One basic assumption lies at the root of all security analysis:

Question

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Passage # 34, Date: 17-Apr-2020
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One basic assumption lies at the root of all security analysis: required financial statements balance sheets, earnings statements, quarterly reports provide information that is meaningful but potentially misleading. The Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth.

Many say that it is a waste of time to stumble through the labyrinth of a companys financial statements. Statistics show that a companys past earnings are not predictive of future earnings and, even if they were, an efficient market would already reflect the change in valuation by affecting the price of the companys stock. The Financial Accounting Standards Board (FASB) argues otherwise: financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality. The FASB believes that if stockholders can understand the effect of corporate strategies and external events on a stock, they can more accurately watch for the recurrence of these or similar events and plan sales or purchases accordingly. Financial statements provide such information.

However long this debate continues will be determined by how useful corporations find the reports in pleasing stockholders and how well the evidence of stock market trends reflects the predictions made in the reports. Complicating this prognosis is the average corporations unwillingness to present a less than rosy picture of its financial situation alongside the many independent factors that affect market volatility.     1 
 1. The passage is primarily concerned with

A. arguing for a reexamination of a previously-held belief
B. explaining the relative merits of two opposing positions
C. revisiting an old question concerning a company's value
D. informing the reader of two similar positions
E. questioning the basis of an accepted piece of wisdom

2 
 2. The function of the second paragraph is to

A. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
B. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
C. support the view described in the first paragraph
D. introduce a new point of view that disagrees with the main point presented in the first paragraph
E. indicate an alternative to the points of view presented in the first and third paragraphs

3 
 3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements

A. must be similar in product and structure
B. are useful benchmarks to predict future earnings
C. may have chosen to represent themselves in similar ways
D. can exercise many prerogatives in operating their companies
E. are required to structure themselves differently

4 
 4. The members of the FASB and their critics disagree about

A. acceptable sources of financial statements
B. the usefulness of financial statements as predictors of future earnings
C. the history of financial statements
D. the accuracy of financial statements
E. the best method of interpreting financial statements

SiffyB · Answer

1. The passage is primarily concerned with
 
A. arguing for a reexamination of a previously-held belief
B. explaining the relative merits of two opposing positions
  C. revisiting an old question concerning a company's value 
 D. informing the reader of two similar positions
E. questioning the basis of an accepted piece of wisdom

(A) The author definitely does not argue about any stance in the passage. Thus, this option is not correct.
(B) passage is simply presenting the two opposing positions, not stating their relative merits. This option is also out.
(C) This can very well be our correct answer.
(D) The two positions discussed in the passage are contrasting, not similar. Thus, this option is incorrect.
(E) The author is not questioning the basis or any piece of wisdom.

2. The function of the second paragraph is to
 
A. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
B. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
C. support the view described in the first paragraph
  D. introduce a new point of view that disagrees with the main point presented in the first paragraph 
 E. indicate an alternative to the points of view presented in the first and third paragraphs

(A) The author is not arguing for the usage of these methods.
(B) No guidelines are discussed and their assessment is definitely not done in the second paragraph.
(C) According to the first paragraph, the financial statement may be meaningful but misleading. According to FASB, this is certainly not the case. How you interpret makes all the difference. Thus, this option is opposite of what is correct.
(D) This is the correct choice.
(E) There is only one point of view suggested in paragraph one and none in three. Alternatives are not suggested. Incorrect choice.

3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements
 
A. must be similar in product and structure
B. are useful benchmarks to predict future earnings
  C. may have chosen to represent themselves in similar ways 
 D. can exercise many prerogatives in operating their companies
E. are required to structure themselves differently

According to the first paragraph, two such companies may be very similar in balance sheets and earnings statements, but may choose to represent themselves in drastically different ways. There is another option to those two companies that they can represent themselves in similar ways. This matches with what is stated in option (C).

