ABA Financial Reporting and Analysis 3 — Questions and Answers
Question 1: Under GAAP, research costs are generally:
- Capitalized and amortized over 5 years
- Expensed as incurred (Correct answer)
- Capitalized only if a patent is obtained
- Reported as a long-term asset
Correct answer: Expensed as incurred
GAAP requires research costs to be expensed as incurred because future benefits are too uncertain to justify capitalization.
Question 2: Which ratio measures the proportion of earnings paid out as dividends to shareholders?
- Price-earnings ratio
- Dividend payout ratio (Correct answer)
- Dividend yield
- Return on equity
Correct answer: Dividend payout ratio
The dividend payout ratio is calculated as dividends per share divided by earnings per share, showing the fraction of earnings distributed.
Question 3: A company using the LIFO inventory method during a period of rising prices will report:
- Higher net income and higher inventory than FIFO
- Lower net income and lower inventory than FIFO (Correct answer)
- Higher net income and lower inventory than FIFO
- Lower net income and higher inventory than FIFO
Correct answer: Lower net income and lower inventory than FIFO
LIFO assigns the most recent (higher) costs to COGS, resulting in lower net income and a lower (older cost) ending inventory balance compared to FIFO.
Question 4: The quick ratio differs from the current ratio because the quick ratio excludes:
- Cash and cash equivalents
- Marketable securities
- Accounts receivable
- Inventory and prepaid expenses (Correct answer)
Correct answer: Inventory and prepaid expenses
The quick ratio excludes inventory and prepaid expenses because these are less liquid and may not be converted to cash quickly.
Question 5: On a common-size income statement, each line item is expressed as a percentage of:
- Total assets
- Net income
- Net sales (revenue) (Correct answer)
- Gross profit
Correct answer: Net sales (revenue)
Common-size income statements express each item as a percentage of net sales, enabling meaningful comparison across companies or periods.
Question 6: Which of the following would be classified as a financing activity on the cash flow statement?
- Purchase of equipment
- Payment of dividends (Correct answer)
- Collection of accounts receivable
- Purchase of inventory
Correct answer: Payment of dividends
Payment of dividends is a financing activity because it involves returning capital to equity holders.
Question 7: Goodwill recognized in a business combination is:
- Amortized straight-line over 40 years
- Tested for impairment annually (Correct answer)
- Expensed immediately in the period acquired
- Amortized over its estimated useful life
Correct answer: Tested for impairment annually
Under current GAAP, goodwill is not amortized but must be tested for impairment at least annually (or when triggering events occur).
ABA Financial Reporting and Analysis 3
Under GAAP, research costs are generally: