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Chapter 1—Overview of Financial Reporting, Financial Statement Analysis, and Valuation
MULTIPLE CHOICE
1. The tools for studying industry economics does not include:
a. Value chain analysis
b. Classification using Porter’s five forces
c. Classification of cash flows
d. Economic attributes framework
2. Which of the following is a question an analyst would ask when assessing the quality of a firm’s
financial statements?
a. Are the company’s products designed to meet a specific market segment?
b. Has the firm integrated forward into retailing to final consumers?
c. Is the firm diversified across several geographical markets?
d. Do earnings include nonrecurring gains or losses?
3. Which of the following economic characteristics is consistent with a grocery store chain?
a. Minimal competition
b. Extensive competition
c. High net income to sales
d. Differentiated product
4. On a common size basis, which of the following assets is normally largest for an electric utility?
a. Accounts receivable
b. Inventory
c. Property, Plant and Equipment
d. Cash and Marketable Securities
5. On a common size basis, which of the following assets is normally largest for a commercial bank?
a. Accounts and Notes Receivable
b. Inventory
c. Property, Plant and Equipment
d. Cash and Marketable Securities
6. Which of the following is not one of Porter’s five forces?
a. Buyer Power
b. Supplier Power
c. Threat of Regulation
d. Threat of Substitutes
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7. When assessing buyer power using Porter’s five forces, which of the following is not consistent with
low buyer power?
a. Brand loyalty
b. Control of distribution channel
c. Large number of suppliers
d. Low price
8. The second step in financial statement analysis is to identify the company strategy. Which of the
following is a question an analyst should ask when performing a strategy analysis?
a. Are industry sales growing rapidly or slowly?
b. Do earnings include revenues that appear mismatched with the business model employed by the
firm?
c. Does the industry include a large number of firms selling similar products?
d. What is the company’s degree of geographical diversification?
9. The third step in financial statement analysis is to assess the quality of the firm’s financial statements.
Which of the following is a question an analyst should ask when performing this step?
a. Are industry sales growing rapidly or slowly?
b. Do earnings include revenues that appear mismatched with the business model employed by the
firm?
c. Does the industry include a large number of firms selling similar products?
d. What is the company’s degree of geographical diversification?
10. An example of an intangible asset is:
a. A patent
b. Land
c. Investment in another company
d. Raw material inventory
11. Which of the following would not appear as a liability on the balance sheet?
a. A labor contract
b. A note due to a bank
c. Salary due employees at year-end
d. Accounts payable
12. Which of the following assets would appear on the balance sheet at an amount greatly below its fair
market value?
a. Inventory
b. Marketable securities
c. Equipment
d. Brand name
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13. The accrual basis of accounting recognizes:
a. Revenue when cash is received from customers
b. Expenses when paid
c. Revenue when all or a substantial portion is performed
d. Revenue when contracts are signed
14. Which of the following is not an activity reported in the Statement of cash Flows?
a. Operating
b. Investing
c. Manufacturing
d. Financing
15. The cash basis method of accounting can be best described as:
a. The recording of transactions and adjustments so that debits equal credits.
b. The method that equates assets with liabilities and owners’ equity.
c. The method that recognizes revenue when money is received and expenses when money is paid.
d. The method that matches incurred expenses with related revenues when they are earned.
16. A value chain for an industry sets forth:
a. The layers of management the needed to be successful
b. Sequence of activities involved in the creation, manufacture, and distribution of its products.
c. Sequence of activities involved in a firm’s research and development activities.
d. Whether the industry is horizontally or vertically integrated.
17. Which of the following economic characteristics is consistent with a commercial bank?
a. Low barriers to entry.
b. High levels of research and development.
c. Low profit margin on lending activities.
d. Low profit margin on fee-based financial services, such as merger consulting.
18. Which of the following economic characteristics is consistent with a pharmaceutical company?
a. Low barriers to entry.
b. High levels of research and development.
c. Low profit margins.
d. Low business risk.
19. Which of the following economic characteristics is consistent with a grocery store chain?
a. Low barriers to entry.
b. High levels of research and development.
c. High profit margins.
d. Low capital intensity.
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20. When attempting to identify the economic characteristics of the industry in which a particular firm
participates an analyst might ask which of the following questions?
a. Does technological change play an important role in the firm maintaining a competitive
advantage?
b. Has the firm diversified across several geographic markets?
c. Has the firm recognized revenues at the proper time?
d. Has the firm structured transactions to make it look more profitable than economic conditions
suggest?
21. Which of the following would not inhibit new entrants into a market?
a. Existing technological expertise.
b. Large required capital investment.
c. Lack of rivalry among current participants.
d. Existing patented technology.
22. Current assets are defined as:
a. Cash and cash equivalents.
b. All assets expected to be quickly used by the firm.
c. Cash and other assets that the firm expects to sell or consume during the normal operating cycle of
a business, usually one year.
d. Cash and other assets that the firm expects maintain for a period including the normal operating
cycle of a business, usually one year.
