Analyzing Financial Statements

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1. Tamika Charles owns and operates her own business. She has recently hired a business advisor to help her both expand her business and improve her profitability. Tamika’s business advisor has strongly urged her to set up a good accounting system. Until now, Tamika has only used a part-time bookkeeper to help her pay her bills.

What key business benefit is Tamika most likely to get by setting up an improved accounting system?

· Better information for making improved decisions

· More detailed tracking of competitor barriers to entry

· More accurate computation of regional inflation numbers

· Better statistics to be submitted for government data collection

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Which statement below describes managerial accounting reports but NOT financial accounting reports?

· They are standardized across companies.

· They are based on the financial statements: balance sheet, income statement, and statement of cash flows.

· They represent general purpose information.

· They are used primarily by internal users.

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In the United States, the FASB establishes financial accounting rules. Why is it important to have one generally accepted set of financial accounting rules?

· Financial statement users can more easily compare financial reports from different companies.

· The American Institute of Certified Public Accountants (AICPA) can use the financial statements in collecting dues from its members.

· Employees can more easily interpret the financial data given with their regular paychecks.

· The Securities and Exchange Commission (SEC) can compute the income taxes to be paid by each taxpayer.

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Diana Thompson has operated her own small business for several years. Her business is doing well, and she wants to expand. In order to do so, she will need a bank loan. In her preliminary meeting with the bank loan officer, she was asked the amount of her “owners’ equity” in the business. Diana doesn’t know this amount because she has never prepared any financial statements for her business. In order to address this “owners’ equity” issue raised by the bank, what evidence should Diana prepare?

· Total assets minus liabilities

· Cash plus bank loan balance

· Cash minus bank loan balance

· Revenues minus expenses

· Total assets plus liabilities

· Revenues plus cash minus expenses

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Tangela Company has now missed three loan payments in a row. As you can imagine, Tangela’s bank is quite upset. Legally, Tangela’s bank can demand full repayment of the loan immediately. Tangela doesn’t have the cash to repay the loan, so an immediate repayment demand would force Tangela into bankruptcy.

Tangela and the bank are now in negotiations. The bank wants some type of guarantee that it will be able to collect its money if Tangela does slide into bankruptcy. Tangela offers to write a new agreement in which the bank will acquire legal title to all of Tangela’s current assets in case of bankruptcy. The bank wants to know what Tangela’s current asset balance is.

Tangela Company’s financial records include these accounts at the end of the year.

Land Accounts Receivable Buildings Inventory Loans Payable Accounts Payable Retained Earnings Capital Stock (also called Paid-in Capital) Cash

Which set of items composes a complete listing of Tangela’s current assets?

· Cash, retained earnings, and capital stock

· Cash, accounts receivable, and inventory

· Cash, buildings, and land

· Cash, inventory, and capital stock

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Tina Catchings has just started her study of accounting. She is finding that the hardest part of understanding accounting is learning what all of the terms mean. For example, Tina is interested in putting the correct label on the obligations she has to her suppliers resulting from her purchase of inventory on account. What is the correct label?

· Loans payable

· Accounts receivable

· Accounts payable

· Cost of goods sold

· Wages payable

· Loans receivable

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Tina Dupree is bewildered by the many different types of “profit” and “income” reported by accountants. She is interested in putting the correct label on the important quantity: “Sales minus cost of goods sold.” What is the correct label?

· Owners’ equity

· Gross profit

· Net income

· Operating income

· Return on sales

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Parker Company is preparing to do an initial public offering (IPO) of its shares next year. Parker knows that investors use a company’s earnings per share (EPS) in their valuation models to determine how much an IPO company’s shares are worth. Parker’s founders, Candace Leslie and Lisa Bonner, are eager for this IPO to do well so that their many years of work will be validated in the stock market.

Here are some data from Parker Company’s financial statements.

Inventory Accounts Payable Number of shares outstanding Capital Stock (also called Paid-in Capital) Accounts Receivable Cash Retained Earnings Net Income Building Loans Payable

Which items are used to compute Parker’s earnings per share (EPS)?

· Cash, net income, and number of shares outstanding

· Net income and number of shares outstanding

· Cash, inventory, accounts receivable, building, and number of shares outstanding

· Net income, capital stock, retained earnings, and number of shares outstanding

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Katie Fowles is beginning her study of the statement of cash flows. She understands the basic idea: a statement of cash flows reports the amount of cash collected and the amount of cash paid during the period. However, she doesn’t understand why there are three different sections in the statement of cash flows. In particular, she wants to correctly classify the activities that are part of the day-to-day business of the company.

