FS Analysis Practice Exam

Which of the following items regarding the corporate income statement is most accurate?

A)

Unusual or infrequent items appear in the income statement of a corporation as a component of net income from continuing operations.

B)Examples of extraordinary items include expropriations of property and equipment by foreign governments, losses from earthquakes and tornados, and gains from the sale of investments in subsidiaries.

C)If a corporation disposes of a business segment that is separable from the company's core business activities, the results of the discontinued segment are reported as a separate line item below income from continuing operations on a pre-tax basis.

Click for Answer and Explanation

Explanations for incorrect answers are as follows:

http://127.0.0.1:20507/online_program/test_engine/browse_question.php?question_id=98010&node_id=153796&operation=next&node_sort_order=#question_110606

The gain on the sale of a subsidiary is an unusual or infrequent item. The results of a discontinued segment are reported below the line, net of tax (after tax).

Matrix, Inc.â€™s common size income statement for the years ended December 31, 20X1 and 20X2 included the following information (percent of net sales):

< >> 20X1 20X2Sales 100 100 Cost of Goods Sold (55) (60)

< > 45> 40 Selling General & Administrative (5) (5)Depreciation (7) (8)

33 < > 37>Interest Expense (15) (7)

18 30 Income Tax Expense (6) (10)

12 20

Analysis of this data indicates that from 20X1 to 20X2:

A)

interest expense per dollar of sales declined.

B) cost of goods sold increased.

C) the effective tax rate increased.


On a common size income statement, all amounts are stated as a percentage of sales. Interest expense per dollar of sales has declined from 0.15 to 0.07. The other interpretations listed are not necessarily correct. COGS increased as a percentage of sales, but if sales decreased, COGS may have decreased as well. The company's effective tax rate (income tax expense / pretax income) can be calculated from a common-size income statement. Here the effective tax rate was 33% in both years.


Selected financial ratios from Mulroy Companyâ€™s common-size income statements are as follows:

Â 20X1 20X2 20X3Gross profit margin 22% 24% 26%Operating profit margin 18% 20% 22%Pretax margin 15% 14% 13%Net profit margin 11% 10% 9%Relative to sales, it is most likely that Mulroyâ€™s: A)

nonoperating expenses are increasing.

B) operating expenses are increasing.

C) income tax expense is increasing.


Nonoperating expenses are equal to the difference between operating profit and pretax profit. Based on the given profit margins, Mulroyâ€™s nonoperating expenses increased from 3% of sales in 20X1 to 9% of sales in 20X3. Because gross profit margin is increasing, cost of goods sold is decreasing as a percentage of sales. Other operating expenses and income tax expense, as a percentage of sales, were stable over the period shown.

An analyst prepares the following common-size income statements for Perez Company:

Â 20X1 20X2 20X3Sales 100% 100% 100%Cost of goods sold 50% 52% 53%Selling and administrative expense 16% 12% 9%Interest income 4% 4% 4%Pretax income 30% 32% 34%Income tax expense 15% 16% 17%Net income 15% 16% 17%

Based only on this information, Perezâ€™s improving net profit margin is most likely a result of:


A)

improving gross margins.

B) greater financial leverage.

C) controlling operating expenses.


The improvement in net profit margin from 15% to 17% appears to result mainly from the firm reducing selling and administrative expense from 16% of sales to 9% of sales, thus decreasing operating expenses from 66% to 62% of sales. Gross margin is decreasing over this period because cost of goods sold is increasing as a percentage of sales. While financial leverage cannot be determined directly from the income statement, the fact that interest expense is a constant percentage of sales suggests financial leverage is stable

A company reports a gain of â‚¬100,000 on the sale of an asset and a loss of â‚¬100,000 due to foreign currency translation adjustment. Which of these items will be included in the companyâ€™s comprehensive income?

A)

Neither of these items is included in comprehensive income.

B) Only one of these items is included in comprehensive income.

C) Both of these items are included in comprehensive income.



Both items are included in comprehensive income. Comprehensive income includes all items that affect ownersâ€™ equity except transactions with the companyâ€™s owners. Any items that are included in net income are also included in comprehensive income. The gain on sale is reported in net income. The foreign currency translation loss is taken directly to ownersâ€™ equity (i.e., not reported in the income statement).

Balance sheet data for two comparable firms are presented below:

Â Amplus, Inc. Brevis, Inc.Cash and equivalents 3,800 500Accounts receivable 2,400 700Inventories 5,800 1,100Current assets 12,000 2,300Land 400 100Property, plant and equipment

24,600 6,400

Noncurrent assets 25,000 6,500Total assets 37,000 8,800Â Â Â Accounts payable 1,800 400Unearned revenue 600 100Current liabilities 2,400 500Long-term borrowing 9,600 3,300Total liabilities 12,000 3,800Â Â Â Common stock 1,500 300Retained earnings 23,500 4,700Total equity 25,000 5,000Â Â Â Total liabilities and equity 37,000 8,800Based on common-size analysis of the two firmsâ€™ balance sheets, Amplus Company: A)

has a greater investment in working capital than Bre


vis Company.

B) is more financially leveraged than Brevis Company.

C) uses relatively more fixed assets then Brevis Company.


Common-size balance sheets for the two firms are as follows:

Â Amplus, Inc. Brevis, Inc.Cash and equivalents 10.3% 5.7%Accounts receivable 6.5% 8.0%Inventories 15.7% 12.5%Current assets 32.4% 26.1%Land 1.1% 1.1%Property, plant and equipment

66.5% 72.7%

Noncurrent assets 67.6% 73.9%Total assets 100.0% 100.0%Â Â Â Accounts payable 4.9% 4.5%Unearned revenue 1.6% 1.1%Current liabilities 6.5% 5.7%Long-term borrowing 25.9% 37.5%Total liabilities 32.4% 43.2%Â Â Â Common stock 4.1% 3.4%Retained earnings 63.5% 53.4%Total equity 67.6% 56.8%Â Â Â Total liabilities and equity 100.0% 100.0%Working capital (current assets minus current liabilities) is 32.4% â€“ 6.5% = 25.9% of assets for Amplus and 26.1% â€“ 5.7% = 20.4% of assets for Brevis. Fixed assets (property, plant, and equipment) are relatively larger for Brevis than for Amplus. Based on long-term borrowing and total liabilities, Brevis is significantly more leveraged than Amplus.