23. Which of the following is not an expense of a business?
a. Depreciation
b. Dividends
c. Salaries
d. Advertising
24. Which of the following is not a characteristic of an extraordinary item?
a. Material in amount.
b. Nonrecurring.
c. Unusual given the nature of the firm’s activities.
d. Requires a cash outflow.
25. Which of the following activities is an operating activity?
a. Collections of accounts receivable.
b. Investing in equity securities of other companies.
c. Payment of dividends.
d. Issuing common stock
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26. What is the principal activity of security analysts?
a. To assign credit ratings.
b. To apply IFRS adjustments.
c. To value firms.
d. To assess the need for audits.
27. All of the following are the building blocks for financial statement analysis except:
a. Targeting growth opportunities that diversify exchange rates, risk exposure, and political
uncertainty.
b. Describing strategies that a firm pursues to differentiate itself from competitors in order to
evaluate competitive advantages, sustainability of the firm’s earnings, and its risks.
c. Evaluating the financial statements, including the accounting concepts and methods that underlie
them and the quality of the information they provide.
d. Identification of the economic characteristics of the industries and the relation of those economic
characteristics to the various financial statement ratios.
28. When a firm attempting to create unique products or services for particular market niches, in order to
achieve relatively high profit margins, this is best known as:
a. A quality strategy
b. A low-cost leadership strategy
c. A vertical integration strategy
d. A product differentiation strategy
29. The following steps make up the steps in financial statement analysis:
1. Identify the strategies the firm pursues to gain and sustain a competitive advantage.
2. Analyze the current profitability and risk of the firm using information in the financial
statements.
3. Value the firm.
4. Identify the economic characteristics and competitive dynamics of the industry in
which a particular firm participates.
5. Assess the quality of the firm’s financial statements and, if necessary, adjust them for
such desirable characteristics as sustainability or comparability.
6. Prepare forecasted financial statements.
Which of the following is the proper order for these interrelated sequential steps?
a. 4,1,5,2,6,3
b. 1,2,3,4,5,6
c. 4,6,2,5,1,3
d. 1,4,2,5,3,6
30. All of the following are reasons that pharmaceutical companies have higher barriers for entry than
grocery stores except:
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a. There is lengthy government testing and approval required.
b. Research and development is a lengthy and uncertain process.
c. Patent protection is needed for exclusive rights.
d. The largest asset is typically capital intensive Property, Plant and Equipment.
31. Which forces typically represent vertical competition in a value chain?
a. Potential entry and substitutes.
b. Buyer power and rivalry among existing firms
c. Supplier power and potential entry.
d. Buyer power and supplier power
32. Which forces typically represent horizontal competition in a value chain?
a. Rivalry among existing firms and supplier power.
b. Potential entry and buyer power.
c. Substitutes and potential entry.
d. Buyer power and supplier power.
33. Which of the following is an independent entity comprising 15 members and a full-time professional
staff that specifies acceptable accounting principles known as IFRS?
a. FASB
b. IASB
c. SEC
d. GAAP
34. Which two organizations are working together to harmonize financial reporting worldwide?
a. FASB and IASB
b. GAAP and FASB
c. SEC and FASB
d. EU and SEC
35. Which of these would be considered Property, Plant, and Equipment?
a. Trademark
b. Office Building
c. Patent
d. Goodwill
36. Extraordinary gains and losses arise from events that have all the following characteristics except:
a. They are unusual given the nature of the firm’s activity.
b. They are nonrecurring.
c. They are material in amount.
d. They result from terminated involvement in a line of business.
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37. Opinions on the effectiveness of the internal control system and the fairness of the amounts reported in
the financial statements are known as:
a. Management Discussion and Analysis.
b. Assurance Opinions.
c. Notes to the Financial Statements
d. Management Assessments.
38. Which SEC form may be the best place to start learning about the economics of an industry and the
particular strategy a firm has selected for competing in the industry?
a. Form 8-K
b. Form 10-K
c. Form MD&A
d. Form FSAP
39. The primary purpose of the balance sheet is to:
a. Report the current value of the business.
b. Measure the net income of a business up to a particular point in time.
c. Report the difference between cash inflows and cash outflows for the period.
d. Report the financial position of the reporting entity at a particular point in time.
40. Which financial statement would you look at to determine whether a company will be able to pay for
the goods when payment is due in 30 days?
a. Statement of cash flows.
b. Statement of stockholders’ equity.
c. Income statement.
d. Balance sheet.
41. Which of the following is not considered to be a liability?
a. Wages payable.
b. Accounts payable.
c. Notes payable.
d. Cost of goods sold.
