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Question #1 of 25 Question ID: 1457192 An analyst who wants to examine a firm's financing transactions during the most recent period is most likely to evaluate the firm's statement of: A) comprehensive income B) financial position C) cash flows Explanation The statement of cash flows describes a firm's inflows and outflows of cash during a reporting period from operating, investing, and financing activities Financing transactions such as issuance of debt or stock are shown on the statement of cash flows The statement of financial position (balance sheet) presents the firm's assets, liabilities, and equity at a point in time The statement of comprehensive income (income statement) does not directly reflect a firm's financing transactions Cash raised is not included in a firm's revenues and dividends paid and debt principal repaid are not included in its expenses (Module 16.1, LOS 16.b) Question #2 of 25 Question ID: 1457197 The standard auditor's report is most likely required to: A) provide an "unqualified" opinion if material uncertainties exist B) provide reasonable assurance that the financial statements contain no material errors C) provide reasonable assurance that management is reliable Explanation The standard auditor's report contains three parts: The financial statements are prepared by management and are their responsibility and the auditor has performed an independent review The audit was conducted using generally accepted auditing standards, which provides reasonable assurance that there are no material errors in the financial statements The auditor is satisfied the statements were prepared in accordance with accepted accounting principles, and the principles chosen and estimates are reasonable Under U.S GAAP, the auditor is required to state an opinion on the company's internal controls The auditor may add this opinion as a fourth element of the auditor's report or provide it separately (Module 16.2, LOS 16.d) Question #3 of 25 Question ID: 1457191 Which financial statement reports information about a company's financial position at a single point in time? A) income statement B) cash flow statement C) balance sheet Explanation The balance sheet reports a company's financial position at a point in time In contrast, the income statement and the cash flow statement report a company's financial performance over a reporting period (Module 16.1, LOS 16.b) Question #4 of 25 Question ID: 1457195 According to IFRS guidance for management's commentary, addressing the company's key relationships is: A) neither recommended nor required B) required C) recommended Explanation IFRS recommends that management commentary address the company's key relationships, resources, and risks, as well as the nature of the business, management's objectives, the company's past performance, and the performance measures used Securities regulators may impose requirements for publicly traded firms to address certain topics in management's commentary, but accounting standards not (Module 16.2, LOS 16.c) Question #5 of 25 Question ID: 1457188 The role of financial statement analysis is most accurately described as: A) a common requirement for companies that are listed on public exchanges B) C) the use of information from a company’s financial statements along with other information to make economic decisions regarding that company the reports and presentations a company uses to show its financial performance to investors, creditors, and other interested parties Explanation Financial statement analysis refers to the use of information from a company's financial statements along with other information to make economic decisions regarding that company Financial reporting refers to the reports and presentations that a company uses to show its financial performance to investors, creditors, and other interested parties Financial reporting is a requirement for companies that are listed on public exchanges (Module 16.1, LOS 16.a) Question #6 of 25 Question ID: 1457193 Which of the following statements concerning the notes to the audited financial statements of a company is least accurate? Financial statement notes: A) include management's assessment of the company's operating performance and financial results B) are audited C) contain information about contingent losses that may occur Explanation Management's perspective on the company's results is provided in the Management's Discussion and Analysis supplement to the financial statements Financial statement notes (footnotes) provide information about matters such as the company's accounting methods and assumptions, contingencies, and acquisitions and disposals Footnotes to the financial statements are audited (Module 16.2, LOS 16.c) Question #7 of 25 Question ID: 1457189 A company's operating revenues for a reporting period are most likely to be shown on its: A) balance sheet B) cash flow statement C) income statement Explanation Revenues for a reporting period are presented on a company's income statement They can be, but are not required to be, classified as operating and nonoperating revenues Cash from operating activities is