Certified Valuation Analyst CVA Financial Statement Analysis 2 — Questions and Answers
Question 1: When normalizing earnings for a closely held company, which adjustment removes the effect of an owner paying themselves above-market compensation?
- Adding back excess officer compensation to pre-tax earnings (Correct answer)
- Capitalizing all officer salaries
- Removing depreciation expense
- Deferring revenue to the next period
Correct answer: Adding back excess officer compensation to pre-tax earnings
Excess compensation above a market rate is added back to normalize earnings to what an arm's-length employer would pay.
Question 2: A non-recurring lawsuit settlement expense appears in the income statement. In normalization, how should an analyst treat it?
- Remove it as a non-recurring item (Correct answer)
- Amortize it over five years
- Treat it as ongoing operating cost
- Add it to cost of goods sold
Correct answer: Remove it as a non-recurring item
One-time, non-recurring items are removed so historical earnings reflect sustainable operations.
Question 3: Which ratio best measures a company's ability to cover interest obligations from operating profit?
- Times interest earned (EBIT / interest expense) (Correct answer)
- Current ratio
- Inventory turnover
- Gross margin
Correct answer: Times interest earned (EBIT / interest expense)
Times interest earned divides EBIT by interest expense to show how easily interest is covered.
Question 4: An analyst restates LIFO inventory to FIFO for comparability. What account adjustment captures this difference?
- The LIFO reserve (Correct answer)
- Goodwill
- Deferred revenue
- Treasury stock
Correct answer: The LIFO reserve
The LIFO reserve is added to LIFO inventory to approximate FIFO inventory values.
Question 5: What does a steadily declining gross profit margin most likely signal in financial statement analysis?
- Rising input costs or pricing pressure (Correct answer)
- Improved tax efficiency
- Lower long-term debt
- Higher dividend payout
Correct answer: Rising input costs or pricing pressure
A falling gross margin typically reflects increasing cost of goods sold or eroding pricing power.
Question 6: In a common-size income statement, each line item is expressed as a percentage of which figure?
- Net sales (revenue) (Correct answer)
- Total assets
- Net income
- Total equity
Correct answer: Net sales (revenue)
Common-size income statements express every line as a percent of net sales for comparability.
Question 7: Which adjustment is appropriate when a company owns a building it uses but records no rent expense?
- Impute a market rent expense (Correct answer)
- Add the building to inventory
- Remove all depreciation
- Capitalize the CEO salary
Correct answer: Impute a market rent expense
Imputing market rent normalizes earnings to reflect the economic cost of occupancy.
Certified Valuation Analyst CVA Financial Statement Analysis 2
When normalizing earnings for a closely held company, which adjustment removes the effect of an owner paying themselves above-market compensation?