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CHAPTER STUDY OBJECTIVES 1. Identify the sections of a classified balance sheet. In a classified balance sheet, companies classify assets as current assets; long-term investments; property, plant, and equipment; or intangibles. They classify liabilities as either current or long-term. A stockholders’ equity section shows common stock and retained earnings. 2. Identify and compute ratios for analyzing a company’s profitability. Profitability ratios, such as earnings per share (EPS), measure aspects of the operating success of a company for a given period of time. 3. Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. The retained earnings statement presents the factors that changed the retained earnings balance during the period. A statement of stockholders’ equity presents the factors that changed stockholders’ equity during the period, including those that changed retained earnings. Thus, a statement of stockholders’ equity is more inclusive. 4. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. Liquidity ratios, such as the current ratio, measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ratios, such as the debt to total assets ratio, measure the ability of an enterprise to survive over a long period. 5. Use the statement of cash flows to evaluate solvency. Free cash flow indicates a company’s ability to generate cash from operations that are sufficient to pay debts, acquire assets, and distribute dividends. 6. Explain the meaning of generally accepted accounting principles. Generally accepted accounting principles are a set of rules and practices recognized as a general guide for financial reporting purposes. The basic objectives of financial reporting is to provide information that is useful for decision making. 7. Discuss financial reporting concepts. To be judged useful, information should posses these qualitative characteristics relevance, reliability, comparability, and consistency. The monetary unit assumption requires that companies include in the accounting records of the economic entity only transaction data capable of being expressed in terms of money. The economic entity assumption states that economic events can be identified with a particular unit of accountability. The time period assumption states that the economic life of a business can be divided into artificial time periods and that meaningful accounting reports can be prepared for
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Chapter 2 Practice Exam

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Page 1: Chapter 2 Practice Exam

CHAPTER STUDY OBJECTIVES

1. Identify the sections of a classified balance sheet. In a classified balance sheet, compa-nies classify assets as current assets; long-term investments; property, plant, and equipment; or intangibles. They classify liabilities as either current or long-term. A stockholders’ equity section shows common stock and retained earnings.

2. Identify and compute ratios for analyzing a company’s profitability. Profitability ratios, such as earnings per share (EPS), measure aspects of the operating success of a company for a given period of time.

3. Explain the relationship between a retained earnings statement and a statement of stockholders’ equity. The retained earnings statement presents the factors that changed the retained earnings balance during the period. A statement of stockholders’ equity presents the factors that changed stockholders’ equity during the period, including those that changed re-tained earnings. Thus, a statement of stockholders’ equity is more inclusive.

4. Identify and compute ratios for analyzing a company’s liquidity and solvency using a balance sheet. Liquidity ratios, such as the current ratio, measure the short-term ability of a company to pay its maturing obligations and to meet unexpected needs for cash. Solvency ra-tios, such as the debt to total assets ratio, measure the ability of an enterprise to survive over a long period.

5. Use the statement of cash flows to evaluate solvency. Free cash flow indicates a com-pany’s ability to generate cash from operations that are sufficient to pay debts, acquire as-sets, and distribute dividends.

6. Explain the meaning of generally accepted accounting principles. Generally accepted accounting principles are a set of rules and practices recognized as a general guide for finan-cial reporting purposes. The basic objectives of financial reporting is to provide information that is useful for decision making.

7. Discuss financial reporting concepts. To be judged useful, information should posses these qualitative characteristics relevance, reliability, comparability, and consistency.

The monetary unit assumption requires that companies include in the accounting records of the economic entity only transaction data capable of being expressed in terms of money. The economic entity assumption states that economic events can be identified with a particular unit of accountability. The time period assumption states that the economic life of a business can be divided into artificial time periods and that meaningful accounting reports can be pre-pared for each period. The going concern assumption states that the enterprise will continue in operation long enough to carry out its existing objectives and commitments.

The cost principle states that the companies should record assets at their cost. The full disclo-sure principle dictates that companies disclose circumstances and events that matter to finan-cial statement users.

