Financial Accounting
Practice Questions
Course Introduction
Financial Accounting introduces students to the fundamental principles and practices of accounting, focusing on the identification, measurement, and communication of financial information. The course covers key concepts such as the accounting cycle, preparation of financial statements, and understanding the role of financial accounting in decision-making for businesses and external stakeholders. Emphasis is placed on generally accepted accounting principles (GAAP), the interpretation of balance sheets, income statements, and cash flow statements, as well as ethical considerations in financial reporting. This course provides a foundation for further study in accounting and finance.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 6th Edition by
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Page 2
Clyde P. Stickney
Chapter 1: Overview of Financial Reporting, Financial
Statement Analysis, and Valuation
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Sample Questions
Q1) ___________________________________ financial statements are helpful in highlighting the relative magnitude of changes in financial statement data from year to year.
Answer: Percentage change
Q2) Current assets are defined as
A) cash and cash equivalents.
B) all assets expected to be quickly used by the firm.
C) cash and other assets that the firm expects to sell or consume during the normal operating cycle of a business, usually one year.
D) cash and other assets that the firm expects maintain for a period including the normal operating cycle of a business, usually one year.
Answer: C
Q3) When assessing buyer power using Porter's five forces which of the following is not consistent with low buyer power?
A) Brand loyalty
B) Control of distribution channel
C) Large number of suppliers
D) Low price
Answer: C
Page 3
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Chapter 2: Asset and Liability Valuation and Income
Measurement
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Q1) Deferred tax assets and liabilities are created due to temporary differences between the tax and financial reporting basis of certain assets and liabilities. Discuss which scenarios result in a deferred tax asset and which result in deferred tax liabilities.
Answer: Deferred tax assets result from the following two scenarios:
1. The tax basis of assets exceeds the financial reporting basis
2. The tax basis of liabilities is less than the financial reporting basis Deferred tax liabilities result from the following two scenarios:
1. The tax basis of assets is less than the financial reporting basis
2. The tax basis of liabilities exceeds the financial reporting basis
Q2) Acquisition costs includes all costs necessary to get an asset ready for its _________________________.
Answer: intended use
Q3) Firms recognize the reduction in service potential of assets such as building and equipment using the process of ____________________.
Answer: depreciation
Q4) The amount that a company would have to pay today to acquire an asset it now holds is called ________________________________________.
Answer: current replacement cost
Page 4
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Chapter 3: Income Flows Versus Cash Flows: Key
Relationships in the Dynamics of a Business
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Q1) Cash flows from ____________________ activities will normally be positive during the introduction and growth phases of the product life cycle.
Answer: financing
Q2) In a statement of cash flows, proceeds from issuing equity instruments should be classified as cash inflows from A) lending activities. B) operating activities. C) investing activities. D) financing activities.
Answer: D
Q3) The acquisition of new investments would be classified as ____________________ activities in the statement of cash flows.
Answer: investing
Q4) Cash flows from ____________________ activities will normally be negative during all of the introduction and growth phase of the product life cycle.
Answer: inv esting
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Chapter 4: Profitability Analysis
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Sample Questions
Q1) One important difference between return on assets (ROA) and return on common shareholder's equity (ROCE) is
A) ROA does not differentiate based on how a company finances its assets, ROCE does.
B) ROA does not distinguish between the different types of income items, such as income from continuing operations, discontinued operations, extraordinary items and changes in accounting principles, ROCE does.
C) ROCE does not distinguish between the different types of income items, such as income from continuing operations, discontinued operations, extraordinary items and changes in accounting principles, ROA does.
D) ROCE does not differentiate based on how a company finances its assets, ROA does.
Q2) Asset turnover represents
A) The ability of the firm to generate income from operations for a particular level of sales.
B) The ability to generate sales from a particular investment in assets.
C) The ability to manage the level of investment in assets for a particular level of assets.
D) The number of days, on average, it takes management to turnover assets.
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Chapter 5: Risk Analysis
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Sample Questions
Q1) When a financial analyst examines the credit risk of a company it is common that he or she uses a set of factors that all begin with the letter "C". Each factor provides a consideration that enters into the lending decision. List and discuss how each of the factors affects a company's credit risk.
