Chapter 02 – Review of Accounting
1. The income statement is the major device for measuring the profitability of a firm over a
period of time.
2. The income statement measures the increase in the assets of a firm over a period of time.
3. Sales minus cost of goods sold is equal to earnings before taxes.
4. Sales minus cost of goods sold is equal to gross profit.
Chapter 02 – Review of Accounting
5. It is not possible for a company with a high profit margin to have a low operating profit.
6. Operating profit is essentially a measure of how efficient management is in generating
revenues and controlling expenses.
7. Dividing Operating Profit by Shares Outstanding produces Earnings per Share.
8. Accounting income is based on verifiably completed transactions.
9. The P/E ratio is strongly related to the past performance of the firm.
Chapter 02 – Review of Accounting
10. When a firm has a sharp drop off in earnings, its P/E ratio may be artificially high.
11. The P/E ratio provides no indication of investors’ expectations about the future of a
company.
12. The real value of a firm is the same from an economic and accounting perspective.
13. A balance sheet represents the assets, liabilities, and owner’s equity of a company at a
given point in time.
14. The investments account includes marketable securities.
Chapter 02 – Review of Accounting
15. The investments account represents a commitment of funds of at least one year or more.
16. Asset accounts are listed in order of their liquidity.
17. Accumulated depreciation shows up in the income statement.
18. Accumulated depreciation should always be equal to the depreciation expense charged in
the income statement.
19. Total assets of a firm are financed with liabilities and stockholders equity.
Chapter 02 – Review of Accounting
20. Marketable securities are temporary investments of excess cash and are valued at their
original purchase price.
21. Book value per share and market value per share are usually the same dollar amount.
22. Book value per share is of greater concern to the financial manager than market value per
share.
23. Book value is equal to net worth.
Chapter 02 – Review of Accounting
24. Equity is a measure of the monetary contributions that have been made directly or
indirectly on behalf of the owners of the company.
25. Stockholders’ equity is equal to liabilities plus assets.
Chapter 02 – Review of Accounting
26. Stockholders’ equity is equal to assets minus liabilities.
27. Stockholders’ equity minus preferred stock is the same thing as what is sometimes called
net worth or book value.
28. Retained earnings shown on the balance sheet represents available cash on hand generated
from prior year’s earnings but not paid out in dividends.
29. Preferred stock is excluded from stockholders equity because it does not have full voting
rights.
Chapter 02 – Review of Accounting
30. Retained earnings represent the firm’s cumulative earnings since inception, minus
dividends and other adjustments.
31. Balance sheet items are usually adjusted for inflation.
32. Cash flow consists of illiquid cash equivalents which are difficult to convert to cash
within 90 days.
33. The statement of cash flows helps measure how the changes in a balance sheet were
financed between two time periods.
34. Cash flow is equal to earnings before taxes minus depreciation.
Chapter 02 – Review of Accounting
35. An increase in an asset represents a source of funds.
36. Assume that two companies both have Net Income of $100,000. The firm with the highest
depreciation expense will have the highest cash flow, assuming all other adjustments are
equal.
37. An increase in inventory represents a source of funds.
38. An increase in a liability account represents a source of funds on the cash flow statement.
39. An increase in accounts receivable represents a reduction in cash flows from operations.
Chapter 02 – Review of Accounting
40. An increase in accounts payable represents a reduction in cash flows from operations.
41. The purchase of a new factory would reduce the cash flows from investing activities on
the statement of cash flows.
42. The sale of corporate bonds held by the firm as a long-term investment would increase
cash flows from investing activities on the statement of cash flows.
43. Paying dividends to common shareholders will not affect cash flows from financing
activities.
Chapter 02 – Review of Accounting
44. The sale of a firm’s securities is a source of funds, whereas the payment of dividends is a
use of funds.
45. Depreciation is an accounting entry and does not involve a cash expense.
46. The use of depreciation is an attempt to allocate the past and future costs of an asset over
its useful life.
47. Free cash flow is equal to cash flow from operating activities plus depreciation.
Chapter 02 – Review of Accounting
48. Free cash flow is equal to cash flow from operating activities minus necessary capital
expenditures and normal dividend payments.
49. For corporations with low taxable income (less than $100,000), the effective tax rate can
be as much as 40%.
50. Interest expense is deductible before taxes and therefore has an after-tax cost equal to the
interest paid times (1 tax rate).
51. Federal corporate tax rates have changed four times since 1980.
Chapter 02 – Review of Accounting
52. A $125,000 credit sale could be a part of a firm’s cash flow from operations if paid off
within the firm’s fiscal year.
53. Preferred stock dividends are paid out before income taxes.
54. Unlike sole proprietorships, corporations do not need to be concerned about individual tax
rates in corporate decisions.
55. Net working capital is the difference between current assets and current liabilities.
56. Book value per share is the most important measure of value for a stockholder.
Chapter 02 – Review of Accounting
57. An increase in accounts receivable results in a cash inflow on the statement of cash flows.
58. A decrease in bonds payable results in a cash outflow on the statement of cash flows.
59. An increase in accrued expenses results in a cash outflow on the statement of cash flows.
60. A cash flow statement is correct if the net cash flow ties to the ending cash balance.
Chapter 02 – Review of Accounting
61. Which of the following is not one of the three basic financial statements?
62. Gross profit is equal to
63. Which of the following is not subtracted out in arriving at operating income?
Chapter 02 – Review of Accounting
64. Increasing interest expense will have what effect on EBIT?
65. The residual income of the firm belongs to
Chapter 02 – Review of Accounting
66. Allen Lumber Company had earnings after taxes of $750,000 in the year 2009 with
300,000 shares outstanding on December 31, 2009. On January 1, 2010, the firm issued
50,000 new shares. Because of the proceeds from these new shares and other operating
improvements, 2010 earnings after taxes were 25 percent higher than in 2009. Earnings per
share for the year 2010 were
Chapter 02 – Review of Accounting
67. Consider the following information for Ball Corp.
What is the Operating Profit for Ball Corp?
Chapter 02 – Review of Accounting
68. Candy Company had sales of $320,000 and cost of goods sold of $112,000. What is the
gross profit margin (ratio of gross profit to sales)?
69. Density Farms, Inc. had sales of $750,000, cost of goods sold of $200,000, selling and
administrative expense of $70,000, and operating profit of $150,000. What was the value of
depreciation expense?
Chapter 02 – Review of Accounting
70. Elgin Battery Manufacturers had sales of $1,000,000 in 2009 and their cost of goods sold
represented 70 percent of sales. Selling and administrative expenses were 10 percent of sales.
Depreciation expense was $100,000 and interest expense for the year was $10,000. The firm’s
tax rate is 30 percent. What is the dollar amount of taxes paid?
71. A firm has $1,500,000 in its common stock account and $1,000,000 in its paid-in capital
account. The firm issued 100,000 shares of common stock. What was the original issue price
if only one stock issue has ever been sold?