CFA Financial Reporting & Analysis 3 — Questions and Answers
Question 1: Which of the following would increase a company's current ratio but NOT its quick ratio?
- Collecting accounts receivable
- Purchasing inventory with cash
- Issuing long-term debt for cash
- Purchasing inventory on credit (Correct answer)
Correct answer: Purchasing inventory on credit
Purchasing inventory on credit increases current assets (inventory) and current liabilities equally, but inventory is excluded from the quick ratio numerator.
Question 2: A finance lease on the lessee's books results in which of the following compared to an operating lease?
- Lower total expenses over the lease term
- Higher debt-to-equity ratio (Correct answer)
- Higher operating cash flows
- Lower asset turnover initially
Correct answer: Higher debt-to-equity ratio
Finance leases require recognizing a liability on the balance sheet, increasing the debt-to-equity ratio compared to an operating lease.
Question 3: Under the percentage-of-completion method for long-term contracts, revenue recognized in a period is based on:
- Cash collected during the period
- Costs incurred to date as a proportion of total estimated costs (Correct answer)
- Contracts completed during the period
- Management's subjective judgment of completion
Correct answer: Costs incurred to date as a proportion of total estimated costs
Revenue is recognized proportionally based on costs incurred to date divided by total estimated costs, reflecting the stage of completion.
Question 4: Common-size income statements express each line item as a percentage of:
- Total assets
- Net income
- Revenue (Correct answer)
- Gross profit
Correct answer: Revenue
Common-size income statements divide each line item by revenue, enabling comparison across companies of different sizes.
Question 5: A write-down of inventory to net realizable value under IFRS will immediately affect:
- Only the balance sheet
- Only the income statement
- Both the balance sheet and income statement (Correct answer)
- Neither statement until inventory is sold
Correct answer: Both the balance sheet and income statement
An inventory write-down reduces the inventory asset on the balance sheet and is recognized as an expense on the income statement in the same period.
Question 6: Which ratio measures the proportion of a company's assets financed by debt?
- Debt-to-equity ratio
- Debt-to-assets ratio (Correct answer)
- Interest coverage ratio
- Financial leverage ratio
Correct answer: Debt-to-assets ratio
The debt-to-assets ratio = Total Debt / Total Assets, directly measuring what fraction of assets are debt-financed.
Question 7: The effective tax rate differs from the statutory tax rate primarily due to:
- Differences in GAAP and IFRS revenue recognition
- Permanent differences between book and taxable income (Correct answer)
- Temporary differences creating deferred taxes
- Changes in accounting estimates
Correct answer: Permanent differences between book and taxable income
Permanent differences (e.g., tax-exempt income, non-deductible expenses) cause the effective rate to diverge from the statutory rate permanently.
CFA Financial Reporting & Analysis 3
Which of the following would increase a company's current ratio but NOT its quick ratio?