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# Ch12

Student: ___________________________________________________________________________

1. We can use ratios to help evaluate a firm's performance and financial position.

True False

2. Vertical analysis expresses each item in a financial statement as a percentage of the same base amount.

True False

3. Vertical analysis calculates the amount and percentage change of an account over time.

True False

4. We use vertical analysis for income statement accounts, but not balance sheet accounts.

True False

5. We use vertical analysis to express each income statement item as a percentage of sales.

True False

## sales. True False

7. Horizontal analysis analyzes trends in financial statement data for a single company over

## time. True False

8. If the base-year amount is zero, we can't calculate a percentage change under horizontal analysis.

True False

9. Using horizontal analysis, if the base year is negative and the following year is positive, the
percentage change is just as useful as if the base year and the following year were both positive.

True False
10. We use horizontal analysis to analyze trends in financial statement data, such as the dollar amount of
change and the percentage change, for one company over time.

True False
11. We measure income statement accounts at a point in time and balance sheet accounts over a period of time.

True False
12. Ratios that compare an income statement account with a balance sheet account should express the
balance sheet account as an average of the beginning and ending balances.

True False
13. Every liquidity ratio is calculated using one or more current asset

## accounts. True False

14. Solvency refers to a company's ability to pay its current liabilities while liquidity refers to a company's
ability to pay its long-term liabilities.

True False
15. The receivables turnover ratio measures how many times, on average, a company collects its
receivables during the year.

True False
16. A low receivables turnover ratio is a positive sign that a company can quickly turn its receivables into cash.

True False

17. The average collection period converts the receivables turnover ratio into

## days. True False

18. A low inventory turnover ratio usually is a positive sign and indicates that inventory is selling quickly.

True False

19. An extremely high inventory turnover ratio may be a signal that the company is losing sales due
to inventory shortages.

True False
20. The average days in inventory converts the inventory turnover ratio into days.

True False

21. A low current ratio indicates that a company has sufficient current assets to pay current liabilities as they
become due.

True False
22. The acid-test ratio is always smaller than the current

## ratio. True False

23. Other things being equal, the higher the debt to equity ratio, the higher the risk of bankruptcy.

True False
24. We use the times interest earned ratio to compare interest payments with a company's income available to
pay those charges.

True False
25. We calculate the times interest earned ratio by dividing net income by interest expense.

True False

26. The gross profit ratio is calculated as gross profit divided by net

## assets. True False

28. Profit margin measures the income earned on each dollar of sales, and is calculated by dividing net income
by net sales.

True False
29. Asset turnover measures sales volume in relation to the investment in assets, and is calculated as net
sales divided by average total assets.

True False
30. Return on equity is calculated by dividing the stock return by average stockholders' equity.

True False

31. The price-earnings (PE) ratio compares a company's share price with its earnings per

## share. True False

32. Growth stocks have high expectations of future earnings growth, and therefore, usually trade at higher
PE ratios.

True False
33. Value stocks have lower share prices in relationship to their fundamental ratios, and therefore, trade at
lower PE ratios.

True False
34. A discontinued operation is the sale or disposal of any long-term asset.

True False

35. We report any profits or losses on discontinued operations in the current year, separately from profits and
losses on the portion of the business that will continue.

True False
36. To be an extraordinary item, an event that produces a gain or loss must be either unusual in nature or
infrequent in occurrence.

True False
37. We report extraordinary items separately, net of taxes, near the bottom of the income statement just below
discontinued operations.

True False
38. If an item meets one but not both criteria for extraordinary item treatment, it is correctly excluded
from extraordinary items and included with other revenue and expenses.

True False
39. The location where a loss is reported in the income statement does not really matter as long as the loss is
reported.

True False
40. When using a company's current earnings to estimate future earnings performance, investors
normally should exclude discontinued operations and extraordinary items.

True False
41. Conservative accounting practices are those that result in reporting higher income, higher assets, and lower
liabilities.

True False
42. Conservative accounting practices are those that result in reporting lower income, lower assets, and
higher liabilities.

True False
43. A larger estimation of the allowance for uncollectible accounts, the write-down of overvalued inventory and
the use of a shorter useful life for depreciation are all examples of conservative accounting.

True False
44. Aggressive accounting practices result in reporting higher income, higher assets, and lower

## liabilities. True False

45. Changes in accounting estimates usually have no effect on a company's underlying cash

## A. Comparisons of sales growth between companies.

B. Comparisons of earnings per share between companies.
C. Comparisons over time.
D. Comparisons to industry.
47. When using vertical analysis,we express income statement accounts as a percentage of

A. Net income.
B. Gross profit.
C. Sales.
D. Total assets.
48. When using vertical analysis, we express balance sheet accounts as a percentage of

A. Sales.
B. Total assets.
C. Total liabilities.
D. Total stockholders' equity.
49. Which of the following is an example of verticalanalysis?

## A. Comparing gross profit across companies.

B. Comparing income statement items as a percentage of sales.
C. Comparing debt with industry averages.
D. Comparing the change in sales over time.
50. Comparing operating expenses as a percentage of sales is an example of:

A. Vertical analysis.
B. Horizontal analysis.
C. Diagonal analysis.
D. Both vertical and horizontal analysis.
51. The following is an example of:

A. Vertical analysis.
B. Horizontal analysis.
C. Diagonal analysis.
D. Both vertical and horizontal analysis.
52. The following is an example of:

A. Vertical analysis.
B. Horizontal analysis.
C. Diagonal analysis.
D. Both vertical and horizontal analysis.
53. Horizontal analysis examines trends in a company

A. Over time.
B. Between income statement accounts in the same year.
C. Between balance sheet accounts in the same year.
D. Between income statement and balance sheet accounts in the same year.
54. Which of the following is an example of horizontal analysis?

## A. Comparing COGS with sales.

B. Comparing net income across companies.
C. Comparing debt with equity.
D. Comparing the growth in sales over time.
55. Which of the following is an example of horizontal analysis?

## A. Comparing gross profit across companies.

B. Comparing gross profit with operating expenses.
C. Comparing assets with equity.
D. Comparing the change in sales over time.
56. Comparing changes in net income for one company over time is an example of:

A. Vertical analysis.
B. Horizontal analysis.
C. Diagonal analysis.
D. Both vertical and horizontal analysis.
57. Which of the following is correct?

A. Option a
B. Option b
C. Option c
D. Option d
58. Which of the following ratios is most useful in evaluating liquidity?

A. Return on assets.
B. Return on equity.
C. Debt to equity ratio.
D. Current ratio.
59. Which of the following ratios is most useful in evaluating solvency?

## A. Debt to equity ratio.

B. Current ratio.
C. Receivables turnover ratio.
D. Inventory turnover ratio.
60. Which of the following is a sign that a company can quickly turn its receivables into cash?

## A. A low receivables turnover ratio.

B. A high receivables turnover ratio.
C. A high average collection period.
D. Both a low receivables turnover ratio and a high average collection period.
61. Which of the following is a sign that a company cannot quickly turn its receivables into cash?

## A. A high receivables turnover ratio.

B. A low receivables turnover ratio.
C. A low average collection period.
D. Both a high receivables turnover ratio and a low average collection period.
62. Which of the following is a negative sign that a company is not selling its inventory quickly?

## A. A low inventory turnover ratio.

B. A high inventory turnover ratio.
C. A low average days in inventory.
D. Both a high inventory turnover ratio and a low average days in inventory.
63. Which of the following is a positive sign that a company is selling its inventory quickly?

## A. A low inventory turnover ratio.

B. A high inventory turnover ratio.
C. A low average days in inventory.
D. Both a high inventory turnover ratio and a low average days in inventory.
64. The current ratio is calculated as:

## A. Current assets divided by noncurrent assets.

B. Current assets divided by current liabilities.
C. Current liabilities divided by noncurrent liabilities.
D. Current liabilities divided by current assets.
65. The acid-test ratio is most similar to the:

A. Current ratio.
B. Debt to equity ratio.
C. Times interest earned ratio.
D. Inventory turnover ratio.
66. The acid-test ratio is:

## A. The liquidity ratio divided by the equity ratio.

B. Current assets minus inventory divided by current liabilities minus accounts payable.
C. Cash, net receivables, and current investments divided by current liabilities.
D. Cash divided by accounts payable.
67. Which of the following is not a solvency ratio?

