ABA Financial Reporting and Analysis 2 — Questions and Answers
Question 1: A company reports accounts receivable of $500,000 with an allowance for doubtful accounts of $25,000. What is the net realizable value of accounts receivable?
- $525,000
- $475,000 (Correct answer)
- $500,000
- $25,000
Correct answer: $475,000
Net realizable value equals gross accounts receivable minus the allowance for doubtful accounts: $500,000 - $25,000 = $475,000.
Question 2: Under the indirect method of preparing the cash flow statement, how is depreciation expense treated?
- Subtracted from net income
- Added back to net income (Correct answer)
- Reported as a financing activity
- Reported as an investing activity
Correct answer: Added back to net income
Depreciation is a non-cash expense deducted in computing net income, so it is added back to reconcile net income to operating cash flows.
Question 3: Which financial statement best reflects a company's ability to meet short-term obligations?
- Income statement
- Statement of retained earnings
- Balance sheet (Correct answer)
- Statement of cash flows
Correct answer: Balance sheet
The balance sheet shows current assets and current liabilities, which are used to assess short-term liquidity at a point in time.
Question 4: An analyst calculates a company's inventory turnover ratio as 8. What does this indicate?
- Inventory is sold and replaced 8 times per year (Correct answer)
- 8% of inventory is unsold at year-end
- Inventory days on hand is 8 days
- The company holds 8 months of inventory
Correct answer: Inventory is sold and replaced 8 times per year
Inventory turnover of 8 means the company sells and replaces its average inventory approximately 8 times during the period.
Question 5: When a company issues bonds at a premium, the carrying value of the bonds will:
- Remain constant over the life of the bond
- Increase each period until maturity
- Decrease each period until maturity (Correct answer)
- Equal the face value at issuance
Correct answer: Decrease each period until maturity
When bonds are issued at a premium (above face value), the premium is amortized over the bond's life, reducing the carrying value toward face value at maturity.
Question 6: Which accounting principle requires that expenses be recorded in the same period as the revenues they help generate?
- Revenue recognition principle
- Matching principle (Correct answer)
- Historical cost principle
- Full disclosure principle
Correct answer: Matching principle
The matching principle requires that expenses be recognized in the same period as the related revenues, ensuring accurate period profitability.
Question 7: A firm's debt-to-equity ratio is 2.5. This means that for every dollar of equity:
- The firm owes $0.40 in debt
- The firm owes $2.50 in debt (Correct answer)
- Total assets are $2.50
- Retained earnings are $2.50
Correct answer: The firm owes $2.50 in debt
A debt-to-equity ratio of 2.5 means there is $2.50 of total debt for every $1.00 of shareholders' equity.
ABA Financial Reporting and Analysis 2
A company reports accounts receivable of $500,000 with an allowance for doubtful accounts of $25,000.
What is the net realizable value of accounts receivable?