Financial Statement Analysis
Exam Preparation Guide
Course Introduction
Financial Statement Analysis provides students with the tools and techniques necessary to interpret and evaluate the financial health and performance of a business. The course covers the analysis of financial statements such as the balance sheet, income statement, and cash flow statement, with a focus on understanding key ratios, trends, and the context behind the numbers. Students learn how to assess profitability, liquidity, solvency, and operational efficiency, as well as how to make informed decisions based on both quantitative and qualitative information. Real-world case studies and practical applications are emphasized to prepare students for careers in finance, accounting, and management.
Recommended Textbook
Intermediate Accounting IFRS 6th Edition by J. David Spiceland
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Chapter 1: Environment and Theoretical Structure of Financial Accounting
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Q1) When there is agreement between a measure or description and the phenomenon it purports to represent, information possesses which characteristic?
A)Verifiability.
B)Predictive value.
C)Representational faithfulness.
D)Timeliness.
Answer: C
Q2) The possibility that the capital markets' focus on periodic profits may tempt a company's management to bend or even break accounting rules to inflate reported net income is an example of:
A)An ethical dilemma.
B)An accounting theory issue.
C)A technical accounting issue.
D)None of these is correct.
Answer: A
Q3) How does the value of an audit affect financial statements?
Answer: Outside auditors add credibility to financial statements, increasing the confidence of capital market participants who rely on financial statements in making investment and credit decisions and recommendations.
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Chapter 2: Review of the Accounting Process
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Sample Questions
Q1) Accounts receivable
Answer: \(\begin{array}{ccc} & \text { Effect } & \text { Classification } \\ \text { Accounts receivable } & 1 & 1 \end{array}\)
Q2) The adjusting entry required to record accrued expenses includes:
A)A credit to cash.
B)A debit to an asset.
C)A credit to an asset.
D)A credit to liability.
Answer: D
Q3) On November 1, 2009, Tim's Toys borrows $30,000,000 at 9% to finance the holiday sales season. The note is for a six-month term and both principal and interest are payable at maturity. What should be the balance of interest payable for the loan as of December 31, 2009?
A)$ 112,500.
B)$ 225,000.
C)$ 450,000.
D)$1,350,000.Accrued interest payable = $30,000,000 9% 2/12 = $450,000
Answer: C
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Chapter 3: The Balance Sheet and Financial Disclosures
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Sample Questions
Q1) Segment reporting requires disclosure of each customer that accounts for more than 5% of total enterprise revenue.
A)True
B)False
Answer: False
Q2) An example of fraud would be:
A)Issuing a purchase order without first securing bids.
B)Buying raw materials from an affiliated company.
C)Knowingly classifying a material non-current receivable as a current receivable.
D)Forgetting to accrue salaries and wages payable.
Answer: C
Q3) HHF's debt-to-equity ratio is:
A)0.75.
B)1.13.
C)0.53.
D)1.80.Debt-to-equity ratio: $540/$480 = 1.13
Answer: B
Q4) Altoid Co.'s acid-test ratio.
Answer: Acid-test ratio: $(150 + 200 + 300) /$450 = 1.44
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Chapter 4: The Income Statement and Statement of Cash
Flows
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Sample Questions
Q1) Reporting comprehensive income according to International Accounting Standards can be accomplished by each of the following methods except:
A)In the statement of shareholders' equity.
B)A combined statement of income and comprehensive income.
C)A separate statement of comprehensive income.
D)All of these are acceptable methods.
Q2) Earnings quality refers to the ability of reported earnings (income) to predict future earnings.
A)True
B)False
Q3) Briefly explain when and why intraperiod tax allocation is necessary.
Q4) Reconciliation between net income and comprehensive income would include:
A)Unrealized losses but not unrealized gains on available for sale securities.
B)Unrealized gains but not unrealized losses on available for sale securities.
C)Unrealized losses and unrealized gains on available for sale securities.
D)Neither unrealized losses nor unrealized gains on available for sale securities.
Q5) Briefly define extraordinary items and explain how they are reported.
Page 6
Q6) Briefly explain why the income statement is referred to as a change statement.