## A. Time interest earned ratio.

B. The debt to equity ratio.
C. The current ratio.
D. All of the other options are solvency ratios.
68. When a company pays a bill from a plumber for previous services on account:

## A. Its debt to equity ratio decreases.

B. Its acid-test ratio always remains unchanged.
C. Its current ratio always remains unchanged.
D. All of the other options are correct.
69. Assuming a current ratio of 1.0, how will the purchase of inventory with cash affect the ratio?

## A. Increase the current ratio.

B. No change to the current ratio.
C. Decrease the current ratio.
D. Could either increase or decrease the current ratio.
70. Assuming an acid-test ratio of 1.0, how will the purchase of inventory with cash affect the ratio?

## A. Increase the acid-test ratio.

B. No change to the acid-test ratio.
C. Decrease the acid-test ratio.
D. Could either increase or decrease the acid-test ratio.
71. Assuming a current ratio of 1.0 and an acid-test ratio of 0.75, how will the purchase of inventory with
cash affect each ratio?

## A. Increase the current ratio and increase the acid-test ratio.

B. No change to the current ratio and decrease the acid-test ratio.
C. Decrease the current ratio and decrease the acid-test ratio.
D. Increase the current ratio and decrease the acid-test ratio.
72. When a company sells land for cash and makes a \$25,000 gain:

## A. Its acid-test ratio decreases.

B. Its current ratio decreases.
C. Its debt to equity ratio decreases.
D. Cannot determine from the given information.
73. Assume a company's current ratio and acid-test ratio are less than 1.0 before it purchases inventory
on credit. When it makes the purchase.

## A. Its current ratio decreases.

B. Its acid-test ratio decreases.
C. Its current ratio remains unchanged.
D. Its acid-test ratio remains unchanged.
A partial balance sheet (\$s in thousands) for Captain D's Seafood Inc. is shown below.

## 74. The current ratio is:

A. 1.98.
B. 1.58.
C. 1.17.
D. 0.66.
75. The acid-test ratio is:

A. 0.25.
B. 0.88.
C. 1.17.
D. 1.58.
76. The debt to equity ratio is:

A. 0.33.
B. 0.77.
C. 1.17.
D. 1.30.
Recent financial statement data for Harmony Health Foods (HHF) Inc. is shown below.

## 77. HHF's debt to equity ratio is:

A. 0.75.
B. 1.13.
C. 0.38.
D. 1.80.
78. HHF's times interest earned ratio is:

A. 3.47.
B. 1.72.
C. 2.47.
D. 10.0.
Excerpts from Stealth Company's December 31, 2013 and 2012, financial statements are presented below:

## 79. Stealth Company's 2013 receivables turnover ratio is:

A. 2.85.
B. 4.70.
C. 5.00.
D. 10.63.
80. Stealth Company's 2013 average collection period is:

A. 73 days.
B. 104 days.
C. 109 days.
D. 128 days.
81. Stealth Company's 2013 inventory turnover is:

A. 3.62 times.
B. 3.96 times.
C. 4.07 times.
D. 6.03 times.
82. Stealth Company's 2013 average days in inventory is:

A. 60.5 days.
B. 92.2 days.
C. 100.8 days.
D. 89.7 days.
83. Stealth Company's 2013 debt to equity ratio is:

A. 77.1%.
B. 80.0%.
C. 40.0%.
D. 60.0%.
84. Stealth Company's 2013 gross profit ratio is:

A. 77.1%.
B. 80.0%.
C. 40.0%.
D. 60.0%.
85. Stealth Company's 2013 return on assets is:

A. 7.1%.
B. 7.8%.
C. 13.5%.
D. 44.7%.
86. Stealth Company's 2013 profit margin is:

A. 17.1%.
B. 13.5%.
C. 7.6%.
D. 4.5%.
87. Stealth Company's 2013 asset turnover is:

A. 3.7 times.
B. 2.8 times.
C. 2.2 times.
D. 0.5 times.
88. Stealth Company's 2013 return on equity is:

A. 17.1%.
B. 14.0%.
C. 12.6%.
D. 7.1%.
Excerpts from TPX Company's December 31, 2013 and 2012, financial statements are presented below:

