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

• Question 2071:

  If a company changes the useful life of its assets from 10 years to 12 years, this will be recorded as ________.

  A. a non recurring gain

  B. a change in accounting principle

  C. an extraordinary item

  D. none of these answers

  Correct Answer: D

  The depreciation schedule for each asset affected is simply recalculated for the remainder of the life.

• Question 2072:

  When preparing a direct method statement of cash flows, the net cash flow must equal

  A. the cash collections minus the cash expenses.

  B. the cash collections plus the net noncash revenues and expenses.

  C. the cash flow from operations plus the cash flow from investments.

  D. the change in cash.

  E. the cash collections plus the changes in the operating accounts.

  Correct Answer: D

  Using the direct method, the net cash flow must equal the change in cash.

• Question 2073:

  Excerpts from the balance sheet of Milton Corporation as of April 30, 1997 are presented as follows:

  Cash $725,000 Accounts receivable (net) $1,640,000 Inventories $2,945,000 Total current assets $5,310,000 Accounts payable $1,236,000 Accrued liabilities $831,000 Total current liabilities $2,067,000

  Cash $725,000 Accounts receivable (net) $1,640,000 Inventories $2,945,000 Total current assets $5,310,000 Accounts payable $1,236,000 Accrued liabilities $831,000 Total current liabilities $2,067,000

  The board of directors of Milton met on May 5, 1997 and declared a quarterly cash dividend in the amount of $200,000 ($0.50 per share). The dividend was paid on May 28, 1997 to shareholders of record as of May 15, 1997. Assume that the only transactions that affected Milton during May 1997 were the dividend transactions. If the dividend declared by Milton had been a 10% stock dividend instead of a cash dividend, Milton's current liabilities would have been

  A. unchanged by either the dividend declaration or the dividend distribution.

  B. unchanged by the dividend declaration and decreased by the dividend distribution.

  C. decreased by the dividend declaration and increased by the dividend distribution.

  D. increased by the dividend declaration and decreased by the dividend distribution.

  E. increased by the dividend declaration and unchanged by the dividend distribution.

  Correct Answer: A

  The declaration and distribution of a stock dividend involves transferring an amount from retained earnings to common stock. However, there is no impact on current liabilities as there is no future obligation created to distribute cash.

• Question 2074:

  If an overstatement of depreciation by 100 and an understatement of accounts receivables by 40 causes a firm's net income to be understated by 70, the firm's tax rate is ________.

  A. 35%

  B. 50%

  C. 40%

  D. 30%

  Correct Answer: D

  An overstatement of depreciation by 100 causes the income to be understated by 100*(1-tax rate). Hence, tax rate = 30%.

• Question 2075:

  When prices are falling, which of the following is/are true?

  I. FIFO results in higher current assets.

  II. LIFO results in higher taxes.

  III. LIFO results in higher income.

  IV.

  FIFO allows earnings manipulation through purchasing behavior.

  A.

  II and III

  B.

  II, III and IV

  C.

  I and IV

  D.

  II only

  Correct Answer: A

  When prices are falling, the units purchased later have a lower purchase price. Therefore, under the FIFO cost-flow assumption, the higher cost goods will be assumed to have been sold first. This will raise COGS, lower the ending inventory value (and therefore lower current assets), lead to lower income and hence lower income taxes compared to LIFO. However, earnings manipulation is not possible under FIFO.

• Question 2076:

  The following is true about liquidating dividends:

  A. all of these answers

  B. these dividends return part of the original investment to the stockholders

  C. the cash dividend account is closed to retained earnings

  D. they only occur when the company is making a major acquisition

  Correct Answer: B

  The cash dividend account is not affected, and they would not likely occur when making an acquisition.

• Question 2077:

  The best indication of a firm's present and continuing ability to generate favorable cash flows is information about enterprise earnings based on which of the following basis?

  A. Tax accounting.

  B. Cash accounting.

  C. Modified cash accounting.

  D. Accrual accounting.

  E. Modified accrual accounting.

  Correct Answer: D

  Information about an enterprise's earnings based on accrual accounting generally provides a better indication of the firm's present and continuing ability to generate favorable cash flows than would information limited to the financial effects of cash receipts and payments.

• Question 2078:

  Under GAAP, when interest rates rise, the carrying value of a long-term bond ________.

  A. remains unchanged

  B. increases

  C. depends on the characteristics of the bond

  D. decreases

  Correct Answer: A

  Long-term debt is recorded at acquisition cost and historical cost accounting does not allow revaluation. Hence, even though the market value of the debt changes due to a change in interest rates, the book value of the debt changes only at the regular amortization schedule, independent of the market changes.

• Question 2079:

  The basic asset-liability equation, assets = liabilities + shareholder equity implies:

  A. operating activities = financing activities

  B. investing activities = financing activities

  C. investing activities = operating activities

  D. none of these answers

  Correct Answer: B

  The asset-liability equation has the results of investing activities on the left-hand side as assets. On the right hand side are results of creditor financing (debt) and equity financing.

• Question 2080:

  Firms X and Y, similar in all respects, recently bought identical securities. However, X has classified the securities as "held-to-maturity" securities while Y has categorized them as "available-for-sale" securities. Which of the following statements is/are true as a result of this difference?

  I. X and Y will show same assets on their balance sheets over time.

  II. X will have a higher income volatility than Y.

  III.

  X and Y will show different total equity values.

  A.

  I and II

  B.

  I and III

  C.

  I, II and III

  D.

  III only

  Correct Answer: D

  "Available-for-sale" securities are reported at their fair market value on the balance sheet while "held- to-maturity" securities are carried at amortized historical cost. Therefore, the reported assets for X and Y will be different over time. Hence, they will also show different equities because liabilities for the two firms are the same. However, changes in the market value of available-for-sale securities are charged directly to the retained earnings account, without going through the income statement. On the other hand, changes in the market value of "held-to-maturity" securities are not even recognized on financial statements due to historical cost accounting. For both the classifications, interest and dividend payments are attributed to the income. So the income volatility is not affected due to the classification.