Financial Accounting Chapter 15 Quiz
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Questions and Answers

What three characteristics of a company are of interest to financial statement analysts?

Liquidity, profitability, and solvency.

Which of these is NOT a tool of Financial Statement Analysis?

  • Vertical Analysis
  • Trend Analysis (correct)
  • Ratio Analysis
  • Horizontal Analysis

What does Ratio Analysis express?

The relationship among selected items of financial statement data.

Which type of ratio measures the short-term ability of the company to pay its maturing obligations and meet unexpected needs for cash?

<p>Liquidity Ratios (A)</p> Signup and view all the answers

What are the four liquidity ratios?

<p>Current Ratio, Acid-Test Ratio, Accounts Receivable Turnover, and Inventory Turnover.</p> Signup and view all the answers

What is the formula for Current Ratio?

<p>Current Assets / Current Liabilities</p> Signup and view all the answers

What is the formula for Acid-Test Ratio?

<p>(Cash + Short-Term Investments + Accounts Receivable (net)) / Current Liabilities</p> Signup and view all the answers

What is the formula for Accounts Receivable Turnover?

<p>Net Credit Sales / Average Net Accounts Receivable</p> Signup and view all the answers

What is the formula for Inventory Turnover?

<p>Cost of Goods Sold / Average Inventory</p> Signup and view all the answers

What does the Profit Margin measure?

<p>The income or operating success of a company for a given period of time.</p> Signup and view all the answers

Why is income important to a company?

<p>It affects the company's ability to obtain debt and equity financing, maintain a strong liquidity position, and achieve future growth.</p> Signup and view all the answers

Which profitability ratio is considered an overall measure of profitability?

<p>Return on Assets (D)</p> Signup and view all the answers

What is the formula for Return on Ordinary Shareholders' Equity?

<p>(Net Income - Preference Dividends) / Average Ordinary Shareholders' Equity</p> Signup and view all the answers

What does Earnings per Share (EPS) measure?

<p>The net income earned on each ordinary share.</p> Signup and view all the answers

What is the formula for Price-Earnings Ratio?

<p>Market Price per Share / Earnings per Share</p> Signup and view all the answers

What does the Payout Ratio demonstrate?

<p>The percentage of earnings distributed in the form of cash dividends.</p> Signup and view all the answers

What do Solvency Ratios measure?

<p>The ability of a company to survive over a long period of time.</p> Signup and view all the answers

Which of these is NOT a solvency ratio?

<p>Acid-Test Ratio (C)</p> Signup and view all the answers

What is the formula for Debt to Assets Ratio?

<p>Total Liabilities / Total Assets</p> Signup and view all the answers

What is the formula for Times Interest Earned?

<p>(Net Income + Interest Expense + Income Tax Expense) / Interest Expense</p> Signup and view all the answers

John Cully Group had a higher Net Income for the year ending June 30, 2020 compared to June 30, 2019.

<p>True (A)</p> Signup and view all the answers

John Cully Group had a higher total assets for the year ending June 30, 2020 compared to June 30, 2019.

<p>True (A)</p> Signup and view all the answers

John Cully Group had higher total equity and liabilities for the year ending June 30, 2020 compared to June 30, 2019.

<p>True (A)</p> Signup and view all the answers

What is the average collection period?

<p>A variant of the Accounts Receivable Turnover ratio is to convert it to an average collection period in terms of days.</p> Signup and view all the answers

What is the purpose of the payout ratio?

<p>It indicates the percentage of earnings distributed in the form of cash dividends.</p> Signup and view all the answers

What are the two solvency ratios mentioned in the textbook?

<p>Debt to Total Assets and Times Interest Earned.</p> Signup and view all the answers

What is the importance of the Times Interest Earned ratio?

<p>It provides an indication of the company's ability to meet interest payments as they come due.</p> Signup and view all the answers

What is the purpose of the Debt to Assets Ratio?

<p>It measures the percentage of total assets provided by creditors.</p> Signup and view all the answers

What is a key takeaway for Quality Department Store from the horizontal analysis of their statement of financial position?

<p>The ending retained earnings increased 38.6%.</p> Signup and view all the answers

What is the key takeaway from the analysis of Quality Department Store's income statement?

<p>The company's gross profit and net income increased substantially, with gross profit increasing 17.1% and net income increasing 26.5%.</p> Signup and view all the answers

What is the main purpose of the income statement?

<p>It summarizes the company's revenues and expenses over a period of time, resulting in a net income or net loss.</p> Signup and view all the answers

What is the key takeaway about John Cully Group's financial position based on the provided information?

