Financial Statement Quiz

The statement is false because the price-earnings ratio is indeed useful for investors to evaluate a company's prospects in the stock market. The price-earnings ratio is a financial metric that compares a company's stock price to its earnings per share. It helps investors assess whether a stock is overvalued or undervalued. A higher ratio suggests that investors are willing to pay more for each dollar of earnings, indicating positive prospects for the company. Conversely, a lower ratio may indicate potential undervaluation or negative prospects. Therefore, the price-earnings ratio is an important tool for investors to make informed decisions in the stock market.

In order to make companies of different sizes comparable, it is essential to use a common size analysis technique. This technique involves expressing financial information as a percentage of a common base, such as sales or total assets. By doing so, it eliminates the influence of company size and allows for a more accurate comparison of their financial performance. This is important because comparing raw financial numbers without adjusting for size can lead to misleading conclusions. Therefore, it is true that evaluating companies of different sizes must use a common size analysis technique to ensure comparability.

When common stock is issued for cash at year-end, it is recorded as an increase in total assets because cash is received. Additionally, it is recorded as an increase in equity because common stock represents ownership in the company. Therefore, both the total assets and equity denominators will increase as a result of the issuance of common stock for cash at year-end.

The acid-test ratio, also known as the quick ratio, is a measure of a company's ability to pay off its current liabilities with its most liquid assets. It does not directly reflect the benefits that stockholders can gain from a company. Instead, it focuses on the company's short-term liquidity position. Therefore, the statement is false.

Stockholders are typically least concerned with the acid-test ratio because it measures a company's short-term liquidity and ability to meet immediate financial obligations. Stockholders are more interested in profitability and returns on their investment, which are reflected in ratios such as earnings per share, dividend yield ratio, and price-earnings ratio. The acid-test ratio is more relevant for creditors and suppliers who want to assess a company's ability to pay off its short-term debts.

The denominator of "return on common stockholder's equity" is not the biggest if a company earns a profit. The denominator of this ratio is the average common stockholder's equity, which includes the company's net income. Therefore, if a company earns a profit, it would increase the numerator (net income) and the denominator (average common stockholder's equity) by the same amount, resulting in no significant change in the ratio.

Common size financial statements allow an analyst to compare the composition of a company's assets, liabilities, capital, revenue, and expenses over a period of time or between companies within the same industry, regardless of their size. This helps in identifying trends, patterns, and differences in financial performance, and allows for a more meaningful comparison and evaluation of companies within the industry. It provides insights into the financial structure and performance of companies, allowing for better decision-making and analysis.

The price-earnings ratio is a measure of a company's stock price relative to its earnings per share. It is commonly used by investors to assess the valuation of a company's stock. However, it is not directly related to a company's ability to pay its expenses and liabilities. Instead, the current ratio and acid-test ratio are more relevant in determining a company's liquidity and ability to meet its short-term obligations. The times interest earned ratio is also important in assessing a company's ability to cover its interest expenses.

Return on common stockholders' equity is likely to be the largest ratio if a company is profitable and effectively using leverage. This is because return on common stockholders' equity measures the profitability of a company's operations in relation to the investment made by common stockholders. If the company is profitable and effectively using leverage, it means that it is generating higher returns on the equity invested by common stockholders, resulting in a larger return on common stockholders' equity ratio.

Issuing common stock for cash at year-end will decrease the return on total assets because it increases the denominator (total assets) without a corresponding increase in the numerator (net income). This will result in a lower return on assets ratio. Additionally, issuing common stock for cash will also decrease the debt-to-equity ratio as it increases the equity portion of the ratio while keeping the debt portion constant. Therefore, both ratios will decrease as a result of this transaction.