Chapter 01

Overview of Financial Statement Analysis

Multiple Choice Questions

1. Which of the following is likely to be the most informative source if you

were interested in a company's business plan or strategy?
A. Auditor's letter
B. Management discussion and analysis
C. Proxy statement
D. Footnotes

2. Which of the following would not be considered a source of financing?

A. Notes receivable
B. Common stockholders' equity
C. Retained earnings
D. Debentures

3. Wilco Company reports the following:

Dividend payout ratio for 2005 was:

A. 27%
B. 12%
C. 22.2%
D. Not determinable

4. If a company receives an alified audit opinion it means the auditors:

A. did not complete a full audit and therefore do not feel qualified to give an opinion
on financial statements.
B. are providing assurance that the company will remain financially viable for at least
the next year.
C. are providing assurance that the company's financial statements fairly
present company's financial performance and position.
D. are providing assurance that the company's financial statements are free from
misstatement, fraudulent accounting and fairly indicate future performance.
5. The Management Discussion and Analysis Section of the annual report:
A. is required by the SEC.
B. is optional but normally included in the annual report.
C. is required by the SEC only if the company has suffered from unfavorable trends
or there are significant uncertainty concerning liquidity of the company.
D. is required by the SEC only if they have a qualified audit opinion.

 You are analyzing a large stable company. For the year ending 12/31/05 the
company reported earnings of $58,900K and book value at the end of 2005
was
$371,700K. You expect earnings to grow at 5% a year in perpetuity, and the
dividend payout ratio of 70% to continue. The company borrows at 8%, and has
a cost of equity of 12%. The company has 25,000K shares outstanding.

6. What is your estimate of price per share using the dividend discount model
at 12/31/05?
A. $20.62
B. $21.65
C. $23.56
D. $24.74

7. What is your estimate of price using the residual income valuation model
at 12/31/05?
A. $20.62
B. $21.65
C. $23.56
D. $24.72

8. Which of the following is not a common tool used in financial statement analysis?
A. Random walk analysis
B. Ratio analysis
C. Common size statement analysis
D. Trend series analysis
 9. A common size income statement would typically be prepared by dividing:
A. all items on income statement in Year t by their corresponding value in Year t-1.
B. all items on income statement in Year t by their corresponding balance sheet
accounts in Year t.
C. all items on income statement in Year t by net income in Year t-1.
D. all items on income statement in Year t by sales in Year t.

10. When conducting comparative analysis by reviewing consecutive balance sheets,

A. all items on the balance sheet in Year t must be divided by their corresponding
value in Year t-1 and subtract 1.
B. all items on the balance sheet in Year t-1 must be subtracted from their
corresponding value in Year t.
C. all items on the balance sheet in Year t must be divided by net income in Year t-1.
D. Both A and B are correct.

 You have prepared a trend series for Company XYZ for three years, 2004-2006
inclusive, using 2004 as the base year. Below are selected data.

11. From the above information, you can infer that:

A. rate of sales growth has decreased.
B. net income to sales (return on sales) is increasing over time.
C. asset turnover is decreasing over time.
D. None of the above

12. Which of the following statements is incorrect?

A. Net Income in 2006 increased by 28% compared to 2004.
B. XYZ's net income to sales (return on sales) increased in 2006 compared to 2004.
C. XYZ's net income to sales (return on sales) decreased in 2006 compared to 2004.
D. Assets have increased over time.

13. While determining the most profitable company from the given number of
companies, which of the following would be the best indicator of relative
profitability?
A. Highest net income
B. Highest retained earnings
C. Highest return on equity
D. Highest operating margin
14. Which of the following statements concerning financial ratios is incorrect?
A. Accounting principles and methods used by a company will not affect
financial ratios.
B. The informational value of a ratio in isolation is limited.
C. A ratio is one number expressed as a percentage or fraction of another number.
D. Calculation of financial ratios is not sufficient for a complete financial analysis of a
company.

15. Which of the following ratios is not generally considered to be helpful in

assessing short-term liquidity?
A. Acid test ratio
B. Current ratio
C. Days to collect receivables
D. Days goodwill held

16. Liquidity of a company is generally defined as a measure of:

A. the ability of a company to pay its employees in a timely manner.
B. the ability to pay interest and principal on all debt.
C. the ability to pay dividends.
D. the ability to pay current liabilities.

 Following is some financial information for Dell Inc.

17. What is Dell's profit margin for

2005? A. 6.27%
B. 6.18%
C. 6.38% = 2,645/41,444
D. 6.86
18. What is Dell's profit margin for
2006? A. 6.27%
B. 6.18%=3,043/49,205
C. 6.38%
D. 6.86%

19. What is Dell's P/E ratio for 2006?

A. 27.63= 33.44/1.21
B. 12.81
C. 23.65
D. 9.70

20. What is Dell's asset turnover for

2006? A. 2.12
B. 3.58
C. 3.65
D. 2.31= 49,205/((23,215+19,311)/2)

21. Given the following information, calculate the inventory turnover for ABC Co. for
2006 (pick closest number).

A. 8.96
B. 7.22
C. 6.93
D. 6.18= COGS/AT inventory = 15,101/((2,809+2,260)/2)=

22. You have been provided the following information about Wert Inc.

Return on Assets for 2006 is:

A. 13.71%
B. 12.68%
C. 10.77%
D. 13.21%
  You have been provided the following information about High Inc.

23. Working Capital for 2005 is:

A. $56,000 = 158-102
B. $20,000
C. $151,000
D. $207,000

24. Owner's Equity for 2006 is:

A. $20,000
B. $154,000
C. $174,000 = (total asset – total liability)
D. $207,000

25. Current Ratio for 2005 is:

A. 1.55 = current asset / current liability
B. 1.51
C. 1.50
D. 1.14

26. Return on Common Equity for 2006 is:

A. 15.46%
B. 24.14%
C. 16.79%
D. 22.04% = NI / Avarage Total Equity

27. Which of the following statements is correct?

A. The more efficiently a company utilizes its assets, the greater its
return on investment, all other things being equal.
B. If return on equity increases, the return on assets must have also increased.
C. If the number of days inventory is held increases, the return on assets will increase,
all other things being equal.
D. If the gross margin decreases, the inventory turnover must have increased, all other
things being equal.
 28. Which of the following statistics would be the most useful in determining
the efficiency of a car rental company?
A. Inventory turnover
B. Number of employees per car rental
C. Average length of car rental
D. Number of days cars are rented as a percentage of number of days available for
rent

29. Which of the following ratios does not relate to market price of a company
under analysis?
A. Price-to-earnings
B. Earnings yield
C. Price-to-book
D. Return on common equity

30. The semistrong efficiency of market implies that:

A. stock prices fully reflect all inside information.
B. stock prices do not reflect information contained in past trading volume.
C. stock prices fully reflect all information found in 10-K filing.
D. stock prices fully reflect all information about future price changes.

31. Which of the following statements is incorrect?

A. It is possible for some markets to be more efficient than others.
B. It is possible for markets to be efficient with respect to some information
and inefficient with respect to other information.
C. The market is likely to be more efficient with respect to companies where there is
greater analyst following.
D. The market is totally efficient with respect to companies providing regular
dividends to investors.

32. Which of the following ratios would be considered useful in assessing

operating profitability?
A. Debt/Equity ratio
B. Acid test ratio
C. Gross profit margin
D. Return on equity
33. How much would you be prepared to pay for a $500 bond which comes due in 5
years and pays $80 interest annually assuming your required rate of return is 8% (pick
closest answer)?
A. $740
B. $660 = 80*((1-(1+8%)^-5)/8%)+500/(1+8%)^5
C. $608
D. $500

34. Fluno Corporation has 1 million shares outstanding at the end of fiscal 2005. Its
stock is trading at $15 per share. It issued $0.6 million in dividends, and had net
income of $1million in fiscal 2005. At the end of 2005, its total assets, liabilities and
retained earnings were $25 million, $15 million and $7.5 million, respectively. Fluno's
price to book ratio and dividend yield ratios for 2005 are:

A. Option A
B. Option B
C. Option C (1.5,4%)
D. Option D

35. Which of the following statements regarding the intrinsic value of a company
is correct?
A. It can be calculated as book value plus the present value of future expected
dividends, discounted at the cost of equity capital.
B. It can be calculated as present value of future expected dividends, discounted at the
cost of debt.
C. It can be calculated as present value of future expected residual income, discounted
at the cost of equity capital.
D. It can be calculated as book value plus the present value of future expected
residual income, discounted at the cost of equity capital

36. Two otherwise equal companies have significantly different dividend payout
ratios. Which of the following statements is most likely to be correct? The company
with higher the dividend payout ratio:
A. will have a higher inventory turnover ratio.
B. will have a lower inventory turnover ratio.
C. will have higher earnings growth.
D. will have lower earnings growth.
37. On January 1, 2005, Systil Corporation issues $50M 10 year bonds with a coupon
rate of 10%. Interest is payable annually at the end of the year. If the required return
on bonds of similar risk at January 1, 2006 is 8%, what will be the price of the bonds
be at this date?
A. $56.71M
B. $56.25M
C. $44.24M
D. $43.86M

38. Which of the following statements is most correct?

A. Technical analysis concerns itself with determining the intrinsic value of a stock.
B. Active investing is defined as buying and selling stock within six months.
C. Fundamental analysis attempts to value a company by examining the past prices
patterns of a company's stock.
D. Individuals who engage in technical analysis by definition do not subscribe
to the weak form of the efficient market hypothesis.

39. Net income is expected to increase by 10% for the next year, and dividend payout
ratio is expected to remain constant. After 2006, retained earnings are expected to
decrease to zero. Using the residual income method what is the value per share of
Rivaz stock as of 12/31/05?
A. $15.25
B. $15.16
C. $14.38
D. $13.77
40. Using the dividend discount model, assuming dividends grow at 10% per year for
the next two years and at 5% thereafter, what is the value per share of Rivaz
Corporation at 12/31/05?
A. $16.61
B. $16.51
C. $16.42
D. $14.87

41. Assuming total assets grew by $5,000 from 2004 to 2005, what is the return on
assets of Rivaz Corporation for 2005?
A. 9.23%
B. 8.57%
C. 10.00%
D. 6.15%

42. Which of the following statements is incorrect?

A. Current assets are expected to be converted into cash sooner than noncurrent assets.
B. Equity investors have unlimited downside exposure if the company
declares bankruptcy.
C. Paid-in capital of company is not affected by the payment of dividends.
D. Retained earnings at the inception of a company equals zero.
43. A company issues 12%, 10-year $1,000 bonds paying interest semi-annually.
Required return for bonds of this risk is 15%. At what price will the bond be sold (pick
closest answer)?
A. $663
B. $849
C. $ 847
D. $ 894

If the students calculate this assuming annual payments (N=10, PMT=120, I=15%),
they will get answer B, not C. The correct solution is calculated with N=20, PMT=60
and I=7.5%. You may wish to award half marks for answer B.

