of Foundations Finance, 7e (Keown)
Chapter 3 Understanding Financial Statements and Cash Flows
3.1 Learning Objective 1
True or False
1) An income statement reports a firm's cumulative revenues and expenses from the inception of
the firm through the income statement date.
Answer: FALSE
Diff: 1
Keywords: Income Statement, Revenues, Expenses
2) Owners equity increases each period by the amount of the corporation's positive net cash flow.
Answer: FALSE
Diff: 1
Keywords: Income Statement, Balance Sheet, Owners Equity
3) If two companies have the same revenues and operating expenses, their net incomes will still
be different if one company finances its assets with more debt and the other company with more
equity.
Answer: TRUE
Diff: 2
Keywords: Income Statement, EBIT, Financing Cost
4) Common-sized income statements are used to compare companies that have the same amount
of revenues.
Answer: FALSE
Diff: 1
Keywords: Common-Sized Income Statement
5) Common-sized income statements restate the numbers in the income statement as a
percentage of sales to assist in the comparison of a firm's financial performance across time and
with competitors.
Answer: TRUE
Diff: 1
Keywords: Common-Sized Income Statement
6) Net profit margin is equal to the gross profit margin times the operating profit margin.
Answer: FALSE
Diff: 1
Keywords: Net Profit Margin, Gross Profit Margin, Operating Profit Margin
7) Earnings before taxes, or taxable income, is equal to operating income minus financing costs.
Answer: TRUE
Diff: 1
Keywords: Earnings Before Taxes, Operating Income, Financing Costs
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8) The more debt a company uses to finance its assets, the lower will be its operating income due
to higher interest expense.
Answer: FALSE
Diff: 2
Keywords: Operating Income, EBIT
9) Changes in depreciation expense do not affect operating income because depreciation is a
non-cash expense.
Answer: FALSE
Diff: 1
Keywords: Depreciation, EBIT, Operating Income
10) Earnings available to common shareholders represents income that may be reinvested in the
firm or distributed to its owners.
Answer: TRUE
Diff: 1
Keywords: Earnings Available to Common Shareholders
11) Earnings available to common shareholders is equal to a corporation's positive net cash flow
over a given period, typically one year.
Answer: FALSE
Diff: 1
Keywords: Earnings Available to Common Shareholders
12) Profits-to-Sales relationships are defined as profit margins.
Answer: TRUE
Diff: 1
Keywords: Profit Margins
Multiple Choice
1) Company A and Company B both report the same level of sales and net income. Therefore,
A) both A and B will report the same Earnings Per Share.
B) both A and B will report the same Gross Profit Margin.
C) both A and B will report the same Net Profit Margin.
D) both A and C are true.
Answer: C
Diff: 2
Keywords: Earnings Per Share, Net Profit Margin, Gross Profit Margin
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2) The A corporation has an operating profit margin of 20%, operating expenses of $500,000,
and financing costs of $15,000. Therefore,
A) the corporation's gross profit margin is less than 20%.
B) the corporation's net profit margin is greater than 20%.
C) the corporation's gross profit margin is greater than 20%.
D) the corporation's gross profit margin is equal to 20% because gross profit is not affected by
operating expenses or financing costs.
Answer: C
Diff: 2
Keywords: Operating Profit Margin, Gross Profit Margin
3) The basic format of an income statement is
A) Sales - Expenses = Profits
B) Income - Expenses = EBIT
C) Sales - Liabilities = Profits
D) Assets - Liabilities = Profits
Answer: A
Diff: 1
Keywords: Income Statement
4) Li Retailing reported the following items for the current year: Sales = $3,000,000; Cost of
Goods Sold = $1,500,000; Depreciation Expense = $170,000; Administrative Expenses =
$150,000; Interest Expense = $30,000; Marketing Expenses = $80,000; and Taxes = $300,000.
Lis gross profit is equal to
A) $770,000.
B) $1,070,000.
C) $1,100,000.
D) $1,500,000.
Answer: D
Diff: 1
Keywords: Gross Profit
Explanation: Sales Cost of Goods Sold = $3,000,000 - $1,500,000 = $1,500,000
5) Li Retailing reported the following items for the current year: Sales = $3,000,000; Cost of
Goods Sold = $1,500,000; Depreciation Expense = $170,000; Administrative Expenses =
$150,000; Interest Expense = $30,000; Marketing Expenses = $80,000; and Taxes = $300,000.
Lis operating income is equal to
A) $770,000.
B) $1,070,000.
C) $1,100,000.
D) $1,500,000.
Answer: C
Diff: 2
Keywords: Operating Income, EBIT
Explanation: Sales Cost of Goods Sold Depreciation Expense Administrative Expenses
Marketing Expenses = EBIT = $3,000,000 1,500,000 170,000 150,000 80,000 =
$1,100,000
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6) Li Retailing reported the following items for the current year: Sales = $3,000,000; Cost of
Goods Sold = $1,500,000; Depreciation Expense = $170,000; Administrative Expenses =
$150,000; Interest Expense = $30,000; Marketing Expenses = $80,000; and Taxes = $300,000.
Lis net profit margin is equal to
A) 25.67%.
B) 35.67%.
C) 36.67%.
D) 50.00%.
