Financial Reporting and Analysis Lawrence Revsine 7e - Test Bank

Financial Reporting and Analysis Lawrence Revsine 7e – Test Bank

 

Instant Download – Complete Test Bank With Answers

 

 

Sample Questions Are Posted Below

 

Financial Reporting and Analysis, 7e (Revsine)

Chapter 5   Essentials of Financial Statement Analysis

 

1) An analyst interested in learning the degree to which a company’s earnings have fluctuated historically in relation to changes in economic growth would employ cross-sectional analysis.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

2) A benchmark comparison is an analytic tool similar in approach to time-series analysis.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

3) Operating and administrative efficiencies that result in lower expenses per dollar of sales possibly explain a trend where net income grows faster than sales.

 

Answer:  TRUE

Difficulty: 2 Medium

Topic:  Cause-of-change analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

4) Return on assets will generally equal return on common equity except when the company has no long-term debt.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

5) Financial leverage is beneficial when the company earns more than the incremental after-tax cost of debt.

 

Answer:  TRUE

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

6) Both common and preferred stock dividends are subtracted in arriving at net income available to common stockholders.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

7) When return on assets is high at a highly levered firm, return on common equity will be low.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

8) Activity ratios describe the profitability of a company.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

9) The Z-score model combines five financial ratios in a precise way to estimate a company’s default risk.

 

Answer:  TRUE

Difficulty: 2 Medium

Topic:  Z-Score and default risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

10) Days payable outstanding helps analysts understand the company’s pattern of cash receipts from customers.

 

Answer:  FALSE

Difficulty: 1 Easy

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

11) A low-credit-risk company generates operating cash flows substantially in excess of what are required to sustain its business activities.

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

12) Although a company’s earnings are important, an analysis of its cash flows is central to credit evaluations and lending decisions.

 

Answer:  TRUE

Difficulty: 1 Easy

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

13) Credit risk analysis uses financial ratios that focus on an assessment of liquidity and solvency.

 

Answer:  TRUE

Difficulty: 2 Medium

Topic:  Use of financial ratios in credit analysis

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

 

 

14) In the highest-risk Standard & Poor’s rating category that is a CCC/C rating, more than half of the firms default within a year.

 

Answer:  FALSE

Difficulty: 2 Medium

Topic:  Use of financial ratios in credit analysis

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

15) When analyzing a company’s risk of bankruptcy using Altman’s Z-score, a high Z-score indicates low risk of default.

 

Answer:  TRUE

Difficulty: 3 Hard

Topic:  Z-Score and default risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

16) All of the following are used as financial analysis tools except:

1. A) managements’ discussion and analysis.
2. B) common-size statements.
3. C) trend statements.
4. D) financial ratios.

 

Answer:  A

Difficulty: 1 Easy

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

17) Time-series analysis helps identify financial trends:

1. A) across companies at a single point in time.
2. B) across business units at a single point in time.
3. C) over time for a single company or business unit.
4. D) among the companies that comprise an industry group.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

18) A type of analysis that helps identify similarities and differences across companies or business units at a single moment in time is:

1. A) trend analysis.
2. B) common-size statements analysis.
3. C) time-series analysis.
4. D) cross-sectional analysis.

 

Answer:  D

Difficulty: 1 Easy

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

19) Which of the following is not correct with respect to an analyst’s use of financial information?

1. A) Analysts use financial statement information to assess the economic activities of a company and its condition.
2. B) The first step to informed financial statement analysis is a careful examination of the auditor’s opinion.
3. C) Analysts need to understand what accounting data do and do not reveal about a company’s economic activities and condition.
4. D) Analysts must always be vigilant about the possibility that accounting distortions are present and complicate the interpretation of financial ratios, percentage relations, and trend indices.

 

Answer:  B

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

20) Which of the following does not reflect disclosures in financial statements?

1. A) Related party transactions must be disclosed.
2. B) GAAP disclosure by segment is required only for some companies.
3. C) GAAP limits how much a company can disclose in their financial statements.
4. D) Management may disclose more than GAAP requires.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

21) Common-size financial statements recast each statement item as:

1. A) a percentage using industry averages for the “base number.”
2. B) a percentage using a base year number for each line item.
3. C) a percentage of some “base number” on the financial statement in question.
4. D) a percentage of the “bottom line.”

 

Answer:  C

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

22) An analytical tool that measures a company’s performance against a predetermined standard is a/an:

1. A) benchmark comparison analysis.
2. B) profitability analysis.
3. C) time-series analysis.
4. D) common-size statement.

 

Answer:  A

Difficulty: 1 Easy

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

23) The financial statement reporting “filter” is:

1. A) SEC reporting regulations that vary from GAAP for publicly traded companies.
2. B) SEC required reporting regulations for all entities.
3. C) management’s distortion of accounting data.
4. D) management’s discretion to choose alternative accounting procedures with in GAAP

 

Answer:  D

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

24) Which one of the following helps the analyst remove the effects of an information filter?

1. A) Financial statements.
2. B) SEC Form 10-K.
3. C) Note disclosures in financial statements.
4. D) Trend analysis.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Basic approaches to financial statement analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

25) Trend statements help the user:

1. A) determine the reason(s) for changes over time in each financial statement line item.
2. B) spot relationships among financial statement items.
3. C) spot changes over time in each financial statement line item.
4. D) identify variations between companies in financial statement line items.

