Chapter 1

True-False

1. A firm’s annual report contains only two pieces of information: the financial
statements and the notes to the financial statements. FALSE

3. The FASB has congressional authority to set accounting policies. FALSE

4. The European Union began requiring publicly traded companies to use U.S.
GAAP in 2005. FALSE

8. Information that is significant enough to make a difference in a decision is

considered to be immaterial. FALSE

9. The time period assumption assumes a two year time frame with interim
reporting occurring daily and weekly. FALSE

2. The SEC regulates U.S. companies that issue securities to the public and
requires the issuance of a prospectus for any new security offering. TRUE

5. External auditors are required to audit the internal control assessment of the
company as well as the financial statements. TRUE

6. Congress passed the Sarbanes-Oxley Act of 2002 in hopes of ending future

accounting scandals and renewing investor confidence in the marketplace.
TRUE

7. The Management Discussion and Analysis is of potential interest to the

analyst because it contains information that cannot be found in the financial
data. TRUE

10. GAAP-based financial statements are prepared according to the accrual basis
of accounting. TRUE
Fill in the Blank

1. The SEC requires all public companies to file a Form 10-K report annually.

2. A corporate annual report contains four financial statements.

3. Management is responsible for the preparation of the financial statements,

including the notes, and the auditor’s report attests to the fairness of the
presentation.

4. The Sarbanes Oxley Act was passed in 2002 and was one of the most
sweeping corporate reforms since the Securities Act of 1934.

5. The proxy statement is a document used to solicit shareholder votes.

6. The monetary unit Assumption is the assumed unit of measurement when

preparing financial statements.

7. The cash basis of accounting recognizes revenues when cash is received and
recognizes expenses when cash is paid.

8. The sharper and clearer the picture presented through the financial data and
the closer that picture is to financial reality, the higher the quality financial
statements and reported earnings.
9. One of the generally accepted accounting principles that provide the
foundation for preparing financial statements is the matching principle.

10. Management exercises control over the budget level and timing of
discretionary expenditures.

Multiple Choice

1. What information would not be found in a firm’s annual report?

a. Notes to the financial statements.
b. Financial Reporting Rulings.
c. Auditor’s report.
d. High and low stock prices.
2. Which agency requires the filing of Form 10-Ks, Form 10-Qs and Form 8-
Ks?
a. FASB.
b. IASB
c. SEC.
d. GAAP.

3. Which of the following statements is true?

a. Foreign firms registered with the SEC may file reports based on IFRS.
b. U.S. firms registered with the SEC may file reports based on IFRS.
c. The European Union requires firms to report based on GAAP.
d. Foreign firms registered with the SEC may file reports based on IFRS only if
they reconcile all amounts to GAAP.

4. Which financial statement presents the results of operations?

a. Balance sheet.
b. Statement of financial position.
c. Income statement.
d. Statement of cash flows.

5. Which financial statement shows the assets, liabilities and stockholders’

equity of the firm on a particular date?
a. Statement of stockholders’ equity.
b. Statement of cash flows.
c. Earnings statement
d. Balance sheet.

6. Which financial statement provides information about operating, financing

and investing activities?
a. Statement of financial position.
b. Statement of cash flows.
c. Statement of stockholders’ equity.
d. Income statement.

7. What information can be found on a statement of stockholders’ equity?

a. A reconciliation of the cash account and the retained earnings account.
b. A reconciliation of the beginning and ending balances of all accounts that
appears in the stockholders’ equity section of the balance sheet.
c. A reconciliation of the operating, investing and financing activities of a firm.
d. A reconciliation of net profit or loss and the cash account.
8. What basic financial statements can be found in a corporate annual report?
a. Balance sheet, income statement, statement of shareholders' equity, and
statement of cash flows.
b. Balance sheet, auditor's report and income statement.
c. Earnings statement and statement of retained earnings.
d. Statement of cash flows and five-year summary of key financial data.

9. What is an unqualified audit report?

a. A report stating that the auditors are not qualified to report on a firm.
b. A report that states the financial statements are in violation of GAAP.
c. A report that states that departures from GAAP exist in the firm’s financial
statements.
d. A report that states the financial statements are presented fairly, in all
material respects, and are in conformity with GAAP.

10. What is a qualified report?

a. A report stating that the auditors are not qualified to report on a firm.
b. A report that states the financial statements are in violation of GAAP.
c. A report that states that departures from GAAP exist in the firm’s
financial statements.
d. A report that states the financial statements are presented fairly, in all
material respects, and are in conformity with GAAP.