Answer: A
Diff: 2
Keywords: Net Profit Margin
Explanation: Sales Cost of Goods Sold Depreciation Expense Administrative Expenses
Marketing Expenses = EBIT = $3,000,000 1,500,000 170,000 150,000 80,000 =
$1.100,000); (EBIT - Interest Expense - Taxes = Net Income = $1,100,000 - 30,000 - 300,000 =
$770,000); (Net Profit Margin = Net Income / Sales = $770,000 / $3,000,000 = 25.67%);
7) Li Retailing reported the following items for the current year: Sales = $3,000,000; Cost of
Goods Sold = $1,500,000; Depreciation Expense = $170,000; Administrative Expenses =
$150,000; Interest Expense = $30,000; Marketing Expenses = $80,000; and Taxes = $300,000;
Lis operating profit margin is equal to
A) 25.67%
B) 35.67%
C) 36.67%
D) 50.00%
Answer: C
Diff: 2
Keywords: Operating Profit Margin, EBIT
Explanation: Operating Profit Margin = EBIT/Sales = $1,100,000/$3,000,000 = 36.67%);
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8) Use the following information to calculate the companys accounting net income for the year.
Credit Sales
Cash Sales
Operating Expenses on Credit
Cash Operating Expenses
Accounts Receivable (Beg. of
Year)
Accounts Receivable (End of
Year)
Accounts Payable (Beg. of Year)
Accounts Payable (End of Year)
Corporate Tax Rate
$800,000
$500,000
$200,000
$700,000
$50,000
$80,000
$50,000
$100,000
40%
A) $300,000
B) $240,000
C) $125,000
D) $120,000
Answer: B
Diff: 2
Keywords: Net Income, Accrual Accounting, Income Statement
Explanation: Sales Operating Expenses Taxes = $1,300,000 - $900,000 - $160,000 =
$240,000
9) A corporation's operating profit margin is equal to
A) Net Income divided by Sales.
B) EBIT divided by Sales.
C) EBIT divided by Net Income.
D) Sales divided by EBIT.
Answer: B
Diff: 1
Keywords: Operating Profit Margin, EBIT
10) Which of the following statements concerning net income is most correct?
A) Net income represents cash available to pay dividends.
B) Net income represents sales minus operating expenses at a specific point in time.
C) Negative net income reduces a company's cash balance.
D) Net income represents income that may be reinvested in the firm or distributed to its owners.
Answer: D
Diff: 1
Keywords: Net Income
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11) Which of the following represents an attempt to measure the net results of the firm's
operations (revenues versus expenses) over a given time period?
A) Balance Sheet
B) Statement of Cash Flows
C) Income Statement
D) Sources and Uses of Funds Statement
Answer: C
Diff: 1
Keywords: Income Statement, Revenues, Expenses
12) What information does a firm's income statement provide to the viewing public?
A) an itemization of all of a firm's assets and liabilities for a defined period of time
B) a complete listing of all of a firm's cash receipts and cash expenditures for a defined period of
time
C) a report of revenues and expenses for a defined period of time
D) a report of investments made and their cost for a specific period of time
Answer: C
Diff: 1
Keywords: Income Statement, Revenues, Expenses
13) PDQ Corp. has sales of $4,000,000; the firm's cost of goods sold is $2,500,000; and its total
operating expenses are $600,000. What is PDQ's EBIT?
A) $850,000
B) $875,000
C) $900,000
D) $1,300,000
Answer: C
Diff: 2
Keywords: EBIT, Operating Income
14) PDQ Corp. has sales of $4,000,000; the firm's cost of goods sold is $2,500,000; and its total
operating expenses are $600,000. The firm's interest expense is $250,000, and the corporate tax
rate is 40%. What is PDQ's net income?
A) $288,000
B) $350,000
C) $377,000
D) $390,000
Answer: D
Diff: 2
Keywords: Net Income
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15) Corporation B reported earnings per share of $10. Corporation B has 100,000 shares of
common stock outstanding and reported an increase in owners equity of $400,000 for the
period. Corporation B paid $50,000 in interest expense during the period. Corporation B paid
dividends per share of
A) $6.00
B) $5.50
C) $6.50
D) $14.003
Answer: A
Diff: 3
Keywords: Earnings Per Share, Dividends Per Share, Income Statement
16) The increase in owners equity for a given period is equal to
A) positive net cash flow minus dividends.
B) net income minus dividends.
C) sales minus dividends.
D) gross profit minus distributions to shareholders.
Answer: B
Diff: 2
Keywords: Owners Equity, Income Statement, Dividends
17) A firm's financing costs include
A) depreciation expense.
B) interest exposure.
C) costs of goods sold.
D) both A and B
Answer: B
Diff: 1
Keywords: Financing Costs, Interest Exposure
18) Corporation A decides to borrow $1,000,000 and use the money to buy back $1,000,000 of
its common stock. The corporation pays 6% interest on its borrowed funds which exactly equals
the amount of the dividend it used to pay on the common stock it repurchased. Therefore,
A) Corporation A's operating income will decrease due to higher interest expense.
B) Corporation A's net income will increase due to the tax deductibility of interest expense.
C) Corporation A will have no change in its operating income since the interest expense exactly
offsets the prior dividend payment.
D) Corporation A's gross profit will decrease.
Answer: B
Diff: 3
Keywords: Income Statement, Financing Costs, Net Income
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19) Gross profit is equal to
A) profits plus depreciation.
B) revenues - expenses.
C) earnings before taxes minus taxes payable.
D) sales - cost of goods sold.
Answer: D
Diff: 1
Keywords: Gross Profit, Income Statement
20) An income statement may be represented as follows:
A) Sales - Liabilities = Profits
B) Revenues - Liabilities = Net Income
C) Sales - Expenses = Retained Earnings
D) Sales - Expenses = Profits
Answer: D
Diff: 1
Keywords: Income Statement
3.2 Learning Objective 2
True or False
1) Common-sized balance sheets show each account as a percentage of total sales to help
analysts in comparing companies of difference sizes.
