Financial Accounting, 5e (Spiceland)
Chapter 12 Financial Statement Analysis
1) We can use ratios to help evaluate a firm’s performance and financial position.
2) Vertical analysis expresses each item in a financial statement as a percentage of the same base
amount.
3) Vertical analysis calculates the amount and percentage change of an account over time.
4) We use vertical analysis for income statement accounts, but not balance sheet accounts.
5) We use vertical analysis to express each income statement item as a percentage of sales.
6) For vertical analysis, we express each balance sheet item as a percentage of sales.
7) Horizontal analysis analyzes trends in financial statement data for a single company over time.
8) If the base-year amount is zero, we can’t calculate a percentage change under horizontal
analysis.
9) Using horizontal analysis, if the base year is negative and the following year is positive, the
percentage change is just as useful as if the base year and the following year were both positive.
10) We use horizontal analysis to analyze trends in financial statement data, such as the dollar
amount of change and the percentage change, for one company over time.
11) We measure income statement accounts at a point in time and balance sheet accounts over a
period of time.
12) Ratios that compare an income statement account with a balance sheet account should express
the balance sheet account as an average of the beginning and ending balances.
13) Every liquidity ratio is calculated using one or more current asset accounts.
14) Solvency refers to a company’s ability to pay its current liabilities while liquidity refers to a
company’s ability to pay its long-term liabilities.
15) The receivables turnover ratio measures how many times, on average, a company collects its
receivables during the year.
16) A low receivables turnover ratio is a positive sign that a company can quickly turn its
receivables into cash.
17) The average collection period converts the receivables turnover ratio into days.
18) A low inventory turnover ratio usually is a positive sign and indicates that inventory is selling
quickly.
19) An extremely high inventory turnover ratio may be a signal that the company is losing sales
due to inventory shortages.
20) The average days in inventory converts the inventory turnover ratio into days.
21) A low current ratio indicates that a company has sufficient current assets to pay current
liabilities as they become due.
22) The acid-test ratio is always smaller than the current ratio.
23) Other things being equal, the higher the debt to equity ratio, the higher the risk of bankruptcy.
24) We use the times interest earned ratio to compare interest payments with a company’s income
available to pay those charges.
25) We calculate the times interest earned ratio by dividing net income by interest expense.
26) The gross profit ratio is calculated as gross profit divided by net sales.
27) Return on assets is calculated as net income divided by ending total assets.
28) Profit margin measures the income earned on each dollar of sales, and is calculated by dividing
net income by net sales.
29) Asset turnover measures sales volume in relation to the investment in assets, and is calculated
as net sales divided by average total assets.
30) Return on equity is calculated by dividing the stock return by average stockholders’ equity.
31) The price-earnings (PE) ratio compares a company’s share price with its earnings per share.
32) Growth stocks have high expectations of future earnings growth, and therefore, usually trade at
higher PE ratios.
33) Value stocks have lower share prices in relationship to their fundamental ratios, and therefore,
trade at lower PE ratios.
34) A discontinued operation is the sale or disposal of any long-term asset.
35) We report any profits or losses on discontinued operations in the current year, separately from
profits and losses on the portion of the business that will continue.
36) We report discontinued items separately, net of taxes, as the last item in an income statement
before net income.
37) Managers can choose the location of where to report a loss in the income statement, as long as
the loss is reported and deducted in calculating net income.
38) When using a company’s current earnings to estimate future earnings performance, investors
normally should exclude discontinued operations.
39) Conservative accounting practices are those that result in reporting higher income, higher
assets, and lower liabilities.
40) Conservative accounting practices are those that result in reporting lower income, lower assets,
and higher liabilities.
41) A larger estimation of the allowance for uncollectible accounts, the write-down of overvalued
inventory and the use of a shorter useful life for depreciation are all examples of conservative
accounting.
42) Use of a longer useful life for depreciation is an example of conservative accounting.
43) Aggressive accounting practices result in reporting higher income, higher assets, and lower
liabilities.
44) Changes in accounting estimates usually have no effect on a company’s underlying cash flows.
45) Which of the following is not a common type of comparison in accounting?
A) Comparisons of sales growth between companies.
B) Comparisons of earnings per share between companies.
C) Comparisons of earnings this year with earnings for the same company last year.
D) Comparisons to industry.
46) When using vertical analysis, we express income statement accounts as a percentage of:
A) Net income.
B) Gross profit.
C) Sales.
D) Total assets.