44. You wish to compare the performance of two companies. Which of the following
statements is most likely to be incorrect?
A. If the companies operate in different industries, this will hinder comparability.
B. The use of different accounting methods will hinder comparability.
C. If the companies are of significantly different sizes, this will hinder comparability.
D. If companies have different auditors, this will hinder comparability.
 45. As of December 31, 2005, two otherwise identical companies in the same
industry, East Co. and West Co., have dividend payouts of 20% and 40%, respectively.
Looking forward one year, which outcomes are least likely?
I. East Co. requires debt financing.
II. West Co. increases its dividend payout.
III. West Co.'s share price is twice that of East Co.
IV. East Co. repurchases outstanding shares.
A. I and II
B. II and IV
C. I, II and III
D. II, III and IV

46. Which of the following, if increased by 10%, results in a 10% higher stock price?
A. Dividend yield
B. Earnings yield
C. Net profit margin
D. None of the above

47. Which of the following is not an equity valuation model?

A. Residual income model
B. Dividend discount model
C. Free cash flow to equity model
D. Terminal value model
 Chapter 02
Financial Reporting and Analysis

1. Which would be issued by auditors where there is a history of significant losses

coupled with uncertain prospects?
A. An "except for" qualification
B. An adverse opinion
C. A disclaimer of opinion
D. An audit warning

2. Which of the following would require the filing of Form 8-K?

I. Major acquisition
II. Audited financial statements
III.Bankruptcy
IV. Change in management control
A. I and III
B. II and IV
C. I, III and IV
D. I, II, III and IV

3. Which of the following is not considered part of GAAP?

A. Statements of Financial Accounting Standards (SFAS)
B. International Accounting Standards (IAS)
C. Accounting Research Bulletins (ARB).
D. Accounting Principles Board Opinions (APB).

4. Which of the following is not considered a monitoring mechanism?

A. The Securities and Exchange Commission (SEC)
B. Top level management
C. The board of director's audit committee
D. The external auditors

5. Which of the following statements about directors of a company is true?

A. Directors are elected by management of a company.
B. Directors only get paid if the company increases its profitability that year.
C. Directors are shareholders' representatives.
D. All directors of a company are senior managers in that company.
6. Which of the following statements about accruals and cash flows is true?
A. All cash flows are value relevant.
B. Cash flows cannot be manipulated.
C. Cash flows are more reliable than accruals.
D. All accrual accounting adjustments are value irrelevant.

7. Which of the following statements about accruals and cash flows is false?
A. Company value can be determined by using accrual accounting numbers.
B. Accrual accounting numbers are subject to accounting distortions.
C. Cash flows are more reliable than accruals.
D. Cash flows cannot be manipulated.

8. The two primary qualities of accounting information to make it useful for decision
making are:
A. reliability and comparability.
B. relevance and reliability.
C. materiality and comparability.
D. full disclosure and relevance.

9. Financial accounting data has some inherent limitations. Which of the following are
limitations?
I. Not all economic events are easily quantifiable.
II. Many accounting entries rely heavily on estimates.
III. Historical cost can distort statements.
IV. Inflation can distort accounting data.
A. I, II and III
B. I, III and IV
C. II, III and IV
D. I, II, III and IV

10. Audit risk represents a danger to users of audited financial statements. The
following are attributes pointing to potential areas of vulnerability except
A. company in financial distress requiring financing.
B. management dominated by one or more strong-willed individuals.
C. deterioration in liquidity or solvency.
D. company earning high profits consistently over a number of years.
11. If a company fails to record a material amount of depreciation in a previous year,
this is considered:
A. a change in accounting principle.
B. an unusual item.
C. an accounting error.
D. a change in estimate.

12. Which of the following are examples of judgments made in the accounting
reporting process?
I. Useful life of machinery
II. Allowance for doubtful accounts
III. Obsolescence of assets
IV. Interest payment on bonds
A. I, II, III and IV
B. I, II and III
C. II and III
D. I and III

13. Which of the following would affect the comparability of accounting

information for a given company from one accounting period to the next?
I. Change in accounting principles
II. Disposition of segment of business
III. Restructuring expenses
IV. Change in auditors
A. I and II
B. I and III
C. I, II and III
D. I, III and IV

14. Which of the following would affect the comparison of financial statements across
two different firms?
I. Different accounting principles
II. Different sizes of the companies
III. Different reporting periods
IV. Different industries
A. I, III and IV
B. I and IV
C. I and II
D. I, II, III and IV
  Byfort Company reports the following in its financial statements:

*All sales are on credit.

