IAR Financial Analysis & Reporting 4 — Questions and Answers
Question 1: A company reports a large deferred tax liability on its balance sheet. This most commonly arises because:
- The company depreciates assets faster for tax purposes than for financial reporting (Correct answer)
- The company has net operating loss carryforwards
- Revenue is recognized later for tax than for book purposes
- The company overpaid its estimated taxes during the year
Correct answer: The company depreciates assets faster for tax purposes than for financial reporting
Accelerated depreciation for tax purposes reduces taxable income now but creates a deferred tax liability because higher book income will be taxed later.
Question 2: Which of the following events would increase a company's reported earnings per share (EPS) without changing net income?
- A share repurchase that reduces the weighted-average shares outstanding (Correct answer)
- Issuing additional common stock
- Declaring a stock dividend
- Increasing the quarterly cash dividend
Correct answer: A share repurchase that reduces the weighted-average shares outstanding
Buying back shares reduces the share count denominator in the EPS calculation, mathematically increasing EPS even if net income is unchanged.
Question 3: Which accounting treatment is required when a company determines that a held-to-maturity bond investment has experienced a credit loss under CECL?
- Record an allowance for credit losses against the amortized cost basis (Correct answer)
- Write the bond down to fair value through other comprehensive income
- Reclassify the bond to the available-for-sale category
- Defer recognition until the loss is realized at maturity
Correct answer: Record an allowance for credit losses against the amortized cost basis
Under CECL (Current Expected Credit Loss), even held-to-maturity securities require an allowance for expected credit losses recorded against their amortized cost.
Question 4: When analyzing a firm's leverage, which ratio most directly measures the ability to service debt from operating earnings?
- Interest coverage ratio (EBIT / Interest expense) (Correct answer)
- Debt-to-equity ratio
- Times interest earned before taxes
- Debt-to-assets ratio
Correct answer: Interest coverage ratio (EBIT / Interest expense)
The interest coverage ratio shows how many times EBIT covers interest charges, directly measuring the company's capacity to service debt from operations.
Question 5: An adviser is comparing two firms using price-to-book (P/B) ratios. Which situation would make P/B least meaningful as a valuation metric?
- A technology firm with large intangible assets that are not capitalized on its balance sheet (Correct answer)
- A bank with a large portfolio of marketable securities marked to market
- A manufacturing company with significant tangible fixed assets
- A utility company with stable regulated cash flows and modest debt
Correct answer: A technology firm with large intangible assets that are not capitalized on its balance sheet
P/B is least meaningful for firms whose primary value drivers (internally developed software, brand, human capital) are expensed and absent from the balance sheet.
Question 6: Which of the following would most likely cause a firm's operating leverage to be high?
- A large proportion of fixed costs relative to total costs (Correct answer)
- Relying heavily on variable-cost contract labor
- Maintaining low levels of long-term debt
- Generating most revenue from commission-based salespeople
Correct answer: A large proportion of fixed costs relative to total costs
High operating leverage arises when fixed costs dominate; small changes in revenue produce amplified changes in operating income because fixed costs don't vary with output.
Question 7: Under IFRS, how are investment properties (real estate held for rental income or capital appreciation) typically reported?
- At fair value with changes recognized in profit or loss, or at cost less depreciation (Correct answer)
- Always at historical cost with no revaluation permitted
- At net realizable value with impairments only
- Consolidated with the parent company's operating properties
Correct answer: At fair value with changes recognized in profit or loss, or at cost less depreciation
IFRS (IAS 40) allows firms to choose either the fair value model (gains/losses in P&L) or the cost model for investment property.
IAR Financial Analysis & Reporting 4
A company reports a large deferred tax liability on its balance sheet.
This most commonly arises because: