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60. Which of the following is least likely to be a characteristic of an effective financial reporting framework?

A. Consistency.
B. Comparability.
C. Comprehensiveness.

Answer: B
“Financial Reporting Standards,” Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Karen O’Connor Rubsam, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, p.115, 118
Study Session: 7-31-g
Identify the characteristics of a coherent financial reporting framework and barriers to creating a coherent financial reporting network.
The characteristics of a coherent financial reporting network are transparency, comprehensiveness and consistency. Comparability is a qualitative characteristic of financial statements.

61. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following data about a company and the industry in which it operates:

	Company ($ millions)	Industry Averages as a percent of sales
Revenues	5,000	100%
Cost of goods sold	2,100	45%
Operating expenses	1,750	32%
rofit margin	475	9.5%

Which of the following conclusions is most reasonable? Compared to the industry, the company:

A. has the same cost structure and net profit margin.
B. has a lower gross profit margin and spends more on its operating costs.
C. is better at controlling product costs, but less effective at controlling operating costs.

Answer: C
“Understanding the Income Statement,” Thomas R. Robinson, CFA, Jan Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp.175-177
Study Session: 8-32-j
Evaluate a company’s financial performance using common-size income statements and financial ratios based on the income statement.

	Company	Industry	Conclusion
Gross Profit	5,000-2,100 = 2,900
Gross Profit Margin	2,900/5,000 = 58%	1-0.45 = 55%	The company’s cost of goods sold, or product costs, is lower; it is controlling them better.
Operating Costs	1,750/5,000 = 35%	32%	The company’s operating costs are higher. It is not as effective at controlling its operating costs as the industry.

  
62. A European based company follows IFRS (International Financial Reporting Standards) and capitalizes new product development costs. During 2008 they spent

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57. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company acquires a manufacturing facility in which it will produce toxic chemicals. The cost of the facility (exclusive of the underlying land) is $25 million and it is expected to provide a 10-year useful life, after which time the company will demolish the building and restore the underlying land. The cost of this restoration and cleanup is estimated to be $3 million at that time. The facility will be amortized on a straight-line basis. The company’s discount rate associated with this obligation is 6.25 percent. The total expense that will be recorded in the first year associated with the asset retirement obligation on this property is closest to:

A. $163,618.
B. $224,945.
C. $265,879.

58. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company receives a payment of $10,000 on 1 December, for rent on a property for December and January. On receipt, they correctly record it as cash and unearned revenue. If at 31 December, their year-end, they failed to make an adjusting entry related to this payment, ignoring taxes, what is the effect on the financial statements for the year?

A. Assets are overstated by $5,000 and Liabilities are overstated by $5,000
B. Assets are overstated by $5,000 and Owner’s equity is overstated by $5,000
C. Liabilities are overstated by $5,000 and Owners’ equity is understated by $5,000

59. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information from a company’s accounting records (all figures in thousands):

Assets, 31 December 2008	$5,250
Liabilities, 31 December 2008	2,200
Contributed capital, 31 December 2008	1,400
Retained earnings, 1 January 2008	800
Dividends declared during 2008	200

The analyst’s estimate of net income ($ thousands) for 2008 is closest to:

A. 650.
B. 850.
C. 1,050.

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57. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company acquires a manufacturing facility in which it will produce toxic chemicals. The cost of the facility (exclusive of the underlying land) is $25 million and it is expected to provide a 10-year useful life, after which time the company will demolish the building and restore the underlying land. The cost of this restoration and cleanup is estimated to be $3 million at that time. The facility will be amortized on a straight-line basis. The company’s discount rate associated with this obligation is 6.25 percent. The total expense that will be recorded in the first year associated with the asset retirement obligation on this property is closest to:

A. $163,618.
B. $224,945.
C. $265,879.

Answer: C
“Long-Lived Assets,” R. Elaine Henry, CFA and Elizabeth Gordon
2009 Modular Level I, Volume 3, pp. 357-361
Study Session 9-36-g
Discuss the liability for closure, removal, and environmental effects of long-lived
operating assets, and discuss the financial statement impact and ratio effects of that liability.
The PV of the future cleanup costs = 1,636,183 (FV = 3,000,000; N = 10; I/Y = 6.25;
PMT = 0; CPT PV). The firm will record asset retirement costs of $1,636,183 as part of the cost of the property and a corresponding ARO liability of $1,636,183.
The asset retirement costs will be amortized at the same rate as the property (10 years, straight-line) and an accretion expense representing the change in the ARO liability will also arise.

