Accounting Principles

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
years 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?
A. Accounts payable
B. Inventory
C. Accounts receivable
D. Cash
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 companys balance sheet?
A. The company issues new common stock.
B. The company repurchases common stock
C. The company pays a dividend.
D. The company purchases a new piece of equipment
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. The statement of cash flows shows where the firms cash is located,
with a listing of all banks and brokerage houses where cash is on
deposit.
2. The statement of cash flows for 2005 shows how much the firms
cash (the total of currency, bank deposits, and short-term liquid
securities, or cash equivalents) increased or decreased during 2005.

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. The statement of cash flows reflects cash flows from operations, but
it does not reflect the effects of buying or selling fixed assets.
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
firms 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. In the statement of cash flows, depreciation charges are reported as
a use of cash.
2. In the statement of cash flows, a decrease in accounts receivable is
reported as a use of cash.
3. In the statement of cash flows, a decrease in inventories is reported
as a use of cash.
4. In the statement of cash flows, a decrease in accounts payable is
reported as a use of cash.
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. Depreciation reduces a firms cash balance, so an increase in
depreciation would normally lead to a reduction in the firms net cash
flow.
2. Net cash flow (NCF) is defined as follows:

Net Cash Flow = Net Income + Depreciation and Amortization

Charges.
3. Depreciation and amortization are not cash charges, so neither of
them has an effect on a firms reported profits.
4. The more depreciation a firm reports, the higher its tax bill, other
things held constant.
5. People sometimes talk about the firms 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 Companys 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
companys financial statements were prepared under generally
accepted accounting principles?
1. The company retired a large amount of its long-term debt.
2. The company repurchased some of its common stock.
3. The company sold some of its fixed assets.
4. The company had high depreciation expenses.
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 companys operating net cash flow increased,
yet cash as reported on the balance sheet declined. Which of the
following factors could explain this situation?
1. The company sold a division and received cash in return.
2. The company cut its dividend.
3. The company made a large investment in a new plant.
4. The company issued new long-term debt.

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. The company had a sharp increase in its depreciation and
amortization expenses.
2. The company had a sharp increase in its inventories.
3. The company sold a new issue of common stock.
4. The company had a sharp increase in its accrued liabilities.
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. The company definitely had zero net income in 2005.
2. The company must have paid no dividends in 2005.
3. Dividends could have been paid in 2005, but they would have had to
equal the earnings for the year.
4. If the company lost money in 2005, they must have paid dividends.
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. Accounts receivable are reported as a current liability on the
balance sheet.
2. Dividends paid reduce the net income that is reported on a
companys income statement.
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. 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. 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 Coxs 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 companys 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
companys 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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