3. Financial Statement Analysis Questions Bank 2023

Question #1 of 25

Question ID: 1457192

An analyst who wants to examine a firm's financing transactions during the most recent
period is most likely to evaluate the firm's statement of:

A) comprehensive income.
B) financial position.
C) cash flows.
Explanation
The statement of cash flows describes a firm's inflows and outflows of cash during a
reporting period from operating, investing, and financing activities. Financing transactions
such as issuance of debt or stock are shown on the statement of cash flows. The
statement of financial position (balance sheet) presents the firm's assets, liabilities, and
equity at a point in time. The statement of comprehensive income (income statement)
does not directly reflect a firm's financing transactions. Cash raised is not included in a
firm's revenues and dividends paid and debt principal repaid are not included in its
expenses.
(Module 16.1, LOS 16.b)

Question #2 of 25

Question ID: 1457197

The standard auditor's report is most likely required to:

A) provide an "unqualified" opinion if material uncertainties exist.
B)

provide reasonable assurance that the financial statements contain no material

errors.

C) provide reasonable assurance that management is reliable.
Explanation


The standard auditor's report contains three parts:
1. The financial statements are prepared by management and are their responsibility
and the auditor has performed an independent review.
2. The audit was conducted using generally accepted auditing standards, which
provides reasonable assurance that there are no material errors in the financial
statements.
3. The auditor is satisfied the statements were prepared in accordance with accepted
accounting principles, and the principles chosen and estimates are reasonable.
Under U.S. GAAP, the auditor is required to state an opinion on the company's internal
controls. The auditor may add this opinion as a fourth element of the auditor's report or
provide it separately.
(Module 16.2, LOS 16.d)

Question #3 of 25

Question ID: 1457191

Which financial statement reports information about a company's financial position at a
single point in time?

A) income statement.
B) cash flow statement.
C) balance sheet.
Explanation

The balance sheet reports a company's financial position at a point in time. In contrast, the
income statement and the cash flow statement report a company's financial performance
over a reporting period.
(Module 16.1, LOS 16.b)

Question #4 of 25

Question ID: 1457195

According to IFRS guidance for management's commentary, addressing the company's key
relationships is:

A) neither recommended nor required.
B) required.
C) recommended.
Explanation


IFRS recommends that management commentary address the company's key
relationships, 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.
(Module 16.2, LOS 16.c)

Question #5 of 25

Question ID: 1457188

The role of financial statement analysis is most accurately described as:

A) a common requirement for companies that are listed on public exchanges.
B)
C)

the use of information from a company’s financial statements along with other
information to make economic decisions regarding that company.
the reports and presentations a company uses to show its financial
performance to investors, creditors, and other interested parties.

Explanation
Financial statement analysis refers to the use of information from a company's financial
statements along with other information to make economic decisions regarding that
company. Financial reporting refers to the reports and presentations that a company uses
to show its financial performance to investors, creditors, and other interested parties.
Financial reporting is a requirement for companies that are listed on public exchanges.
(Module 16.1, LOS 16.a)

Question #6 of 25

Question ID: 1457193

Which of the following statements concerning the notes to the audited financial statements
of a company is least accurate? Financial statement notes:

A)

include management's assessment of the company's operating performance
and financial results.

B) are audited.
C) contain information about contingent losses that may occur.
Explanation


Management's perspective on the company's results is provided in the Management's
Discussion and Analysis supplement to the financial statements. Financial statement notes
(footnotes) provide information about matters such as the company's accounting methods
and assumptions, contingencies, and acquisitions and disposals. Footnotes to the financial
statements are audited.
(Module 16.2, LOS 16.c)

Question #7 of 25

Question ID: 1457189

A company's operating revenues for a reporting period are most likely to be shown on its:

A) balance sheet.
B) cash flow statement.
C) income statement.
Explanation
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.

(Module 16.1, LOS 16.b)

Question #8 of 25

Question ID: 1457187

According to the IASB, which of the following least accurately describes financial reporting?
Financial reporting:

A) provides information about changes in financial position of an entity.
B) is useful to a wide range of users.
C)

uses the information in a company’s financial statements to make economic
decisions.

Explanation


The role of financial reporting is described by the International Accounting Standards
Board (IASB) in its "Framework for the Preparation and Presentation of Financial
Statements":
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 of
users in making economic decisions.
Using the information in a company's financial statements to make economic decisions is
financial analysis, not financial reporting.
(Module 16.1, LOS 16.a)

Question #9 of 25

Question ID: 1457186

Which of the following is least likely to be considered a role of financial statement analysis?