 

Answer:  C

Difficulty: 1 Easy

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

26) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In a common-size income statement for 2019, the operating expenses are expressed as:

28. A) 28.0%
29. B) 30.3%
30. C) 43.8%
31. D) 100.0%

 

Answer:  A

Explanation:  Operating expenses $50,000 ÷ Sales $178,500 = 28.0%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

27) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In a common-size income statement for 2017, the cost of goods sold is expressed as:

40. A) 40.0%
41. B) 64.3%
42. C) 100.0%
43. D) 230.0%

 

Answer:  B

Explanation:  Cost of goods sold $100,000 ÷ Sales $155,500 = 64.3%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

28) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In a common-size income statement for 2019, the cost of goods sold is expressed as:

64. A) 64.5%
65. B) 100.0%
66. C) 112.3%
67. D) 130.0%

 

Answer:  A

Explanation:  Cost of goods sold $115,000 ÷ Sales $178,400 = 64.5%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

29) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In a trend income statement for 2017, where 2017 is the base year, sales are expressed as:

84. A) 84.4%
85. B) 92.6%
86. C) 100.0%
87. D) 150.5%

 

Answer:  C

Explanation:  (2017) $155,500 ÷ (2017) $155,500 = 100%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

30) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In a trend income statement for 2019, where 2017 is the base year, sales are expressed as:

87. A) 87.2%
88. B) 100.0%
89. C) 114.7%
90. D) 148.7%

 

Answer:  C

Explanation:  (2019) $178,400 ÷ (2017) $155,500 = 114.7%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

31) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In comparison to year 2018, the increase in operating income of 2019 was primarily caused by (ignore taxes):

1. A) the effect of sales growth.
2. B) the effect of cost of goods sold growth.
3. C) the effect of margin growth.
4. D) the answer cannot be derived from the information provided.

 

Answer:  C

Explanation:

2019 operating margin ($13,400 ÷ $178,400) = 0.075112

2018 operating margin ($10,000 ÷ $162,500) = 0.061538

Increase in operating margin          0.013574

2018 Operating income               $10,000

Effect of sales growth:

[($178,400 — $162,500) × 0.061538] =     978

Effect of margin increase

2019 sales $178,400 × .013574  increase

in operating margin                          2,422

2019 Operating income                      $13,500

Difficulty: 2 Medium

Topic:  Cause-of-change analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

32) Manero Company included the following information in its annual report:

 

	2019				2018					2017
Sales	$	178,400			$	162,500				$	155,500
Cost of goods sold		115,000				102,500					100,000
Operating expenses		50,000				50,000					45,000
Operating income		13,400				10,000					10,500

 

In comparison to year 2018, the increase in operating income of 2019 was primarily caused by the effect of margin increase of (ignore taxes):

978. A) $978.
979. B) $1,194.
980. C) $2,422.
981. D) $3,400.

 

Answer:  C

Explanation:

2019 operating margin ($13,400 ÷ $178,400) =  0.075112

2018 operating margin ($10,000 ÷ $162,500) =  0.061538

Increase in operating margin           0.013574

2018 Operating income                $10,000

Effect of sales growth:

[($178,400 — $162,500) × 0.061538] =      978

Effect of margin increase

$178,400 × .013574                     2,422

2019 Operating income                 $13,500

Difficulty: 3 Hard

Topic:  Cause-of-change analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

33) Manero Company included the following information in its annual report:

 

	2019					2018						2017
Sales	$	178,400					$	162,500					$	155,500
Cost of goods sold		115,000						102,500						100,000
Operating expenses		50,000						50,000						45,000
Operating income		13,400						10,000						10,500

 

In comparison to year 2017, the effect of sales growth on operating income of 2018 was (ignore taxes):

473. A) $473.
474. B) $431.
475. C) $6,667.
476. D) $7,000.

 

Answer:  A

Explanation:

2017 operating margin ($10,500 ÷ $155,500)	=	0.067524
Effect of sales growth: (2018 sales $162,500 – 2017 sales $155,500) × 0.067524	=	473

 

Difficulty: 2 Medium

Topic:  Cause-of-change analysis

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

34) In a common-size balance sheet, all items are expressed as a percentage of:

1. A) total assets.
2. B) total liabilities.
3. C) total equity.
4. D) total sales.

 

Answer:  A

Difficulty: 1 Easy

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

35) In a trend balance sheet, each balance sheet item is expressed as a percentage of:

1. A) total assets.
2. B) the base year item.
3. C) sales.
4. D) equity.

 

Answer:  B

Difficulty: 1 Easy

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

36) Hansel Corporation’s condensed balance sheets appear below:

 

		2019					2018						2017
Assets:
Current assets		$	55,000					$	56,500					$	70,000
Plant & equipment, net			495,000						410,000						440,000
Intangible assets, net			20,000						27,500						40,000
Total assets		$	570,000					$	494,000					$	550,000
Liabilities & Stockholders’ Equity:
Current liabilities			40,000					$	35,000					$	32,500
Long-term liabilities			395,000						310,000						375,000
Stockholders’ equity			135,000						149,000						142,500
Total liabilities & equity		$	570,000					$	494,000					$	550,000

 

In a common size balance sheet for 2018, plant and equipment (net) is expressed as:

83. A) 83.0%
84. B) 83.6%
85. C) 91.1%
86. D) 100.0%

 

Answer:  A

Explanation:  Plant and equipment $410,000 ÷ Total assets $494,000 = 83.0%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

37) Hansel Corporation’s condensed balance sheets appear below:

 

		2019					2018						2017
Assets:
Current assets		$	55,000					$	56,500					$	70,000
Plant & equipment, net			495,000						410,000						440,000
Intangible assets, net			20,000						27,500						40,000
Total assets		$	570,000					$	494,000					$	550,000
Liabilities & Stockholders’ Equity:
Current liabilities			40,000					$	35,000					$	32,500
Long-term liabilities			395,000						310,000						375,000
Stockholders’ equity			135,000						149,000						142,500
Total liabilities & equity		$	570,000					$	494,000					$	550,000

 

In a common size balance sheet for 2019, total liabilities and equity are expressed as:

89. A) 89.9%
90. B) 96.5%
91. C) 100.0%
92. D) 111.3%

 

