1.

If a company pays a cash dividend to its shareholders, the effect of this payment on the company's retained earnings is best reflected in the:

A. income statement.

 B. statement of changes in equity.

C. statement of comprehensive income.

Explanation

Equity is the owners' investment in a company; the statement of changes in equity details the changes in shareholders' equity from the
company's transactions with its owners. It reports differences that occur between two reporting periods, including information about issuances
of new equity, dividend payments, and stock repurchases, and shows how these events affect retained earnings, paid-in capital, and other
items of shareholders' equity.

(Choice A) Dividends are not considered expenses since they are distributions of previous periods' profits, not costs of generating current net
income; therefore, they are not reported in the income statement.

(Choice C) The statement of comprehensive income, which includes the income statement, explains changes in equity other than transactions
with owners and is a tool to evaluate a company's profitability.

Things to remember:
The statement of changes in equity presents a company's transactions with its owners, including information about issuances of new equity,
dividend payments, and stock repurchases, and shows how these events affect retained earnings, paid-in capital, and other items of shareholders'
equity.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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2. An auditor for a US publicly traded company most likely expresses an opinion on a company's:

A. strategy execution.

 B. internal control system.

C. pro forma financial statements.

Explanation

Management's internal control (IC) regulatory requirements

Assess IC's effectiveness using appropriate measures

Uphold IC's assessment with adequate proof
Write testimony stating IC's condition
Hire auditor to give opinion on company's IC

US law requires US public companies to have their annual financial statements and internal control systems audited. Management is fully
accountable for the company's internal controls; to meet regulatory requirements, management must perform an assessment, substantiate the
assessment, and provide a report. In addition, an independent auditor must provide an opinion on the effectiveness of the company's internal
control system.

(Choice A) A company communicates the execution of its strategy in the management discussion and analysis section of its annual report. It is
not a part of the annual report that is audited, and auditors do not issue an opinion on it.

(Choice C) Management may present pro forma financial statements to show core results. They are not audited since they are presented without
adhering to US GAAP or IFRS. Since management may present results in the best light, some consider pro forma statements as examples of
aggressive accounting.

Things to remember:
US law requires US public companies to be fully accountable for their internal control systems. One part of satisfying this requirement is to have
an independent auditor express an opinion on the effectiveness of the internal control system.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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3. Which of the following best describes the objective of financial statement audits?

A. Prevent management from engaging in fraud

B. Guarantee that statements are true and presented fairly

 C. Evaluate the probability that statements are free of material errors

Explanation

Objective of audits

Reasonable assurance that statements are:

Presented fairly
Free from material misstatements, including:
Errors
Fraud
Illegal acts
Prepared in accordance with US GAAP/IFRS

The objective of audits is to determine the likelihood that management's financial statements are free of material errors and prepared in
accordance with local accounting standards (eg, IFRS). Auditors examine samples of a company's transactions and review its financial reporting
process.

Based on that evidence, auditors form a subjective opinion, deciding whether there is a reasonable assurance that the company recorded its
transactions and presented its financial statements fairly. Auditors express their opinions in a written auditor's report. Although investors prefer
unqualified opinions, analysts must retain a degree of skepticism since auditor's reports are opinions, not facts.

(Choice A) Preventing fraud is not the objective of audits since not every transaction is audited; however, auditors should obtain a reasonable
assurance that financial statements are presented fairly.

(Choice B) Auditors form an opinion as to whether financial statements are true and fairly presented. They cannot guarantee that a company's
financial statements are true and fair.

Things to remember:
The objective of audits is to obtain a reasonable assurance that a company's financial statements are free of material errors and prepared in
accordance with local accounting standards (ie, presented fairly). Analysts must retain a degree of skepticism since auditor's reports are opinions,
not facts.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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4. Which of the following best describes an activity involved in the process data step of the financial statement analysis framework?

