CFA Level 1, Financial Reporting and Analysis

Quick Ratio (Liquidity)

(Cash + Short-term marketable investments + Receivables) / Current Liabilities The quick ratio is more conservative than the current ratio because it includes only the more liquid current assets (sometimes referred to as "quick assets") in relation to current liabilities. Like the current ratio, a higher quick ratio indicates greater liquidity. The quick ratio reflects the fact that certain current assets—such as prepaid expenses, some taxes, and employee- related prepayments—represent costs of the current period that have been paid in advance and cannot usually be converted back into cash. This ratio also reflects the fact that inventory might not be easily and quickly converted into cash, and furthermore, that a company would probably not be able to sell all of its inventory for an amount equal to its carrying value, especially if it were required to sell the inventory quickly. In situations where inventories are illiquid (as indicated, for example, by low inventory turnover ratios), the quick ratio may be a better indicator of liquidity than is the current ratio.

Describe the steps in the financial statement analysis framework

1 Articulate the purpose and context of the analysis. 2 Collect input data 3 Process data 4 Analyze/interpret the processed data 5 Develop and communicate conclusions and recommendations 6 Follow- up

Calculate and compare cost of sales, gross profit, and ending inventory using different inventory valuation methods and using perpetual and periodic inventory systems;

A company must use the same cost formula for all inventories having a similar nature and use to the entity. The inventory accounting system (perpetual or periodic) may result in different values for cost of sales and ending inventory when the weighted average cost or LIFO inventory valuation method is used. The specific identification method is used for inventory items that are not ordinarily interchangeable and for goods that have been produced and segregated for specific projects. This method is also commonly used for expensive goods that are uniquely identifiable, such as precious gemstones FIFO assumes that the oldest goods purchased (or manufactured) are sold first and the newest goods purchased (or manufactured) remain in ending inventory. In other words, the first units included in inventory are assumed to be the first units sold from inventory. In periods of rising prices, the costs assigned to the units in ending inventory are higher than the costs assigned to the units sold. Conversely, in periods of declining prices, the costs assigned to the units in ending inventory are lower than the costs assigned to the units sold. Weighted average cost assigns the average cost of the goods available for sale (beginning inventory plus purchase, conversion, and other costs) during the accounting period to the units that are sold as well as to the units in ending inventory LIFO is permitted only under US GAAP. This method assumes that the newest goods purchased (or manufactured) are sold first and the oldest goods purchased (or manufactured), including beginning inventory, remain in ending inventory. In periods of rising prices, the costs assigned to the units in ending inventory are lower than the costs assigned to the units sold. Conversely, in periods of declining prices, the costs assigned to the units in ending inventory are higher than the costs assigned to the units sold.

Describe the roles of the statement of financial position, statement of comprehensive income, statement of changes in equity, and statement of cash flows in evaluating a company's performance and financial position;

A complete set of financial statements include a statement of financial position (i.e., a balance sheet), a statement of comprehensive income (i.e., a single statement of comprehensive income or an income statement and a statement of comprehensive income), a statement of changes in equity, and a statement of cash flows. The balance sheet portrays the company's financial position at a given point in time. The statement of comprehensive income and statement of cash flows present different aspects of a company's performance over a period of time. The statement of changes in equity provides additional information regarding the changes in a company's financial position.

Equity equals: A Assets - Liabilities. B Liabilities - Assets. C Assets + Liabilities.

A is correct. Assets = Liabilities + Equity and, therefore, Assets - Liabilities = Equity.

Distinguishing between current and non- current items on the balance sheet and presenting a subtotal for current assets and liabilities is referred to as: A a classified balance sheet. B an unclassified balance sheet. C a liquidity- based balance sheet.

A is correct. A classified balance sheet is one that classifies assets and liabilities as current or non- current and provides a subtotal for current assets and current liabilities. A liquidity- based balance sheet broadly presents assets and liabilities in order of liquidity.

A company enters into a finance lease agreement to acquire the use of an asset for three years with lease payments of €19,000,000 starting next year. The leased asset has a fair market value of €49,000,000 and the present value of the lease payments is €47,250,188. Based on this information, the value of the lease pay able reported on the company's balance sheet is closest to: A €47,250,188. B €49,000,000. C €57,000,000.

A is correct. A company that enters into a finance lease reports the value of both the leased asset and lease payable as the lower of the present value of future lease payments and the fair value of the leased asset. The present value of the future lease payments, €47,250,188, is lower than the fair market value of the leased asset, €49,000,000. The company will record a lease payable on the balance sheet of €47,250,188.

Which of the following disclosures regarding new accounting standards provides the most meaningful information to an analyst? A The impact of adoption is discussed. B The standard will have no material impact. C Management is still evaluating the impact.

A is correct. A discussion of the impact would be the most meaningful, although B would also be useful.

A lessee that enters into a finance lease will report the: A lease payable on its balance sheet. B full lease payment on its income statement. C full lease payment as an operating cash flow

A is correct. A finance lease is similar to borrowing money and buying an asset; a company that enters into a finance lease as the lessee reports an asset (leased asset) and related debt (lease payable) on its balance sheet. A company that enters into a finance lease as the lessee will report interest expense and depreciation expense on its income statement. A company that enters into an operating lease will report the lease payment on its income statement. For a finance lease, only the portion of the lease payment relating to interest expense reduces operating cash flow; the portion of the lease payment that reduces the lease liability appears as a cash outflow in the financing section. A company that enters into an operating lease as the lessee will report the full lease payment as an operating cash outflow

Under IFRS, a loss from the destruction of property in a fire would most likely be classified as: A continuing operations. B discontinued operations. C other comprehensive income.

A is correct. A fire may be infrequent, but it would still be part of continuing operations and reported in the profit and loss statement. Discontinued operations relate to a decision to dispose of an operating division.

Which of the following will cause a company to show a lower amount of amortization of intangible assets in the first year after acquisition? A A higher residual value. B A higher amortization rate. C A shorter useful life.

A is correct. A higher residual value results in a lower total depreciable cost and, therefore, a lower amount of amortization in the first year after acquisition (and every year after that).

The most likely company to use a liquidity-based balance sheet presentation is a: A bank. B computer manufacturer holding inventories. C software company with trade receivables and payables

A is correct. A liquidity- based presentation, rather than a current/non- current presentation, may be used by such entities as banks if broadly presenting assets and liabilities in order of liquidity is reliable and more relevant.

A lessor will record interest income if a lease is classified as: A a capital lease. B an operating lease. C either a capital or an operating lease.

A is correct. A portion of the payments for capital leases, either direct financing or sales- type, is reported as interest income. With an operating lease, all revenue is recorded as rental revenue.

Under US GAAP, a lessor's reported revenues at lease inception will be highest if the lease is classified as: A a sales- type lease. B an operating lease. C a direct financing lease.

A is correct. A sales- type lease treats the lease as a sale of the asset, and revenue is recorded at the time of sale equal to the present value of future lease payments. Under a direct financing lease, only interest income is reported as earned. Under an operating lease, revenue from rent is reported when collected.

According to the Conceptual Framework for Financial Reporting, which of the following is not an enhancing qualitative characteristic of information in financial statements? A Accuracy. B Timeliness. C Comparability.

A is correct. Accuracy is not an enhancing qualitative characteristic. Faithful representation, not accuracy, is a fundamental qualitative characteristic.

Compared with a finance lease, an operating lease: A is similar to renting an asset. B is equivalent to the purchase of an asset. C term is for the majority of the economic life of the asset.

A is correct. An operating lease is an agreement that allows the lessee to use an asset for a period of time. Thus, an operating lease is similar to renting an asset, whereas a finance lease is equivalent to the purchase of an asset by the lessee that is directly financed by the lessor.

A company is comparing straight-line and double-declining balance amortization methods for a non-renewable six-year license, acquired for €600,000. The difference between the Year 4 ending net book values using the two methods is closest to: A €81,400. B €118,600. C €200,000.

A is correct. As shown in the following calculations, at the end of Year 4, the difference between the net book values calculated using straight-line versus double-declining balance is closest to €81,400. Net book value end of Year 4 using straight- line method = €600,000 - [4 * (€600,000/6)] = €200,000. Net book value end of Year 4 using double- declining balance method = €600,000 (1 - 33.33%)^4 ≈ €118,600.

Which of the following is most likely to be considered a potential benefit of accounting conservatism? A A reduction in litigation costs B Less biased financial reporting C An increase in current period reported performance

A is correct. Conservatism reduces the possibility of litigation and, by extension, litigation costs. Rarely, if ever, is a company sued because it understated good news or overstated bad news. Accounting conservatism is a type of bias in financial reporting that decreases a company's reported performance. Conservatism directly conflicts with the characteristic of neutrality.

Orange Beverages Plc., a fictitious manufacturer of tropical drinks, reported cost of goods sold for the year of $100 million. Total assets increased by $55 million, but inventory declined by $6 million. Total liabilities increased by $45 million, but accounts payable decreased by $2 million. How much cash did the company pay to its suppliers during the year? A $96 million. B $104 million. C $108 million

A is correct. Cost of goods sold of $100 million less the decrease in inventory of $6 million equals purchases from suppliers of $94 million. The decrease in accounts payable of $2 million means that the company paid $96 million in cash ($94 million plus $2 million).

Purple Fleur S.A., a retailer of floral products, reported cost of goods sold for the year of $75 million. Total assets increased by $55 million, but inventory declined by $6 million. Total liabilities increased by $45 million, and accounts payable increased by $2 million. The cash paid by the company to its suppliers is most likely closest to: A $67 million. B $79 million. C $83 million.

A is correct. Cost of goods sold of $75 million less the decrease in inventory of $6 million equals purchases from suppliers of $69 million. The increase in accounts payable of $2 million means that the company paid $67 million in cash ($69 million minus $2 million).

Debt due within one year is considered: A current. B preferred. C convertible.

A is correct. Current liabilities are those liabilities, including debt, due within one year. Preferred refers to a class of stock. Convertible refers to a feature of bonds (or preferred stock) allowing the holder to convert the instrument into common stock.

Earnings that result from non- recurring activities most likely indicate: A lower- quality earnings. B biased accounting choices. C lower- quality financial reporting.

A is correct. Earnings that result from non- recurring activities are unsustainable. Unsustainable earnings are an example of lower-quality earnings. Recognizing earnings that result from non- recurring activities is neither a biased accounting choice nor indicative of lower quality financial reporting because it faithfully represents economic events.

For financial assets classified as held to maturity, how are unrealized gains and losses reflected in shareholders' equity? A They are not recognized. B They flow through retained earnings. C They are a component of accumulated other comprehensive income.

A is correct. Financial assets classified as held to maturity are measured at amortised cost. Gains and losses are recognized only when realized.

Financial reports of the lowest level of quality reflect A fictitious events. B biased accounting choices. C accounting that is non- compliant with GAAP.

A is correct. Financial reports span a quality continuum from high to low based on decision- usefulness and earnings quality (see Exhibit 2 of the reading). The lowest-quality reports portray fictitious events, which may misrepresent the company's performance and/or obscure fraudulent misappropriation of the company's assets.

CROCO S.p.A sells an intangible asset with a historical acquisition cost of €12 million and an accumulated depreciation of €2 million and reports a loss on the sale of €3.2 million. Which of the following amounts is most likely the sale price of the asset? A €6.8 million B €8.8 million C €13.2 million

A is correct. Gain or loss on the sale = Sale proceeds - Carrying amount. Rearranging this equation, Sale proceeds = Carrying amount + Gain or loss on sale. Thus, Sale price = (12 million - 2 million) + (-3.2 million) = 6.8 million.

Carrying inventory at a value above its historical cost would most likely be permitted if: A the inventory was held by a producer of agricultural products. B financial statements were prepared using US GAAP. C the change resulted from a reversal of a previous write- down.

A is correct. IFRS allow the inventories of producers and dealers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products to be carried at net realisable value even if above historical cost. (US GAAP treatment is similar.)

According to IFRS, all of the following pieces of information about intangible assets must be disclosed in a company's financial statements and footnotes except for: A fair value. B impairment loss. C amortization rate.

A is correct. IFRS do not require fair value of intangible assets to be disclosed.

Fernando's Pasta purchased inventory and later wrote it down. The current net realisable value is higher than the value when written down. Fernando's inventory balance will most likely be: A higher if it complies with IFRS. B higher if it complies with US GAAP. C the same under US GAAP and IFRS.

A is correct. IFRS require the reversal of inventory write- downs if net realisable values increase; US GAAP do not permit the reversal of write- downs.

Deferred tax liabilities should be treated as equity when: A they are not expected to reverse. B the timing of tax payments is uncertain. C the amount of tax payments is uncertain.

A is correct. If the liability will not reverse, there will be no required tax payment in the future and the "liability" should be treated as equity.

All else equal, in the fiscal year when long- lived equipment is purchased: A depreciation expense increases. B cash from operations decreases. C net income is reduced by the amount of the purchase.

A is correct. In the fiscal year when long- lived equipment is purchased, the assets on the balance sheet increase and depreciation expense on the income statement increases because of the new long- lived asset.

The initial measurement of goodwill is most likely affected by: A an acquisition's purchase price. B the acquired company's book value. C the fair value of the acquirer's assets and liabilities.

A is correct. Initially, goodwill is measured as the difference between the purchase price paid for an acquisition and the fair value of the acquired, not acquiring, company's net assets (identifiable assets less liabilities).

Investment property is most likely to: A earn rent. B be held for resale. C be used in the production of goods and services.

A is correct. Investment property earns rent. Inventory is held for resale, and property, plant, and equipment are used in the production of goods and services.

When comparing a US company that uses the last in, first out (LIFO) method of inventory with companies that prepare their financial statements under international financial reporting standards (IFRS), analysts should be aware that according to IFRS, the LIFO method of inventory: A is never acceptable. B is always acceptable. C is acceptable when applied to finished goods inventory only.

A is correct. LIFO is not permitted under IFRS.

LIFO reserve is most likely to increase when inventory unit: A costs are increasing. B costs are decreasing. C levels are decreasing.

A is correct. LIFO reserve is the FIFO inventory value less the LIFO inventory value. In periods of rising inventory unit costs, the carrying amount of inventory under FIFO will always exceed the carrying amount of inventory under LIFO. The LIFO reserve may increase over time as a result of the increasing difference between the older costs used to value inventory under LIFO and the more recent costs used to value inventory under FIFO. When inventory unit levels are decreasing, the company will experience a LIFO liquidation, reducing the LIFO reserve.

Nutmeg, Inc. uses the LIFO method to account for inventory. During years in which inventory unit costs are generally rising and in which the company purchases more inventory than it sells to customers, its reported gross profit margin will most likely be: A lower than it would be if the company used the FIFO method. B higher than it would be if the company used the FIFO method. C about the same as it would be if the company used the FIFO method.

A is correct. LIFO will result in lower inventory and higher cost of sales in periods of rising costs compared to FIFO. Consequently, LIFO results in a lower gross profit margin than FIFO.

Which technique most likely increases the cash flow provided by operations? A Stretching the accounts payable credit period B Applying all non- cash discount amortization against interest capitalized C Shifting classification of interest paid from financing to operating cash flow

A is correct. Managers can temporarily show a higher cash flow from operations by stretching the accounts payable credit period. In other words, the managers delay payments until the next accounting period. Applying all non-cash discount amortization against interest capitalized causes reported interest expenses and operating cash outflow to be higher, resulting in a lower cash flow provided by operations. Shifting the classification of interest paid from financing to operating cash flows lowers the cash flow provided by operations.

Which of the following statements most likely describes a situation that would motivate a manager to issue low- quality financial reports? A The manager's compensation is tied to stock price performance. B The manager has increased the market share of products significantly C The manager has brought the company's profitability to a level higher than competitors.

A is correct. Managers often have incentives to meet or beat market expectations, particularly if management compensation is linked to increases in stock prices or to reported earnings.

Which of the following best describes an opportunity for management to issue low-quality financial reports? A Ineffective board of directors B Pressure to achieve some performance level C Corporate concerns about financing in the future

A is correct. Opportunities to issue low- quality financial reports include internal conditions, such as an ineffective board of directors, and external conditions, such as accounting standards that provide scope for divergent choices. Pressure to achieve a certain level of performance and corporate concerns about future financing are examples of motivations to issue low- quality financial reports. Typically, three conditions exist when low-quality financial reports are issued: opportunity, motivation, and rationalization.

When preparing an income statement, which of the following items would most likely be classified as other comprehensive income? A A foreign currency translation adjustment B An unrealized gain on a security held for trading purposes C A realized gain on a derivative contract not accounted for as a hedge

A is correct. Other comprehensive income includes items that affect shareholders' equity but are not reflected in the company's income statement. In consoli dating the financial statements of foreign subsidiaries, the effects of translating the subsidiaries' balance sheet assets and liabilities at current exchange rates are included as other comprehensive income.

When screening for potential equity investments based on return on equity, to control risk, an analyst would be most likely to include a criterion that requires: A positive net income. B negative net income. C negative shareholders' equity.

A is correct. Requiring that net income be positive would eliminate companies that report a positive return on equity only because both net income and share holders' equity are negative.

Red Road Company, a consulting company, reported total revenues of $100 million, total expenses of $80 million, and net income of $20 million in the most recent year. If accounts receivable increased by $10 million, how much cash did the company receive from customers? A $90 million. B $100 million. C $110 million.

A is correct. Revenues of $100 million minus the increase in accounts receivable of $10 million equal $90 million cash received from customers. The increase in accounts receivable means that the company received less in cash than it reported as revenue.

What does the P/E ratio measure? A The "multiple" that the stock market places on a company's EPS. B The relationship between dividends and market prices. C The earnings for one common share of stock.

A is correct. The P/E ratio measures the "multiple" that the stock market places on a company's EPS.

A company receives advance payments from customers that are immediately taxable but will not be recognized for accounting purposes until the company fulfills its obligation. The company will most likely record: A a deferred tax asset. B a deferred tax liability. C no deferred tax asset or liability.

A is correct. The advances represent a liability for the company. The carrying value of the liability exceeds the tax base (which is now zero). A deferred tax asset arises when the carrying value of a liability exceeds its tax base.

