Financial Management: Core Concepts, 4e (Brooks)
Chapter 2 Financial Statements
1) The purpose of studying financial statements is ________.
A) to mechanically build portfolio analysis
B) to understand those portions of the statements that have relevance for financial decision
making
C) to primarily investigate all portions of the statements that have relevance for dividend policy
D) to mechanically learn how to read and understand footnotes
2) Which of the statements below is FALSE?
A) The purpose of studying financial statements is to understand those portions of the statements
that have relevance for financial decision making.
B) We need to understand how to interpret and use the information presented in financial
statements to form a picture of the financial profile of the firm.
C) Accounting, it has been said, looks back to where a company has been—somewhat like
looking through a rear view mirror.
D) Accounting and finance view the numbers in the same way.
3) Understanding the sources and uses of cash in the recent past will enable a manager to
________ the cash flow for a potential project of the firm.
A) determine with perfect precision
B) forecast with perfect precision
C) predict more accurately
D) know today
4) The fundamental starting point of all the accounting statements is the ________.
A) accounting identity
B) computing identity
C) investing identity
D) financing identity
5) Which of the statements below is TRUE?
A) Accounting Identity is: Assets ≡ Liabilities – Owners’ Equity.
B) Accounting Identity is: Assets ≡ Liabilities + Owners’ Equity.
C) Accounting Identity is: Assets ≡ Owners’ Equity – Liabilities.
D) Accounting Identity is: Liabilities ≡ Assets + Owners’ Equity.
6) There are four primary financial statements that are used to measure the performance of a
firm. Which of the choices below are included among these four?
A) The balance statement and income statement
B) The income sheet and statement of retained earnings
C) The statement of cash flows and statement of balance
D) The balance sheet and statement of cash flows
7) It is important to remember that the fundamental ________ of accounting is the debit and
credit recording activity where debits always equal credits.
A) effect
B) end product
C) outcome
D) identity
8) It is important to remember that the fundamental identity of accounting is the debit and credit
recording activity where debits ________ equal credits.
A) never
B) seldom
C) sometimes
D) always
9) Which of the statements below is FALSE?
A) The income statement summaries and categorizes a company’s revenues and expenses for that
period.
B) Typically, income statements are prepared quarterly and annually for distribution outside the
company, but usually monthly for internal managers.
C) The income statement begins with revenue and subtracts various operating expenses until
arriving at Earnings Before Interest and Taxes (EBIT).
D) The balance sheet reports the performance of the firm over the past period. It summarizes and
categorizes a company’s revenues and expenses for that period.
10) Which of the below statements is FALSE?
A) Typically, income statements are prepared quarterly and annually for distribution outside the
company, but usually semiannually for internal managers.
B) Typically, income statements are prepared quarterly and annually for distribution outside the
company.
C) The income statement begins with revenue and subtracts various operating expenses until
arriving at Earnings Before Interest and Taxes (EBIT).
D) The income statement reports the performance of the firm over the past period. It summaries
and categorizes a company’s revenues and expenses for that period.
11) The income statement begins with revenue and subtracts various operating expenses until
arriving at the intermediate point of ________.
A) earnings after taxes
B) net income
C) taxable income
D) EBIT
12) The income statement begins with revenue and subtracts various operating expenses until
arriving at Earnings Before Interest and Taxes. Next, interest expense is subtracted to find the
________ for the period.
A) EBIT
B) after-tax income
C) net income
D) taxable income
13) The income statement begins with revenue and subtracts various operating expenses until
arriving at Earnings Before Interest and Taxes. Next, interest expense is subtracted to find the
taxable income for the period. Then the appropriate taxes are calculated and subtracted. We
finally arrive at the ________, the so-called bottom line of the income statement.
A) after-tax income
B) before-tax income
C) net income
D) EBIT
14) Net income is ________.
