Chapter 13 1 Apply the concept of sustainable income and quality of 

Document Type
Test Prep
Book Title
Financial Accounting-- Binder Ready Version: Tools for Business Decision Making 8th Edition
Authors
Donald E. Kieso, Jerry J. Weygandt, Paul D. Kimmel
FOR INSTRUCTOR USE ONLY
CHAPTER 13
FINANCIAL ANALYSIS: THE BIG PICTURE
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVE AND BLOOM’S TAXONOMY
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Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
13-2
Multiple Choice Questions (Cont.)
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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
Learning Objective 1
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Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13-3
Learning Objective 2
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Learning Objective 3
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Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
13-4
Learning Objective 4
31.
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Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
Ma = Matching SA = Short Answer Essay
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13-5
CHAPTER LEARNING OBJECTIVES
1. Apply the concept of sustainable income and quality of earnings. Sustainable income
analysis is useful in evaluating a company’s performance. Sustainable income is the most
likely level of income to be obtained by the company in the future. Discontinued operations
and other comprehensive income are presented on the statement of comprehensive to
highlight their unusual nature. Items below income from continuing operations must be
presented net of tax.
A high quality of earnings provides full and transparent information that will not confuse or
mislead users of the financial statements. Issues related to quality of earnings are (1)
alternative accounting methods, (2) pro forma income, and (3) improper recognition.
2. Apply horizontal analysis and vertical analysis. Horizontal analysis is a technique for
evaluating a series of data over a period of time to determine the increase or decrease that
has taken place, expressed as either an amount or a percentage.
Vertical analysis is a technique that expresses each item in a financial statement as a
percentage of a relevant total or a base amount.
3. Analyze a compay's performance using ratio analysis. The price-earnings (P-E) ratio
reflects investors' assessment of a company's future earnings potential. Financial ratios are
provided in Illustration 13-16 (liquidity), Illustration 13-17 (solvency) and Illustration 13-18
(profitability).
*4. Evaluate a company comprehensively using ratio analysis. To evaluate a company, ratios
(liquidity, solvency, and profitability) provide clues to underlying conditions, but intracompany,
intercompany, and industry average comparisons are also needed.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-6
TRUE-FALSE STATEMENTS
1. Analysts are interested in sustainable income, which is equal to the past year’s net income.
2. One objective of the income statement is to separate the results of continuing operations
from those of discontinued operations.
3. When the disposal of a significant segment occurs, the income statement should report
both income from continuing operations and income (loss) from discontinued operations.
4. Other comprehensive income includes all changes in stockholder's equity during a period
including those changes resulting from investments by stockholder's.
5. Companies report most changes in accounting principle currently.
6. The loss on disposal of a significant component of a business is disclosed in the statement
of retained earnings.
7. A change in accounting principle occurs when the principle used in the current year is
different from the one used by competitors in the current year.
8. Comprehensive income includes all changes in stockholders’ equity during a period except
those resulting from investments by stockholders and distributions to stockholders.
9. Comprehensive income includes all revenues, expenses, gains, losses, and dividends.
10. Alternative accounting methods affect the quality of earnings.
11. Improper recognition of income is not one of the factors affecting the quality of earnings.
12. Because pro forma earnings are based on specific rules, these amounts are highly reliable.
Financial Analysis: The Big Picture
13-7
13. In horizontal analysis, the base year is the most current year being examined.
14. Horizontal analysis is a technique for evaluating a financial statement item in the current
year with other items in the current year.
15. Another name for horizontal analysis is trend analysis.
16. If a company has sales of $130 in 2017 and $182 in 2016, the percentage decrease in
sales from 2016 to 2017 is 40%.
17. In horizontal analysis, if an item has a negative amount in the base year, and a positive
amount in the following year, no percentage change for that item can be computed.
18. A primary purpose of vertical analysis is to observe trends over a three-year period.
19. Vertical analysis is a technique for evaluating a series of financial statement data over a
period of time to determine the increase (decrease) that has taken place.
20. Common size analysis expresses each item in a financial statement as a percent of a base
amount.
21. In a common size income statement, net sales are represented by 100%.
22. In a common size income statement, each item is expressed as a percentage of net
income.
23. In a common size balance sheet, total assets are represented by 100%.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-8
24. In the vertical analysis of a balance sheet, the base for current liabilities is total liabilities.
25. Vertical analysis is useful in making comparisons of companies of different sizes.
26. Using vertical analysis of the income statement, a company's net income as a percentage
of net sales is 15%; therefore, the cost of goods sold as a percentage of sales must be
85%.
27. In the vertical analysis of an income statement, each item is generally stated as a
percentage of net income.
28. Intracompany comparisons of the same financial statement items are often useful to detect
changes in financial relationships and significant trends.
29. Comparisons of company data with industry averages provide information about a
company's relative position within the industry.
30. Horizontal, vertical, and circular analyses are the basic tools of financial statement
analysis.
31. Accounts receivable turnover is useful in assessing the profitability of receivables.
32. Inventory turnover measures the number of times on average the inventory was sold
during the period.
33. Inventory turnover is a measure of liquidity that focuses on efficient use of inventory.
34. Profitability ratios are frequently used as a basis for evaluating management's operating
effectiveness.
35. Both profit margin and asset turnover affect a company’s return on assets.
Financial Analysis: The Big Picture
FOR INSTRUCTOR USE ONLY
13-9
36. Leverage and return on equity are closely related.
37. The return on assets will be greater than the rate of return on common stockholders' equity
if the company has been successful in trading on the equity at a gain.
38. The current ratio is one of the most utilized measures of profitability.
39. From a creditor's point of view, the higher the debt to assets ratio, the lower the risk that
the company may be unable to pay its obligations.
40. A current ratio of 1.2 to 1 indicates that a company's current assets exceed its current
liabilities.
41. Using borrowed money to increase the rate of return on common stockholders' equity is
called "trading on the equity."
42. Declining profitability and liquidity ratios are indications that a company may not survive.
43. Liquidity ratios measure the ability of the company to survive over a long period of time.
44. A solvency ratio measures the income or operating success of a company for a given
period of time.
45. The current ratio is a measure of all the ratios calculated for the current year.
Answers to True-False Statements
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-10
MULTIPLE CHOICE QUESTIONS
46. Which of the following income statement figures would probably be the best indicator of a
company’s future performance?
a. Total revenues
b. Income from operations
c. Net income
d. Gross profit
47. Which of the following is the best definition of sustainable income?
a. Sustainable income is a measure of solvency that does not include capital expenditure.
b. Sustainable income is the same as net income.
c. Sustainable income is income that is unusual in nature and infrequent in occurrence.
d. Sustainable income is the most likely level of income to be obtained in the future.
48. When preparing an income statement, which of the following is the proper order for income
statement components?
a. Comprehensive income, Other comprehensive income items, Net income
b. Net income, Comprehensive income, Other comprehensive income items
c. Net income, Other comprehensive income items, Comprehensive income
d. Other comprehensive income items Net income, Comprehensive income
49. If a company has a discontinued operation gain of $30,000 and a 32% tax rate, what is the
effect on net income?
a. Increase of $30,000.
b. Increase of $20,400.
c. Increase of $9,600.
d. No effect.
50. All of the following are reported on the income statement net of tax except
a. loss on operations from a discontinued division.
b. other comprehensive income items.
c. income from operations.
d. loss on disposal of a division.
Financial Analysis: The Big Picture
13-11
51. All of the following statements regarding changes in accounting principles are true except
which of the following?
a. Most changes in accounting principles are only reported in current periods when the
principle change takes place.
b. Changes in accounting principles are allowed when new principles are preferable to old
ones.
c. Most changes in accounting principles are retroactively reported.
d. Consistency is one of the biggest concerns when a change in accounting principle is
undertaken.
52. An income statement would not include
a. other revenue and gains.
b. income from operations.
c. discontinued operations.
d. dividends paid.
53. The discontinued operations section of the income statement refers to
a. discontinuance of a product line.
b. the income or loss on products that have been completed and sold.
c. obsolete equipment and discontinued inventory items.
d. the disposal of a significant component of a business.
54. When a change in depreciation method occurs
a. prior years' financial statements should be changed to reflect the newly adopted
method.
b. the change should be reported in current and future years.
c. the cumulative effect of the change should be reflected on the income statement as of
the beginning of the next year.
d. the cumulative effect of the change in accounting principle should be classified as an
discontinued operations on the income statement.
55. The order of presentation of items that may appear on the statement income of
comprehensive income is
a. Other comprehensive income, Discontinued operations, Income before income taxes.
b. Discontinued operations, Other comprehensive income, Income before income taxes.
c. Income before income taxes, Discontinued operations, Other comprehensive income.
d. Income before income taxes, Other comprehensive income, Discontinued operations.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-12
56. Which of the following items appears on the income statement before income before
income taxes?
a. Other comprehensive income.
b. Comprehensive income.
c. Other revenues and gains.
d. Discontinued operations.
57. Which of the following statements is true with respect to financial statement reporting a
change in accounting principle?
a. Comparability across periods is impaired
b. Only a footnote is required to report the change
c. Changes in both depreciation methods and inventory methods are reported
retroactively.
d. Management must show that the new accounting principle is preferable to the old
method.