Answer:  C

Explanation:  Total liabilities amp; equity $570,000 ÷ Total assets $570,000 = 100%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

38) Hansel Corporation’s condensed balance sheets appear below:

 

		2019					2018						2017
Assets:
Current assets		$	55,000					$	56,500					$	70,000
Plant & equipment, net			495,000						410,000						440,000
Intangible assets, net			20,000						27,500						40,000
Total assets		$	570,000					$	494,000					$	550,000
Liabilities & Stockholders’ Equity:
Current liabilities			40,000					$	35,000					$	32,500
Long-term liabilities			395,000						310,000						375,000
Stockholders’ equity			135,000						149,000						142,500
Total liabilities & equity		$	570,000					$	494,000					$	550,000

 

In a trend balance sheet for 2019, long-term liabilities are expressed as:

69. A) 69.3%
70. B) 100.0%
71. C) 105.3%
72. D) 127.4%

 

Answer:  C

Explanation:  L.T. liabilities 2019 $395,000 ÷ L.T. liabilities 2017 $375,000 = 105.3%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

39) In a trend balance sheet for 2018, stockholders’ equity is expressed as:

10. A) 10.2%
11. B) 100.0%
12. C) 104.6%
13. D) 110.4%

 

Answer:  C

Explanation:  S.E. 2018 $149,000 ÷ S.E. 2017 $142,500 = 104.6%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

40) Trend statements are better than common size statements at indicating which of the following?

1. A) stability.
2. B) monetary changes.
3. C) profitability.
4. D) growth and decline.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

41) In a common size cash flow statement, all items are expressed as a percentage of:

1. A) sales.
2. B) total assets.
3. C) net income.
4. D) total equity.

 

Answer:  A

Difficulty: 1 Easy

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

42) Which statement below is not correct with respect to a company’s strategy?

1. A) There are numerous strategies for achieving superior performance in any business.
2. B) Developing customer loyalty while controlling costs are conflicting strategies.
3. C) Low-cost leadership along with product and service differentiation create strategic advantage for companies.
4. D) Strategy is never dependent upon the company’s industry.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Competitive forces and business strategies

Learning Objective:  05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

43) Advanced technology and performance capabilities, consistent quality, availability in multiple colors and sizes, prompt delivery, technical support services, customer financing, distribution channels, or some other feature of importance to customers are examples of:

1. A) competitive advantage.
2. B) differentiation.
3. C) product leadership.
4. D) low-cost leadership.

 

Answer:  B

Difficulty: 2 Medium

Topic:  Competitive forces and business strategies

Learning Objective:  05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

44) Earnings Before Interest (EBI) adjusts net income for which one of the following groups of items?

1. A) Nonrecurring items, interest, and distortions related to accounting quality concerns.
2. B) Nonoperating items, after-tax interest, and distortions related to accounting quality concerns.
3. C) Nonoperating items, nonrecurring items, and after-tax interest.
4. D) Nonrecurring items, after-tax interest, and distortions related to accounting quality concerns.

 

Answer:  D

Difficulty: 2 Medium

Topic:  EBIT—EBI—ROA

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

 

45) Return on Assets (ROA) measures a firm’s:

1. A) cost effectiveness of its operating activities.
2. B) profitable use of its assets.
3. C) profitability of sales.
4. D) return on shareholders’ investment.

 

Answer:  B

Difficulty: 2 Medium

Topic:  EBIT—EBI—ROA

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

46) Which of the following items will not cause the company’s ROA to increase?

1. A) Reducing company assets without impacting sales.
2. B) Reducing costs.
3. C) Increasing the selling price per unit.
4. D) Increasing company assets.

 

Answer:  D

Difficulty: 2 Medium

Topic:  EBIT—EBI—ROA

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Analyze

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking

47) Return on Assets (ROA) can be broken down into these two components: profit margin and:

1. A) asset utilization margin.
2. B) asset turnover.
3. C) common earnings leverage.
4. D) financial structure leverage.

 

Answer:  B

Difficulty: 1 Easy

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

48) Which one of the following successful strategies will increase the Return on Assets (ROA)?

1. A) Increase the investment in assets used in the business.
2. B) Increase the profit margin.
3. C) Decrease sales volume.
4. D) Increase the annual depreciation amounts of long-lived assets.

 

Answer:  B

Difficulty: 3 Hard

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Analyze

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking

49) The ratio that captures information about property, plant, and equipment utilization is:

1. A) current asset turnover.
2. B) long-term asset turnover.
3. C) asset turnover.
4. D) property turnover.

 

Answer:  B

Difficulty: 2 Medium

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

50) Which of the following is not a valid statement?

1. A) Competitive ceiling is the rate of return that would be earned in the economist’s “perfectly competitive” industry.
2. B) Companies that consistently earn rates of return above the floor are said to have a competitive advantage.
3. C) Competition in an industry continually works to drive down the rate of return on assets toward the competitive floor.
4. D) Rates of return that are higher than the industry floor stimulate more competition as existing companies innovate and expand their market reach or as new companies enter the industry.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

51) Companies that consistently earn rates of return above the competitive floor in the industry are considered to possess a:

1. A) dominant market share.
2. B) niche market.
3. C) competitive advantage.
4. D) monopolistic advantage.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Competitive forces and business strategies

Learning Objective:  05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

52) Strategies to gain a competitive advantage include product differentiation and:

1. A) low-cost leadership.
2. B) building brand loyalty.
3. C) developing superior products.
4. D) improving product quality and reliability.