Galaxy Corporation manufactures custom motorcycles. Galaxy finances the motorcycles over 36 months for customers who make a minimum down payment of 10%. Historically, Galaxy has experienced bad debt losses equal to 1% of sales. Galaxy also provides a 24 month unlimited warranty on all new motorcycles. In the past, warranty expense has averaged 3% of sales. Ignoring taxes, how does the recognition of bad debt expense and warranty expense at the time of sale affect Galaxyâ€™s liabilities?

Bad debt expense Warranty expense


A)

No effect

B) No effect No effect

C) Increase Increase


The recognition of bad debt expense has no effect on liabilities, current revenues are reduced by the expected amount of uncollectable accounts. Bad debt expense reduces net income and reduces assets. The recognition of expected warranty expense decreases net income (following the matching principle), and since it is not currently paid (doesnâ€™t reduce assets) it creates or increases a liability at the time of sale.

Firebird Company reported the following financial information at the end of 2007:

in millions Merchandise inventory $240 Minority interest 70 Cash and equivalents 275 Accounts receivable 1,150 Accounts payable 225 Property & equipment 2,160 Accrued expenses 830 Current portion of long-term debt 120 Long-term debt 1,570 Retained earnings 4,230

Calculate Firebirdâ€™s current assets and working capital.

Current assets Working capital

A)

$1,665 million

B) $1,665 million $490 million

C) $1,735 million $490 million




Current assets are equal to $1,665 ($275 cash and equivalents + $1,150 accounts receivable + $240 inventory). Working capital (current assets minus current liabilities) is equal to $490 ($1,665 current assets â€“ $225 accounts payable â€“ $830 accrued expenses â€“ $120 current portion of long-term debt).

Peterson Painting Company is a commercial painting contractor. At the beginning of 20X7, Petersonâ€™s net working capital was $350,000. The following transactions occurred during 20X7:

Performed services on credit $150,000Purchased office equipment for cash 10,000Recognized salaries expense 54,000Purchased paint supplies on on credit 25,000Consumed paint supplies 20,000Paid salaries 50,000Collected accounts receivable 157,000Recognized straight-line depreciation expense 2,000Paid accounts payable 15,000

Calculate Petersonâ€™s working capital at the end of 20X7 and the change in cash for the year 20X7.

Working capital Change in cash

A)

$414,000

B) $416,000 $80,000

C) $416,000 $82,000


Transaction Amount Working capital CashPerformed services on credit $150,000 Increase A/RPurchased PP&E for cash 10,000 Decrease cash -$10,000Recognized salaries expense 54,000 Increase A/PPurchased paint supplies on on credit 25,000 Increase inventories,

increase A/PConsumed paint supplies 20,000 Decrease

inventoriesPaid salaries 50,000 Decrease cash,

decrease A/P-$50,000

Collected accounts receivable 157,000 Increase cash, decrease A/R

+$157,000

Recognized straight-line depreciation expense 2,000Paid accounts payable 15,000 Decrease cash,

decrease A/P-$15,000


The change in cash was $82,000 ($157,000 collections â€“ $10,000 from equipment purchase â€“ $50,000 salaries paid â€“ $15,000 for payables).

Working capital at the end of 20X7 is $416,000 ($350,000 beginning working capital + $150,000 increase in accounts receivable from services â€“ $10,000 office equipment purchase â€“ $54,000 salaries expense accrual â€“ $20,000 consumed supplies).

Purchasing $25,000 of paint supplies on credit has no net effect on working capital (current assets and current liabilities increase). Consuming $20,000 of these supplies reduces working capital (current assets decrease).

Salary expense reduces working capital by $54,000 when recognized (current liabilities increase). Paying $50,000 of these salaries has no net effect on working capital (current assets and current liabilities decrease).

Collecting accounts receivable has no net effect on working capital (one current asset increases and another decreases).

Recognizing depreciation does not affect working capital.

Paying accounts payable has no net effect on working capital (current assets and current liabilities decrease).

Balance sheet data for two comparable firms are presented below:

Â Amplus, Inc. Brevis, Inc.Cash and equivalents 3,800 500Accounts receivable 2,400 700Inventories 5,800 1,100Current assets 12,000 2,300Land 400 100Property, plant and equipment

24,600 6,400

Noncurrent assets 25,000 6,500Total assets 37,000 8,800Â Â Â Accounts payable 1,800 400Unearned revenue 600 100Current liabilities 2,400 500Long-term borrowing 9,600 3,300Total liabilities 12,000 3,800Â Â Â Common stock 1,500 300Retained earnings 23,500 4,700Total equity 25,000 5,000Â Â Â Total liabilities and equity 37,000 8,800

Based on common-size analysis of the two firmsâ€™ balance sheets, Amplus Company:

A)

is more

financially leveraged than Brevis Company.

B) uses relatively more fixed assets then Brevis Company.

C) has a greater investment in working capital than Brevis Company.


Common-size balance sheets for the two firms are as follows:

Â Amplus, Inc. Brevis, Inc.Cash and equivalents 10.3% 5.7%Accounts receivable 6.5% 8.0%Inventories 15.7% 12.5%Current assets 32.4% 26.1%Land 1.1% 1.1%Property, plant and equipment

66.5% 72.7%

Noncurrent assets 67.6% 73.9%Total assets 100.0% 100.0%Â Â Â Accounts payable 4.9% 4.5%Unearned revenue 1.6% 1.1%Current liabilities 6.5% 5.7%Long-term borrowing 25.9% 37.5%Total liabilities 32.4% 43.2%Â Â Â Common stock 4.1% 3.4%Retained earnings 63.5% 53.4%Total equity 67.6% 56.8%Â Â Â Total liabilities and equity 100.0% 100.0%

Working capital (current assets minus current liabilities) is 32.4% â€“ 6.5% = 25.9% of assets for Amplus and 26.1% â€“ 5.7% = 20.4% of assets for Brevis. Fixed assets (property, plant, and equipment) are relatively larger for Brevis than for Amplus. Based on long-term borrowing and total liabilities, Brevis is significantly more leveraged than Amplus.

Consider the following:

Statement #1: One approach to presenting a common-size cash flow statement is to express each inflow of cash as a percentage of total cash inflows and each outflow of cash as a percentage of total


cash outflows.Statement #2: Expressing each line item of the cash flow statement as a percentage of revenue is useful in

forecasting future cash flows. Which of these statements regarding a common-size cash flow statement is (are) CORRECT?

A)

Both statements are correct.

B) Only statement #1 is correct.

C) Only statement #2 is correct.

Click for Answer and Explanation A cash flow statement can be presented in common-size format by expressing each line item as

a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows. Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows since revenue usually drives the forecast.

