Person 7e Understanding Financial Statements 1-5 Quiz

Chapter 1: Financial Statements: An Overview.

1. What basic financial statements can be found in a corporate annual report? Balance sheet, income statement, statement of shareholders' equity, and statement of cash flows. 2. What information can be found on a balance sheet? The financial position on a particular date; i.e. assets, liabilities and shareholders' equity.

3. What information can be found on an income statement? Revenues, expenditures, net profit or loss and net profit or loss per share.

4. Where are the possible places that the four financial statements can be found? In the Form 10-K filed annually with the SEC. In the annual report mailed to shareholders. In the company's proxy statement or on the company's Web site. All of the above.

5. What item is included in the notes to the financial statements? A summary of the firm's accounting policies.

6. What type of audit report indicates that the financial statements present fairly the financial position, results of operations and the cash flows for the accounting period? An unqualified report.

7. Which of the following items would not be discussed in the management discussion and analysis? The market value of all assets. 8. What organization currently has the legal authority to set accounting policies? SEC.

9. What is a Form 10-K? The annual report of a publicly held company which must be filed with the SEC.

10. Which of the following statements is false? The FASB has legal authority to write international accounting standards.

11. What is the goal of the International Accounting Standards Committee? To have worldwide acceptance of a set of international generally accepted accounting principles.

12. Which of the following statements is true? Companies with complex capital structures will show two figures for earnings per share: basic and diluted.

13. How are revenues and expenses recognized under the accrual basis of accounting? Revenues are recognized in the accounting period when the sale is made and expenses are recognized in the period in which they relate to the sale of the product. 14. Why would management choose to use straight-line depreciation for reporting purposes and MACRS for tax purposes? This would result in the smallest amount of tax paid and the smoothest earnings stream reported.

15. Which of the following items is NOT discretionary in nature? Union wages.

16. Which of the following items would be considered a nonrecurring item? The sale of a major plant asset. Accounting changes. Both (a) and (c).

17. Which of the following statements is true? During a period of inflation, distortions occur in the valuation of assets and the determination of income. 18. Which of the following would increase earnings but lower the quality of reported earnings? Decreasing discretionary expenses.

19. What types of information cannot be found in the financial statements? Reputation of the firm, morale of employees and prestige in the community.

20. What item is probably the least useful when analyzing financial statements? Public relations materials.

Chapter 2: The Balance Sheet.

1. Which item below does not describe a balance sheet? Assets + Liabilities = Stockholders' Equity. 2. Which of the following statements is false? Annual reports must include three-year audited balance sheets and twoyear audited income statements. 3. What are current assets? Assets expected to be converted into cash within one year or operating cycle. 4. Which of the following items could be included in the account "cash and cash equivalents"? US Treasury bills. Certificates of deposit. Commercial paper. All of the above. 5. How are marketable securities valued on the balance sheet? At cost or fair value depending on how the securities are classified.

6. How are accounts receivable reported on the balance sheet? At their net realizable value. At the actual amount less an allowance for doubtful accounts. Both (a) and (b).

7. Which of the following circumstances might indicate that management is manipulating the allowance for doubtful accounts? A company lowers its credit standards and the allowance account decreases.

8. The inventory of a retail company is comparable to which type of inventory of a manufacturing company? Finished goods.

9. Which type of firm would carry little or no inventory? A service firm.

10. If a company chooses the FIFO method of inventory valuation, which inventory will appear as ending inventory on the balance sheet? The last inventory purchased.

11. Why would high technology firms probably choose FIFO as their inventory valuation method? FIFO would cause reported earnings to be lower and allow less to be paid in taxes.

12. Which of the following statements is false? Reserve accounts should only be setup when the amounts can be determined with 100% certainty.

13. Which of the following accounts would be classified as current assets? Accounts receivable, inventory, marketable securities. 14. Which of the following statements is true? The process of depreciation is a method of allocating the cost of longlived assets.

15. Which items would be classified as intangible assets? Goodwill, trademarks, franchises.

16. Which of the following would cause the recognition of a liability? Credit extended by suppliers. Receipt of cash in advance for services. Recognition of expense prior to the actual payment of cash. All of the above.

17. Which of the following would create a deferred tax liability? Using an accelerated method of depreciation for tax purposes and the straight-line method for reporting purposes in the early years of the life of the asset.

18. Which items would be classified as liabilities? Commitments and contingencies, obligations under leases, notes payable.

19. Which statement best describes the retained earnings account? Retained earnings are funds a company has chosen to reinvest in the operations of a business rather than pay out to stockholders in dividends. 20. Which item would be included in the account "Accumulated other comprehensive income (expense)"? Foreign currency translation adjustments.

Chapter 3: Income Statement and Statement of Stockholders' Equity.

1. What can be found on an income statement? Revenues, expenses and net profit (loss). 2. What are the two basic formats of the income statement? Multiple-step and single-step.

3. Which items must be disclosed separately on an income statement? Discontinued operations, extraordinary items, and cumulative effects of changes in accounting principles. 4. How should a company report total comprehensive income? On the face of its income statement. In a separate statement of comprehensive income. In its statement of stockholders' equity. Any of the above ways are acceptable.

5. What could be the cause of an increase in a firm's sales number? The firm has increased prices. More units of product have been sold Both (a) and (b).

6. What relationship exists between cost of goods sold and gross profit? Cost of goods sold plus gross profit equals sales.

7. Of what value is the calculation of gross profit margin? The gross profit margin is the first step of profit measurement indicating how much profit the firm generates after deducting cost of goods sold. 8. Which items below would be classified as operating expenses? Advertising, selling and administrative, repairs and maintenance. 9. Which of the following statements is true? Equity earnings may never result in the actual receipt of cash. 10. What three items must be disclosed separately on the income statement, net of income tax effects? Discontinued operations. Extraordinary items. Cumulative effect of accounting changes. All of the above.