A) not cash flow
B) the cash flow from the operations of the company during the period
C) the increase or decrease in cash flow for the period
D) earnings before interest and taxes
15) Net income is ________.
A) the accounting profit from the operations of the company during the period
B) cash flow
C) the accounting profit from the non-operating assets of the company during the period
D) always equal to the dividends paid to shareholders
16) Cash flow is ________.
A) the increase but not decrease in cash for the period
B) the decrease but not increase in cash for the period
C) the increase or decrease in cash for the period
D) the net income for the period
17) One of the key components to making financial decisions is to ________.
A) understand the timing and amount of dividends
B) understand the timing and amount of cash flow
C) understand the timing of EBIT
D) understand the amount of net income
18) Which of the statements below is FALSE?
A) The textbook uses the framework of the income statement to find the operating income of the
company (an accounting measure) and then makes adjustments to find the true cash flow from
operations.
B) In accrual-based accounting, revenue is recorded at the time of sale if the revenue has been
received in cash.
C) Three fundamental issues separate net income and cash flow: accrual-based accounting,
noncash expense items, and interest expense.
D) Generally Accepted Accounting Principles (GAAP) in the United States allow the use of
accrual accounting to record revenue.
19) Three fundamental issues separate net income and cash flow. Which of the answers below is
NOT one of these three fundamental issues?
A) Accrual accounting
B) Noncash accounting
C) Noncash expense items
D) Interest expense
20) Which of the following statements is TRUE?
A) The finance manager uses the framework of the income statement to find the operating
income of the company (an accounting measure), which is also the true cash flow from
operations.
B) In accrual-based accounting, revenue is recorded at the time of sale if the revenue has been
received in cash.
C) Three fundamental issues separate net income and cash flow: accrual-based accounting,
noncash expense items, and interest expense.
D) Generally accepted accounting principles (GAAP) in the United States do not allow the use of
accrual-based accounting to record revenue.
21) In finance, we separate operating decisions from financing decisions and thus exclude
________ as a part of operating income from the income statement.
A) cash flow
B) dividends
C) interest expense
D) earnings
22) Which of the following statements is FALSE?
A) The income statement is put together at a specific point in time (end of a business quarter, or
business year) and so the sale could be in one period and the cash received in another period.
B) The income statement contains the set of expenses associated with the products or services
sold during the current operating period, with those expenses not associated with current cash
flow labeled as non-cash expense items.
C) In almost all circumstances depreciation is a current expense of a cash outflow in the current
period.
D) Companies depreciate fixed assets (such as office furniture, equipment, machinery, and
buildings) over an assigned time period, but the initial cash outlay for the fixed asset typically
occurs at the time the asset is acquired by the firm.
23) To find operating cash flow for the business for the year, add depreciation expense to EBIT
and then ________.
A) subtract the interest expenses
B) add the taxes
C) subtract the taxes
D) add interest expenses
24) Which of the statements below is FALSE?
A) The cash account is much like your individual checkbook, because it tells you how much
money you currently have for paying bills or spending on new items.
B) Current assets are accounts that will normally be turned into cash over the course of the
operating or business cycle of the firm, and current liabilities are the accounts that will come due
for payment over the operating or business cycle.
C) The long-term capital asset accounts of the balance sheet represent the capital investment of
the company and reflect assets that the company owns and that provide the basis for producing
goods and services for sale.
D) The Plant, Property and Equipment account is straightforward in its description, yet it cannot
tell you the accumulated depreciation.
25) Which of the statements below is FALSE?
A) The cash account is much like your individual checkbook, because it tells you how much
money you currently have for paying bills or spending on new items.
B) Long-term assets are accounts that will normally be turned into cash over the course of the
operating or business cycle of the firm, and current liabilities are the accounts that will come due
for payment over the operating or business cycle.
C) The long-term capital asset accounts of the balance sheet represent the capital investment of
the company and reflect assets that the company owns and that provide the basis for producing
goods and services for sale.
