Financial Statement Analysis
Exam Answer Key
Course Introduction
Financial Statement Analysis focuses on the techniques and tools used to evaluate the financial health and performance of businesses through the interpretation of financial statements. The course covers the key components of financial statements including the balance sheet, income statement, and cash flow statement and explores methods for analyzing profitability, liquidity, solvency, and operational efficiency. Students learn how to use ratio analysis, trend analysis, and comparative analysis to assess a company's financial position, identify red flags, and make informed decisions. Emphasis is placed on understanding the effects of accounting choices and economic events on reported financial results, as well as the implications for investors, creditors, and other stakeholders.
Recommended Textbook
Financial Reporting Financial Statement Analysis and Valuation 8th Edition by
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14 Chapters
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Page 2
James M. Wahlen
Chapter 1: Overview of Financial Reporting, financial
Statement Analysis, and Valuation
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Sample Questions
Q1) What three financial statements are prepared by business firms and what information does each provide?
Answer: 1.Balance sheet--Point in time reporting of assets,liabilities and stockholders' equity.2.Income statement--Measurement of operating performance for a period of time.3.Statement of cash flows--The net cash flows for a period of time from the three business activities: operating,investing and financing.
Q2) Another important step in financial statement analysis is to assess the quality of a firm's ________________________________________ and if necessary adjust them for such characteristics as sustainability or comparability.
Answer: financial statements
Q3) The five economic attributes that are normally studied are demand,supply,manufacturing,____________________,and investing and financing.
Answer: marketing
Q4) Cash and cash equivalents are considered ____________________ assets.
Answer: Monetary
Q5) Normally,intense rivalries have a tendency to reduce ____________________.
Answer: profitability
3
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Chapter 2: Asset and Liability Valuation and Income
Measurement
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Q1) Firms recognize the reduction in service potential of assets such as patents and trademarksusing the process of ____________________.
Answer: amortization
Q2) Acquisition costs includes all costs necessary to get an asset ready for its
Answer: intended use
Q3) Stockholders' equity can be expanded into the following three accounts: Accumulated other comprehensive income,retained earnings and
Answer: contributed capital
Q4) The use of acquisition cost as a valuation method is justified on the basis that acquisition cost is:
A) timely
B) relevant C) subjective D) objective
Answer: D
Page 4
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Chapter 3: Income Flows Versus Cash Flows:
Understanding the Statement of Cash Flows
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Sample Questions
Q1) Normally,cash flows from operations will peak during which phase of the product life cycle?
A) Introduction
B) Growth
C) Maturity
D) Decline
Answer: C
Q2) Which of the following is a cash flow from operating activities?
A) Sale of long-term investments in common stock.
B) Purchase of merchandise for resale.
C) Payment of a note payable.
D) Sale of a piece of land no longer used in operations.
Answer: B
Q3) One factor that may cause cash flow from operations to differ from net income is the length of the ______________________________.
Answer: operating cycle
Q4) EBITDA not only ignores four expenses but also ignores changes in __________________________________________________ accounts.
Answer: operating working capital
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Chapter 4: Profitability Analysis
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Sample Questions
Q1) The statutory tax rate differs from a firm's average tax rate due to which of the following reasons
A) the statutory tax rate is a marginal tax rate.
B) some expenses are included in book income but do not enter into taxable income.
C) the average tax rate is for a period of three years.
D) the statutory tax rate does not effect GAAP measures of revenues and expenses.
Q2) Which of the following is not a way a company can achieve a low-cost position
A) economies of scale
B) production efficiency
C) customer service
D) outsourcing
Q3) When calculating the return on fixed assets sales is divided by
Q4) The rationale for adding back the _______________________________________________________ relates to attaining consistency in the numerator and denominator of ROA.
Q5) Accounts receivable turnover is calculated by dividing ________________________________________ by average net accounts receivable.
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Chapter 5: Risk Analysis
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Q1) The beta coefficient measures the ____________________ of a firm's returns with those of all shares traded in the market (in excess of the risk-free interest rate).
Q2) Financially healthy firms frequently close any cash flow gaps in their operating cycles with ________________________________________.
Q3) The quick acid test ratio contains all of the following except:
A) cash
B) accounts receivable
C) marketable securities
D) prepaid assets
Q4) Hammer Corporation wrote off $185,000 of obsolete inventory at December 31,2011. Required: What effect did this write-off have on the company's 2011 current and quick ratios?
Q5) Refer to the information for Mobile Company.Mobile's 2010 Inventory Turnover ratio is
A) 7.46
B) 11.83
C) 6.16
D) 5.62
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Chapter 6: Accounting Quality
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Q1) Many times an analyst will have to make judgments as to whether to include unrealized gains and losses when assessing earnings persistence and predicting future profitability.Discuss the case for and the case against including unrealized gains and losses as part of sustainable earnings when examining earnings persistence and future profitability.
Q2) Which of the following items is consistent with earnings being informative about current performance and informing the analyst that level of current earnings are not sustainable?
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.
Q3) When evaluating the quality of accounting information the user should consider the _____________________________________________ of the measurements made.
Q4) A change in the useful life of an asset is treated as a _____________
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Chapter 7: Financing Activities
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Sample Questions
Q1) Using the information provided by Santa Corporation calculate the company's 2012 fixed asset ratio.
A) 3.0
B) 3.65
C) 3.23
D) 5.21
Q2) Which kind of dividends typically pay dividends with investments in other corporations' stock?
A) property dividend
B) stock dividend
C) liquidating dividend
D) scrip dividend
Q3) The first date at which employees can exercise their stock options is termed the _________________________.
Q4) Under the fair value method of accounting for stock options,firms must value stock options on the date of ____________________.
