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Understanding Accounting Concepts and Business Performance Evaluation

1. Rickety Company purchased 1,000 widgets and has 200 widgets in its ending inventory at a cost of
$91 each and a current replacement cost of $80 each. What is the ending inventory under lower of
cost or market?

A. $91,000.
B. $80,000.
C. $18,200.
D. $16,000
Option D
2. Atlantis Company's ending inventory is understated $4,000. The effects of this error on the current
year's cost of goods sold and net income, respectively, are
understated(overstated)/overstated(understate).
A. understated, overstated.
B. overstated, understated.
C. overstated, overstated.
D. understated, understated
option B
3. When there is a change in estimated depreciation when is correction made?
a. previous depreciation should be corrected.
b. current and future years' depreciation should be revised.
c. only future years' depreciation should be revised.
d. None of the above.
Option B
4. Which one of the tangible fixed assets would not normally be depreciated?
Land

Driveways

Equipment

Buildings

ANSWER Land
5. Which one of the events must happen before a company can pay final proposed equity dividend?

6. What does it mean when we say a loan is secured by a fixed charge?


A loan secured by fixed charge is the loan that is backed by mortgages such as houses The lender is
secured from non payment of loans

7. What is another word meaning 'debenture'?


the term is now used interchangeably with bond, loan stock or note
the debt instrument used tio borrow money at fixed charge

8. For 2007, FP Ltd had net income of Rs1,000,000. At 1January 2007, there were 1,000,000 shares
outstanding. On 1July 2007, the company issued 100,000 new shares for Rs20 per share. The
company paid Rs200,000 in dividends to common shareholders. What is FP Ltd’s basic earnings per
share for 2007?
net income= $1000000
common dividends= $200000 X (irrelevant information, as you only subtract PREFERRED dividends
in the basic EPS equation)

shares outstanding 1 January= 1000000 x 6/12 (# months until 1 July)= 500000


shares issued 1 July= (100000+1000000) x 6/12= 550000

500000+550000= 1050000= weighted average number of common shares outstanding

basic EPS= (net income- preferred dividends)/weighted average number of shares outstanding

basic EPS= (1000000-0)/1050000= .95


9. CSI Ltd had 1,000,000 average shares outstanding during all of 2007. During 2007, CSI also had
10,000 options outstanding with exercise prices of Rs10 each. The average stock price of CSI during
2007 was Rs15. For purposes of computing diluted earnings per share, how many shares would be
used in the denominator?
10000 options outstanding x exercise price $10 each=
10000 x $10= $100,000 revenue
$100,000/ average stock price $15
$100,000/ $15= 6666.67 Treasury shares purchased
denominator:
shares outstanding+ option exercises - Treasury shares purchased
=1000000+10,000-6666.67
=1003333
10. Nutmeg, Inc. uses the LIFO method to account for inventory. During years in which
inventory unit costs are generally rising and in which the company purchases more
inventory than it sells to customers. What is the impact on gross profit compared with
FIFO method?

lower than it would be if the company used the FIFO method.

higher than it would be if the company used the FIFO method.

about the same as it would be if the company used the FIFO method.
A is correct. LIFO will result in lower inventory and higher cost of sales in periods of
rising costs compared to FIFO. Consequently, LIFO results in a lower gross profit
margin than FIFO.

SC Ltd reported 2007 sales (Rs in millions) of Rs2,157 and cost of goods sold of Rs1,827. Inventories at
year-end 2007 and 2006, respectively, were Rs553and Rs562.The company uses the LIFO method for
inventory valuation and discloses that if the FIFO inventory valuation method had been used,
inventories would have been Rs63.3 million and Rs56.8 million higher in 2007 and 2006, respectively.
Compared to the inventory turnover ratio reported, if SC Ltd had exclusively used the FIFO method its
inventory turnover ratio would have been closest to?

11. You are comparing the property and equipment disclosures for three airline companies, as
summarized in the following table: You find that the average fleet age is lowest for which company
Airline A Airline B Airline C
Historical cost, aircraft $17,239 £23,584 €45,266
Accumulated depreciation, aircraft 6,584 13,654 21,745
Net cost, aircraft 10,655 9,930 23,521
Annual depreciation expense 575 786 1,509

12. When an asset is considered impaired?

13. How is change in accounting estimate reported?

14. Impact when in the early years of an asset's life, compared to a firm using straight-line
depreciation, a firm uses the double-declining balance depreciation method.

15. What is comparison of a company's financial results to other peer companies for the same time
period called?
Technicalanalysis.
time-seriesanalysis.
cross-sectional analysis.
C is correct. Cross-sectional analysis involves the comparison of companies with each other
for the same time period. Technical analysis uses price and volume data as the basis for
investment decisions. Time-series or trend analysis is the comparison of financial data
across different time periods.
16. In order to assess a company's ability to fulfill its long-term obligations, which ratios would an
analyst most likely examine
activity ratios.

liquidity ratios.

solvency ratios.

