Endgame

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
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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 unqualified 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.
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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
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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.
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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 A. Total asset turnover
B. Current ratio B. Acid-test Ratio
C. Days to collect receivables C. Days to collect receivables
D. Current Ratio
D. Days goodwill held
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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%
D. 6.86%
18. What is Dell's profit margin for 2006?

A. 6.27%
B. 6.18%
C. 6.38%
D. 6.86%
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19. What is Dell's P/E ratio for 2006?
A. 27.63
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
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
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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
B. $20,000
C. $151,000
D. $207,000
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24. Owner's Equity for 2006 is:
A. $20,000
B. $154,000
C. $174,000
D. $207,000
25. Current Ratio for 2005 is:

A. 1.55
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%
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
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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.

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
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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
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
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
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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.
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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%

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.
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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
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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
True / False Questions
48. Financial statement analysis is an exact science.

FALSE
49. Theoretically the value of a stock should equal the sum of the present value of
future expected dividends, discounted at the cost of equity.
TRUE
50. The value of a bond is equal to the sum of the present value of future expected interest and
principal payments, discounted at the coupon rate.
FALSE
51. Details of compensation paid to officers and directors can be found in proxy statement.
TRUE
52. The statement of cash flows is separated into four parts: operating, investing, financing
and planning.
FALSE
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53. The SEC requires that Management Discussion and Analysis found in the annual
report (10K) contains, among other things, a discussion about the company's liquidity,
capital resources and results of operations.
TRUE
54. The explanatory notes (footnotes) accompanying the financial statements are generally of
little value in aiding the financial analyst when interpreting the financial statements.
FALSE
55. Two popular techniques of comparative analysis are year-to-year change analysis
and index-number trend analysis.
TRUE
56. Common size statements are useful for inter-company comparisons.

TRUE
57. In a common size balance sheet total assets are expressed as 100 percent.
TRUE
58. In a common size income statement net income is expressed as 100 percent.
FALSE
59. Inventory turnover is generally a more important ratio for a manufacturing firm than a
service firm.
TRUE
60. If a company has no liabilities its return on equity will equal its return on assets.
TRUE
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61. The current ratio will always be greater than or equal to the acid test ratio.
TRUE
62. The current ratio is used to evaluate the company's operating performance.
FALSE
63. When calculating the return on assets you should use average total assets.
TRUE
64. Debt-to-equity ratio is a commonly used measure of liquidity.

FALSE
65. Earnings Yield is the reciprocal of the price/earnings ratio.

TRUE
66. Dividend yield is defined as dividends divided by shareholders' equity.

FALSE
67. A bank with a loan to a company is generally exposed to greater risk than the
shareholders of the company.
FALSE
68. When comparing two companies the company with the highest net income should
normally have the highest stock price.
FALSE
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69. All other things being equal, the lower a company's cost of equity the higher its
stock price should be.
TRUE
70. A creditor's risk is said to be asymmetric because the downside is limited to the
required interest payments.
TRUE
71. The income statement is the only one of the four basic financial statements that does not
contain balances at a specific point in time.
FALSE
72. A capital-intensive company requires high cash turnover.

FALSE
73. A security can be under or overvalued, depending on the extent of an incorrect

interpretation or faulty evaluation of available information by the aggregate
market. TRUE
74. Prospective analysis is the forecasting of future payoffs—typically earnings and

cash flows, or both.
TRUE
Essay Questions
1-18
TEST BANK FOR FINANCIAL
STATEMENT ANALYSIS 11TH
EDITION BY SUBRAMANYAM
Link download full: https://digitalcontentmarket.org/download/test-bank-for-
financial-statement-analysis-11th-edition-by-subramanyam
Chapter 02 Financial Reporting and Analysis

1. 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

A. Statements of Financial Accounting Standards (SFAS)
B. International Accounting Standards (IAS)
C. International Financial Reporting Standards (IFRS)
D. Internal Revenue Services (IRS)
3. 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
4. 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.

A. Accrual income is less relevant than cash flow.
B. Accruals cannot be manipulated.
C. Accruals are less reliable than cash flows.
D. All accrual accounting adjustments are value irrelevant.
6. Which of the following statements about cash flows is true?
A. All cash flows are value relevant.
B. Only current cash flows are relevant for valuation.
C. Cash flows are less reliable than accruals.
D. Cash flows can be manipulated.

7. Relevance, one of the desirable qualities of accounting information,
implies:
A. the capacity of information should be based on five-year average

historical data.
B. the capacity of information to affect a decision.
C. the capacity of information should be based on market expectations.
D. that all companies should use same valuation methods such as LIFO
and FIFO.
8. Financial accounting data has some inherent limitations to

investors. Which of the following is a limitation?
I. Not all economic events are easily quantifiable.

II. Many accounting entries rely heavily on estimates.
III. Historical costs do not accurately reflect the true value of firms.
IV. Inflation can distort analysis of accounting data.
A. I, II and III
B. I, III, and IV
C. II, III, and IV

9. 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. anaccounting error.
D. a change in estimate.
10. Which of the following is an example 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
11. 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
12. 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

Byfort Company reports the following in its financial statements:
*All sales are on credit.
13. How much did the company collect in cash from customers during 2006?
A. $445,389
B. $454,611
C. $484,289
D. $488,900
14. How much sales would have been reported by the company in 2006 if
Byfort used cash accounting and not accrual accounting?
A. $445,389
B. $454,611
C. $484,289
D. $488,900
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

its auditors.
16. 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. clean.
D. disclaimed.
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.
18. 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?
A. Accounting distortions can arise as management may

deliberately manipulate financial statements.
B. Accounting distortions arise often through application of (correct)

accounting principles.
C. Accounting distortions can affect the quality of earnings.
D. Accounting distortions arise if the stock market is not efficient.

I. A change from straight-line depreciation to declining balance 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
B. II, III, and IV
C. I, III, and IV
D. II and III
20. Which of the following is a change 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
B. I, II, and III
C. I, III, and IV
D. I and III
A. Cash budget
B. Standard and Poor's
C. Trade journals
D. Value line
22. 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
23. Accounting standards are:
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. standards measuring the quality of safeguarding assets.

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.
25. Which of the following is required to be filed with the SEC, if a

company changes its auditors?
A. 10-K
B. 10-Q
C. 8-K
D. S-1
26. The primary responsibility for fair and accurate financial reporting rests
with the:
A. shareholders.
B. SEC.
C. management.
D. auditors.
27. 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. theincreased use of estimates.

28. 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 communicate information to investors
D. To respond to increased demands by labor unions
29. are secondary qualities of accounting information that make it

useful for decision making.
A. Consistency and comparability
B. Relevance and reliability
C. Materiality and comparability
D. Full disclosure and relevance

A. asset value.
B. liability value.
C. shareholder value.
D. net cash flows.
31. Which one of the following is not an example of a red flag to one should
be aware of when evaluating earnings quality?
A. Qualified audit report
B. Net income this year is higher than net income from last year
C. Reported earnings consistently higher than operating cash flows
D. Frequent or unexplained changes in accounting policies
32. Economic income includes:
A. recurring components only.
B. nonrecurring components only.
C. both recurring and nonrecurring components.
D. neither recurring nor nonrecurring components.

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.
34. Accounting income consists of all the following components except:
A. permanent component.
B. transitorycomponent.
C. value irrelevant component.
D. realized component.
35. 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. transitory earnings.
C. basic earnings.
D. operating earnings.
36. SFAS 157 defines fair value as the:
A. entry price.
B. exchange price.
C. net asset value.
D. real value.
37. 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.
38. All of the following are basic approaches to valuation except:
A. market approach.
B. book value approach.
C. income approach.
D. cost approach.
39. GAAP stands for General American Accounting Principles, and must be
adhered to by publicly traded companies when preparing their financial
statements.
FALSE
40. FASB stands for Financial Accounting Service Bureau, and is a sub-
division of the Securities and Exchange Commission (SEC).
FALSE
41. Under GAAP accounting, a company has the choice of using cash
or accrual accounting in preparing its financial statements.
FALSE
42. Under cash accounting, a company must recognize revenues in

financial statements when the revenues are earned or realized.
FALSE
43. Under accrual accounting, a company will recognize expenses as they

are paid.
FALSE
44. Accrual income is a better predictor of future cash flows than current
cash flows.
TRUE
45. External auditors provide "reasonable", as opposed to "absolute" assurance

that the financial statements provide no material misstatement.
TRUE
46. Net income is usually higher than free cash flows.
TRUE
47. By using earnings management, managers always try to increase income.
FALSE
48. Income smoothing is a form of earnings management.
TRUE
49. Income shifting is not one of the earnings management mechanics.
FALSE
50. The development of the financial statements is management's

responsibility, and the auditor is not concerned with the process of
development.
FALSE
51. Accounting information is "material" if its omission would cause a

reasonable person to make a different decision if the information
was included.
TRUE
52. Accounting distortions arise from the nature of accrual accounting.
TRUE
53. Primary responsibility for fair and accurate financial statements rests with
the auditors.
FALSE
54. Audits are designed and implemented with the objective of
detecting fraud.
FALSE
55. Accounting standards issued by the SEC are applicable to all

US companies being audited.
FALSE
56. The "big bath" strategy is often used in conjunction with an income-
increasing strategy for other years.
TRUE
57. Accounting standards are set by the American Institute of Certified

Public Accountants (AICPA).
FALSE
58. The Securities and Exchange Commission (SEC) has the power to issue
accounting standards, but generally defers this responsibility to the
Financial Accounting Standards Board (FASB).
TRUE
59. Accrual accounting overcomes both the timing and the matching
problems that are inherent in cash accounting.
TRUE
60. FASB has recognized the conceptual superiority of the historical value
concept and has, in principle, decided to eventually move to a model
where all asset and liability values are recorded at fair value.
FALSE
61. Accounting or reported income is same as economic income.
FALSE
62. Operating income is often referred to as net operating profit before tax.
FALSE
63. Accounting income attempts to capture elements of both

permanent income and economic income, but with measurement
error.
TRUE
64. Operating earnings includes all revenue and expense components that
pertain to the company's operating business, regardless of whether they
are recurring or nonrecurring.
TRUE
65. Under the fair value model, income is determined by matching costs
to recognized revenues, which have to be realized and earned.
FALSE
66. The fair value of an asset is the hypothetical price at which a business
can sell the asset (exit price).
TRUE
Chapter 03
Analyzing Financing Activities
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
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
3. Which of the following would be found listed as a liability on a company's balance sheet?
B. Projected benefit obligation
C. Purchase Commitment obligation
D. Postretirement benefits other than pension obligation
E. Other postretirement employee benefits
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.
3-1
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.
6. Recording a long-term lease as an operating lease, as opposed to a capital lease, for a

lessee will 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
3-2
8. If a company that leases equipment from another company records these leases as
operating leases rather than capital leases, its:
A. I and III
B. II and IV
C. I only
D. II, III and IV
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.
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.
3-3
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
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.
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 is $15,000. What is the amount of
interest expense from this lease?
A. Option A
B. Option B
C. Option C
D. Option D
3-4
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
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
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.
B. I, III and IV
C. I and IV
D. IV only
E. I only
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%.
3-5
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
19. Dylan Corporation issues a zero-coupon bond with $100,000 face value, with a 5-year
maturity, and the market rate is 7%. Interest on corporate bonds is normally paid
semiannually. In the liability section of Dylan's balance sheet, the proceeds from selling
the zero-coupon immediately after issuance will be closest to:
A. $70,892.
B. $71,299.
C. $70,000.
D. $100,000.
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.
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.
3-6
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.
B. II, III, and IV
C. II and III
D. II only
3-7
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.
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.
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
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.
E. leases to be treated like operating leases to lower its debt to equity ratio
3-8
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.
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
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
3-9
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
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
Harms Inc. reported in its 2006 annual report the following information:
3-10
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.
3-11
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.
43. Current liabilities should always be expected to be liquidated within one year.
FALSE
44. A company will record a contingent gain if the gain is probable and reasonably estimable.
FALSE
45. Creditors of a business are more concerned with the future cash flows of a business than
the future return on equity.
TRUE
3-12
46. Evaluating risk of long-term creditors (e.g. bondholders) involves more detail
than evaluating the risk of equity holders.
FALSE
47. Investing in equity is considered to be more risky than investing in bonds.

TRUE
48. Stockholders are the residual claimants of a company.

TRUE
49. A company issues a $100,000K 9% bond and receives $99,000K (ignoring transaction
costs). This implies that the effective interest rate is less than 9%.
FALSE
50. If the lease term is 75% or more of the economic life of the asset, the lease needs to
be classified as a capital lease.
TRUE
51. Operating leases can inflate both return on investment and asset turnover ratios.
TRUE
52. A convertible bond is an equity investment, which is convertible into bonds at the option
of the owner of the convertible bond.
FALSE
53. If a company increases the amount of debt it has, all other things being equal, the risk to
the shareholders increases.
TRUE
3-13
54. A company which leases a piece of machinery (the lessee) will record it as a sales-type
lease if the lessor makes a profit on the lease.
FALSE
55. With a defined contribution plan the risk of pension fund performance rests with the
employees/retirees of the company, while with a defined benefit plan this risk rests with
the company.
TRUE
56. Many postretirement benefits other than pensions are not funded, in part because they are
not required to be funded by law, unlike pension plans.
TRUE
57. Three elements of pension expense for defined benefit plans are: service cost, interest
cost and actual return on plan assets.
FALSE
58. Pension accounting for defined benefit plans requires that retroactive adjustments to the
plan (prior service costs) be recognized immediately in full in the pension expense.
FALSE
59. If a company increases its expected rate of compensation increase for the purposes
of calculating its pension obligations, the accumulated benefit obligation and the
projected benefit obligation will both increase.
FALSE
60. If a company increases its discount rate for the purposes of calculating its pension
obligations, the accumulated benefit obligation and the projected benefit obligation will both
decrease.
TRUE
3-14
61. One reason many companies do not fund their post-retirement obligations other than
pensions is because they are not required to do so by law.
TRUE
62. When analyzing post retirement benefits, one should evaluate the actuarial assumptions
and their effects on the financial statements.
TRUE
63. Actuarial gain or loss is the change in PBO that occurs when one or more actuarial
assumptions are revised in estimating PBO.
TRUE
64. Companies must report the economic pension cost in their financial statements.
FALSE
65. A decrease in the growth rate of the future compensation will cause an increase in pension
cost.
FALSE
66. For a company to report a contingent loss it should be either probable or reasonably
estimable.
FALSE
67. Funding of pension plans is required by GAAP.

FALSE
68. If a company issues new stock, this will always decrease book value per share.
FALSE
3-15
69. The par value of common stock represents the price at which the company offered its
stock to investors when it made its initial public offering.
FALSE
70. An analyst should treat preferred stock on a firm's balance sheet as debt when
calculating leverage ratios if the preferred stock is convertible into common stock.
FALSE
71. Following recent SPE abuses, a new rule requiring a minimum of 3% external
financing was enacted.
FALSE
72. An SPE investor may secure its investment with a guarantee so that the SPE remains
unconsolidated.
FALSE
73. An increase in the pension obligation because of passage of time is referred to as

the interest cost.
TRUE
74. Companies report the funded status of pension plans as a separate line item on the balance
sheet.
FALSE
75. Pension risk arises to the extent to which plan assets have a different risk profile than the
pension obligation.
TRUE
3-16
1. B 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. B 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. C 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. D 4. Analysis of a company's assets will help evaluate its:
I. liquidity.
II. solvency.
III. operational capacity.
IV financing ability.
B. 1, II and IV
C. II, III and IV
D. I, II and III
5. C 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:
Inventories 91
A) Deferred Tax Payable 31.85
Retained Earnings 59.15
B) ... 35.65
... 55.35
C) ... 38.96
... 52.04
D) ... 32.85
... 58.15
A. Option A
B. Option B
C. Option C
D. Option D
6. C The following information can be found in ABC Co.'s

financial statements.
2006 2005
Finished Goods $251,690 $195,360
Work in progress 245,123 17,377

and purchased part
Raw Materials 136,568 106,789
633,381 488,581
Less Excess of current 62,591 71,186

cost over stated LIFO
value
570,430 417,395
Retained earnings 3,526,000 3,159,000
Assume a tax rate of 35%. Inventories valued using the

LIFO method represented approximately 80% of consoli-
dated 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. B The following information can be found in ABC Co.'s
2006 2005

and purchased part
633,381 488,581

value
570,430 417,395

dated inventories.
7. What will be the retained earnings for 2006 if ABC
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430
8. A The following information can be found in ABC Co.'s
2006 2005

and purchased part
633,381 488,581

value
570,430 417,395

dated inventories.
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430
9. C 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. B 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. C 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. A 12. The inventory costing method used by a
company (LIFO, FIFO, etc.) will affect:
Asset TurnOver Debt/Equity Ratio
A) Yes Yes
B) Yes No
C) No No
D) No Yes
A. Option A
B. Option B
C. Option C
D. Option D
13. 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. B 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. A 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. D 16. Companies are supposed to write-down value of as-
sets if a permanent impairment of value or loss of utility
occurs. If a company writes down its assets this year
the effect on:
This year ROA's Next Year ROA's
A) Increased No changed
B) Decreased No changed
C) Decreased Decreased
D) Decreased Increased
A. Option A
B. Option B
C. Option C
D. Option D
17. 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. C 18. Which of the following is not considered an
intangible asset?
A. Goodwill
B. Customer lists
C. Prepaid advertising expenses
D. Memberships
19. C 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. B 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. B 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.
B. II, III and IV
C. I, II and III
D. II and IV
22. C The following information can be found in
Manufacturer Company's financial statements.
2006 2005
COGS $2,500,000 $2,000,000
Inventory 180,000 140,000
Net Income 125,000 100,000
Retained Earnings 500,000 400,000
LIFO Reverse 40,000 30,000
Tax Rate 40% 40%
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. D The following information can be found in
2006 2005
COGS $2,500,000 $2,000,000
Inventory 180,000 140,000
Net Income 125,000 100,000
Tax Rate 40% 40%
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. C 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. D 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. D 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. A 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. C 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.
29. C 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:
Net Income Current Ratio
A) understated by $2,000 too low
B) overstated by $2,000 too low
C) understated by $8,000 too low
D) understated by $8,000 too hig
A. Option A
B. Option B
C. Option C
D. Option D
30. A 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:
Accounts Receivable Turnover Current Ratio
A) higher lower
B) higher higher
C) lower lower
D) lower higher
A. Option A
B. Option B
C. Option C
D. Option D
31. A 31. Depreciation is based on the principle of:

A. allocation.
B. appropriation.
C. estimation.
D. approbation.
32. C 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.
33. C Below is selected information taken from the balance

sheet of Huy Corporation as of 12/31/06.
12/31/05 12/31/06
Land $100,000 $100,000
Machines $80,000 $70,000
Gross P,P&E $180,000
$170,000
Accumulated depreciation $25,000 $10,000
Net P,P&E $155,000 $160,000
Depreciation expense $5,000
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. A 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
12/31/05 12/31/06
Land $100,000 $100,000
Machines $80,000 $70,000
$170,000
Net P,P&E $155,000 $160,000
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. C 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
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
37. D 37. With respect to LIFO, which of the following is incor-

rect?
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 state-
ment than FIFO.
D. LIFO results in inventory levels on the balance sheet
that are closer to current cost than FIFO.
38. A 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.
B. I, II and III
C. I and IV
D. II and III
Chapter 06
Analyzing Operating Activities
1. Which of the following is not a reason for economic income and accounting income to differ?
A. Transaction basis
B. The monetary assumption
C. Conservatism
D. Earnings management
2. As a general rule, revenue is normally recognized when it is:

A. measurable and earned.
B. measurable and received.
C. realizable and earned.
D. realizable.
3. Which of the following measures of accounting income is typically reported in an

income statement?
A. Net income
B. Comprehensive income
C. Continuing income
D. All of the above
4. According to FASB, initial franchise fees should be recognized as income when:

A. the franchiser has substantially performed or satisfied all material services and conditions.
B. the franchiser has collected the majority of fee in cash.
C. the franchisee shows the ability to pay the fee.
D. the franchiser bills the franchisee.
Brierton Company enters a contract at the beginning of year 1 to build a new federal courthouse
for a price of $16 million. Brierton estimates that total cost of the project will be $12 million, and
will take four years to complete.
5. If Brierton used percentage-of-completion method to account for this project, what would
they have reported as profit in year 2?
A. $ 0
B. $ 1.333M
C. $ 1.5M
D. $ 0.667M
6. If Brierton used cash accounting to account for this project, what would they have reported as
profit (loss) in year 2?
A. $ 0
B. $ 1.333M
C. $ (2M)
D. $ (4M)
7. Hurik Company reports the following
Based upon this information which of the following is most correct:

A. Cost of goods sold is a permanent cost.
B. Cost of goods sold is an economic cost.
C. Cost of goods sold is a totally variable cost.
D. Cost of goods sold is a period expense.
8. Which of the following combinations of accounting practices will lead to the highest reported
earnings in an inflationary environment?
A. Choice A
B. Choice B
C. Choice C
D. Choice D
9. Which of the following are correct?
I. If a company uses straight-line depreciation for financial reporting purposes, it is very likely
they have a deferred tax liability with respect to its depreciable assets.
II. Straight line depreciation yields an increasing rate of return on book value over the life of
asset.
III. Straight line depreciation results in lower tax payments than accelerated
depreciation methods over the life of an asset.
IV. If a company revises its estimate of the useful life of an asset upwards this will
decrease annual depreciation expense.
B. I, II and IV
C. I, II and III
D. I and IV
10. Which of the following statements concerning deferred taxes is correct?

A. Deferred taxes will not be found in asset section of the balance sheet.
B. Deferred taxes arise from permanent differences in GAAP and tax accounting.
C. Deferred taxes will only decrease when a cash payment is made.
D. Deferred taxes arising from the depreciation of a specific asset will ultimately reduce to
zero as the item is depreciated.
11. Differences in taxable income and pretax accounting income that will not be offset
by corresponding differences or "turn around" in future periods are called:
A. timing differences.
B. circular differences.
C. permanent differences.
D. reverse differences.
The following information was extracted from Smurm Corporation's 2006 annual report:
12. Basic earnings per share for 2006 was:

A. $3.50
B. $3.16
C. $3.08
D. $3.00
13. Using the treasury stock method, the options would result in how many extra shares
being recognized in the diluted EPS calculation:
A. 500,000
B. 358,975
C. 333,333
D. 285,714
14. Diluted earnings per share for 2006 was:
A. $3.52
B. $1.77 $3.07
C. $2.00
D. $2.03
Tecktroniks Company reported in its annual report software refinement expenses of $12M, 15M
and 18M for fiscal years 2005, 2006 and 2007, respectively. At the end of fiscal 2007, it had
total assets of 140M. Net income was 20M for fiscal 2007, and it had a marginal tax rate of 35%.
15. If software refinement had been capitalized each year and amortized over a three-year
period beginning in the year the cost was incurred, total assets at the end of fiscal 2007 would
have been:
A. $185M
B. $172M
C. $158M
D. $157M
16. If software refinement had been capitalized each year and amortized over a three year
period beginning in the year the cost was incurred, net income for fiscal 2007 would have been:
A. $31.7M
B. $29.75M
C. $21.95M
D. $14.95M
17. If the software refinement had been capitalized and amortized over a three year period
beginning in the year the cost was incurred, but was expensed for tax purposes, the deferred tax
position at the end of fiscal 2005 would have been:
A. A deferred tax credit of $2.8M
B. A deferred tax credit of $3.5M
C. A deferred tax credit of $5.2M
D. A deferred tax debit of $4M
18. If a company that normally expenses advertising costs was to capitalize and amortize
these costs over 3 years instead:
A. after the third year net income would always be higher if it is capitalized.
B. after the third year net income would always be lower if it is capitalized.
C. after the third year net income would be higher (if it is capitalized) only if advertising costs
were increasing.
D. after the third year net income would be lower (if it is capitalized) only if advertising costs
were increasing.
19. Compared with companies that expense costs, firms that capitalize costs can be expected
to report:
A. higher asset levels and lower equity levels.
B. higher asset levels and higher equity levels.
C. lower asset levels and higher equity levels.
D. lower asset levels and lower equity levels.
20. Two growing firms are identical except that one firm capitalizes whereas the other firm
expenses costs for long-lived resources over time. For these two firms, which of the
following statements is generally true?
I. The expensing firm will show a more volatile pattern of reported income than capitalizing
firm.
II. The expensing firm will show a less volatile pattern of return on assets than the capitalizing
firm.
III. The expensing firm will show lower cash flows from operations than the capitalizing firm.
A. I only
B. II only
C. I and III only
D. II and III only
21. The capitalization of interest cost during construction:

A. increases future net income.
B. decreases future depreciation expense.
C. increases net income during construction phase.
D. decreases assets during construction phase.
22. Windsor Company has net temporary differences between tax and book accounting of $80
million, resulting in a deferred tax liability of $28 million. An increase in the tax rate would
have the following impact on deferred taxes and net income:
A. Choice A
B. Choice B
C. Choice C
D. Choice D
23. Exoil recorded an expense and corresponding liability to recognize potential losses relating
to an oil spill in 2006 of $10 million. Its net income for the year was $200 million. It was not
able to take a deduction for tax purposes until later years when it actually paid cash out in
relation to this event. In 2006, with respect to this, Exoil would have:
A. recognized a deferred tax liability.
B. recognized a tax loss carryforward.
C. recognized a deferred tax asset.
D. recognized a deferred equity loss.
24. Which of the following statements are correct?

I. Tax loss carrybacks result in deferred tax assets.
II. Tax loss carryforwards result in deferred tax assets.
III. The tax valuation account is used to adjust deferred tax liabilities if it is "more likely
than not" that they will not result in increased future taxes.
A. I only
B. II only
C. III only
D. I and II
25. Which of the following will cause the reported effective tax rate to differ from the
federal statutory tax rate?
I. Foreign tax rates that are lower than federal statutory tax rate.
II. Tax-exempt income.
III. Different depreciation methods for tax and financial reporting purposes.
IV. Foreign tax rates that are higher than federal statutory tax rate.
A. I, II, and IV
B. I, II and III
C. I and II
D. III only
26. If a company changes the useful life of its assets from 10 years to 12 years, this will
be recorded as:
A. a non-recurring gain.
B. an extraordinary item.
C. a change in accounting principle.
27. If a company estimates that its expected return on pension plan assets will increase to
9.5% from 9.0%, this would be considered:
A. an extraordinary gain.
B. a change in accounting principle.
C. a prior period adjustment.
D. a change in accounting estimate.
28. A company changes its depreciation method from an accelerated system to straight
line. Which of the following would normally be true?
I. The change would be discussed in the auditor's letter.
II. The cumulative effect of the change would appear net of tax on the income statement.
III. The change would appear in cash flow from operations as a cash inflow.
IV.The change would be mentioned in the footnotes.
B. I, II and III
C. II and IV
D. I, II and IV
29. Which of the following is true with respect to extraordinary items?
I. Extraordinary items are recorded net of tax in income statement.
II. Extraordinary items, by definition, are probable and unusual in nature.
III. By definition, gains and losses from strikes are always extraordinary.
IV. By definition, gains and losses from sale of plant, property and equipment are never
extraordinary.
A. I and IV
B. I, III and IV
C. II and IV
D. I, II and III
30. Which of the following would be considered an extraordinary item?

