FRA Questions Flashcards
Prema Singh is the bookkeeper for Octabius Industries. Singh has been asked by the CFO of Octabius to review all purchases that occurred between February 1 and February 8 to investigate an error on the receiving dock. Singh will most likely look at the:
A) initial trial balance.
B) general ledger.
C) general journal.
C (not B…)
Journal entries record every transaction, showing which accounts are changed by what amounts. A listing of all the journal entries in order by date is called the “general journal.”
*GJ contains JE in the order of dates
* general ledger is a complete record of financial transactions over the life of a company.
Which of the following statements comparing straight-line depreciation methods to alternative depreciation methods is least accurate? Companies that use:
A)
straight-line depreciation methods will have higher book values for the assets on the balance sheet than companies that use accelerated depreciation.
B)
accelerated depreciation methods for tax purposes will decrease the amount of taxes paid in early years.
C)
accelerated depreciation methods will have lower asset turnover ratios than if they used straight line depreciation.
C
Accelerated depreciation will lead to lower book values and hence a higher asset turnover ratio.
Which of the following is least likely one of the criteria under U.S. GAAP for classifying a lease as a finance lease? The:
A)
term of the lease is 75% or more of the estimated economic life of the leased property.
B)
lease contains a bargain purchase option.
C)
lessor retains ownership of the property at the end of the lease term.
C
If the lease transfers ownership of the property to the lessee at the end of the lease term, the lessee will classify the lease as a finance lease.
Which of the following is most likely to be considered a barrier to developing one universally recognized set of reporting standards?
A)
GATT already requires sufficient agreement.
B)
Reluctance of firms to adhere to a single set of reporting standards.
C)
Different standard-setting bodies of different countries disagree on the best treatment of a particular issue.
C
A principal obstacle to agreement on a single set of reporting standards is that various standard-setting bodies and regulatory authorities disagree on what the standards should be. Firms generally support the idea because it would reduce the cost of reporting. GATT is the General Agreement on Tariffs and Trade and does not relate to financial reporting.
Which of the following ratios would NOT be used to evaluate how efficiently management is utilizing the firm’s assets?
A) Gross profit margin.
B) Fixed asset turnover.
C) Payables turnover.
A
The gross profit margin is used to measure a firm’s operating profitability, not operating efficiency.
The price to tangible book value ratio subtracts what components from equity?
A)
Goodwill and intangible assets.
B)
Goodwill and property, plant and equipment.
C)
Intangible assets and property, plant and equipment.
A
Price to tangible book value is calculated by removing goodwill and intangible assets from equity. This adjustment reduces assets and equity and produces a ratio that is not affected by differences in intangible asset values that may result from how the assets were acquired.
Darth Corporation’s most recent income statement shows net sales of $6,000, and Darth’s marginal tax rate is 40%. The total expenses reported were $3,200, all of which were paid in cash. In addition, depreciation expense was reported at $800. A further examination of the most recent balance sheets reveals that accounts receivable during that period increased by $1,000. The cash flow from operating activities reported by Darth should be:
A) $1,000.
B) $2,200.
C) $1,200.
A
Net income is ($6,000 - 3,200 - 800)(1 - 0.4) = $1,200. Adjustments to reconcile net income to cash flow from operating activities will require that depreciation ($800) be added back, and increase in accounts receivable ($1,000) be subtracted: $1,200 + 800 - 1,000 = $1,000.
A firm’s balance sheet prepared under IFRS is least likely to include:
A) market value of inventory.
B) fair value of firm PPE.
C) market value of the firm’s equity.
C
The market value of the firm’s common equity (common stock) is not included on the balance sheet. IFRS allows some PP&E assets to be carried at fair value and some types of inventory to be carried at their market values.
Question From: Session 7 > Reading 25 > LOS b
*IFRS Fair Value allowance, need to make a list
A firm has a cash conversion cycle of 80 days. The firm’s payables turnover goes from 11 to 12, what happens to the firm’s cash conversion cycle? It:
A) may shorten or lengthen.
B) lengthens.
C) shortens.
**what is the formula for ccc? Formulas for its components?
B
Cash Conversion Cycle = collection period + Inv Period - Payment period
Inventory period = 365/inventory turnover
Payment period = 365 / payables turnover
Collection period = 365/receivables turnover
In a direct-financing lease, the implicit rate is such that the present value of the minimum lease payments:
A) is lower than the cost of the leased asset.
B) equals the sale price of the leased asset.
C) equals the cost of the leased asset.
C
In a direct-financing lease, the implicit rate is such that the present value of the MLPs equals the cost of the leased asset. Thus, at lease inception the total assets do not change and no gain is recognized.
