CFA Institute CFA Institute Certifications CFA-LEVEL-1 Questions & Answers

• Question 1831:

  Which of the following is/are differences between depreciation and depletion?

  I. Depletion can be applied only to natural resources while depreciation can be applied to most production resources.

  II. The amount of depletion depends upon total production but the amount of depreciation need not be so dependent.

  III.

  Depreciation expenses conform with accrual accounting while depletion expenses conform with cost recovery accounting.

  A.

  II and III

  B.

  I and II

  C.

  I, II and III

  D.

  none of these answers

  Correct Answer: B

  Depletion expenses also conform with accrual accounting.

• Question 1832:

  Why should the analyst place special emphasis in their assessment of cash balances?

  A. Cash represents the point in a firm's operating cycle where management has maximum discretion with the deployment and use of its resources.

  B. Cash is a company's most liquid asset.

  C. All of these answers.

  D. Cash is typically the only asset that is available to meet a firm's financial obligations.

  E. None of these answers.

  Correct Answer: C

  All of these answers are correct because any assessment of a firm's liquidity should be focused on a firm's ability to meet its near-term liabilities. While inventory may be sold, it is subject to shrinkage through loss of value, theft, etc. and while accounts receivable a current assets, not all firms collect the full balance of what they are owed, let alone collecting it when it is due. Cash is king in the world of finance because it is cash and cash alone that is used to meet financial commitments.

• Question 1833:

  A firm has just acquired a long-term asset with a useful life of 5 years. Its acquisition cost was $65,000 and its salvage value is estimated at $10,000. If the firm uses straight-line depreciation method, what's the depreciation expense recognized in Year 3?

  A. $10,600

  B. $14,500

  C. $11,000

  D. $13,000

  Correct Answer: C

  In Straight-line method, depreciation is constant at (1/n)*(acquisition cost - salvage value). In this case, depreciation = (1/5)*(65,000-10,000)=$11,000.

• Question 1834:

  Which of the following relationships is/are correct:

  I. change in assets + change in liabilities = change in equity.

  II. change in retained earnings = net income + dividends paid.

  III. assets - liabilities = retained earnings + contributed capital.

  IV.

  assets = liabilities + revenues - expenses.

  A.

  I, II and III

  B.

  III only

  C.

  I, II, III and IV

  D.

  II and III

  Correct Answer: B

  The basic accounting equation is Total assets = Total liabilities + Total Equity. In I and II, the "plus" should be "minus."

• Question 1835:

  When the Percentage of Sales method is used, the estimated bad debt expense is calculated by: A. multiplying net sales on account times the percentage

  B. multiplying total sales on account times the percentage

  C. subtracting the percentage of net sales on account from the balance of Allowance for Uncollectible Accounts

  D. dividing total sales on account by the percentage

  Correct Answer: A

  This method bases the period adjustment on a percent of net sales on account for the period.

• Question 1836:

  The following data are available for a firm for a given year:

  Net Sales 21,896 Sales and marketing expenses 4,346 Administrative expenses 2,143 COGS 10,084 Depreciation 967 Interest expense 573 Tax rate 35% Dividends paid 3,445 Preferred Dividends 897 Average total equity 37,432 Average common equity 26,782 Average total liabilities 18,583

  In the above example, the firm's return on common equity equals ________.

  A. 5.83%

  B. 4.77%

  C. 6.12%

  D. 4.38%

  Correct Answer: A

  Return on common equity = (Net income - preferred dividends)/average common equity. In the above example, Net Income = Earnings after depreciation, interest expense and taxes = (21,896 - 4,346 - 2,143 10,084 - 967 - 573)*(1 - 0.35) = 2,459. Therefore, Return on common equity = (2,459 - 897)/26,782 = 5.83%.

• Question 1837:

  A defined benefit pension plan:

  A. pays defined benefits for a certain period after retirement.

  B. disburses benefits based on the returns on the fund's investments.

  C. promises to pay retirees a specific income stream.

  D. none of these answers.

  Correct Answer: C

  In a defined benefit pension plan, the retirement benefits are "predefined." The employer commits to providing the benefits regardless of the performance of the pension plan. Thus, in this plan, the risk of pension plan performance is borne by the employer and not the employee.

• Question 1838:

  At the end of a fiscal period, any revenue that has been earned but the company has not received payment for should be debited to an appropriate

  A. asset account

  B. expense account

  C. liability account

  D. revenue account

  Correct Answer: A

  Revenue should be recognized in the period in which it is earned and is credited to the appropriate revenue account. If payment has not been received, then a debit entry to Accounts Receivable must be booked.

• Question 1839:

  Which of the following is/are FALSE about Basic EPS and Diluted EPS?

  I. Basic EPS excludes anti-dilutive securities but Diluted EPS must include these.

  II. Basic EPS ignores instruments like convertible bonds and warrants but Diluted EPS does not.

  III.

  The Treasury stock method, when applied to Basic EPS, compares the average stock price during the period to the strike price in determining conversion.

  A.

  III only

  B.

  I and III

  C.

  I, II and III

  D.

  II only

  Correct Answer: B

  Note that the questions asks for false statements. (I) is false since both methods exclude anti-dilutive securities from computations. Further, since the Basic EPS ignores all potentially dilutive securities and takes into account only simple capital structure instruments (stocks, bonds, preferred equity), it has no need for the Treasury Stock method i.e. the Treasury stock method is never used in the computation of Basic EPS.

• Question 1840:

  Which of the following describes a change in reporting entity?

  A. A company acquires a subsidiary that is to be accounted for as a purchase.

  B. None of these answers.

  C. A business combination is made using the pooling-of-interests method.

  D. A manufacturing company expands its market from regional to nationwide.

  E. A company acquires additional shares of an investee and changes from the equity method of accounting to consolidation of the subsidiary.

  Correct Answer: C

  A change in reporting entity can occur in the following ways: initial publication of consolidated financial statements; change in consolidation policy regarding subsidiaries; and pooling of interests.