Financial Statement Analysis

MODULE 10

small. Which type of numbers would be most meaningful for statement analysis?
A. Absolute numbers would be most meaningful for both the large and small firm.
B. Absolute numbers would be most meaningful in the large firm; relative numbers would be
most meaningful in the small firm.
C. Relative numbers would be most meaningful for the large firm; absolute numbers would
be most meaningful for the small firm.
D. Relative numbers would be most meaningful for both the large and small firm, especially
for interfirm comparisons.

FINANCIAL STATEMENT ANALYSIS

THEORIES:
6. Management is a user of financial analysis. Which of the following comments does not
represent a fair statement as to the management perspective?
A. Management is always interested in maximum profitability.
B. Management is interested in the view of investors.
C. Management is interested in the financial structure of the entity.
D. Management is interested in the asset structure of the entity.

4. Which of these statements is false?

A. Many companies will not clearly fit into any one industry.
B. A financial service uses its best judgment as to which industry the firm best fits.
C. The analysis of an entity's financial statements can be more meaningful if the results are
compared with industry averages and with results of competitors.
D. A company comparison should not be made with industry averages if the company does
not clearly fit into any one industry.

Limitations
1. A limitation in calculating ratios in financial statement analysis is that
A. it requires a calculator.
B. no one other than the management would be interested in them.
C. some account balances may reflect atypical data at year end.
D. they seldom identify problem areas in a company.

Common-sized financial statements

9. Which of the following generally is the most useful in analyzing companies of different sizes?
A. comparative statements
C. price-level accounting
B. common-sized financial statements
D. profitability index

2. Which of the following is not a limitation of financial statement analysis?

A. The cost basis.
C. The diversification of firms.
B. The use of estimates.
D. The availability of information.

12. Statements in which all items are expressed only in relative terms (percentages of a base) are
termed:
A. Vertical statements
C. Funds Statements
B. Horizontal Statements
D. Common-Size Statements

5. Which of the following does not represent a problem with financial analysis?
A. Financial statement analysis is an art; it requires judgment decisions on the part of the
analyst.
B. Financial analysis can be used to detect apparent liquidity problems.
C. There are as many ratios for financial analysis as there are pairs of figures.
D. Some industry ratio formulas vary from source to source.

10. The percent of property, plant and equipment to total assets is an example of:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis

77. The use of alternative accounting methods:

A. is not a problem in ratio analysis because the footnotes disclose the method used.
B. may be a problem in ratio analysis even if disclosed.
C. is not a problem in ratio analysis since eventually all methods will lead to the same end.
D. is only a problem in ratio analysis with respect to inventory.

15. Vertical analysis is a technique that expresses each item in a financial statement
A. in pesos and centavos.
B. as a percent of the item in the previous year.
C. as a percent of a base amount.
D. starting with the highest value down to the lowest value.

Industry Analysis
3. Suppose you are comparing two firms in the steel industry. One firm is large and the other is

17. In performing a vertical analysis, the base for prepaid expenses is

55

Financial Statement Analysis

A. total current assets.

B. total assets.

C. total liabilities.
D. prepaid expenses in a previous year.

69. Which suppliers of funds bear the greatest risk and should therefore earn the greatest return?
A. common stockholders
C. preferred shareholders
B. general creditors such as banks
D. bondholders

Horizontal analysis
8. The percentage analysis of increases and decreases in individual items in comparative
financial statements is called:
A. vertical analysis
C. profitability analysis
B. solvency analysis
D. horizontal analysis
11. Horizontal analysis is also known as
A. linear analysis.
B. vertical analysis.

Measures of Risk
54. The following groups of ratios primarily measure risk:
A. liquidity, activity, and common equity
C. liquidity, activity, and debt
B. liquidity, activity, and profitability
D. activity, debt, and profitability
Financial ratios
7. Ratios are used as tools in financial analysis
A. instead of horizontal and vertical analyses.
B. because they can provide information that may not be apparent from inspection of the
individual components of a particular ratio.
C. because even single ratios by themselves are quite meaningful.
D. because they are prescribed by GAAP.

C. trend analysis.
D. common size analysis.

13. In which of the following cases may a percentage change be computed?

A. The trend of the amounts is decreasing but all amounts are positive.
B. There is no amount in the base year.
C. There is a negative amount in the base year and a negative amount in the subsequent
year.
D. There is a negative amount in the base year and a positive amount in the subsequent
year.

18. In the near term, the important ratios that provide the information critical to the short-run
operation of the firm are:
A. liquidity, activity, and profitability
C. liquidity, activity, and equity
B. liquidity, activity, and debt
D. activity, debt, and profitability

14. Horizontal analysis is a technique for evaluating a series of financial statement data over a
period of time
A. that has been arranged from the highest number to the lowest number.
B. that has been arranged from the lowest number to the highest number.
C. to determine which items are in error.
D. to determine the amount and/or percentage increase or decrease that has taken place.

75. The ability of a business to pay its debts as they come due and to earn a reasonable amount
of income is referred to as:
A. solvency and leverage
C. solvency and liquidity
B. solvency and profitability
D. solvency and equity

Trend analysis
16. Trend analysis allows a firm to compare its performance to:
A. other firms in the industry
C. other industries
B. other time periods within the firm
D. none of the above

Liquidity ratios
Interested parties
19. The primary concern of short-term creditors when assessing the strength of a firm is the
entitys
A. short-term liquidity
C. market price of stock
B. profitability
D. leverage

Risk and return

29. The present and prospective stockholders are primarily concerned with a firm
A. profitability
C. leverage
B. liquidity
D. risk and return

35. Short-term creditors are usually most interested in assessing

A. solvency.
C. marketability.
B. liquidity.
D. profitability.

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Financial Statement Analysis

36. The two categories of ratios that should be utilized to asses a firms true liquidity are the
A. current and quick ratios
C. liquidity and profitability ratios
B. liquidity and debt ratios
D. liquidity and activity ratios

A. accounts receivable turnover.

B. asset turnover.

C. acid test ratio.

D. current ratio.

Current ratio
24. Typically, which of the following would be considered to be the most indicative of a firm's shortterm debt paying ability?
A. working capital
C. acid test ratio
B. current ratio
D. days sales in receivables

47. Which of the following is the most of interest to a firms suppliers?

A. profitability
C. asset utilization
B. debt
D. liquidity
Measures of liquidity
21. The ratios that are used to determine a companys short-term debt paying ability are
A. asset turnover, times interest earned, current ratio, and receivables turnover.
B. times interest earned, inventory turnover, current ratio, and receivables turnover.
C. times interest earned, acid-test ratio, current ratio, and inventory turnover.
D. current ratio, acid-test ratio, receivables turnover, and inventory turnover.

