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

• Question 2111:

  Which of the following relationship is true about the liquidity ratios?

  A. Cash ratio > Quick ratio > Current ratio.

  B. Quick ratio > Cash ratio > Current ratio.

  C. Cash ratio < Quick ratio < Current ratio.

  D. Cash ratio < Current ratio < Quick ratio.

  Correct Answer: C

  The cash ratio is the most conservative of the 3 liquidity ratios since it considers only cash and marketable securities relative to the current liabilities. The quick ratio considers receivables in addition to cash and marketable securities. The current ratio takes all current assets into account.

• Question 2112:

  Which of the following is/are true about marketable securities?

  I. They are carried on the books at the market value.

  II. Transfers between different classifications are carried out at fair market value.

  III.

  Companies are not required to disclose the classification of the specific investment securities in the balance sheet.

  A.

  I and III

  B.

  I, II and III

  C.

  II and III

  D.

  II only

  Correct Answer: C

  Marketable securities are classified into various categories. Securities that are designated as "held-tomaturity" are reported at historical cost, not fair market value. Other categories prescribe a reporting at fair market value. Thus, (I) is not necessarily true. Despite this, when the classification of a security is changed, the assignation of the security to the new account is carried out at the fair market value on the transfer date, with any gain or loss reflected separately on the income statement (in the case of trading and held-to-maturity securities) or as a separate component of shareholder equity (in the case of available-forsale securities). Companies are not required to disclose securities classification on the balance sheet; disclosure can occur in the footnotes.

• Question 2113:

  Which of the following statements about directors of a company is true?

  A. Directors only get paid if the company increases its profitability that year.

  B. All directors of a company are senior managers in that company.

  C. Directors are shareholders' representatives.

  D. Directors are elected by management of a company.

  Correct Answer: C

  The stockholders elect the board of directors, which in turn decide on the major business policies of the corporation.

• Question 2114:

  According to the hierarchy of accounting qualities, which of the following is considered a pervasive constraint?

  A. Timeliness

  B. Benefits versus costs

  C. Verifiability

  D. Conservatism

  E. Relevance

  Correct Answer: B

  All accounting information is subject to two quantitative constraints: materiality and cost/benefit. The constraint of benefit/cost states that the benefits of information must exceed the cost of obtaining it.

• Question 2115:

  The following data are taken from the Ultimate Omega's financial statements ending Dec 31, 1985:

  Increase in inventories 220 Stock's repurchased 135 Provision for warranty expenses 15 Depreciation 90 Interest paid 35 Outstanding bonds retired 225 After-tax gain on bond retirement 25 Net Income 430 Tax rate 40%

  What was Ultimate Omega's operating cash flow in 1985?

  A. 240

  B. 225

  C. 305

  D. 290

  Correct Answer: D

  In this case, OCF = 430 - 220 + 15 + 90 - 25 = 290. Note a few important things: Warranty provision is a non-cash expense and must be added back to net income. Gain on bond retirement is an extraordinary item and is part of financing cash flow. Hence, it must be subtracted from net income to obtain income from continuing operations. Stock repurchase and bond retirement are financing cash flows. Note that tax rate is not relevant in the indirect method since it has already been factored in the net income figure.

• Question 2116:

  When reporting contingencies

  A. disclosure of a loss contingency is to be made if there is a remote possibility that the loss has been incurred.

  B. guarantees of others' indebtedness are reported as a loss contingency only if the loss is considered imminent or highly probable.

  C. disclosure of a loss contingency must include a dollar estimate of the loss.

  D. none of these answers.

  E. a loss that is probable but not estimable must be disclosed with a notation that the amount of the loss cannot be estimated.

  Correct Answer: E

  Contingent losses should be accrued if both probable and reasonably estimable. In this case, the contingent loss is not estimable and, therefore should only be disclosed in the notes since it is probable.

• Question 2117:

  Companies reporting consolidated cash flows using the direct method must report all of the following cash receipts except for:

  A. other operating cash receipts, if any.

  B. cash from customers, including lessees, licensees and similar.

  C. repayments of funds from foreign subsidiaries.

  D. interest and dividend payments received.

  Correct Answer: C

  Subsidiaries are part of the same company. Since the cash flows are consolidated there is no effect on the statement for repayments of funds from foreign subsidiaries.

• Question 2118:

  A firm currently has a negative working capital. Which of the following is true?

  A. The firm is close to bankruptcy.

  B. The firm's accounting profits are low.

  C. The firm's current ratio is less than 1.

  D. The firm has a high debt-to-asset ratio.

  Correct Answer: C

  Working capital = Current assets - Current liabilities. If working capital is negative, then current liabilities exceed current assets, implying a current ratio of less than 1.

• Question 2119:

  Oils Galore is a large firm that prefers to use the Successful Efforts method of accounting. A similar firm, Rival Oil and Gas, Inc., uses the Full Cost method. An inspection of their financial statements would reveal that:

  I. Oils Galore has a higher debt-to-asset ratio.

  II. Rival OandG has higher equity.

  III. Oils Galore is burdened with higher taxes.

  IV.

  Rival OandG shows higher cash flows.

  A.

  I and III

  B.

  II and IV

  C.

  III and IV

  D.

  I and II

  Correct Answer: D

  The Successful-efforts method requires expensing of all dry-hole costs while Full Cost method allows these to be capitalized. Therefore, Rival shows higher assets, higher income and hence, higher taxes. It also shows higher equity. Since Rival pays higher taxes, it has lower cash flows.

• Question 2120:

  A firm's tax rate is 30%. If the beginning inventory was overstated by 50, the purchases understated by 30 and the ending inventory overstated by 10, the income is ________.

  A. overstated by 12

  B. understated by 10

  C. overstated by 21

  D. understated by 7

  Correct Answer: D

  Ending inventory = beginning inventory + Purchases - COGS Hence, in this case, COGS is overstated by 50 + (-30) - 10 = 10. Therefore, income is understated by 10*(1-tax rate) = 7. It should be remembered that implicit in the use of the above inventory equation is the assumption that there have been no write-downs or write-ups in the inventory.