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

• Question 2321:

  Which of the following would not be included as equity in a corporate balance sheet?

  A. Common stock

  B. Preferred stock

  C. Cash

  D. Retained earnings

  Correct Answer: C

  Cash does not represent equity; equity consists of the book value of a company; i.e., assets, minus liabilities.

• Question 2322:

  A firm has legal cash expenses of 300 and a tax rate of 40. If it chooses to capitalize the costs and depreciated them over 3 years, the operating cash flow under capitalization, compared to that under expensing, will be ________.

  A. smaller by 220

  B. larger by 180

  C. larger by 220

  D. smaller by 180

  Correct Answer: C

  Under expensing, the operating cash flow will be reduced due to this expense by 300*(1-0.4) = 180 (there is an outflow of 300 but since the expenses are tax deductible, taxes on total income get reduced by 120). Instead, if the firm capitalized the expense, an asset value of 300 will be generated. The entire expense will be charged against investing cash flow. Depreciation of capitalized expense leads to a depreciation expense of 300/3 = 100. This will reduce taxes paid by 100*0.4 = 40. Thus, capitalization leads to an increase in the operating cash flow of 40. In summary, expensing reduces the expense by 180 while capitalization increases operating cash flow by 40. Thus, operating cash flow under capitalization is larger by 40 - (-180) = 220.

• Question 2323:

  When a business is acquired, the purchasing company calculates goodwill associated with the acquisition as the difference between the purchase price and the ________.

  A. book value of the identifiable net assets acquired

  B. book value of the net tangible assets acquired

  C. fair value of the net tangible assets acquired

  D. book value of the total assets acquired

  E. fair value of the identifiable net assets acquired

  Correct Answer: E

  Goodwill is the difference between the amount paid for the business and the fair value of this business. The fair value can be calculated using net assets (total assets minus total liabilities), or shareholders' equity.

• Question 2324:

  The financial statements of Multiverse for 1997 showed the following:

  a.

  Dividends paid 60

  b.

  Provision for bad debt 15

  c.

  Depreciation 90

  d.

  Interest paid 35

  e.

  Proceeds from new bonds issued 225

  f.

  Bonds retired 400

  g.

  Gain on bonds retired 25

  h.

  Shares repurchased 195

  i.

  Net Income 350

  j.

  Tax rate 50%

  A.

  -405

  B.

  -430

  C.

  -370

  D.

  -380

  Correct Answer: D

  Items a, e, f, g and h are financing items. However, remember that item g, gain on bonds retired, is an extraordinary item under SFAS 4 and presented after-tax. Hence, the total cash spent on retiring bonds = 400 - 25/(1-0.5) = 350.Therefore, financing cash flow = -60 + 225 - (400 - 25/0.5) - 195 = - 380.

• Question 2325:

  For accounting purposes, which of the following is/are TRUE about assets?

  I. Assets are future benefits whose values are known today.

  II. Assets are generated by past transactions or events.

  III. Assets include the value of residual ownership of the firm.

  IV.

  Assets are best viewed as sources of future cash flows.

  A.

  I, II, III and IV

  B.

  I, II and IV

  C.

  II only

  D.

  I and II

  Correct Answer: C

  Assets are defined as "probable future benefits obtained or controlled by a particular entity as a result of past transactions or events." III refers to "Equity" while IV is not correct since the benefits need not be solely in the form of cash.

• Question 2326:

  Suppose the average stock price in the above example were 40. How many shares will be used in the calculation of Diluted EPS now?

  A. none of these answers

  B. 1,250,000

  C. 1,208,333

  D. 1,300,000

  Correct Answer: C

  Since the average stock price now exceeds the strike price, the warrants are assumed converted. The proceeds from the exercise equal 800,000*35 = 28 million. The Treasury Stock method assumes a purchase of shares at 40 using these proceeds. Thus, the number of shares repurchased = 28,000,000/40 = 700,000. Thus, the additional shares arising from warrant exercise equals 800,000 - 700,000 = 100,000. Now, in the Treasury Stock method, options and warrants are assumed to be exercised at the beginning of the period or at the time of issuance, whichever is later. Thus, in this case, the addition 100,000 shares have been outstanding since May 31, 1998. So the weighted number of shares for Diluted EPS = 1 million

  + 200,000*9/12 + 100,000*7/12 = 1,208,333 shares.

• Question 2327:

  A benefit period for accounting amortization can not exceed how many years ________.

  A. 15

  B. 40

  C. 30

  D. 25

  Correct Answer: B

  In accounting no benefit can be amortized over more than 40 years. The difficulties of going further do not provide sufficient benefit to justify the cost.

• Question 2328:

  Which of the following is/are true?

  I. An increase in inventories has a positive impact on cash flows.

  II. An increase in receivables has a negative impact on cash flows.

  III. Deferred taxes increase current cash balance.

  IV.

  Utilization of tax loss carry-forwards has a positive impact on cash flows.

  A.

  I, II and IV

  B.

  II and III

  C.

  I and IV

  D.

  II, III and IV

  Correct Answer: D

  An increase in inventories implies cash was spent to obtain more goods than were sold. An increase in receivables implies part of the sales were made on credit, not a cash basis. Deferring taxes implies some of the cash expense was delayed into the future, increasing the current cash balance. Utilization of taxloss carry-forwards implies a reduction in the taxable income by the amount of the carry-forward. This reduces cash expense on taxes.

• Question 2329:

  The statement of cash flows cannot be used to

  A. consider the interrelationship between cash flow components over time.

  B. examine the trend of different cash flow components over time.

  C. examine the cash flow components and their relationship to related income statement items.

  D. review individual cash flow items for analytic significance.

  E. examine the firm's ability to realize assets and settle liabilities.

  Correct Answer: E

  Income statement and balance sheet data must be combined with cash flows for insights into the firm's ability to realize assets based on reported revenues and settle liabilities resulting from accrued expenses.

• Question 2330:

  The following are all true concerning transactional analysis, except,

  A. it can be used to convert indirect method cash flow from operations to the direct method.

  B. it is a technique that can be used to create a cash flow statement for firms that do not prepare such statements in accordance with SFAS 95 and IAS 7.

  C. it helps to understand the relationship between the accrual of revenues, expenses, assets, and liabilities and their cash flow consequences.

  D. it is a method that groups changes in the current assets and current liabilities and reconciles them to the relevant income statement items.

  E. it is a method that classifies cash flows among operating, financing, and investing activities.

  Correct Answer: D

  This method reconciles line-item changes in the balance sheet with their related income statement components to derive the cash flow consequences of the reported transactions and events.