1) Earnings per share equals ________.
A) retained earnings divided by dividends
B) net income divided by the weighted average shares of outstanding common stock
C) earnings divided by preferred shares outstanding
D) net income divided by average total assets
2) Wall Street analysts focus primarily on a company’s ________.
A) return on assets
B) gross profit
C) dividends per share
D) earnings per share
3) Which financial statement is the best place to look to find earnings per share?
A) Income Statement
B) Statement of Changes in Shareholders’ Equity
C) Balance Sheet
D) both the Income Statement and Balance Sheet
4) The most widely used indicator of a company’s overall performance is ________.
A) return on equity
B) earnings per share
C) sales
D) gross profit
5) Analysts focus on “the number” which is the company’s ________.
A) GDP
B) EPS
C) sales
D) interest rates
6) Earnings per share is ________.
A) net income, minus preferred dividends, divided by average shareholders’ equity
B) total shareholders’ equity divided by the average number of outstanding common shares
C) net income divided by the weighted average number of common shares outstanding
D) net income divided by sales
7) If a company’s earnings are greater than financial analysts’ forecasts ________.
A) the market price of the stock will probably increase
B) the market price of the stock will probably decrease
C) earnings per share will be lower than expected
D) the market price of the stock will probably not be affected
8) If a company’s earnings do not meet financial analysts’ forecasts ________.
A) the market price of the stock will probably increase
B) the market price of the stock will probably decrease
C) earnings per share will be higher than expected
D) the market price of the stock will probably not be affected
9) Investor’s emphasis on earnings ________.
A) is good because it helps companies be more profitable
B) is good because even uneducated people can understand earnings
C) makes it unnecessary for investors to learn anything about accounting
D) can result in serious miscommunication between a company and its owners
10) Most investors focus primarily on a company’s ________.
A) balance sheet
B) earnings per share
C) statement of cash flows
D) GDP
11) Earnings per share equals gross profit divided by the weighted average number of
outstanding shares of (common) stock.
12) Earnings per share equals gross profit divided by the weighted average number of shares in
treasury.
13) Wall Street refers to earnings per share as “the number” because of the importance analysts
give it in assessing the financial health of a company.
14) Wall Street refers to sales as “the number” because of the importance analysts give it in
assessing the financial health of a company.
15) What is considered by analysts to be the most important number on Wall Street? How is this
number calculated?
16) What problems may exist because of Wall Street’s over-emphasis on earnings per share?
Learning Objective 11-2
1) Microsoft sells its corporate customers large computer systems that include a three-year
service contract. Microsoft promises that for three years it will update the systems whenever the
customers need modifications and that it will also provide extensive customer support. Microsoft
has chosen to recognize all revenue for these systems over the three-year life of the service
contracts rather than when the systems are installed. Microsoft’s accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
2) Rent-a-Wreck leases cars and offers low prices to its customers because it requires the
customers to pay a full year’s rent at the time of signing the lease. Rent a Wreck records the
revenue at the time the customer signs the lease. Rent-a-Wreck’s accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
3) X Company began selling appliances this year. The company president has decided not to
record any warranty expense or estimated warranty liability because the company’s products are
so good that he does not expect to have to make any warranty repairs. This accounting choice
would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
4) Three Thugs, Inc. opened a new auto repair shop this year. The owners have decided not to
recognize any bad debts expense or allowance for uncollectible accounts because they think that
their company name will be enough to enforce collection. This accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
5) W Company just bought ten new cars for its salespeople to use. The company expects to use
these cars for two or three years and then replace them. If W Company calculates straight-line
depreciation using an estimated useful life of two years, this accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
6) W Company just bought ten new cars for its salespeople to use. The company expects to use
these cars for two or three years and then replace them. If W Company calculates straight-line
depreciation using an estimated useful life of three years, this accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
7) Tastee Bakery just bought a new delivery truck, which the bakery plans to use for four or five
years before replacing it. If the company calculates straight-line depreciation using an estimated
useful life of four years, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
8) Tastee Bakery just bought a new delivery truck, which the bakery plans to use for four or five
years before replacing it. If the company calculates straight-line depreciation using an estimated
useful life of five years, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
9) Tastee Bakery donated its used delivery truck to the local Health Right Clinic, which provides
free healthcare for people with no medical insurance. The bakery will record the donation as an
operating expense. Since Tastee Bakery uses double-declining-balance depreciation, the book
value of the truck is only $1,500, but the “blue book” market value of the truck is $2,500. If
Tastee Bakery records a charity expense of $1,500, this accounting choice would be considered