Selected information from the most recent cash flow statement of Thibault Company appears below:

Cash collections €8,900Cash paid to suppliers (€3,700)Cash operating expenses (€1,500)Cash taxes paid (€2,400)Cash from operating activities €1,300 Cash paid for plant and equipment (€2,600)Cash interest received €700Cash dividends received €600Cash from investing activities (€1,300) Cash received from debt issuance €2,000Cash interest paid (€400)Cash dividends paid (€600)Cash from financing activities €1,000 Total change in cash €1,000

Thibaultâ€™s reinvestment ratio for this period is closest to:

A)


0.75.

B) 1.00.

C) 0.50.

Click for Answer and Explanation The reinvestment ratio is CFO divided by cash paid for long-term assets: â‚¬1,300 / â‚¬2,600 =

0.5. (Note that on this cash flow statement, CFI includes interest and dividends received and CFF includes interest paid, which is acceptable under IFRS.)

For the year ended December 31, 2007, Gremlin Corporation reported the following transactions:

Issued 5,000 shares of preferred stock for land with a fair value of $4.8 million. Purchased a patent for $3.3 million cash.

Acquired 40% of the common stock of an affiliate for $2.7 million cash which was borrowed from a bank.

Exchanged equipment with a book value of $1.7 million for equipment valued at $2.1 million. The exchange was an even trade.

Converted bonds payable with a book value of $5 million to 50,000 shares of common stock with a fair value of $6 million.

Calculate Gremlinâ€™s cash flow from investing activities and cash flow from financing activities for the year ended December 31, 2007.

Cash flow from investing activities

Cash flow from financing activities

A)

$1.7 million inflow

B) $6.0 million outflow $2.7 million inflow

C) $2.7 million outflow $6.0 million inflow


Only the acquisition of common stock of the affiliate for $2.7 million and the purchase of the patent for $3.3 million are included in cash flow from investing activities. Since the acquisition of the stock purchase was financed with a bank loan, $2.7 million will be reported as a financing inflow. Both remaining transactions are non-cash transactions and are disclosed in the notes to or in a supplementarty schedule to the cash flow statement.

Use the following information to calculate cash flows from operations using the indirect method.



Net Income: $12,000 Depreciation Expense: $1,000

Loss on sale of machinery: $500

Increase in Accounts Receivable: $2,000

Decrease in Accounts Payable: $1,500

Increase in Income taxes payable: $500

Repayment of Bonds: $3,000

A)

Increase in cash of $7,500.

B) Increase in cash of $9,500.

C) Increase in cash of $10,500.


Cash flow from operations would be calculated as +Net Income $12,000 + Depreciation $1,000 + Loss on sale of machinery $500 − A/R $2,000 − A/P $1,500 + Income taxes payable $500 = $10,500.

Repayment of Bonds is a financing activity and would not be included with operating activities. Depreciation is not a cash flow activity and is therefore always added back to net income to calculate CFO. The loss on the sale of machinery is not a cash outflow so it is also added back to calculate CFO. Accounts receivable is subtracted when there is an increase as this increases net income but does not affect cash.

Use the following financial data for Moose Printing Corporation to calculate the cash flow from operations (CFO) using the indirect method.

Net income: $225 Increase in accounts receivable: $55

Decrease in inventory: $33

Depreciation: $65


Decrease in accounts payable: $25

Increase in wages payable: $15

Decrease in deferred taxes: $10

Purchase of new equipment: $65

Dividends paid: $75

A)

Increase in cash of $173.

B) Increase in cash of $248.

C) Increase in cash of $183.


CFO for Moose Printing Corporation is calculated as follows:

+Net Income $225 − A/R $55 + Inventory $33 + Depreciation $65 − A/P $25 + Wages Payable $15 − Deferred taxes $10 = $248.

The purchase of new equipment would be an investing activity and, therefore, would not be included in the CFO. Dividends paid would be a financing activity and would not be included in the CFO.

When using the indirect method for computing cash flow from operating activities, a change in accounts payable will require which of the following?

A)

A negative (positive) adju


stment to net income when accounts payable increases (decreases).

B) A positive (negative) adjustment to net income when accounts payable increases (decreases).

C) A negative adjustment to net income regardless of whether accounts payable increases or decreases.


A decrease in accounts payable represents an outflow. Hence, a negative adjustment will be required. Conversely, an increase represents an inflow and a positive adjustment

Pacific, Inc.â€™s financial information includes the following, with â€œchangeâ€ referring to the �difference from the prior year (in $ millions):

Net Income 27Change in Accounts Receivable +4Change in Accounts Payable +1Change in Inventory +5Loss on sale of equipment -8Gain on sale of real estate +4Change in Retained Earnings +21Dividends declared and paid +4

Pacific, Inc.â€™s cash flow from operations (CFO) in millions was:

A)

$27.

B) $23.

http://127.0.0.1:20507/online_program/test_engine/browse_question.php?question_id=97416&node_id=153823&operation=previous&node_sort_order=#question_109992

C) $15.


Using the indirect method, cash flow from operations is net income less increase in accounts receivable, plus increase in accounts payable, less increase in inventory, plus loss on sale of equipment, less gain on sale of real estate. 27 â€“ 4 + 1 â€“ 5 + 8 â€“ 4 = $23 million.

Eagle Companyâ€™s financial statements for the year ended December 31, 20X5 were as follows (in $ millions):

Income Statement

Sales 150 Cost of Goods Sold (48)Wages Expense (56)Interest Expense (12)Depreciation (22)Gain on Sale of Equipment 6 Income Tax Expense ( 8)Net Income 10

Balance Sheet

12-31-X4 12-31-X5Cash 32 52Accounts Receivable 18 22Inventory 46 44Property, Plant & Equip. (net) 182 160Total Assets 278 278Accounts Payable 28 33Long-term Debt 145 135Common Stock 70 70Retained Earnings 35 40Total Liabilities & Equity 278 278

Cash flow from operations (CFO) for Eagle Company for the year ended December 31, 20X5 was (in $ millions).

A)

$29.

B) $41.

C) $37.



Using the indirect method:

Add: Net Income $10 Add: Depreciation Expense 22 Less: Gain from Sale of Equip. (6)Less: Increase in Accounts Receivable (4)Add: Decrease in Inventory 2 Add: Increase in Accounts Payable 5Cash flow from operations (CFO) 29

A company has the following changes in its balance sheet accounts:

Net Sales $500 An increase in accounts receivable 20 A decrease in accounts payable 40 An increase in inventory 30 Sale of common stock 100 Repayment of debt 10 Depreciation 2 Net Income 100 Interest expense on debt 5

The companyâ€™s cash flow from financing is:

A)

$90.

B) $100.

C) -$10.