I. Write-down of receivables
II. Gains on disposal of a business segment
III. Loss of inventory resulting from a fire
IV. Loss resulting from a strike
A. I and IV
B. I, III and IV
C. III only
D. I, II and III
31. Which of the following items is not included in the calculation of net income but is included
in the calculation of comprehensive income?
A. Unrealized holding gain on available-for-sale marketable securities.
B. Unrealized holding gain on trading marketable securities.
C. Gain from early extinguishments of bonds.
D. Gain arising from sale of available-for-sale marketable securities.
32. Which of the following statements is true? Under GAAP, comprehensive income:
A. may be reported in addition to net income.
B. must be reported in addition to net income.
C. may be reported instead of net income.
D. must be reported instead of net income.
33. Which of the following statements is incorrect? Employee stock options
A. are not recorded as an expense when granted if they are at or out-of-the money under the
intrinsic value method.
B. will not affect the share price of the company when exercised.
C. may reduce agency costs by more closely aligning interests of stockholders and managers.
D. may increase the risk propensity of managers.
A company's net income is $100,000, and its weighted-average shares outstanding are 20,000.
During the year, the company issues 5,000 ESOs at an exercise price of $20.
34. What will be the basic EPS if average stock price during the year is $35 and treasury
shares that can be purchased are 1000?
A. $3
B. $6
C. $5
D. $4.17
35. What will be the basic EPS if average stock price during the year is $15 and treasury
A. $3
B. $6
C. $5
D. $4.17
36. What will be the diluted EPS if average stock price during the year is $15 and treasury
A. $3
B. $5
C. $6
D. $4.17
37. What will be the diluted EPS if average stock price during the year is $35 and treasury
A. $3
B. $5
C. $6
D. $4.17
38. Which of the following is not an extraordinary item?

I. Loss on abandonment of property
II. Gain on disposal of a business segment
III. Effect of a strike against a key supplier
IV.Write-down of deferred research and development costs
A. I and III
B. II and IV
C. I, II and III
D. I, II, III and IV
39. Which of the following overall accounting concepts has a number of exceptions under
GAAP?
A. Historical cost
B. Transaction basis
C. Conservatism
D. Accrual accounting
40. When comparing expensing or capitalizing (with straight-line depreciation) software, return
on assets
A. will decrease over time using capitalization.
B. will increase over time using capitalization.
C. will be constant using expensing.
D. will initially be higher under expensing.
41. The intrinsic value approach ignores two types of costs:
A. Interest cost and opportunity cost
B. Opportunity cost and exercise cost
C. Interest cost and option cost
D. Carrying cost and interest cost
42. Economic income and accounting income are always the same.
FALSE
43. The matching principle in accounting prescribes that costs must be recognized in the
same period when the related revenues are recognized.
TRUE
44. Revenue from sales where the buyer has the right of return can only be recognized after the
return period has expired.
FALSE
45. If two firms are identical except that one firm uses percentage-of-completion accounting and
the other uses completed contract accounting for revenue recognition, the cash flows of the firms
will be identical.
TRUE
46. Generally revenue should be recorded when it is probable and reasonably estimable.
FALSE
47. Revenues are earned inflows that arise from the company's ongoing business activities.
TRUE
48. Gains are earned inflows that arise from the company's ongoing business activities.
FALSE
49. Comprehensive income is computed by adjusting net income for dirty surplus items.
TRUE
50. For item to be considered extraordinary, it should be either unusual in nature or infrequent
in occurrence.
FALSE
51. For item to be considered a special item, it should be either unusual in nature or infrequent
in occurrence but not both.
TRUE
52. Accounting changes are usually cosmetic and do not yield cash flow consequences.
TRUE
53. A long term asset is said to be impaired when its fair value is below its book value.
TRUE
54. Under current accounting standards, gains and losses relating to the extinguishment of
debt must be both unusual and infrequent to be classified as an extraordinary item, and debt
refinancing does not typically meet these criteria.
TRUE
55. One difference between revenues and gains is that gains arise from transactions that
are incidental to the operations of the business.
TRUE
56. Smythe Corporation is in the real estate development business. If they sell a piece of land for
$50,000 that they had previously purchased for $45,000, they should record a loss of $5,000.
FALSE
57. For companies in an expansion phase, capitalizing interest may result in higher earnings over
an extended period of time as the amount of interest amortization will not catch up with the
amount of interest capitalized in the current period.
TRUE
58. The capitalization of interest costs during construction increases future net income.
FALSE
59. Software costs may be capitalized once a company can show that the product is
technologically feasible.
TRUE
60. A company that capitalizes costs, rather than expensing them will have a higher
asset turnover.
FALSE
61. If revenue is recognized for financial reporting purposes but deferred for tax purposes
this results in a deferred tax liability.
TRUE
62. If an expense is recognized for financial reporting purposes but not allowed as a bona-
fide deduction for tax purposes, this results in a deferred tax asset.
FALSE
63. Extraordinary items are defined as those that are both unusual in nature and infrequent
in occurrence. These items are disclosed, net of tax in the income statement.
TRUE
64. Accounting errors are considered accounting changes and treated accordingly.
FALSE
65. When a company disposes of a segment of its business, it must restate all prior year
financial statements as if it had never owned that segment of the business.
FALSE
66. A company that capitalizes rather than expenses software development costs, will have a
less volatile net income, all other things equal.
TRUE
67. Comprehensive income differs from net income in that it reflects certain unrealized
holding gains and losses foreign currency translation adjustments, and minimum pension
liability adjustments.
TRUE
68. If a company, operating in an inflationary environment, uses FIFO for tax purposes
and weighted-average for financial reporting purposes, this will result in a deferred tax
asset. TRUE
69. Deferred taxes arise due to temporary timing differences in recognizing items for tax
and financial reporting purposes.
TRUE
70. If a company depreciates an asset at a faster rate for tax purposes than for financial
reporting purposes this will give rise to a deferred tax liability.
TRUE
71. A deferred tax liability imposes an obligation on the business to pay taxes.
FALSE
72. Some items appear on a company's income statement but never appear on its tax return.
TRUE
73. In order to determine permanent income for the year being analyzed, it is necessary to
consider special charges from other years.
TRUE
74. Timing is one of the few revenue recognition issues that are seldom a concern in
financial analysis.
FALSE
75. R&D expenses for tangible assets that have alternative future uses qualify as deferred
charges.
TRUE
76. Employee stock options (ESOs) usually constitute a wealth transfer from current
shareholders to prospective shareholders (employees) and have no effect on total liabilities
and shareholders' equity.
TRUE
77. Under long-term performance contracts—such as product warranty contracts and software
maintenance contracts—revenues are often collected in advance and are recognized
proportionally over the entire period of the contract.
TRUE
78. ESOs often are granted to managers in growth and innovative industries to induce more
risk- taking.
TRUE
Essay Questions
Chapter 7 Cash Flow Analysis
1. Under the accrual basis of accounting, which of the following statements is
true?
I. Reported net income provides a measure of operating performance
II. Revenue is recognized when cash is received, and expenses are recognized
when payment is made
III. Cash inflows are recognized when they are received, and cash outflows are
recognized when they are made
A. I only
B. III only
C.I and III
D. I, II and III
2. Which of the following would require an adjustment in the computation of

cash flow from operations using the indirect method?
I. Sale of machinery for $50,000 with a net book value of $35,000
II. Purchase of supplies for cash
III. Remittance by customer in payment of goods purchased this accounting period
IV. Acquisition of land with simultaneous issuance of long-term note
A. I
B. I and II
C.I and III
D. IV
3. Which of the following would require an adjustment in the computation of

cash flow from operations using the indirect method?
I. Depreciation expense
II. Loss on sale of asset
III. Sale of services to customers for cash
IV. Utility bill received and paid in cash
B.I and II
4. Beginning and ending accounts receivable are $75,000 and $42,000,
respectively. Sales for the period total $384,000, of which $40,000 was directly
for cash. How much cash was collected from making sales and collecting
accounts receivable?
A. $344,000
B. $416,000 $418,000
C. $378,000
D. $376,000
5. Beginning accounts receivable are $76,000. Sales for the period total
$384,000 of which $40,000 was directly for cash. $418,000 was collected from
making sales and collecting accounts receivable. What is the ending balance
for accounts receivable?
A $42,000
B. $2,000
C. $82,000
D. $68,000
6. A firm has net sales of $6,000, cash expenses (including taxes) of $ 2,800
and depreciation of $ 1,000. If accounts receivable increased in the period by $
800, cash flows from operations equal
A. $ 2,400
B. $ 3,200
C. $ 3,400
D. $ 4,200
7. Which of the following represents an investing activity in the statement of

cash flows
A. depreciation of plant assets
B. sale of plant assets at a loss
C. stock dividend
D. purchase of inventory
8. Which of the following is not a financing activity in the statement of cash
flows?
C. payment of interest on debt
The following information should be used to according to the provisions of SFAS 95

(Statement of Cash flows) and using the following data
9. What is net cash flow from operations?

A. $58,000
B. $55,000
C. $54,000
D. $48,000
10. What is net cash flow from investing?

A. $10,000
B. $5,000
C. ($5,000)
D. ($15,000)
11. What is net cash flow from financing?

A. $6,000
B. $3,000
C. ($14,000)
D. ($17,000)
12. What is change in cash?
A. $49,000
B. $46,000
C. $45,000
D. $39,000
13. On a statement of cash flows that uses the indirect approach, calculation
of cash flow from operations treats depreciation as an adjustment to reported
net income because:
A. depreciation is a direct source of cash
B. depreciation is an outflow of cash to a reserve account for the replacement of
assets
C. depreciation reduces net income and involves an outflow of cash
D. depreciation reduces net income but does not involve an outflow of cash
14. Which of the following statements are correct?

!. A company’s choice of accounting principles for financial reporting purposes does
not affect net cash flow for the accounting period
!!. A company’s choice of accounting principles for financial reporting purposes does
not affect operating cash flow
!!!. !f a company sells its receivables this will increase operating cash flow
!v.!f a company sells its receivables this will increase financing cash flow
A. ! and !!!
B. !, !! and !!!
C. !! and !v
D. ! and !v
Hupta Corporation reports for the year ended December 31, 2005 sales of $9,430
and cost of goods sold of $6,500. Other information as of December 31 is as follows:
15. An increase in accounts payable would be considered:

A. a source of cash
B. a use of cash
C. an adjusting entry
D. a noncash charge to income
16. Cash paid to suppliers for year ended December 31, 2005 is
A. $6,480
B.$6,440
C.$5,520
D.$6,560
17. Cash collected from customers for the year ended December 31, 2005 is:
A. $9,480
B. $9,430
C. $8,930
D. $8,980
Below is an example of an incorrectly prepared statement of cash flows. The
descriptions of activities are correct.
18. The correct Cash flows from operating activities is:

A. $65,500
B. $63,500
C. $53,500
D. none of the above
19. The correct Cash flows from investing activities is:

A. ($41,000)
B. ($45,500)
C. ($48,000)
20. The correct Cash flows from financing activities is:

A. ($45,000)
B. $3,000
C. $1,000
21. The correct change in cash for the year is:
A. $4,000
B. $15,000
C. $16,500
22. The management of a company wishes to window-dress its cash flow from
operations. Which of the following will improve cash flow from operations?
!. factoring accounts receivable
!!. paying suppliers more quickly
!!!. selling of some excess marketable securities
!v. deferring payment of taxes
D. ! and !V
Tracy Company reports the following in its statement of cash flows:
23. If Tracy shows cost of goods sold of $2,050 on its income statement, cash
paid to suppliers is:
A. $1,550
B. $1950
C. $2,150
D. $2,650
24. If Tracy shows depreciation expense of $275 in its income statement, cash
paid for amortization is:
A. $0
B. $75
C. $525
D. not determinable
25. Tracy used the indirect method of determining cash flow from operations
(CFO), had they used the direct method:
A. CFO would have been higher as gains are not deducted in arriving at CFO
B. CFO would have been lower as losses and depreciation are not added back in
arriving at CFO
C. CFO would have been the same
D. it is not possible to determine what CFO would have been without more
information
26. Which of the following items is deducted from net income to arrive at cash
flow from operations when using the indirect method?
A. depreciation expense
B. amortization expense
C. decrease in accounts receivable
D. decrease in accounts payable
27. Firms report payments for capital leases in the cash flow statement:
D.partly as operating cash flows and partly as financing cash flow
28. Compared with firms with capital leases, firms with operating leases
generally report:
B. lower cash flow from operations
29. Which of the following would affect cash flow from operations?
D .Capitalizing costs that were previously expensed
30. Which of the following is true? Depreciation:
B. does not affect the amount of cash realized from operations as it is a non-
cash flow
The following information should be used according to the provisions of SFAS 95,
(Statement of Cash flows) and using the following data

A. $75,000
32. What is net cash flow from Investing?

C. ($2,000)
33. What is net cash flow from Financing?

C. ($11,000)
34. What is change in cash?

D. $62,000
35. Which of the following is True the choice of FIFO versus FIFO will:
C. affect both net income and cash flow from operations
36. Which of the following would be considered a use of cash?

B. an increase in working capital
Schwerin Corporation reports the following on its 2005 financial statements.
37. The net book value of equipment sold was:

D. $60 M
38. If the beginning and ending property, plant, and equipment are $500 million
and $550 million respectively, the gross book value of equipment sold was: $120M
38. The gross book value of equipment sold was:
A. $120 M
39. Beginning and ending plant assets are, respectively $325,000 and $370,000.
Beginning and ending accumulated depreciation is, respectively, $82,800 and
$95,000. Depreciation expense for the period was $30,000 and new assets of
$76,000 were purchased. Plant assets were sold at a $10,500 loss. What were
the cash proceeds from the sale?
C. $2,700
The following information is given for Building Inc:
During 2005 new assets were purchased for of $78,000, and plant assets were sold
at a $10,000 loss
40. What was the book value of the sold assets?

B. $18,000
$38,000
41. What were the cash proceeds from the sale?

D. $8,000
42. Beginning and ending prepaid insurance is, respectively, $36,000, $25,500
during the period, $30,500 of insurance expense was recorded. How much new
insurance was purchased?
D. $21,000
43. The balance for supplies is $41,000 and $27,000 for 12/31/06 and 12/31/05,
respectively. During the 2005, the company recorded $30,500 of supplies
expense was recorded. How much new supplies were purchased?
B.$16,500
44. The cash flow adequacy ratio

C.Measures a company’s ability to generate sufficient cash flows from
operations to cover capital expenditures, inventory additions and dividends
45. A cash flow adequacy ratio, when measured over the last several years, of
less than one:
D. Indicates that a company’s internally generated cash flows have not been
sufficient to cover dividend payments and support past growth levels
Chapter 08
Return on Invested Capital and Profitability Analysis
1. Which of the following ratios best measures the profitability of a company?

A. Return on equity
B. Gross margin
C. Current ratio
D. Net operating asset turnover
2. Below are the net operating asset turnovers and net operating profit margins for
companies that operate in three different industries (A, B and C). The industries are grocery
stores, oil extraction and drug industry.
Match the industry to A, B or C
A. Choice A
B. Choice B
C. Choice C
D. Choice D

A. Net operating profit margin divided by net operating asset turnover equals return on
net operating assets
B. Return on net operating assets can be disaggregated into net operating profit margin
and leverage
C. Return on equity equals return on net operating assets less interest, net of tax
8-1
D. Return on equity can be disaggregated into net operating profit margin, net operating
asset turnover and leverage
4. Which of the following could explain a decrease in net operating asset turnover for
a company?
A. Switching from straight line to accelerated depreciation for financial reporting purposes
B. An increase in the financial leverage of the company
C. Addition of a new plant for production purposes
D. Decrease cost of production inputs
5. Err Company has a major lawsuit against them for unsafe products. It recognizes a huge
liability in 2004 of $300M. The effect of this liability is to decrease stockholders' equity
by 50%. In 2005, the effect of recognizing this liability, all else equal, is:
A. Return on net operating assets will increase dramatically
B. Return on net operating assets will decrease dramatically
C. Return on equity will increase dramatically
D. Return on equity will decrease dramatically
6. Return on operating assets for 2005 is:

A. 7.9%
B. 7.41%
8-2
C. 8.78%
D. 8.1%
7. Return on common equity for 2005 is:

A. 11.42%
B. 10.0%
C. 11.0%
D. 10.47%
Assume all assets are operating assets; all current liabilities are operating liabilities.
8. Return on net operating assets for 2005 is:

A. 11.30%
Assume all assets are operating assets; all current liabilities
B. 12.73% are operating liabilities. Return on net operating assets for 2006 is:
C. 9.93% a.11.19%.
b.11.30%
D. 11.19% c.12.03%.
d.9.93%.
9. Return on equity for 2005 is:

Assume all assets are operating assets; all current liabilities are
A. 20.41% operating liabilities. Return on equity for 2006 is:
B. 19.75% a.19.75%.
b.18.12%.
C. 17.54% c.20.41%.
d.17.54%.
8-3
D. 18.12%
10. Which of the following could cause return on net operating assets to increase, all
things other equal?
A. A decrease in interest rate on debt
B. Increase in days accounts receivable are outstanding
C. Increase in inventory turnover
D. Decrease in gross margin
11. Eyster Corporation reported $10M in earnings and paid dividends of $3M for fiscal
2005.Return on equity and dividend payout are expected to remain constant for the
foreseeable future. Net book value at the end of fiscal 2004 was 100M. Cost of equity is
10%. Using the residual income method, the intrinsic value of Eyster's stock at the end of
2005 should be:
A. $110M
B. $107M
C. $100M
D. not determinable
12. When calculating return on net operating assets, interest expense net of tax is added back
to net income for purposes of calculating the numerator. What tax rate should be used? A.
effective tax rate B. marginal tax rate
C. statutory federal tax rate
D. statutory federal tax rate plus statutory state tax rate
Below is selected information from Tricrop.
8-4
13. Return on Net Operating Assets for Year 1 is:
A. 30.8%
B. 16.3%
C. 15.4%
D. 14.5%
14. Return on Common Equity for Year 1 is:

A. 19.0%
B. 19.60%
C. 21.08%
D. 26.03%
15. Which of the following is correct concerning changes at Tricrop from Year 1 to Year 2?
A. Choice A
B. Choice B
C. Choice C
D. Choice D
8-5
16. Which of the following statements is correct concerning changes from year 1 to year 2
at Tricrop?
A. Despite favorable changes in the tax rate return on net operating assets has
decreased B. Despite favorable changes in net operating asset utilization return on net
operating assets has decreased
C. Largely because of favorable changes in tax rates return on net operating assets
has increased
D. Largely due to favorable changes in leverage return on net operating assets has increased
17. Which of the following will increase the sustainable equity growth of a company, all
other things equal?
A. Increase dividend payout
B. Pay suppliers more quickly
C. Pay suppliers more slowly
D. Decrease dividend payout
18. An increase in net operating income (NOPAT) will cause which of the following?
A. Increase in the return on net operating assets
B. Decrease in the return on net operating assets
C. No change in the return on net operating assets
D. The change in the return on net operating assets is unclear, there is not
sufficient information
19. Which of the following would explain an observed decrease in return on equity, all
else equal?
A. Decrease in tax rate
B. Increase in interest rate on debt
C. Stock split
D. Stock dividend
20. Which of the following is the best measure of operating efficiency?

A. Return on net operating assets
B. Return on equity
C. Return on sales
8-6
D. Return on inventory
21. Return on operating assets is a measure of which of the following?

A. Profitability
B. Efficiency
C. Solvency
D. Liquidity
The following information relates to Yutter Corporation
22. What is Yutter's sustainable equity growth rate?

A. 9.12%
B. 9.88%
C. 11.4%
D. 12.0%
23. What is the value of Yutter's stock at the end of Year 1 using the dividend discount
model assuming that the dividend payout ratio remains constant and Yutter grows at its
sustainable equity growth rate?
A. $83,333
B. $157,642
C. $500,000
D. $557,000
8-7
24. If Yutter's dividend payout ratio increased to 50% after year 1 then:
A. the sustainable equity growth rate would increase
B. the return on equity would increase
C. the value of the stock would decrease
D. the return on net operating assets would decrease
25. Cost of goods sold divided by inventory provides information about (choose one answer):
A. profitability
B. capital structure
C. management of working capital
D. gross profit margin
26. When considering the difference between return on net operating assets (RNOA)
and return on common shareholders' equity (ROCE), which of the following statements
is incorrect?
A. Preferred dividends are deducted from the numerator when calculating ROCE but not
when calculating RNOA
B. RNOA is a pre-interest measure but ROCE is not
C. RNOA is a post-interest measure but ROCE is not
D. RNOA is independent of the form of financing, but ROCE is not.
27. Purchases divided by accounts payable provides information about:

A. capital structure
B. management of working capital
C. gross profit margin
D. profitability
WidgetCo and Tools Inc. both operate in the same industry. They are capital-intensive
companies producing widgets. Below are selected data
8-8
28. Which of the following statements is the most plausible explanation of the difference
in observed net operating profit margins? A. WidgetCo's lower financial leverage
B. WidgetCo uses LIFO and Tools uses FIFO
C. WidgetCo's lower tax rate
D. WidgetCo's net operating asset turnover
29. Which of the following statements best explains the difference in observed net
operating asset turnovers?
A. WidgetCo's lower financial leverage
B. WidgetCo uses FIFO and Tools uses LIFO
D. WidgetCo has significant operating leases and Tool has no leases

A. Widget has higher RNOA than Tools
B. Widget has lower RNOA than Tools
C. Widget has same RNOA as Tools
D. Insufficient information to calculate RNOA
31. Which of the following statements could explain the difference in observed tax rates?
A. Widget uses straight-line depreciation and Tool uses MACRS
B. Widget uses LIFO and Tool uses FIFO
C. Tool has foreign subsidiaries in countries with much lower tax rates
D. Widget has significant amounts of interest income from municipal bonds
8-9
32. Widget has a higher EBIT/Revenue but lower net operating profit margin than
Tool. Which of the following statements could explain this? As a percentage of sales:
A. Widget has greater interest expense and taxes
B. Widget has greater interest expense but lower taxes
C. Widget has lower interest expense but higher taxes
D. Widget has lower interest expense and taxes
33. Which of the following statements about the relationship between RNOA and ROCE
is correct?
A. ROCE is always greater than RNOA
B. ROCE is greater than RNOA if RNOA is greater than after-tax cost of dividends
C. ROCE is greater than RNOA if RNOA is greater than cost of debt
D. ROCE is greater than RNOA if RNOA is greater than after-tax cost of debt
34. Which of the following statements about the equity growth rate is correct?
I. the higher the ROCE the higher equity growth rate, all other things equal
II. the higher the dividend payout the higher the equity growth rate
III. the equity growth rate is unaffected by the cost of debt
IV. the equity growth rate indicates the expected growth in stock price each period A. I, II, III
and IV
B. I, II and III
C. I and III
D. I only
35. Which of the following statements about the return on shareholders' investment (ROSI) is
correct?
A. If book value of equity is less than market value, ROSI is greater than ROCE
B. ROSI will be higher the greater the dividend payout ratio
C. ROSI is likely to be more volatile than ROCE
D. ROSI normally equals ROCE
8-10
36. Which of the following situations is most likely to explain an accounts receivable
turnover that is lower than the industry norm?
A. The company makes less credit sales than industry
B. The company gives customers less time to pay than its competitors
C. The company has been selling inferior products to competitors
D. The company is systematically over-estimating bad debts
37. Which of the following situations is most likely to explain a net operating asset
turnover that is higher than the industry norm?
A. The company has more recently purchased fixed assets
B. The company uses FIFO while competitors use LIFO
C. The company uses accelerated depreciation method while competitors use straight line D.
The company extends more credit to customers than competitors
Selected information for Acme Corp.:
38. When calculating Acme's return on net operating assets in Year 1, which of the
following adjustments to the asset base is most appropriate to consider?
A. Accumulated depreciation adjustment
B. Intangible asset adjustment
C. Nonoperating asset adjustment
D. No asset adjustment
8-11
B. Intangible asset adjustment Tangible asset adjustment
41. An analysis of a company's performance requires joint analysis of net income in

relation to the invested capital.
TRUE
42. There is only one way to measure invested capital.

FALSE
43. A company that operates in a highly competitive industry with low barriers to entry is
likely to have low net operating profit margins compared to companies that operate in
less competitive industries.
TRUE
44. Companies that have low net operating profit margins generally only earn a
reasonable return on net operating assets if they can utilize their net operating assets very
efficiently.
8-12
TRUE
45. The two components of RNOA, net operating profit margin and NOA turnover,
are independent of each other.
FALSE
46. If a company has rapidly growing earnings per share, their return on net operating assets
must be increasing too.
FALSE
47. When calculating return on equity minority interest is added to the numerator as it has
been deducted in arriving at net income.
FALSE
48. When calculating return on net operating assets, deferred taxes should be deducted from
the denominator.
FALSE
49. Return on equity is the return stockholders have received during the past year.
FALSE
50. The relation between a company's return on common equity (ROCE) and return on net
operating assets (RNOA) reveals information about the company's success with financial
leverage.
TRUE
51. A decrease in net operating profit margin will cause both return on net operating assets
and return on equity to decrease, all other things being equal.
8-13
TRUE
52. Return on net operating assets will always be greater than or equal to the pre-tax return
on equity.
FALSE
53. When calculating return on total equity it is normal to add back preferred dividends to net
income.
FALSE
54. It is possible to have an increasing return on net operating assets while net operating
profit margin is decreasing.
TRUE
55. Return on invested capital is a better measure of profitability than earnings as

earnings numbers fail to reflect the capital needed to generate those earnings.
TRUE
56. If two companies both increase their net income by 25% over the prior year this
means they have both been equally profitable this year.
FALSE
57. When calculating return on net operating assets it may be necessary to adjust assets
to reflect the fact that not all assets are operating assets.
TRUE
8-14
58. If future expected return on common stockholders' equity is less than expected required
return by equity holders then the market value of a company's stock should be less than
book value.
TRUE
59. Sustainable equity growth rate is a function of return on common stockholders' equity
and the dividend payout ratio.
TRUE
60. Return on equity can be expressed as return on net operating assets multiplied by
leverage (net operating assets/equity) and by earnings leverage.
TRUE
61. The accounting-based stock valuation formula calculates the value of a stock as the book
value of the net operating assets plus the present value of future expected dividends
discounted at the cost of equity.
FALSE
62. When calculating return on net operating assets, the numerator is net income plus
minority interest.
FALSE
63. Return on net operating assets is a better measure of operating performance than return on
equity, as it is independent of the form of financing.
TRUE
64. It is possible to have increasing earnings growth while having decreasing return on net
operating assets.
8-15
TRUE
65. It is possible to assess the common equity growth rate by analyzing the retention
of earnings.
TRUE
66. An advantage of leverage that benefits common stockholders is successful trading on

the equity.
TRUE
67. Financial statements of a diversified company should be analyzed by segments.

TRUE
68. Practice considers a segment significant if its sales, operating income (or loss), or
identifiable assets are 30% or more of the combined amounts of all the company's
operating assets.
FALSE
Essay Questions
69. Problem One: Return on Equity
8-16
Chapter
10 Credit
Analysis
1. Which of the following best describes the current ratio?

A. debt ratio
B. operating performance ratio
C. liquidity ratio
D. efficiency ratio
2. Which of the following is not likely to be used to measure a company's liquidity?

A. Working capital
B. Financial leverage
C. Current ratio
D. Acid-test (quick) ratio
3. Which of the following is likely to be used to measure a company's solvency?

A. Net operating profit margin
B. Current ratio
C. Financial leverage
D. Cash to current liabilities ratio
4. Which of the following items would not typically be included in the components of
the current ratio?
A. Inventory
B. Accounts payable
C. Capitalized software development costs
D. Deferred charges
10-1
5. Imagine FASB passes a new rule that required the capitalization of R&D. The effect for
a drug company would be to:
A. Increase its current ratio
B. Decrease debt/equity ratio
C. Decrease working capital
D. Improve asset turnover
6. Selling accounts receivable increases which of the following?

A. current ratio
B. accounts receivable turnover
C. debt/equity
D. effective tax rate
7. Which of the following is not likely to be the cause of a company's a low

accounts receivable turnover?
A. Poor collection efforts
B. Low price of product
C. Customers in financial distress
D. Delays in customer payments
8. Which of the following is not a measure of a company's a solvency?