Q2) The source of risk related interest rate changes and demographic changes is ____________________.
Q3) Which of the following states of financial distress would be considered the most troubling for an investor or creditor?
A) failing to make a required interest payment on time
B) paying an accounts payable after the billing date
C) restructuring debt
D) defaulting on a principal payment on debt
Q4) The source of risk related to political unrest and exchange rate changes are
Q5) When management takes deliberate steps at a balance sheet date to produce a better current ratio than is normal it is called
Q6) An analyst can view the revenues to cash ratio as a
Page 7
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Chapter 6: Quality of Accounting Information and Adjustments to Reported Financial Statement Data
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Sample Questions
Q1) Accounting information should be a fair and complete representation of the firm's economic ____________________, ____________________, and ____________________.
Q2) Gains and losses differ from revenues and expenses in that they are produced by ____________________ activities.
Q3) Which of the following items is consistent with earnings being informative about current performance and but not informative about future earnings?
A) The firm recognizes an unexpected gain
B) The firm recognizes a fair value gain on a financial asset as a result of a favorable move in interest rates.
C) The firm recognizes additional expenses this period due to pre-opening costs associated with new stores.
D) The firm experiences a large jump in sales and earnings as a result of successful research and development of new products.
Q4) Accounting information should provide relevant information to forecast the firm's expected future earnings and _________________________.
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Chapter 7: Revenue Recognition and Related Expenses
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Q1) Firms that capitalize routine maintenance and repair charges will end up with the result of having the current period's income being ____________________.
Q2) When input prices are increasing, companies that use the LIFO method of accounting for inventory will report
A) Lower cost of goods sold amounts in comparison to the FIFO method
B) Higher sales amounts in comparison to the FIFO method
C) Higher ending inventory amounts in comparison to the FIFO method
D) Lower gross profit margins in comparison to the FIFO method
Q3) A company that uses LIFO will experience a ______________________________ during a period it sells more units than it purchases.
Q4) GAAP stipulates that firms should do what with expenditures that increase the service potential of an asset beyond that originally anticipated?
A) Expense the expenditure immediately.
B) Capitalize the expenditure and depreciate it over the remaining service life of the asset.
C) Capitalize the expenditure, but do not depreciate the asset.
D) Charge it off to shareholders' equity.
Q5) ___________________________________ is primarily a question of timing.
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Chapter 8: Liability Recognition and Related Expenses
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Q1) Which of the following is not a distinguishing characteristic of a derivative instrument?
A) Derivative instruments have terms that require or permit net settlement.
B) Derivative instruments have a low initial net investment.
C) Derivative instruments are highly effective throughout their term.
D) Derivative instruments have one or more underlyings and notional amounts.
Q2) Which of the following best describes the accounting treatment for derivative instruments not held for purposes of hedging?
A) Record as an asset or liability and recognize changes in fair value in other comprehensive income.
B) Do not record as an asset or liability, record income from the transaction at maturity and recognize in earnings.
C) Record as an asset or liability, recognize changes in fair value currently in earnings.
D) Record as an asset or liability if off-balance sheet risk is material.
Q3) ____________________ differences arise from revenues and expenses that GAAP requires firms to include in income before taxes but that the income tax law excludes from taxable income.
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Chapter 9: Intercorporate Entities
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Q1) Discuss the method of accounting for employee stock options. In your answer discuss the how the accounting has changed during recent years.
Q2) When a foreign entity operates as a relatively self-contained and integrated unit within a foreign country, normally, its functional currency is the
Q3) Interpretation No. 46 relates to the issue of whether an investing firm is the primary beneficiary in a variable-interest entity. When is an entity classified as a variable interest entity?
Q4) The acceptable method of accounting for stock options is the _________________________ method.
Q5) When the purchase price of another entity exceeds the book value of the entity's net assets the purchaser allocates the excess to identifiable assets and liabilities in order to revalue them to market value and any additional excess is allocated to
Q6) When there are two or more investing firms in an entity, how is it determined which entity consolidates the variable interest entity?
