Area I F. financial ratios and performance metrics

Question 1

Markson Co. traded a concrete-mixing truck with a book value of $10,000 to Pro Co. for a cement-mixing machine with a fair value of $11,000. Markson needs to know the answer to which of the following questions in order to determine whether the exchange has commercial substance?
A. Does the book value of the asset given up exceed the fair value of the asset received?
B. Is the gain on the exchange less than the increase in future cash flows?
C. Are the future cash flows expected to change significantly as a result of the exchange?
D. Is the exchange nontaxable?

Answer 1

C. Are the future cash flows expected to change significantly as a result of the exchange?

A significant change in cash flows related to the asset is what determines whether an exchange has commercial substance or not.

Question 2

FAR1B10030
In case of an error where in-kind contributions were not recorded, what is the correct adjustment?
A. Decrease expenses and increase net assets
B. Increase expenses and decrease liabilities
C. Increase revenues and net assets
D. Increase liabilities and decrease net assets

Answer 2

C. Increase revenues and net assets

Failing to record in-kind contributions means that revenues are understated. The correction involves increasing revenues (to account for the value of the in-kind contributions) and correspondingly increasing net assets.

Question 3

Which of the following activities should be excluded when governmental fund financial statements are converted to government-wide financial statements?

A. Proprietary activities.
B. Fiduciary activities.
C. Government activities.
D. Enterprise activities.

Answer 3

B. Fiduciary activities.

Fiduciary funds are funds the government is holding as a trustee and won’t be used to benefit the government entity, so they are left out of government-wide financial statements.

Question 4

FAR2C10026
A company’s inventory at the start of the year was $20,000. During the year, $8,000 worth of inventory was purchased, and inventory costing $6,000 was sold. Additionally, there was a write-off of $500 for damaged goods. What is the year-end inventory balance?
A. $21,500
B. $22,000
C. $19,500
D. $27,500

Answer 4

A. $21,500

The year-end inventory balance is calculated as:
Opening balance + Purchases – Cost of goods sold – Write-offs
= $20,000 + $8,000 – $6,000 – $500
= $21,500

Question 5

FAR1C006aicpa
At which of the following amounts should a nongovernmental not-for-profit organization report investments in debt securities?
A. Potential proceeds from liquidation sale.
B. Discounted expected future cash flows.
C. Quoted market prices.
D. Historical cost.

Answer 5

C. Quoted market prices.

Nonprofits don’t use debt investment classifications such as available-for-sale or held-to-maturity. Everything is valued at market price (fair value).

Question 6

FAR2C10038
In which scenario is it most likely that no adjustment to the general ledger is required after reconciling with the subledger?
A. When discrepancies are due to timing differences in recording transactions
B. When the physical inventory count is less than the subledger balance
C. When inventory is valued lower in the subledger than in the general ledger
D. When there are unexplained losses in inventory

Answer 6

A. When discrepancies are due to timing differences in recording transactions

Timing differences are often temporary and resolve themselves without the need for an adjustment, once the delayed entries are recorded.

Question 7

FAR3F10003
What is the correct accounting treatment for variable lease payments that depend on an index or rate for a lessee?
A. Recognize in profit or loss as incurred.
B. Include in the initial measurement of the lease liability.
C. Recognize as a separate liability.
D. Expense evenly over the lease term.

Answer 7

B. Include in the initial measurement of the lease liability.

Variable lease payments that depend on an index or rate (like inflation or market interest rates) should be included in the initial measurement of the lease liability. This is because these payments are part of the lease obligation and can be reasonably estimated at the inception of the lease.

Question 8

FAR3D10016
In what situation would a valuation allowance for a deferred tax asset typically NOT be required?
A. The company has a history of significant taxable income.
B. The company is expecting to incur losses in the future.
C. The company has a limited operating history.
D. The company is operating in a highly cyclical industry.

Answer 8

A. The company has a history of significant taxable income.
A valuation allowance is typically not required if the company has a history of significant taxable income, as this indicates a strong likelihood of realizing deferred tax assets in the future.

Question 9

FAR1A70012
In the context of data management, why is it important to compare notes to financial statements with source data for debt covenants?
A. To assess the risk of default
B. To evaluate the company’s investment strategy
C. To determine dividend distribution
D. To calculate the market value of assets

Answer 9

A. To assess the risk of default

Comparing notes on debt covenants with source data is crucial for assessing the risk of default. It ensures that the company is complying with the terms of its loans, which is critical for financial stability and credibility.

