Test Bank For Understanding Financial Statements 11th Edition By Ormiston

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Test Bank For Understanding Financial Statements 11th Edition By Ormiston

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WITH ANSWERS

 

Understanding Financial Statements 11th Edition By Ormiston  Test Bank 

 

Test Questions and Solutions

 

Chapter 1

 

True-False

 

  1. A firms annual report contains only two pieces of information: the financial statements and the notes to the financial statements.

 

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

 

  1. The FASB has congressional authority to set accounting policies.

 

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

 

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

 

  1. Congress passed the Sarbanes-Oxley Act of 2002 in hopes of ending future accounting scandals and renewing investor confidence in the marketplace.

 

  1. The Management Discussion and Analysis is of potential interest to the analyst because it contains information that cannot be found in the financial data.

 

  1. Information that is significant enough to make a difference in a decision is considered to be immaterial.

 

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

 

  1. GAAP-based financial statements are prepared according to the accrual basis of accounting.

 

Fill in the Blank

 

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

 

  1. A corporate annual report contains financial statements.

 

  1. is responsible for the preparation of the financial statements, including the notes, and the  attests to the fairness of the presentation.

 

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

 

  1. The is a document used to solicit shareholder votes.

 

  1. The Assumption is the assumed unit of measurement when preparing financial statements.

 

  1. The cash basis of accounting recognizes when cash is received and recognizes when cash is paid.

 

  1. The sharper and clearer the picture presented through the financial data and the closer that picture is to financial reality, the higher the  financial statements and reported earnings.

 

  1. One of the generally accepted accounting principles that provide the foundation for preparing financial statements is the principle.

 

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

 

Multiple Choice

 

  1. What information would not be found in a firms annual report?
  2. Notes to the financial statements.
  3. Financial Reporting Rulings.
  4. Auditors report.
  5. High and low stock prices.

 

  1. Which agency requires the filing of Form 10-Ks, Form 10-Qs and Form 8-Ks?
  2. FASB.
  3. IASB.
  4. SEC.
  5. GAAP.
  6. Which of the following statements is true?
  7. Foreign firms registered with the SEC may file reports based on IFRS.
  8. U.S. firms registered with the SEC may file reports based on IFRS.
  9. The European Union requires firms to report based on GAAP.
  10. Foreign firms registered with the SEC may file reports based on IFRS only if they reconcile all amounts to GAAP.

 

  1. Which financial statement presents the results of operations?
  2. Balance sheet.
  3. Statement of financial position.
  4. Income statement.
  5. Statement of cash flows.

 

  1. Which financial statement shows the assets, liabilities and stockholders equity of the firm on a particular date?
  2. Statement of stockholders equity.
  3. Statement of cash flows.
  4. Earnings statement.
  5. Balance sheet.

 

  1. Which financial statement provides information about operating, financing and investing activities?
  2. Statement of financial position.
  3. Statement of cash flows.
  4. Statement of stockholders equity.
  5. Income statement.

 

  1. What information can be found on a statement of stockholders equity?
  2. A reconciliation of the cash account and the retained earnings account.
  3. A reconciliation of the beginning and ending balances of all accounts that appears in the stockholders equity section of the balance sheet.
  4. A reconciliation of the operating, investing and financing activities of a firm.
  5. A reconciliation of net profit or loss and the cash account.

 

  1. What basic financial statements can be found in a corporate annual report?
  2. Balance sheet, income statement, statement of shareholders equity, and statement of cash flows.
  3. Balance sheet, auditors report and income statement.
  4. Earnings statement and statement of retained earnings.
  5. Statement of cash flows and five-year summary of key financial data.

 

  1. What is an unqualified audit report?
  2. A report stating that the auditors are not qualified to report on a firm.
  3. A report that states the financial statements are in violation of GAAP.
  4. A report that states that departures from GAAP exist in the firms financial statements.
  5. A report that states the financial statements are presented fairly, in all material respects, and are in conformity with GAAP.