4. The members of the FASB and their critics disagree about
 
A. acceptable sources of financial statements
  B. the usefulness of financial statements as predictors of future earnings  
C. the history of financial statements
D. the accuracy of financial statements
E. the best method of interpreting financial statements

The FASB believes that financial statements are not intended to give an indication of value. They are used to indicate causality. There their usage is the point of disagreement here. 
(A) Soirces of these statements is not a point of disagreement.
(B) This is the correct choice.
(C) They're not concerned with the history of these financial statements.
(D) Both are not concerned about the accuracy of these statements.
(E) The best method is not discussed in the passage.

Gowtham91 · Answer

Q1. 
Para1 deals with view based on GAAP. Para2 supports para1 and then introduces opposing view of FASB. Para3 reconciles and concludes. 
Only  Option B  is in line with the passage structure.

Q2.
As per the explanation for Q1, only  Option D  is as per the passage structure.

Q3. 
As per second sentence of para1 - "The Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth.", we can infer  Option C

Q4.
We can infer from para2 - "Many"'s view "Statistics show that a companys past earnings are not predictive of future earnings" and FASB's view that "financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality." Hence the critics and FASB are arguing about -  Option B

AnirudhaS · Answer

Answers are in  bold .

1. The passage is primarily concerned with
A. arguing for a reexamination of a previously-held belief
 B. explaining the relative merits of two opposing positions 
C. revisiting an old question concerning a company's value
D. informing the reader of two similar positions
E. questioning the basis of an accepted piece of wisdom

Explanation of question 1 
I think two choices come close which are B and C. However, lets go through all the choices to see how they fare. As usual the tone of the passage helps with the primary purpose. The author states an assumption then talks for and against it, so its both sides yin and yang of the assumption.
A - The author is not arguing.
B - Yes as we talked about the author talked about both sides of the debate, hence we can say that he is talking about the merits of both opposing positions.
C - He is talking about an assumption, whether it is an age old question we are not sure of. In a way he is revisiting the question so in my opinion this could have been a valid answer choice if B was not present.
D - The positions are in the opposite ends of the spectrum, so not similar.
E - The only problem I have with this choice is the usage of the word 'wisdom'. 
B is our answer.
_______________________________________________________________________________________________________________________

2. The function of the second paragraph is to
A. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
B. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
C. support the view described in the first paragraph
 D. introduce a new point of view that disagrees with the main point presented in the first paragraph 
E. indicate an alternative to the points of view presented in the first and third paragraphs

Explanation of question 2 
The structure of the 2nd para is like this - many say (its a waste of time to look through financial statements), but the FASB says (not its not a waste). Now the options are very confusing to say the least. So I am not confident of this answer, but if I had to select one I will go with D. I will say why I have chosen D. So in the first paragraph the main just is - "the information is USEFUL but MISLEADING". Nice, so then in the 2nd para we see FASB says that it is useful and NOT misleading, because the stockholders can look for events in the market and choose when to buy/sell the security.
_______________________________________________________________________________________________________________________
 
3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements
 A. must be similar in product and structure 
B. are useful benchmarks to predict future earnings
C. may have chosen to represent themselves in similar ways
D. can exercise many prerogatives in operating their companies
E. are required to structure themselves differently

Explanation of question 3 
A - This is an assumption question, remember assumptions in CR? Lets take a quote from the passage - "he Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures  can appear remarkably different  based on how each firm chooses to represent itself in statements of earnings and net worth." Now this says that they SHOULD appear similar but they DON'T if they choose to represent themselves differently. Therefore the assumption is they MUST be similar.
B - Definitely not.
C - They may choose to represent in similar ways, but the author in the passage says that they can appear quite different depending on the way they choose to represent themselves.
D - Out of scope.
E - They are not required to structure differently, absolutely missing the point of the author.
_______________________________________________________________________________________________________________________

4. The members of the FASB and their critics disagree about
A. acceptable sources of financial statements
 B. the usefulness of financial statements as predictors of future earnings 
C. the history of financial statements
D. the accuracy of financial statements
E. the best method of interpreting financial statements

Explanation of question 4 
A - definitely not. All we are worried about here is HOW these financial statements can be used to predict whether to buy/sell stocks.
B - Looks good.
C - Again we are not keen on what the HISTORY of financial statemetns are.
D - accuracy is also not mentioned.
E - Again the METHOD is not discussed here.