11. What organization has the authority to register, inspect, and discipline
auditors of all publicly owned companies?
a. Public Company Accounting Oversight Board.
b. SOX.
c. Congress.
d. FASB.

12. According to Section 302 of the Sarbanes-Oxley Act, who must certify the
accuracy of the financial statements of a public company?
a. Public Company Accounting Oversight Board.
b. SEC.
c. External auditor.
d. CEO and CFO.

13. All of the following items should be discussed in the management

discussion and analysis except for:
a. Anticipated changes in the mix and cost of financing resources.
b. The market value of all assets.
c. The internal and external sources of liquidity.
d. Unusual or infrequent transactions that affect income from continuing
operations.

14. Which of the following is an internal source of liquidity?

a. Borrowing.
b. Sales of stock.
c. Gifts and donations.
d. Sales of products or services.

15. Which of the following is an external source of liquidity?

a. Sales of services.
b. Repurchase of stock.
c. Borrowing.
d. Sales of products.

16. Which of the following is not a condition that must be met for an item to be
recorded as revenue?
a. Revenues must be earned.
b. The amount of the revenue must be measurable.
c. The revenue must be received in cash.
d. The costs of generating the revenue can be determined.

17. How are revenues and expenses recognized under the accrual basis of
accounting?
a. Revenues are recognized when cash is received and expenses are recognized
when cash is paid.
b. Revenues and expenses are recognized equally over a twelve month period.
c. Revenues and expenses are recognized based on the choices of management.
d. 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.

18. In what industry would it be expected that companies would spend a

significant amount on research and development activities?
a. Pharmaceutical.
b. Clothes retailer.
c. Groceries.
d. Wholesale distributor of computer parts.

19. Which of the following items is a discretionary expenditure?

a. Union wages.
b. Factory building to produce inventory.
c. Advertising.
d. Taxes.

20. Which of the following statements is false with regard to quality of financial
reporting?
a. Financial statements should reflect an accurate picture of a company’s
financial condition and performance.
b. It is unlikely that management can manipulate the bottom line due to the
regulations in place to enforce GAAP.
c. Financial information should be useful both to assess the past and predict the
future.
d. The closer that the picture presented through the financial data is to
reality, the higher the quality of financial reporting.

Chapter 2

True-False

1. The balance sheet is also called the statement of condition or statement of

financial position. TRUE

3. A classified balance sheet means that the asset and liability sections are
categorized into key areas. TRUE

4. Companies that use IFRS may switch the order of presentation of assets and
liabilities, listing noncurrent items before current items. TRUE

6. A common-size balance sheet is useful to the analyst because it facilitates the

structural analysis of the firm. TRUE

8. The valuation of marketable securities on the balance sheet requires the

separation of investment securities into three categories: held to maturity,
trading securities, and securities available for sale. TRUE

2. The balance sheet is prepared for a period of time, generally a year. FALSE

5. As part of an integrated disclosure system required by the SEC, the

information presented in annual reports includes three-year audited balance
sheets. FALSE

7. Working capital refers to the investment in property, plant and equipment.

FALSE
9. Accounts receivable are recorded on the balance sheet at gross realizable
value. FALSE

10. Retained earnings is the unused stash of cash that a firm has accumulated
since inception. FALSE

Fill in the Blank

1. A common size balance sheet expresses each item on the balance sheet as a
percentage of total assets.

2. Current assets are those assets expected to be converted into cash within one
year or operating cycle, whichever is longer.

3. Marketable securities are also referred to as short-term investments.

4. The net realizable value of accounts receivable is the actual amount of the
account less an allowance for doubtful accounts .

5. Additional information helpful to the analysis of accounts receivable and the

allowance account is provided in the schedule of valuation and qualifying
accounts.

6. The three cost flow assumptions most frequently used in the U.S. are FIFO,
LIFO and average cost.

7. Goodwill arises when one company acquires another company for a price in
excess of the fair market value of the net identifiable assets.

8. Companies that are paid in advance for services or products record a liability
on the receipt of cash in an account titled unearned revenue or deferred
credits.

9. A capital lease affects both the balance sheet and the income statement.

10. Many companies list an account titled commitments and contingencies on

the balance sheet even though no dollar amount will appear.

Multiple Choice
1. The balancing equation is expressed as:
a. Assets + Liabilities = Stockholders' Equity.
b. Revenues – Expenses = Net Income.
c. Sales – Costs = Net Profit.
d. Assets = Liabilities + Stockholders' Equity.

