FINANCIAL STATEMENT ANALYSIS MOCK EXAM I MULTIPLE CHOICE The following information is relevant for Questions and 2: Austin Corporation’s Year financial statement notes include the following information: a Austin recently entered into operating leases with total future payments of $40 million that equal a discounted present value of $20 million b Long-term assets include held-to-maturity debt securities carried at their amortized cost of $10 million Fair market value of these securities is $12 million c Austin guarantees a $5 million bond issue, due in Year 13 The bonds are issued by Healey, a nonconsolidated 30%-owned affiliate After analysis, you decide to adjust Austin’s balance sheet for each of the above three items Among the effects of these adjustments for the long-term debt to equity ratio is: A Only the held-to-maturity debt securities adjustment decreases this ratio B Only lease capitalization decreases this ratio C All three adjustments decrease this ratio D All three adjustments increase this ratio What is the effect of a cash dividend payment on the following ratios (all else equal)? What is the effect of selling inventory for profit on the following ratios (all else equal)? The existence of uncapitalized operating leases is to (choose one of the following): A Overstate the earnings to fixed charges coverage ratio B Overstate fixed charges C Overstate working capital D Understate the long-term debt to equity ratio Which is least likely one of the conclusions about the impact of a change in financial reporting standards that might appear in management’s discussion and analysis? A Management has chosen not to implement the new standard B Management is currently evaluating the impact of the new standard C The new standard will not have a material impact on the company’s financial statements A manufacturing firm sells a large amount of precision parts and provides financing to the buyer at its usual credit terms The firm should recognize revenue from this transaction: A at the time of the sale B using the installment method C proportionally as payments are received Which of the following best describes the impact of depreciating equipment with a useful life of years using the declining balance method as compared to the straight-line method? A Total depreciation expense will be higher over the life of the equipment B Depreciation expense will be higher in the first year C Scrapping the equipment after five years will result in a larger loss Which of the following is least likely to be included when calculating comprehensive income? A Unrealized loss from cash flow hedging derivatives B Unrealized gain from available-for-sale securities C Dividends paid to common shareholders A company’s quick ratio is 1.2 If inventory were purchased for cash, the: A numerator would decrease more than the denominator, resulting in a lower quick ratio B denominator would decrease more than the numerator, resulting in a higher current ratio C numerator and denominator would decrease proportionally, leaving the current ratio unchanged 10 According to the IASB Conceptual Framework, the fundamental qualitative characteristics that make financial statements useful are: A verifiability and timeliness B relevance and faithful representation C understandability and relevance 11 Which of the following is most likely included in a firm’s ending inventory? A Storage costs of finished goods B Variable production overhead C Selling and administrative costs 12 In periods of rising prices and stable inventory quantities, which of the following best describes the effect on gross profit of using LIFO as compared to using FIFO? A Lower B Higher C The same 13 A firm that uses LIFO for inventory accounting reported COGS of $300,000 and ending inventory of $200,000 for the current period, and a LIFO reserve that decreased from $40,000 to $35,000 over the period If the firm had reported using FIFO, its gross profit would have been: A the same B $5,000 higher C $5,000 lower 14 During a period of increasing prices, compared to reporting under LIFO, a firm that reports using average cost for inventory will have a: A lower gross margin B higher current ratio C higher asset turnover 15 Red Company immediately expenses its development costs while Black Company capitalizes its development costs All else equal, Red Company will: A show smoother reported earnings than Black Company B report higher operating cash flow than Black Company C report higher asset turnover than Black Company 16 Which of the following statements about indefinite-lived intangible assets is most accurate? A They are amortized on a straight-line basis over a period not to exceed 40 years B They are reported on the balance sheet indefinitely C They never appear on the balance sheet unless they are internally developed 17 The author of a new textbook received a $100,000 advance from the publisher this year $40,000 of income taxes were paid on the advance when received The textbook will not be finished until next year Determine the tax basis of the advance at the end of this year A $0 B $40,000 C $100,000 KLH Company reported the following: Gross DTA at the beginning of the year $10,500 Gross DTA at the end of the year $11,250 Valuation allowance at the beginning of the year $2,700 Valuation allowance at the end of the year $3,900 18 Which of the following statements best describes the expected earnings of the firm? Earnings