ACCT/FIN 447

1. Multiple Choice Questions

Group 1 Questions

1. Nonrecurring items are:

    1. Never recorded by corporations
    2. Transactions and events that are unusual in nature and infrequent in occurrence, immaterial in amount
    3. Recurring items that represent income but fail to meet revenue recognition requirements
    4. Non-typical items, usually losses, such as extraordinary items, discontinued operations, or accounting changes
    5. None of the above
2. Which of the following items has economic value, but not recorded on the balance sheet as an asset?
    1. Fixed assets
    2. Marketable securities carried as trading securities
    3. Inventory carried at LIFO
    4. Patents generated from internal research and development
    5. None of the above
3. Automotive companies such as Ford and Chrysler:
    1. Pay no dividends
    2. Are durable goods manufacturers that typically have low price earnings ratios
    3. Have almost no long-term debt
    4. Should be in all growth fund mutual funds
    5. None of the above
4. Comprehensive income:
    1. Is identical with net income
    2. Is identical with current operating income
    3. Will be reported beginning in 1998 under SFAS No. 130 , such as in a statement of income and comprehensive income
    4. Is used with Canadian not U. S. accounting standards
    5. All of the above
5. Where would an investor find a company’s management discussion of results of operations, capital resources, and outlook based on known trends?
    1. SEC 8-K
    2. Auditor’s Opinion in Annual Report
    3. Management discussion & analysis in Annual Report
    4. Earnings announcement in Wall Street Journal
    5. None of the above
6. Financial capital maintenance represents:
    1. Total stockholders’ equity restated to market value
    2. Market value of the firm based on current share price
    3. Recognition of income after recovery of capital based on invested dollars
    4. Stock price divided by book value per share
    5. None of the above
7. According to the FASB (Concept Statement 6), revenue is:
    1. An increase in equity from peripheral or incidental transactions
    2. Total cash flows from operations
    3. Resource inflows from an entity’s ongoing or central operations
    4. Probable future economic benefits
    5. None of the above
8. Charging advertising as an expense at year-end is an example of:
    1. Earnings management
    2. A period cost
    3. A product cost
    4. The big bath theory
    5. None of the above
9. Depreciation expense on fixed assets is recorded on the statement of cash flows as:
    1. Added back to net income as part of cash flows from operations
    2. Cash outflow from investing activities
    3. Cash outflows from financing activities
    4. Not recorded on cash flow statement
    5. None of the above
10. Free cash flow can be measured as:
    1. Cash - current liabilities
    2. Cash from operations - cash from investing activities
    3. Net income + depreciation expense
    4. Cash / earnings before interest & taxes
    5. None of the above
11. Examining a firms operating efficiency can best be done using:
    1. Activity analysis
    2. Liquidity analysis
    3. Solvency and debt analysis
    4. Profitability analysis
    5. None of the above
12. Sales in a common-size income statement is usually stated as:
    1. 100%
    2. A percent of net income
    3. A percent of total assets
    4. A percent of gross profit
    5. None of the above
13. Crashem Co. purchases equipment for $180,000 in cash. How would this transaction affect the financial statements?
    1. Increase fixed assets and decrease cash on the balance sheet; cash outflow from investing activities on the statement of cash flows
    2. Increase expense on the income statement; increase fixed assets on the balance sheet; cash outflow from operations on the statement of cash flows
    3. Increase fixed assets and increase long-term debt on the balance sheet; cash outflow from operations on the statement of cash flows
    4. Decrease revenues on the income statement; increase fixed assets on the balance sheet; cash outflow from financing activities on the statement of cash flows
    5. None of the above
14. Which of the following is found in the statement of cash flows?
    1. Operating income
    2. Auditor’s opinion
    3. Summary of significant accounting policies
    4. Cash dividends
    5. All of the above
Bridget’s Midget Widget

                                       1998 1997 1996 1995
Sales                             $100 $ 95 $ 91 $ 88
Cost of goods sold        65    64     63 62
Gross Profit                     35     31     28 26

Answer questions 15-16 based on the information from above:

15. Gross margin:

    1. Has decreased over the four year period because of inflation
    2. Has stayed the same, with rising sales offset by decreasing cost of goods sold
    3. Has increased as a percentage of sales
    4. Has decreased as a percentage of sales
    5. All of the above
16. Gross Profit has:
    1. Increased over the period because cost of goods sold has increased less rapidly than sales
    2. Stayed the same in dollars, but decreased as a percentage of sales
    3. Decreased over the period
    4. Decreased in dollars, but increased as a percent of sales
    5. None of the above
17. The length of the operating cycle measures:
    1. The number of days to produce goods and pay for related accounts payable
    2. The number of days that work in progress and finished goods are held in inventory
    3. Cash Flow from Operations / Current Assets
    4. The number of days to sell inventory plus the number of days until the resulting receivables are converted to cash
    5. All of the above
Selected Financial Information for Grumpy Gary’s Gimpy Gizmos Year Ended 1998 Year ended 1997

