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This set of Financial Statement Analysis MCQ questions and answers focuses on accounting ratio analysis, forecasting methods and cash flow analysis.
Q1) An asset and liability classification system is used to group various classes of assets and liabilities together in a balance sheet.
A. Pro-forma balance sheet.
B. Classified balance sheet.
C. Common-size balance sheet.
Correct Answer: B
Explanation: A classified balance sheet is one in which different types of assets and liabilities are grouped together into subcategories in order to provide a more effective overview of the company's financial position.
Q2) The presence of an increase in which of the following ratios most likely indicates an improvement in a company's solvency situation?
A. Financial leverage ratio
B. Debt-to-equity ratio
C. Fixed charge coverage ratio
Correct Answer: C
Explanation: An increase in the Debt to-Equity ratio as well as the financial leverage ratio indicates that the solvency position is deteriorating. An increase in the fixed charge coverage ratio suggests that the company will be able to service its debt obligations with greater ease from operating earnings in the future.
Q3) Which of the following is incorrect option as a secondary source of liquidity?
A. Short-term funds
B. Liquidating assets
C. Long term funds
Correct Answer: A
Explanation: Short-term funds are the most important source of liquidity in the company.
Q4) Which of the following are the correct option current assets that result from the accrual process:
A) Cash equivalents.
B) accounts receivable.
C) Marketable securities.
Correct Answer: B
Explanation: The accrual process refers to the accounting for transactions in which revenue or expense recognition does not occur at the same time as the exchange of money. As an example, accounts receivable represents revenue from sales of goods and services that have been recorded as revenue, but for which the company has not yet received payment in cash. Financial instruments with high liquidity, such as Treasury bills, in which a company typically invests its short-term cash balances include "cash equivalent" securities.
Q5) When the return on equity equation (ROE) is decomposed using the original DuPont system, which three ratios make up the components of the return on equity equation (ROE) are revealed?
A) Gross profit margin, asset turnover, equity multiplier.
B) Net profit margin, asset turnover, equity multiplier.
C) Net profit margin, asset turnover, asset multiplier.
Correct Answer: B
Explanation: The three ratios can be further decomposed as follows:
Net profit margin = net income/sales
Asset turnover = sales/assets
Equity multiplier = assets/equity
Q6) The balance sheet of a company indicates whether or not the company has sufficient cash and short-term investments. The company's payables turnover ratio, on the other hand, remains low.
A. The company has a liquidity crisis.
B. Suppliers to the company provide it with favourable credit terms.
C. The company has excellent policies in place for collecting receivables.
Correct Answer: B
Explanation: If a company has sufficient liquid assets while maintaining a low payables turnover ratio, it is likely that its suppliers will offer lenient credit and collection terms to attract business.
Q7) According to which financial statement do you need to know information about a company's financial position at a specific time period?
A) Income Statement.
B) cash flow statement.
C) Balance Sheet.
Correct Answer: B
Explanation: The balance sheet summarizes the financial position of a company at a specific point in time. The income statement and the cash flow statement, on the other hand, are financial statements that report a company's financial performance over a specified period of time.
Q8) When determining whether a company has the ability to meet its long-term debt obligations, which of the following classifications of ratios is most likely to be used?
A. Liquidity ratios
B. Solvency ratios
C. Activity ratios
Correct Answer: B
Explanation:
Solvency ratios are used to assess a company's ability to pay its long-term debt obligations.
Q9) Taxable temporary differences would arise when:
A. The carrying amount of a liability is greater than the liability's tax base.
B. The carrying value of an asset is greater than its tax base.
C. The carrying value of an asset is less than the tax base of the asset..
Correct Answer: B
Explanation: Taxable temporary differences or deferred tax liabilities arise when the carrying amount of an asset exceeds the tax base of the asset or when the carrying amount of a liability exceeds the tax base of the liability, respectively.
Q10) Depreciation expense would be classified as:
A) no cash flow impact.
B) investing cash flow.
C) operating cash flow.
Correct Answer: A
Explanation: Depreciation expense has no cash flow impact.
Q11) Deferred revenue is classified under as:
A. A liability.
B. An asset.
C. Owner’s equity.
Correct Answer: A
Explanation: Deferred or unearned revenue is classified as a liability.
Q12) Identify which of the following sources of short-term financing is most likely to be utilized by small businesses:
A. Overdraft line
B. Revolving credit agreement
C. Uncommitted lines of credit
Correct Answer: A
Explanation: Large and small businesses alike utilise overdraft lines.
Q13) Identify which of the following statements about a company that has convertible preferred stock on its books is the most accurate.
A) If the diluted and basic earnings per share are equal, the company is required to report both the basic and diluted earnings per share in its financial statements.
B) The numerator of diluted earnings per share is calculated by subtracting net income from preferred dividends.
C) When diluted earnings per share (EPS) is less than basic earnings per share (EPS), the convertible preferred is said to be antidilutive.
Correct Answer: A
Explanation: If a company has any potentially dilutive securities outstanding, it is required to report both basic and diluted earnings per share, even if the two figures are equal. If convertible preferred stock dilutes earnings per share, the preferred dividend is re-added to the numerator as if the preferred stock had been converted to common stock instead of preferred stock. When diluted earnings per share (EPS) is less than basic earnings per share, the convertible preferred is said to be dilutive.
Q14) In the context of financial reporting and analysis, which of the following best describes the situation?
A) Financial reporting refers to the manner in which companies present their financial performance, whereas financial analysis refers to the process of using the information to make economic decisions based on the information.
B) Financial reporting refers to the manner in which companies present their financial performance, whereas financial analysis refers to the process of using the information to make economic decisions based on the information.
C) In order to provide information about an entity's financial position that is useful to a wide range of users, financial analysis must first establish the entity's financial position.
Correct Answer B
Explanation: When it comes to financial reporting, it refers to the process by which businesses demonstrate their financial performance to investors, creditors, and other interested parties through the preparation and presentation of financial statements. The purpose of financial statements, rather than their analysis, is to provide information about an entity's financial position, performance, and changes in financial position that is useful to a wide range of users in making economic decisions. Financial statements are not intended to be analytical tools. The purpose of financial statement analysis, rather than financial statement reporting, is to use the information contained 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. Financial statement analysis is distinct from financial statement reporting in that it is concerned with the analysis of financial statements rather than the reporting of financial statements.
Q15) When comparing businesses, the ratio analysis method is the most useful tool.
A) in a variety of industries that use the same financial reporting standards
B) different in terms of size within the same industry
C) that are involved in a variety of different business lines
Correct Answer: B
Explanation: When comparing companies that are similar in operations but different in size, ratio analysis can be a useful tool. It is common for ratios of companies that operate in different industries to be incompatible with one another. When a company operates in multiple industries, the ability to conduct ratio analysis is limited due to the difficulty in determining appropriate industry benchmarks.