Understanding Accounting Concepts and Business Performance Evaluation

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

D. $16,000.

2. Atlantis Company's ending inventory is understated $4,000. The effects of this error on the current year's
cost of goods sold and net income, respectively, are understated(overstated)/overstated(understate).

B. Overstated, understated.

3. When there is a change in estimated depreciation when is correction made?

Ans b) current and future years’ depreciation should be revised

4. Which one of the tangible fixed assets would not normally be depreciated?

A. Land

5. Which one of the events must happen before a company can pay final proposed equity dividend?
Ans: After the shareholders agree to the proposed dividends and after the preferred stock dividends
are paid off.

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

Ans: The loan is backed by a real, identifiable and ascertained asset. The loan is backed by a
definite property.

7. What is another word meaning 'debenture'?

bond, voucher, I.O.U, promise to pay, legal instrument.

8. For 2007, FP Ltd had net income of Rs1,000,000. At 1January 2007, there were 1,000,000 shares
outstanding. On 1July 2007, the company issued 100,000 new shares for Rs20 per share. The company
paid Rs200,000 in dividends to common shareholders. What is FP Ltd’s basic earnings per share for
2007?
A. $0.73
B. $0.91
C.$0.95

Answer: 0.95 . First find the weighted average number of shares outstanding for
2007 is 1,050,000.This can be found by: Beginning shares:1,000,000Ending
shares:1,100,000 Total:2,100,000

9. CSI Ltd had 1,000,000 average shares outstanding during all of 2007. During 2007, CSI also had 10,000
options outstanding with exercise prices of Rs10 each. The average stock price of CSI during 2007 was
Rs15. For purposes of computing diluted earnings per share, how many shares would be used in the
denominator?
Ans. 10000 options outstanding x exercise price $10 each=
10000 x $10= $100,000 revenue

$100,000/ average stock price $15

$100,000/ $15= 6666.67 Treasury shares purchased

denominator:
shares outstanding+ option exercises - Treasury shares purchased
=1000000+10,000-6666.67
=1003333//

10. Nutmeg, Inc. uses the LIFO method to account for inventory. During years in which inventory
unit costs are generally rising and in which the company purchases more inventory than it sells to
customers. What is the impact on gross profit compared with FIFO method?

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

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

Ans. 2.94
EXPLANTION
Cogs/avg.Inventory
Using LIFO
Opening Stock = 562
Add. Purchases = x
-closing stock = (553)
Ending =1827
X = 1818
Using FIFO
Opening Stock = 562+56.8
Add. Purchases = 1818
-closing stock = (553+63.3)
Ending =1820.5

12. You are comparing the property and equipment disclosures for three airline companies, as summarized in
the following table: You find that the average fleet age is lowest for which company
Airline A Airline B Airline C
Historical cost, aircraft $17,239 £23,584 €45,266
Accumulated depreciation, aircraft 6,584 13,654 21,745
Net cost, aircraft 10,655 9,930 23,521
Annual depreciation expense 575 786 1,509
13. When an asset is considered impaired?
Ans. An impaired asset is a company's asset that has a market price less than the value listed on the
company's balance sheet.

14. How is change in accounting estimate reported?

Ans. Whenever a company changes such estimates, it is required to reflect the change only in current and
future periods, but not in past periods.

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

Ans. The depreciation expense will be high

16. What is comparison of a company's financial results to other peer companies for the same time period
called?

Ans. Cross - sectional analysis.

17. In order to assess a company's ability to fulfill its long-term obligations, which ratios would an analyst
most likely examine

Ans. Solvency ratios

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

Ans. Matching principle

19. One of the following statements about the accrual basis of accounting is false. That statement is:

Ans. Revenue is recorded only when cash is received, and expenses are recorded only when cash is paid.

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

Ans. Lower net income because cost of goods sold is higher

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

A. Current/ratio.

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

Ans. Management of receivables has contributed to improved liquidity

23. Marcus Lee is examining the solvency of Apex Manufacturing and has collected the following data (in
millions of euros):
2005 2004 2003
Total debt 2000 1900 1750
Total equity 4000 4500 5000
Which of would be the most appropriate conclusion for Lee?

A. The company is becoming increasingly less solvent, as evidenced by the increase in its
debt - to - equity ratio from 0.35 to 0.50 from 2003 to 2005.

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

Ans. +$0.41million.

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

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

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

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

27. In general, a creditor would consider a decrease in which of the ratios to be positive news?
Ans. Interest coverage

28. What does the P/E ratio measure?

Ans c. The earnings for one common share of stock.

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

Ans. High Expenses

30. Almas Industries has a debt-to-equity ratio of 1.6 compared with the industry average of 1.4. What does
this means for the company?

Ans. D, has greater than average financial risk when compared to other firms in its industry

31. A company can improve (lower) its debt-to-total assets ratio by doing which methods?

Ans. Sell common stock.