Sale of common stock $100 Repayment of debt (10)Financing cash flows $ 90

Determine the cash flow from investing given the following table:

Item AmountCash payment of dividends

$30



Sale of equipment $25Net income $25Purchase of land $15Increase in accounts payable

$20

Sale of preferred stock $25Increase in deferred taxes $5

A) -$5.

B) $10.

C) -$10.


Item AmountCash payment of dividends CFF -$30Sale of equipment CFI +$25Net income CFO +$25Purchase of land CFI -$15Increase in accounts payable

CFO +$20

Sale of preferred stock CFF +$25Increase in deferred taxes CFO +$5

CFI = Sale of Equipment (+25) + Purchase of Land (â€“15) = $10.

An analyst has gathered the following information about a company:

Income Statement for the Year 20X4

Sales $1,500ExpensesCOGS $1,300Depreciation 30Int. Expenses 40

Total expenses 1,370Income from cont. op. 130

Gain on sale 30Income before tax 160Income tax 64Net Income $96Additional Information:Dividends paid $30Common stock sold 20Equipment purchased 50Bonds issued 80


Fixed asset sold for (original cost of $100 with accumulated depreciation of $70) 60Accounts receivable decreased by 30Inventory decreased by 20Accounts payable increased by 20Wages payable decreased by 10

What is the cash flow from operations?

A)

$170.

B) $156.

C) $150.


Net Income +$96Depreciation +30Gain on sale of asset -30Accts. Rec. +30Inventory +20Accts. Payable +20Wages Payable -10

CFO +$156

An analyst contemplates using the indirect method to create the projected statement of cash flows. She decides to research the differences between the direct and indirect methods. Which of the following is least likely a component of the statement of cash flows under the direct method?

A)

Payment of dividends.

B) Net income.

C) Property, Plant, & Equipment.




Property, Plant, & Equipment and payment of dividends are components of the statement of cash flows under both the direct and indirect methods. Net income is the first figure under the indirect method, but it is not a part of the statement of cash flows under the direct method. The correct response is net income.

Determine the cash flow from operations given the following table.

Item AmountCash payment of dividends $30Sale of equipment $25Net income $25Purchase of land $15Increase in accounts payable $20Sale of preferred stock $25Increase in deferred taxes $5

Profit on sale of equipment $15

A) $20.

B) $45.

C) $35.


Using the indirect method, CFO = Net income 25 + increase in accounts payable 20 + increase in deferred taxes 5 − profit on sale of equipment 15 = $35.

Increases in accounts payable and deferred taxes are sources of operating cash that are not included in net income and must be added. Profit on sale of equipment is a CFI item that must be removed from net income.

No adjustment needs to be made for cash payment of dividends (CFF), sale of preferred stock (CFF), or purchase of land (CFI) because they are not included in net income. Only the profit on sale of equipment, not the full proceeds from sale, is included in net income.

Financial information for Jefferson Corp. for the year ended December 31st, was as follows:

Sales $3,000,000Purchases 1,800,000Inventory at Beginning 500,000Inventory at Ending 800,000Accounts Receivable at Beginning 300,000Accounts Receivable at Ending 200,000Accounts Payable at Beginning 100,000Accounts Payable at Ending 100,000Other Operating Expenses Paid 400,000


Based upon this data and using the direct method, what was Jefferson Corp.â€™s cash flow from operations (CFO) for the year ended December 31st?

A)

$1,200,000.

B) $900,000.

C) $800,000.


CFO = sales $3,000,000 â€“ change in accounts receivable ($200,000 â€“ $300,000) â€“ purchases $1,800,000 â€“ other cash operating expenses $400,000 = $900,000.

Note that no adjustment for inventories is necessary because purchases are given. From the inventory equation, P = COGS + EI - BI.

Consider the following:

Statement #1: One approach to presenting a common-size cash flow statement is to express each inflow of cash as a percentage of total cash inflows and each outflow of cash as a percentage of total cash outflows.

Statement #2: Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows.

Which of these statements regarding a common-size cash flow statement is (are) CORRECT?

A)

Only statement #1 is correct.

B) Both statements are correct.

C) Only statement #2 is correct.



A cash flow statement can be presented in common-size format by expressing each line item as a percentage of total revenue or by expressing each inflow of cash as a percentage of total cash inflows and each outflow as a percentage of total cash outflows. Expressing each line item of the cash flow statement as a percentage of revenue is useful in forecasting future cash flows since revenue usually drives the forecast.

Which of the following statements best describes vertical common-size analysis and horizontal common-size analysis?

Statement #1 â€“ Each line item is expressed as a percentage of its base-year amount.

Statement #2 â€“ Each line item of the income statement is expressed as a percentage of revenue and each line item of the balance sheet is expressed as a percentage of ending total assets.

Statement #3 â€“ Each line item is expressed as a percentage of the prior yearâ€™s amount.

Vertical analysis Horizontal analysis

A)

Statement #1

B) Statement #2 Statement #3

C) Statement #2 Statement #1


Horizontal common-size analysis involves expressing each line item as a percentage of the base-year figure. Vertical common-size analysis involves expressing each line item of the income statement as a percentage of revenue and each line item of the balance sheet as a percentage of ending total assets.

Ratio analysis is most useful for comparing companies:

A)

in different industries that use the same account

http://127.0.0.1:20507/online_program/test_engine/browse_question.php?new_node_id=153826#question_110530


ing standards.

B) that operate in multiple lines of business.

C) of different size in the same industry.


Ratio analysis is a useful way of comparing companies that are similar in operations but different in size. Ratios of companies that operate in different industries are often not directly comparable. For companies that operate in several industries, ratio analysis is limited by the difficulty of determining appropriate industry benchmarks.

An analyst gathered the following data about a company:

Current liabilities are $300. Total debt is $900.

Working capital is $200.

Capital expenditures are $250.

Total assets are $2,000.

Cash flow from operations is $400.

If the company would like a current ratio of 2, they could:

A)

decrease current assets by 100 or increase


current liabilities by 50.

B) increase current assets by 100 or increase current liabilities by 50.

C) increase current assets by 100 or decrease current liabilities by 50.


For the current ratio to equal 2.0, current assets would need to move to $600 (or up by $100) or current liabilities would need to decrease to $250 (or down by $50). Remember that CA − CL = working capital (500 − 300 = 200).