 

Answer:  A

Difficulty: 1 Easy

Topic:  Competitive forces and business strategies

Learning Objective:  05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

 

 

53) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The return on assets ratio for 2019 is (rounded):

16. A) 16.3%
17. B) 16.9%
18. C) 17.7%
19. D) 18.2%

 

Answer:  C

Explanation:  (Net income + after-tax interest expense) ÷ average total assets = [$127,500 + ($10,000 ×(1 − 0.30))] ÷ [($825,000 + $695,000) ÷ 2]

Difficulty: 3 Hard

Topic:  EBIT—EBI—ROA

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

54) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The profit margin used to calculate return on assets for 2019 is (rounded):

7. A) 7.9%
8. B) 8.2%
9. C) 8.5%
10. D) 16.3%

 

Answer:  B

Explanation:  (Net income + after-tax interest expense) ÷ sales = [$127,500 + ($10,000 ×(1 − 0.30))] ÷ $1,640,000 = 8.2%

Difficulty: 2 Medium

Topic:  EBIT—EBI—ROA

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

55) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The total asset turnover ratio for 2019 is (rounded):

1. A) 1.7 times.
2. B) 2.0 times.
3. C) 2.2 times.
4. D) 2.4 times

 

Answer:  C

Explanation:  Sales ÷ Average total assets = $1,640,000 ÷ (($825,000 + $695,000) ÷ 2) = 2.2 times.

Difficulty: 2 Medium

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

56) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

If there is no preferred stock, the return on common equity for 2019 is (rounded):

25. A) 25.8%
26. B) 27.9%
27. C) 41.4%
28. D) 43.4%

 

Answer:  B

Explanation:  Net income ÷ Average common equity. Compute common equity ($825,000 – $252,500 − $77,500 = $495,000) and ($695,000 − $200,000 − $75,000 = $420,000). Then $127,500 ÷ (($495,000 + $420,000) ÷ 2) = 27.9%.

Difficulty: 3 Hard

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

57) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

In a common size income statement for 2019, cost of goods sold is expressed as:

92. A) 92.0%
93. B) 60.0%
94. C) 119%
95. D) 167%%

 

Answer:  B

Explanation:  $982,500 ÷ $1,640,000 = 60%

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

58) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

In a common size balance sheet for 2019, accounts receivable is expressed as:

1. A) 86%.
2. B) 116.3%.
3. C) 32.4%.
4. D) 16.3%.

 

Answer:  C

Explanation:  $267,500 ÷ $825,000 = 32.4%.

Difficulty: 2 Medium

Topic:  Common-size and trend statements

Learning Objective:  05-01 Understand how cause-of-change analysis and common-size and trend statements illuminate complex financial statement patterns and shed light on business activities.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

59) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The current ratio for 2019 is (rounded):

1. A) 1.4 to 1
2. B) 2.0 to 1
3. C) 2.7 to 1
4. D) 3.4 to 1

 

Answer:  C

Explanation:  Current assets ÷ Current liabilities = $670,000 ÷ $252,500 = 2.7 to 1.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

60) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The quick ratio for 2019 is (rounded): (Assume that total current assets include cash, marketable securities, accounts receivable and inventory).

1. A) 1.1 to 1
2. B) 1.4 to 1
3. C) 1.6 to 1
4. D) 2.8 to 1

 

Answer:  B

Explanation:  Quick assets ÷ Current liabilities = ($670,000 − $312,500) ÷ $252,500 = 1.4 to 1.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

61) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The accounts receivable turnover for 2019 is (rounded): (Assume all sales are on account.)

2. A) 2.0 times.
3. B) 6.4 times.
4. C) 6.6 times.
5. D) 7.1 times.

 

Answer:  C

Explanation:  Sales ÷ Average accounts receivable = $1,640,000 ÷ [($267,500 + 230,000) ÷ 2] = 6.6 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

62) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The days receivable outstanding for 2019 is (rounded):

1. A) 51 days.
2. B) 55 days.
3. C) 60 days.
4. D) 183 days.

 

Answer:  B

Explanation:  365 days ÷ A/R turnover = 365 ÷ 6.6 = 55 days.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

63) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The inventory turnover for 2019 is (rounded):

2. A) 2.61 times.
3. B) 3.12 times.
4. C) 3.45 times.
5. D) 3.80 times.

 

Answer:  C

Explanation:  Cost of goods sold ÷ Average inventory = $982,500 ÷ [($312,500 + $257,500) ÷ 2] = 3.45 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

64) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The days inventory held for 2019 is (rounded):

1. A) 96 days.
2. B) 106 days.
3. C) 116 days.
4. D) 138 days.

 

Answer:  B

Explanation:  365 days ÷ Inventory turnover = 365 ÷ 3.45 = 106 days.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

65) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The long-term debt to assets for 2019 is (rounded):

9. A) 9.4%
10. B) 10.2%
11. C) 40.0%
12. D) 43.4%

 

Answer:  A

Explanation:  Long-term debt ÷ Total assets = $77,500 ÷ $825,000 = 9.4%.

Difficulty: 1 Easy

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

66) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

If the intangible assets in 2019 are $50,000, then the long-term debt to tangible assets for 2019 is:

10. A) 10.0%
11. B) 10.2%
12. C) 30.7%
13. D) 42.5%

 

Answer:  A

Explanation:  Long-term debt ÷ (Total assets − Intangible assets) = $77,500 ÷ ($825,000 − $50,000) = 10.0%.

Difficulty: 2 Medium

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

67) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The interest coverage for 2019 is:

12. A) 12.8 times.
13. B) 13.8 times.
14. C) 20.5 times.
15. D) 21.5 times.

 

Answer:  D

Explanation:  (Net income + interest expense + income taxes) ÷ Interest expense = ($127,500 + $10,000 + $77,500) ÷ $10,000 = 21.5 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

68) Condensed financial data are presented below for the Phoenix Corporation:

 

	2019					2018
Accounts receivable		267,500					$	230,000
Inventory		312,500						257,500
Total current assets		670,000						565,000
Intangible assets		50,000						60,000
Total assets		825,000						695,000
Current liabilities		252,500						200,000
Long-term liabilities		77,500						75,000
Sales		1,640,000
Cost of goods sold		982,500
Interest expense		10,000
Income tax expense		77,500
Net income		127,500
Cash flow from operations		71,000
Cash flow from investing activities		(6,000	)
Cash flow from financing activities		(62,500	)
Tax rate		30	%

 

The operating cash flows to total liabilities for 2019 is (rounded):

13. A) 13.4%
14. B) 21.5%
15. C) 23.4%
16. D) 28.1%

 

Answer:  C

Explanation:  Operating cash flows ÷ (average current liabilities + long-term liabilities) = $71,000 ÷ [(($252,500 + $200,000) ÷ 2) + $77,500] = 23.4%.