C is correct. Solvency ratios are used to evaluate the ability of a company to meet its
long-term obligations. An analyst is more likely to use activity ratios to evaluate how
efficiently a company uses its assets. An analyst is more likely to use liquidity ratios to
evaluate the ability of a company to meet its short-term obligations.

17. The principle or assumption dictating that efforts (expenses) be matched with accomplishments
(revenues) is called?
expense recognition principle

18. One of the following statements about the accrual basis of accounting is false. That statement is:
A: Events that change a company's financial statements are recorded in the
periods in which the events occur.
B: Revenue is recognized in the period in which the performance obligation is
satisfied.
C: The accrual basis of accounting is in accordance with generally accepted
accounting principles.
D: Revenue is recorded only when cash is received, and expenses are recorded
only when cash is paid.

19. In periods of rising prices, LIFO will produce following effect on net income:

20. Which ratio would a company most likely use to measure its ability to meet short-term obligations?
Current ratio.

Payables turnover.

Gross profit margin.


A is correct. The current ratio is a liquidity ratio. It compares the net amount of current
assets expected to be converted into cash within the year with liabilities falling due in the
same period. A current ratio of 1.0 would indicate that the company would have just enough
current assets to pay current liabilities.

21. John Chan is interested in assessing both the efficiency and liquidity of Spherion PLC. Chan has
collected the following data for Spherion: Based on this data, what is Chan least likely to conclude?
2005 2004 2003
Days of inventory on hand 32 34 40
Days' sales outstanding 28 25 23
Number of days of payables 40 35 35

Based on this data, what is Chan LEAST likely to conclude?

A. Inventory management has contributed to improved liquidity.

B. Management of payables has contributed to improved liquidity.

C. Management of receivables has contributed to improved liquidity.

22. Marcus Lee is examining the solvency of Apex Manufacturing and has collected the following data
(in millions of euros):
2005 2004 2003
Total debt 2000 1900 1750
Total equity 4000 4500 5000
Which of would be the most appropriate conclusion for Lee?
A. The decline in the company ' s equity results from a decline in the market value of this
company ' s common shares.

B. The increase of € 250 in the company ' s debt from 2003 to 2005 indicates that lenders
are viewing the company as increasingly creditworthy.

C. The decline in the company ' s equity indicates that the company may be incurring
losses on its operations, paying dividends greater than income, and/or repurchasing shares.

23. Brown Corporation had an average days sales outstanding of 19 days in 2005. Brown wants to
decrease its collection period in 2006 to match the industry average of 15 days. Credit sales in
2005were $300million, and Brown expects credit sales to increase to $390 million in 2006. To
achieve Brown's goal of decreasing the collection period, what is the change in the average accounts
receivable balance from 2005 to 2006 that must occur?
A.-$1.22million.

B.-$0.42million.
C. $0.42 million.

24. An analyst gathered the following data for a company: Based only on the information above, what
is the the most appropriate conclusion over the period 2003 to 2005?
2005 2004 2003
ROE 22% 20% 19.8%
Return on total asset 7.9% 8% 8.1%
Total asset turnover 2.1 2 2
A. net profit margin and financial leverage have decreased.

B. net profit margin and financial leverage have increased.

C. net profit margin has decreased but its financial leverage has increased.

25. Rent-A-Center reported the following information related to total debt and shareholders' equity in
its 2003 annual report. What would an analyst's most appropriate conclusion based on this
data?
As At December 31
2003 2002 2001 2000 1999
Total debt 698,000 521,330 702,506 741,051 847,160
Stockholders' 794,830 842,400 405,378 309,371 206,690
equity

A. The company ' s solvency improved from 1999 to 2002.

B. The company ' s solvency improved from 2002 to 2003.

C. The data suggest the company increased debt in 2002.

26. In general, a creditor would consider a decrease in which of the ratios to be positive news?

A. Interest coverage (times interest earned)

B. Debt to total assets

C. Return on assets

27. What does the P/E ratio measure?

AThe "multiple" that the stock market places on a company's EPS.

BThe relationship between dividends and market prices.

C The earnings for one common share of stock.


28. The gross profit margin is unchanged, but the net profit margin declined over the same period.
Why would this happened?

29. Almas Industries has a debt-to-equity ratio of 1.6 compared with the industry average of 1.4. What
does this means for the company?
will not experience any difficulty with its creditors

has less liquidity than other firms in the industry.

will be viewed as having high creditworthiness.

has greater than average financial risk when compared to other firms in its industry

30. A company can improve (lower) its debt-to-total assets ratio by doing which methods?
Borrow more.
Shift short-term to long-term debt.
Shift long-term to short-term debt.
Sell common stock.
31. Which of the conditions would NOT improve the current ratio?
Borrow short term to finance additional fixed assets.
Issue long-term debt to buy inventory.
Sell common stock to reduce current liabilities.
Sell fixed assets to reduce accounts payable.