Answer: FALSE
Diff: 1
Keywords: Common-Sized Balance Sheet
2) The balance sheet equation is Total Assets = Total Revenues - Total Liabilities.
Answer: FALSE
Diff: 1
Keywords: Balance Sheet
3) The accounting book value of an asset represents the historical cost of the asset rather than its
current market value or replacement cost.
Answer: TRUE
Diff: 1
Keywords: Accounting Book Value, Market Value
4) Intangible assets such as copyrights and goodwill are not included on the balance sheet
because they are impossible to value objectively.
Answer: FALSE
Diff: 1
Keywords: Intangible Assets, Balance Sheet
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5) Additional Paid in Capital on the balance sheet equals the amount paid by investors for the
company's common stock that exceeds the market price of the stock at the time of purchase.
Answer: FALSE
Diff: 1
Keywords: Additional Paid in Capital, Balance Sheet
6) A firm's income statement reports the results from operating the business for a period of time,
while the firm's balance sheet provides a snapshot of the firm's financial position at a specific
point in time.
Answer: TRUE
Diff: 1
Keywords: Income Statement, Balance Sheet
7) If a company's cash balance increases during the year, and the company also reports positive
net income, then the company's retained earnings balance must increase.
Answer: FALSE
Diff: 2
Keywords: Retained Earnings
8) Fixed assets are assets whose balances will remain the same throughout the year.
Answer: FALSE
Diff: 1
Keywords: Fixed Assets
9) Inventories are considered fixed assets because inventory levels remain fairly constant
throughout the year.
Answer: FALSE
Diff: 1
Keywords: Inventory, Fixed Assets
10) Finished goods held for sale are inventory, but raw materials to be used in the production
process are considered other assets.
Answer: FALSE
Diff: 1
Keywords: Finished Goods Inventory, Raw Materials Inventory, Other Assets
11) Accounting rules specify that assets on the balance sheet must be reported at current market
value, because this is the valuation most useful to potential investors.
Answer: FALSE
Diff: 1
Keywords: Accounting Book Value
12) The retained earnings balance on IBM's balance sheet at the end of 2010 is equal to IBM's
2010 net income minus dividends paid in 2010.
Answer: FALSE
Diff: 1
Keywords: Retained Earnings, Dividends
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13) Financing activities have no impact on the income statement, but rather are reflected in
changes in long-term debt and short-term debt on the balance sheet.
Answer: FALSE
Diff: 1
Keywords: Financing Activities, Income Statement, Balance Sheet
14) Common stockholders' equity equals common stock issued minus treasury stock .
Answer: FALSE
Diff: 1
Keywords: Stockholders' Equity, Common Stock, Treasury Stock
15) An income statement reports the firm's revenues and expenses for a specific period of time
such as one year.
Answer: TRUE
Diff: 1
Keywords: Income Statement, Revenues, Expenses
16) A balance sheet is a statement of the financial position of the firm on a given date, including
its asset holdings, liabilities, and equity.
Answer: TRUE
Diff: 1
Keywords: Balance Sheet, Assets, Liabilities, Equity
17) The profit and loss (income) statement is compiled on a cash basis.
Answer: FALSE
Diff: 1
Keywords: Income Statement, Cash Basis
18) The income statement describes the financial position of a firm on a given date.
Answer: FALSE
Diff: 1
Keywords: Income Statement
19) Under current accounting rules, the plant and equipment account shows the historical cost
(purchase price) of, plus any subsequent improvements to, the plant and equipment.
Answer: TRUE
Diff: 1
Keywords: Plant and Equipment, Historical Cost
20) On an accrual basis income statement, revenues equal cash receipts and expenses equal cash
expenditures.
Answer: FALSE
Diff: 1
Keywords: Accrual Basis, Income Statement, Revenues, Expenses
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21) A balance sheet reflects the current market value of a firm's assets and liabilities.
Answer: FALSE
Diff: 1
Keywords: Balance sheet, Current Market Value
22) Net working capital is equal to gross working capital minus depreciation.
Answer: FALSE
Diff: 1
Keywords: Net Working Capital
23) The balance sheet reflects the accounting equation: Assets = Liabilities + Owners' Equity.
Answer: TRUE
Diff: 1
Keywords: Profit Margins
Multiple Choice
Please refer to Table 3-1 for the following questions.
Table 3-1
Jones Company
Financial Information
December 2009
Net Income
Accounts receivable
Accumulated depreciation
Common stock
Paid-in capital
Retained earnings
Accounts payable
$2,000
750
1,000
4,500
7,500
1,500
750
December 2010
$4,000
950
1,500
5000
8500
3,500
750
1) Based on the information in Table 3-1, calculate the amount of dividends paid by Jones
Company in 2010 (no assets were disposed of during the year, and there was no change in
interest payable or taxes payable).
A) $2,000
B) $2,500
C) $3,500
D) $4,000
Answer: A
Diff: 2
Keywords: Dividends, Retained Earnings
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2) Based on the information in Table 3-1, assuming that no assets were disposed of during 2010,
the amount of depreciation expense was:
A) $375.
B) $500.
C) $2,500.
D) $3,500.
Answer: B
Diff: 1
Keywords: Depreciation Expense
3) Based on the information in Table 3-1, assuming that no common stock was repurchased
during the year, the firm issued how much new common stock during 2010?
