QUIZ

(20 marks)
Understanding Income
statement
1. In one year, a company received 3 shipments of 1,000 sewing
machines at $110 each, then 2,500 sewing machines at $100
each, and finally 3,200 sewing machines at $95 each. During
the year, the company sold 5,600 sewing machines at $200
each. The company is able to readily identify each shipment
received. As a result, the company determines that the entire
first shipment (1,000 sewing machines), 1,800 sewing machines
from the second shipment, and 2,800 sewing machines from the
third shipment were sold to customers during the year. Compute
the sales, cost of sales, gross profit, and ending inventory
amounts under each inventory valuation method (FIFO, LIFO,
AVCO) (12 marks, 2 bonus for full correct answers)
Under the LIFO Method
Sales: 5,600 × $200 = $1,120,000
COGS: (2,400 × $100) + (3,200 × 95) = $544,000
Gross Profit: $1,120,000 – $544,000 = $576,000
Ending Inventory: (1,000 × $110) + (10 0× $100) = $120,000

Under the FIFO Method

Sales: 5,600 × $200 = $1,120,000
COGS: (1,000 × $110) + (2,500 × $100) + (2,100 × $95) = $559,500
Gross Profit: $1,120,000 – $559,500 = $560,500
Ending Inventory: (1,100 × $95) = $104,500

Under the Weighted Average Cost Method

Sales: 5,600 × $200 = $1,120,000
Weighted Average Cost: [(1,000 × $110) + (2,500 × $100) + (3,200 × $95)] / 6,700 = $99.10
COGS: 5,600 × $99,10 = $554,960
Gross Profit: $1,120,000 – $554,960 = $565,040
Ending Inventory: 1,100 × $99.10 = $109,010
2. A company acquires a patent with an expiration date in six years
for ¥100 million. The company assumes that the patent will generate
economic benefits that will decline over time and decides to
amortize the patent using the double-declining balance method. The
annual amortization expense in Year 4 is closest to? (4 marks)
B is correct. As shown in the following calculations, under the
double-declining balance method, the annual amortization
expense in Year 4 is closest to ¥9.9 million.
Annual amortization expense = 2 × Straight-line amortization
rate × Net book value.
Amortization expense Year 4 = 33.3% × ¥29.6 million = ¥9.9
million.
Understanding Balance Sheet
3. Reporting question

Trade receivables are most commonly reported at: (2 marks)

A. net realizable value.
B. net present value.
C. face value.
 Answer
A is correct. Trade receivables are amounts owed to a company by its
customers for products and services already delivered. They are typically
reported at net realizable value, an approximation of fair value based on
estimates of collectability.
B is incorrect. Present value is the present discounted value of future net
cash inflows that the asset is expected to generate in the normal course of
business. Trade receivables are typically reported at net realisable value.
C is incorrect. Face value would not account for the potential for
uncollectability. Trade receivables are typically reported at net realisable
value.
4. Common-size question

A company has total liabilities of £35 million and total stockholders’ equity of
£55 million. Total liabilities are represented on a vertical common-size
balance sheet by a percentage closest to: (2 marks)
A.35%.
B.39%.
C.64%.
B is correct. Vertical common-size analysis involves stating each balance
sheet item as a percentage of total assets. Total assets are the sum of total
liabilities (£35 million) and total stockholders’ equity (£55 million), or £90
million. Total liabilities are shown on a vertical common-size balance sheet
as (£35 million/£90 million) ≈ 39%.
5. Balance sheet ratio calculation
An analyst collects the following information about a company:

The company’s: (4 marks)

A. total asset turnover is 4.
B. financial leverage ratio is 4.
C. average shareholders' equity is €625,000
C is correct because the company had net profit of €100,000 calculated as
revenue × Net profit margin = €2,500,000 × 4% = €100,000. Return on
equity = Net profit ÷ Average shareholders' equity. Therefore, average
shareholders' equity = Net profit ÷ Return on Equity = €100,000 ÷ 16% =
€625,000.
A is incorrect because ROA = Net profit ÷ Average total assets. Therefore,
average total assets = Net profit ÷ 8% = €100,000 ÷ 8% = €1,250,000. Total
asset turnover = Revenue ÷ Average total assets = €2,500,000 ÷ €1,250,000
=2
B is incorrect because Return on equity = ROA × Leverage and, therefore,
Leverage = ROE ÷ ROA = 16% ÷ 8% = 2
Understanding Cash Flow
Statement
1. Cash paid to suppliers/cash collected from customers
An analyst gathers the following information (in € millions) about a company:

Cost of sales 800

Decrease in inventory 250
Increase in accounts payable 100

Compute the cash paid to suppliers (in € millions). (2 marks)