Depreciation Expense:	1/10 x 1,636,183	163,618
Accretion Expense	6.25% x 1,636,183	102,261
Total Expense		265,879

58. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company receives a payment of $10,000 on 1 December, for rent on a property for December and January. On receipt, they correctly record it as cash and unearned revenue. If at 31 December, their year-end, they failed to make an adjusting entry related to this payment, ignoring taxes, what is the effect on the financial statements for the year?

A. Assets are overstated by $5,000 and Liabilities are overstated by $5,000
B. Assets are overstated by $5,000 and Owner’s equity is overstated by $5,000
C. Liabilities are overstated by $5,000 and Owners’ equity is understated by $5,000

Answer: C
“Financial Reporting Mechanics,” Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Karen O’Connor Rubsam, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, p.64
Study Session: 7-30-e
Explain the need for accruals and other adjustments in preparing financial statements.
The company should have made an adjusting entry to reduce the Unearned revenue account (a liability) by $5,000 and increase Revenue, (and hence net income and retained earnings) by $5,000. As the company failed to make the adjusting entry the liabilities are overstated and owners’ equity is understated.

59. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information from a company’s accounting records (all figures in thousands):

Assets, 31 December 2008	$5,250
Liabilities, 31 December 2008	2,200
Contributed capital, 31 December 2008	1,400
Retained earnings, 1 January 2008	800
Dividends declared during 2008	200

The analyst’s estimate of net income ($ thousands) for 2008 is closest to:

A. 650.
B. 850.
C. 1,050.

Answer: C
“Financial Reporting Mechanics,” Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Karen O’Connor Rubsam, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp.38-40
Study Session: 7-30-c, f
Explain the accounting equation in its basic and expanded forms.
Prepare financial statements, given account balances or other elements in the relevant accounting equation, and explain the relationships among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity.
Total assets = liabilities + owner’s equity.
Owner’s equity = $5,250– 2,200= 3,050.
Owners equity = contributed capital + ending retained earnings.
Ending retained earnings = 3,050– 1,400= 1,650.
Ending retained earnings = beginning retained earnings + net income – dividends.
1,650= 800 + net income – 200;
Net income = $1,050

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54. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
Which of the following is the simplest way for a company to increase its reported operating cash flow?

A. Record sales on a bill-and-hold basis.
B. Slow down the rate of payment to suppliers.
C. Use a third party financial institution to pay suppliers.

55. When the financial statements materially depart from accounting standards and are not fairly presented, the audit opinion would be a(n):

A. adverse opinion.
B. qualified opinion.
C. disclaimer of opinion.

56. An issue subject to a vote at a stockholders’ meeting is presented in a(n):

A. interim report.
B. proxy statement.
C. management statement of responsibility.

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54. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
Which of the following is the simplest way for a company to increase its reported operating cash flow?

A. Record sales on a bill-and-hold basis.
B. Slow down the rate of payment to suppliers.
C. Use a third party financial institution to pay suppliers.

Answer: B
“Accounting Shenanigans on the Cash Flow Statement,” Marc A. Siegel
2009 Modular Level I, Volume 3, pp. 568-569
Study Session: 10-41
The candidate should be able to analyze and discuss the following ways to manipulate the cash flow statement:
      stretching out payables
      financing of payables
      securitization of receivables
      using stock buybacks to offset dilution of earnings.
Slowing down the rate or payments to suppliers is the simplest way to increase reported operating cash flow.

55. When the financial statements materially depart from accounting standards and are not fairly presented, the audit opinion would be a(n):

A. adverse opinion.
B. qualified opinion.
C. disclaimer of opinion.

Answer: A
“Financial Statement Analysis: An Introduction,” Thomas R. Robinson, CFA, Jan Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp.18-21
Study Session: 7-29-d
Discuss the objective of audits of financial statements, the types of audit reports, and the importance of effective internal controls.
An adverse opinion occurs when the financial statements materially depart from accounting standards and are not fairly presented. A qualified opinion is one in which there is some limitation or exception to accounting standards.

56. An issue subject to a vote at a stockholders’ meeting is presented in a(n):

A. interim report.
B. proxy statement.
C. management statement of responsibility.

Answer: B
“Financial Statement Analysis: An Introduction,” Thomas R. Robinson, CFA, Jan Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, p.23
Study Session: 7-29-e
Identify and explain information sources other than annual financial statements and supplementary information that analysts use in financial statement analysis.
Proxy statements are prepared and distributed to shareholders on matters that are to be put to a vote at shareholder meetings.