 

  1. What is a qualified report?
  2. A report stating that the auditors are not qualified to report on a firm.
  3. A report that states the financial statements are in violation of GAAP.
  4. A report that states that departures from GAAP exist in the firms financial statements.
  5. A report that states the financial statements are presented fairly, in all material respects, and are in conformity with GAAP.

 

  1. What organization has the authority to register, inspect, and discipline auditors of all publicly owned companies?
  2. Public Company Accounting Oversight Board.
  3. SOX.
  4. Congress.
  5. FASB.

 

  1. According to Section 302 of the Sarbanes-Oxley Act, who must certify the accuracy of the financial statements of a public company?
  2. Public Company Accounting Oversight Board.
  3. SEC.
  4. External auditor.
  5. CEO and CFO.

 

  1. All of the following items should be discussed in the management discussion and analysis except for:
  2. Anticipated changes in the mix and cost of financing resources.
  3. The market value of all assets.
  4. The internal and external sources of liquidity.
  5. Unusual or infrequent transactions that affect income from continuing operations.

 

  1. Which of the following is an internal source of liquidity?
  2. Borrowing.
  3. Sales of stock.
  4. Gifts and donations.
  5. Sales of products or services.

 

  1. Which of the following is an external source of liquidity?
  2. Sales of services.
  3. Repurchase of stock.
  4. Borrowing.
  5. Sales of products.

 

  1. Which of the following is not a condition that must be met for an item to be recorded as revenue?
  2. Revenues must be earned.
  3. The amount of the revenue must be measurable.
  4. The revenue must be received in cash.
  5. The costs of generating the revenue can be determined.

 

  1. How are revenues and expenses recognized under the accrual basis of accounting?
  2. Revenues are recognized when cash is received and expenses are recognized when cash is paid.
  3. Revenues and expenses are recognized equally over a twelve month period.
  4. Revenues and expenses are recognized based on the choices of management.
  5. Revenues are recognized in the accounting period when the sale is made and expenses are recognized in the period in which they relate to the sale of the product.

 

  1. In what industry would it be expected that companies would spend a significant amount on research and development activities?
  2. Pharmaceutical.
  3. Clothes retailer.
  4. Groceries.
  5. Wholesale distributor of computer parts.

 

  1. Which of the following items is a discretionary expenditure?
  2. Union wages.
  3. Factory building to produce inventory.
  4. Advertising.
  5. Taxes.

 

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

 

Short Answer

 

  1. Write a short essay explaining the following statement: Unfortunately, there are mazelike interferences in financial statement data that hinder understanding the valuable information they contain.

 

  1. Describe the relationship between the FASB and the SEC.

 

  1. Explain why the notes are an integral part of the financial statements.

 

  1. Discuss the impact that the Sarbanes-Oxley Act of 2002 had on internal auditing.

 

  1. Define internal and external sources of liquidity. What is a material deficiency in liquidity? If a firm has a material deficiency in liquidity what should be reported in the management discussion and analysis?

 

  1. What types of information may be missing or hard to find in the financial statements?

 

  1. Explain why the characteristics of comparability and consistency are important in financial reporting?

 

8. Write an essay discussing the two key principles that are the foundation of the accrual basis of accounting

 

Chapter 2

 

True-False

 

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

 

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

 

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

 

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

 

  1. As part of an integrated disclosure system required by the SEC, the information presented in annual reports includes three-year audited balance sheets.

 

  1. A common-size balance sheet is useful to the analyst because it facilitates the structural analysis of the firm.

 

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

 

  1. The valuation of marketable securities on the balance sheet requires the separation of investment securities into three categories: held to maturity, trading securities, and securities available for sale.

 

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

 

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

 

Fill in the Blank

 

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

 

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

 

  1. are also referred to as short-term investments.

 

  1. The net realizable value of accounts receivable is the actual amount of the account less an .

 

  1. Additional information helpful to the analysis of accounts receivable and the allowance account is provided in the schedule of .

