Corporate Governance & Financial Management 4 — Questions and Answers
Question 1: Which type of financial restatement carries the greatest governance and legal risk for a company's board and management?
- A revision restatement correcting a prior-period immaterial error
- A Big R restatement indicating previously issued financials can no longer be relied upon (Correct answer)
- A reclassification of expenses between line items
- An adjustment to depreciation useful life estimates
Correct answer: A Big R restatement indicating previously issued financials can no longer be relied upon
A 'Big R' restatement means previously filed financials were materially misstated and unreliable, triggering SEC scrutiny, potential litigation, and heightened board accountability.
Question 2: A company's board is evaluating a major acquisition. Which financial governance practice best reduces the risk of overpaying?
- Relying solely on management's valuation model
- Hiring independent financial advisors to provide a fairness opinion (Correct answer)
- Proceeding quickly to prevent competitor bids
- Using only debt financing to limit equity dilution
Correct answer: Hiring independent financial advisors to provide a fairness opinion
An independent fairness opinion from outside financial advisors provides the board with an objective valuation assessment and legal protection against claims of overpayment.
Question 3: What is the significance of a company's 'going concern' qualification from its external auditor?
- The auditor has found fraud within management
- The auditor has substantial doubt about the company's ability to continue operating for the next 12 months (Correct answer)
- The company must immediately liquidate assets
- The qualification means the audit is incomplete
Correct answer: The auditor has substantial doubt about the company's ability to continue operating for the next 12 months
A going concern qualification signals that the auditor doubts whether the company can sustain operations, prompting urgent board action on liquidity and capital planning.
Question 4: Under US SEC rules, which financial statement disclosure is required to help investors understand management's significant accounting judgments?
- The proxy statement
- Management's Discussion and Analysis (MD&A) (Correct answer)
- The auditor's independence letter
- The Form 8-K
Correct answer: Management's Discussion and Analysis (MD&A)
The MD&A section requires management to explain critical accounting estimates, significant judgments, and factors affecting financial results beyond the raw numbers.
Question 5: A whistleblower reports to the audit committee that the company is improperly capitalizing operating expenses to inflate assets. What is the committee's required first step?
- Notify the CEO and allow management to investigate first
- Conduct an independent internal investigation without tipping off management (Correct answer)
- Immediately file an SEC disclosure
- Dismiss the claim unless corroborated by the external auditor
Correct answer: Conduct an independent internal investigation without tipping off management
Audit committees must conduct independent investigations of accounting misconduct allegations without involving potentially implicated management.
Question 6: Which financial leverage ratio is most commonly used by boards to monitor covenant compliance with lenders?
- Price-to-earnings ratio
- Net debt-to-EBITDA ratio (Correct answer)
- Return on equity
- Current ratio
Correct answer: Net debt-to-EBITDA ratio
Net debt-to-EBITDA is the most widely used leverage covenant metric, as lenders set maximum thresholds to ensure debt remains serviceable.
Question 7: What is the primary governance purpose of requiring auditor rotation at public companies?
- To reduce audit fees through competitive bidding
- To prevent auditor familiarity from impairing independence and objectivity (Correct answer)
- To give smaller audit firms access to large clients
- To allow management to select auditors aligned with their preferences
Correct answer: To prevent auditor familiarity from impairing independence and objectivity
Mandatory audit partner or firm rotation prevents long-term relationships from causing auditors to become too accommodating of management's preferred accounting treatments.
Corporate Governance & Financial Management 4
Which type of financial restatement carries the greatest governance and legal risk for a company's board and management?