22. The current ratio is

A. calculated by dividing current liabilities by current assets.
B. used to evaluate a companys liquidity and short-term debt paying ability.
C. used to evaluate a companys solvency and long-term debt paying ability.
D. calculated by subtracting current liabilities from current assets.

20. Which of the following is a measure of the liquidity position of a corporation?

A. earnings per share
B. inventory turnover
C. current ratio
D. number of times interest charges earned

30. Which of the following ratios is rated to be a primary measure of liquidity and considered of
highest significance rating of the liquidity ratios a bank analyst?
A. Debt/Equity
B. Current ratio
C. Degree of Financial Leverage
D. Accounts Receivable Turnover in Days

37. Which one of the following ratios would not likely be used by a short-term creditor in
evaluating whether to sell on credit to a company?
A. Current ratio
C. Asset turnover
B. Acid-test ratio
D. Receivables turnover

41. A weakness of the current ratio is

A. the difficulty of the calculation.
B. that it does not take into account the composition of the current assets.
C. that it is rarely used by sophisticated analysts.
D. that it can be expressed as a percentage, as a rate, or as a proportion.

51. Which of the following ratios would be least helpful in appraising the liquidity of current
assets?
A. Accounts Receivable turnover
C. Current Ratio
B. Days sales in inventory
D. Days sales in accounts receivable
53. Which ratio is most helpful in appraising the liquidity of current assets?
A. current ratio
C. acid-test ratio
B. debt ratio
D. accounts receivable turnover

Acid-test or quick ratio

42. A measure of a companys immediate short-term liquidity is the
A. current ratio.
B. current cash debt coverage ratio.
C. cash debt coverage ratio.
D. acid-test ratio.

Not a measure of liquidity

79. Which one of the following ratios would not likely be used by a short-term creditor in evaluating
whether to sell on credit to a company?

23. The acid-test or quick ratio

A. is used to quickly determine a companys solvency and long-term debt paying ability.
B. relates cash, short-term investments, and net receivables to current liabilities.
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Financial Statement Analysis

C. is calculated by taking one item from the income statement and one item from the balance
sheet.
D. is the same as the current ratio except it is rounded to the nearest whole percent.

66. Total asset turnover measures the ability of a firm to:

A. generate profits on sales
B. generate sales through the use of assets
C. cover long-term debt
D. buy new assets

Not a liquidity ratio

28. Which one of the following would not be considered a liquidity ratio?
A. Current ratio.
C. Quick ratio.
B. Inventory turnover.
D. Return on assets.

76. A measure of how efficiently a company uses its assets to generate sales is the
A. asset turnover ratio.
C. profit margin ratio.
B. cash return on sales ratio.
D. return on assets ratio.

Activity ratios
Days receivable & receivable turnover
Quality of receivables
25. Which of the following does not bear on the quality of receivables?
A. shortening the credit terms
B. lengthening the credit terms
C. lengthening the outstanding period
D. all of the above bear on the quality of receivables

Solvency ratios
Interested parties
50. Long-term creditors are usually most interested in evaluating
A. liquidity.
C. profitability.
B. marketability.
D. solvency.
Financial Leverage
45. Trading on the equity (leverage) refers to the
A. amount of working capital.
B. amount of capital provided by owners.
C. use of borrowed money to increase the return to owners.
D. earnings per share.

Days receivable
27. A general rule to use in assessing the average collection period is
A. that is should not exceed 30 days.
B. it can be any length as long as the customer continues to buy merchandise.
C. that it should not greatly exceed the discount period.
D. that it should not greatly exceed the credit term period.

90. The tendency of the rate earned on stockholders' equity to vary disproportionately from the
rate earned on total assets is sometimes referred to as:
A. leverage
C. yield
B. solvency
D. quick assets

Asset utilization ratios

Performance measures
65. All of the following are asset utilization ratios except:
A. average collection period
C. receivables turnover
B. inventory turnover
D. return on assets

55. Using financial leverage is a good financial strategy from the viewpoint of stockholders of
companies having:
A. a high debt ratio
C. a steadily declining current ratio
B. steady or rising profits
D. cyclical highs and lows

Asset turnover
63. Asset turnover measures
A. how often a company replaces its assets.
B. how efficiently a company uses its assets to generate sales.
C. the portion of the assets that have been financed by creditors.
D. the overall rate of return on assets.

46. The ratio that indicates a companys degree of financial leverage is the
A. cash debt coverage ratio.
C. free cash flow ratio.
B. debt to total assets.
D. times-interest earned ratio.
73. Interest expense creates magnification of earnings through financial leverage because:
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Financial Statement Analysis

A.
B.
C.
S.

while earnings available to pay interest rise, earnings to residual owners rise faster
interest accompanies debt financing
interest costs are cheaper than the required rate of return to equity owners
the use of interest causes higher earnings

Debt-to-equity ratio
60. Which of the following statements best compares long-term borrowing capacity ratios?
A. The debt/equity ratio is more conservative than the debt ratio.
B. The debt to tangible net worth ratio is more conservative than the debt/equity ratio.
C. The debt/equity ratio is more conservative than the debt to tangible net worth ratio.
D. The debt ratio is more conservative than the debt/equity ratio.