Wells Incorporated reported the following common size data for the year ended December 31, 20X7:

Income Statement %

Sales 100.0

Cost of goods sold 58.2

Operating expenses 30.2

Interest expense 0.7

Income tax 5.7

Net income 5.2

Balance sheet % %

Cash 4.8 Accounts payable 15.0

Accounts receivable 14.9 Accrued liabilities 13.8

Inventory 49.4 Long-term debt 23.2

Net fixed assets 30.9 Common equity 48.0

Total assets 100.00 Total liabilities & equity 100.0

For 20X6, Wells reported sales of $183,100,000 and for 20X7, sales of $215,600,000. At the end of 20X6, Wellsâ€™ total assets were $75,900,000 and common equity was $37,800,000. At the end of 20X7, total assets were $95,300,000. Calculate Wellsâ€™ current ratio and return on equity ratio for 20X7.

Current ratio Return on equity

A)

2.4

B) 2.4 26.8%


C) 4.6 25.2%


The current ratio is equal to 2.4 [(4.8% cash + 14.9% accounts receivable + 49.4% inventory) / (15.0% accounts payable + 13.8% accrued liabilities)]. This ratio can be calculated from the common size balance sheet because the percentages are all on the same base amount (total).

Return on equity is equal to net income divided by average total equity. Since this ratio mixes an income statement item and a balance sheet item, it is necessary to convert the common-size inputs to dollars. Net income is $11,211,200 ($215,600,000 Ã— 5.2%) and average equity is $41,772,000 [($95,300,000 Ã— 48.0%) + $37,800,000] / 2. Thus, 2007 ROE is 26.8% ($11,211,200 net income / $41,772,000 average equity).

A company has a receivables turnover of 10, an inventory turnover of 5, and a payables turnover of 12. The companyâ€™s cash conversion cycle is closest to:

A)

30 days.

B) 79 days.

C) 37 days.


Cash conversion cycle = receivables days + inventory processing days â€“ payables payment period.Receivables days = 365 / receivables turnover = 365 / 10 = 36.5 days.Inventory processing days = 365 / inventory turnover = 365 / 5 = 73.0 days.Payables payment period = 365 / payables turnover = 365 / 12 = 30.4 days.Cash collection cycle = 36.5 + 73.0 â€“ 30.4 = 79.1 days.

A firm has a cash conversion cycle of 80 days. The firm's payables turnover goes from 11 to 12, what happens to the firm's cash conversion cycle? It:

A)

shortens.

B) lengthens.



C) may shorten or lengthen.


CCC = collection period + Inv Period â€“ Payment period.

Payment period = (365 / payables turnover) = (365 / 11) = 33; (365 / 12) = 30. This means the CCC actually increased to 83.

Paragon Company's operating profits are $100,000, interest expense is $25,000, and earnings before taxes are $75,000. What is Paragon's interest coverage ratio?

A)

4 times.

B) 1 time.

C) 3 times.


ICR = operating profit ÷ I = EBIT ÷ I= 100,000 ÷ 25000 = 4

Assume a firm with a debt to equity ratio of 0.50 and debt equal to $35 million makes a commitment to acquire raw materials with a present value of $12 million over the next 3 years. For purposes of analysis the best estimate of the debt to equity ratio should be:

A)

0.500.

B) 0.573.

C) 0.671.





The original debt / equity ratio = 35 / 70 = 0.5. Now adjust the numerator but not the denominator. Why? You have commitments (liabilities) but no new equity because (non-current) liabilities and assets are increased by the same amount. D/E = (35 + 12) / 70 = 0.671.

Using a 365-day year, if a firm has net annual sales of $250,000 and average receivables of $150,000, what is its average collection period?

A)

219.0 days.

B) 1.7 days.

C) 46.5 days.


Receivables turnover = $250,000 / $150,000 = 1.66667

Collection period = 365 / 1.66667 = 219 days

Given the following income statement:

Net Sales 200Cost of Goods Sold 55Gross Profit 145Operating Expenses 30Operating Profit (EBIT) 115Interest 15Earnings Before Taxes (EBT) 100Taxes 40Earnings After Taxes (EAT) 60

What are the gross profit margin and operating profit margin?

Gross Profit Margin Operating Profit Margin

A)

2.630

B) 0.379 0.725

C) 0.725 0.575



Gross profit margin = gross profit / net sales = 145 / 200 = 0.725

Operating profit margin = EBIT / net sales = 115 / 200 = 0.575

XYZ, Inc., latest Income Statement, Balance Sheet and Statement of Cash Flows are below. Use this information to answer the following questions:

Income Statement

Sales Revenue 19,580

Cost of Goods Sold 7,319

Gross Margin 12,261

Wage Expense 900

SG&A 4,336

Depreciation Expense 662

5,898

Income from Operations 6,363

Other Income/Expenses

Interest Expense (750)

Gain on Sale of Land 119

(631)

Pretax Income 5,732

Income tax 1,605

Net Income 4,127

Balance Sheet

12/31/04 12/31/03

Assets

Current Assets

Cash 2,098 410

Accounts receivable 4,570 4,900

Inventory 4,752 4,500

Prepaid SGA 877 908

Total 12,297 10,718


Land 0 4,000

Property, Plant & Equipment 11,000 11,000

Accumulated Depreciation (5,862) (5,200)

Total Assets 17,435 20,518

Cash Flow from Operations

Net Income 4,127

Increase in Accounts Receivable 330

Increase in Accounts Payable (489)

Increase in Inventory (252)

Increase in Wages Payable 94

Increase in Prepaid SGA 31

Depreciation 662

Gain on Sale of Land (119)

Net cash from Operations 4,384

Cash Flow from Investments

Sale of Land 4,119

Net Cash from Investments 4,119

Cash Flow from Financing

Retirement of LT Debt (6,042)

Dividends Paid (773)

Net Cash from Financing (6,815)

Net Increase in Cash 1,688

Beginning Cash 410

Ending Cash 2,098

Liabilities and Equity

12/31/04 12/31/03

Current Liabilities

Accounts Payable 4,651 5,140

Wages Payable 2,984 2,890

Dividends Payable 100 100

Total 7,735 8,130

Long term Debt 1,346 7,388

Equity

Common Stock 4,000 4,000

Retained Earnings 4,354 1,000

Total Liabilities and Equity 17,435 20,518

At the end of 2004, what were XYZâ€™s current, quick and cash ratios?

Current Ratio Quick Ratio Cash Ratio

A)

1.59

B) 1.59 1.59 0.27

C) 1.48 0.86 0.27


Current ratio = current assets / current liabilities = 12,297 / 7,735 = 1.59

Quick ratio = (cash + receivables) / current liabilities = 2,098 + 4,570 / 7,735 = 0.86

Cash ratio = cash / current liabilities = 2,098 / 7,735 = 0.271

What was the return on equity (ROE) based on year-end equity? A)

0.67.

