Profitability Analysis and Analytical Issues Paper 7
At the beginning of last year, Falcon Manufacturing Co. increased its selling price by $10 per unit This price increase has no effect on the volume of sales As a result Falconís operating profit margin will
Answer (A) is correct. Operating profit margin is the percentage of revenues which remains with the firm after costs of merchandise, selling expenses, and general and administrative expenses have been paid. Increasing sales will increase this profit margin.
Hampel Corporationís gross profit margin has decreased substantially over the past 3 years Which one of the following best explains this decrease?
Answer (C) is correct. A physical count showing missing inventory is likely to cause a substantial decrease in gross profit margin.
Grimball Corporationís gross profit margin has remained fairly constant for the past several years. Which one of the following is the best explanation?
Answer (A) is correct. Gross profit margin is the percentage of gross revenues that remains with the firm after paying for merchandise. The key analysis with respect to the gross profit margin is whether it is keeping up with the increase or decrease in sales. For example, a 10% increase in sales should be accompanied by at least a 10% increase in the gross profit margin.
Network Corporation made a large arithmetic error in the preparation of its year-end financial
statements by improper placement of an extra digit in the calculation of bad debt expense allowance. The error caused the net income to be reported at almost half of the proper amount. In accordance with GAAP, correction of the error when discovered in the next year should be treated as
Answer (D) is correct. An accounting error results from (1) a mathematical mistake, (2) a mistake in the application of GAAP, or (3) an oversight or misuse of facts existing when the statements were prepared. An accounting error related to a prior period is reported as a prior-period adjustment by restating the prior-period statements.
A construction company has signed $1,000,000 in new contracts. During the current year, 10% of the required work for these contracts was performed. Historically, the controller has recognized revenue when the contract work was completed using the completed contract method This year the companyís auditors are requiring the new contracts to be recognized under the percentage of completion method. The change in revenue recognition methods will result in a revenue change of
Answer (C) is correct. When the outcome of a transaction involving the rendering of services (e.g., a construction project) cannot be estimated reliably, revenue must be recognized only to the extent of the expenses recognized that are recoverable. If it is probable that the entity will recover the transaction costs incurred, revenue is recognized only to the extent of those costs that are expected to be recoverable. Thus, $100,000, 10% of the $1,000,000 contract, should be recognized as revenue compared with $0 of revenue recognized under the completed contract method, since the contract is not fully completed.
A U.S. company and a German company purchased the same stock on the German stock exchange and held the stock for 1 year. The value of the euro weakened against the dollar over this period Comparing the returns of the two companies the United States companyís return will be
Answer (A) is correct. The returns on the stock are presumably paid in euros. Hence, the change in the value of the euro relative to the dollar does not affect the German companyís return. However, the weakening of the euro reduces the number of dollars it will buy and the U S companyís return in dollars is correspondingly reduced
If an entityís books of account are not maintained in its functional currency U S GAAP require remeasurement into the functional currency prior to the translation process. An item that should be remeasured by use of the current exchange rate is
Answer (A) is correct. When remeasurement is necessary, the temporal method is applied. The essence of the temporal method is to make the financial statement items look as if the underlying transactions had been recorded in the functional currency to begin with. Balance sheet items carried at their future values, such as held-to-maturity investments in bonds, are remeasured using the current rate on the reporting date.
U.S. GAAP require the application of the functional currency concept. Before the financial statements of a foreign subsidiary may be translated into the parent companyís currency the functional currency of the foreign subsidiary must be determined. All of the following factors indicate that a foreign subsidiaryís functional currency is the foreign currency rather than the parentís currency except when
Answer (B) is correct. A companyís functional currency is that of the primary economic environment in which an entity operates, i.e., the currency in which the company primarily generates and expends cash. Sales prices that are responsive to exchange rate fluctuations and international competition suggest that the functional currency is the parentís currency
The economic effects of a change in foreign exchange rates on a relatively self-contained and integrated operation within a foreign country relate to the net investment by the reporting enterprise in that operation. Consequently, translation adjustments that arise from the consolidation of that operation
Answer (C) is correct. When a foreign operation is relatively self-contained, the cash generated and expended by the entity is normally in the currency of the foreign country, and that currency is deemed to be the operationís functional currency. Related translation adjustments do not directly affect the parentís cash flows and are not reflected in net income.
U.S. GAAP require that, in a highly inflationary economy, the financial statements of a foreign entity be remeasured as if the functional currency were the reporting currency. For this requirement, a highly inflationary economy is one that has
Answer (D) is correct. U.S. GAAP recognize that the currency in a highly inflationary economy is not stable enough to be a functional currency. Instead, the more stable currency of the parent corporation should be used as the functional currency. A highly inflationary economy has a cumulative inflation rate over a 3-year period of at least 100%.