10. Washington Company has current assets, current liabilities, and long-term liabilities of
$6,000, $2,000, and $5,000, respectively at the end of 2015. How much cash can
Washington use to acquire equipment and retain a current ratio of at least 3.0?
11. Madison Company has current assets, current liabilities, and long-term liabilities of
$8,000, $4,000, and $6,000, respectively. Within these amounts, inventory was $1,000,
receivables were $3,000, cash was $4,000, and payables were $1,000. Calculate
Madison’s quick ratio. What information does this provide?
Solution:
12. Briefly describe the solvency and profitability of a company with a quick ratio of 3.50 and
return on equity of 0.50.
Solution:
Test Bank – Chapter 5 – Using Financial Statement Information 5-35
Use the information that follows taken from Tyler Company’s financial statements for the years
ending December 31, 2015 and 2014 to answer problems 13 through 19.
Balance Sheet Information
2015
2014
Assets
Cash
$ 90
$ 50
Accounts receivable
60
80
Inventory
40
80
Land, building, and equipment
230
270
Total Assets
$420
$480
Liabilities and Shareholders’ Equity
Accounts payable
$ 5
$ 85
Common stock
260
260
Retained earnings
155
135
Total Liabilities & Shareholders’ Equity
$420
$480
Income Statement Information
Sale revenue
$850
Cost of goods sold
600
Gross profit
$250
Operating expenses
230
Net income
$ 20
13. If the industry in which Tyler is a member has an inventory turnover of 9 times,
determine if Tyler is more or less efficient at converting inventory into sales than the
average firm in its industry during 2015.
Solution:
14. The industry in which Tyler is a member has an average accounts receivable turnover of
10 times. How does Tyler compare in 2015? Comment on what information is provided
with this calculation and how credit managers might use it to make decisions. Assume all
sales were credit sales.
15. If the industry in which Tyler is a member has an average return on assets of 11%,
determine if in 2015, Tyler is more or less profitable than the average firm in its industry.
Assume Tyler has no interest expense.
16. The industry in which Tyler is a member has an average return on equity of 10%. For
2015, determine how Tyler compares.
Solution:
17. The industry in which Tyler operates has an average current ratio of 2.1 on December
31, 2015. Comment on Tyler’s solvency compared to the industry average as measured
by its current ratio.
18. The industry in which Tyler is a member has an average debt/equity ratio of 0.98.
Determine if, as measured by Tyler’s debt/equity ratio on December 31, 2015, Tyler is
taking full advantage of investing borrowed capital in its operations relative to that of the
average firm in its industry.
19. Using the two solvency ratios (current and quick), indicate whether Tyler’s solvency
position improved or deteriorated during 2015.
Solution:
Current ratio = Current assets / Current liabilities =
20. Monroe Company has total assets, liabilities, and shareholders’ equity of $27,000,
$20,000, and $7,000, respectively. Assume no material change occurred during the year
to totals on the balance sheet. What amount of long-term debt must Monroe exchange
for new shares of common stock issued in order to decrease its debt/equity ratio to 1.0?
21. Harrison Company has common stock of $50,000 and retained earnings of $40,000 at
yearend. During the year, 10,000 shares of stock were outstanding. Net income was
reported as $6,000.
A. Calculate earnings per share.
B. How does earnings per share differ from most of the other ratios with respect to
financial statements?
Solution:
22. Briefly describe a company with a current ratio of 0.35 and return on equity of 0.03.
Solution:
23. Taylor Company has the following financial data on January 1, 2015 and January 1,
2014.
1/1/15
1/1/14
Cash
$15,000
$27,000
Accounts receivable
23,000
11,000
Marketable securities
3,000
10,000
Inventory
16,000
35,000
Net plant and equipment
40,000
32,000
Current liabilities
$18,000
$27,000
Long-term debt
49,000
30,000
Shareholders’ equity
30,000
58,000
A. In terms of the quick and current ratio, has the short-term solvency position of Taylor
improved, remained the same, or declined?
B. If you were a potential short-term creditor to Taylor, would you be more willing to
extend credit on either January 1, 2014 or 2015? Explain.
Solution:
A. (in thousands)
1/01/15
1/01/14
Current ratio = Current assets / Current liabilities =
= ($15 + $23 + $3 + $16)/$18 =
3.17
= ($27 + $11 + $10 + $35)/$27 =
3.07
Quick ratio = Quick assets / Current liabilities =
= ($15 + $23 + $3)/$18 =
2.73
= ($27 + $11 + $10)/$27 =
1.78
Taylor’s short-term solvency position has improved. Its current ratio has increased from
3.07 to 3.17, and the quick ratio has increased from 1.78 to 2.73.
B. Taylor’s short-term solvency position on 1/1/15 is acceptable and has increased
since 1/01/14. A short-term creditor would definitely be more willing to extend credit
to Taylor on 1/1/15 than on 1/1/14.
KP 2,5 BT: AN Difficulty: Difficult TOT: 6 min. AACSB: Analytic, Communication
AICPA BB: Critical Thinking AICPA FN: Measurement
24. Briefly describe a company with a quick ratio of 3.70 and return on equity of 0.06.
Solution:
Test Bank – Chapter 5 – Using Financial Statement Information 5-41
SHORT ESSAY QUESTIONS
1. Distinguish between backward-looking and forward-looking as it pertains to financial
statements.
Solution:
2. What role do investment services, such as Moody’s and Standard & Poor’s, play in the
assessment of a business environment?
Solution:
3. Comment on the following news headline: “Van Buren, Inc. Takes a Bath in Current
Year.”
Solution:
When a company experiences an extremely poor year, it sometimes chooses very
4. Indicate three reasons why reported book value and true value may differ.
Solution:
5. What must an analyst learn first prior to assessing a particular business environment?
Solution:
6. Identify two forms of analyzing financial statements at a particular point in time. Which of
these forms is subject to great variation among different analysts?
Solution:
The two forms of financial statement analysis are common-size financial statements and
7. Buchanan Company has the following financial data on December 31, 2015 and 2014:
12/31/14
12/31/15
Cash
$16,000
$21,000
Accounts receivable
12,000
4,000
Inventory
15,000
12,000
Net plant and equipment
5,000
3,000
Current liabilities
8,000
18,000
Common stock
5,000
5,000
Retained earnings
31,000
2,000
Buchanan ‘s 2015 income statement reported:
Revenue
$160,000
Cost of goods sold
150,000
Gross margin
$ 10,000
Depreciation expense
2,000
Net income
$ 8,000
Buchanan ‘s 2015 data from its statement of cash flows:
Cash flow from operations
$ 42,000
Cash flow from investing activities
0
Cash flow from financing activities, including dividends paid
(22,000)
Required: Using appropriate ratios, comment on the change in Buchanan’s solvency
position and assess the probable cause of the change from 2014 to 2015.
Solution:
Current ratio: 2014: ($16,000 + $12,000 + $15,000)/$8,000 = 5.38
8. Why are all companies not audited by certified public accountants?
Solution:
Only those companies whose equity securities are traded on public stock exchanges are
9. Briefly explain how management may influence the quality of earnings of a company.
Solution:
Managers can influence reported accounting numbers by manipulating the timing of
10. How might a company overstate performance? Why might this occur?
Solution:
11. How does off-balance sheet financing make a company appear less risky?
Solution:
Off-balance-sheet financing avoids the recognition of debt directly on the company’s
12. Explain the concept of leverage.
Solution:
Leverage refers to using borrowed funds to generate returns for the shareholders. A
13. In what ways might an investor use accounting information provided by a foreign
company differently from information provided by a domestic corporation?
Solution:
14. How does operating performance differ from financial flexibility?
Solution:
Operating performance represents a company’s ability to grow and increase its assets