Difficulty: 3 Hard

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

69) With respect to asset utilization, which of the following is not correct?

1. A) Efficiency gains arise from improvements in managing accounts receivable.
2. B) How efficient the company is in utilizing its property, plant, and equipment is reflected in the long-term asset turnover ratio.
3. C) Asset turnover is only one part of the ROA calculation.
4. D) Issues with inventory obsolescence will be evidenced in the current asset turnover ratio.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Disaggregating ROA for profit performance

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

70) Financial ratios used to determine credit risk include an assessment of:

1. A) liquidity and asset utilization.
2. B) asset utilization and profitability.
3. C) solvency and liquidity.
4. D) profitability and solvency.

 

Answer:  C

Difficulty: 1 Easy

Topic:  Use of financial ratios in credit analysis

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

 

71) Which of the following is not correct with respect to computing ROCE?

1. A) Both common and preferred stock dividends are subtracted in arriving at net income available to common stockholders.
2. B) ROCE is affected by both ROA and the degree of financial leverage employed by the company.
3. C) The capital provided by common shareholders during the period can be computed by averaging total common shareholders’ equity at the beginning and end of the period.
4. D) Interest charged on loans, and dividends declared on preferred stock, are both subtracted in arriving at net income available to common shareholders.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

72) With respect to financial leverage which of the following is not a valid statement?

1. A) Financial leverage makes bad years look worse by decreasing the shareholder return.
2. B) Return on assets will generally equal return on common equity except when the company has no long-term debt.
3. C) Financial leverage makes good years look better by increasing the shareholder return.
4. D) Financial leverage is beneficial when the company earns more than the incremental after-tax cost of debt.

 

Answer:  B

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

 

73) Post Corporation purchases from suppliers on net 30 day terms, has an Accounts Receivable Turnover of 8 times, and an Inventory Turnover of 12 times. Cash inflows and outflows are:

1. A) evenly matched.
2. B) negatively mismatched by 60 days.
3. C) positively mismatched by 30 days.
4. D) negatively mismatched by 45 days.

 

Answer:  D

Explanation:  Days = Purchases – A/R – Inventory = 30 – 45 – 30 = – 45 days

Difficulty: 3 Hard

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Analyze

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking; FN Measurement

 

74) The percentage of assets financed by long-term debt is best described by the:

1. A) debt to equity ratio.
2. B) interest coverage ratio.
3. C) long-term debt to asset ratio.
4. D) long-term debt to tangible assets ratio.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

 

75) When operating earnings and cash flows from operations are dissimilar, which of the following ratios is a better measure of long-term solvency?

1. A) Interest coverage
2. B) Long-term debt to asset
3. C) Long-term debt to tangible assets
4. D) Operating cash flow to total liabilities

 

Answer:  D

Difficulty: 2 Medium

Topic:  Information from cash flow to assess credit risk; Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

76)  Which of the following financial ratios is not a component of the Z-score model?

1. A) Working capital/total assets.
2. B) Sales/total assets.
3. C) Common stock/total assets.
4. D) Retained earnings/total assets.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Z-Score and default risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Remember

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

77) When assessing a company’s credit risk:

1. A) Analysts use only financial ratios and do not need to review the statement of cash flows.
2. B) Analysts use only the statement of cash flows.
3. C) Both liquidity and solvency must be reviewed.
4. D) The assessment involves looking only at the operating and cash conversion cycles.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Use of financial ratios in credit analysis

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

78) Which of the following best describes measures of immediate liquidity?

1. A) The current ratio and the quick ratio will always have different results regardless of the industry in which the company operates.
2. B) The quick ratio excludes inventory in the denominator because most businesses cannot readily convert inventory to cash.
3. C) The current ratio reflects existing cash as well as amounts to be converted to cash in the normal operating cycle.
4. D) The quick ratio reflects existing cash as well as amounts to be converted to cash in the normal operating cycle.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

79) The accounts receivable turnover ratio:

1. A) is not useful in determining changes in customer payment patterns.
2. B) uses total sales and not just credit sales in the computation.
3. C) is computed using net credit sales and average accounts receivable.
4. D) is computed using net credit sales and ending accounts receivable.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Measurement; BB Resource Management

 

 

 

80) Changes in a company’s capital expenditures or fixed asset sales over time must:

1. A) be carefully analyzed for changes in the company’s strategy.
2. B) be indicative of changes in the company’s strategy.
3. C) indicate incompetent management.
4. D) raise the company’s risk of default on its debt.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

81) Select one of the following statements that best reflects the relationship between the operating cycle and the cash conversion cycle:

1. A) The operating cycle reflects how long it takes to sell inventory.
2. B) The two cycles will always match.
3. C) The cash conversion cycle includes the operating cycle and the number of days related to the purchase of inventory.
4. D) A mismatch between the two cycles indicates the company is headed for bankruptcy.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

 

 

82) Which of the following is not correct with respect to the debt to assets ratio?