15. How much did the company collect in cash from debtors during 2006?
A. $445,389K
B. $454,611K
C. $484,289K
D. $488,900K

16. How much sales would have been reported by the company in 2006 if Byfort
would have been using cash accounting and not accrual accounting?
A. $445,389K
B. $454,611K
C. $484,289K
D. $488,900K

17. 10-K reports are:

A. the quarterly reports to stockholders.
B. quarterly filings made by a company with the SEC.
C. annual filings made by a company with SEC.
D. filings made by a company with SEC when a company changes auditors.

18. The management of Finner Company believes that "the statement of cash flows is
not a very useful statement" and does not include it with the company's financial
statements. As a result the auditor's opinion should be:
A. qualified.
B. unqualified.
C. adverse.
D. disclaimed.

19. Which of the following statements is incorrect?

A. Under GAAP, statements are prepared using accrual accounting.
B. Under GAAP, all assets are marked to market each accounting period.
C. Under GAAP, it is necessary to make certain estimates.
D. Annual statements submitted to the SEC (10-K) must be prepared using GAAP.
20. When analyzing financial statements it is important to recognize that accounting
distortions can arise. Accounting distortions are those things that cause deviations in
accounting information from the underlying economics. Which of the following
statements is not correct? Accounting distortions:
A. can arise as management may deliberately manipulate financial statements.
B. arise often through application of (correct) accounting principles.
C. can affect the quality of earnings.
D. arise if the stock market is not efficient.

21. Which of the following is a change in an accounting estimate?

I. A change from straight line depreciation to an accelerated depreciation method.
II. A change in estimated salvage value of depreciable asset.
III. A change in estimated useful life of an asset.
IV. Recording depreciation for the first time on machinery purchased five years ago.
A. I, II, III and IV
B. II, III and IV
C. I, III and IV
D. II and III

22. Which of the following are changes in accounting principle?

I. A change from LIFO to FIFO.
II. A change in estimated salvage value of depreciable asset.
III. A change from an accelerated depreciation method to straight line depreciation.
IV. Recording depreciation for the first time on machinery purchased five years ago.
A. I, II, III and IV
B. I, II and III
C. I, III and IV
D. I and III

23. Which of the following is not a source of industry information?

A. SEC manuals
B. Standard and Poor's
C. Trade journals
D. Robert Morris Associates
24. Which of the following information would not be filed with the SEC by a publicly
traded company?
A. 10-K report
B. Prospectus
C. Proxy statement
D. Tax return

25. Accounting Standards are best described as:

A. the result of a political process among groups with diverse interests.
B. presentation standards mandated by the Securities and Exchange Commission.
C. the state-of-the-art presentation of the science of accounting.
D. measuring the quality of safeguarding assets.

26. The matching principle requires that:

A. revenues earned and expenses incurred in generating those revenues
should be reported in the same income statement.
B. non-operating gains and losses should be netted against each other.
C. a proportion of each dollar collected will be assumed to be a recovery of cost.
D. assets will be matched to the liabilities incurred to purchase them.

27. If a company changes auditors, it is required to file the following with the SEC:
A. 10-K
B. 10-Q
C. 8-K
D. S-1

28. The primary responsibility for fair and accurate financial reporting rests with the:
A. board of directors.
B. SEC.
C. management.
D. auditors.

29. Which of the following is incorrect? When using the 10-Q, the analyst should be
aware that the usefulness of the quarterly financial statements might be affected by:
A. seasonality.
B. adjustments made in the final quarter of the year.
C. the use of cash accounting.
D. the increased use of estimates.
30. Voluntary disclosure by managers is becoming an increasingly important source
of information. Which of the following is least likely to be a reason for this increased
disclosure?
A. Protection under Safe Harbor Rules.
B. To manage investors' expectations.
C. To signal information to investors.
D. To respond to increased demands by labor unions.

31. The two secondary qualities of accounting information to make it useful for
decision making are:
A. consistency and comparability.
B. relevance and reliability.
C. materiality and comparability.
D. full disclosure and relevance.

32. Economic income measures change in:

A. asset value.
B. liability value.
C. shareholder value.
D. net cash flows.

33. Which one of the following is not an example of a red flag, used to evaluate
earnings quality?
A. Qualified audit report
B. Net income this year is higher then net income last year
C. Poor financial performance
D. Frequent or unexplained changes in accounting policies

34. Economic income includes:

A. recurring components only.
B. nonrecurring components only.
C. both recurring and nonrecurring components.
D. neither recurring nor nonrecurring components.

35. For a going concern, company value can be expressed by:

A. dividing permanent income by the cost of capital.
B. multiplying permanent income by the cost of capital.
C. dividing permanent income by the market value per share.
D. multiplying permanent income by the market value per share.
36. Accounting income consists of all the following components except:
A. permanent component.
B. transitory component.
C. value irrelevant component.
D. temporary component.

37. To determine a company's sustainable earning power, an analyst needs to first

determine the recurring component of the current period's accounting income by
excluding nonrecurring components of accounting income. Such adjusted earnings are
often referred to as:
A. core earnings.
B. permanent earnings.
C. basic earnings.
D. operating earnings.

