Chapter 14
“How Well Am I Doing?” Financial Statement Analysis
True/False
1. Vertical analysis of financial statements is accomplished through the preparation of common-size
statements.
Level: Easy LO: 1 Ans: T
2. The gross margin percentage is computed by dividing the gross margin by net income before interest
and taxes.
Level: Medium LO: 1 Ans: F
3. If a company’s return on assets is substantially higher than its cost of borrowing, then the common
stockholders would normally want the company to have a relatively high debt/equity ratio.
Level: Easy LO: 2,4 Ans: T
4. The dividend yield ratio is calculated by dividing dividends per share by earnings per share.
Level: Easy LO: 2 Ans: F
5. Financial leverage is positive if the interest rate on debt is lower than the return on total assets.
Level: Medium LO: 2 Ans: T
6. To compute the return on total assets, net income should be adjusted by adding after-tax interest
expense and preferred dividends.
Level: Medium LO: 2 Ans: F
7. When computing the return on common equity, the income available for common stockholders is
determined by deducting preferred dividends from net income.
Level: Easy LO: 2 Ans: T
8. Issuing common stock will increase a company’s financial leverage.
Level: Medium LO: 2 Ans: F
9. Book value per share is the key to predicting a company’s future income producing ability.
Level: Easy LO: 2 Ans: F
Brewer, Introduction to Managerial Accounting, 3/e 726
,10. The book value per share of common stock reflects the balance sheet carrying value of already
completed transactions.
Level: Medium LO: 2 Ans: T
11. A company’s acid-test ratio will always be less than or equal to its current ratio.
Level: Medium LO: 3 Ans: T
12. A company could improve its acid-test ratio by selling some equipment it no longer needs for cash.
Level: Medium LO: 3 Ans: T
13. As the accounts receivable turnover ratio decreases, the average collection period decreases.
Level: Medium LO: 3 Ans: F
14. Payment of interest owed would decrease the inventory turnover ratio.
Level: Easy LO: 3 Ans: F
15. When computing the times interest earned ratio, earnings before interest expense and income taxes is
used in the numerator.
Level: Easy LO: 4 Ans: T
Multiple Choice
16. The gross margin percentage is equal to:
A) (Net operating income + Operating expenses)/Sales
B) Net operating income/Sales
C) Cost of goods sold/Sales
D) Cost of goods sold/Net income
Level: Hard LO: 1 Ans: A
17. Earnings per share of common stock is computed by:
A) dividing net income by the average number of common and preferred shares outstanding.
B) dividing net income by the average number of common shares outstanding.
C) dividing net income minus preferred dividends by the average number of common and preferred
shares outstanding.
D) dividing net income minus preferred dividends by the average number of common shares outstanding.
Level: Medium LO: 2 Ans: D
727 Brewer, Introduction to Managerial Accounting, 3/e
,18. Which of the following is true regarding the calculation of return on total assets?
A) The numerator of the ratio consists only of net income.
B) The denominator of the ratio consists of the balance of total assets at the end of the period under
consideration.
C) The numerator of the ratio consists of net income plus interest expense times the tax rate.
D) The numerator of the ratio consists of net income plus interest expense times one minus the tax rate.
Level: Easy LO: 2 Ans: D
19. Which of the following is not a source of financial leverage?
A) Bonds payable.
B) Accounts payable.
C) Interest payable.
D) Prepaid rent.
Level: Medium LO: 2 Ans: D
20. The book value per share of common is usually significantly different from the market value of the
common stock because of:
A) the omission of total assets from the numerator in the calculation of the book value per share.
B) the use of the matching principle in preparing financial statements.
C) the omission of the number of preferred shares outstanding in the calculation of the book value per
share.
D) the use of historical costs in preparing financial statements .
Source: CMA, adapted
Level: Medium LO: 2 Ans: D
21. Sale of a piece of equipment at book value for cash will:
A) increase working capital.
B) decrease the acid-test ratio.
C) decrease the debt-to-equity ratio.
D) increase net income.
Level: Medium LO: 3,4 Ans: A
22. A company’s current ratio is greater than 1. Purchasing raw materials on credit would:
A) increase the current ratio.
B) decrease the current ratio.
C) increase net working capital.
D) decrease net working capital.
Source: CMA, adapted
Level: Hard LO: 3 Ans: B
Brewer, Introduction to Managerial Accounting, 3/e 728
, 23. Zack Company has a current ratio of 2.5. What will be the effect of a purchase of inventory with cash
on the acid-test ratio and on working capital?
A) A above
B) B above
C) C above
D) D above
Level: Medium LO: 3 Ans: B
24. Solomon Company has a current ratio greater than 1 and an acid-test ratio less than 1. How would
cash payments to suppliers to reduce accounts payable affect these ratios?
A) A above
B) B above
C) C above
D) D above
Level: Hard LO: 3 Ans: C
25. Norton Inc. could improve its current ratio of 2 by:
A) paying a previously declared stock dividend.
B) writing off an uncollectible receivable.
C) selling merchandise on credit at a profit.
D) purchasing inventory on credit.
