Free Financial Statement Analysis Questions and Answers — Questions and Answers

Question 1: The payment of cash dividends is an illustration of:

Cash flows from financing activities (Correct answer)
Cash flows from operating activities
Cash flows from investing activities

Correct answer: Cash flows from financing activities

In a statement of cash flows, the payment of cash dividends is classified under financing activities. Financing activities involve transactions that affect the size and composition of a company's debt and equity capital. Paying dividends represents a distribution of profits to shareholders, which is a key aspect of managing the company's equity structure.

Question 2: Basic earnings per share are computed as follows:

[Net Income-Preferred Dividends]/Weighted Avg # of common shares outstanding (Correct answer)
[Net Income]/[Common shares outstanding]
[Net Income- Dividends]/Weighted Avg # of shares outstanding

Correct answer: [Net Income-Preferred Dividends]/Weighted Avg # of common shares outstanding

Basic Earnings Per Share (EPS) is a financial metric that indicates the portion of a company's profit allocated to each outstanding share of common stock. It is calculated by subtracting preferred dividends from net income (as preferred shareholders have a prior claim on earnings) and then dividing the result by the weighted average number of common shares outstanding during the period. This formula provides a fundamental measure of a company's profitability on a per-share basis.

Question 3: The opinion section of an independent auditor's report begins, "In our opinion, the aforementioned financial statements fairly present the financial position in all material respects..." This language specifies .

A disclaimer of opinion
A qualified opinion
An unqualified opinion (Correct answer)

Correct answer: An unqualified opinion

An unqualified opinion, also known as a clean opinion, is issued when an auditor concludes that the financial statements are presented fairly, in all material respects, and in accordance with generally accepted accounting principles (GAAP). The phrase "fairly present the financial position in all material respects" is the standard language used to convey this highest level of assurance. It signifies that the financial statements are free from material misstatements and can be relied upon by users.

Question 4: A company's net income is 200, accounts receivables increased by 30, depreciation increased by 55, and accounts payable decreased by 25. It has a ________ operating cash flow.

285
200 (Correct answer)
230

Correct answer: 200

To calculate operating cash flow using the indirect method, start with net income ($200). Add back non-cash expenses like depreciation ($55). Then, adjust for changes in current operating assets and liabilities: an increase in accounts receivable ($30) reduces cash, and a decrease in accounts payable ($25) also reduces cash. Therefore, the calculation is $200 (Net Income) + $55 (Depreciation) - $30 (Increase in A/R) - $25 (Decrease in A/P) = $200.

Question 5: Stock dividends and stock splits are dissimilar because

A stock dividend results in a decline in the par value per share
Stock splits are paid in additional shares of common stock, whereas a stock dividend results in replacement of all outstanding shares with a new issue of shares
In a stock split a larger number of new shares replaces the outstanding shares (Correct answer)

Correct answer: In a stock split a larger number of new shares replaces the outstanding shares

A stock split fundamentally changes the par value per share by replacing existing shares with a larger number of new shares, proportionally reducing the par value per share. In contrast, a stock dividend issues additional shares without typically changing the par value per share, and it involves a transfer from retained earnings to paid-in capital. The key difference lies in the adjustment of the par value and the magnitude of the share increase.

Question 6: Which of the following would be considered an investment cash inflow?

Proceeds from selling investments in the equity securities of other companies (Correct answer)
Cash paid for dividends
Cash paid to retire bonds

Correct answer: Proceeds from selling investments in the equity securities of other companies

Investment cash inflows are cash flows generated from the sale of long-term assets or investments. Proceeds from selling investments in the equity securities of other companies represent cash received from divesting an investment, thus classifying it as an investment cash inflow. Cash paid for dividends and cash paid to retire bonds are classified as financing cash outflows.

Question 7: Which of the following would be considered an investment cash inflow?<br> I. Proceeds from the sale of debt securities of other entities, excluding cash equivalents II. Proceeds from the collection of loan principals III. Proceeds from the sale of equity investments in other firms

Only I is correct
All responses are correct (Correct answer)
I and II are correct

Correct answer: All responses are correct

Investment cash inflows include cash received from the sale of debt or equity securities of other entities (excluding cash equivalents) and the collection of principal on loans made to other entities. All three listed items—proceeds from the sale of debt securities, proceeds from the collection of loan principals, and proceeds from the sale of equity investments—represent cash generated from investment activities. These activities involve the acquisition and disposal of long-term assets and investments.

