Question 1

Common sized analysis is useful for making comparisons across the various financial statements.

Accepted Answer

False

Question 2

The auditor's report guarantees the accuracy of the information presented in the financial statements.

Accepted Answer

The auditor's report does not guarantee the accuracy of the information presented in the financial statements. Rather, it provides an opinion on whether the financial statements are presented fairly in all material respects, in accordance with the applicable financial reporting framework.

Question 3

When calculating the EPS, the cumulative preferred dividends must be removed even if the dividends have not been declared and paid.

Accepted Answer

According to accounting principles, the cumulative preferred dividends are considered as an obligation and must be subtracted from the net income to arrive at the earnings available to common shareholders. This is irrespective of whether the dividends have been declared or not.

Question 4

Ratio analysis provides a complete picture of the general financial health and wellbeing of a company.

Accepted Answer

Ratio analysis is a useful tool for evaluating financial performance, but it does not provide a complete picture as it relies on historical data and does not account for external factors such as market conditions or economic trends.

Question 5

Analyzing financial data on the same company over time is called cross sectional analysis.

Accepted Answer

Cross sectional analysis involves analyzing financial data for different companies in the same industry at the same point in time, while analyzing financial data on the same company over time is called time series analysis.

Question 6

A banker assessing a loan application and an equity analyst making an investment decision would perform the same type of analysis of a company.

Accepted Answer

While both a banker and an equity analyst may analyze some of the same financial statements of a company (such as income statements and balance sheets), they are looking for different things. A banker is primarily concerned with the borrower's ability to repay the loan, while an equity analyst is interested in the company's potential for earnings growth and stock price appreciation. Therefore, their analysis will differ in terms of the specific financial ratios and metrics they evaluate.

Question 7

Times series analysis compares the data from one company with the data from another company.

Accepted Answer

Time series analysis compares data over time within a single company, not between different companies.

Question 8

When a company can leverage funds at a rate that is less than the after-tax return on assets, the return on equity will exceed the return on assets.

Accepted Answer

This is because leveraging funds at a lower rate results in a lower cost of capital for the company, allowing them to earn a higher return on the assets they invest in. This increased return on assets then translates into a higher return on equity for shareholders.

Question 9

Fully diluted earnings per share is a worst case scenario.

Accepted Answer

Fully diluted earnings per share takes into account all potential dilutive securities, including stock options, warrants, and convertible securities. This calculation assumes that all of these securities are converted into common shares, which results in the highest possible number of outstanding shares and thus a lower earnings per share. Therefore, fully diluted earnings per share is considered a worst case scenario for investors.

Question 10

The point of leverage where a company's ROE is maximized is referred to as its optimal capital structure.

Accepted Answer

This is true. The optimal capital structure refers to the combination of debt and equity that maximizes a company's return on equity (ROE) and minimizes its cost of capital. At this point, the company is achieving the highest possible level of profitability while maintaining an acceptable level of risk.

Question 11

Activity ratios measure how efficiently or effectively a company is managing its short term assets and short term obligations.

Accepted Answer

Activity ratios, also called efficiency ratios, are designed to measure a company's ability to use its assets efficiently to generate sales or revenue. These ratios include inventory turnover, accounts receivable turnover, and accounts payable turnover ratios. They assess how effectively a company is managing its short-term assets and obligations.

Question 12

Retrospective analysis reviews past trends in order to help predict the future.

Accepted Answer

Retrospective analysis looks at past data and trends in order to make predictions about future outcomes.

Question 13

A basic understanding of the range of businesses in which a company is engaged can be obtained by reading the financial statements.

Accepted Answer

The answer of A basic understanding of the range of...

Question 14

The appropriate tax rate to use in the return on assets formula is a company's average tax rate.

Accepted Answer

The appropriate tax rate to use in the return on assets (ROA) formula is not a specific tax rate; the ROA formula typically does not directly incorporate tax rates. ROA is calculated by dividing net income by total assets, focusing on a company's efficiency in using its assets to generate earnings.

Question 15

Return on equity is a measure of performance from management's perspective.

Accepted Answer

The answer of Return on equity is a measure of...

Question 16

The current ratio is an activity ratio.

Accepted Answer

The current ratio is a liquidity ratio, measuring a company's ability to pay short-term obligations with its short-term assets.

Question 17

The denominator in the return on equity ratio should only include the equity accounts that belong to the common shareholders.

Accepted Answer

The return on equity ratio measures the profitability of a company in relation to the amount of equity invested by common shareholders. Therefore, the denominator should only include equity accounts that belong to the common shareholders, such as common stock and retained earnings. Other equity accounts like preferred stock and treasury stock should not be included.

Question 18

Common size income statement analysis uses net revenues as a base for all percentages.

Accepted Answer

The answer of Common size income statement analysis uses net...

Question 19

The return on assets ratio can be broken into two elements: the profit margin and the total equity turnover.

Accepted Answer

The return on assets (ROA) ratio is typically broken down into two elements: the profit margin and the asset turnover ratio, not the total equity turnover.

Question 20

On a common size income statement, all items are shown as:

Accepted Answer

On a common size income statement, all items are shown as percentages of gross revenue to allow for better comparison of financial performance across different companies and industries.

Quiz 12: Financial Statement Analysis