Accounting Principles – Charles Kelly


Question 1:

Under generally acceptable accounting principles, it is possible for two companies with identical operating results may not report identical net incomes.

Answer: false

Question 2:

Ratios are used to compare different firms in the same industry.

True- used to compares firm in an industry and also changes over time

Answer: True:

Question 3:

Profitability ratios are distorted by inflation because profits are stated in current dollars and assets and equity are stated in historical dollars.

Answer: True:

Question 4:

A firm with heavy long-term debt can benefit during inflationary times, as debt can be repaid with „cheaper“ dollars.

True- example if a firm borrows 10 million today, this amount is relatively high today, if there is inflation this means prices go up, if there is inflation then this means that this amount will be look small when the firm repays

Answer: True:

Question 5:

Debt utilization ratios are used to evaluate the firm’s debt position with regard to its asset base and earning power.

False- debt utilisation show level of assets financed through debt

Answer: false

Question 6:

The statement of cash flows helps measure how the changes in a balance sheet were financed between two time periods.

Answer: True:

Question 7:

Net working capital is the difference between current assets and current liabilities.

Working capital = CA – CL

Answer: True:

Question 8:

Depreciation is an accounting entry and does not involve a cash expense.

Answer: True:

Question 9:

Total assets of a firm are financed with liabilities and stockholders equity.

True- finance using debt or equity

Answer: True:

Question 10:

Sales minus operating costs = operating income.

Answer: True:

Question 11:

Shop-Til-You-Drop Inc. recently reported net income of $5.2 million and depreciation of $600,000. What is was net cash flow? (Assume it has no amortization expense.)

Net cash flow = net income + depreciation + amortisation

Net cash flow = 5.2m+0.6m=5.8 million

Answer: 5.8 million

Question 12:

Temple Square Inc. reported that its retained earnings for 2005 were $490,000. In its 2006 financial statements, it reported $60,000 of net income, and it ended 2006 with $510,000 of retained earnings. How much were paid as dividends to shareholders during 2006?

2005 retained earnings = 490,000

2006 net income = 60,000

2006 retained earnings = 510,000

Earnings available for pay out in 2006 = 490,000 + 60,000 = 550,000

If dividends were not paid reined earnings would be 550,000

Dividends = 550,000 – 510,000 = 40,000

Answer 40,000

Question 13:

Fine Breads Inc. paid out $26,000 common dividends during 2005, and it ended the year with $150,000 of retained earnings. The prior year’s retained earnings were $145,500. What was the firm’s 2005 net income?

2004 retained earnings = 145,000

Dividends 2005=26,000

2005 retained earnings = 150,000

Change in retained earnings = 150,000 – 145,000 = 5,000

Net income 2005 = change in retained earnings + dividends

Net income = 5,000 + 26,000 = 31,000

Answer 31,000

Question 14:

Which of the following items is NOT included in current assets?

  1. A. Accounts payable
  2. B. Inventory
  3. C. Accounts receivable
  4. D. Cash
  5. E. Short-term, highly liquid, marketable securities

Answer: Accounts payable

Question 15:

Other things held constant, which of the following actions would increase the amount of cash on a company’s balance sheet?

  1. A. The company issues new common stock.
  2. B. The company repurchases common stock
  3. C. The company pays a dividend.
  4. D. The company purchases a new piece of equipment
  5. E. The company gives customers more time to pay their bills

Answer: The Company issues new common stock.

Question 16:

Miller Metals recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $1,500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. What was its net cash flow?

Net cash flow = net income + amortisation + depreciation

Net income = sales – operating costs – depreciation – interest – tax

Net income =9000 – 6000 – 500 – (4,000*7%) – tax

Net income =2500 – 280 – tax

Net income =2220– tax

Tax = 2220*40%=888

Net income =2220– 888=1332

Net cash flow = net income + amortisation + depreciation

Net cash flow = 1332+280+500=2112

Answer: 2112

Question 17:

Which of the following statements is CORRECT?

  1. 1. The statement of cash flows shows where the firm’s cash is located, with a listing of all banks and brokerage houses where cash is on deposit.
  2. 2. The statement of cash flows for 2005 shows how much the firm’s cash (the total of currency, bank deposits, and short-term liquid securities, or cash equivalents) increased or decreased during 2005.
  3. 3. The statement of cash flows reflects cash flows from operations and from borrowings, but it does not reflect cash obtained by selling new common stock.
  4. 4. The statement of cash flows reflects cash flows from operations, but it does not reflect the effects of buying or selling fixed assets.
  5. 5. The statement of cash flows reflects cash flows from continuing operations, but it does not reflect the effects of changes in working capital.

Answer: The statement of cash flows for 2005 shows how much the firm’s cash (the total of currency, bank deposits, and short-term liquid securities, or cash equivalents) increased or decreased during 2005.

Question 18:

Which of the following statements is CORRECT?

  1. 1. In the statement of cash flows, depreciation charges are reported as a use of cash.
  2. 2. In the statement of cash flows, a decrease in accounts receivable is reported as a use of cash.
  3. 3. In the statement of cash flows, a decrease in inventories is reported as a use of cash.
  4. 4. In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.
  5. 5. Dividends do not show up in the statement of cash flows because dividends are considered to be a financing activity, not an operating activity.

