Financial Statement Analysis A: Core Statements

• Topic 01

  Financial Reporting Standards

  60 questions
• Topic 02

  Income Statement Analysis

  42 questions
• Topic 03

  Balance Sheet Analysis

  66 questions
• Topic 04

  Cash Flow Statement

  55 questions
• Topic 05

  Financial Analysis Techniques

  51 questions
• Topic 06

  Inventories

  73 questions
• Topic 07

  Long-Lived Assets

  43 questions
• Topic 08

  Income Taxes

  30 questions
• Topic 09

  Long-Term Liabilities and Leases

  36 questions

A few questions from this unit, with the answer and a full explanation. The complete bank is available when you start practising.

1. An analyst is comparing two steel manufacturers. Firm X uses FIFO and Firm Y uses LIFO. Firm Y discloses a LIFO reserve of £120,000,000 and a statutory tax rate of 25%. To convert Firm Y's balance sheet to a FIFO-equivalent basis for comparison, what adjustments should the analyst make?

   • A
     Add £90,000,000 to inventory (after-tax reserve); add £90,000,000 to retained earnings
   • B
     Add £120,000,000 to inventory; reduce COGS by £120,000,000; no balance sheet adjustment needed
   • C
     Deduct £120,000,000 from COGS in the income statement; increase equity by £120,000,000
   • D
     Add £120,000,000 to inventory; add £90,000,000 to retained earnings (LIFO reserve after tax); add £30,000,000 to deferred tax liabilities
     Correct answer
   Explanation

   To convert Firm Y from LIFO to FIFO: Inventory increases by the full LIFO reserve = +£120,000,000. This additional asset must be balanced. On the liabilities and equity side: the pre-tax profit that would have been recognised under FIFO is subject to tax, so a deferred tax liability is created: £120,000,000 × 25% = £30,000,000. The after-tax increase flows to retained earnings: £120,000,000 × (1 − 25%) = £90,000,000. Balance check: Assets +£120m = Liabilities +£30m (DTL) + Equity +£90m (retained earnings). ✓

2. Company X has total assets of £12,000,000 and total liabilities of £8,500,000. It has 500,000 ordinary shares outstanding. What is BVPS and how does it compare to a market price of £9.50 per share?

   • A
     BVPS = £17.00; the stock appears undervalued at £9.50
   • B
     BVPS = £24.00; the P/B is 0.40x, signalling the stock is deeply discounted
   • C
     BVPS = £7.00; the market price implies a P/B of 1.36x, suggesting the market values the firm above its net book assets
     Correct answer
   • D
     BVPS = £9.50; the P/B is exactly 1.0x, confirming fair value
   Explanation

   Net assets (equity) = £12,000,000 − £8,500,000 = £3,500,000. BVPS = £3,500,000 / 500,000 = £7.00. P/B = Market price / BVPS = £9.50 / £7.00 = 1.36x. A P/B of 1.36x means investors are paying 36% above the accounting book value for each share — a common outcome for profitable, asset-light businesses. This does not indicate distress; a P/B below 1.0x is the typical distress signal. A P/B of 1.36x simply means the market expects returns above book value in the future.

3. Under the effective interest rate method, how is the amortisation of bond discount calculated in a given period?

   • A
     Face value multiplied by the coupon rate
   • B
     Interest expense minus the coupon payment
     Correct answer
   • C
     Face value multiplied by the effective interest rate
   • D
     Carrying value multiplied by the coupon rate
   Explanation

   For a discount bond, interest expense (calculated as beginning carrying value × market rate) exceeds the coupon payment (face value × coupon rate). The excess of interest expense over the coupon payment is the discount amortisation for the period. This amortisation is added to the carrying value, causing it to increase toward face value. The formula: Discount amortisation = Interest expense − Coupon payment.