Test bank with answers for financial accounting 6e by libby chapter 14

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Chapter 014: Analyzing Financial Statements

True / False Questions
1. A primary objective of financial statements is to provide information to current and
potential investors and creditors.
TRUE

AACSB Tag: Communications
Difficulty: Easy
L.O.: 1

2. The only way an investor will get a return on stock while they own the shares is for the
corporation to distribute a dividend.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 1

3. Return on equity (ROE) is a function of three ratios: net profit margin, return on assets, and
financial leverage.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 1

4. Time series analysis is where we compare information for a specific company over a period
of time to determine changes in operations.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 2

14-1
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Chapter 014: Analyzing Financial Statements

5. Finding comparable companies in order to compare performance is often difficult since no
two companies have identical products, markets and operating strategies.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 2

6. Component percentages are used to express items on financial statements as a percentage of
a base amount.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 3

7. Negative financial leverage occurs when a company has more debt than stockholders'
equity.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

8. Positive financial leverage benefits the common stockholders.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

14-2
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Chapter 014: Analyzing Financial Statements

9. A company that has a high level of inventory and other assets above their investment in
property, plant and equipment, should calculate the total asset turnover ratio in addition to the
fixed asset turnover ratio.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

10. A company with a high amount of inventory will have a much lower fixed asset turnover
ratio when compared to its total asset turnover ratio.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

11. The current ratio is sometimes called the working capital ratio.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 5

12. The average days' supply in inventory is computed by dividing the days in the year by the
ending balance of inventory.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

14-3
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Chapter 014: Analyzing Financial Statements

13. A very high current ratio and low quick ratio may indicate the company is not collecting
its accounts receivables in a timely manner.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

14. The current ratio is a more stringent test of liquidity than the quick ratio.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Easy

L.O.: 5

15. A low inventory turnover ratio can indicate high sales and/or low inventory levels.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

16. The quality of income computation is a test of the solvency of the company.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 6

17. Times interest earned gives an indication of the margin of protection for creditors.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 6

14-4
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Chapter 014: Analyzing Financial Statements

18. Many companies use high levels of debt to finance their assets because of financial
leverage benefits provided to investors when return on assets (ROA) exceeds the after tax cost
of interest.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 6

19. Dividend yield is calculated by dividing dividends per share by earnings per share and
measures the current dividend return to investors.
FALSE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 7

20. A high price earnings ratio usually indicates the market is optimistic about the company's

future earnings potential.
TRUE

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 7

Multiple Choice Questions
21. Ratios are most useful for analysis when
A. used alone.
B. compared with historical ratios of the same company.
C. compared with ratios for other companies of the same size.
D. compared with ratios of other companies in the same locations.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 1

14-5
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Chapter 014: Analyzing Financial Statements

22. There are several fundamental purposes decision makers consider when they use financial
data. Which of the following statements is not one of those fundamental purposes?
A. Measurement of the current condition of the business.
B. Measurement of past performance of the business.
C. Measurement of the book value of the assets of the business to predict future dividends.
D. Prediction of future potential of the business.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 1

23. When considering an investment, which of the following is not one of the three critical
factors used to evaluate future earning potential of that investment?
A. Financial analysts' reports.
B. Economy wide factors.
C. Industry factors.
D. Individual company factors.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 1

24. Which of the following statements is false?

A. A company implementing a cost advantage strategy is attempting to reduce investment in
assets thereby improving the asset turnover ratio.
B. A company implementing a product differentiation strategy is attempting to improve its
profit margin through charging higher prices.
C. A company will attract a higher volume of customers and revenue by following a product
differentiation strategy versus a cost advantage strategy.
D. All of the other answers are false.