2. Which of the following statements is false?

a. Common-size balance sheets allow for comparison of firms with different
levels of total assets by introducing a common denominator.
b. The common-size balance sheet reveals the composition of assets within
major categories.
c. Each item on a common-size balance sheet is expressed as a percentage
of sales.
d. The common-size balance sheet reveals the capital and the debt structure of
the firm.

3. Which of the following accounts would be classified as current assets on the

balance sheet?
a. Accounts receivable, inventory, cash equivalents.
b. Marketable securities, accounts payable, property, plant and equipment.
c. Prepaid expenses, goodwill, long-term investments.
d. Property, plant and equipment, inventory, goodwill.

4. Which of the following items would not be classified as cash equivalents?

a. U.S. Treasury bills.
b. Trading securities.
c. Commercial paper.
d. Money market funds.

5. Which of the following marketable securities are reported at fair value?

a. Held to maturity and trading securities.
b. Trading securities and securities available for sale.
c. Held to maturity and securities available for sale.
d. Corporate bonds and convertible debt.

6. Which of the following items should alert the analyst to the potential for
manipulation when analyzing accounts receivable and the allowance for
doubtful accounts?
a. Sales, accounts receivable and the allowance for doubtful accounts are all
growing at approximately the same rate.
b. A company lowers its credit standards and also increases the balance in the
allowance for doubtful accounts.
c. Accounts receivable is growing at a large rate and the allowance for
doubtful accounts is decreasing.
d. An analysis of the “Valuation and Qualifying Accounts” schedule required in
the Form 10-K reveals that the amounts recorded for bad debt expense are
close in amount to the actual amounts written off each year.
7. Which method of inventory assumes the last units purchased will remain in
ending inventory on the balance sheet?
a. FIFO.
b. LIFO.
c. Average cost.
d. LIFO and FIFO.

8. Which type of firm would most likely carry the most finished goods
inventory?
a. A manufacturing firm.
b. A retail firm.
c. A service firm.
d. A wholesale firm.

9. Which method of inventory would be least likely to be used by a European

firm?
a. FIFO.
b. LIFO.
c. Average cost.
d. LIFO and FIFO.

10. Which of the following statements is false?

a. Companies are allowed to use more than one inventory valuation method.
b. LIFO is an income tax concept.
c. Using FIFO for high-technology products makes sense if the firm is trying to
reduce taxes because the technology industry is generally deflationary.
d. Companies using IFRS may not reverse entries for inventory write-
downs if the market recovers.

Use the following information to answer questions 11 through 13:

ABC Companypurchases five products for sale in the order and at the costs
shown:

Unit Cost per Unit

1 $10
2 $12
3 $15
4 $18
5 $13
11. Assume ABC sells two items and uses the FIFO method of inventory
valuation. What amount would appear in ending inventory on the balance sheet?
a. $22
b. $46
c. $45
d. $31

12. Assume ABC sells two items and uses the LIFO method of inventory
valuation. What amount would appear for cost of goods sold on the income
statement?
a. $37
b. $41
c. $22
d. $31

13. Assume ABC uses the average cost method of inventory valuation. What
unit cost would be used to determine the amount in ending inventory or cost of
goods sold?
a. $12.67
b. $13.60
c. $15.00
d. $13.00

14. Which of the following statements is true?

a. The straight-line method of depreciation allocates a decreasing amount of
depreciation expense each year.
b. Straight-line depreciation is the least used method for financial reporting
purposes.
c. Fixed assets are reported at historical cost less accumulated depreciation
on the balance sheet.
d. The total amount of depreciation over the asset’s life is larger when using an
accelerated method of depreciation.

15. When will a firm regard goodwill on its books?

a. When one company acquires another company for a price in excess of
the fair market value of the net identifiable assets acquired.
b. When the firm donates property to charities.
c. When it is determined that there has been a loss of value of long-term assets.
d. When fixed assets are impaired.

16. Which of the following accounts could be categorized as either a current or

noncurrent liability depending on date the debt is due?
a. Notes payable and deferred taxes.
b. Accounts payable and current portion of long-term debt.
c. Deferred taxes and mortgages due in 30 years.
d. Long-term warranties and accounts payable.

17. Which items would be classified as long-term debt?

a. Accounts payable, unearned revenue, pension liabilities.
b. Common stock, retained earnings, bonds payable.
c. Mortgages, convertible debentures, bonds payable.
d. Deferred taxes, accrued expenses, treasury stock.

18. How are deferred taxes recorded on the balance sheet?

a. As current or noncurrent liabilities.
b. As stockholders’ equity.
c. As noncurrent assets or noncurrent liabilities.
d. As current or noncurrent assets or liabilities.