Measures of solvency
34. The set of ratios that is most useful in evaluating solvency is
A. debt ratio, current ratio, and times interest earned
B. debt ratio, times interest earned, and return on assets
C. debt ratio, times interest earned, and quick ratio
D. debt ratio, times interest earned, and cash flow to debt

Times interest earned

74. A times interest earned ratio of 0.90 to 1 means that
A. the firm will default on its interest payment
B. net income is less than the interest expense
C. the cash flow is less than the net income
D. the cash flow exceeds the net income

49. Which of the following ratios is most relevant to evaluating solvency?

A. Return on assets
C. Days purchases in accounts payable
B. Debt ratio
D. Dividend yield

Fixed charge coverage

61. A fixed charge coverage:
A. is a balance sheet indication of debt carrying ability
B. is an income statement indication of debt carrying ability
C. frequently includes research and development
D. computation is standard from firm to firm

Fixed assets to long-term liabilities

44. Which of the following ratios provides a solvency measure that shows the margin of safety of
noteholders or bondholders and also gives an indication of the potential ability of the business
to borrow additional funds on a long-term basis?
A. ratio of fixed assets to long-term liabilities
B. ratio of net sales to assets
C. number of days' sales in receivables
D. rate earned on stockholders' equity

Off-balance sheet liabilities

62. If a firm has substantial capital or financing leases disclosed in the notes but not capitalized in
the financial statements, then the
A. times interest earned ratio will be overstated, based upon the financial statements
B. debt ratio will be understated
C. working capital will be understated
D. fixed charge ratio will be overstated, based upon the financial statements

Debt ratio
59. The debt ratio indicates:
A. a comparison of liabilities with total assets
B. the ability of the firm to pay its current obligations
C. the efficiency of the use of total assets
D. the magnification of earnings caused by leverage

Profitability ratios
Interested parties
39. The return on assets ratio is affected by the
A. asset turnover ratio.
B. debt to total assets ratio.
C. profit margin ratio.
D. asset turnover and profit margin ratios.

78. The debt to total assets ratio measures

A. the companys profitability.
B. whether interest can be paid on debt in the current year.
C. the proportion of interest paid relative to dividends paid.
D. the percentage of the total assets provided by creditor.

52. Stockholders are most interested in evaluating

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Financial Statement Analysis

A. liquidity.
B. solvency.

C. profitability.
D. marketability.

Dividend yield
57. Which of the following ratios represents dividends per common share in relation to market
price per common share?
A. dividend payout
C. price/earnings
B. dividend yield
D. book value per share

Performance measures
48. The set of ratios that are most useful in evaluating profitability is
A. ROA, ROE, and debt to equity ratio
C. ROA, ROE, and acid-test ratio
B. ROA, ROE, and dividend yield
D. ROA, ROE, and cash flow to debt

Financial Statement Analysis

Accounts Receivable
26. Which of the following reasons should not be considered in order to explain why the
receivables appear to be abnormally high?
A. Sales volume decreases materially late in the year.
B. Receivables have collectibility problems and possibly some should have been written off.
C. Material amount of receivables are on the installment basis.
D. Sales volume expanded materially late in the year.

Earnings per share

82. Which of the following ratios appears most frequently in annual reports?
A. Earnings per Share
C. Profit Margin
B. Return on Equity
D. Debt/Equity
Return on assets
64. Return on assets
A. can be determined by looking at a balance sheet
B. should be smaller than return on sales
C. can be affected by the companys choice of a depreciation method
D. should be larger than return on equity
Return on investments
72. Return on investment measures:
A. return to all suppliers of funds
B. return to all long-term creditors

31. An acceleration in the collection of receivables will tend to cause the accounts receivable
turnover to:
A. decrease
C. either increase or decrease
B. remain the same
D. increase
Inventories
32. Which of the following would best indicate that the firm is carrying excess inventory?
A. a decline in the current ratio
B. stable current ratio with declining quick ratios
C. a decline in days' sales in inventory
D. a rise in total asset turnover

C. return to all long-term suppliers of funds

D. return to stockholders

Market test ratios

Price-earnings ratio
56. The price/earnings ratio
A. measures the past earning ability of the firm
B. is a gauge of future earning power as seen by investors
C. relates price to dividends
D. relates

89. When Tri-C Corp. compares its ratios to industry averages, it has a higher current ratio, an
average quick ratio, and a low inventory turnover. What might you assume about Tri-C?
A. Its cash balance is too low.
C. Its current liabilities are too low.
B. Its cost of goods sold is too low.
D. Its average inventory is too high.
Current ratio
33. Which of the following would be most detrimental to a firm's current ratio if that ratio is
currently 2.0?
A. Buy raw materials on credit
B. Sell marketable securities at cost
C. Pay off accounts payable with cash

58. Which of the following ratios usually reflects investors opinions of the future prospects for the
firm?
A. dividend yield
C. book value per share
B. price/earnings ratio
D. earnings per share

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Financial Statement Analysis

D. Pay off a portion of long-term debt with cash

quick ratios.
B. improve its collection practices and pay accounts payable, there decreasing current
liabilities and increasing the current and quick ratios.
C. decrease current liabilities by utilizing more long-term debt, thereby increasing the
current and quick ratios.
D. increase inventory, thereby increasing current assets and the current and quick ratios.

Fixed asset turnover ratio

68. Which of the following circumstances will cause sales to fixed assets to be abnormally high?
A. A labor-intensive industry.
B. The use of units-of-production depreciation.
C. A highly mechanized facility.
D. High direct labor costs from a new union contract.

43. Recently the M&M Company has been having problems. As a result, its financial situation has
deteriorated. M&M approached the First National Bank for a badly needed loan, but the loan
officer insisted that the current ratio (now 0.5) be improved to at least 0.8 before the bank
would even consider granting the credit. Which of the following actions would do the most to
improve the ratio in the short run?
A. Using some cash to pay off some current liabilities.
B. Collecting some of the current accounts receivable.
C. Paying off some long-term debt.
D. Purchasing additional inventory on credit (accounts payable).

Total asset turnover

81. A firm with a total asset turnover lower than the industry standard and a current ratio which
meets industry standard might have excessive:
A. Accounts receivable
C. Debt
B. Fixed assets
D. Inventory
Profitability analysis
84. Denver Dynamics has net income of P2,000,000. Oakland Enterprises has net income of
P2,500,000. Which of the following best compares the profitability of Denver and Oakland?
A. Oakland Enterprises is 25% more profitable than Denver Dynamics.
B. Oakland Enterprises is more profitable than Denver Dynamics, but the comparison can't
be quantified.
C. Oakland Enterprises is only more profitable if it is smaller than Denver Dynamics.
D. Further information is needed for a reasonable comparison.

