Financial Statement Final Exam

Debt-to-capital ratio

Total Debt/(Total debt+Total shareholders equity)

Debt-to-assets ratio

Total Debt/Total Assets

Debt-to-equity ratio

Total Debt/Total shareholders' equity

According to the IASB Conceptual Framework, the fundamental qualitative characteristics that make financial statements useful are: A. verifiability and timeliness. B. relevance and faithful representation. C. understandability and relevance.

The fundamental qualitative characteristics are relevance and faithful representation. Verifiability, timeliness, and understandability are enhancing qualitative characteristics.

For its fiscal year-end, Sublyme Corporation reported net income of $200 million and a weighted average of 50,000,000 common shares outstanding. There are 2,000,000 convertible preferred shares outstanding that paid an annual dividend of $5. Each preferred share is convertible into two shares of the common stock. The diluted EPS is closest to: $3.52 $3.65 $3.70

$3.70 =200M/(50M+(2M*2))

Which of the following statements is CORRECT? Income tax expense: A) includes taxes payable and deferred income tax expense. B) is the amount of taxes due to the government. C) is the reported net of deferred tax assets and liabilities.

A Income tax expense is defined as expense resulting from current period pretax income. It includes taxes payable and deferred income tax expense. Taxes payable are the amount of taxes due the government.

Formula for Historical Cost

= Accumulated Depreciation + Net PPE See page 520 for complete example

Formula for Estimated Age

=Accumulated Depreciation / Annual Dep. Exp. See page 520 for complete example

Inv. Turnover Equation

=CGS/Avg. Inventory

Equation for Cash Conversion

=DOH+DSO-Number of Days Payable

Formula for Estimated total useful life

=Historical cost / Annual Dep. Exp. OR = Est. Age + Est. Remaining Life See page 520 for complete example

Formula for Estimated Remaining Life

=Net PPE(or PE) / Annual Dep. Exp. See page 520 for complete example

Rec. Turnover Equation

=REV/Avg. Receivables

Sustainable Growth Equation

=Retention Rate*ROE

Total Asset Turnover Equation

=Rev/Avg. Total Assets

The yield to maturity on a discount bond will be: A. Greater than the current yield B. Less than the current yield C. The same as the current yield

A

Which inventory method will provide the largest net income during periods of falling prices? A) LIFO. B) Weighted average cost. C) FIFO.

A During periods of falling prices last in, first out (LIFO) provides a higher net income than first in, first out (FIFO) or the average cost methods because the items most recently purchased are the ones being sold first and these costs are continually falling increasing net income. Using FIFO during periods of falling prices would cause net income to be lower than LIFO or average cost methods because the first inventory purchased is the first sold but during periods of falling prices this is the most expensive inventory causing net income to be lower.

A firm revalues its long-lived assets upward. All other things equal, which of the following financial impacts is least likely to occur? A) Higher profitability in the periods after revaluation. B) Higher earnings in the revaluation period. C) Lower leverage ratios.

A Because the asset has now been increased to a higher depreciable base, there will now be higher depreciation expense and therefore, lower profitability in the periods after revaluation. There could be higher earnings in the revaluation period because there may be impairment losses that can be reversed on the income statement. Otherwise, there will be an adjustment to earnings through other comprehensive income. Leverage ratios (i.e. debt to equity) will decrease since the increase in assets will be balanced by an increase in equity. Higher denominators and unchanged numerators will result in lower leverage ratios.

In 20X8, Oliver Ltd. received $80,000 cash from a customer for goods that it could not deliver until the next year and established a liability for unearned revenue. Oliver reports under U.S. GAAP, faces a 40% tax rate, and is located in a tax jurisdiction where unearned revenue is taxed as received. On their balance sheet for 20X8, what change in deferred tax should Oliver record as a result of this transaction? A) A deferred tax asset of $32,000. B) A deferred tax liability of $32,000. C) There is no effect on deferred tax items from this transaction.

A Oliver has paid tax on the $80,000 revenue in 20X8, but has not recorded the revenue on it for financial statement purposes. This results in a temporary difference of $32,000, which is a deferred tax asset. The tax asset will be realized when the company recognizes the revenue on its financial statements in the subsequent period.

The Hall Corporation had 100,000 shares of common stock outstanding at the beginning of the year. Hall issued 30,000 shares of common stock on May 1. On July 1, the company issued a 10% stock dividend. On September 1, Hall issued 1,000, 10% bonds, each convertible into 21 shares of common stock. What is the weighted average number of shares to be used in computing basic and diluted EPS, assuming the convertible bonds are dilutive? Average shares,=========Average shares, basic==================dilutive A. 132,000=============139,000 B. 132,000=============146,000 C. 139,000=============146,000

A The new stock is weighted by 8 / 12. The bonds are weighted by 4 / 12 and are not affected by the stock dividend. Basic shares = {[100,000 x (12 / 12)] + [30,000 x (8 / 12)]} x 1.10 = 132,000 Diluted shares = 132,000 + [21,000 x (4 / 12)] = 139,000

RGB, Inc.'s receivable turnover is ten times, the inventory turnover is five times, and the payables turnover is nine times. RGB's cash conversion cycle is closest to: A. 69 days. B. 104 days. C. 150 days.

