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

• Question 2251:

  Dilutive warrants are ________ included in the calculation of Diluted EPS.

  A. never

  B. often

  C. always D. sometimes

  Correct Answer: C

  Diluted EPS reflects all securities that are potential shares and which decrease earnings per share. Also remember that all anti-dilutive securities are ignored. A dilutive security, by definition, is one that decreases EPS. Therefore, dilutive warrants are always included in the calculation of Diluted EPS.

• Question 2252:

  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 Basic EPS equals ________.

  A. 8.5

  B. none of these answers

  C. 6.62

  D. 10.4

  Correct Answer: C

  The preferred dividends = 100,000*5%*100*9/12 = 375,000 (they were outstanding for 9 months). Therefore, Basic EPS = (Net Income - Preferred dividends)/weighted # of common shares = (1,700,000 375,000)/200,000 = 6.62

• Question 2253:

  The following is a sign that a company is a "growth company":

  A. It has no earnings and does not pay a dividend.

  B. It has very strong negative cash flows and borrows heavily to make up for the negative cash flows.

  C. It has earnings but does not pay dividends and its employees are not overly compensated.

  D. It has earnings and pays out large dividends.

  Correct Answer: C

  Companies characterized as "growth companies" are those that do make money, but they keep the money within the company so as to grow the company. Companies that pay dividends are not maximizing the funds available to fund future growth. Companies that limit earnings by paying employees exorbitant salaries are not growth companies. Companies like this are giving funds to employees rather than holding them within the corporation to fund future growth.

• Question 2254:

  A credit entry to Allowance for Uncollectible Accounts A. increases the balance

  B. neither of these answers is correct

  C. both of these answers are correct

  D. increases net receivables

  Correct Answer: A

  Allowance for Uncollectible Accounts, sometimes referred to as Bed Debt Reserve, is a contra account to Accounts Receivable. A credit entry increases its balance and the balance reduces the amount of net Accounts Receivable.

• Question 2255:

  Simon Steel Inc. had the following unusual financial events occur this year: Bonds payable were retired 5 years before their scheduled maturity, resulting in a $260,000 gain, Simon has frequently retired bonds early when interest rates declined significantly. A steel forming segment suffered $255,000 in losses from hurricane damage. This was the fourth similar loss sustained in a 5-year period at that location. A segment of Simon's operations, steel transportation, was sold at a net loss of $350,000. This was Simon's first divestiture of one of its operating segments. Before income taxes, what amount should be disclosed as the gain (loss) from extraordinary times for this year?

  A. $260,000

  B. $(345,000)

  C. $5,000

  D. $(90,000)

  E. $(350,000)

  Correct Answer: A

  Accounting rules require that any gain or loss from early retirement of debt must be recognized as an extraordinary item. For all other transactions to be classified as extraordinary items, they must be both unusual and infrequent. In this case, none of the other gains or losses qualify.

• Question 2256:

  Redeemable preferred stock

  A. is reported in stockholders' equity of the balance sheet.

  B. is reported after liabilities but before the equity section of the balance sheet.

  C. must be computed at its market value on the balance sheet.

  D. has higher priority for liquidation and dividends than preferred stock.

  E. is required to be listed only as a footnote in the balance sheet.

  Correct Answer: B

  The liquidation preference or redemption price should be used in the computation of book value per share, leverage, and capital ratios.

• Question 2257:

  A firm has convertible bonds, preferred equity, common equity and straight bonds in its capital structure. In calculating Diluted EPS, which of the following is true about the earnings number used, assuming the convertible bonds are dilutive?

  A. Earnings used = Net income - preferred dividends + interest payments on convertible

  B. Earnings used = Net income - preferred dividends - interest payments on convertible net of taxes.

  C. Earnings used = Net income - preferred dividends - interest payments on convertible before taxes.

  D. Earnings used = Net income - preferred dividends + interest payments on convertible net of taxes.

  Correct Answer: D

  Think of the earnings used in EPS calculations as the earnings that are available for distribution amongst common shareholders. Under Diluted EPS, convertible bonds are assumed converted if dilutive. Hence, for Diluted EPS purposes, convertible bond holders are assumed to be a part of the residual claimants of the earnings available after the liabilities to debt holders and preferred equity holders are satisfied. The earnings available for distribution amongst these security holders then equal Net income - preferred dividends + interest payments on convertible net of taxes.

• Question 2258:

  Which of the following is/are advantages of accelerated methods of depreciation?

  I. They implicitly recognize the loss of productivity and increased maintenance costs over time.

  II. They allow deferral of taxes compared to the straight-line method, thus making more cash available for current operations.

  III.

  The lower depreciation charges in later years compensate for the greater uncertainty in future revenues.

  A.

  I and III

  B.

  II only

  C.

  I, II and III

  D.

  I and II

  Correct Answer: C

  All three responses are correct as advantages of accelerated methods of depreciation.

• Question 2259:

  The following data have been extracted from the financial statements of a firm for two years, 1993 and 1994:

  1993 1994 Assets 10,895 12,444 Sales 8,465 9,275 Inventory 3,126 3,549 COGS 7,120 7,387 Receivables 2,154 1,768

  The receivables turnover ratio and the average receivables collection period for 1994 equal ________.

  A. 4.31, 84.77 days

  B. 5.25, 69.58 days

  C. none of these answers

  D. 4.73, 77.17 days

  Correct Answer: D

  Receivables turnover ratio = Net annual sales/average receivables Average receivables collection period = 365/receivables turnover. Typically, average receivables for a given year are taken to be the average of the ending values of the receivables for this year and the last year. For 1994, the average receivables equal (2154+1768)/2 = 1,961. Receivables turnover ratio = 9,275/1,961 = 4.73. Average receivables collection period = 365/4.73 = 77.17 days.

• Question 2260:

  Which of the following statements about the Securities and Exchange Commission (SEC) is true?

  A. The SEC must audit all financial statements of publicly traded corporations.

  B. The SEC has issued specific rules and regulations concerning the preparation of financial statements and the degree of detail that they contain.

  C. None of these statements are true.

  D. The SEC functions as the standard-setting body of the accounting profession.

  Correct Answer: B

  The Securities and Exchange Commission has issued specific rules and regulations concerning the preparation of financial statements and the degree of detail that they contain.