Introduction to Financial Statement Analysis quiz

The balance sheet reports a company's financial position at a point in time. In contrast, theincome statement and the cash flow statement report a company's financial performanceover a reporting period .

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

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 financial statement analysis framework consists of six steps :

1. State the objective and context. Determine what questions the analysis is meant toanswer, the form in which it needs to be presented, and what resources and howmuch time are available to perform the analysis.

2. Gather data. Acquire the company's financial statements and other relevant data onits 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 thefirst step. Decide what conclusions or recommendations the information supports.

5. Report the conclusions or recommendations. Prepare a report and communicate itto its intended audience. Be sure the report and its dissemination comply with theCode and Standards that relate to investment analysis and recommendations.

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

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 .

Discussion of a firm's past performance and future outlook is most likely to be found inmanagement's commentary.

The role of financial reporting is described by the International Accounting StandardsBoard (IASB) in its "Framework for the Preparation and Presentation of FinancialStatements" :

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 ofusers in making economic decisions .

Using the information in a company's financial statements to make economic decisions isfinancial analysis, not financial reporting .

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 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.

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

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 .

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

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 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.

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

The statements that the financial information was prepared according to GAAP should beincluded 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 theauditors' report.

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

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.

This is the role of financial reporting. The role of financial statement analysis is to evaluate the financial reports.

Securities and Exchange Commission (SEC) filings are available from EDGAR (ElectronicData Gathering, Analysis, and Retrieval System, www.sec.gov). Companies' annual andquarterly financial statements are also filed with the SEC (Form 10-K and Form 10-Q,respectively) .

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

These are components of management commentary.

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 .

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

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 .

IFRS recommends that management commentary address the company's keyrelationships, 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 do not .

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 .