Financial Statement Analysis Test 1

Please send answer sheet at m.sshahid@outlook.com

Part1: Answer the following short questions [2*10=20Marks]

Q1: During times of inflation, which of the inventory costing methods listed below would give the
most realistic valuation of inventory? Which method would give the least realistic valuation of
inventory? Explain.
a. LIFO b. Average c. FIFO
Q2:The number of days’ sales in inventory relates the amount of the ending inventory to the
average daily cost of goods sold. Explain why this computation may be misleading under the
following conditions:
a. The company uses a natural business year for its accounting period.
b. The company closes the year when activities are at a peak.
c. The company uses LIFO inventory, and inflation has been a problem for a number of years.
Q3: The days’ sales in inventory is an estimate of number of days that will take to sell current
inventory.
a. What is the ideal number of days’ sales in inventory?
b. In general, does a company want many days’ sales in inventory?
c. Can days’ sales in inventory be too low?
Q4: Some firms do not report the cost of goods sold separately on their income statements. In such
a case, how should you proceed to compute days’ sales in inventory? Will this procedure produce a
realistic days’ sales in inventory?
Q5: One of the computations used to determine the liquidity of inventory determines the inventory
turnover. In this computation, usually the average inventory is determined by using the beginning-
of-the-year and the end-of-the-year inventory figures, but this computation can be misleading if the
company has seasonal fluctuations or uses a natural business year. Suggest how to eliminate these
distortions.
Q6: Explain the influence of the use of LIFO inventory on the inventory turnover.
Q7: Several comparisons can be made to determine the short-term debt-paying ability of an entity.
Some of these are:
a. Working capital b. Current ratio c. Acid-test ratio d. Cash ratio
Required. Define each of these terms. If the book figures are based on cost, will the results of the
preceding computations tend to be understated or overstated? Explain.
Q8: Discuss some benefits that may accrue to a firm from reducing its operating cycle. Suggest
some ways that may be used to reduce a company’s operating cycle.
Q9: Does the allowance method for bad debts or the direct write-off method result in the fairest
presentation of receivables on balance sheet and fairest matching of expenses against revenue?
Q10: When a firm faces an inflationary condition and the LIFO inventory method is based on a
periodic basis, purchases late in the year can have a substantial influence on profits. Comment.

Part II; MCQs

Q11: Smith Company manufactures industrial products and employs a calendar year for financial
reporting purposes. Items (a) through (e) present several of Smith’s transactions during 2019. The
total of cash equivalents, marketable securities, and net receivables exceeded total current liabilities
both before and after each transaction described. Smith had positive profits in 2019 and a credit
balance throughout 2019 in its retained earnings account.
Required Answer the following MCQs;
(a). Payment of a trade account payable of $64,500 would
1. Increase the current ratio, but the acid-test ratio would not be affected.
2. Increase the acid-test ratio, but the current ratio would not be affected.
3. Increase both the current and acid-test ratios.
4. Decrease both the current and acid-test ratios.
5. Have no effect on the current and acid-test ratios.
 (b). The purchase of raw materials for $85,000 on open account would
1. Increase the current ratio.
2. Decrease the current ratio.
3. Increase net working capital.
4. Decrease net working capital.
5. Increase both the current ratio and net working capital.
(c). The collection of a current accounts receivable of $29,000 would
1. Increase the current ratio.
2. Decrease the current ratio.
3. Increase the acid-test ratio.
4. Decrease the acid-test ratio.
5. Not affect the current or acid-test ratios.
(d). Obsolete inventory of $125,000 was written off during 2009. This would
1. Decrease the acid-test ratio.
2. Increase the acid-test ratio.
3. Increase net working capital.
4. Decrease the current ratio.
5. Decrease both the current and acid-test ratios.
(e). The early liquidation of a long-term note with cash would
1. Affect the current ratio to a greater degree than the acid-test ratio.
2. Affect the acid-test ratio to a greater degree than the current ratio.
3. Affect the current and acid-test ratios to the same degree.
4. Affect the current ratio, but not the acid-test ratio.
5. Affect the acid-test ratio, but not the current ratio.