58. Dandy Candy Company sold its licorice division resulting in a loss of $80,000. Assuming a
tax rate of 25%, the loss on this disposal will be reported on the income statement at what
amount?
a. $100,000
b. $20,000
c. $80,000
d. $60,000
59. Which of the following is not reported net of tax on the statement of comprehensive
income ?
a. Discontinued operations
b. Other comprehensive income
c. Other revenues and expenses
d. Income from continuing operations
60. Which of the following would not be considered an example of a discontinued operation?
a. Shifting production processes within an operation
b. Elimination of a major class of customers
c. Elimination of an entire activity
d. Disposal of a significant component of a business
Financial Analysis: The Big Picture
13-13
61. Other comprehensive income is reported on the statement of comprehensive income
immediately
a. before income from continuing operations.
b. after comprehensive income.
c. before income before income taxes.
d. after discontinued operations.
62. In reporting discontinued operations, the income statement should show in a special
section
1. gains on the disposal of a discontinued component.
2. losses on the disposal of a discontinued component.
a. 1 only.
b. 2 only.
c. neither 1 nor 2.
d. both 1 and 2.
63. The disposal of a significant component of a business is called
a. a change in accounting principle.
b. comprehensive income.
c. an other expense.
d. discontinued operations.
64. Lupton Inc. disposes of an unprofitable segment of its business. The operation of the
segment suffered a $200,000 loss in the year of disposal. The loss on disposal of the
segment was $100,000. If the tax rate is 30%, and income before income taxes was
$1,600,000,
a. the income tax expense on the income before discontinued operations is $390,000.
b. the income from continuing operations is $1,120,000.
c. net income is $1,300,000.
d. the losses from discontinued operations are reported net of income taxes at $300,000.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-14
65. Stellar, Inc. decided on January 1 to discontinue its telescope manufacturing division. On
July 1, the division’s assets with a book value of $1,260,000 are sold for $900,000.
Operating income from January 1 to June 30 for the division amounted to $195,000.
Ignoring income taxes, what total amount should be reported on Stellar’s income statement
for the current year under the caption, Discontinued Operations?
a. $195,000
b. $165,000 loss
c. $360,000 loss
d. $555,000
66. Comprehensive income would not include
a. dividends declared.
b. unrealized gains on available-for-sale securities.
c. discontinued operations.
d. other expenses and losses.
67. Which of the following would be considered an “Other Comprehensive Income” item?
a. Net income
b. Gain on disposal of discontinued operations
c. Other revenues and gains
d. Unrealized loss on available-for-sale securities
68. Jack's by the Tracks. has the following partial balance sheet:
JACK'S BY THE TRACKS.
Balance Sheet (partial)
Stockholders’ equity:
Common stock $6,000,000
Retained earnings 2,000,000
Total paid-in capital and retained earnings 8,000,000
Accumulated other comprehensive income 800,000
Total stockholders’ equity: $8,800,000
What effect will the accumulated other comprehensive income have on comprehensive
income?
a. No effect on comprehensive income.
b. Increase of $800,000 in comprehensive income.
c. Increase of $8,800,000 in comprehensive income.
d. Decrease of $800,000 in comprehensive income.
Financial Analysis: The Big Picture
13-15
69. Reardon Inc. has an investment in trading securities of $140,000. This investment
experienced an unrealized loss of $7,000 during the current year. Assuming a 35% tax
rate, the effect of this loss on comprehensive income will be
a. no effect.
b. $140,000 increase.
c. $49,000 decrease.
d. $91,000 decrease.
70. Which of the following would be considered an “Other comprehensive income” item?
a. Loss on disposal of discontinued operations
b. Unrealized loss on available-for-sale securities
c. Discontinued operations gain
d. Net income
71. Comparisons of financial data made within a company are called
a. intracompany comparisons.
b. interior comparisons.
c. intercompany comparisons.
d. industry comparisons.
72. Which one of the following is not a tool in financial statement analysis?
a. Horizontal analysis
b. Circular analysis
c. Vertical analysis
d. Ratio analysis
73. All of the following statements are true regarding comprehensive income except
a. companies are required to report comprehensive income.
b. a company would add an unrealized loss on available-for-sale securities to net income
to calculate comprehensive income.
c. comprehensive income does not include changes resulting from investments by
stockholders.
d. comprehensive income does not include dividends to stockholders.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-16
74. On January 1, 2017, Tri-State Industries had cash and common stock of $180,000. At that
date the company had no other asset, liability or equity balances. On January 2, 2017, it
purchased $160,000 of equity securities for cash that it classified as available-for-sale. It
received cash dividends of $12,000 during the year on these securities. In addition, it had
an unrealized holding gain on these securities of $32,000 net of tax. Based on this
information, what is the amount of comprehensive income in 2017?
a. $44,000
b. $20,000
c. $12,000
d. $32,000
75. A comparison with other companies that provides insight into a company's competitive
position is most commonly known as which of the following types of comparisons?
a. Industry average comparison
b. Intracompany comparison
c. Intercompany comparison
d. Comprehensive income comparison
76. When a horizontal analysis is performed and a zero or negative amount is reported in the
base year, then
a. no percentage change can be computed.
b. the percent change will be negative.
c. the accountant has made a mistake.
d. the percentage change will be 100% of greater.