Question 8: The primary earnings per share data are calculated using the treasury stock method as though outstanding options and warrants (for the entire year) were exercised at the

Beginning of the period and as if the funds obtained thereby were used to purchase common stock at the average market price during the period (Correct answer)
Beginning of the period and as if the funds obtained thereby were used to purchase common stock at the current market price in effect at the end of the period
End of the period and as if the funds obtained thereby were used to purchase common stock at the current market price in effect at the end of the period

Correct answer: Beginning of the period and as if the funds obtained thereby were used to purchase common stock at the average market price during the period

The treasury stock method, used for calculating primary (basic) earnings per share, assumes that outstanding options and warrants are exercised at the beginning of the period (or date of issuance if later). The hypothetical cash proceeds from this exercise are then assumed to be used to repurchase common stock at the average market price during the reporting period. This method reflects the dilutive effect of these instruments on EPS.

Question 9: Retained profits are what:

Accumulated, undistributed earnings since inception (Correct answer)
Earnings inclusive of any paid-in capital since inception
Undistributed net income in the last accounting period

Correct answer: Accumulated, undistributed earnings since inception

Retained earnings represent the cumulative total of a company's net income that has not been distributed to shareholders as dividends since the company's inception. It is a component of stockholders' equity on the balance sheet, reflecting profits that have been reinvested in the business rather than paid out. It accumulates over time, not just from the last period, and does not include paid-in capital.

Question 10: The following list includes operating cash flows?<br> I. Interest paid; II. Interest earned; and III. Dividends received. IV. Dividends received

I, II & III (Correct answer)
I, II, III & IV
I & III

Correct answer: I, II & III

Under GAAP, interest paid and interest earned are generally classified as operating cash flows because they relate to the core business activities of generating revenue and managing debt. Dividends received from investments are also typically considered operating cash flows, as they represent income from the company's investments. Therefore, I, II, and III are all operating cash flows.

Question 11: A current asset is which of the following?

Notes Receivable
Accumulated Depreciation (Correct answer)
Accounts Receivable

Correct answer: Accumulated Depreciation

Accounts Receivable are amounts owed to the company by customers for goods or services already delivered, typically expected to be collected within one year or the operating cycle. This makes them a current asset. Notes Receivable can be current or non-current depending on their maturity, while Accumulated Depreciation is a contra-asset account that reduces the book value of long-term assets, not a current asset itself.

Question 12: Companies disclose their receivables at:

Their liquidation value
The lower-of-cost-or-market value
Their net realizable value (Correct answer)

Correct answer: Their net realizable value

Companies disclose their accounts receivables at their net realizable value. This is the amount the company expects to collect, calculated by subtracting the allowance for doubtful accounts (an estimate of uncollectible amounts) from the gross accounts receivable. This approach provides a more accurate representation of the cash expected to be received from customers.

Question 13: A company is bought for more than its assets' fair market value.<br>The surplus is:

Considered as "goodwill" (Correct answer)
Written off against the retained earnings on the balance sheet
Treated as an extraordinary loss & presented net of taxes on the income statement

Correct answer: Considered as "goodwill"

When a company is acquired for a price greater than the fair market value of its identifiable net assets, the excess amount paid is recognized as "goodwill." Goodwill is an intangible asset representing the value of the acquired company's non-identifiable assets, such as brand reputation, customer relationships, or strong management. It is recorded on the balance sheet and is subject to impairment testing.

Question 14: When an auditor qualifies her judgment with a "adverse opinion," she is referring to the following:

There is considerable uncertainty in the firm's asset-liability valuation, thus causing a concern about its operational health
The firm's financial statements do not fairly represent the company's financial performance and position (Correct answer)
The firm has inadequate controls in place and needs an on-going, frequent audit

Correct answer: The firm's financial statements do not fairly represent the company's financial performance and position

An adverse opinion is the most severe type of audit opinion, indicating that the auditor has found material misstatements that are pervasive throughout the financial statements. This means the financial statements do not fairly represent the company's financial performance and position in accordance with GAAP. Such an opinion suggests that the financial statements are unreliable and should not be depended upon.

Question 15: Revenue is typically recognized when it is ________, on average.

Realizable and earned (Correct answer)
Measurable and received
Measurable and earned

Correct answer: Realizable and earned

Under the accrual basis of accounting, revenue is recognized when it is both earned and realizable. "Earned" means the company has substantially completed its performance obligation by delivering goods or services. "Realizable" means there is a reasonable assurance of collecting the cash or an asset that can be readily converted to cash. This principle ensures revenue is recorded when the economic event occurs, regardless of when cash is exchanged.

Question 16: What one of the following qualifies as a liability resulting from financing activities?

Notes payable (Correct answer)
Accounts payable
Taxes payable

Correct answer: Notes payable

Notes payable typically represent formal debt obligations, such as loans from banks or other lenders, which are considered financing activities. Accounts payable and taxes payable, on the other hand, are current liabilities that arise from a company's normal operating activities (e.g., purchasing supplies on credit, owing taxes). Therefore, notes payable is the liability most directly associated with financing activities.

Free Financial Statement Analysis Questions and Answers

The payment of cash dividends is an illustration of: