Chapter 17 – Understanding Accounting and Financial Information
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333. Preferred Pet Care Clinic, Inc is a mobile veterinary care company that travels to its
clients’ homes to administer veterinary care to well and sick pets. Its business is
booming, with a full schedule of appointments each week. On a weekly basis, the office
manager orders a larger amount of vaccines, antibiotics, and other products from its
suppliers with the understanding that it will pay for these supplies in one month’s time. A
sizeable percentage of Preferred Pet Care’s clients are elderly persons who are on fixed
incomes. These customers eventually pay their bills, but usually not upon receipt of
service. It sometimes takes them upwards of two months to remit. As an accounting
intern willing to advise the owner, which of the following statements is important to
your analysis?
A. Noting the fact that the clinic continues to order more supplies each month, the
veterinary clinic will certainly not experience a cash flow crunch. If anything, it would
be a good idea to hire additional veterinarians.
B. Noting the fact that the clinic continues to order larger amounts of supplies each
month, the company should make certain that its cost of goods sold is not greater than
50% of the price it is charging.
C. Due to the fact that clients are not paying when service is received, the clinic may
experience a cash flow crunch; an inability to maintain enough cash to pay for its
supplies each month.
D. Preferred Pet Care is doing everything right. It was wise to develop a niche market
because senior citizens have greater savings than younger families. This is a good
business and recessionary proof. The firm will continue to grow and prosper.
Feedback: The clinic owes money to its supplier each month, while its clients only pay (at
best) every two months. The intern should warn the owner that he/she may experience cash
flow problems if the timeliness of the cash receipts do not improve or the timeliness of cash
disbursements is not more lenient.
334.
Chapter 17 – Understanding Accounting and Financial Information
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The financial ratios that measure a firm’s ability to pay its short-term debts are called:
A. leverage ratios.
B. liquidity ratios.
C. equity ratios.
D. profitability ratios.
335. The current ratio is a type of ________ ratio.
A. leverage
B. profitability
C. activity
D. liquidity
336. Which of the following ratios is a liquidity ratio?
A. inventory turnover ratio
B. acid-test ratio
C. debt to owners’ equity ratio
D. basic earnings per share
337.
Chapter 17 – Understanding Accounting and Financial Information
The purpose of the current ratio is to evaluate the firm’s ability to:
A. Generate sales with a given level of current assets.
B. Utilize current assets profitably.
C. Pay its bills in the short run.
D. Effectively use borrowed funds.
338. The _______ ratio helps determine the ability of a firm to repay its short-term debts
even if it has difficulty selling its inventory.
A. acid-test
B. cash flow
C. diluted current asset
D. required reserve
Feedback: The acid test ratio eliminates the inventory account from the current ratio. Acid
test ratio = cash + accounts receivable = marketable securities/current liabilities.
339. Financial ratios that reflect the degree to which a firm relies on borrowed funds are
called ________ ratios.
A. leverage
B. liquidity
C. activity
D. profitability
Feedback: Leverage ratios measure the degree to which a firm relies on borrowed funds as
opposed to funds contributed by the owners.
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340. Earnings per share, return on sales, and return on equity are examples of:
A. leverage ratios.
B. liquidity ratios.
C. equity ratios.
D. profitability ratios.
Feedback: Profitability ratios measure how effectively the company is using its resources to
create profits.
341. ________ measures the amount of profit earned by a company for each share of
outstanding common stock.
A. Basic earnings per share (basic EPS)
B. Diluted earnings per share (diluted EPS)
C. Simple earnings per share (simple EPS)
D. Return on shares outstanding (RSO)
Feedback: Basic EPS measures the earnings per share of common stock outstanding.
342.
Chapter 17 – Understanding Accounting and Financial Information
__________ earnings per share measures the amount of profit a firm earns per share of
outstanding common stock when preferred stock, stock options, warrants and convertible
debt securities are also taken into account.
A. Basic
B. Diluted
C. Restricted
D. Broad-based
Feedback: Diluted Earnings per share takes into account stock options, convertible preferred
stock, warrants, and other convertible debt securities in the earnings per share calculation. The
addition of these sources of funds will dilute the earnings per share. It will be something less
than the basic earnings per share calculation.
343. Generally the higher the risk involved in an activity, the ________ the rate of return
expected by investors.
A. higher
B. lower
C. more stable
D. less frequent
Feedback: An axiom of finance, investors are willing to take on added risk, if they realize
higher returns.
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348. If a firm has a debt to owners’ equity ratio of .54 (or 54%) we can conclude that:
A. It has relied more on debt than equity to finance its operations.
B. The firm is likely to have trouble paying its short term debts when they come due.
C. Its total liabilities are less than its owners’ equity.
D. The firm has expenses that are exactly 54% of its gross profit.
Feedback: This ratio compares the debt (total liabilities) invested in the company with the
total equity (total owners equity) invested in the company. If the result is greater than 1 (or
100%), the firm is funded with more debt capital than equity capital.
349. Generally, a high ___________ ratio could lead investors and creditors to view the
company as being very risky.
A. debt to owners’ equity
B. acid-test
C. diluted earnings per share
D. inventory turnover
Feedback: A high debt to owners’ equity ratio indicates that the company is relying heavily on
debt to fund its operations. Many investors and creditors would view this as a risky approach.
350.
Chapter 17 – Understanding Accounting and Financial Information
In order to calculate the current ratio for your firm, you divide the total value of current
assets by:
A. Earnings per share.
B. The total value of current liabilities.
C. The total owners’ equity.
D. The total cost of goods sold.
Feedback: The current ratio is calculated by dividing current assets by current liabilities.