SOLUTION

Purchases from suppliers = Cost of goods sold – Decrease in inventory =

€800 million – €250 million = €550 million. Cash paid to suppliers =
Purchase from suppliers – Increase in accounts payable = €550 million –
€100 million = €450 million.
TEST

2. Cash paid in salaries/cash paid for interest and taxes

Mothercare, a baby’s clothing seller, reported salaries expense
of $20 million. The beginning balance of salaries payable was
$3 million, and the ending balance of salaries payable was $1
million. How much cash did the company pay in salaries? (2
marks)
C is correct. Beginning salaries payable of $3 million plus salaries
expense of $20 million minus ending salaries payable of $1 million
equals $22 million. Alternatively, the expense of $20 million plus the $2
million decrease in salaries payable equals $22 million.
3. FCFE or FCFF
An analyst gathers the following information (in € millions) about a company:

The income tax rate is 25%. Free cash flow to the firm is: (2 marks)
A. 87.
B. 92.
C. 98.
SOLUTION

A is correct because FCFF = 125 + 22 + 20 × ( 1 – 0.25 ) – 50 – 25 = 87. FCFF is

calculated as FCFF = NI + NCC + Int × ( 1 – tax rate ) – FCInv – WCInv.
B is incorrect because it does not apply the tax rate to the interest expense. The
calculation becomes FCFF = 125 + 22 + 20 – 50 – 25 = 92.
C is incorrect because it adds the dividends declared and paid. The calculation
becomes FCFF = 125 + 22 + 20 × ( 1 – 0.25 ) – 50 – 25 + 11 = 98.
4. IFRS/US GAAP reporting for Cash flow statement elements

With respect to the cash flow statement, under US GAAP, interest paid is
reported as a(n): (1 mark)
A. investing activity.
B. financing activity.
C. operating activity.
SOLUTION

C is correct because under US GAAP, interest paid is reported as an

operating activity.
A is incorrect because under US GAAP, interest paid is not reported as an
investing activity.
B is incorrect because under US GAAP, interest paid is not reported as a
financing activity.
5. OPERATING CASH FLOW INDIRECT METHOD CALCULATION
The following data is available:
Net profit - $100,000
Increase in account receivable - 12,000
Increase in accounts payable - 9,000
Depreciation and amortization – 8,000
Non cash charge for share based compensation – 167

Compute the CFO using indirect method. (2 marks)

CFO=105,167
6. Use the following financial data for Moose Printing Corporation, a U.S. GAAP reporting firm, to
calculate the cash ow from operations (CFO) using the indirect method. (2 marks)

• Net income: $225

• Increase in accounts receivable: $55
• Decrease in inventory: $33
• Depreciation: $65
• Decrease in accounts payable: $25
• Increase in wages payable: $15
• Decrease in deferred taxes: $10
• Purchase of new equipment: $65
• Dividends paid: $75

A) Increase in cash of $248.

B) Increase in cash of $173.
C) Increase in cash of $183.
SOLUTION

CFO for Moose Printing Corporation is calculated as follows: +Net Income

$225 − A/R $55 + Inventory $33 + Depreciation $65 − A/P $25 + Wages
Payable $15 − Deferred taxes $10 = $248. The purchase of new equipment
is an investing activity and therefore is not included in CFO. Dividends paid
is a financing activity and is not included in CFO.
7. Darth Corporation's most recent income statement shows net sales of $6,000,
and Darth's marginal tax rate is 40%. The total expenses reported were $3,200, all
of which were paid in cash. In addition, depreciation expense was reported at
$800. A further examination of the most recent balance sheets reveals that
accounts receivable during that period increased by $1,000. The cash ow from
operating activities reported by Darth should be: (2 marks)
A) $2,200.
B) $1,000.
C) $1,200
SOLUTION

Net income is ($6,000 – 3,200 – 800)(1 – 0.4) = $1,200. Adjustments to

reconcile net income to cash ow from operating activities will require that
depreciation ($800) be added back, and increase in accounts receivable
($1,000) be subtracted: $1,200 + 800 – 1,000 = $1,000.
8. How would a stock split be reported on the statement of cash ows? A stock split
would be reported as …. (max 3 words) (1 mark)
SOLUTION

A supplementary information
9. The dierence between cash ow from operations (CFO) under the direct method
and CFO under the indirect method is: (1 mark)
A) always equal to zero.
B) balanced by an opposite difference in cash ow from investing.
C) disclosed as a reserve in the footnotes to the cash ow statement.
SOLUTION

A. The direct and indirect methods are two ways of presenting the same
total for cash from operations.
10. Depreciation expense would be classied as: (1 mark)
A) investing cash flow.
B) having no cash flow impact.
C) operating cash flow.
SOLUTION

Depreciation expense has no cash flow impact.