87. Tyner Company had P250,000 of current assets and P90,000 of current liabilities before
borrowing P60,000 from the bank with a 3-month note payable. What effect did the
borrowing transaction have on Tyner Company's current ratio?
A. The ratio remained unchanged.
B. The change in the current ratio cannot be determined.
C. The ratio decreased.
D. The ratio increased.

Debt ratio
86. Companies A and B are in the same industry and have similar characteristics except that
Company A is more leveraged than Company B. Both companies have the same income
before interest and taxes and the same total assets. Based on this information we could
conclude that
A. Company A has higher net income than Company B
B. Company A has a lower return on assets than company B
C. Company A is more risky than Company B.
D. Company A has a lower debt ratio than company B

88. Which of the following actions will increase a firm's current ratio if it is now less than 1.0?
A. Convert marketable securities to cash.
B. Pay accounts payable with cash.
C. Buy inventory with short term credit (i.e. accounts payable).
D. Sell inventory at cost.
Acid-test ratio
38. If a company has an acid-test ratio of 1.2:1, what respective effects will the borrowing of
cash by short-term debt and collection of accounts receivable have on the ratio?
A.
B.
C.
D.
Short-term borrowing
Increase
Increase
Decrease
Decrease
Collection of receivable
No effect
Increase
No effect
Decrease

Sensitivity Analysis
Current ratio
40. A firm has a current ratio of 1:1. In order to improve its liquidity ratios, this firm should
A. improve its collection practices, thereby increasing cash and increasing its current and
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Financial Statement Analysis

Profit margin
70. Which of the following would most likely cause a rise in net profit margin?
A. increased sales
C. decreased operating expenses
B. decreased preferred dividends
D. increased cost of sales
Return on assets
67. Return on assets cannot fall under which of the following circumstances?
A.
B.
C.
Net profit margin
Decline
Rise
Rise
Total asset turnover
Rise
Decline
Rise

PROBLEMS:
Horizontal analysis
i
. Kline Corporation had net income of P2 million in 2006. Using the 2006 financial elements as
the base data, net income decreased by 70 percent in 2007 and increased by 175 percent in
2008. The respective net income reported by Kline Corporation for 2007 and 2008 are:
A. P 600,000 and P5,500,000
C. P1,400,000 and P3,500,000
B. P5,500,000 and P 600,000
D. P1,400,000 and P5,500,000

D.
Decline
Decline

ii

Debt ratio
83. Jones Company has long-term debt of P1,000,000, while Smith Company, Jones' competitor,
has long-term debt of P200,000. Which of the following statements best represents an
analysis of the long-term debt position of these two firms?
A. Jones obviously has too much debt when compared to its competitor.
B. Smith Company's times interest earned should be lower than Jones.
C. Smith has five times better long-term borrowing ability than Jones.
D. Not enough information to determine if any of the answers are correct.

Assume that Axle Inc. reported a net loss of P50,000 in 2006 and net income of P250,000 in
2007. The increase in net income of P300,000:
A. can be stated as 0%
C. cannot be stated as a percentage
B. can be stated as 100% increase
D. can be stated as 200% increase

Liquidity ratios
iii
. The following financial data have been taken from the records of Ratio Company:
Accounts receivable
P200,000
Accounts payable
80,000
Bonds payable, due in 10 years
500,000
Cash
100,000
Interest payable, due in three months
25,000
Inventory
440,000
Land
800,000
Notes payable, due in six months
250,000
What will happen to the ratios below if Ratio Company uses cash to pay 50 percent of its
accounts payable?
A.
B.
C.
D.
Current ratio
Increase
Decrease
Increase
Decrease
Acid-test ratio
Increase
Decrease
Decrease
Increase

Times interest earned

85. Which of the following will not cause times interest earned to drop? Assume no other changes
than those listed.
A. A rise in preferred stock dividends.
B. A drop in sales with no change in interest expense.
C. An increase in interest rates.
D. An increase in bonds payable with no change in operating income.
DuPont Analysis
71. Which of the following could cause return on assets to decline when net profit margin is
increasing?
A. sale of investments at year-end
C. purchase of a new building at year-end
B. increased turnover of operating assets
D. a stock split

Question Nos. 4 through 6 are based on the data taken from the balance sheet of Nomad
Company at the end of the current year:
Accounts payable
P145,000
Accounts receivable
110,000
Accrued liabilities
4,000
Cash
80,000
Income tax payable
10,000
Inventory
140,000

80. A firm with a lower net profit margin can improve its return on total assets by
A. increasing its debt ratio
C. increasing its total asset turnover
B. decreasing its fixed assets turnover
D. decreasing its total asset turnover
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Financial Statement Analysis

Marketable securities
Notes payable, short-term
Prepaid expenses
iv

The amount of working capital for the company is:

A. P351,000
C. P211,000
B. P361,000
D. P336,000

The companys current ratio as of the balance sheet date is:

A. 2.67:1
C. 2.02:1
B. 2.44:1
D. 1.95:1

vi

250,000
85,000
15,000

period of the receivables?

A. 30 days
B. 65 days

Cash collection
x
. Deity Company had sales of P30,000, increase in accounts payable of P5,000, decrease in
accounts receivable of P1,000, increase in inventories of P4,000, and depreciation expense of
P4,000. What was the cash collected from customers?
A. P31,000
C. P34,000
B. P35,000
D. P25,000
Inventory turnover
xi
. During 2007, Tarlac Company purchased P960,000 of inventory. The cost of goods sold for
2007 was P900,000, and the ending inventory at December 31, 2007 was P180,000. What
was the inventory turnover for 2007?
A. 6.4
C. 5.3
B. 6.0
D. 5.0

The companys acid-test ratio as of the balance sheet date is:

A. 1.80:1
C. 2.02:1
B. 2.40:1
D. 1.76:1

Activity ratios
Receivables turnover
vii
. Pine Hardware Store had net credit sales of P6,500,000 and cost of goods sold of
P5,000,000 for the year. The Accounts Receivable balances at the beginning and end of the
year were P600,000 and P700,000, respectively. The receivables turnover was
A. 7.7 times.
C. 9.3 times.
B. 10.8 times.
D. 10.0 times.
viii