A is correct. (365 / 10 + 365 / 5 - 365 / 9) = 69 days

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp had used FIFO instead of LIFO, its reported net income for the year ended 31 December 2009 would have been higher by an amount closest to: A. $30 million B. $38 million C. $155 million

A is correct. Karl's net income under FIFO equals Karp's net income under LIFO plus the after-tax increase in the LIFO reserve. For the year ended 31 December 2009, Karp's net income under FIFO equals: NI (FIFO method) = NI (LIFO) + Increase in LIFO reserve * (1-Tax Rate) =$247 million + 38 million * (1-20%) =277.4 million Therefore, the increase in NI is: Increase in NI = NI (FIFO method) - NI (LIFO method) =$277 million - 247 million =$30.4 million

What does the P/E ratio measure? A. The "multiple" that the stock market places on a company's EPS. B. The relationship between dividends and market prices. C. The earnings for one common share of stock.

A is correct. The P/E ratio measures the "multiple" that the stock market places on a company's EPS.

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp has used FIFO instead of LIFO, which of the following ratios computed as of 31 December 2009 would most likely have been lower? A. Cash ratio. B. Current ratio. C. Gross profit margin.

A is correct. The cash ratio (cash and cash equivalents/current liabilities) would be lower because cash would have been less under FIFO. Karl's income before taxes would have been higher under FIFO, and consequently taxes paid by Karp would have also been higher and cash would have been lower. There is no impact on current liabilities. Both Karp's current ratio and gross profit margin would have been higher if FIFO has been used. The current ratio would have been higher because inventory under FIFO increases by a larger amount than the cash decreases for taxes paid. Because the cost of goods sold under FIFO is lower than under LIFO, the gross profit margin would have been higher.

At the beginning of the year, Company P purchased 1,000 shares of Company S for $80 per share. During the year, Company S paid a dividend of $4 per share. At the end of the year, Company S's share price was $75. What amount should Company P report on its balance sheet at year-end if the investment in Company S is considered a trading security, and what amount should be reported if the investment is considered an available-for-sale security? Trading=======Available-for-sale A. $75,000=====$75,000 B. $75,000=====$80,000 C. $80,000=====$80,000

A is correct. Both trading securities and available-for-sale securities are reported on the balance sheet at their fair values. At year-end, the fair value is $75,000 [$75 per share x 1,000 shares].

71. Which of the following ratio levels would suggest that a company is holding obsolete inventory? A) Low inventory turnover ratio. B) Low inventory value compared to cost of goods sold. C) Low number of days in inventory.

A is correct. Low inventory turnover (high number of days in inventory) may be a sign of slow-moving or obsolete inventory, especially when coupled with low or declining revenue growth compared to the industry. Low inventory value compared to cost of goods sold, however, implies a high inventory turnover ratio. This suggests much less risk of obsolescence.

An employer offers a defined benefit pension plan and a defined contribution pension plan. The employer's balance sheet is most likely to present an asset or liability related to: A) the defined benefit plan. B) both of these pension plans. C) the defined contribution plan.

A is correct. Only a defined benefit plan has a funded status that would appear on the balance sheet as an asset or liability. Employer payments into a defined contribution plan are recognized as expenses in the period incurred.

Under IFRS, interest expense would be classified as: A. either operating cash flow or financing cash flow. B. operating cash flow only. C. financing cash flow only.

A is correct. Under IFRS, interest expense can be classified as either an operating cash flow or financing cash flow.

An analyst observes the following data for two companies: =====================Company A ($) Company B ($) Revenue ===============4,500 ========6,000 Net income =============50 ==========1,000 Current assets ==========40,000 =======60,000 Total assets ============100,000=======700,000 Current liabilities ========10,000 =======50,000 Total debt ==============60,000 ======150,000 Shareholders' equity =====30,000 =======500,000 Which of the following choices best describes reasonable conclusions that the analyst might make about the two companies' ability to pay their current and long-term obligations? A. Company A's current ratio of4.0 indicates it is more liquid than Company B, whose current ratio is only 1.2, but Company B is more solvent, as indicated by its lower debt-to-equity' ratio. B. Company A's current ratio of 0.25 indicates it is less liquid than Company B, whose current ratio is 0.83, and Company A is also less solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B's debt-to-equity ratio of only 30 percent. C. Company A's current ratio of 4.0 indicates it is more liquid than Company B, whose current ratio is only 1 .2, and Company A is also more solvent, as indicated by a debt-to-equity ratio of 200 percent compared with Company B's debt-to-equity ratio of only 30 percent.

A is correct. Company A's current ratio of 4.0 (= $40,000/$10,000) indicates it is more liquid than Company B, whose current ratio is only 1.2 (= $60,000/350,000). Company B is more solvent, as indicated by its lower debt to-equity ratio of 30 percent (= $150,000/3500,000) compared with Company A's debt-to-equity ratio of 200 percent (= $60,000/$30,000).

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Taxes payable in year 1 are: A. $4,000. B. $6,000. C. $8,000.

A is correct. Taxes payable is taxable income x tax rate = $10,000 x 40% = $4,000. (The $10,000 was calculated in question #3.)

An analyst is evaluating the solvency and liquidity of Apex Manufacturing and has collected the following data (in millions of euro): ================FY5 (€) =====FY4 (€) ====FY3 (€) Total debt =======2,000 ======1,900 =====1,750 Total equity =====4,000 =======4,500 =====5,000 Which of the following would be the analyst's most likely conclusion? A. The company is becoming increasingly less solvent, as evidenced by the increase in its debt-to-equity ratio from 0.35 to 0.50 from FY3 to FY5. B. The company is becoming less liquid, as evidenced by the increase in its debt-to-equity ratio from 0.35 to 0.50 from FY3 to FY5. C. The company is becoming increasingly more liquid, as evidenced by the increase in its debt-to-equity ratio from 0.35 to 0.50 from FY3 to FY5.

