Chapter 2
Financial Statements and Analysis
Learning Goals
1. Review the contents of the stockholders’ report and the procedures for consolidating
internationalfinancial statements.
2. Understand who uses financial ratios, and how.
3. Use ratios to analyze a firm’s liquidity and activity.
4. Discuss the relationship between debt and financial leverage and the ratios used to analyze a
firm’sdebt.
5. Use ratios to analyze a firm’s profitability and market value.
6. Use a summary of financial ratios and the DuPont System of analysis to perform a complete
ratioanalysis.
True/False
1. The Financial Accounting Standards Board (FASB) is the federal regulatory body that governs
thesale and listing of securities.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
2. GAAP is the accounting profession’s rule setting body.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
3. Generally accepted accounting principles are authorized by the Financial Accounting Standards
Board (FASB).
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
4. Publicly owned corporations are those which are financed by the proceeds from the
treasurysecurities.
, Chapter 2 Financial Statements and Analysis 49
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
5. Publicly owned corporations are required by the Securities and Exchange Commission (SEC)
andindividual state securities commissions to provide their stockholders with an annual
stockholders’report.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
6. The president’s letter, as the first component of the stockholders’ report, is the
primarycommunication from management to the firm’s employees.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Stockholders’ Report
7. Common stock dividends paid to stockholders are equal to the earnings available for
commonstockholders divided by the number of shares of common stock outstanding.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Dividends
8. The income statement is a financial summary of the firm’s operating results during a specifiedperiod
while the balance sheet is a summary statement of the firm’s financial position at a givenpoint in time.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Income Statement
9. The par value of common stock is an arbitrarily assigned per share value used primarily foraccounting
purposes.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
10. Paid in capital in excess of par represents the firm’s book value received from the original sale
ofcommon stock.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
,50 Gitman • Principles of Finance, Eleventh Edition
11. Earnings per share represents amount earned during the period on each outstanding share ofcommon
stock.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Earnings
12. Net fixed assets represent the difference between gross fixed assets and the total expense recordedfor
the depreciation of fixed assets.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
13. Earnings per share results from dividing earnings available for common stockholders by the
numberof shares of common stock authorized.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Earnings
14. Retained earnings represent the cumulative total of all earnings retained and reinvested in the
firmsince its inception.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
15. The balance sheet is a statement which balances the firm’s assets (what it owns) against its debt(what
it owes).
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
16. The amount paid in by the original purchasers of common stock is shown by two entries in thefirm’s
balance sheet—common stock and paid in capital in excess of par on common stock.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
17. The original price per share received by the firm on a single issue of common stock is equal to thesum
of the common stock and paid in capital in excess of par accounts divided by the number ofshares
outstanding.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1 Topic: Balance Sheet
, Chapter 2 Financial Statements and Analysis 51
18. The statement of cash flows reconciles the net income earned during a given year, and any
cashdividends paid, with the change in retained earnings between the start and end of that year.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Statement of Cash Flows
19. The cumulative translation adjustment is an equity reserve account on the parent company’s booksin
which translation gains and losses are accumulated.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: International Accounting
20. The statement of cash flows provides insight into the firm’s assets and liabilities and reconcilesthem
with changes in its cash and marketable securities during the period of concern.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Statement of Cash Flows
21. A U.S. parent company’s foreign equity accounts are translated into dollars using the exchange
ratethat prevailed when the parent’s equity investment was made (the historical rate).
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: International Accounting
22. A U.S. parent company’s foreign retained earnings are adjusted to reflect gains and losses
resultingfrom currency movements as well as each year’s operating profits or losses.
Answer: FALSE
Level of Difficulty: 3
Learning Goal: 1
Topic: International Accounting
23. The Financial Accounting Standards Board (FASB) Standard No. 52 mandates that U.S.
basedcompanies translate their foreign currency denominated assets and liabilities into dollars using
thecurrent rate (translation) method.
Answer: TRUE
Level of Difficulty: 3
Learning Goal: 1
Topic: International Accounting
24. Time series analysis is the evaluation of the firm’s financial performance in comparison to
otherfirm(s) at the same point in time.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 2
Financial Statements and Analysis
Learning Goals
1. Review the contents of the stockholders’ report and the procedures for consolidating
internationalfinancial statements.