C. 73 days
D. 36 days

xii

. Milward Corporations books disclosed the following information for the year ended December
31, 2007:
Net credit sales
P1,500,000
Net cash sales
240,000
Accounts receivable at beginning of year
200,000
Accounts receivable at end of year
400,000
Milwards accounts receivable turnover is
A. 3.75 times
C. 5.00 times
B. 4.35 times
D. 5.80 times

. Selected information from the accounting records of Petals Company is as follows:

Net sales for 2007
P900,000
Cost of goods sold for 2007
600,000
Inventory at December 31, 2006
180,000
Inventory at December 31, 2007
156,000
Petals inventory turnover for 2007 is
A. 5.77 times
C. 3.67 times
B. 3.85 times
D. 3.57 times

xiii

Days receivable
ix
. Batik Clothing Store had a balance in the Accounts Receivable account of P390,000 at the
beginning of the year and a balance of P410,000 at the end of the year. The net credit sales
during the year amounted to P4,000,000. Using 360-day year, what is the average collection
63

. The Moss Company presents the following data for 2007.

Net Sales, 2007
Net Sales, 2006
Cost of Goods Sold, 2007
Cost of Goods Sold, 2007
Inventory, beginning of 2007
Inventory, end of 2007
The merchandise inventory turnover for 2007 is:
A. 5.6
C. 7.5
B. 15.6
D. 7.7

P3,007,124
P 930,247
P2,000,326
P1,000,120
P 341,169
P 376,526

Financial Statement Analysis

xiv

. Based on the following data for the current year, what is the inventory turnover?
Net sales on account during year
P 500,000
Cost of merchandise sold during year
330,000
Accounts receivable, beginning of year
45,000
Accounts receivable, end of year
35,000
Inventory, beginning of year
90,000
Inventory, end of year
110,000
A. 3.3
C. 3.7
B. 8.3
D. 3.0

What is the debt ratio?

A. 0.48
B. 0.49

Times interest earned

xviii
. House of Fashion Company had the following financial statistics for 2006:
Long-term debt (average rate of interest is 8%)
Interest expense
Net income
Income tax
Operating income
What is the times interest earned for 2006?
A. 11.4 times
C. 3.1 times
B. 3.3 times
D. 3.7 times

Days inventory
xv
. Selected information from the accounting records of Eternity Manufacturing Company follows:
Net sales
P3,600,000
Cost of goods sold
2,400,000
Inventories at January 1
672,000
Inventories at December 31
576,000
What is the number of days sales in average inventories for the year?
A. 102.2
C. 87.6
B. 94.9
D. 68.1

P400,000
35,000
48,000
46,000
107,000

xix

. Brava Company reported the following on its income statement:

Income before taxes
P400,000
Income tax expense
100,000
Net income
P300,000
An analysis of the income statement revealed that interest expense was P100,000. Brava
Companys times interest earned (TIE) was
A. 5 times
C. 3.5 times
B. 4 times
D. 3 times

Turnover ratios
Asset turnover
Asset
xvi
. Net sales are P6,000,000, beginning total assets are P2,800,000, and the asset turnover is
3.0. What is the ending total asset balance?
A. P2,000,000.
C. P2,800,000.
B. P1,200,000.
D. P1,600,000.
Solvency ratios
Debt ratio
xvii
. Jordan Manufacturing reports the following capital structure:
Current liabilities
Long-term debt
Deferred income taxes
Preferred stock
Common stock
Premium on common stock
Retained earnings

C. 0.93
D. 0.96

xx

. The balance sheet and income statement data for Candle Factory indicate the following:
Bonds payable, 10% (issued 1998 due 2022)
P1,000,000
Preferred 5% stock, P100 par (no change during year)
300,000
Common stock, P50 par (no change during year)
2,000,000
Income before income tax for year
350,000
Income tax for year
80,000
Common dividends paid
50,000
Preferred dividends paid
15,000
Based on the data presented above, what is the number of times bond interest charges were
earned (round to one decimal point)?
A. 3.7
C. 4.5
B. 4.4
D. 3.5

P100,000
400,000
10,000
80,000
100,000
180,000
170,000

xxi

64

. The following data were abstracted from the records of Johnson Corporation for the year:

Financial Statement Analysis

Sales
Bond interest expense
Income taxes
Net income
How many times was bond interest earned?
A. 7.67
B. 11.67

P1,800,000
60,000
300,000
400,000

on their investments.
C. The dividend yield is 12.5%, which is of interest to bondholders.
D. The dividend yield is 8.0 times the market price, which is important in solvency analysis.
Market Test Ratios
Market/Book value ratio
Price per share
xxv
. What is the market price of a share of stock for a firm with 100,000 shares outstanding, a book
value of equity of P3,000,000, and a market/book ratio of 3.5?
A. P8.57
C. P85.70
B. P30.00
D. P105.00

C. 12.67
D. 13.67

Net income
xxii
. The times interest earned ratio of Mikoto Company is 4.5 times. The interest expense for
the year was P20,000, and the companys tax rate is 40%. The companys net income is:
A. P22,000
C. P54,000
B. P42,000
D. P66,000

P/E ratio
xxvi
. Orchard Companys capital stock at December 31 consisted of the following:

Common stock, P2 par value; 100,000 shares authorized, issued, and

outstanding.