<p>John Cully Group has experienced growth in both its net income and total assets, signifying a positive trend.</p> Signup and view all the answers

What are the important factors in determining if a company is financially healthy?

<p>Liquidity, profitability, and solvency, as they demonstrate a company's ability to manage short-term obligations, generate profits, and meet its long-term financial commitments.</p> Signup and view all the answers

What type of information do ratios provide about a company?

<p>They offer valuable insights into a company's performance, liquidity, and solvency by comparing different financial metrics.</p> Signup and view all the answers

What is the purpose of the statement of financial position?

<p>It presents a snapshot of a company's assets, liabilities, and equity at a point in time.</p> Signup and view all the answers

What are the primary reasons for analyzing financial statements?

<p>Financial statements analysis helps assess a company's performance, liquidity, and solvency, providing valuable information for investors, creditors, and management decisions.</p> Signup and view all the answers

What is the primary goal of John Cully Group?

<p>To generate profits while managing its financial obligations effectively, aimed at achieving sustainable growth and maximizing shareholder value.</p> Signup and view all the answers

What is the connection between the information presented in the income statement and the statement of financial position?

<p>They are interconnected as the income statement shows financial performance over a period, while the statement of financial position presents a snapshot of the company's financial health at a point in time.</p> Signup and view all the answers

What is the importance of considering both liquidity and profitability when evaluating a company?

<p>Both aspects are crucial to assess a company's financial well-being, as liquidity ensures short-term solvency, while profitability drives long-term sustainability and growth.</p> Signup and view all the answers

Why is it important for investors to consider a company's solvency?

<p>It ensures the company has the capacity to meet its long-term financial obligations, signifying a safer investment and the potential for long-term growth.</p> Signup and view all the answers

What are the critical steps for analyzing a company's financial statements?

<p>Analyze the financial statements (income statement, statement of financial position, and statement of cash flow) to gain a clear understanding of the company's performance and its financial trajectory.</p> Signup and view all the answers

What is the importance of comparing a company's financial performance to its industry averages?

<p>It helps identify any strengths or weaknesses relative to its competitors, providing valuable insights for making informed decisions.</p> Signup and view all the answers

What are the key considerations for evaluating a company's financial health from a creditor's perspective?

<p>Creditors prioritize liquidity and solvency to ensure a company's ability to meet its financial obligations, minimizing their risk of financial loss.</p> Signup and view all the answers

What are the common reasons for conducting a financial statement analysis?

<p>It helps understand a company's financial performance and its ability to meet financial obligations, providing valuable information for investors, creditors, and management decisions.</p> Signup and view all the answers

What key factors do investors often prioritize when analyzing a company's financial statements?

<p>Investors typically focus on profitability, growth, and risk, aiming to identify companies that generate strong returns, have potential for future expansion, and present a reasonable level of risk.</p> Signup and view all the answers

What is a significant disadvantage of using ratios for financial analysis?

<p>Ratios can be misleading if used in isolation without considering the company's overall financial position and business context.</p> Signup and view all the answers

What are the factors that can influence a company's profitability?

<p>Profitability is influenced by various factors such as efficient management, sales growth, cost control, and the competitive environment.</p> Signup and view all the answers

What are the potential risks associated with a company that has high debt levels?

<p>High debt levels can increase a company's financial risk, potentially leading to difficulty in servicing its debt, higher interest expenses, and reduced financial flexibility.</p> Signup and view all the answers

What key factors should management consider when assessing a company's financial performance?

<p>Management should focus on key metrics like profitability, efficiency, liquidity, and solvency, ensuring the company's financial health and its ability to achieve its strategic goals.</p> Signup and view all the answers

Flashcards

Horizontal Analysis

A technique to analyze financial statements by comparing figures from different periods.

Vertical Analysis

A technique to analyze financial statements by comparing different components within the same period.

Ratio Analysis

A technique to evaluate a company's performance using ratios calculated from financial statement data.

Liquidity Ratios

Measures a company's ability to pay short-term obligations.

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Profitability Ratios

Measures a company's operating success over a time period.

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Solvency Ratios

Measures a company's ability to survive long-term.

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Current Ratio

Measures a company's ability to pay short-term obligations using current assets.

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Acid-Test Ratio

A stricter measure of liquidity, excluding inventory.

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Accounts Receivable Turnover

Measures how quickly a company collects its receivables.

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Inventory Turnover

Measures how quickly a company sells its inventory.

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Profit Margin

Measures a company's profitability.