19. Which stockholders’ equity account represents the sum of every dollar a
company has earned since its inception, less any payments made to shareholders
in the form of dividends?
a. Treasury stock.
b. Accumulated other comprehensive income
c. Retained earnings.
d. Preferred stock.

20. Which item below would not be a quality of financial reporting issue related
to the balance sheet?
a. Mismatching the type of debt (short or long-term) used to finance assets.
b. Discretionary expenses.
c. Overvaluation of assets.
d. Off-balance sheet financing.

Chapter 3

True-False

1. The income statement presents cash revenues, cash expenses, net income, and
earnings per share for an accounting period. FALSE

3. The income statement comes in two basic formats, the multiple-step and the
single-step versions; however, for analysis purposes the single-step version
should be used. FALSE
4. The common size income statement expresses each income statement item as
a percentage of total assets. FALSE

5. Gross profit is the difference between sales and all operating expenses.
FALSE

8. Operating profit margin is impacted by sales and all operating expenses

except cost of goods sold. FALSE

6. If the cost of goods sold percentage increases or decreases, this does not
necessarily mean that costs have increased or decreased. TRUE

2. The statement of stockholders’ equity is an important link between the

balance sheet and the income statement. TRUE

7. In volatile industries, such as high technology, gross profit margin may

increase or decrease significantly each year. TRUE

9. Users of financial statements need to distinguish between earnings increasing

due to core operations versus items such as tax rate deductions. TRUE

10. Two special items, discontinued operations and extraordinary items, must be
disclosed separately on the income statement. TRUE

Fill in the Blank

1. Two other terms used interchangeably with income are earnings and profit.

2. Comprehensive income is the change in equity of a company during a period

from transactions, other events, and circumstances relating to nonowner sources.

3. The LIFO method of inventory generally results in the matching of current

costs with current revenues and therefore produces higher-quality earnings.

4. The gross profit margin and costs of goods sold percentage are complements
of each other and the two percentages always add up to 100%.

5.Advertising costs are or should be a major expense in the budgets of

companies for which marketing is an important element of success.

6. Depreciation and amortisation represent the cost of assets other than land
that will benefit a business enterprise for more than a year.
7. Impairment charges are the expenses recognized to record a decline in value
of a long-term asset.

8. The equity method of accounting for investments should be used when the
investor can exercise significant influence over the investee’s operating and
financing policies.

9. Foreign currency translation effects, unrealized gains and losses, additional

pension liabilities and cash flow hedges are items that may comprise a
company’s other comprehensive income.

10. Stock dividends and stock splits result in the issuance of additional shares
of stock to existing shareholders.

Multiple Choice

1. Which equation represents an income statement?

a. Assets = liabilities + stockholders’ equity.
b. Cash in – cash out = net income.
c. Revenues - expenses = net income.
d. Beginning retained earnings + revenues – expenses = ending retained
earnings.

2. Which format of the income statement should be used for analysis purposes?
a. Multiple-step.
b. Cash basis.
c. Single-step.
d. Accrual basis.

3. Which of the following is an acceptable method to report total

comprehensive income?
a. On the face of the balance sheet.
b. Total comprehensive income does not have to be reported.
c. In the operating section of the cash flow statement.
d. In the statement of stockholders' equity.

4. How is a common-size income statement prepared?

a. Each income statement item is expressed as a percentage of total assets.
b. Each income statement item is expressed as a percentage of net sales.
c. Each income statement item is expressed as a percentage of net income.
d. Each income statement item is expressed as a percentage of cash flow.

5. How are sales reported on the income statement?

a. Sales are shown for three years net of returns and allowances.
b. Sales amounts are inflation-adjusted.
c. Sales are shown for two years and are reported in nominal terms.
d. Sales are shown at gross amounts, adjusted for inflation.

6. Which of the following statements is true?

a. In stable industries, such as retailers, the gross profit margin is generally
volatile from year to year.
b. Gross profit margin and operating profit margin are complements of each
other and the two percentages add up to 100%.
c. Fixed costs do not vary proportionately with volume changes but remain
the same within a relevant range of activity.
d. In capital intensive industries sales volume changes result in a stable gross
profit margin.

7. How should companies with more than one revenue source report revenue
and cost of goods sold?
a. Each revenue source should be reported separately, but all cost of goods sold
should be added together and reported as a single amount.
b. The revenues and cost of goods sold should be netted together and reported as
a single line item.
c. All revenue sources should be added together and shown as one line item and
all cost of goods sold should be added together and shown as one line item.
d. Each revenue line should be shown separately with a corresponding cost
of goods sold line for each revenue source.

