Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16-5
True/False Questions
1. Common-size statements are financial statements of companies of similar size.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
2. One limitation of vertical analysis is that it cannot be used to compare two companies
that are significantly different in size.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
3. The gross margin percentage is computed by dividing the gross margin by total assets.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Medium
4. The sale of used equipment at book value for cash will increase earnings per share.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
5. Earnings per share is computed by dividing net income (after deducting preferred
dividends) by the average number of common shares outstanding.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
6. The dividend payout ratio divided by the dividend yield ratio equals the price-earnings
ratio.
Ans: True AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
7. An increase in the number of shares of common stock outstanding will decrease a
company’s price-earnings ratio if the market price per share remains unchanged.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
16-6 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition
8. A company’s financial leverage is negative when its return on total assets is less than
its return on common stockholders’ equity.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
9. When computing return on common stockholders’ equity, retained earnings should be
included as part of common stockholders’ equity.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
10. When a retailing company purchases inventory, the book value per share of the
company increases.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
11. If a company’s acid-test ratio increases, its current ratio will also increase.
Ans: True AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
12. Assuming a current ratio greater than 1, acquiring land by issuing more of the
company’s common stock will increase the current ratio.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
13. If a company successfully implements lean production, its inventory turnover ratio
should decrease.
Ans: False AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
14. Short-term borrowing is not a source of working capital.
Ans: True AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16-7
15. Working capital is computed by subtracting long-term liabilities from long-term
assets.
Ans: False AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
Multiple Choice Questions
16. Common size financial statements help an analyst to:
A) Evaluate financial statements of companies within a given industry of the
approximate same size.
B) Determine which companies in a similar industry are at approximately the same
stage of development.
C) Compare the mix of assets, liabilities, capital, revenue, and expenses within a
company over a period of time or between companies within a given industry
without respect to size.
D) Ascertain the relative potential of companies of similar size in different
industries.
Ans: C AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy Source: CMA, adapted
17. Which of the following ratios would be least useful in determining a company’s ability
to pay its expenses and liabilities?
A) current ratio
B) acid-test ratio
C) price-earnings ratio
D) times interest earned ratio
Ans: C AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2,3,4 Level: Medium
18. Most stockholders would ordinarily be least concerned with which of the following
ratios:
A) earnings per share.
B) dividend yield ratio.
C) price-earnings ratio.
D) acid-test ratio.
Ans: D AACSB: Reflective Thinking AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2,3 Level: Easy
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
16-8 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition
19. What effect will the issuance of common stock for cash at year-end have on the
following ratios?
Return on Total Assets
Debt-to-Equity Ratio
A)
Increase
Increase
B)
Increase
Decrease
C)
Decrease
Increase
D)
Decrease
Decrease
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2,4 Level: Medium
20. The market price of Friden Company’s common stock increased from $15 to $18.
Earnings per share of common stock remained unchanged. The company’s price-
earnings ratio would:
A) increase.
B) decrease.
C) remain unchanged.
D) impossible to determine.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
21. If a company is profitable and is effectively using leverage, which
one of the following ratios is likely to be the largest?
A) Return on total assets.
B) Return on total liabilities.
C) Return on common stockholders’ equity.
D) Cannot be determined.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
22. Clark Company issued bonds with an interest rate of 10%. The company’s return on
assets is 12%. The company’s return on common stockholders’ equity would most
likely:
A) increase.
B) decrease.
C) remain unchanged.
D) cannot be determined.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16-9
23. Which of the following transactions could generate positive financial leverage for a
corporation?
A) acquiring assets through the issuance of long-term debt.
B) acquiring assets through the use of accounts payable.
C) acquiring assets through the issuance of common stock.
D) both A and B above
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
24. Book value per common share is the amount of stockholders’ equity per outstanding
share of common stock. Which one of the following statements about book value per
common share is most correct?
A) Market price per common share usually approximates book value per common
share.
B) Book value per common share is based on past transactions whereas the market
price of a share of stock mainly reflects what investors expect to happen in the
future.
C) A market price per common share that is greater than book value per common
share is an indication of an overvalued stock.
D) Book value per common share is the amount that would be paid to stockholders
if the company were sold to another company.
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy Source: CMA, adapted
25. The ratio of total cash, marketable securities, accounts receivable, and short-term
notes to current liabilities is:
A) the debt-to-equity ratio.