Answer: In the statement of cash flows, a decrease in accounts payable is reported as a use of cash.

Question 19:

Which of the following statements is CORRECT?

  1. 1. Depreciation reduces a firm’s cash balance, so an increase in depreciation would normally lead to a reduction in the firm’s net cash flow.
  2. 2. Net cash flow (NCF) is defined as follows:

Net Cash Flow = Net Income + Depreciation and Amortization Charges.

  1. 3. Depreciation and amortization are not cash charges, so neither of them has an effect on a firm’s reported profits.
  2. 4. The more depreciation a firm reports, the higher its tax bill, other things held constant.
  3. 5. People sometimes talk about the firm’s net cash flow, which is shown as the bottom entry on the income statement, as the „bottom line.“

Answer: Net cash flow (NCF) is defined as follows:

Net Cash Flow = Net Income + Depreciation and Amortization Charges.

Question 20:

Last year Aldrin Company’s operations provided a negative net cash flow, yet the cash shown on its balance sheet increased. Which of the following statement could explain the increase in cash, assuming the company’s financial statements were prepared under generally accepted accounting principles?

  1. 1. The company retired a large amount of its long-term debt.
  2. 2. The company repurchased some of its common stock.
  3. 3. The company sold some of its fixed assets.
  4. 4. The company had high depreciation expenses.
  5. 5. The company dramatically increased its capital expenditures.

Answer: The Company repurchased some of its common stock.

Question 21:

Analysts who follow Sierra Nevada Inc. recently noted that, relative to the previous year, the company’s operating net cash flow increased, yet cash as reported on the balance sheet declined. Which of the following factors could explain this situation?

  1. 1. The company sold a division and received cash in return.
  2. 2. The company cut its dividend.
  3. 3. The company made a large investment in a new plant.
  4. 4. The company issued new long-term debt.
  5. 5. The company issued new common stock.

Answer: The Company issued new common stock.

Question 22:

Last year, Owen Technologies reported (1) a negative net cash flow from operations, (2) a negative free cash flow, and (3) an increase in cash as reported on its balance sheet. Which of the following factors could explain this situation?

  1. 1. The company had a sharp increase in its depreciation and amortization expenses.
  2. 2. The company had a sharp increase in its inventories.
  3. 3. The company sold a new issue of common stock.
  4. 4. The company had a sharp increase in its accrued liabilities.
  5. 5. The company made a large capital investment early in the year.

Large investment- reduces free cash flow and net cash flow, investment may have been financed by debt therefore no change in cash

Answer: The Company made a large capital investment early in the year

Question 23:

On its 2004 balance sheet, Sherman Books showed $510 million of retained earnings, and exactly the same amount was shown the following year. Assuming that no earnings restatements were issued, which of the following statements is CORRECT?

  1. 1. The company definitely had zero net income in 2005.
  2. 2. The company must have paid no dividends in 2005.
  3. 3. Dividends could have been paid in 2005, but they would have had to equal the earnings for the year.
  4. 4. If the company lost money in 2005, they must have paid dividends.
  5. 5. The company must have paid out half of its earnings as dividends.

Answer: statement 3: Dividends could have been paid in 2005, but they would have had to equal the earnings for the year.

Question 24:

Which of the following statements is CORRECT?

  1. 1. Accounts receivable are reported as a current liability on the balance sheet.
  2. 2. Dividends paid reduce the net income that is reported on a company’s income statement.
  3. 3. If a company uses some of its bank deposits to buy short-term, highly liquid marketable securities, this will cause a decline in its current assets as shown on the balance sheet.
  4. 4. If a company issues new long-term bonds during the current year, this will increase its reported current liabilities at the end of the year.
  5. 5. If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will fall.

Answer: Statement 5: If a company pays more in dividends than it generates in net income, its retained earnings as reported on the balance sheet will fall.

Question 25:

Cox Corporation reported EBITDA of $22.5 million and $5.4 million of net income. The company has a $6 million interest expense and its corporate tax rate is 35%. What was Cox’s depreciation and amortization expense?

EBITDA= $22.5 million

Net income =5.4 million

Interest expense=6 million

Corporate tax rate= 35%

Depreciation + amortization=Y

Net income = EBITDA – tax – depreciation – amortisation- interest – tax

Calculations:

Tax expenses = 35% X (EBITDA – interest expenses- Y (depreciation and amortisation)

Tax expenses = 35% X (22.5m – 6m- Y)

Net income = EBITDA – tax – depreciation – amortisation- interest – tax

5.4 = 22.5 – [35% X (22.5 – 6- Y)] – Y- 6

5.4 = 16.5 – [35% X (16.5- Y)] – Y

5.4 = 16.5 – [5.775- 0.35Y] – Y

5.4 = 16.5 – 5.775+ 0.35Y – Y

5.4 = 10.725 + 0.35Y – Y

0.65Y= 5.325

Depreciation and amortization expense =Y= 8.19million

Answer = 8.19 million

Question 26:

Byrd Lumber has 2 million shares of common stock outstanding that sell for $15 a share. If the company has $40 million of common equity, what is the company’s Market Value Added (MVA)?

