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

• Question 2101:

  Revenues of an entity are usually measured by the exchange values of the assets or liabilities involved. Recognition of revenue does not occur until

  A. the entity has substantially accomplished what it is agreed to do.

  B. the revenue is realizable.

  C. none of these answers.

  D. products or services are exchanged for cash or claims to cash.

  E. the revenue is realized and earned.

  Correct Answer: E

  Revenues are only recognized when they have been earned. Simply exchanging assets or liabilities does not result in revenue recognition.

• Question 2102:

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

  I. Revenues are recognized when goods are delivered.

  II. Revenues are recognized when cash is received.

  III. Matching principle accounting is followed under accrual accounting.

  IV.

  Cash outflows determine expense recognition.

  A.

  I, III and IV

  B.

  III only

  C.

  I and III

  D.

  I 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. 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 2103:

  On June 30, 1996, Union Inc. purchased goodwill for $125,000 when it acquired the net assets of Apex Corp. During 1996, Union incurred additional costs of developing goodwill by training Apex employees ($50,000) and hiring additional Apex employees ($25,000). Before amortization of goodwill, Union's December 31, 1996 balance sheet should report goodwill of ________.

  A. $150,000

  B. $200,000

  C. $75,000

  D. $175,000

  E. $125,000

  Correct Answer: E

  Goodwill is recorded only when it is purchased. In this case, only $125,000 was purchased goodwill. The costs incurred to maintain, develop, or restore goodwill must be expensed. In this case, $75,000 will be expensed.

• Question 2104:

  While comparing a firm that expenses costs with one that capitalizes them:

  I. The capitalizing firm always shows higher cash flow from operations.

  II. The cumulative difference between the cash flow from operations increases over time.

  III. The capitalizing firm pays lower taxes in the first year.

  IV.

  The capitalizing firm recognizes higher deferred tax liabilities.

  A.

  II and III

  B.

  I, II and IV

  C.

  II, III and IV

  D.

  I and IV

  Correct Answer: B

  Expensing charges the entire cost to CFO while capitalization leads to a charge against the investing cash flow. Over time, depreciation reduces the tax payments. Hence, the cumulative difference in the CFOs increases over time. The expensing firm reports lower income in the first year and hence, pays lower taxes.

• Question 2105:

  The accumulated depreciation account should show:

  A. total depreciation for fixed assets since the business was formed

  B. only the depreciation expense recognized during the current year

  C. total depreciation for fixed assets still in use

  D. current depreciation expense plus estimated depreciation for next year

  Correct Answer: C

  Depreciation recognized and accumulated on fixed assets still on the books is reflected in the Accumulated Depreciation account(s).

• Question 2106:

  The following data pertain to Cosmotron Company's financial state as of Dec 31, 1994:

  Net Income $400 Increase in inventory $120 Decrease in accounts receivable $45 Increase in payables $165 Depreciatio n$100 Dividends paid$85 Tax rate 30%

  What was Cosmotron's operating cash flow in 1994?

  A. $590

  B. $490

  C. $675

  D. $505

  Correct Answer: A

  In this case, OCF = 400 - 120 + 45 + 165 + 100 = $590. Dividends paid are investing cash flows and not part 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.

• Question 2107:

  Which of the following is NOT a financing cash flow?

  A. Both "cash used for share repurchase" and "cash received from issuing bonds."

  B. Cash used for share repurchase.

  C. Cash received from issuing bonds.

  D. Cash acquired from the sale of a liquid asset.

  Correct Answer: D

  You should read the question carefully. It asks for the cash flow that is not a financing cash flow. Cash used for share repurchase and cash received from debt issue are both financing cash flows while cash received from asset sales is an investing cash flow.

• Question 2108:

  Which of the following is/are true about an auditor's opinion?

  I. If an auditor finds that the firm's financial statements fairly represent the company's financial performance and position, he will issue an unqualified opinion.

  II. If an auditor finds that some parts of the firm's financial statements are questionable or do not have sufficient verifiable corroboration, he will issue a qualified opinion.

  III.

  If an auditor finds that the audit is insufficient in scope to render an opinion, he will not issue an opinion.

  A.

  I only

  B.

  I and III

  C.

  I and II

  D.

  III only

  Correct Answer: C

  If an auditor finds that the audit is insufficient in scope to render an opinion, he will issue a Disclaimer of opinion.

• Question 2109:

  In periods of rising prices, which inventory costing method results in the highest net income?

  A. FIFO

  B. Average cost

  C. Perpetual

  D. LIFO

  Correct Answer: A

  FIFO assigns the lowest dollar value amounts to COGS when purchase prices are rising, thus resulting in higher net income.

• Question 2110:

  Which of the following is/are true about expenses?

  I. RandD expenses must always be capitalized.

  II. Software expenses may sometimes be capitalized.

  III.

  In extractive industries like oil and gas, companies have a choice of either expensing or capitalizing extractive costs.

  A.

  I, II and III

  B.

  II and III

  C.

  III only

  D.

  I only

  Correct Answer: B

  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 and dictates that all RandD costs must be expensed immediately (unless they generate tangible or intangible assets which have alternative future uses which are measurable). On the other hand, software development costs which are similar to RandD costs are capitalized after feasibility of the product is determined. In extractive industries, firms are allowed to use either the full-cost method, in which all search and development costs can be capitalized, or the successful-efforts method, where all such costs are expensed unless they result in revenue-generating assets, in which case, they are capitalized.