11. How is it possible for a U.S. firm to have an effective tax rate that is less than the U.S. federal statutory tax rate? Tax rates in foreign countries where the firm operates are lower.

12. Reduction of what expense account might impair the ongoing success of a pharmaceutical firm? Research and development. 13. Which profit measure is best for assessing how well a firm operates within their industry? Operating profit.

14. How is a firm's average income tax rate calculated? Income taxes divided by earnings before income taxes.

15. What indicates a complex capital structure in a company? The existence of convertible securities. 16. How does diluted earnings per share differ from basic earnings per share? Diluted earnings per share considers the effect on earnings per share if convertible securities were converted into common stock. 17. What information can be found on a statement of shareholders' equity? The amount of cash dividends paid, if any. The amount of net profit (loss) generated. Both (a) and (b).

18. What effect would a 2 for 1 stock split have? The stock price will probably drop by half and the number of shares of stock outstanding will double.

19. Use the following information for Gray Co. to answer question 19

Gray Co.'s gross profit, operating profit and net profit margins for 20X9 are: Correct Answer: 37.5%, 17.5%, 12.0%, respectively.

20. Use the following information for Gray Co. to answer question 20.

Gray Co.'s average tax rates for 20X9 and 20X8 are: Correct Answer: 31.4% and 30.8%.

Chapter 4: Statement of Cash Flows

1. Why is the statement of cash flows useful to the analyst? It is the only source in financial statements for learning about cash generation. Focusing on net income can be misleading if a company has a healthy profit, but cannot translate the profit into cash. Both (a) and (b).

2. The following items would be classified as operating activities on the statement of cash flows: Payments for inventory, payments for salaries, cash received from sale of goods.

3. The following items would be classified as investing activities on the statement of cash flows: Sale of property, purchase of equity securities, loans to others. 4. The following items would be classified as financing activities on the statement of cash flows: Proceeds from borrowing, payment of dividends, repayment of debt. 5. What type of accounts are accounts receivable and accounts payable? Operating accounts.

6. What is implied if the accounts receivable account has increased? Cash flow from operating activities is less relative to net income. 7. What impact does depreciation have on the cash account? Depreciation has no impact on the cash account. 8. Which of the following items are included in the adjustments to net income to obtain cash flow from operating activities? The change in inventory and depreciation expense. 9. How would you know if a statement of cash flows had been prepared using the direct or the indirect method? The indirect method begins with net income and adds and subtracts adjustments to obtain cash flow from operating activities. 10. If net cash provided or used by operating, financing and investing activities are added together, the result is: The change in cash. 11. Which item may be of concern when analyzing cash flow from operating activities? Increasing inventories. 12. Which of the following could be indicative of cash flow problems or a result of an expansion? Increasing accounts receivable and increasing inventories. Questions 13-16 are based on the indirect method of presenting cash flow from operating activities.

Indicate whether the following items will be added or subtracted from net income to obtain cash flow from operating activities. 13. An increase in accounts payable. Added

14. A decrease in inventory. Added 15. A gain from an asset sale. Subtracted 16. A decrease in an accrued liability. Subtracted

Use the indirect method to answer questions 17-20. The following information is available for Casey Company:

17. What is cash flow from operating activities for Casey Company? Correct Answer: $210

18. What is cash from investing activities for Casey Company? Correct Answer: ($90)

19. What is cash from financing activities for Casey Company? Correct Answer: $75

20. What is the change in cash for Casey Company? Correct Answer: $195

Chapter 5: The Analysis of Financial Statements.

1. Which of the following items is NOT a source of information from the corporate annual report? Value Line Investment Survey. 2. Which of the following tools and techniques are the most useful to the financial statement analyst? Common size financial statements and financial ratios. 3. What type of ratios measure the liquidity of specific assets and the efficiency of managing assets? Activity ratios. 4. Which of the following statements is false? Financial ratios are predictive.

5. Which of the following ratios would be useful in assessing short-term liquidity? Current ratio, quick ratio, cash-flow liquidity ratio.

6. What does a decreasing inventory turnover ratio usually indicate about a firm? The firm is inefficient in the management of inventory.

7. What relationship exists between the average collection period and accounts receivable turnover? As average collection period increases (decreases) the accounts receivable turnover decreases (increases).

8. Why is it important to calculate cash flow ratios? Firms need cash to service debt, dividends and expenses. Companies that generate healthy profit may be unable to convert profits into cash Both (a) and (b).

9. What is the net trade cycle? The amount of time needed to complete the normal operating cycle of a firm. 10. If a firm is using financial leverage successfully what would be the impact of doubling operating earnings? The return on equity will more than double.

Use the following data to answer questions 11-15.

11. Lazy O's current ratio is: Correct Answer: 1.1 to 1

12. Lazy O's quick ratio is: Correct Answer: 0.75 to 1

13. Lazy O's average collection period is: Correct Answer: 15 days

14. Lazy O's inventory turnover is: Correct Answer: 14 times

15. Lazy O's net trade cycle is: Correct Answer: (11 days)

Use the following data to answer questions 16-20.

16. Happy Valley's debt ratio is:

Your Answer: 67%

17. Happy Valley's cash flow margin is: Correct Answer: 2.5%

18. Happy Valley's operating profit margin is: Correct Answer: 15%

19. Happy Valley's return on equity is: Correct Answer: 17%

20. Happy Valley's net profit margin is: Your Answer: 5.0%