When comparing capitalizing versus expensing costs which of the following statements is most accurate?
A)
Capitalizing costs creates lower cash flows from operations and higher cash flows from investing.
B)
Expensing costs creates lower cash flows from operations and lower cash flows from investing.
C)
Capitalizing costs creates higher cash flows from operations and lower cash flows from investing.
C
Although net cash flows are not affected by the choice of capitalization or expensing, the components of cash flow are affected. Because, a firm that capitalizes classifies the expenditure as investing (not operations), cash flow from operations will be higher for firms that capitalize and investing cash flows will be lower than that of an expensing firm.
*First time picked A, thinking it was cash outflow…
When calculating earnings per share (EPS) for firms with complex capital structures, convertible preferred stock is ordinarily considered to be a:
A) antidilutive security.
B) potentially dilutive security.
C) non-equity security.
B
Dilutive securities are securities that decrease EPS if they are exercised or converted to common stock. Stock options, warrants, convertible debt, and convertible preferred stock are examples of potentially dilutive securities. Note that if diluted EPS when considering the convertible preferred stock is greater than basic EPS, the convertible preferred stock would be antidilutive and should not be treated as common stock in computing diluted EPS.
*it is potentially dilutive, but could be antidilutive
Which of the following items would NOT be included in cash flow from investing?
A) Proceeds related to acquisitions.
B) Buying or selling a building.
C) Selling stock of the company.
C (it is financing cashflow)
Which of the following accounting warning signs is most likely to indicate manipulation of reported operating cash flows?
A)
More aggressive revenue recognition methods than comparable firms.
B)
Higher estimated salvage values than are typical in a firm’s industry.
C)
Capitalizing purchases that comparable firms typically expense.
C
Capitalizing purchases that other firms expense increases reported CFO (operating) by classifying the cash outflows as CFI (investing). Revenue recognition methods and accounting estimates may affect reported income but are unlikely to affect the amount or classification of cash flows.
Goldberg Inc. produces and sells electronic equipment. Which of the following inventory costs is most likely to be recognized as an expense on Goldberg’s financial statements in the period incurred?
A) Conversion cost.
B) Freight costs on inputs.
C) Selling cost.
C
Selling costs are expensed in the period incurred since they result in no future benefit (i.e. the inventory has been sold). Conversion costs and freight costs add value in assisting in the future sale of the related inventory. Therefore, these costs are not recognized until the inventory is ultimately sold.
which costs should be included in inventory and only recog in COGS
Dart Corporation engaged in the following transactions earlier this year:
Transaction #1:
Retired long-term debenture bonds with a face amount of $10 million by issuing 500,000 shares of common stock to the bondholders.
Transaction #2:
Borrowed $5 million from a bank and used the proceeds to purchase equipment used in the manufacturing process.
With respect to these transactions, should Dart report transaction #1 as a financing cash flow and/or transaction #2 as an investing cash flow?
A) Both should be reported as such.
B) Only one should be reported as such.
C) Neither should be reported as such.
B
The process of developing one universally accepted set of accounting standards is best described as:
A) IASB.
B) unification.
C) convergence.
C
A U.S. GAAP firm writes down inventory to net realizable value. In the period of the writedown, what is the most likely effect on cost of goods sold?
A) Decrease.
B) No effect.
C) Increase.
C
A write-down of inventory to net realizable value is typically recognized under U.S. GAAP as an increase in cost of goods sold in the period of the write-down. Consider the inventory equation:
ending inventory = beginning inventory + purchases - cost of goods sold
A write-down to NRV decreases ending inventory, with no effect on beginning inventory or purchases. For the inventory equation to hold, cost of goods sold must increase.
Which of the following statements about financial reporting standards is least accurate? Reporting standards:
A)
are disclosed on Form 8K by publicly traded firms in the United States.
B)
narrow the range within which management estimates can be seen as reasonable.
C)
ensure that the information is “useful to a wide range of users.”
A
Reporting standards ensure that the information is “useful to a wide range of users,” including security analysts, by making financial statements comparable to one another and narrowing the range within which management’s estimates can be seen as reasonable. Securities & Exchange Commission Form 8K addresses acquisitions, divestitures, etc. and not reporting standards.
*10Q or 10K is the quarterly and annual FS, 8K is not..
Using the following data, find the return on equity (ROE).
Net Income=2$
Total Assets=10$
Sales=$10
Equity=$8
A) 100%.
B) 20%.
C) 25%.
C
Net Income / Equity = ROE
2 / 8 = 25%
A temporary difference between income tax expense and taxes payable result in a(n):
A) gain or loss in comprehensive income.
