Chapter

4
Understanding
Balance Sheets

Problems

1. Resources controlled by a company as a result of past events are:

A. equity.
B. assets.
C. liabilities.
2. Equity equals:
A. Assets − Liabilities.
B. Liabilities − Assets.
C. Assets + Liabilities.
3. Distinguishing between current and non-current items on the balance sheet and present-
ing a subtotal for current assets and liabilities is referred to as:
A. a classified balance sheet.
B. an unclassified balance sheet.
C. a liquidity-based balance sheet.
4. Shareholders’ equity reported on the balance sheet is most likely to differ from the market
value of shareholders’ equity because:
A. historical cost basis is used for all assets and liabilities.
B. some factors that affect the generation of future cash flows are excluded.
C. shareholders’ equity reported on the balance sheet is updated continuously.
5. The information provided by a balance sheet item is limited because of uncertainty
regarding:
A. measurement of its cost or value with reliability.
B. the change in current value following the end of the reporting period.
C. the probability that any future economic benefit will flow to or from the entity.

15
16 Problems

6. Which of the following is most likely classified as a current liability?

A. Payment received for a product due to be delivered at least one year after the balance
sheet date.
B. Payments for merchandise due at least one year after the balance sheet date but still
within a normal operating cycle.
C. Payment on debt due in six months for which the company has the unconditional
right to defer settlement for at least one year after the balance sheet date.
7. The most likely company to use a liquidity-based balance sheet presentation is a:
A. bank.
B. computer manufacturer holding inventories.
C. software company with trade receivables and payables.
8. All of the following are current assets except:
A. cash.
B. goodwill.
C. inventories.
9. The most likely costs included in both the cost of inventory and property, plant, and
equipment are:
A. selling costs.
B. storage costs.
C. delivery costs.
10. Debt due within one year is considered:
A. current.
B. preferred.
C. convertible.
11. Money received from customers for products to be delivered in the future is recorded as:
A. revenue and an asset.
B. an asset and a liability.
C. revenue and a liability.
12. An example of a contra asset account is:
A. depreciation expense.
B. sales returns and allowances.
C. allowance for doubtful accounts.
13. The carrying value of inventories reflects:
A. their historical cost.
B. their current value.
C. the lower of historical cost or net realizable value.
14. When a company pays its rent in advance, its balance sheet will reflect a reduction in:
A. assets and liabilities.
B. assets and shareholders’ equity.
C. one category of assets and an increase in another.
15. Accrued expenses (accrued liabilities) are:
A. expenses that have been paid.
B. created when another liability is reduced.
C. expenses that have been reported on the income statement but not yet paid.
Chapter 4 Understanding Balance Sheets 17

16. The initial measurement of goodwill is most likely affected by:

A. an acquisition’s purchase price.
B. the acquired company’s book value.
C. the fair value of the acquirer’s assets and liabilities.
17. Defining total asset turnover as revenue divided by average total assets, all else equal, im-
pairment write-downs of long-lived assets owned by a company will most likely result in
an increase for that company in:
A. the debt-to-equity ratio but not the total asset turnover.
B. the total asset turnover but not the debt-to-equity ratio.
C. both the debt-to-equity ratio and the total asset turnover.
18. A company has total liabilities of £35 million and total stockholders’ equity of £55 million.
Total liabilities are represented on a vertical common-size balance sheet by a percentage
closest to:
A. 35%.
B. 39%.
C. 64%.
19. For financial assets classified as trading securities, how are unrealized gains and losses
reflected in shareholders’ equity?
A. They are not recognized.
B. They flow through income into retained earnings.
C. They are a component of accumulated other comprehensive income.
20. For financial assets classified as available for sale, how are unrealized gains and losses
­reflected in shareholders’ equity?
A. They are not recognized.
B. They flow through retained earnings.
C. They are a component of accumulated other comprehensive income.
21. For financial assets classified as held to maturity, how are unrealized gains and losses
­reflected in shareholders’ equity?
A. They are not recognized.
B. They flow through retained earnings.
C. They are a component of accumulated other comprehensive income.
22. The non-controlling (minority) interest in consolidated subsidiaries is presented on the
balance sheet:
A. as a long-term liability.
B. separately, but as a part of shareholders’ equity.
C. as a mezzanine item between liabilities and shareholders’ equity.
23. The item “retained earnings” is a component of:
A. assets.
B. liabilities.
C. shareholders’ equity.
24. When a company buys shares of its own stock to be held in treasury, it records a reduction in:
A. both assets and liabilities.
B. both assets and shareholders’ equity.
C. assets and an increase in shareholders’ equity.
18 Problems

25. Which of the following would an analyst most likely be able to determine from a common-­
size analysis of a company’s balance sheet over several periods?
A. An increase or decrease in sales.
B. An increase or decrease in financial leverage.
C. A more efficient or less efficient use of assets.
26. An investor concerned whether a company can meet its near-term obligations is most likely
to calculate the:
A. current ratio.
B. return on total capital.
C. financial leverage ratio.
27. The most stringent test of a company’s liquidity is its:
A. cash ratio.
B. quick ratio.
C. current ratio.
28. An investor worried about a company’s long-term solvency would most likely examine its:
A. current ratio.
B. return on equity.
C. debt-to-equity ratio.
29. Using the information presented in Exhibit 4, the quick ratio for SAP Group at
31 ­December 2017 is closest to:
A. 1.00.
B. 1.07.
C. 1.17.
30. Using the information presented in Exhibit 14, the financial leverage ratio for SAP Group
at December 31, 2017 is closest to:
A. 1.50.
B. 1.66.
C. 2.00.

Questions 31 through 34 refer to Exhibit 1.

Exhibit 1 Common-Size Balance Sheets for Company A, Company B, and Sector Average
Sector
Company A Company B Average
ASSETS
Current assets
Cash and cash equivalents 5 5 7
Marketable securities 5 0 2
Accounts receivable, net 5 15 12
Inventories 15 20 16
Prepaid expenses 5 15 11
Chapter 4 Understanding Balance Sheets 19

Exhibit 1 (Continued)

Sector
Company A Company B Average
Total current assets 35 55 48
Property, plant, and equipment, net 40 35 37
Goodwill 25 0 8
Other assets 0 10 7
Total assets 100 100 100

LIABILITIES AND SHAREHOLDERS’ EQUITY

Current liabilities
Accounts payable 10 10 10
Short-term debt 25 10 15
Accrued expenses 0 5 3
Total current liabilities 35 25 28
Long-term debt 45 20 28
Other non-current liabilities 0 10 7
Total liabilities 80 55 63
Total shareholders’ equity 20 45 37
Total liabilities and shareholders’ equity 100 100 100

31. Based on Exhibit 1, which statement is most likely correct?

A. Company A has below-average liquidity risk.
B. Company B has above-average solvency risk.
C. Company A has made one or more acquisitions.
32. The quick ratio for Company A is closest to:
A. 0.43.
B. 0.57.
C. 1.00.
33. Based on Exhibit 1, the financial leverage ratio for Company B is closest to:
A. 0.55.
B. 1.22.
C. 2.22.
34. Based on Exhibit 1, which ratio indicates lower liquidity risk for Company A compared
with Company B?
A. Cash ratio.
B. Quick ratio.
C. Current ratio.