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

• Question 1881:

  Which of the following relationships is true?

  A. Gross profit margin < Net profit margin < Operating profit margin

  B. Gross profit margin < Operating profit margin < Net profit margin

  C. Gross profit margin > Operating profit margin > Net profit margin

  D. Net profit margin > Gross profit margin > Operating profit margin

  Correct Answer: C

  Gross profit = Net sales - COGS Operating profit = Gross Profit - Sales and General Expenses = EBDIT Net Income = Earnings after depreciation, interest expense and taxes = Operating profit - depreciation - interest expense - taxes Since gross profit > operating profit > net income, "Gross profit margin > Operating profit margin > Net profit margin" is the correct choice.

• Question 1882:

  The accumulated depreciation account should show

  A. total depreciation for fixed assets since the business was formed

  B. current depreciation expense plus estimated depreciation for next year

  C. total depreciation for fixed assets still in use

  D. only the depreciation expense recognized during the current year

  Correct Answer: C

  Depreciation recognized and accumulated on fixed assets still on the books is reflected in the Accumulated Depreciation account(s).

• Question 1883:

  When prices are rising, which of the following inventory valuation methods produces the lowest income tax liability?

  A. None of these answers

  B. LIFO

  C. Average cost

  D. FIFO

  Correct Answer: B

  When prices are rising, LIFO will produce the lowest profit, and the lowest income tax liability, because the last in (highest cost) inventory is the first out. This leaves the oldest inventory on hand and since it has the lowest cost, ending inventory will have the lowest value which means that cost of goods sold will be the highest and profits will be the lowest (ending inventory = beginning inventory + net purchases - cost of goods sold).

• Question 1884:

  What impact will the amortization of an intangible asset over a longer than appropriate period have on a firm?

  A. It will result in higher than otherwise sales revenues.

  B. None of these answers.

  C. All of these answers.

  D. It will reduce a firm's current income tax liability.

  E. It will improve reported earnings.

  Correct Answer: E

  Earnings, not revenues will be improved because amortizing an intangible asset over a longer than appropriate period reduces the annual amortization expense; this improves pre-tax and after-tax profits.

• Question 1885:

  The interest expense on a premium bond _______ over time.

  A. decreases

  B. remains constant

  C. can increase or decrease, depending on interest rate movements

  D. increases

  Correct Answer: A

  Remember that the book value of the liability of any straight bond equals the face value at maturity. Hence, when the bond is issued at a premium, the premium amount is amortized over the life of the bond. The outstanding liability thus decreases steadily toward the face value. The decreasing liability decreases the interest expense over time.

• Question 1886:

  According to the FASB conceptual framework, which of the following situations violates the concept of reliability?

  A. Financial statements include property with a carrying amount increased to management's estimate of market value.

  B. None of these answers.

  C. Financial statements are issued 9 months late.

  D. Data on segments having the same expected risks and growth rates are reported to analysts estimating future profits.

  E. Management reports to stockholders regularly refer to new projects undertaken, but that financial statements never report project results.

  Correct Answer: A

  Reliability has 3 primary qualities: verifiability, neutrality and representational faithfulness. Neutrality is violated here as information should not be prepared or reported to obtain a predetermined result, and should be free from bias.

• Question 1887:

  Which of the following is not a current liability?

  A. Allowance for Uncollectible Accounts

  B. Wages Payable

  C. Unearned Revenue

  D. Notes Payable

  Correct Answer: A

  Allowance for Uncollectible Accounts is a contra account to Accounts Receivable, both of which are reported in the current asset section of the balance sheet.

• Question 1888:

  Which of the following is/are true about computation of Basic EPS?

  I. With stock splits and stock dividends, previously reported EPS numbers are retroactively readjusted.

  II. Shares issued for the acquisition of another business are included from the date of issuance.

  III.

  Shares issued in pooling of interests are assumed to have been outstanding at the beginning of all the periods reported.

  A.

  II and III

  B.

  I, II and III

  C.

  I and III

  D.

  I only

  Correct Answer: B

  In the computation of basic EPS, one must be careful about the time period for which shares are assumed to be outstanding. This becomes an issue when the firm issues new shares or reacquires outstanding shares during the accounting period. Further, the purpose for which the shares are issued are also of concern since the computation of the weighted number of shares outstanding must be consistent with the logic behind the accounting treatment of the newly issued shares. Hence, when shares are issued for the acquisition of another business, they are considered as equity issued to raise new capital for investment and therefore included from the date of issuance. On the other hand, under pooling of interests method, the merged companies are assumed to have been a combined entity since their respective inceptions. Therefore, when shares are issued under pooling of interests, they are assumed to have been outstanding at the beginning of all the periods reported. Finally, stock splits and stock dividends change the number of shares without any direct impact on earnings. Hence, for consistency, previously reported EPS numbers are retroactively readjusted.

• Question 1889:

  The cumulative effect of changing to a new accounting principle on the amount of retained earnings at the beginning of the period in which the change is made should be included in net income of ________.

  A. the period of change and future periods

  B. the period of change

  C. future periods

  D. none of these answers

  E. neither future periods nor the period of change

  Correct Answer: B

  A change from one acceptable method of accounting to another should be accounted for as the cumulative effect of a change in accounting principle. The cumulative effect should be recognized as a component of net income, net of tax effect, in the period of change.

• Question 1890:

  A company is currently being sued by a customer. A reasonable estimate can be made of the costs that would result from a ruling unfavorable to the company, and the amount involved is material. The company's managers, lawyers, and auditors agree that there is a remote likelihood of an unfavorable ruling. This contingency

  A. none of these answers.

  B. should be disclosed as a parenthetical comment in the balance sheet.

  C. should be disclosed as an appropriation of retained earnings.

  D. should be disclosed in a footnote.

  E. need not be disclosed in a footnote.

  Correct Answer: E

  Losses arising from litigation should be accrued if both probable and reasonably estimable, and should be disclosed if reasonably possible. In this case, the likelihood is remote. Therefore, no disclosure is required.