A. Debt to equity ratio
B. Equity to assets ratio
C. Sales to assets ratio
D. Debt to assets ratio
10-2
9. Using LIFO rather than FIFO in a time of rising prices:
I. lowers the current ratio
II. increases inventory turnover
III. increases profit margin
IV. increases debt/equity ratio
A. I, II and IV
B. I and II
C. II and III
D. I only
10. Which of the following statements concerning the current ratio are true?
I. It is always larger than the acid-test (quick) ratio
II. Companies can window-dress their current ratios
III. In isolation the current ratio has little meaning
IV. It is a good indicator of solvency of a company
B. I, II and III
C. II, III and IV
D. I, II and IV
11. Which of the following would be least likely to affect the quality of receivables?
A. Credit policy
B. Right of return policy
C. Collection procedures
D. Sales commissions
12. Which of the following industries would you expect to have the longest operating cycle?
A. Fast Food Industry
B. Aerospace Industry
C. Discount retail store industry
D. Utility industry
10-3
13. Which of the following industries would you expect to have the highest inventory
turnover?
A. restaurant
B. car dealer
C. jewelry store
D. department store
14. Which of the following does not represent future expected cash inflows?
A. accounts receivable
B. prepaid expenses
C. inventory
D. notes receivable
Sellograph Corporation reports sales of $10M for Year 2, with a gross profit margin of 40%.
20% of Sellograph's sales are on credit.
15. Accounts receivable days outstanding at the end of Year 2 is closest to:
A. 30.6 days
B. 28.8 days
C. 27.0 days
D. 6.1 days
16. Accounts payable days outstanding at the end of Year 2 is closest to:
A. 57.0 days
B. 69.0 days
C. 72.0 days
D. 43.2 days
10-4
17. Days in inventory at the end of Year 2 is closest to:
A. 60.0 days
B. 69.0 days
C. 66.0 days
D. 54.0 days
18. Which of the following will not affect the calculation of leverage ratios?
A. existence of non-capitalized operating leases
B. existence of assets where market value is much higher than book value
C. existence of significant debt covenants
D. existence of pension liabilities where projected benefit liability is much greater than
plan assets and accumulated benefit obligation
19. An analyst should treat preferred stock on a firm's balance sheet as debt when
calculating leverage ratios if the preferred stock is:
A. redeemable by shareholders
B. convertible into common stock
C. issued at a variable dividend rate
D. callable by the issuer
20. If a firm capitalizes a lease instead of treating the lease as an operating lease, the effect
on the current ratio and the debt-to-equity ratio will be to:
A. Option A
B. Option B
C. Option C
D. Option D
10-5
21. If a company's current ratio increases from 1.1 to 1.3 from one year to the next, it can
be concluded that:
A. company's liquidity has increased
B. current assets have increased
C. current liabilities have decreased
22. If a company's current ratio increases from 1.2 to 1.4 from one year to the next, and
its quick ratio decreases from 0.2 to 0.15 over the same time period, this indicates:
A. company's liquidity must have increased
B. accounts receivable have decreased
C. inventory management should be further examined
D. current liabilities have decreased
23. If a company wishes to increase its current ratio, it could:

A. take out a short-term loan a. take out a short-term loan.
B. pay suppliers more quickly b. sell a fixed asset.
C. increase useful life of machinery c. decrease investments in fixed assets.
D. not determinable without more information d. increase useful life of machinery.
24. The short-term liquidity of a company

A. is only of concern to creditors of a company
B. is determinable by looking at current ratio
C. depends largely upon prospective cash flows
D. is determinable by calculating cash to current liabilities ratio
25. Which of the following is least likely to increase the overall risk of a company?
A. increased sales variability
B. increased debt levels
C. increased variable costs while decreasing fixed costs
D. increased interest rates
10-6
26. Two companies, A and B, both have $1million in assets, net income before interest and
taxes (EBIT) of $160,000, and the same tax rate. Company A is all equity financed and B is
50% debt financed and 50% equity financed. If B's pre-tax cost of debt is 8%, then
Company A will have a ROA that is and a ROE that is than B's.
A. Option A
B. Option B
C. Option C
D. Option D
27. Which of the following is not included in the computation of Altman's Z-score?
A. Liquidity
B. Trendline
C. Leverage
D. Profitability
28. Which of the following statements are true?
I. Pre-tax cost of debt is generally higher than the pre-tax cost of equity
II. Interest is tax deductible
III. Preferred dividends are tax deductible
IV.Total cost of capital is normally less than or equal to cost of equity
A. II and IV
B. II, III and IV
C. I, II and IV
D. II only
10-7
29. A company wishes to increase its financial leverage. Which of the following actions,
all other things being equal, will achieve this?
I. Repurchase stock
II. Issue more dividends
III. Sell accounts receivable at face value
IV. Split stock 2 for 1
A. I, II and III
B. I and II
C. I and IV
D. I, II and IV
30. ABC company is planning a major expansion for which it needs $5 million in external
funding. It has various options as how to finance this expansion. Which of the following
is correct?
A. Future ROA will be higher if it uses all equity financing than if it uses some debt financing
B. Future net income will be higher if it uses common stock rather than preferred stock
to finance expansion
C. Future ROA is independent of the form of financing
D. Future net income is independent of the form of financing
31. If a company increased its dividend payments what would happen to the following
ratios, all other things being equal?
A. Option A
B. Option B
C. Option C
D. Option D
10-8
32. Which of the following statements are correct with respect to the times interest
earned ratio?
I. It is independent of operating income

II. It is independent of the interest rate paid on debt
III. It is independent of the tax rate
IV. It is independent of the amount of dividends paid
A. I, II and III
B. I and III
C. I and IV
D. III and IV
33. The earnings to fixed charges ratio:

A. indicates how efficiently assets are used
B. typically includes depreciation in the denominator
C. typically excludes extraordinary gains and losses from the numerator
D. indicates the proportion of debt used to finance the company
34. If a company issues a 1% stock dividend what is the effect on the following ratios,
all other things being equal?
A. Option A
B. Option B
C. Option C
D. Option D
10-9
Below is information for year ended 12/31/05 for Company A and Company B.
35. Return on assets for Company A and B for 2005 are:
A. Option A
B. Option B
C. Option C
D. Option D
36. Financial leverage ratio for Company A and B for 2005 are:
A. Option A
B. Option B
C. Option C
D. Option D
10-10
37. Company A capitalized $100 in interest costs during the year. Times interest earned
ratio, after necessary adjustments, for Company A is:
A. 3.5
B. 2.8
C. 2.0
D. 1.2
38. Company B has operating leases with a present value of $2,000 when future
minimum lease payments are discounted at 9% as of 12/31/04. Times interest earned
ratio, after necessary adjustments, for Company B is:
A. 10.26
B. 9.26
C. 6.56
D. 5.55

A. Company A has the same ROA as company B
B. Company A has a lower ROE than company B
C. Company A has same ROE as company B
D. Company A has used financial leverage to increase its return to its shareholders
40. Simmons Company is in a high growth industry. You are examining its long-term
solvency and notice that they have significant deferred tax liabilities. Upon further
examination of the tax footnote you find that virtually all of the deferred tax liabilities are due
to plant and equipment. For purposes of analysis the deferred tax liability should be treated
as:
A. a liability as you do not expect it to reverse in the near future
B. a liability as you expect it to reverse in the near future
C. equity as you do not expect it to reverse in the near future
D. equity as you do expect it to reverse in the near future
10-11
41. You are calculating the earnings to fixed charges ratio for a company. Which of
the following is incorrect?
A. Interest expense is considered a fixed charge
B. Long-term rental payments are often considered fixed charges
C. Senior managements' salaries are normally considered fixed charges
D. Preferred stock dividends are normally considered fixed charges
42. When considering whether an earnings coverage ratio is acceptable, consideration is least
likely to be given to:
A. earnings variability
B. earnings persistence
C. cash flow variability
D. dividend policy for common stock
43. A company has significant uncapitalized operating leases. This company has positive
net income. If these were capitalized the effect on the following ratios would be:
A. Option A
B. Option B
C. Option C
D. Option D
Horace Corporation has $200,000 of convertible 5% bonds. Each $500 bond is convertible
into 50 shares of common stock. The bonds were sold at par and are currently trading at par,
and the required return on nonconvertible bonds of similar risk is 11%. Common stock is
trading at $ 23 per share.
10-12
44. The total leverage ratio of a company will:
A. increase if operating leases are capitalized
B. increase if a company sells its receivables
C. increase if a company sells more equity
D. increase if a company pays suppliers more quickly
45. When calculating debt to equity ratio:

A. Convertible bonds should be treated as debt
B. Convertible bonds should be excluded from debt but not included in equity
C. Convertible bonds should be treated as equity
D. Half the convertible bonds should be treated as debt, and the other half as equity
46. Reported operating income for Horace Corporation was $145,000 and reported
interest expense was $ 45,000. Times interest earned for Horace Corporation, after
necessary adjustments, was:
A. 2.22
B. 3.22
C. 4.22
D. 4.48
47. Which of the following transactions or events would have no immediate effect on
the times interest earned ratio but will cause debt/equity ratio to decrease?
A. issuing new debt
B. issuing new equity
C. having a stock split
D. recording large contingent liability for lawsuit
10-13
48. Typical debt covenants would
I. Limit the issuance of additional debt senior to the obligation

II. Specify minimum levels of selected financial ratios
III. Specify minimum levels of earnings coverage
IV. Prohibit excessive dividends or stock repurchases
A. II and III
B. II and IV
C. I, III and IV
49. A primary motivation for a company financing its business activities through debt is not
A. Trading on the equity
B. Reducing earnings variability
C. Tax-deductibility of interest
D. Avoiding earnings dilution
50. Screening hundreds of companies for investment opportunities, you come across
Apex Corp. It is rated AA by the major rating agencies and has a low Z-score. You want
to do detailed analysis, but you preliminarily conclude
A. Apex debt is overvalued
B. Apex stock should appreciate over the short term
C. Apex has untapped growth potential
51. Liquidity is viewed as the company's ability to meet its short term and long
term obligations.
FALSE
10-14
52. Liquidity is generally measured by the company's ability to pay its short term
obligations using its short assets.
TRUE
53. Liquidity depends to a large extent on prospective cash flows and to a lesser extent on
the level of cash and cash equivalents.
TRUE
54. The current ratio is a superior tool to cash flow projections and pro forma
financial statements in assessing short-term liquidity.
FALSE
55. If a company has a current ratio greater than one then there is no chance it will go
bankrupt in the next year.
FALSE
56. All current assets, by definition, will result in cash inflows within the next year or
operating cycle whichever is longer.
FALSE
57. When examining a company's current ratio it is important to also assess the quality of
the current assets and liabilities.
TRUE
58. Companies in certain industries do not make the distinction between current and non-
current on their balance sheets.
TRUE
10-15
59. The higher the company's cash to current liabilities ratio, the better is the company.
FALSE
60. The higher the company's cash to current liabilities ratio, the more liquid is the company.
TRUE
61. An increase in the credit days offered to customers by a company will improve
the company's financial situation because of the likely increase in sales.
FALSE
62. When examining the current ratio and trends in the current ratio it is important to
evaluate the turnover rate of current assets and current liabilities and trends in these turnover
ratios. TRUE
63. An increase in the current ratio over time is always a good indication of
increased liquidity of the firm.
FALSE
64. The use of LIFO will inflate the current ratio under normal economic conditions.
FALSE
65. In assessing the quality of receivables it is important to consider the revenue

recognition methods used by a company.
TRUE
66. Determination of short-term liquidity is important to both investors and creditors.

TRUE
10-16
67. If accounts payable turnover decreases this could be an indication that suppliers are
cutting off credit to the company.
FALSE
68. If a company switches from FIFO to LIFO during a period of rising prices,
inventory turnover will probably increase.
TRUE
69. If a company's days receivables outstanding increases this could be an indication

that there are problems with the quality of the company's products.
TRUE
70. An increase in the current ratio due to increased inventory and receivables could be
consistent with a recession in the economy.
TRUE
71. The cash ratio is a measure of the degree of current asset liquidity.
TRUE
72. If a company sells its receivables this is an indication that it has very high
quality receivables.
FALSE
73. A decrease in provision for doubtful accounts relative to gross accounts receivable could
indicate improved collection of accounts receivable or it could indicate that management has
failed to make adequate provisions for non-collectible accounts.
TRUE
10-17
74. One would expect restaurants to have lower inventory turnovers than general
merchandise stores.
FALSE
75. Management Discussion and Analysis provides information that is useful in helping
assess company's liquidity.
TRUE
76. Analysis of profitability of a company is more important when considering short-

term liquidity than when considering long-term solvency of a company.
FALSE
77. The lower equity is as a proportion of total capital, all other things equal, the greater
the risk borne by the other providers of capital.
TRUE
78. When calculating the times interest earned adjustments should normally be made for
existence of operating leases. A portion of rental payments should be reclassified as
interest. TRUE
79. The higher the company's inventory turnover the better is company.
FALSE
80. When calculating earnings coverage ratios it is common to remove the effects of
extraordinary gains and losses and other one-time gains and losses from the
numerator. TRUE
10-18
81. For purposes of long-term solvency analysis the calculation of balance sheet ratios such
as debt/equity or debt to total capital are of limited value and are used mostly as screening
mechanisms to indicate whether further analysis is warranted.
TRUE
82. Minority shareholders' interest on the balance sheet represents a liability to the
company and should always be included in debt when calculating the debt/equity ratio.
FALSE
83. "Trading on the equity" means that a company is publicly traded as opposed to
being closely held.
FALSE
84. Debt is better than equity because the interest on the debt is tax deductible whereas
dividends are not tax deductible.
FALSE
85. A company's return on assets will equal its return on equity if the after-tax cost of
debt equals the return on assets.
TRUE
86. When examining the debt/equity ratio of a company, consideration should be given to
pension liabilities. Specifically, it should be determined if the projected benefit obligation
significantly exceeds the plan assets, and if it does compare this to any liability recorded
on balance sheet.
TRUE
10-19
87. Guaranteed debt of unconsolidated subsidiaries should generally be ignored when
analyzing the long-term solvency of a parent company, as subsidiaries are separate
legal entities.
FALSE
88. Financial ratios are often used in models that predict financial distress.
TRUE
89. A leveraged buyout is when a group of investors use equity to buy a highly
leveraged company that is in distress, and pay down the debt using their equity.
TRUE
90. Debt may contain sinking fund provisions. This means that bond is insured by
government and that in the event of default on the debt the government will sink into its funds
in order to honor the debt.
FALSE
91. The total debt to total capital ratio is more useful than the total debt to equity capital ratio.
FALSE
92. The greater the variability of sales the higher the earnings coverage ratios should ideally
be, all other things equal.
TRUE
93. A joint venture may result in significant liabilities that are not recorded on the
balance sheet of the parent company.
TRUE
10-20
94. Deferred tax assets should be deducted from the assets and equity if they are not
expected to reverse.
FALSE
95. Capitalization of interest results in an understatement of the times interest earned.

FALSE
96. The SEC requires disclosure if fixed charges exceed earnings.

TRUE
97. Dividends on preferred stock with characteristics of debt such as mandatory

redemption, fixed maturity or sinking fund must be tax-affected and treated as debt for
calculation of common stock dividend coverage.
FALSE
98. Altman's Z-score uses multiple discriminant analysis in a bankruptcy prediction model.
TRUE
Essay Questions
10-21
1. A corporation wants to increase its current ratio from
c. 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.
2. A firm has a current ratio greater than 1.0. During a
the course of the year the firm sells $60 million of
accounts receivable with limited recourse. If it had
not sold the receivables it would have taken out a
short-term loan. The effect of selling the
receivables is:
AR Turnover. Current Ratio
a. Higher . Lower
b. Higher . Higher
c. Lower . Lower
d. Lower . Higher
3. A firm has a current ratio greater than 1.0. If the firm's Net income will
ending inventory is understated by $3,000 and begin- be understated by
ning inventory is overstated by $5,000, the firm's $8000 and the cur-
net income and current ratio will be: rent ratio will be
too low.
4. All other things being equal, if a LIFO liquidation II and IV only

occurs during a period of rising prices, which of
the following statements about the effects on a
firm's financial statements is generally true?

IV. Net income increases.
5. I, II, and III only.

Analysis of a company's assets will help evaluate
its:
I. liquidity.
II. solvency.
IV. financing ability.
This year's ROA
6. Companies are supposed to write-down value of will Decrease.
assets if a permanent impairment of value or loss
of
utility occurs. If a company writes down its assets this Next year's ROA
year, the effect on: will Increase.
7. Look Good Corporation has current assets of $1.1 Sell a building

million and current liabilities of $1 million. It is for $0.2 million in
close to year-end, and it would like to increase its cash
current ratio. Which of the following will achieve
this?
Both the As-
8. The inventory costing method used by a set Turnover Ra-
company (LIFO, FIFO, etc.) will affect: tio and the
Debt-to-Equity Ra-
tio.
II, III, and IV

9. Under current US GAAP, goodwill is:

III. exclusive of separately identifiable intangible
assets.
IV. recorded only upon purchase of another entity.
10. Which of the following is not a common characteristic Higher variability

of a company choosing to use LIFO rather than FIFO? in inventory bal-
ances.
11. Which of the following is not an analysis issue arising Analyzing the ef-
12.
wit fect of the impair-
h ment on asset
im
pai
rm
ent
?
Which of the following is not an effect of Capitalization usu-
capitalization? ally decreases in-
come
13. Which of the following steps is required to adjust LIFO All of the above
to FIFO?
-Inventory needs to be calculated as reported LIFO
-Increase deferred tax payable by LIFO reserve times
Tax rate.
-Retained earnings need to be calculated as reported
rate).
-All of the above
14. A company's current ratio is 1.5. If the company uses Current ratio: In-
cash to retire notes payable due within one year, crease; Return on
would this transaction increase or decrease the assets: Increase
current ratio and return on assets ratio?
15. An analyst should consider whether a company ac- leases to be treat-

quired assets through a capital lease or an operating ed like operating
lease because a company may structure: leases to lower its
debt to equity ratio.
16. One way for a company to increase its book value per buy back shares at
share is to: market prices be-
low their book val-
ue.
17. Reling Company reports the following information as $15.25.

of 12/31/05
The book value per share of common stock is:

18. Reling Company reports the following information as $11
of 12/31/05
The book value per share of preferred stock is:

19. The majority of financing for most companies comes Creditors and
from which of the following sources? owners
20. Treasury stock is: a company's own
stock that it has re-
purchased.
21. Which of the following is reported in the equity section Treasury stock
of the balance sheet?
22. Which of the following statements about stock Stock dividends in-
dividends is true? crease the num-
ber of shares out-
standing.
23. Which one of the following statements is false? Violation of a

long-term debt
covenant automat-
ically means the
company must re-
classify the debt
as current.
24. Which of the following is not a source of Cash budget

industry information?
25. are secondary qualities of accounting infor- Consistency and

mation that make it useful for decision making. comparability
26. Relevance, one of the desirable qualities of the capacity of in-
accounting information, implies: formation to affect
a decision.
27. When analyzing financial statements, it is Accounting distor-
important to recognize that accounting distortions tions arise if the
can arise. Accounting distortions are those things stock market is not
that cause
deviations in accounting information from the under- efficient.
lying economics. Which of the following statements
is not correct?
28. Which of the following would require the filing of Form I, III, and IV
8-K?
I. Major acquisition
II. Audited financial statements
III. Bankruptcy
IV. Change in management control
29. 10-K reports are: annual filings
made by a compa-
ny with SEC.
30. To determine a company's sustainable earning pow- core earnings.

er, 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:
31. Which of the following information would not be filed Tax Return
with the SEC by a publicly traded company?
32. Financial accounting data has some inherent limita- I, II, III, and IV
tions to investors. Which of the following is a
limitation?
I. Not all economic events are easily quantifiable.

II. Many accounting entries rely heavily on estimates.
III. Historical costs do not accurately reflect the
true value of firms.
IV. Inflation can distort analysis of accounting data.
33. Which one of the following is not an example of a Net income this
red flag to one should be aware of when year is higher than
evaluating earnings quality? net income from
last year
34. Which of the following would affect the I, II, and III
comparability of accounting information for a given
company from one accounting period to the
I andnext?
III
I. Change in accounting principles
II. Disposition of segment of business
III. Restructuring expenses
IV. Change in auditors
35. Which of the following would affect the comparison of I, II, III, and IV
financial statements across two different firms?
I. Different accounting principles

II. Different sizes of the companies
III. Different reporting periods
IV. Different industries
36. Following is some financial information of Dell 27.64

Inc. What is Dell's price-to-earnings ratio for 2006?
37. Following is some financial information of Dell 2.31

Inc. What is Dell's asset turnover for 2006?
38. If a company receives an unqualified audit opinion are providing as-

it means the auditors: surance that the
company's finan-
cial statements
fairly present com-
pany's financial
performance and
position.
39. Liquidity of a company is generally defined as a mea- the ability to pay

sure of: current liabilities.
40. The semistrong efficiency of market implies that: stock prices fully
reflect all publicly
available informa-
tion.
41. Which of the following is likely to be the most infor- Management dis-
mative source if you were interested in a cussion and analy-
company's business plan or strategy? sis
42. Which of the following is not a common tool used Random Walk
in financial statement analysis? Analysis
43. Which of the following is not an equity valuation mod- Payback period
el? model
44. Which of the following statements concerning Accounting princi-

financial ratios is incorrect? ples and methods
used by a compa-
ny will not affect fi-
nancial ratios.
45. Which of the following statements is correct? All other things

being equal, the
more efficiently a
company utilizes
its assets, the
greater will be its
return on invest-
ment.
46. Which of the following would not be considered Notes Receivable

a source of financing?
47. While determining the most profitable company from Highest return on
the given number of companies, which of the in perpetuity,
following would be the best indicator of relative and the
profitability? dividend
payout ratio of
48. Wilco Company reports the following: 70%
Assuming retained earnings was only affected by
income and dividends; calculate the dividend
payout ratio for 2005:
49. You are analyzing a large stable company. For the

year ending 12/31/05 the company reported
earnings of $58,900 and book value at the end of
2005 was
$371,700. You expect earnings to grow at 5% a year
equity
22.2%
$24.74
to continue. The company borrows at 8%, and has a
cost of equity of 12%. The company has 25,000
shares outstanding.
What is your estimate of price per share using the

dividend discount model at 12/31/05?
1. Pension intensity of a company can be measured by expressing the pension plan assets and the
pension obligation separately as:
a. a percentage of its shareholders' equity.
b. a percentage of its total liabilities.
c. a percentage of its total assets.
d. a percentage of its net income.
2. With respect to pension liabilities, which of the following statements is 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 and IV
b. I, III, and IV
c. I and III
d. II and IV
3. Below is selected information taken from the balance sheet of Huy Corporation as of
12/31/06.
The average total life span of Huy's depreciable assets as of 2006 is:
a. 14 years.
b. 2 years.
c. 34 years.
d. 7 years.
4. The average age of Huy's depreciable assets as of 2006 is:
a. 14 years.
b. 34 years.
c. 7 years.
d. 2 years.
5. During fiscal 2006, Huy sold fully depreciated assets that originally cost $20,000 for $4,000.
In 2006, they purchased assets that cost:
a. $30,000.
b. $6,000.
c. $5,000.
d. $10,000.
6. Goodwill is:
a. the excess of the purchase price of net assets over the fair value of net assets.
b. the excess of the appraised value of net assets over the fair value of net assets.
c. the excess of the purchase price of net assets over the book value of net assets.
d. the excess of the appraised value of net assets over the book value of net assets.
7. Target Inc. has 30 million shares outstanding and trades at $50 per share. Target has net
identifiable assets with a book value of $1,000 million and a fair value of $1,200 million.
Acquirer Corporation purchases all of Target Inc. stock for $60 per share. How much will
Acquirer records as goodwill upon acquiring Target?
a. $300 million
b. $800 million
c. $600 million
d. $500 million
8. 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. What will be the value of inventory for 2006 if ABC used FIFO
valuation?
a. $633,381
b. $633,485
c. $570,430
d. $488,581
9. Assume a tax rate of 35%. Inventories valued using the LIFO method represented
approximately 80% of consolidated inventories. What will be the retained earnings for 2006 if
ABC used FIFO valuation?
a. $4,096,430
b. $3,205,271
c. $3,566,918
d. $3,893,000
10. Assume a tax rate of 35%. Inventories valued using the LIFO method represented
approximately 80% of consolidated inventories. What will be the retained earnings for 2005 if
a. $3,893,000
b. $4,096,430
c. $3,566,918
d. $3,205,271
11. The following information can be found in Manufacturer Company's financial statements.
If Manufacturer used FIFO, its retained earnings as of the end of fiscal 2006 would be:
a. $440,000.
b. $506,000.
c. $540,000.
d. $524,000.
12. If Manufacturer used FIFO, its net income for fiscal 2006 would be:
a. $149,000.
b. $131,000.
c. $135,000.
d. $165,000.
13. The inventory costing method used by a company (LIFO, FIFO, etc.) will affect:
a. Option D
b. Option A
c. Option B
d. Option C
14. Which of the following statements about inventories is true?
a. FIFO inventory balances generally contain old and outdated costs that have little or no
relationship to current costs.
b. U.S. generally accepted accounting principles (GAAP) require the use of lower of cost or
market valuation basis for inventories.
c. During inflation, LIFO inventory accounting tends to overstate the current ratio.
d. Last-In, First-Out (LIFO) inventory accounting makes management of income more difficult
than First-In, First-Out (FIFO) accounting.
15. Which of the following would not be classified as a current asset?
a. Accounts payable
b. Accounts receivable
c. Prepaid expenses
d. Inventory
16. Which of the following would rarely be classified as a current asset?
a. Marketable securities
b. Work-in-process
c. Goodwill
d. Prepaid insurance
17. Assume a company that normally expenses advertising costs was to capitalize and amortize
these costs over 3 years instead. After the third year net income would:
a. be lower only if advertising costs were increasing.
b. be lower, irrespective of the change in advertising costs.
c. be higher, irrespective of the change in advertising costs.
d. be higher only if advertising costs were increasing.
18. Based on GAAP, which of the following is true of comprehensive income?
a. It should be reported as part of sales in the income statement.
b. It can be reported as part of statement of shareholders' equity.
c. It should be reported as part of operating activities in the statement of cash flows.
d. It should be reported as a line item before earnings after tax in the balance sheet.
19. Tecktroniks Company reported in its annual report software refinement expenses of $12
million, $15 million, and $18 million for fiscal years 2005, 2006, and 2007, respectively. At the
end of fiscal 2007, it had total assets of $140 million. Net income was $20 million for fiscal
2007, and it had a marginal tax rate of 35%. If software refinement had been capitalized each
year and amortized over a three-year period beginning in the year the cost was incurred, total
assets at the end of fiscal 2007 would have been:
a. $157 million.
b. $158 million.
c. $185 million.
d. $172 million.
2007, and it had a marginal tax rate of 35%. If software refinement had been capitalized each
year and amortized over a three-year period beginning in the year the cost was incurred, net
income for fiscal 2007 would have been:
a. $29.75 million.
b. $21.95 million.
c. $14.95 million.
d. $31.7 million.
2007, and it had a marginal tax rate of 35%. If the software refinement had been capitalized and
amortized over a three-year period beginning in the year the cost was incurred, but was expensed
for tax purposes, the deferred tax position at the end of fiscal 2005 would have been:
a. a deferred tax credit of $3.5 million.
b. a deferred tax credit of $5.2 million.
c. a deferred tax debit of $4 million.
d. a deferred tax credit of $2.8 million.
a. Employee stock options may reduce agency costs by more closely aligning interests of
stockholders and managers.
b. Employee stock options are not recorded as an expense when granted if they are
out-of-the money under the intrinsic value method.
c. Employee stock options will not affect the share price of a company when exercised.
d. Employee stock options may increase the risk propensity of managers.
23. Which of the following is true of depreciation?
a. It is added back to net income to calculate cash from operations under the direct method.
b. It does not affect the amount of cash realized from operations as it is a noncash flow.
c. It is recorded so that net book value represents fair value of assets.
d. It represents a fund from which to purchase future assets.
24.
Assume all assets are operating assets; all current liabilities are operating liabilities. Return on
net operating assets for 2006 is:
a. 12.03%.
b. 11.30%
c. 11.19%.
d. 9.93%.
25. Assume all assets are operating assets; all current liabilities are operating liabilities. Return
on equity for 2006 is:
a. 20.41%.
b. 19.75%.
c. 17.54%.
d. 18.12%.
26. All other things being equal, which of the following actions will achieve a company's wish to
increase its financial leverage? I. Repurchase stock; II. Issue more dividends; III. Sell accounts
receivable at face value; IV. Split stock 2 for 1
a. I, II, and IV
b. I and IV
c. I, II, and III
d. I and II
27. Which of the following increases when accounts receivable is sold?
a. Debt-to-equity ratio
b. Accounts receivable turnover
c. Current ratio
d. Days' sales in receivables
28. While screening hundreds of companies for investment opportunities, you come across Apex
Corp. It is rated AA by the major rating agencies and has a low Altman's Z-score of 1.15. You
want to do detailed analysis, but you preliminarily conclude:
a. None of the above
b. Apex debt is overvalued.
c. Apex has untapped growth potential.
d. Apex stock should appreciate over the short-term.
29. Which of the following statements is most correct?
a. Active investing is defined as buying and selling stock within six months.
b. Fundamental analysis attempts to value a company by examining the past prices patterns
of a company's stock.
c. Individuals who apply active investment strategies primarily use technical analysis,
fundamental analysis, or a combination.
d. Technical analysis concerns itself with determining the intrinsic value of a stock.
30. Which of the following will cause an increase in net operating income (NOPAT)?
a. Decrease in the return on net operating asset
b. There is not sufficient information
c. No change in the return on net operating assets
d. Increase in the return on net operating assets