47) When using vertical analysis, we express balance sheet accounts as a percentage of:
A) Sales.
B) Total assets.
C) Total liabilities.
D) Total stockholders’ equity.
48) ________ analysis identifies the relative contribution made by each financial statement line
item.
A) Ratio
B) Vertical
C) Horizontal
D) Diagonal
49) Common-size analysis is another term used for ________ analysis.
A) Ratio
B) Vertical
C) Horizontal
D) Diagonal
50) Which of the following types of analysis allows for the comparison of financial statement
items between companies of different size?
A) Horizontal approach
B) Vertical approach
C) Diagonal approach
D) Circular approach
51) Which of the following is an example of vertical analysis?
A) Comparing gross profit across companies.
B) Comparing income statement items as a percentage of sales.
C) Comparing debt with industry averages.
D) Comparing the change in sales over time.
52) Comparing operating expenses as a percentage of sales is an example of:
A) Vertical analysis.
B) Horizontal analysis.
C) Diagonal analysis.
D) Both vertical and horizontal analysis.
53) To perform a vertical analysis of an income statement, you would divide each line item on the
statement by ________.
A) sales
B) net income
C) total assets
D) operating expenses
54) To perform a vertical analysis of a balance sheet, you would divide each line item on the
statement by ________.
A) total assets
B) net income
C) sales
D) operating expenses
55) Ronaldo Soccer Shop’s income statement reports sales of $100,000; cost of goods sold of
$46,000, operating expenses of $34,000, interest expense of $15,000, income tax expense of
$2,000, and net income of $3,000. If you were to perform a vertical analysis of this income
statement, you would divide each of these income statement line items by:
A) $100,000
B) $46,000
C) $34,000
D) $3,000
56) The following is an example of:
Amount
%
Cash
$ 300,000
6
Accounts receivable
500,000
10
Inventory
800,000
16
Long-term assets
3,400,000
68
Total assets
$ 5,000,000
100
A) Vertical analysis.
B) Horizontal analysis.
C) Diagonal analysis.
D) Both vertical and horizontal analysis.
57) The following is an example of:
Year
Increase (Decrease)
Amount
%
Cash
$
300,000
$
800,000
$
(500,000
)
(62.5
)
Accounts
receivable
500,000
200,000
300,000
150.0
Inventory
800,000
700,000
100,000
14.3
Long-term
assets
3,400,000
2,300,000
1,100,000
47.8
Total assets
$
5,000,000
$
4,000,000
$
1,000,000
25.0
A) Vertical analysis.
B) Horizontal analysis.
C) Diagonal analysis.
D) Both vertical and horizontal analysis.
58) Trend analysis and time-series analysis refer to ________ analysis.
A) horizontal
B) vertical
C) ratio
D) diagonal
59) To calculate a year-to-year percentage change in any financial statement line item such as
sales, you should take the current year’s amount, subtract the prior year’s amount, then divide by
________, and finally multiply the result by 100.
A) net income
B) total assets
C) the current year’s amount
D) the prior year’s amount
60) Brady’s Inflation Needle Co. reports accounts receivable of $100,000 in 2020 and $250,000 in
2021. Using horizontal analysis, what would be the percentage increase or decrease in accounts
receivable?
A) 60% decrease
B) 60% increase
C) 150% decrease
D) 150% increase
61) The type of analysis used to analyze trends in financial statement data over time is:
A) Horizontal analysis
B) Vertical analysis
C) Diagonal analysis
D) Both horizontal and vertical analysis
62) Horizontal analysis is used to analyze trends in financial statement data over time:
A) For one company
B) Between two companies
C) Across an industry
D) None of the other answer choices are correct
63) Horizontal analysis examines trends in a company
A) Over time.
B) Between income statement accounts in the same year.
C) Between balance sheet accounts in the same year.
D) Between income statement and balance sheet accounts in the same year.
64) Which of the following is an example of horizontal analysis?
A) Comparing COGS with sales.
B) Comparing net income across companies.
C) Comparing debt with equity.
D) Comparing the growth in sales over time.
65) Which of the following is an example of horizontal analysis?
A) Comparing gross profit across companies.
B) Comparing gross profit with operating expenses.
C) Comparing assets with equity.
D) Comparing the change in sales over time.
66) Comparing changes in net income for one company over time is an example of:
A) Vertical analysis.
B) Horizontal analysis.
C) Diagonal analysis.
D) Both vertical and horizontal analysis.