The major constraints are materiality and conservation.

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Test Bank for Accounting: Tools for Business Decision Making

TRUE-FALSE STATEMENTS

1.______ Cash and supplies are both classified as current assets.

2.______ Stockholders’ equity is divided into two parts: common stock and retained earn-ings.

3.______ It is possible for an asset to be a current asset even though the expected conver-sion of that asset into cash is to be longer than one year or the normal operating cycle.

4.______ Profitability means having enough funds on hand to pay debts when they fall due.

5.______ The retained earnings statement describes the changes in retained earnings dur-ing the period.

6.______ The retained earnings statement is more comprehensive than the statement of shareholders equity.

7.______ The excess of current assets over current liabilities is called working capital.

8.______ The current ratio takes into account the composition of current assets.

9.______ Solvency ratios measure the short-term ability of the company to pay its maturing obligations.

10.______ Two primary objectives of management are to achieve profitability and liquidity.

11.______ The statement of cash flows is divided into two sections corresponding to investing activities and financing activities.

12.______ Free cash flow is cash from operations less dividends.

13______. The primary accounting standard-setting body in the United States is the Securities and Exchange Commission.

14______. GAAP stands for generally accepted accounting procedures.

15.______ For information to be useful, it must be both relevant and reliable.

16______. The advantage of accounting information is that it provides exact and completely reli-able measures.

17.______ The time period assumption states that the business will remain in operation for the foreseeable future.

18.______ For accounting purposes, business transactions should be kept separate from the personal transactions of the stockholders of the business.

19______. The economic entity assumption states that economic events can be identified with a particular unit of accountability.

20.______ The monetary unit assumption has led to an increase in the notes to financial statements.

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21.______ The economic entity assumption is that an enterprise will remain in operations for the foreseeable future.

22.______ Materiality and conservatism are two constraints in accounting.

23.______ Conservatism in accounting means the accountant should understate assets and income.

MULTIPLE CHOICE QUESTIONS

24.______ In a classified balance sheet, assets are usually classified as:a. current assets; long-term assets; property, plant, and equipment; and intangible as-

sets.b. current assets; long-term investments; property, plant, and equipment; and common

stocks.c. current assets; long-term investments; tangible assets; and intangible assets.d. current assets; long-term investments; property, plant, and equipment; and intangible

assets.

25.______ A current asset isa. the last asset purchased by a business.b. an asset which is currently being used to produce a product or service.c. usually found as a separate classification in the income statement.d. expected to be converted to cash or used in the business within a relatively short pe-

riod of time.

26.______ An intangible asseta. derives its value from the rights and privileges it provides the owner.b. is worthless because it has no physical substance.c. is converted into a tangible asset during the operating cycle.d. cannot be classified on the balance sheet because it lacks physical substance.

27.______ Trademarks would appear in which balance sheet section?a. Intangible assetsb. Investmentsc. Property, plant, and equipmentd. Current assets

28.______ Which of the following would not be classified as a long-term liability?a. Current maturities of long-term debtb. Bonds payablec. Mortgage payabled. Lease liabilities

29.______ Which of the following is not a current liability?a. Wages payableb. Accounts payablec. Taxes payabled. Bonds payable

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.

30.______ The operating cycle of a company is the average time that is required to go from cash toa. sales in producing revenues.b. cash in producing revenues.c. inventory in producing revenues.d. accounts receivable in producing revenues.

31______. These are selected account balances on December 31, 2007.

Land (location of the corporation’s office building) $100,000Land (held for future use) 150,000Corporate Office Building 600,000Inventory 200,000Equipment 450,000Office Furniture 100,000Accumulated Depreciation 300,000

32______. Which of the following is not an alternative means of expressing ratio relationships?a. proportionb. qualitativec. rated. percentage

Use the following information to answer questions 33–37:

Benton Office SuppliesBalance Sheet

December 31, 2007

Cash $ 65,000 Accounts Payable $ 70,000Prepaid Insurance 30,000 Salaries Payable 10,000Accounts Receivable 50,000 Mortgage Payable 90,000Inventory 70,000 Total Liabilities $160,000Land held for investment 75,000Land 90,000Building $100,000 Common Stock $120,000 Less Accumulated Retained Earnings 250,000 Depreciation (20,000) 80,000 Total stockholders’ equity $370,000Trademark 70,000 Total Liabilities and Total Assets $530,000 Stockholders’ Equity $530,000

33.______ The total dollar amount of assets to be classified as current assets isa. $290,000.b. $215,000.c. $180,000.d. $145,000.