38. SFAS 157 defines fair value as the:

A. market price.
B. exchange price.
C. net asset value.
D. real value.

39. SFAS prescribes that information about the level of inputs used for determining
fair values must be reported in the:
A. balance sheet.
B. director's letter.
C. footnotes.
D. MD&A.

40. All of the following are basic approaches to valuation except:

A. market approach.
B. asset approach.
C. income approach.
D. cost approach.
 Chapter 3

Analyzinf Financing Activities

Multiple Choice Questions

1. The majority of financing for most companies comes from which of the following
sources?
A. Owners and customers
B. Creditors and customers
C. Owners and managers
D. Creditors and
owners D

2. Which of the following would not be found listed as a liability on a

company's balance sheet?
A. Operating lease obligations
B. Capital lease obligations
C. Bonds payable
D. Taxes
payable A

3. Which of the following would be found listed as a liability on a company's

balance sheet?
A. Operating lease obligations
B. Projected benefit obligation
C. Purchase Commitment obligation
D. Postretirement benefits other than pension
obligation D

4. Which of the following is not a criterion for defining a lease as a capital lease?
A. Ownership is transferred by the end of the lease agreement.
B. The lease contains an option to purchase the asset at a bargain price.
C. The present value of the lease payments at the beginning of the lease is 75% or
more than the value of the asset.
D. The lease term is at least 75% of the economic life of the asset.
C

5. Which of the following is true concerning bond covenants?

A. Bond covenants are restrictions placed on bondholders to protect rights of equity
holders.
B. Violation of a bond covenant requires that a company declares bankruptcy.
C. If a company violates a bond covenant, it means it has failed to make interest or
principal repayments on debt in a timely manner.
D. Bond covenants are legal restrictions placed in order to minimize the risk of
default on bonds.
D

6. Recording a long-term lease as an operating lease, as opposed to a capital lease, for

a lesseewill cause the following ratios to be:

A. Option A
B. Option B
C. Option C
D. Option D

7. If a company leases equipment to other companies and records these leases

as operating leases rather than capital leases, its:
I. recorded liabilities will be lower.
II. recorded assets will be higher.
III. total cash flows will be higher.
IV. leverage ratios will be higher.
A. I and III
B. II and IV
C. I only
D. II, III and IV
B

8. If a company that leases equipment from another company records these leases
as operating leases rather than capital leases, its:
I. recorded liabilities will be lower.
II. recorded assets will be higher.
III. total cash flows will be higher.
IV. leverage ratios will be higher.
A. I and III
B. II and IV
C. I only
D. II, III and IV
C

9. Which one of the following statements is false?

A. Short-term obligations may be classified as long term if the company intends to
refinance them on a long-term basis and can demonstrate the ability to do so.
B. Violation of a long-term debt covenant automatically means the company
must reclassify the debt as current.
C. Current liabilities are recorded at their maturity value, and not their present value.
D. If a bond is issued at a discount the effective interest rate is greater than the coupon
rate.
B

10. When considering defined benefit pension plans, which of the following will
not increase the projected benefit obligation (PBO)?
A. A decrease in the discount rate.
B. An increase in estimated compensation growth.
C. An increase in expected average length of lives of employees.
D. A decrease in the expected rate of return on plan
assets. D

11. With respect to pension liabilities, which of the following statements are true?
I. The projected benefit obligation (PBO) is always greater than or equal to the
accumulated benefit obligation (ABO).
II. The vested benefit obligation (VBO) is always as least as or as big as the
accumulated benefit obligation (ABO).
III. If the PBO is greater than the plan assets, the plan is said to be overfunded.
IV. If the weighted-average assumed discount rate is increased, the PBO will decrease.
A. I, III and IV
B. I and III
C. II and IV
D. I and
IV D

12. The difference between the accumulated benefit obligation (ABO) and the
projected benefit obligation (PBO) is:
A. the PBO considers non-vested obligations and the ABO does not.
B. the PBO takes into account the time value of money and the ABO does not.
C. the PBO takes into account future pay increases and the ABO does not.
D. the PBO takes into account mortality rates of employees and the ABO does not.
C

13. Hert Corporation acquired a capital lease that is carried on its books at a present
value of $100,000 (discounted at 12%). Its annual rental payment of $15,000. What is
the amount of interest expense from this lease?

A. A above.
B. B above
C. C above
D. D above

The answer is B: First Year: 100,000 x 12% = $12,000 so $3,000 reduces principal;
Second Year: $97,000 x 12% = $11,640 in interest

14. Which of the following might give rise to off-balance sheet financing?
I. Long-term operating leases
II. Sale of receivables without recourse
III. Through-put agreements
IV. Purchase commitments
A. I, II, III and IV
B. I, II and IV
C. II, III and IV
D. I, III and IV
A

15. Which of the following is an example of off-balance sheet financing?

A. Operating leases
B. Capital leases
C. Issuance of convertible bonds
D. Issuance of common stock
A

16. If a company engages in off-balance sheet financing, generally the effect is:
I. to cause assets to be understated.
II. to increase leverage ratios.
III. to increase cash flows.
IV. to cause liabilities to be understated.
A. I, II, III and IV
B. I, III and IV
C. I and IV
D. IV only
C