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 1

14-6
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Chapter 014: Analyzing Financial Statements

25. Which of the following companies is most likely pursuing a product differentiation
strategy?
A. Wal-Mart
B. Kia
C. McDonalds
D. Cadillac

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 1

26. Which of the following is most likely pursuing a cost advantage strategy?
A. Cadillac
B. Tiffany
C. Wal-Mart
D. Mercedes

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 1

27. Home Depot's operating strategy is to offer a broad assortment of high-quality
merchandise and services at competitive prices using highly knowledgeable service-oriented
personnel and aggressive advertising. Which of the following is not critical to achieving its
strategy?
A. Cost control
B. Product differentiation
C. High level of customer service
D. High sales volume

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 1

14-7
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Chapter 014: Analyzing Financial Statements

28. Which of the following statements is false?
A. When computing the component percentages for the income statement, net income is the
base figure.
B. Time series analysis examines a company's performance over time.
C. It is often useful to compare a company's performance with that of a competitor.
D. The North American Industry Classification System assigns industry codes based on

business operations.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 2

29. Which of the following statements is true?
A. It is usually not difficult to find similar companies for financial performance comparisons.
B. One of the advantages of ratio analysis is that it allows companies of different sizes to be
compared.
C. Ratios compare items from the same financial statement.
D. It is preferable to compare a company's performance to industry-wide ratios rather than to
use a competitor's ratios.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 2

30. The base amount in preparing a common-size income statement is usually
A. cost of goods sold.
B. gross profit.
C. net income.
D. net sales.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 3

14-8
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Chapter 014: Analyzing Financial Statements

31. Which of the following statements is true?
A. When cost of goods sold as a percentage of sales increases the gross margin percentage
will increase.
B. It is possible for cost of goods sold in dollars to increase while cost of goods sold as a
percentage of sales decreases.
C. If gross margin percentage is the same for the current and past year, then sales and cost of
goods sold in dollars did not change.
D. If gross margin percentage increases, then the net income percentage will also increase.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 3

32. Which of the following statements is false?
A. If selling and administrative expenses as a percentage of sales increases, then gross margin
percentage will decrease.
B. If cost of goods sold percentage decreases, then profit margin will increase as a percentage
of sales.
C. If sales dollars decrease, we might still report a higher gross profit percentage if cost of
goods sold decreases at a faster rate than the decrease in sales.
D. It is possible for selling and administrative expense in dollars to decrease, while selling and
administrative expenses as a percentage of sales to increase.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 3

14-9
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Chapter 014: Analyzing Financial Statements

33. In 2010, Home Style's cost of goods sold percentage was 68.2% and its selling and store
operating costs was 19.3% of sales. In 2009, their cost of goods sold percentage was 68.9%
while its selling and store operating costs was 19.2% of sales. What effect would the change
in these percentages have on 2010's gross margin percentage and profit margin percentage?
A. Cost of goods sold would increase gross margin and profit margin percentages but selling
and store operating costs would decrease gross margin and profit margin percentages.
B. Cost of goods sold would decrease gross margin and profit margin percentages but selling
and store operating costs would increase gross margin and profit margin percentages.
C. Cost of goods sold would increase gross margin and profit margin percentages but selling
and store operating costs would decrease the profit margin percentage.
D. Cost of goods sold would decrease gross margin and profit margin percentages but selling
and store operating costs would increase profit margin percentage.

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 3

34. Which of the following ratios usually is not considered to be a test of profitability?
A. Current ratio.
B. Profit margin.
C. Return on assets.
D. Earnings per share.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 4

35. Which of the following items is not a category of commonly used financial ratios?
A. Tests of solvency.
B. Tests of liquidity.
C. Tests of timing.
D. Tests of profitability.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 4

14-10
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Chapter 014: Analyzing Financial Statements

36. Financial leverage will always be

A. Positive.
B. Negative.
C. Either positive or negative.
D. Positive, negative, or zero.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 4

37. The records of Everyday Electronics Corporation include the following:

The return on equity is (round to the nearest percent)
A. 13%.
B. 6%.
C. 25%.
D. 8%.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 4

14-11
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Chapter 014: Analyzing Financial Statements

38. The records of Marshall Company include the following:

The return on assets is (round to the nearest tenth of a percent)
A. 14.9%.
B. 18.3%.
C. 15.3%.
D. 14.7%.

