File: ch02, Chapter 2: A Further Look at Financial Statements

Multiple Choice

1. In a classified balance sheet, assets are usually classified as: a) current assets; long-term assets; property, plant, and equipment; and intangible assets. b) current assets; long-term investments; property, plant, and equipment; and common stock. c) current assets; long-term investments; tangible assets; and intangible assets. d) current assets; long-term investments; property, plant, and equipment; and intangible assets. Ans: d Response A: The term long-term assets includes long-term investment, property, plant, and equipment and intangible assets. It does not make sense to include this term with the more specific classifications of long-term assets. Response B: The order of the first three asset classifications is correct, but common stock generally refers to the stock of the firm and is not an asset. Response C: While the term tangible assets is sometimes substituted for property, plant, and equipment, it is better to use the more common terminology, property, plant, and equipment. Response D: Correct!

2. Current assets are listed: a) by liquidity. b) by importance. c) by longevity. d) alphabetically. Ans: a Response A: Correct! Response B: Current assets should be listed in order of liquidity, or in order of how quickly they are expected to be converted into cash. Response C: Current assets should be listed in order of liquidity, or in order of how quickly they are expected to be converted into cash. Response D: Current assets should be listed in order of liquidity, or in order of how quickly they are expected to be converted into cash.

3. Which is an indicator of profitability? a) Current ratio. b) Earnings per share. c) Debt to total assets ratio. d) Free cash flow. Ans: b

Response A: The current ratio is a measure/indicator of liquidity, not profitability. Response B: Correct! Response C: The debt to total assets ratio is a measure/indicator of solvency, not profitability. Response D: Free cash flow is an indicator of the cash-generating capability of a company.

4. For 2007, Stoneland Corporation reported net income, $24,000; net sales, $400,000; and average shares outstanding, 6,000. There were no preferred stock dividends. What was the 2007 earnings per share? a) $4.00 b) $0.06 c) $16.67 d) $66.67 Ans: a Response A: Correct! Response B: Earnings per share is computed by dividing net income (less preferred dividends) by the average shares outstanding. For Stoneland Corporation, 2007 earnings per share is $24,000/6,000 or $4.00. Response C: Earnings per share is computed by dividing net income (less preferred dividends) by the average shares outstanding. For Stoneland Corporation, 2007 earnings per share is $24,000/6,000 or $4.00. Response D: Earnings per share is computed by dividing net income (less preferred dividends) by the average shares outstanding. For Stoneland Corporation, 2007 earnings per share is $24,000/6,000 or $4.00.

5. The balance in retained earnings is not affected by: a) net income. b) net loss. c) issuance of common stock. d) dividends. Ans: c Response A: Net income increases retained earnings. Response B: Net loss decreases retained earnings. Response C: Correct! Response D: Dividends decrease retained earnings.

6. Which of these measures is an evaluation of a companys ability to pay current liabilities? a) Earnings per share. b) Current ratio. c) Both a) and b). d) None of the above.

Ans: b Response A: Earnings per share is a measure of firms profitability, not its ability to pay its current liabilities. Response B: Correct! Response C: Since answer a is not correct, this answer cannot be correct. Response D: Since answer b is correct, this answer cannot be correct.

7. Compaines can use free cash flow to: a) Pay additional dividends. b) Acquire property, plant, and equipment. c) Pay off debts. d) All of the above. Ans: d Response A: Free cash flow can be used to pay dividends; acquire property, plant, and equipment; and pay off debts. Response B: Free cash flow can be used to pay dividends; acquire property, plant, and equipment; and pay off debts. Response C: Free cash flow can be used to pay dividends; acquire property, plant, and equipment; and pay off debts. Response D: Correct!

8. Generally accepted accounting principles are: a) a set of standards and rules that are recognized as a general guide for financial reporting. b) usually established by the Internal Revenue Service. c) the guidelines used to resolve ethical dilemmas. d) fundamental truths that can be derived from the laws of nature. Ans: a Response A: Correct! Response B: Generally accepted accounting principles are not established by the Internal Revenue Service. They are set by the Financial Accounting Standards Board along with the Securities and Exchange Commission. Response C: Generally accepted accounting principles are not intended to provide guidance in resolving ethical dilemmas. Response D: Unlike laws of nature, such as those in physics and chemistry, the fundamental principles used in accounting are created by people and can evolve over time.

9. What organization issues U.S. accounting standards? a) Financial Accounting Standards Board. b) International Accounting Standards Committee. c) International Auditing Standards Committee. d) None of the above.

Ans: a Response A: Correct! Response B: The International Accounting Standards Committee issues international accounting standards, not standards for the U.S. Response C: Organizations concerned with auditing standards are not primarily interested in accounting standards. Response D: This answer is incorrect since answer a is the correct response.

10. What is the primary criterion by which accounting information can be judged? a) Consistency. b) Predictive value. c) Usefulness for decision making. d) Comparability. Ans: c Response A: Consistency, or the use of the same accounting principles from period to period by the same firm, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Response B: Predictive value, or the ability of information to help in predicting future results, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged. Response C: Correct! Response D: Comparability, or the use of the same accounting principles by two firms in the same period, helps make accounting information more useful, but it is not the primary criterion by which accounting information is judged.

11. Verifiability is an ingredient of: Reliability Relevance a) Yes Yes b) No No c) Yes No d) No Yes Ans: c Response A: Verifiability is an element of reliability, but not relevance. Response B: Verifiability is an element of reliability, but not relevance. Response C: Correct! Response D: Verifiability is an element of reliability, but not relevance.

12. What accounting constraint refers to the tendency of accountants to resolve uncertainty in a way least likely to overstate assets and net income? a) Comparability.

b) Materiality. c) Conservatism. d) Consistency. Ans: c Response A: Comparability relates to the usage of common accounting principles by two different companies during the same period. Response B: Materiality relates to whether or not information is significant enough to be included as part of the financial statements. Response C: Correct! Response D: Consistency relates to the usage of the same accounting principles by the same firm over a period of time.