Brown Corporation had average days of sales outstanding of 19 days in the most recent fiscal year. Brown wants to improve its credit policies and collection practices and decrease its collection period in the next fiscal year to match the industry average of 15 days. Credit sales in the most recent fiscal year were $300 million, and Brown expects credit sales to increase to $390 million in the next fiscal year. To achieve Brown's goal of decreasing the collection period, the change in the average accounts receivable balance that must occur is closest to: A +$0.41 million. B -$0.41 million. C -$1.22 million.

A is correct. The average accounts receivable balances (actual and desired) must be calculated to determine the desired change. The average accounts receivable balance can be calculated as an average day's credit sales times the DSO. For the most recent fiscal year, the average accounts receivable balance is $15.62 million [= ($300,000,000/365) . 19]. The desired average accounts receivable balance for the next fiscal year is $16.03 million (= ($390,000,000/365) . 15). This is an increase of $0.41 million (= 16.03 million - 15.62 million). An alternative approach is to calculate the turnover and divide sales by turnover to determine the average accounts receivable balance. Turnover equals 365 divided by DSO. Turnover is 19.21 (= 365/19) for the most recent fiscal year and is targeted to be 24.33 (= 365/15) for the next fiscal year. The average accounts receivable balances are $15.62 million (= $300,000,000/19.21), and $16.03 million (=$390,000,000/24.33). The change is an increase in receivables of $0.41 million

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

A is correct. The balance sheet portrays the company's financial position on a specified date. The income statement and statement of cash flows present different aspects of performance during the period.

Midland Brands issues three- year bonds dated 1 January 2015 with a face value of $5,000,000. The market interest rate on bonds of comparable risk and term is 3%. If the bonds pay 2.5% annually on 31 December, bonds payable when issued are most likely reported as closest to: A $4,929,285. B $5,000,000. C $5,071,401.

A is correct. The bonds payable reported at issue is equal to the sales proceeds. The interest payments and future value of the bond must be discounted at the market interest rate of 3% to determine the sales proceeds.

When accounting standards require an asset to be expensed immediately but tax rules require the item to be capitalized and amortized, the company will most likely record: A a deferred tax asset. B a deferred tax liability. C no deferred tax asset or liability.

A is correct. The capitalization will result in an asset with a positive tax base and zero carrying value. The amortization means the difference is temporary. Because there is a temporary difference on an asset resulting in a higher tax base than carrying value, a deferred tax asset is created.

The most stringent test of a company's liquidity is its: A cash ratio. B quick ratio. C current ratio.

A is correct. The cash ratio determines how much of a company's near- term obligations can be settled with existing amounts of cash and marketable securities.

Costs incurred for intangible assets are generally expensed when they are: A internally developed. B individually acquired. C acquired in a business combination.

A is correct. The costs to internally develop intangible assets are generally expensed when incurred.

Consolidated Enterprises issues €10 million face value, five- year bonds with a coupon rate of 6.5 percent. At the time of issuance, the market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, the carrying value after one year will be closest to: A €10.17 million. B €10.21 million. C €10.28 million.

A is correct. The coupon rate on the bonds is higher than the market rate, which indicates that the bonds will be issued at a premium. Taking the present value of each payment indicates an issue date value of €10,210,618. The interest expense is determined by multiplying the carrying amount at the beginning of the period (€10,210,618) by the market interest rate at the time of issue (6.0 percent) for an interest expense of €612,637. The value after one year will equal the beginning value less the amount of the premium amortised to date, which is the difference between the amount paid (€650,000) and the expense accrued (€612,637) or €37,363. €10,210,618 - €37,363 = €10,173,255 or €10.17 million

Which ratio would a company most likely use to measure its ability to meet short- term obligations? A Current ratio. B Payables turnover. C Gross profit margin.

A is correct. The current ratio is a liquidity ratio. It compares the net amount of current assets expected to be converted into cash within the year with liabilities falling due in the same period. A current ratio of 1.0 would indicate that the company would have just enough current assets to pay current liabilities.

An investor concerned whether a company can meet its near- term obligations is most likely to calculate the: A current ratio. B return on total capital. C financial leverage ratio.

A is correct. The current ratio provides a comparison of assets that can be turned into cash relatively quickly and liabilities that must be paid within one year. The other ratios are more suited to longer- term concerns.

Which of the following elements of financial statements is most closely related to measurement of financial position? A Equity. B Income. C Expenses.

A is correct. The elements of financial statements related to the measurement of financial position are assets, liabilities, and equity.

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

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

The gain or loss on a sale of a long- lived asset to which the revaluation model has been applied is most likely calculated using sales proceeds less: A carrying amount. B carrying amount adjusted for impairment. C historical cost net of accumulated depreciation.

A is correct. The gain or loss on the sale of long- lived assets is computed as the sales proceeds minus the carrying amount of the asset at the time of sale. This is true under the cost and revaluation models of reporting long-lived assets. In the absence of impairment losses, under the cost model, the carrying amount will equal historical cost net of accumulated depreciation.

Which of the following components of the cash flow statement may be prepared under the indirect method under both IFRS and US GAAP? A Operating. B Investing. C Financing.

A is correct. The operating section may be prepared under the indirect method. The other sections are always prepared under the direct method.

Which of the following situations will most likely motivate managers to inflate reported earnings? A Possibility of bond covenant violation B Earnings in excess of analysts' forecasts C Earnings that are greater than the previous year

A is correct. The possibility of bond covenant violations may motivate managers to inflate earnings in the reporting period. In so doing, the company may be able to avoid the consequences associated with violating bond covenants.

Zimt AG wrote down the value of its inventory in 2017 and reversed the write down in 2018. Compared to the results the company would have reported if the write- down had never occurred, Zimt's reported 2018: A profit was overstated. B cash flow from operations was overstated. C year- end inventory balance was overstated.

A is correct. The reversal of the write- down shifted cost of sales from 2018 to 2017. The 2017 cost of sales was higher because of the write- down, and the 2018 cost of sales was lower because of the reversal of the write- down. As a result, the reported 2018 profits were overstated. Inventory balance in 2018 is the same because the write-down and reversal cancel each other out. Cash flow from operations is not affected by the non- cash write- down, but the higher profits in 2018 likely resulted in higher taxes and thus lower cash flow from operations.

Which of the following amortization methods is most likely to evenly distribute the cost of an intangible asset over its useful life? A Straight- line method. B Units- of- production method. C Double- declining balance method.

A is correct. The straight- line method is the method that evenly distributes the cost of an asset over its useful life because amortization is the same amount every year.

In early 2018 Sanborn Company must pay the tax authority €37,000 on the income it earned in 2017. This amount was recorded on the company's 31 December 2017 financial statements as: A taxes payable. B income tax expense. C a deferred tax liability.

A is correct. The taxes a company must pay in the immediate future are taxes payable.

Innovative Inventions, Inc. needs to raise €10 million. If the company chooses to issue zero- coupon bonds, its debt- to- equity ratio will most likely: A rise as the maturity date approaches. B decline as the maturity date approaches. C remain constant throughout the life of the bond.

A is correct. The value of the liability for zero- coupon bonds increases as the discount is amortised over time. Furthermore, the amortised interest will reduce earnings at an increasing rate over time as the value of the liability increases. Higher relative debt and lower relative equity (through retained earnings) will cause the debt-to-equity ratio to increase as the zero-coupon bonds approach maturity.

An analyst has calculated a ratio using as the numerator the sum of operating cash flow, interest, and taxes and as the denominator the amount of interest. What is this ratio, what does it measure, and what does it indicate? A This ratio is an interest coverage ratio, measuring a company's ability to meet its interest obligations and indicating a company's solvency. B This ratio is an effective tax ratio, measuring the amount of a company's operating cash flow used for taxes and indicating a company's efficiency in tax management. C This ratio is an operating profitability ratio, measuring the operating cash flow generated accounting for taxes and interest and indicating a company's liquidity

A is correct. This ratio is an interest coverage ratio, measuring a company's ability to meet its interest obligations and indicating a company's solvency. This coverage ratio is based on cash flow information; another common coverage ratio uses a measure based on the income statement (earnings before interest, taxes, depreciation, and amortisation).

END OF IMPLICIT PERIODIC INVENTORY SYSTEM QUESTIONS Carey Company adheres to US GAAP, whereas Jonathan Company adheres to IFRS. It is least likely that: A Carey has reversed an inventory write- down. B Jonathan has reversed an inventory write- down. C Jonathan and Carey both use the FIFO inventory accounting method.

A is correct. US GAAP do not permit inventory write- downs to be reversed.

Under IFRS, what must be disclosed under the cost model of valuation for investment properties? A Useful lives B The method for determining fair value C Reconciliation between beginning and ending carrying amounts of investment property

A is correct. Under IFRS, when using the cost model for its investment properties, a company must disclose useful lives. The method for determining fair value, as well as reconciliation between beginning and ending carrying amounts of investment property, is a required disclosure when the fair value model is used.

Oil Exploration LLC paid $45,000 in printing, legal fees, commissions, and other costs associated with its recent bond issue. It is most likely to record these costs on its financial statements as: A an asset under US GAAP and reduction of the carrying value of the debt under IFRS. B a liability under US GAAP and reduction of the carrying value of the debt under IFRS. C a cash outflow from investing activities under both US GAAP and IFRS

A is correct. Under US GAAP, expenses incurred when issuing bonds are generally recorded as an asset and amortised to the related expense (legal, etc.) over the life of the bonds. Under IFRS, they are included in the measurement of the liability. The related cash flows are financing activities.

Under the revaluation model for property, plant, and equipment and the fair model for investment property: A fair value of the asset must be able to be measured reliably. B net income is affected by all changes in the fair value of the asset. C net income is never affected if the asset increases in value from its carrying amount.

A is correct. Under both the revaluation model for property, plant, and equipment and the fair model for investment property, the asset's fair value must be able to be measured reliably. Under the fair value model, net income is affected by all changes in the asset's fair value. Under the revaluation model, any increase in an asset's value to the extent that it reverses a previous revaluation decrease will be recognized on the income statement and increase net income.

Which of the following is most likely to appear in the operating section of a cash flow statement under the indirect method? A Net income. B Cash paid to suppliers. C Cash received from customers.

A is correct. Under the indirect method, the operating section would begin with net income and adjust it to arrive at operating cash flow. The other two items would appear in the operating section under the direct method.

Which of the following is not a constraint on the financial statements according to the Conceptual Framework? A Understandability. B Benefit versus cost. C Balancing of qualitative characteristics.

A is correct. Understandability is an enhancing qualitative characteristic of financial information—not a constraint.

Fairmont Golf issued fixed rate debt when interest rates were 6 percent. Rates have since risen to 7 percent. Using only the carrying amount (based on historical cost) reported on the balance sheet to analyze the company's financial position would most likely cause an analyst to: A overestimate Fairmont's economic liabilities. B underestimate Fairmont's economic liabilities. C underestimate Fairmont's interest coverage ratio.

A is correct. When interest rates rise, bonds decline in value. Thus, the carrying amount of the bonds being carried on the balance sheet is higher than the market value. The company could repurchase the bonds for less than the carrying amount, so the economic liabilities are overestimated. Because the bonds are issued at a fixed rate, there is no effect on interest coverage.

If inventory unit costs are increasing from period- to- period, a LIFO liquidation is most likely to result in an increase in: A gross profit B LIFO reserve. C inventory carrying amounts.

A is correct. When the number of units sold exceeds the number of units purchased, a company using LIFO will experience a LIFO liquidation. If inventory unit costs have been rising from period- to- period and a LIFO liquidation occurs, it will produce an increase in gross profit as a result of the lower inventory carrying amounts of the liquidated units (lower cost per unit of the liquidated units).

Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices, the cost of sales reported by: A Zimt is too low. B Nutmeg is too low. C Nutmeg is too high.

A is correct. Zimt uses the FIFO method, so its cost of sales represents units purchased at a (no longer available) lower price. Nutmeg uses the LIFO method, so its cost of sales is approximately equal to the current replacement cost of inventory.

Classify, calculate, and interpret activity, liquidity, solvency, profitability, and valuation ratios

Activity ratios are also known as asset utilization ratios or operating efficiency ratios. This category is intended to measure how well a company manages various activities, particularly how efficiently it manages its various assets. Activity ratios are analyzed as indicators of ongoing operational performance—how effectively assets are used by a company. Liquidity analysis, which focuses on cash flows, measures a company's ability to meet its short- term obligations. Liquidity measures how quickly assets are converted into cash. Liquidity ratios also measure the ability to pay off short- term obligations. Solvency refers to a company's ability to fulfill its long- term debt obligations. Assessment of a company's ability to pay its long- term obligations (i.e., to make interest and principal payments) generally includes an in- depth analysis of the components of its financial structure. Solvency ratios provide information regarding the relative amount of debt in the company's capital structure and the adequacy of earnings and cash flow to cover interest expenses and other fixed charges (such as lease or rental payments) as they come due Profitability ratios measure the return earned by the company during a period.

Explain and evaluate how capitalising versus expensing costs in the period in which they are incurred affects financial statements and ratios

Although capitalizing expenditures, rather than expensing them, results in higher reported profitability in the initial year, it results in lower profitability in subsequent years; however, if a company continues to purchase similar or increasing amounts of assets each year, the profitability- enhancing effect of capitalization continues. Capitalizing an expenditure rather than expensing it results in a greater amount reported as cash from operations because capitalized expenditures are classified as an investing cash outflow rather than an operating cash outflow

Distinguish between conservative and aggressive accounting;

An aspect of financial reporting quality is the degree to which accounting choices are conservative or aggressive. "Aggressive" typically refers to choices that aim to enhance the company's reported performance and financial position by inflating the amount of revenues, earnings, and/or operating cash flow reported in the period; or by decreasing expenses for the period and/or the amount of debt reported on the balance sheet. Conservatism in financial reports can result from either (1) accounting standards that specifically require a conservative treatment of a transaction or an event or (2) judgments made by managers when applying accounting standards that result in conservative results.

Explain appropriate analyst adjustments to a company's financial statements to facilitate comparison with another company

Analyst adjustments to a company's reported financial statements are sometimes necessary (e.g., when comparing companies that use different accounting methods or assumptions). Adjustments can include those related to investments; inventory; property, plant, and equipment; and goodwill.

Distinguish between current and non-current assets and current and non-current liabilities

Assets expected to be liquidated or used up within one year or one operating cycle of the business, whichever is greater, are classified as current assets. Assets not expected to be liquidated or used up within one year or one operating cycle of the business, whichever is greater, are classified as non- current assets. Liabilities expected to be settled or paid within one year or one operating cycle of the business, whichever is greater, are classified as current liabilities. Liabilities not expected to be settled or paid within one year or one operating cycle of the business, whichever is greater, are classified as non- current liabilities.

Financial Leverage Ratio

Avg. Total Assets / Avg. Total Equity This ratio (often called simply the "leverage ratio") measures the amount of total assets supported for each one money unit of equity. For example, a value of 3 for this ratio means that each €1 of equity supports €3 of total assets. The higher the financial leverage ratio, the more leveraged the company is in the sense of using debt and other liabilities to finance assets

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 is correct. 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.

One concern when screening for stocks with low price- to- earnings ratios is that companies with low P/Es may be financially weak. What criterion might an analyst include to avoid inadvertently selecting weak companies? A Net income less than zero B Debt- to- total assets ratio below a certain cutoff point C Current- year sales growth lower than prior- year sales growth

B is correct. A lower value of debt/total assets indicates greater financial strength. Requiring that a company's debt/total assets be below a certain cutoff point would allow the analyst to screen out highly leveraged and, therefore, potentially financially weak companies.

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 is most likely to result in an audit opinion that is: A adverse. B qualified C unqualified

B is correct. 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.

Which of the following most likely signals that a manufacturing company expects demand for its product to increase? A Finished goods inventory growth rate higher than the sales growth rate B Higher unit volumes of work in progress and raw material inventories C Substantially higher finished goods, with lower raw materials and work- in- process

B is correct. A significant increase (attributable to increases in unit volume rather than increases in unit cost) in raw materials and/or work- in- progress inventories may signal that the company expects an increase in demand for its products. If the growth of finished goods inventories is greater than the growth of sales, it could indicate a decrease in demand and a decrease in future earnings. A substantial increase in finished goods inventories while raw materials and work- in- progress inventories are declining may signal a decrease in demand for the company's products.

Which of the following would best explain an increase in receivables turnover? A The company adopted new credit policies last year and began offering credit to customers with weak credit histories. B Due to problems with an error in its old credit scoring system, the company had accumulated a substantial amount of uncollectible accounts and wrote off a large amount of its receivables. C To match the terms offered by its closest competitor, the company adopted new payment terms now requiring net payment within 30 days rather than 15 days, which had been its previous requirement.

B is correct. A write off of receivables would decrease the average amount of accounts receivable (the denominator of the receivables turnover ratio), thus increasing this ratio. Customers with weaker credit are more likely to make payments more slowly or to pose collection difficulties, which would likely increase the average amount of accounts receivable and thus decrease receivables turnover. Longer payment terms would likely increase the average amount of accounts receivable and thus decrease receivables turnover.

If a particular accounting choice is considered aggressive in nature, then the financial performance for the reporting period would most likely: A be neutral. B exhibit an upward bias. C exhibit a downward bias.

B is correct. Aggressive accounting choices aim to enhance the company's reported performance by inflating the amount of revenues, earnings, and/or operating cash flow reported in the period. Consequently, the financial performance for that period would most likely exhibit an upward bias.

When computing net cash flow from operating activities using the indirect method, an addition to net income is most likely to occur when there is a: A gain on the sale of an asset. B loss on the retirement of debt. C decrease in a deferred tax liability.

B is correct. An addition to net income is made when there is a loss on the retirement of debt, which is a non- operating loss. A gain on the sale of an asset and a decrease in deferred tax liability are both subtracted from net- income.

Which is an appropriate method of preparing a common- size cash flow statement? A Show each item of revenue and expense as a percentage of net revenue. B Show each line item on the cash flow statement as a percentage of net revenue. C Show each line item on the cash flow statement as a percentage of total cash outflows

B is correct. An appropriate method to prepare a common- size cash flow statement is to show each line item on the cash flow statement as a percentage of net revenue. An alternative way to prepare a statement of cash flows is to show each item of cash inflow as a percentage of total inflows and each item of cash outflows as a percentage of total outflows

Which of the following best describes reporting and disclosure requirements for a company that enters into an operating lease as the lessee? The operating lease obligation is: A reported as a receivable on the balance sheet. B disclosed in notes to the financial statements. C reported as a component of debt on the balance sheet.