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Chapter 5: Income Measurement
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Q1) Suppose that, in 2010, Indiana incurred costs of $63.75 million and estimated an additional $42.75 million in costs to complete the project. Using the percentage-of-completion method, Indiana:
A)Recognized $3.75 million loss on the project in 2010.
B)Recognized $5.25 million gross profit on the project in 2010.
C)Recognized $7.5 million gross profit on the project in 2010.
D)None of these is correct.The project is 70% complete after 2010 (i.e., $99.75 million costs to date/ $142.5 million estimated total costs).The estimated gross profit is now $7.5 million (i.e., $150 million $142.5 million), so gross profit to date is $5.25 million.$9 million was recognized in 2009, so a $3.75 million loss is recognized in 2010.
Q2) Use of the installment sales method requires that firms track the gross-profit percentage associated with a particular sale.
A)True
B)False
Q3) Required: Compute the inventory turnover ratio for 2008.
Q4) Required: Compute the return on shareholders' equity for 2008.
Q5) Required: Compute the asset turnover ratio for 2008.
Q6) Its asset turnover ratio for 2009.
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Chapter 6: Time Value of Money Concepts
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Sample Questions
Q1) At the end of each quarter, Patti deposits $500 into an account that pays 12% interest compounded quarterly. How much will Patti have in the account in three years?
A)$7,096.
B)$7,013.
C)$7,129.
D)$8,880.FVA = $500 x 14.1920* = $7,096 *FVA of $1: n=12; i=3%
Q2) Briefly explain how you would arrive at the monthly payment for a 48-month loan where the first payment is due one month from the loan date. In your explanation, include the use of present and future value tables.
Q3) Bison Mfg. is considering two options for purchasing comparable machinery. Machine 1 will cost $27,500 plus an annual maintenance fee of $1,500 per year for four years. Machine 2 will cost $25,000 with maintenance being an add-on charge. The estimated cost of maintenance is $1,000 the first year, $3,000 the second year, and $4,000 the third year and the fourth year. Assume the purchase cost is paid up front, but that maintenance is paid for at the end of each year. Interest is at 10%. Ignore income taxes and residual values.
Required: Determine which machine should be chosen based on present value considerations.
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Chapter 7: Cash and Receivables
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Sample Questions
Q1) Frasquita acquired equipment from the manufacturer on 6/30/09 and gave a noninterest-bearing note in exchange. Frasquita is obligated to pay $550,000 on 4/30/10 to satisfy the obligation in full. If Frasquita accrued interest of $15,000 on the note in its 2009 year-end financial statements, what would the manufacturer record in its 2009 income statement for this transaction?
A)$15,000 of interest revenue
B)$25,000 of interest revenue
C)$15,000 of interest revenue and $525,000 of sales revenue
D)$550,000 of sales revenue $15,000 was interest for 6 months in 2009.The note lasts 10 months, so 10/6 $15,000 = $25,000 is the total interest for 10 months; the rest ($525,000) is principal, which is the sales revenue for the manufacturer of the equipment.
Q2) A company's investment in receivables is influenced by several variables, including:
A)The level of sales.
B)The nature of the product or service sold.
C)The credit and collection policies.
D)All of these are correct.
Q3) Describe some key elements of an internal control system for cash.
Q4) Briefly explain the accounting treatment for sales returns.
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Chapter 8: Inventories: Measurement
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Sample Questions
Q1) What is Nueva's gross profit ratio if it elects FIFO?
A)30%.
B)32%.
C)10.7%.
D)60%.
Q2) What is Nu's net income if it elects FIFO?
A)$ 480.
B)$ 288.
C)$1,360.
D)$ 144.
Q3) Compared to dollar-value LIFO, unit LIFO is:
A)Less costly to implement.
B)Less susceptible to LIFO liquidation.
C)More costly to implement.
D)More concerned with cost indexes.
Q4) During periods of falling prices, LIFO ending inventory will be less than FIFO ending inventory.
A)True
B)False
Q5) Briefly explain the advantages of dollar-value LIFO (DVL).
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Chapter 9: Inventories: Additional Issues
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Sample Questions
Q1) \[\begin{array} { | l | l | l | }
\hline { \text { Error } } & \text { Cost of goods sold } & \text { Retained earnings } \\
\hline \begin{array} { l }
\text { Recorded purchases for } \$ 523,000 \text { that } \\
\text { should have been } \$ 532,000 .