17. Minority interest appears on the balance sheet of some companies. Minority
interest:
A. is classified as a liability.
B. is classified as an equity.
C. arises when a company records investments using the equity method.
D. arises when a company owns controlling interest in another company, but less
than 100%.
D

18. A lessee must account for a lease as a capital lease if:

I. lease transfers ownership to lessee at the end of the lease.
II. lease contains option to purchase the asset at the end of the lease at a bargain price.
III. lease is longer than 20 years.
IV. present value of lease is greater than 10% of lessee's assets.
A. I and II
B. I, II and III
C. I, III and IV
D. I, II and IV
A

20. Which of the following statements about stock dividends is true?

A. Stock dividends increase the number of shares outstanding.
B. Stock dividends are more valuable than stock splits.
C. Stock dividends are recorded as a reduction in cash.
D. Stock dividends are dividends given in the form of stock from another
company. A

21. Treasury stock is:

A. investments in government securities.
B. retained earnings that have been appropriated to make equity investments.
C. a company's own stock that it has repurchased.
D. assets held for safekeeping in company's vaults.
C

 Reling Company reports the following information as of 12/31/05

22.The book value per share of common stock is:
A. $12.20
B. $12.40
C. $15.25
D. $15.50

23.The book value per share of preferred stock is:

A. $ 22
B. $ 20
C. $ 11
D. $ 10

24. Which of the following statements concerning contingencies is correct?

I. Gain contingencies are recorded if they are probable and reasonably estimable.
II. Unredeemed frequent flyer mileage is an example of a loss contingency.
III. A loss contingency is a form of off-balance sheet financing.
IV. Loss contingencies are not recognized unless there is a greater than 95% chance
they will be realized.
A. I, II, III and IV
B. II, III, and IV
C. II and III
D. II only
D

25. Many of the postretirement health benefit plans offered by companies to their
employees are unfunded, while all of their pension plans have some degree of funding.
Which of the following statements is false?
A. There is no legal requirement to fund postretirement health benefits, but there are
legal requirements covering pension funding.
B. Contributions to pension plans are normally tax deductible, but contributions to
postretirement health plans are not tax deductible.
C. Funds contributed to a pension plan can be withdrawn at any time, but
funds contributed to a postretirement health plan cannot be withdrawn by law.
D. Taxes do not have to be paid on investment income earned by assets in pension
plan, but they do normally have to be paid on postretirement health plans.
C

26. One way for a company to increase its book value per share is to:
A. issue long-term debt.
B. retire long-term debt.
C. increase dividend payout ratio.
D. buy back shares at market prices below their book value.
D

27. A company's current ratio is 1.5. If the company uses cash to retire notes payable
due within one year, would this transaction increase or decrease the current ratio and
return on assets ratio?
A. Current Ratio: Increase; Return on Assets: Increase
B. Current Ratio: Increase; Return on Assets: Decrease
C. Current Ratio: Decrease; Return on Assets: Increase
D. Current Ratio: Decrease; Return on Assets: Decrease
A

28. An analyst should consider whether a company acquired assets through a capital
lease or an operating lease because a company may structure:
A. leases to be treated like capital leases to enhance its leverage ratios.
B. leases to be treated like capital leases to enhance its cash flow.
C. leases to be treated like operating leases to enhance its leverage ratios.
D. leases to be treated like operating leases to enhance its cash flow.
C

29. Which of the following lease provisions would cause a lease to be classified as an
operating lease?
A. The lease contains a bargain purchase option.
B. The collectibility of lease payments by the lessor is unpredictable.
C. The term of the lease is more than 75 percent of the estimated economic life of the
leased property.
D. The present value of the minimum lease payments equals or exceeds 90 percent of
the fair value of the leased property.
B
30. On January 1, a company entered into a capital lease resulting in an obligation of
$20,000 being recorded on the balance sheet. The lessor's implicit interest was 10
percent. At the end of the first year of the lease, the cash flow from financing activities
section of the lessee's statement of cash flows showed a use of cash of $2,200
applicable to the lease. How much did the company pay the lessor in the first year of
the lease?
A. $2,000
B. $2,200
C. $4,200
D. $20,000

31. Which of the following is not a component of recognized OPEB cost?

A. Service cost
B. Amortization of prior service costs
C. Interest cost
D. Amortization of prior interest costs
D

32. Which of the following is reported in the equity section of the balance sheet?
A. Redeemable Preferred stock
B. Treasury stock
C. Investment in affiliates
D. Debentures
B

33. Which of the following is not a component of pension expense?

A. Service cost
B. Interest cost
C. Actual return on plan assets
D. Expected return on plan assets
C

34. If a company increases its expected return on plan assets this year, the effect would
be to:
I. increase plan assets.
II. decrease PBO.
III. decrease pension expense.
IV. decrease minimum liability.
A. I, II and IV
B. I and IV
C. III and IV
D. III only
D

 Harms Inc. reported in its 2006 annual report the following information

35. Funded status at the end of 2006 was:

A. $15M.
B. $12M.
C. $10M.
D. $0M.

36. If Harms had decreased its compensation growth rate to 4.5% in 2006, the effect
would
have been:
A. an increased ABO.
B. an increased PBO.
C. a decreased ABO.
D. a decreased PBO.