A) Assessing the management skill of the company’s executives.
B) Determining whether to invest in the company's securities.
C) To make economic decisions.
Explanation
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. Examples
of such decisions include whether to invest in the company's securities or recommend
them to other investors, or whether to extend trade or bank credit to the company.
Although the financial statements might provide indirect evidence about the management
skill of the company's executives, that is not generally considered the role of financial
statement analysis.

(Module 16.1, LOS 16.a)

Question #10 of 25

Question ID: 1457184

Which of the following statements about financial statement analysis and reporting is least
accurate?

A)
B)

Financial statement analysis focuses on the way companies show their financial
performance to investors by preparing and presenting financial statements.

Providing information about changes in a company’s financial position is a role
of financial reporting.


C)

Deciding whether to recommend a company’s securities to investors is a role of
financial statement analysis.

Explanation
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.
(Module 16.1, LOS 16.a)

Question #11 of 25

Question ID: 1457204

In addition to the audited financial statements included in a firm's annual report, which of
the following sources of information is most likely to contain audited data?

A) Footnotes to the annual financial statements.
B) Management’s commentary.

C) Interim financial statements filed with the SEC.
Explanation
The footnotes are an integral part of the audited financial statements in a firm's annual
report and are included in the audit opinion.
(Module 16.2, LOS 16.e)

Question #12 of 25

Question ID: 1457203

Which of the following is least likely to be available on EDGAR (Electronic Data Gathering,
Analysis, and Retrieval System)?

A) Corporate press releases.
B) Form 10Q.
C) SEC filings.
Explanation


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

(Module 16.2, LOS 16.e)

Question #13 of 25

Question ID: 1457196

For publicly traded firms in the United States, the Management Discussion and Analysis
(MD&A) portion of the financial disclosure is least likely required to discuss:

A) capital resources and liquidity.
B) results of operations.
C) unusual or infrequent items.
Explanation
For publicly traded U.S. firms, the MD&A portion of the financial disclosure is required to
discuss results of operations, capital resources and liquidity and a general business
overview based on known trends. A discussion of unusual or infrequent items may be
included in the MD&A, but is not required.

(Module 16.2, LOS 16.c)

Question #14 of 25

Question ID: 1457190

Which of the following statements represents information at a specific point in time?

A) The balance sheet.
B) The income statement and the balance sheet.
C) The income statement.
Explanation
The balance sheet represents information at a specific point in time. The income
statement represents information over a period of time.

(Module 16.1, LOS 16.b)

Question #15 of 25

Question ID: 1457200

A firm's internal controls are most accurately described as:

A) directly affecting the firm’s financial reporting quality.
B) outside the scope of an audit report under IFRS and U.S. GAAP.
C) a responsibility of the firm’s board of directors.
Explanation
Weak internal controls provide an opportunity for low-quality or even fraudulent financial
reporting. A firm's management, not its board of directors, is responsible for ensuring the
effectiveness of a firm's internal controls. Under U.S. GAAP, auditors are required to state
an opinion on a firm's internal controls.
(Module 16.2, LOS 16.d)

Question #16 of 25

Question ID: 1457206

The step in the financial statement analysis framework that includes making any appropriate
adjustments to the financial statements and calculating ratios is best described as:

A) analyzing and interpreting the data.
B) gathering the data.
C) processing the data.
Explanation


The financial statement analysis framework consists of six steps:

1. State the objective and context. Determine what questions the analysis is meant to
answer, the form in which it needs to be presented, and what resources and how
much time are available to perform the analysis.
2. Gather data. Acquire the company's financial statements and other relevant data on
its 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 the
first step. Decide what conclusions or recommendations the information supports.
5. Report the conclusions or recommendations. Prepare a report and communicate it
to its intended audience. Be sure the report and its dissemination comply with the
Code and Standards that relate to investment analysis and recommendations.
6. Update the analysis. Repeat these steps periodically and change the conclusions or
recommendations when necessary.

(Module 16.2, LOS 16.f)

Question #17 of 25

Question ID: 1457194

Which of the following statements regarding footnotes to the financial statements is least
accurate? Financial statement footnotes:

A) may contain information regarding contingent losses.
B) provide information about assumptions and estimates used by management.
C) typically include a discussion of the firm’s past performance and future outlook.
Explanation
Discussion of a firm's past performance and future outlook is most likely to be found in

management's commentary.