34.______ The total dollar amount of assets to be classified as property, plant, and equipment

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isa. $320,000.b. $170,000.c. $245,000.d. $190,000.

35.______ The total dollar amount of assets to be classified as investments isa. $0.b. $150,000.c. $75,000.d. $180,000.

36.______ The total amount of working capital isa. $135,000.b. $295,000.c. $75,000.d. $60,000.

37.______ The current ratio isa. 1.94 : 1.b. 1.57 : 1.c. 3.14 : 1.d. 2.69 : 1.

38.______ L2 Corporation has assets of $2.7 million, common stock of $702,000, and re-tained earnings of $428,000. What are the creditors’ claims on their assets?a. $2,426,000b. $1,130,000c. $1,570,000d. $2,974,000

39.______ A measure of profitability is thea. current ratio.b. debt to total assets ratio.c. earnings per share.d. working capital.

40.______ For 2007 Mossland Corporation reported net income of $28,000; net sales $400,000; and average share outstanding 6,000. There were no preferred stock divi-dends. What was the 2007 earnings per share?a. $4.67b. $0.25c. $66.67d. $14.86

41______. Most companies use a(n) _________ rather than a retained earnings statement.a. balance sheetb. income statementc. statement of cash flowsd. statement of stockholders’ equity

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42.______ Issuing new shares of common stock willa. increase retained earnings.b. decrease retained earnings.c. increase common stock.d. decrease common stock.

43.______ Reporting a net income of $95,000 willa. increase retained earnings.b. decrease retained earnings.c. increase common stock.d. decrease common stock.

44. Liondale Corporation had beginning retained earnings of $2,292,000 and ending retained earnings of $2,499,000. During the year they issued common stock totaling $141,000. What was their net income for the year?a. $207,000b. $ 66,000c. $348,000d. $273,000

45______. At December 31, 2007 Shorts Company had retained earnings of $2,184,000. During 2007 they issued stock for $98,000, and paid dividends of $34,000. Net income for 2007 was $402,000. The retained earnings balance at the beginning of 2007 was: a. $2,552,000b. $1,816,000c. $1,914,000d. $2,454,000

46.______ The relationship between current assets and current liabilities is important in evaluat-ing a company'sa. profitability.b. liquidity.c. market value.d. solvency.

47.______ A short-term creditor is primarily interested in the __________ of the borrower.a. liquidityb. profitabilityc. consistencyd. solvency

48.______ Working capital is a measure ofa. consistency.b. liquidity.c. profitability.d. solvency.

49______. Based on the following data, what is the amount of working capital?

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Accounts payable……………………………………………………….. $32,000Accounts receivable…………………………………………………….. 57,000Cash………………………………………………………………………. 20,000Intangible assets………………………………………………………… 50,000Inventory…………………………………………………………………. 69,000Long-term investments…………………………………………………. 80,000Long-term liabilities……………………………………………………………. 100,000Marketable securities……………………………………………………. 40,000Notes payable (short-term)……………………………………………… 28,000Plant assets……………………………………………………………… 670,000Prepaid expenses……………………………………………………….. 1,000

a. $127,000b. $151,000c. $170,000b. $148,000

Use the following balance sheet and income statement information to answer questions 50–53:

Current assets $ 7,000 Net income $ 12,000Current liabilities 4,000 Stockholders’ equity 27,000Average assets 40,000 Total liabilities 9,000Total assets 30,000Average common shares outstanding was 10,000

50.______ What is the total amount of working capital?a. $1,000b. $7,000c. $2,000d. $3,000

51.______ What is the current ratio?a. 1.75 : 1b. 1.6 : 1c. 0.57 : 1d. 2 : 1

52.______ What is the earnings per share?a. $3.60b. $4.00 c. $1.20 d. $0.83

53______. What is the debt to total assets?a. 22.5 percentb. 13 percentc. 75 percentd. 30 percent

54.______ A useful measure of solvency is the

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a. current ratio.b. earnings per share.c. return on assets ratio.d. debt to total assets ratio.