37. The estimated interest cost for 2007 is:

A. 7.95M.
B. 7.60M.
C. 7.36M.
D. 7.20M

38. Synthetic leases may achieve all of the following benefits to the borrower except:
A. window dress the balance sheet.
 B. increase cash flow.
C. reduce tax expense on the income statement.
D. increase net income.

39. The plan is said to be underfunded, if:

A. the pension obligation is more than the asset value.
B. the pension obligation is less than the asset value.
C. the pension obligation is equal to the asset value.
D. none of the above.

40. Which of the following is not an actuarial assumption underlying the computation
of the pension obligation?
A. Employee turnover
B. Life expectancy
C. Interest rate
D. Service cost

41. Pension intensity can be measured by expressing the pension plan assets and the
pension obligation separately as:
A. a percentage of company's total liabilities.
B. a percentage of company's total assets.
C. a percentage of company's net income.
D. a percentage of company's shareholders' equity.

42. The net deferrals are included in the balance sheet as part of:
A. assets.
B. current liabilities.
C. shareholders' equity.
D. long-term liabilities

Chapter 04
Analyzing Investing Activities

Multiple Choice Questions

 
1. Which of the following would rarely be classified as a current asset? 
A. Prepaid insurance
B. Goodwill
C. Marketable Securities
D. Work-in-progress

2. Which of the following would not be classified as a current asset? 

A. Inventory
B. Accounts payable
C. Accounts receivable
D. Prepaid expenses

3. An asset is considered to be liquid if: 

A. it is readily converted into a current asset.
B. it is an intangible asset.
C. it is readily converted into cash.
D. it is part of retained earnings.

4. Analysis of a company's assets will help evaluate its:

I. liquidity.
II. solvency.
III. operational capacity.
IV financing ability. 
A. I, II, III and IV
B. 1, II and IV
C. II, III and IV
D. I, II and III

 
5. For Control Furniture Co.,
LIFO Reserve in Year 2006 $91 million
LIFO Reserve in Year 2005$82 million
Tax Rate is 35%.
To restate Year 2006 LIFO inventories to a FIFO basis, we use the following analytical entry:

 
A. Option A
B. Option B
C. Option C
D. Option D

 
 The following information can be found in ABC Co.'s financial statements.

Assume a tax rate of 35%. Inventories valued using the LIFO method represented approximately 80% of
consolidated inventories.

6. What will be the value of inventory for 2006 if ABC used FIFO valuation? 
A. 633,485
B. 570,430
C. 633,381
D. 488,581

7. What will be the retained earnings for 2006 if ABC used FIFO valuation? 
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430

 
8. What will be the retained earnings for 2005 if ABC used FIFO valuation? 
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430

9. The use of LIFO rather than FIFO for inventory costing under normal economic conditions results in:
I. lower net income.
II. higher total assets.
III. gher retained earnings.
IV. unchanged retained earnings. 
A. II and III
B. I, II and IV
C. I only
D. I and IV

10. Which of the following is not a common characteristic of a company choosing to use LIFO rather
than FIFO? 
A. Larger inventory balances
B. Higher variability in inventory balances
C. Greater expected tax savings
D. Larger in size

11. Financial Statements of ABC Corp. indicates that ending inventory levels in 2005 and 2006 were
$200,000 and $350,000 respectively. Cost of Goods sold for 2005 and 2006 were $1,900,000 and
$2,200,000 respectively. Purchases in 2006 were: 
A. $1,950,000
B. $2,150,000
C. $2,350,000
D. $1,850,000

 
12. The inventory costing method used by a company (LIFO, FIFO, etc.) will affect:

 
A. Option A
B. Option B
C. Option C
D. Option D

13. Which of the following steps are required to adjust LIFO to FIFO? 

A. Inventory needs to be calculated as reported LIFO inventory plus LIFO reserve.
B. Increase deferred tax payable by LIFO reserve times Tax rate.
C. Retained earnings need to be calculated as reported retained earnings plus LIFO reserve times (1 –
Tax rate).
D. All of the above.

14. One advantage of LIFO over FIFO under normal conditions is that: 

A. it reports higher retained earnings.
B. it results in higher cash flows.
C. it results in higher current ratios.
D. it results in higher gross margins.

15. Which of the following is not an effect of capitalization? 

A. Capitalization usually reduces net income.
B. Capitalization usually yields a smoother net income.
C. Capitalization usually decreases the volatility of the return on investment.
D. Capitalization usually increases net income.

 
16. Companies are supposed to write-down value of assets if a permanent impairment of value or loss of
utility occurs. If a company writes down its assets this year the effect on:

 
A. Option A
B. Option B
C. Option C
D. Option D

17. A write-down in asset value is: 

A. a very rare occurrence.
B. not allowed under GAAP.
C. results in a direct debit to stockholders' equity.
D. required if an asset is deemed to have permanent impairment of value.

18. Which of the following is not considered an intangible asset? 

A. Goodwill
B. Customer lists
C. Prepaid advertising expenses
D. Memberships

19. Target Inc. has 30M shares outstanding and trades at $50 per share. Target has net identifiable assets
with a book value of $1,000M and a fair value of $1,200M. Acquirer Corporation purchases all of Target
Inc. stock for $60 per share. How much will Acquirer record as goodwill upon acquiring Target? 
A. 300M
B. 500M
C. 600M
D. 800M

 
20. Which of the following is incorrect with respect to recognized goodwill on the balance sheet? 
A. It should not be amortized over 30 years.
B. It arises when another company is purchased or when internally generated.
C. It should be written-down if the future benefits no longer exist.
D. It may be negative.

