Chapter 1 – A Framework for Business Analysis and Valuation Using

Financial Statements

1. Lemons problems arise in capital markets when

A. ? Managers are better informed about the value of their business ideas than investors
B. ? Managers have an incentive to understate the value of their business ideas
C. ? Managers and investors have conflicting interests
D. ? A, B, and C

E. :-) A and C

2. Consider the following statement: “In countries with a model of strong legal protection of investors’
rights, information intermediaries play a bigger role in preventing lemons problems than in countries with
a model of weak legal protection of investors’ rights.” This statement is:

A. :-) True

B. ? False

3. Mandatory publication of audited financial statements is an imperfect solution to incentive and

information problems between managers and investors because

A. ? Accounting profits are typically less informative about firms’ economic performance than
cash flows

B. ? The accounting standards governing the preparation of such financial statements are
typically too loosely defined
C. :-) Managers unintendedly as well as strategically introduce noise into reported accounting
performance through their accounting decisions
D. ? None of the above

4. Consider the following statement: “The extent to which financial statements accurately reflect the
consequences of managers’ operating, investment and financing decisions is a function of characteristics
of the accounting environment and managers’ accounting strategy.” This statement is

A. :-) True

B. ? False

5. Consider the following statement: “Accounting conventions and regulations that leave management no
accounting discretion lead to more useful financial statements than accounting conventions and
regulations that do grant accounting discretion.” This statement is

A. ? True

B. :-) False
6. Consider the following statement: “Financial reports of publicly listed firms are prepared using accrual
accounting rather than cash accounting.” This statement is

A. :-) True

B. ? False

7. Consider the following statement: “The outcomes of business strategy analysis affect the financial and
prospective analyses but have no relevance for the accounting analysis.” This statement is

A. ? True

B. :-) False

8. Which of the following statements is correct?

A. ? The accounting analysis follows the financial analysis

B. ? The prospective analysis precedes the strategy analysis

C. :-) The prospective analysis follows the financial analysis
D. ? The financial analysis precedes the strategy analysis

9. The outcomes of the strategy analysis affect the accounting analysis because

A. ? The strategy analysis also includes an analysis of the firm’s accounting strategy

B. X Firms with poor strategies are more likely to have low-quality financial statements than firms
with successful strategies
C. :-) A firm’s industry and competitive strategy affect which accounting choices are appropriate.
D. ? None of the above.

10. Two reasons for why financial statements tend to be less useful in the analysis of privately held
businesses than in the analysis of publicly held businesses (within the EU) is that

A. :-) (i) Private firm’s financial statements are strongly influenced by tax rules and (ii) managers of
private firms have less incentive to prepare informative financial statements than managers of
public firms.

B. ? Private firm’s financial statements (i) do not comply with tax rules and (ii) are not publicly
available.
C. ? Private firm’s (i) financial reporting is unregulated and (ii) financial statements are not
publicly available.
D. ? None of the above.

11. Which of the following items is not a required component of European public firms’ financial
statements?

A. ? A comprehensive income statement (or statement of total recognized income and expense)
 B. ? An income statement
C. ? A cash flow statement (or statement of cash flows)
D. ? A balance sheet (or statement of financial position)

E. :-) All of the above items are required components

12. Consider the following statement: “An economic resource whose future benefits cannot be measured
with a reasonable degree of certainty is not considered to be an asset for accounting purposes.” This
statement is:

A. :-) True

B. ? False

13. Which of the following statements is correct?

A. ? Revenues cannot be recognized before cash is collected.

B. ? Expenses cannot be recognized before the cash outflow has occurred.

C. :-) Revenues cannot be recognized if cash collection is uncertain.
D. ? Expenses will always be recognized before or when the cash outflow occurs.
E. ? None of the above.

14. Which of the following statements is true?

A. ? The implementation of the Eight Company Law Directive in the European Union has
removed all systematic differences in the effectiveness of external auditing across countries.

B. :-) One of the objectives of the Eight Company Law Directive in the European Union is to set
minimum standards for public audits that improve auditor independence.
C. X All audits of public firms within the European Union must be carried out in accordance with the
set of Generally Accepted Auditing Standards, as promulgated by the Public Company
Accounting Oversight Board.
D. ? None of the above

