3 Financial Reporting and Analysis Questions

Financial Reporting and Analysis
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Question 1
The owner's contribution in a company is $45,000. The company pays dividends in the current year on its
net income of $37,500. The payout ratio being 22.67%. If the retained earnings in the previous year was
$ 30,000. Find the current balance of the owner's equity.
A. $59,000
B. $104,000
C. $75,000
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Solution 1
B.
Balance (prev year) Contributed capital Retained earnings Total

$45,000 $30,000 $75,000
Net income $37,500 $37,500
Distributions ($8,500) ($8,500)
Balance $45,000 $59,000 $104,000

Question 2
▪ Strauss Corporation purchases a machine for $50,000. The machine has a useful life of 5 years and
no residual value. If the double declining method is used which of the following is least likely correct
about the depreciation expense?
A. The depreciation expense in year 3 is $7,200
B. The DDM will never fully depreciate the machine
C. The straight line method should be used for year 4 and 5 for depreciating the asset completely

Solution 2
▪ C.
After the asset reaches the salvage value, the depreciation expense by using Double Declining Balance
Method is taken as zero for all subsequent years.

Question 3
▪ Goodman and Co has issued $2 million as cash dividend to its preferred share holders and $3.5
million as cash dividend to its common share holders. The net income of the company at the
beginning of the year was $180 million. The company issued 120,000 new shares in July in addition
to the already existing 300,000 outstanding shares in the beginning of the year. Find the basic EPS
of the firm.
A. $423
B. $ 494
C. $ 567

Solution 3
▪ B.
Weighted average no of shares is (12*300,000+6*120,000)/12 = 360,000. The EPS is (180-2)/0.36 = 494

Question 4
▪ The following information is available regarding a company
Ratio Industry Standards Actual for company

Net Profit ratio 5% 2.4%
Total debt to total assets 7.5% 10%
Which of the following is least likely true about the company?

A. The company must increase its efforts to reduce the cost of production
B. The return on equity is most likely to be lower for the company as compared to the industry
standards
C. The company is likely to carry a higher financial risk than the industry standards

Solution 4
▪ B.
The company has taken on higher debt than the industry standards. However higher leverage adds to the
financial risk but also increase the ROE for the share holders if the ROA is good.

Question 5
Which of the following statements about goodwill accounting is least likely true:
A. Accounting goodwill arises from the expected future performance of the firm's assets after the
acquisition
B. Goodwill is not amortized
C. Goodwill, if impaired is reduced and a loss should be recognized in the income statement

Solution 5
▪ A.
It is the economic goodwill that arises from the expected future performance of the firm not accounting
goodwill

Question 6
Seal Corporation would like to change its reporting standards from US GAAP to IFRS. Which of the
following changes is most likely to occur with respect to reporting of the cash flow statement?
A. The interest and dividends received would be classified as operating activities
B. Interest paid on company's debt may be classified as either operating or financing activity
C. The taxes paid would be reported as operating activities

Solution 6
▪ B.
Under IFRS, interest paid on company's debt may be classified as either operating or financing activity

Question 7
Karl Inc reports the following in its year- end financial statements:
▪ Net income of $32 million
▪ Depreciation expense $3 million
▪ Increase in accounts receivables $ 0.95 million
▪ Increase in capital stock of $ 35 million
▪ Purchased equipment for $ 12 million Find Karl's FCFF.
A. $37 million
B. $12.56 million
C. $22.05 million

Solution 7
▪ C.
CF due to operating activities is ($ 32 million + $ 3 million-$ 0.95 million)= $ 34.05. Net capital
expenditure is $ 12 million. FCFF = 34.05 – 12 =$22.05 million

Question 8
A high inventory turnover ratio to industry norms commensurate with low number of days of inventory can
indicate
A. Company can have adequate inventory sufficient to handle increased sale.
B. Company can have low inventory sufficient to handle increased sale.
C. Company may have inadequate inventory leading to shortages in inventory resulting in lost sales and
lower revenue.