A) $500
B) $1,000
C) $1,500
D) $2,000
Answer: C
Diff: 2
Keywords: Common Stock, Balance Sheet
4) The December 31, 2009 balance sheet shows net fixed assets of $150,000 and the December
31, 2010 balance sheet shows net fixed assets of $250,000. Depreciation expense for 2009 is
$25,000 and depreciation expense for 2010 is $35,000. Based on this information, the cost of
fixed assets purchased during 2010 is
A) $100,000.
B) $110,000.
C) $135,000.
D) $160,000.
Answer: C
Diff: 2
Keywords: Net Fixed Assets, Depreciation Expense, Accumulated Depreciation, Balance Sheet
5) All of the following would result in an increase in stockholders equity except:
A) the company sold common stock at par value.
B) the company sold common stock above par value.
C) the company purchased treasury stock.
D) the company had positive net income greater than dividends paid.
Answer: C
Diff: 2
Keywords: Stockholders' Equity, Treasury Stock, Balance Sheet
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6) Wheeler Corporation had retained earnings as of 12/31/10 of $15 million. During 2011,
Wheelers net income was $7 million. The retained earnings balance at the end of 2011 was
equal to $20 million. Therefore,
A) Wheeler paid a dividend in 2010 of $5 million.
B) Wheeler paid a dividend in 2010 of $2 million.
C) Wheeler sold common stock during 2010 for $5 million.
D) Wheeler purchased treasury stock in 2010 for $2 million.
Answer: B
Diff: 2
Keywords: Retained Earnings, Dividends
7) All of the following are equity accounts on a balance sheet except:
A) retained earnings.
B) cash.
C) common stock.
D) paid-in capital.
Answer: B
Diff: 1
Keywords: Balance Sheet, Equity
8) The two principal sources of financing for corporations are
A) debt and accounts payable.
B) debt and equity.
C) common equity and preferred equity.
D) cash and common equity.
Answer: B
Diff: 2
Keywords: Sources of Financing, Debt, Equity
9) Net working capital is equal to
A) total assets minus total liabilities.
B) current assets minus total liabilities.
C) total operating capital minus net income.
D) current assets minus current liabilities.
Answer: D
Diff: 1
Keywords: Net Working Capital, Current Assets, Current Liabilities
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10) Given the following financial statements for ACME Corporation, what amount did the
company pay in dividends for 2010?
Income Statement
Balance Sheet
Year Ended 12/31/10
Sales
$1,300,000
Cost of Goods Sold 750,000
Operating Expenses
200,000
Depreciation
Expense
EBIT
Interest Expense
EBT
Taxes
Net Income
100,000
250,000
50,000
200,000
80,000
$120,000
12/31/2010
Current Assets
$50,000
Gross Fixed Assets
880,000
Less Accumulated
450,000
Depreciation
Fixed Assets
430,000
Total Assets
12/31/2009
$45,000
650,000
350,000
350,000
$480,000
$395,000
Current Liabilities
$35,000
Long-term Debt
330,000
Common Stock
5,000
Retained Earnings
110,000
Total Liabilities & Equity
$480,000
$50,000
270,000
5,000
70,000
$395,000
A) $45,000
B) $25,000
C) $100,000
D) $80,000
Answer: D
Diff: 2
Keywords: Retained Earnings, Dividends
Explanation: beginning retained earnings plus net income minus dividends = ending retained
earnings, so $70,000 + $120,000 dividends = $110,000, and dividends = $190,000 - $110,000
= $80,000
11) All of the following statements about balance sheets are true except:
A) Assets - Liabilities = Shareholders' Equity
B) assets are reported at historical cost.
C) balance sheets show average asset balances over a one-year period.
D) a balance sheet reports a company's financial position at a specific point in time.
Answer: C
Diff: 1
Keywords: Balance Sheet
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12) All of the following are income statement items except:
A) accrued expenses.
B) depreciation expense.
C) cost of goods sold.
D) interest expense.
Answer: A
Diff: 1
Keywords: Income Statement, Accrued Expenses
13) PDQ Corp. has sales of $4,000,000; the firm's cost of goods sold is $2,500,000; and its total
operating expenses are $600,000. The firms interest expense is $250,000, and the corporate tax
rate is 40%. The firm paid dividends to preferred stockholders of $40,000, and the firm
distributed $60,000 in dividend payments to common stockholders. What is PDQ's "Addition to
Retained Earnings"?
A) $650,000
B) $390,000
C) $330,000
D) $290,000
Answer: D
Diff: 2
Keywords: Retained Earnings, Common Dividends, Preferred Dividends
14) What information does a firm's balance sheet provide to the viewing public?
A) a report of investments made and their cost for a specific period of time
B) a complete listing of all of a firm's cash receipts and cash expenditures for a defined period of
time
C) a report of revenues and expenses for a defined period of time
D) an itemization of all of a firm's assets, liabilities, and equity as of the balance sheet date
Answer: D
Diff: 1
Keywords: Balance Sheet, Assets, Liabilities, Equity
15) Which of the following accounts belongs on the asset side of a balance sheet?
A) depreciation expense
B) accounts payable
C) inventory
D) accruals
Answer: C
Diff: 1
Keywords: Balance Sheet, Inventory, Assets
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16) Which of the following accounts does not belong on the asset side of a balance sheet?
A) accounts receivable
B) marketable securities
C) common cash
D) stock
Answer: D
Diff: 1
Keywords: Balance Sheet, Assets
17) Which of the following accounts does NOT belong on the asset side of a balance sheet?