10% noncumulative, nonconvertible preferred stock, P100 par value; 1,000 shares
authorized, issued, and outstanding.
Orchards common stock, which is listed on a major stock exchange, was quoted at P4 per
share on December 31. Orchards net income for the year ended December 31 was P50,000.
The yearly preferred dividend was declared. No capital stock transactions occurred. What
was the price earnings ratio on Orchards common stock at December 31?
A. 6 to 1
C. 10 to 1
B. 8 to 1
D. 16 to 1

Profitability Ratios
Return on Common Equity
xxiii
. Selected information for Ivano Company as of December 31 is as follows:
2006
2007
Preferred stock, 8%, par P100, nonconvertible,
P250,000
P250,000
noncumulative
Common stock
600,000
800,000
Retained earnings
150,000
370,000
Dividends paid on preferred stock for the year
20,000
20,000
Net income for the year
120,000
240,000
Ivanos return on common stockholders equity, rounded to the nearest percentage point, for
2007 is
A. 17%
C. 21%
B. 19%
D. 23%

xxvii

Dividend yield
xxiv
. The following information is available for Duncan Co.:
2006
Dividends per share of common stock
P 1.40
Market price per share of common stock
17.50
Which of the following statements is correct?
A. The dividend yield is 8.0%, which is of interest to investors seeking an increase in market
price of their stocks.
B. The dividend yield is 8.0%, which is of special interest to investors seeking current returns

. On December 31, 2006 and 2007, Renegade Corporation had 100,000 shares of common
stock and 50,000 shares of noncumulative and nonconvertible preferred stock issued and
outstanding.
Additional information:
Stockholders equity at 12/31/07
P4,500,000
Net income year ended 12/31/07
1,200,000
Dividends on preferred stock year ended 12/31/07
300,000
Market price per share of common stock at 12/31/07
144
The price-earnings ratio on common stock at December 31, 2007, was
A. 10 to 1
C. 14 to 1
B. 12 to 1
D. 16 to 1

Payout ratio
65

Financial Statement Analysis

xxviii

xxxii

. Selected financial data of Alexander Corporation for the year ended December 31, 2007, is
presented below:
Operating income
P900,000
Interest expense
(100,000)
Income before income taxes
800,000
Income tax
(320,000)
Net income
480,000
Preferred stock dividend
(200,000)
Net income available to common stockholders
280,000
Common stock dividends were P120,000. The payout ratio is:
A. 42.9 percent
C. 25.0 percent
B. 66.7 percent
D. 71.4 percent

Leverage Ratio
Degree of financial leverage
xxxiii
. A summarized income statement for Leveraged Inc. is presented below.
Sales
Cost of Sales
Gross Profit
Operating Expenses
Operating Income
Interest Expense
Earnings Before Tax
Income Tax
Net Income
The degree of financial leverage is:
A. P 150,000 P 30,000
C. P1,000,000 P400,000
B. P 150,000 P120,000
D. P 150,000 P 80,000

P/E ratio & Payout ratio

Use the following information for question Nos. 33 and 34:
Terry Corporation had net income of P200,000 and paid dividends to common stockholders of
P40,000 in 2007. The weighted-average number of shares outstanding in 2007 was 50,000
shares. Terry Corporations common stock is selling for P60 per share in the local stock
exchange.
xxix

xxx

. Terry Corporations price-earnings ratio is

A. 3.8 times
B. 15 times

C. 18.8 times
D. 6 times

. Terry Corporations payout ratio for 2007 is

A. P4 per share
B. 12.5 percent

C. 20.0 percent
D. 25.0 percent

. Assume you are given the following relationships for the Orange Company:
Sales/total assets
Return on assets (ROA)
Return on equity (ROE)
The Orange Companys debt ratio is
A. 40%
C. 35%
B. 60%
D. 65%

1.5X
3%
5%

P1,000,000
600,000
P 400,000
250,000
P 150,000
30,000
P 120,000
40,000
P 80,000

Other Ratios
Book value per share
xxxiv
. M Corporations stockholders equity at December 31, 2007 consists of the following:
6% cumulative preferred stock, P100 par, liquidating value
was P110 per share; issued and outstanding 50,000 shares
P5,000,000
Common stock, par, P5 per share; issued and
outstanding, 400,000 shares
2,000,000
Retained earnings
1,000,000
Total
P8,000,000
Dividends on preferred stock have been paid through 2006.
At December 31, 2007, M Corporations book value per share was
A. P5.50
C. P6.75
B. P6.25
D. P7.50

DuPont Model
Debt ratio
xxxi
. The Board of Directors is dissatisfied with last year's ROE of 15%. If the profit margin and
asset turnover remain unchanged at 8% and 1.25 respectively, by how much must the total
debt ratio increase to achieve 20% ROE?
A. Total debt ratio must increase by .5
B. Total debt ratio must increase by 5
C. Total debt ratio must increase by 5%
D. Total debt ratio must increase by 50%

66

Financial Statement Analysis

xxxv

. The following data were gathered from the annual report of Desk Products.
Market price per share
Number of common shares
Preferred stock, 5% P100 par
Common equity
The book value per share is:
A. P30.00
C. P14.00
B. P15.00
D. P13.75

Quick ratio
Current liabilities
Inventory turnover (based on cost of sales)
Gross profit margin
Mildreds net sales for the year were
A. P 800,000
C. P 480,000
B. P 672,000
D. P1,200,000

P30.00
10,000
P10,000
P140,000

Gross margin
xxxix
. Selected information from the accounting records of the Blackwood Co. is as follows:
Net A/R at December 31, 2006
P 900,000
Net A/R at December 31, 2007
P1,000,000
Accounts receivable turnover
5 to 1
Inventories at December 31, 2006
P1,100,000
Inventories at December 31, 2007
P1,200,000
Inventory turnover
4 to 1
What was the gross margin for 2007?
A. P150,000
C. P300,000
B. P200,000
D. P400,000

Integrated ratios
Liquidity & activity ratios
Inventory
xxxvi
. The current assets of Mayon Enterprise consists of cash, accounts receivable, and
inventory. The following information is available:
Credit sales
75% of total sales
Inventory turnover
5 times
Working capital
P1,120,000
Current ratio
2.00 to 1
Quick ratio
1.25 to 1
Average Collection period
42 days
Working days
360
The estimated inventory amount is:
A. 840,000
C. 720,000
B. 600,000
D. 550,000
xxxvii

1.5
P120,000
8 times
40%

Market Test Ratio

Dividend yield
xl
. Recto Co. has a price earnings ratio of 10, earnings per share of P2.20, and a pay out ratio
of 75%. The dividend yield is
A. 25.0%
C. 7.5%
B. 22.0%
D. 10.0%

