Financial Statements - Chapter 1 - 48Qs

Victor Chow

Which of the following statements is correct?
A. Liabilities are future sacrifices of economic benefits arising from present
obligations of a particular entity to transfer assets or provide services to other
entities in the future as a result of past transactions or events.
B. Stockholders' Equity includes the residual interest in the net assets of an
entity that remain after deducting short-term liabilities.
C. Assets are probable future economic benefits to be obtained or
controlled by a particular entity as a result of future transactions or events.

A.

Stockholders' Equity is the residual interest in the net assets of an entity that
remains after deducting all of its liabilities (both short-term and long-term).
Assets are probable future economic benefits obtained or controlled by a
particular entity as a result of past transactions or events.

Which of the following is true with regards to the footnotes included in
financial statements?
I. They include detailed information and analysis on the major income
statement and balance sheet items.
II. They are not required under U.S. GAAP.
III.They are used to cite the sources of data used in forecasts.
A I, II and III
B I and II only
C I only

C.

Footnotes are required by U.S. GAAP and have nothing to do with citing
sources

Which component is not likely to be included in the statement of
stockholders' equity?
A Retained earnings
B Preferred shares
C Total assets

C.

Total assets are reported on the balance sheet.

Which of the following items would not be found on the income statement?
A. Earnings Before Interest and Taxes
B. Goodwill
C. Interest Expense

B.

Goodwill is recorded as an asset on the balance sheet.
EBIT, interest expense, and revenue are all income statement items.

Which of the following sources of financial information about the firm is not
audited?
A Management Discussion and Analysis (MD & A)
B Income Statement and Balance Sheet
C Financial Statement Footnotes

A.

Management Discussion and Analysis (MD & A) and corporate press releases
are not audited. All other sources of financial information, including some
supplementary schedules, are audited

All of the following statements represent the description of the role of the
external auditor except:
A. Hired by management, the auditor must help the CFO prepare Financial
Statements in accordance with GAAP in order to improve the accountability of
the firm's operations.
B. The auditor must identify those circumstances in which GAAP principles
have not been consistently observed in the current period in relation to the
preceding period.
C. The auditor is supposed to be independent and to serve the stockholders
and the other users of the financial statements

A.

Though hired by management, the auditor is supposed to be independent and
serve the stockholders and the other users of the financial statements.
Therefore, it is not the function of the auditor to help the CFO prepare Financial
Statements in accordance with GAAP in order to improve accountability of the
firm's operations. This is rather a function of a consultant. All other statements
correctly describe the role of an auditor

Which of the following would be found on a firm's balance sheet?
I. Net Income
II. Total Assets
III. Accounts Payable
IV. Cost of Goods Sold
A II only
B II and III only
C I, II, and III only

B.

Assets are always reported on the balance sheet, as is accounts payable (a key
component of liability). Net income and COGS are income statement items

Interim reports most likely:
A are issued semi-annually or quarterly
B include a full set of financial statements and notes
C are audited

A.

Interim reports are provided semi-annually or quarterly, depending on applicable
regulatory requirements.

Which of the following will disclose accounting policies, methods, and
estimates used in the financial statements?
A management commentary
B notes to the financial statements
C auditor’s report

B.

The notes disclose choices in accounting policies, methods, and estimates

Which of the following indicates that the company’s financial performance
and position are in accordance with the accounting standards?
A Unqualified opinion
B Qualified opinion
C Adverse opinion

A.

An unqualified opinion is a “clean” opinion and indicates that the financial
statements present the company’s performance and financial position fairly in
accordance with a specified set of accounting standards

Which of the following statements best describes the role of footnotes as a
source of financial information?
A They provide information on the results of operations, including discussion of
trends in sales and categories of expense, and on capital resources and liquidity,
including discussion of cash flow trends and the outlook based on known trends.
B They provide information on oil and gas reserves reported by oil and gas
companies, the impact of changing prices, sales revenue, operating income and
other information for major business segments.
C They provide information about the accounting methods, assumptions, and
estimates used by management to develop the data reported in the financial
statements.

C.

Footnotes are essential as they detail the accounting methods, assumptions, and estimates that management uses in preparing the financial statements, helping users to better understand the figures presented.

All of the following actions are allowed under U.S. Generally Accepted
Accounting Principles (GAAP) except:
A Carrying preferred stock at its originally issued par value of $90, while its
current market value is $70.
B Charging retained earnings in order to satisfy a potential lawsuit payment.
C Recording treasury stock at its repurchase price

B.