 

  1. The three cost flow assumptions most frequently used in the U.S. are , , and                       .

 

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

 

  1. Companies that are paid in advance for services or products record a liability on the receipt of cash in an account titled or                         .

 

  1. A lease affects both the balance sheet and the income statement.

 

  1. Many companies list an account titled on the balance sheet even though no dollar amount will appear.

 

Multiple Choice

  1. The balancing equation is expressed as:
  2. Assets + Liabilities = Stockholders Equity.
  3. Revenues Expenses = Net Income.
  4. Sales Costs = Net Profit.
  5. Assets = Liabilities + Stockholders Equity.

 

  1. Which of the following statements is false?
  2. Common-size balance sheets allow for comparison of firms with different levels of total assets by introducing a common denominator.
  3. The common-size balance sheet reveals the composition of assets within major categories.
  4. Each item on a common-size balance sheet is expressed as a percentage of sales.
  5. The common-size balance sheet reveals the capital and the debt structure of the firm.

 

  1. Which of the following accounts would be classified as current assets on the balance sheet?
  2. Accounts receivable, inventory, cash equivalents.
  3. Marketable securities, accounts payable, property, plant and equipment.
  4. Prepaid expenses, goodwill, long-term investments.
  5. Property, plant and equipment, inventory, goodwill.

 

  1. Which of the following items would not be classified as cash equivalents?
  2. U.S. Treasury bills.
  3. Trading securities.
  4. Commercial paper.
  5. Money market funds.

 

  1. Which of the following marketable securities are reported at fair value?
  2. Held to maturity and trading securities.
  3. Trading securities and securities available for sale.
  4. Held to maturity and securities available for sale.
  5. Corporate bonds and convertible debt.

 

  1. Which of the following items should alert the analyst to the potential for manipulation when analyzing accounts receivable and the allowance for doubtful accounts?
  2. Sales, accounts receivable and the allowance for doubtful accounts are all growing at approximately the same rate.
  3. A company lowers its credit standards and also increases the balance in the allowance for doubtful accounts.
  4. Accounts receivable is growing at a large rate and the allowance for doubtful accounts is decreasing.
  5. An analysis of the Valuation and Qualifying Accounts schedule required in the Form 10-K reveals that the amounts recorded for bad debt expense are close in amount to the actual amounts written off each year.

 

  1. Which method of inventory assumes the last units purchased will remain in ending inventory on the balance sheet?
  2. FIFO.
  3. LIFO.
  4. Average cost.
  5. LIFO and FIFO.

 

 

  1. Which type of firm would most likely carry the most finished goods inventory?
  2. A manufacturing firm.
  3. A retail firm.
  4. A service firm.
  5. A wholesale firm.

 

  1. Which method of inventory would be least likely to be used by a European firm?
  2. FIFO.
  3. LIFO.
  4. Average cost.
  5. LIFO and FIFO.

 

  1. Which of the following statements is false?
  2. Companies are allowed to use more than one inventory valuation method.
  3. LIFO is an income tax concept.
  4. Using FIFO for high-technology products makes sense if the firm is trying to reduce taxes because the technology industry is generally deflationary.
  5. Companies using IFRS may not reverse entries for inventory write-downs if the market recovers.

 

Use the following information to answer questions 11 through 13:

 

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

 

Unit                        Cost per Unit

1                                 $10

2                                 $12

3                                 $15

4                                 $18

5                                 $13

 

  1. Assume ABC sells two items and uses the FIFO method of inventory valuation. What amount would appear in ending inventory on the balance sheet?
  2. $22
  3. $46
  4. $45
  5. $31

 

  1. Assume ABC sells two items and uses the LIFO method of inventory valuation. What amount would appear for cost of goods sold on the income statement?
  2. $37
  3. $41
  4. $22
  5. $31

 

  1. Assume ABC uses the average cost method of inventory valuation. What unit cost would be used to determine the amount in ending inventory or cost of goods sold?
  2. $12.67
  3. $13.60
  4. $15.00
  5. $13.00

 

  1. Which of the following statements is true?
  2. The straight-line method of depreciation allocates a decreasing amount of depreciation expense each year.
  3. Straight-line depreciation is the least used method for financial reporting purposes.
  4. Fixed assets are reported at historical cost less accumulated depreciation on the balance sheet.
  5. The total amount of depreciation over the assets life is larger when using an accelerated method of depreciation.