A is correct. The company is becoming increasingly less solvent, as evidenced by its debt-to-equity ratio increasing from 0.35 to 0.50 from FY3 to FY5. The amount of a company's debt and equity do not provide direct information about the company's liquidity position. Debt to equity: FY5: 2,000/4,000 = 0.5000 FY4: 1,900/4,500 = 0.4222 FY3: 1,750/5,000 = 0.3500

Which of the following components of the cash flow statement may be prepared under the indirect method under both IFRS and US GAAP? Operating. Investing. Financing.

A is correct. The operating section may be prepared under the indirect method. The other sections are always prepared under the direct method.

In early 2009 Sanborn Company must pay the tax authority €37,000 on the income it earned in 2008. This amount was recorded on the company's 31 December 2008 financial statements as: A. taxes payable. B. income tax expense. C. a deferred tax liability.

A is correct. The taxes a company must pay in the immediate future are taxes payable.

Which of the following is most likely to appear in the operating section of a cash flow statement under the indirect method? Net income. Cash paid to suppliers. Cash received from customers.

A is correct. Under the indirect method, the operating section would begin with net income and adjust it to arrive at operating cash flow. The other two items would appear in the operating section under the direct method.

Cell Services Inc. (CSI) had 1,000,000 average shares outstanding during all of 2009. During 2009, CSI also had 10,000 options outstanding with exercise prices of $10 each. The average stock price of CSI during 2009 was $15. For purposes of computing diluted earnings per share, how many shares would be used in the denominator? 1,003,333. 1,006,667. 1,010,000.

A is correct. With stock options, the treasury stock method must be used. Under that method, the company would receive $100,000 (10,000 × $10) and would repurchase 6,667 shares ($100,000/$15). The shares for the denominator would be: Shares outstanding 1,000,000 Options exercises 10,000 Treasury shares purchased (6,667) Denominator 1,003,333

Assume the following for a piece of equipment: Fair value 21,100,000 Cost to sell 100,000 Value in use 13,000,000 Net carrying amount 25,000,000 The amount of the impairment would be closest to: 4,000,000 3,900,000 12,000,000

A. 4,000,000

Financial leverage ratio

Average Total Assets/Average Total Equity

Selected information from Feder Corp.'s financial activities for the year is as follows: Net income was $7,650,000. 1,100,000 shares of common stock were outstanding on January 1. The average market price per share was $62. Dividends were paid during the year. The tax rate was 40%. 10,000 shares of 6% $1,000 par value preferred shares convertible into common shares at a rate of 20 common shares for each preferred share were outstanding for the entire year. 70,000 options, which allow the holder to purchase 10 shares of common stock at an exercise price of $50 per common share, were outstanding the entire year. Feder Corp.'s diluted earnings per share (EPS) was closest to: A) $5.87. B) $5.32. C) $4.91.

B Feder's basic earnings per share ((net income - preferred dividends) / weighted average shares outstanding) was (($7,650,000 - ($1,000 × 10,000 × 0.06)) / 1,100,000 =) $6.41. If the convertible preferred stock was converted to common stock at January 1, (10,000 × 20 =) 200,000 additional common shares would have been issued, dividends on the preferred stock would not have been paid, and Diluted EPS would have been ($7,650,000 / (1,100,000 + 200,000) = $5.88. Because $5.88 is less than basic EPS of $6.41, the preferred shares are dilutive. Using the treasury stock method, if the options were exercised cash inflow would be (70,000 × 10 × $50 =) $35,000,000. The number of Feder shares that can be purchased with the inflow (cash inflow divided by the average share price) is ($35,000,000 / $62 =) 564,516. The number of shares that would have been created is (700,000 - 564,516 =) 135,484. Diluted EPS was ($7,650,000 / (1,100,000 + 135,484) =) $6.19. Because this is less than the EPS of $6.41, the options are dilutive. Combining the calculations, Diluted EPS was (($7,650,000) / (1,100,000 + 200,000 + 135,484) = $5.32.

A firm has a dividend payout ratio of 40%, a net profit margin of 10%, an asset turnover of 0.9 times, and a financial leverage multiplier of 1.2 times. The firm's sustainable growth rate is closest to: A. 4.3%. B. 6.5%. C. 8.0%

B is correct. g = (retention rate) (ROE) ROE = net profit margin x asset turnover x equity multiplier = (0.1)(0.9)(1.2) = 0.108 g = (1-0.4)(0.108) = 6.5%

Which of the following best describes valuation allowance? Valuation allowance is a reserve: A) created when deferred tax assets are greater than deferred tax liabilities. B) against deferred tax assets based on the likelihood that those assets will not be realized. C) against deferred tax liabilities based on the likelihood that those liabilities will be paid.

B Valuation allowance is a reserve against deferred tax assets based on the likelihood that those assets will not be realized. Deferred tax assets reflect the difference in tax expense and taxes payable that are expected to be recovered from future operations.

An impairment write-down is least likely to decrease a company's: A) assets. B) debt-to-equity ratio. C) future depreciation expense.

B An impairment write-down reduces equity and has no effect on debt. The debt-to- equity ratio would therefore increase.

As part of a major restructuring of business units, General Security (an industrial conglomerate operating solely in the U.S. and subject to U.S. GAAP) recognizes significant impairment losses. The Investor Relations group is preparing an informational packet for shareholders, employees, and the media. Which of the following statements is least accurate? A) The write-downs are reported as a component of income from continuing operations. B) Write-downs taken on asset values can be reversed in later years if market conditions improve. C) During the year of the write-downs, retained earnings and deferred taxes will decrease.

B Impairments cannot be restored under U.S. GAAP. Both remaining statements are correct.

Under normal circumstances, intangible assets with indefinite lives are: A) amortized over a reasonable period but not subject to impairment. B) not amortized but subject to impairment. C) amortized over a reasonable period and subject to impairment.

B Intangible assets with indefinite lives are not amortized but are subject to impairment charges. Under such situations, there may be in impairment in the asset value where events and circumstances indicate that the firm may not be able to recover the carrying value through future use. Examples include significant declines in market value of the asset or significant deterioration in the asset's physical condition.

Which of the following statements about tax deferrals is NOT correct? A) A deferred tax liability is expected to result in future cash outflow. B) Taxes payable are determined by pretax income and the tax rate. C) Income tax paid can include payments or refunds for other years.

B Taxes payable are the taxes due to the government and are determined by taxable income and the tax rate. Note that pretax income is income before tax expense and is used for financial reporting. Taxable income is the income based upon IRS rules that determines taxes due and is used for tax reporting.

avis Inc. is a large manufacturing company operating in several European countries. Davis has long-lived assets currently in use that are valued on the balance sheet at $600 million. This includes previously recognized impairment losses of $80 million. The original cost of the assets was $750 million. The fair value of the assets was determined by in independent appraisal to be $690 million. Which of the following entries may Davis record under IFRS? A) $90 million gain on income statement. B) $80 million gain on income statement and a $10 million revaluation surplus. C) $90 million revaluation surplus.

B Under IFRS, firms may choose to report long-lived assets at fair value. Upward revaluations are permitted and will result in a gain recognized on the income statement to the extent it reverses a previously recognized loss. Any excess is reported as a revaluation surplus, a direct adjustment to equity. In this case, the carrying value of the assets is $600 million ($750 million original cost less $70 million accumulated depreciation and less $80 million impairment loss). The fair value is $690 million. Of the $90 million excess of fair value over carrying value, $80 million is recognized as a gain on the income statement to reverse the $80 million impairment loss that was previously recognized. The remaining $10 million is recorded as a revaluation surplus in shareholders' equity.

An analyst gathered the following information about a company: • 100,000 common shares outstanding from the beginning of the year. • Earnings of $125,000. • 1,000, 7%, $1,000 par bonds convertible into 25 shares each, outstanding as of the beginning of the year. • The tax rate is 40%. The company's diluted EPS is closest to: A. $1.22. B. $1.25. C. $1.34.

B First, calculate basic EPS = $125,000/100,000= $1.25 Next, check if the convertible bonds are dilutive: numerator impact = (1,000 x 1,000 x 0.07) x (1 - 0.4) = $42,000 denominator impact = (1,000 x 25) = 25,000 shares per share impact = $42,000/25,000 shares = $1.68 Since $1.68 is greater than the basic EPS of $1.25, the bonds are antidilutive. Thus, diluted EPS = basic EPS = $1.25.

In applying the treasury stock method, if warrants allow the purchase of 1 million shares at $42 per share when the average price is $56 per share, how many shares will be added to the firm's weighted average number of shares outstanding? A) 1,000,000. B) 250,000. C) 420,000.

B The treasury stock method would allow the 1 million additional shares to be partially offset by the number of shares that could be repurchased with the amount of money received for those shares. In this case, the 1 million shares issued would be offset by (1,000,000 × $42 / $56) or 750,000 shares.

An analyst has gathered the following information about a company: • 50,000 common shares outstanding from the beginning of the year. • Warrants outstanding all year on 50,000 shares, exercisable at $20 per share. • Stock is selling at year end for $25. • The average price of the company's stock for the year was $15. How many shares should be used in calculating the company's diluted EPS? A. 16,667. B. 50,000. C. 66,667.

B The warrants in this case are antidilutive. The average price per share of $15 is less than the exercise price of $20. The year-end price per share is not relevant. The denominator consists of only the common stock for basic EPS.

An analyst who needs to model and forecast a company's earnings for the next three years would be least likely to: A. assume that key financial ratios will remain unchanged for the forecast period. B. use common-size financial statements to estimate expenses as a percentage of net income. C. examine the variability of the predicted outcomes by performing a sensitivity or scenario analysis.

B An earnings forecast model would typically estimate expenses as a percentage of sales.

An analyst is studying the impairment of the manufacturing equipment of WLP Corp., a UK-based corporation that follows IFRS. He gathers the following information about the equipment: Fair value ==£16,800,000 Costs to sell ==£800,000 Value in use ==£14,500,000 Net carrying amount ==£19,100,000 The amount of the impairment loss on WLP Corp.'s income statement related to its manufacturing equipment is closest to: A. £2,300,000. B. £3,100,000. C. £4,600,000

B is correct The impairment loss equals £3,100,000. Impairment = max(Recoverable amount; Value in use) — Net carrying amount = max(16,800,000- 800,000; 14,500,000)- 19,100,000 =-3,100.000

Under IFRS, a loss from the destruction of property in a fire would most likely be classified as: A. an extraordinary' item. B. continuing operations. C. discontinued operations.

B is correct A fire may be infrequent, but it would still be part of continuing operations. IFRS do not permit classification of an item as extraordinary. Discontinued operations relate to a decision to dispose of an operating division.

