Book 2 - Chapter 30

Multiple Choice

1.	d
2.	d
3.	b
4.	a	Earnings per share is also used directly for comparing profitability on a per-share basis.
5.	d
6.	c	An airline would have a much greater investment in property, plant, and equipment assets than an accounting firm. Therefore, the denominator in the fraction will be much bigger, making the answer for turnover much smaller. A much bigger asset investment is needed to create a dollar of revenue in an airline. An accounting firm and an airline are service businesses and do not have merchandise inventory or cost of goods sold.
7.	b	First, this focuses blame on the old management. Second, future years’ results will now look better when compared to the current large loss year in which the “big bath” was recorded.
8.	c	Both ratios relate to potential near-term cash flow and are also indicators of management efficiency.
9.	d	If sales on account are overstated, the average balance of accounts receivable will also be overstated. Also, these overstated receivables will remain uncollected. The denominator in the ratio calculation will increase, which reduces the turnover and increases the days. Example: Assume correct amounts are: sales 100, beginning A/R 14, and ending A/R 10. Answer: [100/(14 + 10)]/2 = 8.33. Now assume sales overstated by 20. Answer: [120/(14 + 30)]/ 2 = 5.45 (lower turnover). (Note: The gross profit ratio will also provide a clue as it begins to increase above historical averages.)
10.	b	Changing from LIFO to FIFO in a period of rising prices reduces cost of goods sold, and the numerator of the ratio becomes smaller. As well, the ending inventory becomes greater, which increases the average inventory in the denominator. These changes decrease the inventory turnover answer, although items are not actually being sold any slower. Be careful when comparing companies using different inventory methods!
11.	d
12.	a	This organization was created by the Sarbanes-Oxley Act in 2002.
13.	d	This is an off-balance sheet financing technique. All the other items represent potential liability of varying degrees of probability.
14.	b
15.	b	Trading on equity can result in either better returns or worse returns and increased risk.
16.	c

Learning Goal 30

SOLUTIONS

Learning Goal 30: Analyze Financial Statements

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Worthy & James Publishing is a provider of basic accounting books covering fundamental accounting principles, business accounting, and business math. Topics in financial accounting and business accounting covered include the balance sheet, the income statement, financial ratios, and bank reconciliation.