\end{array} & & \\
\hline
\end{array}\]
Q2) On July 5, 2009, a fire destroyed the entire inventory of Kinard Music Mart. The following information is available from its accounting records: Required:
Compute the estimated cost of inventory lost in the fire. \(\begin{array}{lr}
\text { Inventory, January 1, 2009 } & \$ 211,000 \\
\text { Purchases, Jan. 1 - July } 5 & 500,000 \\
\text { Sales, Jan. 1 - July 5 } & 900,000 \\
\text { Normal gross margin } & 30 \% \end{array}\)
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Chapter 10: Operational Assets: Acquisition and Disposition
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Sample Questions
Q1) Average accumulated expenditures for 2009 was:
A)$300,000.
B)$350,000.
C)$500,000.
D)$400,000.
Q2) Use a T- account to show the balances and changes during 2007 in Boston Beer's: Property, Plant, and Equipment account and its Accumulated depreciation-Property, Plant, & equipment account.
($ in thousands)
Q3) Operational assets are:
A)Created by the normal operation of the business and include accounts receivable.
B)All assets except cash and cash equivalents.
C)Current and long-term assets used in the production of either goods or services.
D)Long-term revenue-producing assets.
Q4) Use a T- account to show the balances and changes during 2009 in Plank Breweries: Fixed assets account and Accumulated depreciation-fixed assets account (in $ thousands).
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Chapter 11: Operational Assets: Utilization and Impairment
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Sample Questions
Q1) Depreciation for 2009, using the straight-line method is:
A)$13,500.
B)$15,000.
C)$ 4,500.
D)$ 5,000.($200,000 20,000) 10 3/12 = $4,500
Q2) Statutory depletion is the maximum amount of depletion that may be reported in financial statements prepared according to GAAP.
A)True
B)False
Q3) Canliss Mining uses the retirement method to determine depreciation on its office equipment. During 2007, its first year of operations, office equipment was purchased at a cost of $14,000. Useful life of the equipment averages 4 years and no salvage value is anticipated. In 2009, equipment costing $5,000 was sold for $600 and replaced with new equipment costing $6,000. Canliss would record 2009 depreciation of:
A)$3,500.
B)$4,400.
C)$5,400.
D)None of these.Cost of equipment sold of $5,000 less proceeds of $600 = $4,400.
Q4) Briefly explain how a change in depreciation method is accounted for.
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Chapter 12: Investments
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Q1) On January 1, 2009, Green Corporation purchased 20% of the outstanding voting common stock of Gold Company for $300,000. The book value of the acquired shares was $275,000. The excess of cost over book value is attributable to an intangible asset on Gold's books that was undervalued and had a remaining useful life of five years. For the year ended December 31, 2009, Gold reported net income of $125,000 and paid cash dividends of $25,000. What is the carrying value of Green's investment in Gold at December 31, 2009?
A)$295,000.
B)$300,000.
C)$315,000.
D)$320,000.
Q2) Both fair values and subsequent growth of the investee are not as relevant for investments in which of the following categories?
A)Securities reported under the equity method.
B)Trading securities.
C)Held-to-maturity securities.
D)Securities available for sale.
Q3) Prepare the journal entry (in thousands) that Kirby made at the end of 2008 to record the information disclosed above.
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Chapter 13: Current Liabilities and Contingencies
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Sample Questions
Q1) On June 30, 2009, Chu Industries issued 9-month notes in the amount of $700,000. Assume that interest is payable at maturity in the following three independent cases: Required:
Determine the amount of interest expense that should be accrued in a year-end adjusting entry under each assumption: \[\begin{array}{l}
\text { Interest rate } \quad \text { Fiscal Year End }\\
\begin{array} { c c c }
\text { 1. } & 9 \% & \text { December } 31 \\
\text { 2. } & 6 \% & \text { August } 31 \\
\text { 3. } & 12 \% & \text { October } 31 \end{array}
\end{array}\]
Q2) Bank loans are often arranged in advance as lines of credit. What is a line of credit? How do a committed and a noncommitted line of credit differ?
Q3) Define a loss contingency and give two examples that almost always are accrued.
Q4) Define and distinguish between current and noncurrent liabilities.
Q5) How are customer advances and refundable deposits similar and yet different?
