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

• Question 2151:

  Under an inflationary environment with stable inventories, a firm may change to FIFO from LIFO due to which of the following reason(s)?

  I. To allow earnings manipulation.

  II. To improve the reported working capital.

  III. To reduce tax drain on cash.

  IV.

  Show a more accurate representation of reported assets than LIFO.

  A.

  II and IV

  B.

  III only

  C.

  I and IV

  D.

  I and III

  Correct Answer: A

  Under FIFO, inventory is overstated and hence, working capital is overstated under normal, inflationary conditions. At the same time, COGS is lower than under LIFO due to rising prices, increasing the taxable income and leading to higher taxes. However, firms cannot manipulate earnings under FIFO by changing purchasing patterns at the end of an accounting period, as it is able to do under LIFO, because FIFO prices are determined by the earliest goods purchased in the inventory.

• Question 2152:

  In a common-size balance-sheet statement, a firm's current assets are reported at 37% and the long- term liabilities are at 12%. The equity is shown to be 64%. The firm's current ratio equals ________.

  A. 1.12

  B. 1.54

  C. 0.65

  D. 1.37

  Correct Answer: B

  In a common-size balance-sheet statement, all quantities are expressed as a fraction of the total assets. Therefore, since equity equals 64%, total liabilities equal 36%, of which 12% equals long-term liabilities. Thus, current liabilities equal 24%, giving the current ratio equal to 37%/24% = 1.54.

• Question 2153:

  Which of the following is NOT an objective of the conceptual framework devised by FASB?

  A. Establish a logical and coherent system of accounting thought.

  B. Establish objectives of financial reporting by businesses.

  C. Identify the characteristics of accounting information that make its disclosure useful.

  D. Enforce a single standard of accounting disclosures across the various industries.

  Correct Answer: D

  The conceptual framework devised by FASB is not concerned with enforcing any rigid standards of accounting disclosures. Rather, it is a system of laying out the goals and objectives of accounting disclosure and formulating standards which could best serve the needs of the industry. In such a framework, a fair amount of flexibility is built-in so that the differing characteristics of various industries can be accommodated. The various SFACs which comprise the conceptual framework are the foundation on which the detailed principles and pronouncements of the FASB are based.

• Question 2154:

  The accounting equation reads:

  A. Revenue minus expenses equals profit

  B. Assets equal Liabilities plus Stockholders' Equity

  C. Assets plus Liabilities is equal to Stockholders' Equity

  D. None of these answers is correct

  Correct Answer: B

  The accounting equation shows us that the Assets (Own) are equal to the Liabilities (obligations) plus the Stockholders' Equity.

• Question 2155:

  On January 1, 1992, Carter Inc. purchased equipment having an estimated salvage value equal to 20% of its original cost at the end of a 10 year life. The equipment was sold December 31, 1996 for 50% of itsoriginal cost. If the equipment's disposition resulted in a reported loss, which of the following depreciation methods did Carter use?

  A. Straight-line.

  B. Double-declining-balance.

  C. Composite.

  D. Sum-of-the-years'-digits

  E. Accelerated.

  Correct Answer: A

  The straight-line method yields the lowest amount of depreciation for the early part of the depreciable life of the asset. Because only 50% of the original cost was received and straight-line accumulated depreciation equaled 40% of cost ((100%-20%) / 10 years X 5 years( at time of sale, a 10% loss (50%-(100%-40%)) occurs.

• Question 2156:

  Quasar, Inc., currently shows assets worth 5,000 and a debt of 1,500. During the year, it capitalized interest expense worth 300, of which 60 was amortized. Quasar's tax rate is 50%. If it had expensed the interest paid, which of the following would be true?

  A. Its operating cash flow would be lower by 150.

  B. Its tax expense would be lower by 150.

  C. Its equity would be higher by 300.

  D. Its operating cash flow would be lower by 300.

  Correct Answer: A

  If Quasar had expensed the interest, its tax savings would have been 300*50% = 150. By capitalizing, it amortized 60, leading to a tax savings of 60*50%=30. Thus, if it had expensed the interest, the tax expense would have been lower by 150-30=120 (What would the effect on net income be? The net income would be lower by (300 - 60 - 120 = 120). When capitalizing, all the expense gets charged to investing cash flow while expensing charges the entire cash flow to operating cash flow. After tax, this results in an operating cash flow of -300*(1-0.5) = -150. Thus, expensing would have resulted in an operating cash flow lower by 150.

• Question 2157:

  Which of the following is an essential characteristic of a liability?

  A. The identity of the recipient entity must be known to the obligated entity before the time of settlement.

  B. Liabilities represent an obligation that has arisen as the result of a previous transaction.

  C. None of these answers.

  D. Liabilities must be legally enforceable.

  E. Liabilities must require the obligated enterprise to pay cash to a recipient entity.

  Correct Answer: B

  A liability has 3 essential characteristics:

  1.

  It represents an obligation that requires settlement by probable future transfer or use of assets.

  2.

  The firm has little or no discretion to avoid the obligation.

  3.

  The transaction or other event, giving rise to the obligation has already occurred.

• Question 2158:

  Employers' income tax expense consists of the following obligations except:

  A. Medicare tax

  B. Social Security tax

  C. Federal income tax

  D. State unemployment tax

  Correct Answer: C

  Federal income tax is withheld from employee paychecks; it is not an expense to the company.

• Question 2159:

  A firm has purchased heavy machinery with a useful life of 7 years. It cost $28,000 and its salvage value is estimated at $4,000. If the firm uses double declining method, what's the depreciation expense recognized in Year 1?

  A. $3,429

  B. $8,000

  C. $6,857

  D. $4,000

  Correct Answer: B

  In Double Declining method, depreciation = (2/n)*book value = (2/7)*28,000.

• Question 2160:

  GAAP requires that:

  A. cash flows from interest related inflows and outflows on debt be considered investing cash flows.

  B. cash flows from dividend receipts be considered investing cash flows.

  C. all of these answers.

  D. none of these answers.

  Correct Answer: D

  It is very important to remember the following points about dividends and interests:

  1.

  Dividends received from stock investments are considered operating cash flows.

  2.

  Dividends paid on equity are considered financing cash flows.

  3.

  Interest payments on debt are considered operating cash flows.

  4.

  Interest received from debt investments are considered operating cash flows.