presented on the company's statement of cash flows, but this is not necessarily equal to operating revenues because revenue might be recognized in a different period than cash is collected The balance sheet displays a company's financial position at a fixed point in time (Module 16.1, LOS 16.b) Question #8 of 25 Question ID: 1457187 According to the IASB, which of the following least accurately describes financial reporting? Financial reporting: A) provides information about changes in financial position of an entity B) is useful to a wide range of users C) uses the information in a company’s financial statements to make economic decisions Explanation The role of financial reporting is described by the International Accounting Standards Board (IASB) in its "Framework for the Preparation and Presentation of Financial Statements": The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions Using the information in a company's financial statements to make economic decisions is financial analysis, not financial reporting (Module 16.1, LOS 16.a) Question #9 of 25 Question ID: 1457186 Which of the following is least likely to be considered a role of financial statement analysis? A) Assessing the management skill of the company’s executives B) Determining whether to invest in the company's securities C) To make economic decisions Explanation The role of financial statement analysis is to use the information in a company's financial statements, along with other relevant information, to make economic decisions Examples of such decisions include whether to invest in the company's securities or recommend them to other investors, or whether to extend trade or bank credit to the company Although the financial statements might provide indirect evidence about the management skill of the company's executives, that is not generally considered the role of financial statement analysis (Module 16.1, LOS 16.a) Question #10 of 25 Question ID: 1457184 Which of the following statements about financial statement analysis and reporting is least accurate? A) B) Financial statement analysis focuses on the way companies show their financial performance to investors by preparing and presenting financial statements Providing information about changes in a company’s financial position is a role of financial reporting C) Deciding whether to recommend a company’s securities to investors is a role of financial statement analysis Explanation Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements, including information about changes in a company's financial position The role of financial statement analysis is to use the information in a company's financial statements, along with other relevant information, to make economic decisions, such as whether to invest in the company's securities or recommend them to other investors Analysts use financial statement data to evaluate a company's past performance and current financial position in order to form opinions about the company's ability to earn profits and generate cash flow in the future (Module 16.1, LOS 16.a) Question #11 of 25 Question ID: 1457204 In addition to the audited financial statements included in a firm's annual report, which of the following sources of information is most likely to contain audited data? A) Footnotes to the annual financial statements B) Management’s commentary C) Interim financial statements filed with the SEC Explanation The footnotes are an integral part of the audited financial statements in a firm's annual report and are included in the audit opinion (Module 16.2, LOS 16.e) Question #12 of 25 Question ID: 1457203 Which of the following is least likely to be available on EDGAR (Electronic Data Gathering, Analysis, and Retrieval System)? A) Corporate press releases B) Form 10Q C) SEC filings Explanation Securities and Exchange Commission (SEC) filings are available from EDGAR (Electronic Data Gathering, Analysis, and Retrieval System, www.sec.gov) Companies' annual and quarterly financial statements are also filed with the SEC (Form 10-K and Form 10-Q, respectively) (Module 16.2, LOS 16.e) Question #13 of 25 Question ID: 1457196 For publicly traded firms in the United States, the Management Discussion and Analysis (MD&A) portion of the financial disclosure is least likely required to discuss: A) capital resources and liquidity B) results of operations C) unusual or infrequent items Explanation For publicly traded U.S firms, the MD&A portion of the financial disclosure is required to discuss results of operations, capital resources and liquidity and a general business overview based on known trends A discussion of unusual or infrequent items may be included in the MD&A, but is not required (Module 16.2, LOS 16.c) Question #14 of 25 Question ID: 1457190 Which of the following statements represents information at a specific point in time? A) The balance sheet B) The income statement and the balance sheet C) The income statement Explanation The balance sheet represents information at a specific point in time The income statement represents information over a period of time (Module 16.1, LOS 16.b) Question #15 of 25 Question ID: 1457200 A firm's internal controls