Practice questions with answers: Introduction to Financial Statement Analysis

1. Which of the following is least likely to be considered a role of financial statement

analysis?
A. To help users of financial statements make better economic decisions
B. To give insights into a company’s growth, liquidity, profitability, and solvency trends
C. To assess the accuracy and completeness of the financial statements of a company

Answer: C
The primary role of financial statement analysis is to help users of financial statements make
better financial, investment, or other economic decisions. This type of analysis uses a company’s
financial statements, along with other relevant information, to provide more insights into a
company’s business and its growth, liquidity, profitability, and solvency trends.

Therefore, the least correct answer is C. It is the auditors’ role to review and make an assessment
of a company’s financial statements. The audit opinion confirms whether the financial statements
make a true and fair representation of a firm’s performance. In essence, it certifies (or doesn’t)
the credibility of the figures within an Annual Report.

2. Which of the following is not included in a company’s complete set of financial

statements?
A. Management Discussion and Analysis
B. Proxy Statements
C. Footnotes to the financial statements

Answer: B
An Annual Report (or a complete set of financial statements) comprises the following:
 Auditor’s report (when the company is audited)
 Management Discussion and Analysis (MD&A) Section
 Primary Financial Statements (Statement of Financial Position, Statement of
Comprehensive Income, Cash Flow Statement, and Statement of Changes in Equity)
 Notes or footnotes to the financial statements
Proxy Statements are not part of a company’s financial statements. They are issued to
shareholders on an ad-hoc basis when some business matters require their attention. Proxy
statements are a good source of information about the election of board members and their
compensation, management qualifications, or the issuance of stock options.

3. What type of audit opinion will be issued, if the company prepares its financial
statements, following the generally accepted accounting rules, and there are no material
errors and omissions?
A. Qualified Opinion
B. Unqualified Opinion
C. Adverse Opinion
Answer: B
An unqualified opinion means “clean” opinion. It states that the financial statements are free
from any material omissions and errors.
A qualified opinion shows that auditors have identified some major exceptions to the accounting
rules. However, with few irregularities, most accounting and financial reporting issues have been
dealt with adequately.
On the other hand, when auditors find out material and pervasive issues in a company’s financial
reports, they issue an adverse opinion. It postulates that the financial statements are
misrepresented, misstated, or do not reflect accurately on a company’s overall financial
performance.

4. Where can you find information about a company’s assumptions, accounting estimates,
and methods used, within the context of financial reporting?
A. In the Management Discussion and Analysis section
B. In the footnotes to the financial statement
C. In the primary financial statements

Answer: B
Notes (or footnotes) to the financial statements are additional disclosures that provide further
details about the information published in the primary financial statements. They describe the
accounting policies, methods, assumptions, and estimates as used by the management of a
company.

5. Which of the following IS part of the financial statement analysis framework?

A. Updating the analysis regularly
B. Making an internal control assessment
C. Understanding the company’s operations risks

Answer: A
Any financial statement analysis needs to be updated regularly. You have to repeat the steps in
the framework periodically and change the conclusions or recommendations whenever
necessary.
The other suggestions are useful when analyzing a company, however, they are not defined as an
explicit step in the financial statement’s analysis framework.

6. Which of the following affects the Statement of Changes in Owners’ Equity?

A. A decrease in receivables from clients
B. Payments to suppliers
C. Declaring of a common stock dividend
Answer: C
Changes in trade payables or receivables affect the cash balance and the outstanding accounts
payable/receivable. The results are visible in the Statement of Financial Position and the Cash
Flow Statement.
Accounts receivable decrease => cash increases
Accounts payable decrease => cash decreases

However, upon dividend declaration, The Statement of Changes in Owners’ Equity is affected.
The following effects occur:
Dividend payable increases => liabilities increase
Retained earnings decrease => equity decreases

Dividends are distributed out of profits accumulated in retained earnings, which is part of the
Total Equity of a company.