Question 10

FAR2B10005
A company’s allowance for doubtful accounts has a debit balance of $1,000 before adjustment. The company estimates that $3,000 of its receivables will be uncollectible. What is the amount of bad debt expense for the period?
A) $2,000
B) $3,000
C) $4,000
D) $1,000

Answer 10

C) $4,000

The bad debt expense is calculated by adding the existing debit balance in the allowance account to the estimated uncollectible amount. $1,000 (existing debit balance) + $3,000 (new estimate) = $4,000.

Question 11

FAR3C10011
When does a nongovernmental, not-for-profit entity recognize revenue from an unconditional promise to give?
A. When the promise is received
B. When the cash is received
C. When the related expenses are incurred
D. When the promise is communicated to the public

Answer 11

A. When the promise is received

Revenue from an unconditional promise to give is recognized when the promise is received, as it represents an unconditional commitment to give.

Question 12

FAR3B10025
A company is assessing whether to recognize or disclose a potential liability related to an environmental claim. The legal team estimates a 40% chance of losing the case, which would result in a $2 million loss. What should the company do?
A. Recognize a liability of $800,000.
B. Recognize a liability of $2 million.
C. Disclose the potential liability in the notes.
D. No action is required.

Answer 12

C. Disclose the potential liability in the notes.

Since the probability of the loss is not high enough to be considered probable, the company should disclose the potential liability in the notes.

Question 13

FAR3B10026
A company is involved in a lawsuit with a potential payout of $1 million. The probability of losing the lawsuit is 80%. The company’s insurance is expected to cover $600,000 of the loss. How should the company report this in its financial statements?
A. Recognize a liability of $1 million and an insurance receivable of $600,000.
B. Recognize a net liability of $400,000.
C. Disclose in notes only, no liability recognition.
D. Recognize a liability of $1 million, no receivable.

Answer 13

B. Recognize a net liability of $400,000.

The company should recognize a net liability of $400,000, considering the expected insurance coverage.

Question 14

FAR4A002aicpa
Roy City received a gift, the principal of which is to be invested in perpetuity with the income to be used to support the local library. In which fund should this gift be recorded?
A. Permanent fund
B. Investment trusts fund
C. Private-purpose trusts fund
D. Special revenue fund

Answer 14

A. Permanent fund
Permanent fund is the right answer because the principal is to remain invested forever, but the point of the investment’s income is to benefit the government. That’s the definition of a permanent fund.
In contrast, any government “trust” funds refer to funds being commingled from other funds or external entities for investment purposes.
Special revenue funds are funds where money is committed and set aside for a specific government purpose. It is usually funded by money transferred from the general fund.

Question 15

FAR2G10012
How should a company measure a liability for one-time termination benefits that are based on continued service?
A) Based on the number of employees expected to leave immediately.
B) As the sum of benefits for the remaining service period of each employee.
C) By discounting the total expected benefits to the present value.
D) As a fixed amount determined at the initiation of the plan.

Answer 15

B) As the sum of benefits for the remaining service period of each employee.

For benefits requiring continued service, the liability should be measured based on the benefits for the remaining service period of each employee.

Question 16

FAR2A004nsim
Tim’s monthly bank statement shows a balance of $500. A reconciliation of the statement and Tim’s books reveals the following:
Bank service charge: $20
Checks outstanding: $100
Deposits in transit: $200
Checked cleared by the bank for $50 but recorded by Tim as $500
After the reconciliation, what is the adjusted bank balance?
A. $1,150
B. $1,050
C. $600
D. $1,070

Answer 16

C. $600

The bank service charge would already be included in the bank’s balance. Therefore the only reconciling items are the checks outstanding and deposits in transit.
The adjusted bank cash balance is: $500 – $100 + $200 = $600
The error with the $50 check was recorded properly on the bank statement. The error is on Tim’s books, not with the bank, so it’s not part of reconciling the bank balance. This would be different if the bank recorded the amount incorrectly

Question 17

FAR1C007n
If a donor gave a gift to a nonprofit with specific instructions about how the gift is to be spent, but also specifies that the entire amount can be spent at any time, how is this gift classified by the nonprofit?
A. Net assets without donor restrictions
B. Net assets with donor restrictions
C. Functional contributions revenue
D. Gifts with no donor restrictions

Answer 17

B. Net assets with donor restrictions

If a donation has donor-specified 1) time restrictions or 2) use restrictions, then it is classified as contributions with a donor restrictions, which increases net assets with donor restrictions.