Source: CMA, adapted
Level: Hard LO: 3 Ans: C
729 Brewer, Introduction to Managerial Accounting, 3/e
“How Well Am I Doing?” Financial Statement Analysis
True/False
1. Vertical analysis of financial statements is accomplished through the preparation of common-size
statements.
Level: Easy LO: 1 Ans: T
2. The gross margin percentage is computed by dividing the gross margin by net income before interest
and taxes.
Level: Medium LO: 1 Ans: F
3. If a company’s return on assets is substantially higher than its cost of borrowing, then the common
stockholders would normally want the company to have a relatively high debt/equity ratio.
Level: Easy LO: 2,4 Ans: T
4. The dividend yield ratio is calculated by dividing dividends per share by earnings per share.
Level: Easy LO: 2 Ans: F
5. Financial leverage is positive if the interest rate on debt is lower than the return on total assets.
Level: Medium LO: 2 Ans: T
6. To compute the return on total assets, net income should be adjusted by adding after-tax interest
expense and preferred dividends.
Level: Medium LO: 2 Ans: F
7. When computing the return on common equity, the income available for common stockholders is
determined by deducting preferred dividends from net income.
Level: Easy LO: 2 Ans: T
8. Issuing common stock will increase a company’s financial leverage.
Level: Medium LO: 2 Ans: F
9. Book value per share is the key to predicting a company’s future income producing ability.
Level: Easy LO: 2 Ans: F
Brewer, Introduction to Managerial Accounting, 3/e 726
,10. The book value per share of common stock reflects the balance sheet carrying value of already
completed transactions.
Level: Medium LO: 2 Ans: T
11. A company’s acid-test ratio will always be less than or equal to its current ratio.
Level: Medium LO: 3 Ans: T
12. A company could improve its acid-test ratio by selling some equipment it no longer needs for cash.
Level: Medium LO: 3 Ans: T
13. As the accounts receivable turnover ratio decreases, the average collection period decreases.
Level: Medium LO: 3 Ans: F
14. Payment of interest owed would decrease the inventory turnover ratio.
Level: Easy LO: 3 Ans: F
15. When computing the times interest earned ratio, earnings before interest expense and income taxes is
used in the numerator.
Level: Easy LO: 4 Ans: T
Multiple Choice
16. The gross margin percentage is equal to:
A) (Net operating income + Operating expenses)/Sales
B) Net operating income/Sales
C) Cost of goods sold/Sales
D) Cost of goods sold/Net income
Level: Hard LO: 1 Ans: A
17. Earnings per share of common stock is computed by:
A) dividing net income by the average number of common and preferred shares outstanding.
B) dividing net income by the average number of common shares outstanding.
C) dividing net income minus preferred dividends by the average number of common and preferred
shares outstanding.
D) dividing net income minus preferred dividends by the average number of common shares outstanding.
Level: Medium LO: 2 Ans: D
727 Brewer, Introduction to Managerial Accounting, 3/e
,18. Which of the following is true regarding the calculation of return on total assets?
A) The numerator of the ratio consists only of net income.
B) The denominator of the ratio consists of the balance of total assets at the end of the period under
consideration.
C) The numerator of the ratio consists of net income plus interest expense times the tax rate.
D) The numerator of the ratio consists of net income plus interest expense times one minus the tax rate.
Level: Easy LO: 2 Ans: D
19. Which of the following is not a source of financial leverage?
A) Bonds payable.
B) Accounts payable.
C) Interest payable.
D) Prepaid rent.
Level: Medium LO: 2 Ans: D
20. The book value per share of common is usually significantly different from the market value of the
common stock because of:
A) the omission of total assets from the numerator in the calculation of the book value per share.
B) the use of the matching principle in preparing financial statements.
C) the omission of the number of preferred shares outstanding in the calculation of the book value per
share.
D) the use of historical costs in preparing financial statements .
Source: CMA, adapted
Level: Medium LO: 2 Ans: D
21. Sale of a piece of equipment at book value for cash will:
A) increase working capital.
B) decrease the acid-test ratio.
C) decrease the debt-to-equity ratio.
D) increase net income.
Level: Medium LO: 3,4 Ans: A
22. A company’s current ratio is greater than 1. Purchasing raw materials on credit would:
A) increase the current ratio.
B) decrease the current ratio.
C) increase net working capital.
D) decrease net working capital.
Source: CMA, adapted
Level: Hard LO: 3 Ans: B
Brewer, Introduction to Managerial Accounting, 3/e 728
, 23. Zack Company has a current ratio of 2.5. What will be the effect of a purchase of inventory with cash
on the acid-test ratio and on working capital?
A) A above
B) B above
C) C above
D) D above
Level: Medium LO: 3 Ans: B
24. Solomon Company has a current ratio greater than 1 and an acid-test ratio less than 1. How would
cash payments to suppliers to reduce accounts payable affect these ratios?
A) A above
B) B above
C) C above
D) D above
Level: Hard LO: 3 Ans: C
25. Norton Inc. could improve its current ratio of 2 by:
A) paying a previously declared stock dividend.
B) writing off an uncollectible receivable.
C) selling merchandise on credit at a profit.
D) purchasing inventory on credit.
Source: CMA, adapted
Level: Hard LO: 3 Ans: C
729 Brewer, Introduction to Managerial Accounting, 3/e