8. Selling and administrative expenses include which of the following income

statement items?
a. Salaries, insurance, interest.
b. Salaries, rent, advertising.
c. Rent, interest, cost of goods.
d. Advertising, research & development, amortization.

9. What is amortization?
a. The process used to allocate the cost of natural resources.
b. The process used to allocate the cost of tangible fixed assets.
c. The process used to allocate the cost of capital leases, leasehold
improvements and intangible assets.
d. The process used to allocate the cost of oil, gas, minerals and standing timber.

10. Which item would not be classified as an operating expense?

a. Interest expense.
b. Rent expense.
c. Depreciation.
d. Repairs and maintenance.

11. Which of the following statements is true?

a. It is unnecessary to analyze operating expenses over which management
exercises discretion.
b. Impairment charges do not need to be analyzed since they are generally a
non-recurring expense.
c. A good way to improve operating profit is to cut repairs and maintenance
costs as much as possible.
d. Operating expenses can be easily analyzed by preparing a common-size
income statement.

12. Why is it important to assess operating profit?

a. Operating profit represents the firm’s profits after consideration of all
revenues, expenses and comprehensive income.
b. The figure for operating profit provides a basis for assessing the success
of the firm apart from its financing and investing activities and separate
from tax considerations.
c. Operating profit represents the firm’s profits after consideration of all
revenues and expenses.
d. Operating profit represents the firm’s profits after consideration of all
revenues and expenses, except for taxes.

13. Which of the items below would be included under “Other income and
expense”?
a. Salaries, interest expense, equity losses.
b. Equity earnings, gains from sale of assets, interest income.
c. Research and development, dividend income, interest expense.
d. Advertising, cost of goods sold, selling and administrative expenses.

14. How does the equity method distort earnings?

a. Income is recognized even though cash may never be received.
b. Equity earnings are recorded even if the investor cannot exercise influence
over the investee’s policies.
c. Equity earnings are only recorded on a cash basis of accounting.
d. Equity earnings are recorded when investment ownership is 100%.

15. How is it possible for a U.S. firm to have increasing earnings but a lower
effective tax rate?
a.The firm has expenses that are not deductible for tax purposes.
b. Tax rates in foreign countries where the firm operates are higher.
c. Tax rates in foreign countries where the firm operates are lower.
d. It is not possible for a firm to have an effective tax rate different from the
U.S. federal statutory tax rate.

16. Which item is not a special item that must be disclosed separately on the
income statement?
a. Extraordinary gain.
b. Extraordinary loss.
c. Foreign currency translation adjustments.
d. Discontinued operations.

17. How is earnings per common share calculated?

a. Operating profit divided by the average number of common stock shares
outstanding.
b. Net profit divided by the average number of common and preferred stock
shares outstanding.
c. Operating profit divided by the average number of repurchased common
stock shares.
d. Net profit divided by the average number of common stock shares
outstanding.

18. Which of the following items could be found on a statement of shareholders'

equity?
a.Reasons for retained earnings increases or decreases.
b. A reconciliation of beginning to ending cash.
c. The market value of the firm’s common stock.
d. Assets = Liabilities + Stockholders’ Equity.

Use the following information for Jett Co. to answer questions 19 and 20.

2015 2014
Sales 1,200 1,000
COGS 850 700
Operating expenses 200 200
Income taxes 30 35

19. Jett Co.'s gross profit, operating profit and net profit margins for 2015 are:
a. 50.0%, 32.5%, 22.5% respectively.
b. 29.2%, 12.5%, 10.0%, respectively.
c. 27.0%, 11.0%, 10.5%, respectively.
d. 21.5%, 17.5%, 12.0%, respectively.

20. Jett Co.'s average tax rates for 2015 and 2014 are:
a. 15.5% and 10.0%
b. 20.0% and 35.0%
c. 25.8% and 35.4%
d. 31.4% and 36.8%.

Chapter 4

True-False

1. The analyst of financial statements should consider cash flows over a period
of time, looking at patterns of performance and exploring underlying causes of
strength and weakness. TRUE

2. The statement of cash flows shows the changes in the balance sheet accounts
between periods. TRUE

3. Cash flow from operations represents the “cash” income from the company’s
business operations. TRUE

7. Cash outflows result from increases in asset accounts and decreases in

liability and equity accounts.TRUE

8. Analyzing the statement of cash flows helps determine the future external
financing needs of a business firm.TRUE

4. Cash from sales of property, plant and equipment is considered an operating

activity on the cash flow statement. FALSE

5. Proceeds from borrowing are a financing cash outflow. FALSE

6. Repurchase of a firm’s own shares is an investing cash outflow. FALSE

9. An analysis of the statement of cash flows should, at a minimum, cover the

following areas: analysis of cash inflows, analysis of cash outflows, and an
analysis of the structure of asset and liabilities. FALSE

10. The amounts on a cash flow statement cannot be manipulated. FALSE

Fill in the Blank

1. Cash flows are segregated on a statement of cash flows by operating

activities, financing activities, and investing activities.
2. A change in the retained earnings account is the result of the net income for
the period and the payment of dividends.