A) accounts receivable
B) accumulated depreciation
C) cash
D) accruals
Answer: D
Diff: 1
Keywords: Balance Sheet, Assets
18) Which of the following accounts belong in the liability section of a balance sheet?
A) interest expense
B) accumulated depreciation
C) accounts payable
D) preferred stock
Answer: C
Diff: 1
Keywords: Balance Sheet, Liabilities, Accounts Payable
19) Which of the following accounts does not belong in the liability section of a balance sheet?
A) accruals
B) short-term debt
C) additional paid-in capital
D) long-term debt
Answer: C
Diff: 1
Keywords: Balance Sheet, Liabilities
20) Which of the following accounts belongs in the equity section of a balance sheet?
A) retained earnings
B) cash
C) long-term debt
D) dividends
Answer: A
Diff: 1
Keywords: Balance Sheet, Equity, Retained Earnings
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21) Which of the following accounts does not belong in the equity section of a balance sheet?
A) retained earnings
B) paid-in-Surplus
C) long-term debt
D) preferred stock
Answer: C
Diff: 1
Keywords: Balance Sheet, Equity
22) Baron, Inc. has total current assets of $1,200,000; long-term debt of $600,000; total current
liabilities of $500,000; and long-term assets of $800,000. How much is the firm's net working
capital?
A) $1,000,000
B) $900,000
C) $600,000
D) $700,000
Answer: D
Diff: 1
Keywords: Balance Sheet, Net Working Capital
23) Global.Com has cash of $75,000; short-term notes payable of $100,000; accounts receivables
of $275,000; accounts payable of $135,000: inventories of $350,000; and accrued expenses of
$75,000. What is Globals net working capital?
A) $390,000
B) $175,000
C) $700,000
D) $210,000
Answer: A
Diff: 2
Keywords: Balance Sheet, Net Working Capital
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Essay
1) Prepare a balance sheet using the information given below. Make sure to identify current
assets, net fixed assets, total assets, current liabilities, long-term debt, total equity, and total
liabilities and equity.
Gross fixed assets
Cash
Other assets
Accumulated
depreciation
Common stock
Short-term notes
payable
Accounts payable
Inventories
Retained earnings
Accounts receivable
Long-term notes
payable
Long-term bonds
payable
Sales
Cost of goods sold
Depreciation expense
$40,000
$18,000
$5,000
$30,000
$43,000
$12,000
$35,000
$122,000
$100,000
$60,000
$10,000
$15,000
$300,000
$150,000
$3,000
Answer: Cash
Accounts receivable
Inventories
Current assets
Gross fixed assets
Less: Accumulated
Depreciation
Net fixed assets
Other assets
$18,000
60,000
122,000
200,000
40,000
Accounts payable
Short-term notes payable
Current liabilities
Long-term notes payable
Long-term bonds payable
$35,000
12,000
47,000
10,000
15,000
(30,000)
10,000
5,000
Total Assets
$215,000
Long-term debt
Common stock
Retained earnings
Total Equity
Total Liabilities & Equity
25,000
43,000
100,000
143,000
$215,000
Diff: 2
Keywords: Balance Sheet, Current Assets, Current Liabilities, Long-term Debt, Net Fixed
Assets, Total Assets, Total Equity, Total Liabilities & Equity
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3.3 Learning Objective 3
True or False
1) Generally accepted accounting principles (GAAP) require finance statements prepared on a
cash basis because these statements are most useful for investors and managers.
Answer: FALSE
Diff: 1
Keywords: Cash Basis, Accrual Basis, GAAP
2) A company with negative net income will also have negative operating cash flow.
Answer: FALSE
Diff: 1
Keywords: Operating Cash Flow, Net Income
3) According to accrual accounting, revenues are recognized when earned and expenses are
recognized when incurred.
Answer: TRUE
Diff: 1
Keywords: Accrual Accounting
4) In order to be conservative, accrual accounting requires that expenses be recorded when
incurred, but revenues are recorded only after the cash has been received.
Answer: FALSE
Diff: 1
Keywords: Accrual Accounting, Revenues, Expenses
5) The statement of cash flow explains the changes that took place in the firm's cash balance over
the period of interest.
Answer: TRUE
Diff: 1
Keywords: Statement of Cash Flows
Multiple Choice
1) What financial statement explains the changes that took place in the firm's cash balance over a
period?
A) statement of cash flow
B) balance sheet
C) income statement
D) reconciliation of free cash flow
Answer: A
Diff: 1
Keywords: Financial Statements, Statement of Cash Flow
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Please refer to Table 3-1 for the following questions.
Table 3-1
Jones Company
Financial Information
December 2009
Net Income
Accounts receivable
Accumulated depreciation
Common stock
Paid-in capital
Retained earnings
Accounts payable
$2,000
750
1,000
4,500
7,500
1,500
750
December 2010
$4,000
950
1,500
5000
8500
3,500
750
2) Based on the information in Table 3-1, calculate the after tax cash flow from operations for
2008 (no assets were disposed of during the year, and there was no change in interest payable or
taxes payable).
A) $4,300
B) $1,450
C) $5,500
D) $6,250
Answer: A
Diff: 2
Keywords: After-tax Cash Flow from Operations
3) Based on the information in Table 3-1, the change in cash for 2010 is
A) $4,000.
B) $4,950.
C) $5,800.
D) $5,500.
Answer: C
Diff: 2
Keywords: Statement of Cash Flows
4) A company borrows $2,000,000 and uses the money to purchase high technology machinery
for its operations. These are examples of
A) cash flow from financing and cash flow from operations.
B) cash flow from investing and cash flow from operations.
C) cash flow from financing and cash flow from investing.