B) adjustment to the effective tax rate.
C) deferred tax item.
C
Taxes payable is defined as the taxes due to the government as determined by taxable income and the tax rate, while income tax expense is the amount recognized on the income statement. A temporary difference results in a deferred tax liability if income tax expense is greater than taxes payable, or a deferred tax asset if income tax expense is less than taxes payable. A permanent difference results in an adjustment to the firm’s effective tax rate. Neither results in a gain or loss.
Do the following characteristics have to be met in order to classify a liability as current on the balance sheet?
Characteristic #1 - Settlement is expected within one year or operating cycle, whichever is less.
Characteristic #2 - Settlement will require the use of cash within one year or operating cycle, whichever is greater.
Characteristic #1 Characteristic #2
A) No Yes
B) No No
C) Yes No
B
A current liability is expected to be settled within one year or operating cycle, whichever is greater. It is not necessary to settle a current liability with cash. There are a number of ways to settle a current liability. For example, unearned revenue is a liability that is settled by providing goods or services.
First in, first out (FIFO) inventory equals:
A) LIFO inventory + LIFO reserve.
B) change in LIFO reserve − ending LIFO reserve.
C) LIFO cost of goods sold − change in LIFO reserve.
A
To convert LIFO inventory balances to a FIFO basis, simply add the LIFO reserve to LIFO inventory.
A common-size cash flow statement is least likely to provide payments to employees as a percentage of:
A) revenues for the period.
B) operating cash flow for the period.
C) total cash outflows for the period.
B
There are two formats for a common-size cash flow statement, expressing each type of outflow as a percentage of total cash outflows or as a percentage of total revenue for the period. Operating cash flow for the period mixes inflows and outflows and is not used to calculate percentage flows for payment made.
How will dilutive securities affect earnings per share (EPS) when determining diluted earnings per share?
A) Increase EPS.
B) Either decrease or increase EPS depending upon if the security is dilutive or antidilutive.
C) Decrease EPS.
C
Dilutive securities such as convertibles and options are found in a complex capital structure and always decrease EPS. Convertibles and options may also be antidilutive, which will increase EPS hence the name antidilutive. The only way to know if a security is dilutive or antidilutive is to compare the basic EPS to diluted EPS. If the diluted EPS is higher than the basic EPS then the security is antidilutive and should not be included when determining diluted EPS.
Which of the following circumstances is most likely indicative of an increase in a company’s future earnings?
A) Work-in-process inventory increasing faster than finished goods inventory.
B) Finished goods inventory increasing faster than sales.
C) Finished goods inventory increasing faster than work-in-process inventory.
A
Work-in-process inventory increasing faster than finished goods inventory is a likely indicator that a firm expects demand to increase, which should increase future revenues and earnings. Finished goods inventory increasing faster than sales or work-in-process inventory may indicate that demand is decreasing. Analysts should refer to sources such as management’s commentary to further examine the reasons for an increase in finished goods inventory.
Which of the following statements is CORRECT? Income tax expense:
A)
includes taxes payable and deferred income tax expense.
B)
is the reported net of deferred tax assets and liabilities.
C)
is the amount of taxes due to the government.
A
Income tax expense is defined as expense resulting from current period pretax income. It includes taxes payable and deferred income tax expense. Taxes payable are the amount of taxes due the government.
In the financial statement analysis framework, using the data to address the objectives of the analysis and deciding what conclusions or recommendations the information supports is best described as: A) reporting the conclusions. B) processing the data. C) analyzing and interpreting the data. *what are the six steps?
The financial statement analysis framework consists of six steps:
1 - State the objective and context. Determine what questions the analysis is meant to answer, the form in which it needs to be presented, and what resources and how much time are available to perform the analysis.
2 - Gather data. Acquire the company’s financial statements and other relevant data on its industry and the economy. Ask questions of the company’s management, suppliers, and customers, and visit company sites.
3 - Process the data. Make any appropriate adjustments to the financial statements. Calculate ratios. Prepare exhibits such as graphs and common-size balance sheets.
4 - Analyze and interpret the data. Use the data to answer the questions stated in the first step. Decide what conclusions or recommendations the information supports.
5 - Report the conclusions or recommendations. Prepare a report and communicate it to its intended audience. Be sure the report and its dissemination comply with the Code and Standards that relate to investment analysis and recommendations.
6 - Update the analysis. Repeat these steps periodically and change the conclusions or recommendations when necessary.
Graphics, Inc. has a deferred tax asset of $4,000,000 on its books. As of December 31, it became more likely than not that $2,000,000 of the asset’s value may never be realized because of the uncertainty of future income. Graphics, Inc. should:
A)
reverse the asset account permanently by $2,000,000.