________.
A) conservative
B) fundamental
C) basic
D) aggressive
10) Tastee Bakery donated its used delivery truck to the local Health Right Clinic, which
provides free healthcare for people with no medical insurance. The bakery will record the
donation as an operating expense. Since Tastee Bakery uses double-declining-balance
depreciation, the book value of the truck is only $1,500, but the “blue book” market value of the
truck is $2,500. If Tastee Bakery records a charity expense of $2,500, this accounting choice
would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
11) For the past twenty years, Ace Electronics has had a policy of expensing all assets that cost
less than $50, even if they are expected to last for more than a year, because it is simpler and
easier than depreciating low-cost assets over their useful lives. This year Ace Electronics decided
that because of inflation it would begin expensing all assets that cost less than $100. This
accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
12) For the past twenty years, Bijou Company has had a policy of expensing all assets that cost
less than $50, even if they are expected to last for more than a year, because it is simpler and
easier than depreciating low-cost assets over their useful lives. This year, Bijou bought a new
computerized accounting system and decided to depreciate all assets over their useful lives, even
low-cost assets like wastebaskets and pencil sharpeners. This accounting choice would be
considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
13) This year Ace Electronics tried calculating its bad debts expense two different ways. Using a
percentage of credit sales, bad debts expense would be $1,500. Based on an aging of accounts
receivable, however, bad debts expense would be only $1,200. If Ace decides to report $1,500 of
bad debts expense, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
14) This year Ace Electronics tried calculating its bad debts expense two different ways. Using a
percentage of credit sales, bad debts expense would be $1,500. Based on an aging of accounts
receivable, however, bad debts expense would be only $1,200. If Ace decides to report $1,200 of
bad debts expense, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
15) This year Beta Business tried calculating its bad debts expense two different ways. Using a
percentage of credit sales, bad debts expense would be $2,500. Based on an aging of accounts
receivable, however, bad debts expense would be $2,750. If Beta Business decides to report
$2,500 of bad debts expense, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
16) This year Beta Business tried calculating its bad debts expense two different ways. Using a
percentage of credit sales, bad debts expense would be $2,500. Based on an aging of accounts
receivable, however, bad debts expense would be $2,750. If Beta Business decides to report
$2,750 of bad debts expense, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
17) Tim’s Tams has been using LIFO to value its inventory because it gives a higher cost of
goods sold, lower income, and lower taxes. This year Tim’s Tams has decided to make a
permanent switch to FIFO, even though it will then have to pay more taxes on its higher reported
income. This accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
18) Alpha, Inc. bought land and a new warehouse for $100,000. Because Alpha needs to separate
the cost of the land (which will not be depreciated) from the cost of the building (which will be
depreciated), Alpha got two independent appraisals. The first appraiser said the land was worth
$10,000. The second appraiser said the land was worth $15,000. If Alpha records the land at
$10,000 and the building at $90,000, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
19) Alpha, Inc. bought land and a new warehouse for $100,000. Because Alpha needs to separate
the cost of the land (which will not be depreciated) from the cost of the building (which will be
depreciated), Alpha got two independent appraisals. The first appraiser said the land was worth
$10,000. The second appraiser said the land was worth $15,000. If Alpha records the land at
$15,000 and the building at $85,000, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
20) Tim’s Tams donated 100 baseball caps to the local homeless shelter. The company will
record the donation as an operating expense. The caps cost Tim’s Tams $2.00 each and the
company usually sells them for $8.50. If Tim’s Tams reports a charity expense of $200, this
accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
21) Tim’s Tams donated 100 baseball caps to the local homeless shelter. The company will
record the donation as an operating expense. The caps cost Tim’s Tams $2.00 each and the
company usually sells them for $8.50. If Tim’s Tams reports a charity expense of $850, this
accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
22) Tom’s Ware donated 100 T-shirts to the local high school. The company will record the
donation as an operating expense. The shirts cost Tom’s Ware $6.00 each and the company
usually sells them for $10.50. If Tom’s Ware reports a charity expense of $1,050, this accounting
choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
23) Tom’s Ware donated 100 T-shirts to the local high school. The company will record the
donation as an operating expense. The shirts cost Tom’s Ware $6.00 each and the company
usually sells them for $10.50. If Tom’s Ware reports a charity expense of $600, this accounting
choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
24) The town of Columbia gave a piece of land to Wind Energy, Inc. so that the company would
build its new factory in Columbia and create many local jobs. One appraiser said the land was
worth $200,000, while a second appraiser said the land was worth $220,000. If Wind Energy,
Inc. records the land at $200,000, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
25) The town of Columbia gave a piece of land to Wind Energy, Inc. so that the company would
build its new factory in Columbia and create many local jobs. One appraiser said the land was
worth $200,000, while a second appraiser said the land was worth $220,000. If Wind Energy,
Inc. records the land at $220,000, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
26) Ken’s Candy has been selling to Art’s Quik Mart for thirty years. Lately Art’s has been
paying its bills increasingly slowly. Right now, Ken’s Candy has $10,000 in accounts receivable
on its books from Art’s Quik Mart for candy sold to Art’s over the last six months. Art’s Quik
Mart says it will pay the bill as soon as it can. Ken’s Candy is trying to decide whether it should
increase its allowance for uncollectible accounts to cover the amount owed by Art’s. If Ken’s
Candy increases the allowance, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
27) Ken’s Candy has been selling to Art’s Quik Mart for thirty years. Lately Art’s has been
paying its bills increasingly slowly. Right now, Ken’s Candy has $10,000 in accounts receivable
on its books from Art’s Quik Mart for candy sold to Art’s over the last six months. Art’s Quik
Mart says it will pay the bill as soon as it can. Ken’s Candy is trying to decide whether it should
increase its allowance for uncollectible accounts to cover the amount owed by Art’s. If Ken’s
Candy does not increase the allowance, this accounting choice would be considered ________.
A) conservative
B) fundamental
C) basic
D) aggressive
28) A firm with high quality earnings may indicate the firm ________.
A) has fewer internal controls
B) postpones recognition of revenue
C) delays recognition of expenses
D) has fewer external risks than internal risks
29) A firm with low quality earnings may indicate the firm ________.
A) has made conservative accounting choices resulting in lower net income
B) postpones recognition of revenue
C) delays recognition of expenses
D) has fewer external risks than internal risks
30) Quality of earnings is considered higher if management ________.
A) depreciates its long-term assets over a shorter period than the industry average
B) uses larger salvage values for its long-term, depreciable assets
C) uses a lower percentage for its bad debts expense estimate
D) reduces its internal controls
31) The quality of earnings is considered to be higher when ________.
A) the internal and external risks of the company are higher
B) revenues are recognized early or expenses are postponed to a later period
C) the company has an incentive-based compensation plan for executives that is tied to earnings
per share
D) management chooses accounting methods that result in conservative earnings
32) Which of the following is considered aggressive accounting?
A) depreciating long-term assets over a longer period than the industry average
B) using larger salvage values for its long-term, depreciable assets
C) using a lower percentage for its bad debts expense estimate
D) using LIFO instead of FIFO
33) Analyst’s emphasis on earnings ________.
A) may cause companies to report lower quality earnings
B) is good because it helps companies be more profitable
C) causes stocks to be valued unfairly
D) causes gross profit to be overstated
34) Quality of earnings is considered higher if management depreciates its long-term assets over
a shorter period than the industry average.
35) Quality of earnings is considered higher if management depreciates its long-term assets over
a longer period than the industry average.