 

  1. When will a firm regard goodwill on its books?
  2. When one company acquires another company for a price in excess of the fair market value of the net identifiable assets acquired.
  3. When the firm donates property to charities.
  4. When it is determined that there has been a loss of value of long-term assets.
  5. When fixed assets are impaired.

 

  1. Which of the following accounts could be categorized as either a current or noncurrent liability depending on date the debt is due?
  2. Notes payable and deferred taxes.
  3. Accounts payable and current portion of long-term debt.
  4. Deferred taxes and mortgages due in 30 years.
  5. Long-term warranties and accounts payable.

 

  1. Which items would be classified as long-term debt?
  2. Accounts payable, unearned revenue, pension liabilities.
  3. Common stock, retained earnings, bonds payable.
  4. Mortgages, convertible debentures, bonds payable.
  5. Deferred taxes, accrued expenses, treasury stock.

 

  1. How are deferred taxes recorded on the balance sheet?
  2. As current or noncurrent liabilities.
  3. As stockholders equity.
  4. As noncurrent assets or noncurrent liabilities.
  5. As current or noncurrent assets or liabilities.

 

  1. Which stockholders equity account represents the sum of every dollar a company has earned since its inception, less any payments made to shareholders in the form of dividends?
  2. Treasury stock.
  3. Accumulated other comprehensive income
  4. Retained earnings.
  5. Preferred stock.

 

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

 

Short Answer/Problem

  1. Explain the format and key components of a balance sheet prepared in the U.S. or overseas.

 

  1. Define current assets and current liabilities and give two examples of each.

 

  1. Why should the allowance for doubtful accounts and the valuation and qualifying accounts schedule be analyzed?

 

  1. Write a short explanation of why you agree or disagree with the following statement:

 

The LIFO method of inventory valuation cannot be used by grocery stores.

 

  1. Explain the impact of calculating depreciation using the straight-line method versus an accelerated method on the amounts shown on a balance sheet.

 

  1. Using the following information analyze the accounts receivable and the allowance for doubtful accounts for this company:

 

2015                              2014

Sales                                                 $11,230                $10,340

Accounts receivable, net                                 1,510                    1,860

Allowance for doubtful accounts               43                         32

 

  1. Using the following excerpts from the most recent annual report of WooHoo, a high technology firm, analyze the accounts receivable and allowance for doubtful accounts. Be sure to show all calculations and write a thorough interpretation of those calculations.

 

(dollars in millions) 2015 2014
Net sales $7,200 $6,400
Accounts receivable less allowance for doubtful accounts of $22 at April 30, 2015 and $40 April 30, 2014 $1,000 $1,030

 

WooHoo

Valuation And Qualifying Accounts

For the Years Ended April 30, 2015, 2014 and 2013

 

  Balance at beginning of period Charged to expenses Deductions Balance at end of period
Allowance for doubtful accounts        
2015 $40 $5 ($23) $22
2014 $51 $4 ($15) $40
2013 $46 $25 ($20) $51

 

  1. Why is the inventory accounting method chosen by a company important to the user of financial statement information?

 

  1. Using the following information calculate the ending inventory balance and the cost of goods sold expense that would be reported at the end of the year if the following inventory valuation methods are used:

 

  1. Average cost
  2. FIFO
  3. LIFO

Units                    Purchase Price

Beginning inventory                100                               $25

Purchase #1                                         80                               $26

Purchase #2                                      160                                $23

Purchase #3                                         90                               $24

Sales                                        260

 

  1. Using the following information calculate the ending inventory balance and the cost of goods sold expense that would be reported at the end of the year if the following inventory valuation methods are used:

 

  1. Average cost
  2. FIFO
  3. LIFO

Units                    Purchase Price

Beginning inventory                      8                              $8

Purchase #1                                          15                              $9

Purchase #2                                          24                              $11

Purchase #3                                          12                              $13

Sales                                            40

 

  1. The Breakfast Company purchases equipment for $100,000. Management estimates that the equipment will have a useful life of eight years and no salvage value.

 

  1. Calculate depreciation expense and the book value of the equipment at the end of the first year using the straight-line method of depreciation.
  2. Calculate depreciation expense and the book value at the end of the first year using the double-declining balance method of depreciation.

 

  1. Redtop Co. purchased a piece of equipment last year for $300,000. Management estimates that the equipment will have a useful life of five years and no salvage value. The depreciation expense recorded for tax purposes will be $72,000 this year (Year 2).  The company uses the straight-line method of depreciation for reporting purposes.

 

  1. Calculate the amount of depreciation expense for reporting purposes this year (Year 2).
  2. What will be the net book value of the equipment reported on the balance sheet at the end of this year (Year 2)?
  3. Will a deferred tax asset or liability be created as a result of the depreciation recorded for tax and financial reporting purposes?
  4. What amount will be added to the deferred tax account as a result of the depreciation timing difference?

 

  1. Explain the differences between accounts payable, short-term debt, current maturities of long-term debt, accrued liabilities and unearned revenue.

 

  1. Explain the differences between long-term notes payable, mortgages, debentures, bonds payable, and convertible debt.

 

  1. Using the following balance sheet, prepare a common size balance sheet:

 

Assets                                                         Liabilities and stockholders equity

Current assets                                            Current liabilities

Cash                                4                         Accounts payable          28

Short-term investments   9                         Current portion of

Accounts receivable       32                         long-term debt               12       Inventory                       41               Total current liabilities            40

Prepaid expenses             2               Long-term liabilities

Deferred taxes, current    7                         Long-term debt              48

Total current assets                 95               Total liabilities                        88

Long-term assets                                        Stockholders equity

Property & equipment   53                         Common stock and PIC 51               Goodwill                             12                         Retained earnings          30

Long-term investments    8

Other assets                               1               Total stockholders equity       81

Total assets                              169             Total liabilities and equity        169

 

 

 

  1. Analyze the following common size balance sheet:

 

2015           2014

Current assets:

Cash                                                     1%           16%

Accounts receivable                          24              18

Inventory                                          35              30

Total current assets                                    60%           64%

 

Property, plant and equipment                            37              26

Other assets                                                           3              10

Total assets                                                100%           100%

 

Current liabilities:

Accounts payable                               29%            27%

Short-term debt                                   23               33

Total current liabilities                                 52%            60%

 

Long-term debt                                             22               17

Total liabilities                                              74%            77%

 

Common stock and paid in capital                 9               10

Retained earnings                                         17               13

Total stockholders equity                            26%           23%

Total liabilities and stockholders equity    100%          100%

 


 

Chapter 3

 

True-False

 

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

 

  1. The statement of stockholders equity is an important link between the balance sheet and the income statement.

 

  1. The income statement comes in two basic formats, the multiple-step and the single-step versions; however, for analysis purposes the single-step version should be used.

 

  1. The common size income statement expresses each income statement item as a percentage of total assets.

 

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

 

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

 

  1. In volatile industries, such as high technology, gross profit margin may increase or decrease significantly each year.

 

  1. Operating profit margin is impacted by sales and all operating expenses except cost of goods sold.

 

  1. Users of financial statements need to distinguish between earnings increasing due to core operations versus items such as tax rate deductions.