32. Which of the is a true statement concerning the use of financial ratios to compare financial results
of two or more companies
A The interpretation of an entity’s financial statements using ratios is only useful for potential
investors
B Ratios based on historical data can predict the future performance of an entity
C The analysis of financial statements using ratios provides useful information when compared
with previous performance or industry averages
D An entity’s management will not assess an entity’s performance using financial ratios

33. Earnings per share (EPS) is computed by using which equation:


(net income – dividends on preferred stock) / average outstanding common
shares
34. This is how the acid-test ratio is calculated
(Current assets – Inventory) / Current Liabilities
(Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
35. What is the counter impact if the size of an asset increases on a balance sheet,
Liabilities or owner equity will increase

36. What does the “Going Concern’ concept assumes?


The going concern principle is the assumption that an entity will remain in
business for the foreseeable future. Conversely, this means the entity
will not be forced to halt operations and liquidate its assets in the near term
at what may be very low fire-sale prices. By making this assumption, the
accountant is justified in deferring the recognition of certain expenses until a
later period, when the entity will presumably still be in business and using its
assets in the most effective manner possible.
37. At what stage a manufacturer is permitted to recognized a transaction for inclusion within its profit
and loss account?

38. Which one of the following most closely defines 'Amortization'?


Amortization is the paying off of debt with a fixed repayment schedule in regular installments over a period
of time for example with a mortgage or a car loan. It also refers to the spreading out of capital
expenses for intangible assets over a specific duration (usually over the asset's useful life) for accounting
and tax purposes.

39. Which is usually the first dividend to be paid in a financial year?

Interim dividend in case

40. In calculating basic earnings per share, which 'weighted average' figure is used in the formula?

41. A decomposition of ROE for Company A and Company B is as follows: Which best
describes reasonable conclusions an analyst might make based on this ROE
decomposition?
Company A Company B
2005 2004 2005 2004
ROE 26.46% 18.90% 26.33% 18.9%
Tax burden 0.70 0.75 0.75 0.75
Interest burden 0.90 0.90 0.90 0.90
EBIT margin 7% 10% 13% 10%
Asset turnover 1.50 1.40 1.50 1.40
Leverage 4 2 2 2

A. Company A ' s ROE is higher than Company B ' s in 2005, but the difference between
the two companies ' ROE is very small and was mainly the result of Company A ' s increase
in its financial leverage.

B. Company A ' s ROE is higher than Company B ' s in 2005, apparently reflecting a
strategic shift by Company A to a product mix with higher profit margins.

C. Company A ' s ROE is higher than Company B ' s in 2005, which suggests that
Company A may have purchased new, more efficient equipment.

42. In calculating basic earnings per share, net profit or loss is included in the formula after deduction
of these this
The formula for computing basic earnings per share is: earnings for the year (available to ordinary
shareholders after deduction of all expenses and distribution to preference shareholders) divided by
the weighted-average number of ordinary shares. All other items listed are to be excluded.

43. How is the market value of a company whose shares are listed on a stock market can be found?
Market capitalization refers to the total dollar market value of a company's outstanding shares. Commonly
referred to as "market cap," it is calculated by multiplying a company's shares outstanding by the current
market price of one share. The investment community uses this figure to determine a company's size, as
opposed to using sales or total asset figures.

44. When does a post balance sheet period ends?

45. A limited liability company in which you are a shareholder has just gone bankrupt. Its liabilities are
far in excess of its assets. What would you will be called on to pay:
Nothing
46. Is a corporation is a “legal entity’ that can be sued?
Yes
47. Equity financing has a tax advantage since dividends paid out to shareholders reduce a firm's
taxable income.
False

48. Frank Collins observes the following data for two companies: Which of the following
choices best describes reasonable conclusions that Collins might make about the two
companies' ability to pay their current and long-term obligations?
Company A Company B
Revenue 4,500 6,000
Net income 50 1,000
Current assets 40,000 60,000
Total assets 100,000 700,000
Current liabilities 10,000 50,000
Total debt 60,000 150,000
Shareholders' equity 30,000 500,000

49. What is meant by a share sale is underwritten?

50. What is the significance of a preference share being described as cumulative?

51. Which circumstances might cause the gross margin to increase?

52. What is an advantage to shareholders in a low-geared company is:

53. What does it mean when a company shows a dividend cover of 3 times?

54. If a '5 for 3' rights issue is made at Rs.1.90 per share, How much would a shareholder who owns
15,000 shares pay to the company to buy all the shares he is entitled to?

55. If a '3 for 2' bonus issue is made to a shareholder who originally paid Rs.2 per share for 10,000
shares, how much would the shareholder pay for the bonus shares if the current market value is
Rs.4 per share?

56. A company has issued 2m shares at Rs.3.50 each. The nominal value of each share is Rs.0.50, and
the stock market price is Rs.5. What entries must be made on the balance sheet to record this share
issue?
57. What is the role of an auditor?

58. Which one of the statements is not contained within a published annual report?

59. What is Horizontal analysis?

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