A company purchased a new pizza oven directly from Italy for $12,676. It will work for 5 years and has no salvage value. The tax rate is 41%, and annual revenues are constant at $7,192. For financial reporting, the straight-line depreciation method is used, but for tax purposes depreciation is accelerated to 35% in years 1 and 2, and 30% in year 3. For purposes of this exercise ignore all expenses other than depreciation. What is the tax payable for year one? A) $1,909. B) $1,130. C) $779.

B is correct. Tax payable for year 1 will be $1,130 = [{$7,192 - ($12,676 × 0.35)} × 0.41]

When computing net cash flow from operating activities using the indirect method, an addition to net income is most likely to occur when there is a: gain on the sale of an asset. loss on the retirement old debt. decrease in a deferred tax liability.

B is correct. An addition to net income is made when there is a loss on the retirement of debt, which is a non-operating loss. A gain on the sale of an asset and a decrease in deferred tax liability are both subtracted from net-income.

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Taxable income in year 1 is: A. $6,000. B. $10,000. C. $20,000.

B is correct. Annual depreciation expense for tax purposes is ($120,000 cost- $0 salvage value) / 3 years = $40,000. Taxable income is $50,000- $40,000 = $10,000.

Rodgers Corp. has a defined benefit pension plan. At 31 December, its pension obligation is $20 million and pension assets are $18 million. Under either IFRS or U.S. GAAP, the reporting on the balance sheet would be closest to which of the following? A) $20 million is shown as a liability and $18 million appears as an asset. B) $2 million is shown as a net pension obligation C) Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.

B is correct. The company will report a net pension obligation of $2 million equal to the pension obligation ($20 million) less the plan assets ($18 million).

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp had use FIFO instead of LIFO, its debt to equity ratio computed as of 31 December 2009 would have: A. increased. B. decreased. C. remained unchanged.

B is correct. If Karp has used FIFO instead of LIFO, the debt-to-equity ratio would have decreased. No change in debt would have occurred, but shareholder's equity would have increase as a result of higher retained earnings.

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp had used FIFO instead of LIFO, the amount of cost of goods sold reported as of 31 December 2009 would have been closest to: A. $2,056 million. B. $2,173 million. C. $2,249 million.

B is correct. Karl's COGS under the FIFO equals Karp's COGS under LIFO minus the increase in the LIFO reserve. Therefore, for the year ended 31 December 2009, Karp's COGS under FIFO equals: COGS (FIFO method) = COGS(LIFO) - Increase in LIFO reserve =$2,211 million - (155 million - 117 million) =$2,173 million

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp had used FIFO instead of LIFO, Karp's retained earnings as of 31 December 2009 would have been higher by an amount closest to: A. $117 million. B. $124 million. C. $155 million.

B is correct. Karp's retained earnings under FIFO equals Karp's retained earnings under LIFO plus the after-tax LIFO reserve. Therefore, for the year ended 31 December 2009, Karp's retained earnings under FIFO equals: RE (FIFO method) = RE (LIFO) + LIFO reserve * (1-Tax) =$787 million + 155 million * (1-20%) =$911 million Therefore, the increase in retained earnings is: Increase is RE = RE(FIFO) - RE(LIFO) =$911 million - 787 million =$124 million

Using the following information, what is the firm's cash flow from operations? Net income ========================$120 Decrease in accounts receivable =======20 Depreciation =======================25 Increase in inventory ================10 Increase in accounts payable ==========7 Decrease in wages payable ===========5 Increase in deferred tax liabilities ======15 Profit from the sale of land ===========2 A. $158. B. $170. C. $174.

B is correct. Net income — profits from sale of land + depreciation + decrease in receivables — increase in inventories + increase in accounts payable- decrease in wages payable + increase in deferred tax liabilities = 120- 2 + 25 + 20- 10 + 7- 5 + 15 = $170.

The difference between income tax expense and taxes payable is a: A) deferred tax liability. B) deferred income tax expense. C) timing difference.

B is correct. Taxes payable is defined as the taxes due to the government as determined by taxable income and the tax rate, while income tax expense is the amount actually recognized on the income statement. Deferred income tax expense is defined as the difference in income tax expense and taxes payable. Each individual deferred item is expected to be paid (or recovered) in future years.

At the beginning of the year, Company P purchased 1,000 shares of Company S for $80 per share. During the year, Company S paid a dividend of $4 per share. At the end of the year, Company S's share price was $75. What amount of investment income should Company P recognize in its income statement if the investment in Company S is considered trading, and what amount should be recognized if the investment is considered available-for-sale? Trading=======Available-for-sale A. ($1,000)=====($1,000) B. ($1,000)=====$4,000 C. ($5,000)=====$4,000

B is correct. A loss of $1,000 is recognized if the securities are considered trading securities ($4 dividend x $1,000 shares) - ($5 unrealized loss x 1,000 shares). Income is $4,000 if the investment in Company S is considered available-for-sale [$4 dividend x $1,000].

Compared with a company that uses the FIFO method, during a period of rising unit inventory costs, a company using the LIFO method will most likely appear more: A. liquid B. efficient C. profitable

B is correct. During a period of rising inventory prices, a company using the LIFO method will have higher cost of cost of goods sold and lower inventory compared with a company using the FIFO method. The inventory turnover ratio will be higher for the company using the LIFO method, thus making it appear more efficient. Current assets and gross profit margin will be lower for the company using the LIFO method, thus making it appear less liquid and less profitable.

Compared to using the FIFO method to account for inventory, during periods of rising prices, a company using the LIFO method is most likely to report higher: A. net income. B. cost of sales. C. income taxes.

B is correct. LIFO method increases cost of sales, this reducing profits and the taxes thereon.