Question 18

FAR3C10007
In the context of the five-step model, how does an entity treat a significant financing component in a contract?
A. By adjusting the transaction price
B. By recognizing it as a separate performance obligation
C. By including it in the cost of goods sold
D. By ignoring it unless it is explicitly stated in the contract

Answer 18

A. By adjusting the transaction price

When a contract contains a significant financing component, the entity adjusts the transaction price, reflecting the time value of money. This is part of the third step in the model.

Question 19

FAR1A20024
If a sale was recorded in the wrong period, what is the correct adjustment in the income statement
A) Increase revenues in the current period and decrease in the next period.
B) Decrease revenues in the current period and increase in the next period.
C) Increase revenues in both periods.
D) No adjustment is needed as it will balance over the two periods.

Answer 19

B) Decrease revenues in the current period and increase in the next period.
The correct adjustment is to shift the revenue from the incorrect period to the correct one: decrease revenues in the period where the sale was wrongly recorded and increase it in the correct period.
A) is incorrect as it does the opposite. C) is incorrect as it increases revenues in both periods, which is not required. D) is incorrect because accurate period reporting is essential for financial statements.

Question 20

FAR2E013nsim
Adell Corp. is a manufacturer of paper products with a December 31 year end. Adell has not elected the fair value option.
For the transaction below, provide the correct classification and how should it be reported in the company’s (bond issuer) balance sheet.
$525,000 is held in a sinking fund, as required by the bond agreement, for principal repayment in five years.

A. Current asset
B. Current liability
C. Non-current asset
D. Long term liability

Answer 20

C. Non-current asset

A bond sinking fund is a restricted asset of a corporation that was required to set aside money for redeeming or buying back some of its bonds payable.
The bond sinking fund begins when the corporation deposits money with an independent trustee. The trustee then invests the money in order for the balance in the sinking fund to increase. The balance in the sinking fund will also grow from additional required deposits made by the corporation. The bond sinking fund decreases when the trustee purchases or redeems the corporation’s bonds.
A bond sinking fund is reported on the bond issuer’s balance sheet under the caption Investments, the first long-term or noncurrent section appearing immediately after current asset.

Question 21

FAR2E20017
Which of the following would not be included in the initial measurement of an investment at amortized cost?
A) Purchase price of the investment.
B) Transaction costs directly attributable to the acquisition.
C) Future interest payments to be received from the investment.
D) Any discounts or premiums on purchase.

Answer 21

C) Future interest payments to be received from the investment.

Future interest payments are not included in the initial measurement of an investment. The initial measurement includes the purchase price, transaction costs, and any discounts or premiums.

Question 22

Cuthbert Industrials, Inc. prepares three-year comparative financial statements. In year 3, Cuthbert discovered an error in the previously issued financial statements for year 1. The error affects the financial statements that were issued in years 1 and 2. How should the company report the error?

A. The financial statements for years 1 and 2 should be restated; an offsetting adjustment to the cumulative effect of the error should be made to the comprehensive income in the year 3 financial statements.
B. The financial statements for years 1 and 2 should not be restated; financial statements for year 3 should disclose the fact that the error was made in prior years.
C. The financial statements for years 1 and 2 should not be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.
D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.

Answer 22

D. The financial statements for years 1 and 2 should be restated; the cumulative effect of the error on years 1 and 2 should be reflected in the carrying amounts of assets and liabilities as of the beginning of year 3.

Since Cuthbert prepares three-year financials, the error needs to be corrected in years 1 and 2, and the beginning balances of year 3 should reflect the correction so that all 3 years of the financials are comparable. Also, the year 1 and 2 financials should be restated.

Question 23

FAR2D10038
What happens if the selling price of an asset held for sale is renegotiated to a lower value than its carrying amount?
A. An impairment loss is recognized
B. The carrying amount is increased
C. There is no impact on the financial statements
D. The difference is recognized in equity

Answer 23

A. An impairment loss is recognized

If the selling price is renegotiated to a lower value than the carrying amount, an impairment loss is recognized.
Option B is incorrect as the carrying amount is not increased. Option C is incorrect as there is an impact (the impairment loss). Option D is incorrect as the difference affects the income statement, not equity directly.

Question 24

FAR3C10042
How should an entity record the capitalization of costs incurred to fulfill a contract?
A. Debit Contract Costs; Credit Cash or Accounts Payable
B. Debit Expense; Credit Cash or Accounts Payable
C. Debit Accounts Receivable; Credit Contract Costs
D. Debit Cash; Credit Revenue

Answer 24

A. Debit Contract Costs; Credit Cash or Accounts Payable

The capitalization of costs incurred to fulfill a contract is recorded by debiting Contract Costs and crediting Cash or Accounts Payable, reflecting the asset created by these costs.