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51. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
The year-end balances in a company’s LIFO reserve are $56.8 million in the company’s financial statements for both 2007 and 2008. For 2008, the measure that will most likely be the same regardless of whether the company uses the LIFO or FIFO inventory method is the:

A. inventory turnover.
B. gross profit margin.
C. amount of working capital.

52. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information about a company:

Shares of common stock outstanding	1,000,000
Net income for the year	$1,500,000
Par value of convertible bonds with a 4 percent coupon rate	$10,000,000
Par value of cumulative preferred stock with a 7 percent dividend rate	$2,000,000
Tax rate	30%

The bonds were issued at par and can be converted into 300,000 common shares. All securities were outstanding for the entire year. Diluted earnings per share is closest to:

A. $1.05.
B. $1.26.
C. $1.36.

53. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
At the beginning of the year, two companies issued debt with the same market rate, maturity date, and total face value. One company issued coupon-bearing bonds at par and the other company issued zero-coupon bonds. All other factors being equal for that year, compared with the company that issued par bonds, the company that issued zero-coupon debt will most likely report:

A. higher cash flow from operations but not higher interest expense.
B. both higher cash flow from operations and higher interest expense.
C. neither higher cash flow from operations nor higher interest expense.

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51. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
The year-end balances in a company’s LIFO reserve are $56.8 million in the company’s financial statements for both 2007 and 2008. For 2008, the measure that will most likely be the same regardless of whether the company uses the LIFO or FIFO inventory method is the:

A. inventory turnover.
B. gross profit margin.
C. amount of working capital.

Answer: B
“Inventories,” Elbie Antonites, CFA, and Michael Broihahn, CFA
2009 Modular Level I, Volume 3, pp. 312-318
Financial Statement Analysis: Applications,” Thomas R. Robinson, CFA, Jan Hendrik van Greuning, CFA, R. Elaine Henry, CFA, and Michael A. Broihahn CFA
2009 Modular Level I, Volume 3, pp. 599-601
Study Session 9-35-e, f, 10-42-e
Analyze the financial statements of companies using different inventory accounting methods to compare and describe the effect of the different methods on cost of goods sold, inventory balances, and other financial statement items; and compute and describe the effects of the choice of inventory method on profitability, liquidity, activity, and solvency ratios.
Calculate adjustments to reported financial statements related to inventory assumptions in order to aid in comparing and evaluating companies.
Determine and justify appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company.
The LIFO reserve did not change from 2007 to 2008. Without a change in the LIFO reserve, cost of goods sold would be the same under both methods. Sales are always the same for both; so gross profit margin would be the same in 2008. The FIFO
inventory would be higher because the LIFO inventory and LIFO reserve are added to compute FIFO inventory. Because the inventory balances would be different under FIFO, inventory turnover, and net working capital would also be different under FIFO.

52. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information about a company:

Shares of common stock outstanding	1,000,000
Net income for the year	$1,500,000
Par value of convertible bonds with a 4 percent coupon rate	$10,000,000
Par value of cumulative preferred stock with a 7 percent dividend rate	$2,000,000
Tax rate	30%

The bonds were issued at par and can be converted into 300,000 common shares. All securities were outstanding for the entire year. Diluted earnings per share is closest to:

A. $1.05.
B. $1.26.
C. $1.36.

Answer: B
“Understanding The Income Statement”, Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp. 165-171
Study Session 8-32-h
Describe the components of earnings per share and calculate a company’s earnings per share (both basic and diluted earnings per share) for both a simple and complex capital structure.
Dividends of $140,000 (0.07 x 2,000,000) should be deducted from net income to determine the amount available to common shareholders: $1,360,000 = (1,500,000 – 140,000). Basic EPS would be $1,360,000 / 1,000,000 or $1.36 per share. Diluted EPS would consider the convertible bonds if they were dilutive. Interest on the bonds is $400,000 and the after-tax amount add back to net income is $400,000 (1-.30) = $280,000. Diluted EPS, assuming conversion, is ($1,360,000 + 280,000) / (1,000,000 +300,000) = 1,640,000/1,300,000= $1.26 per share. The bonds are dilutive.

53. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
At the beginning of the year, two companies issued debt with the same market rate, maturity date, and total face value. One company issued coupon-bearing bonds at par and the other company issued zero-coupon bonds. All other factors being equal for that year, compared with the company that issued par bonds, the company that issued zero-coupon debt will most likely report:

A. higher cash flow from operations but not higher interest expense.
B. both higher cash flow from operations and higher interest expense.
C. neither higher cash flow from operations nor higher interest expense.

