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

• Question 2051:

  Which of the following is/are true under accrual accounting?

  I. Expenses are recognized as services are used.

  II. Revenues are recognized when service is performed.

  III. Revenues are recognized in proportion to expenditures incurred.

  IV.

  Revenues are matched with the associated costs.

  A.

  I and III

  B.

  I, II, III and IV

  C.

  I, II and IV

  D.

  II, III and IV

  Correct Answer: C

  Accrual accounting follows the Matching Principle, which requires that revenues and gains be recognized when earned and expenses and losses be recognized when incurred. Under this, (I), (II) and (IV) are correct. However, (III) is not necessarily true.

• Question 2052:

  Over a given year, a firm's total assets increased by $8,000 and total liabilities decreased by $6,000. If the firm did not issue any new equity and paid out $1,800 in dividends, then its net income during the year was ________.

  A. $12,200

  B. $200

  C. $3,800

  D. $15,800

  Correct Answer: D

  Total assets - Total liabilities = Equity. Hence,

  Change in Assets - Change in Liabilities = Change in Equity.

  Thus, change in equity = 8,000-(-6,000) = $14,000 All of the net income not paid out as dividends goes into

  increasing the equity. Since no new shares were issued, Net Income = change in equity + dividends paid.

  This gives net income = $14,000 + $1,800 = $15,800.

• Question 2053:

  A liability can be recognized when A. when the amount is uncertain

  B. when the identity of the creditor is uncertain

  C. an obligation exists to make a future payment based on a past event

  D. all of these answers are correct

  Correct Answer: D

  The amount or the creditor need not be certain and some future payments such as wages to be paid in the future may not be reported as liabilities.

• Question 2054:

  Which of the following is/are not extraordinary items?

  I. Write-downs of inventory

  II. Expropriation by a foreign government

  III. Losses due to hurricanes

  IV.

  Gains from disposal of a business segment

  A.

  I and III

  B.

  I and IV

  C.

  II, III and IV

  D.

  I and II

  Correct Answer: B

  Gains from disposal of a business segment are part of "Discontinued Operations," not extraordinary items. They appear segregated from the income from continuing operations as well as extraordinary items and are reported net of tax effects. Inventory write-downs and other such asset revaluations are considered unusual but not extraordinary items. These appear as part of income from continuing operations.

• Question 2055:

  Which of the following could decrease outstanding capital stock?

  A. The exercise of warrants.

  B. All of these answers.

  C. The retention of earnings.

  D. The payment of a cash dividend.

  E. The purchase of treasury stock.

  Correct Answer: E

  Only the purchase of treasury stock would cause a firm's capital stock account to decrease because the firm acquires outstanding shares and immediately retires these shares.

• Question 2056:

  When prices are rising, which of the following inventory valuation methods produces a lower ending inventory value?

  A. LIFO

  B. Average cost

  C. None of these answers

  D. FIFO

  Correct Answer: A

  When prices are rising, LIFO will produce the lowest ending inventory value because the last in (highest cost) inventory is the first out. This leaves the oldest inventory on hand and since it was purchased at lower prices, it has the lowest cost and ending inventory will have the lowest value.

• Question 2057:

  Under the current US GAAP, the treatment of RandD expenses:

  I. underestimates current income and leads to lower taxes.

  II. leads to a more conservative balance sheet.

  III.

  is tantamount to asserting that RandD outlays have no current benefits.

  A.

  I only

  B.

  none of these are correct

  C.

  I, II and III

  D.

  I and II

  Correct Answer: C

  Difficulties in measuring the current value of assets being generated by RandD prevent a reliable application of the accrual principles, which require allocation of expenses in proportion to the current benefits generated. Hence, US GAAP takes the easiest solution of expensing all the RandD costs (unless they generate tangible or intangible assets which have alternative future uses which are measurable). Since RandD does generate future benefits on an expected basis, the full expensing of the costs when incurred tends to under-estimate current income and leads to lower taxes. Further, when the RandD activities do lead to profitable results, income gets overstated because of non-recognition of a portion of it in previous periods. Thus, RandD expensing adds volatility to income. On the other hand, expensing leads to a more conservative balance sheet since no assets or equity is recognized until the benefits actually materialize. Thus, by assuming that current RandD has no current benefits, the GAAP accounting tries to prevent "bad" surprises.

• Question 2058:

  Prepaid expenses are:

  A. classified as current liabilities on the balance sheet.

  B. advance payments for goods not yet received which extend beyond the current accounting period.

  C. not included in the calculation of a company's working capital.

  D. advance payments for work that the company has not yet performed. The work will be completed within the current accounting period.

  Correct Answer: B

  Prepaid expenses occur when you pay for a service before you actually receive the benefits of the service.

• Question 2059:

  A firm's accountant has mistakenly overstated depreciation by 50 and understated accounts receivables by

  35. The firm's tax rate is 40%. Then, which of the following is/are true?

  I. Income is understated by 30.

  II. Income is understated by 50.

  III. Operating cash flow is overstated by 55.

  IV.

  Operating cash flow is overstated by 85.

  A.

  I, II and III

  B.

  II, III and IV

  C.

  I and III

  D.

  II and IV

  Correct Answer: C

  If depreciation is overstated by 50, the income is actually understated by 50*(1-tax rate) = 30. The understatement of accounts receivables does not affect the income statement; it understates the reported current assets. It also affects the operating cash flow. Note that operating cash flow = net income + noncash expenses - non-cash revenues - cash reductions in operating accounts Since income is understated by 30, non-cash expense (depreciation) is overstated by 50 and noncash revenue (accounts receivable) is understated by 35, operating cash flow is overstated by -30 + 50 - (-35) = 55.

• Question 2060:

  A firm with a simple capital structure had a net income of 7,700 last year. It had 1,000 common shares outstanding and its reported EPS was 6.6. What was the firm's payment to its preferred stock holders?

  A. 1,300

  B. 900

  C. 1,100

  D. 1,200

  Correct Answer: C

  For a simple capital structure, EPS = (Net Income - Preferred stock dividends)/weighted # of common shares This gives 6.6 = (7700- Preferred stock dividends)/1000. Hence, payment to preferred equity holders = 1,100.