. The following data were obtained from the records of Salacot Company:
Current ratio (at year end)
1.5 to 1
Inventory turnover based on sales and ending inventory
15 times
Inventory turnover based on cost of goods sold and ending inventory
10.5 times
Gross margin for 2007
P360,000
What was Salacot Companys December 31, 2007 balance in the Inventory account?
A. P120,000
C. P 80,000
B. P 54,000
D. P 95,000

xli

Net sales
xxxviii
.Selected data from Mildred Companys year-end financial statements are presented below.
The difference between average and ending inventory is immaterial.
Current ratio
2.0
67

. The following were reflected from the records of Salvacion Company:

Earnings before interest and taxes
Interest expense
Preferred dividends
Payout ratio
Shares outstanding throughout 2006
Preferred
Common
Income tax rate
Price earnings ratio
The dividend yield ratio is

P1,250,000
250,000
200,000
40 percent
20,000
25,000
40 percent
5 times

Financial Statement Analysis

A. 0.50
B. 0.12

C. 0.40
D. 0.08

Comprehensive
xlii
. The balance sheets of Magdangal Company at the end of each of the first two years of
operations indicate the following:
2007
2006
Total current assets
P600,000
P560,000
Total investments
60,000
40,000
Total property, plant, and equipment
900,000
700,000
Total current liabilities
150,000
80,000
Total long-term liabilities
350,000
250,000
Preferred 9% stock, P100 par
100,000
100,000
Common stock, P10 par
600,000
600,000
Paid-in capital in excess of par-common stock
60,000
60,000
Retained earnings
300,000
210,000
Net income is P115,000 and interest expense is P30,000 for 2007.
What is the rate earned on total assets for 2007 (round percent to one decimal point)?
A. 9.3 percent
C. 8.9 percent
B. 10.1 percent
D. 7.4 percent
xliii

. What is the rate earned on stockholders' equity for 2007 (round percent to one decimal point)?
A. 10.6 percent
C. 12.4 percent
B. 11.2 percent
D. 15.6 percent

xliv

. What is the earnings per share on common stock for 2007, (round to two decimal places)?
A. P1.92
C. P1.77
B. P1.89
D. P1.42

xlv

. If the market price is P30, what is the price-earnings ratio on common stock for 2007 (round to
one decimal point)?
A. 17.0
C. 12.4
B. 12.1
D. 15.9

68

ii

iii

Answer: A
2007: P2,000,000 (1 0.7) = P600,000
2008: P2,000,000 (1 + 1.75) = P5,500,000
Note: For 2007 & 2008, 2006 was used as a base year.
Answer: C
Answer: C
Current Assets:
Cash
Accounts receivable
Total liquid assets
Inventory
Total current assets
Current Liabilities:
Accounts payable
Notes payable, due in 6 months
Interest payable
Total current liabilities
Current Ratio (740,000 355,000)
Acid-test Ratio (300,000 355,000)

P100,000
200,000
300,000
440,000
P740,000
P 80,000
250,000
25,000
P355,000
2.08:1.00
0.85:1.00

Before any payment, the current ratio is above 1:1 and acid test ratio is below 1:1. Therefore, the current ratio shall
rise but acid test ratio shall go down. If any of these two ratios is below 1:1, the equal change in current assets and
current liabilities brings direct effect on the ratio, that is, equal increase in current assets and current liabilities causes
the ratio to rise.
iv

. Answer: A
Working capital equals the difference between the total current assets and total current liabilities.
Current Assets:
Cash
P 80,000
Marketable securities
250,000
Accounts receivable
110,000
Total liquid assets
440,000
Inventory
140,000
Prepaid expense
15,000
Total Current Assets
P595,000
Current Liabilities:
Accounts payable
Income tax payable
Notes payable, short-term 85,000
Accrued liabilities
Working Capital

P145,000
10,000
4,000

244,000
P351,000

Answer: B
Current Ratio: Current Assets Current Liabilities
(P595,000 P244,000) = 2.44:1.00

vi

Answer: A
Acid-Test Ratio: Liquid Assets Current Liabilities
(P440,000 P244,000) = 1.80:1.00

vii

. Answer: D
AR Turnover: Credit sales Average AR
6,500,000/650,000 = 10.0 times

viii

. Answer: C
Accounts Receivable Turnover: Net Credit Sales Average Accounts Receivable
P1,500,000 [(P200,000 + P400,000) 2] = 5.0 times

ix

. Answer: D
Average Daily Sales: Annual credit sales Days Year
P4 million 360 days = P11,111
Average Collection Period: Average Accounts Receivable Average Daily Sales
[(P390,000 + P410,000) 2] P11,111 = 36 days

xi

xii

xiii

xiv

xv

Answer: A
Sales
Add decrease in Accounts Receivable
Cash collected from sales

P30,000
1,000
P31,000

Answer: B
Inventory Turnover: Cost of Goods Sold Average Inventory
Cost of goods sold
P 900,000
Add Ending inventory
180,000
Total cost available for sales
1,080,000
Deduct cost of purchases
960,000
Beginning inventory
P 120,000
Average Inventory: (P120,000 + P180,000) 2
P150,000
Inventory Turnover: (P900,000 P150,000)
6 times
An alternative computation of the inventory turnover is to use Net Sales instead of Cost of Goods Sold.

Answer: D
Average inventory: (P180,000 + P156,000) 2
Inventory Turnover: (P600,000 P168,000)

P168,000
3.57 times

Answer: A
Average Inventory: (P341,169 + P376,526) 2
Inventory Turnover: (P2,000,326 P358,847.50)

P358,847.50
5.6 times

Answer: A
Average Inventory: (P90,000 + P110,000) 2
Inventory Turnover: (P330,000 P100,000)

P100,000
3.3 times

Answer: B
Average Inventory: (P672,000 + P576,000) 2
Inventory Turnover: (P2,400,000 P624,000)
Inventory Turnover in Days: 365 days 3.846

P624,000
3.846 times
94.9 days

Alternative Computation:
Average daily cost of goods sold: = (P2,400,000 365)
Turnover in Days: P624,000 P6,575.34
xvi

xvii

P6,575.34
94.9 days

Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2
Average inventory; (P1.1M + P1.2M) 2

P 950,000
P1,150,000

Net sales: (P950,000 x 5)