Answer: A
“Long-term Liabilities and Leases” Elizabeth Gordon and R. Elaine Henry, CFA
2009 Modular Level I, Volume 3, pp. 430-433
Study Session 9-38-a
Compute the effects of debt issuance and amortization of bond discounts and premiums on financial statements and ratios.
When a company issues a zero-coupon bond, cash flow from operations is overstated over the life of the bond. Interest expense is recorded for income statements purposes, but is added back in the statement of cash flows as a non-cash adjustment to cash flow from operations.

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48. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information about three equipment sales that a company made at the end of the year:

	Original    Cost	Accumulated Depreciation     at Date of Sale	Sales Proceeds
1	$200,000	$150,000	$70,000
2	$200,000	$200,000	$30,000
3	$300,000	$250,000	$40,000

All else equal for that year, the company’s cash flow from operations will most likely be:

A. the same as net income.
B. $40,000 less than net income
C. $140,000 less than net income.

 

49. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
The following information is from a company’s 2008 financial statements ($ millions):

Balances as of the year ended 31 December	2008	2007
Retained earnings	140	120
Accounts receivable	43	38
Inventory	48	45
Accounts payable	29	36

In 2008 the company declared and paid cash dividends of $5 million and recorded depreciation expense in the amount of $25 million. The company’s 2008 cash flow from operations ($ millions) is closest to:

A. 25.
B. 30.
C. 35.

50. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company using the LIFO inventory method reports a LIFO reserve at year-end of $85,000, which is $20,000 lower than the prior year. If the company had used FIFO instead of LIFO in that year, the company’s financial statements would have reported:

A. a lower cost of goods sold, but a higher inventory balance.
B. a higher cost of goods sold, but a lower inventory balance.
C. both a higher cost of goods sold and a higher inventory balance.

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48. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
An analyst gathers the following information about three equipment sales that a company made at the end of the year:

	Original    Cost	Accumulated Depreciation     at Date of Sale	Sales Proceeds
1	$200,000	$150,000	$70,000
2	$200,000	$200,000	$30,000
3	$300,000	$250,000	$40,000

All else equal for that year, the company’s cash flow from operations will most likely be:

A. the same as net income.
B. $40,000 less than net income
C. $140,000 less than net income.

 

Answer: B
“Understanding the Cash Flow Statement,” Thomas R. Robinson, CFA, Jan Hendrik van Greuning, CFA, R. Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp.263 - 265, 267-270
“Long-Lived Assets,” R. Elaine Henry, CFA, and Elizabeth Gordon 2009 Modular Level I, Volume 3, pp.361-366
Study Session 8-34-f, 9-36-h
Demonstrate the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data.
Discuss the impact of sales or exchanges of long-lived assets on financial statements.
Equipment sale 1 results in a gain of $20,000, sale 2 results in a gain of $30,000, and sale 3 results in a loss of $10,000. The net gain is $40,000. The amount that would be deducted from net income to determine cash flow from operations is equal to the net gain of $40,000.

49. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
The following information is from a company’s 2008 financial statements ($ millions):

Balances as of the year ended 31 December	2008	2007
Retained earnings	140	120
Accounts receivable	43	38
Inventory	48	45
Accounts payable	29	36

In 2008 the company declared and paid cash dividends of $5 million and recorded depreciation expense in the amount of $25 million. The company’s 2008 cash flow from operations ($ millions) is closest to:

A. 25.
B. 30.
C. 35.

Answer: C
“Financial Reporting Mechanics,” Thomas R. Robinson, CFA, Hendrik van Greuning, CFA, Karen O’Connor Rubsam, CFA, R. Elaine Henry, CFA, and Michael A. Broihahn, CFA 2009 Modular Level I, Volume 3, p.40 “Understanding The Cash Flow Statement”, Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp.267-271
Study Session 7-30-f, 8-34-f
Prepare financial statements, given account balances or other elements in the relevant accounting equation, and explain the relationships among the income statement, balance sheet, statement of cash flows, and statement of owners’ equity.
Demonstrate the steps in the preparation of direct and indirect cash flow statements, including how cash flows can be computed using income statement and balance sheet data.
The change in retained earnings is $20 and dividends are paid from retained earnings.
2008 net income equals the change in retained earnings plus any dividends paid during 2008. Depreciation expense is added to net income and the changes in balance sheet accounts are also considered to determine cash flow from operations.
$20 + 5 (dividends) + 25 (depreciation) – 5 (increase in receivables) – 3 (increase in inventory) – 7 (decrease in payables) = $35 million.

50. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
A company using the LIFO inventory method reports a LIFO reserve at year-end of $85,000, which is $20,000 lower than the prior year. If the company had used FIFO instead of LIFO in that year, the company’s financial statements would have reported:

A. a lower cost of goods sold, but a higher inventory balance.
B. a higher cost of goods sold, but a lower inventory balance.
C. both a higher cost of goods sold and a higher inventory balance.

Answer: C
“Inventories,” Elbie Antonites, CFA, and Michael Broihahn, CFA
2009 Modular Level I, Volume 3, pp. 312-318
“Financial Statement Analysis: Applications,” Thomas R. Robinson, CFA, Jan Hendrik van Greuning, CFA, R. Elaine Henry, CFA, and Michael A. Broihahn CFA
2009 Modular Level I, Volume 3, pp. 599-601
Study Session 9-35-e, f, g, 10-42-e
Analyze the financial statements of companies using different inventory accounting methods to compare and describe the effect of the different methods on cost of goods sold, inventory balances, and other financial statement items; and compute and describe the effects of the choice of inventory method on profitability, liquidity, activity, and solvency ratios.
Calculate adjustments to reported financial statements related to inventory assumptions in order to aid in comparing and evaluating companies.
Discuss the reasons that a LIFO reserve might decline during a given period and discuss the implications for financial analysis.
Determine and justify appropriate analyst adjustments to a company’s financial statements to facilitate comparison with another company.
The negative change in the LIFO reserve would increase the cost of goods sold under FIFO compared to LIFO. FIFO COGS = LIFO COGS – Change in LIFO reserve.
The LIFO reserve has a positive balance so that FIFO inventory would be higher than LIFO inventory. FIFO inventory = LIFO inventory + LIFO reserve.

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45. An analyst gathers the following information about a company:

Cost of goods sold	$18.4 million
Average inventory	$2.5 million
Receivables turnover	24 times
Number of days of payables	25 days

The company’s cash conversion cycle (in days) is closest to:

A. 40.
B. 59.
C. 65.

Answer: A
“Financial Analysis Techniques”, Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn, CFA
2009 Modular Level I, Volume 3, pp. 506-509
“Working Capital Management,” Edgar A. Norton, Jr., CFA, Kenneth L. Parkinson, and Pamela P. Peterson, CFA
2009 Modular Level I, Volume 4, pp. 87-90,
Study Session 10-39-c, 11-46-a, b
Calculate, classify and interpret activity, liquidity, solvency, profitability, and valuation ratios.
Evaluate overall working capital effectiveness of a company, using the operating and cash conversion cycles, and compare its effectiveness with other peer companies.
Calculate and interpret liquidity measures using selected financial ratios for a company and compare it with peer companies.


46. Assume U.S. GAAP (generally accepted accounting principles) applies unless otherwise noted.
Two companies operating in the same industry both achieved the same return on equity with the same net sales, but the two companies were different with respect to return on total assets. Compared with the company that had the higher return on total assets, the company with the lower return on total assets most likely had a higher:

A. total asset turnover.
B. financial leverage multiplier.
C. proportion of common equity in its capital structure.

Answer: B
“Financial Analysis Techniques”, Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn CFA
2009 Modular Level I, Volume 3, pp. 520-525
“Financial Statement Analysis,” Pamela P. Peterson, CFA 2009 Modular Level I Volume 4, pp. 132-136
Study Session 10-39-e, 11-47-a
Demonstrate the application of and interpret changes in the component parts of the DuPont analysis (the decomposition of return on equity).
Calculate, interpret, and discuss the DuPont expression and extended DuPont expression for a company’s return on equity and demonstrate its use in corporate analysis.
The DuPont system can be used to break down return on equity (ROE) into three components: Profit margin, total asset turnover, and financial leverage multiplier.
The first two components can be multiplied to calculate the return on total assets (ROA). If the two companies have the same ROE, the company with the lower ROA must have a higher financial leverage multiplier (lower proportion of common equity in the capital structure).

47. If an analyst is preparing common-size financial statements the most appropriate way of expressing the interest expense is as a percentage of:

A. sales.
B. total liabilities.
C. total interest-bearing debt.

Answer: A
“Financial Analysis Techniques”, Thomas R. Robinson, CFA, Hennie van Greuning, CFA, Elaine Henry, CFA, and Michael A. Broihahn CFA
2009 Modular Level I, Volume 3, pp. 490-492
Study Session 10-39-a
Evaluate and compare companies using ratio analysis, common-size financial statements, and charts in financial analysis.
Interest expense is an income statement account and the common-size percentage should be computed as a percentage of sales for that company.