B is correct. An operating lease is economically similar to renting an asset. A company that enters into an operating lease as a lessee reports a lease expense on its income statement during the period it uses the asset and reports no asset or liability on its balance sheet. The operating lease is disclosed in notes to the financial statements.

Compared to using a finance lease, a lessee that makes use of an operating lease will most likely report higher: A debt. B rent expense. C cash flow from operating activity.

B is correct. An operating lease is not recorded on the balance sheet (debt is lower), and lease payments are entirely categorised as rent (interest expense is lower.) Because the rent expense is an operating outflow but principal repayments are financing cash flows, the operating lease will result in lower cash flow from operating activity.

A company acquires a patent with an expiration date in six years for ¥100 million. The company assumes that the patent will generate economic benefits that will decline over time and decides to amortize the patent using the double declining balance method. The annual amortization expense in Year 4 is closest to: A ¥6.6 million. B ¥9.9 million. C ¥19.8 million.

B is correct. As shown in the following calculations, under the double-declining balance method, the annual amortization expense in Year 4 is closest to ¥9.9 million. Annual amortization expense = 2 . Straight-line amortization rate . Net book value. Amortization expense Year 4 = 33.3% . ¥29.6 million = ¥9.9 million.

Resources controlled by a company as a result of past events are: A equity. B assets. C liabilities.

B is correct. Assets are resources controlled by a company as a result of past events.

Which attribute of financial reports would most likely be evaluated as optimal in the financial reporting spectrum? A Conservative accounting choices B Sustainable and adequate returns C Emphasized pro forma earnings measures

B is correct. At the top of the quality spectrum of financial reports are reports that conform to GAAP, are decision useful, and have earnings that are sustainable and offer adequate returns. In other words, these reports have both high financial reporting quality and high earnings quality.

The information provided by a balance sheet item is limited because of uncertainty regarding: A measurement of its cost or value with reliability. B the change in current value following the end of the reporting period. C the probability that any future economic benefit will flow to or from the entity.

B is correct. Balance sheet information is as of a specific point in time, and items measured at current value reflect the value that was current at the end of the reporting period. For all financial statement items, an item should be recognized in the financial statements only if it is probable that any future economic benefit associated with the item will flow to or from the entity and if the item has a cost or value that can be measured with reliability.

Bias in revenue recognition would least likely be suspected if: A the firm engages in barter transactions. B reported revenue is higher than the previous quarter. C revenue is recognized before goods are shipped to customers.

B is correct. Bias in revenue recognition can lead to manipulation of information presented in financial reports. Addressing the question as to whether revenue is higher or lower than the previous period is not sufficient to determine if there is bias in revenue recognition. Additional analytical procedures must be performed to identify warning signals of accounting malfeasance. Barter transactions are difficult to value properly and may result in bias in revenue recognition. Policies that make it easier to prematurely recognize revenue, such as before goods are shipped to customers, may be a warning sign of accounting malfeasance.

Company A adheres to US GAAP and Company B adheres to IFRS. Which of the following is most likely to be disclosed on the financial statements of both companies? A Any material income resulting from the liquidation of LIFO inventory B The amount of inventories recognized as an expense during the period C The circumstances that led to the reversal of a write down of inventories

B is correct. Both US GAAP and IFRS require disclosure of the amount of inventories recognized as an expense during the period. Only US GAAP allows the LIFO method and requires disclosure of any material amount of income resulting from the liquidation of LIFO inventory. US GAAP does not permit the reversal of prior- year inventory write downs.

NEXT SEVERAL QUESTIONS ASSUME THE COMPANIES USA A PERIODIC INVENTORY SYSTEM Cinnamon Corp. started business in 2017 and uses the weighted average cost method. During 2017, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2018, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2018 cost of sales (€ thousands) was closest to: A €490. B €491. C €495.

B is correct. Cinnamon uses the weighted average cost method, so in 2018, 5,000 units of inventory were 2017 units at €10 each and 50,000 were 2008 purchases at €11. The weighted average cost of inventory during 2008 was thus (5,000 . 10) + (50,000 . 11) = 50,000 + 550,000 = €600,000, and the weighted average cost was approximately €10.91 = €600,000/55,000. Cost of sales was €10.91 . 45,000, which is approximately €490,950.

Which statement is most accurate? A common size income statement: A restates each line item of the income statement as a percentage of net income. B allows an analyst to conduct cross- sectional analysis by removing the effect of company size. C standardizes each line item of the income statement but fails to help an analyst identify differences in companies' strategies.

B is correct. Common size income statements facilitate comparison across time periods (time- series analysis) and across companies (cross- sectional analysis) by stating each line item of the income statement as a percentage of revenue. The relative performance of different companies can be more easily assessed because scaling the numbers removes the effect of size. A common size income statement states each line item on the income statement as a percentage of revenue. The standardization of each line item makes a common size income statement useful for identifying differences in companies' strategies.

Which of the following would an analyst most likely be able to determine from a common- size analysis of a company's balance sheet over several periods? A An increase or decrease in sales. B An increase or decrease in financial leverage. C A more efficient or less efficient use of assets.

B is correct. Common- size analysis (as presented in the reading) provides information about composition of the balance sheet and changes over time. As a result, it can provide information about an increase or decrease in a company's financial leverage.

When earnings are increased by deferring research and development (R&D) investments until the next reporting period, this choice is considered: A non- compliant accounting. B earnings management as a result of a real action. C earnings management as a result of an accounting choice.

B is correct. Deferring research and development (R&D) investments into the next reporting period is an example of earnings management by taking a real action.

During periods of rising inventory unit costs, a company using the FIFO method rather than the LIFO method will report a lower: A current ratio. B inventory turnover. C gross profit margin.

B is correct. During a period of rising inventory costs, a company using the FIFO method will allocate a lower amount to cost of goods sold and a higher amount to ending inventory as compared with the LIFO method. The inventory turnover ratio is the ratio of cost of sales to ending inventory. A company using the FIFO method will produce a lower inventory turnover ratio as compared with the LIFO method. The current ratio (current assets/current liabilities) and the gross profit margin [gross profit/sales = (sales less cost of goods sold)/sales] will be higher under the FIFO method than under the LIFO method in periods of rising inventory unit costs.

Compared with a company that uses the FIFO method, during a period of rising unit inventory costs, a company using the LIFO method will most likely appear more: A liquid. B efficient. C profitable

B is correct. During a period of rising inventory prices, a company using the LIFO method will have higher cost of cost of goods sold and lower inventory compared with a company using the FIFO method. The inventory turnover ratio will be higher for the company using the LIFO method, thus making it appear more efficient. Current assets and gross profit margin will be lower for the company using the LIFO method, thus making it appear less liquid and less profitable

Low quality earnings most likely reflect A low- quality financial reporting. B company activities which are unsustainable. C information that does not faithfully represent company activities.

B is correct. Earnings quality pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition. Low quality earnings are likely not sustainable over time because the company does not expect to generate the same level of earnings in the future or because earnings will not generate sufficient return on investment to sustain the company. Earnings that are not sustainable decrease company value. Earnings quality is distinguishable from financial reporting quality, which pertains to the quality of the information contained in financial reports.

In contrast to earnings quality, financial reporting quality most likely pertains to: A sustainable earnings. B relevant information. C adequate return on investment.

B is correct. Financial reporting quality pertains to the quality of information in financial reports. High- quality financial reporting provides decision-useful information, which is relevant and faithfully represents the economic reality of the company's activities. Earnings of high quality are sustainable and provide an adequate level of return. Highest- quality financial reports reflect both high financial reporting quality and high earnings quality.

To properly assess a company's past performance, an analyst requires: A high earnings quality. B high financial reporting quality. C both high earnings quality and high financial reporting quality.

B is correct. Financial reporting quality pertains to the quality of the information contained in financial reports. If financial reporting quality is low, the information provided is of little use in assessing the company's performance. Financial reporting quality is distinguishable from earnings quality, which pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition.

For financial assets classified as trading securities, how are unrealized gains and losses reflected in shareholders' equity? A They are not recognized. B They flow through income into retained earnings. C They are a component of accumulated other comprehensive income.

B is correct. For financial assets classified as trading securities, unrealized gains and losses are reported on the income statement and flow to shareholders' equity as part of retained earnings.

Which of the following is an appropriate method of computing free cash flow to the firm A Add operating cash flows to capital expenditures and deduct after- tax interest payments. B Add operating cash flows to after- tax interest payments and deduct capital expenditures. C Deduct both after- tax interest payments and capital expenditures from operating cash flows

B is correct. Free cash flow to the firm can be computed as operating cash flow plus after- tax interest expense less capital expenditures.

All of the following are current assets except: A cash. B goodwill. C inventories.

B is correct. Goodwill is a long- term asset, and the others are all current assets

A high- quality financial report may reflect A earnings smoothing. B low earnings quality. C understatement of asset impairment.

B is correct. High- quality financial reports offer useful information, meaning information that is relevant and faithfully represents actual performance. Although low earnings quality may not be desirable, if the reported earnings are representative of actual performance, they are consistent with high-quality financial reporting. Highest-quality financial reports reflect both high financial reporting quality and high earnings quality.

Valuing assets at the amount of cash or equivalents paid or the fair value of the consideration given to acquire them at the time of acquisition most closely describes which measurement of financial statement elements? A Current cost. B Historical cost. C Realizable value

B is correct. Historical cost is the consideration paid to acquire an asset.

According to IFRS, all of the following pieces of information about property, plant, and equipment must be disclosed in a company's financial statements and footnotes except for: A useful lives. B acquisition dates. C amount of disposals.

B is correct. IFRS do not require acquisition dates to be disclosed

A company redeems $1,000,000 face value bonds with a carrying value of $990,000. If the call price is 104 the company will: A reduce bonds payable by $1,000,000. B recognize a loss on the extinguishment of debt of $50,000. C recognize a gain on the extinguishment of debt of $10,000.

B is correct. If a company decides to redeem a bond before maturity, bonds payable is reduced by the carrying amount of the debt. The difference between the cash required to redeem the bonds and the carrying amount of the bonds is a gain or loss on the extinguishment of debt. Because the call price is 104 and the face value is $1,000,000, the redemption cost is 104% of $1,000,000 or $1,040,000. The company's loss on redemption would be $50,000 ($990,000 carrying amount of debt minus $1,040,000 cash paid to redeem the callable bonds).

If a company uses a non- GAAP financial measure in an SEC filing, then the company must: A give more prominence to the non- GAAP measure if it is used in earnings releases. B provide a reconciliation of the non- GAAP measure and equivalent GAAP measure. C exclude charges requiring cash settlement from any non- GAAP liquidity measures.

B is correct. If a company uses a non- GAAP financial measure in an SEC filing it is required to provide the most directly comparable GAAP measure with equivalent prominence in the filing. In addition, the company is required to provide a reconciliation between the non-GAAP measure and the equivalent GAAP measure. Similarly, IFRS require that any non- IFRS measures included in financial reports must be defined and their potential relevance explained. Th non- IFRS measures must be reconciled with IFRS measures.

A company wishing to increase earnings in the reporting period may choose to: A decrease the useful life of depreciable assets. B lower estimates of uncollectible accounts receivables. C classify a purchase as an expense rather than a capital expenditure.

B is correct. If a company wants to increase reported earnings, the company's managers may reduce the allowance for uncollected accounts and the related expense reported for the period. Decreasing the useful life of depreciable assets would increase depreciation expense and decrease earnings in the reporting period. Classifying a purchase as an expense, rather than capital expenditure, would decrease earnings in the reporting period. The use of accrual accounting may result in estimates in financial reports, because all facts associated with events may not be known at the time of recognition. These estimates can be grounded in reality or managed by the company to present a desired financial picture.

Analysts should treat deferred tax liabilities that are expected to reverse as: A equity. B liabilities. C neither liabilities nor equity.

B is correct. If the liability is expected to reverse (and thus require a cash tax payment) the deferred tax represents a future liability.

Which of the following would most likely signal that a company may be using aggressive accrual accounting policies to shift current expenses to later periods? Over the last five- year period, the ratio of cash flow to net income has: A increased each year. B decreased each year. C fluctuated from year to year.

B is correct. If the ratio of cash flow to net income for a company is consistently below 1 or has declined repeatedly over time, this may be a signal of manipulation of information in financial reports through aggressive accrual accounting policies. When net income is consistently higher than cash provided by operations, one possible explanation is that the company may be using aggressive accrual accounting policies to shift current expenses to later periods.

Like many technology companies, TechnoTools operates in an environment of declining prices. Its reported profits will tend to be highest if it accounts for inventory using the: A FIFO method. B LIFO method. C weighted average cost method.

B is correct. In a declining price environment, the newest inventory is the lowest- cost inventory. In such circumstances, using the LIFO method (selling the newer, cheaper inventory first) will result in lower cost of sales and higher profit

Compared to using the weighted average cost method to account for inventory, during a period in which prices are generally rising, the current ratio of a company using the FIFO method would most likely be: A lower. B higher. C dependent upon the interaction with accounts payable.

B is correct. In a rising price environment, inventory balances will be higher for the company using the FIFO method. Accounts payable are based on amounts due to suppliers, not the amounts accrued based on inventory accounting.

In a period of declining inventory unit costs and constant or increasing inventory quantities, which inventory method is most likely to result in a higher debt-to-equity ratio? A LIFO B FIFO C Weighted average cost

B is correct. In an environment of declining inventory unit costs and constant or increasing inventory quantities, FIFO (in comparison with weighted average cost or LIFO) will have higher cost of goods sold (and net income) and lower inventory. Because both inventory and net income are lower, total equity is lower, resulting in a higher debt- to- equity ratio.

A creditor most likely would consider a decrease in which of the following ratios to be positive news? A Interest coverage (times interest earned). B Debt- to- total assets. C Return on assets.

B is correct. In general, a creditor would consider a decrease in debt to total assets as positive news. A higher level of debt in a company's capital structure increases the risk of default and will, in general, result in higher borrowing costs for the company to compensate lenders for assuming greater credit risk. A decrease in either interest coverage or return on assets is likely to be considered negative news.

MARU S.A. de C.V., a Mexican corporation that follows IFRS, has elected to use the revaluation model for its property, plant, and equipment. One of MARU's machines was purchased for 2,500,000 Mexican pesos (MXN) at the beginning of the fiscal year ended 31 March 2010. As of 31 March 2010, the machine has a fair value of MXN 3,000,000. Should MARU show a profit for the revaluation of the machine? A Yes. B No, because this revaluation is recorded directly in equity. C No, because value increases resulting from revaluation can never be recognized as a profit

B is correct. In this case, the value increase brought about by the revaluation should be recorded directly in equity. The reason is that under IFRS, an increase in value brought about by a revaluation can only be recognized as a profit to the extent that it reverses a revaluation decrease of the same asset previously recognized in the income statement.

Mustard Seed PLC adheres to IFRS. It recently purchased inventory for €100 million and spent €5 million for storage prior to selling the goods. The amount it charged to inventory expense (€ millions) was closest to: A €95. B €100. C €105.

B is correct. Inventory expense includes costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. It does not include storage costs not required as part of production.

Which of the following characteristics is most likely to differentiate investment property from property, plant, and equipment? A It is tangible. B It earns rent. C It is long- lived.

B is correct. Investment property earns rent. Investment property and property, plant, and equipment are tangible and long- lived.

Compared to a company that uses the FIFO method, during periods of rising prices a company that uses the LIFO method will most likely appear more: A liquid. B efficient C profitable

B is correct. LIFO will result in lower inventory and higher cost of sales. Gross margin (a profitability ratio) will be lower, the current ratio (a liquidity ratio) will be lower, and inventory turnover (an efficiency ratio) will be higher

Which of the following concerns would most likely motivate a manager to make conservative accounting choices? A Attention to future career opportunities B Expected weakening in the business environment C Debt covenant violation risk in the current period

B is correct. Managers may be motivated to understate earnings in the reporting period and increase the probability of meeting or exceeding the next period's earnings target.

Which of the following situations represents a motivation, rather than an opportunity, to issue low- quality financial reports? A Poor internal controls B Search for a personal bonus C Inattentive board of directors

B is correct. Motivation can result from pressure to meet some criteria for personal reasons, such as a bonus, or corporate reasons, such as concern about future financing. Poor internal controls and an inattentive board of directors offer opportunities to issue low- quality financial reports.

Fairplay had the following information related to the sale of its products during 2009, which was its first year of business: Revenue $1,000,000 Returns of goods sold $100,000 Cash collected $800,000 Cost of goods sold $700,000 Under the accrual basis of accounting, how much net revenue would be reported on Fairplay's 2009 income statement? A $200,000. B $900,000. C $1,000,000.

B is correct. Net revenue is revenue for goods sold during the period less any returns and allowances, or $1,000,000 minus $100,000 = $900,000.

Zimt AG uses the FIFO method, and Nutmeg Inc. uses the LIFO method. Compared to the cost of replacing the inventory, during periods of rising prices the ending inventory balance reported by: A Zimt is too high. B Nutmeg is too low. C Nutmeg is too high.

B is correct. Nutmeg uses the LIFO method, and thus some of the inventory on the balance sheet was purchased at a (no longer available) lower price. Zimt uses the FIFO method, so the carrying value on the balance sheet represents the most recently purchased units and thus approximates the current replacement cost.

Which of the following is an off- balance- sheet financing technique? The use of: A capital leases. B operating leases. C the last in, first out inventory method.

B is correct. Operating leases can be used as an off- balance-sheet financing technique because neither the asset nor liability appears on the balance sheet. Inventory and capital leases are reported on the balance sheet.

The three major classifications of activities in a cash flow statement are: A inflows, outflows, and net flows B operating, investing, and financing C revenues, expenses, and net income.

B is correct. Operating, investing, and financing are the three major classifications of activities in a cash flow statement. Revenues, expenses, and net income are elements of the income statement. Inflows, outflows, and net flows are items of information in the statement of cash flows

Which of the following is most likely classified as a current liability? A Payment received for a product due to be delivered at least one year after the balance sheet date B Payments for merchandise due at least one year after the balance sheet date but still within a normal operating cycle C Payment on debt due in six months for which the company has the unconditional right to defer settlement for at least one year after the balance sheet date

B is correct. Payments due within one operating cycle of the business, even if they will be settled more than one year after the balance sheet date, are classified as current liabilities. Payment received in advance of the delivery of a good or service creates an obligation or liability. If the obligation is to be fulfilled at least one year after the balance sheet date, it is recorded as a non- current liability, such as deferred revenue or deferred income. Payments that the company has the unconditional right to defer for at least one year after the balance sheet may be classified as non- current liabilities.

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

The sale of a building for cash would be classified as what type of activity on the cash flow statement? A Operating. B Investing. C Financing.

B is correct. Purchases and sales of long- term assets are considered investing activities. Note that if the transaction had involved the exchange of a building for other than cash (for example, for another building, common stock of another company, or a long- term note receivable), it would have been considered a significant non- cash activity.

When a company buys shares of its own stock to be held in treasury, it records a reduction in: A both assets and liabilities. B both assets and shareholders' equity. C assets and an increase in shareholders' equity.

B is correct. Share repurchases reduce the company's cash (an asset). Shareholders' equity is reduced because there are fewer shares outstanding and treasury stock is an offset to owners' equity.

Compared to using the FIFO method to account for inventory, during periods of rising prices, a company using the LIFO method is most likely to report higher: A net income. B cost of sales. C income taxes.

B is correct. The LIFO method increases cost of sales, thus reducing profits and the taxes thereon.

For a bond issued at a premium, using the effective interest rate method, the: A carrying amount increases each year. B amortization of the premium increases each year. C premium is evenly amortized over the life of the bond.

B is correct. The amortization of the premium equals the interest payment minus the interest expense. The interest payment is constant and the interest expense decreases as the carrying amount decreases. As a result, the amortization of the premium increases each year.

On 1 January 2010, Elegant Fragrances Company issues £1,000,000 face value, five-year bonds with annual interest payments of £55,000 to be paid each 31 December. The market interest rate is 6.0 percent. Using the effective interest rate method of amortisation, Elegant Fragrances is most likely to record: A an interest expense of £55,000 on its 2010 income statement. B a liability of £982,674 on the 31 December 2010 balance sheet. C a £58,736 cash outflow from operating activity on the 2010 statement of cash flows

B is correct. The bonds will be issued at a discount because the market interest rate is higher than the stated rate. Discounting the future payments to their present value indicates that at the time of issue, the company will record £978,938 as both a liability and a cash inflow from financing activities. Interest expense in 2010 is £58,736 (£978,938 times 6.0 percent). During the year, the company will pay cash of £55,000 related to the interest payment, but interest expense on the income statement will also reflect £3,736 related to amortisation of the initial discount (£58,736 interest expense less the £55,000 interest payment). Thus, the value of the liability at 31 December 2010 will reflect the initial value (£978,938) plus the amortised discount (£3,736), for a total of £982,674. The cash outflow of £55,000 may be presented as either an operating or financing activity under IFRS.

Money received from customers for products to be delivered in the future is recorded as: A revenue and an asset. B an asset and a liability. C revenue and a liability.

B is correct. The cash received from customers represents an asset. The obligation to provide a product in the future is a liability called "unearned income" or "unearned revenue." As the product is delivered, revenue will be recognized and the liability will be reduced.

A company issues €1 million of bonds at face value. When the bonds are issued, the company will record a: A cash inflow from investing activities. B cash inflow from financing activities. C cash inflow from operating activities.

B is correct. The company receives €1 million in cash from investors at the time the bonds are issued, which is recorded as a financing activity.

Penben Corporation has a defined benefit pension plan. At 31 December, its pension obligation is €10 million and pension assets are €9 million. Under either IFRS or US GAAP, the reporting on the balance sheet would be closest to which of the following? A €10 million is shown as a liability, and €9 million appears as an asset. B €1 million is shown as a net pension obligation. C Pension assets and obligations are not required to be shown on the balance sheet but only disclosed in footnotes.

B is correct. The company will report a net pension obligation of €1 million equal to the pension obligation (€10 million) less the plan assets (€9 million).

A company incurs a capital expenditure that may be amortized over five years for accounting purposes, but over four years for tax purposes. The company will most likely record: A a deferred tax asset. B a deferred tax liability. C no deferred tax asset or liability.

B is correct. The difference is temporary, and the tax base will be lower (because of more rapid amortization) than the carrying value of the asset. The result will be a deferred tax liability.

At the time of issue of 4.50% coupon bonds, the effective interest rate was 5.00%. The bonds were most likely issued at: A par. B a discount. C a premium.

B is correct. The effective interest rate is greater than the coupon rate and the bonds will be issued at a discount.

Lesp Industries issues five- year bonds dated 1 January 2015 with a face value of $2,000, 000 and 3% coupon rate paid annually on 31 December. The market interest rate on bonds of comparable risk and term is 4%. The sales proceeds of the bonds are $1,910,964. Under the effective interest rate method, the interest expense in 2017 is closest to: A $77,096. B $77,780. C $77,807.

B is correct. The interest expense for a given year is equal to the carrying amount at the beginning of the year times the effective interest of 4%. Under the effective interest rate method, the difference between the interest expense and the interest payment (based on the coupon rate and face value) is the discount amortized in the period, which increases the carrying amount annually. For 2017, the interest expense is the beginning carrying amount ($1,944,499) times the effective interest of 4%.

Which inventory method is least likely to be used under IFRS? A First in, first out (FIFO). B Last in, first out (LIFO). C Weighted average.

B is correct. The last in, first out (LIFO) method is not permitted under IFRS. The other two methods are permitted.

Which of the following is most likely a lessee's disclosure about operating leases? A Lease liabilities. B Future obligations by maturity. C Net carrying amounts of leased assets.

B is correct. The lessee will disclose the future obligation by maturity of its operating leases. The future obligations by maturity, leased assets, and lease liabilities will all be shown for finance leases.

A firm issues a bond with a coupon rate of 5.00% when the market interest rate is 5.50% on bonds of comparable risk and terms. One year later, the market interest rate increases to 6.00%. Based on this information, the effective interest rate is: A 5.00%. B 5.50%. C 6.00%.

B is correct. The market interest rate at the time of issuance is the effective interest rate that the company incurs on the debt. The effective interest rate is the discount rate that equates the present value of the coupon payments and face value to their selling price. Consequently, the effective interest rate is 5.50%.

The non- controlling (minority) interest in consolidated subsidiaries is presented on the balance sheet: A as a long- term liability. B separately, but as a part of shareholders' equity. C as a mezzanine item between liabilities and shareholders' equity.

B is correct. The non- controlling interest in consolidated subsidiaries is shown separately as part of shareholders' equity.

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

Under which section of a manufacturing company's cash flow statement are the following activities reported? Item 1: Purchases of securities held for trading Item 2: Sales of securities considered cash equivalents A Both items are investing activities. B Both items are operating activities. C Only Item 1 is an investing activity.

B is correct. The purchase and sale of securities considered cash equivalents and securities held for trading are considered operating activities even for companies in which this activity is not a primary business activity.

When developing forecasts, analysts should most likely: A develop possibilities relying exclusively on the results of financial analysis. B use the results of financial analysis, analysis of other information, and judgment. C aim to develop extremely precise forecasts using the results of financial analysis.

B is correct. The results of an analyst's financial analysis are integral to the process of developing forecasts, along with the analysis of other information and judgment of the analysts. Forecasts are not limited to a single point estimate but should involve a range of possibilities.

Zimt AG presents its financial statements in accordance with US GAAP. In Year 3, Zimt discloses a valuation allowance of $1,101 against total deferred tax assets of $19,201. In Year 2, Zimt disclosed a valuation allowance of $1,325 against total deferred tax assets of $17,325. The change in the valuation allowance most likely indicates that Zimt's: A deferred tax liabilities were reduced in Year 3. B expectations of future earning power has increased. C expectations of future earning power has decreased.

B is correct. The valuation allowance is taken against deferred tax assets to represent uncertainty that future taxable income will be sufficient to fully utilize the assets. By decreasing the allowance, Zimt is signaling greater likelihood that future earnings will be offset by the deferred tax asset.

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

B is correct. These are components of management commentary

Under IFRS, an impairment loss on a property, plant, and equipment asset is measured as the excess of the carrying amount over the asset's: A fair value. B recoverable amount. C undiscounted expected future cash flows

B is correct. Under IFRS, an impairment loss is measured as the excess of the carrying amount over the asset's recoverable amount. The recoverable amount is the higher of the asset's fair value less costs to sell and its value in use. Value in use is a discounted measure of expected future cash flows. Under US GAAP, assessing recoverability is separate from measuring the impairment loss. If the asset's carrying amount exceeds its undiscounted expected future cash flows the asset's carrying amount is considered unrecoverable and the impairment loss is measured as the excess of the carrying amount over the asset's fair value.

Under IFRS, income includes increases in economic benefits from: A increases in liabilities not related to owners' contributions. B enhancements of assets not related to owners' contributions. C increases in owners' equity related to owners' contributions

B is correct. Under IFRS, income includes increases in economic benefits from increases in assets, enhancement of assets, and decreases in liabilities.

Eric's Used Book Store prepares its financial statements in accordance with IFRS. Inventory was purchased for £1 million and later marked down to £550,000. One of the books, however, was later discovered to be a rare collectible item, and the inventory is now worth an estimated £3 million. The inventory is most likely reported on the balance sheet at: A £550,000. B £1,000,000. C £3,000,000.

B is correct. Under IFRS, the reversal of write- downs is required if net realisable value increases. The inventory will be reported on the balance sheet at £1,000,000. The inventory is reported at the lower of cost or net realisable value. Under US GAAP, inventory is carried at the lower of cost or market value. After a write-down, a new cost basis is determined and additional revisions may only reduce the value further. The reversal of write- downs is not permitted.

Comte Industries issues $3,000,000 worth of three- year bonds dated 1 January 2015. The bonds pay interest of 5.5% annually on 31 December. The market interest rate on bonds of comparable risk and term is 5%. The sales proceeds of the bonds are $3,040,849. Under the straight- line method, the interest expense in the first year is closest to: A $150,000. B $151,384. C $152,042.

B is correct. Under the straight- line method, the bond premium is amortized equally over the life of the bond. The annual interest payment is $165,000 ($3,000,000 . 5.5%) and annual amortization of the premium under the straight-line method is $13,616 [($3,040,849 - $3,000,000)/3)]. The interest expense is the interest payment less the amortization of the premium ($165,000 - $13,616 = $151,384).

A company has total liabilities of £35 million and total stockholders' equity of £55 million. Total liabilities are represented on a vertical common-size balance sheet by a percentage closest to: A 35%. B 39%. C 64%.

B is correct. Vertical common-size analysis involves stating each balance sheet item as a percentage of total assets. Total assets are the sum of total liabilities (£35 million) and total stockholders' equity (£55 million), or £90 million. Total liabilities are shown on a vertical common-size balance sheet as (£35 million/£ 90 million) ≈ 39%.

When constructing an asset for sale, directly related borrowing costs are most likely: A expensed as incurred. B capitalized as part of inventory. C capitalized as part of property, plant, and equipment.

B is correct. When a company constructs an asset, borrowing costs incurred directly related to the construction are generally capitalized. If the asset is constructed for sale, the borrowing costs are classified as inventory.

For a lessor, the leased asset appears on the balance sheet and continues to be depreciated when the lease is classified as: A a sales- type lease. B an operating lease. C a financing lease.

B is correct. When a lease is classified as an operating lease, the underlying asset remains on the lessor's balance sheet. The lessor will record a depreciation expense that reduces the asset's value over time.

Describe how non-cash investing and financing activities are reported

Because no cash is involved in non-cash transactions (by definition), these transactions are not incorporated in the cash flow statement. However, because such transactions may affect a company's capital or asset structures, any significant non- cash transaction is required to be disclosed, either in a separate note or a supplementary schedule to the cash flow statement

For its fiscal year- end, Sublyme Corporation reported net income of $200 million and a weighted average of 50,000,000 common shares outstanding. There are 2,000,000 convertible preferred shares outstanding that paid an annual dividend of $5. Each preferred share is convertible into two shares of the common stock. The diluted EPS is closest to: A $3.52. B $3.65. C $3.70.

C is correct Diluted EPS = (Net income)/(Weighted average number of shares outstanding + New common shares that would have been issued at conversion) = $200,000,000/[50,000,000 + (2,000,000 x 2)] =$3.70 The diluted EPS assumes that the preferred dividend is not paid and that the shares are converted at the beginning of the period

A company is most likely to: A use a fair value model for some investment property and a cost model for other investment property. B change from the fair value model when transactions on comparable properties become less frequent. C change from the fair value model when the company transfers investment property to property, plant, and equipment.

C is correct. A company will change from the fair value model to either the cost model or revaluation model when the company transfers investment property to property, plant, and equipment.

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

C is correct. A company's revenues and expenses are presented on the income statement, which is used to evaluate a company's financial results (or profit ability) from business activities over a period of time. A company's 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.

An example of a contra asset account is: A depreciation expense. B sales returns and allowances. C allowance for doubtful accounts.

C is correct. A contra asset account is netted against (i.e., reduces) the balance of an asset account. The allowance for doubtful accounts reduces the balance of accounts receivable. Accumulated depreciation, not depreciation expense, is a contra asset account. Sales returns and allowances create a contra account that reduce sales, not an asset.

A core objective of the International Organization of Securities Commissions is to: A eliminate systemic risk. B protect users of financial statements. C ensure that markets are fair, efficient, and transparent.

C is correct. A core objective of IOSCO is to ensure that markets are fair, efficient, and transparent. The other core objectives are to reduce, not eliminate, systemic risk and to protect investors, not all users of financial statements.

The management of Bank EZ repurchases its own bonds in the open market. They pay €6.5 million for bonds with a face value of €10.0 million and a carrying value of €9.8 million. The bank will most likely report: A other comprehensive income of €3.3 million. B other comprehensive income of €3.5 million. C a gain of €3.3 million on the income statement.

C is correct. A gain of €3.3 million (carrying amount less amount paid) will be reported on the income statement.

Which of the following is most likely to reflect conservative accounting choices? A Decreased reported earnings in later periods B Increased reported earnings in the period under review C Increased debt reported on the balance sheet at the end of the current period

C is correct. Accounting choices are considered conservative if they decrease the company's reported performance and financial position in the period under review. Conservative choices may increase the amount of debt reported on the balance sheet. They may decrease the revenues, earnings, and/or operating cash flow reported for the period and increase those amounts in later periods.

When accounting standards require recognition of an expense that is not permitted under tax laws, the result is a: A deferred tax liability. B temporary difference C permanent difference

C is correct. Accounting items that are not deductible for tax purposes will not be reversed and thus result in permanent differences

Galambos Corporation had an average receivables collection period of 19 days in 2003. Galambos has stated that it wants to decrease its collection period in 2004 to match the industry average of 15 days. Credit sales in 2003 were $300 million, and analysts expect credit sales to increase to $400 million in 2004. To achieve the company's goal of decreasing the collection period, the change in the average accounts receivable balance from 2003 to 2004 that must occur is closest to: A -$420,000. B $420,000. C $836,000.

C is correct. Accounts receivable turnover is equal to 365/19 (collection period in days) = 19.2 for 2003 and needs to equal 365/15 = 24.3 in 2004 for Galambos to meet its goal. Sales/turnover equals the accounts receivable balance. For 2003, $300,000,000/19.2 = $15,625,000, and for 2004, $400,000,000/24.3 = $16,460,905. The difference of $835,905 is the increase in receivables needed for Galambos to achieve its goal.

Accrued expenses (accrued liabilities) are: A expenses that have been paid. B created when another liability is reduced. C expenses that have been reported on the income statement but not yet paid.

C is correct. Accrued liabilities are expenses that have been reported on a company's income statement but have not yet been paid.

A write down of the value of inventory to its net realizable value will have a positive effect on the: A balance sheet. B income statement. C inventory turnover ratio.

C is correct. Activity ratios (for example, inventory turnover and total asset turnover) will be positively affected by a write down to net realizable value because the asset base (denominator) is reduced. On the balance sheet, the inventory carrying amount is written down to its net realizable value and the loss in value (expense) is generally reflected on the income statement in cost of goods sold, thus reducing gross profit, operating profit, and net income.

Which of the following is an example of an affirmative debt covenant? The borrower is: A prohibited from entering into mergers. B prevented from issuing excessive additional debt. C required to perform regular maintenance on equipment pledged as collateral.

C is correct. Affirmative covenants require certain actions of the borrower. Requiring the company to perform regular maintenance on equipment pledged as collateral is an example of an affirmative covenant because it requires the company to do something. Negative covenants require that the borrower not take certain actions. Prohibiting the borrower from entering into mergers and preventing the borrower from issuing excessive additional debt are examples of negative covenants.

An audit opinion of a company's financial reports is most likely intended to: A detect fraud. B reveal misstatements. C assure that financial information is presented fairly.

C is correct. An audit is intended to provide assurance that the company's financial reports are presented fairly, thus providing discipline regarding financial reporting quality. Regulatory agencies usually require that the financial statements of publicly traded companies be audited by an independent auditor to provide assurance that the financial statements conform to accounting standards. Privately held companies may also choose to obtain audit opinions either voluntarily or because an outside party requires it. An audit is not typically intended to detect fraud. An audit is based on sampling and it is possible that the sample might not reveal misstatements.

Intangible assets with finite useful lives mostly differ from intangible assets with infinite useful lives with respect to accounting treatment of: A revaluation. B impairment. C amortization.

C is correct. An intangible asset with a finite useful life is amortized, whereas an intangible asset with an indefinite useful life is not.

The first step in cash flow statement analysis should be to: A evaluate consistency of cash flows B determine operating cash flow drivers. C identify the major sources and uses of cash.

C is correct. An overall assessment of the major sources and uses of cash should be the first step in evaluating a cash flow statement.

What type of audit opinion is preferred when analyzing financial statements? A Qualified B Adverse. C Unqualified

C is correct. 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.

