Chapter 2 1 Use Ratios Evaluate Company’s Profitability Liquidity And

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 2
A FURTHER LOOK AT FINANCIAL STATEMENTS
SUMMARY OF QUESTIONS BY LEARNING OBJECTIVE AND BLOOM’S TAXONOMY
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True-False Statements
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Multiple Choice Questions
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Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
2-2
Brief Exercises
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Completion Statements
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SUMMARY OF LEARNING OBJECTIVES BY QUESTION TYPE
Learning Objective 1
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Learning Objective 2
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A Further Look at Financial Statements
FOR INSTRUCTOR USE ONLY
2-3
Learning Objective 3
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Note: TF = True-False C = Completion
MC = Multiple Choice Ex = Exercise
Ma = Matching SA = Short Answer Essay
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
FOR INSTRUCTOR USE ONLY
2-4
CHAPTER LEARNING OBJECTIVES
1. Identify the sections of a classified balance sheet. In a classified balance sheet,
companies classify assets as current assets; long-term investments; property, plant, and
equipment; and intangibles. They classify liabilities as either current or long-term. A
stockholders’ equity section shows common stock and retained earnings.
2. Use ratios to evaluate a company’s profitability, liquidity, and solvency. Ratio analysis
expresses the relationship among selected items of financial statements data. Profitability
ratios, such as earnings per share (EPS), measure aspects of the operating success of a
company for a given period of time.
Liquidity ratios, such as the current ratio, measure the short-term ability of a company to pay
its maturing obligations and to meet unexpected needs for cash. Solvency ratios, such as the
debt to assets ratio, measure the ability of a company to survive over a long period.
Free cash flow indicates a company’s ability to generate cash from operations that is
sufficient to pay debts, acquire assets, and distribute dividends.
3. Discuss financial reporting concepts. Generally accepted accounting principles are a set
of rules and practices recognized as a general guide for financial reporting purposes. The
basic objective of financial reporting is to provide information that is useful for decision
making.
To be judged useful, information should have the primary characteristics of relevance and
faithful representation. In addition, useful information is comparable, consistency, verifiable,
timely, and understandable.
The monetary unit assumption requires that companies include in the accounting records only
transaction data that can be expressed in terms of money. The economic entity assumption
states that economic events can be identified with a particular unit of accountability. The
periodicity assumption states that the economic life of a business can be divided into artificial
time periods and that meaningful accounting reports can be prepared for each period. The
going concern assumption states that the company will continue in operation long enough to
carry out its existing objectives and commitments.
The historical cost principle states that the companies should record assets at their cost. The
fair value principle indicates that assets and liabilities should be reported at fair value. The full
disclosure principle requires that companies disclose circumstances and events that matter to
financial statement users.
The cost constraint weighs the cost that companies incur to provide a type of information
against its benefit to financial statement users.
A Further Look at Financial Statements
2-5
TRUE-FALSE STATEMENTS
1. Cash and supplies are both classified as current assets.
2. Long-term investments appear in the property, plant, and equipment section of the
balance sheet.
3. A liability is classified as a current liability if it is to be paid within the coming year.
4. Stockholders’ equity is divided into two parts: common stock and retained earnings.
5. It is possible for an asset to be a current asset even though the expected conversion of
that asset into cash is to be longer than one year or the normal operating cycle.
6. The investment category on the balance sheet normally includes investments that are
intended to be held for a short period of time (less than one year).
7. The main difference between intangible assets and property, plant and equipment is the
length of the asset’s life.
8. Profitability means having enough funds on hand to pay debts when they fall due.
9. Earnings per share is calculated by dividing net income minus preferred stock dividends
for the period by the average number of common shares outstanding during the period.
10. Earnings per share measures the net income earned on each share of common stock.
11. Liquidity ratios measure the short-term ability of a company to pay its maturing obligations
and meet unexpected needs for cash.
12. Solvency ratios measure the ability of a company to survive over a short period of time.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-6
13. Profitability ratios measure the operating success of a company for a given period of time.
14. The current ratio is computed as current liabilities divided by current assets.
15. The excess of current assets over current liabilities is called working capital.
16. The current ratio takes into account the composition of current assets.
17. Solvency ratios measure the short-term ability of the company to pay its maturing
obligations.