3. Per FASB rules, firms may use the direct method or the indirect method to
calculate and present cash flow from operating activities.

4. The summary analysis is one way to common size the cash flow statement.

For questions 5 through 10, insert the word “added” or “subtracted” in the blank.

5. An increase in inventory should be subtracted to convert net income to cash

flow from operating activities.

6. An increase in accounts payable should be added to convert net income to

cash flow from operating activities.

7. A decrease in accrued liabilities should be subtracted to convert net income

to cash flow from operating activities.

8. A decrease in accounts receivable should be added to convert net income to

cash flow from operating activities.

9. Depreciation and amortization should be added to convert net income to cash

flow from operating activities.

10. A gain on sale of asset should be subtracted to convert net income to cash
flow from operating activities.

Multiple Choice

1. All of the following are reasons that the statement of cash flows is useful to
the analyst except:

a. The statement of cash flows shows how cash is generated during an

accounting period and how it has been used.
b. A positive net income figure on the income statement is ultimately
insignificant unless a company can translate its earnings into cash, and the
only source in financial statements for learning about cash generation is the
statement of cash flows.
c. The statement of cash flows shows the adjustments made to net income in
order to calculate cash flow from operations; those should be examined to
determine why cash flow from operations is negative or positive.
d. The statement of cash flows is the only financial statement that cannot be
manipulated.

2. How is the statement of cash flows connected to the balance sheet?

a. The statement of cash flows shows changes in the asset and liability accounts
to explain cash from operating activities.
b. The changes in all revenue and expense accounts are calculated and then
listed as cash inflows or outflows.
c. The changes in all of the balance sheet accounts are calculated and then
listed as inflows or outflows, except for cash.
d. Changes in asset accounts are recorded as operating activities, changes in
liability accounts are recorded as financing activities and changes in equity
accounts are recorded as investing activities.

3. The following item would be classified as an operating activity on the

statement of cash flows:
a. Payments for inventory.
b. Acquisitions of equipment.
c. Proceeds from borrowing.
d. Payments on loans.

4. The following item would be classified as an investing activity on the

statement of cash flows:
a. Proceeds from borrowing.
b. Sale of goods.
c. Sale of property.
d. Payment to lenders.

5. The following item would be classified as a financing activity on the

statement of cash flows:
a. Payments for inventory.
b. Payment of dividends.
c. Acquisition of land.
d. Sales of goods.

6. Which item is a noncash item that would be added to net income to convert it
to cash flow from operating activities?
a. Accounts receivable.
b. Depreciation.
c. Accounts payable.
d. Inventory.
Use the indirect method to answer questions 7-10. The following information is
available for Armstrong Company:

Net income $450 Increase in plant and equip.

$170
Depreciation expense 80 Payment of dividends 10
Decrease in accts. receiv. 20 Increase in long-term debt 100
Increase in inventories 15 Decrease in accounts payable 30

7. What is cash flow from operating activities for Armstrong Company?

a. $505
b. $495
c. $335
d. $55

8. What is cash from investing activities for Armstrong Company?

a. ($160)
b. $160
c. $170
d. ($170)

9. What is cash from financing activities for Armstrong Company?

a. $70
b. $60
c. $90
d. ($110)

10. What is the change in cash for Armstrong Company?

a. $315
b. $565
c. $425
d. $215

Use the indirect method to answer questions 11-14. The following information
is available for Felix Company:

Net income $300 Decrease in plant and equip. $40

Depreciation expense 20 Increase in deferred tax asset 5
Gain on sale of assets 35 Decrease in long-term debt 50
Increase in inventories 25 Decrease in accounts payable 15

11. What is cash flow from operating activities for Felix Company?
a. $240
b. $70
c. $320
d. $250

12. What is cash from investing activities for Felix Company?

a. $5
b. $40
c. $75
d. $10

13. What is cash from financing activities for Felix Company?

a. $50
b. $65
c. ($50)
d. $60

14. What is the change in cash for Felix Company?

a. $310
b. $205
c. $330
d. $230

15. What is implied if the inventory account has increased?

a. Cash flow from financing activities has decreased relative to net income.
b. Cash flow from operating activities has increased relative to net income.
c. Cash flow from operating activities has decreased relative to net income.
d. Cash flow from financing activities has increased relative to net income.