Market value added = value of the firm in the market – capital invested in the firm

Market value added = (2 million X 15) – 40 million

Market value added = -30,000

Answer: Market value added = -30,000

Question 27:

Hybrid Battery Systems recently reported $9,000 of sales, $6,000 of operating costs other than depreciation, and $500 of depreciation. The company had no amortization charges, it had $4,000 of bonds that carry a 7% interest rate, and its federal-plus-state income tax rate was 40%. In order to sustain its operations and thus generate sales and cash flows in the future, the firm was required to make $800 of capital expenditures on new fixed assets and to invest $500 in net operating working capital. By how much did the firm’s net income exceed its free cash flow?

Net income = sales – operating costs – depreciation – interest – tax

Net income =9000 – 6000 – 500 – (4,000*7%) – tax

Net income =2500 – 280 – tax

Net income =2220– tax

Tax = 2220*40%=888

Net income =2220– 888=1332

Free cash flow = net income + amortisation + depreciation-change in working capital

Free cash flow = 1332+280+500=2112

Difference between free cash flow and net income=2112-1332=780

Answer =-780

Question 28:

Ramala Corp’s sales last year were $48,000, and its total assets were $25,500. What was its total assets turnover ratio (TATO)?

Asset turnover ratio = sales/ assets

Asset turnover ratio =48000/25500

Asset turnover ratio =1.8824

Answer: 1.8824

Question 29:

Roberts Corp’s sales last year were $300,000, and its net income after taxes was $25,000. What was its profit margin on sales?

Profit margin = income after tax/ sales

Profit margin = 25000/300000

Profit margin=0.0833 = 8.33%

Answer: 8.33%

Question 30:

Reynolds Corp’s total assets at the end of last year were $300,000 and its net income after taxes was $25,000. What was its return on total assets?

Returns on total assets = income after tax/ assets

Returns on total assets =25,000/300,000, Returns on total assets =0.0833 = 8.33%

Answer: 8.33%

Question 31:

Rutland Corp’s stock price at the end of last year was $30.25 and its earnings per share for the year were $2.45. What was its P/E ratio?

P/E ratio = price per share / earnings per share

P/E ratio = 30.25/2.45

P/E ratio = 12.347

Answer: 12.347

Question 32:

Rand Corp’s stock price at the end of last year was $40.00, and its book value per share was $24.50. What was its Market/Book ratio?

Market/Book ratio= market value/ book value

Market/Book ratio= 40/ 24.5

Market/Book ratio= 1.6327

Answer: 1.6327

Question 33:

Rolle Corp has $500,000 of assets, and it uses no debt–it is financed only with common equity. The new CFO wants to employ enough debt to bring the Debt/Assets ratio to 45%, using the proceeds from the borrowing to buy back common stock at its book value. How much must the firm borrow to achieve the target debt ratio?

Debt ratio = debt/total assets

Required debt ratio = 0.45 or 60%

Debt ratio = 0.45 = [x / 500,000]

Where x is amount of debts

Solution for x:

0.6 = [x / 500,000]

300,000 = x

X = 300,000

Answer: borrowing should be 300,000

Question 34:

Rull Corp’s assets are $500,000, and its total debt outstanding is $200,000. The new CFO wants to employ a debt ratio of 60%. How much debt must the company add or subtract to achieve the target debt ratio?

Debt ratio = debt/total assets

Rull debt ratio = 200,000/500,000 = 0.4 or 40%

Required debt ratio = 0.6 or 60%

In order to increase debt ratio debts should be increased:

Debt ratio = 0.6 = [200,000 + x / 500,000]

Where x is amount of debts to increase

Solution for x:

0.6 = [200,000 + x / 500,000]

300,000 = 200,000 + x

X = 100,000

Answer: increase debt by 100,000

Question 35:

Rangoon Corp’s sales last year were $400,000, and its year-end total assets were $300,000. The average firm in the industry has a total assets turnover ratio (TATO) of 2.5. The new CFO believes the firm has excess assets that can be sold so as to bring the TATO down to the industry average without affecting sales. By how much must the assets be reduced to bring the TATO to the industry average?

Industry asset turnover =2.5

Asset turnover = sales/ total assets

Rangoon asset turnover = 400,000/300,000 = 1.333333

To achieve industry average then:

Rangoon asset turnover = [400,000/ (300,000 – x)] = 2.5

Where x is the amount of assets to be sold

Solution for x:

[400,000/ (300,000 – x)] = 2.5

400,000 = 750,000 – 2.5 x

2.5x = 350,000

X = 140,000

Answer: assets should be reduced by 140,000

Question 36:

Considered alone, which of the following would increase a company’s current ratio?

Current ratio = current assets/ current liabilities,

Current ratio will increase if current assets increase or current liabilities decrease

Answer: Increase in current assets or decline in current liabilities

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Source by Charles Kelly