36) Firms that recognize revenue early or postpone recognition of expenses often have a lower
quality of earnings.
37) Incentive-based compensation plans should offer rewards to management for performance
that creates increased shareholder value to help avoid management’s incentive to manipulate
earnings per share.
38) Firms that choose larger salvage values for their depreciable assets often have higher quality
of earnings.
39) Team Instructions: Divide the class into teams of three or four people. Give the students
time in class to work with their teammates and put together a final correct copy of the problem.
Each team should turn in only one copy of the problem for grading. All team members will
receive the same grade.
Acme Enterprise just paid $280,000 to buy ten new company cars for its salespeople to use.
Acme expects to use these cars for two or three years and then replace them.
1. If Acme uses the ten cars for three years, it then expects to be able to sell them for $10,000
each. How much depreciation expense will Acme record each year using the straight-line
method?
2. If Acme uses the ten cars for only two years, it then expects to be able to sell them for $12,000
each. How much depreciation expense will Acme record each year using the straight-line
method?
3. If Acme has 1,000,000 weighted-average shares of common stock outstanding, how much
difference will the choice of useful life make in the company’s earnings per share?
4. Which useful life would be considered aggressive?
5. Which useful life would improve the quality of Acme’s earnings?
6. Explain the relationship between management’s choice of accounting method and a company’s
quality of earnings.
40) The city of Morgantown gave a piece of land to Acme, Inc. so that the company would build
its new factory in Morgantown and create many local jobs. One appraiser said the land was
worth $500,000, while a second appraiser said the land was worth $520,000.
1. What effect will it have on Acme’s earnings per share if it records the land at $500,000 rather
than $520,000?
(circle one) increase decrease no effect
2. What effect will it have on Acme’s total assets if it records the land at $500,000 rather than
$520,000?
(circle one) increase decrease no effect
3. Name one ratio that will be affected by Acme’s choice of value for the land. Will this ratio be
higher or lower if Acme records the land at $500,000 rather than $520,000?
4. Explain the relationship between management’s choice of recorded value for the land and the
company’s quality of earnings.
41) During the year, Core, Rupt, and Baroque, Inc. had sales revenue of $13,200. For each of the
following ranges of estimates provided, indicate which percent is the more conservative choice.
a. Estimated sales returns range from 1 to 2% of total sales
b. Bad debts are expected to be between 1 and 2% of net sales
c. Estimated warranty costs are 1 to 2% of net sales
d. Straight-line depreciation rate could be 10% or 20% for its buildings
Learning Objective 11-3
1) How can you tell if a company is taking big bath charges this year?
A) Compare this year’s accounts receivable with last year’s. If this year’s accounts receivable are
much bigger, there must have been many charges.
B) Compare this year’s income statement with several previous years’, looking for unusual
expenses or write-offs.
C) Compare this year’s cash flow from operating activities with several previous years’. If this
year’s cash flow from operating activities is much smaller, there must have been many charges.
D) Look for a note titled “Big Bath Charges” in the annual report.
2) Which of the following may indicate a company is setting up a cookie jar reserve this year?
A) The current year’s estimated warranty liability is significantly larger than prior years’.
B) The current year’s warranty expense is significantly smaller than several previous years’.
C) The current year’s cash flow from operating activities is significantly larger than previous
years’.
D) There is a note titled “Cookie Jar Reserves” in the annual report.
3) What may be the effect on a company’s financial statements in the year a company sets up a
cookie jar reserve?
A) Net income and total assets may be too high.
B) Net income and total liabilities may be too low.
C) Net income may be too high and total assets may be too low.
D) Net income may be too low and total liabilities may be too high.
4) What may be the effect on a company’s financial statement in the year a company sets up a
cookie jar reserve?
A) Net income and total assets may be too high.
B) Net income and total assets may be too low.
C) Net income may be too high and total assets may be too low.
D) Net income and total liabilities may be too high.
5) Out of Africa, a multi-national corporation, had a very bad year. Management decided to write
off a large amount of its long-term assets because they might lose value in future years.