 A. Prepare a five-year forecast

B. Collect five years of financial statements

C. Explain insights from adjusted financial statements

Explanation

Financial statement analysis framework

Phase Action Result

Articulate purpose of analysis Written objective of analyses

Articulate purpose
Determine the audience Nature of reporting

Obtain financial data Organized financial statements

Collect data
Visit company Insight to goals and operations

Adjusted financial statements

Adjust numbers
Process data Common-sized statements
Calculate data
Financial ratios and forecasts

Analyze/interpret data Understand the processed data Analyst's report

Develop recommendation Plot course of action Recommendation report

Follow-up Repeat analysis as data changes Reissue analyses and reports

The financial statement analysis framework is a series of six phases describing how financial statement analysis is accomplished. During the
data processing phase, analysts adjust the raw financial data obtained during the data collection phase. This may include making changes to
reported financial statements to improve the comparability among companies due to accounting differences. It also may include preparing
financial ratios or developing a forecast.

(Choice B) Organizing multiple years of a company's financial statements is part of the data collection phase. During this phase, analysts collect
and organize data (eg, reported financial statements) including management information, industry data, and economic statistics.

(Choice C) Explaining insights from data that has been processed is part of the data interpretation phase. Interpreting data most often includes
using multiple pieces of adjusted data and formulating an opinion.

Things to remember:
The financial statement analysis framework is a series of six phases describing the process of financial analysis. During the data processing
phase, analysts may adjust the raw financial data to make financial statements, ratios, and forecasts more comparable.

Describe the steps in the financial statement analysis framework

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5. An independent auditor determines that a company's financial statements are fairly presented except that the company's records regarding
accounts payable are materially incomplete. The auditor will most appropriately give an opinion that is:

A. adverse.

 B. qualified.

C. unqualified.

Explanation

Regulatory agencies usually require that publicly traded companies have their annual financial reports audited by an independent accounting firm.
Auditors use sampling techniques with an overall goal to:

provide reasonable assurance that the financial statements are free from material errors or misstatements and

determine whether the financial statements have been prepared in accordance with the applicable accounting standards (eg, US GAAP,
IFRS).

The auditor then gives an opinion based on what is sampled. A qualified opinion is used when financial statements are largely presented fairly
but:

the audit is limited in scope (eg, incomplete records) or

there is an exception from the applicable accounting standards.

A qualified audit opinion suggests that a company's financial statements are less reliable than statements with an unqualified, or "clean," opinion.
In this situation, the auditor appends the opinion with additional details explaining the exception so users of the financial statements can decide
whether the exception is important.

(Choice A) An adverse opinion is given when an auditor determines that a company's financial statements differ materially from applicable
accounting standards in a way that would affect investors' decision-making.

(Choice C) An unqualified opinion is given when an auditor deems that the financial reports are fairly presented in all respects and in accordance
with applicable accounting standards.

Things to remember:
An audit concludes with the auditor's assignment of an unqualified, qualified, or adverse opinion to financial reports, which depends on the reports'
scope, quality, and adherence to accounting standards. A qualified audit opinion implies that the audit was limited in scope (eg, incomplete
records) or there was an exception from the applicable accounting standards. Companies prefer to receive an unqualified audit opinion.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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6. The role of a balance sheet is best described as a way to convey information about a company's:

A. cash inflows and outflows.

B. performance and profitability.

 C. resources and claims on resources.

Explanation

The role of a company's financial statements is to provide decision-makers (eg, investors, lenders) with economic information about a company. A
company's balance sheet is a snapshot of the company's assets and liabilities on a specific date (eg, year-end). One-way analysts evaluate a
company's financial position is by assessing the company's resources (ie, assets) and the claims on those resources (ie, liabilities and equities).

(Choice A) Cash flow statements, not balance sheets, show cash collections (ie, inflows) and cash payments (ie, outflows) during a period. Cash
flow statements show a company's ability to generate cash; investors prefer companies with consistent cash generation since this can fund future
growth opportunities.