31. A common-size income statement would typically be prepared by dividing: all items on
income statement in Year t by sales in Year t.
32. The semi strong efficiency of market implies that: stock prices fully reflect all publicly
available information.
33. Which of the following ratios is not generally considered to be helpful in assessing
short-term liquidity: Total asset turnover
1. Prepaid expenses are usually classified as
TRUE
current assets.
TRUE or FALSE
2. Asset classification is: current

(short-term, within
1 year) or
noncurrent
(long-term beyond
1 year)
3. Compensating balances are: required balances
in a bank in or-
der to fulfil the loan
they are getting.
4. Securitization (or factoring) is: when a company
sells all or a por-
tion of its receiv-
ables to a third
party.
5. Accounts receivable are usually not classified as FALSE

a current asset.
TRUE or FALSE
6. The cash operating cycle is the amount of days be- FALSE

tween making a sale and collecting money from
customers.
TRUE or FALSE
7. If management underestimates the allowance for TRUE

non-collectible accounts, this will cause net
income for the period to be overstated.
TRUE or FALSE
8. The LIFO conformity rule states that if a TRUE
company uses LIFO for tax purposes, it must
also use it for financial reporting purposes.
TRUE or FALSE
9. In a period of rising prices, using FIFO would produce TRUE

a lower cost of goods sold than using LIFO.
TRUE or FALSE
10. 8. Target Inc. has 30 million shares outstanding and i

trades at $50 per share. Target has net identifiable s
assets with a book value of $1,000 million and a fair :
value of $1,200 million. Acquirer Corporation
purchases all of Target Inc. stock for $60 per share. S
How much will Acquirer records as goodwill upon e
acquiring Target? l
e
c
A. $300 million t
o
B. $500 million n
e
C. $600 million :
D. $800 million
11. Depreciation is based on the principle of:
A. allocation.
B. appropriation.
C. lower of cost or market.
D. approbation.
12. A write-down in asset value

C. $600 million
A. allocation
d. required if an
asset is deemed
to have permanent
a. a very rare occurrence. impairment of val-
ue.
b. not allowed under GAAP.
c. results in a direct debit to stockholders' equity.
d. required if an asset is deemed to have permanent

13. Which of the following would not be classified as b. Accounts

a current asset? payable
Select one:
a. Inventory
b. Accounts payable
c. Accounts receivable
d. Prepaid expenses
14. Which of the following is not a common characteristic b. Higher variabili-

of a company choosing to use LIFO rather than FIFO? ty in inventory bal-
Select one: ances
a. Higher cost of goods sold
b. Higher variability in inventory balances
c. Greater expected tax savings
d. Larger in size
15. Look Good Corporation has current assets of $1.1 c. Sell building
million and current liabilities of $1 million. It is for $0.2 million in
close to year-end, and it would like to increase its cash.
current ratio. Which of the following will achieve
this? Select one:
a. Encourage customers to pay their bills more
quickly.
b. Increase short-term borrowings by $0.1 million.
c. Sell building for $0.2 million in cash.
d. Liquidate some of its trading marketable securities.

16. Analysis of a company's assets will help evaluate its: c. II, III, and IV
I. financing ability.
II. solvency.
IV. liquidity.
Select one:
a. I, II, III, and IV
b. I, II, and IV
c. II, III, and IV
d. I, II, and III

17. Klausenheimer Company sells many products. Sol is 18880
one of its popular items. Below is an analysis of the
inventory purchases and sales of Sol for the month
of September. Klausenheimer Company uses the pe-
riodic inventory system.
Using the FIFO assumption, calculate the amount

charged to cost of goods sold for September.
18. Which of the following is not considered an intangible c. Prepaid adver-
asset? tising expenses
Select one:
a. Goodwill
b. Customer lists
c. Prepaid advertising expenses
d. Memberships
19. LIFO liquidation occurs d. the quantity

when: Select one: of goods sold is
greater than the
a. a firm changes from LIFO to another inventory quantity produced.
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 quan-
tity produced.
20. The classification of marketable equity securities A. by manage-
as trading or available-for-sale is determined: ment's intent re-
garding the dispo-
A. by management's intent regarding the disposition sition of the securi-
of the securities. ties.
B. when the securities mature.
C. whether the current assets are greater or less

than the current liabilities.
D. whether management wants to mark them to

market or not.
21. The cash adequacy ratio is normally measured TRUE

over an extended period of time to remove the
effect of
random disturbances.
TRUE or FALSE
22. An increase in a liability is a use of cash. FALSE

TRUE or FALSE
23. Interest income is recorded as an operating inflow of TRUE

cash.
TRUE or FALSE
24. On a statement of cash flows that uses the indirect D. depreciation re-
approach, calculation of cash flow from operations duces net income
treats depreciation as an adjustment to reported net but does not in-
income because: volve an outflow of
cash.
A. depreciation is a direct source of cash.
B. depreciation is an outflow of cash to a

reserve account for the replacement of assets.
C. depreciation reduces net income and involves

an outflow of cash.
D. depreciation reduces net income but does not in-

volve an outflow of cash.
25. Which of the following is not a financing activity in the C. Payment of in-
statement of cash flows? terest on debt
A. Cash dividend
B. Repurchase of common stock
C. Payment of interest on debt
D. Issuance of new debt

26. Which of the following represents an investing activity B. Sale of plant as-
in the statement of cash flows? sets at a loss
A. Depreciation of plant assets
B. Sale of plant assets at a loss
C. Stock dividend
D. Purchase of inventory
27. A firm has net sales of $6,000, cash expenses (in- A. $2, 400
cluding taxes) of $2,800, and depreciation of $1,000.
If accounts receivable increased in the period by
$800, cash flows from operations equal:
A. $2,400.
B. $3,200.
C. $3,400.
D. $4,200.
28. Beginning and ending accounts receivable are B. $418,000

$76,000 and $42,000, respectively. Sales for the
period total $384,000, of which $40,000 was directly
for cash. How much cash was collected from making
sales and collecting accounts receivable?
A. $344,000
B. $418,000
C. $378,000
D. $376,000
29. Which of the following would require an adjustment in B. I and II

the computation of cash flow from operations using
the indirect method?
A. I
B. I and II
C. I and III
D. IV
30. Under the accrual basis of accounting, which of C. I and III

the following statements is true?
I. Reported net income provides a measure of operat-
ing performance.
II. Revenue is recognized when cash is received,
and expenses are recognized when payment is
made.
III. Cash inflows are recognized when they are re-
ceived, and cash outflows are recognized when they
are made.
A. I only
B. III only
C. I and III
D. I, II, and III
31. Accounting changes are usually cosmetic and do T rue

not yield cash flow consequences.
True or False
32. If two firms are identical except that one firm uses per-
True centage-of-completion accounting and the other
uses completed contract accounting for revenue recogni-
tion, the cash flows of the firms will be identical.
True or False
33. As a general rule, revenue is normally c. realizable and

recognized when it is: earned
a. measurable and earned.
b. measurable and received.
c. realizable and earned.
d. realizable and measurable.
34. The matching principle in accounting prescribes that True

costs must be recognized in the same period when
the related revenues are recognized.
True or False
35. Which of the following statements concerning e. Both B and D

deferred taxes is correct? are correct
a. Deferred taxes will not be found in the asset
section of a balance sheet.
b. Deferred taxes arise from temporary differences

in GAAP and tax accounting.
c. Deferred taxes will only decrease when a cash

payment is made.
d. Deferred taxes arising from the depreciation of a

specific asset will ultimately reduce to zero as the
item is depreciated.
e. Both B and D are correct.
36. Which of the following statements is correct? b. II only

II.Tax loss carryforwards result in deferred tax
assets. III. The tax valuation account is used to
adjust deferred tax liabilities if it is "more likely than
not" that they will not result in increased future taxes
a. I only
b. II only
c. III only
d. I and II
37. Gains are earned inflows that arise from a company's FALSE
ongoing business activities.
TRUE or FALSE
38. Revenues are earned inflows that arise from a compa- TRUE
ny's ongoing business activities.
TRUE or FALSE
39. Generally revenue should be recorded when it is prob- FALSE

able and reasonably estimable.
TRUE or FALSE
40. Old Co. was acquired by Raptor for cash, at a sig- a. An increase in
nificant premium to book value, on January 1, Old's total assets
2004.
Since that time, the now wholly owned subsidiary has from 2003 to 2005
had modest growth and all of its earnings have been
distributed to its parent. Some of Old's bonds remain
publicly traded. Which of the following is most likely
be true considering the above scenario?
a. An increase in Old's total assets from 2003 to 2005.
b. An increase in Old's pretax income from 2003

to 2005.
c. An increase in Old's stockholders' equity from

2003 to 2005.
d. A Raptor guarantee of the bonds.

41. If software refinement had been capitalized each year C. $21.95 million
and amortized over a three-year period beginning in
the year the cost was incurred, net income for
fiscal 2007 would have been:
A. $31.7 million.
B. $29.75 million.
C. $21.95 million.
D. $14.95 million.
42. The equity method of accounting for investments B. proportionate

requires: share of investee's
earnings should
A. investment should be marked to market each be recorded as in-
accounting period. vestment income.
B. proportionate share of investee's earnings should
be recorded as investment income.
C. company should not have significant

influence over investee.
D. goodwill related to purchase of investee stock to

be recorded separately on balance sheet.
43. Agwen Corporation owns 25% of the shares of Bron- C. Equity method
wo Corporation, which is traded on the New York
Stock Exchange. Which method is Agwen most likely
to use to account for this investment?
A. Cost method
B. Market method
C. Equity method
D. Consolidation method
44. Which of the following is an effect of the reclassifica- D. There would be
tion of trading securities as available-for-sale? no effect on the
balance sheet and
A. The balance sheet would need to be adjusted unrealized gains
to report the securities at fair market value and or losses on the
there would be no effect on the income statement. date of the transfer
would be included
B.There would be no effect on either the balance sheet in net income.
or the income statement.
C. The balance sheet would need to be adjusted to

report the securities at fair market value and
unrealized gains or losses on the date of the transfer
would be included in net income.
D. There would be no effect on the balance sheet and

45. Held-to-maturity securities are equity securities that FALSE

management intends and has the ability to hold to
maturity.
TRUE or FALSE
46. FALSE
Held-to-maturity securities are always classified as
noncurrent assets.
FALSE
TRUE or FALSE
47. The equity method of accounting for investments FALSE

should be used when a company has a
controlling interest in the investee.
TRUE or FALSE
48. Goodwill recorded as the result of an acquisition is FALSE

defined as the purchase price less the book value
of net assets.
TRUE or FALSE
49. Target Company is trading at $20 a share at the 3500000

end of the year 2006 and has 1 million shares
outstanding. Acquirer Corp. is trading at $50 a
share and
has 3 million shares outstanding. Acquirer offers
Tar- get's shareholders of one share of its stock for
every two shares of Target Company. For the year
ending 12/31/06, Acquirer and Target had earnings
of $5 million and $2 million, respectively. The book
value of Target's net assets is $12 million and fair
value is $15 million as of 12/31/06. The book value of
Acquirer's net assets is $35 million and fair value is
$48 million as of 12/31/06.
How many outstanding shares will Acquirer have if

they are successful in its acquisition?
50. One of the problems with consolidated financial state-

True ments is that all intercompany transactions are not
reported.
True or False
51. When a security is reclassified from available-for-sale True
to trading, it is transferred at fair market value, and
any unrealized gains or losses must be recognized in
the income statement.
True or False
52. Investment securities should always be reported False

at lower of cost or market.
True or False
53. Trading marketable securities: d. are marked to

market each ac-
a. are considered noncurrent assets. counting period.
b. are recorded at amortized cost.
c. are marked to the lower of cost or market

each accounting period.
d. are marked to market each accounting period.
54. A long-term asset is said to be impaired when its book False

value is below its fair value.
True or False
55. For an item to be considered extraordinary, it False

should
be either unusual in nature or infrequent in occur-
rence.
True or False
56. If a company changes the useful life of its assets from d. None of the
10 years to 12 years, this will be recorded as: b. an extraordinary
item.
a. a nonrecurring gain.
above
c. a change in accounting principle.
d. None of the above.
57. Compared with companies that expense costs, b. higher asset lev-
firms that capitalize costs can be expected to els and higher eq-
report: uity levels
a. higher asset levels and lower equity levels.
b. higher asset levels and higher equity levels.
c. lower asset levels and higher equity levels.
d. lower asset levels and lower equity levels.

D. I, II, and IV
58. 3. A company changes its depreciation method
from an accelerated system to straight-line. Which
of the following would normally be true?
I. The change would be discussed in the auditor's

report.
II. The cumulative effect of the change would appear,
net of tax, on the income statement.
III. The change would appear in cash flow from
operations as a cash inflow.
B. I, II, and III
C. II and IV
D. I, II, and IV
59. 2. The capitalization of interest cost during construc- C. increases
tion: net income dur-
A. increases future net income. ing construction
phase.
60. If the software refinement had been capitalized and A. a deferred tax
amortized over a three-year period beginning in the credit of $2.8 mil-
year the cost was incurred, but was expensed for tax lion.
purposes, the deferred tax position at the end of fiscal
2005 would have been:
A. a deferred tax credit of $2.8 million.
B. a deferred tax credit of $3.5 million.
C. a deferred tax credit of $5.2 million.
D. a deferred tax debit of $4 million.
61. Tecktroniks Company reported in its annual report D. $157 million.

software refinement expenses of $12 million, $15
million, and $18 million for fiscal years 2005, 2006,
and 2007, respectively. At the end of fiscal 2007, it
had total assets of $140 million. Net income was $20
million for fiscal 2007, and it had a marginal tax rate
of 35%.
If software refinement had been capitalized each

year and amortized over a three-year period
beginning in the year the cost was incurred, total
A. $185 million.
B. $172 million.
C. $158 million.
D. $157 million.
62. When accounting for an investment under the equity c. I, II, and III
method, what situations may reduce the carrying
value of the investment?
I. Investee experiences significant losses.

II. Investee distributes dividends in excess of earn-
ings.
III. Investee sells additional shares for less than book
value.
IV. Investee engages in a stock split.
a. I and II
b. II and IV
c. I, II, and III
d. I, III, and IV
63. All derivatives are recorded at market value on T rue

the balance sheet.
True or False
64. Top of Form c. II and IV

If a company uses the purchase method to account
for a merger, which of the following is true?
I. Prior year's statements must be restated as if

merged companies had always been one
company.
II. Net income of combined companies will probably
be lower than net income of two separate companies
added together.
III. Goodwill is never recorded.
IV. Assets of acquired company will be recorded on
acquirer's books at their fair value.
a. II, III, and IV
b. I, II, and III
c. II and IV
d. I and III
1. D 1. The majority of financing for most companies
comes from which of the following sources?
2. A 2. Which of the following would not be found listed as
a liability on a company's balance sheet?
C. Bonds payable
D.Taxes payable
3. D 3. Which of the following would be found listed as a
liability on a company's balance sheet?
D. Postretirement benefits other than pension obligation
4. C 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 begin-
ning 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.
5. D 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.
6. C 6. Recording a long-term lease as an operating lease,
as opposed to a capital lease, for a lessee will cause the
following ratios to be:
Debt/Equity Total Asset Turnover
A Higher Lower
B Higher Higher
C Lower Higher
D Lower Lower
A. Option A
B. Option B
C. Option C
D. Option D
7. B 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.
A. I and III
B. II and IV
C. I only
D. II, III and IV
8. C 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.
A. I and III
B. II and IV
C. I only
D. II, III and IV
9. B 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.
10. D 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.
C. An increase in expected average length of lives of
employees.
D. A decrease in the expected rate of return on plan
assets.
11. 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 in-
creased, the PBO will decrease. A. I, III and IV
B. I and III
C. II and IV
D. I and IV
12. C 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.
13. B 13. Hert Corporation acquired a capital lease that is car-
ried on its books at a present value of $100,000
(discounted at 12%). Its annual rental payment is
$15,000. What is the amount of interest expense from
this lease?
First Year Second Year
A 12,000 10,200
B 12,000 11,640
C 12,000 12,350
D 15,000 15,000
A. Option A
B. Option B
C. Option C
D. Option D
14. A 14. Which of the following might give rise to off-
balance sheet financing?
IV.Purchase commitments
B. I, II and IV
C. II, III and IV
D. I, III and IV
15. A 15. Which of the following is an example of off-
A. Operating leases
B. Capital leases
16. C 16. If a company engages in off-balance sheet financing,
generally the effect is: I. to cause assets to be
understated.
IV.to cause liabilities to be understated.
B. I, III and IV
C. I and IV
D. IV only
17. D 17. Minority interest appears on the balance sheet of
some companies. Minority interest: A. is classified as a
liability.
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%.
18. A 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.
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
19. A 19. Dylan Corporation issues a zero-coupon bond with
$100,000 face value, with a 5-year maturity, and the
market rate is 7%. Interest on corporate bonds is
normally paid semiannually. In the liability section of
Dylan's balance sheet, the proceeds from selling the
zero-coupon immediately after issuance will be closest
to:
A. $70,892.
B. $71,299.
C. $70,000.
D. $100,000.
20. A 20. Which of the following statements about stock
dividends is true?
A. Stock dividends increase the number of shares out-
standing.
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.
21. C 21. Treasury stock is:
B. retained earnings that have been appropriated to
make equity investments.
22. C Reling Company reports the following information as
of 12/31/05
A. $12.20
B. $12.40
C. $15.25
D. $15.50
23. C 23. The book value per share of preferred stock is:
A. $ 22
B. $ 20
C. $ 11
D. $ 10
24. D 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 financ-
ing.
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
25. C 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 de-
ductible, 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.
26. D 26. One way for a company to increase its book value
per share is to: A. issue long-term debt.
D. buy back shares at market prices below their book
value.
27. A 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?
B. Current Ratio: Increase; Return on Assets: Decrease
C. Current Ratio: Decrease; Return on Assets: Increase
D. Current Ratio: Decrease; Return on Assets: Decrease
28. C 28. An analyst should consider whether a company ac-
quired 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.
29. B 29. Which of the following lease provisions would cause a

lease to be classified as an operating lease?
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.
30. C 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. D
31. Which of the following is not a component of recog-
nized OPEB cost?
A. Service cost
C. Interest cost
32. B 32. Which of the following is reported in the equity section

B. Treasury stock
D. Debentures
33. C 33. Which of the following is not a component of pension

expense?
A. Service cost
B. Interest cost
34. D 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.
A. I, II and IV
B. I and IV
C. III and IV
D. III only
35. A 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. D
36. If Harms had decreased its compensation growth rate
to 4.5% in 2006, the effect would have been:
C. a decreased ABO.
D. a decreased PBO.
37. B 37. The estimated interest cost for 2007 is:

A. 7.95M.
B. 7.60M.
C. 7.36M.
D. 7.20M.
38. C 38. Synthetic leases may achieve all of the following ben-
efits to the borrower except:
39. A 39. The plan is said to be underfunded, if:

40. D 40. Which of the following is not an actuarial assumption

underlying the computation of the pension obligation?
B. Life expectancy
C. Interest rate
D. Service cost
41. B 41. Pension intensity can be measured by expressing the

pension plan assets and the pension obligation separately
as:
42. B 42. The net deferrals are included in the balance sheet
as part of:
A. assets.
D. long-term liabilities.
1. The net deferrals are included in the balance sheet as B
part of:
A. assets.
D. long-term liabilities
2. Pension intensity can be measured by expressing the
B pension plan assets and the pension obligation
separately as:
3. Which of the following is not an actuarial assumption
D underlying the computation of the pension obliga-
tion?
B. Life expectancy
C. Interest rate
D. Service cost
4. The plan is said to be underfunded, if: A
5. Synthetic leases may achieve all of the following ben- C
efits to the borrower except:
6. If Harms had decreased its compensation growth rate D.
to 4.5% in 2006, the effect would have been:
C. a decreased ABO.
D. a decreased PBO.
7. If a company increases its expected return on plan D
assets this year, the effect would be to:
I. increase plan assets.
II. decrease PBO.
A. I, II and IV
B. I and IV
C. III and IV
D. III only
8. Which of the following is not a component of pension C
expense?
A. Service cost
B. Interest cost
9. Which of the following is reported in the equity section B
B. Treasury stock
D. Debentures
10. Which of the following is not a component of recog- D
nized OPEB cost?
A. Service cost
C. Interest cost
11. On January 1, a company entered into a capital lease C
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
12. Which of the following lease provisions would cause B
a lease to be classified as an operating lease?
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
13. An analyst should consider whether a company ac- C
quired 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 en-
hance its leverage ratios.
D. leases to be treated like operating leases to en-
hance its cash flow.
14. A company's current ratio is 1.5. If the company uses A
cash to retire notes payable due within one year,
would this transaction increase or decrease the cur-
rent ratio and return on assets ratio?
B. Current Ratio: Increase; Return on Assets: De-
crease
C. Current Ratio: Decrease; Return on Assets:
In- crease
D. Current Ratio: Decrease; Return on Assets:
De- crease
15. One way for a company to increase its book value per D
share is to:
A. issue long-term debt.
value.
16. Many of the postretirement health benefit plans of- C
fered 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 postretire-
ment 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 with-
drawn at any time, but funds contributed to a postre-
tirement 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.
17. Which of the following statements concerning contin- D
gencies 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.
B. II, III, and IV
C. II and III
D. II only
18. Treasury stock is: C
B. retained earnings that have been appropriated
to make equity investments.
19. Which of the following statements about stock divi- A
dends 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.
20. Dylan Corporation issues a zero-coupon bond with A
market rate is 7%. Interest on corporate bonds is
normally paid semiannually. In the liability section
of Dylan's balance sheet, the proceeds from selling
the zero-coupon immediately after issuance will be
closest to:
A. $70,892.
B. $71,299.
C. $70,000.
D. $100,000.
21. A lessee must account for a lease as a capital lease if: A
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.
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
22. Minority interest appears on the balance sheet of D
some companies. Minority interest:
A. is classified as a liability.
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%.
23. If a company engages in off-balance sheet financing, C
generally the effect is:
I. to cause assets to be understated.
B. I, III and IV
C. I and IV
D. IV only
24. Which of the following is an example of off-balance A
sheet financing?
A. Operating leases
B. Capital leases
25. Which of the following might give rise to off-balance A
sheet financing?
B. I, II and IV
C. II, III and IV
D. I, III and IV
26. The difference between the accumulated benefit C
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 em-
ployees and the ABO does not.
27. With respect to pension liabilities, which of the follow- D
ing statements are true?
I. The projected benefit obligation (PBO) is always
greater than or equal to the accumulated benefit
ation
oblig-(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
28. D
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.
C. An increase in expected average length of lives
of employees.
D. A decrease in the expected rate of return on plan
assets.
29. Which one of the following statements is false? B.
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 automati-
cally means the company must reclassify the debt as
current.
C. Current liabilities are recorded at their
maturity value, and not their present value.
interest rate is greater than the coupon rate.
30. If a company that leases equipment from another C
company records these leases as operating leases
rather than capital leases, its:
A. I and III
B. II and IV
C. I only
D. II, III and IV
31. If a company leases equipment to other companies B
and records these leases as operating leases rather
than capital leases, its:
A. I and III
B. II and IV
C. I only
D. II, III and IV
32. Recording a long-term lease as an operating lease, as
C opposed to a capital lease, for a lessee will cause
the following ratios to be:
Debt/ Equity Total Asset Turnover
A. Higher; Lower
B. Higher; Higher
C. Lower; Higher
D. Lower; Lower
33. Which of the following is true concerning bond D.
covenants?
A. Bond covenants are restrictions placed on
bondholders to protect rights of equity holders.
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.
34. Which of the following is not a criterion for defining a C
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.
35. Which of the following would be found listed as a D.
D. Postretirement benefits other than pension obliga-
tion
36. Which of the following would not be found listed as a A.
C. Bonds payable
D. Taxes payable
37. The majority of financing for most companies comes D.
from which of the following sources?
38. Securitization through the use of a properly struc- A.
tured SPE may result in the following benefits to the
company:
B. I, II and III
C. I and IV
D. II and III
39. With respect to LIFO, which of the following is incor- D
rect?
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.
40. Goodwill is: C
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
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.
41. During fiscal 2006, Huy sold fully depreciated assets C
purchased assets that cost:
A. $5,000
B. $6,000
C. $10,000
D. $30,000
42. Which of the following is not an analysis issue arising C
with impairment?
A. Evaluating the appropriateness of the amount
of the impairment.
B. Evaluating the appropriateness of the timing of
the impairment.
43. Depreciation is based on the principle of: A
A. allocation.
B. appropriation.
C. estimation.
D. approbation.
44. A firm has a current ratio greater than 1.0. During the
A 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:
AR Turnover Current Ratio
A. Higher; Lower
B. Higher; Higher
C. Lower; Lower
D. Lower; Higher
45. A Corporation wants to increase its current ratio from
C its present level of 1.2 before it ends the fiscal year.
The action having the desired effect is:
D. selling current marketable securities at cash
for their book value.
46. A firm has a current ratio greater than 1.0. If the firm's
C. ending inventory is understated by $3,000 and
beginning inventory is overstated by $5,000, the firm's
A. understated by 2,000; Too low
B. Overstated by 2,000; Too low
C. Understated by 8,000; Too low
D. Understated by 8,000; Too high
47. Which of the following statements about inventories A.
is true?
A. U.S. generally accepted accounting principles
(GAAP) require the use of lower-of-cost or market-
uation basis for inventories.
val-
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.
48. If a LIFO liquidation occurs during a period of rising D
prices, which of the following statements about the ef-
fects on a firm's financial statements, all other things
equal, is generally true?
A. I only
B. II only
C. I and III only
D. II and IV only
49. LIFO liquidation occurs when: D
A. a firm changes from LIFO to another inventory
method.
B. a firm experiences an increase in cost of raw mate-
rials.
D. the quantity of goods sold is greater than the quan-
tity produced.
50. Look Good Corporation has current assets of $1.1M C
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.
51. Under current US GAAP, goodwill is: B
assets.
B. II, III and IV
C. I, II and III
D. II and IV
52. Which of the following is incorrect with respect to B
recognized goodwill on the balance sheet?
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.
53. Target Inc. has 30M shares outstanding and trades at C.
$50 per share. Target has net identifiable assets with
Ac- quirer 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
54. Which of the following is not considered an intangible C
asset?
A. Goodwill
B. Customer lists
D. Memberships
55. A write-down in asset value is: D
56. Companies are supposed to write-down value of as- D
sets if a permanent impairment of value or loss of
utility occurs. If a company writes down its assets this
year the effect on:
This year's ROA New Year's ROA
A. Increased; No Change
B. Decreased; No Change
C. Decreased; Decreased
D. Decreased; Increased
57. Which of the following is not an effect of capitaliza- A
tion?
B. Capitalization usually yields a smoother net
income.
58. One advantage of LIFO over FIFO under normal con- B
ditions is that:
59. Which of the following steps are required to adjust D
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).
60. The inventory costing method used by a company A
(LIFO, FIFO, etc.) will affect:
Asset Turnover Debt/Equity Ratio
A. Yes; Yes
B. Yes; No
C. No; No
D. No; Yes
61. Financial Statements of ABC Corp. indicates that end-
C ing 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 respec-
tively. Purchases in 2006 were:
A. $1,950,000
B. $2,150,000
C. $2,350,000
D. $1,850,000
62. Which of the following is not a common characteristic B
of a company choosing to use LIFO rather than FIFO?
D. Larger in size
63. The use of LIFO rather than FIFO for inventory costing C
under normal economic conditions results in:
IV. unchanged retained earnings.
A. II and III
B. I, II and IV
C. I only
D. I and IV
64. Which of the following would rarely be classified as a B
current asset?
B. Goodwill
D. Work-in-progress
65. Which of the following would not be classified as a B
current asset?
A. Inventory
B. Accounts payable
D. Prepaid expenses
66. An asset is considered to be liquid if: C
67. Analysis of a company's assets will help evaluate its: D.
I. liquidity.
II. solvency.
B. 1, II and IV
C. II, III and IV
D. I, II and III
1. Cash flow from operations is usually less volatile than False
net income
2. An increase in assets would usually show as an T

outflow in the statement of cash flows
3. Cash flow operations will often be negative for rue

companies experiencing tremendous growth
4. Practice requires separate disclosure of cash flows T

in the statement of cash flows
rue
alse
5. A gain on sale of an asset would require adjusting net True

income if preparing the statement of cash flows using
the indirect method
6. net cash flow is not affected by a company's choice T rue

of accounting principles for financial reporting
purposes
7. The only time a company experiences a negative F

cash flow from operations is when they are in
trouble
alse
8. Interest income is recorded as an operating inflow
of cash
T rue
9. The following should be used according to the previ- B. $75,000

ous GAAP (Statement of CF) and using the following
data:
Net income $80,000

Amortization of goodwill 2,000
Decrease in accounts receivable 2,000
Increase in inventory 3,000
Purchase of marketable securities 13,000
Sale of land for $10,000 gain 11,000
Depreciation expense 4,000
Repayment of Debt 8,000
Payment of dividend 3,000
Interest Payment 2,000
What is net cash flow from operations?
A. $74,000
B. $75,000
C. $83,000
D. $85,000
10. A firm has net sales of $6,000, cash expense A. $2,400

(including taxes) of $2,800, and depreciation of
$1,000. If accounts receivable increased in the
period by $800, cash flows from operations equal:
A. $2,400
B. $3,200
C. $3,400
D. $4,200
11. Beginning and ending prepaid insurances is $36,000 D. $21,000

and $26,500 respectively. During the period, $30,500
of insurance expense was recorded. How much new
A. $2,500
B. $15,600
C. $49,000
D. $21,000
12. Hupta Corporation reports for the year ended A. $9,480

Decem- ber 31, 2005, sales of $9,350 and cost of
goods sold at $6,500. Other information as of
December 31 is as follows:
2004 2005
Accounts Receivable $500 $550
Inventory $400 $380
Accounts Payable $250 $290
Cash collected from customers for the year ended
December 31, 2005 is:
A. $9,480
B. $9,430
C. $8,930
D. $8,980
13. Hupta Corporation reports for the year ended B. $6,440
Decem- ber 31, 2005, sales of $9,350 and cost of
goods sold at $6,500. Other information as of
December 31 is as follows:
2004 2005
Accounts Receivable $500 $550
Inventory $400 $380
Accounts Payable $250 $290
Cash paid to suppliers for year ended December 31,
2005 is:
A. $6,480
B. $6,440
C. $5,520
D. $6,560
14. Compared with firms with capital leases, firms B. lower cash flow
with operating leases generally report: from operations
A. higher cash flow from operations
B. lower cash flow from operations
C. Identical cash flow from operations
D. lower or higher cash flow from operations
depending upon market interest rates
15. On a statement of CF that uses the indirect approach, D. depreciation re-

calculation of CF from operations treats duces net income
depreciation as an adjustment to reported net but does not in-
income because: volve an outflow of
A. depreciation is a direct source of cash cash
B. depreciation is an outflow of cash to a reserve
account for the replacement of assets
an outflow of cash
volve an outflow of cash
16. The following should be used according to the previ- C. ($14,000)

ous GAAP (Statement of CF) and using the following
data:
Net income $50,000

Provisions for bad debts 2,000
Increase in inventory 1,000
Increase in accounts payable 2,000
Purchase of new equipment 15,000
Sale of equipment for $10,000 gain 20,000
Depreciation expense 5,000
Repurchase of common stock 10,000
Payment of dividend 4,000
What is net cash flow from financing?

A. $6,000
B. $3,000
C. ($14,000)
D. ($17,000)
17. The following information is given for Building D. $8,000

Inc. As of 12/31 2004 2005
PPE $570,000 $530,000
Accumulated Depreciation 102,000 92,000
Depreciation Expense 30,000 32,000
During 2005 new assets were purchased for
$78,000, and plant assets were sold at a $10,000
loss.
What were the cash proceeds from the sale?
A. $38,000
B. $18,000
C. $10,000
D. $8,000
D. Capitalizing
18. Which of the following would affect cash flow costs that were
from operations? previously ex-
A. Sale of land for a gain pensed
B. Payment of dividends
C. Depreciation of fixed assets
D. Capitalizing costs that were previously expensed
19. Beginning accounts receivable are $76,000. Sales for A. $42,000

the period total $384,000, of which $40,000 was di-
rectly for cash. $418,000 was collected from making
sales and collecting accounts receivable. What is
the ending balance for accounts receivable?
A. $42,000
B. $62,000
C. $82,000
D. $68,000
20. The balance for supplies is $41,000 and $27,000 for $16,500
12/31/05 and 12/31/06, respectively. During 2006, the
company recorded $30,500 of supplies expenses
were recorded. How much new supplies were
purchased?
21. If a company has rapidly growing earnings per share, F alse

their return on net operating assets must be increas-
ing too.
22. A company that operates in a highly competitive in- while having

dustry with low net operating profit margins com- decreasing
pared to companies that operate in less competitive return on net
industries operating
assets
23. The accounting-based stock valuation formula
calculates the value of a stock as the book value of
the net operating assets plus the present value of
future expected dividends discounted at the cost of
equity.
24. When calculating return on net operating assets it

may be necessary to adjust assets to reflect the
fact that not all assets are operating assets
25. If two companies both increase their net income

by 25% over the prior year this means they have
both been equally profitable this year
26. Sustainable equity growth rate is a function of

return on common stockholders' equity and the
dividend payout ratio.
27. It is possible to have increasing earnings growth

T rue
F alse
T rue
F alse
True
T rue
28. A decrease in net operating profit margin will T rue
cause both return on net operating assets and
return on equity to decrease, all other things being
equal
D. Widget Co has
29. Widget Co. and Tools Inc. both operate in the significant operat-
same industry. They are capital-intensive ing leases and
companies producing widgets. Below are Tool Inc. has no
selected data: leases
Widget Tools
Net operating assets/common equity 1.37 1.53
Net operating profit margin 19% 21%
Income Tax rate 47% 28%
Revenues/net operating assets 0.81 0.61
EBIT/revenues 38% 32%
Which of the following statements best explains the

difference in observed net operating asset turnover?
A. Widget Co's lower financial leverage

B. Widget Co uses FIFO and Tools uses LIFO
C. Widget Co's lower tax rate
D.Widget Co has significant operating leases and
Inc. has no leases
Tool
30. Widget Co. and Tools Inc. both operate in the operating profit
same industry. They are capital-intensive margins?
companies producing widgets. Below are
selected data: A. Widget Co's
Widget Tools lower financial
Net operating assets/common equity 1.37 1.53 leverage
Which of the following statements is the most plau-

sible explanation of the difference in observed net
B. Widget Co uses
FIFO and Tools
uses LIFO
B. Widget Co uses FIFO and Tools uses LIFO
C. Widget Co's lower tax rate
D. Widget Co's net operating asset turnover
31. Widget Co. and Tools Inc. both operate in the Despite favorable
same industry. They are capital-intensive changes in the tax
companies producing widgets. Below are rate, return on net
selected data: operating assets
Widget Tools has decreased
Which of the following statements is correct

concerning changes from year 1 to year 2 at
Tricrop?
A. Despite favorable changes in the tax rate, return

net operating assets has decreased
on sets in Year 1,
B. Despite favorable changes in net operating asset which of the
utilization, return on net operating assets has de- following
creased adjustments to
C. Largely because of favorable changes in tax
rates, return on net operating assets has increased
D. Largely due to favorable changes in leverage,
return on net operating assets has increased
32. Selected information for Acme

Corp: Y1 Y2 Y3
Cash $1000 $1500 $1500
Marketable securities 8000 2000 2000
Accounts Receivable, Net 2000 3000 2500
Other current assets 2500 3000 3000
PPE 4500 6000 7000
Less: accumulated depreciation (4000) (4200) (4400)
Goodwill and other intangibles 5000 7500 1000
When calculating Acme's return on net operating as-

C. Non-operating asset adjustment
the asset base is most appropriate to consider?
A. A/D adjustment
C. Non-operating asset adjustment
33. Return on operating assets is a measure of which B. Efficiency

of the following?
A. Profitability
B. Efficiency
C. Solvency
D. Liquidity
34. Widget Co. and Tools Inc. both operate in the C. Widget has
same industry. They are capital-intensive lower interest ex-
companies producing widgets. Below are pense but higher
selected data: taxes
Widget Tools
Widget has a higher EBIT/Revenue but lower net op-

erating profit margin than Tool. Which of the
following statements could explain this better as a
percentage of sales?

B.Widget has greater interest expense but lower
taxes
35. 2006 2005 Long-term debt

Current assets 4,650 4,730 3,830 3,760
Long-term assets 7,120 6,450
Current Liabilities 1,440 1,340
D. 18.12%
Common equity 6,500 6,080
operating income 2,140

interest expense 240
tax expense (40%) 760
net income 1,140
Assume all assets are operating assets; all current

liabilities are operating liabilities
Return on equity for 2006 is:
A. 20.41%
B. 19.75%
C. 17.54%
D. 18.12%
36. When calculating Acme's return on net operating as- D. No asset adjust-
sets in Year 3, which of the following adjustments to ment
the assets base is most appropriate to consider?
A. A/D adjustment
C. Operating asset adjustment
37. When considering the difference between return on C. RNOA is a

net operating assets (RNOA) and return on post-interest mea-
common shareholders' equity (ROCE), which of the sure but ROCE is
following statements is incorrect? not
A. Preferred dividends are deducted from the numer-
ator when calculating ROCE but not when
calculating RNOA
D. RNOA is independent of the form of financing
but ROCE is not
38. Widget Co. and Tools Inc. both operate in the

same industry. They are capital-intensive
companies pro-
ducing widgets. Below are selected data: A. Widget has
Widget Tools higher RNOA
Net operating assets/common equity 1.37 1.53 than Tools
Which of the following statements is correct?

39. Widget Co. and Tools Inc. both operate in the C. Option C
same industry. They are capital-intensive
companies producing widgets. Below are
selected data:
Year 1 Year 2
Which of the following is correct concerning

changes at Tricrop from Year 1 to Year 2
RNOA ROCE
A) Increased Increased
B) Increased Decreased
A. Option A
B. Option B
C. Option C
D. Option D
40. 2005 2004 A. 7.9%
Operating assets 10,500 10,000
Short-term debt 1,000 1,000
Long-term debt 3,500 3,000
Minority interest 500 450
Common equity 5,500 5,000
Operating income 1,350

Interest expense 350
Tax expense (40%) 400
Minority interest 50
Net income 550
Return on operating assets for 2005 is:

A. 7.9%
B. 7.41%
C. 8.78%
D. 8.1%
1. B 1. Which of the following would rarely be classified as
a current asset?
B. Goodwill
D. Work-in-progress
2. B 2. Which of the following would not be classified as
a current asset?
A. Inventory
B. Accounts payable
D. Prepaid expenses
3. C 3. An asset is considered to be liquid if:
4. D 4. Analysis of a company's assets will help evaluate its:
I. liquidity.
II. solvency.
B. 1, II and IV
C. II, III and IV
D. I, II and III
5. C 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:
Inventories 91
A) Deferred Tax Payable
31.85 Retained Earnings
59.15
B) ... 35.65
... 55.35
C) ... 38.96
... 52.04
D) ... 32.85
... 58.15
A. Option A
B. Option B
C. Option C
D. Option D
6. C The following information can be found in ABC Co.'s
2006 2005

and purchased part
633,381 488,581

value
570,430 417,395

dated inventories.
6. What will be the value of inventory for 2006 if ABC
A. 633,485
B. 570,430
C. 633,381
D. 488,581
7. B The following information can be found in ABC Co.'s
2006 2005

and purchased part
633,381 488,581

value
570,430 417,395

dated inventories.
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430
8. A The following information can be found in ABC Co.'s
2006 2005

and purchased part
633,381 488,581

value
570,430 417,395

dated inventories.
A. 3,205,271
B. 3,566,918
C. 3,893,000
D. 4,096,430
9. C 9. The use of LIFO rather than FIFO for inventory
costing under normal economic conditions results in:
IV.unchanged retained earnings.
A. II and III
B. I, II and IV
C. I only
D. I and IV
10. B 10. Which of the following is not a common
characteristic of a company choosing to use LIFO rather
than FIFO?
D. Larger in size
11. C 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
A. $1,950,000
B. $2,150,000
C. $2,350,000
D. $1,850,000
12. A 12. The inventory costing method used by a
company (LIFO, FIFO, etc.) will affect:
Asset TurnOver Debt/Equity Ratio
A) Yes Yes
B) Yes No
C) No No
D) No Yes
A. Option A
B. Option B
C. Option C
D. Option D
13. D 13. Which of the following steps are required to
adjust LIFO to FIFO?
A. Inventory needs to be calculated as reported LIFO
B. Increase deferred tax payable by LIFO reserve
times Tax rate.
C. Retained earnings need to be calculated as reported
rate).
14. B 14. One advantage of LIFO over FIFO under normal
conditions is that:
15. A 15. Which of the following is not an effect of capitalization?
B. Capitalization usually yields a smoother net income.
16. D 16. Companies are supposed to write-down value of as-
sets if a permanent impairment of value or loss of utility
occurs. If a company writes down its assets this year
the effect on:
This year ROA's Next Year ROA's
A) Increased No changed
B) Decreased No changed
A. Option A
B. Option B
C. Option C
D. Option D
17. D 17. A write-down in asset value is:
18. C 18. Which of the following is not considered an
intangible asset?
A. Goodwill
B. Customer lists
D. Memberships
19. C 19. Target Inc. has 30M shares outstanding and trades
at $50 per share. Target has net identifiable assets
with
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. B 20. Which of the following is incorrect with respect
to recognized goodwill on the balance sheet?
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.
21. B 21. Under current US GAAP, goodwill is:
III. exclusive of separately identifiable intangible assets.
IV.recorded only upon purchase of another entity.
B. II, III and IV
C. I, II and III
D. II and IV
22. C The following information can be found in
2006 2005
COGS $2,500,000 $2,000,000
Inventory 180,000 140,000
Net Income 125,000 100,000
Tax Rate 40% 40%
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. D The following information can be found in
2006 2005
COGS $2,500,000 $2,000,000
Inventory 180,000 140,000
Net Income 125,000 100,000
Tax Rate 40% 40%
23. If Manufacturer used FIFO its Net Income for
A. $ 165,000
B. $ 149,000
C. $ 135,000
D. $ 131,000
24. C 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.
25. D 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.
D. the quantity of goods sold is greater than the quantity
produced.
26. D 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?
IV.Net income increases.
A. I only
B. II only
C. I and III only
D. II and IV only
27. A 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. C 29. A Corporation wants to increase its current ratio
from its present level of 1.2 before it ends the fiscal
D. selling current marketable securities at cash for
their book value.
29. C 28. A firm has a current ratio greater than 1.0. If the
beginning inventory is overstated by $5,000, the firm's
A) understated by $2,000 too low
B) overstated by $2,000 too low
C) understated by $8,000 too low
D) understated by $8,000 too hig
A. Option A
B. Option B
C. Option C
D. Option D
30. A 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:
Accounts Receivable Turnover Current Ratio
A) higher lower
B) higher higher
C) lower lower
D) lower higher
A. Option A
B. Option B
C. Option C
D. Option D
31. A 31. Depreciation is based on the principle of:

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

12/31/05 12/31/06
Land $100,000 $100,000
Machines $80,000 $70,000
$170,000
Net P,P&E $155,000 $160,000
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. A 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
12/31/05 12/31/06
Land $100,000 $100,000
Machines $80,000 $70,000
$170,000
Net P,P&E $155,000 $160,000
35. During fiscal 2006, Huy sold fully depreciated assets
purchased assets that cost:
A. $5,000
B. $6,000
C. $10,000
D. $30,000
36. C 36. Goodwill is:
A. the excess of the purchase price of net assets over the
B. the excess of the appraised value of net assets over the
C. the excess of the purchase price of net assets over the
D. the excess of the appraised value of net assets over the
37. D 37. With respect to LIFO, which of the following is incor-

rect?
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 state-
ment than FIFO.
D. LIFO results in inventory levels on the balance sheet
that are closer to current cost than FIFO.
38. A 38. Securitization through the use of a properly structured

SPE may result in the following benefits to the company:
B. I, II and III
C. I and IV
D. II and III
1. B. 418,000 Beginning and ending accounts re-
ceivable are 75,000 and 42000, re-
spectively. Sales for the period total
64,000, of which 40,000 was
directly for cash. How much cash
was collected from making sales
and collecting accounts
receivable?
A. 4,000
B. 418,000
C. 378,000
D 376,000
2. B. sale of plant assets at a loss Which of the following represents an
investing activity in the statement of
cash flows
A. depreciation of plant assets
B. sale of plant assets at a loss
C. stock dividend'.
D. purchase of inventory
3. c. payment of interest on debt Which of the following is not a financ-
ing activity in the statement of cash
flows?
a. Cash dividend
b. repurchase of common stock
c. payment of interest on debt
d. issuance of new debt
4. d. depreciation reduces net On a statement of cash flows that

income but does not involve an uses the indirect approach, calcu-
outflow of cash. lation of cash flow from operations
treats depreciation as an
adjustment to reported income
because:
a. depreciation is a direct source of

cash
b. depreciation is an outflow of cash

to a reserve account for the replace-
ment of assets
c. depreciation reduces net income

and involves an outflow of cash
d. depreciation reduces net income

but does not involve an outflow of
cash.
5. d. decrease in accounts payable Which of the following items is de-
ducted from net income to arrive at
cash flow from operations when
using the indirect method?
a. depreciation expense
b. amortization expense
c. Decrease in accounts receivable
d. decrease in accounts payable
6. d. partly as operating cash flows Firms report payments for capital

and partly as financing cash flows leases in the cash flow statement:
a. only as financing cash flows
b. only as investing cash flows
c. partly as operating cash flows

and partly as investing cash flows
d. partly as operating cash flows and

partly as financing cash flows
7. b. lower cash flows from operations Compared with firms with capital
leases, firms with operating leases
generally report:
a. higher cash flows from operations
b. lower cash flows from operations
c. identical cash flow from

operations
d. lower or higher cash flow from

operations depending upon
market interest rates
8. d. Capitalizing costs that were Which of the following would affect

previously expensed cash flow from operations?
a. Sale of land for gain
b. Payment of dividends
c. Depreciation of fixed assets
d. Capitalizing costs that were previ-

ously expensed
9. b. does not affect the amount of Which of the following is true?

cash realized from operations as it Depre- ciation:
is a non-cash flow
a. is recorded so that net book
value represents fair value of assets
b. does not affect the amount of cash

realized from operations as it is a
non-cash flow
c. is added back to net income to

calculate cash from operations
under the direct method
d. represents a fund from which to

purchase future assets
10. c. affect both net income and 35) Which of the following is true?
cash flow from operations The choice of LIFO versus FIFO will:
a. not affect the net income or

cash flow from operations
b. not affect net income but will

affect cash flow from operations
c. affect both net income and cash

flow from operations
d. affect net income but will not

affect cash flow from operations
11. b. an increase in working capital Which of the following would be con-

sidered a use of cash?
a. depreciation
b. an increase in working capital
c. sale of bonds
d an increase in wages payable
12. C. Measures a company's ability to The cash flow adequacy ratio

generate sufficient cash flows from
operations to cover capital a. measures a company's ability to
expenditures, inventory additions generate sufficient cash flow from
and dividends investing to cover debt
repayments
b. measures a company's ability to

operations to cover capital
expenditures and debt
repayments
c. Measures a company's ability to
operations to cover capital expendi-
tures, inventory additions and divi-
dends
d. measures a company's ability to

operations to cover capital expendi-
tures, debt repayment and
dividends
13. d. Indicates that a company's in-
ternally generated cash flows have a cash flow adequacy ratio, when
not been sufficient to cover measured over the last several
dividend payment and support past year, of less than one:
growth levels
a. Indicates that a company's net
income is too low relative to its
sale level
b. Indicates that a company

should decrease its dividend
payout ratio
c. Indicates that a company needs

to pay down its debt to decrease
interest costs
d. Indicates that a company's inter-

nally generated cash flows have not
been sufficient to cover dividend pay-
ment and support past growth levels
14. TRUE Companies can construct the state-

ment of cash flows using either the
direct method or the indirect method
15. F ALSE Cash flow from operations is
usually less volatile than net income
16. FALSE The only time a company experi-
ences a negative cash flow from
operations is when they are in
trouble.
17. TRUE Cash flow from operations will
often be negative for companies
experiencing tremendous growth.
18. TRUE Cash flow from investing when av-
eraged over an extended period of
time would normally be expected
to be negative (i.e. net outflow)
19. FALSE Cash flow from financing is normally
negative during the start-up phase
for a company.
20. TRUE Over an extended period of time
average cash flow from operations
would be expected to be higher
than average net income
21. FALSE Amortization of goodwill reduces
net income and is a cash outflow
22. TRUE Payment of a 5% stock dividend
will not appear in the statement of
cash flows.
23. TRUE A gain on sale of an asset would re-
quire adjusting net income if prepar-
ing the statement of cash flows
using the indirect method.
24. FALSE An increase in accounts receivable
does not require adjusting net in-
come if preparing the statement of
cash flows using the indirect
method.
25. TRUE Depreciation and amortization ex-
pense needs to be added back to
net income if preparing the
statement of cash flows using the
indirect method.
26. TRUE An increase in assets would usually
show as an outflow in the statement
of cash flows.
27. TR UE A decrease in liabilities would usually
show as an outflow in the statement
of cash flows.
28. FALSE Practice requires separate disclo-

sure of cash flows in the statement
of cash flows.
29. TRUE Many financial analysts subtract in-

terest paid from cash from opera-
tions, and reclassify it as part of cash
from financing activities
30. F ALSE Three formats are acceptable under

SFAS 95 for presenting cash flow
from operations: the direct method,
the summary method and the indi-
rect method
31. F ALSE The financing section of the state-

ment of cash flows contains all cash
inflows and cash outflows relating to
the financing of a company.
32. TRUE Depreciation expense decreases net

income but is not a use of cash.
33. F ALSE Cash flows from operations is bet-

ter measure of profitability than net
income as it is less susceptible to
manipulation by management
34. TRUE Users sometimes compute net in-

come plus depreciation and amorti-
zation as a crude proxy for operating
cash flows.
35. F ALSE Increases in working capital are a
source of funds.
36. TRUE Taxes paid on capital gains from
the sale of marketable securities are
recorded as cash outflows from op-
erations.
37. TRUE Net cash flow is not affected by
a company's choice of accounting
principles for financial reporting pur-
poses.
38. FALSE In firms that are experiencing
tremendous growth, it is rare that
net income will exceed cash
generated by all activities
39. TRUE Interest income is recorded as an
investing inflow of cash.
40. FALSE An increase in a liability is a use of
cash.
41. TRUE The cash adequacy ratio is normally
measure over an extended period
of time to remove the effect of
random disturbances
42. F ALSE The cash reinvestment ratio mea-
sures the percentage of money
reinvested in the company's
operating asset's that is funded by
retained earnings
1. A stable current Which of the following would best indicate that the firm
ratio with declin- is carrying excess inventory?
ing quick ratios
2. Current ratio Typically, which of the following would be considered to

be the most indicative of a firm's short-term debt paying
ability?
3. A grocery store Which of the following types of businesses would
normally have the shortest operating cycle?
4. Cash restricted Which of the following accounts would not be classified

for retirement as a current asset?
of bonds A. Cash restricted for retirement of bonds
B. Cash and equivalents
C. Cash and certificates of deposit
D.Time deposits
E. Cash
5. Merchandise in- Which of the following ratios does not represent some
ventory turnover form of comparison between accounts in current assets
and accounts in current liabilities?
A. Working capital
B. Current ratio
C. Acid-test ratio
D. Cash ratio
E. Merchandise inventory turnover
6. Prepayments Which of the following current assets will not generate

cash in the future?
A. Prepayments
B. Accounts receivable
C. Inventory
D. Marketable securities
E. Notes receivable
7. A seller of resort Which of the following types of business would normally

property have the longest operating cycle?
8. Company B will Company A uses LIFO and Company B uses FIFO for
have relatively inventory valuation. Otherwise, the firms are of similar
higher profit and size and have the same revenue and expense. Assume
a higher current inflation. In analyzing liquidity and profitability of the two
ratio. firms, which of the following will hold true?
9. All of the an- Which of the following does not bear on the quality of
swers bear on receivables?
the quality of re- A. Shortening the credit terms
ceivables
B. Lengthening the credit terms
C. Right of return privilege
D. Lengthening the outstanding period
E. All of the answers bear on the quality of receivables

10. Sales volume de- Which of the following reasons should not be
creases material- considered in order to explain why the receivables
ly late in the appear to be ab- normally high?
year.
A. Sales volume expanded materially late in the year.
B. Receivables have collectibility problems and

possibly some should have been written off.
C. The company seasonally dates invoices.

D. Material amount of receivables are on the
installment basis.
E. Sales volume decreases materially late in the year.

11. Investments Which of the following would not be classified as a
current asset?
A. Cash
B. Marketable securities
C. Receivables
D. Inventories
E. Investments
12. Next-In, First-Out Which of the following is not an acceptable inventory

(NIFO) costing method?
A. Specific identification
B. Last-In, First-Out (LIFO)
C. First-In, First-Out (FIFO)
D. Average cost
E. Next-In, First-Out (NIFO)
13. Current ratio Which of the following ratios would generally be used
to evaluate a firm's overall liquidity position?
14. current assets Prepayments should be reported in the:

section of the
balance sheet.
1. 1. Which of the following is not a reason for over
economic income and accounting income to differ?
A. Transaction basis
C. Conservatism
D. Earnings management
2. 2. As a general rule, revenue is normally

recognized when it is:
A. measurable and earned.
B. measurable and received.
D. realizable
3. 3. Which of the following measures of accounting

income is typically reported in an income
statement?
A. Net income
B. Comprehensive income
C. Continuing income
D. All of the above
4. 4. According to FASB, initial franchise fees should

be recognized as income when:
A. the franchiser has substantially performed or sat-
isfied all material services and conditions.
B. the franchiser has collected the majority of fee
in cash.
C. the franchisee shows the ability to pay the fee.
D. the franchiser bills the franchisee.
5. 9. Which of the following are correct?