B) the current ratio.
C) the acid-test ratio.
D) working capital.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3,4 Level: Easy
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
16–10 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition
26. A company has just converted a long-term note receivable into a short-term note
receivable. The company’s acid-test and current ratios are both greater than 1. This
transaction will:
A) increase the current ratio and decrease the acid-test ratio.
B) increase the current ratio and increase the acid-test ratio.
C) decrease the current ratio and increase the acid-test ratio.
D) decrease the current ratio and decrease the acid-test ratio.
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Hard
27. Broca Corporation has a current ratio of 2.5. Which of the following transactions will
increase Broca’s current ratio?
A) the purchase of inventory for cash.
B) the collection of an account receivable.
C) the payment of an account payable.
D) none of the above.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Hard
28. Allen Company’s average collection period for accounts receivable was 25 days in
year 1, but increased to 40 days in year 2. Which of the following would most likely
be the cause of this change:
A) a decrease in accounts receivable relative to sales in year 2.
B) an increase in credit sales in year 2 as compared to year 1.
C) a relaxation of credit policies in year 2.
D) a decrease in accounts receivable in year 2 as compared to year 1.
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Hard
29. Wolbers Company wrote off $100,000 in obsolete inventory. The company’s inventory
turnover ratio would:
A) increase.
B) decrease.
C) remain unchanged.
D) impossible to determine.
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 3 Level: Medium
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16–11
30. Gottlob Corporation’s most recent income statement appears below:
Sales (all on account) …………………………..
$824,000
Cost of goods sold ……………………………….
477,000
Gross margin ………………………………………
347,000
Selling and administrative expense ………..
208,000
Net operating income …………………………..
139,000
Interest expense …………………………………..
37,000
Net income before taxes ……………………….
102,000
Income taxes ……………………………………….
30,000
Net income …………………………………………
$ 72,000
The gross margin percentage is closest to:
A) 20.7%
B) 72.7%
C) 42.1%
D) 481.9%
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 1 Level: Easy
Solution:
Gross margin percentage = Gross margin ÷ Sales = $347,000 ÷ $824,000 = 42.1%
31. Crandall Company’s net income last year was $60,000. The company paid preferred
dividends of $10,000 and its average common stockholders’ equity was $480,000. The
company’s return on common stockholders’ equity for the year was closest to:
A) 12.5%
B) 10.4%
C) 2.1%
D) 14.6%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Return on common stockholders’ equity = (Net income − Preferred dividends)
÷ Average common stockholders’ equity
= ($60,000 − $10,000) ÷ $480,000 = 10.4%
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
16–12 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition
32. Ardor Company’s net income last year was $500,000. The company has 150,000
shares of common stock and 30,000 shares of preferred stock outstanding. There was
no change in the number of common or preferred shares outstanding during the year.
The company declared and paid dividends last year of $1.00 per share on the common
stock and $0.70 per share on the preferred stock. The earnings per share of common
stock is closest to:
A) $3.33
B) $3.19
C) $2.33
D) $3.47
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Earnings per share = (Net Income − Preferred Dividends)
÷ Average number of common shares outstanding
= ($500,000 − $21,000) ÷ [(150,000 shares + 150,000 shares) ÷ 2]
= $3.19 per share
33. The following information relates to Konbu Corporation for last year:
15
30%
$5
What is Konbu’s dividend yield ratio for last year?
A) 1.5%
B) 2.0%
C) 4.5%
D) 10.0%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16–13
Solution:
Dividend yield ratio = Dividends per share* ÷ Market price per share **
= $0.06 ÷ $3 = 2.0%
* Dividends per share = Dividend payout ratio ÷ Earnings per share
= 30% ÷ $5 = $0.06 per share
** Market price per share = Price earnings ratio ÷ Earnings per share
= 15 ÷ $5 = $3 per share
34. Richmond Company has 100,000 shares of $10 par value common stock issued and
outstanding. Total stockholders’ equity is $2,800,000 and net income for the year is
$800,000. During the year Richmond paid $3.00 per share in dividends on its common
stock. The market value of Richmond’s common stock is $24. What is the price-
earnings ratio?