Chapter 2 – Strategy Analysis Statements

 1. Industry profitability is a function of
A. ? Rivalry among existing firms
B. ? Competitive advantage of industry members
C. ? Bargaining power of customers
D. ? A, B, and other factors
E. :-) A, C, and other factors
2. Which of the following industry factors does not affect the nature of rivalry among existing
firms in the industry?
A. ? Ratio of fixed to variable costs
B. ? Concentration of competitors
C. ? Industry growth
D. :-) First mover advantage
3. Which of the following industry factors does not affect the threat of new firms entering the
industry?
A. ? Legal barriers
B. ? Ratio of fixed to variable costs
C. :-) Price sensitivity of buyers
D. ? First mover advantage
4. Which of the following industry factors does not affect the bargaining power of buyers in
the industry?
A. ? Concentration of buyers relative to the concentration of sellers
B. :-) Ratio of fixed to variable costs
C. ? Price sensitivity of customers
D. ? None of the above
5. Consider the following statement: “A firm’s industry choice, competitive positioning and
corporate strategy all influence the difference between the firm’s actual and required
return on capital.” This statement is
A. :-) True
B. ? False
6. Consider the following statement: “Single-segment businesses have lower transaction
costs than multi-segment businesses.” This statement is
A. X True
B. :-) False
7. The existence of conglomerates in emerging markets is partly the result of
A. X Low transaction costs in emerging labor markets
B. :-) High transaction costs in emerging capital markets
C. X High transaction costs in emerging production markets
D. X Low transaction costs in emerging production markets
E. ? None of the above
8. Economic theory indicates that the optimal corporate strategy and structure minimizes
the firm’s
A. ? Production costs
B. ? Service costs
C. ? Book value of assets
D. :-) Transaction costs
E. ? None of the above
9. Managers’ choice whether or not to diversify activities across geographical areas or
product segments is part of the
A. :-) Corporate strategy decision
B. ? Competitive strategy decision
C. ? None of the above
10. Consider the following statement: “Firms following a cost leadership strategy tend to earn
higher margins on their products or services than firms following a differentiation
strategy.” This statement is
A. ? True
B. :-) False
11. Consider the following statement: “Very few firms are successful in combining a cost
leadership strategy with a differentiation strategy because both strategies require different
and typically irreconcilable core competences.” This statement is
A. :-) True
B. ? False
12. Consider the following statement: “In industries with high rivalry among existing firms, the
optimal competitive strategy is to be a cost leader.” This statement is
A. ? True
B. :-) False
13. Consider the following statement: “Discount retailers follow a cost leadership strategy.”
This statement is
A. :-) True
B. ? False
14. The price sensitivity of customers in the hotel industry
A. ? Varies depending on what day of the week it is.
B. :-) Is positively affected by the availability of web booking systems and the resulting price
transparency in the industry.
C. ? Is negatively affected by the lack of hotels in a particular geographical area.
D. ? None of the above
15. European airlines’ structural excess capacity (i.e., low load factors) negatively affected
the average profitability in the European airline industry between 1995 and 2004. This is
an example of how
A. :-) The rivalry among existing firms affects industry profitability.
B. X The threat of new entrants affects industry profitability.
C. ? The threat of substitute products affects industry profitability.
D. ? The bargaining power of buyers affects industry profitability.
E. ? The bargaining power of suppliers affects industry profitability.

Chapter 3 – Overview of Accounting Analysis

1. The objective of accounting analysis is typically not to

A. ? Identify areas in the financial statements that are most strongly affected by management’s
discretionary accounting choices.
B. ? Identify accounting choices that are most critical to a firm’s accounting performance.
C. :-) Assess whether the financial statements fully comply with accounting conventions and
regulations.
D. ? Understand management’s reporting incentives and strategy.
E. ? Undo the financial statements from distortions
2. Which of the following items is not a required component of European public firms’
financial statements?
A. ? A comprehensive income statement (or statement of total recognized income and expense)
B. ? An income statement
C. ? A cash flow statement (or statement of cash flows)
D. ? A balance sheet (or statement of financial position)
E. :-) All of the above items are required components
3. Consider the following statement: “An economic resource whose future benefits cannot
be measured with a reasonable degree of certainty is not considered to be an asset for
accounting purposes.” This statement is
A. :-) True
B. ? False
4. Consider the following statement: “The use of rules-based standards rather than
principles-based standards decreases the verifiability of financial statements but
increases the extent to which financial statements reflect the economic substance of a
firm’s transaction.” This statement is
A. X True
B. :-) False
5. Which of the following statements is true?
A. ? Managerial legal liability regimes are equally strict across the member states of the
European Union.
B. ? Under a strict legal liability regime, managers tend to provide more forward-looking
disclosures than under a loose regime.
C. :-) Managerial legal liability regimes are less strict in Germany and the UK than in the US.
D. ? None of the above
6. Which of the following statements is true?
A. X Managers of firms that are close to violating accounting-based debt covenants have an
incentive to manage earnings and working capital ratios downwards.
B. X In share-for-share mergers managers of the acquiring firm have an incentive to understate
their firm’s accounting performance.
C. ? Managers have an incentive to understate accounting performance shortly before a large
option award is granted to them.
D. X Managers who aggressively manage their firm’s taxes have an incentive to consistently
overstate their firm’s accounting performance.
7. Which of the following accounting policies is most likely to be a key accounting policy of
Carrefour, one of the world’s largest retailers?
A. ? Accounting for payables
B. ? Accounting for legal claims
C. ? Accounting for revenues
D. :-) Accounting for property
8. Which of the following factors is not relevant in evaluating a firm’s accounting strategy?
A. ? Management’s incentives to manage earnings
B. :-) The presence of mandatory changes in accounting policies
C. X Average accounting choices in the industry
D. ? Accuracy of past accounting estimates
E. X The presence of voluntary changes in accounting policies