I. If a company uses straight-line depreciation for fi-
nancial reporting purposes, it is very likely they
have a deferred tax liability with respect to its
depreciable assets.
II. Straight line depreciation yields an increasing rate
of return on book value over the life of asset.
III. Straight line depreciation results in lower tax
payments than accelerated depreciation methods
D. All of the above
A. the franchiser has substantially performed or satisfied

all material services and conditions.
B. I, II and IV
the life of an asset.
IV. If a company revises its estimate of the useful life
of an asset upwards this will decrease annual
depreciation expense.
B. I, II and IV
C. I, II and III
D. I and IV
6. 10. Which of the following statements concerning D. Deferred

deferred taxes is correct? taxes arising
A. Deferred taxes will not be found in asset section from the
of the balance sheet. depreciation of a
specific asset will
B. Deferred taxes arise from permanent differences in ultimately reduce
GAAP and tax accounting. to zero as the
C. Deferred taxes will only decrease when a item is
cash payment is made. depreciated.
D. Deferred taxes arising from the depreciation of a
specific asset will ultimately reduce to zero as the
is depreciated.
item
7. 11. Differences in taxable income and pretax beginning

accounting income that will not be offset by
corresponding differences or "turn around" in future
periods are called:
A. timing differences.
B. circular differences.
C. permanent differences.
D. reverse differences.
8. Tecktroniks Company reported in its annual report

software refinement expenses of $12M, 15M and 18M
for fiscal years 2005, 2006 and 2007, respectively. At
the end of fiscal 2007, it had total assets of 140M.
Net income was 20M for fiscal 2007, and it had a
marginal tax rate of 35%.
15. If software refinement had been capitalized each

C. permanent differences.
D. $157M
in the year the cost was incurred, total assets at the
end of fiscal 2007 would have been:
A. $185M
B. $172M
C. $158M
D. $157M
9. Tecktroniks Company reported in its annual report C. $21.95M

software refinement expenses of $12M, 15M and 18M
for fiscal years 2005, 2006 and 2007, respectively. At
the end of fiscal 2007, it had total assets of 140M.
Net income was 20M for fiscal 2007, and it had a
marginal tax rate of 35%.
16. If software refinement had been capitalized each
year and amortized over a three year period
beginning in the year the cost was incurred, net
income for fiscal 2007 would have been:
A. $31.7M
B. $29.75M
C. $21.95M
D. $14.95M
10. 17. If the software refinement had been capitalized and A. A deferred tax
amortized over a three year period beginning in the credit of $2.8M
year the cost was incurred, but was expensed for tax
purposes, the deferred tax position at the end of
A. A deferred tax credit of $2.8M
B. A deferred tax credit of $3.5M
C. A deferred tax credit of $5.2M
D. A deferred tax debit of $4M
11. 18. If a company that normally expenses advertising C. after the third
costs was to capitalize and amortize these costs over year net income
3 years instead: would be higher
A. after the third year net income would always (if it is capital-
be higher if it is capitalized. ized) only if adver-
B. after the third year net income would always tising costs were
be lower if it is capitalized. increasing.
C. after the third year net income would be higher (if it
D. after the third year net income would be lower (if it year was $200
is capitalized) only if advertising costs were million. It was
increasing. not able to take
a deduction
12. 19. Compared with companies that expense costs,
firms that capitalize costs can be expected to report:
A. higher asset levels and lower equity levels.
B. higher asset levels and higher equity levels.
C. lower asset levels and higher equity levels.
D. lower asset levels and lower equity levels
13. 20. Two growing firms are identical except that one
firm capitalizes whereas the other firm expenses
costs for long-lived resources over time. For these
two firms, which of the following statements is
generally true?
I. The expensing firm will show a more volatile
pattern of reported income than capitalizing firm.
II. The expensing firm will show a less volatile
pattern of return on assets than the capitalizing firm.
III.The expensing firm will show lower cash flows
from operations than the capitalizing firm.
A. I only
B. II only
C. I and III only
D. II and III only
14. 21. The capitalization of interest cost during

construction:
A. increases future net income.
15. 23. Exoil recorded an expense and corresponding li-

ability to recognize potential losses relating to an oil
spill in 2006 of $10 million. Its net income for the
is capitalized) only if advertising costs were increas-
ing.
B. higher asset levels and higher equity levels.
C. I and III only
C. increases net income during construction phase.
C. recognized a
deferred tax asset.
for tax purposes until later years when it actually
paid cash out in relation to this event. In 2006, with
respect to this, Exoil would have:
A. recognized a deferred tax liability.
B. recognized a tax loss carryforward.
C. recognized a deferred tax asset.
D. recognized a deferred equity loss.
16. 24. Which of the following statements are correct? B. II only

II.Tax loss carryforwards result in deferred tax
assets. III. The tax valuation account is used to adjust
deferred tax liabilities if it is "more likely than not"
that they will not result in increased future taxes.
A. I only
B. II only
C. III only
D. I and II
17. 25. Which of the following will cause the reported A. I, II, and IV
effective tax rate to differ from the federal
statutory tax rate?
I. Foreign tax rates that are lower than federal
statutory tax rate.
II. Tax-exempt income.
III. Different depreciation methods for tax and
financial reporting purposes.
IV.Foreign tax rates that are higher than federal
statutory tax rate.
A. I, II, and IV
B. I, II and III
C. I and II
D. III only
18. 26. If a company changes the useful life of its D. None of the
assets from 10 years to 12 years, this will be above
recorded as:
A. a non-recurring gain.
B. an extraordinary item.
C. a change in accounting principle.
19. 27. If a company estimates that its expected return D. a change in ac-
on pension plan assets will increase to 9.5% from counting estimate.
9.0%, this would be considered:
A. an extraordinary gain.
B. a change in accounting principle.
C. a prior period adjustment.
D. a change in accounting estimate.
20. 28. A company changes its depreciation method D. I, II and IV

from an accelerated system to straight line. Which of
the following would normally be true?
I. The change would be discussed in the
auditor's letter.
II. The cumulative effect of the change would
appear net of tax on the income statement.
III. The change would appear in cash flow from
operations as a cash inflow.
B. I, II and III
C. II and IV
D. I, II and IV
21. 29. Which of the following is true with respect to A. I and IV

extraordinary items?
I. Extraordinary items are recorded net of tax in
income statement.
II. Extraordinary items, by definition, are probable
and unusual in nature.
III. By definition, gains and losses from strikes
are always extraordinary.
IV. By definition, gains and losses from sale of
plant, property and equipment are never
extraordinary.
A. I and IV
B. I, III and IV
C. II and IV
D. I, II and III
22. 30. Which of the following would be considered C. III only

an extraordinary item?
I. Write-down of receivables
II. Gains on disposal of a business segment
III. Loss of inventory resulting from a fire
IV. Loss resulting from a strike
A. I and IV
B. I, III and IV
C. III only
D. I, II and III
23. 31. Which of the following items is not included in A. Unreal-

the calculation of net income but is included in ized holding
the calculation of comprehensive income? gain on avail-
A. Unrealized holding gain on available-for-sale mar- able-for-sale mar-
ketable securities. ketable securities.
B. Unrealized holding gain on trading marketable se-
curities.
C. Gain from early extinguishments of bonds.
D. Gain arising from sale of available-for-sale
marketable securities
24. 32. Which of the following statements is true? B. must be report-

Under GAAP, comprehensive income: ed in addition to
A. may be reported in addition to net income. net income.
B. must be reported in addition to net income.
C. may be reported instead of net income.
D. must be reported instead of net income.
25. 33. Which of the following statements is B. will not affect

incorrect? Employee stock options the share price of
A. are not recorded as an expense when granted the company
if they are at or out-of-the money under the when exercised.
intrinsic value method.
B. will not affect the share price of the company when
exercised.
C. may reduce agency costs by more closely aligning
interests of stockholders and managers.
D. may increase the risk propensity of managers.
26. A company's net income is $100,000, and its weight- C. $5

ed-average shares outstanding are 20,000. During
the year, the company issues 5,000 ESOs at an
exercise price of $20.
34. What will be the basic EPS if average stock price

during the year is $35 and treasury shares that can
be purchased are 1000?
A. $3
B. $6
C. $5
D. $4.17
27. A company's net income is $100,000, and its weight- B. $5

36. What will be the diluted EPS if average stock
price during the year is $15 and treasury shares that
can be purchased are 6000?
A. $3
B. $5
C. $6
D. $4.17
28. A company's net income is $100,000, and its weight- D. $4.17

37. What will be the diluted EPS if average stock
price during the year is $35 and treasury shares that
can be purchased are 1000?
A. $3
B. $5
C. $6
D. $4.17
29. 38. Which of the following is not an D. I, II, III and IV
extraordinary item?
I. Loss on abandonment of property
II. Gain on disposal of a business segment
III. Effect of a strike against a key supplier
IV.Write-down of deferred research and
development costs
A. I and III
B. II and IV
C. I, II and III
30. 39. Which of the following overall accounting A. Historical cost

concepts has a number of exceptions under
GAAP?
A. Historical cost
B. Transaction basis
C. Conservatism
D. Accrual accounting
B. will increase
31. 40. When comparing expensing or capitalizing (with over time
straight-line depreciation) software, return on using
assets capitalization.
A. will decrease over time using capitalization.
B. will increase over time using capitalization.
C. will be constant using expensing.
D. will initially be higher under expensing.
C. Interest cost
32. 41. The intrinsic value approach ignores two types and option cost
of costs:
A. Interest cost and opportunity cost
B. Opportunity cost and exercise cost
C. Interest cost and option cost
D. Carrying cost and interest cost
d. All of these
33. QN=1 Which of the following would be found listed
as a liability on a company's balance sheet?
a. Capital lease obligations
b. Bonds payable
c. Taxes payable
d. All of these
34. QN=2 Which of the following is an example of off- d. Issuance of

balance sheet financing? common stock
a. Operating leases
b. Capital leases
c. Issuance of bonds
d. Issuance of common stock
35. QN=3 Operating leases is listed on: a. off-balance

a. off-balance sheet financing sheet financing
b. balance sheet
c. income statement
d. statement of cash flow
36. QN=4 Which of the following is an example of off- a. none of these

balance sheet financing?
a. none of these
b. Capital leases
37. QN=5 Which of the following is an example of off- a. none of these

balance sheet financing?
a. none of these
b. Capital leases
38. QN=6 Which of the following items would rarely a. none of these.
be classified as a current asset?
a. none of these.
b. Marketable Securities.
c. Work-in-progress.
d. Prepaid insurance.
39. QN=7 The concepts of profitability are given by: d. All of these
a. Return on assets
b. Return on common equity
c. Earnings per common share
d. All of these
40. QN=8 Which ratio is a measure of how well the d. All of these
firm uses its assets to generate income:
a. Return on assets
b. Return on common equity
c. Earnings per common share
d. None of these
41. QN=9 Which activity help to provide necessary a. Financing activi-

funds to start a business and expand it after it ty
begins operating?
a. Financing activity
b. Operating activity
c. Investing activity
d. None of these
42. QN=10 Which activity help to provide valuable c. Investing activity

assets required to run a business?
d. None of these
43. QN=11 Which activity focus on selling goods and b. Operating activi-
services, but they also consider expenses as ty
important elements of sound financial management.
d. None of these
44. QN=12 Which ratio indicates the number of times a. Inventory

merchandise inventory moves through a business? turnover
a. Inventory turnover ratio ratio
b. Asset turnover ratio
c. Day in inventory
d. Account receivable ratio
45. QN=13 Which ratio measures the extent to which a. Leverage ratios
a firm relies on debt financing:
a. Leverage ratios
b. Liquidity ratios
c. Profitability ratios
d. Efficiency ratios
46. QN=14 Which statement is true: d. Total liabilities

a.Total liabilities to total assets ratio <50 percent to total assets ra-
indicates that a firm is relying more on borrowed tio > 50 percent
money than owners' equity. indicates that a
b. Total liabilities to total assets ratio > 60 percent in- firm is relying
dicates that a firm is relying more on borrowed more on borrowed
money than owners' equity. money than
c.Total liabilities to total assets ratio <60 percent owners' equity.
indicates that a firm is relying more on borrowed
money than owners' equity.
d. Total liabilities to total assets ratio > 50 percent in-
dicates that a firm is relying more on borrowed
than
money owners' equity.
47. QN=15 Which activity is an example of operating c. All of these

activities?
a. Providing service
b. Advertising
c. All of these
d. Paying utilities
48. QN=16 Which activity is an example of operating d. All of these

activities?
a. Selling goods
b. Paying employees
c. Advertising
d. All of these
49. QN=17 Which item is listed on the owner equity of d. All of these
the balance sheet?
a. Paid-in capital
b. Common stock
c. Retained earning b. Comprehens
d. All of these ive income
50. QN=18 Which asset is very liquid that can be

converted into cash quickly:
a. Trading Marketable Securities
b. Inventory
c. Prepaid expense
d. All of these
51. QN=19 Trading Marketable Securities:

a. are considered current assets.
b. are considered current liability
c. are considered non-current liability
c
52. QN=20 The classification of marketable equity

securities as trading or available-for-sale is
determined by:
a. management's intent regarding the disposition of
the securities
b. when the securities mature
c. whether the current assets are greater or less than
the current liabilities
d. whether management wants to mark them to

market or not
53. QN=21 As a general rule, revenue is normally

recognized when it is:
a. received
b. realizable and received
c. realizable and earned
d. realizable
54. QN=22 Which of the following measures of

accounting income is typically reported in an income
statement?
a. Net income
a. Trading Mar- ketable Securities
a. Trading Mar- ketable Securities
a. management's intent regarding the disposition of the

securities
c. realizable and earned
d. All of these
c. Continuing income
d. All of these
55. QN=23 Which statement is true: b. The match-

a. Economic income and accounting income are ing principle in
always the same. accounting pre-
b. The matching principle in accounting prescribes scribes that costs
that costs must be recognized in the same period must be recog-
when the related revenues are recognized. nized in the same
c. Gains are cash inflows that arise from the period when the
company's ongoing business activities. related revenues
d. Losses are cash outflows that arise from the are recognized.
company's ongoing business activities.
56. QN=24 Which statement is true: d. None of these

a. Gains are cash inflows that arise from the
company's ongoing business activities.
b. Gains are cash outflows that arise from the
company's ongoing business activities.
c. Losses are cash outflows that arise from the
company's ongoing business activities.
d. None of these
57. QN=25 Major current assets include: c. all of these

a. cash and cash equivalents
b. marketable securities
c. all of these
d. derivative financial instruments
58. QN=26 It is an indicator of a company's ability to a. Liquidity

meet financial obligations
a. Liquidity
b. Solvency
c. Profitability
d. Efficiency
59. QN=27 Major noncurrent assets include: b. All of these

a. Property
b. All of these
c. Equipment
d. Investments
60. QN=28 Which statement is true: d. Solvency refers

a. Liquidity refers to the ability of a company to to the ability of a
meets its long-term (and current) obligations. company to
b. Profitability refers to the ability of a company meets its long-
to meets its long-term (and current) obligations. term (and current)
obliga-
c. Efficiency refers to the ability of a company to meets tions.
its long-term (and current) obligations.
d. Solvency refers to the ability of a company to meets
its long-term (and current) obligations.
61. QN=29 In indirect method, the net income figure a. the income
from the income statement is used to calculate the statement is pre-
amount of net cash flow from operating activities pared on accrual
because:
a. the income statement is prepared on accrual basis basis in which rev-
in which revenue is recognized when earned and not enue is
when received recognized when
earned and
b. the income statement is prepared on cash basis not when received
in which revenue is recognized when earned and
not when received
c. the cash flow statement is prepared on accrual
basis in which revenue is recognized when
earned and not when received
d. the cash flow statement is prepared on cash basis
in which revenue is recognized when earned and
not when received
62. QN=30 Which statement is true: d. Financial analy-

a. Financial analysis is the use of financial statements sis is the use
to analyze a company's financial position and perfor- of financial state-
mance. and balance
b. Financial analysis is the use of balance sheet to sheet to analyze
analyze a company's financial position and a company's
performance, and to assess future performance. financial
c. Financial analysis is the use of income statement position and
performance, and to assess future per- ments to analyze
a company's finan-
cial position and
performance, and
to assess future
performance.
formance.
d. Financial analysis is the use of financial statements
to analyze a company's financial position and perfor-
mance, and to assess future performance.
1. a 1. Which of the following ratios best measures the
profitability of a company?
A. Return on equity
B. Gross margin
C. Current ratio
D. Net operating asset turnover
2. a 2. Below are the net operating asset turnovers and net
operating profit margins for companies that operate in
three different industries (A, B and C). The industries
are grocery stores, oil extraction and drug industry.
Match the industry to A, B or C
A. Choice A ( b , c ,a )
B. Choice B(b,a,c)
C. Choice C(c,a,b)
D. Choice D(c,b,a)
3. d 3. Which of the following statements is correct?
A. Net operating profit margin divided by net
operating asset turnover equals return on net
operating assets
B. Return on net operating assets can be disaggregated
into net operating profit margin and leverage
C. Return on equity equals return on net operating
assets less interest, net of tax
D. Return on equity can be disaggregated into net op-
erating profit margin, net operating asset turnover and
leverage
4. c 4. Which of the following could explain a decrease in
net operating asset turnover for a company?
A. Switching from straight line to accelerated
depreciation for financial reporting purposes
B. An increase in the financial leverage of the company
C. Addition of a new plant for production purposes
D. Decrease cost of production inputs
5. c 5. Err Company has a major lawsuit against them for
unsafe products. It recognizes a huge liability in 2004
of
$300M. The effect of this liability is to decrease
stockholders' equity by 50%. In 2005, the effect of
recognizing this liability, all else equal, is:
A. Return on net operating assets will increase
dramatically
B. Return on net operating assets will decrease dramati-
cally
C. Return on equity will increase dramatically
D. Return on equity will decrease dramatically
6. a 6. Return on operating assets for 2005 is:
A. 7.9%
B. 7.41%
C. 8.78%
D. 8.1%
7. d 7. Return on common equity for 2005 is:
A. 11.42%
B. 10.0%
C. 11.0%
D. 10.47%
8. b Assume all assets are operating assets; all current
liabilities are operating liabilities.
8. Return on net operating assets for 2005 is:

A. 11.30%
B. 12.73%
C. 9.93%
D. 11.19%
9. d 9. Return on equity for 2005 is:
A. 20.41%
B. 19.75%
C. 17.54%
D. 18.12%
10. c
10. Which of the following could cause return on net oper-
ating assets to increase, all things other equal?
A. A decrease in interest rate on debt
B. Increase in days accounts receivable are outstanding
C. Increase in inventory turnover
D. Decrease in gross margin
11. b 11. Eyster Corporation reported $10M in earnings and
paid dividends of $3M for fiscal 2005.Return on equity
and dividend payout are expected to remain constant for
the foreseeable future. Net book value at the end of
fiscal 2004 was 100M. Cost of equity is 10%. Using the
residual income method, the intrinsic value of Eyster's
stock at the end of 2005 should be:
A. $110M
B. $107M
C. $100M
D. not determinable
12. b 12. When calculating return on net operating assets,
interest expense net of tax is added back to net
income for purposes of calculating the numerator.
What tax rate should be used?
A. effective tax rate
B. marginal tax rate
C. statutory federal tax rate
D. statutory federal tax rate plus statutory state tax rate
13. b 13. Return on Net Operating Assets for Year 1 is:
A. 30.8%
B. 16.3%
C. 15.4%
D. 14.5%
14. c 14. Return on Common Equity for Year 1 is:
A. 19.0%
B. 19.60%
C. 21.08%
D. 26.03%
15. c 15. Which of the following is correct concerning
changes at Tricrop from Year 1 to Year 2?
A. Choice A
B. Choice B
C. Choice C( decrease/decrease)
D. Choice D
16. a 16. Which of the following statements is correct
concerning changes from year 1 to year 2 at Tricrop?
A. Despite favorable changes in the tax rate return on net
operating assets has decreased
B. Despite favorable changes in net operating asset
utilization return on net operating assets has decreased
C. Largely because of favorable changes in tax rates
return on net operating assets has increased
D. Largely due to favorable changes in leverage return
on net operating assets has increased
17. d 17. Which of the following will increase the
sustainable equity growth of a company, all other
things equal?
A. Increase dividend payout
B. Pay suppliers more quickly
C. Pay suppliers more slowly
D. Decrease dividend payout
18. d 18. An increase in net operating income (NOPAT)
will cause which of the following?
A. Increase in the return on net operating assets
B. Decrease in the return on net operating assets
C. No change in the return on net operating assets
D.The change in the return on net operating assets is
unclear, there is not sufficient information
19. b 19. Which of the following would explain an
observed decrease in return on equity, all else
equal?
A. Decrease in tax rate
B. Increase in interest rate on debt
C. Stock split
D. Stock dividend
20. a 20. Which of the following is the best measure of
operating efficiency?
A. Return on net operating assets
B. Return on equity
C. Return on sales
D. Return on inventory
21. b 21. Return on operating assets is a measure of which
of the following?
A. Profitability
B. Efficiency
C. Solvency
D. Liquidity
22. c The following information relates to Yutter Corporation
22. What is Yutter's sustainable equity growth rate?

A. 9.12%
B. 9.88%
C. 11.4%
D. 12.0%
23. d 23. What is the value of Yutter's stock at the end of
Year 1 using the dividend discount model assuming
that the dividend payout ratio remains constant and
Yutter grows at its sustainable equity growth rate?
A. $83,333
B. $157,642
C. $500,000
D. $557,000
24. c 24. If Yutter's dividend payout ratio increased to 50%
after year 1 then:
A. the sustainable equity growth rate would increase
B. the return on equity would increase
C. the value of the stock would decrease
D. the return on net operating assets would decrease
25. c 25. Cost of goods sold divided by inventory provides
information about (choose one answer):
A. profitability
B. capital structure
C. management of working capital
D. gross profit margin
26. c 26. When considering the difference between return on
net operating assets (RNOA) and return on common
shareholders' equity (ROCE), which of the following
statements is incorrect?
A. Preferred dividends are deducted from the
numerator when calculating ROCE but not when
calculating RNOA
D. RNOA is independent of the form of financing,
but ROCE is not
27. b 27. Purchases divided by accounts payable provides
information about:
A. capital structure
B. management of working capital
C. gross profit margin
D. profitability
28. b 28. Which of the following statements is the most
plausible explanation of the difference in observed net
operating profit margins?
B. WidgetCo uses LIFO and Tools uses FIFO
D. WidgetCo's net operating asset turnover
29. d 29. Which of the following statements best explains
the difference in observed net operating asset
turnovers?
B. WidgetCo uses FIFO and Tools uses LIFO
D. WidgetCo has significant operating leases and Tool has
no leases
30. a 30. Which of the following statements is correct?
31. c 31. Which of the following statements could explain the

difference in observed tax rates?
A. Widget uses straight-line depreciation and Tool uses
MACRS
B. Widget uses LIFO and Tool uses FIFO
C. Tool has foreign subsidiaries in countries with much
lower tax rates
D. Widget has significant amounts of interest income from
municipal bonds
32. c 32. Widget has a higher EBIT/Revenue but lower net

operating profit margin than Tool. Which of the following
statements could explain this? As a percentage of sales:
B. Widget has greater interest expense but lower taxes
33. d 33. Which of the following statements about the relation-

ship between RNOA and ROCE is correct?
A. ROCE is always greater than RNOA
B. ROCE is greater than RNOA if RNOA is greater than
after-tax cost of dividends
C. ROCE is greater than RNOA if RNOA is greater than
cost of debt
D. ROCE is greater than RNOA if RNOA is greater than
after-tax cost of debt
34. d 34. Which of the following statements about the equity

growth rate is correct?
I. the higher the ROCE the higher equity growth rate, all
other things equal
II. the higher the dividend payout the higher the equity
growth rate
III. the equity growth rate is unaffected by the cost of debt
IV. the equity growth rate indicates the expected growth in
stock price each period
B. I, II and III
C. I and III
D. I only
35. c 35. Which of the following statements about the return on

shareholders' investment (ROSI) is correct?
A. If book value of equity is less than market value, ROSI
is greater than ROCE
B. ROSI will be higher the greater the dividend payout ratio
C. ROSI is likely to be more volatile than ROCE
D. ROSI normally equals ROCE
36. c 36. Which of the following situations is most likely to ex-

plain an accounts receivable turnover that is lower than
the industry norm?
A. The company makes less credit sales than industry
B. The company gives customers less time to pay than its
competitors
C. The company has been selling inferior products to com-
petitors
D. The company is systematically over-estimating bad
debts
37. c 37. Which of the following situations is most likely to ex-

plain a net operating asset turnover that is higher than the
industry norm?
A. The company has more recently purchased fixed assets
B. The company uses FIFO while competitors use LIFO
C. The company uses accelerated depreciation method
while competitors use straight line
D. The company extends more credit to customers than
competitors
38. c 38. When calculating Acme's return on net operating as-
sets in Year 1, which of the following adjustments to the
asset base is most appropriate to consider?
39. b 39. When calculating Acme's return on net operating as-

40. d 40. When calculating Acme's return on net operating as-

1. The majority of financing for most companies
D. Creditors and
comes from which of the following sources?
owners
2. Which of the following would not be found listed as

A. Operating
a liability on a company's balance sheet?
lease obligations
C. Bonds payable
D. Taxes payable
3. Which of the following is not a criterion for defining

C. The present
a lease as a capital lease?
value of the
A. Ownership is transferred at the end of the lease payments at
the beginning of
lease agreement.
the lease is 75%
B. The lease contains an option to purchase the or more than the
asset at a bargain price. value of the
asset. 90% PV
75% of life
C. The present value of the lease payments at the
beginning of the lease is 75% or more than the value
of the asset. 90% PV 75% of life
D. The lease term is at least 75% of the economic

life of the asset.
4.
Which of the following is true concerning bond D. Bond covenants
covenants? are legal restric-
tions placed in or-
der to minimize
A. Bond covenants are restrictions placed on the risk of default
bondholders to protect rights of equity holders. on bonds.
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.
5. Recording a long-term lease as an operating lease, C. Option C Less

as opposed to a capital lease, for a lessee will cause Debt lower ratio,
the following ratios to be: less assets higher
turns
A. Option A
B. Option B
C. Option C Less Debt lower ratio, less assets higher

turns
D. Option D
6. If a company that leases equipment from another C. I only Operating

company records these leases as operating means asset and
leases rather than capital leases, its: liability are NOT
recorded.
I. recorded liabilities will be lower. Yes
II. recorded assets will be higher. no
III. total cash flows will be higher. no
IV. leverage ratios will be higher. Debt will be
less, reducing debt to equit
A. I and III
B. II and IV
C. I only Operating means asset and liability are NOT
recorded.
D. II, III, and IV
7. Which one of the following statements is false? B. Violation of

a long-term debt
covenant automat-
A. Short-term obligations may be classified as ically means the
long-term if the company intends to refinance them company must re-
on a long-term basis and can demonstrate the ability classify the debt
to do so. as current. Simply
not true.
B. Violation of a long-term debt covenant automati-
cally means the company must reclassify the debt as
current. Simply not
true.
C. Current liabilities are recorded at their
maturity value, and not their present value.

interest rate is greater than the coupon rate.
8. Hert Corporation acquired a capital lease that is car- B. Option B

ried on its books at a present value of $100,000 (dis- 100,000 *12%,
counted at 12%). Its annual rental payment is $15,000. (100,000-3,000) *
What is the amount of interest expense from 12%
this lease?
A. Option A
B. Option B 100,000 *12%, (100,000-3,000) * 12%

C. Option C
D. Option D
9. Which of the following will give rise to off- A. I, II, III, and IV
I. Take-or-pay arrangements
B. I, II, and IV
C. II, III, and IV
D. I, III, and IV
10. Which of the following is an example of off- A. Operating leas-

balance sheet financing? es
A. Operating leases
B. Capital leases

11. If a company engages in off-balance sheet financing, C. I and !V onlyAs-
generally the effect is: sets are unrecord-
ed, understating
I. to cause assets to be understated. them Liabilities are
II. to increase leverage ratios. unrecorded also
B. I, III, and IV
C. I and !V onlyAssets are unrecorded, understating

them Liabilities are unrecorded also
D. IV only
12. A lessee must account for a lease as a capital lease if: A. I and II 75% of
life, 90% of pre-
I. lease transfers ownership to lessee at the end of sent value
the lease.
II. lease contains option to purchase the asset at
the end of the lease at a bargain price.
IV. present value of lease is greater than 10%
of lessee's assets.
A. I and II 75% of life, 90% of present value
B. I, II and III
C. I, III and IV
D. I, II and IV
13. Dylan Corporation issues a zero coupon bond with A. $70,892.