SSandy066 · Answer

1. The passage is primarily concerned with

A. arguing for a reexamination of a previously-held belief
B. explaining the relative merits of two opposing positions
C. revisiting an old question concerning a company's value
D. informing the reader of two similar positions- > Correct
Exp:
Para1 About Financial reports provide information that is meaningful but potentially misleading. Two similar earning Company present reports in different ways.
Para 2: Two opposite view to check the financial reports and their merits.
Para 3: Describe long debated for Financial report use for Stakeholder and stock market prediction. conclusion.  
E. questioning the basis of an accepted piece of wisdom
2. The function of the second paragraph is to

A. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
B. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
C. support the view described in the first paragraph
D. introduce a new point of view that disagrees with the main point presented in the first paragraph- > Correct 
Exp:
Para 1 main point Financial reports information is meaningful but potentially misleading.
Para 2 "..financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality. …. stockholders can understand the effect of corporate strategies and external events on a stock, they can more accurately watch for the recurrence of these or similar events and plan sales or purchases accordingly. ….." 
E. indicate an alternative to the points of view presented in the first and third paragraphs

3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements
A. must be similar in product and structure
B. are useful benchmarks to predict future earnings
C. may have chosen to represent themselves in similar ways. -> Correct .
Exp:
Para 1 "...offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth" 
D. can exercise many prerogatives in operating their companies
E. are required to structure themselves differently

4. The members of the FASB and their critics disagree about
A. acceptable sources of financial statements
B. the usefulness of financial statements as predictors of future earnings- > Correct.
Exp: 
Para 2: Critics view: "Statistics show that a company's past earnings are not predictive of future earnings..."
Para 2 FASB view: "..Stockholders can understand the effect of corporate strategies and external events on a stock, they can more accurately watch for the recurrence of these or similar events and plan sales or purchases accordingly.."
Both have different views on Financial Report analysis. 
C. the history of financial statements
D. the accuracy of financial statements
E. the best method of interpreting financial statements

bM22 · Answer

1. The passage is primarily concerned with

A. arguing for a reexamination of a previously-held belief
B. explaining the relative merits of two opposing positions
 C. revisiting an old question concerning a company's value
 D. informing the reader of two similar positions
E. questioning the basis of an accepted piece of wisdom

Confused b/w C & E
 Correct Answer - C,
 Explanation - as, the author is merely going back on the old question, as to what calculates a company values.
Option A - incorrect, as no previously-held belief has been discussed.
Option B - incorrect, as out of scope.
Option D - incorrect, reason similar to B, as no 2 positions have been discussed. It's just one assumptions whuch has been discussed in detail.
Option E - incorrect, as its not questioning of an accepted wisdom, its just long going on debate of already accepted fact.

2. The function of the second paragraph is to

A. argue against the use of the GAAP-supported accounting methods mentioned in the first paragraph
 B. present an assessment of the usefulness of the GAAP guidelines presented in the first paragraph
C. support the view described in the first paragraph
D. introduce a new point of view that disagrees with the main point presented in the first paragraph
E. indicate an alternative to the points of view presented in the first and third paragraphs

Correct Answer - A,
 Explanation - as mentioned in the 2nd para "Many say that it is a waste of time to stumble through the labyrinth of a companys financial statements. ". It implies that 2nd para focusses against the comparison of a company's financial statements.
Option B - incorrect, not mentioned in the passage.
Option C - incorrect, as 2nd para doesnt support the use of GAAP.
Option D - incorrect, the 2nd para is just not in the view of use GAAP guidelines, not against the main point of the passage.
Option E - incorrect, no alternative to the points of view have been mentioned.

3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements

A. must be similar in product and structure
B. are useful benchmarks to predict future earnings
 C. may have chosen to represent themselves in similar ways
 D. can exercise many prerogatives in operating their companies
E. are required to structure themselves differently

Correct Answer - C.
 Explanation - as its mentioned in the passage: "The Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth.", clearly implying that 2 companies may choose to represent themselves in a similar or different manner.
Option A - incorrect, not a necessity.
Option B - incorrect, as mentioned in the 3rd para.
Option D - incorrect, could be but not mentioned in the passage.
Option E - incorrect, not required, their choice.