## 89. TPX Company's 2013 receivables turnover ratio is:

A. 5.3 times.
B. 5.6 times.
C. 5.0 times.
D. 0.2 times.
90. TPX Company's 2013 average collection period is:

A. 69 days.
B. 65 days.
C. 73 days.
D. 1,825 days.
91. TPX Company's 2013 inventory turnover is:

A. 3.0 times.
B. 5.2 times.
C. 3.3 times.
D. 3.6 times.
92. TPX Company's 2013 average days in inventory is:

A. 121.7 days.
B. 70.2 days.
C. 110.6 days.
D. 101.4 days.
93. TPX Company's 2013 debt to equity ratio is:

A. 50.0%.
B. 60.0%.
C. 70.0%.
D. 80.0%.
94. TPX Company's 2013 gross profit ratio is:

A. 57.5%.
B. 36.5%.
C. 63.5%.
D. 60.0%.
95. TPX Company's 2013 return on assets is:

A. 48.2%.
B. 9.3%.
C. 8.8%.
D. 9.0%.
96. TPX Company's 2013 profit margin is:

A. 18.8%.
B. 9.0%.
C. 19.4%.
D. 15.1%.
97. TPX Company's 2013 asset turnover is:

A. 3.7 times.
B. 2.8 times.
C. 2.2 times.
D. 0.5 times.
98. TPX Company's 2013 return on equity is:

A. 16.7%.
B. 15.0%.
C. 15.8%.
D. 21.4%.
99. Given the information below, what is the company's gross profit?

A. Option a
B. Option b
C. Option c
D. Option d
100.Return on assets equals:

## A. Gross profit ratio x Inventory turnover.

B. Profit margin x Inventory turnover.
C. Gross profit ratio x Asset turnover.
D. Profit margin x Asset turnover.
101.Nerf Mania reports net income of \$500,000, net sales of \$4,000,000, and average assets of \$2,000,000. The
return on assets is:

A. 200%.
B. 25%.
C. 50%.
D. 12.5%.
102.Nerf Mania reports net income of \$500,000, net sales of \$4,000,000, and average assets of \$2,000,000. The
profit margin is:

A. 12.5%.
B. 25%.
C. 50%.
D. 8 times.
103.Nerf Mania reports net income of \$500,000, net sales of \$4,000,000, and average assets of \$2,000,000. The
asset turnover is:

A. 0.25 times.
B. 0.5 times.
C. 2 times.
D. 8 times.
104.Richard's Sporting Goods reports net income of \$100,000, net sales of \$500,000, and average assets
of \$1,000,000. The return on assets is:

A. 10%.
B. 20%.
C. 50%.
D. 5 times.
105.Richard's Sporting Goods reports net income of \$100,000, net sales of \$500,000, and average assets
of \$1,000,000. The profit margin is:

A. 10%.
B. 20%.
C. 50%.
D. 5 times.
106.Richard's Sporting Goods reports net income of \$100,000, net sales of \$500,000, and average assets
of \$1,000,000. The asset turnover is:

A. 0.1 times.
B. 0.5 times.
C. 2 times.
D. 5 times.
107.The sale or disposal of a significant component of a company's operations is referred to as:

A. A discontinued operation.
B. An extraordinary item.
C. Other revenues and expenses.
D. Gain or loss on sale of assets.
108.A discontinued operation refers to:

## A. The sale or disposal of a significant component of a company's operations.

B. Discontinued inventory items.
C. Inventory items that have been completed and sold.
D. The sale of most long-term assets.
109.An extraordinary item must meet which of the following criteria?

A. Unusual in nature.
B. Infrequent in occurrence.
C. Unusual in nature and infrequent in occurrence.
D. Unusual in nature or infrequent in occurrence.
110. Extraordinary items:

A. Option a
B. Option b
C. Option c
D. Option d
111.Which of the following items is most likely to be reported as an extraordinary loss?

A. Option a
B. Option b
C. Option c
D. Option d
112.What is the correct order to present the following items on the income statement?

A. Option a
B. Option b
C. Option c
D. Option d
113. Popson Inc. incurred a material loss which was not unusual in character, but was clearly an infrequent
occurrence. This loss should be reported as:

A. An extraordinary loss.
B. A loss from discontinued operations.
C. Other revenues and expenses.
D. A separate line item in retained earnings.
114.The financial statements of a firm that uses more aggressive accounting practices would be likely to report:

A. Option a
B. Option b
C. Option c
D. Option d
115.Which of the following is NOT an example of applying conservatism in accounting?

