PRACTICE EXAM 2 MODULES 6-10

Quick Ratio

(Current Assets - Inventories) / Current Liabilities (Liquidity ratio)

Cash Conversion Cycle

(Days of inventory outstanding + days sales outstanding - days payable outstanding) (Liquidity ratio)

Mod 7.3: Assume a company purchased inventory for $40 on account and then sold it to a customer for $10 of cash. Compute the change in the company's Common Stock account.

-$0 Revenues and Expenses do NOT influence a company's common stock account because common stock represents contributed equity and revenues and expenses only influence earned equity (i.e. Retained Earnings).

Mod 6.3: At the end of the prior month Charlie Co's balance sheet had the following balances: Assets $100, Liabilities $20, Equity $80 On Day 1, Charlie Co. owners contributed cash of $70. What is the balance in Charlie Co.'s liabilities at the end of Day 1?

-0 (with margin: 0) -20 (with margin: 0) In this case Charlie Co. did not increase or decrease its borrowings, so liabilities are not affected and therefore remain at $20. FYI: Assets and equity will increase by the amount the owners contributed (assets increase because cash was received and equity increases because the owners are the ones who financed the increase in assets).

Mod 9.2: Here are some random excerpts from the Income Statements of two companies in the same industry for the same year: Company A Sales Revenue: 100 Rental Expense: 26 Cost of Goods Sold: 139 Advertising Expense: 18 Company B Sales Revenue: 58 Rental Expense: 23 Cost of Goods Sold: 23 Advertising Expense: 22 Company C Sales Revenue: 332 Rental Expense: 27 Cost of Goods Sold: 188 Advertising Expense: 97 Using the concept of a Common-Size Income Statement, enter the Advertising Expense ratio, as a decimal, for the company that was able to generate the most Sales Revenue $'s per each $1 spent on advertising. (Please round your answer to the nearest two decimal places, if you compute it to be .20735, please enter your answer as .21)

-0.18 In this example, because Company A had the smallest Advertising Expense to Sales Revenue ratio, it means that each $1 spent on advertising was able to generate more Sales Revenue dollars than Companies B and C. For example, if Company A's Advertising Expense ratio is .20, that means that each $.20 spent on Advertising Expense generated $1 of Sales Revenue. If Company B's Advertising Expense ratio were .30, it indicates that Company B has to spend $.30 (i.e. $.10 more than Company A) to generate each Sales Revenue dollar. Company A's advertising expenditures are therefore more effective than Company B and C.

Mod 9.3: Based on the information for Company G below, compute the % change in Revenue from 20X8 to 20X9. 20X8 Revenue: 31 Cost of Goods Sold: 14 20X9 Revenue: 61 Cost of Goods Sold: 33 Please enter your answer as a decimal rounded to the nearest two decimals. For example, if Revenue increased by 122% enter your answer as 1.22.

-0.97 The computation for the % change in Revenue is as follows: (X9Revenue-X8Revenue)/X8Revenue.

Mod 9.1c: The following table provides selected information (some of which is irrelevant to this question) for four Businesses 1, 2, 3, and 4. Please enter the number of the business below (enter either the number 1, 2, 3, or 4) that represents the business that has the highest Gross Margin Ratio (Note, I am not asking which business has the highest Gross Margin in $, but rather that you enter the number that represents the business with the highest GM ratio). 1. Cost of Goods Sold: 12 Sales Expense: 8 Net Sales Revenue: 81 Dividends: 3 Inventory: 3 2. Cost of Goods Sold: 71 Sales Expense: 3 Net Sales Revenue: 113 Dividends: 8 Inventory: 2 3. Cost of Goods Sold: 32 Sales Expense: 2 Net Sales Revenue: 93 Dividends: 8 Inventory: 4 4. Cost of Goods Sold: 43 Sales Expense: 7 Net Sales Revenue: 52 Dividends: 2 Inventory: 4

-1 Business 1 has the largest Gross Margin Ratio. It indicates that it is able to sell its product at a much highest price in relation to its cost than any of the other businesses. It is computed as (Net Sales Revenues - Cost of Goods Sold)/Net Sales Revenues.

