AIFA Financial Statement Analysis & Accounting 2 — Questions and Answers
Question 1: In a DuPont analysis, Return on Equity (ROE) is decomposed into which three components?
- Gross margin, asset turnover, and leverage ratio
- Net profit margin, asset turnover, and equity multiplier (Correct answer)
- Operating margin, current ratio, and debt-to-equity
- Revenue growth, net margin, and dividend payout
Correct answer: Net profit margin, asset turnover, and equity multiplier
The classic DuPont formula breaks ROE into net profit margin (profitability) × asset turnover (efficiency) × equity multiplier (financial leverage).
Question 2: Under FIFO inventory accounting during a period of rising prices, compared to LIFO, a company will report:
- Lower net income and lower ending inventory
- Higher net income and higher ending inventory (Correct answer)
- Higher net income and lower ending inventory
- Lower net income and higher ending inventory
Correct answer: Higher net income and higher ending inventory
Under FIFO during rising prices, older (cheaper) costs flow through COGS first, leaving newer (higher) costs in ending inventory—resulting in lower COGS, higher net income, and higher ending inventory than LIFO.
Question 3: Which of the following is classified as an off-balance-sheet financing arrangement?
- Long-term bonds payable
- Operating lease under ASC 842
- Finance lease liability
- Special purpose entity (SPE) used to transfer assets (Correct answer)
Correct answer: Special purpose entity (SPE) used to transfer assets
Special purpose entities (SPEs) can be used to remove assets and liabilities from a company's consolidated balance sheet, constituting off-balance-sheet financing when consolidation is avoided.
Question 4: Goodwill recorded on an acquisition must be:
- Amortized over 40 years under US GAAP
- Tested for impairment annually under US GAAP (Correct answer)
- Written off immediately against retained earnings
- Amortized over its useful economic life under IFRS only
Correct answer: Tested for impairment annually under US GAAP
Under US GAAP (ASC 350), goodwill is not amortized but must be tested for impairment at least annually or more frequently if triggering events occur.
Question 5: Earnings quality is considered HIGH when a company's earnings are primarily driven by:
- One-time gains from asset sales
- Aggressive revenue recognition policies
- Recurring operating cash flows closely matching net income (Correct answer)
- Significant accruals and deferrals
Correct answer: Recurring operating cash flows closely matching net income
High-quality earnings are sustainable and verifiable, meaning operating cash flows closely track net income without reliance on non-recurring items or aggressive accounting choices.
Question 6: A deferred tax liability arises when:
- Tax expense exceeds taxes currently payable (Correct answer)
- Taxes currently payable exceed tax expense
- A company has net operating loss carryforwards
- Accelerated tax depreciation creates a future deduction
Correct answer: Tax expense exceeds taxes currently payable
A deferred tax liability is created when book income exceeds taxable income (e.g., due to faster tax depreciation), meaning more taxes will be owed in the future than currently payable.
Question 7: An analyst notes that a company's accounts receivable days (DSO) increased from 35 to 58 days over two years while revenue grew 5%. This most likely indicates:
- Improved efficiency in collecting receivables
- Potential revenue recognition issues or collection problems (Correct answer)
- A reduction in credit sales as a percentage of total sales
- Strong demand leading to faster order fulfillment
Correct answer: Potential revenue recognition issues or collection problems
A significant increase in DSO relative to modest revenue growth suggests the company may be extending credit terms aggressively, recognizing revenue prematurely, or facing collection difficulties.
AIFA Financial Statement Analysis & Accounting 2
In a DuPont analysis, Return on Equity (ROE) is decomposed into which three components?