(Module 16.2, LOS 16.c)

Question #18 of 25

Question ID: 1457198

Which of the following would NOT require an explanatory paragraph added to the auditors'
report?


A) Doubt regarding the "going concern" assumption.
B) Uncertainty due to litigation.
C) Statements that the financial information was prepared according to GAAP.
Explanation
The statements that the financial information was prepared according to GAAP should be
included 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 the
auditors' report.
(Module 16.2, LOS 16.d)

Question #19 of 25

Question ID: 1457185

Which of the following best describes financial reporting and financial statement analysis?

Financial reporting refers to how companies show their financial performance
A) and financial analysis refers to using the information to make economic

decisions.
Financial reports assess a company’s past performance in order to draw
B) conclusions about the company’s ability to generate cash and profits in the
future.
C)

The objective of financial analysis is to provide information about the financial
position of an entity that is useful to a wide range of users.

Explanation
Financial reporting refers to the way companies show their financial performance to
investors, creditors, and other interested parties by preparing and presenting financial
statements. The objective of financial statements, not analysis, is to provide information
about the financial position, performance and changes in financial position of an entity
that is useful to a wide range of users in making economic decisions. The role of financial
statement analysis, not reporting, is to use the information 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.

(Module 16.1, LOS 16.a)

Question #20 of 25

Question ID: 1457208


In the financial statement analysis framework, using the data to address the objectives of
the analysis and deciding what conclusions or recommendations the information supports is

best described as:

A) analyzing and interpreting the data.
B) processing the data.
C) reporting the conclusions.
Explanation
The financial statement analysis framework consists of six steps:
1. State the objective and context. Determine what questions the analysis is meant to
answer, the form in which it needs to be presented, and what resources and how
much time are available to perform the analysis.
2. Gather data. Acquire the company's financial statements and other relevant data on
its 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 the
first step. Decide what conclusions or recommendations the information supports.
5. Report the conclusions or recommendations. Prepare a report and communicate it
to its intended audience. Be sure the report and its dissemination comply with the
Code and Standards that relate to investment analysis and recommendations.
6. Update the analysis. Repeat these steps periodically and change the conclusions or
recommendations when necessary.

(Module 16.2, LOS 16.f)

Question #21 of 25

Question ID: 1457207

The step in the financial statement analysis framework of "processing the data" is least likely

to include which activity?

A) Acquiring the company’s financial statements.
B) Preparing exhibits such as graphs.
C) Making appropriate adjustments to the financial statements.
Explanation


The financial statement analysis framework consists of six steps. Step 2: "Gather data"
includes acquiring the company's financial statements and other relevant data on its
industry and the economy. Step 3. "Process the data" includes activities such as making
any appropriate adjustments to the financial statements and preparing exhibits such as
graphs and common-size balance sheets.
(Module 16.2, LOS 16.f)

Question #22 of 25

Question ID: 1457205

Which of the following is the best description of the financial statement analysis framework?

A)

Gather data, analyze and interpret the data, process the conclusions, assess the
context, report the recommendations, update the analysis.
State the objective and context, gather data, process the data, analyze and

B) interpret the data, report the conclusions or recommendations, update the
analysis.
C)

Gather data, analyze and interpret the data, determine the context, report the
conclusions, update the analysis.

Explanation
The financial statement analysis framework consists of six steps:
1. State the objective and context.
2. Gather data.
3. Process the data.
4. Analyze and interpret the data.
5. Report the conclusions or recommendations.
6. Update the analysis.
(Module 16.2, LOS 16.f)

Question #23 of 25

Question ID: 1457202

Which of the following is an analyst least likely to rely on as objective information to include
in a company analysis?

A) Corporate press releases.
B)

Government agency statistical data on the economy and the company’s
industry.

C) Proxy statements.

Explanation
Corporate reports and press releases are written by management and are often viewed as
public relations or sales materials. An analyst should review information on the economy
and the company's industry and compare the company to its competitors. This
information can be acquired from sources such as trade journals, statistical reporting
services, and government agencies. Securities and Exchange Commission (SEC) filings
include Form 8-K, which a company must file to report events such as acquisitions and
disposals of major assets or changes in its management or corporate governance and
proxy statements, which are a good source of information about the election of (and
qualifications of) board members, compensation, management qualifications, and the
issuance of stock options.

(Module 16.2, LOS 16.e)

Question #24 of 25

Question ID: 1457199

Which of the following is an independent auditor least likely to do with respect to a
company's financial statements?