Mod 9.5: Based on Company G's current year transactions below, what is its TOTAL change in cash for the year? Paid $21 to purchase inventory. Sold $15 of inventory for $33. Purchased a $2,000 vehicle for $1,500 cash and financed the other $500 with the car dealership. Declared and paid dividends of $15. Issued 15 shares of Capital Stock in exchange for $41. Received and paid for a utility bill of $3. If your answer indicates that cash decreased enter it as a negative number as follows: -1298

-1,465 Correct. The only transactions that directly affected the company's cash balance are as follows: - Purchase of inventory + Cash sales price of inventory- Cash paid for vehicle of 1500 - Cash paid for dividends + Cash received on issuance of Stock - Cash paid for UtilityBill. The cost of the inventory sold is not a cash outflow so it was excluded.

Mod 6.3: At the end of the prior month Sage Co's balance sheet had the following balances: Assets $200, Liabilities $160, Equity $40 On Day 1, Sage Co. sold $70 of inventory to customers for $100 on account (i.e. on credit) What is the balance in Sage Co.'s liabilities at the end of Day 1?

-160 (with margin: 0) This sales transaction has no effect on liabilities. Assets will be affected by receivables increasing by the sales price, and decrease for the cost of the inventory sold, and equity will increase by the sales revenue earned and decreasing by the cost of goods sold incurred (which netted equals the gross margin on the sale), but liabilities are unaffected.

Mod 8.1: Assuming all else being equal except the sources and amounts of financing in each business, compute the "net assets" of each business and enter the net asset amount for the business that is likely to be the most valuable to an investor. Business 1: Assets 20; Liabilities 19Business 2: Assets 20; Liabilities 13Business 3: Assets 20; Liabilities 7Business 4: Assets 20; Liabilities 2

-18 In order to arrive at the correct answer, you should compute the Net Assets for each business using the following equation Assets - Liabilities = Net Assets or Equity and choose the one with the largest Net Assets. This is true because, if all else is equal except the amount of debt financing in each business, the business with the least amount of debt (i.e. liabilities) will be the most valuable.

Mod 7.1: Assume Mikey Moose Company decided to purchase Noofy Inc. for a total purchase price of $54. Based on the details of the agreement, the market value of Noofy's identifiable assets were $42. In addition, Noofy had $7 of liabilities that Mikey Moose Company also accepted responsibility for. Compute the Goodwill, if any, that Mikey Moose will record on the purchase of Noofy Inc.

-19 Goodwill is an intangible asset and is computed as follows: Purchase price Less: (Net market value of identifiable assets) = Goodwill Note: Net market value = (Market Value of Identifiable Assets purchased less Liabilities assumed)

Mod 9.1d: Use the following key account balances from Gumball Company's Balance Sheet and Income Statement as of and for the year ended December 31, 20X1 to compute its Operating Income. If Gumball Company had an operating loss, please enter its loss as a negative number such as -5. Sales Revenue 56 Utilities Expense 5 Postage Expense 3 Cash 7 Wages Expense 4 Income Tax Expense 2 Rent Expense 8 Cost of Goods Sold 8

-28 Operating income is computed as a company's Gross Margin (i.e. Sales Revenues less Cost of Goods Sold) less its Operating Expenses, such as Utilities Expense, Postage Expense, Wages Expense, and Rent Expense. Cash is an asset on the Balance Sheet and is not used to compute operating income. Income tax expense is only computed after operating income and income before taxes are computed, therefore, it is not an operating expense.

Mod 9.1e: Use the following key account balances from Lemonade Company's Balance Sheet and Income Statement as of and for the year ended December 31, 20X1 to compute its Earnings Before Taxes. Sales Revenue 88 Utilities Expense 3 Cost of Goods Sold 22 Advertising Expense 8 Prepaid Insurance Expense 12 Interest Revenue 9 Rent Expense 6 Income Tax Expense 3

-58 Earnings Before Taxes is the same as Income Before Taxes. It is all of a company's revenues less all of its expenses (except for income taxes) as follows: Sales Revenues-Cost Of Goods Sold = Gross Margin; Gross Margin - Utilities Expense - Advertising Expense - Rent Expense = Operating Income; Operating Income + Other Revenues such as Interest Revenue - Other Expenses of which there were none = Earnings Before Taxes. Note: Prepaid Insurance Expense is an asset not an expense.