 

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

 

Fill in the Blank

 

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

 

  1. income is the change in equity of a company during a period from transactions, other events, and circumstances relating to nonowner sources.

 

  1. The method of inventory generally results in the matching of current costs with current revenues and therefore produces higher-quality earnings.

 

  1. The gross profit margin and are complements of each other and the two percentages always add up to 100%.

 

  1. costs are or should be a major expense in the budgets of companies for which marketing is an important element of success.

 

  1. and                       represent the cost of assets other than land that will benefit a business enterprise for more than a year.

 

  1. charges are the expenses recognized to record a decline in value of a long-term asset.

 

  1. The method of accounting for investments should be used when the investor can exercise significant influence over the investees operating and financing policies.

 

  1. Foreign currency translation effects, unrealized gains and losses, additional pension liabilities and cash flow hedges are items that may comprise a companys other  income.

 

  1. Stock and stock                       result in the issuance of additional shares of stock to existing shareholders.

 

Multiple Choice

 

  1. Which equation represents an income statement?
  2. Assets = liabilities + stockholders equity.
  3. Cash in cash out = net income.
  4. Revenues expenses = net income.
  5. Beginning retained earnings + revenues expenses = ending retained earnings.

 

  1. Which format of the income statement should be used for analysis purposes?
  2. Multiple-step.
  3. Cash basis.
  4. Single-step.
  5. Accrual basis.

 

  1. Which of the following is an acceptable method to report total comprehensive income?
  2. On the face of the balance sheet.
  3. Total comprehensive income does not have to be reported.
  4. In the operating section of the cash flow statement.
  5. In the statement of stockholders equity.

 

  1. How is a common-size income statement prepared?
  2. Each income statement item is expressed as a percentage of total assets.
  3. Each income statement item is expressed as a percentage of net sales.
  4. Each income statement item is expressed as a percentage of net income.
  5. Each income statement item is expressed as a percentage of cash flow.

 

  1. How are sales reported on the income statement?
  2. Sales are shown for three years net of returns and allowances.
  3. Sales amounts are inflation-adjusted.
  4. Sales are shown for two years and are reported in nominal terms.
  5. Sales are shown at gross amounts, adjusted for inflation.

 

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

 

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

 

  1. Selling and administrative expenses include which of the following income statement items?
  2. Salaries, insurance, interest.
  3. Salaries, rent, advertising.
  4. Rent, interest, cost of goods.
  5. Advertising, research & development, amortization.

 

  1. What is amortization?
  2. The process used to allocate the cost of natural resources.
  3. The process used to allocate the cost of tangible fixed assets.
  4. The process used to allocate the cost of capital leases, leasehold improvements and intangible assets.
  5. The process used to allocate the cost of oil, gas, minerals and standing timber.

 

  1. Which item would not be classified as an operating expense?
  2. Interest expense.
  3. Rent expense.
  4. Depreciation.
  5. Repairs and maintenance.

 

  1. Which of the following statements is true?
  2. It is unnecessary to analyze operating expenses over which management exercises discretion.
  3. Impairment charges do not need to be analyzed since they are generally a non-recurring expense.
  4. A good way to improve operating profit is to cut repairs and maintenance costs as much as possible.
  5. Operating expenses can be easily analyzed by preparing a common-size income statement.

 

  1. Why is it important to assess operating profit?
  2. Operating profit represents the firms profits after consideration of all revenues, expenses and comprehensive income.
  3. The figure for operating profit provides a basis for assessing the success of the firm apart from its financing and investing activities and separate from    tax considerations.
  4. Operating profit represents the firms profits after consideration of all revenues and expenses.
  5. Operating profit represents the firms profits after consideration of all revenues and expenses, except for taxes.

 

  1. Which of the items below would be included under Other income and expense?
  2. Salaries, interest expense, equity losses.
  3. Equity earnings, gains from sale of assets, interest income.
  4. Research and development, dividend income, interest expense.
  5. Advertising, cost of goods sold, selling and administrative expenses.

