Chapter 2: Review of Accounting

A company's earnings after taxes are $200,000 and the firm pays preferred stockholders $18,000 in dividends. The company has 91,000 shares of common stock outstanding.Earnings per share is equal to ________ dollars. (Round to the nearest whole number and do not include the dollar sign)

$2

True/ False: Accumulated depreciation shows up in the income statement, while depreciation expense shows up on the balance sheet.

False

True/ False: An increase in assets represents a positive source of funds.

False

True/ False: Book value per share is the most important measure of value of a firm for a stockholder.

False

True/ False: Stockholders equity is equal to liabilities plus assets.

False

True/False: Dividing earnings after taxes (which includes all profits distributed to both preferred stockholders and common stockholders) by common shares outstanding produces earnings per share.

False

True/False: Stockholders equity is equal to liabilities plus assets.

False

True/False: The corporate tax rate change of 2018 means that corporations are no longer responsible to pay state and foreign taxes.

False

True/False: Accumulated depreciation should always be equal to the depreciation expense charged in the income statement.

False

True/False: An increase in accrued expenses results in a cash outflow on the statement of cash flows.

False

True/False: An increase in assets represents a positive source of funds.

False

True/False: Book value per share of stock and market value per share of stock are usually the same dollar amount.

False

True/False: Book value per share of stock is of greater concern to the financial manager than market value per share of stock.

False

True/False: For corporations with low taxable income (less than $50,000), the effective tax rate can be as much as 40%.

False

True/False: Free cash flow is equal to cash flow from operating activities plus depreciation.

False

True/False: It is not possible for a company with a high gross profit margin to have a low operating profit.

False

True/False: Liquidity means that the items that can convert to cash show up as cash on the balance sheet.

False

True/False: Marketable securities are short term investments and are valued on the balance sheet at their original purchase price.

False

True/False: Preferred stock dividends are tax deductible.

False

True/False: Sales minus cost of goods sold is equal to earnings before taxes.

False

True/False: The real value of a firm is the same from an economic and accounting perspective.

False

Free cash flow is equal to cash flow from operating activities minus necessary capital expenditures and normal dividend payments. True or False

True

Total assets of a firm are paid for with liabilities and stockholders' equity. True or False

True

True/ False: Assume that two companies both have a net income of $100,000. The firm with the highest depreciation expense will have the highest cash flow, assuming all other adjustments are equal.

True

True/ False: The indirect method of preparing the Cash Flow Statement basically adjusts the net income to reflect what the financials would have looked like if cash basis was used instead of accrual basis.

True

True/False: A $125,000 credit sale could be a part of a firm's cash flow from operations if money is received within the firm's same fiscal year.

True

True/False: A cash flow statement is considered correct if the change in cash flow plus the beginning balance ties to the ending cash balance.

True

True/False: A decrease in bonds payable results in a cash outflow on the statement of cash flows.

True

True/False: Asset accounts are listed in order of their liquidity.

True

True/False: Balance sheet items should be adjusted for inflation when valuing a company.

True

True/False: Depreciation is an accrual accounting entry that does not affect the cash account so it needs to be adjusted for when using the indirect method of the Cash Flow Statement.

True

True/False: Operating profit is essentially a measure of how efficient management is in generating revenues and controlling expenses.

True

True/False: Retained earnings shown on the balance sheet represents profits generated from prior year's earnings less any prior dividends.

True

True/False: Stockholders equity is equal to assets minus liabilities.

True

The major limitation of financial statements are their complexity. their lack of comparability. their use of historical cost accounting. their lack of detail.

their use of historical cost accounting.

Net worth is equal to stockholders' equity -plus dividends. -minus preferred stock. -plus preferred stock. -minus liabilities.

-minus preferred stock.

A company sells 500 shirts at a price of $15 each with a cost of goods sold of $2 per shirt. The company has selling and administrative expenses of $2,500, depreciation expenses of $500, interest expenses of $1,000, and a tax rate of 35%. Calculate the EBT?