32. Which of the conditions would NOT improve the current ratio?

Ans. Something that lowers Current Assets or Increases Current liabilities or is not related at all

33. Which of the is a true statement concerning the use of financial ratios to compare financial results of two
or more companies
Ans. Companies should belong to the same industry, and have similar businesses. Compare the companies’
performances for the same year.

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

EPS = net income ÷ average outstanding common shares

35. This is how the acid-test ratio is calculated

Ans. (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

Acid-Test Ratio = (Current assets – Inventory) / Current Liabilities

36. What is the counter impact if the size of an asset increases on a balance sheet,

Ans. Assets represent the equity in the business. As the value of the assets increases, the equity in the
business increases. The equity calculation on the balance sheet is directly impacted by the value of the
company assets.

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

Ans. The going concern principle is the assumption that an entity will remain in business for the foreseeable
future. Conversely, this means the entity will not be forced to halt operations and liquidate its assets in the
near term at what may be very low fire-sale prices

38. At what stage a manufacturer is permitted to recognized a transaction for inclusion within its profit and
loss account?

Ans. The SEC set forth seven criteria, all of which must be met in order to recognize revenue when delivery
has not occurred:

A. Risk of ownership must have passed to the buyer.

 B. Customer must have made a fixed commitment to purchase the goods.
C. The buyer, not the seller, must request that the transaction be on a bill and hold basis and must have a
substantial business purpose for ordering the goods on a bill and hold basis.
D. There must be a fixed schedule for delivery of the goods.
E. The seller must not have retained any specific performance obligations such that the earnings process
is not complete.
F. The ordered goods must have been segregated from the seller’s inventory and not be subject to being
used to fill other orders.
G. The equipment or product must be complete and ready for shipment.

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

Ans. Amortization is paying off, writing off, depreciation of intangible assets

Ans. Amortization is an accounting term that refers to the process of allocating the cost of an intangible
asset over a period of time. It also refers to the repayment of loan principal over time.
Example:

Let's assume Company XYZ owns the patent on a piece of technology, and that patent lasts 15 years. If the
company spent $15 million to develop the technology, then it would record $1 million each year for 15 years
as amortization expense on its income statement.

Alternatively, let's assume Company XYZ has a $10 million loan outstanding. If Company XYZ repays
$500,000 of that principal every year, we would say that $500,000 of the loan has amortized each year.

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

Ans. Interim Dividend

Many ASX listed companies pay dividends twice each year, usually as an 'interim' dividend and a 'final'
dividend.

Companies are not limited to paying twice a year and may pay more or less frequently. A company may also
pay a 'special' dividend, related to a particular event. There is no requirement for the company to pay a
dividend from earnings, some companies might elect to reinvest the earnings back into the business

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

Ans. Say on 1 January we had 500 shares outstanding, on 1 July we issued 100 shares, and on 1 October we
issued 400 shares.
 Weighted average:

 1 January 500 shares 12/12 500

 1 July 100 shares 6/12 50
 1 October 400 shares 3/12 100
 Total share in issue at y/e = 1,000 shares
 Weighted average number of shares in issue = 650

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

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

43. In calculating basic earnings per share, net profit or loss is included in the formula after deduction of
these this

Ans

44. How is the market value of a company whose shares are listed on a stock market can be found?
Ans. Market Value = Market Capitalization = Stock Price x No. of outstanding shares.
45. When does a post balance sheet period ends?

Ans. A post balance sheet event is something that occurs after a reporting period, but before the
financial statements for that period have been issued or are available to be issued.

46. A limited liability company in which you are a shareholder has just gone bankrupt. Its liabilities are far in
excess of its assets. What would you will be called on to pay:
1) a proportionate share of bondholder claims based on the number of common shares that you
own.

2) a proportional share of all creditor claims based on the number of common shares that you
own.

3) an amount that could, at most, equal what you originally paid for the shares of common stock
in the corporation.

4) nothing.

47. Is a corporation is a “legal entity’ that can be sued?

Ans. True, it can be sued.

Only an actual legal entity may initiate a lawsuit. A natural person is a legal entity, for example, and any num
ber of peoplecan be parties on either side of a lawsuit. A corporation is endowed by its charter with existence
as a separate legal entity.A business partnership is usually not considered a legal entity, but generally it can su
e or be sued in the partnership nameor in the names of the individual partners.

48. Equity financing has a tax advantage since dividends paid out to shareholders reduce a firm's taxable
income.

Ans. FALSE: Interest payments -- NOT dividends -- are subtracted from earnings, thus reducing taxable
income. It is DEBT FINANCING, then, that offers a tax advantage.

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

A. Company A ' s current ratio of 4.0x indicates it is more liquid than Company B, whose current ratio is only
1.2x, but Company B is more solvent, as indicated by its lower debt - to - equity ratio.