Question 25

FAR2H20010
If a company has a debt covenant that limits capital expenditures to a certain percentage of operating cash flow, this covenant is primarily aimed at ensuring the company:
A. Maintains a steady dividend payout
B. Does not over-leverage itself with new investments
C. Keeps its share price stable
D. Increases its profitability

Answer 25

B. Does not over-leverage itself with new investments

A covenant limiting capital expenditures as a percentage of operating cash flow is designed to prevent the company from over-leveraging itself with new investments.

Question 26

FAR2H504
For which of the following transactions is calculating the present value unnecessary?
A. Issuance of a noninterest-bearing note.
B. Selling of 8% bonds to yield 10%.
C. Selling of 8% bonds to yield 8%.
D. Selling of 8% bonds to yield 5%.

Answer 26

C. Selling of 8% bonds to yield 8%.
Selling 8% bonds to yield 8% doesn’t need the present value calculated since the calculated present value and the face amount of the bond is the same.
The other responses would require a present value calculation.

Question 27

A company that is a large accelerated filer must file its Form 10-Q with the United States Securities and Exchange Commission within how many days after the end of the period?

A. 30 days
B. 40 days
C. 45 days
D. 60 days

Answer 27

B. 40 days

A large accelerated filer has a market cap of $700 million or more. They have 40 days after the end of the period to file their form 10-Q (quarterly), and 60 days after the company’s fiscal year end to file their 10-K (annual report).
An accelerated filer on the other hand, is a company with a market cap of more than $75 million but less than $700 million. They have 40 days after each period to file their 10-Q, and 75 days after fiscal year end to file their 10-K.

n 2002, the SEC approved a deadline of 75 days for Form 10-K “accelerated filers.” An accelerated filer is an issuer:
with a public float of greater than or equal to $75 million;
subject to the Securities Exchange Act’s reporting requirements for greater than or equal to 12 months;
that previously filed at least one report;
which is not eligible to file quarterly and annual reports on Forms 10-QSB and 10-KSB.
Smaller reporting companies, which are entities with annual revenues of less than $100 million, are excluded from the definition of large accelerated filers or accelerated filers.

Question 28

FAR1A20049
Upon reconciling the income statement, a discrepancy is found in utility expenses. The amount on the income statement is significantly higher. What should be investigated first?
A) The possibility of unrecorded utility bill payments.
B) The accuracy of meter readings or billings from the utility provider.
C) Potential fraudulent activities.
D) Incorrect recording of sales.

Answer 28

B) The accuracy of meter readings or billings from the utility provider.

The first step should be to verify the accuracy of meter readings and billing. A) would usually result in a lower amount recorded. C) should only be suspected after ruling out more common errors. D) is unrelated to utility expenses.

Question 29

FAR2F10016
When an intangible asset with a finite life is initially recognized, what journal entry is made?
A. Debit Intangible Asset; Credit Cash or Payables.
B. Debit Cash; Credit Revenue.
C. Debit Amortization Expense; Credit Intangible Asset.
D. Debit Cash; Credit Intangible Asset.

Answer 29

A. Debit Intangible Asset; Credit Cash or Payables.

The initial recognition of an intangible asset involves recording the asset at its cost. This is done by debiting the Intangible Asset account and crediting Cash or Payables, depending on the mode of payment.

Question 30

FAR2H10033
A bond with a face value of $200,000 is issued at a premium of 10%. What is the carrying amount of the bond immediately after issuance?
A. $200,000
B. $180,000
C. $220,000
D. $20,000

Answer 30

C. $220,000

The carrying amount of a bond issued at a premium is the face value plus the premium. Here, the premium is 10% of $200,000, which is $20,000. Therefore, the carrying amount is $200,000 + $20,000 = $220,000.

Question 31

FAR1D003n

Form 10-K is made up of how many parts?

A. 6 parts
B. 15 parts
C. 4 parts
D. 2 parts

Answer 31

C. 4 parts

There are 4 “parts” to the 10-K, and 15 “items” or “sections” that make up those 4 parts.
Part 1 includes an overview of the business, risk factors, properties, and info on legal proceedings.

Part 2 includes financial data, management’s discussion and analysis (MD&A), and the audited financial statements.

Part 3 includes info on the directors and executives of the company, executive compensation, any related transactions info, and info on fees being paid to their accounting firm for the year.

Part 4 contains exhibits and financial statement schedules.

