Introduction to Financial Statement Analysis quiz

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 .

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 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 .

Preparing common-size financial statements is part of the process data step.

(Collect data) is incorrect. The financial statements are obtained in the collect data step, but not converted into common-size statements until the process step.

(Analyze/interpret data) is incorrect. Preparing common-size financial statements is part of the process data stage, after which the analyst will analyze/interpret the processed data.

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.

(profitability) is incorrect. Assessment of performance includes analysis of profitability.

(cash flow generating ability) is incorrect. Assessment of performance includes analysis of cash flow generating ability.

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 .

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 .

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 .

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.

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 .

The notes disclose information about the accounting policies, methods, and estimates used to prepare the financial statements.

(a discussion of significant trends, events, and uncertainties that affect the operating results) is incorrect. 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.

(an auditor’s opinion as to the fair presentation of the financial statements) is incorrect. 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.

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 .

Proxy statements contain information related to matters that come before shareholders for a vote, such as elections of board members .

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 .

 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 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 .

The balance sheet reports a company’s Financial position as of a specific date. The income statement, cash flow statement, and statement of changes in owners’ equity show the company’s performance during a specific period .

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

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.

(Share repurchase ) is incorrect because for the paid-in capital account an example of a decrease in owners’ equity is the repurchase of previously issued shares.

(Cash dividend) is incorrect because a cash dividend payment is the most common cause of a decrease in owners’ equity.

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.

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 .

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.

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

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.

Auditors make an independent review of financial statements, which are prepared by company management and are management's responsibility. It is the responsibility of auditors to confirm the assets, liabilities, and other items included in the statements and then issue an opinion concerning their fairness and reliability.

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.

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.

Corporate reports and press releases are written by management and are often viewed as public relations or sales materials. An analyst should review information on the economy and the company's industry and compare the company to its competitors. This information can be acquired from sources such as trade journals, statistical reporting services, and government agencies. Securities and Exchange Commission (SEC) filings include Form 8-K, which a company must file to report events such as acquisitions and disposals of major assets or changes in its management or corporate governance and proxy statements, which are a good source of information about the election of (and qualifications of) board members, compensation, management qualifications, and the issuance of stock options.

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