Assuming no changes in other variables, which of the following would decrease ROA? A A decrease in the effective tax rate. B A decrease in interest expense. C An increase in average assets.

C is correct. Assuming no changes in other variables, an increase in average assets (an increase in the denominator) would decrease ROA. A decrease in either the effective tax rate or interest expense, assuming no changes in other variables, would increase ROA.

A company recently engaged in a non- cash transaction that significantly affected its property, plant, and equipment. The transaction is: A reported under the investing section of the cash flow statement. B reported differently in cash flow from operations under the direct and indirect methods. C disclosed as a separate note or in a supplementary schedule to the cash flow statement.

C is correct. Because no cash is involved in non- cash transactions, these transactions are not incorporated in the cash flow statement. However, non- cash transactions that significantly affect capital or asset structures are required to be disclosed either in a separate note or a supplementary schedule to the cash flow statement.

Using the straight- line method of depreciation for reporting purposes and accelerated depreciation for tax purposes would most likely result in a: A valuation allowance. B deferred tax asset. C temporary difference

C is correct. Because the differences between tax and financial accounting will correct over time, the resulting deferred tax liability, for which the expense was charged to the income statement but the tax authority has not yet been paid, will be a temporary difference. A valuation allowance would only arise if there was doubt over the company's ability to earn sufficient income in the future to require paying the tax.

White Flag, a women's clothing manufacturer, reported salaries expense of $20 million. The beginning balance of salaries payable was $3 million, and the ending balance of salaries payable was $1 million. How much cash did the company pay in salaries? A $18 million. B $21 million. C $22 million.

C is correct. Beginning salaries payable of $3 million plus salaries expense of $20 million minus ending salaries payable of $1 million equals $22 million. Alternatively, the expense of $20 million plus the $2 million decrease in salaries payable equals $22 million.

The most likely costs included in both the cost of inventory and property, plant, and equipment are: A selling costs. B storage costs. C delivery costs.

C is correct. Both the cost of inventory and property, plant, and equipment include delivery costs, or costs incurred in bringing them to the location for use or resale.

An example of an expense classification by function is: A tax expense. B interest expense. C cost of goods sold.

C is correct. Cost of goods sold is a classification by function. The other two expenses represent classifications by nature.

Green Glory Corp., a garden supply wholesaler, reported cost of goods sold for the year of $80 million. Total assets increased by $55 million, including an increase of $5 million in inventory. Total liabilities increased by $45 million, including an increase of $2 million in accounts payable. The cash paid by the company to its suppliers is most likely closest to: A $73 million. B $77 million. C $83 million.

C is correct. Cost of goods sold of $80 million plus the increase in inventory of $5 million equals purchases from suppliers of $85 million. The increase in accounts payable of $2 million means that the company paid $83 million in cash ($85 million minus $2 million) to its suppliers.

Debt covenants are least likely to place restrictions on the issuer's ability to: A pay dividends. B issue additional debt. C issue additional equity.

C is correct. Covenants protect debtholders from excessive risk taking, typically by limiting the issuer's ability to use cash or by limiting the overall levels of debt relative to income and equity. Issuing additional equity would increase the company's ability to meet its obligations, so debtholders would not restrict that ability.

Credit analysts are likely to consider which of the following in making a rating recommendation? A Business risk but not financial risk B Financial risk but not business risk C Both business risk and financial risk

C is correct. Credit analysts consider both business risk and financial risk.

Comparison of a company's financial results to other peer companies for the same time period is called: A technical analysis. B time- series analysis. C cross- sectional analysis.

C is correct. Cross- sectional analysis involves the comparison of companies with each other for the same time period. Technical analysis uses price and volume data as the basis for investment decisions. Time- series or trend analysis is the comparison of financial data across different time periods.

The information provided by a low- quality financial report will most likely: A decrease company value. B indicate earnings are not sustainable. C impede the assessment of earnings quality.

C is correct. Financial reporting quality pertains to the quality of the information contained in financial reports. High-quality financial reports provide decision-useful information that faithfully represents the economic reality of the company. Low-quality financial reports impede assessment of earnings quality. Financial reporting quality is distinguishable from earnings quality, which pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition. Low- quality earnings are not sustainable and decrease company value.

Which of the following is most likely not an objective of financial statements? A To provide information about the performance of an entity. B To provide information about the financial position of an entity. C To provide information about the users of an entity's financial statements.

C is correct. Financial statements provide information, including information about the entity's financial position, performance, and changes in financial position, to users. They do not typically provide information about users.

In a comprehensive financial analysis, financial statements should be: A used as reported without adjustment. B adjusted after completing ratio analysis. C adjusted for differences in accounting standards, such as international financial reporting standards and US generally accepted accounting principles.

C is correct. Financial statements should be adjusted for differences in accounting standards (as well as accounting and operating choices). These adjustments should be made prior to common- size and ratio analysis.

Projecting profit margins into the future on the basis of past results would be most reliable when the company: A is in the commodities business. B operates in a single business segment. C is a large, diversified company operating in mature industries.

C is correct. For a large, diversified company, margin changes in different business segments may offset each other. Furthermore, margins are most likely to be stable in mature industries.

For financial assets classified as available for sale, how are unrealized gains and losses reflected in shareholders' equity? A They are not recognized. B They flow through retained earnings. C They are a component of accumulated other comprehensive income.

C is correct. For financial assets classified as available for sale, unrealized gains and losses are not recorded on the income statement and instead are part of other comprehensive income. Accumulated other comprehensive income is a component of Shareholders' equity

Denali Limited, a manufacturing company, had the following income statement information: Revenue $4,000,000 Cost of goods sold $3,000,000 Other operating expenses $500,000 Interest expense $100,000 Tax expense $120,000 Denali's gross profit is equal to: A $280,000. B $500,000. C $1,000,000.

C is correct. Gross margin is revenue minus cost of goods sold. Answer A represents net income and B represents operating income.

Income tax expense reported on a company's income statement equals taxes payable, plus the net increase in: A deferred tax assets and deferred tax liabilities. B deferred tax assets, less the net increase in deferred tax liabilities. C deferred tax liabilities, less the net increase in deferred tax assets.

C is correct. Higher reported tax expense relative to taxes paid will increase the deferred tax liability, whereas lower reported tax expense relative to taxes paid increases the deferred tax asset.

Expenses on the income statement may be grouped by: A nature, but not by function. B function, but not by nature. C either function or nature.

C is correct. IAS No. 1 states that expenses may be categorized by either nature or function.

Juan Martinez, CFO of VIRMIN, S.A., is selecting the depreciation method to use for a new machine. The machine has an expected useful life of six years. Production is expected to be relatively low initially but to increase over time. The method chosen for tax reporting must be the same as the method used for financial reporting. If Martinez wants to minimize tax payments in the first year of the machine's life, which of the following depreciation methods is Martinez most likely to use? A Straight- line method. B Units- of- production method. C Double- declining balance method.

C is correct. If Martinez wants to minimize tax payments in the first year of the machine's life, he should use an accelerated method, such as the double declining balance method.

A company chooses to change an accounting policy. This change requires that, if practical, the company restate its financial statements for: A all prior periods. B current and future periods. C prior periods shown in a report.

C is correct. If a company changes an accounting policy, the financial statements for all fiscal years shown in a company's financial report are presented, if practical, as if the newly adopted accounting policy had been used throughout the entire period; this retrospective application of the change makes the financial results of any prior years included in the report comparable. Notes to the financial statements describe the change and explain the justification for the change.

Which of the following is an indication that a company may be recognizing revenue prematurely? Relative to its competitors, the company's: A asset turnover is decreasing. B receivables turnover is increasing. C days sales outstanding is increasing.

C is correct. If a company's days sales outstanding (DSO) is increasing relative to competitors, this may be a signal that revenues are being recorded prematurely or are even fictitious. There are numerous analytical procedures that can be performed to provide evidence of manipulation of information in financial reporting. These warning signs are often linked to bias associated with revenue recognition and expense recognition policies.

Under US GAAP, which of the following would require the lessee to classify a lease as a capital lease? A The term is 60% of the useful life of the asset. B The lease contains an option to purchase the asset at fair value. C The present value of the lease payments is 95% of the fair value.

C is correct. If the present value of the lease payments is greater than 90% of the fair value of the asset, the lease is considered a capital lease. A lease with a term that is 75% or more of the useful life of the asset is deemed to be a capital lease. The option to purchase the asset must be deemed to be cheap (bargain purchase option), not just include the option to purchase the asset.

Defining total asset turnover as revenue divided by average total assets, all else equal, impairment write- downs of long- lived assets owned by a company will most likely result in an increase for that company in: A the debt- to- equity ratio but not the total asset turnover. B the total asset turnover but not the debt- to- equity ratio. C both the debt- to- equity ratio and the total asset turnover.

C is correct. Impairment write- downs reduce equity in the denominator of the debt-to-equity ratio but do not affect debt, so the debt- to- equity ratio is expected to increase. Impairment write- downs reduce total assets but do not affect revenue. Thus, total asset turnover is expected to increase.

A company is experiencing a period of strong financial performance. In order to increase the likelihood of exceeding analysts' earnings forecasts in the next reporting period, the company would most likely undertake accounting choices for the period under review that: A inflate reported revenue. B delay expense recognition. C accelerate expense recognition.

C is correct. In a period of strong financial performance, managers may pursue accounting choices that increase the probability of exceeding earnings forecasts for the next period. By accelerating expense recognition or delaying revenue recognition, managers may inflate earnings in the next period and increase the likelihood of exceeding targets.

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 is correct. 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.

Interest paid is classified as an operating cash flow under: A US GAAP but may be classified as either operating or investing cash flow under IFRS. B IFRS but may be classified as either operating or investing cash flows under US GAAP. C US GAAP but may be classified as either operating or financing cash flow under IFRS.

C is correct. Interest expense is always classified as an operating cash flow under US GAAP but may be classified as either an operating or financing cash flow under IFRS.

Golden Cumulus Corp., a commodities trading company, reported interest expense of $19 million and taxes of $6 million. Interest payable increased by $3 million, and taxes payable decreased by $4 million over the period. How much cash did the company pay for interest and taxes? A $22 million for interest and $10 million for taxes. B $16 million for interest and $2 million for taxes. C $16 million for interest and $10 million for taxes.

C is correct. Interest expense of $19 million less the increase in interest payable of $3 million equals interest paid of $16 million. Tax expense of $6 million plus the decrease in taxes payable of $4 million equals taxes paid of $10 million.

A conversion of a face value $1 million convertible bond for $1 million of common stock would most likely be: A reported as a $1 million investing cash inflow and outflow B reported as a $1 million financing cash outflow and inflow C reported as supplementary information to the cash flow statement.

C is correct. Non- cash transactions, if significant, are reported as supplementary information, not in the investing or financing sections of the cash flow statement.

Black Ice, a fictitious sportswear manufacturer, reported other operating expenses of $30 million. Prepaid insurance expense increased by $4 million, and accrued utilities payable decreased by $7 million. Insurance and utilities are the only two components of other operating expenses. How much cash did the company pay in other operating expenses? A $19 million. B $33 million. C $41 million

C is correct. Other operating expenses of $30 million plus the increase in prepaid insurance expense of $4 million plus the decrease in accrued utilities payable of $7 million equals $41 million.

When a company pays its rent in advance, its balance sheet will reflect a reduction in: A assets and liabilities. B assets and shareholders' equity. C one category of assets and an increase in another.

C is correct. Paying rent in advance will reduce cash and increase prepaid expenses, both of which are assets.

Which of the following is an example of a financing activity on the cash flow statement under US GAAP? A Payment of interest. B Receipt of dividends. C Payment of dividends.

C is correct. Payment of dividends is a financing activity under US GAAP. Payment of interest and receipt of dividends are included in operating cash flows under US GAAP. Note that IFRS allow companies to include receipt of interest and dividends as either operating or investing cash flows and to include payment of interest and dividends as either operating or financing cash flows

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

Blue Bayou, a fictitious advertising company, reported revenues of $50 million, total expenses of $35 million, and net income of $15 million in the most recent year. If accounts receivable decreased by $12 million, how much cash did the company receive from customers? A $38 million. B $50 million. C $62 million

C is correct. Revenues of $50 million plus the decrease in accounts receivable of $12 million equals $62 million cash received from customers. The decrease in accounts receivable means that the company received more in cash than the amount of revenue it reported.

In order to assess a company's ability to fulfill its long- term obligations, an analyst would most likely examine: A activity ratios. B liquidity ratios. C solvency ratios.

C is correct. Solvency ratios are used to evaluate the ability of a company to meet its long- term obligations. An analyst is more likely to use activity ratios to evaluate how efficiently a company uses its assets. An analyst is more likely to use liquidity ratios to evaluate the ability of a company to meet its short- term obligations.

When a database eliminates companies that cease to exist because of a merger or bankruptcy, this can result in: A look- ahead bias. B back- testing bias. C survivorship bias.

C is correct. Survivorship bias exists when companies that merge or go bankrupt are dropped from the database and only surviving companies remain. Look- ahead bias involves using updated financial information in back-testing that would not have been available at the time the decision was made. Back testing involves testing models in prior periods and is not, itself, a bias.

To compute tangible book value, an analyst would: A add goodwill to stockholders' equity. B add all intangible assets to stockholders' equity. C subtract all intangible assets from stockholders' equity.

C is correct. Tangible book value removes all intangible assets, including goodwill, from the balance sheet.

When certain expenditures result in tax credits that directly reduce taxes, the company will most likely record: A a deferred tax asset. B a deferred tax liability. C no deferred tax asset or liability.

C is correct. Tax credits that directly reduce taxes are a permanent difference and permanent differences do not give rise to deferred tax.

Cash flows from taxes on income must be separately disclosed under: A IFRS only. B US GAAP only. C both IFRS and US GAAP

C is correct. Taxes on income are required to be separately disclosed under IFRS and US GAAP. The disclosure may be in the cash flow statement or elsewhere.

The assumption that an entity will continue to operate for the foreseeable future is called: A accrual basis. B comparability. C going concern.

C is correct. The Conceptual Framework identifies two important underlying assumptions of financial statements: accrual basis and going concern. Going concern is the assumption that the entity will continue to operate for the foreseeable future. Enterprises with the intent to liquidate or materially curtail operations would require different information for a fair presentation.

Mabel Corporation (MC) reported accounts receivable of $66 million at the end of its second fiscal quarter. MC had revenues of $72 million for its third fiscal quarter and reported accounts receivable of $55 million at the end of its third fiscal quarter. Based on this information, the amount of cash MC collected from customers during the third fiscal quarter is: A $61 million. B $72 million. C $83 million.

C is correct. The amount of cash collected from customers during the quarter is equal to beginning accounts receivable plus revenues minus ending accounts receivable: $66 million + $72 million - $55 million = $83 million. A reduction in accounts receivable indicates that cash collected during the quarter was greater than revenue on an accrual basis.

The valuation technique under which assets are recorded at the amount that would be received in an orderly disposal is: A current cost. B present value. C realizable value.

C is correct. The amount that would be received in an orderly disposal is realizable value.

The impairment of intangible assets with finite lives affects A the balance sheet but not the income statement. B the income statement but not the balance sheet. C both the balance sheet and the income statement.

C is correct. The carrying amount of the asset on the balance sheet is reduced by the amount of the impairment loss, and the impairment loss is reported on the income statement.

An analyst observes a decrease in a company's inventory turnover. Which of the following would most likely explain this trend? A The company installed a new inventory management system, allowing more efficient inventory management. B Due to problems with obsolescent inventory last year, the company wrote off a large amount of its inventory at the beginning of the period. C The company installed a new inventory management system but experienced some operational difficulties resulting in duplicate orders being placed with suppliers.

C is correct. The company's problems with its inventory management system causing duplicate orders would likely result in a higher amount of inventory and would, therefore, result in a decrease in inventory turnover. A more efficient inventory management system and a write off of inventory at the beginning of the period would both likely decrease the average inventory for the period (the denominator of the inventory turnover ratio), thus increasing the ratio rather than decreasing it.

Cavalier Copper Mines has $840 million in total liabilities and $520 million in shareholders' equity. It discloses operating lease commitments over the next five years with a present value of $100 million. If the lease commitments are treated as debt, the debt- to- total- capital ratio is closest to: A 0.58. B 0.62. C 0.64.

C is correct. The current debt- to- total- capital ratio is $840/($840 + $520) = 0.62. To adjust for the lease commitments, an analyst should add $100 to both the numerator and denominator: $940/($940 + $520) = 0.64.

An investor worried about a company's long-term solvency would most likely examine its: A current ratio. B return on equity. C debt-to-equity ratio.

C is correct. The debt- to- equity ratio, a solvency ratio, is an indicator of financial risk.

When both the timing and amount of tax payments are uncertain, analysts should treat deferred tax liabilities as: A equity. B liabilities. C neither liabilities nor equity.

C is correct. The deferred tax liability should be excluded from both debt and equity when both the amounts and timing of tax payments resulting from the reversals of temporary differences are uncertain.

Which of the following ratios would be most useful in determining a company's ability to cover its lease and interest payments? A ROA. B Total asset turnover. C Fixed charge coverage.

C is correct. The fixed charge coverage ratio is a coverage ratio that relates known fixed charges or obligations to a measure of operating profit or cash flow generated by the company. Coverage ratios, a category of solvency ratios, measure the ability of a company to cover its payments related to debt and leases.

The item "retained earnings" is a component of: A assets. B liabilities. C shareholders' equity.

C is correct. The item "retained earnings" is a component of shareholders' equity.

Regarding a company's debt obligations, which of the following is most likely presented on the balance sheet? A Effective interest rate B Maturity dates for debt obligations C The portion of long- term debt due in the next 12 months

C is correct. The non- current liabilities section of the balance sheet usually includes a single line item of the total amount of a company's long- term debt due after 1 year, and the current liabilities section shows the portion of a company's long- term debt due in the next 12 months. Notes to the financial statements generally present the stated and effective interest rates and maturity dates for a company's debt obligations

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

A company purchases a piece of equipment for €1,500. The equipment is expected to have a useful life of five years and no residual value. In the first year of use, the units of production are expected to be 15% of the equipment's lifetime production capacity and the equipment is expected to generate €1,500 of revenue and incur €500 of cash expenses. The depreciation method yielding the lowest operating profit on the equipment in the first year of use is: A straight line. B units of production. C double- declining balance.