55.______ How can a company improve its current ratio?a. Work with a creditor to reclassify some current debt into long-term debtb. Use cash to reduce current liabilitiesc. Nothing can ethically be done to improve the current ratiod. Use excess cash to buy new equipment

56.______ The statement of cash flows begins with cash flows froma. financing activities.b. investing activities.c. operating activities.d. solvent activities.

57.______ In 2007 Bombay Corporation had cash receipts of $21,000 and cash disburse-ments of $12,000. Their ending cash balance at December 31, 2007 was $33,000. What was their beginning cash balance?a. $24,000b. $30,000c. $45,000d. $42,000

58.______ Generally accepted accounting principlesa. are accounting rules formulated by the Internal Revenue Service.b. are sound in theory but rarely used in real life.c. are accounting rules that are recognized as a general guide for financial reporting.d. have eliminated all errors in accounting.

59______. The agency of the United States Government that oversees the U.S. financial markets is thea. Internal Revenue Serviceb. Security Exchange Commissionc. Financial Accounting Standards Board.d. International Auditing Standards Committee.

60.______ All of the following are characteristics of accounting information except a. Reliability.b. Comparability.c. Relevance.d. Flexibility.

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61.______ In order for accounting information to be relevant, it musta. have very little cost.b. help predict future events or confirm prior expectations.c. not be reported to the public.d. be used by a lot of different firms.

62.______ Accounting information should be neutral in order to enhancea. reliability.b. consistency.c. comparability.d. relevance.

63.______ Which of the following statements is not true?a. Comparability means using the same accounting principles from year to year within a

company.b. Reliability is the quality of information that gives assurance that it is free of error or

bias.c. Relevant accounting information must be capable of making a difference in the deci-

sion.d. The FASB’s overriding criterion is that the accounting rule adopted should be the one

that generates the most useful financial information for making a decision.

64.______ A company can change to a new method of accounting if management can justify that the new method results ina. more meaningful financial information.b. a higher net income.c. a lower net income for tax purposes.d. less likelihood of clerical errors.

65.______ Selecting the method or procedure that yields less net income is an application ofa. consistency.b. conservatism.c. full disclosure.d. materiality.

66.______ A common application of the conservatism constraint is the use of the

1. straight-line depreciation method for plant assets.2. lower of cost or market method for inventories.3. FIFO method for inventory valuation.

a. 1b. 2c. 3d. 1 and 2

67.______ The time period assumption states that the economic life of a business can be divided into

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a. equal time periods.b. cyclical time periods.c. artificial time periods.d. perpetual time periods.

68.______ The going concern assumption underlies thea. cost principle.b. monetary unit assumption.c. time period assumption.d. full disclosure principle.

69______. The economic entity assumption states that economic eventsa. of different entities can be combined if all the entities are corporations.b. must be reported to the Securities and Exchange Commission.c. of a sole proprietorship cannot be distinguished from the personal economic events of

its owners.d. of every entity can be separately identified and accounted for.

70.______ The ACE Company has five plants nationwide that cost $300 million. The current market value of the plants is $500 million. The plants will be reported as assets ata. $200 million.b. $800 million.c. $300 million.d. $500 million.

71.______ The cost principle requires that when assets are acquired, they be recorded ata. market value.b. the amount paid for them.c. selling price.d. list price.

72.______ Valuing assets at their market value rather than at their cost is inconsistent with the:a. economic entity assumption.b. cost principle.c. time period assumption.d. full disclosure principle.