are expected to: A increase B decrease C remain relatively stable 19 Which one of the following statements is most accurate? Under the liability method of accounting for deferred taxes, a decrease in the tax rate at the beginning of the accounting period will: A increase taxable income in the current period B increase a deferred tax asset C reduce a deferred tax liability 20 A U.S GAAP reporting firm reports an increased valuation allowance at the end of the current period What effect will this have on the firm’s income tax expense in the current period? A Increase B Decrease C No effect 21 For analytical purposes, what is the impact on the debt-to-equity ratio if the market rate of interest increases after the bond is issued? A An increase B A decrease C No change 22 How should an analyst most appropriately adjust the financial statements of a firm that uses operating leases to finance its plant and equipment? A Increase liabilities B Decrease long-lived assets C Decrease shareholders’ equity 23 A decrease in a firm’s inventory turnover ratio is most likely to result from: A a write-down of inventory B goods in inventory becoming obsolete C decreasing purchases in a period of stable sales 24 If a firm’s management wishes to use its discretion to increase operating cash flows, it is most likely to: A capitalize an expense B decrease the allowance for uncollectible accounts C change delivery terms from FOB destination to FOB shipping point 25 Which of the following situations best correspond with a ratio of “sales to average net tangible assets” exceeding the industry norm? (Choose one answer.) a A company expanding plant and equipment during the past three years b A company inefficiently using its assets c A company with a large proportion of aged plant and equipment 26 A measure of asset utilization (turnover) is (choose one answer): a Sales divided by average long-term operating assets b Return on net operating assets c Return on common equity d NOPAT divided by sales 27 Return on net operating assets depends on the (choose one answer): a Interest rates and pretax profits c After-tax operating profit margin and NOA turnover b Debt to equity ratio d Sales and total assets II WRITTEN QUESTIONS (1 mark) A colleague who is aware of your understanding of financial statements asks for help in analyzing the transactions and events of Zett Corporation The following data are provided: Additional data for the period January 1, Year 2, through December 31, Year 2, are: Sales on account, $70,000 Purchases on account, $40,000 Depreciation, $5,000 Expenses paid in cash, $18,000 (including $4,000 of interest and $6,000 in taxes) Decrease in inventory, $2,000 Sales of fixed assets for $6,000 cash; cost $21,000 and two-thirds depreciated (loss or gain is included in income) Purchase of fixed assets for cash, $4,000 Fixed assets are exchanged for bonds payable of $30,000 Sale of investments for $9,000 cash 10 Purchase of treasury stock for cash, $11,500 11 Retire bonds payable by issuing common stock, $10,000 12 Collections on accounts receivable, $65,000 13 Sold unissued common stock for cash, $1,000 Required: Prepare a statement of cash flows (indirect method) for the year ended December 31, Year and comment on the firm using cash flow analysis approach (1 marks) Comparative income statements of Spyres Manufacturing Company for Years and are reproduced below: Required: a) Prepare common size statements showing the percent of each item to net sales for both Year and Year Include a column reporting the percentage increase or decrease for Year relative to Year (round numbers to the tenth of 1%) b) Interpret the trend shown in your percentage calculations of a What areas identified from this analysis should be a matter of managerial concern (1 mark) Selected income statement and balance sheet data from Merck & Co for Year are reproduced below: Required: a Calculate return on common equity for Year using year-end amounts and assuming no preferred dividends b Disaggregate Merck’s ROCE into operating (RNOA) and nonoperating components Comment on Merck’s use of leverage (Assume all assets and current liabilities are operating and a 35% tax rate.) (1 mark) a RAM is considering changing its credit policy This change implies ending accounts receivable would represent 90 days of sales What is the impact of this policy change on RAM’s current cash position? Will the company be required to borrow? b RAM is considering a change to a 120-day collection period based on ending accounts receivable What is the effect(s) of this change on its cash position? c Suppliers are considering changing their policy of extending credit to RAM to require payment on purchases within 60 days; there would be no change in RAM’s collection period What is the effect(s) of this change on its cash position? ... Required: Prepare a statement of cash flows (indirect method) for the year ended December 31, Year and comment on the firm using cash flow analysis approach (1 marks) Comparative income statements of... impact of the new standard C The new standard will not have a material impact on the company’s financial statements A manufacturing firm sells a large amount of precision parts and provides financing... According to the IASB Conceptual Framework, the fundamental qualitative characteristics that make financial statements useful are: A verifiability and timeliness B relevance and faithful representation