D) The Plant, Property and Equipment account is straightforward in its description, yet it really
contains two pieces: the original value (purchase price) of the equipment and the accumulated
depreciation.
26) Debts to be paid more than one year from now are claims against the firm’s assets: in other
words, they are long-term liabilities. These claims are from ________ who have provided capital
to the firm but whose entire repayment is not due during the coming year or operating cycle.
A) banks and bondholders
B) banks and stockholders
C) stockholders and bondholders
D) all long-term lenders
27) Which of the statements below is TRUE?
A) The ownership accounts or owners’ equity section of the balance sheet reflects the owners’
stake in the firm.
B) The ownership accounts or owners’ equity section of the balance sheet is made up of common
stock but not retained earnings.
C) The retained earnings amount on the balance sheet really reflect retained earnings and other
stockholder equity, but not treasury stock.
D) The Statement of Retained Earnings is used to show the distribution of the interest paid for
the past period.
Use the information below for the Michigan Auto Corporation (MAC) to answer the following
questions.
Balance Sheet Accounts of Michigan Auto Corporation (MAC) Corporation
Account
Balance 12/31/2017
Accumulated depreciation
$7,650
Accounts payable
$6,875
Accounts receivable
$8,000
Cash
$3,750
Common stock
$15,625
Inventory
$11,250
Long-Term debt
$17,750
Plant, property, and equipment
$37,000
Retained earnings
$12,100
28) Refer to the Balance Sheet Accounts of MAC Corporation. The value of total assets for the
year-end is ________.
A) $52,350
B) $60,000
C) $37,000
D) $29,350
29) Refer to the Balance Sheet Accounts of MAC Corporation. The value of net working capital
at the year-end is ________.
A) $4,825
B) $16,125
C) $29,875
D) $27,725
30) Refer to the Balance Sheet Accounts of MAC Corporation. The value of current assets for
the year-end is ________.
A) $29,875
B) $9,200
C) $23,000
D) $11,740
31) Refer to the Balance Sheet Accounts of MAC Corporation. The value of equity for the year-
end is ________.
A) $11,740
B) $16,625
C) $11,090
D) 27,725
Use the information below to answer the following questions about the Canary Cruises
Corporation.
The Canary Cruises Corporation Income Statement Accounts for the year ending December 31,
2017
Account
Balance
Cost of goods sold
$345,000
Interest expense
$79,000
Taxes
$57,100
Revenue
$836,000
Selling, general, and administrative expenses
$93,000
Depreciation
$126,000
32) Refer to the Canary Cruises Corporation Income Statement Accounts. What is the net
income for the Canary Cruises Corporation for 2017?
A) $339,750
B) $135,900
C) $261,100
D) $345,000
33) Refer to the Canary Cruises Corporation Corporation Income Statement Accounts. What is
the operating cash flow for the Canary Cruises Corporation for 2017?
A) $340,900
B) $654,750
C) $261,100
D) $528,000
34) Refer to the Canary Cruises Corporation Corporation Income Statement Accounts. What is
the EBIT for the Canary Cruises Corporation for 2017?
A) $345,000
B) $654,750
C) $680,000
D) $272,000
35) The basic accounting identity that assets equal liabilities plus owners’ equity usually, but not
always, holds.
36) Equity on the balance sheet refers to what the owners receive after liabilities have been
satisfied.
37) In double-entry bookkeeping, every time an economic transaction is recorded, equal debit
and credit amounts must be recorded.
38) Debts to be paid more than one year from now are considered short-term liabilities.
39) EBIT (earnings before interest and taxes) is obtained by adding together revenue and
operating expenses.
40) Net income is not cash flow.
41) Explain the three main areas of the balance sheet.
42) From the finance perspective, there are five principal line accounts of particular interest on
the balance sheet: the cash account, the working capital accounts, long-term capital assets
accounts, long-term debt accounts, and ownership accounts. Briefly explain each.