Question 32

FAR1F10038
When calculating the Times Interest Earned ratio, which financial statement item is used as the numerator?
A. Net Income
B. Earnings Before Interest and Taxes (EBIT)
C. Total Revenue
D. Gross Profit

Answer 32

B. Earnings Before Interest and Taxes (EBIT)

In the Times Interest Earned ratio, EBIT is used as the numerator. This ratio measures how many times a company can cover its interest payments with its operating income. Net Income (A) includes taxes and other expenses, Total Revenue (C) does not account for expenses, and Gross Profit (D) does not consider operating expenses.

Question 33

FAR1F10010
Which ratio would an analyst use to assess a company’s ability to pay off its short-term debts with its current assets?
A. Quick Ratio
B. Debt-to-Equity Ratio
C. Current Ratio
D. Price-to-Earnings Ratio

Answer 33

C. Current Ratio

The Current Ratio (C) is used to assess a company’s ability to pay off its short-term debts with its current assets, making it ideal for this analysis. The Quick Ratio (A) excludes inventory from current assets, Debt-to-Equity Ratio (B) is for long-term solvency analysis, and Price-to-Earnings Ratio (D) is a valuation metric.

Question 34

FAR1F10048
In the calculation of EBITDA, why is depreciation added back to operating income?
A. To assess the company’s profitability excluding non-cash expenses.
B. To calculate the company’s ability to pay dividends.
C. To determine the total assets of the company.
D. To evaluate the company’s revenue growth.

Answer 34

A. To assess the company’s profitability excluding non-cash expenses.

Depreciation is added back to operating income in the EBITDA calculation to assess the company’s profitability excluding non-cash expenses like depreciation and amortization. This provides a clearer view of operational performance.

Question 35

FAR1A50028
When reconciling the cash flow from operating activities, what could explain a difference between the increase in inventory as per the balance sheet and the cash paid for inventory in the cash flow statement?
A. Inventory was purchased on credit.
B. Inventory was overvalued at year-end.
C. There was a significant amount of inventory write-off.
D. Goods were received in advance and recorded as prepaid inventory.

Answer 35

A. Inventory was purchased on credit.

If inventory was purchased on credit, it would increase inventory but not immediately affect cash, causing a discrepancy.

Question 36

FAR2A10028
In the context of cash reconciliation, what is the implication of a bank collecting a note receivable on behalf of the company?
A. The general ledger balance should be decreased
B. The bank statement balance should be decreased
C. The amount should be added to the general ledger balance
D. No adjustment is necessary in the general ledger

Answer 36

C. The amount should be added to the general ledger balance.
When a bank collects a note receivable on behalf of the company, the amount should be added to the general ledger balance (C) since it increases the company’s cash assets.
Decreasing either the general ledger or bank statement balance (A and B) is incorrect. Not adjusting the general ledger (D) is also incorrect as the collection increases the company’s cash balance.

Question 37

During the year, Hauser Co. wrote off a customer’s account receivable. Hauser used the allowance method for uncollectible accounts. What impact would the write-off have on net income and total assets?
A. Net income: decrease. Total assets: decrease
B. Net income: decrease. Total assets: no effect
C. Net income: no effect. Total assets: decrease
D. Net income: no effect. Total assets: no effect

Answer 37

D. Net income: no effect. Total assets: no effect

Under the allowance method, the allowance for doubtful accounts sits as a contra account to AR. If a customer’s receivable is determined to be uncollectible, it is written off from AR, and deducted from the allowance account. This means there is no net effect on the balance sheet, and no effect on the income statement.
Under the direct write-off method, the bad debt would be expensed through the bad debt expense account, and both net income and total assets would be reduced.

Question 38

FAR1C012aicpa
What is the primary purpose of the statement of activities of a nongovernmental not-for- profit organization?
A. To report the change in net assets for the period.
B. To report the liquidity of the entity as of a specific date.
C. To report assets, liabilities, and net assets as of a specific date.
D. To report the cash flow position of the entity for the period.

Answer 38

A. To report the change in net assets for the period.

The statement of activities for a nonprofit explains the changes in net assets for the period.

Question 39

Alta Co. spent $400,000 during the current year developing a new idea for a product that was patented during the year. The legal cost of applying for a patent license was $40,000. Also, $50,000 was spent to successfully defend the rights of the patent against a competitor. The patent has a life of 20 years. What amount should Alta capitalize related to the patent?
A. $40,000
B. $50,000
C. $90,000
D. $490,000

Answer 39

C. $90,000

The $40,000 for applying the patent license can be capitalized, and since the defense of the patent was successful, the $50,000 of legal costs can be capitalized as well. The $400,000 R&D spent developing the patent is expensed as incurred, not capitalized.