B)
reduce the asset by establishing a valuation allowance of $2,000,000 against the asset.
C)
not make any adjustments until it is certain that the tax benefits will not be realized.
B
If it becomes more likely than not that deferred tax assets will not be fully realized, a valuation allowance that reduces the asset and also reduces income from continuing operations should be established.
Train, Inc.’s cash flow from operations (CFO) in 20X8 was $14 million. Train paid $8 million cash to acquire a franchise at the beginning of 20X8 that was expensed in 20X8. If Train had elected to amortize the cost of the franchise over eight years, 20X8 cash flow from operations (CFO) would have been:
A) $22 million.
B) $21 million.
C) $14 million.
A
!! Amortization is a non-cash expense
If Train decided to amortize the cost, the franchise would be capitalized as a balance sheet asset and the cash outflow would have been classified as CFI. As a result CFO would have been $8 million higher, or $14 million + $8 million = $22 million. Amortization would be a non-cash expense.
The cash conversion cycle is the:
A)
sum of the time it takes to sell inventory and the time it takes to collect accounts receivable.
B)
sum of the time it takes to sell inventory and collect on accounts receivable, less the time it takes to pay for credit purchases.
C)
length of time it takes to sell inventory.
B
Cash conversion cycle = (average receivables collection period) + (average inventory processing period) − (payables payment period)
Determine the cash flow from operations given the following table.
Item Amount
Cash payment of dividends $30
Sale of equipment $25
Net income $25
Purchase of land $15
Increase in accounts payable $20
Sale of preferred stock $25
Increase in deferred taxes $5
Profit on sale of equipment $15
A) $35.
B) $45.
C) $20.
A
Using the indirect method, CFO = Net income 25 + increase in accounts payable 20 + increase in deferred taxes 5 − profit on sale of equipment 15 = $35.
Increases in accounts payable and deferred taxes are sources of operating cash that are not included in net income and must be added. Profit on sale of equipment is a CFI item that must be removed from net income.
No adjustment needs to be made for cash payment of dividends (CFF), sale of preferred stock (CFF), or purchase of land (CFI) because they are not included in net income. Only the profit on sale of equipment, not the full proceeds from sale, is included in net income.
An analyst has gathered the following information about a company:
Cost of goods sold = 65% of sales.
Inventory of $450,000.
Sales of $1 million.
What is the value of this firm’s average inventory processing period using a 365-day year?
A) 252.7 days.
B) 0.7 days.
C) 1.4 days.
A
COGS = (0.65)($1,000,000) = $650,000
Inventory turnover = CGS / Inventory = $650,000 / $450,000 = 1.4444
Average Inventory Processing Period = 365 / 1.4444 = 252.7 days
An airplane manufacturing company routinely builds fighter jets for the U.S. armed forces. It takes fourteen months to build one jet, and the government pays for them in installments over the fourteen-month period. Which revenue recognition method should be used?
A) Percentage-of-completion method.
B) Installment sales method.
C) Completed contract method.
A
The percentage-of-completion method is appropriate in this case because payment is assured when dealing with the U.S. government, and cost and price estimates are assumed reliable due to the ongoing and routine nature of the contract.
Liquidity-based presentation of a balance sheet is most likely to be used by a:
A) retailer.
B) bank.
C) manufacturer.
B
Required financial statements, according to International Accounting Standard (IAS) No. 1, include a(n):
A) balance sheet and explanatory notes.
B) cash flow statement and auditor’s report.
C) income statement and working capital summary.
what else are required? (total of 6)
A
Financial statements that are required by IAS No. 1 include
- a balance sheet,
- a statement of comprehensive income,
- a cash flow statement,
- a statement of changes in owners’ equity,
- and explanatory notes that include a summary of the company’s accounting policies.
MJ Inc. reported cost of goods sold of $80,000 for the year under the LIFO inventory valuation method. MJ had a beginning LIFO reserve of $8,000 and an ending LIFO reserve of $11,000. Cost of goods sold under the FIFO inventory valuation method is:
A) $77,000.
B) $83,000.
C) $91,000.
A
To convert the LIFO inventory to FIFO, you take LIFO Inv. + LIFO Reserve.
==> LIFO Inv + LIFO Reserve
To convert COGS LIFO to COGS FIFO, you take COGS FIFO and subtract the increase in LIFO reserve.
==> COGS FIFO - Increase in LIFO reserve
(no need to convert FIFO to LIFO, at least in exam)
If timing differences that give rise to a deferred tax liability are not expected to reverse then the deferred tax:
A)
must be reduced by a valuation allowance.