        Cash                                                     $ 1,300 $ 1,350
        Accounts Receivable                             2,200 1,850
        Inventory                                                 3,600 3,800
        Property, Plant & Equipment (net)     8,900 8,000
        Total Assets                                     $ 16,000 $15,000
        Current Liabilities                                    3,400 3,300
        Total Liabilities                                         4,900 4,800
        Sales                                                     $24,000 $20,000
        Cost of Goods Sold                             15,300 12,000
        General and Administrative Expenses 1,500 1,380
        Taxes                                                         2,200 2,050
        Net Income                                         $ 5,000 $ 4,570

Use this information to answer 18-21.

18 What is Grumpy Gary’s receivables turnover for 1998?

    1. 2.27x
    2. 4.44x
    3. 10.86
    4. 11.85x
    5. Some other amount
19. What is Grumpy Gary’s quick ratio for 1998?
    1. 38%
    2. 71%
    3. 103%
    4. 209%
    5. Some other amount
20. Return on equity for 1998 is:
    1. 31%
    2. 47%
    3. 216%
    4. 313%
    5. Some other amount
21. Gross profit increased by how much from 1997 to 1998?
    1. $430
    2. $700
    3. $4,000
    4. $8,700
    5. Some other amount
22. The operating cash flow ratio is:
    1. Cash / current liabilities
    2. Cash from operations / current liabilities
    3. Average cash balance / cash from investments
    4. Cash from operations / gross profit
    5. None of the above
23. Starr Co. had 1997 sales of $210. Sales for 1998 increase by 15% and cost of goods sold remains 65% of sales. Starr Co.’s 1998 income statement will show gross profit of:
    1. $73.50
    2. $84.52
    3. $144.90
    4. $241.50
    5. Some other amount
24. Fixed asset turnover is calculated as:
    1. Fixed Assets / Accounts Receivable
    2. Cost of Goods Sold / Average Fixed Assets
    3. Sales / Average Fixed Assets
    4. Average Fixed Assets / Average Total Assets
    5. None of the above
25. High quality of earnings is usually associated with:
    1. A price earnings ratio above the market average of 30
    2. A high percentage return on assets
    3. A high return on equity based on the Du Pont model
    4. Full disclosure and conservative reporting of earnings
    5. None of the above
26. Assume General Motors has a price earnings (PE) ratio of 10. This can be evaluated for an investment decision by:
    1. Comparing GMs PE ratio over time
    2. An automobile industry analysis of PE ratios
    3. Benchmarking of PE ratios across industries
    4. Decision goals, such as investing for a retirement fund
    5. All of the above
The following information on Gore Co. is used for questions 27-28:

Stock price, 12/31/98 $58
High, low stock price, 1998 32-65
Actual earnings per share (EPS), 12/31/98 2.20
Forecasted EPS for 1999 2.60
Dividends per share for 1998 1.00

27. What is Gore Co’s. PE ratio, assuming year-end closing price & 1999 forecasted EPS?

    1. 14.5
    2. 22.3
    3. 25.0
    4. 26.4
    5. Some other amount
28. What is Gore Co’s. dividend yield based on year-end closing price?
    1. 1.5%
    2. 1.7%
    3. 3.1%
    4. 3.8%
    5. Some other amount
29. Industry norms:

                Earnings Growth % PE Ratio Yield
Drugs         18.1                             44           1.07
Steel             1.6                             10            1.85

Based on the industry norms above, which statement is true?

    1. Drug stocks are more likely to be acquired by an income mutual fund
    2. Steel stocks are more likely to have a higher price to book ratio
    3. Drug stocks should be more volatile but have a higher stock price growth potential than steel
    4. Steel stocks have higher growth, but pay lower dividend yields
    5. None of the above
30. Normalizing income is associated with:
    1. Averaging net income for the last 10 years
    2. Focusing exclusively on gross profit
    3. The process of estimating forecasted earnings per share for the next 5 years
    4. Attempt to determine earning power, related to normal operating earnings
    5. None of the above
Group 1 Possible Answers
1. D 11. A 21. B
2. D 12. A 22. B
3. B 13. A 23. B
4. C 14. D 24. C
5. C 15. C 25. D
6. C 16. A 26. E
7. C 17. D 27. B
8. B 18. D 28. B
9. A 19. C 29. C
10. B 20. B 30. D