Cost of goods sold (P1,150,000 x 4)
Gross margin

P4,750,000
4,600,000
P 150,000

Answer: B
Current liabilities
Long-term debt
Deferred income tax
Total Liabilities
Stockholders Equity
Preferred stock
Common stock
Premium on common stock
Retained earnings
Total Assets

P 100,000
400,000
10,000
510,000
P 80,000
100,000
180,000
170,000

530,000
P1,040,000

Debt Ratio: P510,000 P1,040,000 = 0.49

xviii

xix

Answer: D
Times interest earned: Earnings before interest Interest
Income before tax (P48,000 + P46,000)
Add Interest expense
Income before Interest expense

P 94,000
35,000
P129,000

TIE: P129,000 P35,000

3.7 times

Answer: A

TIE: Income before interest expense Interest expense

Income before income tax
Add back Interest expense
Income before interest expense

P400,000
100,000
P500,000

TIE: P500,000 P100,000

xx

xxi

5 times

Answer: C
Interest Expense: P1M x 0.1
Income before interest expense: P350,000 + P100,000
Times interest earned: (P450,000 P100,000)
Answer: C
Net income
Add: Income taxes
Interest
Income before interest

P100,000
P450,000
4.5 times
P400,000
P300,000
60,000

TIE: P760,000 P60,000

xxii

xxiii

Answer: B
Earnings before interest expense (P20,000 x 4.5)
Deduct interest expense
Income before income tax
Deduct income tax (P70,000 x 0.4)
Net income
Answer: D
Income to Common; (P240,000 P20,000)
Average Common Equity: (P750,000 + P1,170,000) 2
Return on Common Equity: (P220 P960)

360,000
P760,000
12.67 times
P90,000
20,000
P70,000
28,000
P42,000
P220,000
P960,000
23 percent

xxiv

. Answer: B
The dividend yield is 8 percent (P1.40 P17.50)
The dividend yield measures the return of investment in terms of dividends received. The total expected returns
consists of Dividend Yield and the Appreciation in market price and dividend

xxv

xxvi

xxvii

Answer: D
Market Value of Equity (P3M x 3.5)
Market price per share: (P10.5M 100,000)

P10,500,000
P105

Answer: B
EPS: P50,000 100,000 shares
P/E Ratio: P4.00 P0.50

P0.50
8 to 1

Answer: D
EPS: (P1,200,000 P300,000) 100,000
P/E Ratio: 144 9

P9.00
16

xxviii

. Answer: A
Payout Ratio: Common Dividends Income Available to Common
P120,000 P280,000 = 42.9%

xxix

xxx

xxxi

Answer: B
Price-earnings ratio: Market price EPS
EPS: Net income /Weighted-average common shares
EPS: P200,000 50,000 shares
P4.00
P/E Ratio: P60 P4
15.0X
Answer: C
Payout Ratio: Dividends Income to Common
P40,000 P200,000 = 20.0%
Answer: D
ROE: (8% x 1.25)
Last years Debt Ratio 1 (10% 15%)
Proposed Debt Ratio 1 (10% 20%)
Increase in debt ratio: (50.00% - 33.33%) 33.33%

10.00%
33.33%
50.00%
50.00%

xxxii

Answer: A
1 (0.03 0.05) = 40%

xxxiii

Answer: B
Degree of Financial Leverage: Operating Income Interest Expense

xxxiv

Answer: A
Total stockholders equity
Deduct:
Liquidation value of Preferred Stock (50,000 s P110) P5,500,000
Unpaid Preferred Dividends (P5M x 6%)
300,000
Common Equity

P8,000,000
5,800,000
P2,200,000

Book Value per Share: P2.2M 400,000 shares

P5.50

xxxv

. Answer: C
Book Value per Share: Common Equity Outstanding Shares
P140,000 10,000 shares = P14.00

xxxvi

. Answer: A
The inventory amount can be calculated as follows:
Current liabilities: Working Capital = current liabilities based on 2:1 current ratio. At 2:1 current ratio, the amount of
working capital and current liabilities are both P1,120,000.
Inventory: Current liabilities x (Current ratio Acid test ratio)
P1,120,000 x (2.0 1.25)
A detailed computation can be made as follows:
Current assets: P1,120,000 x 2
Liquid assets: P1,120,000 x 1.25
Inventory

xxxvii

xl

xli

Answer: A
Inventory balance (P120,000 x (2.0 1.5)
Cost of goods sold 60,000 x 8
Sales (P480,000 0.60)

P 60,000
P480,000
P800,000

Answer: A
Average Accounts Receivable: (P900,000 P1,000,000) 2
Average inventory; (P1.1M + P1.2M) 2

P 950,000
P1,150,000

Net sales: (P950,000 x 5)

Cost of goods sold (P1,150,000 x 4)
Gross margin

P4,750,000
4,600,000
P 150,000

Answer: C
Dividend per share: 0.75 x P2.20
Market price: 10 x 2.20
Dividend yield: P1.65 P22.00 = 7.5%
Answer: D
EBIT
Less interest expense
Earnings before tax
Less Income tax 40%
Net income
Less Preferred dividends
Earnings to Common Stock
Earnings per share 400,000/25,000
Dividend per share: 400,000 x 0.40 25,000
Dividend yield 6.4 (16 x 5)

xlii

P2,240,000
1,400,000
P 840,000

. Answer: C
Inventory balance: Gross profit (Difference between 2 inventory turnovers)
360,000/(15 10.5) = P80,000

xxxviii

xxxix

P840,000

. Answer: B
ROA: Operating income Average Total Assets

P1.65
22.00

1,250,000
250,000
1,000,000
400,000
600,000
200,000
400,000
16.00
6.40
8.0%

P145,000 P1,430,000 = 10.1%

xliii

. Answer: B
Return on stockholders equity: Net income Average stockholders equity
P115,000 P1,027,500 = 11.2%

xliv

Answer: C
Net income
Deduct Preferred Dividends
Income available to common shares
EPS: (P106,000 60,000)

xlv

Answer: A
P/E Ratio: P30 1.766 = 17.0 times

P115,000
9,000
P106,000
P1.77