BRIEF EXERCISES

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BE. 73

The following information (in millions of dollars) is available for Jones Sportswear for 2007:Sales revenue $6,300 Net income $504.6Stock price per share $18.45 Preferred stock dividend $0

Average shares outstanding 420.5 millionCompute the earnings per share for Jones Sportswear.

BE. 74

These selected condensed data are taken from a recent balance sheet of Barnes Porporia (in mil-lions of dollars).

Cash $ 2.2Accounts receivable 10.4Inventories 18.0Other current assets 11.1Total current assets $ 41.7Total current liabilities $ 24.8

Additional information: Current liabilities at the beginning of the year were $35.6 million.

What are (a) the working capital, and (b) the current ratio?

BE. 75

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Insert the qualitative characteristics listed below that are associated with relevance and reliability.

Confirm Prior Expectations TimelyVerifiable Faithful RepresentationNeutral Predict Future Events

RELEVANCE RELIABILITY

1. _________________________ 1. _________________________

2. _________________________ 2. _________________________

3. _________________________ 3. _________________________

Be. 76

Each of the following statements is justified by a concept or convention of accounting. Write the letter in the blank next to each statement corresponding to the concept involved.

a. Consistencyb. Materialityc. Full disclosured. Conservatism

1. A company uses the lower of cost or market to value inventories.

2. This characteristic best enhances comparability of financial statements between years.

3. A merger agreed on just after the balance sheet date nevertheless is reported in the notes to the financial statement.

4. A large company rounds its financial statement figures to the nearest thousand.

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Be. 77

Presented below are the basic assumptions and principles underlying financial statements.

a. Cost principle d. Going concern assumptionb. Economic entity assumption e. Monetary unit assumptionc. Full disclosure principle f. Time period assumption

Identify the basic assumption or principle that is described below.

_____ 1. The economic life of a business can be divided into artificial time periods.

_____ 2. The business will continue in operation long enough to carry out its existing objectives.

_____ 3. Assets should be recorded at their cost.

_____ 4. Economic events can be identified with a particular unit of accountability.

_____ 5. Circumstances and events that make a difference to financial statement users should be disclosed.

_____ 6. Only transaction data that can be expressed in terms of money should be included in the accounting records.

EXERCISES

Ex. 78

The following information is available for Juxton Company for the year ended December 31, 2007:

Accounts payable 2,700Building not currently used 9,500Accumulated depreciation, equipment 4,000Retained earnings 16,000Common stock 4,800Intangible assets 2,500Notes payable (due in 5 years) 7,500Accounts receivable 1,500Cash 2,600Short-term investments 1,000Land 10,000Equipment 7,500Long-term investments 400

Instructions

Use the above information to prepare a classified balance sheet for the year ended December 31, 2007.

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Ex.79

The Caltor Company gathered the following condensed data for the year ended December 31, 2007:

Cost of goods sold $ 710,000Net sales 1,279,000Administrative expenses 239,000Interest expense 68,000Dividends paid 38,000Selling expenses 45,000

InstructionsPrepare an income statement for the year ended December 31, 2007.

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Ex.80

Use the following data to calculate the liquidity and profitability ratios listed below.

Average common shares 10,000 Current liabilities 100,000Capital expenditures 20,000 Net income $ 21,000Cash provided by operations 28,000 Net sales 150,000Dividends paid 5,000 Total liabilities 105,000Current assets 150,000 Total assets 175,000

InstructionsCompute the following:(a) Current ratio. (d) Debt to total assets ratio.(b) Working capital. (e) Free cash flow.(c) Earnings per share.

Ex. 81

For each of the ratios listed below, indicate by the appropriate code letter, whether it is a liquidity ratio, a profitability ratio, or a solvency ratio.

Code:L = Liquidity ratioP = Profitability ratioS = Solvency ratio

_____ 1. Price-earnings ratio

_____ 2. Free cash flow

_____ 3. Debt to total assets ratio

_____ 4. Earnings per share

_____ 5. Current ratio

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