16. Why are gains and losses from asset sales removed from net income when
calculating the cash flows from operating activities?
a. Selling assets is a noncash item.
b. Gains and losses from asset sales are a financing activity.
c. Gains and losses are not removed from net income when calculating the
cash flows from operating activities
d. The entire proceeds from sales of long-lived assets are included in
investing activities.

17. What is the preferred method to generate cash in a firm?

a. Operating activities.
b. Investing activities.
c. Financing activities.
d. Investing and financing activities.
18. Which item may be of concern when analyzing cash flow from financing
activities?
a. Increasing inventories.
b. Borrowing each year to repay debt from prior years.
c. Repayment of debt.
d. Payments of dividends.

19. Which of the following would increase cash from operating activities?
a. Increasing accounts receivable.
b. Increasing inventories.
c. Decreasing accounts payable.
d. Decreasing accounts receivable.

20. Which of the following items would be a way to manipulate the cash flow
from operating activities amount on the statement of cash flows?
a. Adding depreciation back to net income to determine cash flow from
operating activities.
b. Including interest expense and tax expense in the calculation of cash flow
from operating activities.
c. Recording an item that should be recorded as an operating activity as an
investing activity.
d. The cash flow statement cannot be manipulated.

Chapter 5

True-False

1. The objectives of a financial statement analysis will vary depending on the

perspective of the financial statement user. TRUE

2. A creditor is ultimately concerned with the ability of a firm to generate

profits. FALSE

3. Supplementary schedules, such as data related to the breakdown of key

financial figures by operating segment, are helpful to financial statement
analysts. TRUE

4. Form 10-Ks and Form 10-Qs can be located through the Dun & Bradstreet
Information services. FALSE

5. Articles from current business periodicals should not be used in financial

statement analysis as journalists are often biased. FALSE
6. Financial ratios are powerful tools due to the fact that standard definitions
exist and there is a set standard that should be met for each ratio. FALSE

7. Three ratios that help the financial analyst assess short-term solvency are the
current ratio, the quick ratio and the cash flow liquidity ratio. TRUE

8. The accounts receivable turnover, inventory turnover and accounts payable

turnover ratios are mathematical complements to the ratios that make up the
cash conversion cycle. TRUE

9. The debt ratio considers the proportion of all stockholders’ equity that is
financed with debt. FALSE

10. Tools used in a financial statement analysis should generally include

common-size financial statements, key financial ratios, trend analysis, structural
analysis, and comparison with industry competitors. TRUE

Fill in the Blank

1. A proxy statement contains useful information about the board of directors

and executive compensation, option grants, audit-related matters, related party
transactions and proposals to be voted on by shareholders.
2. liquidity ratios measure a firm’s ability to meet cash needs as they arise.

3. activity ratios measure the liquidity of specific assets and the efficiency of
managing assets.

4.leverage ratios measure the extent of a firm’s financing with debt relative to
equity and its ability to cover interest and other fixed charges.

5. market ratios measure returns to stockholders and the value the marketplace
puts on a company’s stock.

6. The cash conversion cycle or net trade cycle is the normal operating cycle
of a firm that consists of buying or manufacturing inventory, selling inventory
and paying accounts payable and collecting accounts receivable.

7. The fixed charge coverage ratio is a broader measure of coverage capability

than the times interest earned ratio because it includes the fixed payments
associated with leasing.

8. The dividend yield shows the relationship between cash dividends and
market price.
9. The Du Poet System helps the analyst see how the firm’s decisions and
activities over the course of an accounting period interact to produce an overall
return to the firm’s shareholders, the return on equity.

10. Pro forma financial statements are projections of financial statements based
on a set of assumptions regarding future revenues, expenses, level of
investments in assets, financing methods and costs, and working capital
management.

Multiple Choice

1. Which group of people would be the most concerned about the ability of a
firm to make interest and principal payments?
a. Auditors.
b. Customers.
c. Creditors.
d. Investors.

2. Which group of people would be the most concerned about the operating
areas that have contributed to the success of the firm and which have not?
a. Customers.
b. Management
c. Auditors.
d. Creditors.

3. Which ratios help assess the firm’s ability to meet cash needs as they arise?
a. Current ratio and cash flow liquidity ratio.
b. Average collection period and net profit margin.
c. Debt ratio and dividend payout.
d. Operating profit margin and return on equity.