A. Option a
B. Option b
C. Option c
D. Option d
116.Which of the following is a conservative accounting practice?

## A. The use of a longer service life for depreciation.

B. Waiting to record a litigation loss.
C. Adjust the allowance for uncollectible accounts to a smaller amount.
D. The write-down of overvalued inventory.
117.Which of the following is an aggressive accounting practice?

## A. The use of a shorter service life for depreciation.

B. Waiting to record a litigation loss.
C. Adjust the allowance for uncollectible accounts to a larger amount.
D. The write-down of overvalued inventory.
118.Which of the following is a conservative accounting practice?

## A. Change from double-declining balance to straight-line depreciation.

B. Record sales revenue before it is actually earned.
C. Adjust the allowance for uncollectible accounts to a larger amount.
D. Record inventory at market rather than lower of cost or market.
119.Which of the following is an aggressive accounting practice?

## A. Change from straight-line to double-declining balance depreciation.

B. Record sales revenue before it is actually earned.
C. Adjust the allowance for uncollectible accounts to a larger amount.
D. Record inventory at lower of cost or market rather than at cost.
120.Perform a vertical analysis on the following information:

121.Perform a horizontal analysis on the following information providing both the dollar amount and
percentage change:

122.Assume a company's sales are \$1.6 million in 2011, \$1.8 million in 2012, and \$1.7 million in 2013. What
is the percentage change from 2011 to 2012? What is the percentage change from 2012 to 2013? Be sure
to indicate whether the percentage change is an increase or a decrease.
123.If a company's sales are \$648,000 in 2012, and this represents an 8% increase over sales in 2011, what were
sales in 2011?

124.United Products began the year with an Accounts Receivable balance of \$250,000, and had a year-
end balance of \$280,000. Credit sales of \$800,000 generated a gross profit of \$150,000. Calculate
the receivables turnover ratio for the year.

125.United Products began the year with an Inventory balance of \$180,000, and had a year-end balance of
\$200,000. Sales of \$800,000 generated a gross profit of \$150,000. Calculate the inventory turnover ratio for
the year.

126.BC Training reports sales revenue of \$2,200,000. Average inventory during the year was \$200,000. The
inventory turnover ratio for the year is 8.0. What amount of gross profit would the company report in its
income statement?
127.LeBron's Kids Camps has a current ratio of 0.75 to 1, based on current assets of \$3 million and current
liabilities of \$4 million. How, if at all, will a \$500,000 cash purchase of inventory affect the current ratio?
How, if at all, will a \$500,000 purchase of inventory on account affect the current ratio?
128.The following income statement and balance sheets for Laser World are provided:

Assuming that all sales were on account, calculate the following risk ratios for 2012:
129.The following income statement and balance sheets for Laser World are provided:

Earnings per share for the year-ended December 31, 2012, is \$1.90. The closing stock price on
December 31, 2012, is \$30.40.
Calculate the following profitability ratios for 2012:
130.Barry's BBQ had sales revenue for the year of \$200 million and net income of \$20 million. Total assets
were \$70 million at the beginning of the year, and \$80 million at the end of the year. Calculate Barry's
return on assets, profit margin, and asset turnover ratios.

131.Paul Pierce Enterprises reports net income of \$800,000, average total assets of \$2,400,000, and average
total liabilities of \$400,000. Calculate the return on asset and return on equity ratios.

132.Phillip's Fun Center has go-karts, miniature golf, bumper boats, paintball, and laser tag. Determine
whether the company should report each of the following items as discontinued operations, extraordinary
items, or other expenses:
1. Uninsured losses of \$200,000 were incurred due to a hurricane that swept through the area for the
first time in 50 years.
2. The company sold its old go-karts at a loss of \$25,000 and replaced them with all new go-karts.
3. The company sold its laser tag center at a loss of \$10,000 to focus on the other more profitable segments.
Laser tag is considered to be a separate business segment.
4. The company restructured its business at a cost of \$75,000, replacing some employee positions
with automated equipment.
133.Classify each of the following accounting practices as conservative or aggressive:
1. Increase the allowance for uncollectible accounts.
2. When costs are rising, change from FIFO to LIFO.
3. Increase the estimated useful life of equipment.

