Chapter 14 Return on assets is a measure for evaluating how efficient a company 

Document Type
Test Prep
Book Title
Financial Accounting: A Bridge to Decision Making 6th Edition
Authors
Robert W. Ingram, Thomas L. Albright
483
Chapter 14--Analysis of Operating Activities
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484 Chapter 14
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Analysis of Operating Activities 485
TRUE/FALSE
1. Return on assets is a measure for evaluating how efficient a company is at generating net income
from its existing level of sales..
2. Operating profit margin measures a company's efficiency in controlling product costs and selling
and administration expenses.
3. Companies that sell large quantities of similar low-cost products, usually will compete on the basis
of product differentiation.
4. Inventory turnover measures a company's ability to convert its profits into cash.
5. Accounts receivable turnover measures a company's ability to convert its inventory into accounts
receivable.
6. Inventory turnover is the ratio of cost of goods sold to inventory
7. Gross profit margin is the ratio of gross profit to net income.
8. The three components of return on equity are profit margin, asset turnover, and financial leverage.
9. The income statement, balance sheet, and statement of cash flows are the primary financial
accounting reports.
486 Chapter 14
10. Accounting is primarily the process of recording transactions in journals and ledgers.
MULTIPLE CHOICE
1. Determining how to price a company's products is a(n)
a.
financial reporting decision
b.
operating decision
c.
financing decision
d.
investing decision
2. Companies will usually compete on the basis of price when
a.
the product market is highly competitive
b.
their products can be differentiated by special features
c.
customers are willing to pay for special features
d.
prices are set at a high level
3. The price a company charges for its product depends on
a.
how much customers are willing to pay
b.
how long the product lasts
c.
the decision of the Board of Directors
d.
the economic conditions of the country
4. Which of the following statements is NOT true?
a.
return on assets is a simple measure for evaluating how well a firm is utilizing its assets to
generate profits
b.
return on assets is equal to net income divided by total assets
c.
return on assets is a combination of profit margin and asset turnover
d.
return on assets measures performance using cash-based net income
5. Which of the following is a measure of the company's ability to create profit from existing sales?
a.
operating decision
b.
asset turnover
c.
profit margin
d.
return on assets
Analysis of Operating Activities 487
6. Which of the following statements is NOT true?
a.
asset turnover is a measure of efficiency
b.
asset turnover is the ratio of operating revenues to total assets
c.
asset turnover is a measure of a firm's ability to generate sales from its investment in assets
d.
asset turnover is a component of return on assets
7. Which of the following is a measure of the company's ability to generate profits from existing
assets?
a.
return on assets
b.
profit margin
c.
asset turnover
d.
sales revenue
8. Which of the following statements is NOT true?
a.
profit margin is the ratio of net income to operating revenues
b.
profit margin is a measure of a company's ability to generate profit from its sales
c.
profit margin is a measure of effectiveness
d.
profit margin is a component of return on assets
9. Refer to the table in Figure 13-1. What is the profit margin for Opie Technologies?
a.
12.0%
b.
18.9%
c.
15.2%
d.
16.0%
488 Chapter 14
10. Refer to the table in Figure 13-1. What is return on assets for Bea Corporation?
a.
11.0%
b.
11.4%
c.
8.7%
d.
9.6%
11. Refer to the table in Figure 13-1. What is asset turnover for Bea Corporation?
a.
1.27%
b.
60.0%
c.
1.18%
d.
72.4%
12. Refer to the table in Figure 13-1. What is the profit margin for Bea Corporation?
a.
12.0%
b.
18.9%
c.
15.2%
d.
16.0%
13. Refer to the table in Figure 13-1. What is asset turnover for Opie Technologies?
a.
72.4%
b.
1.18%
c.
60.0%
d.
1.27%
14. Refer to the table in Figure 13-1. What is return on assets for Opie Technologies?
a.
11.0%
b.
11.4%
c.
8.7%
d.
