Reading 30: Financial Reporting Mechanics - LOS h ～ Q1-3

investment, management, companies, concerned, office

Q1. Jack Rivers is an investment analyst for the equity fund of a family office. The head of the family, Charlotte Blackmon, is concerned that management may be manipulating the earnings of some of the companies that the fund invests in. Rivers explains to Blackmon, “Even though we don’t have access to the detailed transactions that underlie the financial statements, we can be sure that management is not manipulating earnings because I read the footnotes to the financial statements of every company we invest in. The footnotes would disclose any deviation from appropriate accounting parameters.” Rivers is:

A) incorrect because even within appropriate accounting parameters, management can manipulate earnings through the assumptions that rely on their discretion.

B) correct.

C) incorrect because deviation from appropriate accounting parameters is addressed in the auditor’s report, so a qualified opinion in the auditor’s report ensures that management is not manipulating earnings.

Q2. Sergey Martinenko is an investment analyst with Profis, Martinenko and Verona. He is explaining to his new assistant, John Stevenson, why it is crucial for an investment analyst to read the footnotes to a firm’s financial statement and the Management Discussion and Analysis (MD&A) before making an investment decision. Which rationale is Martinenko least likely to provide to Stevenson regarding the importance of analyzing the footnotes and MD&A?

A) Accruals, adjustments and assumptions are often explained in the footnotes and MD&A.

B) The footnotes disclose whether or not the company is adhering to GAAP.

C) Evaluating the footnotes helps the analyst assess whether management is manipulating earnings.

Q3. Reading the footnotes to a company’s financial statements and the Management Discussion & Analysis is least likely to help an analyst determine:

A) the various accruals, adjustments and assumptions that went into the financial statements.

B) how well the financial statements reflect the company’s true performance.

C) the detailed information that underlies the company’s accounting system.