Chapter 04 – Financial Reporting and Analysis
TRUE/FALSE
1. Both investors and creditors have an interest in a company’s ability to generate favorable cash flows.
2. Investors and creditors use financial statements to evaluate a company’s ability to pay dividends and
interest.
3. Financial statements are important to the efficient allocation of resources in our economy.
4. Financial statements are generally prepared for a limited number of users.
5. A different set of financial statements usually is prepared for each user.
6. The relevance of accounting information is also an indication of its reliability.
7. An advantage of accounting information is that it provides exact and completely reliable measures.
8. Even when no errors have been made, accounting is never 100 percent accurate because of the
extensive use of estimates.
9. Accounting information contains numerous estimates, classifications, summarizations, judgments, and
allocations.
10. For accounting information to be useful, it must be both relevant and reliable.
11. The Sarbanes-Oxley Act requires a company to guarantee that its financial statements are 100 percent
accurate.
12. Only the chief financial officer and the company’s CPAs are responsible for the accuracy of financial
statements. The chief executive officer is not expected to understand financial information.
13. To understand accounting information, users must be familiar with the accounting conventions, or
rules of thumb, used in preparing financial statements.
14. Full disclosure of all important facts aids in overcoming the limitations of accounting information.
15. Consistency in accounting means that a company uses the same generally accepted accounting
principles from one accounting period to the next accounting period.
16. The convention of consistency pertains to the use of the same accounting principles by firms in the
same industry.
17. A material item is one that is likely to affect a user’s decision.
18. In accounting, $1,000 is considered the dividing line between material and immaterial amounts.
19. Although a stapler that costs $15 is a long-term asset, can be expensed because the amount is
immaterial and will not affect anyone’s decision making.
20. Illegal acts of a small dollar amount can be ignored because they are immaterial.
21. The convention of full disclosure requires that financial statements present all the information relevant
to users’ understanding of the statements.
22. General-purpose external financial statements that are divided into subcategories are called classified
financial statements.
23. Classified balance sheets list accounts in alphabetical order.
24. Natural resources, such as coal mines and oil wells, are classified as intangible assets.
25. 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.
26. The investments category on the balance sheet normally includes investments that are intended to be
held for a short period of time.
27. The main difference between intangible assets and property, plant, and equipment is the length of the
asset’s life.
28. The main difference among the balance sheets of the sole proprietorship, the partnership, and the
corporation is found in the owners’ equity section.
29. The two parts of a corporation’s stockholders’ equity section are contributed capital and retained
earnings.
30. The Retained Earnings portion of a corporation represents the initial contribution of capital to the
business.
31. Contributed capital is shown on a corporate balance sheet as two amounts: the par value of the issued
stock and additional paid-in capital.
32. The term net worth is a more accurate term than owner’s equity because assets are recorded at original
cost rather than at current value.
33. Operating expenses include cost of goods sold.
34. Both wholesalers and retailers are types of merchandising companies.
35. For a merchandising company, the difference between net sales and operating expenses is called gross
margin.
36. The income statement of a company that provides a service only will contain gross margin.
37. Sales returns and allowances are deducted from gross sales on the balance sheet.
38. On the income statement of a merchandising company, net income is the amount by which net sales
exceed operating expenses.
39. Delivery expense is a selling expense on the income statement.
40. General and administrative expenses are a category of operating expense.
41. Advertising expense appears as a selling expense on the income statement.
42. An advantage of the single-step income statement is that it is less complex than the multistep form.
43. Freight paid on goods shipped to customers is classified as a selling expense.
44. Interest paid on bank loans is classified as cost of goods sold.
45. The condensed form of the income statement refers only to the single-step type.
46. The single-step and multistep income statements result in different net income figures.
47. Advertising expense should be included in the general and administrative expenses section of a
multistep income statement.
48. Earnings per share, often called net income per share, is the net income earned on each share of
common stock.
49. Both return on assets and working capital are profitability measures.
50. Return on assets is a measure of liquidity.
51. Return on assets is a better measure of profitability than profit margin because it takes into account the
assets invested in the business.
52. Profitability means having enough cash on hand to pay bills when they become due.
53. Asset turnover measures how efficiently assets are used to produce sales.
54. A company with a current ratio of 1.0 is considered more liquid than one with a current ratio of 2.0.
55. A debt to equity ratio of 1.0 means that half of the company’s assets are financed by creditors.
56. A company with a low debt to equity ratio is in a more vulnerable position during poor economic
times than a company with a high debt to equity ratio.
57. Profit margin and gross margin are the same thing.
58. A company with a profit margin of 6 percent earns six cents profit for every dollar of net sales.
MULTIPLE CHOICE
1. All the following are standards of accounting information except
a.
flexibility.
b.
reliability.
c.
understandability.
d.
relevance.
2. According to the FASB, the usefulness of accounting is judged by which of the following two prime
qualitative characteristics of accounting information?
a.
Comparability and neutrality
b.
Understandability and comparability
c.
Verifiability and timeliness
d.
Relevance and reliability
3. The qualitative characteristic of faithful representation contains all the following features except
a.
complete.
b.
verifiability.
c.
neutral.
d.
free from material error.
4. Accounting information should make a difference to the outcome of a decision, according to the
qualitative characteristic of
a.
reliability.
b.
relevance.
c.
understandability.
d.
verifiability.
5. The user can depend on the accuracy of financial information when which of the following qualitative
characteristics has been followed?
a.
Relevance
b.
Faithful representation
c.
Understandability
d.
Timeliness
6. The lower-of-cost-or-market method of accounting for inventories follows the convention of
a.
full disclosure.
b.
materiality.
c.
conservatism.
d.
cost-benefit.
7. The convention of consistency refers to consistent use of accounting principles
a.
among firms.
b.
throughout the accounting period.
c.
within industries.
d.
among accounting periods.
8. A practical decision to expense small capital expenditures rather than record them as property, plant,
and equipment and depreciate them probably is made on the basis of the convention of
a.
conservatism.
b.
consistency.
c.
materiality.
d.
full disclosure.
9. The accounting convention that is most responsible for the increase in the number of notes to financial
statements is
a.
materiality.
b.
full disclosure.
c.
consistency.
d.
conservatism.
10. The convention of consistency relates most closely to
a.
cost-benefit.
b.
comparability.
c.
materiality.
d.
full disclosure.
11. To obtain a slightly more accurate measure of net income, Gabrielli, Inc., has determined that it must
hire two full-time accountants. If it decides against the hiring, it has followed the convention of
a.
full disclosure.
b.
materiality.
c.
comparability.
d.
cost-benefit.
12. Which of the following accounting conventions would an accountant most likely apply when facing
major uncertainties?
a.
Full disclosure
b.
Conservatism
c.
Materiality
d.
Consistency
13. Expensing a building in the year of purchase represents an abuse of which of the following accounting
conventions?
a.
Full disclosure
b.
Cost-benefit
c.
Conservatism
d.
Consistency
14. Which accounting convention could cause an overload of information for the financial statement user?
a.
Consistency
b.
Conservatism
c.
Full disclosure
d.
Materiality
15. Which accounting convention describes a note to the financial statements explaining the company’s
method of revenue recognition?
a.
Comparability and consistency
b.
Materiality
c.
Conservatism
d.
Full disclosure
16. The Securities and Exchange Commission instituted rules requiring the chief executive officers and
chief financial officers of all publicly traded companies to certify that, to their knowledge, the
quarterly and annual statements that their companies file with the SEC are
a.
100 percent accurate and contain no misstatements, errors, or mistakes.
b.
accurate and complete.
c.
subject to interpretation due to the many accounting rules and regulations.
d.
not to be used except by individuals working for the company.
17. Who is responsible for preparing financial statements?
a.
The CPA firm that audits the financial statements
b.
Management
c.
A company’s accounting department
d.
The SEC
18. A company should classify land held for a planned manufacturing facility as
a.
an intangible asset.
b.
an investment.
c.
a current asset.
d.
property, plant, and equipment.
19. Which of the following should be classified as an intangible asset?
a.
Land held for future use
b.
Accounts receivable
c.
Building
d.
Franchises
20. A corporation’s stockholders’ equity section of the balance sheet may contain all except
a.
T. McDonald, capital
b.
Retained earnings
c.
Additional paid-in capital
d.
Common stock
21. The owner’s capital for a sole proprietorship is similar in nature to which of the following for
corporations?
a.
Stockholders’ equity
b.
Retained earnings
c.
Common stock
d.
