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Chapter 12 Financial Statement Analysis Answer Key
True / False Questions
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.
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Difficulty: 1 Easy
Learning Objective: 12-01 Perform vertical analysis.
Topic: Vertical Analysis
4.
We use vertical analysis for income statement accounts, but not balance sheet accounts.
5.
Learning Objective: 12-01 Perform vertical analysis.
Topic: Vertical Analysis
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.
Learning Objective: 12-01 Perform vertical analysis.
Topic: Vertical Analysis
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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.
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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.
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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.
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Topic: Risk Analysis
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.
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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.
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Topic: Risk Analysis
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.
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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.
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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.
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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.
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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, near the bottom of the income
statement.
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37.
The location where a loss is reported in the income statement does not really matter as
long as the loss is reported.
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.
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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.
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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.
Multiple Choice Questions
45.
Which of the following is
not
a common type of comparison in accounting?
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46.
When using vertical analysis, we express income statement accounts as a percentage of
47.
When using vertical analysis, we express balance sheet accounts as a percentage of
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48.
______ analysis identifies the relative contribution made by each financial statement line
item.
49.
Common-size analysis is another term used for ____ analysis.
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50.
Which of the following types of analysis allows for the comparison of financial statement
items between companies of different size?
51.
Which of the following is an example of vertical analysis?
52.
Comparing operating expenses as a percentage of sales is an example of:
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53.
To perform a vertical analysis of an income statement, you would divide each line item on
the statement by ______.
54.
To perform a vertical analysis of a balance sheet, you would divide each line item on the
statement by ______.
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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:
Topic: Vertical Analysis
56.
The following is an example of:
Amount
%
Cash
$300,000
6.0
Accounts receivable
500,000
10.0
Inventory
800,000
16.0
Long-term assets
3,400,000
68.0
Total assets
$5,000,000
100.0