B) 0.49.

C) 0.58.


ROE = net income / equity = 4,127 / 8,354 = 0.49



The following data applies to the XTC Company:

Sales = $1,000,000. Receivables = $260,000.

Payables = $600,000.

Purchases = $800,000.

COGS = $800,000.

Inventory = $400,000.

Net Income = $50,000.

Total Assets = $800,000.

Debt/Equity = 200%.

What is the average collection period, the average inventory processing period, and the payables payment period for XTC Company?

AverageCollection Period

Average InventoryProcessing Period

PayablesPayments Period

A)

55 days

B) 45 days 45 days 132 days

C) 95 days 183 days 274 days


Receivables turnover = $1,000,000 / $260,000 = 3.840Average collection period = 365 / 3.840 = 95.05 or 95 days

Inventory turnover = $800,000 / $400,000 = 2Average inventory processing period = 365 / 2 = 183 days

Payables turnover ratio = $800,000 / $600,000 = 1.333Payables payment period = 365 / 1.333 = 273.82 or 274 days

Eagle Manufacturing Company reported the following selected financial information for 2007:

Accounts payable turnover 5.0Cost of goods sold $30 millionAverage inventory $3 millionAverage receivables $8 million


Total liabilities $35 millionInterest expense $2 millionCash conversion cycle 13.5 days

Assuming 365 days in the calendar year, calculate Eagle's sales for the year.

A)

$52.3 million.

B) $57.8 million.

C) $58.4 million.


Set up the cash conversion cycle formula and solve for the missing variable, sales. Days in payables is equal to 73 [365 / 5 accounts payable turnover]. Days in inventory is equal to 36.5 [365 / ($30 million COGS / $3 million average inventory)]. Given the cash conversion cycle, days in inventory, and days in payables, calculate days in receivables of 50 [13.5 days cash conversion cycle + 73 days in payables â€“ 36.5 days in inventory]. Given days in receivables of 50 and average receivables of $8 million, sales are $58.4 million [($8 million average receivables / 50 days) × 365].

Income Statements for Royal, Inc. for the years ended December 31, 20X0 and December 31, 20X1 were as follows (in $ millions):

Â 20X0 20X1Sales 78Â 82Â Cost of Goods Sold (47) (48)Â Gross Profit 31Â 34Â Sales and AdministrationÂ Â Â Â

(13) (14)

Â Operating Profit (EBIT) 18Â 20Â Interest Expense (6) (10)Â Earnings Before Taxes 12Â 10Â Income Taxes (5) (4)Â Earnings after Taxes Â 7Â Â 6Â

Analysis of these statements for trends in operating profitability reveals that, with respect to Royalâ€™s gross profit margin and net profit margin:

A)

gross profi


t margin decreased but net profit margin increased in 20X1.

B) both gross profit margin and net profit margin increased in 20X1.

C) gross profit margin increased in 20X1 but net profit margin decreased.


Royalâ€™s gross profit margin (gross profit / sales) was higher in 20X1 (34 / 82 = 41.5%) than in 20X0 (31 / 78 = 39.7%), but net profit margin (earnings after taxes / sales) declined from 7 / 78 = 9.0% in 20X0 to 6 / 82 = 7.3% in 20X1.

firmâ€™s financial statements reflect the following:

Net profit margin 15%

Sales $10,000,000

Interest payments $1,200,000

Avg. assets $15,000,000

Equity $11,000,000

Avg. working capital $800,000

Dividend payout rate 35%

Which of the following is the closest estimate of the firmâ€™s sustainable growth rate?

A)

10%.

B) 8%.


C) 9%.


Return on equity (ROE) = net profit margin × asset turnover × leverage = (0.15)(0.67)(1.364) = 0.137.

The sustainable growth = (1 â€“ dividend rate)(ROE) = (0.65)(0.137) = 8.9%.

McQueen Corporation prepared the following common-size income statement for the year ended December 31, 20X7:

Sales 100%Cost of goods sold 60%Gross profit 40%

For 20X7, McQueen sold 250 million units at a sales price of $1 each. For 20X8, McQueen has decided to reduce its sales price by 10%. McQueen believes the price cut will double unit sales. The cost of each unit sold is expected to remain the same. Calculate the change in McQueenâ€™s expected gross profit for 20X8 assuming the price cut doubles sales.

A)

$50 million increase.

B) $150 million increase.

C) $80 million increase.


20X7 gross profit is equal to $100 million ($1 × 250 million units sold × 40% gross profit margin). The 10% price cut to $0.90 will increase cost of goods sold to 67% of sales [COGS=0.6($1) = $0.60; $0.60 / $0.90 = 67%.]. As a result, gross profit will decrease to 33% of sales. If unit sales double in 20X8, gross profit will equal $150 million ($0.90 × 500 million units × 33% gross profit margin). Therefore, gross profit will increase $50 million ($150 million 20X8 gross profit â€“ $100 million 20X7 gross profit).

Lightfoot Shoe Company reported sales of $100 million for the year ended 20X7. Lightfoot expects sales to increase 10% in 20X8. Cost of goods sold is expected to remain constant at 40% of sales and Lightfoot would like to have an average of 73 days of inventory on hand in 20X8. Forecast Lightfootâ€™s average inventory for 20X8 assuming a 365 day year.



A)

$8.0 million.

B) $8.8 million.

C) $22.0 million.


20X8 sales are expected to be $110 million [$100 million × 1.1] and COGS is expected to be $44 million [$110 million sales × 40%]. With 73 days of inventory on hand, average inventory is $8.8 million [($44 million COGS / 365) × 73 days].

An analysis of the industry reveals that firms have been paying out 45% of their earnings in dividends, asset turnover = 1.2; asset-to-equity (A/E) = 1.1 and profit margins are 8%. What is the industryâ€™s projected growth rate?

A)

4.55%.

B) 4.95%.

C) 5.81%.


ROE = profit margin × asset turnover × A/E = 0.08 × 1.2 × 1.1 = 0.1056 RR = (1 - 0.45) = 0.55 g = ROE × RR = 0.1056 × 0.55 = 0.0581

Sterling Company is a start-up technology firm that has been experiencing super-normal growth over the past two years. Selected common-size financial information follows:

Â 2007 Actual % of Sales

2008 Forecast % of Sales

Sales 100% 100%

Cost of goods sold 60% 55%

Selling and administration expenses 25% 20%

Depreciation expense 10% 10%

Net income 5% 15%



Non-cash operating working capital a 20% 25% a Non-cash operating working capital = Receivables + Inventory â€“ Payables

For the year ended 2007, Sterling reported sales of $20 million. Sterling expects that sales will increase 50% in 2008. Ignoring income taxes, what is Sterlingâ€™s forecast operating cash flow for the year ended 2008, and is this forecast likely to be as reliable as a forecast for a large, well diversified, firm operating in mature industries?