Dividends
22. Use this information to answer the following question.
J. & B. Auto Parts, Inc.
Balance Sheet
December 31, 2010
Assets
Cash
$ 10,000
Short-term investments
40,000
Notes receivable (due in ten months)
30,000
Accounts receivable
20,000
Merchandise inventory
70,000
Land held for future use
80,000
Land
90,000
Building
$100,000
Less accumulated depreciation
20,000
80,000
Trademark
70,000
Total assets
Liabilities
Notes payable (due in six months)
$ 50,000
Accounts payable
20,000
Salaries payable
10,000
Mortgage payable (due in seven years)
90,000
Total liabilities
Stockholders’ Equity
Common stock
$260,000
Retained earnings
60,000
Total stockholders’ equity
Total liabilities and stockholders’ equity
The total dollar amount of assets to be classified as current assets is
a.
$140,000.
b.
$220,000.
c.
$120,000.
d.
$170,000.
23. Use this information to answer the following question.
J. & B. Auto Parts, Inc.
Balance Sheet
December 31, 2010
Assets
Cash
$ 60,000
Short-term investments
40,000
Notes receivable (due in ten months)
30,000
Accounts receivable
20,000
Merchandise inventory
70,000
Land held for future use
80,000
Land
90,000
Building
$100,000
Less accumulated depreciation
20,000
80,000
Trademark
70,000
Total assets
Liabilities
Notes payable (due in six months)
$ 50,000
Accounts payable
20,000
Salaries payable
10,000
Mortgage payable (due in seven years)
90,000
Total liabilities
Stockholders’ Equity
Common stock
$310,000
Retained earnings
60,000
Total stockholders’ equity
Total liabilities and stockholders’ equity
The total dollar amount of assets to be classified as investments is
a.
$100,000.
b.
$180,000.
c.
$0.
d.
$80,000.
24. Use this information to answer the following question.
J. & B. Auto Parts, Inc.
Balance Sheet
December 31, 2010
Assets
Cash
$ 60,000
Short-term investments
40,000
Notes receivable (due in ten months)
30,000
Accounts receivable
20,000
Merchandise inventory
70,000
Land held for future use
80,000
Land
90,000
Building
$100,000
Less accumulated depreciation
20,000
80,000
Trademark
70,000
Total assets
Liabilities
Notes payable (due in six months)
$ 50,000
Accounts payable
20,000
Salaries payable
10,000
Mortgage payable (due in seven years)
90,000
Total liabilities
Stockholders’ Equity
Common stock
$310,000
Retained earnings
60,000
Total stockholders’ equity
Total liabilities and stockholders’ equity
The total dollar amount of assets to be classified as property, plant, and equipment is
a.
$320,000.
b.
$240,000.
c.
$190,000.
d.
$170,000.
25. An investment is classified as short term or long term based on
a.
whether the investment can be sold immediately.
b.
the length of time the investor expects to hold it.
c.
the purpose for which it is held.
d.
the dollar amount of the investment.
26. Which of the following appears on the balance sheet?
a.
Interest income
b.
Income taxes
c.
Net sales
d.
Merchandise inventory
27. Which of the following accounts is most likely to appear on the balance sheet as a current liability?
a.
Accumulated Depreciation
b.
Bonds Payable
c.
Mortgage Payable
d.
Wages Payable
28. Which accounting term does not mean the same as the others?
a.
Retained earnings
b.
Net worth
c.
Capital
d.
Owner’s equity
29. Which of the following should not be classified as a current asset?
a.
A one-year installment receivable from the sale of a truck
b.
An investment expected to be needed for operations in the next year
c.
A one-year prepaid insurance policy
d.
A fund to be used to purchase land
30. Patents would appear in which section of the balance sheet?
a.
Investments
b.
Property, plant, and equipment
c.
Current assets
d.
Intangible assets
31. Oil wells and coal mines used in the normal course of business would appear in which section of the
balance sheet?
a.
Property, plant, and equipment
b.
Investments
c.
Current assets
d.
Intangible assets
32. The normal operating cycle helps define which of the following balance sheet sections?
a.
Intangible assets
b.
Current assets
c.
Property, plant, and equipment
d.
Stockholders’ equity
33. Liabilities have which of the following two major categories?
a.
Accounts payable and notes payable
b.
Contributed capital and retained earnings
c.
Current and long term
d.