## 134.Classify each of the following accounting practices as conservative or aggressive.

1. Choosing a shorter life for calculating depreciation.
2. The write-down of inventory.
3. Decrease the allowance for uncollectible accounts.
4. Recording revenues sooner.

## 135.Explain the difference between vertical and horizontal analysis.

136.Explain why ratios that compare an income statement account with a balance sheet account should
express the balance sheet account as an average of the beginning and ending balances.
137.Sideline Sports Products reports a return on assets of 6%, and a return on equity of 10%. Why do these
two ratios differ?

138.Define earnings persistence. How does earnings persistence relate to the reporting of
discontinued operations and extraordinary items?

139.Explain the difference between conservative and aggressive accounting practices. Provide an example of a
conservative accounting practice and explain why this practice is conservative. Provide an example of an
aggressive accounting practice and explain why this practice is aggressive.
140.Listed below are eight risk ratios followed by a list of phrases that describe or characterize the ratios.
Match each phrase with the correct ratio placing the letter designating the ratio in the space provided.

_
1. Average Cost of goods sold divided by average inventory; the number_
collection of times the firm sells its average inventory balance during a_
period reporting period._
_

2. Times _
interest Total liabilities divided by total stockholders' equity; measure_
earned ratio a company's solvency risk._
_

_
3. Current _
ratio Approximate number of days the average inventory is held._
_

_
4. Acid- Ratio that compares interest expense with income available to_
test ratio pay those charges._
5. _

## Receivables Net sales divided by average accounts receivable; the number_

turnover of times during a year that the average accounts receivable_
ratio balance is collected._
_

## 6. Inventory Cash, short-term investments, and accounts receivable divided_

turnover by current liabilities; measures the availability of liquid current_
ratio assets to pay current liabilities._
_

_
7. Debt to Current assets divided by current liabilities; measures_
equity ratio the availability of current assets to pay current liabilities._
_

8. Average _
days in Approximate number of days the average accounts receivable_
inventory balance is outstanding._
141.Listed below are six profitability ratios followed by a list of phrases that describe or characterize the ratios.
Match each phrase with the correct ratio placing the letter designating the ratio in the space provided.

## Net income divided by average total assets; measures the

1. Return amount of net income generated for each dollar invested in__
on assets assets.__
2. Profit Compares a company's share price with its earnings per__

margin share.__
3. Price-
earnings Net income divided by average stockholders' equity;__
(PE) ratio measures the income generated per dollar of equity.__
Gross profit divided by net sales; measures the amount by
4. Gross which the sale price of inventory exceeds its cost per dollar of__
profit ratio sales.__
5. Asset Net sales divided by average total assets; which measures__

## turnover the sales per dollar of assets invested.__

6. Return Net income divided by net sales; indicates the earnings per__

## on equity dollar of sales.__

142.Listed below are seven terms followed by a list of phrases that describe or characterize the terms.
Match each phrase with the best term placing the letter designating the term in the space provided.
Learning Objectives: 1, 2, 3, 4

## Analyzes trends in financial statement data for a single__

1. Liquidity company over time.__
2. Growth Have lower share prices in relationship to their__

## stocks fundamental ratios and therefore trade at lower PE ratios.__

3. Vertical Expresses each item in a financial statement as a percentage__

4. Horizontal __

__

## 5. Solvency Refers to a company's ability to pay its long-term liabilities.__

6. Value Have high expectations of future earnings and therefore__

## Stocks usually trade at higher P/E ratios.__

7.
Profitability Measure the earnings or operating effectiveness of a__
ratios company.__
143.Listed below are five terms followed by a list of phrases that describe or characterize the terms. Match
each phrase with the best term placing the letter designating the term in the space provided.
Learning Objectives: 5, 6

1. _
Conservative _
accounting An event that is (1) unusual in nature and (2) infrequent in_
practices occurrence._
_

_
2. Quality The sale or disposal of a significant component of a_
of earnings company's operations._
_

## 3. Refers to the ability of reported earnings to reflect the_

Discontinued company's true earnings, as well as the usefulness of reported_
operation earnings to predict future earnings._
_

4. Aggressive _
accounting Practices that result in reporting lower income, lower_
practices assets, and higher liabilities._
_