AACSB Tag: Analytic
Difficulty: Hard
L.O.: 4

39. Maxwell Company's return on equity was 18% and the financial leverage percentage was
13% (positive). Return on assets was
A. 31%.
B. 18%.
C. 13%.
D. 5%.

AACSB Tag: Analytic

Difficulty: Medium
L.O.: 4

14-12
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Chapter 014: Analyzing Financial Statements

40. Trenton Company has outstanding shares as follows: common stock, no par, 150,000
shares and preferred stock, par $10, 25,000 shares. The number of shares that should be used
in the denominator to compute earnings per share should be
A. 150,000.
B. 175,000.
C. 125,000.
D. 100,000.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 4

41. Cecilia Company reported net income of $1,200,000. Their average total liabilities were
$4,300,000 and average total stockholders' equity was $5,200,000. Interest expense was
$100,000 and they are in a 30% tax bracket. Their return on assets is
A. 12.6%.
B. 16.3%.
C. 13.3%.
D. 13.7%.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 4

42. The use of borrowed funds to enhance the return to the stockholders is known as
A. liquidity.
B. factoring.
C. discounting.
D. financial leverage.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 4

14-13
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Chapter 014: Analyzing Financial Statements

43. Negative financial leverage occurs when the
A. average net (after tax) interest rate on borrowed funds is less than the return on assets.
B. return on assets is more than the return on equity.
C. return on equity is more than the return on assets.
D. two of the other answers are correct.

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 4

44. A quality of income ratio higher than one is an indicator
A. of a company's high debt position.
B. that fixed assets are the company's most important resources.
C. that a company has cash earnings generated by operations higher than the amount of net
income.

D. that a company has too many extraordinary items.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

45. A company with a very high gross profit ratio would most likely be
A. an advertising agency.
B. a CPA firm.
C. a local grocery store.
D. a Porsche dealership.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

14-14
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Chapter 014: Analyzing Financial Statements

46. If a company's return on equity (ROE) ratio increases from one year to the next, the most
likely cause is
A. an increase in net income.
B. a reduction in total expenses as a percentage of sales.
C. an increase in stockholders' equity.
D. an increase in net income and/or a reduction in total expenses as a percentage of sales.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 4

47. If a company's return on assets (ROA) stays the same from one year to the next but its
financial leverage ratio increases, then the most likely cause is
A. an increase in the debt to equity ratio.
B. a decrease in net income.
C. an increase in total assets.
D. an increase in stockholders' equity.

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 4

48. Which of the following statements is true?
A. We add in the after tax cost of interest to net income when calculating return on equity
(ROE).

B. Return on assets (ROA) shows the return generated on the use of all the company's assets
but return on equity (ROE) shows the return generated on the financing provided by the
common stockholders only.
C. Both return on assets (ROA) and return on equity (ROE) always use net income in the
numerator.
D. Both A and B are true

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 4

14-15
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Chapter 014: Analyzing Financial Statements

49. Which of the following ratios is not an indicator of a company's liquidity?
A. Price/earnings ratio
B. Receivable turnover ratio
C. Working capital ratio
D. Quick ratio

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 5

50. An important measure of the average movement of goods "on and off the shelf" of a
company is the
A. profit margin.
B. price/earnings ratio.
C. inventory turnover ratio.
D. gross inventory ratio.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 6

51. Teague Company's working capital was $40,000 and total current liabilities were 1/4 of
that amount. The current ratio was
A. 1 to 1.
B. 3 to 1.
C. 5 to 1.
D. 7 to 1.

AACSB Tag: Analytic
Difficulty: Hard

L.O.: 5

14-16
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Chapter 014: Analyzing Financial Statements

52. Agnes Company reported the following data:

The current ratio was
A. 0.5 to 1.
B. 1.5 to 1.
C. 2.5 to 1.
D. 0.75 to 1.