2. Understand who uses financial ratios, and how.
3. Use ratios to analyze a firm’s liquidity and activity.
4. Discuss the relationship between debt and financial leverage and the ratios used to analyze a
firm’sdebt.
5. Use ratios to analyze a firm’s profitability and market value.
6. Use a summary of financial ratios and the DuPont System of analysis to perform a complete
ratioanalysis.
True/False
1. The Financial Accounting Standards Board (FASB) is the federal regulatory body that governs
thesale and listing of securities.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
2. GAAP is the accounting profession’s rule setting body.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
3. Generally accepted accounting principles are authorized by the Financial Accounting Standards
Board (FASB).
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
4. Publicly owned corporations are those which are financed by the proceeds from the
treasurysecurities.
, Chapter 2 Financial Statements and Analysis 49
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
5. Publicly owned corporations are required by the Securities and Exchange Commission (SEC)
andindividual state securities commissions to provide their stockholders with an annual
stockholders’report.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Accounting Standards and Regulation
6. The president’s letter, as the first component of the stockholders’ report, is the
primarycommunication from management to the firm’s employees.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Stockholders’ Report
7. Common stock dividends paid to stockholders are equal to the earnings available for
commonstockholders divided by the number of shares of common stock outstanding.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Dividends
8. The income statement is a financial summary of the firm’s operating results during a specifiedperiod
while the balance sheet is a summary statement of the firm’s financial position at a givenpoint in time.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Income Statement
9. The par value of common stock is an arbitrarily assigned per share value used primarily foraccounting
purposes.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
10. Paid in capital in excess of par represents the firm’s book value received from the original sale
ofcommon stock.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
,50 Gitman • Principles of Finance, Eleventh Edition
11. Earnings per share represents amount earned during the period on each outstanding share ofcommon
stock.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Earnings
12. Net fixed assets represent the difference between gross fixed assets and the total expense recordedfor
the depreciation of fixed assets.
Answer: TRUE
Level of Difficulty: 1
Learning Goal: 1
Topic: Balance Sheet
13. Earnings per share results from dividing earnings available for common stockholders by the
numberof shares of common stock authorized.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Earnings
14. Retained earnings represent the cumulative total of all earnings retained and reinvested in the
firmsince its inception.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
15. The balance sheet is a statement which balances the firm’s assets (what it owns) against its debt(what
it owes).
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
16. The amount paid in by the original purchasers of common stock is shown by two entries in thefirm’s
balance sheet—common stock and paid in capital in excess of par on common stock.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: Balance Sheet
17. The original price per share received by the firm on a single issue of common stock is equal to thesum
of the common stock and paid in capital in excess of par accounts divided by the number ofshares
outstanding.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1 Topic: Balance Sheet
, Chapter 2 Financial Statements and Analysis 51
18. The statement of cash flows reconciles the net income earned during a given year, and any
cashdividends paid, with the change in retained earnings between the start and end of that year.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Statement of Cash Flows
19. The cumulative translation adjustment is an equity reserve account on the parent company’s booksin
which translation gains and losses are accumulated.
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: International Accounting
20. The statement of cash flows provides insight into the firm’s assets and liabilities and reconcilesthem
with changes in its cash and marketable securities during the period of concern.
Answer: FALSE
Level of Difficulty: 2
Learning Goal: 1
Topic: Statement of Cash Flows
21. A U.S. parent company’s foreign equity accounts are translated into dollars using the exchange
ratethat prevailed when the parent’s equity investment was made (the historical rate).
Answer: TRUE
Level of Difficulty: 2
Learning Goal: 1
Topic: International Accounting
22. A U.S. parent company’s foreign retained earnings are adjusted to reflect gains and losses
resultingfrom currency movements as well as each year’s operating profits or losses.
Answer: FALSE
Level of Difficulty: 3
Learning Goal: 1
Topic: International Accounting
23. The Financial Accounting Standards Board (FASB) Standard No. 52 mandates that U.S.
basedcompanies translate their foreign currency denominated assets and liabilities into dollars using
thecurrent rate (translation) method.
Answer: TRUE
Level of Difficulty: 3
Learning Goal: 1
Topic: International Accounting
24. Time series analysis is the evaluation of the firm’s financial performance in comparison to
otherfirm(s) at the same point in time.
Answer: FALSE
Level of Difficulty: 1
Learning Goal: 2