2,500 Explanation: GP@ 6,500= (500X (15-2)): Less operating expenses @ $3,000= 2,500 +500; EBIT=$3,500; Less Int@ $1,000; EBT= $2,500

Candy Company had sales of $320,000 and cost of goods sold of $112,000. What is the gross profit margin (ratio of gross profit to sales)? 65% 73.3% 55% 35%

65% Explanation Sales: $320,000 Cost of goods sold:112,000 Gross Profit: $208,000 Gross Profit Margin=Gross Profit/Sales =$208,000/$320,000 = 0.65

Which of the following factors do not influence the firm's P/E ratio? Shares outstanding Past earnings All of the options influence the firm's P/E ratio. Volatility in business performance

All of the options influence the firm's P/E ratio.

Which of the following would represent a use of funds and, indirectly, a reduction in cash balances? An increase in inventories A decrease in marketable securities An increase in accounts payable The sale of new bonds by the firm

An increase in inventories

Before issuing new shares of stock, the financial manager must ensure that the additional shares will generate sufficient earnings to avoid a reduction in which of the following?

EPS

A measure of the earnings available to common stockholders per share of stock owned.

Earnings per share

True/False: An increase in accounts receivable results in a cash inflow on the statement of cash flows.

False

True/False: Book value per share is the most important measure of value of a firm for a stockholder.

False

True/False: Cash flow from operations is equal to earnings before taxes minus depreciation.

False

True/False: The income statement shows the amount of profits earned based on any one given day.

False

True/False: The investments account includes marketable securities.

False

True/False: The price-earnings (P/E) ratio is strongly related to the past performance of the firm.

False

How many of the following items decrease cash flow in the statement of cash flows? Increase in accounts receivable Increase in notes payable Depreciation expense Increase in investments Decrease in accounts payable Decrease in prepaid expenses Dividend payment Increase in accrued expenses Two of these items decrease cash flow Three of these items decrease cash flow Four of these items decrease cash flow Five of these items decrease cash flow

Four of these items decrease cash flow

The difference between the cost of purchased or manufactured goods and the revenue generated by such costs is called:

Gross profit

Earnings before taxes (EBT) is equal to:

Gross profit minus operating expenses and interest expense

A financial statement that measures a firm's profitability over a period of time.

Income statement

Increasing interest expense will have what effect on Earnings Before Interest and Taxes (EBIT)? Decrease it. Increase it. It will have no effect. There is not enough information to tell.

It will have no effect.

Increasing interest expense will have what effect on Earnings Before Interest and Taxes (EBIT)? Increase it. Decrease it. It will have no effect. There is not enough information to tell.

It will have no effect.

Classify the following balance sheet items as current or noncurrent:

Items Current/ Non-current Retained earnings Noncurrent Accounts payable Current Prepaid expenses Current Plant and equipment Noncurrent Inventory Current Common stock Noncurrent Bonds payable Noncurrent Accrued wages payable Current Accounts receivable Current Capital in excess of par Noncurrent Preferred stock Noncurrent Marketable securities Current

A measure of how efficient management is in generating revenues and controlling expenses.

Operating profit

How many of the following items are found on the income statement, rather than the balance sheet? Sales Notes payable (due in six months) Bonds payable (mature in 10 years) Common stock Depreciation expense Inventories Capital in excess of par value Net income (earnings after taxes) Income tax payable Two of these items are found on the income statement. Three of these items are found on the income statement. Four of these items are found on the income statement. Five of these items are found on the income statement.

Three of these items are found on the income statement.

The income statement is the major device for measuring the profitability of a firm over a period of time. True or False

True

True/ False: The Statement of Cash Flows has three parts: operating, investing, and financing under both the indirect and direct method.

True

True/False: The sale of a firm's securities is a source of positive funds, whereas the purchase of securities is a use of funds.

True

True/False: Total assets of a firm are paid for with liabilities and stockholders' equity.

True

Reinvested funds into retained earnings theoretically belong to bond holders. common stockholders. employees. All of the options

common stockholders.