[Current Ratio = Current Assets/Current Liabilities]
351. Leverage ratios indicate the extent to which ________ has been used to fund a
business’s operations.
A. debt
B. equity
C. owner invested capital
D. profit
Feedback: Leverage ratios refer to the degree to which a firm relies on borrowed funds in its
operations. Borrowed funds represent debts of the business.
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354. As a bank loan officer, you are considering a loan application by Peak Performance
Sporting Goods. The company has provided you with the following information from its
Balance Sheet:
Peak Performance’s current ratio is:
A. 1.0.
B. 1.5.
C. 2.5.
D. 3.0.
Feedback: The current ratio is found by dividing total current assets by total current liabilities.
Peak Performance’s current assets = $210,000 and its current liabilities = $70,000.
$210,000/$70,000 = 3.0.
355.
Chapter 17 – Understanding Accounting and Financial Information
Peak Performance Sporting Goods Company has just applied for a bank loan in order to
expand the business. Using the most recent Balance Sheet data provided by the company
owner, you calculate that the company’s current ratio is 2.5. In your presentation to the
company boss, you remark:
A. Peak Performance is currently having trouble meeting its short-term obligations.
B. Peak Performance has $2.50 that it owes each month, for every $1.00 of cash that it is
generating.
C. Peak Performance has $2.50 of current assets for each $1.00 of currently liabilities.
D. Due to the fact that most of Peak Performance’s current assets are tied-up in
inventory, there is no need to worry about whether Peak Performance will be able to
make loan payments.
Feedback: The current ratio compares total current assets to total current liabilities. A current
ratio of 2.5 can be written as a fraction: 2.5/1. This means: The firm has $2.50 worth of
current assets for every $1.00 of current liabilities.
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359. You have just calculated the acid-test ratio for Peak Performance Sporting Goods [acid
test ratio = 1.0]. As a loan officer for the local bank, you are called into your boss’s
office to interpret the results of this ratio. Which of the following statements best reflects
an understanding of these results?
A. A company with an acid-test ratio = 1.0 demonstrates the ability to operate very
conservatively. The bank should anticipate that this firm will always be able to meet its
short-term liabilities.
B. This company is already having problems meeting its short-term liabilities.
C. An acid-test ratio = 1.0 means that this firm has $1.00 in current assets for every
$2.00 in current liabilities. Peak Performance is a well-run operation, as long as it can
continue to sell-off its inventory.
D. An acid test ratio = 1.0 tells us that without adequate inventory turnover, this
company may represent a higher risk. Peak Performance’s acid test ratio shows that the
firm maintains $1.00 in current assets for every $1.00 in current liabilities.
Feedback: The acid test ratio calculation: [Cash + Accounts Receivables + Marketable
Securities/Current Liabilities]. Unlike the current ratio, the acid-test ratio does not include the
inventory value in the calculation. It is a more conservative measure of liquidity.
360.
Chapter 17 – Understanding Accounting and Financial Information
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As a recent college graduate with a degree in accounting, Jeff is helping a newly formed
construction company set up its accounting system. Although the company had
purchased accounting software, Jeff wants to make certain that future reports will
distinguish between current liabilities and long-term liabilities. In the future, he will
need to know the amount of total current liabilities in order to ____________________.
A. know when it is time to make a long-term mortgage payment ities.
B. calculate if the company has purchased too much inventory for home building.
C. analyze whether the company can afford to make capital purchases such as additional
land acquisition.
D. analyze whether the company has enough funds to pay the near term bills.
Feedback: In order to analyze whether the company has enough funds to pay bills that come
due in less than a year, Jeff will perform the current ratio. The accountant must separate
current liabilities from long-term liabilities. Total current assets (cash + accounts
receivables + inventory) are divided by Total current liabilities. The resulting multiple
[known as the Current Ratio] serves as a gauge that helps the accountant determine if the
company has an adequate cash position to pay near-term bills.
361.
Chapter 17 – Understanding Accounting and Financial Information
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Backstreet Books, a small eclectic bookstore in a bustling college town wants to open
another store at the west end of campus. Allison Robards, the store owner, plans to visit
her banker in the hopes of obtaining additional financing. In preparation for her visit, the
banker asks her for the following information:
Calculate the debt to equity ratio for Backstreet Books.
A. 250%
B. 105%
C. 75%
D. 30%
Feedback: The formula for calculating debt to equity ratio = Total Liabilities/Owner’s Equity.
Total Liabilities = Current Liabilities + Long Term Liabilities. For this problem, the debt to
equity ratio = $210,000/$200,000 = 1.05 or 105%.
362.
Chapter 17 – Understanding Accounting and Financial Information
Peak Performance Sporting Goods Company continues to perform well in spite of an
economic recession. Company executives credit this to the strong partnerships it enjoys
with category killer and large discount chains. Last week Peak Performance reported
basic EPS [earnings per share] = $.80/share. If the firm has 4,000,000 shares
outstanding, net income after taxes for the same period = ______.
A. $80,000
B. $5,000,000
C. $3,200,000
D. $32,000
Feedback: Basic Earning per share = Net Income after taxes/Number of common stock shares
outstanding. This problem asks the student to determine one component of this formula: net
income after taxes. Net Income after taxes = Basic Earnings per share X Number of common
stock shares outstanding. Net Income after taxes = $.80 X 4,000,000 shares = $3,200,000.
363. The top managers of Highbrow Bookstores want to indicate to the firm’s shareholders
how effectively they have managed the company. Perhaps the most meaningful way to
do this would be by reporting strong:
A. liquidity ratios.
B. leverage ratios.
C. activity ratios.
D. profitability ratios.
Feedback: Profitability ratios measure how effectively managers are using the firm’s
resources to generate profits for the firm’s owners.