A) Confirm assets and liabilities contained in them.
B) Prepare and accept responsibility for them.
C) Provide an opinion concerning their fairness and reliability.
Explanation
Auditors make an independent review of financial statements, which are prepared by
company management and are management's responsibility. It is the responsibility of
auditors to confirm the assets, liabilities, and other items included in the statements and
then issue an opinion concerning their fairness and reliability.

(Module 16.2, LOS 16.d)

Question #25 of 25

Question ID: 1457201

Which of the following statements about proxy statements is least accurate? Proxy
statements are:

A) not filed with the SEC.


B)

a good source of information about the qualifications of board members and
management.

C) available on the EDGAR web site.
Explanation
Proxy statements are issued to shareholders when there are matters that require a
shareholder vote. These statements, which are also filed with the SEC and available from
EDGAR, are a good source of information about the election of (and qualifications of)
board members, compensation, management qualifications, and the issuance of stock
options.
(Module 16.2, LOS 16.e)


Question #1 of 12

Question ID: 1457214

Which of the following is least likely a qualitative characteristic accounting information must
possess in order to provide useful information to an analyst, according to the IASB
Conceptual Framework?

A) Conservatism.
B) Relevance.
C) Faithful representation.
Explanation
Qualitative characteristics that accounting information must possess according to the IASB
Conceptual Framework are relevance and faithful representation, which are enhanced by
the characteristics of timeliness, verifiability, understandability, and comparability. While
conservatism in accounting has traditionally been viewed as a desirable characteristic, it is
not one of the qualitative characteristics specified in the IASB Conceptual Framework.
(Module 17.2, LOS 17.c)

Question #2 of 12

Question ID: 1457209

The objective of financial reporting is most accurately described as providing information
about a firm that is:

A) complete, neutral, and free from error.
B) compliant with accepted accounting principles.
C) useful to decision makers.
Explanation
According to the Conceptual Framework for Financial Reporting, the objective of financial
reporting is to provide information about the firm to current and potential investors and
creditors that is useful for making their decisions about investing in or lending to the firm.

(Module 17.1, LOS 17.a)

Question #3 of 12

Question ID: 1457217


Question #3 of 12

Question ID: 1457217

Required financial statements, according to International Accounting Standard (IAS) No. 1,
include a(n):

A) balance sheet and explanatory notes.
B) cash flow statement and auditor’s report.
C) income statement and working capital summary.
Explanation
Financial statements that are required by IAS No. 1 include a balance sheet, a statement of
comprehensive income, a cash flow statement, a statement of changes in owners' equity,
and explanatory notes that include a summary of the company's accounting policies. IAS
No. 1 does not require an auditor's report or a working capital summary.

(Module 17.2, LOS 17.d)

Question #4 of 12

Question ID: 1457220

A firm engages in a new type of financial transaction that has a material effect on its
earnings. An analyst should most likely be suspicious of the new transaction if:

A) management has not explained its business purpose.
B) no accounting standard exists that applies to the transaction.
C) the transaction is not governed by existing regulations.
Explanation
New types of transactions may emerge that are not covered by existing accounting
standards or regulations. Analysts should obtain information from a firm's management
about the economic substance of such transactions to ensure that they serve a business
purpose and have not been created primarily to manipulate the firm's financial
statements.

(Module 17.2, LOS 17.e)

Question #5 of 12

Question ID: 1457219


Which of the following is least likely one of the general requirements for financial statements
under IFRS?

A) Statements should be prepared under a going concern assumption.
B) Statements should be prepared at least quarterly.
C)

No offsetting of income against expenses unless a standard permits or requires
it.

Explanation
IFRS require reporting at least annually. The other two choices are requirements included
in IAS No. 1.
(Module 17.2, LOS 17.d)

Question #6 of 12

Question ID: 1457211

Two underlying assumptions of financial statements, according to the IASB conceptual
framework, are:

A) going concern and accrual accounting.
B) accrual accounting and historical cost.
C) historical cost and going concern.
Explanation
The two underlying assumptions of financial statements according to the conceptual
framework are accrual accounting and the going concern assumption. Historical cost is
one of several measurement bases that may be used for financial reporting.
(Module 17.2, LOS 17.c)

Question #7 of 12

Question ID: 1462803

Which of the following is least likely a fundamental characteristic of financial statements that
makes them useful, according to the IASB Conceptual Framework for Financial Reporting?

A) Reliability.
B) Relevance.

C) Faithful representation.