C is correct. The operating income or earnings before interest and taxes will be lowest for the method that results in the highest depreciation expense. The double-declining balance method results in the highest depreciation expense in the first year of use. Depreciation expense: Straight line = €1,500/5 = €300. Double-declining balance = €1,500 * 0.40 = €600. Units of production = €1,500 * 0.15 = €225.

To better evaluate the solvency of a company, an analyst would most likely add to total liabilities: A the present value of future capital lease payments. B the total amount of future operating lease payments. C the present value of future operating lease payments.

C is correct. The present value of future operating lease payments would be added to total assets and total liabilities.

A benefit of using the direct method rather than the indirect method when reporting operating cash flows is that the direct method: A mirrors a forecasting approach. B is easier and less costly. C provides specific information on the sources of operating cash flows

C is correct. The primary argument in favor of the direct method is that it provides information on the specific sources of operating cash receipts and payments. Arguments for the indirect method include that it mirrors a forecasting approach and it is easier and less costly

Cinnamon, Inc. recorded a total deferred tax asset in Year 3 of $12,301, offset by a $12,301 valuation allowance. Cinnamon most likely: A fully utilized the deferred tax asset in Year 3. B has an equal amount of deferred tax assets and deferred tax liabilities. C expects not to earn any taxable income before the deferred tax asset expires.

C is correct. The valuation allowance is taken when the company will "more likely than not" fail to earn sufficient income to offset the deferred tax asset. Because the valuation allowance equals the asset, by extension the company expects no taxable income prior to the expiration of the deferred tax assets.

For 2009, Flamingo Products had net income of $1,000,000. At 1 January 2009, there were 1,000,000 shares outstanding. On 1 July 2009, the company issued 100,000 new shares for $20 per share. The company paid $200,000 in dividends to common shareholders. What is Flamingo's basic earnings per share for 2009? A $0.80. B $0.91. C $0.95.

C is correct. The weighted average number of shares outstanding for 2009 is 1,050,000. Basic earnings per share would be $1,000,000 divided by 1,050,000, or $0.95.

Zimt AG wrote down the value of its inventory in 2017 and reversed the write down in 2018. Compared to the ratios that would have been calculated if the write- down had never occurred, Zimt's reported 2017: A current ratio was too high. B gross margin was too high. C inventory turnover was too high.

C is correct. The write- down reduced the value of inventory and increased cost of sales in 2017. The higher numerator and lower denominator mean that the inventory turnover ratio as reported was too high. Gross margin and the current ratio were both too low.

Which combination of depreciation methods and useful lives is most conservative in the year a depreciable asset is acquired? A Straight- line depreciation with a short useful life. B Declining balance depreciation with a long useful life. C Declining balance depreciation with a short useful life.

C is correct. This would result in the highest amount of depreciation in the firs year and hence the lowest amount of net income relative to the other choices.

An analyst reviewing a firm with a large reported restructuring charge to earnings should: A view expenses reported in prior years as overstated. B disregard it because it is solely related to past events. C consider making pro forma adjustments to prior years' earnings.

C is correct. To extrapolate historical earnings trends, an analyst should consider making pro forma analytical adjustments of prior years' earnings to reflect in those prior years a reasonable share of the current period's restructuring and impairment charges.

Inventory cost is least likely to include: A production- related storage costs. B costs incurred as a result of normal waste of materials. C transportation costs of shipping inventory to customers.

C is correct. Transportation costs incurred to ship inventory to customers are an expense and may not be capitalized in inventory. (Transportation costs incurred to bring inventory to the business location can be capitalized in inventory.) Storage costs required as part of production, as well as costs incurred as a result of normal waste of materials, can be capitalized in inventory. (Costs incurred as a result of abnormal waste must be expensed.)

Which of the following conditions best explains why a company's manager would obtain legal, accounting, and board level approval prior to issuing low quality financial reports? A Motivation B Opportunity C Rationalization

C is correct. Typically, conditions of opportunity, motivation, and rationalization exist when individuals issue low- quality financial reports. Rationalization occurs when an individual is concerned about a choice and needs to be able to justify it to herself or himself. If the manager is concerned about a choice in a financial report, she or he may ask for other opinions to convince herself or himself that it is okay.

The carrying value of inventories reflects A their historical cost. B their current value. C the lower of historical cost or net realizable value.

C is correct. Under IFRS, inventories are carried at historical cost, unless net realizable value of the inventory is less. Under US GAAP, inventories are carried at the lower of cost or market.

Which of the following is a required financial statement disclosure for long lived intangible assets under US GAAP? A The useful lives of assets B The reversal of impairment losses C Estimated amortization expense for the next five fiscal years

C is correct. Under US GAAP, companies are required to disclose the estimated amortization expense for the next five fiscal years. Under US GAAP, there is no reversal of impairment losses. Disclosure of the useful lives—finite or indefinite and additional related details—is required under IFRS.

Under US GAAP, when assets are acquired in a business combination, goodwill most likely arises from: A contractual or legal rights. B assets that can be separated from the acquired company. C assets that are neither tangible nor identifiable intangible assets.

C is correct. Under both International Financial Reporting Standards (IFRS) and US GAAP, if an item is acquired in a business combination and cannot be recognized as a tangible asset or identifiable intangible asset, it is recognized as goodwill. Under US GAAP, assets arising from contractual or legal rights and assets that can be separated from the acquired company are recognized separately from goodwill.

A company previously expensed the incremental costs of obtaining a contract. All else being equal, adopting the May 2014 IASB and FASB converged accounting standards on revenue recognition makes the company's profitability initially appear: A lower. B unchanged. C higher.

C is correct. Under the converged accounting standards, the incremental costs of obtaining a contract and certain costs incurred to fulfill a contract must be capitalized. If a company expensed these incremental costs in the years prior to adopting the converged standards, all else being equal, its profitability will appear higher under the converged standards.

If a company uses the fair value model to value investment property, changes in the fair value of the asset are least likely to affect A net income. B net operating income. C other comprehensive income.

C is correct. When a company uses the fair value model to value investment property, changes in the fair value of the property are reported in the income statement—not in other comprehensive income.

Which costs incurred with the purchase of property and equipment are expensed? A Delivery charges B Installation and testing C Training required to use the property and equipment

C is correct. When property and equipment are purchased, the assets are recorded on the balance sheet at cost. Costs for the assets include all expenditures required to prepare the assets for their intended use. Any other costs are expensed. Costs to train staff for using the machine are not required to prepare the property and equipment for their intended use, and these costs are expensed.

Zimt AG started business in 2017 and uses the FIFO method. During 2017, it purchased 45,000 units of inventory at €10 each and sold 40,000 units for €20 each. In 2018, it purchased another 50,000 units at €11 each and sold 45,000 units for €22 each. Its 2018 ending inventory balance (€ thousands) was closest to: A €105. B €109. C €110.

C is correct. Zimt uses the FIFO method, and thus the first 5,000 units sold in 2018 depleted the 2017 inventory. Of the inventory purchased in 2018, 40,000 units were sold and 10,000 remain, valued at €11 each, for a total of €110,000.

Contrast cash flow statements prepared under International Financial Reporting Standards (IFRS) and US generally accepted accounting principles (US GAAP);

Cash flow statements under IFRS and US GAAP are similar; however, IFRS provide companies with more choices in classifying some cash flow items as operating, investing, or financing activities.

Common-Size Analysis

Common- size analysis involves expressing financial data, including entire financial statements, in relation to a single financial statement item, or base. Items used most frequently as the bases are total assets or revenue. In essence, common- size analysis creates a ratio between every financial statement item and the base item. A vertical common- size income statement divides each income statement item by revenue, or sometimes by total assets (especially in the case of financial institutions). A horizontal common- size balance sheet, prepared by computing the increase or decrease in percentage terms of each balance sheet item from the prior year or prepared by dividing the quantity of each item by a base year quantity of the item, highlights changes in items

Distinguish between the direct and indirect methods of presenting cash from operating activities and describe arguments in favor of each method;

Companies can use either the direct or the indirect method for reporting their operating cash flow The direct method discloses operating cash inflows by source (e.g., cash received from customers, cash received from investment income) and operating cash outflows by use (e.g., cash paid to suppliers, cash paid for interest) in the operating activities section of the cash flow statement The indirect method reconciles net income to operating cash flow by adjusting net income for all non- cash items and the net changes in the operating working capital accounts. Indirect method is most commonly used by companies The primary argument in favor of the direct method is that it provides information on the specific sources of operating cash receipts and payments. This is in contrast to the indirect method, which shows only the net result of these receipts and payments. Just as information on the specific sources of revenues and expenses is more useful than knowing only the net result—net income—the analyst gets additional information from a direct- format cash flow statement

Describe conditions that are conducive to issuing low-quality, or even fraudulent, financial reports

Conditions that are conducive to the issuance of low-quality financial reports include a cultural environment that result in fewer or less transparent financial disclosures, book/tax conformity that shifts emphasis toward legal compliance and away from fair presentation, and limited capital markets regulation.

Cross-Sectional Analysis

Cross- sectional analysis (sometimes called "relative analysis") compares a specific metric for one company with the same metric for another company or group of companies, allowing comparisons even though the companies might be of significantly different sizes and/or operate in different currencies

Describe the differences between accounting profit and taxable income and define key terms, including deferred tax assets, deferred tax liabilities, valuation allowance, taxes payable, and income tax expense

Differences between the recognition of revenue and expenses for tax and accounting purposes may result in taxable income differing from accounting profit. The discrepancy is a result of different treatments of certain income and expenditure items. Deferred tax assets, which appear on the balance sheet, arise when an excess amount is paid for income taxes (taxable income higher than accounting profit) and the company expects to recover the difference during the course of future operations Deferred tax liabilities, which also appear on the balance sheet, arise when a deficit amount is paid for income taxes and the company expects to eliminate the deficit over the course of future operations Valuation allowance, which is a reserve created against deferred tax assets. The valuation allowance is based on the likelihood of realizing the deferred tax assets in future accounting periods A company's taxable income is the basis for its income tax payable (a liability) or recoverable (an asset), which is calculated on the basis of the company's tax rate and appears on its balance sheet A company's tax expense, or tax benefit in the case of a recovery, appears on its income statement and is an aggregate of its income tax payable (or recoverable in the case of a tax benefit) and any changes in deferred tax assets and liabilities.

Describe the financial statement presentation of and disclosures relating to inventories

Disclosures are useful when analyzing a company. IFRS require the following financial statement disclosures concerning inventory: a the accounting policies adopted in measuring inventories, including the cost formula (inventory valuation method) used; b the total carrying amount of inventories and the carrying amount in classifications (for example, merchandise, raw materials, production supplies, work in progress, and finished goods) appropriate to the entity; c the carrying amount of inventories carried at fair value less costs to sell; d the amount of inventories recognised as an expense during the period (cost of sales); e the amount of any write- down of inventories recognised as an expense in the period; f the amount of any reversal of any write- down that is recognised as a reduction in cost of sales in the period; g the circumstances or events that led to the reversal of a write- down of inventories; h the carrying amount of inventories pledged as security for liabilities

Evaluate a company's past financial performance and explain how a company's strategy is reflected in past financial performance

Evaluating a company's historical performance addresses not only what happened but also the causes behind the company's performance and how the performance reflects the company's strategy.

Describe accounting methods (choices and estimates) that could be used to manage earnings, cash flow, and balance sheet items

Examples of accounting choices that affect earnings and balance sheets include inventory cost flow assumptions, estimates of uncollectible accounts receivable, estimated realizability of deferred tax assets, depreciation method, estimated salvage value of depreciable assets, and estimated useful life of depreciable assets.

Distinguish between financial reporting quality and quality of reported results (including quality of earnings, cash flow, and balance sheet items)

Financial reporting quality can be thought of as spanning a continuum from the highest (containing information that is relevant, correct, complete, and unbiased) to the lowest (containing information that is not just biased or incomplete but possibly pure fabrication). Reporting quality, the focus of this reading, pertains to the information disclosed. High- quality reporting represents the economic reality of the company's activities during the reporting period and the company's financial condition at the end of the period. Results quality (commonly referred to as earnings quality) pertains to the earnings and cash generated by the company's actual economic activities and the resulting financial condition, relative to expectations of current and future financial performance. Quality earnings are regarded as being sustainable, providing a sound platform for forecasts.

Analyze and interpret both reported and common-size cash flow statements

For the common- size cash flow statement, there are two alternative approaches. The first approach is to express each line item of cash inflow (outflow) as a percentage of total inflows (outflows) of cash, and the second approach is to express each line item as a percentage of net revenue

Describe the effective interest method and calculate interest expense, amortisation of bond discounts/premiums, and interest payments

Future cash payments on bonds usually include periodic interest payments (made at the stated interest rate or coupon rate) and the principal amount at maturity. When the market rate of interest equals the coupon rate for the bonds, the bonds will sell at par (i.e., at a price equal to the face value). When the market rate of interest is higher than the bonds' coupon rate, the bonds will sell at a discount. When the market rate of interest is lower than the bonds' coupon rate, the bonds will sell at a premium. An issuer amortises any issuance discount or premium on bonds over the life of the bonds.

Gross Profit Margin

Gross Profit/Revenue Gross profit margin indicates the percentage of revenue available to cover operating and other expenses and to generate profit. Higher gross profit margin indicates some combination of higher product pricing and lower product costs. The ability to charge a higher price is constrained by competition, so gross profits are affected by (and usually inversely related to) competition. If a product has a competitive advantage (e.g., superior branding, better quality, or exclusive technology), the company is better able to charge more for it. On the cost side, higher gross profit margin can also indicate that a company has a competitive advantage in product costs.

Gross Profit Margin

Gross Profit/Sales The gross profit margin, the ratio of gross profit to sales, indicates the percentage of sales being contributed to net income as opposed to covering the cost of sales. Firms in highly competitive industries generally have lower gross profit margins than firms in industries with fewer competitors. A company's gross profit margin may be a function of its type of product. A company selling luxury products will generally have higher gross profit margins than a company selling staple products. The inventory turnover of the company selling luxury products, however, is likely to be much lower than the inventory turnover of the company selling staple products

Compare the financial reporting of the following types of intangible assets: purchased, internally developed, acquired in a business combination

Intangible assets purchased in situations other than business combinations, such as buying a patent, are treated at acquisition the same as long- lived tangible assets; they are recorded at their fair value when acquired, which is assumed to be equivalent to the purchase price In contrast with the treatment of construction costs of tangible assets, the costs to internally develop intangible assets are generally expensed when incurred When one company acquires another company, the transaction is accounted for using the acquisition method of accounting. Under the acquisition method, the company identified as the acquirer allocates the purchase price to each asset acquired (and each liability assumed) on the basis of its fair value. If the purchase price exceeds the sum of the amounts that can be allocated to individual identifiable assets and liabilities, the excess is recorded as goodwill

Long-Lived Assets

Long- lived assets, also referred to as non- current assets or long- term assets, are assets that are expected to provide economic benefits over a future period of time, typically greater than one year Long- lived assets may be tangible, intangible, or financial assets Examples of long- lived tangible assets, typically referred to as property, plant, and equipment and sometimes as fixed assets, include land, buildings, furniture and fixtures, machinery and equipment, and vehicles; examples of long- lived intangible assets (assets lacking physical substance) include patents and trademarks; and examples of long- lived financial assets include investments in equity or debt securities issued by other entities The two main types of long- lived assets with costs that are typically not allocated over time are land, which is not depreciated, and those intangible assets with indefinite useful lives

Describe motivations that might cause management to issue financial reports that are not high quality

Managers may be motivated to issue less-than-high-quality financial reports in order to mask poor performance, to boost the stock price, to increase personal compensation, and/or to avoid violation of debt covenants.

Describe mechanisms that discipline financial reporting quality and the potential limitations of those mechanisms

Mechanisms that discipline financial reporting quality include the free market and incentives for companies to minimize cost of capital, auditors, contract provisions specifically tailored to penalize misreporting, and enforcement by regulatory entities.

Diluted EPS using the if-converted method for preferred stock

Net Income ------------------------------------------------------- (Weighted avg # of shares outstanding) + (New common shares that would have been issued at conversion)

Return on Equity

Net Income / Average Shareholder's Equity

Return on Assets

Net Income/Average Total Assets ROA measures the return earned by a company on its assets. The higher the ratio, the more income is generated by a given level of assets

Net Profit Margin

Net Income/Revenue

Net Profit Margin

Net Income/Revenue Net profit, or net income, is calculated as revenue minus all expenses. Net income includes both recurring and non- recurring components. Generally, the net income used in calculating the net profit margin is adjusted for non- recurring items to offer a better view of a company's potential future profitability

Compare cash flows from operating, investing, and financing activities Classify cash flow items as relating to one of those three categories given a description of the items

Operating activities include the company's day- to-d ay activities that create revenues, such as selling inventory and providing services, and other activities not classified as investing or financing. Cash inflows result from cash sales and from collection of accounts receivable. Cash outflow result from cash payments for inventory, salaries, taxes, and other operating related expenses and from paying accounts payable. Investing activities include purchasing and selling long- term assets and other investments. These long- term assets and other investments include property, plant, and equipment; intangible assets; other long- term assets; and both longterm and short- term investments in the equity and debt (bonds and loans) issued by other companies. Cash inflows in the investing category include cash receipts from the sale of non- trading securities; property, plant, and equipment; intangibles; and other long- term assets. Cash outflows include cash payments for the purchase of these assets. Financing activities include obtaining or repaying capital, such as equity and long- term debt. The two primary sources of capital are shareholders and creditors. Cash inflows in this category include cash receipts from issuing stock (common or preferred) or bonds and cash receipts from borrowing. Cash outflows include cash payments to repurchase stock (e.g., treasury stock) and to repay bonds and other borrowings.

Distinguish between temporary and permanent differences in pre-tax accounting income and taxable income

Permanent difference are differences between tax and financial reporting of revenue (expenses) that will not be reversed at some future date. Because they will not be reversed at a future date, these differences do not give rise to deferred tax. Temporary differences arise from recognition of differences in the tax base and carrying amount of assets and liabilities. The creation of a deferred tax asset or liability as a result of a temporary difference will only be allowed if the difference reverses itself at some future date and to the extent that it is expected that the balance sheet item will create future economic benefits for the company.