A creditor most likely would consider a decrease in which of tire following ratios to be positive news? A. Interest coverage (times interest earned). B. Debt-to-total assets. C. Return on assets.

B is correct. In general, a creditor would consider a decrease in debt to total assets as positive news. A higher level of debt in a company's capital structure increases the risk of default and will, in general, result in higher borrowing costs for the company to compensate lenders for assuming greater credit risk. A decrease in either interest coverage or return on assets is likely to be considered negative news.

Laurelli Builders (LB) reported the following financial data for year-end 31 December: Common shares outstanding, 1 January: 2,020,000 Common shares issued as stock dividend, 1 June: 380,000 Warrants outstanding, 1 January: 500,000 Net income: $3,350,000 Preferred stock dividends paid: $430,000 Common stock dividends paid: $240,000 Which statement about the calculation of LB's EPS is most accurate? LB's basic EPS is $1.12 LB's diluted EPS is equal to or less than its basic EPS The weighted average number of shares outstanding is 2,210,000

B is correct. LB has warrants in its capital structure; if the exercise price is less than the weighted average market price during the year, the effect of their conversion is to increase the weighted average number of common shares outstanding, causing diluted EPS to be lower than basic EPS. If the exercise price is equal to the weighted average market price, the number of shares issued equals the number of shares repurchased. Therefore, the weighted average number of common shares outstanding is not affected and diluted EPS equals basic EPS. If the exercise price is greater than the weighted average market price, the effect of their conversion is anti-dilutive. As such, they are not included in the calculation of basic EPS. LB's basic EPS is $1.22 [= ($3,350,000 - $430,000)/2,400,000]. Stock dividends are treated as having been issued retroactively to the beginning of the period.

Oppnox Company reported net income of $750,000 for the year ended 31 December 2009. The company had a weighted average of 690,000 shares of common stock outstanding. In addition, the company has only one potentially dilutive security: $50,000 of 6 percent convertible bonds, convertible into a total of 10,000 shares. Assuming a tax rate of 30 percent, calculate Oppnox's basic and diluted EPS.

Basic EPS (750,000/690,000) = $1.09 Dilutive EPS (750,000+(50,000*6%-30%))/(60,000+10,000)=$1.07 If-converted method: Income Increases by 2,100 Common Stock Increases by 10,000

An analyst who is interested in a company's long-term solvency would most likely examine the: A. return on total capital. B. defensive interval ratio. C. fixed charge coverage ratio.

C Fixed charge coverage is a solvency ratio. Return on total capital is a measure of profitability and the defensive interval ratio is a liquidity measure.

Return on equity using the traditional DuPont formula equals: A. (net profit margin) (interest component) (solvency ratio). B. (net profit margin) (total asset turnover) (tax retention rate). C. (net profit margin) (total asset turnover) (financial leverage multiplier).

C This is the correct formula for the three-ratio DuPont model for ROE.

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Pretax income in year 4 is: A. $6,000. B. $10,000. C. $20,000.

C Annual depreciation expense for financial purposes is ($120,000 cost- $0 salvage value) / 4 years = $30,000. Pretax income is $50,000 - $30,000 = $20,000.

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. At the end of year 2, the firm's balance sheet will report a deferred tax: A. asset of$4,000. B. asset of$8,000. C. liability of $8,000.

C At the end of year 2, the tax base is $40,000 ($120,000 cost — $80,000 accumulated tax depreciation) and the carrying value is $60,000 ($120,000 cost- $60,000 accumulated financial depreciation). Since the carrying value exceeds the tax base, a DTL of $8,000 [($60,000 carrying value- $40,000 tax base) x 40%] is reported.

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Income tax expense in year 4 is: A. $4,000. B. $6,000. C. $8,000.

C Because there has been no change in the tax rate, income tax expense is pretax income x tax rate = $20,000 x 40% = $8,000. (The $20,000 was calculated in question #5.)

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Taxes payable in year 4 are: A. $4,000. B. $6,000. C. $20,000.

C Note that the asset was fully depreciated for tax purposes after year 3, so taxable income is $50,000. Taxes payable for year 4 = taxable income x tax rate = $50,000 x 40% = $20,000.

A firm acquires an asset for $120,000 with a 4-year useful life and no salvage value. • The asset will generate $50,000 of cash flow for all four years. • The tax rate is 40% each year. • The firm will depreciate the asset over three years on a straight-line (SL) basis for tax purposes and over four years on a SL basis for financial reporting purposes. Suppose tax rates rise during year 2 to 50%. At the end of year 2, the firm's balance sheet will show a deferred tax liability of: A. $5,000. B. $6,000. C. $10,000.

C The deferred tax liability is now $10,000 [($60,000 carrying value — $40,000 tax base) x 50%].

An analyst is interested in assessing both the efficiency and liquidity of Spherion PLC. The analyst has collected the following data for Spherion: ==========================FY3 ===FY2 ===FY1 Days of inventory on hand ====32 ====34 ====40 Days sales outstanding=======28 ====25 ====23 Number of days of payables == 40 ====35 ====35 Based on this data, what is the analyst least likely to conclude? A. Inventory management has contributed to improved liquidity. B. Management of payables has contributed to improved liquidity. C. Management of receivables has contributed to improved liquidity.

C is correct The analyst is unlikely to reach the conclusion given in Statement C because days of sales outstanding increased from 23 days in FY1 to 25 days in FY2 to 28 days in FY3, indicating that the time required to collect receivables has increased over the period. This is a negative factor for Spherioris liquidity. By contrast, days of inventory on hand dropped over the period FY1 to FY3, a positive for liquidity. The company's increase in days payable, from 35 days to 40 days, shortened its cash conversion cycle, thus also contributing to improved liquidity.