 

  1. How does the equity method distort earnings?
  2. Income is recognized even though cash may never be received.
  3. Equity earnings are recorded even if the investor cannot exercise influence over the investees policies.
  4. Equity earnings are only recorded on a cash basis of accounting.
  5. Equity earnings are recorded when investment ownership is 100%.

 

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

 

  1. Which item is not a special item that must be disclosed separately on the income statement?
  2. Extraordinary gain.
  3. Extraordinary loss.
  4. Foreign currency translation adjustments.
  5. Discontinued operations.

 

  1. How is earnings per common share calculated?
  2. Operating profit divided by the average number of common stock shares outstanding.
  3. Net profit divided by the average number of common and preferred stock shares outstanding.
  4. Operating profit divided by the average number of repurchased common stock shares.
  5. Net profit divided by the average number of common stock shares outstanding.

 

  1. Which of the following items could be found on a statement of shareholders equity?
  2. Reasons for retained earnings increases or decreases.
  3. A reconciliation of beginning to ending cash.
  4. The market value of the firms common stock.
  5. Assets = Liabilities + Stockholders Equity.

 

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

 

2015           2014

Sales                                                 1,200          1,000

COGS                                                 850             700

Operating expenses                              200              200

Income taxes                                          30               35

 

  1. Jett Co.s gross profit, operating profit and net profit margins for 2015 are:
  2. 50.0%, 32.5%, 22.5% respectively.
  3. 29.2%, 12.5%, 10.0%, respectively.
  4. 27.0%, 11.0%, 10.5%, respectively.
  5. 21.5%, 17.5%, 12.0%, respectively.

 

  1. Jett Co.s average tax rates for 2015 and 2014 are:
  2. 15.5% and 10.0%
  3. 20.0% and 35.0%
  4. 25.8% and 35.4%.
  5. 31.4% and 36.8%.

 


 

Short Answer/Problem

 

  1. Explain why the multiple-step format of the income statement is best for analysis?

 

  1. What questions should the analyst try to answer when analyzing the trend of a firms sales number?

 

  1. The gross profit margin is increasing for a firm. Give three reasons that could explain the increase.

 

  1. Discuss the following statement: Gross profit margin should be stable for all firms.

 

  1. Why might it be unfavorable for a firm to reduce repairs and maintenance, advertising, and research and development expenses?

 

  1. If an investor wants to understand how well a firm is performing in their core industry, which profit number (gross, operating or net) would be the best to analyze? Explain why.

 

  1. RBO Company purchased 25% of the voting common stock of YJD Company on January 1 and paid $800,000 for the investment. YJD Company reported $50,000 of earnings for the year and paid $10,000 in cash dividends. Calculate investment income and the balance sheet investment account balance for RBO Company using the following methods:

 

  1. Cost method.
  2. Equity method.

 

  1. Using the single-step income statement for ABC Company prepare a multiple-step income statement.

ABC Company

Income Statement

 

Income

Net sales                                           $1,750

Interest income                                         90

1,840

 

Costs and expenses

Cost of goods sold                                        1,000

Interest expense                                       70

Depreciation expense                             220

Income tax expense                                  70

Advertising expense                               110

General and administrative expenses              180

Net earnings                                                           $ 190

 

  1. Prepare an income statement using the following information:

 

Gross profit margin                          40%

Gross profit                                               $7,500

Tax rate                                            35%

Operating profit                                $400

 

  1. Using the following information prepare a common size income statement:

 

Net sales                                           $9,500

Cost of goods sold                                        5,900

Gross profit                                                $3,600

General and administrative expenses           1,250

Selling expenses                                     920

Operating profit                                $1,430

Income tax expense                                460

Net profit                                          $   970

 

  1. The following information is available for Escalante Computer Company. Analyze the gross profit margin making any calculations deemed necessary.

 

2015           2014           2013

Product sales                           $2,700        $2,400        $1,960

Service revenues                  &n

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