Question 40

FAR2E10029
A trading security’s fair value increased from $100,000 to $105,000. How should this be reflected in the financial statements?
A) As an increase in equity.
B) As an increase in liabilities.
C) As an increase in assets.
D) As an increase in expenses.

Answer 40

C) As an increase in assets.

The increase in fair value of a trading security is reflected as an increase in assets (and income) in the financial statements.

Question 41

FAR1A40015
A company reports a beginning treasury stock balance of $15,000. During the year, it purchases additional treasury stock worth $5,000. What is the ending balance of treasury stock?
A) $10,000
B) $20,000
C) $15,000
D) $5,000

Answer 41

B) $20,000

The ending balance of treasury stock is calculated by adding the cost of additional treasury stock purchased to the beginning balance. The calculation is:
Ending balance = Beginning balance + Additional purchase
Ending balance = $15,000 + $5,000 = $20,000

Question 42

FAR3D10025
Which of the following best describes a current tax receivable?
A. Taxes paid in advance for future periods.
B. Taxes that are overpaid in the current period and are recoverable.
C. Deferred tax assets to be realized in the current year.
D. Future tax benefits related to current year losses.

Answer 42

B. Taxes that are overpaid in the current period and are recoverable.

A current tax receivable arises when the taxes paid exceed the tax liability for the current period, meaning the company has overpaid and can recover this amount.

Question 43

FAR1A60028
In correcting a consolidated financial statement, if an impairment loss on a subsidiary’s asset was previously omitted, what should be done?
A. Record the impairment loss in the current year’s consolidated income statement
B. Adjust the subsidiary’s individual financial statements
C. Revise the previous year’s consolidated financial statements
D. Increase the parent company’s investment in the subsidiary

Answer 43

C. Revise the previous year’s consolidated financial statements

If an impairment loss on a subsidiary’s asset was omitted in a previous year, the appropriate action is to revise the previous year’s consolidated financial statements to include the impairment loss. This ensures the accuracy and integrity of historical financial data.

Question 44

FAR1C10008
What is a key difference between the economic resources measurement focus and the current financial resources measurement focus?
A. Economic resources focus includes only current assets and liabilities
B. Current financial resources focus includes all assets and liabilities
C. Economic resources focus includes long-term assets and liabilities
D. There is no significant difference between the two focuses

Answer 44

C. Economic resources focus includes long-term assets and liabilities

The economic resources measurement focus includes all assets and liabilities, both current and long-term, providing a comprehensive view of the government’s financial position. The current financial resources focus, on the other hand, is concerned only with current assets and liabilities.

Question 45

FAR1A10006
Which of the following would not appear on a classified balance sheet?
A) Accumulated Depreciation
B) Sales
C) Common Stock
D) Accounts Payable

Answer 45

B) Sales
Sales is an income statement item representing the revenue earned from selling goods or services. It does not appear on the balance sheet, which shows the company’s financial position at a point in time. Accumulated Depreciation, Common Stock, and Accounts Payable are all items that appear on a classified balance sheet.

Question 46

FAR1F10040
Which ratio is not a solvency ratio?
A. Debt-to-Equity Ratio
B. Times Interest Earned
C. Total Debt Ratio
D. Return on Equity

Answer 46

D. Return on Equity

Return on Equity is not a solvency ratio; it measures a company’s profitability relative to shareholders’ equity. The Debt-to-Equity Ratio (A), Times Interest Earned (B), and Total Debt Ratio (C) are all solvency ratios, which assess a company’s ability to meet its long-term financial obligations.

Question 47

Financial statement ratios and performance metrics are crucial tools used

Answer 47

in the analysis of a company’s financial health and performance

Question 48

Liquidity Ratios
These ratios measure a company’s ability to meet its short-term obligations.

Answer 48

● Current Ratio: Current Assets / Current Liabilities. It indicates whether the company can cover its short-term debts with its short-term assets. It considers cash, marketable securities, inventory, and receivables
● Quick Ratio (Acid-Test Ratio): (Current Assets - Inventory - Prepaids) / Current Liabilities. A more stringent measure than the current ratio as it excludes inventory. It assesses a company’s ability to meet short-term obligations with its most liquid assets, excluding inventory and prepaids

Question 49

Solvency Ratios
These assess a company’s ability to meet long-term obligations and its financial leverage.

