CFA Practice Question

There are 89 practice questions for this study session.

CFA Practice Question

Which of the following statements is (are) true with respect to the adjustments that an analyst should make to a company's balance sheet before interpreting them?

I. Marketable securities should be restated at lower of cost or market.
II. Remove any intangible assets and liability amounts from the balance sheet.
III. If a company reports its inventory using the FIFO method, then no adjustments need be made to its reported value for inventory.
IV. Liabilities that are unlikely to be reversed in the future should be turned into equity.
Correct Answer: III and IV

I is incorrect because marketable securities should simply be restated to reflect their current market values. The whole point of adjusting financial statements is so that they better reflect economic reality, not historical cost.

II is also incorrect. We don't want to remove any intangible assets and liability amounts from the balance sheet; instead, we want to estimate their current values by calculating the present value of the cash flows stemming from them.

User Contributed Comments 6

User Comment
Nightsurfer It's a reference to future tax liability. If it won't be realized (i.e. company keeps adding assets) it may as well be equity. In effect, this is an equity injection from the government.
HenryQ In IV the correct term is 'Deferred liabilities'...
AusPhD I am not sure that you are correct HenryQ, as it specifically states that they are unlikely to be reversed.
vi2009 HenryQ: The example will be life deferred taxes which if over time has accumulated and unlikely to be reversed, then we treat it as equity. So in a way, an example will be a deferred liability .. but it must be seen as not reversible over time.
NIKKIZ I had a doubt regarding III - I wouldn't say that the use of FIFO automatically means that inventory shouldn't be scrutinized because there may be obsolescence issues lurking which would be less of a concern if LIFO was employed... Specifically, if reported inventory is growing without a corresponding increase in sales, then that's a cause for concern.
daverco @NIKKIZ: FIFO simply means inventory is carried at most recent costs, thus reflecting economic reality more closely than LIFO (again, on the balance sheet; the reverse is true from the income-statement perspective). I don't think the issue of obsolescence has anything to do with it. LIFO and FIFO are just cost allocation methods. Your actual/physical inventory is the same.
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