(Choice B) Both a company's income statement and its cash flow statement, not its balance sheet, convey a measure of a company's
performance. The income statement shows how profitable the company is over a period; a cash flow statement presents the company's change in
cash during a period.

Things to remember:
The role of a company's balance sheet is to show its assets, liabilities, and equity at a point in time. Income statements reveal profitability. Cash
flow statements offer insight into a company's ability to generate cash.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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7. An analyst is responsible for monitoring developments in financial reporting standards. Which of the following is least likely to help the analyst?

A. Examining standard setters' exposure drafts.

 B. Monitoring changes in standards from a preparer's perspective.

C. Checking companies' disclosures regarding their new accounting policies.

Explanation

As financial reporting standards evolve, analysts must monitor ongoing developments since new and changing standards can impact financial
analyses. Since they are not accountants, analysts should monitor standards from a user's, not a preparer's, perspective. They can accomplish
this by staying aware of new products and transactions, reviewing the actions of standard setters, and identifying new critical accounting
policies from company disclosures.

It is important to stay current on new financial businesses, such as fintech companies, by reviewing business journals. Reading exposure drafts
from the International Accounting Standards Board, Financial Accounting Standards Board, and CFA Institute websites increases awareness of
upcoming changes in financial reporting. However, analysts should expect a lag between a new accounting transaction and its eventual reporting
standard. Reviewing a company's annual report provides information about new accounting policies (Choices A and C).

Things to remember:
Analysts should monitor evolving financial reporting standards from a user's perspective. They can accomplish this by staying aware of new
products and transactions, reviewing the actions of standard setters, and identifying new critical accounting policies from company disclosures.

Describe implications for financial analysis of alternative financial reporting systems and the importance of monitoring developments in financial
reporting standards
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8. Based on the financial statement analysis framework, which of the following is least likely a source of information when collecting input data?

A. Industry and economic data

 B. Financial statement forecasts

C. Discussions with management

Explanation

Financial statement analysis framework

Phase Action Result

Articulate purpose of analysis Written objective of analysis

Articulate purpose
Determine the audience Nature of reporting

Obtain financial data Organized financial statements

Collect data
Visit company Insight into goals and operations

Adjusted financial statements

Adjust numbers
Process data Common-sized statements
Calculate data
Financial ratios and forecasts

Analyze/interpret data Understand the processed data Analyst's report

Develop recommendation Plot course of action Recommendation report

Follow-up Repeat analysis as data changes Reissue analyses and reports

The financial statement analysis framework is a series of six phases that describe how financial statement analysis is accomplished when
evaluating investments in a company's securities. In each phase, the analyst acts on information and turns it into a result that can be used to
complete the next phase. In the data collection phase, an analyst collects all pertinent data after articulating the purpose(s) of the analysis. Data
collected can be quantitative and qualitative items pertaining to:

Macroeconomic data (eg, GDP, inflation)

The prospects of the industry in which the company operates (Choice A)
The prospects of the company within the industry (eg, historical financial data, discussions with management) (Choice C)

The result of this phase is a collection of data that can be processed in the data processing phase. The results of processing the data include:

Financial statement forecasts

Ratios and common-sized financial statements
Charts and graphs

This data can then be used to analyze the company as an investment.

Things to remember:
The financial statement analysis framework describes how financial statement analysis is accomplished when evaluating investments in a
company's securities. The data collection phase results in a collection of data that can be processed in the data processing phase. The results of
processing the data include financial statement forecasts, which can be used to analyze the company as an investment.

Describe the steps in the financial statement analysis framework

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9. Which of the following is most likely an external source of information that analysts use?

 A. Peer analysis

B. Proxy statement

C. Earnings conference call

Explanation

Analysts use both external and internal information when researching companies; it is critical for insightful financial statement analysis. External
information refers to information not published by the company. Internal information refers to information produced by the company. Examples
of external data include information from central banks, industry associations (eg, peer analysis), and the press.

