CFA: Financial Reporting & Analysis
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.
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.
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. Q. 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.
An analyst's examination of the performance of a company is least likely to include an assessment of a company's: a) assets relative to its liabilities. b) profitability. c) cash flow generating ability.
A is correct. Assessment of performance includes analysis of profitability and cash flow generating ability. The relationship between assets and liabilities is used to assess a company's financial position, not its performance. B is incorrect because assessment of performance includes analysis of profitability. C is incorrect because assessment of performance includes analysis of cash flow generating ability.
Inherent risks in an investment are most appropriately evaluated in which step of the financial statement analysis framework? a) Develop and communicate conclusions/recommendations b) Articulate the purpose and context of analysis c) Process data
A is correct. Discussion and presentation of inherent risks in an investment is appropriate in the develop and communicate conclusions/recommendations step. B and C are incorrect because risks are evaluated and presented after data are collected and processed.
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.
Which of the following best describes a responsibility of the SEC? a) Overseeing the Public Companies Accounting Oversight Board (PCAOB) b) Prosecuting analysts who disseminate conclusions based on non-material non-public information c) Promoting the adoption of global financial reporting standards
A is correct. The SEC is responsible for overseeing the PCAOB under the Sarbanes-Oxley Act of 2002. B is incorrect because under mosaic theory, it is not a violation of CFA Institute standards or securities laws to disseminate conclusions based on non-material non-public information in combination with an analysis of public information. C is incorrect because this is one of the principle objectives of the IFRS Foundation.
Which of the following reports is least likely to be filed with the US SEC? a) Annual report b) Form 10-K c) Proxy statement
A is correct. The annual report is not a requirement of the SEC. B is incorrect because the 10-K is required by the SEC. C is incorrect because a proxy statement is required by the SEC
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.
Providing information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users is most accurately described as the role of: a) financial reporting. b) the audit report. c) financial statement analysis.
A is correct. The role of financial reporting is to provide information about the performance of a company, its financial position, and changes in financial position that is useful to a wide range of users in making economic decisions. B is incorrect because audit reports express an opinion about the fair presentation of the financial statements. C is incorrect because the role of financial statement analysis is to take the financial reports and evaluate the past, current, and prospective performance and financial position of a company for the purpose of making investment, credit, and other economic decisions.
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.
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.
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.
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.
Company A owns 60% of Company B. Company A's consolidated income statement most likely includes 100% of Company A's revenues and expenses and what portion of Company B's? a) 0% b) 100% c) 60%
B is correct. Because Company A owns more than 50% of the shares in Company B it must present consolidated financial statements, which will include 100% of Company B's revenues and expenses. A is incorrect because all subsidiaries, even those that are partially owned, are included in a consolidated statement. C is incorrect because all subsidiary revenues and expenses are included, even if they are not 100% owned by the parent.
To evaluate the potential effect of an innovative and unique type of business transaction on financial statements, an analyst's best approach is to: a) monitor the actions of standard setters and regulators. b) gain an understanding of the transaction's economic purpose. c) consider the approach taken for "new" transactions that arose in the past.
B is correct. By understanding the economic purpose of a transaction and applying the conceptual framework, an analyst may be able to evaluate the potential effect on financial statements, even in the absence of specific standards. A is incorrect because given the lag between new product development and regulatory action, the actions of standard setters and regulators are unlikely to be helpful when the new transactions initially arise. C is incorrect because new types of transactions have unique elements that distinguish them from the transactions that arose previously. They may or may not affect the financial statements in the same way.
The best description of a classified statement of financial position is one that: a) is supported by note disclosures relevant to understanding its components. b) distinguishes between current and non-current assets and liabilities. c) has not been audited.
B is correct. Classified statements of financial position distinguish between current and non-current assets and liabilities. Classified statements are required under International Financial Reporting Standards unless a liquidity-based presentation provides more relevant and reliable information.
Reviewing the MD&A section of an annual report is important because: a) future revenue projections must be disclosed. b) accounting policies may require subjective judgment by management. c) management commentary is typically unaudited.
