CPA Financial Analysis & Reporting 3 — Questions and Answers
Question 1: Which inventory costing method results in the highest net income during a period of rising prices?
- LIFO
- FIFO (Correct answer)
- Weighted-average cost
- Specific identification
Correct answer: FIFO
FIFO assigns the oldest (lowest) costs to cost of goods sold during rising prices, leaving the most recent (higher) costs in ending inventory, which produces the highest gross profit.
Question 2: A firm's debt-to-equity ratio is 1.5 and total equity is $400,000. What is total debt?
- $266,667
- $600,000 (Correct answer)
- $267,000
- $1,000,000
Correct answer: $600,000
Total debt = Debt-to-equity ratio × Total equity = 1.5 × $400,000 = $600,000.
Question 3: Under US GAAP, which method is permitted for measuring inventory at the lower of cost or net realizable value?
- LIFO and FIFO only
- FIFO, LIFO, and weighted-average (Correct answer)
- FIFO and weighted-average only
- Specific identification only
Correct answer: FIFO, LIFO, and weighted-average
US GAAP permits FIFO, LIFO, and weighted-average cost methods, all subject to the lower of cost or net realizable value (or market for LIFO/retail).
Question 4: An analyst notices that a company's days sales outstanding (DSO) increased from 35 to 52 days year-over-year. This most likely indicates:
- Improved collection efficiency
- Declining sales volume
- Slower collection of receivables or relaxed credit terms (Correct answer)
- Higher inventory turnover
Correct answer: Slower collection of receivables or relaxed credit terms
A rising DSO signals that receivables are taking longer to collect, which may reflect relaxed credit policies, customer financial stress, or billing issues.
Question 5: Which of the following is a non-cash item that must be added back to net income when using the indirect method to prepare the cash flow from operations?
- Decrease in prepaid expenses
- Gain on sale of equipment
- Amortization of intangible assets (Correct answer)
- Increase in accounts payable
Correct answer: Amortization of intangible assets
Amortization is a non-cash charge that reduced net income but did not use cash, so it is added back under the indirect method.
Question 6: The price-to-earnings (P/E) ratio is most useful for comparing companies that:
- Have negative earnings
- Are in the same industry with similar growth profiles (Correct answer)
- Use different capital structures
- Report under different accounting standards
Correct answer: Are in the same industry with similar growth profiles
P/E comparisons are most meaningful between companies in the same industry because industry-specific growth rates and risk profiles affect what constitutes a 'reasonable' multiple.
Question 7: Which financial statement reconciles the beginning and ending balances of shareholders' equity?
- Income statement
- Balance sheet
- Statement of cash flows
- Statement of changes in equity (Correct answer)
Correct answer: Statement of changes in equity
The statement of changes in equity (or statement of stockholders' equity) details all transactions affecting equity accounts during the period, bridging beginning and ending balances.
CPA Financial Analysis & Reporting 3
Which inventory costing method results in the highest net income during a period of rising prices?