4. Which ratios measure the extent of a firm’s financing with debt relative to
equity and its ability to cover interest and fixed charges?
a. Debt ratio and price-to-earnings ratio.
b. Cash flow adequacy and fixed charge coverage.
c. Days payable outstanding and gross profit margin.
d. Cash interest coverage and average collection period.

5. How is the cash conversion cycle calculated?

a. Average collection period + days inventory held + Days payable
outstanding.
b. Average collection period - days inventory held + Days payable
outstanding.
c.Average collection period - days inventory held - Days payable
outstanding.
d.Average collection period + days inventory held - Days payable
outstanding.

6. What does a low asset turnover compared to the industry imply?

a. The investment in assets may be too high.
b. Sales are higher than average.
c.The investment in assets is too low.
d. Net income is low relative to the investment in assets.

7. All of the following are steps of a financial statement analysis except:

a. Establish objectives of the analysis.
b. Prepare pro forma statements.
c. Study the industry in which the firm operates.
d. Develop knowledge of the firm and the quality of management.

8. What does a financial leverage index greater than one indicate about a firm?
a. Return on assets exceeds the return on equity.
b. Return on equity exceeds the return on assets.
c. The firm is not employing debt successfully.
d. The firm does not generate enough funds to cover interest payments.

9. The Du Pont System shows which of the following series of relationships?

a. Net profit margin x total asset turnover = Return on investment.
b. Net profit margin x financial leverage = Return on equity.
c. Net profit margin x total asset turnover = Return on investment and
Return on investment x financial leverage = Return on equity.
d. Net profit margin x total asset turnover = Return on equity and Return on
equity x financial leverage = Return on investment.

10. What is important to understand about the label “pro forma”?

a. Pro forma refers to GAAP-based financial statements.
b. Pro forma requires firms to present two distinct net profit amounts in their
Form 10-Ks.
c. Pro forma relates to the amount of debt in a firm’s capital structure.
d. Pro forma earnings or financial statements are sometimes based on a
firm’s own definition which is not technically a correct definition.

Use the following selected financial information for Wilcox Corporation to

answer questions 11-20.
 Wilcox Corporation
Income Statement
For the Year Ended December 31, 2015

Net sales $2,870

Cost of goods sold 1,985
Gross profit $ 885
Operating expenses 620
Operating profit $ 265
Interest expense 40
Earnings before taxes $ 225
Income tax expense 80
Net profit $ 145

Wilcox Corporation
Balance Sheet
December 31, 2015

Assets Liabilities and stockholders' equity

Current assets Current liabilities
Cash $25 Accounts payable $
85
Short-term investments 15 Accrued liabilities 45
Accounts receivable 70 Total current liabilities
130
Inventory 150 Long-term debt 240
Total current assets 260 Total liabilities 370

Long-term assets Stockholders' equity

Net PPE 390 Common stock and PIC
80
Goodwill 210 Retained earnings 410
Total stockholders' equity 490
Total assets $860 Total liabilities and equity $860

WilcoxCorporation
Statement of Cash Flow Information
For the Year Ended December 31, 2015

Cash from operating activities $150

Investing activities:
 Capital expenditures $ 60
Acquisitions $ 10

Financing activities:
Proceeds from long-term borrowing $ 50
Payments on long-term borrowing $ 25
Payments of cash dividends $ 20

Cash paid for interest $ 10

Cash paid for income taxes $ 75
11. Wilcox’squick ratio is:
a. 0.85
b. 2.00
c. 1.00
d. 0.75

12. Wilcox’saverage collection period is:

a. 5 days
b. 9 days
c. 13 days
d. 15 days

13. Wilcox’sdays payable outstanding is:

a. 7 days
b. 11 days
c. 16 days
d. 22 days

14. Wilcox’s total asset turnover ratio is:

a. 3.98
b. 4.22
c. 5.91
d. 3.34

15. Wilcox’stimes interest earned ratio is:

a. 1.50
b. 4.50
c. 6.63
d. 8.60

16. Wilcox’s cash flow adequacy ratio is:

a. 1.43
b. 2.15
c. 1.90
d. 0.54

17. Wilcox’scash flow margin is:

a. 5.23%
b. 5.85%
c. 6.24%
d. 6.67%
18. Wilcox’s effective tax rate is:
a. 24.67%
b. 27.36%
c. 35.00%
d. 35.56%

19. Wilcox’sdebt ratio is:

a. 40.11%
b. 43.02%
c. 55.80%
d. 56.32%

20. Wilcox’sreturn on equity is:

a. 20.62%
b. 25.50%
c. 29.59%
d. 28.49%