D) cash flow from investing and cash flow from financing.
Answer: C
Diff: 1
Keywords: Statement of Cash Flows
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5) Two companies have identical assets and operating activities. Which of the follow statements
is true?
A) Both companies have the same net income.
B) The company with more debt will have lower operating income due to interest expense.
C) The company with more debt will have higher operating income due to leverage.
D) The company with more debt will have lower net income due to interest expense.
Answer: D
Diff: 2
Keywords: Operating Income, Net Income, Interest Expense
6) Jones Finance Company had a cash balance of $3 million at the beginning of 2010. During
2010, Sales were $8 million and expenses were $7 million. Therefore,
A) the cash balance at the end of 2010 is $4 million.
B) the cash balance at the end of 2010 must be greater than $3 million.
C) the cash balance at the end of 2010 must be less than $11 million.
D) the cash balance at the end of 2010 cannot be determined from the information given.
Answer: D
Diff: 2
Keywords: Cash Flow, Accrual Accounting vs. Cash Accounting
7) A corporation has annual sales of $18 million, total assets of $4 million, a debt ratio of 40%,
depreciation expense of $200,000, and a tax rate of 40%. The corporations total stockholders
equity is equal to
A) $5,600,000.
B) $2,800,000.
C) $2,400,000.
D) $1,800,000.
Answer: C
Diff: 2
Keywords: Stockholders' Equity, Debt Ratio
Explanation: 1 debt ratio = the percentage of assets that equals common equity, so common
equity = 60% times $4 million or $2.4 million
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8) Use the following information to calculate the change in the companys cash balance for the
year.
Credit Sales
Cash Sales
Operating Expenses on Credit
Cash Operating Expenses
Accounts Receivable (Beg. of
Year)
Accounts Receivable (End of
Year)
Accounts Payable (Beg. of Year)
Accounts Payable (End of Year)
Income Taxes Paid
$800,000
$500,000
$200,000
$700,000
$50,000
$80,000
$50,000
$100,000
$160,000
A) $145,000
B) $180,000
C) $260,000
D) $365,000
Answer: C
Diff: 2
Keywords: Cash, Cash Flow
Explanation: Cash Sales of $500,000 plus Credit Sales Collected of $770,000 [$800,000
increase in accounts receivable of $30,000] minus Cash Operating Expenses of $700,000 minus
Credit Operating Expenses Paid of $150,000 [$200,000 minus the increase in accounts payable
of $50,000] minus Income Taxes Paid of $160,000 = $260,000
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9) Given the following financial statements for ACME Corporation, what is the companys aftertax cash flow from operations?
Income Statement
Year Ended 12/31/10
Sales
$1,300,000
Cost of Goods
750,000
Sold
Operating
200,000
Expenses
Depreciation
100,000
EBIT
250,000
Interest Expense
50,000
EBT
200,000
Taxes
80,000
Net Income
$120,000
Balance Sheet
12/31/2010
Current Assets
$50,000
Fixed Assets
430,000
Total Assets
12/31/2009
$45,000
350,000
$480,000
$395,000
Current Liabilities
$35,000
Long-term Debt
330,000
Common Stock
5,000
Retained Earnings
110,000
Total Liabilities & Equity
$480,000
$50,000
270,000
5,000
70,000
$395,000
A) $10,000
B) $270,000
C) $120,000
D) $295,000
Answer: B
Diff: 2
Keywords: After-tax Cash Flow from Operations
Explanation: EBIT + Depreciation Income Taxes = $250,000 + $100,000 - $80,000 =
$270,000
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10) Given the following financial statements for ACME Corporation, and assuming that ACME
paid a common dividend of $80,000 in 2010, what is the companys financing cash flow for
2010?
Income Statement
Year Ended 12/31/10
Sales
$1,300,000
Cost of Goods Sold 750,000
Operating Expenses
200,000
Depreciation
Expense
EBIT
Interest Expense
EBT
Taxes
Net Income
100,000
250,000
50,000
200,000
80,000
$120,000
Balance Sheet
12/31/2010
Current Assets
$50,000
Gross Fixed Assets
880,000
Less Accumulated
450,000
Depreciation
Fixed Assets
430,000
Total Assets
12/31/2009
$45,000
650,000
350,000
350,000
$480,000
$395,000
Current Liabilities
$35,000
Long-term Debt
330,000
Common Stock
5,000
Retained Earnings
110,000
Total Liabilities & Equity
$480,000
$50,000
270,000
5,000
70,000
$395,000
A) -$10,000
B) -$15,000
C) -$65,000
D) -$70,000
Answer: D
Diff: 2
Keywords: Financing Cash Flow
Explanation: uses of cash = interest paid and dividends = $50,000 + $80,000 = $130,000;
sources of cash = increase in long-term debt and increase in common stock = $60,000 + $0 =
$60,000; financing cash flow = sources of cash minus uses of cash = $60,000 - $130,000 = $70,000
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11) Racing Horse Corporation reported net income for 2010 of $200,000, sales of $540,000,
expenses (excluding depreciation) of $180,000, and depreciation expense of $60,000. The
companys accounts receivable balance increased by $40,000 during the year and its accounts
payable balance remained the same. The companys change in cash for the year is estimated to
be
A) $100,000.
B) $160,000.
C) $220,000.
D) $380,000.
Answer: C
Diff: 2
Keywords: Cash Flow, Net Income, Depreciation Expense
Explanation: net income plus depreciation minus the increase in accounts receivable = $200,000
+ $60,000 - $40,000 = $220,000
12) Examples of uses of cash include
A) paying cash dividends to stockholders.