Answer 49

● Debt-to-Equity Ratio: Total Liabilities / Shareholders’ Equity. It shows the proportion of equity and debt the company uses to finance its assets. It indicates how
much the company is financing its operations through debt versus wholly owned funds. It helps in assessing the financial leverage and risk profile of a company. A higher ratio suggests higher
financial risk due to more debt, which could be a concern for creditors and investors.
● Times interest earned or Interest Coverage Ratio: Earnings Before Interest and Taxes (EBIT) / Interest Expense. This ratio indicates how easily a company can pay interest on its outstanding debt. It indicates how many times a company can cover its interest obligations with its
earnings before interest and taxes. It measures the margin of safety a company has for paying interest during a given
period. It’s crucial for creditors and investors to assess a company’s ability to meet its debt obligations. A higher ratio suggests greater ability to meet interest
obligations, implying lower risk of bankruptcy

Total Debt Ratio
Formula: Total Debt Ratio = (Total Liabilities / Total Assets) × 100; measures the proportion of a company’s assets that are financed by debt. It provides insight into the company’s financial structure and the extent to which it relies on debt. A higher percentage indicates more reliance on debt,
potentially increasing financial risk. Example: With $500,000 in total liabilities and $1,000,000 in total assets, the total debt ratio is 50% ($500,000 / $1,000,000 × 100)

Question 50

Profitability Ratios
These ratios evaluate a company’s ability to generate earnings relative to its revenue, operating costs, and shareholders’ equity.

Answer 50

● Net Profit Margin: Net Income / Revenue. It measures how much profit a company makes for each dollar of its sales.
● Return on Assets (ROA): (Net Income / Total Assets) X 100. This indicates how efficiently a company uses its assets to generate profit.
● Return on Equity (ROE): (Net Income / Shareholder’s Equity) X 100. It measures how effectively a company uses investments to generate earnings growth.

Gross Profit Margin
Formula: Gross Profit Margin = (Gross Profit / Revenue) × 100; measures how much of each dollar of revenue is left over after paying for the cost of producing the goods or services (COGS). A higher gross profit margin indicates that a company is efficient at managing its production costs and pricing its products. It helps in assessing a company’s production efficiency and pricing strategy. Investors and managers use it to compare profitability against competitors
and industry averages. It’s crucial for determining whether a company can cover its operating expenses and still generate profit.
Example:
● Revenue: $200,000
● Cost of Goods Sold (COGS): $120,000
● Gross Profit: Revenue - COGS = $200,000 - $120,000 = $80,000
Calculation:
𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 = ( $80,000/200,000 ) 𝑥 100 = 40%

Return on Sales (Operating Profit Margin)
Formula: Return on Sales = (Operating Profit / Revenue) × 100; shows the percentage of revenue that is converted into operating profit. It reflects a company’s ability to
generate profit from its operations, before considering financial expenses like interest and taxes. It’s used to evaluate a company’s
operational efficiency and pricing strategy. A higher ratio suggests better control over operating costs and the ability to generate more profit from sales. It’s crucial for managers in decision-making regarding cost control, pricing, and operational strategies.
Example:
● Revenue: $200,000
● Operating Expenses (including COGS): $150,000
● Operating Profit: Revenue - Operating Expenses = $200,000 - $150,000 = $50,000
Calculation:
𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑆𝑎𝑙𝑒𝑠 = ($50,000/$200,000 ) 𝑥 100 = 25%

Question 51

Efficiency Ratios
These ratios indicate how well a company utilizes its assets and liabilities internally.

Answer 51

● Asset Turnover Ratio: Net Sales / Average Total Assets. This measures a firm’s efficiency in using its assets to generate
sales. It shows how well the company is using its assets to produce revenue. It’s useful for comparing the efficiency of different companies in using their assets to generate sales. Higher turnover indicates better performance.
● Inventory Turnover Ratio: Cost of Goods Sold / Average Inventory. It shows how quickly a company sells and replaces its inventory. It’s critical for evaluating how efficiently inventory is managed. A higher turnover rate often indicates strong sales or effective inventory management.

Question 52

Market Value Ratios
These provide insight into the stock market’s valuation of the company.

Answer 52

● Earnings Per Share (EPS): Net Income / Number of Common Shares Outstanding. EPS indicates the profitability of a company on a per-share basis.
● Price-to-Earnings (P/E) Ratio: Market Price per Share / Earnings per Share. It reflects investors’ expectations of future earnings. It measures a company’s current share price relative to its per-share earnings. It indicates what the market is willing to pay today for a stock based on its past or future earnings. It is used by investors to evaluate the relative value of a company’s shares and to compare the company’s valuation with those of others. A higher P/E ratio might indicate higher expectations for future growth

Question 53

Cash Flow Ratios
These ratios use the data from the cash flow statement to assess the company’s cash flow health.