In the event the company incurs a loss as the result of the law suit, the loss
must be recognized (if it meets the recognition criteria) on the income
statement for the accounting period in which the loss occurs

Whatson Toy is a company selling toys in the United States. In 20x6,
Whatson sold toys for $1,150,000 in cash. The raw materials were purchased
on credit for $500,000. The supplier required Whatson to pay the $500,000 in
January 20x7 for the raw materials it received in 20x6. In addition to the
purchase and sale of the toys, Whatson paid $50,000 in cash for salaries and
taxes in 20x6. How much is Whatson’s profit and cash flow in 20x6?
A $600,000 and $650,000
B $600,000 and $1,100,000
C $650,000 and $600,000

B.

Whatson’s profit in 20x6 is calculated as the sales price minus the cost of the
goods sold and salaries and taxes:
1,150,000 – 500,000 – 50,000 = 600,000
The cash flow is the amount of cash received from the customer less the cash
paid for salaries and taxes:
1,150,000 – 50,000 = 1,100,000

Which of the following statements is most accurate about the responsibilities
of an auditor for a publicly traded firm in the United States? The auditor must:
A express an opinion about the effectiveness of the company's internal control
systems.
B state that the financial statements are prepared according to generally
accepted accounting principles.
C ensure that the financial statements are free from error, fraud, or illegal acts

A.

For a publicly traded firm in the United States, the auditor must express an
opinion as to whether the company's internal control system is in accordance
with the Public Accounting Oversight Board, under the Sarbanes–Oxley Act.
The opinion is given either in a final paragraph in the auditor's report or as a
separate opinion

During the process data phase of financial statement analysis, an analyst will
most likely develop a:
A cash flow statement
B statement of purpose
C common-size balance sheet

C.

During the process data phase, an analyst will produce a variety of reports and
documents based on the information collected. These may include common-
size statements, ratios and graphs, forecasts, adjusted statements, and
analytical results

Providing information about the performance and financial position of
companies so that users can make economic decisions best describes the role
of:
A auditing.
B financial reporting.
C financial statement analysis

B.

This is the role of financial reporting.
The role of financial statement analysis is to evaluate the financial report

Which of the following best describes the role of financial statement
analysis?
A To provide information about a company’s performance
B To provide information about a company’s changes in financial position
C To form expectations about a company’s future performance and financial
position

C.

In general, analysts seek to examine the past and current
performance and financial position of a company in order to form expectations
about its future performance and financial position.

The role of financial statement analysis is best described as:
A providing information useful for making investment decisions.
B evaluating a company for the purpose of making economic decisions.
C using financial reports prepared by analysts to make economic decisions.

B.

The primary role of financial statement analysis is to use financial reports
prepared by companies to evaluate the past, current, and potential performance
and financial position of a company for the purpose of making investment, credit,
and other economic decisions.

A company’s current financial position would best be evaluated using the:
A balance sheet.
B income statement.
C statement of cash flows

A.

The balance sheet portrays the current financial position. The income statement
and statement of cash flows present different aspects of performance

A company’s profitability for a period would best be evaluated using the:
A balance sheet.
B income statement.
C statement of cash flows.

B.

Profitability is the performance aspect measured by the income statement. The
balance sheet portrays the current financial position. The statement of cash flows
presents a different aspect of performance

The financial statement that presents a shareholder’s residual claim on
assets is the:
A balance sheet.
B income statement.
C cash flow statement.

A.

Owners’ equity is the owners’ residual interest in (i.e., residual claim on) the
company’s assets after deducting its liabilities, which is information presented
on the balance sheet.

A company’s profitability over a period of time is best evaluated using the:
A balance sheet.
B income statement.
C cash flow statement

B.

A company’s profitability is best evaluated using the income
statement. The income statement presents information on the financial results
of a company’s business activities over a period of time by communicating how
much revenue was generated and the expenses incurred to generate that
revenue.

The income statement is best used to evaluate a company’s:
A current financial position.
B sources of cash flow.
C financial results from business activities

C.

A company’s revenues and expenses are presented on the income
statement, which is used to evaluate a company’s financial results (or
profitability) from business activities over a period of time. A company’s current
financial position is best evaluated by using the balance sheet. A company’s
sources of cash flow are best evaluated using the cash flow statement.

Accounting policies, methods, and estimates used in preparing financial
statements are most likely found in the:
A auditor’s report.
B management commentary.
C notes to the financial statements

C.

The notes disclose choices in accounting policies, methods, and
estimates.

Information about management and director compensation would least likely
be found in the:
A auditor’s report.
B proxy statement.
C notes to the financial statements

A.

Information about management and director compensation is not
found in the auditor’s report. Disclosure of management compensation is
required in the proxy statement, and some aspects of management
compensation are disclosed in the notes to the financial statements.

Information about a company’s objectives, strategies, and significant risks
would most likely be found in the:
A auditor’s report.
B management commentary
C notes to the financial statements

B.