Mod 9.1a: Using the following information, compute the business' Net Income and enter the amount below. Net Sales Revenues $100, Rent Expense $4, Advertising Expense $5, Cash $38, Cost of Goods Sold $1, Interest Expense $2, Utilities Expense $2, Accounts Payable $10, Income Tax Expense $8, Dividends $4.

-78 Net Income is computed as Total Revenues - Total Expenses. In this example you take Net Sales Revenues and deduct all of the other items EXCEPT cash (which is an asset) and accounts payable (which is a liability). Watch out, Dividends are never an expense. They are a distribution of Net Income to the owners. Watch out, Dividends are never an expense. They are a distribution of Net Income to the owners. This is a common error that students make. They want to deduct Dividends on the Income Statement, but they are not an Expense.

Mod 6.3: At the end of the prior month Charlie Co's balance sheet had the following balances: Assets $100, Liabilities $20, Equity $80 On Day 1, Charlie Co. paid off an account payable to its vendor in the amount of $11. What is the balance in Charlie Co.'s assets at the end of Day 1?

-89 Assets of $100 will be reduced by the payment on the account payable because cash (which is an asset) would have been used to make such payment.

Mod 6.3: At the end of the prior month Sage Co's balance sheet had the following balances: Assets $200, Liabilities $160, Equity $40 On Day 1, Sage Co. sold $41 of inventory to customers for $91 on account (i.e. on credit) What is the balance in Sage Co.'s equity at the end of Day 1?

-90 Equity will increase by the gross margin earned on this sale as follows: Beginning Equity $40 + Net Income (i.e. in this case the only net income we have was generated by this sale with Sales Revenues Less the Cost of the Goods Sold) = Ending Equity

Mod 8.3: The key defining aspect that makes a normal balance sheet into a comparative balance sheet is:

-A comparative balance sheet is prepared for more than one balance sheet date. -A comparative balance sheet is a balance sheet that provides asset, liability and equity account balances as of more than one balance sheet date.

Mod 7.2: Match the terms on the left with their definition on the right. -Accounts payable -Unearned sales revenue -Notes payable -Salaries and wages payable -Prepaid rent -Amounts owed to suppliers in relation to purchases on account that have not been paid for yet. -The amount of goods or services owed to customers because customers prepaid for them and have not yet received them. -The outstanding amount still payable related to an amount borrowed under a formalized agreement, which usually includes interest. -Amounts still owed to employees who performed work for the company but have not yet been paid. -An asset representing services to be received in the future in relation to payments paid for in the past.

-Accounts payable = Amounts owed to suppliers in relation to purchases on account that have not been paid for yet. -Unearned sales revenue= The amount of goods or services owed to customers because customers prepaid for them and have not yet received them. -Notes payable= The outstanding amount still payable related to an amount borrowed under a formalized agreement, which usually includes interest. -Salaries and wages payable= Amounts still owed to employees who performed work for the company but have not yet been paid. -Prepaid rent= An asset representing services to be received in the future in relation to payments paid for in the past.

Mod 8.1: Match the account types on the left with their respective definition on the right. -Assets -Liabilities -Equity -Probable future economic benefit obtained or controlled by an entity as the result of a past transaction or event. -Probable future sacrifice of a resource by an entity as the result of a past transaction or event. -The total claims that owners have against the business entity.

-Assets= Probable future economic benefit obtained or controlled by an entity as the result of a past transaction or event. -Liabilities= Probable future sacrifice of a resource by an entity as the result of a past transaction or event. -Equity= The total claims that owners have against the business entity.

Mod 6.2: Choose the statements from the list below that will be labeled "As of" or "As at" a specific point in time and are described as being a "financial photograph" or "financial snapshot" of the company as opposed to being a financial video covering a period of time.

-Balance Sheet -Statement of Financial Position The Statement of Shareholder Equity, which includes the Statement of Retained Earnings, the Income Statement, and the Statement of Cash Flows are the three financial statements that articulate into the Balance Sheet and help describe how the balances on the Balance Sheet changed from the beginning of the period to the end of the period.

Mod 9.4: What two statements does the Statement of Retained Earnings bridge together during the process known as articulation?

-Balance Sheet and Income Statement The Net Income from the Income Statement is added to the beginning Retained Earnings Balance on the Statement of Retained Earnings, the ending Retained Earnings Balance is then included within the Total Stockholders' Equity section of the Balance Sheet.