B)
should be considered an increase in equity.
C)
should be considered an asset or liability.
B
If deferred tax liabilities are expected to reverse in the future, then they should be classified as liabilities. If, however, they are not expected to reverse in the future, then they should be classified as equity.
Question From: Session 8 > Reading 30 > LOS b
Lucille Edgewater, CFA, is analyzing Pfaff Company, which reports its long-lived assets using the revaluation model. Edgewater needs to determine 1) what Pfaff’s carrying value of property, plant and equipment would be under the historical cost model, and 2) which of Pfaff’s intangible assets have finite useful lives. Will these items be disclosed in Pfaff’s financial statements?
A)
Only one of these items is required to be disclosed.
B)
Both of these items are required to be disclosed.
C)
Neither of these items is required to be disclosed.
B
Under IFRS, firms that use the revaluation model for PP&E must disclose its carrying value under the historical cost model. Firms must also disclose whether the useful lives of intangible assets are finite or indefinite.
A zero coupon bond, compared to a bond issued at par, will result in higher:
A) interest expense.
B) cash flows from operations (CFO).
C) cash flows from financing (CFF).
B (Not C, since interest expense is operating)
The zero-coupon bond will have higher cash flows from operations, as the cash interest expense in this case is zero and no cash is paid until maturity. Candidates should remember that any bond issued at a discount will have more cash flow from operations and less cash flow from financing.
When bonds are issued at a premium:
A)
coupon interest paid decreases each period as bond premium is amortized.
B)
earnings of the firm increase over the life of the bond as the bond premium is amortized.
C)
earnings of the firm decrease over the life of the bond as the bond premium is amortized.
B
As bond premium is amortized, interest expense will be successively lower each period, thus increasing earnings over the life of the bond.
An oil exploration company has been contracted to dig 100 exploratory holes for $200,000. The cost to complete this job is estimated to be $150,000, but the company doesn’t recognize any of the $50,000 profit until the job is completed. Which revenue recognition method is being used?
A) Cost recovery method.
B) Percentage-of-completion method.
C) Completed contract method.
C
The completed contract method doesn’t recognize revenue and expense until the contract is completed. The percentage-of-completion method would have recognized a portion of the $50,000 profit prior to completion.
Capitalizing interest costs related to a company’s construction of assets for its own use is required by:
A) both IFRS and U.S. GAAP.
B) IFRS only.
C) U.S. GAAP only.
A
Both U.S. GAAP and IFRS require companies to capitalize the interest that accrues during a the construction of capital assets for their own use.
A firm with a capital structure consisting of only common stock and non-convertible bonds is said to have a:
A) non-diluted capital structure.
B) simple capital structure.
C) straight capital structure.
B
A simple capital structure is one that contains no securities that have the potential to dilute a firm’s earnings per share. For example, convertible bonds, convertible preferred stock, options, and warrants have the potential to dilute earnings per share upon conversion or exercise.
A firm revalues its long-lived assets upward. All other things equal, which of the following financial impacts is least likely to occur?
A) Higher profitability in the periods after revaluation.
B) Higher earnings in the revaluation period.
C) Lower solvency ratios.
*(what’s solvency ratio’s formula)
A
A - Because the asset has now been increased to a higher depreciable base, there will now be higher depreciation expense and therefore, lower profitability in the periods after revaluation.
B - There could be higher earnings in the revaluation period because there may be impairment losses that can be reversed on the income statement. Otherwise, there will be an adjustment to earnings through other comprehensive income.
C - Solvency ratios (i.e. debt to equity) will decrease since the increase in assets will be balanced by an increase in equity. Higher denominators and unchanged numerators will result in lower solvency ratios.
United Corporation and Intrepid Company are similar firms operating in the same industry. United follows U.S. Generally Accepted Accounting Principles and Intrepid follows International Financial Reporting Standards. At the end of last year, Intrepid had a higher inventory turnover ratio than United. Are the following plausible explanations for the difference?
Explanation #1 - United accounts for its inventory using the first-in, first-out method and Intrepid uses the last-in, first-out method.
Explanation #2 - United recognized an upward valuation of inventory that had been previously written down. Intrepid does not revalue its inventory upward.
Explanation #1 Explanation #2 A) No Yes B) Yes No C) No No
C (need to read which company uses GAAP vs IFRS!!)
While the LIFO firm will typically report lower average inventory (higher inventory turnover), Intrepid cannot be a LIFO firm because LIFO is not permitted under IFRS. An upward revaluation of inventory would lower the inventory turnover ratio; however, United cannot revalue its inventory upward because it follows U.S. GAAP. U.S. GAAP prohibits upward inventory revaluations (except in very limited circumstances which are beyond the scope of the Level I exam).
