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

• Question 2021:

  The retail industry has __________ asset turnover ratio compared to that of a capital intensive industry like the auto industry.

  A. a higher

  B. about the same

  C. a higher and lower are both possible

  D. a lower

  Correct Answer: A

  Total asset turnover = net sales/average total assets Since the auto industry is highly capital intensive compared to the retail industry, it require far more capital assets to generate the same revenues as the retail industry.

• Question 2022:

  According to FASB, initial franchise fees should be recognized as income when

  A. the franchisee shows the ability to pay the fee.

  B. the franchisor has substantially performed or satisfied all material services and conditions.

  C. the franchisor has collected the majority of fee in cash.

  D. the franchisor bills the franchisee.

  Correct Answer: B

  Accounting and reporting standards for franchisors require that revenue be recognized when the franchisor has substantially performed or satisfied all material services and conditions.

• Question 2023:

  Which of the following is a long-term liability?

  A. Cost of goods sold

  B. Bonds

  C. Commercial paper

  D. Accounts payable

  E. None of these answers

  Correct Answer: B

  Only bonds would be a long-term liability. Long-term liabilities are repaid over a time frame of greater than one year. Bonds are repaid over many years, whereas accounts payable and commercial paper are current liabilities (repaid over less than one year); cost of goods sold is an expense not a liability.

• Question 2024:

  The construction of cash flow statement using the indirect method requires which of the following?

  I. Income Statement.

  II. Balance Sheet.

  III. Statement of Retained Earnings.

  IV.

  Statement of Shareholders' Equity.

  A.

  I and II

  B.

  I, II and III

  C.

  I, II and IV

  D.

  I and III

  Correct Answer: A

  In the indirect method of construction of the cash flow statement, you start with the net income and start adding back non-cash expenses, adjusting for tax effects. In addition, one needs to look at changes in assets and liabilities accounts to back out investing and financing cash flows. Thus, you need both income statement and the balance sheet for the indirect method of cash flow construction.

• Question 2025:

  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 total capital equals ________.

  A. 11.3%

  B. 3.9%

  C. 5.4%

  D. 6.2%

  Correct Answer: C

  Return on total capital = (Net income + interest expense)/average total capital. The average total capital includes debt, common equity and preferred stock. Note that since Total assets = Total liabilities + Total Equity, the denominator is also equal to total assets. 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 total capital = (2,459 + 573)/(37,432 + 18,583) = 5.41%.

• Question 2026:

  The deferred income tax account

  A. none of these answers

  B. is always reported as a long-term liability since the tax is not due until the next fiscal year

  C. is reported as an other asset even though it has a credit balance

  D. is where the difference between income tax expense and income tax payable is reconciled

  Correct Answer: D

  The difference between income tax expense (based on accounting income) and the actual income taxes payable (based on taxable income) is reconciled in an account called deferred income taxes.

• Question 2027:

  The correction of an error in the financial statements of a prior-period should be reported, net of applicable income taxes, in the current

  A. none of these answers.

  B. income statement after income from continuing operations and after extraordinary items.

  C. income statement after income from continuing operations and before extraordinary items.

  D. retained earnings statement after net income but before dividends.

  E. retained earnings statement as an adjustment of the opening balance.

  Correct Answer: E

  Accounting rules require that prior-period adjustments due to a correction of an error cannot be reported on the current year income statement because they do not affect this year's operations. They are shown as an adjustment to the opening balance of retained earnings.

• Question 2028:

  A firm has 400 preferred stocks outstanding. It started the year with 900 common stocks and over the year,

  had the following transactions:

  Feb 15 Issued 300 common shares.

  May 1 Redeemed 100 preferred shares.

  Aug 15 Repurchased 150 common shares.

  Nov. 30 Issued 400 common shares.

  In the calculation of EPS, the number in the denominator would be closest to:

  A. 1440

  B. 1140

  C. 1220

  D. 1540

  Correct Answer: B

  The number of preferred stocks is not relevant in the calculation of the denominator of simple EPS. It had 900-150 = 750 shares for 12 months, 150 shares for 7.5 months (repurchased in Aug), 300 shares for 10.5 months (issued in Feb) and 400 shares for 1 month (issued in Nov). Hence, weighted # of shares = 750 + (7.5/12*150) + (10.5/12*300) + (1/12*400) = 1,139.6

• Question 2029:

  What should an analyst look for when evaluating a firm's cash and cash equivalent position that would cause the firm's cash position to be less liquid?

  A. The amount of stock dividends required during the coming year.

  B. None of these answers.

  C. All of these answers.

  D. Potential limitations on the use of cash such as restricted balances.

  E. The amount of deposit collection float.

  Correct Answer: D

  Companies may have restrictions place upon the disposition of the cash position. For example, a firm may maintain cash equivalents that are earmarked for plant expansion, sinking fund payments, or legally restricted compensation balance requirements. A careful review of the firm's operations must be undertaken to uncover any cash or cash equivalents that are restricted from use in the general operation of the business.

• Question 2030:

  Which of the following would affect both net income and cash flow from operations?

  A. credit sale to a customer

  B. sale of marketable security for a gain

  C. interest payment on capitalized interest

  D. none of these answers

  Correct Answer: D

  The sale of a marketable security falls under an investing activity. Interest payments fall under financing activities. Credit sale to a customer doesn't apply.