Analysis of Financial Statements Chapter -19

ANALYSIS OF FINANCIAL
STATEMENTS

PRACTICE QUESTIONS
The following information relates to question 1 & 2.

1) Xena has the following working capital ratios:

20X9 20X8
Current ratio 1·2:1 1·5:1
Receivables days 75 days 50 days
Payables days 30 days 45 days
Inventory turnover 42 days 35 days

Which of the following statements is correct?

a) Xena’s liquidity and working capital has improved in 20X9
b) Xena is receiving cash from customers more quickly in 20X9 than in 20X8
c) Xena is suffering from a worsening liquidity position in 20X9
d) Xena is taking longer to pay suppliers in 20X9 than in 20X8

2) Which of the following statements is true?

a) The interpretation of an entity’s financial statements using ratios is only useful for potential
investors
b) Ratios based on historical data can predict the future performance of an entity
c) The analysis of financial statements using ratios provides useful information when compared with
previous performance or industry averages
d) An entity’s management will not assess an entity’s performance using financial ratios

3) The following extracts are from Hassan’s financial statements:

$
Profit before interest and tax 10,200
Interest (1,600)
Tax (3,300)
–––––––
Profit after tax 5,300
–––––––
Share capital 20,000
Reserves 15,600
–––––––
35,600
Loan liability 6,900
–––––––
42,500
Analysis of Financial Statements Chapter -19

What is Hassan’s return on capital employed?

a) 15%
b) 29%
c) 24%
d) 12%

4) A company’s gross profit as a percentage of sales increased from 24% in the year ended
31 December 20X1 to 27% in the year ended 31 December 20X2.
Which of the following events is most likely to have caused the increase?
a) An increase in sales volume
b) A purchase in December 20X1 mistakenly being recorded as happening in January 20X2
c) Overstatement of the closing inventory at 31 December 20X1
d) Understatement of the closing inventory at 31 December 20X1

5) Which one of the following would help a company with high gearing to reduce its
gearing ratio?
a) Making a rights issue of equity shares.
b) Issuing further long-term loan notes.
c) Making a bonus issue of shares.
d) Paying dividends on its equity shares.

6) Which one of the following would cause a company’s gross profit percentage on sales to
fall?
a) Sales volume has declined
b) Closing inventory is lower than opening inventory
c) Some closing inventory items were included at less than cost
d) Selling and distribution costs have risen.

7) Extracts from the financial statements of Kafka, a limited liability company, are given
below:
Statement of financial position Statement of Profit or Loss and Other
Comprehensive Income as at 30 June 2006 for the year
ended 30 June 2006
$m $m
Non-current assets 15
Current assets 14 Operating profit 8
–––
29 Finance costs (2)
––– –––
Ordinary share capital 10 Profit for year 6
–––
Share premium account 3
Retained earnings 7
–––
20
10% Loan notes 5
Current liabilities 4
–––
29
Analysis of Financial Statements Chapter -19

Using these figures, which of the following are correct calculations of return on total capital employed
(ROCE) and return on owners’ equity (ROOE)? (Tax ignored)
ROCE ROOE
a) 8/25 = 32% 6/10 = 60%
b) 8/25 = 32% 6/20 = 30%
c) 6/25 = 24% 8/20 = 40%
d) 8/20 = 40% 6/20 = 30%

The following information is relevant for questions 8 and 9

Extracts from a company’s financial statements for 2005 are given below:
Statement of financial position
As at 31 December 2005
$m
Non-current assets 90
Current assets 80
––––
170
––––
Ordinary share capital 40
Share premium account 25
Retained earnings 35
––––
100
10% Loan notes 50
Current liabilities 20
––––
170
––––
Statement of Profit or Loss and Other Comprehensive Income
for the year ended 31 December 2005
$m
Profit before finance costs 20
Finance costs (5)
––––
Profit before tax 15
––––
8) What is the company’s return on total capital employed?
a) 20/150 = 13·3%
b) 15/150 = 10%
c) 20/100 = 20%
d) 15/100 = 15%

9) What is the company’s return on shareholders’ equity?

a) 15/40 = 37·5%
b) 20/100 = 20%
c) 15/100 = 15%
d) 20/150 = 13·3%
Analysis of Financial Statements Chapter -19