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Asset Turnover

Measures how efficiently a company uses its assets to generate sales.

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Return on Assets (ROA)

An overall measure of a company's profitability.

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Return on Ordinary Shareholders’ Equity

Measures profitability for shareholders.

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Earnings per Share (EPS)

Measures net income earned on each ordinary share.

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Price-Earnings Ratio

Evaluates investor expectations related to future earnings.

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Payout Ratio

Measures the percentage of earnings distributed as dividends.

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Debt to Assets Ratio

Percentage of total assets provided by creditors.

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Times Interest Earned

Measures ability to meet interest payments.

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Study Notes

Financial Accounting - IFRS 4th Edition

  • Weygandt, Kimmel, Kieso authors
  • Chapter 15: Financial Analysis: The Big Picture

Learning Objectives

  • LO 1: Apply horizontal and vertical analysis to financial statements.
  • LO 2: Analyze a company's performance using ratio analysis.
  • LO 3: Apply the concept of sustainable income.

Basics of Financial Statement Analysis

  • Need for Comparative Analysis: Every item in a financial statement is significant.
  • Analytical Techniques: Used to evaluate the significance of financial statement data.
  • Characteristics: Liquidity, Profitability, Solvency
  • Comparison Bases: Intracompany, Industry averages, Intercompany
  • Tools of Analysis: Horizontal, Vertical, Ratio

Learning Objective 2: Analyzing Company Performance Using Ratio Analysis

  • Ratio Analysis: Expresses relationships among selected financial statement data items.
  • Liquidity Ratios: Measure short-term ability to pay maturing obligations and meet unexpected cash needs.
    • Short-term creditors (bankers, suppliers) are interested.
    • Ratios include: current ratio, acid-test ratio, accounts receivable turnover, inventory turnover.
  • Profitability Ratios: Measure income or operating success over a given time period.
    • Income affects debt/equity financing, liquidity, and growth.
    • Ratios include: profit margin, asset turnover, return on assets, return on ordinary shareholders' equity, earnings per share, price-earnings ratio, payout ratio.
  • Solvency Ratios: Measure company's ability to survive over a long period.
    • Ratios include: debt-to-total assets ratio, times interest earned.

Specific Ratio Examples

  • Current Ratio: (Current Assets / Current Liabilities)
    • Quality Department Store 2020: 2.96:1, 2019: 3.12:1, Industry Average: 1.70:1
  • Acid-Test Ratio: (Cash + Short-term Investments + Net Current Receivables / Current Liabilities)
    • Quality Department Store 2020: 1.02:1, 2019: 1.34:1, Industry Average: 0.70:1
  • Accounts Receivable Turnover: (Net Credit Sales / Average Net Accounts Receivable), measures the efficiency of collecting receivables.
  • Inventory Turnover: (Cost of Goods Sold / Average Inventory), measures how quickly inventory is sold.
  • Profit Margin: (Net Income / Net Sales), measures the percentage of sales that results in net income.
  • Asset Turnover: (Net Sales / Average Total Assets), measures how efficiently assets are used to generate sales.
  • Return on Assets (ROA): (Net Income / Average Total Assets), overall profitability measure.
  • Return on Ordinary Shareholders' Equity: (Net Income - Preference Dividends / Average Ordinary Shareholders' Equity), measures profitability of owners' investment.
  • Earnings Per Share (EPS): (Net Income - Preference Dividends / Weighted-Average Ordinary Shares Outstanding), measures the net income earned on each ordinary share.
  • Price-Earnings Ratio (P/E): Market Price per Share / Earnings per Share, reflecting investors' assessments of future earnings.
  • Payout Ratio: (Cash Dividends Declared on Ordinary Shares / Net Income), percentage of earnings distributed as dividends; industry average 16.1%.
  • Debt to Assets Ratio: (Total Liabilities / Total Assets), measures percentage of assets creditors provide.
  • Times Interest Earned: (Net Income + Interest Expense + Income Tax Expense / Interest Expense), ability to meet interest payments.

Additional Information

  • Retained Earnings Statement: Describes how retained earnings increased between two years.
  • Quality Department Store: Specific amounts provided for various financial statements (balance sheet, income statement) and ratios for years 2020 and 2019.
  • John Cully Group: Condensed financial statements are provided for use in performing ratio analysis problems.

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Description

Test your understanding of financial statement analysis with this quiz based on Chapter 15 of the 4th Edition of IFRS by Weygandt, Kimmel, and Kieso. Dive into horizontal and vertical analysis, ratio analysis, and the concept of sustainable income to evaluate company performance effectively.

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