5. _
Extraordinary Practices that result in reporting higher income, higher_
item assets, and lower liabilities._
144.Listed below are eight terms followed by a list of phrases that describe or characterize the terms.
Match each phrase with the best term placing the letter designating the term in the space provided.
Learning Objectives: 1, 2, 3, 4, 5, 6

1. Aggressive __
accounting practices A company's ability to pay its current liabilities.__
Accounting choices that result in reporting__

## 2. Horizontal analysis lower income, lower assets, and higher liabilities.__

A profit or loss unusual in nature and infrequent in__

3. Solvency occurrence.__
4. Discontinued Accounting choices that result in reporting__

## operation higher income, higher assets, and lower liabilities.__

A tool to analyze trends in financial statement data__

## 5. Vertical analysis for a single company over time.__

The sale or disposal of a significant component of a__

## 6. Liquidity company's operations.__

7. Conservative A means to express each item in a financial__

__

## 8. Extraordinary item A company's ability to pay its long-term liabilities.__

Ch12 Key
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38. TRUE

39. FALSE

40. TRUE

41. FALSE

42. TRUE

43. TRUE

44. TRUE

45. TRUE

46. B

47. C

48. B

49. B

50. A

51. A

52. B

53. A

54. D

55. D

56. B

57. D

58. D

59. A

60. B

61. B

62. A

63. D

64. B

65. A

66. C

67. C
68. A

69. B

70. C

71. B

72. C

73. B

74. B

75. B

76. D

77. B

78. A

79. C

80. A

81. A

82. C

83. A

84. C

85. B

86. A

87. D

88. B

89. A

90. A

91. C

92. C

93. C

94. B

95. D

96. A

97. D

98. C

99. D

100. D

101. B

102. A
103. C

104. A

105. B

106. B

107. A

108. A

109. C

110. B

111. D

112. A

113. C

114. A

115. D

116. D

117. B

118. C

119. B

120.

121.

122. % change from 2011 to 2012 = (\$1.8 million - \$1.6 million) / \$1.6 million = 12.5% increase.% change from 2012 to 2013 = (\$1.7 million - \$1.8
million) / \$1.8 million = 5.6% decrease.

## 123. \$648,000 / 1.08 = \$600,000.

124.

125.
126.
Feedback: *COGS = \$200,000 x 8.0 = \$1,600,000.
Given sales of \$2,200,000 and calculating COGS of \$1,600,000, gross profit is \$600,000.

127. A cash purchase of inventory will not affect the current ratio, but a purchase of inventory on account will increase the current ratio as shown
below:

128.
129.

130.

131.

## 132. 1. Extraordinary items.

2. Other expenses.
3. Discontinued operations.
4. Other expenses.

133.

134.

135. For vertical analysis, we express each item as a percentage of the same base amount, such as a percentage of sales in the income statement or as
a percentage of total assets in the balance sheet. We use horizontal analysis to analyze trends in financial statement data, such as the dollar amount of
change and the percentage change, for one company over time.

136. We measure income statement accounts over a period of time (like a video), while we measure balance sheet accounts at a point in time (like a
photograph). Therefore, ratios that compare an income statement account with a balance sheet account should express the balance sheet account as an
average of the beginning and ending balances.

137. The return on assets and the return on equity differ due to financial leverage - the amount of debt a company carries. If a company earns a
return on investment above the interest cost of borrowing, then the additional debt will benefit investors in the company. The result, as is the case for
Sideline Sports Products, is that the return on equity will exceed the return on assets.
138. Earnings persistence is the ability of current earnings to continue or persist into future years. Certain items are part of net income in the
current year but are not expected to persist. We refer to these as one-time income items. The two primary examples are discontinued operations and
extraordinary items.

139. Conservative accounting practices are those that result in reporting lower income, lower assets, and higher liabilities. In contrast, aggressive
accounting practices result in reporting higher income, higher assets, and lower liabilities.
A larger estimation of the allowance for uncollectible accounts, the write-down of overvalued inventory, the use of a shorter useful life for
depreciation, and the recording of a contingent litigation loss are all examples of conservative accounting. They are conservative because all of these
practices report lower net income.
A lower estimation of the allowance for uncollectible accounts, waiting to report an inventory write-down, choosing a longer useful life for
depreciation, and waiting to record a litigation loss all are examples of more aggressive accounting. They are aggressive because all of these practices
report higher net income.