21. Under current US GAAP, goodwill is:

I. amortized over a period not to exceed 40 years.
II. tested annually for impairment.
III. exclusive of separately identifiable intangible assets.
IV. recorded only upon purchase of another entity. 
A. I, II, III and IV
B. II, III and IV
C. I, II and III
D. II and IV

 The following information can be found in Manufacturer Company's financial statements.

22. If Manufacturer used FIFO its retained earnings as of the end of fiscal 2006 would be: 
A. $ 540,000
B. $ 440,000
C. $ 524,000
D. $ 506,000

 
23. If Manufacturer used FIFO its Net Income for fiscal 2006 would be: 
A. $ 165,000
B. $ 149,000
C. $ 135,000
D. $ 131,000

24. Look Good Corporation has current assets of $1.1M and current liabilities of $1M. It is close to year-
end and it would like to increase its current ratio. Which of the following will achieve this? 
A. Encourage customers to pay their bills more quickly.
B. Increase short-term borrowings by $0.1M.
C. Sold building for $0.2M in cash.
D. Liquidate some of its trading marketable securities.

25. LIFO liquidation occurs when: 

A. a firm changes from LIFO to another inventory method.
B. a firm experiences an increase in cost of raw materials.
C. the LIFO reserves decline in value.
D. the quantity of goods sold is greater than the quantity produced.

26. If a LIFO liquidation occurs during a period of rising prices, which of the following statements about
the effects on a firm's financial statements, all other things equal, is generally true?
I. Cost of goods sold increases.
II. Gross profit margin increases.
III. Taxes decrease.
IV. Net income increases. 
A. I only
B. II only
C. I and III only
D. II and IV only

 
27. Which of the following statements about inventories is true? 
A. U.S. generally accepted accounting principles (GAAP) require the use of lower-of-cost or market-
valuation basis for inventories.
B. Last-in, last-out (LIFO) inventory accounting makes management of income more difficult than first-
in, first-out (FIFO) accounting.
C. During inflation, LIFO inventory accounting tends to overstate the current ratio.
D. FIFO inventory balances generally contain old and outdated costs that have little or no relationship to
current costs.

28. A firm has a current ratio greater than 1.0. If the firm's ending inventory is understated by $3,000 and
beginning inventory is overstated by $5,000, the firm's net income (before taxes) and current ratio will
be:

 
A. Option A
B. Option B
C. Option C
D. Option D

29. A Corporation wants to increase its current ratio from its present level of 1.2 before it ends the fiscal
year. The action having the desired effect is: 
A. delaying the next payroll.
B. writing down impaired assets.
C. selling furniture for cash.
D. selling current marketable securities at cash for their book value.

 
30. A firm has a current ratio greater than 1.0. During the course of the year the firm sells $60M of
accounts receivable with limited recourse. If it had not sold the receivables it would have to have taken
out a short-term loan. The effect of selling the receivables is:

 
A. Option A
B. Option B
C. Option C
D. Option D

31. Depreciation is based on the principle of: 

A. allocation.
B. appropriation.
C. estimation.
D. approbation.

32. Which of the following is not an analysis issue arising with impairment? 

A. Evaluating the appropriateness of the amount of the impairment.
B. Evaluating the appropriateness of the timing of the impairment.
C. Analyzing the effect of the impairment on asset.
D. Analyzing the effect of the impairment on income.

 Below is selected information taken from the balance sheet of Huy Corporation as of 12/31/06.

 
33. The average depreciable life of Huy's depreciable assets as of 2006 is: 
A. 2 years
B. 7 years
C. 14 years
D. 34 years

34. The average age of Huy's depreciable assets as of 2006 is: 

A. 2 years
B. 7 years
C. 14 years
D. 34 years

35. During fiscal 2006, Huy sold fully depreciated assets that originally cost $20,000 for $4,000. In 2006,
they purchased assets that cost: 
A. $5,000
B. $6,000
C. $10,000
D. $30,000

36. Goodwill is: 
A. the excess of the purchase price of net assets over the book value of net assets.
B. the excess of the appraised value of net assets over the book value of net assets.
C. the excess of the purchase price of net assets over the fair value of net assets.
D. the excess of the appraised value of net assets over the fair value of net assets.

37. With respect to LIFO, which of the following is incorrect? 

A. If a company uses LIFO for tax purposes it must use it for GAAP purposes.
B. If the LIFO reserve increases in a given year, the LIFO COGS is higher than it would have been if
FIFO had been used for that year.
C. LIFO results in better matching on the income statement than FIFO.
D. LIFO results in inventory levels on the balance sheet that are closer to current cost than FIFO.

 
38. Securitization through the use of a properly structured SPE may result in the following benefits to the
company:
I. Remove receivables from the balance sheet.
II. Remove debt from the balance sheet.
III. Lower financing costs.
IV. Recognize gains on the sale of assets to the SPE. 
A. I, II, III and IV
B. I, II and III
C. I and IV
D. II and III