Financial Accounting, 3e (Kemp/Waybright)
Chapter 12 Financial Statement Analysis
12.1 Questions
1) The economic environment of a business describes how a business is affected by competitors.
2) The competitive environment of a business describes how a business competes for critical
resources.
3) Financial analysis is used to predict the future of a business.
4) Financial statement analysis indicates only that a problem may exist and offers clues as to
what the problem might be.
5) Financial analysis focuses on evaluating a company’s past performance to predict its current
performance.
6) Financial analysis is the process of using a company’s financial information to evaluate
whether or not the company is creating value.
7) Net income belongs to a company’s stockholders.
8) The management discussion and analysis is typically located after the financial statements in a
company’s annual report.
9) A business model describes what a business does, what it sells, and who it sells to.
10) A business model deals with how a business makes customers want to buy their product.
11) Comparing your company with a competing company in the same category of business is
called benchmarking.
12) Kroger would probably benchmark with other:
A) general merchandise retailers.
B) big box retailers.
C) grocery chains.
D) companies that sell food.
13) What is financial analysis?
A) The process of using value to create financial statements and related information
B) Creating value in a company
C) The process of using financial statements and related information to evaluate whether a
company is creating value
D) The process of creating information related to the financial statements
14) Which of the following is NOT one of the steps in financial analysis?
A) Understanding the environment in which a business operates
B) Analyzing a business’ operations
C) Preparing a business’ financial statements
D) Understanding a business’ model and strategy
15) Which of the following is NOT part of what a company’s business model describes?
A) What products the company sells
B) How the company creates a competitive advantage
C) Who the company sells to
D) What the company does
16) A company’s business strategy describes:
A) what the business does.
B) how the business is affected by the overall economy.
C) who the business sells to.
D) how the business creates a competitive advantage.
17) A business’s competitive environment describes:
A) how a business competes for critical resources.
B) how a business is affected by the overall economy.
C) how a business uses its business model to create a competitive advantage.
D) how a business makes its product.
18) When an analyst compares a business with a similar business it is referred to as:
A) comparative analysis.
B) mentoring.
C) benchmarking.
D) idolizing.
19) Which of the following is typically NOT one of the questions asked when analyzing a
business’ operations?
A) How is the business investing its money?
B) When was the business started?
C) Is the business a going concern?
D) Can the business pay its debt obligations?
20) Management discussion and analysis is:
A) part of a business’s annual report.
B) prepared by the external auditors.
C) a summary of all the business’s press releases for the year.
D) both A and B.
21) A business’s economic environment describes how a business:
A) competes for critical resources.
B) is affected by the overall economy.
C) uses its business model to create a competitive advantage.
D) makes its product.
1) Return on equity measures the relationship between net income and average total assets.
2) Computing trend percentages over a period of years helps to indicate the direction in which
the business is going.
3) The three ways to analyze financial statements are by using horizontal, vertical and ratio
analysis.
4) Operating profit (EBIT) is first used to pay dividends to a company’s stockholders.
5) In computing trend percentages, the most recent year amounts become the base and are always
set to 100%.
6) The fixed asset turnover ratio measures a company’s ability to generate sales using all of its
assets.
7) The return on assets measures the relationship between sales and average total assets.
8) Most companies want a low inventory turnover ratio.
9) Determining the percentage changes in line items on financial statements for two consecutive
years is called horizontal analysis.
10) Knowing the dollar amount of change from year-to-year in an account is less relevant than
knowing the percentage change.
11) The most recent period in a horizontal analysis is called the base period.
12) Horizontal analysis is only done on the Income Statement.
13) The formula for determining the percentage change in an account from one year to the next
year is [(amount in later period – amount in earlier period)/ amount in earlier period] times 100.
14) In a vertical analysis, an item is selected as the base amount and all other items are computed
as a percentage of the base amount.
15) The base amounts for a vertical analysis are net income and total equity.
16) Common-size statements are useful when comparing a company’s performance against that
of a company of a different size.
17) Common-size statements use the same percentages that are computed during a vertical
analysis, but no dollar amounts are shown.
18) Common-size statements should NOT be used to compare a company’s performance against
a company of a different size.
19) A useful tool to reduce the bias when comparing the performance of different sized
companies is to do a horizontal analysis on each one.
20) The net working capital for a company with current assets of $70,000, quick assets of
$30,000, total assets of $150,000, current liabilities of $50,000 and net sales of $80,000 would
be:
A) $100,000.
B) $50,000.
C) $30,000.
D) $20,000.
21) The net working capital for a company with current assets of $78,000, quick assets of
$42,000, total assets of $177,000 current liabilities of $60,000 and net sales of $90,000 would be:
A) $60,000.
B) $30,000.
C) $18,000.
D) $117,000.
22) The current ratio for a company with current assets of $78,000, quick assets of $42,000, total
assets of $177,000 current liabilities of $60,000 and net sales of $90,000 would be:
A) 0.70.
B) 2.95.
C) 1.30.
D) 1.50.
23) Ironworks, Inc. has a cash balance of $80,000; short-term investments of $20,000; net
receivables of $60,000; and inventory of $450,000. Current liabilities total $200,000. Red Line’s
current ratio is:
A) 3.05 to 1.
B) 2.75 to 1.
C) 0.80 to 1.
D) 0.70 to 1.
24) Perkins Company has $56,000 in cash; $12,000 in Accounts Receivable; $25,000 in short-
term investments and $100,000 in merchandise inventory. The company also has $60,000 in
current liabilities. The company’s current ratio is:
A) 0.933.
B) 1.550.
C) 1.133.
D) 3.217.