These are components of management commentary.

Which of the following best describes why the notes that accompany the
financial statements are required? The notes:
A permit flexibility in statement preparation.
B standardize financial reporting across companies.
C provide information necessary to understand the financial statements

C.

The notes provide information that is essential to understanding the
information provided in the primary statements

Which of the following audit opinions indicates that the financial statements
contain significant misrepresentations and do not accurately reflect a company’s
financial position?
A. Unqualified Opinion
B. Qualified Opinion
C. Adverse Opinion

C.

Adverse Opinion is issued when the auditor concludes that the financial statements contain
significant misrepresentations and do not accurately reflect the company’s financial position and
performance.

An auditor determines that a company’s financial statements are prepared
in accordance with applicable accounting standards except with respect to
inventory reporting. This exception most likely results in an audit opinion that is:
A Adverse.
B Qualified.
C Unqualified.

B.

A qualified audit opinion is one in which there is some scope
limitation or exception to accounting standards. Exceptions are described in the
audit report with additional explanatory paragraphs so that the analyst can
determine the importance of the exception.

An independent audit report is most likely to provide:
A absolute assurance about the accuracy of the financial statements.
B reasonable assurance that the financial statements are fairly presented.
C a qualified opinion with respect to the transparency of the financial
statements.

B.

The independent audit report provides reasonable assurance that
the financial statements are fairly presented, meaning that there is a high
probability that the audited financial statements are free from material error,
fraud, or illegal acts that have a direct effect on the financial statements

Interim financial reports released by a company are most likely to be:
A monthly.
B unaudited.
C unqualified.

B.

Interim reports are typically provided semiannually or quarterly and
present the four basic financial statements and condensed notes. They are not
audited. Unqualified is a type of audit opinion.

Which of the following sources of information used by analysts is found
outside a company’s annual report?
A Auditor’s report
B Peer company analysis
C Management’s discussion and analysis

B.

When performing financial statement analysis, analysts should
review all company sources of information as well as information from external
sources regarding the economy, the industry, the company, and peer
(comparable) companies.

Ratios are an input into which step in the financial statement analysis
framework?
A Process data.
B Collect input data.
C Analyze/interpret the processed data.

C.

Ratios are an output of the process data step but are an input into
the analyze/interpret data step.

Which phase in the financial statement analysis framework most likely
involves
producing updated reports and recommendations?
A Follow-up
B Analyze/interpret the processed data
C Develop and communicate conclusions and recommendations

A.

The follow-up phase involves gathering information and repeating
the analysis to determine whether it is necessary to update reports and
recommendations and then updating if necessary.

Inherent risks in an investment are most appropriately evaluated in which step
of the financial statement analysis framework?
A Develop and communicate conclusions/recommendations
B Articulate the purpose and context of analysis
C Process data

B.

Articulating the purpose and context of analysis is a critical early step in the
financial statement analysis framework. This step involves defining the
objectives of the analysis, understanding the business and economic
environment, and identifying key risk factors, including inherent risks in the
investment. Understanding inherent risks, which are risks directly linked to the
nature of the business or investment, is crucial in this stage. It allows for a more
informed and contextual analysis as subsequent steps in the analysis process
are undertaken.

Which of the following most likely results in an increase of owners’ equity?
A Share repurchase
B Cash dividend
C New equity issuance

C.

The basic components of owners’ equity are paid-in capital and
retained earnings. In the paid-in capital account, an example of an increase in
owners’ equity is a new equity issuance. Cash dividends reduce retained
earnings and owners’ equity. Share repurchases reduce paid-in capital and
owners’ equity.

In the phase of "Articulate the purpose and context of the analysis," which of the
following is NOT a key source of information?
A. Communication with client or supervisor on needs and concerns.
B. Adjusted financial statements.
C. Institutional guidelines related to developing a specific work product

B.

Adjusted financial statements are an output of the
"Process data" phase and are not a source of information in the initial phase of
articulating the purpose and context.

Which phase directly involves the creation of common-size statements and graphs
for the financial analysis?
A. Articulate the purpose and context of the analysis.
B. Follow-up.
C. Process data.

C.

Process data. During this phase, the analyst processes the data collected in the
previous phase, creating tools such as adjusted financial statements, common-size
statements, and various financial ratios and graphs.

Which of the following statements least accurately describes a role of financial
statement analysis?
A. Use the information in financial statements to make economic decisions.
B. Provide reasonable assurance that the financial statements are free of
material errors.
C. Evaluate an entity’s financial position and past performance to form
opinions about its future ability to earn profits and generate cash flow

B.

This statement describes the role of an auditor, rather than the role of an
analyst. The other responses describe the role of financial statement analysis.

