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

• Question 2161:

  The ROE equals:

  I. profit margin times equity turnover.

  II. profit margin times asset turnover times financial leverage.

  III.

  financial leverage times sales-to-debt ratio.

  A.

  none of these answers

  B.

  II and III

  C.

  I and II

  D.

  I, II and III

  Correct Answer: C

  ROE = Net income/Equity

  = (Net income/sales)*(sales/equity)

  = (profit margin)*(equity turnover).

  You can also express this as:

  ROE = Net income/Equity

  = (Net income/sales)*(sales/total assets)*(total assets/equity)

  = (profit margin)*(asset turnover)*(financial leverage)

  Exam J

• Question 2162:

  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, the number of shares used in Diluted EPS equals ________.

  A. 575,000

  B. 500,000

  C. 600,000

  D. 200,000

  Correct Answer: B

  With dilution, there are 300,000 additional shares from the convertible bonds. Preferred equity does not count. Therefore, the number of shares used in Diluted EPS equals 200,000 + 300,000 = 500,000.

• Question 2163:

  Ratios are best interpreted when compared to which of the following?

  A. Predetermined standards.

  B. The ratios of prior periods.

  C. All of these answers are correct.

  D. Ratios of competitors.

  Correct Answer: C

  Ratios are best interpreted when compared to, the ratios of prior periods, predetermined standards, and the ratios of competitors.

• Question 2164:

  Which of the following is used to calculate the actual adjustment for bad debt expense for the period?

  A. aging

  B. percent of accounts receivable

  C. percent of net sales

  D. all of these answers are correct

  Correct Answer: C

  The aging and percent of Accounts Receivable methods calculate what the balance of the allowance account should be, however, percent of net sales method calculates the actual expense for the period.

• Question 2165:

  The consistency principle

  A. requires that the company use a selected accounting method period after period

  B. all of these answers are correct

  C. is limited to inventory pricing methods

  D. requires that a company use one inventory method exclusively

  Correct Answer: A

  The consistency principle requires that an accounting procedure, once adopted by a company, remain in use from one period to the next unless users are informed of the change. It is not limited to inventory valuation methods.

• Question 2166:

  Deferred credits arise because of:

  A. an over-estimation of assets or earnings, which must now be reversed.

  B. none of these answers.

  C. the concept of accrual accounting.

  D. the use of cash accounting.

  Correct Answer: C

  Deferred credits can be liabilities incurred in the course of current business which are not yet recognized in the income statement or are unearned assets or revenues which have been recognized prematurely, as determined by the matching principle. Examples of these include deferred income taxes and unearned royalties received. In either case, accrual accounting dictates that such "mistakes" be corrected for through the use of deferred credits.

• Question 2167:

  Which of the following is/are true in an inflationary environment?

  I. For income statement purposes, LIFO is preferable to FIFO.

  II. For balance sheet purposes, LIFO is preferable to FIFO.

  III. The weighted average cost method provides a better balance sheet representation than LIFO.

  IV.

  The weighted average cost method provides a better income statement representation than FIFO.

  A.

  II, III and IV

  B.

  II and IV

  C.

  III only

  D.

  I, III and IV

  Correct Answer: D

  Remember that for income statement, it is desirable to have the COGS as close to true, current cost, as possible. For balance sheet, the assets must be as close to current, market value, as possible. Hence, for income statement, LIFO preferred to average cost preferred to FIFO. For balance sheet, FIFO preferred to average cost preferred to LIFO.

• Question 2168:

  Which of the following statements is true?

  A. Allocation of plant asset costs, through depreciation, if consistently applied, does not lend itself to serious distortion.

  B. None of these answers.

  C. All of these answers.

  D. Determination of the useful life of an asset, if consistently applied, does not lend itself to serious distortion.

  E. Historical cost valuation of plant assets, if consistently applied, does not lend itself to serious distortion.

  Correct Answer: E

  Determining the useful life of an asset is central to the allocation of its cost and its period-to-period valuation; the same is true with depreciation schedules that are selected. These pose problems in determining the fair value of plant and equipment.

• Question 2169:

  At December 31, 1995, Del Monte Co. had the following balances in the accounts it maintains at Royal Street Bank:

  Checking account #101 $175,000 Checking account #102 $(10,000) Money market account $25,000 90-day certificate of deposit due 2/28/96 $50,000 180-day certificate of deposit due 3/15/96 $80,000

  Del Monte classifies investments with original maturities of 3 months or less as cash equivalents. In its December 31, 1995 balance sheet, what amount should Del Monte report as cash and cash equivalents?

  A. $240,000

  B. $190,000

  C. $320,000

  D. $165,000

  E. $200,000

  Correct Answer: A

  Cash consists of coins, currency on hand, checking accounts (demand deposits), certificates of deposit (time deposits) and near-cash assets (money market accounts). Cash equivalents are limited to investments with original maturities to the holding entity of 3 months or less. As a result, cash and cash equivalents will be $240,000 ($175,000 - 10,000 + 25,000 + 50,000).

• Question 2170:

  Materiality is one of the pervasive concepts in financial accounting. Which of the following statements is true with regard to materiality?

  A. Relevant items are very material.

  B. Materiality judgments generally may be made without consideration of the magnitude of the item involved.

  C. None of these answers.

  D. The nature and magnitude of an item as well as the circumstances in which the judgment has to be made are integral aspects of a materiality judgment.

  E. Materiality judgments generally may be based solely on the magnitude of the item.

  Correct Answer: D

  The basis for a materiality judgment is generally not sufficient unless the nature of the item, the circumstances in which the judgment has to be made, and the magnitude of the item are all considered.