18. The debt to assets ratio measures the percentage of assets financed by creditors.
19. Solvency is a company's ability to pay interest as it comes due and to repay the balance
of a debt due at its maturity.
20. Net cash provided by operating activities takes into account that a company must invest in
capital expenditures just to maintain its current level of operations.
21. Both investors and creditors have an interest in a company’s ability to generate favorable
cash flows.
22. Free cash flow is net cash provided by operating activities less capital expenditures.
23. In the statement of cash flows, net cash provided by operating activities indicates the
cash-generating capability of the company.
24. Free cash flow is net cash provided by operating activities less dividends.
25. Long-term creditors consider a high free cash flow amount an indication of solvency.
A Further Look at Financial Statements
2-7
26. The primary accounting standard-setting body in the United States is the Securities and
Exchange Commission.
27. Generally accepted accounting principles are rules and practices that are recognized as a
general guide for financial reporting purposes.
28. GAAP stands for generally accepted accounting procedures.
29. To be faithfully representative, accounting information should predict future events,
confirm prior expectations, and be reported on a timely basis.
30. In order for information to be relevant, it must be reported on a monthly basis.
31. For information to be useful, it must be both relevant and faithfully representative.
32. Consistent use of the same accounting principles and methods is necessary for
meaningful analysis of trends within a company.
33. A major function of management is to provide the accountant with relevant and useful
information.
34. The advantage of accounting information is that it provides exact and completely reliable
measures.
35. Consistency in accounting means that a company uses the same generally accepted
accounting principles from one accounting period to the next accounting period.
36. The convention of consistency pertains to the use of the same accounting principles by
firms in the same industry.
37. The periodicity assumption states that the business will remain in operation for the
foreseeable future.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-8
38. If a building is offered for sale at $100,000 and the buyer pays $95,000 cash for it, the
buyer would record the building at $100,000.
39. The most generally accepted value used in accounting is market value.
40. For accounting purposes, business transactions should be kept separate from the
personal transactions of the stockholders of the business.
41. The economic entity assumption states that economic events can be identified with a
particular unit of accountability.
42. The economic entity assumption states that assets should be recorded at their cost.
43. The monetary unit assumption states that transactions that can be measured in terms of
money should be recorded in the accounting records.
44. The monetary unit assumption has led to an increase in the notes to financial statements.
45. The going concern assumption is that the business will continue in operation long enough
to carry out its existing objectives and commitments.
46. When preparing financial statements, the accountant assumes that the business will stay
in business for the foreseeable future.
47. Full disclosure of all important facts aids in overcoming the limitations of accounting
information.
48. The economic entity assumption is that a company will remain in operations for the
foreseeable future.
49. Materiality is a company-specific aspect of faithful representation.
A Further Look at Financial Statements
FOR INSTRUCTOR USE ONLY
2-9
50. Relevance and cost are two constraints in accounting.
51. Materiality relates to whether an item is large enough to likely influence the decision of an
investor or creditor.
52. Cost constraint weighs the cost that companies incur to provide a type of information
against its benefit to financial statement users.
53. In general, the FASB indicates that most assets must follow the fair value principle.
54. A material item is one that is likely to influence an investor's decision.
55. The periodicity assumption states that every economic entity can be separately identified
and accounted for.
Answers to True-False Statements
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-10
MULTIPLE CHOICE QUESTIONS
56. In a classified balance sheet, assets are usually classified as
a. current assets; long-term assets; property, plant, and equipment; and intangible
assets.
b. current assets; long-term investments; property, plant, and equipment; and common
stocks.
c. current assets; long-term investments; tangible assets; and intangible assets.
d. current assets; long-term investments; property, plant, and equipment; and intangible
assets.
57. On a classified balance sheet, short-term investments are classified as
a. an intangible asset.
b. property, plant, and equipment.
c. a current asset.
d. a long-term investment.
58. A current asset is
a. the last asset purchased by a business.
b. an asset which is currently being used to produce a product or service.
c. usually found as a separate classification in the income statement.
d. expected to be converted to cash or used in the business within a relatively short
period of time.