Group 2 Question

1.  A firm with a high default risk on debt is likely to have:

    1. Low leverage and a high return on assets
    2. Increasing sales, but a rising gross margin
    3. High leverage, low liquidity, and erratic earnings
    4. Low leverage and a high Altman’s Z-score
    5. All of the above
2. An Altman’s Zscore of 1.1-2.6 is in the gray area. Therefore, a score of 0.8 means:
    1. A firm categorized as failing
    2. A firm categorized as healthy
    3. A firm that must file for Chapter 11 bankruptcy
    4. A firm that will be acquired by a healthier firm
    5. None of the above
3. Which of the following is NOT a ratio used in Altman’s (1968) model for manufacturing firms:
    1. Working capital/total assets
    2. EBIT/total assets
    3. Retained earnings/total assets
    4. Cash flow from operations/gross margin
    5. None of the above
4. Assume that Altman’s Zscore classifies firms as:

------------Predicted-------------

Actual Bankrupt Nonbankrupt

Bankrupt        47             3

Nonbankrupt 2             48

How many firms are classified correctly?

    1. 47
    2. 50
    3. 95
    4. 100
    5. Some other amount
5. Given the information from 4 above, how many firms represent Type II errors?
    1. 0
    2. 2
    3. 3
    4. 47
    5. Some other amount
6. Which of the following bonds is classified as investment grade according to Standard & Poors?
    1. A
    2. BB
    3. CCC
    4. D
    5. All of the above
7. Which of the following bonds is likely to have the lowest Altman’s Z-score?
    1. AAA
    2. BBB
    3. B
    4. D
    5. Cannot be determine        8.  Bond covenants:
    1. Are Contract provisions to protect investors
    2. May limit dividends or restrict new debt or acquisitions
    3. May require the maintenance of certain financial ratios
    4. Can lead to technical default of provisions are violated
    5. All of the above
  1. 9.  Earnings management is:
    1. Maximizing sales by fraud
    2. Operations and discretionary accounting methods to manipulate earnings to a desired outcome
    3. Maintaining bond covenants that are never violated so that management bonuses always increase over time
    4. Maximizing disclosure and presenting the most complex information so that users cannot determine actual performance levels
    5. All of the above
10. The purpose of income smoothing is:
    1. Use fraud so that earnings always increases to maintain analysts forecasts
    2. Sell off or buy assets to insure that this year’s income is identical to last year’s
    3. Manipulate sales so that it increases exactly 10% each year
    4. Maintain relatively stable earnings growth from year to year—which should have beneficial effects such as higher stock prices and improved management compensation
    5. None of the above
  1. 11.  According to efficient contracting economic theory, opportunism:
    1. Is illegal
    2. Represents self interest with guile
    3. Is associated only with bankrupt companies
    4. Never exists if contracting is efficient
    5. None of the above
  1. 12.  The economic concept of bounded rationality assumes:
    1. The managers maximize income
    2. People are intendedly rational but limited
    3. Irrational behavior by agents, but perfect knowledge by principals
    4. Financial reports provide perfect knowledge that leads to optimal decision making
    5. All of the above
13. In agency theory, when a corporation hires an auditor, the auditor is a(n):
    1. Agent
    2. Principal
    3. Lobbyist
    4. Loser
    5. None of the above
14. Aligning the preferences of principals and agents can be used to reduce agency costs. An example is:
    1. Lobbying
    2. Financial audits and financial reporting
    3. Political costs
    4. Issuing stock options to managers and employees
    5. All of the above
15. An example of an agency cost is:
    1. Moral hazard
    2. Broker’s fees
    3. Lobbying
    4. Production activities
    5. None of the above
16. During a period of rising prices, which of the following is lower using FIFO rather than LIFO?
    1. Income before tax
    2. Income tax
    3. Cost of goods sold
d. Net income e. All of the above 17. Why would a firm use accelerated depreciation for tax purposes and straight-line for financial reporting?

