Reading 19 Into to F/S Analysis

Question 1

Give the equation that comprises the three components of the balance sheet and define each.

Answer 1

The balance sheet presents a company’s assets, liabilities, and equity at a point in time.

Assets = Liabilities + Owners’ equity

Assets are the productive resources that a company owns. Liabilities are amounts that the company owes other entities. Owners’ equity represents shareholders’ residual claim on the company’s assets after deducting liabilities from assets.

Question 2

Identify the detailed explanatory information provided in financial notes.

Answer 2

Accounting policies, methods, and estimates

Business divisions and geographic segments; acquisitions and disposals; related-party transactions

Commitments and contingencies, legal proceedings, and subsequent events

Financial instruments and risks arising from them

Question 3

Explain the objectives of an audit.

Answer 3

1. To obtain reasonable assurance about whether the financial statements are free from material misstatement due to fraud or error, and whether the statements are prepared in accordance with an applicable financial reporting framework.
2. To report on the financial statements, and communicate as required by the ISAs, in accordance with the auditor’s findings.

Question 4

What does the statement of changes in owners’ equity report?

Answer 4

Any changes in owners’ investment in the business after liabilities are subtracted from assets. It is useful in understanding changes in the financial position of a company.

Question 5

Describe an income statement.

Answer 5

It provides operating information relating to a company’s business activities over an accounting period. The income statement presents revenues earned by a company and corresponding costs.

Net income = Revenue − Expenses

Question 6

Differentiate between an unqualified, qualified, disclaimer, and adverse audit opinion.

Answer 6

Unqualified opinion: the financial statements have been presented fairly in accordance with applicable accounting standards.

Qualified opinion: the financial statements have been presented fairly, but do contain exception(s) to the accounting standards.

Disclaimer of opinion: issued when the auditor, for whatever reason, is not able to issue an opinion on the financial statements.

Adverse opinion: the financial statements have not been presented fairly and significantly deviate from acceptable accounting standards.

Question 7

Distinguish between the three activities (operating, investing, and financing) on a cash flow statement.

Answer 7

Operating activities refer to the day-to-day core business activities of a company.

Investing activities relate to the acquisition or disposal of long-term assets.

Financing activities relate to the injection or repayment of capital.

Question 8

Differentiate between liquidity and solvency.

Answer 8

Liquidity refers to a company’s ability to meet its short-term obligations.

Solvency refers to a company’s ability to meet its long-term obligations.

Question 9

List the six steps of the general framework for financial statement analysis.

Answer 9

1. Define the purpose and context of the analysis.
2. Collect data.
3. Process data.
4. Analyze/interpret the processed data.
5. Develop and communicate conclusions.
6. Follow up.