Q7) The _________________________ is the date a firm gives a stock option to employees.
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Chapter 10: Forecasting Financial Statements
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Q1) Projecting sales price changes depends on factors specific to the firm and its industry that might affect demand and price elasticity. Which of the following companies would most likely not be able to increase prices in the near future?
A) A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B) A firm in a capital intensive industry in which excess capacity exists.
C) A firm operating in an industry that is expected to maintain its current production processes.
D) A firm operating in an industry that is transitioning from the introduction phase to the high growth phase of its life cycle.
Q2) The analyst can capture projected levels of operating activity by using ______________________________ to develop forecasts for individual assets.
Q3) For some types of assets, such as accounts receivable asset growth typically ____________________ future sales growth.
Q4) For some types of assets, such as plant, property and equipment, asset growth typically ____________________ future sales growth.
Q5) Realistic expectations are ____________________ and ____________________.
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) Under the assumption of clean surplus accounting how would you compute total dividends paid to common equityholders in order to value the firm?
Q2) One criticism in using the CAPM to calculate the cost of equity capital is that ______________________________ and the __________________________________________________ are quite sensitive to the time period and methodology used in their computation.
Q3) Equity based valuation models are based on all metrics except A) dividends B) cash flow C) working capital D) earnings
Q4) In some valuation scenarios, such as a leveraged buyout, it may be necessary to adjust the market equity beta to reflect a ________________________________________.
Q5) A company with a market beta of 1 has systemic risk ____________________ to the average amount of systemic risk of all equity securities in the market.
Q6) In theory, the value of a share of common equity is the present value of
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Chapter 12: Valuation: Cash-Flow-Based Approaches
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Q1) The risk-adjusted discount rate used to compute the present value of all the projected free cash flows for common equity shareholders equals the
Q2) If the objective is to value operating assets net of operating liabilities of a firm then the appropriate free cash flow measure to be used is
Q3) The conceptual framework for free cash flows separates all assets and liabilities into the following categories:
A) Current and non-current
B) Monetary and non-monetary
C) Operating and non-operating
D) Operating and financial
Q4) If an analyst wants to value a potential investment in the net operating assets of a division of another firm the relevant cash flows the analyst should use are
A) free cash flow from operations
B) free cash flows for all debt and equity capital stakeholders
C) free cash flows to common equity shareholders
D) cash flow from operations
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Chapter 13: Valuation: Earnings-Based Approaches
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Q1) Assume that a firm's book value at the beginning of the year is $17,800 and that the firm reports net income of $6,200. If the firm's book value at the end of the year is $20,000 what was the amount of dividends paid during the year?
A) $4,000
B) $8,800
C) $2,200
D) Insufficient information to determine
Q2) Currently U.S. GAAP does not follow clean surplus accounting, what are the four dirty surplus items that do not flow through net income?
Q3) Assume that a firm had shareholders' equity on the balance sheet at a book value of $1,200 at the end of 2005. During 2006 the firm earns net income of $900, pays dividends to shareholders of $400, and issues new stock to raise $250 of capital. The book value of shareholders equity at the end of 2006 is:
A) $2,750
B) $250
C) $1,450
D) $1,950
Q4) What is the rationale for using expected earnings as a basis for valuations?
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Chapter 14: Valuation: Market-Based Approaches
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Q1) Investors have invested $25,000 in common equity in a company. The investors expect that the company will reinvest all income back into projects. The company is forecasted to earn $6,000 the first year, $5,000 the second year, $5,500 the third year and $6,244 each year after the third year. The company's current stock price is $17 per share. Assuming that the company has 3,200 shares outstanding and the risk free rate of interest is 6% calculate the price differential for this company?
Q2) Firms with low P/E ratios tend to have current residual income that is greater than A) future actual income.
B) future residual income.
C) past actual income.
D) past residual income.
Q3) Discuss how risk and profitability factors cause differences in price-earnings ratios across firms.
Q4) The ______________________________ represents the difference between the current stock price and risk-neutral value.
Q5) What information can a PEG ratio provide about a company's stock price? What does a PEG ratio greater than mean? less than one?
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