are most accurately described as: A) directly affecting the firm’s financial reporting quality B) outside the scope of an audit report under IFRS and U.S GAAP C) a responsibility of the firm’s board of directors Explanation Weak internal controls provide an opportunity for low-quality or even fraudulent financial reporting A firm's management, not its board of directors, is responsible for ensuring the effectiveness of a firm's internal controls Under U.S GAAP, auditors are required to state an opinion on a firm's internal controls (Module 16.2, LOS 16.d) Question #16 of 25 Question ID: 1457206 The step in the financial statement analysis framework that includes making any appropriate adjustments to the financial statements and calculating ratios is best described as: A) analyzing and interpreting the data B) gathering the data C) processing the data Explanation The financial statement analysis framework consists of six steps: State the objective and context Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis Gather data Acquire the company's financial statements and other relevant data on its industry and the economy Ask questions of the company's management, suppliers, and customers, and visit company sites Process the data Make any appropriate adjustments to the financial statements Calculate ratios Prepare exhibits such as graphs and common-size balance sheets Analyze and interpret the data Use the data to answer the questions stated in the first step Decide what conclusions or recommendations the information supports Report the conclusions or recommendations Prepare a report and communicate it to its intended audience Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations Update the analysis Repeat these steps periodically and change the conclusions or recommendations when necessary (Module 16.2, LOS 16.f) Question #17 of 25 Question ID: 1457194 Which of the following statements regarding footnotes to the financial statements is least accurate? Financial statement footnotes: A) may contain information regarding contingent losses B) provide information about assumptions and estimates used by management C) typically include a discussion of the firm’s past performance and future outlook Explanation Discussion of a firm's past performance and future outlook is most likely to be found in management's commentary (Module 16.2, LOS 16.c) Question #18 of 25 Question ID: 1457198 Which of the following would NOT require an explanatory paragraph added to the auditors' report? A) Doubt regarding the "going concern" assumption B) Uncertainty due to litigation C) Statements that the financial information was prepared according to GAAP Explanation The statements that the financial information was prepared according to GAAP should be included in the regular part of the auditors' report and not as an explanatory paragraph The other information would be contained in explanatory paragraphs added to the auditors' report (Module 16.2, LOS 16.d) Question #19 of 25 Question ID: 1457185 Which of the following best describes financial reporting and financial statement analysis? Financial reporting refers to how companies show their financial performance A) and financial analysis refers to using the information to make economic decisions Financial reports assess a company’s past performance in order to draw B) conclusions about the company’s ability to generate cash and profits in the future C) The objective of financial analysis is to provide information about the financial position of an entity that is useful to a wide range of users Explanation Financial reporting refers to the way companies show their financial performance to investors, creditors, and other interested parties by preparing and presenting financial statements The objective of financial statements, not analysis, is to provide information about the financial position, performance and changes in financial position of an entity that is useful to a wide range of users in making economic decisions The role of financial statement analysis, not reporting, is to use the information in a company's financial statements, along with other relevant information, to assess a company's past performance in order to draw conclusions about the company's ability to generate cash and profits in the future (Module 16.1, LOS 16.a) Question #20 of 25 Question ID: 1457208 A) Continental National B) Continental Continental C) National Continental Explanation Continental likely has the highest gross profit margin percentage since it is selling a customized product and does not compete primarily based on price Because of the research and development costs of developing a new hybrid motorcycle, Continental likely has the higher operating expense stated as a percentage of total cost (Module 27.1, LOS 27.a) Question #3 of 24 Question ID: 1457944 Falcon Financial Group is considering the purchase of Company A or Company B based on a low price-to-book investment strategy that also considers differences in solvency Selected financial data for both firms, as of December 31, 20X7, follows: in millions, except per-share data Company A Company B Current assets $3,000 $5,500 Fixed assets $5,700 $5,500 Total debt $2,700 $3,500 Common equity $6,000 $7,500 500 750 $26.00 $22.50 Outstanding shares Market price per share The firms' financial statement footnotes contain the following: Company A values its inventory using the first in, first out (FIFO) method Company B's inventory is based on the last in, first out (LIFO) method Had Company B used FIFO, its inventory would have been $700 million higher Company A leases its manufacturing plant The remaining operating lease payments total $1,600 million Discounted at 10%, the present value of the remaining payments is $1,000 million Company B owns its manufacturing plant To make the firms financials ratios comparable, calculate the adjusted price-to-book ratios for Company A and Company B Company A Company B A) $1.63 $2.06 B) $2.17 $2.06 C) $2.17 $2.81 Explanation Company A should be adjusted for the operating lease liability and the related assets; however, adding the present value of the lease payments to both assets and liabilities does not change equity (book value) Thus, Company A's adjusted P/B ratio is 2.17 = [$26 price / ($6,000 million equity / 500 million shares)] Company B's inventory should be adjusted back to FIFO by adding the LIFO reserve to both assets and equity Thus, Company B's P/B ratio is 2.06 = $22.50 / [($7,500 million equity + $700 million LIFO reserve) / 750 million shares] (Module 27.2, LOS 27.e) Question #4 of 24 Question ID: 1462858 The most likely problem with using financial statement ratios to screen for stocks to include in a portfolio is that: A) specific industries are often over-represented B) firms with undesirable characteristics will be included C) firm characteristics are not identified well by financial statement measures Explanation It is often the case a screening metric, such as low P/E, high dividend yield, or high ROE, will identify many stocks in the same industry Undesirable characteristics can be avoided by including additional screening metrics Financial statement measures provide a great amount of information about a firm's characteristics (Module 27.2, LOS 27.d) Question #5 of 24 Question ID: 1457936 An analyst makes the following two statements: Statement #1 – From a lender's perspective, higher volatility of a borrower's profit margins is undesirable for floating-rate debt but not for fixed-rate debt Statement #2 – Product and geographic diversification should lower a borrower's credit risk With respect to these statements: A) both are correct B) both are incorrect C) only one is correct Explanation Margin stability is desirable from the lender's perspective for both floating-rate and fixedrate debt Higher volatility will increase credit risk Product and geographic diversification should lower credit risk as the borrower is less sensitive to adverse events and conditions (Module 27.2, LOS 27.c) Question #6 of 24 Question ID: 1457952 Among companies in a peer group for analysis, which of the following accounting differences would make the estimated useful life of property, plant, and equipment appear to be lower if an analyst does not adjust for them? A) U.S GAAP cost model, if peer companies use the IFRS cost model B) Higher estimated salvage values compared to those of peer companies C) Accelerated depreciation, if peer companies use straight-line depreciation Explanation Estimated useful life of PP&E assets (gross PP&E / annual depreciation expense) is likely to be lower for a company that uses an accelerated depreciation method than for a company that uses straight-line depreciation Higher salvage values would decrease annual depreciation expense and increase estimated useful life The cost model is identical under IFRS and U.S GAAP (Module 27.2, LOS 27.e) Question #7 of 24 Question ID: 1457930 Portsmouth Industries has stated that in the market for their medical imaging product, their strategy is to grow their market share in the premium segment by leveraging their research and development capabilities to produce machines with greater resolution for the most challenging cases of spinal degeneration An analyst examining their financials for subsequent periods would most likely conclude that they are successfully pursuing this strategy if she finds: A) an increase in gross margins greater than the increase in operating margins B) an increase in revenue and operating margins C) increasing research and development expense and decreasing operating margins Explanation A shift to premium, rather than commodity-like, products should result in higher gross margins, higher average revenue per unit (selling price per unit), and an increase in gross margins relative to operating margins (because of the increase in R&D and marketing expenditures) A successful shift to a premium product should increase operating margins rather than increase operating income through increased unit sales Revenue would not necessarily increase as the company shifted to premium products (Module 27.1, LOS 27.a) Question #8 of 24 Question ID: 1457947 To adjust for operating leases before calculating financial statement ratios, what value should an analyst add to a firm's liabilities? A) Present value of future operating lease payments