a. It is required by federal law

    1. This always increases stock price, which always increases management compensation
    2. This reduces current taxes and increases accounting income
    3. This has no benefit and is seldom done
    4. None of the above
  1. 18.  What are the incentives for "Big Bath" writeoffs?
    1. Always done prior to a merger to lower stock price
    2. It’s a plan to increase current management bonuses
    3. This is done for tax purposes only
    4. Taking large losses in bad years to "clear the deck" of problem items
    5. None of the above
19. IBM capitalizes computer software development costs under SFAS 86. Microsoft does not. By capitalizing, IBM will have:
    1. A lower bond rating
    2. Lower net income
    3. Fewer programmers
    4. Higher net income
    5. None of the above
20. Large oil and gas drilling companies typically use successful efforts for drilling costs rather than full costing. Using successful efforts results in:
    1. Lower income and assets
    2. Higher net income
    3. Higher income taxes
    4. Huge increases in cash
    5. All of the above
21. Assume the managers want to maximize bonuses which are based on current net income. Managers should prefer:
    1. Using LIFO rather than FIFO for inventory
    2. Using accelerated depreciation for financial reporting
    3. Expensing research & development costs
    4. Using full costing rather than successful efforts for oil drilling
    5. All of the above
  1. 22.  Accounting Research Bulletin 43, issued in 1953, was the first codification of generally accepted accounting principles. It was issued by:
    1. Financial Accounting Standards Board
    2. Securities & Exchange Commission
    3. Committee on Accounting Procedures
    4. Accounting Principles Board
    5. None of the above
23. The members of the Financial Accounting Standards Board are appointed by:
    1. Financial Accounting Foundation
    2. Financial Accounting Standards Advisory Committee
    3. Securities & Exchange Commission
    4. Congress
    5. None of the above
  1. 24.  Statement of Financial Accounting Standards No. 13 on leases was considered one of the "worst" standards by Reither (1998) because:
    1. It requires income smoothing
    2. It always increases taxes
    3. It’s complexity and use of "cookbook accounting"
    4. It always reduces net income and therefore management bonuses
    5. All of the above
  1. 25.  Arthur Levitt (SEC Chairman) accuses the accounting profession of the "gimmick business" and earnings management because of practices such as:
    1. "Merger magic" of acquisition accounting
    2. Use of diverting earnings to reserve accounts
    3. "Big Bath" charges
    4. Revenue recognition before the earnings process is complete
    5. All of the above
26. Tobin’s Q is:
    1. Stock price / earnings per share
    2. A model to predict bankruptcy
    3. Accounting Beta / Market Beta
    4. An asset-based valuation model
    5. None of the above
27. A Tobin’s Q less than 1 represents:
    1. A poor performing firm
    2. A firm with a stock price out-performing the market
    3. A firm likely to go bankrupt
    4. A high leverage firm
    5. None of the above
  1. 28.  A discounted cash flow firm valuation model is measured as:
    1. Tobin’s Q
    2. S Cash flows / rate of return
    3. S Price earnings ratios last 3 years
    4. (Working capital + leverage) / (stock price x shares outstanding)
    5. None of the above
29. A no-growth dividend discount model is:
    1. Value = Price earnings ratio
    2. Value = market value of firm / book value of firm on replacement cost basis
    3. Equity = dividends / rate of return
    4. Equity = (working capital + leverage) / (stock price x shares outstanding)
    5. None of the above
  1. 30.  In the capital asset pricing model (CAPM) rf is:
    1. Market rate of return
    2. Risk free rate of return
    3. Price earnings ratio
    4. Return on Dow-Jones average
    5. None of the above
  1. 31. In the CAPM, a b greater than 1 means:
    1. The firm will go bankrupt
    2. If the stock market rises by 1%, the individual stock will rise by more than 1%
    3. The stock price will e higher than the 30 year Treasury bond interest rate
    4. The market return will be greater than 1%
    5. None of the above
32. ABC Co. has the following information:

19X1 earnings per share (EPS) $20.00
19X1 dividends per share 4.00
19X2 estimated dividends per share 5.00
19X2 estimated EPS 22.00
Predicted long-term growth rates
Dividends per share 15%
EPS 14%
Discount rate [r] 20%
Dividend discount model P = D / (r-g) where D is 19X2 estimated dividends
Earnings discount model P = kE / (r-g) where E is 19X2 estimated EPS and k is the
dividend payout rate for 19X1

Given this information, the calculated share value of equity (P) for the dividend discount model is:

    1. $20
    2. $60
    3. $80
    4. $100
    5. Some other amount
33. Given the information from 32 above, the calculated share price of equity for the earnings discount model is:
    1. $66.67
    2. $73.33
    3. $80.00
    4. $88.00
    5. Some other amount
34. Which of the following is a random walk with a drift model?
    1. P = E / r
    2. r = rf + b (rm - rf)
    3. Earningsit = ait + biEarningsmt + eit
    4. E(Yt) = Yt-1 + D
    5. All of the above
35. Research indicates that the most accurate earnings forecasts generally are:
    1. Based on Altman’s Z-score
    2. Management forecasts
    3. Time series martingale process models
    4. Analysts forecasts
    5. None of the above
Group 2 Possible Answers

1. C    11. B    21. D    31. B
2. A    12. B    22. C    32. D
3. D    13. A    23. A    33. B
4. C    14. D    24. C    34. D
5. B    15. A    25. E.    35. D
6. A    16. B     26. D
7. D    17. C    27. A
8. E    18. D    28. B
9. B    19. D    29. C
10. D    20. A    30. B