When a firm's earnings are falling more rapidly than its stock price, its P/E ratio will either go up or down. go down. remain the same. go up.

go up.

Depreciation is a source of cash inflow because it is a non-cash expense, so it needs to be added back to net income when using the indirect method. it supplies cash for future asset purchases. it is a tax-deductible cash expense. it is a taxable expense.

it is a non-cash expense, so it needs to be added back to net income when using the indirect method.

Asset accounts on the balance sheet are listed in order of importance. profitability. liquidity. dollar amount.

liquidity.

Net worth is equal to stockholders' equity plus dividends. minus preferred stock. plus preferred stock. minus liabilities.

minus preferred stock.

Earnings per share is -net income minus preferred dividends divided by number of shares outstanding. -net income divided by stockholders' equity. -net income divided by number of shares outstanding. -operating profit divided by number of shares outstanding. Prev

net income minus preferred dividends divided by number of shares outstanding.

Total stockholders' equity consists of preferred stock and common stock. common stock and retained earnings. common stock, preferred stock, and capital paid in excess of par. preferred stock, common stock, capital paid in excess of par, and retained earnings.

preferred stock, common stock, capital paid in excess of par, and retained earnings.

The income statement provides a detail of the firm's______ over a period of time.

revenues and expenses

Operating profit is equal to:

sales minus cost of goods sold, selling and administrative expenses, and depreciation

Gross profit is equal to sales minus cost of goods sold. selling and administrative expenses. sales minus cost of goods sold and selling and administrative expenses. sales minus cost of goods sold and depreciation expense.

sales minus cost of goods sold.

Which of the following is an outflow of cash? Profitable operations The sale of equipment The sale of the company's common stock The payment of cash dividends

The payment of cash dividends

Accounting income is based on verifiably completed transactions. True or False

True

Farah Snack Co. has earnings after taxes of $150,000. Interest expense for the year was $20,000; preferred dividends paid were $20,000; and common dividends paid were $30,000. Taxes were $22,500. The firm has 100,000 shares of common stock outstanding. Earnings per share on the common stock was $1.30. $1.10. $0.75. $0.80.

$1.30 Explanation Earnings after taxes − Preferred stock dividends = Earnings available to common $150,000 − $20,000 = $130,000 EAC Earnings per share = Earnings available to common/number of shares outstanding $130,000/100,000 = $1.30

Assuming a tax rate of 21%, the after-tax cost of a $100,000 dividend payment is $100,000 $70,000 $30,000 None of the options

$100,000 Explanation Dividends are not tax deductible.

Assuming a tax rate of 21%, the after-tax cost of a $100,000 dividend payment is None of the options $30,000 $100,000 $70,000

$100,000 Explanation Dividends are not tax deductible.

Given the following, what is free cash flow? Cash flow from operating activities$200,000 Cash flow from investing activities$140,000 Cash flow from financing activities$56,000 Building purchases$50,000 Dividends Paid$20,000 $396,000 $270,000 $326,000 $130,000

$130,000 Explanation Cash flow from operations activities$200,000 − Capital Expenditures 50,000 − Common stock dividends 20,000 Free Cash flow$130,000

A firm has $1,500,000 in its common stock account and $1,000,000 in its capital paid in excess of par account. The firm issued 100,000 shares of common stock. What was the issue price (market value) if only one stock issuance has occurred? Not enough information to determine $15 per share $25 per share $35 per share

$25 per share Explanation Original price=(Common stock + paid-in-capital)/number of shares outstanding =($1,500,000 + $1,000,000)/100,000 = $25

A firm has $1,500,000 in its common stock account and $1,000,000 in its capital paid in excess of par account. The firm issued 100,000 shares of common stock. What was the issue price (market value) if only one stock issuance has occurred? $35 per share $25 per share $15 per share Not enough information to determine

$25 per share Original price=(Common stock + paid-in-capital)/number of shares outstanding =($1,500,000 + $1,000,000)/100,000 = $25