Operating cash flow Reliable forecast

A)

$4.5 million

B) $4.0 million No

C) $4.0 million Yes


2008 sales are expected to be $30 million ($20 million 2007 sales Ã— 1.5) and 2008 net income is expected to be $4.5 million ($30 million 2008 sales Ã— 15%). 2007 non-cash operating working capital was $4 million ($20 million 2007 sales Ã— 20%) and 2008 non-cash operating working capital is expected to be $7.5 million ($30 million 2008 sales Ã— 25%). 2008 operating cash flow is expected to be $4 million ($4.5 million 2008 net income + $3 million 2008 depreciation â€“ $3.5 million increase in non-cash operating working capital). Forecasts for small firms, start-ups, or firms operating in volatile industries may be less reliable than a forecast for a large, well diversified, firm operating in mature industries.

Baetica Company reported the following selected financial statement data for the year ended December 31, 20X7:

in millions Â % of Sales

For the year ended December 31, 20X7: $500 100%

Sales

Cost of goods sold (300) 60%

Selling and administration expenses (125) 25%

Depreciation (50) 10%

Net income $25 5%

< >>

As of December 31, 20X7:

Non-cash operating working capital a $100 20%

Cash balance $35 N/Aa Non-cash operating working capital = Receivables + Inventory â€“ Payables

http://127.0.0.1:20507/online_program/test_engine/browse_question.php?new_node_id=153888#question_110292

Baetica expects that sales will increase 20% in 20X8. In addition, Baetica expects to make fixed capital expenditures of $75 million in 20X8. Ignoring taxes, calculate Baeticaâ€™s expected cash balance, as of December 31, 2008, assuming all of the common-size percentages remain constant. A)

$40 million.

B) $80 million.

C) $30 million.


2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%). 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%). The change in cash is expected to be â€“$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation â€“ $20 million increase in non-cash operating working capital â€“ $75 million 20X8 capital expenditures). The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance â€“ $5 million decrease in cash).

For 2007, Morris Company had 73 days of inventory on hand. Morris would like to decrease its days of inventory on hand to 50. Morrisâ€™ cost of goods sold for 2007 was $100 million. Morris expects cost of goods sold to be $124.1 million in 2008. Assuming a 365 day year, compute the impact on Morrisâ€™ operating cash flow of the change in average inventory for 2008.

A)

$6.3 million source of cash.

B) $3.0 million use of cash.

C) $3.0 million source of cash.


2007 inventory turnover was 5 (365 / 73 days in inventory). Given inventory turnover and COGS, 2007 average inventory was $20 million ($100 million COGS / 5 inventory turnover). 2008 inventory turnover is expected to be 7.3 (365 / 50 days in inventory). Given expected inventory turnover, 2008 average



inventory is $17 million ($124.1 million COGS / 7.3 expected inventory turnover). To achieve 50 days of inventory on hand, average inventory must decline $3 million ($20 million 2007 average inventory â€“ $17 million 2008 expected inventory). A decrease in inventory is a source of cash.

Selected financial information gathered from Alpha Company and Omega Corporation follows:

Â Alpha Omega

Revenue $1,650,000 $1,452,000

Earnings before interest, taxes, Â Â depreciation, and amortization

69,400 79,300

Quick assets 216,700 211,300

Average fixed assets 300,000 323,000

Current liabilities 361,000 404,400

Interest expense 44,000 58,100

Which of the following statements is most accurate?

A)

Omega has less tolerance for leverage than Alpha.

B) Omega uses its fixed assets more efficiently than Alpha.

C) Alpha is more operationally efficient than Omega.


Using the EBITDA coverage (EBITDA / Interest expense) to measure leverage tolerance, Omega has less tolerance for leverage. Omegaâ€™s EBITDA coverage is 1.4 ($79,300 EBITDA / $58,100 interest expense) and Alphaâ€™s EBITDA coverage is 1.6 ($69,400 EBITDA / $44,000 interest expense). Using EBITDA margin to measure operational efficiency, Alpha is less operationally efficient than Omega. Alphaâ€™s EBITDA margin is 4.2% ($69,400 EBITDA / $1,650,000 revenue) and Omegaâ€™s EBITDA margin is 5.5% ($79,300 EBITDA / $1,452,000 revenue). Using fixed asset turnover to measure the efficiency of fixed assets, Omega uses its fixed assets less efficiently than Alpha. Alphaâ€™s fixed asset turnover is 5.5 ($1,650,000 revenue / $300,000 average fixed assets) and Omegaâ€™s fixed asset turnover is 4.5 ($1,452,000 revenue / $323,000 average fixed assets).


To adjust for operating leases before calculating financial statement ratios, what value should an analyst add to a firmâ€™s liabilities?

A)

Sum of future operating lease obligations.

B) Difference between present values of lease payments and the assetâ€™s future earnings.

C) Present value of future operating lease payments.


Before calculating ratios involving liabilities, an analyst should estimate the present value of operating lease obligations and add this value to the firmâ€™s liabilities.

A firm recognizes a goodwill impairment in its most recent financial statement, reducing goodwill from $50 million to $40 million. How should an analyst most appropriately adjust this financial statement for goodwill when calculating financial ratios?

A)

Decrease assets and increase earnings.

B) Make no adjustments to assets or earnings because both reflect the impairment.

C) Decrease earnings but make no adjustment to assets.



The recommended adjustment for goodwill before calculating financial ratios is to remove goodwill from the balance sheet (decreasing assets) and reverse any losses recognized due to goodwill impairment (increasing earnings).

National Scooter Company and Continental Chopper Company are motorcycle manufacturing companies. Nationalâ€™s target market includes consumers that are switching to motorcycles because of the high cost of operating automobiles and they compete on price with other manufacturers. The average age of Nationalâ€™s customers is 24 years.

Continental manufactures premium motorcycles and aftermarket accessories and competes on the basis of quality and innovative design. Continental is in the third year of a five-year project to develop a customized hybrid motorcycle. Which of the two firms would most likely report higher gross profit margin, and which firm would most likely report higher operating expense stated as a percentage of total cost?

Higher gross profit marginHigher percentage operating

expense

A)

Continental

B) National Continental

C) Continental Continental


Continental likely has the highest gross profit margin percentage since it is selling a customized product and does not compete primarily based on price. Because of the research and development costs of developing a new hybrid motorcycle, Continental likely has the higher operating expense stated as a percentage of total cost.