A firm’s financial position at a specific point in time is reported in the:
A. balance sheet.
B. income statement.
C. cash flow statement.

A.

The balance sheet reports a company’s financial position as of a specific date.
The income statement, cash flow statement, and statement of changes in
owners’ equity show the company’s performance during a specific period.

Information about accounting estimates, assumptions, and methods chosen
for
reporting is most likely found in:
A. the auditor’s opinion.
B. financial statement notes.
C. Management’s Discussion and Analysis.

B.

Information about accounting methods and estimates is contained in the
footnotes to the financial statements.

If an auditor finds that a company’s financial statements have made a specific
exception to applicable accounting principles, she is most likely to issue a:
A. dissenting opinion.
B. cautionary note.
C. qualified opinion.

C.

An auditor will issue a qualified opinion if the financial statements make any
exceptions to applicable accounting standards and will explain the effect of
these exceptions in the auditor’s report.

Information about elections of members to a company’s Board of Directors is
most likely found in:
A. a 10-Q filing.
B. a proxy statement.
C. footnotes to the financial statements.

B.

Proxy statements contain information related to matters that come before
shareholders for a vote, such as elections of board members.

Which of these steps is least likely to be a part of the financial statement
analysis framework?
A. State the purpose and context of the analysis.
B. Determine whether the company’s securities are suitable for the client.
C. Adjust the financial statement data and compare the company to its
industry peers.

B.

Determining the suitability of an investment for a client is not one of the six
steps in the financial statement analysis framework. The analyst would only
perform this function if he also had an advisory relationship with the client.
Stating the objective and processing the data are two of the six steps in the
framework. The others are gathering the data, analyzing the data, updating the
analysis, and reporting the conclusions.

Which of the following items would typically be reported in Other
Comprehensive Income (OCI) and not in net income?
A. Gain on sale of manufacturing equipment
B. Unrealized gains on available-for-sale securities
C. Interest expense from bonds payable

B.

Other Comprehensive Income (OCI) includes revenues, expenses, gains, and
losses that have not been realized and hence are not included in net income.
Unrealized gains on available-for-sale securities are a classic example of an item
that would be reported in OCI because the gains are not realized until the
securities are sold. Gain on the sale of manufacturing equipment and interest
expense from bonds payable are realized items that would be included in the
calculation of net income.

Under U.S. GAAP, how is Other Comprehensive Income (OCI) typically
presented?
A. As a separate component of equity in the balance sheet
B. As a combined figure with net income in the income statement
C. As a separate statement that is part of the financial statements

C.

Other Comprehensive Income (OCI) can be presented in one of two ways under
U.S. GAAP: (1) in a single continuous statement of comprehensive income that
combines net income and OCI, or (2) in a separate statement of comprehensive
income that follows the income statement. While it is not combined with net income
in the income statement, OCI items are aggregated to total comprehensive
income, which is then reported in the equity section of the balance sheet as
accumulated other comprehensive income (AOCI). The correct answer reflects
that OCI is either presented as part of a continuous statement of comprehensive
income or in a separate statement that is part of the overall financial statements,
not as a separate component of equity in the balance sheet.

On a company's balance sheet, retained earnings are adjusted annually after closing
the books for the fiscal year. If a company decides to issue a dividend after a profitable
year, which of the following statements accurately describes the subsequent accounting
treatment and its impact on the balance sheet?
A. Issuing a dividend will increase total stockholders' equity, reflecting the distribution of
profits to shareholders.
B. Issuing a dividend will decrease retained earnings and total stockholders' equity,
reflecting the payout of accumulated profits.
C. Issuing a dividend will have no impact on total stockholders' equity as it is a reallocation
of profits from retained earnings to liabilities until paid.

B.

Dividends represent a distribution of profits to shareholders and are deducted from retained earnings,
which is a component of stockholders' equity. When a dividend is declared, it is recorded as a liability
(dividend payable) and simultaneously reduces retained earnings. As a result, the total stockholders'
equity decreases by the amount of the dividend declared. This is because retained earnings are part
of equity, and reducing retained earnings thus reduces the total equity.
Option A is incorrect because issuing a dividend does not increase equity; it does the opposite by
reducing retained earnings and thereby reducing total equity.

When analyzing a company's financial statements, an investor notices detailed
explanations regarding the recognition of revenue from long-term contracts and the
estimation of warranty liabilities. Where would such explanatory information most likely be
found?
A. In the Management's Discussion and Analysis (MD&A) section, which includes detailed
analyses of the company's operational results and financial condition.
B. In the business segments note, which includes detailed breakdowns of revenues and
operating income by each significant segment of the business.
C. In the footnotes to the financial statements, which provide detailed information about
the accounting policies, methods, and estimates used in preparing the financial
statements.

C.