Q5) The _________________________ is the date a firm gives a stock option to employees.
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Chapter 8: Investing Activities
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Q1) Goodwill represents
A) the synergies that will be achieved through the acquisition.
B) the difference between the acquisition cost and the market value of the identifiable assets and liabilities.
C) the difference between the acquisition cost and the book value of the identifiable assets and liabilities.
D) the merger premium.
Q2) Interpretation No.46R 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?
Q3) Most publicly traded firms in the United States use the _________________________ method of depreciation for ______________ statement purposes.
Q4) Held-to-maturity securities are accounted for at __________________________________________________.
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 ____________________.
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Chapter 9: Operating Activities
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Q1) When cash collectibility is uncertain the ___________________________________ method matches the costs of generating revenues dollar for dollar with cash receipts until the firm recovers all such costs.
Q2) ___________________________________ is primarily a question of timing.
Q3) The _____________________________________________ is equal to the actuarial present value of amounts that the employer expects to pay to retired employees based on the employees' service to date and using expected future salary amounts.
Q4) Derivative instruments acquired to hedge exposure to changes in the fair value of an asset or liability are ______________________________ hedges.
Q5) All of the following are conditions for revenue recognition outlined by SAB 104 except: A) There is pervasive evidence that an arrangement exists. B) Delivery has occurred or services have been performed. C) The seller's price to the buyer can be variable. D) Collectability is reasonably assured.
Q6) When cash collectibility is uncertain,a firm using the ____________________ method recognizes revenue as it collects portions of the selling price in cash.
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Chapter 10: Forecasting Financial Statements
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Q1) Firms which have differentiated ___________________________________ for its products may have a greater potential to increase prices.
Q2) If a firm operates at less then full capacity then price _______________________ are not likely
Q3) Projected financial statements can be used to assess the sensitivity of all of the following except:
A) a firm's liquidity
B) a firm's leverage to changes in assumptions
C) conditions under which the firm's debt covenants may become binding
D) unusual patterns for projected total assets.
Q4) The objective of forecasting is to develop
A) stand-alone financial statements for future analysis.
B) a set of realistic expectations for future value-relevant payoffs.
C) a balance sheet and income statement that articulate.
D) financial statements for comparison to industry averages.
Q5) A firm in a mature industry with little expected change in its market share might anticipate volume increases equal to the growth rate in the _________________________ within its geographic markets.
Q6) Realistic expectations are ____________________ and ____________________.
Page 12
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Chapter 11: Risk-Adjusted Expected Rates of Return and the Dividends Valuation Approach
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Q1) Identify the types of firm-specific factors that increase a firm's nondiversifiable risk (systematic risk).Identify the types of firm-specific factors that increase a firm's diversifiable risk (idiosyncratic risk or nonsystematic risk).Why do models of risk-adjusted expected returns include no expected return premia for diversifiable risk?
Q2) If a firm has a market beta of 0.9,is subject to an income tax rate of 35 percent,has a risk-free rate of 6 percent,a market risk premium of 7 percent,and has a market value of debt to market value of equity ratio of 60 percent,what does the market expect the firm to generate in terms of equity returns using CAPM?
A) 6%
B) 7%
C) 12.3%
D) 13%
Q3) If dividend projections include the effect of inflation,then the discount rate used should be a ____________________ rate.
Q4) 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) Starting with free cash flows from operations,discuss how an analyst would measure free cash flows to common equity shareholders.
Q2) If a firm's stock returns covary identically with returns to a marketwide portfolio,then its market beta from such a regression is:
A) equal to zero. B) equal to one.
C) less than one.
D) greater than one.
Q3) An equity security with systematic risk equal to the average amount of systematic risk of all equity securities in the market
A) has a market beta equal to one. B) should expect to earn the same rate of return as the average stock in the market portfolio.
C) gives no insight into the risk premium of stock.
D) Both a and b are correct.
Q4) ________________________________________ typically include accounts payable,accrued expenses,accrued taxes,deferred taxes,pension obligations and other retirement benefit obligations.
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Chapter 13: Valuation: Earnings-Based Approaches
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Q1) Residual income valuation focuses on
A) dividend-paying capacity in free-cash flows.
B) earnings as a periodic measure of shareholder wealth creation.
C) free cash flows as a periodic measure of shareholder wealth creation.
D) dividends as a periodic measure of shareholder wealth creation.
Q2) Investors have invested $25,000 in common equity in a company.Given the risk inherent in the company the investors expect to earn a 15 percent return.In addition,the investors expect the company to return all income to investors in the form of dividends.The company is forecasted to earn $4,000 the first year,$5,000 the second year,$4,500 the third year and $3,750 each year after the third year.For this company determine the company's residual income valuation
Q3) Compute the value of Jarrett Corp.on January 1,2011,using the residual income valuation model.Use the half-year adjustment.
A) $112,768
B) $185,329
C) $195,540
D) $133,624
Q4) ____________________ are the fundamental,value-relevant attribute of expected future returns.
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Chapter 14: Valuation: Market-Based Approaches
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Q1) In the value-to-book model growth adds value to shareholders only if the growth is
Q2) When a company has a high market to book ratio this could be a result of the company having__________________________________________________.
Q3) Valuation using market multiples captures
A) absolute valuation per dollar of book value or per dollar of earnings.
B) dollar of book value or dollar of earnings per dollar of common equity.
C) relative valuation per dollar of book value or per dollar of earnings.
D) intrinsic valuation per dollar of book value or per dollar of earnings.
Q4) 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.
Q5) Discuss how risk and profitability factors cause differences in price-earnings ratios across firms.Explain the difference between abnormal and normal earnings.
Q6) Explain the analysts' role in making the capital markets efficient.
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