140. Inventory turnover ratio :: Cost of goods sold divided by average inventory; the number of times the firm sells its average inventory balance
during a reporting period. and Debt to equity ratio :: Total liabilities divided by total stockholders' equity; measure a company's solvency risk. and
Average days in inventory :: Approximate number of days the average inventory is held. and Times interest earned ratio :: Ratio that compares
interest expense with income available to pay those charges. and Receivables turnover ratio :: Net sales divided by average accounts receivable; the
number of times during a year that the average accounts receivable balance is collected. and Acid-test ratio :: Cash, short-term investments,
and accounts receivable divided by current liabilities; measures the availability of liquid current assets to pay current liabilities. and Current ratio ::
Current assets divided by current liabilities; measures the availability of current assets to pay current liabilities. and Average collection period ::
Approximate number of days the average accounts receivable balance is outstanding.

141. Return on assets :: Net income divided by average total assets; measures the amount of net income generated for each dollar invested in assets.
and Price-earnings (PE) ratio :: Compares a company's share price with its earnings per share. and Return on equity :: Net income divided by
average stockholders' equity; measures the income generated per dollar of equity. and Gross profit ratio :: Gross profit divided by net sales;
measures the amount by which the sale price of inventory exceeds its cost per dollar of sales. and Asset turnover :: Net sales divided by average
total assets; which measures the sales per dollar of assets invested. and Profit margin :: Net income divided by net sales; indicates the earnings per
dollar of sales.

142. Horizontal analysis :: Analyzes trends in financial statement data for a single company over time. and Value Stocks :: Have lower share prices
in relationship to their fundamental ratios and therefore trade at lower PE ratios. and Vertical analysis :: Expresses each item in a financial
statement as a percentage of the same base amount. and Liquidity :: Refers to a company's ability to pay its current liabilities. and Solvency ::
Refers to a company's ability to pay its long-term liabilities. and Growth stocks :: Have high expectations of future earnings and therefore usually
trade at higher P/E ratios. and Profitability ratios :: Measure the earnings or operating effectiveness of a company.

143. Extraordinary item :: An event that is (1) unusual in nature and (2) infrequent in occurrence. and Discontinued operation :: The sale or disposal
of a significant component of a company's operations. and Quality of earnings :: Refers to the ability of reported earnings to reflect the company's
true earnings, as well as the usefulness of reported earnings to predict future earnings. and Conservative accounting practices :: Practices that result in
reporting lower income, lower assets, and higher liabilities. and Aggressive accounting practices :: Practices that result in reporting higher income,
higher assets, and lower liabilities.

144. Liquidity :: A company's ability to pay its current liabilities. and Conservative accounting practices :: Accounting choices that result
in reporting lower income, lower assets, and higher liabilities. and Extraordinary item :: A profit or loss unusual in nature and infrequent in
occurrence. and Aggressive accounting practices :: Accounting choices that result in reporting higher income, higher assets, and lower liabilities.
and Horizontal analysis :: A tool to analyze trends in financial statement data for a single company over time. and Discontinued operation :: The
sale or disposal of a significant component of a company's operations. and Vertical analysis :: A means to express each item in a financial statement
as a percentage of a base amount. and Solvency :: A company's ability to pay its long-term liabilities.
Ch12 Summary
Category # of Questions
AACSB: Analytic 44
AACSB: Reflective Thinking 100
AICPA: Critical Thinking 16
AICPA: Decision Making 25
AICPA: Measurement 79
AICPA: Reporting 24
Blooms: Analysis 44
Blooms: Application 7
Blooms: Comprehension 50
Blooms: Knowledge 32
Blooms: Synthesis 11
Difficulty: Easy 39
Difficulty: Hard 20
Difficulty: Medium 85
Learning Objective: 12-01 Perform vertical analysis. 14
Learning Objective: 12-02 Perform horizontal analysis. 15
Learning Objective: 12-03 Use ratios to analyze a companys risk. 52
Learning Objective: 12-04 Use ratios to analyze a companys profitability. 32
Learning Objective: 12-05 Distinguish persistent earnings from one-time items. 16
Learning Objective: 12-06 Explain quality of earnings and distinguish between conservative and aggressive accounting 14
practices.
Spiceland - Chapter 12 148