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Exam 13: Financial Statement Analysis

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Question 61

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Which of the following statements regarding the information disclosed in financial statements is incorrect?

A) The costs of providing all possible information about a firm would be prohibitively high for the business.
B) Some information disclosed in financial statements may be irrelevant to some users.
C) Financial statements should be detailed enough to answer any financial-related question an investor might have.
D) When too much information is presented, users may suffer from information overload.

E) A) and C)
F) A) and B)

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Question 62

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Financial ratio analysis is a form of horizontal analysis in that comparisons are made between different accounts in the same set of financial statements.

A) True
B) False

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Question 63

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The only requirement involved in communicating useful information is that the information be accurate.

The study of an individual item or account over several periods in the same financial year or over many years is known as:

The following information is from the financial records of Newton Company for Year 2: $\begin{array} { l r } \text { Sales } & \$ 620,000 \\\text { Interest expense } & 26,000 \\\text { Income tax expense } & 46,000 \\\text { Net income } & 104,000\end{array}$ Required: Calculate the number of times interest is earned for Newton in Year 2.(Round your answer to one decimal place.)

Long-term creditors are usually most interested in evaluating:

Which of the following statements is correct regarding the quick ratio?

Milton Company has total current assets of $46,000,including inventory of $10,000,and current liabilities of $20,000.The company's current ratio is:

Denver Corporation and Cheyenne Company are in different industries.Denver's current ratio is 1.89,while Cheyenne's current ratio is 1.65.Therefore,is it safe to conclude that Denver's liquidity position is better than that of Cheyenne?

Crawford Company's current ratio for Year 2 was 1.42,which was slightly above the current ratio for similar companies in its industry.Crawford's quick ratio for Year 2 was 0.68,which is substantially lower than for similar companies in its industry.What conclusion would you draw based on this information?

The following balance sheet information is provided for Santana Company for Year 2: $\begin{array}{lr}\text { Cash } & \$ 5,400 \\\text { Accounts receivable } & 15,500 \\\text { Inventory } & 18,000 \\\text { Prepaid expenses } & 1,600\\\text { Plant and equipment, net of depreciation } & 20,200 \\\text { Land } & \underline{19,950} \\\text { Total assets } & \underline{\$ 80,650} \\\text { Liabilities and Stockholders'Equity }\\\text { Accounts payable } & \$ 4,500 \\\text { Salaries payable } & 11,500\\\text { Bonds payable (due in ten year's) } & 19,000 \\\text { Common stock, no par } & 30,000 \\\text { Retained earnings } & \underline{ 15,650}\\\text { Total liabilities and stockholder's' equity } & \underline{ \$ 80,650}\end{array}$ What is the company's debt to equity ratio? (Rounded to nearest whole percent.)

Many companies have to monitor closely certain ratios,such as the current ratio,due to debt covenants.Selected transactions are provided below for a company that uses a perpetual inventory system,sells its merchandise at a selling price that exceeds cost,and had a current ratio of 1.85 and a quick ratio of 1.19 before the event occurred. $\begin{array}{|l|l|}\hline &\text { Impact on } & \text { Impact on } \\\hline& \text { Current Ratio } & \text { Ouick Ratio } \\\hline \text {Description of Transaction}&\text { (+) or (-) or (0)}&\text {(+) or (-) or (0 )}\\\hline \text { 1. Collected accounts receivable } & \\\hline 2 . \text { Issued common stock for cash } & \\\hline \text { 3. Purchased one-year insurance policy } & \\\hline \text { 4. Paid previously declared cash dividend } & \\\hline \text { 5. Paid the balance on an account payable } & \\\hline \text { 6. Purchased a building by issuing a long-term } & \\ \text { note } & \\ \hline \text {7. Purchased inventory on account }\\\hline \text { 8. Purchased current marketable securities for } & \\\text{cash}\\\hline \text { 9. Sold merchandise for cash } \\\hline 10 \text { Sold merchandise on account } \\\hline\end{array}$ Required: In the above table,indicate whether each transaction would increase (+),decrease (-),or not affect (0)the company's current ratio and quick ratio.

The study of an individual financial statement item over several accounting periods is called:

As of December 31,Year 1,Gant Corporation had a current ratio of 1.29,quick ratio of 1.05,and working capital of $18,000.The company uses a perpetual inventory system and sells merchandise for more than it cost.On January 1,Year 2,Gant paid $250 for transportation in cost on merchandise it had received.Which of the following statements is incorrect?

A banker may perform a financial ratio analysis to assess a firm's ability to repay debt in a timely manner.

Working capital is defined as:

Indicate whether each of the following statements about financial statement analysis is true or false. Solvency ratios measure a company's short-term debt-paying ability and its financial structure.______ A company with a high debt to assets ratio probably would be considered to have a high level of financial risk.______ The debt to equity ratio and debt to assets ratio are two ways to measure the same relationship.______ From the point of view of stockholders,a decline in the debt to equity ratio is always good news.______ The lower the debt to equity ratio,the higher a company's financial leverage.______

Alpha Company provided the following balance sheet for Year 2: $\begin{array}{lr}\text { Cash } & \$ 5,400 \\\text { Accounts receivable } & 15,500 \\\text { Inventory } & 18,000 \\\text { Prepaid expenses } & 1,600\\\text { Plant and equipment, net of depreciation } & 20,200 \\\text { Land } & \underline{19,950} \\\text { Total assets } & \underline{\$ 85,450} \\\text { Liabilities and Stockholders'Equity }\\\text { Accounts payable } & \$ 4,500 \\\text { Salaries payable } & 11,500\\\text { Bonds payable (due in ten year's) } & 10,000 \\\text { Common stock, no par } & 30,000 \\\text { Retained earnings } & \underline{ 29,450}\\\text { Total liabilities and stockholder's' equity } & \underline{ \$ 85,450}\end{array}$ What is the company's plant assets to long-term liabilities ratio?

Which of the following is (are) objective(s) of ratio analysis?

The Fortune Company reported the following income for Year 2: $\begin{array}{lrr}\text { Sales } & \$ 130,000 \\\text { Cost of goods sold } & \underline{80,000} \\\text { Gross margin } & 50,000 \\\text { Selling and administrative expense } & \underline{ 15,000} \\\text { Operating income } & \$ 35,000 \\\text { Interest expense } & \underline{ 5,000} \\\text { Income before taxes } & \$ 30,000 \\\text { Income tax expense } & \underline{10,000}\\\text { Net income } & \underline{\$ 20,000}\end{array}$ What is the company's number of times interest is earned ratio?