If a firm overestimates its warranty expenses, which of the following results is least likely? A) A deferred tax asset will result. B) A timing difference will result between tax and financial reporting. C) Income tax expense will be greater than taxes payable.

C is correct. Income tax expense will be less than taxes payable because the firm can only recognize warranty expense as they occur. Thus, if the warranty expenses are overestimated on the financial statements income tax expense will be less that taxes payable.

If a firm uses accelerated depreciation for tax purposes and straight-line depreciation for financial reporting, which of the following results is least likely? A) Income tax expense will be greater than taxes payable. B) A temporary difference will result between tax and financial reporting. C) A permanent difference will result between tax and financial reporting.

C is correct. A permanent difference between tax and financial reporting is a difference that is expected to not reverse itself. Under normal circumstances, the effects of the different depreciation methods will reverse.

Balance Sheet info as of 31 December: 2009 2008 Cash and cash equivalents 172 157 Accounts receivable 626 458 Inventories 620 539 Other current assets 125 65 Total current assets 1,543 1,219 Property and equipment, net 3,035 2,972 Total assets 4,578 4,191 Total current liabilities 1,495 1,395 Long-term debt 644 604 Total liabilities 2,139 1,999 Common stock & P.I.C. 1,652 1,652 Retained Earnings 787 540 Total shareholders' equity 2,439 2,192 Total liabilities & equity 4,578 4,191 Income Statement for year ended 31 December: 2009 2008 Sales 4,346 4,161 Cost of goods sold 2,211 2,147 Depreciation & Amort exp 139 119 SGA expense 1,656 1,637 Interest expense 31 18 Income tax expense 62 48 Net income 247 192 -The LIFO reserves as of 31 December 2009 and 2008 are $155 million and $117 million respectively -The effective income tax rate applicable to Karp for 2009 and earlier periods is 20% If Karp has used FIFO instead of LIFO, the amount of inventory reported as of 31 December 2009 would have been closest to: A. $465 million. B. $658 million. C. $775 million.

C is correct. Karl's inventory under FIFO equals Karp's inventory under LIFO plus the LIFO reserve. Therefore, as of 31 December 2009, Karp's inventory under FIFO equals: Inventory (FIFO method) = Inventory (LIFO) + LIFO reserve =$620 million + $155 million =$775 million

Which of the following tax definitions is least accurate? A. Taxable income is income based on the rules of the tax authorities. B. Taxes payable are the amount due to the government. C. Pretax income is income tax expense divided by one minus the statutory tax rate.

C is correct. Pretax income and income tax expense are not always linked because of temporary and permanent differences.

An analyst is evaluating the solvency and liquidity of Apex Manufacturing and has collected the following data (in millions of euro): ================FY5 (€) =====FY4 (€) ====FY3 (€) Total debt =======2,000 ======1,900 =====1,750 Total equity =====4,000 =======4,500 =====5,000 what would be the most reasonable explanation of the financial data? A. The decline in the company's equity results from a decline in the market value of this company's common shares. B. The €250 increase in the company's debt from FY3 to FY5 indicates that lenders are viewing the company as increasingly creditworthy. C. The decline in the company's equity' indicates that the company may be incurring losses, paying dividends greater than income, and/or repurchasing shares.

C is correct. The decline in the company's equity indicates that the company may be incurring losses, paying dividends greater than income, or repurchasing shares. Recall that Beginning equity +New shares issuance — Shares repurchased + Comprehensive income — Dividends = Ending equity. The book value of a company's equity is not affected by changes in the market value of its common stock. An increased amount of lending does not necessarily indicate that lenders view a company as increasingly creditworthy. Creditworthiness is not evaluated based on how much a company has increased its debt but rather on its willingness and ability to pay its obligations. (Its financial strength is indicated by its solvency, liquidity, profitability, efficiency, and other aspects of credit analysis.)

A benefit of using the direct method rather than the indirect method method when reporting operating cash flows is that the direct method: mirrors a forecasting approach. is easier and less costly. provides specific information on the sources of operating cash flows.

C is correct. The primary argument in favor of the direct method is that it provides information on the specific sources of operating cash receipts and payments. Arguments for the indirect method include that it mirrors a forecasting approach and it is easier and less costly.

79. Which of the following is most likely for a firm with high inventory turnover and lower sales growth than the industry average? The firm: A. is managing its inventory effectively. B. may have obsolete inventory that requires a writedown. C. may be losing sales by not carrying enough inventory.

C is correct. High inventory turnover coupled with low sales growth relative to the industry may be an indication of inadequate inventory levels. In this case, the firm may be losing sales by not carrying enough inventory.

70. The inventory turnover ratio and the number of days in inventory are least likely used to evaluate the: A) effectiveness of a firm's inventory management. B) age of a firm's inventory. C) stability of a firm's inventory levels.

C is correct. Neither metric is directly relevant in evaluating the stability of a firm's inventory levels. Determining stability would presumably require other information such as purchase and sales levels, for example. The inventory turnover ratio and the number of days in inventory can be used to evaluate the relative age of a firm's inventory as well as the effectiveness of a firm's inventory management.

Income tax expense reported on a company's income statement equals taxes payable, plus the net increase in: A. deferred tax assets and deferred tax liabilities. B. deferred tax assets, less the net increase in deferred tax liabilities. C. deferred tax liabilities, less the net increase in deferred tax assets.

C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability', whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.

