Introduction to Financial Statement Analysis quiz

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 footnotes are an integral part of the audited financial statements in a firm's annual report and are included in the audit opinion .

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.

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.

The standard auditor's report contains three parts :

1. The financial statements are prepared by management and are their responsibility and the auditor has performed an independent review.
2. The audit was conducted using generally accepted auditing standards, which provides reasonable assurance that there are no material errors in the financial statements .
3. 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 .

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.

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.

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.

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 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 .

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.

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 .

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.

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.

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 .

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 .

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 .

 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 .

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) .

These are components of management commentary.

For a publicly traded firm in the United States, the auditor must express an opinion as to whether the company’s internal control system is in accordance with the Public Accounting Oversight Board, under the Sarbanes–Oxley Act. The opinion is given either in a final paragraph in the auditor’s report or as a separate opinion.

(state that the financial statements are prepared according to generally accepted accounting principles) is incorrect. The statements are those prepared by management, not the auditor. The auditor is expressing an opinion as to whether the statements are fairly presented and free from material error.

(ensure that the financial statements are free from error, fraud, or illegal acts) is incorrect. The auditor only provides reasonable assurance that the statements are free from material error.

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 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.

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.

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 .

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 .

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.

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.

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

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