Chapter 4 – Implementing Accounting Analysis

1. Which of the following statements is correct?
A. :-) “General and Administrative Expense” is an income statement line item that firms use under a
classification of operating expenses by function.
B. ? “Raw Materials” is an income statement line item that firms use under a classification of
operating expenses by function.
C. ? “Marketing and Selling Expense” is an income statement line item that firms use under a
classification of operating expenses by nature.
D. ? “Cost of Services” is an income statement line item that firms use under a classification of
operating expenses by nature.
2. Company A’s non-current assets have a residual value of zero, a beginning book value of €5,000,
and an initial cost of €10,000. Company A uses an annual depreciation percentage of 10%. Its
statutory (and effective) tax rate is 30 percent. What adjustments would an analyst make to
company A’s beginning equity and non-current assets if she assumes that company A’s
depreciation percentage should be 12%?
A. X Decrease non-current assets by €1,000; decrease equity by €1,000
B. X Decrease non-current assets by €2,000; decrease equity by €2,000
C. :-) Decrease non-current assets by €1,000; decrease equity by €700
D. ? Decrease non-current assets by €2,000; decrease equity by €1,400

A. :-) Decrease tax expense by €60

B. ? Increase tax expense by €60
C. ? Decrease tax expense by €30
D. ? Increase tax expense by €30
E. ? No adjustment
3. Incorrectly treating finance leases as operating leases in the financial statements helps firms to
A. ? Overstate asset turnover and overstate leverage
B. ? Overstate profit margins and understate asset turnover
C. ? Understate asset turnover and overstate leverage

D. :-) Overstate asset turnover and understate leverage

4. A pharmaceutical company spends €5,000, €6,000, and €4,000 on research in 2008, 2009, and
2010, respectively. Assume that research investments have an expected life of two years and
occur evenly throughout the year. If an analyst decides to capitalize all research expenditures and
uses the straight-line method to amortize research assets, her estimate of the book value of the
pharmaceutical’s research asset at the end of 2010 equals
A. X €15,000
B. X €10,000
C. :-) €4,500
D. ? €0

What if her estimate of the pharmaceutical’s research amortization expense in 2010 equals

A. ? €4,000

B. ? €5,000
C. ? €5,200
D. :-) €5,250
5. Consider the following statement: “An analyst’s primary concern in her analysis of discounted
receivables is to make sure that all receivables that have been legally transferred to third parties
have been derecognized from the seller’s balance sheet.” This statement is
A. X True
B. :-) False
6. A car manufacturer recognizes the sale of 40,000 cars in its income statement. The cars have a
total selling price of €450,000 and a total cost of €350,000. All cars have been prepaid but not yet
shipped to the customer. The car manufacturer’s statutory and effective tax rate is 0 percent. The
recognition of this sale leads to the following distortions:
A. ? No overstatement/understatement of net profit and equity; overstatement of total assets and
total liabilities by €350,000.
B. ? Overstatement of net profit and equity by €100,000; overstatement of total assets by
€350,000; overstatement of total liabilities by €250,000.
C. ? Overstatement of net profit and equity by €100,000; overstatement of total assets by
€100,000.
D. :-) Overstatement of net profit and equity by €100,000; understatement of total assets by
€350,000; understatement of total liabilities by €450,000
7. Company B reduces the discount rate it uses to estimate its post-employment benefit obligation
from 8 percent (at the beginning of fiscal year 2009) to 7 percent (at the beginning of fiscal year
2010). Analysts following company B believe that this reduction is unjustified. According to these
analysts company B
A. :-) Understates its 2010 interest cost, overstates its 2010 service cost; overstates the cumulative
actuarial gains at the beginning of 2010.

B. ? Understates its 2010 interest cost, overstates its 2010 service cost; overstates the fair value
of plan assets at the beginning of 2010.

C. ? Overstates its 2010 interest cost, understates its 2010 service cost; understates the
cumulative actuarial gains at the beginning of 2010.
D. ? Understates its 2010 interest cost, understates its 2010 service cost; understates the fair
value of plan assets at the beginning of 2010.
8. Under IFRS the recognized (on-balance) post-employment liability may not be equal to the
unfunded post-employment benefit obligation because
A. ? Firms can delay the recognition of current actuarial gains or losses.
B. ? Firms can delay the recognition of unexpected plan contributions.
C. ? Firms can delay the recognition of past service cost.
D. ? Both A and B are correct
E. :-) Both A and C are correct
9. New (planned) international rules for the recognition of fair value gains or losses on equity
securities, which will replace IAS 39, imply that gains or losses are no longer recycled. This
means that
A. ? Fair value gains or losses that have been recognized in net profit can no longer be reversed
in later periods.
B. :-) Fair value gains or losses will no longer be recognized in comprehensive income while
being unrealized and recognized in net profit upon realization.
C. ? None of the above