B is correct. Companies should disclose in management commentary any critical accounting policies that require management to make subjective judgements that may have a significant impact on reported financial results. These subjective judgements should be carefully reviewed because they may materially alter an analyst's conclusions about the future performance or financial position of a company. A is incorrect because companies are not required to disclose future revenue projections in the management's discussion and analysis section of financial statements, but should highlight any favorable or unfavorable trends or uncertainties that may impact future performance or financial position. C is incorrect because although management commentary is typically unaudited, it is not a reason why management commentary is of importance to analysts. Rather, analysts should be aware that management commentary is unaudited and interpret accordingly.
Q. Which of the following best describes a component of the income statement? a) Amounts that a company owes its vendors for purchases of goods and services b) Outflows or depletions of assets in the course of a business's activities c) Obligations from past events that are expected to result in an outflow of economic benefits
B is correct. Expenses are a component of the income statement and are defined as outflows, asset depletions, and liabilities incurred in the course of a business's activities. A is incorrect because accounts payable is a liability, a component of the balance sheet, and is defined as amounts that a company owes its vendors for purchases of goods and services. C is incorrect because liabilities are a component of the balance sheet and are defined as obligations from past events that on settlement are expected to result in an outflow of economic benefits.
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.
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
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 Q. 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.
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.
According to the International Accounting Standards Board's (IASB) Conceptual Framework for Financial Reporting, the two fundamental qualitative characteristics that make financial information useful are best described as: a) understandability and verifiability. b) relevance and faithful representation. c) timeliness and accrual accounting.
B is correct. Relevance and faithful representation are the two fundamental qualitative characteristics that make financial information useful, according to the IASB Conceptual Framework. A is incorrect because verifiability and understandability are two characteristics that enhance the usefulness of relevant and faithfully represented financial information. C is incorrect because timeliness enhances the usefulness of relevant and faithfully represented financial information. Accrual accounting is an underlying assumption.
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.
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.
An independent audit report is most likely to provide: a) absolute assurance about the accuracy of the financial statements. b) reasonable assurance that the financial statements are fairly presented. c) a qualified opinion with respect to the transparency of the financial statements.
B 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.
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.
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.
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.
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.
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.
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.
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.
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.
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 profitability) 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.
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.
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.
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.
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 Q. 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.
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.
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.
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.
Analysts can best address the challenges of comparing financial statements prepared under US GAAP with those prepared under International Financial Reporting Standards (IFRS) by: a) referring to the reconciliation from IFRS to US GAAP provided in the notes. b) assuming differences are minor given US GAAP and IFRS convergence. c) monitoring changes in both sets of standards and interpreting cautiously.
C is correct. Significant differences still exist between IFRS and US GAAP, and in most cases, analysts will lack the information necessary to make specific adjustments to address these differences. As such, comparisons must be interpreted cautiously. B is incorrect because significant differences still exist between IFRS and US GAAP, and should not be ignored. A is incorrect because reconciliations are no longer readily available. The SEC eliminated the reconciliation requirement for companies that prepared their financial statements according to IFRS in 2007.
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.
Which of the following statements is least accurate? a) IFRS Foundation trustees appoint members of the IASB. b) The IASB is monitored by a board that includes the US SEC. c) IFRS Foundation trustees oversee the policy decisions of the FASB.
C is correct. The Financial Accounting Foundation, not the IFRS, oversees FASB. A is incorrect because IFRS Foundation trustees do appoint the members of the IASB. B is incorrect because the Monitoring Board that oversees the IASB includes representatives from the European Commission, IOSCO, the Japan Financial Services Agency, and the US SEC.
Which of the following statements best describes the role of the International Organization of Securities Commissions (IOSCO)? The IOSCO a) is the oversight body to which the International Accounting Standards Board (IASB) reports. b) is responsible for regulating financial markets of member nations. c) assists in attaining the goal of cross-border cooperation in combating violations of securities laws.