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

Basically, the shares were issued for less than the company was worth.
 For example, if Company XYZ prices its 10 million share IPO at $15 per share but the shares trade at
$30 two days after the IPO, this suggests that the underwriter probably underestimated the demand
for the issue. As a result, Company XYZ received $150 million (less underwriting fees) when it could
have possibly fetched $300 million. Thus, the issuing company must also follow a robust due diligence
process on their end in order to optimize their capital raising efforts.

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

In case of cumulative preference shares, if the profits of the company in any year are not sufficient to pay
dividend on such shares, the deficiency accumulates, to be paid out of the profits of subsequent years.

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

EXPLANATION
A change in GP Margin Ratio could be attributed to numerous factors in different
scenarios as summarized in the below:
a) Increase in GP Margin Ratio & Decrease in Total Gross Profit
Possible Causes:
 Increase in selling price not resulting in greater sales revenue due to price
elastic demand of company products.
 Decrease in production costs achieved in the later stages of product life cycle
(e.g. through better manufacturing efficiency) offset by a lower demand.
b) Increase in GP Margin Ratio & Increase in Total Gross Profit
Possible Causes:
 Increase in selling price of products with inelastic demand.
 Increase in sales volume resulting in the decrease of production costs due to
economies of scale.
 Decrease in the level of competition (e.g. due to acquisition of rival companies)
resulting in higher selling price, lower production costs (e.g. due to greater
economies of scale and synergies) and improved market share.
c) Decrease in GP Margin Ratio & Increase in Total Gross Profit
Possible Causes:
 Decrease in selling price resulting in greater sales revenue due to price elastic
demand of the company products
d) Decrease in GP Margin Ratio & Decrease in Total Gross Profit
Possible Causes:
 Increase in competition forcing a decrease in selling price and reduction in
market share.
 Lower market demand forcing a downward pressure on selling price.
 The burden of increase in production costs not being transferred to customers
through increased selling price.
 Inefficient production.

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

A Safer for shareholders
EXPLANATION
gearing ratio measures the degree to which the capital of the business is financed with long-term
loans
HIGHLY GEARED = GREATER RELIANCE OF A BUSINESS ON LOAN CAPITAL
so lower = better/safer
disadvantages of low gearing ratio
business might be missing potentially profitable investment opportunities

54. What does it mean when a company shows a dividend cover of 3 times?
Ans. A dividend cover of 3 implies that a company has sufficient earnings to pay dividends amounting to 3
times of the present dividend payout during the period.

EXPLANATION
Definition
Dividend Coverage Ratio states the number of times an organization is capable
of paying dividends to shareholders from the profits earned during an accounting
period.
Formula
Dividend cover in respect of ordinary share capital may be calculated as follows:

Profit after tax - Dividend paid on Irredeemable

Dividend Cover Preference Shares
=
Ratio
Dividend paid to Ordinary Shareholders

Explanation
Dividend Coverage Ratio indicates the capacity of an organization to pay dividends
out of profit attributable to the shareholders. A dividend cover of 3 implies that a
company has sufficient earnings to pay dividends amounting to 3 times of the
present dividend payout during the period.
When calculating dividend coverage for ordinary share capital, it is necessary to
deduct any dividend paid on irredeemable preference shares from the net profit
earned during the accounting period in order to arrive at the earnings attributable
to ordinary share holders. Dividend on redeemable preference shares is already
deducted from the income statement as interest expense (finance cost) and hence
no further adjustment is required in its respect in the dividend cover calculation.

55. If a '5 for 3' rights issue is made at Rs.1.90 per share, How much would a shareholder who owns 15,000
shares pay to the company to buy all the shares he is entitled to?
A 47,500
EXPLANATION
15000 shares they,
5 for 3 ka rights issue
toh 3 pe 5 milney they
15000 pe > 15000x5/3=25000
25000-15000
10000x1.9=19000

56. If a '3 for 2' bonus issue is made to a shareholder who originally paid Rs.2 per share for 10,000 shares,
how much would the shareholder pay for the bonus shares if the current market value is Rs.4 per share?
A He would not pay
EXPLANATION
Bonus shares are free of cost
 Bonus shares are issued in a certain proportion to the existing holders. A 2 for 1 bonus would mean
you get two additional shares — free of cost — for the one share you hold in the company. If you hold
100 shares of a company and a 2:1 bonus offer is declared, you get 200 shares free. That means your
total holding of shares in that company will now be 300 instead of 100 at no cost to you.

57. A company has issued 2m shares at Rs.3.50 each. The nominal value of each share is Rs.0.50, and the
stock market price is Rs.5. What entries must be made on the balance sheet to record this share issue?
A 7,000,000
EXPLANATION
Share Capital (2,000,000x0.5) = 1,000,000
Share Premium (2,000,000x3) = 6,000,000
Total 7,000,000

58. What is the role of an auditor?

Ans. The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement, whether caused by error or fraud.

59. Which one of the statements is not contained within a published annual report?
Ans. Yar matlab kuch bhi hosakta hai

60. What is Horizontal analysis?

Ans Changes in amounts of corresponding Financial statements items over a period of time