B) Sum of future operating lease obligations C) Difference between present values of lease payments and the asset’s future earnings Explanation Before calculating ratios involving liabilities, an analyst should estimate the present value of operating lease obligations and add this value to the firm's liabilities (Module 27.2, LOS 27.e) Question #9 of 24 Question ID: 1457943 Comet Corporation is a capital intensive, growing firm Comet operates in an inflationary environment and its inventory quantities are stable Which of the following accounting methods will cause Comet to report a lower price-to-book ratio, all else equal? Inventory method Depreciation method A) Last-in, First-out Accelerated B) First-in, First-out Accelerated C) First-in, First-out Straight-line Explanation FIFO results in higher assets and higher equity in an inflationary environment as compared to LIFO Equity is higher because COGS is lower (and inventory higher) under FIFO Straight-line depreciation will result in greater assets and equity compared to accelerated depreciation for a stable or growing firm Equity is greater because depreciation expense is less with straight-line depreciation Greater equity will result in greater book value per common share, the denominator of the price-to-book ratio Greater book value per share will result in a lower price-to-book ratio (Module 27.2, LOS 27.e) Question #10 of 24 Question ID: 1457934 Jane Epworth, CFA, is preparing pro forma financial statements for Gavin Industries, a mature U.S manufacturing firm with three distinct geographic divisions in the Midwest, South and West Epworth prepares estimates of sales for each of Gavin's divisions using economists' estimates of next-period GDP growth and sums the three estimates to forecast Gavin's sales Epworth's approach to estimating Gavin's sales is: A) inappropriate, because sales should be forecast on a firm-wide basis B) appropriate C) inappropriate, because sales should be forecast on a firm-wide basis and are unlikely to be related to GDP growth Explanation Sales estimates can be more sophisticated than simply estimating a single growth rate One common approach is to estimate the linear relationship between sales growth and economic growth and use this relationship to estimate sales growth based on economists' forecasts of GDP growth Segment-by-segment analysis can also be applied, summing segment or division sales forecasts to produce an overall sales forecast for the firm (Module 27.1, LOS 27.b) Question #11 of 24 Question ID: 1457931 Sterling Company is a start-up technology firm that has been experiencing super-normal growth over the past two years Selected common-size financial information follows: 2007 Actual % of Sales 2008 Forecast % of Sales Sales 100% 100% Cost of goods sold 60% 55% Selling and administration expenses 25% 20% Depreciation expense 10% 10% Net income 5% 15% Non-cash operating working capitala 20% 25% a Non-cash operating working capital = Receivables + Inventory – Payables For the year ended 2007, Sterling reported sales of $20 million Sterling expects that sales will increase 50% in 2008 Ignoring income taxes, what is Sterling's forecast operating cash flow for the year ended 2008, and is this forecast likely to be as reliable as a forecast for a large, well diversified, firm operating in mature industries? Operating cash flow Reliable forecast A) $4.0 million No B) $4.0 million Yes C) $4.5 million No Explanation 2008 sales are expected to be $30 million ($20 million 2007 sales × 1.5) and 2008 net income is expected to be $4.5 million ($30 million 2008 sales × 15%) 2007 non-cash operating working capital was $4 million ($20 million 2007 sales × 20%) and 2008 non-cash operating working capital is expected to be $7.5 million ($30 million 2008 sales × 25%) 2008 operating cash flow is expected to be $4 million ($4.5 million 2008 net income + $3 million 2008 depreciation – $3.5 million increase in non-cash operating working capital) Forecasts for small firms, start-ups, or firms operating in volatile industries may be less reliable than a forecast for a large, well diversified, firm operating in mature industries (Module 27.1, LOS 27.b) Question #12 of 24 Question ID: 1457933 For 2007, Morris Company had 73 days of inventory on hand Morris would like to decrease its days of inventory on hand to 50 Morris' cost of goods sold for 2007 was $100 million Morris expects cost of goods sold to be $124.1 million in 2008 Assuming a 365 day year, compute the impact on Morris' operating cash flow of the change in average inventory for 2008 A) $3.0 million use of cash B) $6.3 million source of cash C) $3.0 million source of cash Explanation 2007 inventory turnover was (365 / 73 days in inventory) Given inventory turnover and COGS, 2007 average inventory was $20 million ($100 million COGS / inventory turnover) 2008 inventory turnover is expected to be 7.3 (365 / 50 days in inventory) Given expected inventory turnover, 2008 average inventory is $17 million ($124.1 million COGS / 7.3 expected inventory turnover) To achieve 50 days of inventory on hand, average inventory must decline $3 million ($20 million 2007 average inventory – $17 