FINANCIAL REPORTING AND

ANALYSIS

Financial Statement Analysis

– An Introduction
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 1.

Providing information about the performance of a company, its financial

position, and changes in financial position that is useful to a wide range of
users is most accurately described as the role of:

A. financial reporting.
B. the audit report.
C. financial statement analysis.

1
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

A is correct.

The role of financial reporting is to provide information about the performance of

a company, its financial position, and changes in financial position that is useful
to a wide range of users in making economic decisions.

B is incorrect because audit reports express an opinion about the fair

presentation of the financial statements.

C is incorrect because the role of financial statement analysis is to take the

financial reports and evaluate the past, current, and prospective performance and
financial position of a company for the purpose of making investment, credit, and
other economic decisions.
2
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 2.

The financial statement that would be most useful to an analyst in

understanding the changes that have occurred in a company’s retained
earnings over a year is the statement of:

A. comprehensive income.
B. financial position.
C. changes in equity.

3
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

The statement of changes in equity reports the changes in the components of

shareholders’ equity over the year, which would include the retained earnings account.

A is incorrect because the net income determined in the calculation of comprehensive

income is a component of the change in retained earnings, but there are other changes
that may also have occurred (the payment of dividends, for example) that are not
included on the statement of comprehensive income.

B is incorrect because although the year-end balances of retained earnings may be

reported on the statement of financial position (depending on if the company breaks out
the components of shareholders’ equity), it would not detail the changes over the year.

4
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 3.

Which of the following most likely results in an increase of owners’ equity?

A. Share repurchase
B. Cash dividend
C. New equity issuance

5
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

The basic components of owners’ equity are paid-in capital and retained
earnings. In the paid-in capital account, an example of an increase in owners’
equity is a new equity issuance. Cash dividends reduce retained earnings and
owners’ equity. Share repurchases reduce paid-in capital and owners’ equity.

A is incorrect because for the paid-in capital account an example of a decrease in

owners’ equity is the repurchase of previously issued shares.

B is incorrect because a cash dividend payment is the most common cause of a

decrease in owners’ equity.

6
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 4.

Notes to financial statements most likely include:

A. a discussion of significant trends, events, and uncertainties that affect the

operating results.
B. an auditor’s opinion as to the fair presentation of the financial statements.
C. supplementary information about accounting policies, methods, and
estimates.

7
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

The notes disclose information about the accounting policies, methods, and
estimates used to prepare the financial statements.

A is incorrect because the management commentary (or MDA), which is not part
of the notes to financial statements, includes a discussion of significant trends,
events, and uncertainties that affect the operating results.

B is incorrect because the Auditor’s Report, which is not part of the notes to
financial statements, includes the auditor’s opinion as to the fair presentation of
the financial statements.

8
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 5.

Management’s commentary (also known as management’s discussion and

analysis) most likely includes:

A. supplementary information about accounting policies, methods, and

estimates.
B. an auditor’s opinion as to the fair presentation of the financial statements.
C. a discussion of significant trends, events, and uncertainties that affect the
operating results.

9
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

Management’s commentary includes a discussion of significant trends, events,

and uncertainties that affect the operating results.

A is incorrect because the notes disclose information about the accounting

policies, methods, and estimates used to prepare the financial statements.

B is incorrect because the Auditor’s Report includes the auditor’s opinion as to

the fair presentation of the financial statements.

10
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 6.

Reviewing the MD&A section of an annual report is important because:

A. future revenue projections must be disclosed.

B. accounting policies may require subjective judgment by management.
C. management commentary is typically unaudited.

11
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

B is correct.
Companies should disclose in management commentary any critical accounting policies that
require management to make subjective judgements that may have a significant impact on
reported financial results. These subjective judgements should be carefully reviewed because
they may materially alter an analyst’s conclusions about the future performance or financial
position of a company.

A is incorrect because companies are not required to disclose future revenue projections in the
management’s discussion and analysis section of financial statements, but should highlight any
favorable or unfavorable trends or uncertainties that may impact future performance or financial
position.

C is incorrect because although management commentary is typically unaudited, it is not a

reason why management commentary is of importance to analysts. Rather, analysts should be
aware that management commentary is unaudited and interpret accordingly.
12
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 7.

For a company issuing securities in the United States to meet its

obligations under the Sarbanes–Oxley Act, which of the following is
management required to attest to?

A. The suitability of management and director compensation agreements

B. The adequacy of internal control over financial reporting
C. The accuracy of estimates and assumptions used in preparing the financial
statements

13
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

B is correct.

To be in compliance with Sarbanes–Oxley, it is mandatory that management’s

Report to Shareholders discuss internal financial controls and their effectiveness,
as well as the company’s auditor’s opinion of these internal controls.

A is incorrect because information on management and director compensation

agreements will be found in the proxy statement and/or notes to the financial
statements.

C is incorrect because estimates and assumptions used in preparing financial

statements are found in the notes to the financial statements.

14
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 8.

Updated information on a company’s performance and financial position

since the last annual report is most likely found in:

A. management discussion and analysis.

B. proxy statements.
C. interim reports.

15
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

Interim reports, either quarterly or semi-annual, contain updated information on a

company’s performance and financial position since the last annual report.

A is incorrect because the MD&A is part of the annual report and is not an update
since the last annual report.

B is incorrect because proxy statements contain information about matters that

will be put to a vote at shareholders’ meetings.

16
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 9.

Which of the following statements is most accurate about the

responsibilities of an auditor for a publicly traded firm in the United States?
The auditor must:

A. state that the financial statements are prepared according to generally

accepted accounting principles.
B. ensure that the financial statements are free from error, fraud, or illegal acts.
C. express an opinion about the effectiveness of the company’s internal control
systems.

17
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

For a publicly traded firm in the United States, the auditor must express an
opinion as to whether the company’s internal control system is in accordance with
the Public Accounting Oversight Board, under the Sarbanes–Oxley Act. The
opinion is given either in a final paragraph in the auditor’s report or as a separate
opinion.
A is incorrect because the statements are those prepared by management, not
the auditor. The auditor is expressing an opinion as to whether the statements
are fairly presented and free from material error.
B is incorrect because the auditor only provides reasonable assurance that the
statements are free from material error.
18
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 10.

Interim reports most likely:

A. are audited.
B. are issued semi-annually or quarterly.
C. include a full set of financial statements and notes.

19
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

B is correct.

Interim reports are provided semi-annually or quarterly, depending on applicable

regulatory requirements.

A is incorrect because interim reports are not audited.

C is incorrect because interim reports generally present the four basic financial
statements and condensed notes.

20
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Question 11.

Common-size financial statements are most likely a component of which

step in the financial analysis framework?

A. Collect data
B. Analyze/interpret data
C. Process data

21
 Financial Reporting & Analysis
CFA LEVEL1 Financial Statement Analysis: An Introduction

Solution

C is correct.

Preparing common-size financial statements is part of the process data step.

A is incorrect because the financial statements are obtained in the collect data
step, but not converted into common-size statements until the process step.

B is incorrect because preparing common-size financial statements is part of the

process data stage, after which the analyst will analyze/interpret the processed
data.

22