What is the correct classification of these activities?

· Liquidity activities

· Investing activities

· Operating activities

· Profitability activities

· Financing activities

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Cappie Bird considers herself to be quite comfortable with company balance sheets and income statements. However, Cappie is a little nervous about her understanding of the statement of cash flows. In particular, she doesn’t understand which cash flows fit into the cash flow categories. She wants to correctly classify those activities associated with buying and selling long-term assets—primarily the purchase and sale of land, buildings, and equipment.

What is the correct classification of these activities?

· Operating activities

· Investing activities

· Financing activities

· Capital activities

· Purchasing activities

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The chief financial officer (CFO) of DeWanna Company is preparing a presentation to give to the company’s major banks and investors. These groups are concerned about DeWanna’s liquidity. The CFO knows that a common measure of liquidity is the CURRENT RATIO. Consider the items below. Which items are used in computing CURRENT RATIO?

Current Liabilities Capital Stock Current Assets Net Income Long-term Debt Retained Earnings

· Current Assets and Retained Earnings

· Net Income and Long-term Debt

· Current Assets and Current Liabilities

· Capital Stock and Current Liabilities

· Net Income and Current Liabilities

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Lauren Company is currently under scrutiny by government regulators. Lauren hasn’t been charged with any crimes, but government investigators are suspicious about Lauren’s entire industry. The suspicion is that Lauren Company, and its industry competitors, have taken advantage of current market conditions to substantially increase their level of borrowing—putting the banking system at risk.

Government regulators want to see what Lauren Company’s DEBT RATIO is this year in order to assess whether Lauren has indeed increased borrowing to a dangerous level.

Consider the items below. Which items are used in computing DEBT RATIO?

Capital Stock Cost of Goods Sold Total Assets Total Liabilities Net Income Retained Earnings Sales

· Total Assets and Total Liabilities

· Sales and Total Liabilities

· Retained Earnings and Total Assets

· Total Assets and Capital Stock

· Total Liabilities and Net Income

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The common-size income statement data below are for Julian Company and Standard Company. Standard Company is the best company in Julian’s industry; all companies in the industry strive to do things the way that Standard does them.

Julian % of Sales ||| Standard % of Sales

Sales 20,000 100.0% ||| 130,000 100.0%

Cost of Goods Sold (6,000) -30.0% ||| (39,000) -30.0%

Wage Expense (10,000) -50.0% ||| (65,000) -50.0%

Research Expense (2,000) -10.0% ||| (13,000) -10.0%

Advertising Expense (1,600) -8.0% ||| (6,000) -4.6%

Net Income 400 2.0% ||| 7,000 5.4%

Which ONE of the following statements is TRUE regarding Julian’s income statement? Remember, Standard Company represents the standard of performance in Julian’s industry.

· Julian Company’s profitability is better than Standard Company’s profitability.

· Julian Company has a problem with its wage expense.

· Julian Company has a problem with its research expense.

· Julian Company has a problem with its advertising expense.

· Julian Company has a problem with its cost of goods sold.

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Pondexter Company, a large retail furniture store, is under investigation for price fixing. Customers in some isolated communities are complaining that Pondexter is setting its prices in its stores in these communities substantially higher than the prices for similar items in stores located closer to large population centers. According to these complaints, Pondexter can get away with this because there are few competitors in these isolated communities.

To see whether Pondexter is earning above-normal profits, the judge in the case has ordered an investigation into Pondexter’s finances. Specifically, the judge wants to see Pondexter’s income statement. The judge has stated that she intends to compare Pondexter’s return on sales with the corresponding percentages for similar companies.

What income statement numbers are used in computing RETURN ON SALES?

· Capital Stock and Sales

· Net Income and Sales

· Cash and Sales

· Accounts Receivable

· Retained Earnings and Sales

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Consider the items below. Which items are used in computing ASSET TURNOVER?

Accounts Payable Total Assets Capital Stock Cost of Goods Sold Long-term Debt Net Income Retained Earnings Sales

· Net Income and Sales

· Capital Stock and Sales

· Total Assets and Sales

· Accounts Payable and Sales

· Retained Earnings and Sales

Analyzing Financial Statements

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