Mod 7.2: Choose all of the liabilities noted in the following listing: -Bonds Payable -Accounts payable -Unearned sales revenue -Rent expense -Cost of goods sold -Salaries and wages expense -Warehouse equipment

-Bonds Payable -Accounts payable -Unearned sales revenue

Mod 8.2: How are the asset accounts classified on a classified balance sheet?

-By their liquidity with the most liquid of assets at the top. A classified balance sheet is classified in order of liquidity with the most liquid of assets at the top of the list and the least liquid of assets at the bottom of the list.

Mod 7.1: Click on all of the asset accounts below. -Notes Payable -Retained Earnings -Land -Office Supplies -Inventory -Cash -Accounts Payable

-Land -Correct Answer Office Supplies -Correct Answer Inventory -Correct Answer Cash The easiest way to think of an asset is "Is it something a company can possess or control?" "Is it something that can be obtained through a transaction or event?" "Will it provide a probable future economic benefit?" If the answer to all three are "Yes", then what you are looking at is an asset.

Mod 6.2: Which of the following items would cause an INCREASE in a company's Retained Earnings account from one year to the next? Choose all that apply.

-Net Income When a company earns Net Income, such income belongs to the owners and will be retained in the company (as Retained Earnings) until the owners are able to convince the company to pay the earnings out in the form of a Dividend. If one owner owns 100% of the company, they will not have a very difficult time convincing the company to pay the dividends out thus reducing the owners' Retained Earnings. Net Income is the key that serves to increase Retained Earnings. The formula for the Statement of Retained Earnings is as follows: Beginning Retained Earnings + Net Income - Net Loss - Dividends = Ending Retained Earnings See additional explanations above.

Mod 7.3: Between the beginning of the year and the end of the year, Peach Co.'s Retained Earnings increased. Which of the following is the best and most likely explanation for this increase.

-Peach Co's net income was greater than its dividends. It appears you missed an item or two. Only the following items are liabilities: bonds payable, accounts payable and unearned sales revenue See additional information above to better understand why the others are not liabilities. Net Income= Revenue - Cost of Goods Sold - Expenses

Mod 7.1: Which of the following items are assets? -Prepaid rent -Inventory -Copyrights -Cash -Land -Revenues -Warranty obligations -Accounts payable

-Prepaid rent -Inventory -Copyrights -Cash -Land The easiest way to think of an asset is "Is it something a company can possess or control?" "Is it something that can be obtained through a transaction or event?" "Will it provide a probable future economic benefit?" If the answer to all three are "Yes", then what you are looking at is an asset.

Mod 6.1: Choose the financial statement below that is NOT a name of one of the four general-purpose financial statements.

-Statement of Asset Purchases This is one of the four general-purpose financial statements as is included in the following list: 1)Balance Sheet (also known as the Statement of Financial Position) 2)Income Statement (also known as the Statement of Comprehensive Income and Statement of Operations. Internationally, it is known as the Profit amp; Loss account) 3)Statement of Shareholder Equity (also known as Statement of Stockholder Equity, it includes the Statement of Retained Earnings) 4) Statement of Cash Flows

Mod 9.1b: If you wanted to clearly see the amount of Net Income a company earned during a given period of time, which of the following statements would clearly show, in black and white, the words "Net Income" (or "Net Loss" in a bad year) and indicate the amount? Choose all that apply.

-Statement of Retained Earnings -Multi-Step Income Statement -Single-Step Income Statement -A Balance Sheet will show the revised ending balance or Retained Earnings as of the end of the period, which revised balance will include Net Income, but because Net Income already appeared on the Statement of Retained Earnings and is already included in the ending balance of Retained Earnings that appears on the Balance Sheet, Net Income does not appear on it.

Mod 6.1: If you wanted to clearly see the total that all owners had invested in a given company at the beginning of a year and see how such total investment had changed during the year to arrive at the owners' ending balance, which of the following statements would be most helpful to you?

-Statement of Shareholder Equity The purpose of the Statement of Shareholder Equity is to provide information about the shareholders' beginning equity balances, changes in those balances during the year, and the ending balances. See additional explanations above as to why your response was not the best of those provided.

Mod 6.2: What does it mean for the general purpose financial statements to "articulate"?

-The financial statements interrelate to each other. The financial statements articulate because changes in one financial statement, such as the Income Statement influences other financial statements such as the Statement of Retained Earnings and the Balance Sheet.

Mod 7.2: If you were given a complete list of all of a company's liabilities in T-account format, with their ending balance on their normal balance side, what side of the T-account would you normally expect the liabilities' account balances to appear on?

-The right side As noted in the videos, because liabilities are on the right-hand side of the balance sheet equation, their normal balance is on the right-hand side. The normal balance side is also the side on which all increases for liabilities are recorded.

Mod 6.3: It is possible that a company can report positive net income on the income statement, but have negative cash flows from operating activities on the statement of cash flows.

-True This is a true statement. Because under accrual accounting, revenues are recorded when they are earned, even if the cash may not be received until much later, and because expenses are recorded when incurred not necessarily when cash is paid, the accrual-basis income statement could show positive income even though the actual cash flows from operating activities are negative.

Mod 10.2: Which of the following ratios computes the amount of excess current assets a company should have after using all of its current assets to pay off all of its current liabilities? -Cash conversion cycle -Correct Answer Working capital -Quick ratio -Current ratio

-Working capital Working capital computes the excess current assets that a company has available after using such assets to pay off all of its current liabilities.

Mod 10.3: Based on the following information as of December 31, X1, compute the company's debt ratio and type it into the box below. Note: round your answer to the nearest two decimal places. Current assets 10 Current liabilities 1 Non-current assets 11 Non-current liabilities 8 Total equity 12

0.43 (with margin: 0.01) The debt ratio is total liabilities of $9 (i.e. current liabilities $1 + non-current liabilities $8) / total assets of $21 (i.e. current assets of $10 + non-current assets of $11). This debt ratio indicates that for every $1 of asset, $.43 of it was funded by debt, which would mean that the other $.57 was funded by equity.

Mod 10.1: You have been given the following account information for 4 similar companies in the same industry with the same suppliers and the same type of customers. All of their assets and liabilities are expected to be converted to cash or paid in cash evenly throughout the coming years based on their noted classifications. Enter the current ratio of the company that is the least liquid. Please round it to the nearest two decimal places. For example, 10/3 should be entered as 3.33, not as 333.33%. Company: Long-term assets 8; Long-term Liabilities 15; Current assets 77; Current Liabilities 92 Company 2 Long-term assets 5; Long-term Liabilities 6; Current assets 56; Current Liabilities 4 Company 3 Long-term assets 3; Long-term Liabilities 3; Current assets 60; Current Liabilities 2

0.84 You just needed to compute the current ratio for each company and choose the one with the smallest current ratio and enter its company number. The current ratio indicates a company's ability to convert current assets into cash sufficient to pay its current liabilities as they come due. It is computed as follows: Current assets/current liabilities

Mod 10.1: Company L has the following balances on its 12/31/X1 classified balance sheet. Current assets: Cash $47, Accounts receivable $35, Inventory $80 Non-current assets: Land $62, Building $84, Goodwill $7 Current liabilities: Accounts payable $11, Salaries and Wages Payable $9 Non-current liabilities: Notes payable $76, Bonds payable 1 Based on the information above enter the number 1 if Company L would be considered to be liquid and a 2 if it would be considered to be illiquid.

1 Because current assets are significantly greater than current liabilities resulting in a large current ratio this company would be considered to be liquid. Some analysts use a general rule of thumb that if the current ratio is 2 the company is considered to be fairly liquid. Having said that, some industries operate on current ratios that are much lower than 2, such as 1.5.

Four General- Purpose Financial Statements

1) Balance Sheet (Also Known as the Statement of Financial Position) 2) Income Statement (Also known as the Statement of Comprehensive Income & Statement of Operations. Internationally, it is known as the Profit & Loss Account) 3) Statement of Shareholder Equity (Also Known as the Statement of Stockholder Equity, it includes the statements of retained earnings) 4) Statement of Cash Flows

The four types of liquidity ratios

1) Current ratio 2) Quick ratio 3) Working capital 4) Cash conversion cycle

The two types of solvency ratios:

1) Debt- equity ratio 2) Debt assets ratio

THREE REQUIREMENTS FOR A BALANCE SHEET (IN ORDER)

