FINANCE 324 FINAL EXAM

The following multiple choice questions are worth 2 points apiece

  1. The payment of an account payable would:
  2. Increase owner’s equity
  3. Increase net assets
  4. Have no effect on net assets
  5. Have no effect on total assets
  6. Increase liabilities
  1. The balance in the capital account after all closing entries have been posted is:
  2. Equal to net income or loss for the period
  3. The same as the balance of the account on the work sheet
  4. The balance that will appear on the balance sheet
  5. Always more than the balance of the account on the work sheet
  6. Equals the difference between total debt and cash
  1. The ______provides a financial summary of the firm’s operating results during a specified period.
  2. Balance sheet
  3. Income statement
  4. Statement of cash flows
  5. Statement of retained earnings
  6. Footnotes to the financial statements
  1. Which of the following represents an income-earning activity?
  2. A firm sells goods on credit
  3. A client makes a payment on account
  4. A firm records the sale of an asset at book value
  5. A firm deposits the cash proceeds of a new loan into the bank
  6. All of the above
  1. The accounting equation is defined as:
  2. Assets + Liabilities = Owner’s Equity
  3. Assets + Owner’s Equity = Liabilities
  4. Assets = Liabilities + Owner’s Equity
  5. Assets = Liabilities – Owner’s Equity
  6. None of the above
  1. The Statement of Cash flows identifies three main activities. They are:
  2. Operating, Cash and Investing
  3. Income, Operating and Financing
  4. Cash, Investing and Financing
  5. Income, Operating, Investing
  6. Operating, Investing and Financing
  7. Which of the following does not measure a company’s profitability?
  8. Gross Margin
  9. Inventory turn
  10. Return on equity
  11. Net margin
  12. Return on assets
  1. Which of the following statements is false?
  2. The current ratio measures the ability to pay current liabilities with current assets
  3. A company generally prefers to have a high debt ratio
  4. The debt ratio measures a business’s ability to pay long-term liabilities with long-term assets
  5. A company generally prefers to have high profit margins
  6. A company generally prefers to have a high current ratio
  1. A ‘fixed cost’ is a cost that ______at all output levels over a relevant range
  2. Is always computed as a percentage of sales revenues
  3. Varies with differing output levels
  4. Is computed based upon profit levels
  5. Is always a ‘period’ costs
  6. Remains constant and the same value
  1. In computing the Operating Leverage, of a product (or products), which of the following items is not used?
  2. Variable costs
  3. Fixed costs
  4. Number of units produced
  5. Total revenue
  6. ‘Period’ costs
  1. Which of the following is not a component of working capital?
  2. Cash
  3. Accounts receivable
  4. Inventory
  5. Equipment
  6. Marketable securities
  1. Which of the following is not a goal of working capital management?
  2. Manage risk within the components of working capital
  3. Maximize the level of cash
  4. Optimize the combination of margins and turn
  5. Provide capacity for sales growth
  6. Support product sales
  1. Cash management can be enhanced by all but the following:
  2. Timely receipt of funds
  3. Large cushion of cash balances
  4. Concentration and investment of excess funds
  5. Establishing credit and other contingency reserves
  6. Managed disbursement of funds
  1. All of the following are functions of security exchanges except:
  2. Allocating scarce capital
  3. Aiding in new financing
  4. Creating continuous markets
  5. Holding demand deposits
  6. Trading shares of stock
  1. Short-term securities are traded in the ______markets.
  2. Capital
  3. Operations
  4. Money
  5. Both a and c
  6. All of the above
  1. Securities regulators such as the SEC serve the public by:
  2. Telling the public which are good and bad investments
  3. Requiring transparency, timeliness and adherence to GAAP of publicly traded firms
  4. Requiring all firms that have equity investors to adhere to the same rules for reporting
  5. All of the above
  6. None of the above
  1. Closing the accounts consists of journalizing and posting entries which will zero out all temporary accounts.
  2. True
  3. False
  1. Financial ratios are often inter-related such that there may be trade-offs between them
  2. True
  3. False
  1. A financial intermediary is an organization that raises money from investors and provides financing for individual, companies and other organizations.
  2. True
  3. False
  1. Every time that stock is sold on a stock market, the company whose share is bought receives the proceeds.
  2. True
  3. False

Questions 21 and 22 are worth 20 points apiece

  1. Cash and Accrual Basis Accounting

In the course of your examination of the books and records of Karen Company, you find the following data:

Salaries earned by employees in 2009 $61,000

Salaries paid in 2009 53,000

Total sales revenue in 2009 927,000

Cash collected from sales in 2009 952,000

Utilities expense incurred in 2009 7,500

Utility bills paid in 2009 6,300

Cost of goods sold in 2009 602,000

Cash paid on purchases in 2009 613,000

Inventory at December 31, 2009 416,000

Tax assessment for 2009 6,210

Taxes paid in 2009 5,930

Rent Expense for 2009 36,000

Rent paid in 2009 41,000

Required:

  1. Compute Karen’s net income for 2009 using cash-basis accounting

Sales952,000

Expenses

Salaries927,000

Utilities6,300

Purchases613,000

Rent41,0001,587,300

Income before tax-635,300

Tax5,930

Net Income-641,230

  1. Compute Karen’s net income for 2009 using accrual-basis accounting

Sales927,000

Expenses

Salaries61,000

Utilities7,500

Cost of goods sold602,000

Rent36,000706,500

Income before tax220,500

Tax6,210

Net Income214,290

  1. Why is accrual-basis accounting normally used?

Accrual basis is normally used since it represents the financial condition better. Many time transactions happen but cash does not change hands. Once the transaction happens, an exchange has taken place and should be recorded even if no cash changes hands. Also such transactions have future implication which is missed if only cash basis accounting is done.

  1. Financial Ratios

The following information for SuperStar Company is provided:

Current Assets $215,000

Long-term assets 780,000

Current Liabilities 120,000

Long-term liabilities 330,000

Owners’ Equity 545,000

Sales for year 1,875,000

Net income for year 178,000

Average market price per share 90.00

Average number of shares outstanding 50,000

Required:

  1. Compute the current ratio, debt ratio, return on sales, return on equity, asset turnover, and price-earnings ratio.

Current ratio = Current Assets/Current Liabilities

= 215,000/120,000 = 1.79

Debt ratio = Total liabilities/Total Assets

= (120,000+330,000)/(215,000+780,000) = 0.45

Return on sales = Net Income/Sales

= 178,000/1,875,000 = 9.5%

Return on equity = Net Income/Equity

=178,000/545,000 = 32.7%

Asset turnover = Sales/Total Assets

= 1,875,000/(215,000+780,000) = 1.9

Price earnings ratio = Market Price/EPS

EPS = 178,000/50,000 = 3.56

P/E ratio = 90/3.56 = 25.28

  1. What do these ratios show for SuperStar Company?

These ratios show that the company is in a good financial health. The liquidity is good as current ratio is above 1, the solvency is also good as the debt ratio is low and so the financial risk is less. The return on sales and asset turnover have resulted in a high return on equity and the market sees good performance in future and so the P/E is high.

Questions 23 and 24 are worth 10 points apiece

  1. Recognizing Revenue

The Ho Man Tin Tennis Club sells lifetime memberships for $20,000 each. A lifetime membership entitles a person to unlimited access to the club’s tennis courts, weight room, exercise equipment and swimming pool. Once a lifetime membership fee is paid, it is not refundable for any reason.

Judy Chan and her partners are owners of Ho Man Tin Tennis Club. In order to overcome a cash shortage, they intend to seek investment funds from new partners. Judy and her partners are meeting with their accountant to provide information for preparation of financial statements. They are considering when they should recognize revenue from the sale of lifetime memberships.

Required:

Answer the following questions:

  1. When should the lifetime membership fees be recognized as revenue? Remember they are nonrefundable.

Life time membership fee should be recognized evenly over the life of the member. Based on historical data, the company should calculate the average time period over which the life time membership is used and then recognize the revenue evenly over this time period.

Even if the membership fee is nonrefundable, it does not make a difference since revenues are recognized when services are rendered.

  1. What incentives would Judy and her partners have for recognizing the entire amount of the lifetime membership fee as revenue at the time it is collected? Since the entire amount will ultimately be recognized anyway, what difference does the timing make?

The incentive would be that revenues for the period is which cash is received would be much higher as all cash received is recognized as revenue and this will increase the net income.

The timing makes a difference due to time period concept. A firm prepares its financial statements over different time periods. It is correct that ultimately all revenue will be recognized, but the revenue will not be correctly recognized in the time period it is earned.

  1. Product Costing

The total manufacturing cost data on DuPont’s Teflon product line are provided below:

Direct materials $60.00 per gallon

Direct labor $1.80 per gallon

Manufacturing overhead:

Variable $3.20 per gallon

Fixed $3,200,000 per month

General corporate sales and admin costs $6,400,000 per month

Assuming that DuPont expects to produce 100,000 gallons in the next month, what appears to be the total manufacturing cost on average to produce one gallon of Teflon?

Total manufacturing cost per gallon

Direct material60

Direct labor1.80

Variable overhead3.20

Fixed overhead (3,200,000/100,000)32

Total manufacturing cost per gallon$97