Larry Purcell, an entry-level fixed income analyst at Knowlton & Smeades LLC, was discussing debt covenants with his supervisor, Andy Holzman. During the meeting Purcell made the following statements regarding bond covenants:
Statement 1: If a firm violates any of its debt covenants, the company will immediately go into bankruptcy and the creditors of the firm will take over the liquidation of its assets.
Statement 2: Debt covenants are important in evaluating a firm’s credit risk and to better understand how the restrictions of the covenants can affect the firm’s growth prospects and choice of accounting policies.
With respect to these statements:
A) both are incorrect.
B) only one is correct.
C) both are correct.
B
Lenders and other creditors use debt covenants in their lending agreements to restrict the activities of the debtor that could adversely impact the creditors’ position. If any bond covenant is violated, the firm is in technical default on its debt. The creditors can demand payment of the debt, however, the terms are generally renegotiated. As such, the company does not automatically enter into bankruptcy and have its assets liquidated by the creditors.
return on equity=?
Return on equity = net income / average equity
ROE = net profit margin × asset turnover × leverage ratio
A U.S. GAAP reporting firm changes its inventory cost flow assumption from average cost to LIFO. The firm must apply this change:
A)
retrospectively, because it is a change in accounting principle.
B)
prospectively, with LIFO layers calculated from past purchases and sales.
C)
prospectively, with the carrying value as the first LIFO layer.
C
Changing the inventory cost flow assumption to LIFO is an exception to the retrospective application of changes in accounting principle. This change is applied prospectively, with the carrying value of inventory on the date of the change as the first LIFO layer.
The effect of an inventory writedown on a firm’s return on assets (ROA) is most accurately described as:
A)
lower ROA in the current period and higher ROA in later periods.
B)
higher ROA in the current period and lower ROA in later periods.
C)
lower ROA in the current period and no effect on ROA in later periods.
A
Writing down inventory to net realizable value decreases both net income and total assets in the period of the writedown. Because net income is most likely less than assets, the result in the period is a decrease in ROA. In later periods, lower-valued inventory will decrease COGS and increase net income. Combined with a lower value of total assets, this will increase ROA.
Orchard Supply Company uses LIFO inventory valuation. Orchard had a cost of goods sold of $1 million for the most recent year. Inventory was $500,000 at the beginning of the year and $600,000 at the end of the year. Orchard Supply’s LIFO reserve was $100,000 at the beginning of the year and $200,000 at the end of the year. What is Orchard Supply’s cost of goods sold using FIFO inventory valuation?
A) $1.1 million.
B) $800,000.
C) $900,000.
*what’s FIFO ending inventory?
C
FIFO COGS = LIFO COGS − change in LIFO reserve = $1 million − $100,000 = $900,000
*600K+200K=800K
FIFO inventory = LIFO inventory + LIFO reserve.
When a reliable estimate of costs exists, ultimate payment is assured, and revenue is earned as costs are incurred, which of the following revenue recognition methods should be used?
A) Cost recovery method.
B) Percentage-of-completion method.
C) Installment sales method.
B
C - The installment sales method recognizes revenue and associated cost of goods sold only when cash is received. Gross profit (sales - cost of goods sold) reflects the proportion of cash received.
A - The cost recovery method is similar to the installment sales method but is more conservative. Sales are recognized when cash is received, but no gross profit is recognized until all of the cost of goods sold is collected.
Which description of the objective of financial statements is most accurate? The objective of financial statements is:
A)
to provide economic decision makers with useful information about a firm’s financial performance and changes in financial position.
B)
to provide a wide range of users with information about a firm’s financial prospects.
C)
to provide securities analysts with objective data about a firm’s financial prospects.
A (pay attention to “prospect” - that’s associated with analyst)
The objective of financial statements is to provide economic decision makers with useful information about a firm’s financial performance and changes in financial position. Assessing its prospects is the responsibility of analysts. Financial statements fall under the purview of the FASB in the US, not the IASB. The SEC does not set the objectives of financial statements, it is a regulatory authority.
Which of the following statements regarding deferred taxes is NOT correct?
A)
If deferred tax liabilities are not included in equity, debt-to-equity ratio will be reduced.
B)
Only those components of deferred tax liabilities that are likely to reverse should be considered a liability.
C)
If deferred taxes are not expected to reverse in the future then they should be classified as equity.
A
(注意B和C选项，都是正确的）
When deferred tax liabilities are included in equity, it will reduce the debt-to-equity ratio (by increasing the denominator), in some cases considerably.
