Answers

CHAPTER 4

ANALYSIS OF FINANCIAL STATEMENTS

(Difficulty Levels: Easy, Easy/Medium, Medium, Medium/Hard, and Hard)

To keep this chapter from involving too much memorization, we provide our students with a formula sheet for use on exams. That makes a few of the questions trivially easy, but most require some thought, and some are downright challenging. Even the very easy ones make students think about the ratios. The challenging questions are labeled HARD, and most students will agree with that designation.

Some of these questions are just definitions, but others require real thought about the make-up of the ratios and relationships among the ratios. We tell our students that to answer some of these questions it is useful (1) to write out the relevant ratio or ratios, (2) then to think about how the ratios would change if the accounting data changed, and (3) occasionally to make up illustrative data to test their conclusions.

Note that there is some overlap between the T/F and the multiple choice questions, as some T/F statements are used in the MC questions. Also, please see the preface for information on the AACSB letter indicators (F, M, etc.) on the subject lines.

Multiple Choice: True/False

(4-1) Ratio analysis C F K Answer: a EASY

[i]. Ratio analysis involves analyzing financial statements to help appraise a firm's financial position and strength.

a. True

b. False

(4-2) Liquidity ratios C F K Answer: a EASY

[ii]. The current and inventory turnover ratios both help us measure a firm's liquidity. The current ratio measures the relationship of the firm's current assets to its current liabilities, while the inventory turnover ratio gives us an indication of how long it takes the firm to convert its inventory into cash.

a. True

b. False

(4-2) Liquidity ratios C F K Answer: a EASY

[iii]. Although a full liquidity analysis requires the use of a cash budget, the current and quick ratios...