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Chapter 14: Bonds and Long-Term Notes
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Q1) What is the annual stated interest rate on the bonds?
A)3.5%
B)6%
C)7%
D)None of these is correct.This is the annual cash interest paid ($14,000), divided by the maturity (face) value of $200,000.
Q2) When bonds are sold at a premium and the effective interest method is used, at each interest payment date, the interest expense:
A)Remains constant.
B)Is equal to the change in book value.
C)Increases.
D)Decreases.
Q3) The rate of return on shareholders' equity indicates
A)the margin of safety provided to creditors.
B)the extent of "trading on the equity" or financial leverage.
C)profitability without regard to how resources are financed .
D)the effectiveness of employing resources provided by owners.
Q4) Required: Explain why the estimated fair value of the debentures exceeds their carrying amount at the end of fiscal year 2009.
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Chapter 15: Leases
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Q1) Discuss the interest rates used by the lessee and the lessor for determining the present value of a capital lease.
Q2) What would be the amount of interest expense recorded with payment #5?
A)$2,000.
B)$ 893.
C)$7,107.
D)$1,107.Interest rate = $2,660 / $26,600 = 10% Interest, #5 = $8,925 10% = $893
Q3) At what amount would Reagan record the leased asset at inception of the agreement?
A)$519,115
B)$429,115
C)$540,000
D)$576,000
Q4) From the perspective of the lessee, leases may be classified as either:
A)Direct financing or sales-type.
B)Capital or direct financing.
C)Capital or operating.
D)Direct financing or operating.
Q5) Discuss the three major types of leases that may apply to the lessor. How do they differ?
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Chapter 16: Accounting for Income Taxes
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Q1) What is a valuation allowance for deferred tax assets and when is it used?
Q2) A reconciliation of pretax financial statement income to taxable income is shown below for Fieval Industries for the year ended December 31, 2009, its first year of operations. The income tax rate is 40%. What amount(s) should Fieval report related to deferred income taxes in its 2009 balance sheet?
A)Current asset of $10,000 and noncurrent liability of $28,000.
B)Noncurrent liability of $18,000.
C)Current asset of $4,000 and noncurrent liability of $28,000.
D)Noncurrent liability of $24,000.
Q3) Why are the depreciation and patent amortization listed as deferred tax liabilities?
Q4) Which of the following would never require reporting deferred tax assets or deferred tax liabilities?
A)Depreciation on equipment.
B)Accrual of warranty expense.
C)Life insurance premiums.
D)Rent revenue received in advance.
Q5) What argument serves as the basis for the FASB's requirement that deferred taxes should be recognized for all temporary differences?
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Chapter 17: Pensions and Other Postretirement Benefits
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Q1) Carpenter Gems began the year with a net pension liability of $84 million (underfunded pension plan). Pension expense for the year included the following ($ in millions): service cost, $30; interest cost, $18; expected return on assets, $12; amortization of net loss, $6.
Required:
Prepare the appropriate general journal entry to record Carpenter's pension expense.
Q2) The EPBO for a particular employee on January 1, 2009, was $30,000. The APBO at the beginning of the year was $6,000. The appropriate discount rate for this postretirement plan is 5%. The employee is expected to serve the company for a total of twenty-five years with five of those years already served as of January 1, 2009. What is the APBO at December 31, 2009?
A)$6,300.
B)$7,200
C)$7,500.
D)$7,560.($30,000 1.05) 6/25 = $7,560
Q3) Pension plans typically require some minimum period of employment before benefits vest. What is the 1974 federal law governing vesting (as well as other aspects of pensions)? What are the vesting rules?
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Chapter 18: Shareholders Equity
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Q1) The par value of common stock represents:
A)The arbitrary dollar amount assigned to a share of stock.
B)The liquidation value of a share.
C)The book value of a share of stock.
D)The amount received when the stock was issued.
Q2) When stock is issued in exchange for property, the best evidence of fair value might be any of the following except:
A)The appraised value of the property received.
B)The selling price of the stock in a recent transaction.
C)The price of the stock quoted on the stock exchange.
D)The average book value of outstanding stock.
Q3) Identify the three common forms of business organization and the primary difference in the way we account for them.