1. Business Name 2. Financial Statement Name 3. Financial Statement Period

Mod 10.2: Below are excerpts from DEF Co's 20X1 and 20X2 balance sheet. Using the information below, compute DEF Co's quick ratio for both years, but only enter the quick ratio for the year with the higher level of liquidity. Please enter your answer to the nearest two decimal places (e.g. current ratio is 4.7329 should be entered below as 4.73). 20X1 Cash 43 Accounts receivable 75 Inventory 78 Non-current assets 37 Accounts Payable 28 Salaries Payable 35 Long-term liabilities 13 20X2 Cash 49 Accounts receivable 87 Inventory 21 Non-current assets 30 Accounts Payable 19 Salaries Payable 13 Long-term liabilities 19

4.25 margin of error +/- 0.2 DEF's quick ratio in 20X2 was larger than it was in 20X1 indicating that it has become more liquid. The quick ratio is computed as follows: (Current Assets of Cash + Acct. Rec)/(Current Liabilities of Accounts Payable + Salaries Payable) As you can see, inventories are left our (i.e. removed) from the numerator when computing the quick ratio. Another way of presenting the computation of the quick ratio that more closely matches the lessons I prepared would be as follows: (Current Assets, which are Cash + Accounts Receivable + Inventory, LESS Inventory, which is not so liquid) / Current Liabilities. In this formula we effectively include inventory because it is part of total current assets, BUT then we have to remove it because inventory is not very, quickly convertible to cash and hence is not the more liquid of current assets.

Statement of Shareholder Equity

Aka in the U.S. as Statement of Shareholder Equity, it includes the Statement of Retained Earning

Liquidity Ratios focus on

Assessing the company's liabilities to pay off its current liabilities as they come due within the next year

Solvency ratios focus on

Assessing the company's liability to pay off all their current and non-current liabilities as they come due.

Working Capital

Current assets - current liabilities (Liquidity ratio)

Current Ratio

Current assets/ Current liabilities (Liquidity ratio)

Mod 6.4: If you were a potential investor in a publicly-traded company and you could only request the company to provide you one of the following documents to assist you in making your investment decision, which one would provide you the most extensive and reliable information?

Form 10-K

Mod 10.4: Use the income statements for ABC Co. below to compute its Return on Sales Ratio for the year ending December, 31, 20X2. Please round your answer to the nearest two decimal places, for example if you compute it to be .5878, enter .59 in the box below. This is how it appears on the income statement: Net Income : $10,299 Less: Income Tax Expense: $1,530 Other: Interest Expense: $66 Net Sales Revenues: $20, 638

Net Income: $10,299 + Less: Income Tax Expense: $1,530 + Other: Interest Expense: $66 / Net Sales Revenue: $20,638 = .58

Net Income

Revenues - Expenses

Balance Sheet Synonym

Statement of Financial Poisition

Debt to Assets Ratio

Total Liabilities/ total assets (Solvency Ratio)

Mod 10.3: What would it mean for a company with $10 M in assets to have a debt to equity ratio of .5?

for every $1 of debt it has $2 of equity.

Debt-Equity Ratio

total liabilities/total equity (Solvency Ratio)

Mod 10.5: An investor has computed the Return on Equity ratio (ROE) for 5 different companies from the same industry as follows: Company 1: 9%; Company 2: 15%; Company 3: 14%; Company 4: 11%; Company 5: 12% Based on the ROE's provided above, enter the ROE for the company that would be rated the best out of the 5. Example: If you feel the correct answer is 35%, please enter just the number 35.

15 Because Company 2 had the highest ROE, it would be an indicator that it is using common shareholder-provided resources the most efficiently.

Return on Sales

A MEASURE OF THE COMPANY'S EFFICIENCY. ALSO REFERRED TO S THE "OPERATING MARGIN, OPERATING INCOME MARGIN, AND OPERATING PROFIT MARGIN) EBIT/ SALES EBIT= Net Income + Interest Expense + Income Tax Expense Net Sales= Gross Sales - Sales Returns and Allowances - Sales Discounts *More return on sales -> More efficient*

Advertising Expense Ratio

Advertising Expense/ Sales Revenue

Income Statement

Aka as the Statement of Comprehensive Income & Statement of Operations. Internationally, it is known as the Profit & Loss Account)