Explanation
The IASB Conceptual Framework names relevance and faithful representation as the two
fundamental characteristics that make financial information useful. (Module 17.2, LOS
17.c)

Question #8 of 12

Question ID: 1457213

According to the IFRS framework, timeliness is a characteristic that enhances:

A) only relevance.
B) only faithful representation.
C) both relevance and faithful representation.
Explanation
In the IFRS framework, timeliness, comparability, verifiability, and understandability are
characteristics that enhance the two fundamental qualitative characteristics, relevance
and faithful representation. Information that is not timely will not be relevant or faithfully
represent the activities of a firm over the reporting period.
(Module 17.2, LOS 17.c)

Question #9 of 12

Question ID: 1457218

Which of the following is a company least likely required to present according to
International Accounting Standard (IAS) No. 1?

A) Disclosures of material events.
B) Statement of changes in owners’ equity.
C) A summary of accounting policies.
Explanation


International Accounting Standard (IAS) No. 1 defines which financial statements are
required and how they must be presented. The required financial statements are:
Balance sheet.
Statement of comprehensive income.
Cash flow statement.
Statement of changes in equity.
Explanatory notes, including a summary of accounting policies.
Disclosures of material events that affect the company are required by the Securities and
Exchange Commission (Form 8-K) for firms that are publicly traded in the United States.
(Module 17.2, LOS 17.d)

Question #10 of 12

Question ID: 1457210

Accounting standard setting bodies are best described as:

A)
B)

government agencies that exercise regulatory authority over financial reporting
standards.
organizations of securities commissions that establish international financial

reporting standards.

C) professional organizations that establish financial reporting standards.
Explanation
Standard-setting bodies are professional organizations of accountants and auditors that
establish financial reporting standards. Regulatory authorities are government agencies
that have the legal authority to enforce compliance with financial reporting standards.
Regulatory authorities, such as the Securities and Exchange Commission in the U.S. and
the Financial Conduct Authority in the United Kingdom, are established by national
governments. Most national authorities belong to the International Organization of
Securities Commissions (IOSCO).
(Module 17.1, LOS 17.b)

Question #11 of 12

Question ID: 1457215

According to the IASB Conceptual Framework for Financial Reporting, one of the qualitative
characteristics of financial statements is:

A) faithful representation.
B) going concern.


C) timeliness.
Explanation
In the IASB conceptual framework, the two qualitative characteristics of financial
statements are relevance and faithful representation. Timeliness is a characteristic that
enhances relevance and faithful representation. Going concern is an underlying
assumption of financial statements.

(Module 17.2, LOS 17.c)

Question #12 of 12

Question ID: 1457212

According to the IASB conceptual framework, characteristics that enhance relevance and
faithful representation include:

A) comparability, understandability, and thoroughness.
B) assurance, timeliness, and understandability.
C) timeliness, comparability, and verifiability.
Explanation
The four characteristics that enhance relevance and faithful representation are
comparability, verifiability, timeliness, and understandability.
(Module 17.2, LOS 17.c)


Question #1 of 155

Question ID: 1457361

Royster Company presents the following income statement:
Sales

$12,000

Cost of goods sold

$6,000

Selling and administrative expense

$1,200

Interest expense

$600

Pretax income

$4,200

Income tax expense

$1,470

Net income

$2,730

Which of the following line items would appear on a common-size income statement for this
period?

A) Pretax income 35%.
B) Income tax expense 54%.
C) Net income 65%.
Explanation
Common-size income statements express each line item as a percentage of sales.

Sales

100%

Cost of goods sold

50%

Selling and administrative expense

10%

Interest expense
Pretax income

5%
35%

Income tax expense

12.25%

Net income

22.75%

(Module 18.5, LOS 18.i)

Question #2 of 155

Question ID: 1457339


Antidilutive securities should be assumed to have been converted to common shares when
calculating:

A) basic EPS but not diluted EPS.
B) diluted EPS but not basic EPS.
C) neither basic nor diluted EPS.
Explanation
Antidilutive securities would increase EPS if exercised or converted to common stock.
Therefore we do not assume they are converted when we calculate diluted EPS. Basic EPS
is calculated before assuming any potentially dilutive securities are converted.

(Module 18.4, LOS 18.h)

Question #3 of 155

Question ID: 1457296

At the beginning of the year, BJC Company had 40,000 shares of $1 par common stock
outstanding. On April 1, BJC issued a 2-for-1 stock split and on July 1, BJC reacquired 20,000
shares. On October 1, BJC issued 8,000 shares of $10 par, 5% cumulative preferred stock.
How many shares should BJC use to calculate diluted earnings per share?