Describe presentation choices, including non-GAAP measures, that could be used to influence an analyst's opinion

Pro forma earnings (also commonly referred to as non-G AAP or non-IFRS earnings) adjust earnings as reported on the income statement. Pro forma earnings that exclude negative items are a hallmark of aggressive presentation choices.

Describe different inventory valuation methods (cost formulas)

The allowable inventory valuation methods implicitly involve different assumptions about cost flows. The choice of inventory valuation method determines how the cost of goods available for sale during the period is allocated between inventory and cost of sales. IFRS allow three inventory valuation methods (cost formulas): first-in, first-out (FIFO); weighted average cost; and specific identification. The specific identification method is used for inventories of items that are not ordinarily interchangeable and for goods or services produced and segregated for specific projects. US GAAP allow the three methods above plus the last- in, first- out (LIFO) method. The LIFO method is widely used in the United States for both tax and financial reporting purposes because of potential income tax savings.

Cash Conversion Cycle (Liquidity)

The cash conversion cycle, a financial metric not in ratio form, measures the length of time required for a company to go from cash paid (used in its operations) to cash received (as a result of its operations). DOH + DSO - Number of days of payables

Cash Flow Statement

The cash flow statement classifies all cash flows of the company into three categories: operating, investing, and financing. Cash flows from operating activities generally involve the cash effects of transactions involved in the determination of net income and, hence, comprise the day-to-day operations of the company. Cash flow from investing activities are associated with the acquisition and disposal of long term assets, such as property and equipment. Cash flows from financing activities relate to obtaining or repaying capital to be used in the business.

The income statement

The income statement presents information on the financial performance of a company's business activities over a period of time. It communicates how much revenue and other income the company generated during a period and the expenses it incurred to generate that revenue and other income The income statement is sometimes referred to as a statement of operations or profit and loss (P&L) statement. The basic equation underlying the income statement is Revenue + Other income - Expenses = Income - Expenses = Net income.

Forecast a company's future net income and cash flow

The projection of a company's future net income and cash flow often begins with a top- down sales forecast in which the analyst forecasts industry sales and the company's market share. By projecting profit margins or expenses and the level of investment in working and fixed capital needed to support projected sales, the analyst can forecast net income and cash flow Projections of future performance are needed for discounted cash flow valuation of equity and are often needed in credit analysis to assess a borrower's ability to repay interest and principal of a debt obligation.

Determine the initial recognition, initial measurement and subsequent measurement of bonds

The sales proceeds of a bond issue are determined by discounting future cash payments using the market rate of interest at the time of issuance (effective interest rate). The reported interest expense on bonds is based on the effective interest rate.

Calculate the tax base of a company's assets and liabilities

The tax base of an asset is the amount that will be deductible for tax purposes in future periods as the economic benefits become realized and the company recovers the carrying amount of the asset. The tax base of a liability is the carrying amount of the liability less any amounts that will be deductible for tax purposes in the future

Distinguish between costs included in inventories and costs recognized as expenses in the period in which they are incurred

The total cost of inventories comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. Storage costs of finished inventory and abnormal costs due to waste are typically treated as expenses in the period in which they occurred

Current Ratio (Liquidity)

This ratio expresses current assets in relation to current liabilities. A higher ratio indicates a higher level of liquidity (i.e., a greater ability to meet short- term obligations). A current ratio of 1.0 would indicate that the book value of its current assets exactly equals the book value of its current liabilities. A lower ratio indicates less liquidity, implying a greater reliance on operating cash flow and outside financing to meet short- term obligations. Liquidity affects the company's capacity to take on debt. The current ratio implicitly assumes that inventories and accounts receivable are indeed liquid (which is presumably not the case when related turnover ratios are low). Current Assets/Current Liabilities

Inventory Turnover Ratio

Three ratios often used to evaluate the efficiency and effectiveness of inventory management are inventory turnover, days of inventory on hand, and gross profit margin The inventory turnover ratio measures the number of times during the year a company sells (i.e., turns over) its inventory. The higher the turnover ratio, the more times that inventory is sold during the year and the lower the relative investment of resources in inventory. Days of inventory on hand can be calculated as days in the period divided by inventory turnover. A high inventory turnover ratio and a low number of days of inventory on hand might indicate highly effective inventory management. Alternatively, a high inventory ratio and a low number of days of inventory on hand could indicate that the company does not carry an adequate amount of inventory A low inventory turnover ratio and a high number of days of inventory on hand relative to industry norms could be an indicator of slow- moving or obsolete inventory

Debt to EBITDA

Total Debt/EBITDA This ratio estimates how many years it would take to repay total debt based on earnings before income taxes, depreciation and amortization (an approximation of operating cash flow)

Debt to Equity Ratio

Total Debt/Total Equity The debt- to- equity ratio measures the amount of debt capital relative to equity capital. Interpretation is similar to the preceding two ratios (i.e., a higher ratio indicates weaker solvency). A ratio of 1.0 would indicate equal amounts of debt and equity, which is equivalent to a debt- to- capital ratio of 50 percent. Alternative definitions of this ratio use the market value of stockholders' equity rather than its book value (or use the market values of both stockholders' equity and debt).

Describe the measurement of inventory at the lower of cost and net realizable value

Under IFRS, inventories are measured at the lower of cost and net realisable value. Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs necessary to make the sale. Under US GAAP, inventories are measured at the lower of cost, market value, or net realisable value depending upon the inventory method used. Market value is defined as current replacement cost subject to an upper limit of net realizable value and a lower limit of net realizable value less a normal profit margin. Reversals of previous write-downs are permissible under IFRS but not under US GAAP.

Explain LIFO reserve and LIFO liquidation and their effects on financial statements and ratios

Under US GAAP, companies that use the LIFO method must disclose in their financial notes the amount of the LIFO reserve or the amount that would have been reported in inventory if the FIFO method had been used. This information can be used to adjust reported LIFO inventory and cost of goods sold balances to the FIFO method for comparison purposes. LIFO liquidation occurs when the number of units in ending inventory declines from the number of units that were present at the beginning of the year. If inventory unit costs have generally risen from year to year, this will produce an inventory- related increase in gross profits

Changes in Income Tax Rates

When income tax rates change, the deferred tax assets and liabilities are adjusted to the new tax rate. If income tax rates increase, deferred taxes (that is, the deferred tax assets and liabilities) will also increase. Likewise, if income tax rates decrease, deferred taxes will decrease. A decrease in tax rates decreases deferred tax liabilities, which reduces future tax payments to the taxing authorities. A decrease in tax rates will also decrease deferred tax assets, which reduces their value toward the offset of future tax payments to the taxing authorities.

Distinguish between costs that are capitalized and costs that are expensed in the period in which they are incurred

When property, plant, or equipment is purchased, the buyer records the asset at cost. In addition to the purchase price, the buyer also includes, as part of the cost of an asset, all the expenditures necessary to get the asset ready for its intended use. Subsequent expenditures related to long- lived assets are included as part of the recorded value of the assets on the balance sheet (i.e., capitalised) if they are expected to provide benefits beyond one year in the future and are expensed if they are not expected to provide benefits in future periods

Describe the use of financial statement analysis in screening for potential equity investments

When ratios constructed from financial statement data and market data are used to screen for potential equity investments, fundamental decisions include which metrics to use as screens, how many metrics to include, what values of those metrics to use as cutoff points, and what weighting to give each metric.

P/BV

price per share/book value per share Price to Book value, or P/B, which is the ratio of price to book value per share. This ratio is often interpreted as an indicator of market judgment about the relationship between a company's required rate of return and its actual rate of return. Assuming that book values reflect the fair values of the assets, a price to book ratio of one can be interpreted as an indicator that the company's future returns are expected to be exactly equal to the returns required by the market. A ratio greater than one would indicate that the future profitability of the company is expected to exceed the required rate of return, and values of this ratio less than one indicate that the company is not expected to earn excess returns

P/E

price per share/earnings per share EPS is simply the amount of earnings attributable to each share of common stock. In isolation, EPS does not provide adequate information for comparison of one company with another. For example, assume that two companies have only common stock outstanding and no dilutive securities outstanding. In addition, assume the two companies have identical net income of $10 million, identical book equity of $100 million and, therefore, identical profitability (10 percent, using ending equity in this case for simplicity). Furthermore, assume that Company A has 100 million weighted average common shares outstanding, whereas Company B has 10 million weighted average common shares outstanding. So, Company A will report EPS of $0.10 per share, and Company B will report EPS of $1 per share. The difference in EPS does not reflect a difference in profitability—the companies have identical profits and profitability. The difference reflects only a different number of common shares outstanding

P/S

price per share/sales per share Price to sales is calculated in a similar manner and is sometimes used as a comparative price metric when a company does not have positive net income.

Diluted EPS using the if-converted method for convertible debt

(Net income + After-tax interest on convertible debt - Preferred dividends) ------------------------------------------------------------- Weighted avg # shares outstanding + Additional common shares that would have been issued at conversion

Apex Consignment sells items over the internet for individuals on a consignment basis. Apex receives the items from the owner, lists them for sale on the internet, and receives a 25 percent commission for any items sold. Apex collects the full amount from the buyer and pays the net amount after commission to the owner. Unsold items are returned to the owner after 90 days. During 2009, Apex had the following information: -Total sales price of items sold during 2009 on consignment was €2,000,000. -Total commissions retained by Apex during 2009 for these items was €500,000. How much revenue should Apex report on its 2009 income statement? A €500,000. B €2,000,000. C €1,500,000.

A is correct. Apex is not the owner of the goods and should only report its net commission as revenue.

A company with no debt or convertible securities issued publicly traded common stock three times during the current fiscal year. Under both IFRS and US GAAP, the company's: A basic EPS equals its diluted EPS. B capital structure is considered complex at year- end. C basic EPS is calculated by using a simple average number of shares outstanding.

A is correct. Basic and diluted EPS are equal for a company with a simple capital structure. A company that issues only common stock, with no financial instruments that are potentially convertible into common stock has a simple capital structure. Basic EPS is calculated using the weighted average number of shares outstanding.

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

A is correct. 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.

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 is correct. 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.

At the beginning of 2009, Glass Manufacturing purchased a new machine for its assembly line at a cost of $600,000. The machine has an estimated useful life of 10 years and estimated residual value of $50,000. Under the straight-line method, how much depreciation would Glass take in 2010 for financial reporting purposes? A $55,000. B $60,000. C $65,000. Using the same information as in Question 16, how much depreciation would Glass take in 2009 for financial reporting purposes under the double- declining balance method? A $60,000. B $110,000. C $120,000.

A is correct. Straight- line depreciation would be ($600,000 - $50,000)/10, or $55,000 C is correct. Double- declining balance depreciation would be $600,000 * 20 percent (twice the straight- line rate). The residual value is not subtracted from the initial book value to calculate depreciation. However, the book value (carrying amount) of the asset will not be reduced below the estimated residual value.

When calculating diluted EPS, which of the following securities in the capital structure increases the weighted average number of common shares outstanding without affecting net income available to common shareholders? A Stock options B Convertible debt that is dilutive C Convertible preferred stock that is dilutive

A is correct. When a company has stock options outstanding, diluted EPS is calculated as if the financial instruments had been exercised and the company had used the proceeds from the exercise to repurchase as many shares possible at the weighted average market price of common stock during the period. As a result, the conversion of stock options increases the number of common shares outstanding but has no effect on net income available to common shareholders. The conversion of convertible debt increases the net income available to common shareholders by the after- tax amount of interest expense saved. The conversion of convertible preferred shares increases the net income available to common shareholders by the amount of preferred dividends paid; the numerator becomes the net income.

Describe different types of assets and liabilities and the measurement bases of each

Accounts payable, also called trade payables, are amounts that a business owes its vendors for purchases of goods and services Deferred revenue (also known as unearned revenue) arises when a company receives payment in advance of delivery of the goods and services associated with the payment received. Property, plant, and equipment (PPE) are tangible assets that are used in company operations and expected to be used over more than one fiscal period. Examples of tangible assets include land, buildings, equipment, machinery, furniture, and natural resources such as mineral and petroleum resources. IFRS provide companies with the choice to report PPE using either a historical cost model or a revaluation model. US GAAP permit only the historical cost model for reporting PPE. Depreciation is the process of recognizing the cost of a long-lived asset over its useful life. (Land is not depreciated.) Under IFRS, property used to earn rental income or capital appreciation is considered to be an investment property. IFRS provide companies with the choice to report an investment property using either a historical cost model or a fair value model.

Calculate revenue given information that might influence the choice of revenue recognition method

An analyst should identify differences in companies' revenue recognition methods and adjust reported revenue where possible to facilitate comparability. Where the available information does not permit adjustment, an analyst can characterize the revenue recognition as more or less conservative and thus qualitatively assess how differences in policies might affect financial ratios and judgments about profitability

The assumption that the effects of transactions and other events are recognized when they occur, not when the cash flows occur, is called: A relevance. B accrual basis. C going concern.

B is correct. Accrual basis reflects the effects of transactions and other events being recognized when they occur, not when the cash flows. These effects are recorded and reported in the financial statements of the periods to which they relate.

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

B is correct. 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

US generally accepted accounting principles are currently developed by which entity? A The Securities and Exchange Commission. B The Financial Accounting Standards Board. C The Public Company Accounting Oversight Board.

B is correct. The FASB is responsible for the Accounting Standards Codification, the single source of nongovernmental authoritative US generally accepted accounting principles.

International financial reporting standards are currently developed by which entity? A The IFRS Foundation. B The International Accounting Standards Board. C The International Organization of Securities Commissions.

B is correct. The IASB is currently charged with developing International Financial Reporting Standards.

Shareholders' equity reported on the balance sheet is most likely to differ from the market value of shareholders' equity because: A historical cost basis is used for all assets and liabilities. B some factors that affect the generation of future cash flows are excluded. C shareholders' equity reported on the balance sheet is updated continuously.

B is correct. The balance sheet omits important aspects of a company's ability to generate future cash flows, such as its reputation and management skills. The balance sheet measures some assets and liabilities based on historical cost and measures others based on current value. Market value of shareholders' equity is updated continuously. Shareholders' equity reported on the balance sheet is updated for reporting purposes and represents the value that was current at the end of the reporting period.

Which of the following elements of financial statements is most closely related to measurement of performance? A Assets. B Expenses. C Liabilities.

B is correct. The elements of financial statements related to the measure of performance are income and expenses.

For its fiscal year- end, Calvan Water Corporation (CWC) reported net income of $12 million and a weighted average of 2,000,000 common shares outstanding. The company paid $800,000 in preferred dividends and had 100,000 options outstanding with an average exercise price of $20. CWC's market price over the year averaged $25 per share. CWC's diluted EPS is closest to: A $5.33. B $5.54. C $5.94.

B is correct. The formula to calculate diluted EPS is as follows: Diluted EPS = (Net income - Preferred dividends) / [Weighted average number of shares outstanding + (New shares that would have been issued at option exercise - Shares that could have been purchased with cash received upon exercise) * (Proportion of year during which the financial instruments were outstanding)]. The underlying assumption is that outstanding options are exercised, and then the proceeds from the issuance of new shares are used to repurchase shares already outstanding: Proceeds from option exercise = 100,000 * $20 = $2,000,000 Shares repurchased = $2,000,000/$25 = 80,000 The net increase in shares outstanding is thus 100,000 - 80,000 = 20,000. Therefore, the diluted EPS for CWC = ($12,000,000 - $800,000)/2,020,000 = $5.54.

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 financia statements.

B is correct. 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.

Which of the following is not a required financial statement according to IAS No. 1? A Statement of financial position. B Statement of changes in income. C Statement of comprehensive income.

B is correct. There is no statement of changes in income. Under IAS No. 1, a complete set of financial statements includes a statement of financial position, a statement of comprehensive income, a statement of changes in equity, a statement of cash flows, and notes comprising a summary of significant accounting policies and other explanatory information.

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

During 2009, Accent Toys Plc., which began business in October of that year, purchased 10,000 units of a toy at a cost of $10 per unit in October. The toy sold well in October. In anticipation of heavy December sales, Accent purchased 5,000 additional units in November at a cost of $11 per unit. During 2009, Accent sold 12,000 units at a price of $15 per unit. Under the first in, first out (FIFO) method, what is Accent's cost of goods sold for 2009? A $120,000. B $122,000. C $124,000. Using the same information as in Question 8, what would Accent's cost of goods sold be under the weighted average cost method? A $120,000. B $122,000. C $124,000.

B is correct. Under the first in, first out (FIFO) method, the first 10,000 units sold came from the October purchases at £10, and the next 2,000 units sold came from the November purchases at £11. C is correct. Under the weighted average cost method: October purchases. 10,000 units $100,000 November purchases 5,000 units $55,000 -------------------------------------------------------------- Total 15,000 units $155,000 $155,000/15,000 units = $10.3333 * 12,000 units = $124,000.

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 is correct. 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.

Calculate and interpret liquidity and solvency ratios

Balance sheet ratios include liquidity ratios (measuring the company's ability to meet its short- term obligations) and solvency ratios (measuring the company's ability to meet long-term and other obligations). Current: Current Assets/Current Liabilities Quick(Acid test): (Cash + Marketable securities + Receivables) / Current liabilities Debt-to-equity: Total debt/Total equity Financial Leverage: Total assets/total equity

Describe how earnings per share is calculated and calculate and interpret a company's earnings per share (both basic and diluted earnings per share) for both simple and complex capital structures;

Basic EPS is the amount of income available to common shareholders divided by the weighted average number of common shares outstanding over a period. The amount of income available to common shareholders is the amount of net income remaining after preferred dividends (if any) have been paid. The EPS that would result if all dilutive financial instruments were converted is called diluted EPS

Neutrality of information in the financial statements most closely contributes to which qualitative characteristic? A Relevance. B Understandability. C Faithful representation.

C is correct. The fundamental qualitative characteristic of faithful representation is contributed to by completeness, neutrality, and freedom from error.