According to the Management Discussion and Analysis section of Frankfurt Supply Companyâ€™s annual report, Frankfurt recently decreased the sales prices of its products in order to increase market share. In addition, Frankfurt recently lowered its requirements for credit customers and increased the credit limits of some customers. What is the most likely impact on Frankfurtâ€™s accounts receivable turnover and inventory turnover as a result of these changes?

A)

Both will decr



ease.

B) Both will increase.

C) Only one will decrease.


Accounts receivable turnover will likely decrease as a result of offering credit to customers with weak credit histories. Collections will likely slow down and bad debt expense will likely increase. Inventory turnover is likely to increase as sales of Frankfurtâ€™s products increase from more liberal credit terms and the decrease in price.

Analysis of the quality of the cash flow statement is:

A)

unnecessary because cash is not an accrual accounting value.

B) necessary because accounting choices can increase operating cash flows unsustainably.

C) necessary because of the possibility of fraud.


Accounting choices can increase reported operating cash flows artificially or in ways that are unsustainable. Quality concerns are separate from fraud concerns.



During 2007, Big 4 Companyâ€™s warehouse was totally destroyed by a tornado. Tornados are very rare in the region where Big 4 is located. The book value of the warehouse at the time of the tornado was â‚¬10 million and Big 4 is self-insured. In addition, on June 30, 2007, Big 4 acquired one of its major suppliers. The fair value of the net assets acquired by Big 4 was greater than the purchase price. According to International Financial Reporting Standards, should Big 4 recognize an extraordinary item for tornado damage and should Big 4 recognize negative goodwill on its balance sheet due to the acquisition?

Extraordinary loss Negative goodwill

A)

No

B) Yes No

C) No Yes


IFRS does not permit income statement items to be recognized as â€œextraordinaryâ€ in the income �statement. Negative goodwill is not reported on the balance sheet; rather, the excess of fair value over the price paid in an acquisition is recognized as a gain in the income statement.

On January 1, 2004, JME purchased a truck that cost $24,000. The truck had an estimated useful life of 5 years and $4,000 salvage value. The amount of depreciation expense recognized in 2006 assuming that JME uses the double declining balance method is:

A)

$5,760.

B) $3,456.

C) $4,000.


yr. 2004 = 24,000 × 2/5 = 9,600

yr. 2005 = (24,000 − 9,600) × 2/5 = 5,760

yr. 2006 = (24,000 − 9,600 − 5,760) × 2/5 = 3,456



Walsh Furniture has purchased a machine with a 7-year useful life for $250,000. At the end of its life it will have an estimated salvage value of $15,000. Using the double-declining balance (DDB) method, depreciation expense in year 2 is closest to:

A)

$51,020.

B) $58,750.

C) $71,430.


Year 2 / Depreciable Life Ã— Book Value at

Beginning of the Year = Depreciation

1 0.2857 250,000 71,429

2 0.2857 178,571 51,020

Davis Inc. is a large manufacturing company operating in several European countries. Davis has long-lived assets currently in use that are valued on the balance sheet at $600 million. This includes previously recognized impairment losses of $80 million. The original cost of the assets was $750 million. The fair value of the assets was determined by in independent appraisal to be $690 million. Which of the following entries may Davis record under IFRS?

A)

$90 million gain on income statement.

B) $80 million gain on income statement and a $10 million revaluation surplus.

C) $90 million revaluation surplus.




Under IFRS, firms may choose to report long-lived assets at fair value. Upward revaluations are permitted and will result in a gain recognized on the income statement to the extent it reverses a previously recognized loss. Any excess is reported as a revaluation surplus, a direct adjustment to equity. In this case, the carrying value of the assets is $600 million ($750 million original cost less $70 million accumulated depreciation and less $80 million impairment loss). The fair value is $690 million. Of the $90 million excess of fair value over carrying value, $80 million is recognized as a gain on the income statement to reverse the $80 million impairment loss that was previously recognized. The remaining $10 million is recorded as a revaluation surplus in shareholders' equity

An impairment write-down is least likely to decrease a company's:

A)

assets.

B) debt-to-equity ratio.

C) future depreciation expense.


An impairment write-down reduces equity and has no effect on debt. The debt-to- equity ratio would therefore increase.

An analyst determined the following information concerning Franklin, Inc.â€™s stamping machine:

Acquired seven years ago for $22 million Straight line method used for depreciation

Useful life estimatedÂ to be 12 years

Salvage value originally estimated to be $4 million

The stamping machine is expected to generate $1,500,000 per year for five more years and will then be sold for $1,000,000. Under U.S. GAAP, the stamping machine is:

A)

impaired because its carry


ing value exceeds expected future cash flows.

B) not impaired.

C) impaired because expected salvage value has declined.


The carrying value of the stamping machine is its cost less accumulated depreciation. Depreciation taken through 7 years was ($22,000,000 - $4,000,000) / 12 Ã— 7 = $10,500,000, so carrying value is $22,000,000 - $10,500,000 = $11,500,000. Because the $11,500,000 carrying value is more than expected future cash flows of (5 Ã— $1,500,000) + $1,000,000 = $8,500,000, the stamping machine is impaired.

Spenser Inc. owns a piece of specialized machinery with a current fair value of $400,000. The original cost of the machinery was $500,000 and to date has generated accumulated depreciation of $140,000. Which of the following must Spenser record on the income statement if it decides to abandon the asset?

A)

Gain of $40,000.

B) Loss of $100,000.

C) Loss of $360,000.

http://127.0.0.1:20507/online_program/test_engine/browse_question.php?question_id=150013&node_id=153843&operation=previous&node_sort_order=#question_106653


With an abandonment of an asset, the carrying value of the machinery is removed from the balance sheet and a loss of that amount is recognized in the income statement. The carrying value is $360,000, which equals the original cost ($500,000) less the accumulated depreciation ($140,000).

When comparing capitalizing versus expensing costs which of the following statements is most accurate?

A)

Expensing costs creates lower cash flows from operations and lower cash flows from investing.

B) Capitalizing costs creates higher cash flows from operations and lower cash flows from investing.

C) Capitalizing costs creates lower cash flows from operations and higher cash flows from investing.


Although net cash flows are not affected by the choice of capitalization or expensing, the components of cash flow are affected. Because, a firm that capitalizes classifies the expenditure as investing (not operations), cash flow from operations will be higher for firms that capitalize and investing cash flows will be lower than that of an expensing firm.



Documents

FS Analysis Practice Exam