Interest paid is classified as an operating cash flow under: A. US GAAP but may be classified as either operating or investing cash flows under IFRS. B. IFRS but may be classified as either operating or investing cash flows under US GAAP. C. US GAAP but may be classified as either operating or financing cash flows under IFRS.

C is correct. Interest expense is always classified as an operating cash flow under US GAAP but may be classified as either an operating or financing cash flow under IFRS.

In order to assess a company's ability to fulfill its long-term obligations, an analyst would most likely examine: activity ratios. liquidity ratios. solvency ratios.

C is correct. Solvency ratios are used to evaluate the ability of a company to meet its long-term obligations. An analyst is more likely to use activity ratios to evaluate how efficiently a company uses its assets. An analyst is more likely to use liquidity ratios to evaluate the ability of a company to meet its short-term obligations.

An analyst compiles the following data for a company: FY13 FY14 FY15 ROE 19.8% 20.0% 22.0% Return on total assets 8.1% 8.0% 7.9% Total asset turnover 2.0 2.0 2.1 Based only on the information above, the most appropriate conclusion is that, over the period FY13 to FY15, the company's: net profit margin and financial leverage have decreased. net profit margin and financial leverage have increased. net profit margin has decreased but its financial leverage has increased.

C is correct. The company's net profit margin has decreased and its financial leverage has increased. ROA = Net profit margin × Total asset turnover. ROA decreased over the period despite the increase in total asset turnover; therefore, the net profit margin must have decreased. ROE = Return on assets × Financial leverage. ROE increased over the period despite the drop in ROA; therefore, financial leverage must have increased.

A decomposition of ROE for Company A and Company B is as follows: Company A Company B FY15 FY14 FY15 FY14 ROE 26.46% 18.90% 26.33% 18.90% Tax burden 0.7 0.75 0.75 0.75 Interest burden 0.9 0.9 0.9 0.9 EBIT margin 7.00% 10.00% 13.00% 10.00% Asset turnover 1.5 1.4 1.5 1.4 Leverage 4 2 2 2 An analyst is most likely to conclude that: Company A's ROE is higher than Company B's in FY15, and one explanation consistent with the data is that Company A may have purchased new, more efficient equipment. Company A's ROE is higher than Company B's in FY15, and one explanation consistent with the data is that Company A has made a strategic shift to a product mix with higher profit margins. The difference between the two companies' ROE in FY15 is very small and Company A's ROE remains similar to Company B's ROE mainly due to Company A increasing its financial leverage.

C is correct. The difference between the two companies' ROE in 2015 is very small and is mainly the result of Company A's increase in its financial leverage, indicated by the increase in its Assets/Equity ratio from 2 to 4. The impact of efficiency on ROE is identical for the two companies, as indicated by both companies' asset turnover ratios of 1.5. Furthermore, if Company A had purchased newer equipment to replace older, depreciated equipment, then the company's asset turnover ratio (computed as sales/assets) would have declined, assuming constant sales. Company A has experienced a significant decline in its operating margin, from 10 percent to 7 percent which, all else equal, would not suggest that it is selling more products with higher profit margins.

Which of the following ratios would be most useful in determining a company's ability to cover its lease and interest payments? ROA. Total asset turnover. Fixed charge coverage.

C is correct. The fixed charge coverage ratio is a coverage ratio that relates known fixed charges or obligations to a measure of operating profit or cash flow generated by the company. Coverage ratios, a category of solvency ratios, measure the ability of a company to cover its payments related to debt and leases.

A decomposition of ROE for Integra SA is as follows: FY12 FY11 ROE 18.90% 18.90% Tax burden 0.70 0.75 Interest burden 0.90 0.90 EBIT margin 10.00% 10.00% Asset turnover 1.50 1.40 Leverage 2.00 2.00 Which of the following choices best describes reasonable conclusions an analyst might make based on this ROE decomposition? A. Profitability and the liquidity position both improved in FY12. B. The higher average tax rate in FY12 offset the improvement in profitability, leaving ROE unchanged. C. The higher average tax rate in FY12 offset the improvement in efficiency, leaving ROE unchanged.

C is correct. The increase in the average tax rate in FY12, as indicated by the decrease in the value of the tax burden (the tax burden equals one minus the average tax rate), offset the improvement in efficiency indicated by higher asset turnover) leaving ROE unchanged. The EBIT margin, measuring profitability, was unchanged in FY12 and no information is given on liquidity.

For 2009, Flamingo Products had net income of $1,000,000. At 1 January 2009, there were 1,000,000 shares outstanding. On 1 July 2009, the company issued 100,000 new shares for $20 per share. The company paid $200,000 in dividends to common shareholders. What is Flamingo's basic earnings per share for 2009? $0.80. $0.91. $0.95.

C is correct. The weighted average number of shares outstanding for 2009 is 1,050,000. Basic earnings per share would be $1,000,000 divided by 1,050,000, or $0.95.

Relationship among yield measures: For Par Value Bonds

Coupon rate = current yield = YTM

Relationships among yield measures: For Premium Bonds:

Coupon rate > current yield > YTM

Relationships among yield measures: For Discount Bonds

Coupon rate < current yield < YTM

Debt Ratios

Focus on the balance sheet and measure the amount of debt capital relative to equity capital -Debt-to-assets -Debt-to-capital -Debt-to-equity -Financial leverage

Interest Expense is classified as O, I, or F for financing services under GAAP vs. IFRS?

Operating Activities for both.

Coverage Ratios

focus on the income statement and measure the ability of a company to cover its debt payments -Interest coverage -fixed charge coverage