market rate is 7%. Interest on corporate bonds is
normally paid semiannually. In the liability section
of Dylan's balance sheet, the proceeds from selling
the zero-coupon immediately after issuance will be
closest to:
A. $70,892.
B. $71,299.
C. $70,000.
D. $100,000.
14. Which of the following statements about stock A. Stock

dividends is true? dividends
increase the num-
ber of shares out-
A. Stock dividends increase the number of shares standing.
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.
15. Treasury stock is: C. a company's

own stock that it
has repurchased.
B. retained earnings that have been appropriated

to make equity investments.
16. C. $15.25.
A. $12.20. BV = 100K +40K +350K +230K =720K

less 10,000 *11 =610,000/40=15.25
B. $12.40.
C. $15.25.
D. $15.50.
17. The book value per share of preferred stock is: C. $11. The $11
liquidation value
A. $22.
B. $20.
C. $11. The $11 liquidation value
D. $10.
18. 19. Which of the following statements concerning con- D. II only

tingencies 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.
B. II, III, and IV

C. II and III
D. II only
19. One way for a company to increase its book value D.buy back
per share is to: shares at market
prices below their
A. issue long-term debt. book value.

value.
20. A company's current ratio is 1.5. If the company A. Current ratio:

uses cash to retire notes payable due within one Increase;
year, would this transaction increase or decrease Return on
the current ratio and return on assets ratio? assets:
IncreaseMathe-
matically true,
A. Current ratio: Increase; Return on assets: assets down
Mathematically
Increase- true, assets down
B. Current ratio: Increase; Return on assets:

Decrease A. leases to be
treated like
C. Current ratio: Decrease; Return on assets: capital
Increase leases to
enhance
D. Current ratio: Decrease; Return on assets:
De- crease
21. An analyst should consider whether a company ac-

quired assets through a capital lease or an
operating lease because a company may structure:
C. leases to be treated like operating leases to lower its
debt to equity ratio.
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 lower

its debt to equity ratio.
D. leases to be treated like operating leases to en-

hance its cash flow.
22. Which of the following lease provisions would cause B. The collec-
a lease to be classified as an operating lease? Key is tability of lease
the word operating, other options relevant to payments by
capitalized leases. the lessor is
unpredictable.
B.The collectability of lease payments by the lessor

unpredictable.
is
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
23. On January 1, a company entered into a capital lease C. $4,200
resulting in an obligation of $20,000 being recorded
on the balance sheet. Estimated economic life of the
leased asset is ten years with an expected salvage
value of zero at the end of ten years. The company
will depreciate this asset on a straight-line basis
over its economic life. 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?
Interest was 10% * 20,000 principal or $2,000, the

2,200 represents the
Principal payment. Total cash outlay 4,200
A. $2,000
B. $2,200
C. $4,200
D. $20,000
24. Which of the following is reported in the equity section B. Treasury stock
A. Notes Receivable
B. Treasury stock
D. Debentures
25. Which of the following would rarely be classified as B. Goodwill I have

a current asset? never seen good-
will, which is creat-
A. Prepaid insurance ed through acqui-
sition treated as a
B. Goodwill I have never seen goodwill, which is cre- current asset
ated through acquisition treated as a current asset
C. Marketable securities
D. Work-in-process
26. Which of the following would not be classified as B. Accounts
a current asset? payable Liability
A. Inventory
B. Accounts payable Liability
D. Prepaid expenses
27. An asset is considered to be liquid if: C. it is readily

converted into
A. it is readily converted into a fixed asset. cash. Cash is the
most liquid of all
B. it is an intangible asset. assets
C. it is readily converted into cash. Cash is the most
liquid of all assets
28. For Control Furniture Co., A. Option A 91

*65%=59.15Re-
tained earnings,
after tax effect on
income
To restate Year 2006 LIFO inventories to a FIFO basis, 91*35% =31.85
we use the following analytical entry: Deferred Taxes
A. Option A 91 *65%=59.15Retained earnings, after tax

effect on income
91*35% =31.85 Deferred Taxes
B. Option B
C. Option C
D. Option D
29. The following information can be found in ABC C. $633,381

Co.'s financial statements. Amount is clear-
ly shown in the
schedule as
"Total FIFI Value"
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

A. $633,485
B. $570,430
C. $633,381
Amount is clearly shown in the schedule as "Total
Value"
FIFI
D. $488,581
30. What will be the retained earnings for 2006 if B. $3,566,918

ABC used FIFO valuation? 65% * 62,951
+3,526,000
A. $3,205,271
B. $3,566,918
65% * 62,951 +3,526,000
C. $3,893,000
D. $4,096,430
31. What will be the retained earnings for 2005 if
A. $3,205,271
A. $3,205,271 65% *71,186 +
65% *71,186 + 3,159,000 3,159,000
B. $3,566,918
C. $3,893,000
D. $4,096,430
32. The use of LIFO rather than FIFO for inventory C. I only
costing under normal economic conditions results COGS are higher,
in: so income is
lower. (Could
I. lower net income. argue I and II
II. higher total assets. since lower tax-
III. higher retained earnings. es=>$$$
IV. unchanged retained earnings.
A. II and III
B. I, II, and IV
C. I only
COGS are higher, so income is lower. (Could argue
Iand II since lower taxes=>$$$
D. I and IV
33. Which of the following is not a common B. Higher

characteristic of a company choosing to use LIFO variability in
rather than FIFO? inventory bal-
ances No,values
flatline around
A. Higher cost of goods sold Yes, Inflation olders layer
creates higher COGS
B. Higher variability in inventory balances No,values

flatline around olders layer
C. Greater expected tax savings Yes, higher cogs,
lower income, lower taxes
D. Inventory values aren't current
34. Financial Statements of ABC Corp. indicates that C. $2,350,000

ending inventory levels in 2005 and 2006 were 2,200,000+350,000-2
$200,000 and $350,000 respectively. Cost of goods
A. $1,950,000
B. $2,150,000
C. $2,350,000
2,200,000+350,000-200,000
D. $1,850,000
35. The inventory costing method used by a A. Option A As-

company (LIFO, FIFO, etc.) will affect: set values are dif-
ferent to turnover
ratio changes, In-
come is different
so equity changes
A. Option A Asset values are different to turnover ratio along with debt eq-
changes, Income is different so equity changes along uity ratio
with debt equity ratio
B. Option B
C. Option C
D. Option D
36. Which of the following steps is required to adjust LIFO D. All of the above
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
37. One advantage of LIFO over FIFO under normal B. it results in

conditions is that: higher cash flows.
Lower taxes more
cash
A. it reports higher retained earnings. Income is
lower so lower RE
B. it results in higher cash flows. Lower taxes more

cash
C. it results in higher current ratios. Lower

assets lower ratio
D. it results in higher gross margins. Higher

COGS, lower Gross margin
38. Which of the following is not an effect of A. Capitalization

capitalization? usually reduces
net income.Capi-
talization reduces
A. Capitalization usually reduces net income.Capital- expenses
ization reduces expenses
B. Capitalization usually yields a smoother net

income.
39. Companies are supposed to write-down value of as- D. Option D

sets if a permanent impairment of value or loss of Current year prof-
utility occurs. If a company writes down its assets it is lower for low-
this year, the effect on: er return, in future
assets less higher
ROA
A. Option A
B. Option B
C. Option C
D. Option D
Current year profit is lower for lower return, in future
assets less higher ROA
40. A write-down in asset value is: D. required if an

asset is deemed
to have
A. a very rare occurrence. permanent
impairment of val-
B. not allowed under GAAP. ue.

41. Which of the following is not considered an C. Prepaid adver-

intangible asset? tising expenses
A. Goodwill
B. Customer lists
D. Memberships
42. Target Inc. has 30 million shares outstanding and C. $600 million
trades at $50 per share. Target has net identifiable $60 * 30 mil-
as-
sets with a book value of $1,000 million and a fair value lion =1,800 million
of $1,200 million. Acquirer Corporation purchases =1,200 million =
all of Target Inc. stock for $60 per share. How much 600 million
will Acquirer records as goodwill upon acquiring
Target?
A. $300 million
B. $500 million
C. $600 million
$60 * 30 million =1,800 million =1,200 million = 600
million
D. $800 million
B. It arises when
43. Which of the following is incorrect with respect another compa-
to recognized goodwill on the balance sheet? ny is purchased
or when internally
generated.
A. It should not be amortized.
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.
44. Under current US GAAP, goodwill is:

assets.
B. II, III, and IVGoodwill is not amortized
C. I, II, and III
D. II and IV
45. The following information can be found in Manufac- C. $524,000

turer Company's financial statements. .40,000*60%=24,000+
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
.40,000*60%=24,000+$500,000
D. $506,000.
46. If Manufacturer used FIFO, its net income for D.$131,000.

A. $165,000.
B. $149,000.
C. $135,000.
D. $131,000.
47. Look Good Corporation has current assets of $1.1 C. Sell building
million and current liabilities of $1 million. It is for $0.2 million
close to year-end, and it would like to increase its in cash. Yes,
current ratio. Which of the following will achieve Long
this? term Asset to short
term
A. Encourage customers to pay their bills more
quickly. Swaps cash for AR -no change
B. Increase short-term borrowings by $0.1

million. Small effect +cash, +debt
C. Sell building for $0.2 million in cash. Yes, Long

Asset
termto short term
D. Liquidate some of its trading marketable

securities. Swaps current assets
48. LIFO liquidation occurs when: D. the quantity

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

materials.

D. the quantity of goods sold is greater than the quan-
tity produced.
49. All other things being equal, if a LIFO liquidation D.II and IV only
occurs during a period of rising prices, which of
the following statements about the effects on a
firm's financial statements is generally true?

A. I only
B. II only
C.I and III only
D.II and IV only
50. Which of the following statements about A. U.S. general-

inventories is true? ly accepted ac-
counting princi-
ples (GAAP) re-
A. U.S. generally accepted accounting principles quire the use of
(GAAP) require the use of lower of cost or market lower of cost or
valuation basis for inventories. market valuation
basis for invento-
B. Last-In, First-Out (LIFO) inventory accounting ries.
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.
51. A firm has a current ratio greater than 1.0. If the C. Option C
beginning inventory is overstated by $5,000, the
firm's net income and current ratio will be:
A. Option A
B. Option B
C. Option C
D. Option D
52. A corporation wants to increase its current ratio C. selling furniture

from its present level of 1.2 before it ends the fiscal for cash.
D. selling current marketable securities at cash

for their book value. No effect
53. Depreciation is based on the principleof: A. allocation.

A. allocation.
B. appropriation.
C. lower of cost or market.

D. approbation.
54. Which of the following is not an analysis issue C. Analyzing the

arising with impairment? effect of the im-
pairment on asset
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
55. Below is selected information taken from the C. 14 years.

balance sheet of Huy Corporation as of 12/31/06. 70,000/5,000=14
33. The average total life span of Huy's

depreciable assets as of 2006 is:
A. 2 years.
B. 7 years.
C. 14 years.70,000/5,000=14
D. 34 years.
56. The average age of Huy's depreciable assets as A. 2 years.

of 2006 is: 10,000/5,000
A. 2 years. 10,000/5,000
B. 7 years.
C. 14 years.
D. 34 years.
57. During fiscal 2006, Huy sold fully depreciated C. $10,000.

assets that originally cost $20,000 for $4,000. In
2006, they purchased assets that cost: 80,000 -20,000
=60,000 to get
to 70K, they
A. $5,000. purchased
10K
B. $6,000.
C. $10,000.
D. $30,000.
58. Goodwill is:

C. the excess of
the purchase price
of net assets over
A. the excess of the purchase price of net assets over the fair value of net
the book value of net assets. assets.
B. the excess of the appraised 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.
59. With respect to LIFO, which of the following is C. LIFO results in

incorrect? better matching
on the income
statement than
A. If a company uses LIFO for tax purposes, it FIFO. Inventory
must use it for GAAP purposes.
sold is closer to recent
cost of purchase in
B. If the LIFO reserve increases in a given year, cost FIFO.
of goods sold under the LIFO inventory costing is
higher than it would have been if FIFO had been
used for that year.
C. LIFO results in better matching on the income

ment than FIFO.
state-
Inventory sold is closer to recent cost of purchase in

FIFO.
D. LIFO results in inventory levels on the

balance sheet that are closer to current cost
than FIFO.
1. 1. Trading marketable securities: D. are marked
to market each
A. are considered noncurrent assets. accounting
period.
B. are recorded at amortized cost.
C. are marked to the lower of cost or market

each accounting period.
D. are marked to market each accounting period.
2. The classification of marketable equity securities

as trading or available-for-sale is determined:
A. by manage-
by management's intent regarding the disposition
ment's intent re-
of the securities.
garding the dispo-
sition of the secu-
A. when the securities mature.
rities.
B. whether the current assets are greater or less
than the current liabilities.
C. whether management wants to mark them to mar-

ket or not.
3. Which of the following is an effect of the reclassifica- D.There would be

tion of trading securities as available-for-sale? no effect on the
A.The balance sheet would need to be adjusted to balance sheet and
report the securities at fair market value and there unrealized gains
would be no effect on the income statement. or losses on the
date of the transfer
B. There would be no effect on either the balance would be included
sheet or the income statement. in net income.
C.The balance sheet would need to be adjusted to

report the securities at fair market value and
unrealized gains or losses on the date of the
transfer would be included in net income.
D.There would be no effect on the balance sheet and

4. The equity method of accounting for investments proportionate
requires: share of
A. investment should be marked to market each investee's
accounting period. earnings should
be recorded as
proportionate share of investee's earnings should investment
be recorded as investment income. income.
B. company should not have significant
influence over investee.
C. goodwill related to purchase of investee stock to

be recorded separately on balance sheet.
5. Which of the following is incorrect? An analyst C.They must mark

should be aware of the following when analyzing a investment in in-
company that has significant investments vestee to market
recorded using the equity method. even though there
A. Cash flow received from investee may be may be no ready
substantially different from investment income market in which
recorded. they can sell their
investment.
B. As investee's liabilities are not recorded on the
company's balance sheet, there may be
significant off-balance-sheet financing.
They must mark investment in investee to market

even though there may be no ready market in which
they can sell their investment.
C. Company must record pro rata share of

investee's earnings, which may not be well
correlated with changes in market value of
investee.
6. Agwen Corporation owns 25% of the shares of Bron- C.Equity method
wo Corporation, which is traded on the New York
Stock Exchange. Which method is Agwen most likely
to use to account for this investment?
A. Cost method
B. Market method
Equity method
D.Consolidation
method C.lower
earnings and no
7. Compared to the equity method, the cost method of effect on cash
accounting for an investment in a profitable flows.
company results in:
A. lower earnings and lower cash flows.
B. higher earnings and higher cash flows.
lower earnings and no effect on cash flows.
D.higher earnings and no effect on cash flows.

8. Guido Inc. buys 2,000 shares of Weiner Company for C.Option C
$30 per share on January 1, 2006. At the end of 2006, Trading
Weiner shares are trading at $33 per share. Weiner MES:16000
has a total of 200,000 shares outstanding and report- AFS MES:10000
ed net income of $3,000,000 and paid dividends of Cost:10000
$1,000,000 for fiscal 2006.
8.
Determine the amount Guido Inc. will record as
investment income in its income statement under
the three scenarios: Weiner is considered trading
marketable equity security (MES), available-for-sale
(AFS) MES, or using cost method. Trade & AFS: Net
Inc. 6K gain +10K div. AFS 6K goes to comp. inc.,
10K to div inc., Cost 10K to Div. inc.
A. Option A
Trading MES:10000
AFS MES:10000
Cost:30000
B. Option B
Trading MES:10000
AFS MES: 16000
Cost: 10000
C. Option C
Trading MES:16000
AFS MES:10000
Cost:10000
D. Option D
Trading MES:16000
AFS MES:16000
Cost:10000
9. Determine the amount Guido Inc. will record as an D.Option D

investment on its balance sheet under the three sce- Trading
narios: Weiner is considered trading marketable MES:66000
equity security (MES), available for sale (AFS) AFS MES:66000
MES, or using cost method. AFS and Trading to Cost:60000
FMV, Cost basis remains purchase price
A. Option A
Trading MES:60000
AFS MES:60000
Cost:60000
B.Option B
Trading MES:66000
AFS MES:60000
Cost:60000
C.Option C
Trading MES:60000
AFS MES:66000
Cost:60000
D.Option D
Trading MES:66000
AFS MES:66000
Cost:60000
10. Company A acquires 40% of Company B in a D.Company A will
stock-for-stock exchange. With respect to most likely use
preparing financial statements, which of the the equity
following statements is correct? method.
A. Company A will most likely use pooling-of-
interest accounting for consolidation purposes.
B. Company A will most likely use purchase

accounting.
C. Company A will most likely use the cost method.
D. Company A will most likely use the equity method.
11. Company ABC acquires company XYZ on 12/31/06 C.$4 million.

in a share-for-share transaction worth $10 million.
On 12/31/06, XYZ financial statements reported
the following:
Total assets: $12 million
Liabilities: $8million
SHE: $4million
Net income for 2006: $2million
At the time of acquisition, the fair value of XYZ's
assets equals its book values, except for property,
plant and equipment which has a fair value $2
million higher than its book value. Goodwill is
expected to be amortized over 10 years, and the
average life of depreciable assets is 10 years. If
ABC uses purchase accounting to record the
acquisition, the amount of goodwill that will appear
on its balance sheet as of 12/31/06 with respect to
the acquisition of XYZ will be:
Excess of Purchase price over Equity (10-4)=6, less

write of to FMV of $2MM = $4 MM
A. $0.
B. $2 million. if they are
successful
$4 million. D. in its
acquisition
$6 million. ? 2 for one
12. If a company uses the purchase method to account

for a merger, which of the following is true?I. Prior
year's statements must be restated as if merged
companies had always been one company.
Net income of combined companies will probably
be lower than net income of two separate
companies added together. III. Goodwill is never
recorded.
IV. Assets of acquired company will be recorded
on acquirer's books at their fair value.
A. I, III, and IV
B. I, II, and III
C. II and IV
D. I and III
13. Target Company is trading at $20 a share at the

end of the year 2006 and has 1 million shares
outstanding. Acquirer Corp. is trading at $50 a
share and
has 2 million shares outstanding. Acquirer offers
Tar- get's shareholders of one share of its stock for
every two shares of Target Company. For the year
ending 12/31/06, Acquirer and Target had earnings
of $5 million and $2 million, respectively. The book
value of Target's net assets is $12 million and fair
value is $15 million as of 12/31/06. The book value
of Acquirer's net assets is $35 million and fair value
is $48 million as of 12/31/06.
How many outstanding shares will Acquirer have

C.II and IV
C.2.5 million
means one million shares goes to 500,000 shares
issued above 2 million outstanding
A.2 million
B.2.4 million
C.2.5 million
D.3 million
14. If the acquisition is completed as of 12/31/06, what A. $2.00

will the reported earnings per share be for the year
ended 12/31/06 assuming purchase accounting is
used? $5 million/2.5 million shares. During the
year of acquisition Target's profits aren't included
$2.00
A. $2.33
C.$2.50
D.$2.80
15. If the acquisition is completed as of 12/31/06, what A. $24.00

will the book value per share be for the year ended Original BV of
12/31/06 assuming purchase accounting is used? $35M plus stock
issuance of $25M
=$60/2.5 =$24
A.$24.00
B.$20.00
C.$18.80
D.$15.67
16. Sachen Company uses the local currency for each current rate
country in which it operates as its functional curren- method.
cy. When translating statements into U.S. dollars they
should use: Always current unless hyper inflation
or currency uunstable
current rate method.
B.temporal method.
C.remeasurement method.
D.exchange rate method.
17. Parent Company Inc. successfully bids for Child .$27,231

Company Inc. in year X1. Parent Company Inc. has
purchased all of Child's shares outstanding for
$8,500. Following are excerpts from both
companies' financial statements for year X1, prior to
the acquisition. Also assume the following
information: the acquisition was accounted for
using the purchase method. $1,500 of the excess
price relates to depreciable assets, and those
assets have an additional useful life of 10 years at
the time of the acquisition.
Parent Company Inc. uses the straight line depreci-
ation method and has a 34% tax rate. The combined
net income for both companies for year X2
(excluding any expenses that need to be recorded
as a result of the purchase method accounting for
the merger) was
$1,560.
What would be total liabilities in the consolidated

financial statements for the date on which the merg-
er became effective, assuming any excess purchase
price relates to goodwill?
A.
$28,221
B.
$27,231
C.
$27,741
D.
$25,462
18. What would be total assets in the consolidated B. $49,498

financial statements for the date on which the
merger became effective, assuming any excess
purchase price relates to goodwill?
A. $50,008
$49,498
C.$41,508
D.$44,113
19. What would be the net income in the consolidated A.$1,461

income statement for year X2?
A.$1,461
B.$1,560
C.$1,450
D.$1,611
20. What would be the net income in the consolidated D.

income statement for year X2 assuming any excess $730
purchase price relates to goodwill, and goodwill
was found to be impaired by $830? Do not consider
the depreciation in prior question. Net Income is
simply
$1,560
A.
$1,461
B.
$1,560
C.
$1,012.2
D.
$730
21. When an acquisition is made and accounted for D.

using the purchase method, the post-acquisitionis the pre-ac-
common stock account: quisition common
A. stock account of
is the sum of the pre-acquisition common stock the acquiring com-
accounts of the two combining companies. pany plus the fair
value of new stock
B. issued to affect the
is the pre-acquisition common stock account of acquisition.
the acquired company only.
C.
is the pre-acquisition common stock account of
the acquiring company plus the par value of new
stock issued to affect the acquisition.
D.
is the pre-acquisition common stock account of the
acquiring company plus the fair value of new stock
issued to affect the acquisition.
22. When an acquisition is made and accounted for B.

using the purchase method, the post-acquisition is the pre-acquisi-
retained earnings account: tion retained
A. earnings
is the sum of the pre-acquisition retained earnings account of the
accounts of the two combining companies. acquiring com-
pany only.
B.
is the pre-acquisition retained earnings account of
the acquiring company only.
C.
is the pre-acquisition retained earnings accounts of
the acquiring company plus net income of acquired
company in year of acquisition.
D.
is the pre-acquisition retained earnings accounts
of the acquiring company less treasury stock of the
acquired company.
23. In-process B. is only an is-

R&D: A. sue when pur-
is written-off immediately to retained earnings. chase accounting
is used.
B.
is only an issue when purchase accounting is used.
C.
is capitalized on the balance sheet and never amor-
tized.
D.
is expensed immediately under pooling of interests.
24. Under U.S. GAAP, the method used to convert the functional cur-
financial statements of foreign subsidiaries into rency of the sub-
the reporting currency depends upon: sidiary.
A.
the size of the subsidiary.
B.
the functional currency of the subsidiary.
C.
the temporal location of the subsidiary.
D.
the current method used by the subsidiary.
25. Under U.S. GAAP, the method used to convert C.the temporal
financial statements of foreign subsidiaries in method.
countries
experiencing hyperinflation is:
A.
the current rate method.
B.
the inflation method.
C.
the temporal method.
D.
the transition method.
26. When accounting for an investment under the C.

equity method, what situations may reduce the I, II, and III
carrying value of the investment?I. Investee
experiences significant losses.II. Investee
distributes dividends in excess of earnings.III.
Investee sells additional shares for less than book
value.IV. Investee engages in a stock split. Stock
splits have no effecct
A.
I and II
B.
II and IV
C.
I, II, and III
D.
I, III, and IV
27. Which of the following is not a reason for B.

economic income and accounting income to The monetary as-
differ? sumption
A.
Transaction basis
B.
The monetary assumption
C.
Conservatism
D.
Earnings management
28. As a general rule, revenue is normally C.

recognized when it is: realizable
A. and earned.
measurable and earned.
B.
measurable and received.
C.
realizable and earned.
D.
realizable and measurable.
29. Which of the following measures of accounting in- D.

come is typically reported in an income statement? All of the above
A.
Net income
B.
Comprehensive income
C.
Continuing income
D.
All of the above
30. According to FASB, initial franchise fees should A. the franchiser

be recognized as income when: has substantially
A. performed or sat-
the franchiser has substantially performed or satis- isfied all material
fied all material services and conditions. services and con-
ditions.
B.
the franchiser has collected the majority of fee in
cash.
C.
the franchisee shows the ability to pay the fee.
D.
the franchiser bills the franchisee.
31. If Brierton used percentage-of-completion method B.

to account for this project, what would they have $1.33 million
reported as profit in year 2?
A.
$0
B.
$1.33 million
C.
$1.50 million
D.
$0.67 million
32. If Brierton used cash accounting to account for this C.

project, what would they have reported as profit $(2 million)
(loss) in year 2?
A.
$0
B.
$1.33 million
C.
$(2 million)
D.
$(4 million)
33. Which of the following combinations of C.

accounting practices will lead to the highest Option C Straight
reported earnings in an inflationary environment? line fifo
A.
Option A straight line lifo
B.
Option double declining lifo
C.
Option C Straight line fifo
D.
Option D double declining fifo
34. 8. D.
Which of the following is correct?I. If a company uses I and IV
straight-line depreciation for financial reporting pur-
poses, it is very likely they have a deferred tax
liability with respect to its depreciable assets.
II. Straight-line depreciation for financial reporting
purposes, it is very likely to have a deferred tax
asset with respect to depreciable assets.
III. Straight-line depreciation results in lower tax

payments than accelerated depreciation methods
over the life of an asset.
IV. If a company revises its estimate of the useful
life of an asset upwards this will decrease
annual depreciation expense.
A.
I, II, III, and IV
B.
II, and IV
C.
I, II, and III
D.
I and IV
35. Which of the following statements concerning D.

deferred taxes is correct? Deferred taxes
A. arising from the
Deferred taxes will not be found in the asset depreciation of a
section of a balance sheet. specific asset will
ultimately reduce
B. to zero as the item
Deferred taxes arise from permanent differences in is depreciated.
GAAP and tax accounting.
C.
Deferred taxes will only decrease when a cash pay-
ment is made.
D.
Deferred taxes arising from the depreciation of a
cific asset will ultimately reduce to zero as the item is
spe-
depreciated.
36. Differences in taxable income and pretax C.

accounting income that will not be offset by permanent differ-
corresponding differences or "turn around" in ences.
future periods are called:
A.
timing differences.
B.
circular differences.
C.
permanent differences.
D.
reverse differences.
37. Basic earnings per share for 2006 C.

was: A. $3.08.
$3.50.
B.
$3.16.
C.
$3.08.
D.
$3.00.
38. Using the treasury stock method, calculate the C.

number of extra shares being recognized in the 333,333
dilut-
ed EPS calculation resulting from options. 1 million
*50=50M which can by 666,667 shares at $75
making dilution 333,333
A.
500,000
B.
358,975
C.
333,333
D.
285,714
39. 13. 300,000,000/(97,500,

Diluted earnings per share for 2006 was: B.
A. $3.07.
$3.52.
B.
$3.07.
C.
$2.00.
D.
$2.03.
40. Tecktroniks Company reported in its annual report D.

software refinement expenses of $12 million, $15 $157 million.
million, and $18 million for fiscal years 2005, 2006,
and 2007, respectively. At the end of fiscal 2007, it
had total assets of $140 million. Net income was
$20 million for fiscal 2007, and it had a marginal tax
rate of 35%.
14.
If software refinement had been capitalized each
beginning in the year the cost was incurred, total
A.
$185 million.
B.
$172 million.
C.
$158 million.
D.
$157 million.
41. If software refinement had been capitalized each year C.