A) 3.0
B) 3.5
C) 4.8
D) 8.0
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium Source: CPA, adapted
Solution:
Price-earnings ratio = Market price per share ÷ Earnings per share*
= $24 ÷ $8 = 3.0
* Earnings per share = (Net income – Preferred dividends) ÷ Average # of common
shares outstanding
= ($800,000 – $0) ÷ [(100,000 shares + 100,000 shares) ÷ 2] = $8 per share
35. Hurst Company has 20,000 shares of common stock outstanding. These shares were
originally issued at a price of $15 per share. The current book value is $25.00 per
share and the current market value is $30.00 per share. The dividends on common
stock for the year totaled $45,000. The dividend yield ratio is:
A) 9%
B) 7.5%
C) 15%
D) 10%
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
16–14 Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition
Solution:
Dividend yield ratio = Dividends per share ÷ Market price per share
= ($45,000 ÷ 20,000) ÷ $30.00 = 7.5%
36. Bramble Company’s net income last year was $65,000 and its interest expense was
$15,000. Total assets at the beginning of the year were $620,000 and total assets at the
end of the year were $650,000. The company’s income tax rate was 40%. The
company’s return on total assets for the year was closest to:
A) 11.7%
B) 10.2%
C) 12.6%
D) 11.2%
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
Solution:
Return on total assets = Adjusted net income* ÷ Average total assets**
= $74,000 ÷ $635,000 = 11.7%
*Adjusted net income = Net income + [Interest expense × (1-Tax rate)]
= $65,000 + 15,000 × (1 − 0.40) = $74,000
**Average total assets = ($620,000 + $650,000) ÷ 2 = $635,000
37. Dahl Company can borrow funds at 15% interest. Since the company’s tax rate is 40%,
its after-tax cost of interest is only 9%. Thus, the company reasons that if it can earn
$70,000 per year before interest and taxes on a new investment of $500,000, then it
will be better off by $25,000 per year.
A) The company’s reasoning is correct.
B) The company’s reasoning is not correct, since the after-tax cost of interest would
be 6 percent, rather than 9%.
C) The company’s reasoning is not correct, since interest is not tax-deductible.
D) The company’s reasoning is not correct, since it would be worse off by $3,000
per year after taxes.
Ans: D AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Hard
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
Garrison/Noreen/Brewer, Managerial Accounting, Twelfth Edition 16–15
38. Bucatini Corporation is contemplating the expansion of operations. This expansion
will generate a 11% return on the funds invested. To finance this operation, Bucatini
can either issue 12% bonds, issue 12% preferred stock, or issue common stock.
Bucatini currently has a return on common stockholders’ equity of 16%. Bucatini’s tax
rate is 30%. In which of the financing options above is positive financial leverage
being generated?
A) none of the options generate positive financial leverage
B) the bonds
C) the common stock
D) the preferred stock
Ans: B AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Medium
39. Consolo Corporation’s net income for the most recent year was $809,000. A total of
100,000 shares of common stock and 200,000 shares of preferred stock were
outstanding throughout the year. Dividends on common stock were $2.05 per share
and dividends on preferred stock were $1.80 per share. The earnings per share of
common stock is closest to:
A) $2.44
B) $8.09
C) $4.49
D) $6.04
Ans: C AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Earnings per share = (Net Income – Preferred Dividends)
÷ Average number of common shares outstanding
= [$809,000 − (200,000 × $1.80)] ÷ [(100,000 shares + 100,000 shares) ÷ 2] = $4.49
Chapter 16 “How Well Am I Doing?”—Financial Statement Analysis
40. Bary Corporation’s net income last year was $2,604,000. The dividend on common
stock was $2.50 per share and the dividend on preferred stock was $2.40 per share.
The market price of common stock at the end of the year was $73.50 per share.
Throughout the year, 300,000 shares of common stock and 100,000 shares of preferred
stock were outstanding. The price-earnings ratio is closest to:
A) 9.33
B) 11.89
C) 13.66
D) 8.47
Ans: A AACSB: Analytic AICPA BB: Critical Thinking
AICPA FN: Reporting LO: 2 Level: Easy
Solution:
Price-earnings ratio = Market price per share ÷ Earnings per share*
= $73.50 ÷ $7.88 = 9.33
* Earnings per share = (Net income − Preferred dividends) ÷ Average number of
common shares outstanding
= [$2,604,000 − (100,000 × $2.40)] ÷ [(300,000 shares + 300,000 shares) ÷ 2] = $7.88