On January 1, 20X4, Cayman Corporation bought manufacturing equipment for $30 million. On December 31, 20X6, Cayman determined the equipment was impaired and recognized a $5 million impairment loss in its income statement. As of December 31, 20X7, the fair value of the equipment exceeded the book value by $7 million. Cayman may recognize a gain in its 20X7 income statement if it reports under:
A) neither IFRS nor U.S. GAAP.
B) IFRS, but not U.S. GAAP.
C) either IFRS or U.S. GAAP.
B
U.S. GAAP does not permit upward valuations of plant and equipment. Under IFRS, the recovery is reported in the income statement to the extent that the previous downward adjustment (loss) was reported in net income. Any further increase in value is reported as revaluation surplus in shareholders’ equity.
A tax rate that has been substantively enacted is used to determine the balance sheet values of deferred tax assets and deferred tax liabilities under:
A) both IFRS and U.S. GAAP.
B) IFRS only.
C) U.S. GAAP only.
B
Under IFRS, a tax rate that has been enacted or substantively enacted is used to measure deferred tax items. Under U.S. GAAP, only a tax rate that has actually been enacted can be used.
GTO Corporation purchased all of the common stock of Charger Company for $4 million. At the time, Charger reported total assets of $3 million and total liabilities of $1 million. At the acquisition date, the fair value of Charger’s assets was $3.5 million and the fair value of Charger’s liabilities was $1.3 million. What amount of goodwill should GTO report as a result of the acquisition and is it necessary for GTO to amortize the goodwill?
Goodwill Amortization required A) $1.8 million Yes B) $2.2 million No C) $1.8 million No
C
The acquisition goodwill is equal to $1.8 million [$4 million purchase price - $2.2 million fair value of net assets acquired ($3.5 million assets at fair value - $1.3 million liabilities at fair value)]. Under IFRS or U.S. GAAP, goodwill is not amortized but is subject to an annual impairment test.
*Goodwill not amortize but subject to impairment test
Under which financial reporting standards is a firm required to discuss the circumstances when reversing an inventory writedown?
A) Neither IFRS nor U.S. GAAP.
B) IFRS, but not U.S. GAAP.
C) Both IFRS and U.S. GAAP.
B (reverse is not allowed under GAAP!!)
Reversals of inventory writedowns are permitted under IFRS but not under U.S. GAAP. If an IFRS reporting firm reverses an inventory writedown, the firm is required to discuss the circumstances of the reversal.
Young Distributors, Inc. issued convertible bonds two years ago, and those bonds are the only potentially dilutive security Young has issued. In 20X5, Young’s basic earnings per share (EPS) and diluted EPS were identical, but in 20X4 they were different. Which of the following factors is least likely to explain the difference between basic and diluted EPS? The:
A)
bonds were redeemed by Young Distributors at the beginning of 2005.
B)
bonds were antidilutive in 2005 but not in 2004.
C)
average market price of Young common stock increased in 20X5.
C
Average stock price is not a factor in determining whether convertible bonds are dilutive or antidilutive.
If Young redeemed the bonds, they would have no potentially dilutive securities outstanding in 20X5 and diluted EPS, if the company reported it, would equal basic EPS. Basic and diluted EPS would also be equal in 20X5 if the bonds were antidilutive in that year.
An analyst compares two companies that are identical except that Company X uses finance leases and Company Y uses operating leases. The analyst would expect Company X’s debt-to-equity ratio, relative to Company Y’s, to be:
A) higher.
B) lower.
C) the same.
A
Lease capitalization adds both current and noncurrent liabilities to debt, resulting in a corresponding increase in the debt-to-equity and other leverage ratios. Thus, Company X’s (Debt + Lease)/Equity is greater than Company Y’s Debt/Equity.
Connecticut, Inc.’s stock transactions during the year 20X5 were as follows:
January 1: 360,000 common shares outstanding.
April 1: 1 for 3 reverse stock split.
July 1: 60,000 common shares issued.
When computing for earnings per share (EPS) computation purposes, what is Connecticut’s weighted average number of shares outstanding during 20X5?
A) 140,000.
B) 210,000.
C) 150,000.
C
Connecticut’s January 1 balance of common shares outstanding is adjusted retroactively for the 1 for 3 reverse stock split, meaning there are (360,000 / 3) = 120,000 “new” shares treated as if they had been outstanding since January 1. The weighted average of the shares issued in July, (60,000 × 6 / 12) = 30,000 is added to that figure, for a total of 150,000.
When analyzing profitability ratios, which inventory accounting method is preferred?
A) Weighted average.
B) Last in, first out (LIFO).