Answer 53

● Operating Cash Flow Ratio: Operating Cash Flow / Total Debts. This ratio indicates a company’s ability to cover its total debts with its annual cash flow from operations.
● Free Cash Flow to Equity (FCFE): Cash Flow from Operations - Capital Expenditures - Debt Payments + New Debt Issued. This measures the cash a company generates that is available to its shareholders.

Question 54

Accounts Receivable Turnover
Formula: Accounts Receivable Turnover =

Answer 54

Net Credit Sales / Average Accounts Receivable; measures how effectively a company manages its accounts receivable and how quickly it converts them into cash; It helps assess the efficiency of credit policies and collection processes. A higher turnover rate indicates more efficient collection.

Question 55

Accounts Payable Turnover
Formula: Accounts Payable Turnover =

Answer 55

Total Supplier Purchases /Average Accounts Payable; measures the rate at which a company pays off its suppliers. It’s useful for assessing the company’s creditworthiness and payment habits to suppliers. A higher turnover rate might indicate that the company is paying off
suppliers quickly.
Example: With $500,000 in purchases and $100,000 in average accounts payable, the turnover is 5 ($500,000 / $100,000)

Question 56

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization)

Answer 56

Formula: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization. EBITDA is a measure of a company’s overall financial performance and is used as an
alternative to simple earnings or net income. It presents the company’s profitability before deductions for interest, taxes, depreciation, and amortization. It allows for comparisons of profitability
between different companies by eliminating the effects of financing and accounting decisions. This is particularly useful in comparing companies with different capital structures and tax situations.
Example: If a company’s net income is $100,000, with interest expenses of $20,000, tax expenses of $30,000, depreciation of $10,000, and amortization of $5,000, the EBITDA would be $165,000 ($100,000 + $20,000 + $30,000 + $10,000 + $5,000)

Question 57

3. Dividend Payout Ratio

Answer 57

Formula: Dividend Payout Ratio = (Total Dividends Paid / Net Income) × 100. It shows the percentage of a company’s earnings that is paid out as dividends to
shareholders. It indicates how well a company’s earnings support the dividend payments. Investors use it to assess if
a company’s dividend payments are sustainable.
Example: If a company’s net income is $200,000 and it pays out $50,000 in dividends, the dividend payout ratio is 25% ($50,000 / $200,000 × 100).

Question 58

Sales Variance

Answer 58

Formula: Sales Variance = Actual Sales - Budgeted Sales. It measures the difference between what a company expected to sell and what it actually sold. This can be further broken down into volume variance (difference due to the number of units sold) and price variance (difference due to the selling price). It helps identify whether the variance is due to selling fewer products than expected, selling them at a different price, or both. This information is crucial for marketing and sales strategies.
Example: If actual sales are $200,000 against budgeted sales of $180,000, the sales variance is +$20,000, indicating better
performance than expected

Question 59

Expense or Cost Variance

Answer 59

Formula: Expense Variance = Actual Expenses - Budgeted Expenses. It measures the difference between what was expected to be spent and what was actually spent. It can be favorable (less spending than budgeted) or unfavorable (more spending than budgeted). It helps in controlling costs, identifying inefficiencies, and adjusting operational strategies. Understanding why costs vary from the budget is crucial for
effective financial management.
Example: If actual expenses are $50,000 against budgeted expenses of $55,000, the expense variance is -$5,000, which is favorable.

Question 60

Profit Variance

Answer 60

Formula: Profit Variance = Actual Profit - Budgeted Profit. It indicates the difference between the expected profitability and actual profitability. This variance is critical for assessing overall financial performance. It helps in understanding the effectiveness of sales and cost management strategies.
Example: If actual profit is $150,000 against a budgeted profit of $140,000, the profit variance is +$10,000, a favorable outcome.

Question 61

Material Variance

Answer 61

Formula: Material Variance = (Actual Quantity Used × Actual Price) - (Standard Quantity Expected × Standard Price). It measures the difference between the actual cost of materials used and what the cost
should have been according to standards. It includes both material price variance and material quantity variance. It identifies inefficiencies in the use of materials and deviations in purchasing costs, aiding in
supply chain and production management.
Example: If the actual cost of materials is $80,000 versus a standard (budgeted) cost of $75,000, the material variance is +$5,000, indicating higher costs than expected