Solution 8
▪ B.
Since the inventory turnover is high the company would always have low inventory levels to keep pace
with the increase level of sales. The inventory management is efficient which indicates it is not likely to
lose out on sales.

Question 9
Which of the following is not a cause of deferred tax assets?

A. Post employment benefits
B. Warranty expenses
C. Municipal bond interest

Solution 9
▪ C.
Municipal bond interest is not taxable. No deferred taxes are recognized

Question 10
James Company has purchased an asset worth $ 41,000 and leased it to Thompson Inc for a period of 5
years. The annual lease payment is $ 10,000 to be paid at the end of each year. If the implied interest
rate in the lease is 7%, which of the following statements is most likely true about the transaction and
accounting?
A. It is a sale type lease
B. The lessor is most likely to remove the asset from the balance sheet and create a lease receivable in
the same amount
C. In the cash flow statement the interest portion of the lease payment is reported as inflow from
investing

Solution 10
▪ B.
The carrying cost of the asset is same as the present value of the lease payments, therefore it is a direct
financing lease.

Question 11
Which of the following financial statement line items is least likely to affect shareholders' equity but does
affect income statement of the company?
A. Foreign currency translation gains and losses
B. Adjustments for pension liability
C. Realized gains and losses from available for sale securities

Solution 11
▪ C.
Both Foreign currency translation gains and losses and adjustments for pension liability directly affect the
statement of owner's equity while realized gains and losses are figured in the income statement.

Question 12
▪ What will be the effect of using LIFO method of inventory accounting instead of FIFO on company's
current ratio and debt to equity ratio, assuming there is no LIFO liquidation and prices are rising?
Current ratio
A. Lower Debt to equity ratio

B. Lower Lower
C. Higher Higher No effect

Solution 12
▪ B.
LIFO will result into lower inventory and lower shareholders' equity and hence higher debt/equity ratio and
lower current ratio.

Question 13
As on 10th July, 2010 Goodman Inc purchased 100 shares of BBA for $ 105 per share. At the end of the
year BBA's share price was $ 95 and during the year BBA paid a dividend of $ 2 per share. What amount
of investment income should be recognized by company in its income statement and what amount should
be reported on the balance sheet, if the investment is considered an available for sale securities?
Investment income Balance sheet value

A. $ -800 $ 9,500
B. $ 200 $ 9,500
C. $ -800 $ 10,500

Solution 13
▪ B.
In case of an available for sale securities, only realized gains or losses will be realized in income
statement and security should be marked on the balance sheet at fair value. Hence investment income =
Rs 2*100= 200

Question 14
S&P Inc. leases out a crane for its own use for six years with an annual payment of $ 15mn. At the end of
the lease period crane will have salvage value of zero and company has the option to purchase the crane
from lessee at the discount price. Calculate the interest expense for the first year, if appropriate interest
rate is 7%.
A. $ 6.3mn
B. $ 4.3mn
C. $ 5.0 mn

Solution 14
▪ C.
N=6, I/Y=7%, PMT=-15mn,
Interest expense = 71.5*7% = 5.0mn
FV=0,
CPT PV= 71.5mn

Question 15
During 2009 R&M Corporation reported net income was $ 120.5 mn and had $ 85 mn weighted average
number of common shares outstanding for the entire year. R &M had 10,000 outstanding preference
shares of face value $ 1,000 and paying dividend of 8% end of the year 2009. R &M has 100,000 stock
options outstanding at the end of the year, convertible into 100 normal equity shares per option at the
strike price of $ 25. Compute the diluted EPS, if average market price of the stock for the entire year 2009
was $ 50?
A. $ 1.41
B. $ 1.26
C. $ 1.33

Solution 15
▪ C.
New equity shares= 100,000*100= 10,000,000
Repurchase of shares= 10mn*25/50= 5 mn outstanding shares after dilution= 85+5= 90mn Diluted EPS=
120.5mn – 10000*8%*1000= 119.7mn diluted EPS= 119.7/90= 1.33mn

Question 16
Which of the following statements regarding costs incurred by company for developing goodwill and cost
associated with acquired goodwill reported on the balance sheet is least likely to be incorrect?
A. Company can capitalize the expenses associated with developing goodwill
B. Company cannot capitalize the costs associated with research and development of new product or
goodwill
C. Company cannot capitalize the costs associated with the acquired goodwill

Solution 16
▪ B.

