# 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 full access to CoursePaper, a membership subscription is required.

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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True-False Statements

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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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Brief Exercises

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Completion Statements

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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE

Learning Objective 1

Item

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1.

TF

10.

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SA

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204.

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256.

SA

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Financial Analysis: The Big Picture

FOR INSTRUCTOR USE ONLY

13-3

Learning Objective 2

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13.

TF

26.

TF

81.

MC

94.

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108.

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217.

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14.

TF

27.

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82.

MC

95.

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109.

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218.

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15.

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28.

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96.

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110.

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228.

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29.

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84.

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97.

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111.

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229.

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85.

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98.

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112.

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230.

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TF

71.

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86.

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99.

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113.

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231.

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TF

72.

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87.

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232.

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TF

75.

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88.

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101.

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76.

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89.

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102.

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234.

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TF

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90.

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243.

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91.

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TF

79.

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92.

MC

106.

MC

215.

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257.

SA

25.

TF

80.

MC

93.

MC

107.

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216.

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Learning Objective 3

31.

TF

121.

MC

143.

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165.

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187.

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225.

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32.

TF

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144.

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167.

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146.

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168.

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TF

127.

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149.

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171.

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193.

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128.

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172.

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239.

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129.

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151.

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41.

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42.

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43.

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155.

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177.

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44.

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134.

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178.

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249.

C

45.

TF

135.

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179.

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201.

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C

114.

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136.

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115.

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116.

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117.

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118.

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260.

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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.

TF

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143.

MC

165.

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187.

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32.

TF

122.

MC

144.

MC

166.

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188.

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226.

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33.

TF

123.

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145.

MC

167.

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189.

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227.

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34.

TF

124.

MC

146.

MC

168.

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190.

MC

235.

Ex

35.

TF

125.

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147.

MC

169.

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191.

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236.

Ex

36.

TF

126.

MC

148.

MC

170.

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192.

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237.

Ex

37.

TF

127.

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149.

MC

171.

MC

193.

MC

238.

Ex

38.

TF

128.

MC

150.

MC

172.

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194.

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239.

Ex

39.

TF

129.

MC

151.

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173.

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195.

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240.

Ex

40.

TF

130.

MC

152.

MC

174.

MC

196.

MC

245.

C

41.

TF

131.

MC

153.

MC

175.

MC

197.

MC

246.

C

42.

TF

132.

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154.

MC

176.

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198.

MC

247.

C

43.

TF

133.

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155.

MC

177.

MC

199.

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248.

C

44.

TF

134.

MC

156.

MC

178.

MC

200.

MC

249.

C

45.

TF

135.

MC

157.

MC

179.

MC

201.

MC

250.

C

114.

MC

136.

MC

158.

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180.

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202.

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251.

C

115.

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137.

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159.

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181.

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219.

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252.

C

116.

MC

138.

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160.

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182.

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253.

Ma

117.

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139.

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161.

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183.

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221.

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254.

Ma

118.

MC

140.

MC

162.

MC

184.

MC

222.

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258.

SA

119.

MC

141.

MC

163.

MC

185.

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260.

SA

120.

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142.

MC

164.

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186.

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224.

Be

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

13-19

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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