9.6%
Analysis of Operating Activities 489
15. Which of the following is a measure of a company's ability to generate sales by using its assets?
a.
return on assets
b.
profit margin
c.
asset turnover
d.
sales revenue
16. A company "generates $3.40 of sales revenues for each $1 invested in assets." This represents a
measure of
a.
return on assets
b.
profit margin
c.
asset turnover
d.
sales revenue
17. A company "generates $0.10 in net income for every $1 of sales" is a(n)
a.
description of how effective the company is
b.
description of how efficient the company is
c.
description of how the company is using assets
d.
impossible situation
18. Which of the following statements about operating strategies is NOT true?
a.
a cost leadership strategy has a high asset turnover and low profit margin
b.
a cost leadership strategy relies on high sales volume
c.
cost leadership strategy focuses on effectiveness
d.
cost leadership companies keep their operations streamlined to keep costs low
19. Which of the following compares the "bottom line result" on an income statement to the first item
on the income statement?
a.
gross profit margin
b.
operating profit margin
c.
profit margin
d.
asset turnover
490 Chapter 14
20. The following information was taken from the annual report of Mandala Company:
Net income
$ 400
Total assets
5,000
Total liabilities
3,400
What is the return on assets (ROA) and return on equity (ROE)?
ROA ROE
a.
$0.25 $0.08
b.
0.08 0.25
c.
0.08 0.12
d.
0.12 0.08
21. Which of the following is a summary measure of the success of a company's financing, investing,
and operating activities?
a.
return on assets
b.
profit margin
c.
return on equity
d.
financial leverage
22. Which of the following companies, whose ROE and ROA are given, is probably the most valued
by investors?
Co. #1
Co. #2
Co. #3
Co. #4
ROA
6.2%
8.2%
4.5%
7.5%
ROE
5.4%
8.6%
11.5%
12.8%
a.
Co. #1
b.
Co. #2
c.
Co. #3
d.
Co. #4
23. Companies in highly-competitive markets with very similar products, usually will compete on the
basis of
a.
product differentiation
b.
price
c.
asset turnover
d.
return on assets
Analysis of Operating Activities 491
24. Companies that compete using special product features
a.
generally have a low profit margin
b.
can charge a higher price and earn more per unit
c.
keep their prices low to attract customers
d.
depend on high sales volumes to earn a profit
25. Companies that rely on low costs
a.
use a product differentiation strategy
b.
require high profit margin
c.
use a cost leadership strategy
d.
require a low asset turnover
26. Companies that rely on product features
a.
use a cost leadership strategy
b.
require high asset turnover
c.
keep their prices low to attract customers
d.
require a high profit margin
27. Which of the following is NOT true?
a.
a company selects operating strategies depending on the types of products they produce
and sell
b.
a company cannot compete in both cost leadership and product differentiation markets
c.
a company that relies on low costs use a cost leadership strategy
d.
product differentiation companies normally rely on brand name identification
28. Which of the following is consistent with a cost leadership strategy?
a.
buying and selling in high volume
b.
a higher profit margin than companies that do not follow a cost leadership strategy
c.
offering many specialized customer services
d.
a very low asset turnover
29. The ratio of cost of goods sold to inventory is known as
a.
inventory turnover
b.
asset turnover
c.
accounts receivable turnover
d.
return on sales
492 Chapter 14
30. A company’s ability to convert its credit sales into cash is measured by
a.
Inventory turnover
b.
Asset turnover
c.
Accounts receivable turnover
d.
Return on sales
31. Which of the following is NOT a component of return on equity?
a.
profit margin
b.
asset turnover
c.
financial leverage
d.
gross profit margin
32. A high _______ indicates that a company is controlling its product costs.
a.
return on assets
b.
return on equity
c.
gross profit margin
d.
operating profit margin
33. Which of the following is used to measure a firm's ability to convert its profits into cash?
a.
operating cash flow to assets
b.
operating profit margin
c.
return on assets
d.
accounts receivable turnover
34. Inventory turnover
a.
is the ratio of inventory to sales
b.
measures the ability of a company to convert its investment in inventory into sales
c.
is the ratio of sales to inventory
d.
cannot be used to evaluate a firm's operating strategy
35. Which of the following statements about inventory turnover is NOT true?
a.
inventory turnover compares income statement information with balance sheet information
b.
inventory turnover is the ratio of cost of goods sold to inventory
c.
if the amount of inventory increases relative to cost of goods sold, a company is less
effective in using its resources
d.
an increase in inventory turnover indicates that a company is investing too heavily in
inventory for the amount of product it is selling
Analysis of Operating Activities 493
36. Which of the following is primarily an effectiveness measure?
a.
collection turnover
b.
net income
c.
industry average
d.
accounts receivable turnover
37. Which of the following is a measure of a company's efficiency in controlling period costs (i.e.,
selling and administrative expenses)?
a.
operating profit margin
b.
profit margin
c.
gross profit margin
d.
net income
38. Which of the following is NOT a measure of effectiveness?
a.
inventory turnover
b.
asset turnover
c.
accounts receivable turnover
d.
operating profit margin
Figure 13-2
Wannamaker's Wonders
Delano's Deals
Accounts receivable
$ 159,000
$126,000
Inventory
384,000
254,000
Operating revenues
1,060,000
768,000
Cost of goods sold
559,000
235,000
Operating income
360,000
305,000
Gross profit
501,000
533,000
39. Refer to the table in Figure 13-2. What is inventory turnover for Wannamaker's Wonders?
a.
1.07
b.
.93
c.
1.46
d.
.83
494 Chapter 14
40. Refer to the table in Figure 13-2. What is inventory turnover for Delano's Deals?
a.
1.46
b.
.83
c.
1.07
d.
.93
41. Refer to the table in Figure 13-2. What is accounts receivable turnover for Wannamaker's
Wonders?
a.
6.67
b.
6.10
c.
2.42
d.
2.26
42. Refer to the table in Figure 13-2. What is accounts receivable turnover for Delano's Deals?
a.
6.67
b.
6.10
c.
2.42
d.
2.26
43. Refer to the table in Figure 13-2. What is gross profit margin for Wannamaker's Wonders?
a.
.47
b.
.52
c.
.31
d.
.69
44. Refer to the table in Figure 13-2. What is gross profit margin for Delano's Deals?
a.
.47
b.
.52
c.
.31
d.
.69
Analysis of Operating Activities 495
45. Refer to the table in Figure 13-2. What is operating profit margin for Wannamaker's Wonders?
a.
.69
b.
.34
c.
.40
d.
.47
46. Refer to the table in Figure 13-2. What is operating profit margin for Delano's Deals?
a.
.40
b.
.69
c.
.34
d.
.47
47. Refer to the table in Figure 13-2. Which of the following statements is true?
a.
Wannamaker’s Wonders has a higher gross profit margin
b.
Delano’s Deals has a higher accounts receivable turnover
c.
Wannamaker's Wonders appears to be more efficient
d.
Delano's Deals appears to be more efficient
48. Accounting is
a.
the process of recording transactions in journals and ledgers
b.
very precise, with a set of unchanging rules
c.
an information system for measuring and reporting the transformation process in a
business entity
d.
a set of standards, developed by a government agency
49. Which of the following is NOT part of the transformation process?
a.
financial resources are obtained through financing activities
b.
financial resources are used to acquire other resources through investing activities
c.
resources are used to produce and sell goods and services through operating activities
d.
investors make decisions about the allocation of their resources through decision-making
activities
496 Chapter 14
MATCHING
Firms use different strategies to produce profits. Match each strategy with the statements below.
a.
Cost leadership
b.
Product differentiation
1. Firms typically buy and sell in high volume
2. Companies produce and sell specialized products
3. Tend to combine low profit margin and high asset turnover
4. Companies with brand-name products
5. Mens/Womens Specialty Clothing Store
6. Tend to combine high profit margin and low asset turnover
Listed below are some frequently used accounting measures. Following this listing are some
numbered statements. Match the accounting measure with the appropriate statements. Note that
each statement will have only one accounting measurement. Also note that the accounting
measurements may be used more than once or not at all.
a.
Accounts receivable turnover
b.
Return on assets
c.
Gross profit margin
d.
Inventory turnover
e.
Profit margin
f.
Asset turnover
g.
Operating profit margin
7. The ratio of net income to operating revenues
8. A measure of a firm's ability to generate sales from its investment in assets
9. A measurement composed of profit margin and asset turnover
10. The ratio of cost of goods sold to inventory
11. A measure of a firm's ability to convert revenues to cash
12. An indicator of a firm's efficiency in controlling operating costs
13. It measures the ability of a company to use its investments to generate operating results
14. It measures the ability of a company to operate efficiently to produce profits
15. It measures efficiency on the production or purchase of goods for sale
16. The ratio of operating income to operating revenues
17. A measure of the success of a firm in converting its investment in inventory into sales
18. The ratio of (operating revenues less cost of goods sold) to operating revenues
Analysis of Operating Activities 497
Shown below are several measures of firms' abilities. Match the measures with the statement that
best describes it.
a.
Operating profit margin
b.
Gross profit margin
c.
Inventory turnover
d.
Return on equity
e.
Return on assets
f.
Profit margin
g.
Accounts receivable turnover
h.
Asset turnover
19. A measure of a company's ability to generate sales from its investment in assets
20. A measure of a company's ability to convert revenues into cash
21. A measure of a company's ability to create profit from its sales
22. Measures efficiency in the production or purchase of goods for sale
23. A measure of a company's ability to convert its investment in inventory into sales
24. A summary measure of a company's financing, investing, and operating activities
25. Measures a company's ability to use its investments to generate operating results
26. An indicator of a company's efficiency in controlling non-product operating costs
498 Chapter 14
PROBLEM
1. Harris Strong, the Marketing Manager for the Turboprop Company, has presented you with the
following marketing options:
Option 1:
Product selling price, $9; expected sales total, 58,000 units; variable costs are
$3.80 per unit; fixed costs total $126,000
Option 2:
Product selling price, $8; expected sales total 72,000 units; variable costs, $4.00
per unit; spend an additional $10,000 on advertising, which increases total fixed
costs to $136,000
Option 3:
Product selling price, $7.60; expected sales total, 76,000 units; variable costs
reduced to $3.60 per unit; fixed costs total $142,000
Required:
Develop a schedule showing the profit from each of the three options. Which would you
recommend? Why?
Analysis of Operating Activities 499
2. The following information is from the accounting systems of two local businesses:
Blondie's Catering
Olga's Delights
Operating revenues
$ 738,000
$630,000
Net income
406,000
176,000
Total assets
$1,420,000
$840,000
Required:
a.
Compute asset turnover, profit margin and return on assets for each firm.
b.
Based on your answers to part (a), describe the operating strategy for each firm.
3. Information is presented below for two companies:
(in thousands)
San Martin
Shaquil
Operating revenues
$1,875
$1,250
Net income
450
150
Total assets
2,500
1,000
Required:
a.
Compute profit margin, asset turnover, and return on assets for each firm.
b.
Compare the operating strategies of both firms and explain which is doing a better
job with its strategy.
500 Chapter 14
4. Steamer Corporation's management has decided to invest $3.0 million in production facilities with
the capacity to produce 500,000 units per year. Variable expenses will be $4 per unit. Fixed
expenses will be $1,600,000 per year. The firm has developed two sales scenarios for the coming
year:
a.
At a price of $10, below most of the competition, sales will be 400,000 units.
b.
At a price of $14, sales will be 200,000 units.
Required:
Develop a schedule showing profit from both scenarios. Which would you recommend? Why?

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