59. Which of the following is not classified properly as a current asset?
a. Supplies
b. Debt investments
c. A fund to be used to purchase a building within the next year
d. A receivable from the sale of an asset to be collected in two years
60. An intangible asset
a. derives its value from the rights and privileges it provides the owner.
b. is worthless because it has no physical substance.
c. is converted into a tangible asset during the operating cycle.
d. cannot be classified on the balance sheet because it lacks physical substance.
A Further Look at Financial Statements
2-11
61. Which of the following is not considered an asset?
a. Equipment
b. Dividends
c. Accounts receivable
d. Inventory
62. Trademarks would appear in which balance sheet section?
a. Intangible assets
b. Investments
c. Property, plant, and equipment
d. Current assets
63. Liabilities are generally classified on a balance sheet as
a. small liabilities and large liabilities.
b. present liabilities and future liabilities.
c. tangible liabilities and intangible liabilities.
d. current liabilities and long-term liabilities.
64. Which of the following would not be classified as a long-term liability?
a. Current maturities of long-term debt
b. Bonds payable
c. Mortgage payable
d. Lease liabilities
65. Which of the following is not a current liability?
a. Salaries and Wages Payable
b. Accounts Payable
c. Taxes Payable
d. Bonds Payable
66. Equipment is classified on the balance sheet as
a. a current asset.
b. property, plant, and equipment.
c. an intangible asset.
d. a long-term investment.
67. It is not true that current assets are resources that are expected to be
a. realized in cash within one year.
b. sold within one year.
c. consumed within one year.
d. acquired within one year.
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-12
68. The operating cycle of a company is the average time that is required to go from cash to
a. sales in producing revenues.
b. cash in producing revenues.
c. inventory in producing revenues.
d. accounts receivable in producing revenues.
69. On a classified balance sheet, companies usually list current assets
a. in alphabetical order.
b. with the largest dollar amounts first.
c. in the order in which they are expected to be converted into cash.
d. in the order of acquisition.
70. Intangible assets are
a. listed directly under current assets on the balance sheet.
b. not listed on the balance sheet because they do not have physical substance.
c. listed after property, plant, and equipment.
d. listed as a long-term investment on the balance sheet.
71. Which statement about long-term investments is not true?
a. They will be held for more than one year.
b. They are not currently used in the operation of the business.
c. They include investments in stock of other companies and land held for future use.
d. They do not include long-term notes receivable.
72. These are selected account balances on December 31, 2017.
Land $150,000
Land (held for future use) 225,000
Buildings 1,200,000
Inventory 300,000
Equipment 675,000
Furniture 150,000
Accumulated Depreciation 450,000
What is the total amount of property, plant, and equipment that will appear on the balance
sheet?
a. $2,250,000
b. $1,950,000
c. $2,700,000
d. $1,725,000
A Further Look at Financial Statements
2-13
73. What is the order in which assets are generally listed on a classified balance sheet?
a. Current and long-term
b. Current; property, plant and equipment; long-term investments; intangibles
c. Current; property, plant and equipment; intangibles; long-term investments
d. Current; long-term investments; property, plant and equipment, intangibles
74. Ratios that measure the income or operating success of a company for a given period of
time are
a. liquidity ratios.
b. profitability ratios.
c. solvency ratios.
d. trending ratios.
75. Use the following data to determine the total dollar amount of assets to be classified as
current assets.
Koonce Office Supplies
Balance Sheet
December 31, 2017
Cash $ 195,000 Accounts payable $ 210,000
Accounts receivable 150,000 Salaries and wages payable 30,000
Inventory 165,000 Mortgage payable 240,000
Prepaid insurance 90,000 Total liabilities $480,000
Stock investments 255,000
Land 270,000
Buildings $315,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 255,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,590,000 stockholders’ equity $1,590,000
a. $855,000
b. $600,000
c. $510,000
d. $435,000
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-14
76. Use the following data to determine the total dollar amount of assets to be classified as
property, plant, and equipment.
Koonce Office Supplies
Balance Sheet
December 31, 2017
Cash $ 195,000 Accounts payable $ 210,000
Accounts receivable 150,000 Salaries and wages payable 30,000
Inventory 165,000 Mortgage payable 240,000
Prepaid insurance 90,000 Total liabilities 480,000
Stock investments 255,000
Land 270,000
Buildings $315,000 Common stock 360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 255,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,590,000 stockholders’ equity $1 590,000
a. $990,000
b. $525,000
c. $735,000
d. $585,000
77. Use the following data to determine the total dollar amount of assets to be classified as
investments.
Koonce Office Supplies
Balance Sheet
December 31, 2017
Cash $ 195,000 Accounts payable $ 210,000
Accounts receivable 150,000 Salaries and wages payable 30,000
Inventory 165,000 Mortgage payable 240,000
Prepaid insurance 90,000 Total liabilities $480,000
Stock investments 255,000
Land 270,000
Buildings $315,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 255,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,590,000 stockholders’ equity $1,590,000
a. $0
b. $525,000
c. $255,000
d. $465,000
A Further Look at Financial Statements
2-15
78. Use the following data to determine the total amount of working capital.
Koonce Office Supplies
Balance Sheet
December 31, 2017
Cash $ 195,000 Accounts payable $ 210,000
Accounts receivable 150,000 Salaries and wages payable 30,000
Inventory 165,000 Mortgage payable 240,000
Prepaid insurance 90,000 Total liabilities $480,000
Stock investments 255,000
Land 270,000
Buildings $315,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 275,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,590,000 stockholders’ equity $1,590,000
a. $360,000
b. $390,000
c. $130,000
d. $180,000
79. Use the following data to calculate the current ratio.
Koonce Office Supplies
Balance Sheet
December 31, 2017
Cash $ 195,000 Accounts payable $ 210,000
Accounts receivable 150,000 Salaries and wages payable 30,000
Inventory 165,000 Mortgage payable 240,000
Prepaid insurance 90,000 Total liabilities $480,000
Stock investments 255,000
Land 270,000
Buildings $315,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 275,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,590,000 stockholders’ equity $1,590,000
a. 2.13 : 1
b. 1.44 : 1
c. 2.86 : 1
d. 2.50 : 1
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-16
80. Use the following data to determine the total dollar amount of assets to be classified as
current assets.
Carne Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 70,000 Accounts payable $ 130,000
Accounts receivable 100,000 Salaries and wages payable 20,000
Inventory 140,000 Mortgage payable 180,000
Prepaid insurance 80,000 Total liabilities $330,000
Stock investments 180,000
Land 190,000
Buildings $230,000 Common stock $240,000
Less: Accumulated Retained earnings 500,000
depreciation (60,000) 170,000 Total stockholders’ equity $740,000
Trademarks 140,000 Total liabilities and
Total assets $1,070,000 stockholders’ equity $1,070,000
a. $390,000
b. $250,000
c. $570,000
d. $330,000
81. Use the following data to determine the total dollar amount of assets to be classified as
property, plant, and equipment.
Carne Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 70,000 Accounts payable $ 130,000
Accounts receivable 100,000 Salaries and wages payable 20,000
Inventory 140,000 Mortgage payable 180,000
Prepaid insurance 80,000 Total liabilities $330,000
Stock investments 180,000
Land 190,000
Buildings $230,000 Common stock $240,000
Less: Accumulated Retained earnings 500,000
depreciation (60,000) 170,000 Total stockholders’ equity $740,000
Trademarks 140,000 Total liabilities and
Total assets $1,070,000 stockholders’ equity $1,070,000
a. $540,000
b. $500,000
c. $360,000
d. $420,000
A Further Look at Financial Statements
2-17
82. Use the following data to determine the total dollar amount of assets to be classified as
investments.
Carne Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 70,000 Accounts payable $ 130,000
Accounts receivable 100,000 Salaries and wages payable 20,000
Inventory 140,000 Mortgage payable 180,000
Prepaid insurance 80,000 Total liabilities $330,000
Stock investments 180,000
Land 190,000
Buildings $230,000 Common stock $240,000
Less: Accumulated Retained earnings 500,000
depreciation (60,000) 170,000 Total stockholders’ equity $740,000
Trademarks 140,000 Total liabilities and
Total assets $1,070,000 stockholders’ equity $1,070,000
a. $0
b. $320,000
c. $180,000
d. $280,000
83. Use the following data to determine the total amount of working capital.
Carne Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 70,000 Accounts payable $ 130,000
Accounts receivable 100,000 Salaries and wages payable 20,000
Inventory 140,000 Mortgage payable 180,000
Prepaid insurance 80,000 Total liabilities $330,000
Stock investments 180,000
Land 190,000
Buildings $230,000 Common stock $240,000
Less: Accumulated Retained earnings 500,000
depreciation (60,000) 170,000 Total stockholders’ equity $740,000
Trademarks 140,000 Total liabilities and
Total assets $1,070,000 stockholders’ equity $1,070,000
a. $260,000
b. $240,000
c. $160,000
d. $420,000
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-18
84. Use the following data to calculate the current ratio.
Carne Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 70,000 Accounts payable $ 130,000
Accounts receivable 100,000 Salaries and wages payable 20,000
Inventory 140,000 Mortgage payable 180,000
Prepaid insurance 80,000 Total liabilities $330,000
Stock investments 180,000
Land 190,000
Buildings $230,000 Common stock $240,000
Less: Accumulated Retained earnings 500,000
depreciation (60,000) 170,000 Total stockholders’ equity $740,000
Trademarks 140,000 Total liabilities and
Total assets $1,070,000 stockholders’ equity $1,070,000
a. 2.07 : 1
b. 1.67 : 1
c. 3.00 : 1
d. 2.60 : 1
85. N3 Corporation has assets of $4,200,000, common stock of $1,092,000, and retained
earnings of $665,000. What are the creditors’ claims on their assets?
a. $3,773,000
b. $1,757,000
c. $2,443,000
d. $4,627,000
86. K2 Corporation has assets of $3,600,000, common stock of $936,000, and retained
earnings of $570,000. What are the creditors’ claims on their assets?
a. $3,234,000
b. $1,506,000
c. $2,094,000
d. $3,966,000
A Further Look at Financial Statements
2-19
87. Use the following data to determine the total dollar amount of assets to be classified as
current assets.
Eddy Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 126,000 Accounts payable $ 165,000
Accounts receivable 120,000 Salaries and wages payable 30,000
Inventory 210,000 Mortgage payable 270,000
Prepaid insurance 90,000 Total liabilities $465,000
Stock investments 255,000
Land 285,000
Buildings $339,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 279,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,050,000 stockholders’ equity $1,575,000
a. $801,000
b. $336,000
c. $546,000
d. $546,000
88. Use the following data to determine the total dollar amount of assets to be classified as
property, plant, and equipment.
Eddy Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 126,000 Accounts payable $ 165,000
Accounts receivable 120,000 Salaries and wages payable 30,000
Inventory 210,000 Mortgage payable 270,000
Prepaid insurance 90,000 Total liabilities $465,000
Stock investments 255,000
Land 285,000
Buildings $339,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 279,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,050,000 stockholders’ equity $1,575,000
a. $1,029,000
b. $774,000
c. $834,000
d. $564,000
Test Bank for Financial Accounting: Tools for Business Decision Making, Eighth Edition
2-20
89. Use the following data to determine the total dollar amount of assets to be classified as
investments.
Eddy Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 126,000 Accounts payable $ 165,000
Accounts receivable 120,000 Salaries and wages payable 30,000
Inventory 210,000 Mortgage payable 270,000
Prepaid insurance 90,000 Total liabilities $465,000
Stock investments 255,000
Land 285,000
Buildings $339,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 279,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,050,000 stockholders’ equity $1,575,000
a. $0
b. $465,000
c. $255,000
d. $585,000
90. Use the following data to determine the total amount of working capital.
Eddy Auto Supplies
Balance Sheet
December 31, 2017
Cash $ 126,000 Accounts payable $ 165,000
Accounts receivable 120,000 Salaries and wages payable 30,000
Inventory 210,000 Mortgage payable 270,000
Prepaid insurance 90,000 Total liabilities $465,000
Stock investments 255,000
Land 285,000
Buildings $339,000 Common stock $360,000
Less: Accumulated Retained earnings 750,000
depreciation (60,000) 279,000 Total stockholders’ equity $1,110,000
Trademarks 210,000 Total liabilities and
Total assets $1,050,000 stockholders’ equity $1,575,000
a. $606,000
b. $351,000
c. $381,000
d. $261,000

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