42. Assets for a particular business might include:
a. Cash, retained earnings, and accounts payable.
b. Cash, common shareholders’ equity, and accounts receivable.
c. Cash, property, plant, and equipment, and accumulated other comprehensive income.
d. Cash, inventories, and goodwill.
43. The two categories of shareholders’ equity usually found on the balance sheet of a corporation are:
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a. Contributed capital and property, plant, and equipment.
b. Retained earnings and notes payable.
c. Common stock and retained earnings.
d. Contributed capital and equity securities.
44. Which financial statement for a business would you look at to determine the company’s earnings
performance during an accounting period?
a. Balance sheet.
b. Income statement.
c. Statement of cash flows.
d. The Management Assessment.
45. Accounts payable represent:
a. Amounts which are due to stockholders.
b. Amounts which have been borrowed to finance operations.
c. Amounts which are owed to the company by its customers resulting from credit sales.
d. Amounts which are owed by the company to its suppliers for past purchases.
46. On the statement of cash flows, depreciation would be classified as?
a. A financing activity.
b. An operating activity.
c. An investing activity.
d. A noncash activity.
47. Which form does the balance sheet equation take in the United Kingdom?
a. Noncurrent Assets + Noncurrent Liabilities = Shareholders’ Equity
b. Revenues – Expenses = Shareholders’ Equity
c. Noncurrent Assets + [Current assets – Current Liabilities] – Noncurrent Liabilities = Shareholders’
Equity
d. Noncurrent Assets – Current assets = Noncurrent Liabilities – Current Liabilities + Shareholders’
Equity
48. Net income is equal to:
a. Assets minus Liabilities
b. Revenues and Gains minus Expenses and Losses
c. Shareholders’ Equity minus Assets
d. Revenues and Assets minus Expenses and Liabilities
49. All of the following are principal provisions of the Sarbanes-Oxley Act of 2002 except:
a. At least one member of the audit committee of the board of directors must be a “financial expert.”
b. The lead audit or coordinating partner and the reviewing partner of the public accounting firm
must rotate, or change, every five years.
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c. The firm’s chief executive officer and the chief financial officer must issue a statement along with
the audit report stating that the financial statements and notes fairly present the operations and
financial position of the firm.
d. The FASB has oversight and enforcement authority over the SEC.
50. Why is the operating activities section of the statement of cash flows often believed to be the most
important part of the statement?
a. Because it shows the dividends that have been paid to stockholders.
b. Because it indicates a company’s ability to generate cash from sales to meet current cash payments
for goods or services.
c. Because shows the net increase or decrease in cash during the period.
d. Because it gives the most information about how operations have been financed.
COMPLETION
1. The tools of effective financial statement analysis are useful for assessing whether to extend
____________________ to a firm, either for a short-term or for a long-term.
2. The Second step in financial statement analysis requires businesses to analyze strategies that will
__________________________ itself from the firms’ competitors.
3. Another important step in financial statement analysis is to assess the quality of a firm’s
_____________________________ and if necessary adjust them for such characteristics as
sustainability or comparability.
4. The fourth step in financial statement analysis is using the financial statements to analyze the current
____________________, _______________ and ____________________ of the firm.
5. When identifying the strategies that a particular firm pursues to gain a competitive advantage it is
important to determine if its products are designed to meet the needs of a specific market segment or
are they intended for a(n) _____________________________________________.
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6. The ______________________________ sets forth the sequence of activities involved in the creation,
manufacture and distribution of its products and services.
7. The higher the value added from any activity, the higher should be the ____________________ from
engaging in that activity.
8. Normally, intense rivalries have a tendency to reduce ____________________.
9. The threat of new entrants is measured by whether there are entry barriers, such as capital investment,
________________________________________, patents, or regulation that inhibit new entrants.
10. The five economic attributes that are normally studied are demand, supply, manufacturing,
____________________, and investing and financing.
11. Obtaining a competitive advantage by being the first company to introduce new concepts or ideas is
referred to as ________________________________________.
12. Resources that have the potential for providing a firm with future economic benefits are called
____________________.
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20. Depreciation is a(n) ___________________ added back to net income when preparing the operating
21. The _____________________________________________ defines more clearly the explicit
responsibility of managers for financial statements, the relation between the independent auditor and
the firm audited and the kinds of services permitted and not permitted.
22. Under the Sarbanes-Oxley Act ____________________ assumes responsibility for establishing and
maintaining adequate internal control structure and procedures.
23. Most financial statement analysis aims to assess a firm’s ____________________ and
____________________.
24. ___________________________________ financial statements are helpful in highlighting the relative
magnitude of changes in financial statement data from year to year.
25. Basic EPS is calculated as net income minus _____________________________________________
divided by the weighted average number of shares outstanding.
26. The prospectus must be filed with the ________ before the company can sell new issues of stocks or
bonds.
A SEC
27. ______________________________ relates to the relative number of buyers and sellers in a particular
industry.