Q4) When dividends are declared in one fiscal year and paid in the next fiscal year, the liability for the dividend should be recorded as of the:
A)Date the dividend is declared.
B)Last day of the fiscal year.
C)Date of record.
D)Date of payment.
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Chapter 19: Share-Based Compensation and Earnings Per Share
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Q1) What amount should M recognize as compensation expense for 2009?
A)$ 30,000
B)$ 60,000
C)$120,000
D)$150,000 (90,000 5 = $450,000; $450,000 / 3 yrs = $150,000)
Q2) During 2009, Quattro entered into the following transactions relating to shareholders' equity. The corporation was authorized to issue 20 million common shares, $1 par per share.
Required:
Compute basic and diluted EPS for 2009.
Net income for 2009 was \( \$ 110 \) million.
Jan. 2:\(\quad\) Issued 10 million common shares for cash.
Jan. 3: \(\quad\)Entered an agreement with the company president to issue up to 2 million additional
\(\quad\)\(\quad\)\(\quad\)shares of common stock in 2009 based on the earnings of Quattro in 2009. If net \(\quad\)\(\quad\)\(\quad\) income exceeds \( \$ 100 \) million, the president will receive 1 million shares; 2 million \(\quad\)\(\quad\)\(\quad\)shares if net income exceeds \( \$ 120 \) million.
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Chapter 20: Accounting Changes
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Q1) Lugar Company purchased a piece of machinery for $30,000 on January 1, 2007, and has been depreciating the machine using the sum-of-the-years'-digits method based on a five-year estimated useful life and no salvage value. On January 1, 2009, Lugar decided to switch to the straight-line method of depreciation. The salvage value is still zero and the estimated useful life is changed to a total of six years from the date of purchase. Ignore income taxes.
Required:
(1.) Prepare the appropriate journal entry, if any, to record the accounting change.
(2.) Prepare the journal entry to record depreciation for 2009.
Q2) Due to an error in computing depreciation expense, Crote Corporation understated accumulated depreciation by $60 million as of December 31, 2009. Crote has a tax rate of 40%. Crote's retained earnings as of December 31, 2009, would be:
A)Overstated by $36 million.
B)Understated by $36 million.
C)Overstated by $24 million.
D)Understated by $24 million.
Q3) How may accounting changes detract from accounting information?
Q4) How are accounting errors treated?
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Chapter 21: The Statement of Cash Flows
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Q1) Partial balance sheets and additional information are listed below for Sowell Company.
Additional information for 2009: Net income was $88,000. Depreciation expense was $19,000.
Required:
Prepare the operating activities section of the statement of cash flows for 2009 using the indirect method.
Sowell Company
Partial Balance Sheets as of December 31
\(\begin{array} { l r r } \text { Assets } & \mathbf { 2 0 0 9 } & \mathbf { 2 0 0 8 } \\ \text { Cash } & \$ 40,000 & \$ 20,000 \\ \text { Accounts receivable } & 70,000 & 85,000 \\ \text { Inventory } & 40,000 & 35,000 \\ \text { Liabilities } & & \\ \text { Accounts payable } & \$ 54,000 & \$ 62,000 \end{array}\)
Q2) All of the following may qualify as cash equivalents except:
A)Money market accounts.
B)Certificates of deposit.
C)U.S.Treasury bills.
D)Newly issued corporate bonds.
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Chapter 22: Appendix a Derivatives
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Q1) The financial futures market exists to provide a mechanism to buy and sell the underlying financial instruments.
A)True
B)False
Q2) In an annual report to shareholders, Merck & Co., Inc. disclosed the following in regard to its financial instruments:
Q3) Arshan Inc. engaged in an interest rate swap on several of its fixed interest debenture notes in order to hedge against interest rate reduction that would raise the value of its debt. Possibly, investor perceptions may cause the value of the debentures to rise beyond the prices due to changes in general interest rates. If they do, the additional increase in the value of the debt:
A)Would be recorded as an extraordinary loss in that accounting period.
B)Would be recorded as part of continuing operations in that period's income statement.
C)Would be recorded as an unrealized loss in that period's income statement.
D)Would be ignored in that accounting period.
Q4) What is a futures contract? A financial futures contract? Provide an example of each.
Q5) Explain why a stock option is a type of derivative instrument.
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