The following summarised financial statements for Q are relevant for questions 10 to 11. (Income tax
is ignored)

Statement of Profit or Loss and Other Comprehensive Income for the year ended 31 July 2004
$m
Operating profit 1 40
Interest payable 11 (8)
––––
1 32
Dividends paid 1 (18)
––––
1 14
––––
Statement of financial position as at 31 July 2004
$m
Non-current assets plus net current assets 400
––––
Ordinary share capital 200
Share premium account 1 30
Revaluation reserve 1 20
Accumulated profits 1 50
––––
300
Loans 100
––––
400
––––
10) What is the company’s return on total capital employed?
a) 32/200 = 16%
b) 32/400 = 8%
c) 40/400 = 10%
d) 14/300 = 42/3%

11) What is the company’s return on owners’ equity?

a) 32/200 = 16%
b) 32/300 = 10.67%
c) 18/300 = 6%
d) 14/300 = 42/3%

12) What is the company’s gearing ratio?

a) 300/400 = 75%
b) 100/200 = 50%
c) 100/400 = 25%
d) 300/100 = 300%
Analysis of Financial Statements Chapter -19

13) Which one of the following formulas would give a valid calculation of a company’s
gearing ratio?
a)
Ordinary share capital
––––––––––––––––––––––––––––– x 100
Ordinary share capital + reserves
b)
Loan capital+ preference share capital
–––––––––––––––––––––––––––––––––––––––––– x 100
Ordinary share capital + preference share capital
c)
Total share capital + reserves
––––––––––––––––––––––––––––––––– x 100
Loan capital + preference share capital
d)
Loan capital + preference share capital
––––––––––––––––––––––––––––––––––––– x 100
Total equity+ preference share capital+ Loan capital

14) A company’s gross profit percentage on sales has decreased by 5% in 2002 compared
with 2001.
Which one of the following matters could have caused the decrease?
a) The level of sales in 2002 is lower than that in 2001
b) There have been more bad debts in 2002 than in 2001
c) Inventory at the end of 2002 is lower than that at the end of 2001
d) Theft of inventory by staff and customers has increased.

15) A company’s capital structure at 31 December 2002 is as follows:

$m
Ordinary share capital 380
Accumulated profits 120
——
500
8% Loan notes 100
——
600
——
The company’s Statement of Profit or Loss and Other Comprehensive Income shows the following for
the year ended 31 December 2002:
$m
Operating profit 40
Interest paid 8
——
32
Taxation 10
——
22
Dividends paid 10
——
Analysis of Financial Statements Chapter -19

Retained profit for year 12

——
What is the return on equity shareholders’ capital employed, using closing capital figures?
a) 4·4%
b) 2·4%
c) 3·7%
d) 5·8%

16) A company’s summarised financial statements, ignoring tax, are shown below:
Statement of Profit or Loss and Other Comprehensive Income Statement of
financial position
$m $m
Profit before interest 200 Non-current assets 1,000
Interest paid (80) Net current assets 1,600
–––– ––––––
Profit after interest 120 2,600
––––––
Ordinary share capital 1,000
Dividends paid (40) Reserves 800
––––––
1,800
Loan capital 800
–––– ––––––
Retained profit 80 2,600
–––– ––––––
What is the correct calculation of return on shareholders’ capital employed?
a) 120/1,800 = 16·7%
b) 200/2,600 = 17·7%
c) 40/1,800 1 = 12·2%
d) 120/1,000 = 12·0%

17) The capital of a limited liability company is made up as follows:

$m
Issued ordinary share capital 1,000
Share premium account 1, 500
Accumulated profits 3,000
8% loan notes 1,500

Which of the following calculations of the company’s gearing ratio, based on these figures, is correct?
a) 1,500/6,000 = 1 25%
b) 4,500/1,500 = 300%
c) 4,500/6,000 = 1 75%
d) 1,500/1,000 = 150%

18) When calculating a company’s gearing ratio which of the following factors would cause
it to fall?
1. A rights issue of ordinary shares.
2. An issue of loan notes.
3. An upward revaluation of non-current assets.
Analysis of Financial Statements Chapter -19

a) 1 only
b) 1 and 2
c) 2 and 3
d) 1 and 3

19) Which one of the following formulae should be used to calculate the rate of inventory
turnover in a retail business?
a) Sales divided by average inventory
b) Sales divided by year-end inventory
c) Purchases divided by year-end inventory
d) Cost of sales divided by average inventory

20) A company’s working capital was $43,200. Subsequently, the following transactions
occurred.
1. Suppliers were paid $3,000 by cheque.
2. An irrecoverable debt of $250 was written off.
3. Inventory valued at $100 was sold for $230 on credit.

