Question 1

U.S. regulators are fundamentally opposed to changing from Generally Accepted Accounting Principles (GAPP) to International Financial Reporting Standards (IFRS).

Accepted Answer

U.S. regulators have expressed some concerns and reservations about adopting IFRS, but they have not fundamentally opposed changing from GAAP to IFRS. In fact, the Securities and Exchange Commission (SEC) has been working on a plan to potentially allow U.S. companies to use IFRS in their financial reporting.

Question 2

The times-interest-earned ratio is one, but not the only, indication of a firm's ability to meet its long-term and short-term debt obligations.

Accepted Answer

The times-interest-earned ratio is a useful tool, but other factors such as cash flow, liquidity, and overall profitability should also be considered when evaluating a company's ability to repay its debts.

Question 3

Significant variations in accounting methods among firms make meaningful ratio comparisons between firms more difficult than if all firms used similar accounting methods.

Accepted Answer

Different accounting methods can result in different financial statements and ratios, making it harder to compare firms on an apples-to-apples basis.

Question 4

Determining whether a firm's financial position is improving or deteriorating requires analyzing more than the ratios for a given year. Trend analysis is one method of measuring changes in a firm's performance over time.

Accepted Answer

Trend analysis helps to measure changes in a firm's performance over time by comparing financial data from multiple years.

Question 5

The "apparent," but not the "true," financial position of a company whose sales are seasonal can differ dramatically, depending on the time of year when the financial statements are constructed.

Accepted Answer

Seasonal companies typically have higher sales and profits during certain periods of the year, such as holiday seasons or summer months, and lower sales and profits during other periods. Therefore, the financial position depicted in the financial statements of such companies can appear better during the peak seasons and worse during the off-season. This is why it is important to analyze financial statements of seasonal companies over a period of time and adjust for seasonality, rather than making conclusions based on a single financial statement.

Question 6

The average collection period tells how many days it takes a business to pay money for trade credits to its suppliers.

Accepted Answer

The average collection period tells how many days it takes a business to collect money from its customers, not pay money to its suppliers.

Question 7

Debt management ratios show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

Accepted Answer

Debt management ratios, such as debt-to-equity ratio and interest coverage ratio, indicate how much debt a company is using to finance its operations and how well it is able to meet its debt obligations. The use of financial leverage can increase returns for shareholders, but it also increases financial risk. Therefore, debt management ratios do show the extent to which a firm's managers are attempting to magnify returns on owners' capital through the use of financial leverage.

Question 8

Market value ratios provide management with an indication of how investors view the firm's past performance and especially its future prospects.

Accepted Answer

Market value ratios, such as price-to-earnings ratio and market-to-book ratio, reflect investors' perception of a company's future growth and earnings potential. This information can provide valuable insights to management regarding how the market values their company and its future prospects.

Question 9

Profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.

Accepted Answer

Profitability ratios are calculations used to evaluate a company's ability to generate earnings relative to its revenue, assets, and equity. They take into account factors such as gross margin, operating income, and return on investment to determine how efficiently a company is using its resources to generate profits. Therefore, profitability ratios show the combined effects of liquidity, asset management, and debt management on operating results.

Question 10

A decline in a firm's inventory turnover ratio suggests that it is managing its inventory more efficiently and also that its liquidity position is improving, i.e., it is becoming more liquid.

Accepted Answer

A decline in inventory turnover ratio indicates that a firm is holding onto its inventory for a longer period, indicating poor inventory management and potentially poor liquidity.

Question 11

"Mark to Market" is the process of adjusting the valuation of assets from their recorded accounting value to a valuation based on market prices.

Accepted Answer

"Mark to Market" is indeed the process of adjusting the valuation of assets based on market prices.

Question 12

Ratio analysis involves analyzing financial statements in order to appraise a firm's financial position and strength.

Accepted Answer

Ratio analysis involves using financial ratios from a company's financial statements to assess its financial performance and health. The ratios are compared to industry benchmarks and historical trends to determine the company's financial position and strength.

Question 13

Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios provide fast and easy-to-use measures of a firm's liquidity position.

Accepted Answer

The current and quick ratios are commonly used as measures of a firm's liquidity position because they provide a quick and easy analysis. However, a full liquidity analysis would require the use of additional tools such as a cash budget to provide a more comprehensive view of the company's liquidity.

Question 14

High current and quick ratios always indicate that a firm is managing its liquidity position well.

Accepted Answer

High current and quick ratios indicate that a firm has enough current assets to cover its current liabilities, but it doesn't necessarily mean that the firm is managing its liquidity position well. Factors like inventory management, accounts receivable collection, and debt repayment schedule also affect a firm's liquidity position.

Question 15

The basic earning power ratio (BEP) shows the earning power of a firm's assets after giving consideration to financial leverage and tax effects.

Accepted Answer

The basic earning power (BEP) ratio measures a firm's earning power from its assets before the influence of financial leverage and taxes, focusing solely on its operational efficiency.

Question 16

The inventory turnover and current ratio are related. The combination of a high current ratio and a low inventory turnover ratio, relative to industry norms, suggests that the firm has an above-average inventory level and/or that part of the inventory is obsolete or damaged.

Accepted Answer

A high current ratio indicates that the firm has a strong liquidity position, while a low inventory turnover ratio suggests that the inventory is not selling quickly or efficiently. This combination, relative to industry norms, could indicate that the firm has an excessive inventory level or obsolete/damaged inventory that is not being sold.

Question 17

It is appropriate to use the fixed assets turnover ratio to appraise firms' effectiveness in managing their fixed assets if and only if all the firms being compared have the same proportion of fixed assets to total assets.

Accepted Answer

The fixed assets turnover ratio should not be used solely on the basis of the proportion of fixed assets to total assets. It is not necessary for firms to have the same proportion of fixed assets in order to use this ratio to appraise their effectiveness in managing their fixed assets. The ratio compares the net sales generated by a company to the value of its fixed assets, regardless of the proportion of fixed assets to total assets.

Question 18

The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its assets.

Accepted Answer

The inventory turnover ratio measures how efficiently a company is managing its inventory while the DSO measures how efficiently a company is collecting on its sales. Both ratios are used to assess a company's asset management effectiveness.

Question 19

To take full advantage of the credit term provided, management should try to lengthen the average payables period with cautions.

Accepted Answer

By lengthening the average payables period, a company can delay its payments to suppliers, thereby holding on to cash for a longer period of time. However, management should be cautious not to abuse this practice and damage relationships with suppliers or risk being unable to make timely payments in the future.

Question 20

Current ratio and quick ratio both help us measure the firm's liquidity. The current ratio measures the relationship of a firm's current assets to its current liabilities, while the quick ratio subtracts inventory from other current assets.

Accepted Answer

This is correct. The current ratio includes all current assets, while the quick ratio focuses on the most liquid assets (excluding inventory). Both ratios are used to evaluate a company's liquidity position.

Quiz 3: Analysis of Financial Statements