A) 60,000.
B) 62,000.
C) 70,000.
Explanation
The stock split is applied from the beginning of the year. Because the preferred stock is

not convertible, it has no impact on the number of common shares for calculating diluted
EPS. Beginning shares (40,000 shares × 12 months) + split shares (40,000 shares × 12
months) − reacquired shares (20,000 shares × 6 months) = 840,000, and 840,000 / 12
months = 70,000 shares.

(Module 18.4, LOS 18.g)

Question #4 of 155

Question ID: 1457262


The following data pertains to the McGuire Company:
Net income equals $15,000.
5,000 shares of common stock issued on January 1.
10% stock dividend issued on June 1.
1000 shares of common stock were repurchased on July 1.
1000 shares of 10%, par $100 preferred stock each convertible into 8 shares of
common were outstanding the whole year.
What is the company's basic earnings per share (EPS)?

A) $2.50.
B) $1.20.
C) $1.00.
Explanation
Number of average shares:
1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000
7/1 1,000 shares repurchased × 6 months = 6,000
66,000 − 6,000 = 60,000
60,000 shares / 12 months = 5,000 average shares

Preferred dividends = ($10)($1,000) = $10,000
Basic EPS = [$15,000(NI) – $10,000(preferred dividends)] / 5,000 shares = $5,000 / 5,000
shares = $1/share
(Module 18.4, LOS 18.g)

Question #5 of 155

Question ID: 1457303

Firewalz, Inc., had 500,000 shares of common stock and 20,000 shares of 6%, $100 par
preferred stock outstanding at the beginning of the year. Each share of the preferred can be
converted into two shares of common stock. On July 1, the company repurchased 100,000
shares of its common stock. If net income for the year is $1.2 million, the reported diluted
EPS for the year is closest to:

A) $2.42.
B) $2.45.
C) $2.40.


Explanation
Preferred dividends = 6% × $100 × 20,000 = $120,000.
Basic EPS = ($1.2 million – $120,000) / [500,000 – (0.5)100,000] = $2.40.
The preferred dividend per common share that results from conversion = $120,000 / (2 ×
20,000) = $3.00, which is greater than $2.40. The preferred is antidilutive (conversion
would not reduce EPS). Therefore, reported diluted EPS will be the same as basic EPS:
$2.40.
(Module 18.4, LOS 18.g)

Question #6 of 155

Question ID: 1457221

During 2007, Topeka Corporation entered into the following transactions:
Transaction #1 – Interest on a certificate of deposit owned by Topeka was
credited to Topeka's investment account.
Transaction #2 – Topeka sold 10,000 shares of common stock at $30 that had
been repurchased by Topeka last year for $20.
Should Topeka recognize the results of these transactions as income on the income
statement for the year ended December 31, 2007?

A) Both should be recognized.
B) Neither should be recognized.
C) Only one should be recognized.
Explanation
Interest earned on the CD is recognized as interest income. The gain on the sale of
treasury stock is not reported on the income statement but is reflected on the statement
of changes in stockholders' equity and on the balance sheet. The sale proceeds simply
increase equity and increase cash.

(Module 18.1, LOS 18.a)

Question #7 of 155

Question ID: 1457364


An analyst prepares the following common-size income statements for Perez Company:
20X1
Sales

Cost of goods
sold

20X2

20X3

100%

100%

100%

50%

52%

53%

16%

12%

9%

4%

4%

4%

30%

32%

34%

15%

16%

17%

15%

16%

17%

Selling and
administrative
expense
Interest
income
Pretax income
Income tax
expense
Net income

Based only on this information, Perez's improving net profit margin is most likely a result of:

A) greater financial leverage.
B) controlling operating expenses.
C) improving gross margins.
Explanation
The improvement in net profit margin from 15% to 17% appears to result mainly from the
firm reducing selling and administrative expense from 16% of sales to 9% of sales, thus
decreasing operating expenses from 66% to 62% of sales. Gross margin is decreasing over
this period because cost of goods sold is increasing as a percentage of sales. While
financial leverage cannot be determined directly from the income statement, the fact that
interest expense is a constant percentage of sales suggests financial leverage is stable.
(Module 18.5, LOS 18.j)

Question #8 of 155
Changes in asset lives and salvage values are changes in accounting:

A) principle and are applied retrospectively.
B) estimates and are applied retrospectively.

Question ID: 1457240