Elgin Battery Manufacturers had sales of $1,000,000 in 2015 and their cost of goods sold is $700,000. Selling and administrative expenses were $100,000. Depreciation expense was $80,000 and interest expense for the year was $10,000. The firm's tax rate is 30 percent. What is the dollar amount of taxes paid in 2015? $36,000 $117,800 $33,000 $300,000

$33,000 Explanation Sales $1,000,000 Cost of goods sold (70%) 700,000 Gross Profit 300,000 Selling and administrative expense (10%) 100,000 Depreciation 80,000 Operating profit $120,000 Interest 10,000 Earnings before tax 110,000 Taxes (30%) $33,000

A company sells 500 shirts at a price of $15 each with a cost of goods sold of $2 per shirt. The company has selling and administrative expenses of $2,500, depreciation expenses of $500, interest expenses of $1,000, and a tax rate of 35%. Caculate the gross profit?

$6,500 Explanation: GP@ 6,500= (500 X (15-2))

A firm with earnings per share of $3 and a price-earnings (P/E) ratio of 24 will have a stock market price of $72.00. $15.00. $6.67. $3.00.

$72.00. Explanation Stock price = EPS × P/E ratio = $3 × 24 = $72

Candy Company had sales of $320,000 and cost of goods sold of $112,000. What is the gross profit margin (ratio of gross profit to sales)? 55% 65% 35% 73.3%

65% Explanation Sales$320,000 Cost of goods sold 112,000 Gross Profit$208,000 Gross Profit Margin=Gross Profit/Sales =$208,000/$320,000 = 0.65

A statement of cash flows allows a financial analyst to determine All of the options. whether a cash dividend is affordable. how increases in assets have been financed. whether long-term assets are being financed with long-term or short-term financing.

All of the options

A statement of cash flows allows a financial analyst to determine whether a cash dividend is affordable. how increases in assets have been financed. whether long-term assets are being financed with long-term or short-term financing. All of the options

All of the options

Which of the following factors do not influence the firm's P/E ratio? Past earnings Shares outstanding Volatility in business performance All of the options influence the firm's P/E ratio.

All of the options influence the firm's P/E ratio.

How many of the following balance sheet items are classified as a current asset or current liability? Retained earnings Accounts payable Plant and equipment Inventory Common stock Bonds payable Accrued wages payable Accounts receivable Preferred stock Three of these items. Four of these items. Five of these items. Six of these items.

Four of these items.

One of the primary factors evaluated when a company is pursuing a leveraged buyout is Net cash flow. Free cash flow. Cash flow from financing activities. Cash flow from investing activities.

Free cash flow.

Arrange the following income statement items so they are in the proper order of an income statement: (In determining operating profit or loss, select the operating expense first, followed by the non-cash expense.) Taxes Earnings per share Common shares outstanding Earnings before taxes Interest expense Cost of goods sold Depreciation expense Earnings after taxes Preferred stock dividends Earnings available to common stockholders Operating profit Selling and administrative expense Sales Gross profit P

Income Statement Sales Cost of goods sold Gross profit Selling and administrative expense Depreciation expense Operating profit Interest expense Earnings before taxes Taxes Earnings after taxes Preferred stock dividends Earnings available to common stockholders Common shares outstanding Earnings per share

Identify whether each of the following items increases or decreases cash flow. Assume the firm pays taxes.

Increase in accounts receivable: Decrease Increase in notes payable: Increases Depreciation expense: Increase Increase in investments: Decrease Decrease in accounts payable: Decreases Decrease in prepaid expenses: Increases Increase in inventory: Decreases Dividend payment: Decreases Increase in accrued expenses: Increases

Free cash flow is used to help determine: I.) the amount of cash that is generated from the business operations, including normal sales and normal costs, payments made to owners, and purchases of property. II.) the amount of cash that is available for extra activities that the firm may want to get involved in. III.) the amount of cash that is considered taxable for federal income taxes. Option I only Option II only Options I and II. Options I and III

Options I and II.

