) how efficiently a company uses its assets to generate sales.

c) the portion of the assets that have been financed by creditors.

d) the overall rate of return on assets.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

123. The profit margin is calculated by dividing

a) sales by cost of goods sold.

b) gross profit by net sales.

c) profit by shareholders' equity.

d) profit by net sales.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

124. Penny Corporation had profit of $ 250,000 and paid dividends to common shareholders of $ 50,000 in 2021. The weighted average number of shares issued in 2021 was 50,000 shares. Penny Corporation's common shares are selling for $ 40 per share on the Toronto Stock Exchange. Penny Corporation's price-earnings ratio is

a) 2 times.

b) 8 times.

c) 10 times.

d) 5 times.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

125. Shannon Corporation had profit of $ 250,000 and paid dividends to common shareholders of $ 50,000 in 2021. The weighted average number of shares issued in 2021 was 50,000 shares. Shannon Corporation's common shares are selling for $ 40 per share on the Toronto Stock Exchange. Shannon Corporation's payout ratio is

a) $ 5 per share.

b) 25%.

c) 20%.

d) 12.5%.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

126. Investors would most likely favour a company with which of the following ratios if they wished to purchase shares for the purpose of capital appreciation (growth)?

a) a low payout ratio

b) a low price-earnings ratio

c) a high payout ratio

d) a high free cash flow

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

127. Earnings per share is calculated

a) only for common shares.

b) only for preferred shares.

c) for common and preferred shares.

d) only for bonds.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

128. Which of the following is NOT a profitability ratio?

a) payout ratio

b) profit margin

c) interest coverage

d) gross profit margin

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

129. The ratio that uses the weighted average number of common shares in the denominator is the

a) price-earnings ratio.

b) return on equity.

c) earnings per share.

d) payout ratio.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

130. An increase in the gross profit margin combined with a decrease in the profit margin indicates to investors that the company’s

a) sales decreased during the period.

b) cost of goods sold increased during the period.

c) profit increased during the period.

d) operating expenses increased during the period.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

131. An increase in a company’s gross profit margin indicates that the company

a) has increased sales volume.

b) has increased selling prices.

c) has decreased its cost of goods sold.

d) potentially any of the above could have occurred.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

132. The price-earnings ratio measures

a) the ratio of the market price of each share to the earnings per share.

b) the ratio of the market price of each share to the total profit for the year.

c) the ratio of the sales price to the profit.

d) cash flow per share.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

133. Because of the importance of this ratio, publicly traded companies are required to report it directly on the income statement.

a) payout ratio

b) EPS ratio

c) asset turnover ratio

d) profit margin ratio

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

134. A higher price-earnings ratio generally means that

a) investors favour that company and have a high expectation of future profitability.

b) investors do not expect future profitability.

c) investors feel the shares are underpriced.

d) investors will not see growth or expansion.

Difficulty: Easy

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios

CPA: Financial Reporting

AACSB: Analytic

135. Gilbert’s Hydraulics has provided you with the following selected information from 2020 and 2021:

Which of the following best interprets Gilbert’s profit margin?

a) Profit margin has weakened compared to prior year, decreasing from 45.6% to 41.2%.

b) Profit margin has weakened compared to prior year, decreasing from 18.6% to 11.9%.

c) Profit margin has weakened compared to prior year, decreasing from 17.3% to 11.1%.

d) Profit margin has weakened compared to prior year, decreasing from 55.7% to 50.9%.

Difficulty: Medium

Learning Objective: Identify and use ratios to analyze profitability.

Section Reference: Profitability Ratios – Profit Margin

CPA: Financial Reporting

AACSB: Analytic

136. Ratios are used as tools in financial analysis

a) instead of horizontal and vertical analyses.

b) because they may provide information that is not apparent from inspection of the individual components of the ratio.

c) because even single ratios by themselves are quite meaningful.

d) because they are prescribed by GAAP.

Difficulty: Medium

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

137. A limitation in calculating ratios in financial statement analysis is that

a) it requires comparisons.

b) no one other than management would be interested in them.

c) some financial statements contain many estimates.

d) they seldom identify problem areas in a company.

Difficulty: Medium

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

138. The use of alternative accounting principles

a) is not a problem in ratio analysis because the notes to the statements disclose the principles used.

b) may be a problem in ratio analysis even if disclosed.

c) is not a problem in ratio analysis since eventually all principles will lead to the same end.

d) is only a problem in ratio analysis with respect to inventory.

Difficulty: Medium

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

139. Although depreciation expense and the carrying amount of property, plant and equipment may be different in one or more periods because of the choice of depreciation methods, in total, over the life of the assets, there is no difference. This is called

a) difference in assumptions.

b) permanent difference.

c) timing difference.

d) irrelevant differences.

Difficulty: Easy

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

140. There are no standard ratio formulas incorporating

a) comprehensive income.

b) profit.

c) net sales.

d) total assets.

Difficulty: Easy

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

141. The CEO and CFO of a publicly traded company must ensure and personally declare that the reported financial information is

a) accurate.

b) relevant.

c) understandable.

d) all of the above.

Difficulty: Easy

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

142. Which of the following is NOT considered an economic measure that could have a significant impact on a company’s performance?

a) changes in supply and demand

b) unemployment

c) rate of interest

d) natural disasters

Difficulty: Easy

Learning Objective: Recognize the limitations of financial statement analysis.

Section Reference: Limitations of Financial Statement Analysis

CPA: Financial Reporting

AACSB: Analytic

MATCHING QUESTIONS

143. Set A

For each of the ratios or measures listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio.

Code:

L = Liquidity ratio

P = Profitability ratio

S = Solvency ratio

____ 1. Price-earnings

____ 2. Asset turnover

____ 3. Receivables turnover

____ 4. Earnings per share

____ 5. Payout ratio

____ 6. Current ratio

____ 7. Free cash flow

____ 8. Debt to total assets

____ 9. Interest coverage

____ 10. Inventory turnover

144. Set B

Match the ratios or measures with the appropriate ratio calculation by entering the appropriate letter in the space provided.

A. Current ratio F. Interest coverage

B. Operating Cycle G. Inventory turnover

C. Profit margin H. Collection period

D. Asset turnover I. Days sales in inventories

E. Price-earnings J. Payout ratio

Cost of goods sold

____ 1. —————————

Average inventory

Profit

____ 2. —————

Net sales

Cash dividends

____ 3. ———————

Profit

Net sales

____ 4. ———————

Average assets

Current assets

____ 5. ————————

Current liabilities

365 days

____ 6. ——————————

Receivables turnover

Market price per share

____ 7. ———————————

Earnings per share

365 days

____ 8. ————————

Inventory turnover

Profit before income taxes and interest expense

____ 9. ——————————————————————

Interest expense

____ 10. Days sales in inventory + Collection period