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

• Question 2271:

  In a period of falling prices, the inventory method that gives the lowest possible value for ending inventory is:

  A. gross profit

  B. FIFO

  C. LIFO

  D. weighted average

  Correct Answer: B

  The first-in-first-out (FIFO) method is based on the assumption that the costs of the first items acquired should be assigned to the first items sold, therefore ending inventory on hand is based on the most recent prices.

• Question 2272:

  A firm has preferred equity outstanding but has not declared payment of dividend on it. If the firm's net income is 1000 and there are 100 common shares outstanding, the firm's Basic EPS is ________.

  A. equal to 10

  B. insufficient information

  C. less than 10

  D. more than 10

  Correct Answer: C

  Even when preferred dividends have not been declared, they must be subtracted from net income while calculating Basic EPS since no dividends can be paid on common share unless the preferred dividends are paid. Basic EPS includes only the amount that is available for distribution on common shares.

• Question 2273:

  The primary purpose of the statement of cash flows is to

  A. provide information about a company's cash receipts and cash payments during the accounting period

  B. measure the change in the company's assets

  C. state the company's financial position at period-end

  D. analyze net income during the accounting period

  Correct Answer: A

  Other financial statements are used to analyze revenues, expenses, assets, liabilities, and stockholders' equity. The statement of cash flows summarizes transactions affecting cash; it is the balance sheet that states the company's financial position at a point in time.

• Question 2274:

  The main purpose of the statement of financial position is to reflect

  A. the market value of the firm's assets at some point in time.

  B. the status of the firm's assets in case of forced liquidation of the firm.

  C. items of value, debts and net worth.

  D. none of these answers.

  E. the firm's potential for growth in stock values in the stock market.

  Correct Answer: C

  The Statement of Financial position or balance sheet presents 3 major elements: assets (items of value), liabilities (debts)), and shareholders' equity (net worth).

• Question 2275:

  In a period of falling prices, the inventory method that gives the lowest possible value for ending inventory is

  A. FIFO

  B. LIFO

  C. gross profit

  D. weighted average

  Correct Answer: A

  The first-in-first-out (FIFO) method is based on the assumption that the costs of the first items acquired should be assigned to the first items sold, therefore ending inventory on hand is based on the most recent prices.

• Question 2276:

  Which of the following is/are FALSE?

  I. Depreciation does not affect cash flows since it is a non-cash expense.

  II. Depreciation does not affect the cash flow statement since it is an allocation of past investing expense.

  III.

  Under US GAAP, companies can use different methods of depreciation for financial reporting and tax purposes.

  A.

  III only

  B.

  I and II

  C.

  II and III

  D.

  I, II and III

  Correct Answer: B

  Depreciation does affect cash flows since it reduces the amount of income tax paid. Further, US firms have the latitude of choosing an accelerated method of depreciation for tax purposes and a different method (like straight-line method) for financial reporting. This flexibility has an important effect on the reported balance sheet, which has to recognize an explicit liability in the form of deferred taxes payable.

• Question 2277:

  The section of a firm's annual report entitled "Management's Discussion and Analysis" (MDandA)

  A. is a technical analysis of past results and a defense of those results of management.

  B. includes the company president's letter.

  C. covers three financial aspects of a firm's business: liquidity, capital resources, and results of operations.

  D. covers marketing and product line issues.

  E. none of these answers.

  Correct Answer: C

  The MDandA is included in SEC filings. It addresses in a nonquantified manner the prospects of a company. The SEC examines it with care to determine that management has disclosed material information affecting the company's future results.

• Question 2278:

  When merchandise inventory is purchased under a periodic system, which account is debited?

  A. Accounts Payable

  B. Cash

  C. Merchandise Inventory

  D. Purchases

  Correct Answer: D

  The periodic inventory system records purchases of merchandise inventory in an income statement account called Purchases.

• Question 2279:

  Jumbotron's accountant has mistakenly understated depreciation by 125 and understated accounts payables by 65. Jumbotron's tax rate is 40%. Which of the following is/are true?

  I. Assets are overstated by 125

  II. Income is overstated by 125

  III. Current liabilities are understated by 65

  IV.

  Operating cash flow is understated by 125

  A.

  III only

  B.

  I and III

  C.

  none of them

  D.

  II, III and IV

  Correct Answer: B

  If depreciation is understated by 125, the income is actually overstated by 125*(1-tax rate) = 75. The understatement of accounts payables does not affect the income statement; it understates the reported current liabilities. It also affects the operating cash flow. Note that operating cash flow = net income + noncash expenses - non-cash revenues - cash reductions in operating accounts Since income is overstated by 75, a non-cash expense (depreciation) is understated by 125 and another non-cash expense (accounts payable) is understated by 65, operating cash flow is understated by -75 + 125 + 65 = 115.

• Question 2280:

  Which of the following temporary differences will result in a deferred tax asset?

  A. Installment sale profits accounted for on the accrual basis for financial statement purposes and on a cash basis for income tax purposes.

  B. Prepaid expenses accounted for on the accrual basis for financial statement purposes and on a cash basis for income tax purposes.

  C. Use of the straight-line depreciation method for financial statement purposes and the Modified Accelerated Cost Recovery System (MACRS) for income tax purposes.

  D. None of these answers.

  E. Advance rental receipts accounted for on the accrual basis for financial statement purposes and on a cash basis for tax purposes.

  Correct Answer: E

  A deferred tax asset records deferred tax consequences attributable to deductible temporary differences. Advance rental receipts accounted for on the accrual basis for accounting purposes and on a cash basis for tax purposes would give rise to a deferred tax asset. The income statement would show no revenue and no related tax expense. However, on the tax return, the cash received is reported as revenue and the tax would be due now, resulting in a prepaid tax on the balance sheet called a deferred tax asset.