C is correct. The IOSCO is not a regulator of financial markets. Its role is to assist in attaining the goal of uniform regulation and enforcement of international financial standards and in attaining the goal of cross-border cooperation in combating violations of securities and derivative laws. A is incorrect because the IOSCO assists in attaining the goal of uniform regulation of international financial standards including IFRS, but the IASB does not report to it. B is incorrect because the IOSCO is not a regulatory authority.
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.
Which of the following most likely results in an increase of owners' equity? a) Share repurchase b) Cash dividend c) New equity issuance
C is correct. The basic components of owners' equity are paid-in capital and retained earnings. In the paid-in capital account, an example of an increase in owners' equity is a new equity issuance. Cash dividends reduce retained earnings and owners' equity. Share repurchases reduce paid-in capital and owners' equity. A is incorrect because for the paid-in capital account an example of a decrease in owners' equity is the repurchase of previously issued shares. B is incorrect because a cash dividend payment is the most common cause of a decrease in owners' equity.
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.
The joint conceptual framework project of the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) guides the development of standards that are best described as: a) integrated with local legal and economic norms. b) comprehensive, complex rules designed to increase uniformity. c) based on principles that limit the range of acceptable approaches.
C is correct. The joint conceptual framework project aims to develop accounting standards based on principles in an attempt to achieve consistency in financial reporting approaches and judgments while trying to limit the range of acceptable answers. A is incorrect because the joint conceptual framework project reflects the widespread recognition that coordination among global standard-setting bodies is better suited to global capital markets than independent development of financial reporting standards within each country. B is incorrect because this statement describes rules-based standards. The joint conceptual framework is designed to foster the development of principles-based standards.
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.
Notes to financial statements most likely include: a) a discussion of significant trends, events, and uncertainties that affect the operating results. b) an auditor's opinion as to the fair presentation of the financial statements. c) supplementary information about accounting policies, methods, and estimates.
C is correct. The notes disclose information about the accounting policies, methods, and estimates used to prepare the financial statements. A is incorrect because the management commentary (or MDA), which is not part of the notes to financial statements, includes a discussion of significant trends, events, and uncertainties that affect the operating results. B is incorrect because the Auditor's Report, which is not part of the notes to financial statements, includes the auditor's opinion as to the fair presentation of the financial statements.
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.
The financial statement that would be most useful to an analyst in understanding the changes that have occurred in a company's retained earnings over a year is the statement of: a) comprehensive income. b) financial position. c) changes in equity.
C is correct. The statement of changes in equity reports the changes in the components of shareholders' equity over the year, which would include the retained earnings account. A is incorrect because the net income determined in the calculation of comprehensive income is a component of the change in retained earnings, but there are other changes that may also have occurred (the payment of dividends, for example) that are not included on the statement of comprehensive income. B is incorrect because although the year-end balances of retained earnings may be reported on the statement of financial position (depending on if the company breaks out the components of shareholders' equity), it would not detail the changes over the year.
The International Financial Reporting Standards (IFRS) Conceptual Framework identifies fundamental qualitative characteristics that make financial information useful. Which of the following is least likely to be one of these characteristics? a) Faithful representation b) Relevance c) Materiality
C is correct. The two fundamental qualitative characteristics that make financial information useful are relevance and faithful representation. Materiality relates to the level of detail of the information needed to achieve relevance. A and B are incorrect because the two fundamental qualitative characteristics that make financial information useful are relevance and faithful representation. Materiality relates to the level of detail of the information needed to achieve relevance.
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.
Which of the following statements is most accurate with respect to the jurisdiction underlying financial reporting? a) The requirement to prepare financial reports in accordance with specified accounting standards is the responsibility of standard-setting bodies. b) Regulatory authorities are typically private sector, self-regulated organizations. c) Standard-setting bodies have authority because they are recognized by regulatory authorities.
C is correct. Without the recognition of the standards by the regulatory authorities, such as the US SEC, private sector standard-setting bodies, such as the US Financial Accounting Standards Board, would have no authority. A is incorrect because the requirement to prepare financial statements in accordance with specific accounting standards is the responsibility of regulatory authorities. B is incorrect because standard-setting bodies (not regulatory authorities) are typically private sector, self-regulated organizations.