The balance sheet for Schultz Bone Company at December 31, 2011

P 8-3 The balance sheet for Schultz Bone Company at December 31, 2011 had the following account balances:

Total current liabilities (non-interest-bearing) $450,000
Bonds payable, 6% (issued in 1982; due in 2018) 750,000
Preferred stock, 5%, $100 par 300,000
Common stock, $10 par 750,000
Premium on common stock 150,000
Retained earnings 600,000

Income before income tax was $200,000, and income taxes were $80,000 for the current
year.

Required Calculate each of the following:

a. Return on assets (using ending assets)
b. Return on total equity (using ending total equity)
c. Return on common equity (using ending common equity)
d. Times interest earned

P 8-13
Required Answer the following multiple-choice questions:

a. Which of the following is not considered to be a nonrecurring item?

1. Discontinued operations
2. Extraordinary items
3. Cumulative effect of change in accounting principle
4. Interest expense
5. None of the above.

b. Ideally, which of these ratios will indicate the highest return for an individual firm?

1. Return on assets
2. Return on assets variation
3. Return on investments
4. Return on total equity
5. Return on common equity

c. If a firm’s gross profit has declined substantially, this could be attributed to all but which of the following reasons?

1. The cost of buying inventory has increased more rapidly than selling prices.
2. Selling prices have declined due to competition.
3. Selling prices have increased due to competition.
4. The mix of goods has changed to include more products with lower margins.
5. Theft is occurring.

d. Gross profit analysis could be of value for all but which of the following?

1. Projections of profitability
2. Estimating administrative expenses
3. Inventory for interim statements
4. Estimating inventory for insurance claims
5. Replacing the physical taking of inventory on an annual basis

e. Total asset turnover measures

1. Net income dollars generated by each dollar of sales.
2. The ability of the firm to generate sales through the use of the assets. 3. The firm’s ability to make productive use of its property, plant, and equipment
through generation of profits.
4. The relationship between the income earned on the capital invested.
5. Return to the common shareholders.

f. Equity earnings can represent a problem in analyzing profitability because

1. Equity earnings may not be related to cash flow.
2. Equity earnings are extraordinary.
3. Equity earnings are unusual.
4. Equity earnings are not from operations.
5. Equity earnings are equal to dividends received.

g. Which of the following is not a type of operating asset?

1. Intangibles
2. Receivables
3. Land
4. Inventory
5. Building

h. Earnings based on percent of holdings by outside owners of consolidated subsidiaries are termed

1. Equity earnings.
2. Earnings of subsidiaries.
3. Investment income.
4. Noncontrolling interest.
5. None of the above.

i. Net profit margin × total asset turnover measures

 
1. DuPont return on assets.
2. Return on investment.
3. Return on stockholders’ equity.
4. Return on common equity.
5. None of the above.

j. Return on assets cannot rise under which of the following circumstances? Net profit margin Total asset turnover

1. Decline Rise
2. Rise Decline
3. Rise Rise
4. Decline Decline
5. The ratio could rise under
all of the above.

k. A reason that equity earnings create a problem in analyzing profitability is because

1. Equity earnings are nonrecurring.
2. Equity earnings are extraordinary.
3. Equity earnings are usually less than the related cash flow.
4. Equity earnings relate to operations.
5. None of the above.

l. Which of the following ratios will usually have the highest percent?

1. Return on investment
2. Return on total equity
3. Return on common equity
4. Return on total assets
5. There is not enough information to tell.

m. Which of the following ratios will usually have the lowest percent?

1. Return on investment
2. Return on total equity
3. Return on common equity
4. Return on total assets
5. There is not enough information to tell.

n. Which of the following items will be reported on the income statement as part of net income?

1. Prior period adjustment
2. Unrealized decline in market value of investments
3. Foreign currency translation
4. Gain from selling land
5. None of the above.

o. Noncontrolling interest in earnings is

1. The total earnings of unconsolidated subsidiaries.
2. Earnings based on the percent of holdings by the parent of unconsolidated subsidiaries.
3. Total earnings of unconsolidated subsidiaries.
4. Earnings based on the percent of holdings by outside owners of unconsolidated subsidiaries.
5. None of the above.

p. Which of the following could cause return on assets to decline when net profit margin is increasing?

1. Purchase of land at year-end
2. Increase in book value
3. A stock dividend
4. Increased turnover of operating assets
5. None of the above.

P 8-14
Warranty Obligations—Ethics Consideration

The Bishop Company has a balance in the warranty obligation account of $400,000. An analysis of the products sold under warranty indicates that a balance of $900,000 should be adequate for this year-end. The president of Bishop Company directs that the balance be adjusted to $600,000. If more is needed, it will be adjusted next quarter. The president indicates that there is not
adequate liquidity currently to pay more than $600,000.

Required
a. 1. Adjusting to $600,000 will add how much to expense for the current year?
2. Adjusting to $900,000 will add how much to expense for the current year?
b. If the balance in the warranty obligation account is not adequate, will this prevent
subsequent payments? Comment.
c. Comment on the ethics of not providing a balance that is reasonably close to what the
analysis indicates.

Here’s the SOLUTION

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