AACSB Tag: Analytic

Difficulty: Medium
L.O.: 5

53. If the current ratio is 2 to 1, the payment of a cash dividend, which was recorded as a
liability on the date of declaration, will
A. increase the current ratio.
B. decrease the current ratio.
C. have no effect on the current ratio.
D. invalidate earnings per share.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

14-17
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Chapter 014: Analyzing Financial Statements

54. Which of the following transactions would increase the current ratio of a company if the
ratio is currently more than 1 to 1?
A. Paid the principal on a long-term note payable.
B. Borrowed cash on a short-term note.
C. Sold inventory for more than cost.
D. Purchased supplies with cash.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

55. Potaw Company reported the following data at the end of 2010:

The average number of days to collect receivables during 2010 was
A. 16.2.
B. 14.3.
C. 36.5.
D. 21.9.

AACSB Tag: Analytic
Difficulty: Hard
L.O.: 5

56. The ratio of quick assets to current liabilities is known as the
A. working capital.
B. current ratio.
C. acid-test ratio.

D. cash coverage.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 5

14-18
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Chapter 014: Analyzing Financial Statements

57. If accounts receivable are collected quickly,
A. the accounts receivable turnover is low.
B. the company's credit policies may be overly stringent.
C. credit is often granted to poor credit risks.
D. liquidity is poor.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

58. Cromwell Company began the year with a balance in inventory of $110,000 and ended the
year with a balance of $102,000. The net sales for the year were $983,000 with a gross profit
on sales of $295,000. What was the inventory turnover ratio?
A. 2.78 times.
B. 9.27 times.
C. 6.49 times.
D. 2.89 times.

AACSB Tag: Analytic
Difficulty: Hard
L.O.: 5

59. Thomas Company had income before interest and taxes of $120,000. Interest expense for
the period was $17,000 and income taxes amounted to $28,500. The average stockholders'
equity was $680,000. What is Thomas Company's return on equity (ROE)?
A. 17.65%.
B. 15.15%.
C. 13.46%.
D. 10.96%.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 5

14-19

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Chapter 014: Analyzing Financial Statements

60. Wildlife Co. reported net income of $8.3 million, interest expense of $.5 million and they
are in a 30% tax rate bracket. Their average total assets are $65.8 million and average
stockholders' equity is $48.6 million. What is Wildlife Co.'s financial leverage percentage?
A. 3.7%
B. 4.5%
C. 4.0%
D. 4.7%

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 5

61. Which of the following is false?
A. The cash ratio is the most stringent and reliable test of liquidity.
B. A company with a high level of inventory will have a quick ratio significantly lower than
its current ratio.
C. A current ratio that is too high could indicate funds tied up in inventory and other working
capital assets.
D. Analysts consider a current ratio of 2 to be financially conservative.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

62. Which of the following is false?
A. The major difference between the quick and current ratios is whether or not inventory is
included.
B. Current liabilities are the denominator in the cash, quick, and current ratios.
C. Companies that sell expensive merchandise tend to have high inventory turnover ratios.
D. Some analysts do not use the cash ratio because it is very sensitive to small events.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

14-20
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Chapter 014: Analyzing Financial Statements

63. Which of the following companies is most likely to have the highest inventory turnover
ratio?
A. Taco Bell franchises.
B. Publix food supermarkets.
C. Wal-Mart.
D. Mercedes Benz dealership.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 5

64. Which of the following ratios is not a test of solvency?
A. Debt to equity ratio.
B. Cash coverage ratio.
C. Times interest earned.
D. Earnings per share ratio.

AACSB Tag: Relative Thinking

Difficulty: Medium
L.O.: 6

65. Bailey Corporation reported the following information for 2009

Bailey Corporation's debt/equity ratio was
A. 33 .0
B. 1.25
C. 1.0
D. 3.0

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 6

14-21
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Chapter 014: Analyzing Financial Statements

66. The following ratio would be used to evaluate the long-term risk and capital structure of a
company:
A. debt/equity ratio.
B. quick ratio.
C. profit margin.
D. cash ratio.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 6

67. The accounting ratio which considers the importance of cash flows relating to required
interest payments is the
A. times interest earned ratio.
B. debt/equity ratio.
C. cash coverage ratio.
D. receivable turnover ratio.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 6

68. Which of the following is true?
A. The times interest earned ratio is considered a better test of the ability to cover interest
charges than the cash coverage ratio.
B. The debt to equity ratio shows the relative proportion of total assets financed by debt.