Question 17
At the beginning of the year company purchased all 10mn shares of its competitor for $25. Company
valued its competitor's net assets $25 mn higher than $200 mn reported on its balance sheet just before
the acquisition date. What amount of goodwill should company report on its balance sheet as a result of
its acquisition of competitor?
A. $ 25mn
B. $ 50mn
C. $ 75mn

Solution 17
▪ A.
Goodwill= 10*$25 – ($200+$25) = $25mn

Question 18
An infrastructure company has launched a new residential cum commercial project. Project is worth of $
5,000 mn, costs are estimated to be $ 3,000 mn and the time to completion is three years. What will be
the effect on the company's second year's book value per share and first year's cash flow from
operations, if company would have chosen percentage of completion method for revenue recognition
instead of completed contract method?
A. Selection of revenue recognition method will not have any effect on either book value or cash flow
from operations
B. Book value per share will increase but cash flow from operations will not change
C. Both ratios will increase if company opts for percentage of completion method

Solution 18
▪ B.
Percentage of completion method is aggressive in revenue recognition and hence recognizes profit much
earlier than completed project method. Thus increases net profit and retained earnings for year two in
case of Percentage of completion method.

Question 19
▪ At the beginning of the year, Thomson Inc. purchased 1mn shares of S&P for $25 per share. During
the year S&P paid $5 in the form of final and interim dividend. At the end of financial year shares of
S&P were trading at $30 per share. What amount of investment income should Thomson recognize
in its income statement if S&P is considered as trading security and an available for sale security?
Trading security Available for sale
A. $ 5mn $ 10mn
B. $ 10mn $ 5mn
C. $ 5mn $ 5mn

Solution 19
▪ B.
If shares are classified as trading Securities Company will report unrealized gain of $5 and dividend of $5
per share. If shares are classified as available for sale only dividend income of $5 mn will be reported in
income statement

Question 20
▪ The financial statement is prepared according to IFRS. The carrying value of its inventory was $5.2
million before a $ .3 million write down was recorded in 2007 for Veritose Company. In 2008, the fair
value of Veritose Company inventory was $0.5 greater than carrying value.
The effect of recovery of Veritose financial statement for inventory is:
A. $ 0.5 million
B. $ 4.9 million
C. $ 0.3 million

Solution 20
▪ C.

Question 21
A real estate firm capitalizes expenses as against expensing. Which of the following is most likely to be
correct for the firm?
A. Stockholders' equity is lower
B. In later years interest coverage ratio is higher
C. Cash flow from investing activities is lower

Solution 21
▪ C.
If a company expenses its cost it will be included in cash flow from operations. If it capitalizes, then it will
be included in cash flow from investing (lower investment cash flow and higher cash flow from
operations).

Question 22
A company classifies a 8% bond as held to maturity. If the market rate of interest decreases after the
bond is issued, what is the impact on the debt to equity ratio?
A. Increases
B. Decreases
C. No change

Solution 22
▪ C.
Held to maturity securities are reported on the balance sheet at its book value and hence market rate of
interest will not have any effect on the reported bond value. Thus there will not be any change in debt
equity ratio

Question 23
IASB expresses the objective of financial statements in "Framework for preparation and presentation of
financial statements" What is the objective?
A. Financial implications, measurement and changes in assets and liabilities.
B. Financial position, performance and changes in financial position of an entity.
C. Changes in income and expenses, financial position and changes in assets and liabilities.

Solution 23
▪ B.

Question 24
In recording accounting entries on accrual basis, for cash movement prior to accounting recognition,
adjusting entry will consider for Unearned (Deferred) Revenue
▪ Reducing the liability while recording revenue.
▪ Increasing the liability while recording revenue.
▪ Eliminate the receivable on cash collection.

Solution 24
▪ B.

