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

• Question 2081:

  The "Treasury Stock" method of calculating EPS involves:

  A. considering call option exercise when the average stock price is below strike price.

  B. considering call option exercise when the average stock price is above the strike price.

  C. using options as stock equivalents only if they are anti-dilutive.

  D. considering repurchase of shares at the highest market price.

  Correct Answer: B

  In the Treasury stock method, it is assumed that the proceeds from the exercise of warrants and employee call options are used to repurchase shares at the average market price during the period. Considering call option exercise when the average stock price is below strike price is incorrect since it is an irrational strategy and leads to anti-dilution of EPS.

• Question 2082:

  Stockholders' equity may contain all of the following components, except:

  A. Minimum pension liability

  B. Minority interests in consolidated subsidiaries

  C. Employee Stock Option Plan accruals

  D. Treasury stock

  E. Reinvested earnings

  Correct Answer: B

  Classified as a liability, minority interests in consolidated subsidiaries represent the equity held by investors other than the subject firm in those subsidiaries.

• Question 2083:

  Under accrual accounting, which of the following is/are correct?

  I. Revenues are recognized when cash is received.

  II. Expenses do not always involve cash flows.

  III. Revenues and the related costs are matched in the same period.

  IV.

  The reported income is a good indicator of the firm's current performance.

  A.

  II, III and IV

  B.

  I and III

  C.

  I, II, III and IV

  D.

  I and II

  Correct Answer: A

  Accrual accounting requires that revenues and gains be recognized when earned and expenses and losses be recognized when incurred. Hence, revenue recognition is completely separate from cash flows. In the sales process, the earnings process is completed when goods are delivered and that's when revenue is recognized under accrual accounting.

• Question 2084:

  Which of the following are changes in accounting principle?

  I. a change from LIFO to FIFO

  II. a change in estimated salvage value of depreciable asset

  III. a change from an accelerated depreciation method to straight line depreciation

  IV.

  recording depreciation for first time on machinery purchased five years ago

  A.

  I, II, III and IV

  B.

  I, II and III

  C.

  I, III and IV

  D.

  I and III

  Correct Answer: D

  Both I and III involve changes in the method of accounting.

• Question 2085:

  New Gestalt, Inc., a software firm had a net income of 1.7 million last year. It has 200,000 common shares and 300,000 convertible bonds with face value of 100 outstanding. The convertible bonds carry a coupon of 4% and can be converted one-for-one. The average stock price last year was 39 and the maximum price was 57. The effective interest rate on the convertible debt is 8%. New Gestalt issued 100,000 preferred shares with face value 100 and a coupon of 5% on March 31st of last year. Assume the convertible bonds are dilutive and that New Gestalt faces a 30% tax rate. Given the above, New Gestalt's Diluted EPS equals ________.

  A. 7.45

  B. 2.65

  C. 6.01

  D. 7.51

  Correct Answer: C

  Diluted EPS = (Net Income - Preferred dividends + interest on convertibles net of taxes)/(weighted # of common shares assuming convertible conversion) In this case, numerator = 1.7 million - 375,000 + 300,000*8%*100*(1-30%) = 3,005,000. The denominator equals 200,000 + 300,000 = 500,000. Therefore, Diluted EPS = 6.01. Note that the interest expense on the convertible bond is calculated using the effective interest rate, not the coupon rate.

• Question 2086:

  The following data are taken from the AlphaBeta Company's financial statements ending Dec 31, 1990:

  Increase in salaries payable 120 Decrease in accounts payable 45 Provision for bad debt 15 Depreciation 90 Interest paid 35 Proceeds from new bonds issued 225 Net Income 350 Tax rate 35%

  What was AlphaBeta's operating cash flow in 1990?

  A. 450

  B. 405

  C. 720

  D. 530

  Correct Answer: D

  In this case, OCF = 350 + 120 - 45 + 15 + 90 = 530. Proceeds from bond issue are part of financing cash

  flow, not of OCF. Note that tax rate is not relevant in the indirect method since it has already been factored

  into in the net income figure.

  Also, only non-cash items need to be adjusted.

• Question 2087:

  Sparten, Inc., a plumbing contractor, received a check for $3,000 on June 29 for services to be performed in the following fiscal month. During the July accounting period, Sparten completed all but $500 of the job. What adjusting entry needs to be made at the end of July?

  A. increase Unearned revenue and decrease cash for $500

  B. debit Unearned Revenue and credit Revenue for $2,500

  C. increase cash and revenue for $3,000

  D. decrease accounts receivable and increase revenue for $2,500

  Correct Answer: B

  When the check for was received on June 30, a liability was established for $3,000 because revenue could not be recognized until it was earned. During July, $2,500 of revenue was earned and should be recognized, along with a reduction (debit) to the Unearned Revenue account.

• Question 2088:

  A firm has entered into a long-term purchase obligation. This will allow the firm to obtain raw materials for operations at a known price over the next 6 years. This obligation must be reflected on the balance sheet as:

  A. a current liability until the first purchase occurs.

  B. a footnote disclosure.

  C. none of these answers.

  D. a long-term liability.

  Correct Answer: B

  It is important to recognize that liabilities arise and are recognized on the balance-sheet only if the firm has consumed at least a part of the services or goods under the contract. Until then, a liability is not admitted since there is no corresponding asset or equity that has been generated (a similar principle holds for the recognition of assets). However, due to the bonding nature of the contract, it must be disclosed in footnotes along with the relevant details so that analysts can figure in the impact of all such agreements while evaluating the future health of the firm.

• Question 2089:

  The two primary qualities of accounting information to make it useful for decision-making are ________.

  A. materiality and comparability

  B. full disclosure and relevance

  C. reliability and comparability

  D. relevance and reliability

  Correct Answer: D

  The financial information used to make decisions should be both reliable and relevant.

• Question 2090:

  The following data have been extracted from the financial statements of a firm for two years, 1991 and 1992:

  1991 1992 Assets 9,947 9,682 Sales 11,035 10,377 Current liabilities 4,193 3,920 Non-current liabilities 3,827 3,476

  The asset turnover and the equity turnover for 1992 equal ________.

  A. 0.98, 2.56

  B. 1.06, 4.93

  C. 2.11, 3.92

  D. 1.34, 6.38

  Correct Answer: B

  Total asset turnover = net sales/average total assets

  Total equity turnover = net sales/average equity

  The total liabilities in 1991 = 4,193 + 3,827 = 8,020 and total liabilities in 1992 = 3,920 + 3,476 = 7,396.

  Therefore, using the equation, Total Assets = Total Liabilities + Total Equity,

  the equity in 1991 was 9,947 - 8020 = 1,927 and in 1992, it was 9,682 - 7,396 = 2,286. Thus, the average

  equity for 1992 equals (1,927 + 2,286)/2 = 2,107 and average assets for 1992 equal (9,682 + 9,947)/2 =

  9,815. Therefore, asset turnover for 1992 = 10,377/9,815 = 1.06 and equity turnover = 10,377/2,107 =

  4.93.