C. The higher the debt to equity ratio, the higher the potential return to the stockholders if
return on assets (ROA) exceeds the after tax cost of interest.
D. The cash coverage ratio compares the cash generated by a company to its cash obligations
for the prior period.

AACSB Tag: Relative Thinking
Difficulty: Hard
L.O.: 6

14-22
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Chapter 014: Analyzing Financial Statements

69. Which of the following statements is true?
A. Tests of profitability focus on measuring the adequacy of income.

B. Liquidity focuses on the ability of a company to pay their long- and short-term debts.
C. The inventory turnover ratio is an important solvency test for retail companies.
D. Growth in total sales volume always indicates that a company is successful.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 7

70. Which ratio reflects the stock market's assessment of a company's future performance?
A. price/earnings ratio.
B. dividend yield ratio.
C. book value per share.
D. cash coverage ratio.

AACSB Tag: Relative Thinking
Difficulty: Easy
L.O.: 7

71. The Apple Pie Company had net income of $47,500 and earnings per share of $3.17
during 2010. On December 31, 2010, the stock had a market price of $18.50 per share. What
is Apple Pie Company's price/earnings ratio?
A. 25.70.
B. 8.11.
C. 5.84.
D. 0.17.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 7

14-23
©2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e


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Chapter 014: Analyzing Financial Statements

72. Main Street Company paid out $2.30 in dividends per share during 2010. The market
price of the stock on December 31, 2010 was $21.00 per share. There were 15,000 shares of
stock outstanding for the entire year. The dividend yield as of December 31, 2010 was
A. 16.43%.
B. 10.95%.
C. 9.13%.
D. 913.04%.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 7

73. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2010 and
2009. MusicPod's stock was trading at $53.00 and $41.50 per share in 2010 and 2009
respectively. The company paid cash dividends per share of $.85 in 2010 and $.63 in 2009.
Total stockholders' equity was $13,572 million and $11,896 million in 2010 and 2009
respectively. The common shares outstanding were approximately 1,782,000 in both 2010 and
2009.
Calculate MusicPod's price earnings ratio for 2010 and 2009 respectively.
A. 21.5 and 0.20 times.
B. 1.0% and 2.9%.
C. 21.5% and 20.0%.
D. 21.5 and 20.0 times.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 7

14-24
©2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e


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Todownload
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moreslides,
slides,ebook,
ebook,solutions
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andtest
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bank,visit
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Chapter 014: Analyzing Financial Statements

74. MusicPod's earnings per share ratios were $2.47 and $2.07 respectively for 2010 and
2009. MusicPod's stock was trading at $53.00 and $41.50 per share in 2010 and 2009
respectively. The company paid cash dividends per share of $.85 in 2010 and $.63 in 2009.
Total stockholders' equity was $13,572 million and $11,896 million in 2010 and 2009
respectively. The common shares outstanding were 1,782,000 in both 2010 and 2009.
Calculate MusicPod's dividend yield for 2010 and 2009 respectively.
A. 39.1% and 39.1%.
B. 39.3% and 33.8%.
C. 1.6% and 1.5%.
D. 3.2% and 1.1%.

AACSB Tag: Analytic
Difficulty: Medium
L.O.: 7

75. A new company with a high property, plant, and equipment balance would most likely be
A. a cell phone retailer.
B. a hotel.
C. a pizza take-out company.
D. a hot dog vendor on an airport concourse.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 7

76. A company with a high merchandise inventory balance would most likely be
A. a hotel.
B. a travel agency.
C. a jewelry store.
D. a law firm.

AACSB Tag: Relative Thinking
Difficulty: Medium
L.O.: 7

14-25
©2009 McGraw-Hill Inc. Test Bank to accompany Libby Financial Accounting 6/e