Management is ________.
A) acting ethically and being conservative
B) recording big bath charges
C) recognizing revenue too early
D) setting up a cookie jar reserve
6) RH Company shipped goods to a customer on December 31, 2011 that the customer had not
ordered. RH Company recorded a credit sale of $75,000. What is the effect of recording this sale
on RH Company’s 2011 financial statements?
A) Net income and total assets are too high.
B) Net income and total assets are too low.
C) Net income is too high and total assets are too low.
D) Net income is too low and total assets are too high.
7) RH Company shipped goods to a customer on December 31, 2011 that the customer had not
ordered. RH Company recorded a credit sale of $75,000. As a result of recording this sale, which
of the following will be overstated on RH Company’s 2011 financial statements?
A) sales
B) accounts receivable
C) earning per share
D) all of these
8) Trading Places, a multi-national corporation, had a very successful year and was more than
meeting analyst’s expectations. Management decided to increase the amount of its warranty
expense to more than was needed. Management is ________.
A) acting ethically and being conservative
B) recording big bath charges
C) recognizing revenue too late
D) setting up a cookie jar reserve
9) GB Company had a very bad year in 2011. The controller knew that the company already had
a significant loss for the year, so he put the paperwork in his bottom drawer for some of the
shipments made in the last two weeks of 2011. As a result, $100,000 of sales were not recorded
and the customers weren’t billed until 2012. The controller is ________.
A) acting ethically and being conservative
B) recording big bath charges
C) recognizing revenue too late
D) setting up a cookie jar reserve
10) GB Company had a very bad year in 2011. The controller knew that the company already
had a significant loss for the year, so he put the paperwork in his bottom drawer for some of the
shipments made in the last two weeks of 2011. As a result, $100,000 of sales were not recorded
and the customers weren’t billed until 2012. What is the effect of omitting these sales from GB
Company’s 2011 financial statements?
A) Net income and total assets are too high.
B) Net income and total assets are too low.
C) Net income is too high and total assets are too low.
D) Net income is too low and total assets are too high.
11) Which of the following may indicate a company is manipulating earnings using cookie jar
reserves?
A) higher than usual revenues for the year
B) lower than usual expenses for the year
C) higher than usual allowance for uncollectible accounts at yearend
D) lower than usual payables at yearend
12) Out of Africa, a multi-national corporation, was having a very bad year. Management
decided to record all shipments made to customers in the first two weeks of the next year as sales
in the current year. Management is ________.
A) acting ethically and being conservative
B) recording big bath charges
C) recognizing revenue too early
D) setting up a cookie jar reserve
13) Out of Africa, a multi-national corporation, had a very successful year and more than met
analysts’ expectations. Management decided to increase the amount of its allowance for
uncollectible accounts by more than what is needed. Management is ________.
A) acting ethically and being conservative
B) recording big bath charges
C) recognizing revenue too early
D) setting up a cookie jar reserve
14) Using LIFO instead of FIFO to value inventory when prices are rising ________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) increases shareholders’ equity
15) Using a shorter useful life to depreciate long-term assets ________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) increases shareholders’ equity
16) Using a longer useful life to depreciate long-term assets ________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) decreases shareholders’ equity
17) Using a larger salvage value when calculating depreciation expense for long-term assets
________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) decreases shareholders’ equity
18) Using a smaller salvage value when calculating depreciation expense for long-term assets
________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) decreases shareholders’ equity
19) The repurchase of treasury stock ________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) increases shareholders’ equity
20) Paying a cash dividend ________.
A) increases earnings per share
B) decreases earnings per share
C) has no effect on earnings per share
D) increases shareholders’ equity
21) Which of the following may indicate a company is manipulating earnings by creating a
cookie jar reserve?
A) higher than usual revenues for the year
B) lower than usual expenses for the year
C) higher than usual estimated warranty liability at yearend
D) lower than usual payables at yearend
22) The cookie-jar-reserve theory is the type of manipulation where management maximizes a
current loss to get rid of expenses that belong on future income statements.