(Choice B) A proxy statement is prepared by the company when it seeks shareholder votes (eg, for board member selection). It includes voting
instructions, executive pay structure, and auditor compensation.

(Choice C) Earnings conference calls are discussions between management and the investing public. Management explains results and
sometimes provides guidance on forward-looking issues. Most often, a company holds its earnings calls immediately after announcing its
earnings.

Things to remember:
External information refers to information not published by the company. Internal information refers to information produced by the company.
Analysts use both external and internal information.

Describe information sources that analysts use in financial statement analysis besides annual and interim financial reports
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10. An analyst examines the last five years of a company's financial statements. Which of the following would be best to use to analyze the
company's ability to fund growth opportunities?

A. Income statement

 B. Cash flow statement

C. Statement of changes in equity

Explanation

Cash flow statements show how a company collects cash (ie, cash inflows) and spends cash (ie, cash outflows). Cash flows are classified as
operating, investing, or financing activities based on their source or use. Cash from operations (CFO) shows how the company generated cash
from its core business.

CFO is typically a cheaper and more sustainable source of cash than investing or financing activities; a company that reliably generates CFO is in
a better position to fund growth opportunities than one that does not. Analysts can examine multiple years of CFO to determine whether the
company consistently generates cash from its core business; this gives investors confidence that the company can continue to fund growth
opportunities.

(Choice A) An income statement exhibits a company's profitability (ie, revenue minus expenses). In this case, it is not the best statement to use
since accrual accounting aligns revenues with expenses during a period, regardless of whether cash was exchanged. Although profitability is
important, it does not reflect cash generation.

(Choice C) A statement of changes in equity presents the increases (eg, issuances of capital) and decreases (eg, dividend payments) to the
value of owners' investment in the firm. Analyzing a statement of changes in equity does not explain how the company could fund new projects.

Things to remember:
The role of cash flow statements is to present information regarding cash inflows (cash collected) and outflows (cash used) during a period.
Consistent cash generation from its core business gives investors confidence that the company can continue funding growth opportunities.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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11. The purpose of management's commentary in the annual report is most likely to:

A. illustrate the compensation structure of senior executives and directors.

 B. explain the company's goals and risks associated with not reaching them.

C. provide reasonable assurance that the financial statements are fairly presented.

Explanation

Management's commentary, also known as management's discussion and analysis (MD&A), is a section of a company's annual report. It
explains current results and highlights significant events. Suggested elements of the MD&A include the company's goals, financial results, and
stock performance. Most regulatory agencies require publicly traded companies to publish the MD&A.

The MD&A is a summary of how the company did in the past year and provides information on its achievements and setbacks. Topics
management may cover in the MD&A include how the general economy impacted results, sales performance, and profitability. The MD&A may
also provide investors with updates on its competition and specific obstacles the company is facing.

(Choice A) The proxy statement, not management's commentary, illustrates the compensation structure of senior executives and directors.

(Choice C) The auditor's report, not the MD&A, states that the auditors, not management, provide reasonable assurance that the financial
statements are fairly presented.

Things to remember:
Management's commentary, also known as management's discussion and analysis (MD&A), is a section of a company's annual report. It explains
current results and highlights significant events. Elements of the MD&A include descriptions of the company's operations, current goals, financial
results, and stock performance.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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12. The notes to a company's financial statements most likely contain:

A. details on the company's strategic objectives.

 B. accounting estimates used in the statements' preparation.

C. an evaluation of the appropriateness of the statements' presentation.

Explanation

The notes (ie, footnotes) are an essential part of a complete set of annual financial statements. They offer explanatory calculations (ie,
estimates) and detailed accounting information that analysts read to improve their comprehension of the financial statements. Since it is
considered a part of the financial statements, footnote information is audited.

Analysts use the footnotes to understand reporting differences (eg, FIFO versus LIFO) since US GAAP and IFRS allow companies flexibility in
preparing financial statements. Using the footnotes, analysts can adjust the financials to make them comparable to other companies' statements.