B) borrowing an additional amount using a secured loan.
C) selling machinery.
D) all of the above
Answer: A
Diff: 2
Keywords: Uses of Cash
13) Baron, Inc. has total current assets of $1,200,000; total current liabilities of $500,000; and
long-term assets of $800,000. How much is the firm's Total Liabilities & Equity?
A) $2,500,000
B) $1,300,000
C) $2,000,000
D) $1,800,000
Answer: C
Diff: 2
Keywords: Balance Sheet, Total Liabilities & Equity
14) Baron, Inc. has total current assets of $1,200,000; total current liabilities of $500,000; longterm assets of $800,000; and long-term debt of $600,000. How much is the firm's total equity?
A) $1,200,000
B) $800,000
C) $900,000
D) $2,000,000
Answer: C
Diff: 2
Keywords: Balance Sheet, Equity
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15) What information does a firm's statement of cash flows provide to the viewing public?
A) a report of investments made and their cost for a specific period of time
B) a report documenting a firm's cash inflows and cash outflows from operating, financing, and
investing activities for a defined period of time
C) a report of revenues and expenses for a defined period of time
D) an itemization of all of a firm's assets, liabilities, and equity for a defined period of time
Answer: B
Diff: 1
Keywords: Statement of Cash Flows
16) Which of the following best describes cash flow from financing activities?
A) Interest income, plus dividend income, minus taxes
B) Interest expense, minus dividends paid
C) Interest paid, plus dividends paid, plus increase (or minus decrease) in stock, plus increase (or
minus decrease) in debt
D) Increase (or minus decrease) in stock, plus increase (or minus decrease) in debt, minus
interest paid, minus dividends paid.
Answer: D
Diff: 2
Keywords: Financial Statements, Statement of Cash Flow
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Please refer to Table 3-2 for the question below.
Table 3-2
Enigma has the following financial information:
Net Income
$70,000
Taxable Income (EBT)
$100,000
Interest Expense
$20,000
Depreciation Expense
$15,000
Tax Expense
$30,000
Increase in Current Assets
Increase in A/P and
Accruals
Decrease in Gross Fixed
Assets
$20,000
$10,000
$100,000
No changes were made in interest payable or taxes payable.
17) Based on the information in Table 3-2, what is Enigma's cash flow from operations?
A) $85,000
B) $100,000
C) $105,000
D) $75,000
Answer: D
Diff: 2
Keywords: After-tax Cash Flow from Operations
18) A firm has after-tax cash flow from operations equal to $100,000. Operating working capital
increased by $20,000, and the firm purchased $30,000 of fixed assets. The firm's free cash flow
was:
A) $50,000.
B) $90,000.
C) $110,000.
D) $150,000.
Answer: A
Diff: 2
Keywords: Free Cash Flow
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19) A firm paid dividends of $10,000, paid interest of $20,000, reduced debt principal
outstanding (paid off debt) in the amount of $100,000, and sold new stock for $150,000. What
was the firms cash flow from financing activities?
A) +$20,000 ($20,000 flowed into the firm)
B) -$20,000 ($20,000 flowed out of the firm)
C) +$280,000 ($280,000 flowed into the firm)
D) -$280,000 ($280,000 flowed out of the firm)
Answer: A
Diff: 2
Keywords: Free Cash Flow
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Essay
1) Table 3-3
Marlett Company
Financial Information
December 2009
Net Income
Accounts receivable
Accumulated depreciation
Common stock
Paid-in capital
Retained earnings
Accounts payable
$2,000
750
1,000
4,500
7,500
1,500
750
December 2010
$4,000
1,250
1,400
5500
8500
3,500
950
Based on the information in Table 3-3, prepare a statement of cash flows for 2010. Assume that
there were no changes in any other asset or liability accounts, and that the ending cash balance
for 2009 was $100.
Answer: Marlett Company
Statement of Cash Flows
For the Year Ended Dec. 31, 2008
Operating Activities
Net Income
Depreciation Expense
Increase in Accounts Receivable
Increase in Accounts Payable
Cash Flow from Operations
$4,000
400
(500)
200
$4,100
Investing Activities
Cash Flow from Investing Activities
$0
Financing Activities
Increase in Common Stock
Increase in Paid-in-Capital
Dividends Paid
Cash Flow from Financing Activities
$1,000
1,000
(2,000)
$0
Change in Cash
Beginning Cash Balance
Ending Cash Balance
$4,100
100
$4,200
Diff: 2
Keywords: Cash Flow
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2) Is it possible for a company that has negative net income and negative operating cash flow to
end the year with an increase in cash and an increase in stock price? Explain your answer.
Answer: Yes! Many start-up companies or research companies in high growth industries are
financed by borrowing money or selling more shares of stock to cover operating losses and
finance development costs until, hopefully, the companies become profitable and cash-flow
positive. Many of the familiar Internet companies of today, such as Amazon and Yahoo, began
with negative income and high negative operating cash flows as infrastructure and business
relationships were put into place. Investors are willing to provide capital to such companies
hoping that business growth will lead to positive and growing cash flows in the future. If
financing cash flows are more than enough to cover operating losses and additional investments
in working capital and long-term assets, then the company's cash balance could actually increase
despite negative net income and negative operating cash flow.