Q12:Bichette Furniture Company recently issued new common stock and used the proceeds to reduce
its short-term notes payable and accounts payable. This action had no effect on the company's total
assets or operating income. Which of the following effects did occur as a result of this action?
a. The company's current ratio decreased.
b. The company's basic earning power ratio increased.
c. The company's time interest earned ratio decreased.
d. The company's debt ratio increased.
e. The company's equity multiplier decreased.
Q13.Van Buren Company has a current ratio = 1.9. Which of following actions will increase
company's current ratio?
a. Use cash to reduce short-term notes payable.
b. Use cash to reduce accounts payable.
c. Issue long-term bonds to repay short-term notes payable.
d. All of the statements above are correct.
e. Statements b and c are correct.
Q14. Which of the following actions can a firm take to increase its current ratio?
a. Issue short-term debt and use proceeds to buy back long-term debt with a maturity of more than one
year.
b. Reduce the company's days sales outstanding to the industry average and use the resulting cash
savings to purchase plant and equipment.
c. Use cash to purchase additional inventory.
d. Statements a and b are correct.
e. None of the statements above is correct.
Part III; Short Problems
Q15:
Metro Cash & Carry has $5 million in current assets, $3 million in current liabilities, and its initial
inventory level is $1 million. The company plans to increase its inventory, and it will raise additional
short-term debt to purchase the inventory. Assume that the value of the remaining current assets will
not change. METRO,s bond covenants require it to maintain a current ratio that is greater than or
equal to 1.5. What is the maximum amount that the company can increase its inventory before it is
restricted by these covenants?
Q16:
Calculate the COGS of a firm with the following financial data.
Current ratio 3.00
Acid-test 2.5
Current liabilities $350,000
Inventory turnover 4 times
Q17:
The following financial data were taken from financial statements of Sunny Corporation:
2015 2016 2017
Current assets $350,000 $450,000 $500,000
Current liabilities 300,000 340,000 350,000
Sales 1,450,000 1,500,000 1,400,000
Cost of goods sold 1,150,000 1,100,000 1,200,000
Inventory 280,000 250,000 200,000
Accounts receivable 100,000 105,000 120,000
Required : (I)Based on these data, calculate the following for 2008 and 2009:
1. Working capital 4. Accounts receivable 5. Merchandise inventory
2. Current ratio turnover turnover
3. Acid-test ratio 6. Inventory turnover in days
(II): Evaluate the results of your computations in regard to the short-term liquidity of the firm.
Q18:
A company has $20 million of inventory, $5 million of receivables, and $4 million of payables. Its
annual sales revenue is $80 million, and its cost of goods sold is $60 million. What is its CCC?
Q19
Cannon Company has enjoyed a rapid increase in sales in recent years, following a decision to sell
on credit. However, the firm has noticed a recent increase in its collection period. Last year, total
sales were $1 million, and $250,000 of these sales were on credit. During the year, the accounts
receivable account averaged $41,096. It is expected that sales will increase in the forthcoming year
by 50 percent, and, while credit sales should continue to be the same proportion of total sales, it is
expected that the days sales outstanding will also increase by 50 percent. If the resulting increase in
accounts receivable must be financed externally, how much external funding will Cannon need?
Assume a 365-day year.
Q20
Ruth Company currently has $1,000,000 in accounts receivable. Its days sales outstanding (DSO) is
50 days. The company wants to reduce its DSO to the industry average of 32 days by pressuring
more of its customers to pay their bills on time. The company's CFO estimates that if this policy is
adopted the company's average sales will fall by 10 percent. Assuming that the company adopts this
change and succeeds in reducing its DSO to 32 days and does lose 10 percent of its sales, what will
be the level of accounts receivable following the change? Assume a 365-day year