and amortized over a three-year period beginning $21.95 million.
in the year the cost was incurred, net income for
A.
$31.7 million.
B.
$29.75 million.
C.
$21.95 million.
D.
$14.95 million.
42. If the software refinement had been capitalized and A.

amortized over a three-year period beginning in the a deferred tax
year the cost was incurred, but was expensed for credit of $2.8 mil-
tax purposes, the deferred tax position at the end of lion.
A.
a deferred tax credit of $2.8 million.
B.
C.
D.
a deferred tax debit of $4 million.
43. 2005 is year one. Books would have recorded a 4 mil- B.
lion expense. Taxes would have recorded a 12 million higher asset levels
expense. For an 8 million difference. The sax savings and higher equity
on the extra expense is 8 million times 35% or 2.8 levels.
million. This creates a deferred tax credit (liability)
because the company paid less taxes and will even-
tually owe them.
18.
Compared with companies that expense costs,
firms that capitalize costs can be expected to
report:
A.
higher asset levels and lower equity levels.
B.
higher asset levels and higher equity levels.
C.
lower asset levels and higher equity levels.
D.
lower asset levels and lower equity levels.
44. Two growing firms are identical except that one C.

firm capitalizes, whereas the other firm expenses I and III only
costs for long-lived resources over time. For these
two firms, which of the following statements is
generally true?I. The expensing firm will show a
more volatile pattern of reported income than
capitalizing firm.II. The expensing firm will show a
less volatile pattern of return on assets than the
capitalizingfirm
expensing firm.III. The lower cash flows from
will show
ations than the capitalizing firm.
oper-
No 1. Is true because amortizing an expense over

time smooths the expense out/
No. 11 is false for the same reason that No 1 is true.
No, III has to do with the cash flow statement. All
of the expense in a in the expensing firm will flow
through cash flow from operations making it
lower, whereas depreciation will flow through
operations
making cash flow from operations higher. The differ-
ence is that the capitalizing firm will have the cash
effect of the investment flow though the investing
section o the cash flow statement.
A.
I only
B.
II only
C.
I and III only
D.
II and III only
45. The capitalization of interest cost during construc- C.

tion: increases net in-
A. come during con-
increases future net income. struction phase.
B.
decreases future depreciation expense.
C.
increases net income during construction phase.
D.
decreases assets during construction phase.
46. 21. B.
Windsor Company has net temporary differences Option B increase
between tax and book accounting of $80 million, decrase
resulting in a deferred tax liability of $28 million.
An increase in the tax rate would have the following
impact on deferred taxes and net income: As the
liability increase the expense must also goup
decreasing net income
A.
Option A
B.
Option B increase decrase
C.
Option C
D.
Option D
47.
Exoil recorded an expense and corresponding C.
liability to recognize potential losses relating to an recognized a de-
oil spill in 2006 of $10 million. Its net income for the ferred tax asset.
year was
$200 million. It was not able to take a deduction for
tax purposes until later years when it actually paid
cash out in relation to this event. In 2006, with
respect to this, Exoil would have:
A.
recognized a deferred tax liability.
B.
recognized a tax loss carryforward.
C.
recognized a deferred tax asset.
D.
recognized a deferred equity loss.
48. Which of the following will NOT cause the reported D.
effective tax rate to differ from the federal statutory III only
tax rate?I. Foreign tax rates that are lower than
federal statutory tax rateII. Tax-exempt incomeIII.
Different depreciation methods for tax and financial
reporting purposesIV. Foreign tax rates that are
higher than federal statutory tax rate
A.
I, II, and IV
B.
I, II, and III
C.
I and II
D.
III only
49.
If a company changes the useful life of its assets D.
from 10 years to 12 years, this will be recorded as: None of the above
A.
a nonrecurring gain.
B.
an extraordinary item.
C.
a change in accounting principle.
D.
None of the above
50. Which of the following is true with respect to A.

extraor-
dinary items?I. Extraordinary items are recorded net I and IV
of tax in income statement.II. Extraordinary items, by
definition, are probable and unusual in nature.III. By
definition, gains and losses from strikes are always
extraordinary.IV. By definition, gains and losses from
sale of property, plant and equipment are never
ordinary.
extra-
A.
I and IV
B.
I, III, and IV
C.
II and IV
D.
I, II, and III
51. Which of the following would be considered an extra- C.
ordinary item?I. Write-down of receivablesII. Gains on III
only disposal of a business segmentIII. Loss of inventory
resulting from a fireIV. Loss resulting from a strike
Extraordinary items are very rare
A.
I and IV
B.
I, III, and IV
C.
III only
D.
I, II, and III
52. Which of the following items is not included in the A.

calculation of net income but is included in the Unrealized hold-
calculation of comprehensive income? ing gain on avail-
A. able-for-sale
Unrealized holding gain on available-for-sale mar- mar- ketable
ketable securities securities
B.
Unrealized holding gain on trading marketable
securities
C.
Gain from early extinguishments of bonds
D.
Gain arising from sale of available-for-sale mar-
ketable securities
53. Based on GAAP, which of the following is true B.

of comprehensive income? It can be report-
A. ed as part of state-
It should be reported as part of sales in the income ment of share-
statement. holders' equity.
B.
It can be reported as part of statement of sharehold-
ers' equity.
C.
It should be reported as a line item before
earnings after tax in the balance sheet.
D.
It should be reported as part of operating activities in
the statement of cash flows.
54. A company's net income is $100,000, and its weight- C.
ed-average shares outstanding are 20,000. During the
$5 year, the company issues 5,000 ESOs at an exercise
price of $20.
33.
What will be the basic EPS if average stock price
during the year is $35?
A.
$4.44
B.
$6
C.
$5
D.
$4.17
55. What will be the basic EPS if average stock C.

price during the year is $15? $5
A.
$4.44
B.
$6
C.
$5
D.
$4.17
56. 35. B.
What will be the diluted EPS if average stock price $5
during the year is $15?
A.
$4.44
B.
$5
C.
$6
D.
$4.17
57. What will be the diluted EPS if average stock price A.

during the year is $40? $4.44
A.
$4.44
B.
$5
C.
$6
D.
$4.17
58. 37. D.
Which of the following is not an extraordinary item?I. I, II, III, and IV
Loss on abandonment of propertyII. Gain on
disposal of a business segmentIII. Effect of a strike
against a
key supplierIV. Write-down of deferred research and
development costs
A.
I and III
B.
II and IV
C.
I, II, and III
D.
I, II, III, and IV
59. 1. Under the accrual basis of accounting, which of C. I and III

the following statements is true?
I. Reported net income provides a measure of

operating performance.
II. Revenue is recognized when cash is received,

and expenses are recognized when payment is
made.
III. Cash inflows are recognized when they are re-

ceived, and cash outflows are recognized when
they are made.
A. I only
B. III only
C. I and III
D. I, II, and III
60. Which of the following would require an adjustment in B. I and II

the computation of cash flow from operations using
the indirect method?
A. I
B. I and II
C. I and III
D. IV
61. Beginning and ending accounts receivable are B. $418,000
$76,000 and $42,000, respectively. Sales for the peri- Which equals
od total $384,000, of which $40,000 was directly for 418,000
cash. How much cash was collected from making
sales and collecting accounts receivable?
A. $344,000 AR is down which 76 -42 = 34 extra cash

collected above sales of 384
B. $418,000 Which equals 418,000
C. $378,000
D. $376,000
62. Beginning accounts receivable are $76,000. Sales for A. $42,000 Flip
the period total $384,000, of which $40,000 was di- side of question 4.
rectly for cash. $418,000 was collected from making
sales and collecting accounts receivable. What is
the ending balance for accounts receivable?
A. $42,000
B. $62,000
C. $82,000
D. $68,000
63. A firm has net sales of $6,000, cash expenses (in- A. $2,400.
cluding taxes) of $2,800, and depreciation of $1,000.
If accounts receivable increased in the period by
$800, cash flows from operations equal:
$6,000 of possible cash from sales less 2,800 of ex-

penses paid in cash leaves 3,200 of possible cash
which is reduced by 800 for increase in AR (credit
sales) yielding 2,400. Depreciation was included in
question to distract
A. $2,400.
B. $3,200.
C. $3,400.
D. $4,200.
64. Which of the following represents an investing activ- B. Sale of plant

ity in the statement of cash flows? assets at a loss
A. Depreciation of plant assets
B. Sale of plant assets at a loss
C. Stock dividend
D. Purchase of inventory
65.
Depreciation is in the operating section, the stock C. Payment of
dividend is not included anywhere, and inventory is interest on debt
in the operating section. The actual loss creates a
gain in the operating section but the SALE is
recorded in the investing section.
8. Which of the following is not a financing activity

in the statement of cash flows?
A. Cash dividend
B. Repurchase of common stock
C. Payment of interest on debt
D. Issuance of new debt
66. Net Income $50,000 D. $48,000

Decrease in Accounts Receivable 2,000
Increase in Inventory 1,000
Increase in Accounts Payable 2,000
Purchase of new equipment 15,000
Cash sale of equipment (actual gain $10,000) 20,000
Depreciation Expense 5,000
Repurchase of Common Stock 10,000
Payment of Dividend 4,000
A. $58,000
B. $55,000
C. $54,000
D. $48,000
NI 50,000
AR 2,000
Inv (1,000)
AP 2,000
Gain (10,000)
Dep 5,000
Total 48,000
67. What is net cash flow from investing? B. $5000Equip-

ment sale 20,000
A. $10,000 less Equipment
purchase 15,000
B. $5,000
C. ($5,000)
D. ($15,000)
68. What is net cash flow from financing? C. ($14,000) Re-

purchase -10,000,
A. $6,000 dividend - 4,000
B. $3,000
C. ($14,000)
D. ($17,000)
69. What is change in cash? D. $39,000

48+5=52-14=39
A. $49,000
B. $46,000
C. $45,000
D. $39,000
70.
On a statement of cash flows that uses the indirect D. depreciation
approach, calculation of cash flow from operations reduces net
treats depreciation as an adjustment to reported net income but does
income because: not involve an
outflow of cash.
A. depreciation is a direct source of cash.
B. depreciation is an outflow of cash to a reserve

account for the replacement of assets.

an outflow of cash.

volve an outflow of cash.
71. An increase in accounts payable would be A. a source of

considered: cash. Increases in
liabilities are con-
A. a source of cash. sidered sources of
cash.
B. a use of cash.
C. an adjusting entry.
D. a noncash charge to income.
72. Hupta Corporation reports for the year ended Decem- B. $6,440.
ber 31, 2005, sales of $9,430 and cost of goods sold COGS 6,500 -
of $6,500. Other information as of December 31 is Beg inv 400 +
as follows: End inventory 380
=6,480 purchased
2004 2005 AP beg 250 - AP
Accounts Receivable $500 $550 end 290, means
Inventory $400 $380 40K not paid
Accounts Payable $250 $290 for. 6,480-
40=6,440
Cash paid to suppliers for year ended December
31, 2005, is:
A. $6,480.
B. $6,440.
C. $5,520.
D. $6,560.
73. Cash collected from customers for the year A. $9,380.

ended December 31, 2005, is: Sales 9,430
but AR went
A. $9,380. up 550-500=50
meaning cash
B. $9,430. collected (50K)
9,430 -50K =
C. $8,930. 9,380
D. $8,980.
74. Cash from operating B. $63,500

activities Net Income $ 60,000
Depreciation 4,000
Increase in accounts receivable (2,000)
Increase in deferred tax liability 2,000
Increase in short-term debt 500
$63,500
Cash from investing activities

Purchase of marketable securities ($ 48,000)
Cash from financing activities

Dividends paid (1,500)
Increase in long-term debt 2,500
$ 1,000
Net increase in Cash $ 16, 500
18. The correct cash flows from operating

activities is:
A. $65,500.
B. $63,500.
C. $53,500.
75. . The correct cash flows from investing activities C. ($48,000).

is:
A. ($41,000).
B. ($45,500).
C. ($48,000).

C. $1,000
76. The correct cash flows from financing activities is:
A. ($4,500).
B. $3,000.
C. $1,000.

77. The correct change in cash for the year is: C. $16,500
A. $4,000
B. $15,000
C. $16,500
78. The management of a company wishes to win- D. I and IV

dow-dress its cash flow from operations. Which of
the following will improve cash flow from
operations?
I. Factoring accounts receivable Reduces AR,

im- proves cash
II. Paying suppliers more quickly Reduces

cash, lessens cash
III. Selling of some excess marketable securities

Just swaps cash equivalents
IV. Deferring payment of taxes Increases AP,

improv- ing cash
A. IV only
B. III and IV
C. II, III, and IV
D. I and IV
79. Tracy Company reports the following in its statement C. $2,150.
of cash flows: 2050 COGS-de-
crease in inv 200
Net Income $ 1,000 + 300 decrease in
Depreciation and amortization 350 AP
Decrease (increase) in accounts receivable (10)
Decrease (increase) in inventory 200
Decrease (increase) in prepaid expenses 80
Increase (decrease) in trade payables (300)
Increase (decrease) in taxes payable 75
Cash flow from Operations $1,395
23. If Tracy shows cost of goods sold of $2,050 on

its income statement, cash paid to suppliers is:
A. $1,550.
B. $1,950.
C. $2,150.
D. $2,650.
80. If Tracy shows depreciation expense of $275 in A. $0 Deprecia-

its income statement, cash paid for amortization tion is a non-cash
is: item.
A. $0
B. $75
C. $525
D. not determinable
C. CFO would
81. Tracy used the indirect method of determining have been the
cash flow from operations (CFO). If it had used the same.
direct method:
A. CFO would have been higher as gains are
not deducted in arriving at CFO.
B. CFO would have been lower as losses and

depreciation are not added back in arriving at
CFO.
C. CFO would have been the same.
D. it is not possible to determine what CFO

would have been without more information.
D. Decrease in
82. Which of the following items is deducted from net accounts payable
income to arrive at cash flow from operations Subtracted Liab.
when using the indirect method? up, Cash up
A. Depreciation expense
B. Amortization expense
C. Decrease in accounts
receivable D. Decrease in
D. partly as op-
accounts payable erating cash flows
and partly as
83. Firms report payments for capital leases in the cash financing cash
flow statement: flows.
A. only as financing cash flows.
B. only as investing cash flows.
C. partly as operating cash flows and partly as

investing cash flows.
D. partly as operating cash flows and partly as financ-

ing cash flows.
84.
Compared with firms with capital leases, firms with B. lower cash
operating leases generally report: flow from
operations.
A. higher cash flow from operations.
B. lower cash flow from operations.
C. identical cash flow from operations.
D. lower or higher cash flow from operations

depending upon market interest rates.
85. Which of the following would NOT affect cash

flow from operations? B. Payment of
dividends Goes
A. Sale of land for a gain to financing
section.
B. Payment of dividends
C. Depreciation of fixed assets
D. Capitalizing costs that were previously expensed
86. Cash Flow Below

Net income $80,000
Amortization 2,000 B. $75,000
Depreciation 4,000
Decrease in AR 2,000
Increase in Inventory
(3,000)
Gain on Sale of property (10,000)
Cash Flow from Operations 75,000
Investing
Purchase of marketable securities (13,000)
Sale of property 11,000
Cash Flow from investing (2,000)
Financing
Repayment of debt (8,000)
Payment of dividend (3,000)
Cash Flow from investing (11,000)
Net Cash Flow 62,000
A. $74,000
B. $75,000
C. $83,000
D. $85,000
87. 32. What is net cash flow from investing? C. ($2,000)
A. $11,000
B. $7,000
C. ($2,000)
D. ($12,000)
88. What is net cash flow from financing? C. ($11,000)
A. ($5,000)
B. ($10,000)
C. ($11,000)
D. ($13,000)
89. What is change in cash? D. $62,000

A. $81,000
B. $72,000
C. $71,000
D. $62,000
90. Which of the following is true? The choice of C. affect both net
LIFO versus FIFO will: income and cash
flow from opera-
A. not affect net income or cash flow from operations. tions.
B. not affect net income but will affect cash flow

from operations.
C. affect both net income and cash flow from opera-

tions.
D. affect net income but will not affect cash flow

from operations.
91. Which of the following would be considered a use B. An increase in

of cash? working capital
Plus assets, less
A. Depreciation liabilities. Both use
cash.
B. An increase in working capital
C. Sale of bonds
D. An increase in wages payable
92. Schwerin Corporation reports the following on D. $60 million

its 2005 financial statements.
2004 2005
From statement of cash flows

Cash proceeds from sale of equipment $100 million
Cash outflow from purchase of equipment 170
million Depreciation 30 million
Gain from sale of equipment 40 million
37. The net book value of equipment sold was:
A. $120 million
B. $100 million
C. $80 million
D. $60 million
93. If the beginning and ending property, plant, and A. $120 million
equipment are $500 million and $550 million respec- 500 million +170
tively, the gross book value of equipment sold was: million -550 million
=120 million
A. $120 million
B. $100 million
C. $80 million
D. $60 million
94. Beginning and ending plant assets are $325,000 and C. $2,700
$370,000 respectively. Beginning and ending accu-
mulated depreciation are $82,800 and $95,000 re-
spectively. Depreciation expense for the period
was
$30,000, and new assets of $76,000 were purchased.
Plant assets were sold at a $10,500 loss. What were
the cash proceeds from the sale?
A. $17,800
B. $3,100
C. $2,700
D. $31,000
95. The following information is given for Building Inc.: A. $38,000
530,000 +78,000 -
2005 2004 570,000
PPE $ 570,000 $ 530,000
Accumulated depreciation 102,000 92,000
Depreciation expense 30,000 32,000
During 2005 new assets were purchased for of

$78,000, and plant assets were sold at a $10,000
loss.
40. What was the book value of the sold assets?
A. $38,000
B. $18,000
C. $10,000
D. $8,000
96. What were the cash proceeds from the sale? D. $8,000
A. $38,000
B. $18,000
C. $10,000
D. $8,000
97. Beginning and ending prepaid insurance is $36,000 D. $21,000

and $26,500 respectively. During the period,
$30,500 of insurance expense was recorded. How
much new
A. $2,500
B. $15,600
C. $49,000
D. $21,000
98. The balance for supplies is $41,000 and $27,000 for B. $16,500
12/31/05 and 12/31/06, respectively. During the 2006, =30,500 +27,000 -
the company recorded $30,500 of supplies expense 41,000
was recorded. How much new supplies were pur-
chased?
A. $44,500
B. $16,500
C. $14,000
D. $30,500
99. Held-to-maturity securities are equity securities that F

management intends and has the ability to hold to
maturity
100. Held-to-maturity securities are always classified as F
noncurrent assets.
101. Investment securities should always be reported at F
lower of cost or market.
102. When a security is reclassified from available-for-sale T
to trading, it is transferred at fair market value, and
any unrealized gains or losses must be recognized in
the income statement.
f
103. The equity conformity rule requires that marketable
securities must be marked to market for tax
purposes.
f
104. The equity method of accounting for investments
should be used when a company has a
controlling interest in the investee.
105. All derivatives are recorded at market value on t
the balance sheet
106. When purchase accounting is used for acquisitions, f
prior year financial statements presented for
comparative purposes should be restated as if the
companies had always been combined.
107. Goodwill recorded as the result of an acquisition is f
defined as the purchase price less the book value
of net assets.
108. One of the problems with purchase accounting is t
that there is often very little basis for
comparability of financial statements before
acquisition and after acquisition
109. One of the problems with consolidated financial t
statements is that all intercompany transactions
are not reported.
110. Under SFAS 141, accounting for acquisitions can t
no longer result in an increase in the consolidated
entity's stockholders' equity.
111. If a company chooses the fair value option for an t
asset or liability, all changes in the fair value of the
asset (or liability), including unrealized gain and
losses, will be included in net income.
112.
f
Economic income and accounting income are not yield
always the same. cash flow
conseque
113. The matching principle in accounting prescribes t nces
that costs must be recognized in the same period
when the related revenues are recognized
114. Revenue from sales where the buyer has the right of f
return can only be recognized after the return
period has expired
115. If two firms are identical except that one firm uses t
percentage-of-completion accounting and the oth-
er uses completed contract accounting for revenue
recognition, the cash flows of the firms will be
identical
116. Generally, revenue should be recorded when it f

is probable and reasonably estimable
117. Revenues are earned inflows that arise from a t

company's ongoing business activities
118. Gains are earned inflows that arise from a f

company's ongoing business activities
119. Comprehensive income is computed by adjusting t

net income, on an after-tax basis, for certain
unrealized gains and losses.
120. For item to be considered extraordinary, it should f

be either unusual in nature or infrequent in
occurrence
121. For item to be considered a special item, it should t

be either unusual in nature or infrequent in
occurrence but not both.
122. Accounting changes are usually cosmetic and do t

FALSE
123. A long-term asset is said to be impaired when its fair t
value is below its book value.
124. Income from continuing operations is a measure that
t excludes certain nonrecurring items, such as extra-
ordinary items, and the effects of discontinued oper-
ations, from net income.
125. Smythe Corporation is in the real estate develop- f
ment business. If they sell a piece of land for $50,000
that they had previously purchased for $45,000, they
should record a loss of $5,000.
126. For companies in an expansion phase, capitalizing in-
t terest may result in higher earnings over an
extended period, compared to expensing interest
127. The capitalization of interest costs during construc- f
tion increases future net income.
128. Software costs may be capitalized once a company t
can show that the product is technologically feasible
129. A company that capitalizes costs, rather than expens- f
ing them will have a higher asset turnover
130. If revenue is recognized for financial reporting pur- t
poses but deferred for tax purposes this results in a
deferred tax liability.
131. If an expense is recognized for financial reporting f
purposes but not allowed as a bona-fide, meaning not
ever allowed, deduction for tax purposes, this results
in a deferred tax asset.
132. Extraordinary items are defined as those that are t
both unusual in nature and infrequent in occurrence.
These items are disclosed, net of tax in the income
statement.
133. Accounting errors are considered accounting f
changes and treated accordingly.
134. When a company disposes of a segment of its busi- f
ness, it must restate all prior year financial state-
ments as if it had never owned that segment of the
business.
135. All other things equal, a company that capitalizes t
rather than expenses software development costs,
will have a less volatile net income
136. Comprehensive income reflects nearly all changes to
t equity, other than those from owner activities (such
as dividends and share issuances
137. If a company, operating in an inflationary environ- t
ment, uses FIFO for tax purposes and weighted-av-
erage for financial reporting purposes, this will result
in a deferred tax asset.
138. Deferred taxes arise due to temporary timing differ- t
ences in recognizing items for tax and financial re-
porting purposes.
139. If a company depreciates an asset at a faster rate for
t tax purposes than for financial reporting purposes
this will give rise to a deferred tax liability.
140. A deferred tax liability imposes an obligation on the f
business to pay taxes.
141. Some items appear on a company's income state- t
ment but never appear on its tax return.
142. In order to determine permanent income for the year t
being analyzed, it is necessary to consider special
charges from other years.
143. f
Timing is one of the few revenue recognition
issues that are seldom a concern in financial false
analysis.
144. Only costs of materials, equipment, and facilities hav-

t ing alternative future uses (in R&D projects or
otherwise) are capitalized as tangible assets
145. Employee stock options (ESOs) usually constitute t

a wealth transfer from current shareholders to
prospective shareholders (employees) and have no
effect on total liabilities and shareholders' equity.
146. Under long-term performance contracts—such as t
product warranty contracts and software mainte-
nance contracts—revenues are often collected in ad-
vance and are recognized proportionally over the en-
tire period of the contract.
147. ESOs often are granted to managers in growth and t
innovative industries to induce more risk-taking.
148. Companies can construct the statement of cash t
flows using either the direct method or the indirect
method.
149. Cash flow from operations is usually less volatile f
than net income.
150. The only time a company experiences a negative f
cash flow from operations is when they are in trouble.
151. Cash flow from operations will often be negative for t
companies experiencing tremendous growth.
152. Cash flow from investing when averaged over an ex-
t tended period of time would normally be expected
to be negative (i.e. net outflow).
153. Cash flow from financing is normally negative during f
the start-up phase for a company
154. Over an extended period-of-time average cash flow t
from operations would be expected to be higher than
average net income.
155. Amortization of goodwill reduces net income and is f
a cash outflow.
156. Payment of a 5% stock dividend will not appear in the t
statement of cash flows.
157. A gain on sale of an asset would require adjusting r
net income, if preparing the statement of cash flows
using the indirect method
158. An increase in accounts receivable does not require f
adjusting net income, if preparing the statement of
cash flows using the indirect method.
159. Depreciation and amortization expense need to be t
added back to net income if preparing the statement
of cash flows using the indirect method.
160. An increase in assets would usually show as an out- t
flow in the statement of cash flows.
161. A decrease in liabilities would usually show as an t
outflow in the statement of cash flows.
162. Many financial analysts subtract interest paid from t
cash from operations and reclassify it as part of cash
from financing activities
163. The financing section of the statement of cash flows f
(prepared in accordance with GAAP) contains all
cash inflows and cash outflows, relating to the
financing of a company.
164. Depreciation expense decreases net income but is t
not a use of cash.
165. Cash flows from operations is better measure of prof-
f itability than net income as it is less susceptible to
manipulation by management
166. Users sometimes compute net income plus depre- t
ciation and amortization (for example EBITDA) as
a crude proxy for operating cash flows.
167. Increases in working capital are a source of funds. f
168. Taxes paid on capital gains from the sale of mar- t
ketable securities are recorded as cash outflows
from operations.
169. Net cash flow is not affected by a company's
choice of accounting principles for financial t
reporting purposes.
170. In firms that are experiencing tremendous growth, it
is rare that net income will exceed cash generated f
by all activities.
171. Interest income is recorded as an operating inflow
of cash t
172. An increase in a liability is a use of cash.

f
173. The cash adequacy ratio is normally measured
over an extended period-of-time to remove the t
effect of random disturbances.
174. The cash reinvestment ratio is a measure of the per-
centage of investment in assets representing t
operating cash retained and reinvested in the
company for both replacing assets and growth in
operations.

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Chapter 01

Overview of Financial Statement Analysis

Multiple Choice Questions

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

Dividend payout ratio for 2005 was:

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

9. A common size income statement would typically be prepared by dividing:

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

12. Which of the following statements is incorrect?

14. Which of the following statements concerning financial ratios is incorrect?

Following is some financial information for Dell Inc.

17. What is Dell's profit margin for 2005?

18. What is Dell's profit margin for 2006?

20. What is Dell's asset turnover for 2006?

Return on Assets for 2006 is:

23. Working Capital for 2005 is:

25. Current Ratio for 2005 is:

26. Return on Common Equity for 2006 is:

27. Which of the following statements is correct?

30. The semistrong efficiency of market implies that:

31. Which of the following statements is incorrect?

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

38. Which of the following statements is most correct?

42. Which of the following statements is incorrect?

True / False Questions

48. Financial statement analysis is an exact science.

56. Common size statements are useful for inter-company comparisons.

64. Debt-to-equity ratio is a commonly used measure of liquidity.

65. Earnings Yield is the reciprocal of the price/earnings ratio.

66. Dividend yield is defined as dividends divided by shareholders' equity.

72. A capital-intensive company requires high cash turnover.

73. A security can be under or overvalued, depending on the extent of an incorrect

74. Prospective analysis is the forecasting of future payoffs—typically earnings and

Chapter 02 Financial Reporting and Analysis

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

D. I, II, III, and IV

B. International Accounting Standards (IAS)

C. International Financial Reporting Standards (IFRS)

D. Internal Revenue Services (IRS)

3. 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

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

A. Directors are elected by management of a company.

C. Directors are shareholders' representatives.

D. All directors of a company are senior managers in that company.

B. Accruals cannot be manipulated.

C. Accruals are less reliable than cash flows.

D. All accrual accounting adjustments are value irrelevant.

6. Which of the following statements about cash flows is true?

A. All cash flows are value relevant.

B. Only current cash flows are relevant for valuation.

C. Cash flows are less reliable than accruals.

D. Cash flows can be manipulated.

A. the capacity of information should be based on five-year average

B. the capacity of information to affect a decision.

C. the capacity of information should be based on market expectations.

8. Financial accounting data has some inherent limitations to