25) The 2013 and 2014 balance sheets for Shadow Industries showed Cash of $8,000 and $9,500
respectively, Accounts Receivable of $14,000 and $16,000, respectively, Inventory of $11,000
and $8,000, respectively, and Accounts Payable of $5,000 and $7,000, respectively. Its 2014
Income Statement showed Net Sales of $108,000, Cost of Goods Sold of $62,000, and Net
Income of $27,000. The cash conversion cycle for 2014 was (round calculations to two decimal
places):
A) 141.94 days.
B) 40.56 days.
C) 30.08 days.
D) 71.30 days.
26) The 2013 and 2014 balance sheets for Northwest Plumbing showed Cash of $6,500 and
$8,000 respectively, Accounts Receivable of $15, 000 and $18,000, respectively, Inventory of
$12,500 and $9,500, respectively, and Accounts Payable of $5,000 and $8,000, respectively. Its
2014 Income Statement showed Net Sales of $116,000, Cost of Goods Sold of $58,000, and Net
Income of $31,000. The cash conversion cycle for 2014 was (round calculations to two decimal
places):
A) 58.22 days.
B) 80.24 days.
C) 162.06 days.
D) 23.60 days.
27) After income from continuing operations, the next section on an Income Statement is:
A) earnings per share data.
B) discontinued operations.
C) continuing operations.
D) extraordinary items.
28) The last section of an Income Statement report is:
A) extraordinary items.
B) discontinued operations.
C) continuing operations.
D) income tax expense.
29) Business activities that are unusual and infrequent in occurrence are reported in the:
A) other income (expense) section.
B) discontinued operations section.
C) continuing operations section.
D) extraordinary items section.
30) Everyday business activities are reported in the:
A) continuing and discontinued operations section.
B) discontinued operations section.
C) continuing operations section.
D) extraordinary items section.
31) When a company sells off part of the business, this would be reported:
A) as a retrospective application.
B) in the discontinued operations section.
C) in the continuing operations section.
D) in the extraordinary items section.
32) Predictions about a company’s future earnings can best be inferred from the:
A) earnings per share data.
B) discontinued operations section.
C) continuing operations section.
D) extraordinary items section.
33) Other income (such as rental income) and other expenses (such as interest expense) are listed
immediately after:
A) gross profit.
B) operating expenses.
C) operating income.
D) income tax expense.
34) Gains and losses on plant, property, and equipment are reported:
A) as a retrospective application.
B) in the discontinued operations section.
C) in the continuing operations section.
D) in the extraordinary items section.
35) A(n) ________ is a distinguishable part of a business that is subject to a different set of risks
and returns than other parts of the business.
A) extraordinary event
B) business segment
C) product line
D) manufacturing line
36) On the Income Statement, the results of discontinued operations are reported:
A) as part of other income (expense).
B) immediately after the extraordinary items section.
C) net of income tax or net of income tax savings.
D) before the operating income section.
37) Which would NOT be considered an extraordinary item?
A) Expropriation of a plant’s assets in India
B) Tornado damage in Maine
C) Hurricane damage in Miami
D) Flood damage in Arizona
38) On the Income Statement, extraordinary items are reported:
A) immediately after the continuing operations section.
B) immediately before the discontinued operations section.
C) net of income tax or net of income tax savings.
D) before the operating income section.
39) Which section of the Income Statement is NOT reported net of income taxes or net of
income tax savings?
A) All sections are reported net of taxes.
B) Discontinued operations section
C) Continuing operations section
D) Extraordinary items section
40) A comparison of the amounts for the same item in the financial statements of two or more
periods is called:
A) vertical analysis.
B) comparative analysis.
C) horizontal analysis.
D) trend analysis.
41) Which analysis deals with the percentage of changes in certain items over a period of years?
A) Horizontal analysis
B) Vertical analysis
C) Incremental analysis
D) Trend analysis
42) Franklin Fisheries had extraordinary losses of $150,000. If their corporate tax rate is 30%, at
what amount will the losses be shown on the Income Statement?
A) $150,000
B) $105,000
C) $45,000
D) Not enough information is given to answer the question.
43) Evergreen Supply Co. sells hiking and other outdoor equipment. It also sells a few trail
books and outdoor guides about the area. In their Income Statement, the revenue from the books
and guides would probably be recorded as:
A) operating income.
B) other income.
C) other expenses.
D) extraordinary income.
44) TNT Guitar’s sales were $13,444 in 2014 and $12,898 in 2013. The percentage change in
TNT’s sales from 2013 to 2014 was:
A) +4.06%.
B) -4.23%.
C) +4.23%.
D) -4.06%.
45) Island Coffee’s cash reported on the comparative Balance Sheet was $235,000 in 2013 and
$245,300 in 2014. The percentage change in cash from 2013 to 2014 was:
A) +4.20%.
B) +4.38%.
C) -4.38%.
D) -4.20%.
46) Revere, Inc. reported $23,400 in A/R in 2014 and $25,100 in A/R in 2013. The percentage
change in A/R from 2013 to 2014 was:
A) +6.77%.
B) +7.26%.
C) -6.77%.
D) -7.26%.
47) If cash is $4,450 in 2014 and $3,670 in 2013, what is the percent increase or decrease from
2013 to 2014?
A) +2.125.
B) +21.250.
C) -1.753.
D) +17.530.
48) Net income was $45,000 in 2013 and $60,000 in 2014. The percentage increase or decrease
in net income from 2013 to 2014 was:
A) +33.33.
B) +133.33.
C) -25.00
D) -33.33.
49) If current assets were $100,000 in 2013 and $88,000 in 2014, what was the amount of
increase or decrease in percentage terms from 2013 to 2014? (Round to the nearest percent.)
A) Increase of 14%
B) Decrease of 14%
C) Increase of 12%
D) Decrease of 12%