77. Danner Corporation reported net sales of $650,000, $720,000, and $780,000 in the years
2016, 2017, and 2018, respectively. If 2016 is the base year, what percentage do 2018
sales represent of the base?
a. 108%
b. 120%
c. 83%
d. 20%
78. In analyzing financial statements, horizontal analysis is a
a. requirement.
b. tool.
c. principle.
d. theory.
Financial Analysis: The Big Picture
13-17
79. Horizontal analysis is also known as
a. linear analysis.
b. vertical analysis.
c. trend analysis.
d. common size analysis.
80. Under which of the following cases may a percentage change be computed?
a. The trend of the amounts is decreasing but all amounts are positive.
b. There is no amount in the base year.
c. There is a negative amount in the base year and a negative amount in the subsequent
year.
d. There is a negative amount in the base year and a positive amount in the subsequent
year.
81. Horizontal analysis is a technique for evaluating a series of financial statement data over a
period of time
a. that has been arranged from the highest number to the lowest number.
b. that has been arranged from the lowest number to the highest number.
c. to determine which items are in error.
d. to determine the amount and/or percentage increase or decrease that has taken place.
82. Horizontal analysis of comparative financial statements includes the
a. development of common size statements.
b. calculation of liquidity ratios.
c. calculation of dollar amount and percentage changes from financial statements over a
period of time, as compared to a base year.
d. evaluation of financial statement data that expresses each item in a financial statement
as a percentage of a base amount.
83. Horizontal analysis is a technique for evaluating financial statement data
a. within a period of time.
b. over a period of time.
c. on a certain date.
d. as it may appear in the future.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-18
84. If Year 1 equals $750, Year 2 equals $840, and Year 3 equals $900, the percentage to be
assigned for Year 3 in a trend analysis, assuming that Year 1 is the base year, is
a. 120%.
b. 112%.
c. 83%.
d. 107%.
85. If Year 1 equals $780, Year 2 equals $819, and Year 3 equals $896, the percentage to be
assigned for Year 2 in a trend analysis, assuming that Year 1 is the base year, is
a. 95%.
b. 115%.
c. 105%.
d. 109%.
86. Assume the following sales data for a company:
2018 $980,000
2017 875,000
2016 700,000
If 2016 is the base year, what is the percentage increase in sales from 2016 to 2017?
a. 140%
b. 125%
c. 40%
d. 25%
87. If Year 1 equals $700, Year 2 equals $840, and Year 3 equals $630, the percentage to be
assigned for Year 1 in a trend analysis, assuming that Year 1 is the base year, is
a. 100%.
b. 90%.
c. 111%.
d. 120%.
88. In horizontal or trend analysis, each item is expressed as a(n)
a. amount.
b. percentage.
c. rate.
d. amount or a percentage.
Financial Analysis: The Big Picture
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89. Assume the following sales data for a company:
2018 $960,000
2017 750,000
2016 600,000
If 2016 is the base year, what is the percentage increase in sales from 2016 to 2017?
a. 60%
b. 25%
c. 125%
d. 160%
90. Comparative balance sheets
a. are usually prepared for at least one year.
b. are usually prepared for at least two years.
c. do not show both dollar amount and percentage changes.
d. do not show a comparison of total stockholders’ equity.
91. Assume the following cost of goods sold data for a company:
2018 $1,400,000
2017 1,200,000
2016 1,000,000
If 2016 is the base year, what is the percentage increase in cost of goods sold from 2016
to 2018?
a. 140%
b. 40%
c. 20%
d. 17%
92. In horizontal analysis, each item is expressed as a percentage of the
a. net income amount.
b. stockholders’ equity amount.
c. total assets amount.
d. base-year amount.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
13-20
93. Boone Trading Company reported net sales of $400,000, $440,000, and $560,000 in the
years 2016, 2017, and 2018, respectively. If 2016 is the base year, what is the trend
percentage for 2018?
a. 71%
b. 127%
c. 140%
d. 110%
94. Comparisons of data within a company are an example of the following comparative basis
a. industry averages.
b. intercompany.
c. intracompany.
d. interregional.
95. Vertical analysis is also known as
a. perpendicular analysis.
b. common size analysis.
c. trend analysis.
d. straight-line analysis.
96. In a common size balance sheet, the 100 percent figure is
a. total current assets.
b. total property, plant and equipment.
c. total liabilities.
d. total assets.
97. In a common size financial statement, which of the following is given a percentage of 100
percent?
a. Total liabilities
b. Net income
c. Total assets
d. Cost of goods sold
98. In a common size income statement, the 100% figure is
a. net income.
b. cost of goods sold.
c. gross profit.
d. net sales.

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