million 2008 expected inventory) A decrease in inventory is a source of cash (Module 27.1, LOS 27.b) Question #13 of 24 Question ID: 1457940 An analyst screening potential equity investments to identify value stocks is most likely to exclude companies with: A) high dividend payout ratios B) low earnings growth rates C) high price-to-earnings ratios Explanation Value stocks are considered to be those that have low prices relative to earnings (or relative to sales, cash flow, or book value) Screens that exclude firms with low earnings growth rates or high dividend payout ratios are more likely to be used to identify growth stocks (Module 27.2, LOS 27.d) Question #14 of 24 Question ID: 1457938 Selected financial information gathered from Alpha Company and Omega Corporation follows: Alpha Revenue Omega $1,650,000 $1,452,000 Earnings before interest, taxes, depreciation, and amortization 69,400 79,300 Quick assets 216,700 211,300 Average fixed assets 300,000 323,000 Current liabilities 361,000 404,400 Interest expense 44,000 58,100 Which of the following statements is most accurate? A) Omega has lower interest coverage than Alpha B) Omega uses its fixed assets more efficiently than Alpha C) Alpha has a higher operating profit margin than Omega Explanation Using the EBITDA coverage ratio (EBITDA / Interest expense), Omega's EBITDA coverage is 1.4 ($79,300 EBITDA / $58,100 interest expense) and Alpha's EBITDA coverage is 1.6 ($69,400 EBITDA / $44,000 interest expense) Using EBITDA to measure operating profit, Alpha has a lower operating profit margin than Omega Alpha's EBITDA margin is 4.2% ($69,400 EBITDA / $1,650,000 revenue) and Omega's EBITDA margin is 5.5% ($79,300 EBITDA / $1,452,000 revenue) Using fixed asset turnover to measure the efficiency of fixed assets, Omega uses its fixed assets less efficiently than Alpha Alpha's fixed asset turnover is 5.5 ($1,650,000 revenue / $300,000 average fixed assets) and Omega's fixed asset turnover is 4.5 ($1,452,000 revenue / $323,000 average fixed assets) (Module 27.2, LOS 27.c) Question #15 of 24 Question ID: 1457941 An analyst has decided to identify value stocks for investment by screening for companies with high book-to-market ratios and high dividend yields A potential drawback of using these screens to find value stocks is that the firms selected may: A) be those that have significantly underperformed the market B) have unsustainable dividend payments C) be concentrated in specific industries Explanation A screen for firms with high dividend yields and high book-to-market ratios would likely result in an inordinate proportion of financial services companies and add a significant element of industry (sector) risk Uncertainty about sustainability of dividend payments and recent market underperformance are typical characteristics of value stocks in general and not a drawback to using this screen to identify them (Module 27.2, LOS 27.d) Question #16 of 24 Question ID: 1457932 Baetica Company reported the following selected financial statement data for the year ended December 31, 20X7: in millions % of Sales For the year ended December 31, 20X7: $500 100% Sales Cost of goods sold (300) 60% Selling and administration expenses (125) 25% Depreciation (50) 10% Net income $25 5% Non-cash operating working capitala $100 20% Cash balance $35 N/A As of December 31, 20X7: aNon-cash operating working capital = Receivables + Inventory – Payables Baetica expects that sales will increase 20% in 20X8 In addition, Baetica expects to make fixed capital expenditures of $75 million in 20X8 Ignoring taxes, calculate Baetica's expected cash balance, as of December 31, 2008, assuming all of the common-size percentages remain constant A) $40 million B) $80 million C) $30 million Explanation 2008 sales are expected to be $600 million ($500 million 2007 sales × 1.2) and 20X8 net income is expected to be $30 million ($600 million 20X8 sales × 5%) 2008 non-cash operating working capital is expected to be $120 million ($600 million 20X8 sales × 20%) The change in cash is expected to be –$5 million ($30 million 20X8 net income + $60 million 20X8 depreciation – $20 million increase in non-cash operating working capital – $75 million 20X8 capital expenditures) The 20X8 ending balance of cash is expected to be $30 million ($35 million beginning cash balance – $5 million decrease in cash) (Module 27.1, LOS 27.b) Question #17 of 24 Question ID: 1457935 In estimating pro forma cash flows for a company, analysts typically hold which of the following factors constant? A) Repayments of debt B) Noncash working capital as a percentage of sales C) Sales Explanation To estimate pro forma cash flows, the analyst must make assumptions about future sources and uses of cash The most important of these will be increases in working capital, capital expenditures on new fixed assets, issuance or repayments of debt, and issuance or repurchase of stock A typical assumption is that noncash working capital will remain constant as a percentage of sales (Module 27.1, LOS 27.b) Question #18 of 24 Question ID: 1457946 Patch Grove Nursery uses the LIFO inventory accounting method Maria Huff, president, wants to determine the