Question 25
An internet company buys advertisement space from another internet company in exchange for ad space
on its own website for the same value. Which of the following is most likely true under US GAAP and
IFRS?
A. According to US GAAP the revenue is not recognized.
B. According the IFRS the revenue is to be recognized at a discount to market vale
C. According to IFRS revenue is to be recognized by fair value

Solution 25
▪ C.
This is a barter transaction. Under IFRS, revenue in such cases is to be recognized at fair value.

Question 26
▪ A company is faced with a threat of arrival of a new and improved version of the product that it
manufactures in the market. Which of the following inventory accounting method should it follow to
minimize its loss? Assume prices are rising at the normal rate of inflation
A. LIFO
B. FIFO
C. Inventory accounting method will not mitigate the losses

Solution 26
▪ A.
Since the company is faced with the threat of obsolescence, it should do away with the latest inventory
first to be able to recover the higher costs of inventory.

Question 27
▪ S & D Company has 20,000 shares of common stock outstanding and 1,000 shares of convertible
preferred stock. It has reported net income of $ 40,000. It also has 2,000 outstanding warrants all
year, convertible to one share each of $25 per share. The convertible10%, $100 par value,
outstanding for the entire year, is convertible to 15 shares of common stock. If the tax rate applicable
is 35% and the average stock price is $36. Find the diluted EPS of the firm if the preferred stock is
converted into common stock at the beginning of the year.
A. 1.5
B. 1.12
C. 1.14

Solution 27
▪ B.
The numerator will be $40,000 - $10,000+$10,000 = $40,000. The warrants would be exercised and the
company would receive $50,000 with which the company can repurchase 50,000/36= 1,389 no of shares.
On converting the preferred stock to common stock the no of shares to be issued by the company is
1,000*15=15,000.
EPS = 40,000/(20,000+15,000+2,000-1,389) = $ 1.12

Question 28
▪ Frank & Co's equity shares are being traded in the market at $54 per share with a price- earning ratio
of 9. It has 10,000 equity shares of $10 each and no preference shares. Find the net income.
A. $73,000
B. $100,000
C. $60,000

Solution 28
▪ C.
▪ EPS = Market price/p/e ratio = 54/9 =$ 6 EPS = net income/no of shares outstanding Net income =
6*10,000 = $ 60,000

Question 29
▪ A pension fund has invested in a 6% bond, at par, for $240,000. The yield of the bond has dropped
by 2%. Which of the following is least likely true regarding the accounting of the investment?
A. The interest income of the bond is reported in the income statement
B. The interest income and the unrealised profit on the bond are both reported in the income statement
C. The bond is reported in the balance sheet at the amortised cost

Solution 29
▪ B.
Pension funds are long term investors. Hence it is more likely that the bond would be held to maturity.
Therefore the unrealized profit is not recognized and reported in the income statement.

Question 30
▪The following information is available:

▪ Net income $290
▪ Decrease in accounts receivables $30
▪ Depreciation $12
▪ Increase in inventory $16
▪ Increase in deferred tax liability $10
▪ Increase in accounts payable $12
▪ Taxes paid $24
▪Find the cash flow from operating activities according to the US GAAP.
▪ $450
▪ $224
▪ $338

Solution 30
▪ C.
NI + Depreciation + decrease in receivables – increase in inventories + increase in accounts payables +
increase in deferred tax liability = 290+12+30-16+12+10=338

Question 31
Parity Inc reported the following from their financial statements:

▪ Debts collection period: 0 days.
▪ Stock turnover ratio 5
▪ Gross profit ratio 30%
▪ Sales of the year 1,000,000
▪ Collection of debts 30 days
▪ If it plans to introduce a new product, it expects to generate additional annual sales of

▪ $200,000 with gross profit rate of 20%. Find the increase in debt collection period after the
introduction of the new product.
▪ 10 days
▪ 36 days
▪ 6 days

Solution 31
▪ C.
Credit sales - $1,000,000 / 12 = 83,333; Additional credit sale - $200,000 / 12 = 33,333 Total =
83,333+33,333= 116,666
Debt Collection period = (Projected Debtors / Sales) * 365 = 116,666/1,200,000 = 36 days Increase in the
debt collection period is 6 days

