Introduction to Financial Statement Analysis quiz

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 .

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 .

The financial statement analysis framework consists of six steps. Step 2: "Gather data" includes acquiring the company's financial statements and other relevant data on its industry and the economy. Step 3. "Process the data" includes activities such as making any appropriate adjustments to the financial statements and preparing exhibits such as graphs and common-size balance sheets.

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

auditor will issue a qualified opinion if the financial statements make any exceptions to applicable accounting standards and will explain the effect of these exceptions in the auditor’s report .

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.

 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 .

These are components of management commentary.

This statement describes the role of an auditor, rather than the role of an analyst. The other responses describe the role of financial statement analysis .

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

(future revenue projections must be disclosed) 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.

(management commentary is typically unaudited) 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.

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 .

Interim reports, either quarterly or semi-annual, contain updated information on a company’s performance and financial position since the last annual report.

(management discussion and analysis) is incorrect . The MD&A is part of the annual report and is not an update since the last annual report .

(proxy statements) is incorrect . Proxy statements contain information about matters that will be put to a vote at shareholders’ meetings .

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.

Information about accounting methods and estimates is contained in the footnotes to the financial statements .

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 .

The financial statement analysis framework consists of six steps :

1. 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.

2. 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.

3. Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.

4. 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. 

5. 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.

6. Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.

To be in compliance with Sarbanes–Oxley, it is mandatory that management’s Report to Shareholders discuss internal financial controls and their effectiveness, as well as the company’s auditor’s opinion of these internal controls.

(The suitability of management and director compensation agreements) is incorrect. Information on management and director compensation agreements will be found in the proxy statement and/or notes to the financial statements.

(The accuracy of estimates and assumptions used in preparing the financial statements) is incorrect. Estimates and assumptions used in preparing financial statements are found in the notes to the financial statements.

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

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.

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 balance sheet represents information at a specific point in time. The income  statement represents information over a period of time .

Interim reports are provided semi-annually or quarterly, depending on applicable regulatory requirements.

(are audited) is incorrect. Interim reports are not audited.

(include a full set of financial statements and notes) is incorrect. Interim reports generally present the four basic financial statements and condensed notes.

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.

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) .

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.

(the audit report) is incorrect. Audit reports express an opinion about the fair presentation of the financial statements.

(financial statement analysis) is incorrect. 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 .

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 .

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.

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 .

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 .

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.