(Choice A) The details on a company's strategic objectives and risks are written in the management's discussion and analysis, a supplemental
disclosure that is not considered part of the footnotes.

(Choice C) An evaluation of the appropriateness of the statements' presentation describes the auditor's report. The auditor's report supplements
a company's annual report; it is not contained in the footnotes. The auditor's report is an independent opinion regarding whether the company
fairly presented its financials and abided by local accounting standards.

Things to remember:
The notes (ie, footnotes), an essential part of a complete set of annual financial statements, describe the calculations, accounting policies, and
estimates used to prepare the statements. The footnotes are an excellent source of information for adjusting company reports for accounting
differences.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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13. Which of the following least likely describes the role of financial statement analysis?

 A. Supply information about a company's financial position to market participants

B. Evaluate the intrinsic value of a stock based on data from a company and the market

C. Develop guidance about a company's future operations based on its past performance

Explanation

The role of financial reporting, not financial statement analysis, is to disseminate data about a company's business and financial situation to the
marketplace. Companies summarize data to show how they have performed and explain the results. Accounting standards (eg, IFRS and US
GAAP) set the rules for how companies record the data and produce summaries.

Financial statement analysis uses these financial reports to appraise a company's past, present, and future execution of its goals and economic
fitness. The role of financial statement analysis is to make investment decisions (eg, buy or sell) using these reports. Types of decisions
analysts make include merger and acquisition evaluations, conclusions of creditworthiness, forecasts of future earnings, and security selections
(Choices B and C).

Things to remember:
The role of financial statement analysis is to make investment decisions using companies' financial reports. Types of decisions analysts make
include merger and acquisition evaluations, conclusions of creditworthiness, and stock selections. The role of financial reporting, not financial
statement analysis, is to disseminate data about a company's business and financial situation to the marketplace.

Describe the roles of financial statement analysis

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14. Income statement elements most likely reflect:

A. values at a point in time.

 B. performance over a certain period.

C. inflows and outflows of cash transactions.

Explanation

An income statement shows the results of a firm's business activity over a specific period (eg, fiscal year, quarter). It displays how much
expense the firm took to produce the revenue generated during the period.

(Choice A) Balance sheet elements (ie, assets, liabilities, equity), not income statement elements, are reported as a snapshot in time.

(Choice C) Inflows and outflows of cash transactions are reported in the statement of cash flows, not the income statement.

Things to remember:
The income statement shows the results of a firm's business activity and displays how much expense the firm took to produce the revenue
generated over a specific period.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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15. If a company receives a qualified audit opinion, its financial statements are most likely:

 A. prepared with incomplete records.

B. accurate and presented fairly in all material respects.

C. unreliable due to intentional accounting misstatements by management.

Explanation

Regulatory agencies require that publicly traded companies have their financial statements audited by an independent accounting firm. The
auditor samples transactions to determine whether there is reasonable assurance that the financial statements are free from material
misstatements and presented fairly. Subsequently, the auditor issues an opinion on whether the financial statements were prepared in accordance
with the applicable accounting standards (eg, US GAAP, IFRS).

A qualified audit opinion implies that the audit was limited in scope (eg, incomplete records) or there was an exception from the applicable
accounting standards. Companies strongly prefer not to have a qualified opinion since it reflects poorly on management. Qualified audit
opinions suggest that the company's financial statements are less reliable than statements with an unqualified opinion.

(Choice B) If the company's financial statements are accurate and presented fairly in all material respects, the most likely audit opinion is
unqualified, not qualified.

(Choice C) If the company's financial statements are unreliable due to management's intentional accounting misstatements, the most likely audit
opinion is adverse, not qualified.

Things to remember:
A qualified audit opinion implies that the audit was limited in scope (eg, incomplete records) or there was an exception from the applicable
accounting standards. Companies prefer to receive an unqualified audit opinion.

Describe the importance of regulatory filings, financial statement notes and supplementary information, management’s commentary, and audit
reports
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