Unearned revenues and other payables
34. Use this information to answer the following question.
Coyne Corporation
Balance Sheet
December 31, 2010
Assets
Cash
$ 70,000
Short-term investments
56,000
Accounts receivable
28,000
Notes receivable (due in one year)
42,000
Merchandise inventory
98,000
Land held for future use
112,000
Land
140,000
Building
$150,000
Less accumulated depreciation
28,000
122,000
Trademark
92,000
Total assets
$760,000
Liabilities
Notes payable (due in one year)
$ 70,000
Accounts payable
30,000
Salaries payable
14,000
Mortgage payable (due in seven years)
146,000
Total liabilities
$260,000
Stockholders’ Equity
Common stock
$300,000
Retained earnings
200,000
500,000
Total liabilities and stockholders’ equity
$760,000
The total dollar amount of assets to be classified as current assets is
a.
$252,000.
b.
$238,000.
c.
$294,000.
d.
$244,000.
35. Use this information to answer the following question.
Coyne Corporation
Balance Sheet
December 31, 2010
Assets
Cash
$ 70,000
Short-term investments
56,000
Accounts receivable
28,000
Notes receivable (due in one year)
42,000
Merchandise inventory
98,000
Land held for future use
112,000
Land
140,000
Building
$150,000
Less accumulated depreciation
28,000
122,000
Trademark
92,000
Total assets
Liabilities
Notes payable (due in one year)
$ 70,000
Accounts payable
30,000
Salaries payable
14,000
Mortgage payable (due in seven years)
146,000
Total liabilities
Stockholders’ Equity
Common stock
$300,000
Retained earnings
200,000
Total liabilities and stockholders’ equity
The total dollar amount of assets to be classified as investments is
a.
$168,000.
b.
$0.
c.
$112,000.
d.
$56,000.
36. A merchandiser will earn an operating income of exactly $0 when
a.
gross margin equals operating expenses.
b.
net sales equals cost of goods sold.
c.
cost of goods sold equals gross margin.
d.
operating expenses equal net sales.
37. Gross margin equals the difference between net sales and
a.
net income.
b.
cost of goods sold plus operating expenses.
c.
operating expenses.
d.
cost of goods sold.
38. Positive operating income will result if gross margin exceeds
a.
operating expenses.
b.
purchases.
c.
cost of goods sold.
d.
cost of goods sold minus operating expenses.
39. Which of the following is not considered an operating expense?
a.
General office expenses
b.
Cost of goods sold
c.
Freight-out expense
d.
Advertising expense
40. Which of the following accounts is not classified as a selling expense on the income statement?
a.
Freight-out expense
b.
Advertising expense
c.
Sales salaries expense
d.
Interest expense
41. Interest expense on a mortgage would be classified on a multistep income statement under the heading
a.
general and administrative expenses.
b.
selling expenses.
c.
cost of goods sold.
d.
other revenues and expenses.
42. Income from operations is arrived after considering all except
a.
administrative salaries.
b.
interest income.
c.
the cost of sales.
d.
sales returns and allowances.
43. Which of the following appears in different sections of the income statement when prepared on a
single-step basis and when prepared on a multistep basis?
a.
Sales commissions
b.
Office salaries
c.
Interest income
d.
Sales
44. Which type of account is cost of goods sold?
a.
An asset account
b.
A liability account
c.
An expense account
d.
An income account
45. To which account is the cost of inventory transferred when a product is sold?
a.
Sales
b.
Operating expenses
c.
Inventory sold
d.
Cost of goods sold
46. Which type of account is gross margin?
a.
An income account
b.
An expense account
c.
An asset account
d.
None of the above
47. Which of the following is not a subtotal?
a.
Cost of goods sold
b.
Gross margin
c.
Net income
d.
Income from operations
48. Earnings per share are found on which financial statement?
a.
Balance sheet
b.
Income statement
c.
Statement of cash flows
d.
Statement of retained earnings
49. In which category would office salaries expense be included?
a.
Net sales
b.
Cost of goods sold
c.
Selling expenses
d.
General and administrative expenses
50. Which of the following is not considered a selling expense?
a.
Cost of goods sold
b.
Sales salaries expense
c.
Freight-out expense
d.
Insurance on the sales office
51. Interest paid on debt would be entered on the multistep income statement in the category called
a.
selling expenses.
b.
other revenues and expenses.
c.
general and administrative expenses.
d.
operating expenses.
52. An advantage of the single-step income statement over the multistep form is
a.
the amount of information it provides.
b.
its simplicity.
c.
its comprehensiveness.
d.
its use in computing ratios.
53. Use this information to answer the following question.
Alcorn & Zeto Company
Income Statement
For the Year Ended December 31, 2010
Revenues
Net sales
$100,000
Dividend income
8,750
Total revenues
$108,750