financial statement impact of changing to the FIFO accounting method Selected company information follows: Year-end inventory: $22,000 LIFO reserve: $4,000 Change in LIFO reserve: $1,000 LIFO cost of goods sold: $18,000 After-tax income: $2,000 Tax rate: 40% Under FIFO, the nursery's ending inventory and after-tax profit for the year would have been: FIFO ending inventory FIFO after-tax profit A) $26,000 $2,600 B) $18,000 $2,600 C) $26,000 $1,400 Explanation FIFO ending inventory = LIFO ending inventory + LIFO reserve = 22,000 + 4,000 = $26,000 FIFO after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 – t) = $2,000 + ($1,000)(1 – 0.4) = $2,000 + $600 = $2,600 (Module 27.2, LOS 27.e) Question #19 of 24 Question ID: 1457949 LIFO ending inventory can be adjusted to a FIFO basis by: A) subtracting the change in the LIFO reserve B) adding the change in the LIFO reserve C) adding the LIFO reserve Explanation LIFO ending inventory can be adjusted to a FIFO basis by adding the LIFO reserve, which a firm using LIFO must disclose in the notes to its financial statements (Module 27.2, LOS 27.e) Question #20 of 24 Question ID: 1457939 Other things equal, which of the following firm characteristics are most likely to be viewed favorably by credit rating agencies? A) Large size in a concentrated geographic region B) Large size and diverse product lines C) Focused product line in widespread geographic regions Explanation Other things equal, credit rating agencies tend to rate larger companies and those with diversified product lines and greater geographic diversification to be better credit risks (Module 27.2, LOS 27.c) Question #21 of 24 Question ID: 1457948 A firm recognizes a goodwill impairment in its most recent financial statement, reducing goodwill from $50 million to $40 million How should an analyst most appropriately adjust this financial statement for goodwill when calculating financial ratios? A) Make no adjustments to assets or earnings because both reflect the impairment B) Decrease earnings but make no adjustment to assets C) Decrease assets and increase earnings Explanation The recommended adjustment for goodwill before calculating financial ratios is to remove goodwill from the balance sheet (decreasing assets) and reverse any losses recognized due to goodwill impairment (increasing earnings) (Module 27.2, LOS 27.e) Question #22 of 24 Question ID: 1457950 A firm that uses higher estimates of assets' useful lives or salvage values relative to its peers will report: A) lower depreciation expense and lower net income B) higher depreciation expense and higher net income C) lower depreciation expense and higher net income Explanation Estimates of useful lives or salvage values that are too high will result in lower depreciation expense and higher net income (Module 27.2, LOS 27.e) Question #23 of 24 Question ID: 1457937 When assessing credit risk, which of the following ratios would best measure a firm's tolerance for additional debt and a firm's operational efficiency? Ratio #1 – Retained cash flow (CFO – dividends) divided by total debt Ratio #2 – Current assets divided by current liabilities Ratio #3 – Earnings before interest, taxes, depreciation, and amortization divided by revenues Tolerance for leverage Operational efficiency A) Ratio #2 Ratio #3 B) Ratio #1 Ratio #3 C) Ratio #3 Ratio #1 Explanation A firm's tolerance for additional debt can be measured by its capacity to repay debt Retained cash flow divided by total debt is one of several measures that can be used Operational efficiency refers to the firm's cost structure and can be measured by the "margin" ratios EBITDA divided by sales is one version of an operating margin ratio The current ratio is a measure of short-term liquidity (Module 27.2, LOS 27.c) Question #24 of 24 Question ID: 1457951 A firm has a debt-to-equity ratio of 0.50 and debt equal to $35 million The firm acquires new equipment with a 3-year operating lease that has a present value of lease payments of $12 million The most appropriate analyst treatment of this operating lease will: A) leave the debt-to-equity ratio unchanged at 0.5 B) increase the debt-to-equity ratio to 0.57 C) increase the debt-to-equity ratio to 0.67 Explanation Shareholders' equity = $35 million / 0.5 = $70 million The most appropriate analyst adjustment for an operating lease is to add the present value of lease payments to the firm's assets and long-term debt (leaving equity unchanged) This will result in a debt-toequity ratio of ($35 million + $12 million) / $70 million = 0.6714 (Module 27.2, LOS 27.e) ... following best describes financial reporting and financial statement analysis? Financial reporting refers to how companies show their financial performance A) and financial analysis refers to using... considered the role of financial statement analysis (Module 16.1, LOS 16.a) Question #10 of 25 Question ID: 1457184 Which of the following statements about financial statement analysis and reporting... preparing and presenting financial statements The objective of financial statements, not analysis, is to provide information about the financial position, performance and changes in financial position