Financial Statement Analysis MCQ Questions With Answers Part 2

Q1) The term "goodwill" refers to the value created by a company based on its past performance and future prospects.

A. Potential goodwill.

B. Economic goodwill.

C. Accounting goodwill.

Correct Answer: B

Explanation: According to accounting standards, only acquisitions where the purchase price exceeds the fair value of the acquired company's net assets are required to be recorded as goodwill in the accounting records. A company's performance and future prospects are used to determine the value of economic goodwill, which is not included on the balance sheet.

Q2) The interest on convertible debt is included in the numerator for diluted Earnings Per Share.

A) After tax adjustments, added to earnings available to common shareholders

B) Earnings available to common shareholders are increased.

C) After tax adjustments, subtracted from earnings available to common shareholders

Correct Answer: A

Explanation: Formula = Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options)]

Q3) The following are the most likely metrics to use if management wants to report an increasing return on assets over time:

A. Accelerated depreciation method.

B. Straight line method.

C. units of production method.

Correct Answer: A

Explanation: Asset turnover, operating profit margins, and return on assets all improve as a result of the use of expedited depreciation methods over the long term.

Q4) If all other variables remain constant, an increase in a company's asset turnover will result in an increase in its return on equity.

A) will increase.

B) will decrease.

C) may increase, decrease, or remain the same.

Correct Answer: A

Explanation: The DuPont decomposition (ROE = net profit margin X asset turnover X leverage ratio) demonstrates that ROE will increase if asset turnover increases, assuming that net profit margin and leverage remain constant, as long as net profit margin and leverage remain constant.

Q5) Which of the following is the most likely source of information for an analyst seeking to learn more about a company's operating activities?

A. Dividends declared

B. Accounts receivable

C. Goodwill

Correct Answer: B

Explanation: A company's operating activities are likely to be evaluated by an analyst by looking at its current assets, which include accounts receivable.

Q6) If a company has a longer operating cycle than its competitors, it means that it:

A) has a higher ratio of payables turnover than its competitors.

B) has a higher inventory turnover ratio than the majority of its competitors

C) credit terms to its customers that are more lenient than those of its competitors

Correct Answer: C

Explanation: Credit terms that are more lenient can be expected to increase the number of days receivables are outstanding and, as a result, the operating cycle.

Q7) A higher turnover of working capital is indicative of

A. Higher operating efficiency.

B. Lower liquidity management.

C. Poor operating efficiency.

Correct Answer: A

Explanation: In general, a higher working capital turnover ratio indicates that the company is generating revenue from its working capital as efficiently as possible.

Q8) What will be seen by a user who is interested in learning about the current state of a company's assets is the following:

A. Balance sheet.

B. Cash flow statement.

C. Income statement.

Correct Answer: A

Explanation: It is the balance sheet that contains information about the company's assets, liabilities, and owners' equity.

Q9) Working capital is the excess of a company’s:

A. Assets over its liabilities.

B. Noncurrent liabilities over its noncurrent assets.

C. Current assets over its current liabilities.

Correct Answer: C

Explanation: Working capital is calculated as current assets less current liabilities.

Q10) In order to assess a company's ability to meet its long-term obligations, an analyst will look at its ability to do so in the following ways:

A. Total debt ratio.

B. Net operating cycle.

C. Quick ratio.

Correct Answer: A

Explanation: To determine a company's ability to meet its long-term obligations, the total debt to total assets ratio (total debt divided by total assets) is calculated.

Q11) When a company requires short-term financing, which of the following factors is most likely to be present?

A) The return of principal from investments that have reached maturity.

B) Compared to the industry average, cash conversion cycle is shorter.

C) Seasonal fluctuations in operating cash inflows are expected.

Correct Answer: C

Explanation: Firms with seasonal fluctuations in operating cash inflows are likely to experience short-term imbalances between cash inflows and cash outflows, and they must forecast these imbalances in order to manage their net daily cash positions. For example, firms with seasonal fluctuations in operating cash inflows may arrange short-term borrowing over seasons when operating cash inflows are expected to be relatively low and operating cash outflows are expected to be relatively high.

Q12) Is it possible to predict how a reduction in accounts receivable and an increase in accounts payable will affect a company's operating cash flow?

A) Increasing operating cash flow is one thing, and decreasing operating cash flow is quite another.

B) Both of these will result in an increase in operating cash flow.

C) Both of these will have a negative impact on operating cash flow.

Correct Answer: B

Explanation: It is an indication that cash collections have outpaced revenue growth if the amount of accounts receivable on the balance sheet has decreased (sales). This results in an increase in operating cash flow due to the fact that receivables are now being collected. Purchases from suppliers have outpaced cash payments on the balance sheet, as indicated by an increase in the amount of accounts payable on the balance sheet. This results in an increase in operating cash flow because the cash was not used to pay the suppliers, as opposed to the previous scenario.

Q13) Which of the following statements about the calculation of earnings per share is the most accurate and why?

A) If the diluted earnings per share (EPS) is less than the basic earnings per share, the diluted earnings per share is said to be anti-dilutive.

B) When calculating diluted earnings per share, you must first add the shares created as a result of the bond conversion to the denominator, and then add the interest expense multiplied by the tax rate to the numerator.

C) Both of these options are incorrect.

Correct Answer: C

Explanation: Anti-dilutive is when dilutive EPS > basic EPS. When calculating diluted EPS, you must add the shares created from the conversion of the bonds to the denominator and the interest (1 – tax rate) to the numerator.

Q14) Which of the following types of assets is will be amortized

A. Goodwill

B. Tangible assets with finite useful lives

C. Intangible assets with finite lives

Correct Answer: C

Explanation: Intangible assets with a limited useful life are depreciated over the course of their respective useful lives.

Q15) If an analyst wants to look into a company's revenue recognition policies, what will consult the following documents:

A. Management discussion and analysis.

B. Financial statement footnotes.

C. Additional supplementary schedules.

Correct Answer: B

Explanation: Generally, companies are required to disclose their revenue recognition policies in the footnotes of their financial statements.