CFE Financial Analysis & Reporting 3 — Questions and Answers
Question 1: An examiner is reviewing a company's financial statements and finds that goodwill on the balance sheet has remained unchanged for five consecutive years. Which concern should this raise?
- Goodwill is being amortized too aggressively
- Management may be avoiding required impairment testing or recognizing impairment losses (Correct answer)
- The company has not made any acquisitions
- Goodwill should be zero under GAAP
Correct answer: Management may be avoiding required impairment testing or recognizing impairment losses
Under ASC 350, goodwill must be tested for impairment at least annually; an unchanged figure for five years may indicate impairment testing is not being performed properly.
Question 2: The DuPont analysis decomposes return on equity (ROE) into which three components?
- Liquidity, solvency, and profitability
- Net profit margin, asset turnover, and financial leverage (Correct answer)
- Gross margin, operating margin, and net margin
- Current ratio, quick ratio, and cash ratio
Correct answer: Net profit margin, asset turnover, and financial leverage
DuPont breaks ROE into net profit margin × asset turnover × equity multiplier (financial leverage), revealing the drivers of shareholder returns.
Question 3: A company capitalizes an expenditure that should have been expensed. The immediate effect on financial statements is:
- Understated assets and overstated expenses
- Overstated assets and understated expenses, leading to overstated net income (Correct answer)
- No effect on net income in the current period
- Understated cash flow from operations
Correct answer: Overstated assets and understated expenses, leading to overstated net income
Improper capitalization inflates assets and defers expense recognition, overstating current-period net income.
Question 4: When comparing financial statements across companies that use different inventory costing methods, an analyst should use the LIFO reserve to:
- Convert LIFO financials to a FIFO-equivalent basis for comparability (Correct answer)
- Determine the company's cost of goods sold under GAAP
- Assess whether inventory obsolescence exists
- Calculate the company's effective tax rate
Correct answer: Convert LIFO financials to a FIFO-equivalent basis for comparability
The LIFO reserve is the cumulative difference between LIFO and FIFO costs; adding it back to LIFO inventory converts it to approximate FIFO values for comparability.
Question 5: Which of the following is most indicative of earnings management through channel stuffing?
- Accounts payable growing faster than inventory
- Revenue increasing sharply at period end while receivables grow disproportionately (Correct answer)
- Depreciation expense declining as assets age
- Operating cash flows exceeding net income
Correct answer: Revenue increasing sharply at period end while receivables grow disproportionately
Channel stuffing artificially inflates period-end revenues by pushing excess product to distributors, causing receivables to spike disproportionately to sales growth.
Question 6: For a defined-benefit pension plan, which item increases the projected benefit obligation (PBO)?
- Actual benefits paid to retirees
- Service cost and interest cost (Correct answer)
- Actuarial gains
- Positive plan asset returns
Correct answer: Service cost and interest cost
Service cost (benefit earned during the year) and interest cost (unwinding of discount on the obligation) both increase the PBO.
Question 7: Under IFRS, how are development costs treated when all required criteria are met?
- Expensed immediately as incurred
- Capitalized as an intangible asset and amortized (Correct answer)
- Treated as a deferred tax liability
- Recorded as goodwill on the balance sheet
Correct answer: Capitalized as an intangible asset and amortized
IFRS (IAS 38) requires capitalization of development costs once technical feasibility and other specified criteria are satisfied, unlike U.S. GAAP which generally expenses them.
CFE Financial Analysis & Reporting 3
An examiner is reviewing a company's financial statements and finds that goodwill on the balance sheet has remained unchanged for five consecutive years.
Which concern should this raise?