Managerial Accounting, 16e (Garrison)
Chapter 15: Financial Statement Analysis
1) Vertical analysis of financial statements is accomplished by preparing common-size statements.
2) In determining whether a company’s financial condition is improving or deteriorating over time,
horizontal analysis of financial statement data would be more useful than vertical analysis.
3) A common-size financial statement is a vertical analysis in which each financial statement
account is expressed as a percentage.
4) The acid-test ratio is usually greater than the current ratio.
5) Liquidity refers to how quickly an asset can be converted into cash.
6) If the acid-test ratio is less than one, then paying off some current liabilities with cash will
increase the acid-test (quick) ratio.
7) A company could improve its acid-test ratio by selling some equipment it no longer needs for
cash.
8) Acquiring land by taking out a long-term mortgage will not affect the current ratio.
9) Purchasing marketable securities with cash will have no effect on a company’s acid-test ratio.
10) As the accounts receivable turnover ratio decreases, the average collection period increases.
11) If a company’s operating cycle is much longer than its average payment period for suppliers, it
creates the need to borrow money to fund its inventories and accounts receivable.
12) All other things the same, purchasing inventory would decrease the inventory turnover ratio.
13) Buying inventory in large lots to take advantage of quantity discounts can be responsible for a
high inventory turnover ratio.
14) All other things the same, when a company increases its inventories in anticipation of later
higher sales, the accounts receivable turnover ratio for the current period increases.
15) All other things the same, purchasing merchandise inventory would have no effect on the
accounts receivable turnover ratio at a retailer.
16) All other things the same, when a customer purchases an item for cash, the accounts receivable
turnover ratio increases.
17) As the inventory turnover increases, the average sales period decreases.
18) To increase total asset turnover, management must either increase sales or reduce total
stockholders’ equity.
19) The formula for the average sale period is: Average sale period = Accounts receivable turnover
÷ Inventory turnover.
20) The formula for total asset turnover is: Total asset turnover = Total assets ÷ Total stockholders’
equity.
21) A company whose inventory turnover ratio is much slower than the average for its industry
may have too much inventory or the wrong sorts of inventory.
22) All other things the same, those who hold the company’s debt (i.e., its creditors) would like a
low debt-to-equity ratio to provide a buffer of protection.
23) All other things the same, if long-term debt is exchanged for short-term debt, the
debt-to-equity ratio will be unchanged.
24) The times interest earned ratio is based on net income because that is the amount of earnings
that is available for making interest payments. Interest expense is deducted before taxes are
determined; creditors have first claim on the earnings before taxes are paid.
25) Issuing common stock will decrease a company’s financial leverage.
26) The formula for the times interest earned ratio is: Times interest earned = Earnings before
interest expense and income taxes ÷ Interest expense.
27) If a company’s return on assets is substantially lower than its cost of borrowing, then the
common stockholders would normally want the company to have a relatively high debt/equity
ratio.
28) The formula for the return on equity is: Return on equity = Net income ÷ Average total
stockholders’ equity.
29) When computing the return on equity, retained earnings should be excluded from the average
total stockholders’ equity.
30) When computing the return on total assets, the interest expense is added back to net income to
show what earnings would have been if the company had no debt.
31) When a company sells used equipment for a loss, the net profit margin percentage is
unaffected.
32) All other things the same, if a company uses long-term debt to purchase land to develop in the
future, the company’s return on total assets will decrease.
33) If a retailer sells a product whose contribution margin equals the gross margin percentage, the
gross margin percentage will be unaffected by the transaction.
34) The gross margin percentage is computed by dividing the gross margin by net income before
interest and taxes.
35) The formula for the net profit margin percentage is: Net profit margin percentage = Net income
÷ Sales.
36) When fixed costs are included in the cost of goods sold, the gross margin percentage should
increase and decrease with sales volume.
37) The gross margin percentage is computed by dividing sales by the gross margin.
38) A high price-earnings ratio means that investors are willing to pay a premium for the
company’s stock.
39) An increase in the number of shares of common stock outstanding will increase a company’s
price-earnings ratio if the market price per share remains unchanged.
40) The dividend payout ratio is equal to the dividend per share divided by the earnings per share.
41) All other things the same, if the company purchases equipment on credit, this transaction
would have no impact on the company’s book value per share.
42) Purchasing inventory on credit increases the book value per share of a retailer.
43) The price-earnings ratio is determined by dividing market price per share of stock by the
earnings per share.
44) Earnings per share is computed by multiplying net income by the average number of common
shares outstanding.
45) Selling used equipment at book value for cash will:
A) increase working capital.
B) decrease working capital.
C) decrease the debt-to-equity ratio.
D) increase net income.
46) If current assets exceed current liabilities, prepaying an expense on the last day of the year will:
A) decrease the current ratio.
B) increase the acid-test ratio.
C) decrease the acid-test ratio.
D) increase the current ratio.
47) Zack Company has a current ratio of 2.5. What will be the effect of a purchase of inventory
with cash on the acid-test ratio and on working capital?
Acid-Test Ratio
Working Capital
A)
decrease
decrease
B)
decrease
no effect
C)
no effect
decrease
D)
no effect
no effect
A) Choice A
B) Choice B
C) Choice C
D) Choice D
48) Norton Inc. could improve its current ratio of 2 by:
A) paying a previously declared stock dividend.
B) writing off an uncollectible receivable.
C) selling merchandise on credit at a profit.
D) purchasing inventory on credit.
49) 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.
50) A company’s current ratio is greater than 1. Purchasing raw materials on credit would:
A) increase the current ratio.
B) decrease the current ratio.
C) increase working capital.
D) decrease working capital.
51) Sand Company has an acid-test ratio of 0.8. Which of the following actions would improve the
acid-test ratio?
A) Collect some accounts receivable.
B) Acquire some inventory on account.
C) Sell some equipment for cash.
D) Use cash to pay off some accounts payable.
52) A company’s current ratio and its acid-test ratio are both greater than 1. Payment of an account
payable would:
A) increase the current ratio but the acid-test ratio would not be affected.
B) increase the acid-test ratio but the current ratio would not be affected.
C) increase both the current and acid-test ratios.
D) decrease both the current and acid-test ratios.
53) Which of the following actions would improve a current ratio of 0.8?
A) Use cash to pay off some current liabilities.
B) Purchase additional marketable securities with cash.
C) Acquire a parcel of land in exchange for common stock.
D) Purchase additional inventory on credit.
54) Accounts receivable turnover will normally decrease as a result of:
A) the write-off of an uncollectible account against the allowance for bad debts.
B) a significant sales volume decrease near the end of the accounting period.
C) an increase in cash sales in proportion to credit sales.
D) a change in credit policy to lengthen the period for cash discounts.
55) The gross margin percentage is equal to:
A) (Net operating income + Selling and administrative expenses)/Sales
B) Net operating income/Sales
C) Cost of goods sold/Sales
D) Cost of goods sold/Net income
56) Which of the following is not a source of financial leverage?
A) Bonds payable.
B) Accounts payable.
C) Taxes payable.
D) Prepaid rent.
57) Which one of the following statements about book value per 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.