Working capital is now

a) $43,080
b) $46,080
c) $40,080
d) $42,850

21) The formula for calculating the rate of inventory turnover is

a) Average inventory at cost divided by cost of goods sold
b) Sales divided by average inventory at cost
c) Sales divided by average inventory at selling price
d) Cost of goods sold divided by average inventory at cost

22) Given a selling price of $350 and a gross profit mark-up of 40%, the cost price would be
a) $100
b) $140
c) $210
d) $250

23) Which of the following transactions would result in an increase in capital employed?
a) Selling inventories at a profit
b) Writing off a bad debt
c) Paying a creditor in cash
d) Increasing the bank overdraft to purchase a non current asset

24) Sales are $110,000. Purchases are $80,000. Opening inventory is $12,000. Closing
inventory is $10,000. What is the inventory turnover?
a) 7.27 times
b) 7.45 times
c) 8 times
d) 10 times
Analysis of Financial Statements Chapter -19

25) Which of the following statements are correct?

1. A company might make a rights issue if it wished to raise more equity capital.
2. A rights issue might increase the share premium account whereas a bonus issue is likely to reduce it.
3. A bonus issue will reduce the gearing (leverage) ratio of a company.
4. A rights issue will always increase the number of shareholders in a company whereas a bonus issue will
not.

a) 1 and 2
b) 1 and 3
c) 2 and 3
d) 2 and 4

26) The rate of inventory turnover is 6 times where

a) Sales are $120,000 and average inventory at selling price is $20,000
b) Purchases are $240,000 and average inventory at cost is $40,000
c) Cost of goods sold is $180,000 and average inventory at cost is $30,000
d) Net purchases are $90,000 and closing inventory at cost is $15,000

27) Working capital will reduce by $500 if

a) Goods costing $3,000 are sold for $3,500 on credit
b) Goods costing $3,000 are sold for $3,500 cash
c) Noncurrent assets costing $500 are purchased on credit
d) Noncurrent assets with a net book value of $750 are sold for $250 cash

28) From the following information regarding the year to 31 August 20X6, what is the
payables’ payment period?
$
Sales 43,000
Cost of sales 32,500
Opening inventory 6,000
Closing inventory 3,800
Payables at 31 August 20X6 4,750

a) 38 days
b) 50 days
c) 42 days
d) 57 days

29) A business has the following trading account for the year ending 31 May 20X8:

$ $
Sales 45,000
Opening inventory 4,000
Purchases 26,500
30,500
Less: closing inventory 6,000
24,500
Gross profit 20,500
Analysis of Financial Statements Chapter -19

Its rate of inventory turnover for the year is

a) 4.9 times
b) 5.3 times
c) 7.5 times
d) 9 times

30) A company’s gearing ratio would rise if

a) A decrease in long term loans is less than a decrease in shareholders’ funds
b) A decrease in long-term loan is more than a decrease in shareholders’ funds
c) Interest rates rose
d) Dividends were paid

31) A company has the following details extracted from its Statement of Financial Position:
$000
Inventories 2100
Receivables 1,100
Bank overdraft 700
Payables 1,200

What will be the working capital after following transactions?

- Sale of inventory worth $800 for $950 on credit
- A receivable of $200 has been declared bankrupt
a) $2,250
b) $1,250
c) $300
d) $2,050

32) A company has the following current assets and liabilities at 31 October 20X8:
$’000
Current assets: Inventory 970
Receivables 380
Bank 40
1,390
Current liabilities Payables 420

When measured against accepted ‘norms’, the company can be said to have:
a) A high current ratio and an ideal acid test ratio
b) An ideal current ratio and a low acid test ratio
c) A high current ratio and a low acid test ratio
d) Ideal current and acid test ratios