CHAPTER 1
Introduction to Financial Statement Analysis

Solutions

  1. B is correct. This is the role of financial reporting. The role of financial statement analysis is to evaluate the financial reports.
  2. C is correct. In general, analysts seek to examine the past and current performance and financial position of a company in order to form expectations about its future performance and financial position.
  3. B is correct. The primary role of financial statement analysis is to use financial reports prepared by companies to evaluate their past, current, and potential performance and financial position for the purpose of making investment, credit, and other economic decisions.
  4. A is correct. The balance sheet portrays the company’s financial position on a specified date. The income statement and statement of cash flows present different aspects of performance during the period.
  5. B is correct. Profitability is the performance aspect measured by the income statement. The balance sheet portrays the financial position. The statement of cash flows presents a different aspect of performance.
  6. A is correct. Owners’ equity is the owners’ residual interest in (i.e., residual claim on) the company’s assets after deducting its liabilities, which is information presented on the balance sheet.
  7. B is correct. A company’s profitability is best evaluated using the income statement. The income statement presents information on the financial results of a company’s business activities over a period of time by communicating how much revenue was generated and the expenses incurred to generate that revenue.
  8. C is correct. A company’s revenues and expenses are presented on the income statement, which is used to evaluate a company’s financial results (or profitability) from business activities over a period of time. A company’s financial position is best evaluated by using the balance sheet. A company’s sources of cash flow are best evaluated using the cash flow statement.
  9. C is correct. The notes disclose choices in accounting policies, methods, and estimates.
  10. A is correct. Information about management and director compensation is not found in the auditor’s report. Disclosure of management compensation is required in the proxy statement, and some aspects of management compensation are disclosed in the notes to the financial statements.
  11. B is correct. These are components of management commentary.
  12. C is correct. The notes provide information that is essential to understanding the information provided in the primary statements.
  13. C is correct. An unqualified opinion is a “clean” opinion and indicates that the financial statements present the company’s performance and financial position fairly, in accordance with a specified set of accounting standards.
  14. B is correct. A qualified audit opinion is one in which there is some scope limitation or exception to accounting standards. Exceptions are described in the audit report with additional explanatory paragraphs so that the analyst can determine the importance of the exception.
  15. B is correct. The independent audit report provides reasonable assurance that the financial statements are fairly presented, meaning that there is a high probability that the audited financial statements are free from material error, fraud, or illegal acts that have a direct effect on the financial statements.
  16. B is correct. Interim reports are typically provided semiannually or quarterly and present the four basic financial statements and condensed notes. They are not audited. Unqualified is a type of audit opinion
  17. B is correct. When performing financial statement analysis, analysts should review all company sources of information as well as information from external sources regarding the economy, the industry, the company, and peer (comparable) companies.
  18. C is correct. Ratios are an output of the process data step but are an input into the analyze/interpret data step.
  19. A is correct. The follow-up phase involves gathering information and repeating the analysis to determine whether it is necessary to update reports and recommendations.