4. The members of the FASB and their critics disagree about

A. acceptable sources of financial statements
 B. the usefulness of financial statements as predictors of future earnings
 C. the history of financial statements
D. the accuracy of financial statements
E. the best method of interpreting financial statements

Correct Answer - B,
 Explanation - as mentioned in the passage: "The Financial Accounting Standards Board (FASB) argues otherwise: financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality.", so its a direct answer.
Option A - incorrect, as they dont argue about acceptable sources of financial statements.
Option C - incorrect, out of scope.
Option D - incorrect, out of scope.
Option E - incorrect, just one method is discussed with its pros and cons.

Sajjad1994 · Answer

OAs of this RC are as follow:

1. B
2. A
3. C
4. B

Difficulty Level of questions is as follow:

1. 700
2. 750
3. 700
4. 600

Overall: 700 (Hard)

Explanations by  Gautam12121991  and  bm2201  are best among the available here. Good Luck for the next RCs.

SiffyB · Answer

Please share OEs of Q1 and Q2.

Sajjad1994 · Answer

Official Explanation

1. The passage is primarily concerned with

Difficulty Level:   700

Explanation

The phrase is  primarily concerned  with indicates that this is a primary purpose question. The task of the question is to determine why the author wrote the passage. The subject of the question is the entire passage. In order to answer the question, determine why the author wrote the passage, then evaluate the answer choices, eliminating any choice which does not match the author’s primary purpose.

The passage states that  one basic assumption lies at the root of all security analysis: required financial statements balance sheets, earnings statements, and quarterly reports provide information that is meaningful but potentially misleading. The second paragraph introduces one side of an argument about this assumption. Many say that it is a waste of time to stumble through the labyrinth of a companys financial statements, and then introduces a counterargument, The Financial Accounting Standards Board (FASB) argues otherwise. The last paragraph then considers the future of this argument with the statements however long this debate continues will be determined by...and complicating this prognosis is.  Thus, the author's purpose is to examine both sides of a debate without taking a specific position.

Choice A:  No. The word arguing is extreme language and a memory trap from Financial Accounting Standards Board (FASB) argues otherwise in the second paragraph. However, the author does not take any specific stance and is therefore not arguing for a reexamination. There is also no previously-held belief discussed in the passage.

Choice B:  Correct. The author explains the merits of two positions, that it is a waste of time to stumble through...financial statements and the FASB's argument otherwise. These positions are opposing, so this choice correctly describes the author's purpose.

Choice C:  No. The phrase revisiting an old question is a memory trap for the first sentence of the passage which states one basic assumption lies at the root of all security analysis. However, the purpose of the passage is not about a question but rather about the merits of two opposing positions. While the phrase however long this debate continues in the passage indicates that the debate is ongoing, the word old in the answer choice is extreme language and is not supported by the text.

Choice D:  No. This is a reversal since the two positions are not similar. The passage states that Financial Accounting Standards Board (FASB) argues otherwise and mentions that this debate continues which indicates two opposing positions.

Choice E:  No. The word questioning and the phrase accepted piece of wisdom are extreme language. The author is not questioning either position but is rather examining both sides of a debate without taking a specific position. Additionally, the two positions are presented as part of a debate that continues, and so neither can be considered an accepted piece of wisdom.

Answer: B

2. The function of the second paragraph is to

Difficulty Level:   750

Explanation

The word  function  indicates that this is a purpose question. The subject of the question is the second paragraph of the passage. The task is to describe why the author wrote the second paragraph. The second paragraph presents the two opposing positions, the relative merits of which are the primary focus of the passage. Those two positions are 1) it is a waste of time to stumble through the labyrinth of a company’s financial statements because statistics show that a company’s past earnings are not predictive of future earnings and 2) the FASB states that financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality.

