Financial Reporting and Analysis Flashcards

When a company restates its financial statements due to an error discovered in a prior period, the restatement should be reflected as:

Answer: A change to the opening balance of retained earnings for the earliest period presented

Prior-period errors require retrospective restatement, adjusting the opening retained earnings balance of the earliest period presented so that all periods are restated as if the error never occurred.

Which of the following best describes a goodwill impairment test under U.S. GAAP?

Answer: Goodwill is tested annually for impairment at the reporting unit level

Under U.S. GAAP (ASC 350), goodwill is not amortized but is tested at least annually for impairment at the reporting unit level.

An analyst computes a company's return on equity (ROE) using the DuPont decomposition. An increase in financial leverage (equity multiplier) while net profit margin and asset turnover remain constant will:

Answer: Increase ROE because more assets are being financed with debt

In the DuPont framework (ROE = Net Profit Margin × Asset Turnover × Equity Multiplier), a higher equity multiplier directly increases ROE holding the other two components constant.

Under IFRS, which of the following costs must be capitalized as part of the cost of property, plant, and equipment?

Answer: Costs directly attributable to bringing the asset to its intended location and condition

IAS 16 requires capitalization of costs directly attributable to bringing the asset to its working condition, while general overhead, training, and abnormal costs are expensed.

A company changes from straight-line depreciation to accelerated depreciation. Under U.S. GAAP, this change in accounting estimate should be accounted for:

Answer: Prospectively, applied to the asset's remaining book value going forward

Changes in accounting estimates (including depreciation method as it relates to the asset's useful economic life) are applied prospectively under U.S. GAAP, affecting only current and future periods.

Which ratio best measures a company's ability to meet its short-term obligations using only its most liquid assets?

Answer: Cash ratio

The cash ratio (cash and cash equivalents divided by current liabilities) is the most conservative liquidity measure, using only the most liquid assets.

Under the equity method of accounting, when an investor receives a cash dividend from an investee, the investor should:

Answer: Reduce the carrying value of the investment on the balance sheet

Under the equity method, dividends received are treated as a return of investment and reduce the carrying value of the investment account, not recognized as income.