Vriend Software Inc.'s book value per share is $15.20. Earnings per share is $1.88, and the firm's stock trades in the stock market at 3.5 times book value per share. What will the P/E ratio be? (Do not round intermediate calculations. Round your final answer to 2 decimal places.)

P/E ratio: 28.30 times Explanation Price= Market to book ratio × Book value per share = 3.5 × $15.20 = $53.20 P/E= Price / Earnings per share = $53.20 / $1.88 = 28.30 times

Which of the following would not be classified as a current asset? Marketable securities Prepaid expenses Inventory Plant property and equipment

Plant property and equipment

Prepare an income statement for Virginia Slim Wear. Take your calculations all the way to computing earnings per share. (Round EPS answer to 2 decimal places.) Sales $1,360,000 Shares outstanding 104,000 Cost of goods sold 700,000 Interest expense 34,000 Selling and administrative expense 49,000 Depreciation expense 23,000 Preferred stock dividends 86,000 Taxes 100,000

Virginia Slim Wear Income Statement Sales $1,360,000 Cost of goods sold 700,000 Gross profit $660,000 Depreciation expense 23,000 Selling and administrative expense 49,000 Operating profit $588,000 Interest expenses 34,000 Earnings before taxes $554,000 Taxes 100,000 Earnings after taxes $454,000 Preferred stock dividends 86,000 Earnings available to common stockholders $368,000 Shares outstanding 104,000 Earnings per share $3.54

Elite Trailer Parks has an operating profit of $200,000. Interest expense for the year was $10,000; preferred dividends paid were $18,750; and common dividends paid were $30,000. The tax was $61,250. The firm has 20,000 shares of common stock outstanding. a. Calculate the earnings per share and the common dividends per share for Elite Trailer Parks. (Round your answers to 2 decimal places.) b. What was the increase in retained earnings for the year?

a. Earnings per share: $5.50 Common dividends per share: $1.50 b. Increase in retained earnings$80,000 Explanation: a. Elite Trailer Parks Operating profit (EBIT):$200,000 Interest expense: 10,000 Earnings before taxes (EBT):$190,000 Taxes: 61,250 Earnings after taxes (EAT):$128,750 Preferred dividends:18,750 Earnings available to common stockholders:$110,000 Common dividends: 30,000 Increase in retained earnings:$80,000 Earnings per share=Earnings available to common stockholders Number of shares of common stock outstanding =$110,000 / 20,000 shares =$5.50 Dividends per share=Common dividends / Number of shares =$30,000 / 20,000 shares =$1.50 b. Increase in retained earnings=Earnings available to common stockholders - Common dividends =$110,000 - $30,000 =$80,000

Frantic Fast Foods had earnings after taxes of $420,000 in 20X1 with 309,000 shares outstanding. On January 1, 20X2, the firm issued 20,000 new shares. Because of the proceeds from these new shares and other operating improvements, earnings after taxes increased by 30 percent. a. Compute earnings per share for the year 20X1. (Round your answer to 2 decimal places.) b. Compute earnings per share for the year 20X2. (Round your answer to 2 decimal places.)

a. $1.36 b. $1.66 Explanation a.Year 20X1 Earnings per share=Earnings after taxesShares outstanding =$420,000 309,000 =$1.36 b. Year 20X2Earnings after taxes = $420,000 × 1.30 = $546,000Shares outstanding = 309,000 + 20,000 = 329,000 Earnings per share=$546,000 329,000 =$1.66

Botox Facial Care had earnings after taxes of $370,000 in 20X1 with 200,000 shares of stock outstanding. The stock price was $31.50. In 20X2, earnings after taxes increased to $436,000 with the same 200,000 shares outstanding. The stock price was $42.00. a. Compute earnings per share and the P/E ratio for 20X1. The P/E ratio equals the stock price divided by earnings per share. (Do not round intermediate calculations. Round your final answers to 2 decimal places.) b. Compute earnings per share and the P/E ratio for 20X2. (Do not round intermediate calculations. Round your final answers to 2 decimal places.) c. Why did the P/E ratio change? (Do not round intermediate calculations. Input your answers as percents rounded to 2 decimal places.)

a. Earnings per share $1.85 P/E ratio 17.03 times b. Earnings per share $2.18 P/E ratio19.27 times c. The stock price (increased by) (33.33) percent while EPS (increased by) (17.84) percent. Explanation a. EPS (20X1)= Earnings after taxes / Number of shares = $370,000 / 200,000 = $1.85 P/E ratio (20X1)= Price / EPS = $31.50 / $1.85 = 17.03 times b. EPS (20X2)= Earnings after taxes / Number of shares = $436,000 / 200,000 = $2.18 P/E ratio (20X2)= Price / EPS = $42.00 / $2.18 = 19.27 times c.The stock price increased by 33.33 percent while EPS only increased 17.84 percent. Stock price increase= (New price - Old price) / Old price = ($42.00 - 31.50) / $31.50 = 0.3333, or 33.33% EPS increase= (New EPS - Old EPS) / Old EPS = ($2.18 - 1.85) / $1.85 = 0.1784, or 17.84%

Nova Electrics anticipates cash flow from operating activities of $6 million in 20X1. It will need to spend $1.2 million on capital investments to remain competitive within the industry. Common stock dividends are projected at $0.4 million and preferred stock dividends at $0.55 million. a. What is the firm's projected free cash flow for the year 20X1? (Enter your answer in millions of dollars rounded to 2 decimal places.) b. What does the concept of free cash flow represent? Free cash flow equals cash flow from operating activities. Free cash flow represents the funds that are available for investing activities, such as purchasing plant and equipment assets. Free cash flow represents the funds that are available for special financing activities, such as a leveraged buyout.

a. Free cash flow$3.85 million b. What does the concept of free cash flow represent? -Free cash flow represents the funds that are available for special financing activities, such as a leveraged buyout. Explanation a. Nova Electronics Cash flow from operating activities$6.00million Less: Capital expenditures 1.20 Common stock dividends 0.40 Preferred stock dividends 0.55 Free cash flow$3.85million b.Free cash flow represents the funds that are available for special financing activities, such as a leveraged buyout, increased dividends, common stock repurchases, acquisitions, or repayment of debt.

An item which may be converted to cash within one year or one operating cycle of the firm is classified as a current liability. long-term asset. current asset. long-term liability.

current asset.

Preferred stock dividends __________ earnings available to common stockholders. increase decrease do not effect There is not enough information to determine.

decrease

Profits reinvested into the firm theoretically belong to the stockholders, who hope is that they will provide future______________.

earnings and dividends

The best indication of the operational efficiency of management is net income. earnings per share. earnings before interest and taxes (EBIT). gross profit.

earnings before interest and taxes (EBIT).

The book value per share is based off of ________ data, while the market value per share is based off of_________ data. -short term; long term -future; historical -historical; future -long term; short term

historical; future

Indicate whether the item is on the balance sheet or the income statement. If it is on the balance sheet, designate which category. (If there is no category, select "None" from the drop down menu.)

|Item| |Income Statement/ Balance Sheet| |Category| -Accounts receivable, Balance sheet Current assets -Retained earnings, Balance sheet, Stockholders' equity -Income tax expense, Income statement, None -Accrued expenses, Balance sheet, , Current liabilities -Cash, Balance sheet, Current assets -Selling and administrative expenses, Income statement, None -Plant and equipment, Balance sheet, Fixed assets -Operating expenses, Income statement, None -Marketable securities, Balance sheet, Current assets -Interest expense, Income statement, ,None -Sales, Income statement, None -Notes payable (6 months), Balance sheet, Current liabilities -Bonds payable-maturity 20 years, Balance sheet, Long-term liabilities -Common stock, Balance sheet, Stockholders' equity -Depreciation expense, Income statement, None -Inventories, Balance sheet, Current assets -Capital in excess of par value, Balance sheet, Stockholders' equity -Net income (earnings after taxes), Income statement, None