Diff: 2
Keywords: Cash Flow
3) Mr. Wizards Magic Shoppe had the following condensed balance sheet at the end of
operation for 2010:
Mr. Wizards Magic Shoppe
Balance Sheet
December 31, 2010
Cash
Other current assets
Total current assets
Investments
Fixed assets (net)
Land
Total assets
$40,000
60,000
$100,000
$25,000
110,000
$120,000
$355,000
Current Liabilities
$35,000
Long-term Notes Payable
40,000
Bonds Payable
50,000
Capital Stock
150,000
Retained earnings
80,000
Total Liabilities and Equity
$355,000
During 2011, the following occurred
a. Mr. Wizards sold some of its investments for $13,000 which resulted in a gain of $300
after taxes. The gain (net of taxes) has been included in the companys 2011 net income.
b. Additional land for a plant expansion was purchased for $25,000.
c. Bonds payable were paid in the amount of $10,000.
d. An additional $35,000 in capital stock was issued.
e. Dividends of $15,000 were paid to stockholders.
f. Net income for 2011 was $48,000 after allowing for $15,000 in depreciation.
g. A second parcel of land was purchased through the issuance of $10,000 in bonds, and
$5,000 in long-term notes payable.
Required:
a. Prepare a statement of cash flows for the year ended 12/31/2011. (check figure: ending
cash balance = $72,500)
b. Prepare a condensed balance sheet for Mr. Wizards at December 31, 2011.
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Answer:
Mr. Wizards Magic Shoppe
Statement of Cash Flow
For the Year Ended December 31, 2011
Cash balance (December 31, 2010)
Net Income (from the statement of income)
Add (deduct) to reconcile net income to net cash
flow:
Depreciation Expense
Loss (Gain) from the sale of investments
Net cash inflow from operating activities
Cash flows from investing activities:
Sale of Investments
Purchase of Land (25,000+10,000+5,000)
Net cash flow from investing activities:
Cash flows from financing activities:
Issuance of capital stock
Issuance of bonds
Issuance of notes payable
Repayment of bonds payable
Dividends
Net cash flow from financing activities:
$40,000
$48,000
15,000
(300)
$62,700
13,000
(40,000)
(27,000)
35,000
10,000
5,000
(10,000)
(15,000)
25,000
Net increase (decrease) in cash during the period
$60,700
Cash balance (December 31, 2011)
$100,700
Cash
Other current assets
Total current assets
Investments
Fixed assets (net)
Land
Total assets
Mr. Wizards Magic Shoppe
Balance Sheet
December 31, 2011
$100,700
Current Liabilities
$35,000
60,000
Long-term Notes Payable
45,000
$160,700
Bonds Payable
50,000
$12,300
Capital Stock
185,000
95,000
Retained earnings
113,000
$160,000
$428,000
Total Liabilities and Equity
$428,000
Diff: 3
Keywords: Statement of Cash Flows, Balance Sheet
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4) Given the information below, calculate the companys cash balance at the end of the year.
Cash Balance at Beginning of Year
Activity During the Year
Increase in Accounts Payable
Decrease in Accounts Receivable
Depreciation Expense
Net Income
Purchase of Fixed Assets
Sales of Common Stock
Decrease in Notes Payable
Dividends Paid
Answer:
Increase in Accounts Payable
Decrease in Accounts Receivable
Depreciation Expense
Net Income
Purchase of Fixed Assets
Sales of Common Stock
Decrease in Notes Payable
Dividends Paid
Change in Cash for the Year
$80,000
$60,000
$40,000
$500,000
$2,000,000
$800,000
$100,000
$85,000
$15,000
$60,000
$40,000
$500,000
$2,000,000
$800,000
$100,000
$85,000
$15,000
$1,800,000
(source)
(source)
(source)
(use)
(source)
(use)
(use)
Cash Balance at the End of Year = $80,000 + $1,800,000 = $1,880,000
Diff: 3
Keywords: Statement of Cash Flows, Sources and Uses of Cash
3.4 Learning Objective 4
Multiple Choice
1) PDQ Corp. has sales of $4,000,000; the firm's cost of goods sold is $2,500,000; and its total
operating expenses are $600,000. The firm's interest expense is $250,000, and the corporate tax
rate is 40%. What is PDQ's tax liability?
A) $258,000
B) $260,000
C) $360,000
D) $600,000
Answer: B
Diff: 2
Keywords: Tax Liability, Interest Expense
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2) The income statement for Brit, Inc. indicates that tax expense was $20,000. The balance sheet
indicates that taxes payable for the same year increased by $5,000. What amount did Brit, Inc.
actually pay in taxes during this year?
A) $15,000
B) $20,000
C) $25,000
D) Cannot be determined without the cash balance
Answer: A
Diff: 2
Keywords: Tax Expense, Taxes Payable, Accrual vs. Cash Accounting
Essay
1) Prepare an income statement using the information given below. Make sure to identify gross
profit, operating income, and net income.
Inventories
Cost of Goods Sold
Administrative Expenses
Accumulated Depreciation
Sales
Depreciation Expense
Selling Expenses
Common Stock Dividends
Interest Expense
Corporate Tax Rate
$50,000
$250,000
$50,000
$150,000
$600,000
$25,000
$150,000
$8,000
$8,000
40%
Answer: Sales
Cost of Goods Sold
Gross Profit
Selling Expenses
Administrative Expenses
Depreciation Expense
Operating Income (EBIT)
Interest Expense
Earning Before Taxes
(EBT)
Taxes (40%)
Net Income
$600,000
250,000
350,000
150,000
50,000
25,000
125,000
8,000
117,000
46,800
$70,200
Diff: 2
Keywords: Income Statement, Gross Profit, Operating Income (EBIT), Net Income
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Copyright 2011 Pearson Education, Inc.