Question 32
The sales figure of Rutherford Inc stood at $ 10 million with a gross profit margin of 30%. The company is
planning to launch another product in the market with expected annual sales of $2 million. The cost of
sales is expected to be $ 1.3 million in the initial year. What is the Gross Profit ratio, if it goes ahead with
its plan of launching the new product?
A. 30.83%
B. 69.17%
C. 43.24%

Solution 32
▪ A.
Total sales = $10 million + $ 2 million = $12 million. Total cost of sales = 0.7*10 + 1.3 = $8.3 million. GPM
= (12-8.3)/12 = 30.83%
Does not always lead to increase in the ROE. If the interest burden increases the ROE will begin to fall if
the financial leverage ratio (total assets/ total equity) is not increasing proportionately.

Question 33
▪ S &P Corporation has invested $ 30,000 in an asset that depreciates over a period of 5 years by the
straight-line method of depreciation. However, for tax purposes the asset is depreciated using an
accelerated method of depreciation for 5 years with $ 8,000 paid in the first year. The tax rate is
40%.Which of the following statements is most likely true?
A. There would be a deferred tax liability of $1,000 in the first year created in the balance sheet
B. The carrying value of the asset will be lower than the tax base
C. The tax payable in the fifth year is most likely to be higher than the tax expensed in that year

Solution 33
▪ C.
The tax base is more likely to be higher than the expensed tax rate to reverse the deferred tax liability so
created

Question 35
▪ M&P Corporation leases out a crane for its own use for ten years with an annual payment of $ 10mn.
At the end of the lease period crane will have salvage value of zero and company has the option to
purchase the crane from lessee at the discount price. Calculate the lease liability reported on the
balance sheet end of the first year, if appropriate interest rate is 8%?
A. $ 67.10mn
B. $ 62.47mn
C. $ 57.47mn

Solution 35
B.
N=10 I/Y=8% PMT=-10mn FV=0 CPT= PV?
PV= 67.1mn
Interest expense = 67.1*8% =

5.37mn
Principal repayment = 10 mn - 5.37mn=
4.63mn
Lease liability= 67.1 – 4.63=
62.47mn

Question 36
▪ An analyst gathered the financial information about a company, which has earned $235 mn during
the year and which have 80mn common shares outstanding from the beginning of the year.
Company has 100,000 outstanding bonds of 9% coupon rate of par value $1,000 per bonds
convertible into 10 shares each. Which of the following will be the closest value of diluted EPS, if
effective tax rate is 35%?
A. $5.85
B. $2.94
C. $4.36

Solution 36
▪ B.
Basic EPS= 235/80= $2.94
saving in earnings= 100,000*9%*1,000*(1-35%) = $5.85mn
Increase in no of shares= 100,000*10= 1mn Per share impact=5.85/1 = $5.85
Since per share impact is higher than basic EPS, securities are Antidilutive in nature Diluted EPS = basic
EPS = $2.94

Question 37
▪ US Vineyard Inc is a loss making wine maker that has a deferred tax asset of $ 68mn on its balance
sheet. As of 31st March, 2010 it is probable that $ 15mn of the deferred tax asset will never be
realized because of the uncertainty about future profit. Which of the following will be the most likely
change to be recorded on its balance sheet?
A. It is likely to create deferred tax liability of $ 15mn to offset this transaction
B. It is likely to create a valuation allowance of $ 15mn
C. It is likely to reduce deferred tax assets by $ 15mn

Solution 37
▪ B.
A valuation allowance serves to reduce the value of deferred tax assets which will not be realized

Thank You!
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Financial Reporting and Analysis

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Balance (prev year) Contributed capital Retained earnings Total

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▪ The following information is available regarding a company

Ratio Industry Standards Actual for company

Total debt to total assets 7.5% 10%

Which of the following is least likely true about the company?

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Which of the following is not a cause of deferred tax assets?

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A. Lower Debt to equity ratio

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Investment income Balance sheet value

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