Choice A:  Correct. The two opposing positions introduced in the second paragraph are 1) it is a waste of time to stumble through the labyrinth of a company’s financial statements because statistics show that a company’s past earnings are not predictive of future earnings and 2) the FASB states that financial statements are not intended to give an indication of value otherwise unavailable to the common stockholder, but rather to give an indication of causality. Both of these positions argue against the use of the GAAP-supported accounted methods.

Choice B:  No. This answer is a reversal. The second paragraph is an argument against the usefulness rather than an assessment of the usefulness of GAAP methods.

Choice C:  No. This answer is a reversal. The second paragraph refutes the view described in the first paragraph.

Choice D:  No. The word new is extreme language as there is no indication that the two opposing positions presented in the second paragraph are new. Additionally, there is more than one point of view.

Choice E:  No. This answer is a reversal since the second paragraph does not provide an alternative to the points of view presented in the first and third paragraphs but rather presents the two opposing positions, the relative merits of which are the primary focus of the passage.

Answer: A

Hope it helps

AnirudhaS · Answer

Hi  SajjadAhmad , can you please share OE of question 3 please?

Sajjad1994 · Answer

Official Explanation

3. The passage suggests that two companies with similar GAAP-acceptable balance sheets and earnings statements

Difficulty Level:  650-700

Explanation

This is a retrieval question, as indicated by the phrase the passage suggests that. The subject of the question is companies with similar GAAP-acceptable balance sheets and earnings statements. In order to answer the question, determine what the passage says about the subject and evaluate the answer choices, eliminating any choice that cannot be supported by the text.

The passage discusses GAAP practices in the first paragraph, stating that Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different based on how each firm chooses to represent itself in statements of earnings and net worth.

Choice A:  No. The phrase must be similar is extreme language and the answer choice is a reversal, since GAAP methods afford a wide latitude, with the result that two companies with equivalent production and earnings figures can appear remarkably different.

Choice B:  No. This answer choice is a reversal since it directly contradicts the statement in the second paragraph of the passage that states that statistics show that a companys past earnings are not predictive of future earnings.

Choice C:  Correct. The statements Generally Accepted Accounting Principles (GAAP) offer accountants a wide latitude and based on how each firm chooses to represent itself can appear remarkably different indicate that companies have significant leeway in the way they choose to represent themselves. Thus, two companies with similar financial statements may have just chosen similar representations.

Choice D:  No. This answer choice is a memory trap, because the phrase exercise many prerogatives in the answer choice sounds similar to offer accountants a wide latitude in the passage. However, the passage refers to how companies choose to represent themselves in financial statements not in operating their companies.

Choice E:  No. The phrase are required to is extreme language and the answer choice relies upon outside knowledge. The passage indicates that GAAP offer accountants a wide latitude… based on how each firm chooses to represent itself in statements of earnings and net worth. It does not refer to how companies structure themselves.

The correct answer is choice C.

shwvkrm · Answer

Q2.
How is this arguing against the "GAAP-supported accounting methods" and not its interpretation?
As per my understanding, the accounting method hasn't been challenged by FASB but its interpretation has been.

bM22 · Answer

Hi  shwvkrm ,

Let me know if this helps.

First para of the passage discusses that a basic assumption of all security analysis that financial statements balance sheets, earnings statements, quarterly reports provide information that is meaningful but potentially misleading. Now what GAAP does is, it helps accounts broaden the scope of their analysis. GAAP is nothing but set of prinicples, in which comparison is done between the finances of 2 companies.

Now in 2nd para, author presents arguments against the above use of GAAP, as according to the statistics, the GAAP principles don't really help in the analysis. It is also opposed by FASB, though little differently.
So, here, from above inference, we can see that its the accounting method that is being challenged in the 2nd paragraph.

Thanks.

finisher009 · Answer

The answer in solution is d for q2, but the OA is still not changed. Please make changes.

Bunuel · Answer

The OA for Q1 is A. Check here: https://gmatclub.com/forum/one-basic-as ... l#p2499551

One basic assumption lies at the root of all security analysis:

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One basic assumption lies at the root of all security analysis:

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