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

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

Convert income statements to common-size income statements

Common- size analysis of the income statement involves stating each line item on the income statement as a percentage of sales. Common- size statements facilitate comparison across time periods and across companies of different sizes

Describe, calculate, and interpret comprehensive income

Comprehensive income includes both net income and other revenue and expense items that are excluded from the net income calculation (collectively referred to as Other Comprehensive Income).

Describe the roles of financial reporting and financial statement analysis

Financial analysis is the process of examining a company's performance in the context of its industry and economic environment in order to arrive at a decision or recommendation Overall, a central focus of financial analysis is evaluating the company's ability to earn a return on its capital that is at least equal to the cost of that capital, to profitably grow its operations, and to generate enough cash to meet obligations and pursue opportunities. The role of financial statement analysis is to use financial reports prepared by companies, combined with other information, 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

Describe general requirements for financial statements under International Financial Reporting Standards (IFRS)

IFRS Financial Statements: IAS No. 1 prescribes that a complete set of financial statements includes a statement of financial position (balance sheet), a statement of comprehensive income (either two statements—one for net income and one for comprehensive income—or a single statement combining both net income and comprehensive income), a statement of changes in equity, a cash flow statement, and notes. The notes include a summary of significant accounting policies and other explanatory information. Financial statements need to reflect certain basic features: fair presentation, going concern, accrual basis, materiality and aggregation, and no offsetting Financial statements must be prepared at least annually, must include comparative information from the previous period, and must be consistent. Financial statements must follow certain presentation requirements including a classified statement of financial position (balance sheet) and minimum information on both the face of the financial statements and in the notes.

Distinguish between dilutive and antidilutive securities and describe the implications of each for the earnings per share calculation

If a company has a simple capital structure (i.e., one with no potentially dilutive securities), then its basic EPS is equal to its diluted EPS. If, however, a company has dilutive securities, its diluted EPS is lower than its basic EPS. Diluted EPS is calculated using the if-converted method for convertible securities and the treasury stock method for options

For the year ended 31 December 2018, Dim- Cool Utility Company (fictitious) had net income of $1,750,000. The company had an average of 500,000 shares of common stock outstanding, 20,000 shares of convertible preferred, and no other potentially dilutive securities. Each share of preferred pays a dividend of $10 per share, and each is convertible into three shares of the company's common stock. What was the company's basic and diluted EPS?

If the 20,000 shares of convertible preferred had each converted into 3 shares of the company's common stock, the company would have had an additional 60,000 shares of common stock (3 shares of common for each of the 20,000 shares of preferred). If the conversion had taken place, the company would not have paid preferred dividends of $200,000 ($10 per share for each of the 20,000 shares of preferred). The effect of using the if- converted method would be EPS of $3.13, as shown in Exhibit 14. Because this is greater than the company's basic EPS of $3.10, the securities are said to be antidilutive and the effect of their conversion would not be included in diluted EPS. Diluted EPS would be the same as basic EPS (i.e., $3.10). Basic EPS: $1,750,000 - $200,000 / 500,000 Basic EPS = $1,550,000 / 500,000 = $3.10 Diluted EPS: $1,750,000/(500,000 + 60,000) Diluted EPS = $1,750,000/560,000 = $3.13 Exceeds basic EPS; security is antidilutive and, therefore, not included. Reported diluted EPS = $3.10.

For the year ended 31 December 2018, Bright- Warm Utility Company (fictitious) had net income of $1,750,000. The company had an average of 500,000 shares of common stock outstanding, 20,000 shares of convertible preferred, and no other potentially dilutive securities. Each share of preferred pays a dividend of $10 per share, and each is convertible into five shares of the company's common stock. Calculate the company's basic and diluted EPS.

If the 20,000 shares of convertible preferred had each converted into 5 shares of the company's common stock, the company would have had an additional 100,000 shares of common stock (5 shares of common for each of the 20,000 shares of preferred). If the conversion had taken place, the company would not have paid preferred dividends of $200,000 ($10 per share for each of the 20,000 shares of preferred). As shown in Exhibit 11, the company's basic EPS was $3.10 and its diluted EPS was $2.92. Basic EPS: $1,750,000 - $200,000 = $1,550,000 Basic EPS = $1,550,000/500,000 = $3.10 Diluted EPS: $1,750,000/(500,000 + 100,000) Diluted EPS = $2.92

Oppnox Company (fictitious) reported net income of $750,000 for the year ended 31 December 2018. The company had a weighted average of 690,000 shares of common stock outstanding. In addition, the company has only one potentially dilutive security: $50,000 of 6 percent convertible bonds, convertible into a total of 10,000 shares. Assuming a tax rate of 30 percent, calculate Oppnox's basic and diluted EPS.

If the debt securities had been converted, the debt securities would no longer be outstanding and instead, an additional 10,000 shares of common stock would be outstanding. Also, if the debt securities had been converted, the company would not have paid interest of $3,000 on the convertible debt, so net income available to common shareholders would have increased by $2,100 [= $3,000(1 - 0.30)] on an after- tax basis. Exhibit 12 illustrates the calculation of diluted EPS using the if- converted method for convertible debt. Basic EPS: $750,000/690,000 = $1.09 Diluted EPS: $750,000 + $2,100/690,000+10,000 Diluted EPS = $752,100/700,000 = $1.07

Intangible Assets

Intangible assets refer to identifiable non-monetary assets without physical substance. Examples include patents, licenses, and trademarks. For each intangible asset, a company assesses whether the useful life is finite or indefinite An intangible asset with a finite useful life is amortised on a systematic basis over the best estimate of its useful life, with the amortisation method and useful-life estimate reviewed at least annually. Impairment principles for an intangible asset with a finite useful life are the same as for PPE. An intangible asset with an indefinite useful life is not amortised. Instead, it is tested for impairment at least annually. For internally generated intangible assets, IFRS require that costs incurred during the research phase must be expensed. Costs incurred in the development stage can be capitalized as intangible assets if certain criteria are met, including technological feasibility, the ability to use or sell the resulting asset, and the ability to complete the project. The most common intangible asset that is not a separately identifiable asset is goodwill, which arises in business combinations. Goodwill is not amortised; instead it is tested for impairment at least annually.

Basic EPS

Net Income - Preferred dividends ------------------------------------------------------- Weighted average number of shares outstanding The weighted average number of shares outstanding is a time weighting of common shares outstanding. For example, assume a company began the year with 2,000,000 common shares outstanding and repurchased 100,000 common shares on 1 July. The weighted average number of common shares outstanding would be the sum of 2,000,000 shares * 1/2 year + 1,900,000 shares * 1/2 year, or 1,950,000 shares. So the company would use 1,950,000 shares as the weighted average number of shares in calculating its basic EPS

Evaluate a company's financial performance using common-size income statements and financial ratios based on the income statement

Net Profit Margin = Net Income/Revenue Net profit margin measures the amount of income that a company was able to generate for each dollar of revenue. A higher level of net profit margin indicates higher profitability and is thus more desirable Gross Profit Margin = Gross Profit/Revenue The gross profit margin measures the amount of gross profit that a company generated for each dollar of revenue. A higher level of gross profit margin indicates higher profitability and thus is generally more desirable

Distinguish between the operating and non-operating components of the income statement;

Non-operating items are reported separately from operating items on the income statement. Under both IFRS and US GAAP, the income statement reports separately the effect of the disposal of a component operation as a "discontinued" operation

Describe the roles of financial reporting standard-setting bodies and regulatory authorities in establishing and enforcing reporting standards

Private sector standard setting bodies and regulatory authorities play significant but different roles in the standard setting process. In general, standard setting bodies make the rules, and regulatory authorities enforce the rules. However, regulators typically retain legal authority to establish financial reporting standards in their jurisdiction.

Describe general principles of revenue recognition and accounting standards for revenue recognition

Revenue is recognized in the period it is earned, which may or may not be in the same period as the related cash collection. Recognition of revenue when earned is a fundamental principal of accrual accounting. 1 Identify the contract(s) with a customer 2 Identify the separate or distinct performance obligations in the contract 3 Determine the transaction price 4 Allocate the transaction price to the performance obligations in the contract 5 Recognize revenue when (or as) the entity satisfies a performance obligation

For the year ended 31 December 2018, Shopalot Company had net income of $1,950,000. The company had 1,500,000 shares of common stock outstanding, no preferred stock, and no convertible financial instruments. What is Shopalot's basic EPS?

Shopalot's basic EPS is $1.30 ($1,950,000 divided by 1,500,000 shares).

Describe the components of shareholders' equity

Six potential components that comprise the owners' equity section of the balance sheet include: contributed capital, preferred shares, treasury shares, retained earnings, accumulated other comprehensive income, and non controlling interest. The statement of changes in equity reflects information about the increases or decreases in each component of a company's equity over a period.

Assume a company's beginning shareholders' equity is €200 million, its net income for the year is €20 million, its cash dividends for the year are €3 million, and there was no issuance or repurchase of common stock. The company's actual ending shareholders' equity is €227 million. 1 What amount has bypassed the net income calculation by being classified as other comprehensive income? A €0. B €7 million. C €10 million. 2 Which of the following statements best describes other comprehensive income? A Income earned from diverse geographic and segment activities. B Income that increases stockholders' equity but is not reflected as part of net income. C Income earned from activities that are not part of the company's ordinary business activities.

Solution to 1: C is correct. If the company's actual ending shareholders' equity is €227 million, then €10 million [€227- (€200 + €20 - €3)] has bypassed the net income calculation by being classified as other comprehensive income. Solution to 2: B is correct. Answers A and C are not correct because they do not specify whether such income is reported as part of net income and shown in the income statement.

Sennett Designs (SD) sells furniture on a retail basis. SD began operations during December 2017 and sold furniture for €250,000 in cash. The furniture sold by SD was purchased on credit for €150,000 and delivered by the supplier during December. The credit terms granted by the supplier required SD to pay the €150,000 in January for the furniture it received during December. In addition to the purchase and sale of furniture, in December, SD paid €20,000 in cash for rent and salaries. 1 How much is SD's profit for December 2017 if no other transactions occurred? 2 How much is SD's cash flow for December 2017? 3 If SD purchases and sells exactly the same amount in January 2018 as it did in December and under the same terms (receiving cash for the sales and making purchases on credit that will be due in February), how much will the company's profit and cash flow be for the month of January?

Solution to 1: SD's profit for December 2017 is the excess of the sales price (€250,000) over the cost of the goods that were sold (€150,000) and rent and salaries (€20,000), or €80,000. Solution to 2: The December 2017 cash flow is €230,000, the amount of cash received from the customer (€250,000) less the cash paid for rent and salaries (€20,000). Solution to 3: SD's profit for January 2018 will be identical to its profit in December: €80,000, calculated as the sales price (€250,000) minus the cost of the goods that were sold (€150,000) and minus rent and salaries (€20,000). SD's cash flow in January 2018 will also equal €80,000, calculated as the amount of cash received from the customer (€250,000) minus the cash paid for rent and salaries (€20,000) and minus the €150,000 that SD owes for the goods it had purchased on credit in the prior month.

For the year ended 31 December 2018, Angler Products had net income of $2,500,000. The company declared and paid $200,000 of dividends on preferred stock. The company also had the following common stock share information: Shares outstanding on 1 January 2018 1,000,000 Shares issued on 1 April 2018 200,000 Shares repurchased 1 October 2018 (100,000) ------------------------------------------------------------------------- Shares outstanding on 31 December 2018 1,100,000 1 What is the company's weighted average number of shares outstanding? 2 What is the company's basic EPS? 3 Assume the same facts as Example 7 except that on 1 December 2018, a previously declared 2- for- 1 stock split took effect. Each shareholder of record receives two shares in exchange for each current share that he or she owns. What is the company's basic EPS?

Solution to 1: The weighted average number of shares outstanding is determined by the length of time each quantity of shares was outstanding: 1,000,000 * (3 months/12 months) = 250,000 1,200,000 * (6 months/12 months) = 600,000 1,100,000 * (3 months/12 months) = 275,000 ------------------------------------------------------------ Weighted average shares outstanding 1,125,000 Solution to 2: Basic EPS = (Net income - Preferred dividends)/Weighted average number of shares = ($2,500,000 - $200,000)/1,125,000 = $2.04 Solution to 3 For EPS calculation purposes, a stock split is treated as if it occurred at the beginning of the period. The weighted average number of shares would, therefore, be 2,250,000, and the basic EPS would be $1.02 [= ($2,500,000 - $200,000)/2,250,000].

The balance sheet

The balance sheet (also called the statement of financial position or statement of financial condition) presents a company's financial position by disclosing the resources the company controls (assets) and its obligations to lenders and other creditors (liabilities) at a specific point in time. Owners' equity (sometimes called "net assets") represents the excess of assets over liabilities The relationship among the three parts of the balance sheet (assets, liabilities, and owners' equity) can be expressed in the following equation form: Assets = Liabilities + Owners' equity

Describe the elements of the balance sheet: assets, liabilities, and equity

The balance sheet discloses what an entity owns, what it owes, and what the owners' claims are at a specific point in time Assets (A) are what the company owns (or controls). More formally, assets are resources controlled by the company as a result of past events and from which future economic benefits are expected to flow to the entity. Liabilities (L) are what the company owes. More formally, liabilities represent obligations of a company arising from past events, the settlement of which is expected to result in a future outflow of economic benefits from the entity. Equity (E) represents the owners' residual interest in the company's assets after deducting its liabilities. Commonly known as shareholders' equity or owners' equity, equity is determined by subtracting the liabilities from the assets of a company, giving rise to the accounting equation: A-L=E or A=L+E

Describe alternative formats of balance sheet presentation

The balance sheet distinguishes between current and non-current assets and between current and non- current liabilities unless a presentation based on liquidity provides more relevant and reliable information

Describe general principles of expense recognition, specific expense recognition applications, and implications of expense recognition choices for financial analysis

The general principles of expense recognition include a process to match expenses either to revenue (such as, cost of goods sold) or to the time period in which the expenditure occurs (period costs such as, administrative salaries) or to the time period of expected benefits of the expenditures (such as, depreciation). In expense recognition, choice of method (i.e., depreciation method and inventory cost method), as well as estimates (i.e., uncollectible accounts, warranty expenses, assets' useful life, and salvage value) affect a company's reported income. An analyst should identify differences in companies' expense recognition methods and adjust reported financial statements where possible to facilitate comparability. Where the available information does not permit adjustment, an analyst can characterize the policies and estimates as more or less conservative and thus qualitatively assess how differences in policies might affect financial ratios and judgments about companies' performance.

Describe the components of the income statement and alternative presentation formats of that statement

The income statement presents revenue, expenses, and net income The components of the income statement include: revenue; cost of sales; sales, general, and administrative expenses; other operating expenses; non-operating income and expenses; gains and losses; non-recurring items; net income; and EPS. An income statement that presents a subtotal for gross profit (revenue minus cost of goods sold) is said to be presented in a multi- step format. One that does not present this subtotal is said to be presented in a single- step format.

Describe the importance of financial statement notes and supplementary information—including disclosures of accounting policies, methods, and estimates— and management's commentary

The notes (also sometimes referred to as footnotes) that accompany the four financial statements are required and are an integral part of the complete set of financial statements. The notes provide information that is essential to understanding the information provided in the primary statements. The notes disclose the basis of preparation for the financial statements. The notes also disclose information about the accounting policies, methods, and estimates used to prepare the financial statements The discussion by management is arguably one of the most useful parts of a company's annual report besides the financial statements themselves; however, other than excerpts from the financial statements, information included in the management commentary is typically unaudited. When using information from the management report, an analyst should be aware of whether the information is audited or unaudited

Describe the International Accounting Standards Board's conceptual framework, including qualitative characteristics of financial reports, constraints on financial reports, and required reporting elements

The objective of fair presentation of useful information is the center of the IASB's Conceptual Framework. The qualitative characteristics of useful information include fundamental and enhancing characteristics. Information must exhibit the fundamental characteristics of relevance and faithful representation to be useful. The enhancing characteristics identified are comparability, verifiability, timeliness, and understandability. A limitation of financial reporting involves information that is not included. Financial statements, by necessity, omit information that is non- quantifiable. For example, the creativity, innovation, and competence of a company's work force are not directly captured in the financial statements. Similarly, customer loyalty, a positive corporate culture, environmental responsibility, and many other aspects about a company may not be directly reflected in the financial statements

Describe the objective of financial reporting and the importance of financial reporting standards in security analysis and valuation

The objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity

Statement of Changes in Equity

The statement of changes in equity, sometimes called the "statement of changes in owners' equity" or "statement of changes in shareholders' equity," primarily serves to report changes in the owners' investment in the business over time. The basic components of owners' equity are paid-in capital and retained earnings

Describe the financial reporting treatment and analysis of non-recurring items (including discontinued operations, unusual or infrequent items) and changes in accounting policies

To assess a company's future earnings, it is helpful to separate those prior years' items of income and expense that are likely to continue in the future from those items that are less likely to continue Under IFRS, a company should present additional line items, headings, and subtotals beyond those specified when such presentation is relevant to an understanding of the entity's financial performance. Some items from prior years clearly are not expected to continue in future periods and are separately disclosed on a company's income statement. Under US GAAP, unusual and/or infrequently occurring items, which are material, are presented separately within income from continuing operations.

Describe the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls

To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor's finding 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 Unqualified Audit opinion states that the financial statements give a "true and fair view" (international) or are "fairly presented" (international and US) in accordance with applicable accounting standards. Referred to as an "unmodified" or a "clean" opinion and is the one that analysts would like to see in a financial report Qualified Audit opinion is one in which there is some scope limitation or exception to accounting standards Adverse Audit opinion is issued when an auditor determines that the financial statements materially depart from accounting standards and are not fairly presented Disclaimer of opinion occurs when, for some reason, such as a scope limitation, the auditors are unable to issue an opinion In the United States, under the Sarbanes-Oxley Act, the auditors must also express an opinion on the company's internal control systems. The internal control system is the company's internal system that is designed, among other things, to ensure that the company's process for generating financial reports is sound. Although management has always been responsible for maintaining effective internal control, the Sarbanes-Oxley Act greatly increases management's responsibility for demonstrating that the company's internal controls are effective

Convert balance sheets to common-size balance sheets and interpret common-size balance sheets

Vertical common- size analysis of the balance sheet involves stating each balance sheet item as a percentage of total assets