Question 1

When measuring short-term solvency, the current ratio compares current assets to current liabilities, but inventory is normally excluded when calculating the quick ratio.

Accepted Answer

The quick ratio is calculated by excluding inventory from current assets when comparing to current liabilities. The current ratio, on the other hand, includes inventory in the calculation.

Question 2

Comparing the performance of an entity with the industry norms is complicated by:

Accepted Answer

A) not all businesses in the industry being the same makes it difficult to compare their performance as they may have different products, size, location, or target market.

B) different businesses using different accounting methods can make it difficult to compare financial statements as there may be variations in the way data is presented.

C) business being diversified can also affect their performance and make it harder to compare to their peers as their portfolio may span across multiple industries.

Therefore, all of the above factors make it complicated to compare the performance of an entity with industry norms.

Question 3

The 'true and fair view' of the auditor with respect to the financial statements of an entity, asserts that the financial assertions contained in the report are accurate in detail.

Accepted Answer

The 'true and fair view' refers to the overall presentation of financial statements being free from material misstatements and accurately reflecting the entity's financial position and performance, rather than asserting the accuracy of every detail.

Question 4

Which of the following is a technique for analysing financial statement data?

Accepted Answer

Trend analysis, financial ratio analysis, and vertical analysis are all techniques used for analyzing financial statement data. Trend analysis involves comparing financial data over time to identify patterns and changes. Financial ratio analysis involves calculating key ratios to assess a company's financial performance and health. Vertical analysis involves analyzing a company's financial statements by comparing each line item to a base item, such as sales or total assets.

Question 5

Trend analysis involves choosing a base year and plotting the trend in key outcome indicators, such as sales and profits, in subsequent years.

Accepted Answer

This statement is true. Trend analysis involves the comparison of key outcome indicators in subsequent years to a chosen base year.

Question 6

What are some of the factors that are directly relevant to an analysis of business performance?

Accepted Answer

All of the listed factors are directly relevant to an analysis of business performance. The size and riskiness of the business can provide insight into its financial stability and potential for growth. The economic, social, and political environment can affect the overall demand for goods and services, as well as the regulatory environment in which the business operates. Industry trends and changes in technology can impact the competitiveness of the business within its market. Therefore, a comprehensive analysis should consider all of these factors.

Question 7

Unlike ordinary shareholders, preference shareholders are more likely to be interested in the extent to which profit is safe, rather than in profit growth, due to the fact that the return on their investment is typically fixed.

Accepted Answer

Preference shareholders generally receive a fixed rate of dividend, and therefore their main concern is the safety of their investment and the stability of the company's profits, rather than any potential for growth in profits.

Question 8

An implication of the efficient markets hypothesis (EMH) is that managers will choose accounting policies in order to influence reported net profit.

Accepted Answer

The efficient markets hypothesis suggests that markets are efficient and all available information (including accounting policies) is already reflected in the stock price. Therefore, managers cannot influence reported net profit through accounting policies as investors will already have incorporated that information into their decisions.

Question 9

Financial statement analysis must be:

Accepted Answer

Financial statement analysis is a complex process that cannot be viewed in isolation. It needs to be conducted in a wider context of the industry and the political and social environments to accurately reflect the company's standing. Moreover, the analysis should be targeted to the needs of the users of the analysis, such as investors, creditors or management. Additionally, the quality of the analysis is as good as the base information on which it is made. Therefore, all of the above options are correct.

Question 10

The statement of cash flow is considered a source of internal information for the financial analysis of an entity's solvency and its capacity to continue as a going concern.

Accepted Answer

The statement of cash flow provides information about an entity's cash inflows and outflows, which is useful for analyzing its ability to meet short-term obligations and to sustain operations in the long-term. As such, it is primarily used as an internal tool for financial analysis, rather than as a means of communicating financial performance to external stakeholders.

Question 11

A company has no prepayments and has a current ratio of 0.98:1 and a quick ratio of 0.95:1. This indicates that the company cannot pay its debts if called upon to do so.

Accepted Answer

The current and quick ratios below 1 do indicate that the company's liquid assets are less than its current liabilities, but this does not necessarily mean the company cannot pay its debts if called upon to do so, as it might have access to other sources of cash or the ability to quickly convert assets to cash.

Question 12

Under the efficient markets hypothesis (EMH), it is possible that individual shares may be under- or over-priced.

Accepted Answer

The EMH suggests that, in general, financial markets are efficient and that individual share prices reflect all available information. However, the theory acknowledges the possibility of short-term mispricings due to unpredictable events or investor irrationality.

Question 13

After analysing a company's financial statements over a five-year period, the current year being Year 5, it was determined that the current ratio was as follows: 1.6:1 (Year 5); 1.5:1 (Year 4); 1.1:1 (Year 3); 0.95:1 (Year 3); 0.90:1 (Year 1). From this information we can conclude that the company has been increasing the amount of cash at bank.

Accepted Answer

The current ratio measures a company's ability to pay its current liabilities with its current assets. An increasing current ratio may indicate an improvement in the company's liquidity, but it does not necessarily mean that the company has increased the amount of cash at bank. Other current assets, such as accounts receivable, inventory, or prepaid expenses, may have also increased, contributing to the higher current ratio. Moreover, the current ratio has fluctuated over the five-year period, indicating that the company's liquidity position has varied over time.

Question 14

Comparability, as a qualitative characteristic of useful information, calls for consistency in the application of accounting policy choice.

Accepted Answer

Comparability means that information can be compared over time or across different entities. This requires consistency in the application of accounting policies, so that similar transactions are accounted for in the same way. Therefore, the statement is true.

Question 15

If a company has a debt to equity ratio of 1:48, it means that for every $1 of equity, the company has $1.48 in liabilities.

Accepted Answer

The debt to equity ratio is calculated by dividing the total debt by the total equity. In this case, the debt to equity ratio is 1:48, which means that for every $1 of equity, the company has $1.48 in liabilities.

Question 16

The accounts receivable and inventory turnover ratios are important in evaluating the short-term efficiency of an entity.

Accepted Answer

The accounts receivable turnover ratio measures how efficiently a company is able to collect its outstanding debts from customers, while inventory turnover ratio measures how efficiently a company is able to manage its inventory. Both ratios are important in evaluating the short-term efficiency of an entity.

Question 17

A secured lender is exposed to a higher level of financial risk than an unsecured lender.

Accepted Answer

An unsecured lender is exposed to a higher level of financial risk than a secured lender as they do not have any collateral or assets to claim in case of a default.

Question 18

General purpose reporting by corporations contributes to the efficiency of the share market and, ultimately, the allocation of scarce resources.

Accepted Answer

General purpose reporting by corporations provides important information to investors and analysts, allowing for better-informed investment decisions and a more efficient allocation of resources in the share market.

Question 19

Lenders can be classified as short, medium or long-term lenders. In regard to financial statement analysis for lenders, which of the following statements is incorrect?

Accepted Answer

Short-term lenders are particularly interested in the net realisable value of specific assets because they need to be able to recover their loans quickly in the event of a default.

Question 20

Asset turnover, return on assets, and debt to total assets are all examples of long-term solvency ratios.

Accepted Answer

Asset turnover and return on assets are examples of asset management ratios, while debt to total assets is an example of a leverage ratio. These ratios are used to evaluate a company's short-term and long-term financial health, but they are not all examples of long-term solvency ratios. Long-term solvency ratios typically measure a company's ability to meet its long-term debt obligations, such as the debt-to-equity ratio or interest coverage ratio.

Quiz 10: Financial Statement Analysis