1. A) Cyclical companies (those whose sales fluctuate widely due to changing economic conditions) generally have a smaller debt to assets ratio.
2. B) Cyclical companies (those whose sales fluctuate widely due to changing economic conditions) generally have a higher debt to assets ratio.
3. C) The percentage of long-term debt to assets would be higher for a utility company than for a retailer.
4. D) A high debt ratio increases long-term solvency risk.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management; BB Industry

83) Solvency refers to:

1. A) short-term ability to fund the company’s operating needs.
2. B) long-term ability to generate cash to for plant capacity needs and to fuel growth.
3. C) long-term ability to generate sufficient cash to satisfy plant capacity needs, fuel growth, and to repay debt when due.
4. D) the company’s ability to generate sufficient cash to repay debt when due.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Use of financial ratios in credit analysis

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

 

 

84)  Which of the following does not describe the impact of a firm’s capital structure on ROA and ROCE?

1. A) For a high-debt firm experiencing a profitable year, ROCE will likely be lower than ROA if the debt was not used to support operations.
2. B) A highly levered firm can be advantageous to common stockholders.
3. C) For a firm with no debt, ROCE will likely be the same as the ROA.
4. D) For a high-debt firm experiencing a profitable year, ROCE will likely be higher than ROA if the debt was used to support operations.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Analyze

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking

85) Although a company’s earnings are important in financial statement analysis, with respect to credit evaluations and lending decisions an analysis of its cash flows is:

1. A) optional.
2. B) central.
3. C) only important if the company has a high debt/equity ratio.
4. D) required by banking regulations.

 

Answer:  B

Difficulty: 1 Easy

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

 

 

86) Financially healthy companies:

1. A) will always generate positive operating cash flows.
2. B) should generate positive operating cash flows in most years.
3. C) should generate positive investing cash flows.
4. D) should always see total cash inflows exceed total cash outflows.

 

Answer:  B

Difficulty: 2 Medium

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

87) Which of the following factors does not negatively impact operating cash flows?

1. A) Accounts receivable are increasing.
2. B) Inventories are increasing.
3. C) Operating costs are increasing faster than sales.
4. D) Sales are increasing faster than operating costs.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Information from cash flow to assess credit risk

Learning Objective:  05-06 Understand how to use cash flow statement information when assessing credit risk.

Bloom’s:  Analyze

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking; FN Measurement

88) Debt financing:

1. A) is always a better choice than equity financing because of the tax deductibility of interest expense.
2. B) is only used by emerging growth companies with no access to equity capital.
3. C) is one option available to both established and emerging companies.
4. D) is only used by established growth companies because they are able to secure a low interest rate.

 

Answer:  C

Difficulty: 2 Medium

Topic:  Effect of financial leverage—ROCE assessment

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  FN Risk Analysis; BB Resource Management

 

89) Financial ratio, percentage, and trend comparisons can be distorted by all of the following except:

1. A) the presence of nonrecurring items among the firms being analyzed.
2. B) aggressive revenue recognition practices.
3. C) the timing of asset purchases.
4. D) accounting for similar economic fundamentals in similar fashion.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Interpret profitability and credit risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

90) With respect to financial ratios:

1. A) There may be accounting distortions which require the analyst to get “behind the numbers”.
2. B) There is only one correct way to compute many financial ratios.
3. C) Analysts make adjustments in computing financial ratios only for industry practice.
4. D) Financial ratios give analysts the answers they are searching for.

 

Answer:  A

Difficulty: 2 Medium

Topic:  Interpret profitability and credit risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking

 

91) Which of the following does not properly describe the Altman Z-score?

1. A) The Z-score is a multiple discriminant analysis using five financial ratios to estimate default risk.
2. B) The Z-score was originally designed only for publicly traded manufacturing firms.
3. C) Each ratio has its own unique weight in calculating the final score.
4. D) A high score is an indication of default risk.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Z-Score and default risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

92) Which of the following actions is not an option for the lender when the borrower is in default?

1. A) Petition a court to judge the borrower insolvent.
2. B) Adjust the loan payment schedule to better suit the company’s anticipated operating cash flows.
3. C) Modify the payment schedule in exchange for an increased interest rate or additional collateral, such as receivables, inventory, or equipment.
4. D) Contact the borrower’s customers and collect their receivables.

 

Answer:  D

Difficulty: 2 Medium

Topic:  Use of financial ratios in credit analysis; Interpret profitability and credit risk

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Understand

AACSB:  Reflective Thinking

AICPA:  BB Critical Thinking; FN Risk Analysis

 

 

 

93) Panera Bread Company is a national bakery-cafe concept with 1,380 Company-owned and franchise-operated bakery-cafe locations in 40 states and in Ontario, Canada. The company has grown from serving approximately 60 customers a day at its first bakery-cafe to currently serving nearly six million customers a week system-wide, becoming one of the largest food service companies in the United States. Sara Lee Corporation is a global manufacturer and marketer of high-quality, brand-name products for consumers throughout the world focused primarily on the meats, bakery and beverage categories. Selected financial information about each company follows:

 

	Sara Lee				Panera Bread
Sales	$	10,793	million		$	1,353.5	million
Net Income	$	527	million		$	86.8	million
Return on Assets (ROA)		8.32	%			11.55	%
Profit margin		7.05	%			6.45	%
Asset turnover		1.18	%			1.79

 

Required:

Why is Sara Lee less profitable than Panera Bread?

 

Return on assets and return on sales in the bakery industry are 4.85% and 8.16%, respectively. How do these two companies compare to their industry and what might explain any noted differences?

Answer:

a.) Return on assets, the measure of profitability in this case, is a function of both profit margin and asset turnover.  While Sara Lee has a slightly higher profit margin than Panera Bread (7.05% vs. 6.45%), its asset turnover is much lower than Panera Bread’s which explains the lower return on assets.

b.) Neither beats the industry average profit margin, but both are quite a bit better with respect to ROA; thus, both must have asset turnovers that are significantly higher than the industry average.

 

ROA = Profit margin × asset turnover.  For example, for Sara Lee, 8.32 = 7.05 × 1.18.

Difficulty: 2 Medium

Topic:  Interpret profitability and credit risk

Learning Objective:  05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Evaluate

AACSB:  Analytical Thinking

AICPA:  BB Critical Thinking

 

 

 

94) Selected data of the Peninsula Company follow:

 

	As of December 31
Balance Sheet Data	2019					2018
Accounts receivable	$	671,000				$	642,000
Allowance for doubtful accounts		31,000					22,000
Net accounts receivable	$	640,000				$	620,000
Inventories—lower of cost or market	$	542,500				$	642,500

 

	Year Ended December 31
Income Statement Data	2019					2018
Net credit sales	$	3,150,000				$	3,000,000
Net cash sales		800,000					600,000
Net sales	$	3,950,000				$	3,600,000
Cost of goods sold	$	2,370,000				$	2,160,000
Selling, general, and administrative expenses		475,000					350,000
Other		150,000					125,000
Total operating expenses	$	2,995,000				$	2,635,000
Net income	$	955,000				$	965,000

 

Required:

1. What is the accounts receivable turnover for 2019?
2. What is the inventory turnover for 2019?

Answer:

a.)  Accounts receivable turnover = 5.0 times.

b.)  Inventory turnover = 4.0 times.

Average trade receivables = ($640,000 + $620,000) ÷ 2 = $630,000

Accounts receivable turnover = Net credit sales ÷ Average trade receivables = $3,150,000 ÷ $630,000 = 5.0 times.

Average inventory = ($542,500 + $642,500) ÷ 2 = $592,500

Inventory turnover = Cost of goods sold ÷ average inventory = $2,370,000 ÷ $592,500 = 4.0 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

95) Selected information taken from the 2019 annual report of Aardvark Company follows. During 2019, the company had no nonoperating or nonrecurring items included in income and had no outstanding preferred stock.

 

($ in millions)	2019					2018
Sales	$	19,903					$	18,781
Interest expense		130						169
Net income		1,153						1,088
Total assets		12,673						12,461
Dividends		(153	)					(131	)
Total stockholders’ equity	$	4,288					$	4,007
Assumed tax rate		35	%					35	%
Industry ROA		7.32	%
Industry operating profit margin		6.1	%

 

Required:

12. For 2019, calculate: ROA, ROCE, operating profit margin, and asset turnover. Round your percentage answers to one decimal place. For example, .1234 = 12.3%.
13. Based on the industry data provided, does Aardvark appear to have a competitive advantage (briefly explain your answer)? If so, what strategy is the firm apparently following?

 

 

 

Answer:

a.

	Aardvark							Industry
ROA		9.8	%				7.3			%
ROCE		27.8	%
Operating profit margin		6.2	%				6.1			%
Asset turnover		1.584	times						1.2			times

 

b.) Aardvark does appear to have a competitive advantage because the company’s ROA exceeds that of its industry. To gain insight into the company’s strategy, first determine the asset turnover for the industry by dividing the industry ROA by the industry operating profit margin: 7.32% ÷ 6.1 = 1.2 times. Next, compare Aardvark’s operating profit margin and asset turnover to the industry’s statistics where it becomes apparent that the primary difference is Aardvark’s higher asset turnover. Higher asset turnovers are normally found in firms that adopt a low-cost leadership strategy. Thus, that appears to be Aardvark’s strategy.

 

a.) First, calculate EBI which equals after-tax operating profits plus after-tax interest charges = $1,153 + [130 × (1 − .35)] = $1,237.5

ROA = EBI ÷ Average assets = $1,237.5 ÷ [($12,673 + $12,461) ÷ 2] = 9.8%

ROCE = (Net income − Preferred dividends) ÷ Average common stockholders’ equity = ($1,153 − $0) ÷ (($4,288 + $4,007) ÷ 2) = 27.8%

Operating profit margin = EBI ÷ Sales = $1,237.5 ÷ $19,903 = 6.2%

Asset turnover = Sales ÷ Average assets = $19,903 ÷ (($12,673 + $12,461) ÷ 2) = 1.584

Difficulty: 3 Hard

Topic:  Effect of financial leverage—ROCE assessment; Disaggregating ROA for profit performance; Competitive forces and business strategies; Interpret profitability and credit risk

Learning Objective:  05-04 Understand how return on common equity (ROCE) can be used to assess the effect of financial leverage on profitability.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.; 05-02 Understand how competitive forces and business strategies affect a company’s profitability and financial position.; 05-03 Understand how return on assets (ROA) can be used to analyze a company’s profitability, and what insights are gained from disaggregating ROA into its profit margin and asset turnover components.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

96) In comparison of 2019 to 2018 performance, Weir Company’s inventory turnover decreased substantially, although sales and inventory amounts were essentially unchanged.

 

Required:

Which of the following statements best explains the decreased inventory turnover ratio?  Explain your answer choice.

 

• Cost of goods sold increased.
• Gross profit percentage increased.
• Accounts receivable turnover decreased.
• Total asset turnover decreased.

 

Answer:  Statement (b) best explains the decreased inventory turnover ratio. The gross profit margin increased. Sales were unchanged, so the gross profit margin increase would be due to decreased cost of goods sold. If inventory were also unchanged, the lower cost of goods sold would result in lower inventory turnover.

Difficulty: 3 Hard

Topic:  Financial ratios to assess liquidity; Interpret profitability and credit risk

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Apply

AACSB:  Critical Thinking

AICPA:  BB Critical Thinking

97) On January 1, 2018 Creek Company’s beginning inventory was $500,000. During 2018 the company purchased $2,400,000 of additional inventory, and on December 31, 2018 Creek’s ending inventory was $300,000.

 

Required:

What was Creek’s inventory turnover for 2018?

 

Answer:  Cost of goods sold = $500,000 + $2,400,000 – $300,000 = $2,600,000

Average inventory = ($500,000 + $300,000) ÷ 2 = $400,000

Inventory turnover = Cost of goods sold ÷ average inventory = $2,600,000 ÷ $400,000 = 6.5 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

98) Rome Company’s net accounts receivable was $200,000 at December 31, 2018 and $350,000 at December 31, 2019. Net cash sales for 2019 were $250,000. The accounts receivable turnover for 2019 was 8.0, and this turnover figure was computed from net credit sales for the year.

 

Required:

What were Rome’s total net sales for 2019?

 

Answer:  Total net sales equals total credit sales plus total cash sales. The accounts receivable ratio is used to find total credit sales. Average receivables = ($200,000 + $350,000) ÷ 2 = $275,000. Accounts receivable turnover = Total credit sales ÷ average receivables. 8.0 = Total credit sales ÷ $275,000. Total credit sales = $2,200,000. Total net sales = $2,200,000 + $250,000 = $2,450,000

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

99) Crue Company’s merchandise inventory and other related accounts for 2019 follow:

Sales	$	3,937,500
Cost of goods sold		2,756,250
Merchandise inventory:
Beginning of year		750,000
End of year		825,000

 

Required:

Calculate Crue’s inventory turnover during 2019 assuming that the merchandise inventory buildup was relatively constant during the year.

 

Answer:  Average inventory = ($750,000 + $825,000) ÷ 2 = $787,500

Inventory turnover = Cost of goods sold ÷ Average inventory = $2,756,250 ÷ $787,500 = 3.5 times

Difficulty: 2 Medium

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement

 

 

 

100) Selected information taken from the accounting records of Rigor Company follows:

 

Net accounts receivable at December 31, 2018	$	8,000,000
Net accounts receivable at December 31, 2019	$	9,000,000
Accounts receivable turnover		7 to 1
Inventories at December 31, 2018	$	1,000,000
Inventories at December 31, 2019	$	1,200,000
Inventory turnover		3 to 1

 

Required:

1. What was Rigor’s gross margin for 2019?
2. Suppose there are 360 business days in the year.  What was the number of days’ sales outstanding in average receivables and the number of days’ sales outstanding in average inventories for 2019, respectively?

 

Answer:

a.) Gross margin equals net sales minus cost of goods sold. Net sales can be found by using the accounts receivable turnover ratio:

Accounts receivable turnover = Net sales ÷ Average receivables

7.0 = Net sales ÷ (($800,000 + $900,000) ÷ 2). Net sales = $5,950,000.

Cost of goods sold can be found by using the inventory turnover ratio:

Inventory turnover = Cost of goods sold ÷ Average inventory

3.0 = Cost of goods sold ÷ (($1,000,000 + $1,200,000) ÷ 2). Cost of goods sold = $3,300,000. Gross margin = $5,950,000 − $3,300,000 = $2,650,000.

b.) Days’ sales in average receivables = 360 ÷ 7.0 = 51.4 days; Days’ sales in average inventories = 360 ÷ 3.0 = 120 days.

Difficulty: 3 Hard

Topic:  Financial ratios to assess liquidity

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

 

 

 

101) Jones Corporation wrote off $150,000 of obsolete inventory at December 31, 2018.

 

Required:

Describe the effect of this write-off on the company’s 2018 current and quick ratios.

 

Answer:  The write-off of obsolete inventory would decrease Todd Corporation’s current assets, thus decreasing the current ratio. The quick ratio would be unaffected by the inventory write-off because the quick ratio takes only the most liquid assets (cash, marketable securities, and receivables) into account.

Difficulty: 2 Medium

Topic:  Interpret profitability and credit risk

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Analyze

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

 

102) Vince Corporation has current assets of $300,000 and current liabilities of $175,000.

 

Required:

Compute the effect of each of the following transactions on Vince’s current ratio:

 

• Refinanced a $50,000 long-term mortgage with a short-term note.
• Purchasing $80,000 of merchandise inventory with short-term accounts payable.
• Paying $30,000 of short-term accounts payable.
• Collecting $40,000 of short-term accounts receivable.

Answer:  The refinancing of a $50,000 long-term mortgage with a short-term note would increase Vince’s current liabilities, decreasing the current ratio to 1.33 (= $300,000 ÷ $225,000) from the current ratio of 1.71 prior to this transaction.

Purchasing $80,000 of inventory with a short-term account payable would increase Vince’s current assets to $380,000, and increase the current liabilities to $255,000, making the current ratio 1.49 which is a decrease from the current ratio of 1.71 prior to this transaction.

Paying $30,000 of short-term accounts payable decreases both the current assets and liabilities by $30,000, making the current ratio 1.86 which is an increase from the current ratio of 1.71 prior to this transaction.

Collection of $40,000 of short-term accounts receivable has no effect on Vince’s current ratio.

Difficulty: 2 Medium

Topic:  Interpret profitability and credit risk

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.; 05-07 Understand how to interpret the results of an analysis of profitability and risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  BB Critical Thinking; FN Measurement

103) The following data were taken from the financial records of Happy Corporation for 2018:

 

Sales	$	3,600,000
Bond interest expense		100,000
Income taxes		700,000
Net income		900,000

 

Required:

How many times was bond interest covered in 2018?

 

Answer:  Interest Coverage  = Operating income before interest and taxes ÷ Interest expense = ($900,000 + $700,000 + $100,000) ÷ $100,000 = 17 times.

Difficulty: 2 Medium

Topic:  Financial ratios to assess solvency

Learning Objective:  05-05 Understand how short-term liquidity risk differs from long-term solvency risk, and what financial ratios are helpful in assessing these two dimensions of credit risk.

Bloom’s:  Apply

AACSB:  Knowledge Application

AICPA:  FN Measurement