Foundations of Financial Management, 17e (Block)
Chapter 2 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 shows the amount of profits earned based on any one given day.
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.
5) It is not possible for a company with a high gross profit margin to have a low operating profit.
6) Gross profit margin is a measurement of how much gross profit a company generated from the
amount of sales it earned.
7) Operating profit is essentially a measure of how efficient management is in generating
revenues and controlling expenses.
8) Another way of writing net income after tax is earnings after taxes (EAT).
9) Dividing earnings after taxes (which includes all profits distributed to both preferred
stockholders and common stockholders) by common shares outstanding produces earnings per
share.
10) The price-earnings (P/E) ratio is strongly related to the past performance of the firm.
11) Accounting income is based on verifiably completed transactions.
12) When a firm has a sharp drop off in earnings, its P/E ratio may be artificially high.
13) The P/E ratio provides no indication of investors’ expectations about the future of a
company.
14) The real value of a firm is the same from an economic and accounting perspective.
15) A balance sheet represents the assets, liabilities, and owner’s equity of a company at a given
point in time.
16) A balance sheet represents what the firm owns, owes, and ownership of a company at a given
date.
17) Liquidity means that the items that can convert to cash show up as cash on the balance sheet.
18) The investments account includes marketable securities.
19) The long-term investments account represents a commitment of funds of at least one year or
more.
20) Asset accounts are listed in order of their liquidity.
21) Accumulated depreciation shows up in the income statement, while depreciation expense
shows up on the balance sheet.
22) Accumulated depreciation should always be equal to the depreciation expense charged in the
income statement.
23) Total assets of a firm are paid for with liabilities and stockholders’ equity.
24) Marketable securities are short term investments and are valued on the balance sheet at their
original purchase price.
25) Book value per share of stock and market value per share of stock are usually the same dollar
amount.
26) Book value per share of stock is of greater concern to the financial manager than market
value per share of stock.
27) Book value of a company is equal to net worth of a company, which is not always equal to
the market value of the company.
28) Equity is a measure of the monetary contributions that have been made directly or indirectly
on behalf of the owners of the company.
29) Stockholders equity is equal to liabilities plus assets.
30) Stockholders equity is equal to assets minus liabilities.
31) Retained earnings shown on the balance sheet represents profits generated from prior year’s
earnings less any prior dividends.
32) Balance sheet items should be adjusted for inflation when valuing a company.
33) Balance sheet items consider inflation and market value when assigning the amount to assets,
liabilities, and equity accounts.
34) Cash and cash equivalents are considered anything that can convert to cash within one year.
35) The Statement of Cash Flows has three parts: operating, investing, and financing under both
the indirect and direct method.
36) The statement of cash flows helps measure how the changes in a balance sheet accounts were
financed between two time periods, the beginning and the ending balance.
37) Cash flow from operations is equal to earnings before taxes minus depreciation.
38) The indirect method of preparing the Cash Flow Statement basically adjusts the net income
to reflect what the financials would have looked like if cash basis was used instead of accrual
basis.
39) Assume that two companies both have a net income of $100,000. The firm with the highest
depreciation expense will have the highest cash flow, assuming all other adjustments are equal.
40) An increase in assets represents a positive source of funds.
41) An increase in a liability account represents a source of positive funds on the cash flow
statement.
42) The purchase of a new factory building would reduce the cash flows from investing activities
on the statement of cash flows.
43) Paying cash dividends to common shareholders will not affect the Cash Flow Statement.
44) The sale of a firm’s securities is a source of positive funds, whereas the purchase of securities
is a use of funds.
45) Depreciation is an accrual accounting entry that does not affect the cash account so it needs
to be adjusted for when using the indirect method of the Cash Flow Statement.
46) Free cash flow is equal to cash flow from operating activities plus depreciation.
47) Free cash flow is equal to cash flow from operating activities minus necessary capital
expenditures and normal dividend payments.
48) Beginning in 2018, one of the major changes regarding the corporate tax rate was its
reduction from 35% to a flat rate of 21%.
49) The corporate tax rate change of 2018 means that corporations are no longer responsible to
pay state and foreign taxes.
50) For corporations with low taxable income (less than $50,000), the effective tax rate can be as
much as 40%.
51) The corporate tax rate reduction to a flat rate of 21% in 2018 was done to make the U.S.
corporate tax rate more competitive with rates imposed by other countries and to encourage
economic activity in the U.S.
52) Interest expense is deductible before taxes and therefore has an after-tax cost equal to the
interest paid times (1 – tax rate).
53) Federal corporate tax rates have changed several times since 1980.
54) A $125,000 credit sale could be a part of a firm’s cash flow from operations if money is
received within the firm’s same fiscal year.
55) Preferred stock dividends are tax deductible.
56) Book value per share is the most important measure of value of a firm for a stockholder.
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 considered correct if the change in cash flow plus the beginning
balance ties to the ending cash balance.
61) Although depreciation does not provide cash to the firm directly, the fact that it is tax–
deductible can provide cash inflow to the company.
62) Gross profit is equal to
A) sales minus cost of goods sold.
B) sales minus selling and administrative expenses.
C) sales minus cost of goods sold and selling and administrative expenses.
D) sales minus cost of goods sold and depreciation expense.
63) Which of the following is not subtracted in arriving at operating income?
A) Interest expense
B) Cost of goods sold
C) Depreciation
D) Selling and administrative expense
64) Increasing interest expense will have what effect on Earnings Before Interest and Taxes
(EBIT)?
A) Increase it.
B) Decrease it.
C) It will have no effect.
D) There is not enough information to tell.
65) Allen Lumber Company had earnings after taxes of $750,000 in the year 2015 with 300,000
shares outstanding on December 31, 2015. On January 1, 2016, the firm issued 50,000 new
shares. The company took the proceeds from these new shares as well as other operating
improvements and earned $937,500 earnings after taxes in 2016. Earnings per share for the year
2016 were
A) $2.14.
B) $2.68.
C) $3.13.
D) None of the options.
66) Consider the following information for Ball Corp.
Selling and administrative expense
$
40,000
Depreciation expense
70,000
Sales
350,000
Interest expense
30,000
Cost of goods sold
110,000
Taxes
17,500
What is the operating profit for Ball Corp.?
A) $71,450
B) $90,000
C) $130,000
D) None of the options
Sales
$
350,000
Cost of goods sold
110,000
Gross Profit
240,000
Selling and administrative expense
40,000
Depreciation expense
70,000
Operating profit
$
130,000
67) 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)?
A) 55%
B) 65%
C) 35%
D) 73.3%
68) 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?
A) $150,000
B) $230,000
C) $330,000
D) $0