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

• Question 1991:

  When merchandise inventory is purchased under a periodic system, which account is debited?

  A. Accounts Payable

  B. Cash

  C. Merchandise Inventory

  D. Purchases

  Correct Answer: D

  The periodic inventory system records purchases of merchandise inventory in an income statement account called Purchases.

• Question 1992:

  Firms A and B have simple capital structure with the same number of common stock outstanding. A finances its operations relying on debt financing while B prefers issuing preferred equity. If both the firms had the same net income last year, Firm A will have a:

  A. higher EPS than B.

  B. lower EPS than B.

  C. all of these answers can happen.

  D. the same EPS as B.

  Correct Answer: A

  For a simple capital structure, EPS = (Net Income - Preferred stock dividends)/weighted # of common shares Since both the firms have the same net income and common shares outstanding, Firm B will show a lower EPS due to the payment of preferred stock dividends.

• Question 1993:

  A firm has just experienced a LIFO liquidation under inflation. Which of the following could be true?

  I. The firm's purchases were lower than the number of units sold.

  II. The firm experienced a cash drain due to taxes.

  III.

  The firm's income was understated.

  A.

  II only

  B.

  I and III

  C.

  II and III

  D.

  I, II and III

  E.

  Correct Answer: D

  The LIFO Reserve is defined as the difference between the values of the inventory under FIFO and under LIFO. A decrease in this reserve is referred to as LIFO liquidation. Under the usual case of rising prices, this occurs when units sold exceed units purchased, leading to a "dipping" into the LIFO layers. Since some of the goods sold were purchased at lower prices in previous periods as accounted for by LIFO, COGS gets understated compared to the case where the firm purchases the sold goods in the current period instead of dipping into the LIFO layers. Hence, the firm's income is overstated, leading to higher taxes paid.

• Question 1994:

  Which of the following is/are TRUE under GAAP?

  I. The change in the assets of a firm net of the change in liabilities represents a change in the total equity of the firm.

  II. If the assets of the firm increase by $100 and liabilities remain unchanged, the common stock equity increases by $100.

  III. A firm can increase its assets by borrowing money and keeping it as cash reserve.

  IV.

  A firm can increase its equity by borrowing money and keeping it as cash reserve.

  A.

  I and II

  B.

  I, II and III

  C.

  II only

  D.

  I and III

  Correct Answer: D

  Use the basic equation, Assets = Liabilities + Total Equity.

  II is false since you need "Total equity" comprises of common stock as well as other forms of equity like

  preferred issues. IV is false since the borrowing increases only the liabilities while the cash increases only

  the assets, leaving equity unchanged.

• Question 1995:

  Employers' income tax expense consists of the following obligations except:

  A. Federal Income Tax

  B. Social Security Tax

  C. State Unemployment Tax

  D. Medicare Tax

  Correct Answer: A

  Federal income tax is withheld from employee paychecks; it is not an expense to the company.

• Question 1996:

  If a firm recognizes expenses before that dictated by accrual accounting, which of the following best describes the effects on income, total assets and retained earnings?

  Income Total assets Retained earnings

  I. Understated Understated Understated

  II. Understated Overstated Understated

  III. Overstated Understated Overstated

  IV.

  Understated Overstated Overstated

  A.

  I.

  B.

  II.

  C.

  IV.

  D.

  III.

  Correct Answer: A

  Total assets Retained earnings Understated Understated Overstated Understated Understated Overstated Overstated Overstated

  If expenses are recognized before they should be, then income gets understated since you subtract more from the revenues than you should. Hence, retained earnings get understated, leading to an understatement of total equity. Since assets equal liabilities plus equity and liabilities have not been affected, the understatement of equity leads to an understatement of assets.

• Question 1997:

  In a period of rising prices, the inventory method that gives the lowest possible value for ending inventory is:

  A. weighted average

  B. LIFO

  C. FIFO

  D. gross profit

  Correct Answer: B

  The ending inventory under LIFO is priced at the earliest, and thus the lowest prices (in a period of rising prices) than any of the other methods.

• Question 1998:

  An EPS amount is always shown for:

  A. income before extraordinary items and the cumulative effect of accounting changes

  B. income from continuous operations

  C. cumulative effect of accounting changes

  D. all of these answers are correct

  Correct Answer: D

  All of the responses are true.

• Question 1999:

  The XYZ Company operates a catering service specializing in business luncheons for large businesses. XYZ requires customers to place their orders two weeks in advance of the scheduled events. XYZ bills its customers on the tenth day of the month following the date of service and requires that payment be made within 30 days of the billing date. Conceptually, XYZ should recognize revenue from its catering services at the date when a ________.

  A. billing is mailed

  B. customer's payment is received

  C. customer places an order

  D. luncheon is served

  E. none of these answers

  Correct Answer: D

  Revenues should be recognized when they are realized or realizable and earned. The most common time at which these two conditions are met is when the product or service is delivered.

• Question 2000:

  Calculate the book value per share of General Industries common stock, given the following information. Par value of common stock, $1 per share; total assets, $12,565,000; retained earnings, $5,550,000; total liabilities, $5,012,500; number of common shares outstanding, 475,000; number of preferred shares outstanding, 0. Market value of common stock, $96.25.

  A. $26.45

  B. $96.25

  C. None of these answers

  D. $15.90

  E. $10.55

  Correct Answer: D

  The book value of the firm's common stock is $15.90 which is calculated as follows: total assets of $12,565,000, minus total liabilities of $5,012,500, minus, preferred stock outstanding of $0, divided by the number of common shares outstanding of 475,000.