C) First in, first out (FIFO).
B (第一次有选对但理由不一样）
Using LIFO cost of goods sold (COGS) gives a more accurate measure of future earnings because the LIFO COGS is more representative of the current cost of product sold as compared to using FIFO therefore net income will be more accurately represented.
In periods of rising prices and stable or increasing inventory quantities, using the LIFO method for inventory accounting compared to FIFO will result in:
A)
higher cost of sales, lower income, higher cash flows, and lower inventory.
B)
lower cost of sales, higher income, identical cash flows, and lower inventory.
C)
higher cost of sales, lower income, lower cash flows, and lower inventory.
A In periods of rising prices and stable or increasing inventory quantities, the LIFO method will result in - higher cost of sales, - lower taxes, - lower net income, - lower inventory balances, - lower working capital, and - higher cash flows.
Quick ratio vs. current ratio?
Quick ratio = (cash + marketable securities + receivables) / current liabilities
Current ratio = (cash + marketable securities + receivables + inventory) / current liabilities
Paragon Company’s operating profits are $100,000, interest expense is $25,000, and earnings before taxes are $75,000. What is Paragon’s interest coverage ratio?
A) 3 times.
B) 1 time.
C) 4 times.
C
ICR = operating profit ÷ Interest = EBIT ÷ Interest
= 100,000 ÷ 25000 = 4
Pinto Corporation is an automobile manufacturer located in North America. Pinto owns a 5 percent interest in one of its suppliers, Continental Supply Company. Each year, Pinto receives a cash dividend from Continental. Pinto’s engine supplier, National Supply Company, recently increased prices on goods sold to all customers due to higher labor costs. Should Pinto report the dividends received from Continental and the price increase from National as an operating or nonoperating component on its year-end income statement?
A) Only one is operating.
B) Both are operating.
C) Both are nonoperating.
A
Since Pinto is a nonfinancial firm, dividends received would be considered a nonoperating component. An increase in cost of goods sold would be considered a part of normal operations.
Selected information from Kentucky Corp.’s financial statements for the year ended December 31 was as follows (in $ millions):
Property, Plant & Equip. = 10
Deferred Tax Liability = 0.6
Accumulated Depreciation= (4)
The balances were all associated with a single asset. The asset was permanently impaired and has a present value of future cash flows of $4 million. After Kentucky writes down the asset, Kentucky’s tax accounts will be affected as follows (the tax rate is 40%):
A) taxes payable will decrease $800,000.
B) deferred tax liability will be eliminated and deferred tax assets will increase $1.4 million.
C) deferred tax liability will be eliminated and deferred tax assets will increase $200,000.
C （remember it is a permanent write down but the asset is not disposed)
A permanently impaired asset must be written down to the present value of its future cash flows. The asset’s carrying value of ($10 − $4 =) $6 million must be reduced by $2 million to $4 million. An impaired value write-down reduces net income for accounting purposes, but not for tax purposes until the asset is sold or disposed of, so taxes payable do not decrease. At a 40% tax rate, the eventual writedown for tax purposes of $2 million will cause $800,000 of changes in deferred tax items. The $600,000 deferred tax liability associated with this asset is eliminated and a deferred tax asset of $200,000 is established.
Crawford Corp. and Vernon Corp. are lessors who have leased assets on identical terms to firms with similar credit ratings. Crawford reports its lease as a sales-type lease and Vernon reports its lease as a direct financing lease. It is most likely that:
A) Crawford retains the leased asset on its balance sheet. B) Vernon reports under IFRS. C) both firms report under U.S. GAAP.
C
For a lessor, under U.S. GAAP, a capital lease may be reported as either a sales-type or direct financing lease. This distinction is not made for a financing (capital) lease under IFRS.
Which of the following is least likely to be a motivation for managers to issue financial reports of low quality?
A)
Enhancement of the manager’s career.
B)
Keeping earnings above the same period in the prior year.
C)
Accounting controls are weak within the company.
C (this is an opportunity, not motivation)
Weak accounting controls may offer an opportunity to issue low quality reports but is not in itself a motivation to do so. The other two choices are motivations that might cause management to issue low quality financial reports.
A company must report separate financial information for any segment of their business which:
A)
accounts for more than 10% of the firm’s assets and has risk and return characteristics distinguishable from the company’s other lines of business.
B)
is more than 20% of a firm’s revenues.
C)
is located in a country other than the firm’s home country.
A
Financial statement items must be reported separately for any segment of a firm’s business that is greater than 10% of revenue or assets and has risk and return characteristics that are distinguishable from those of the company’s other lines of business. Requirements for reporting of geographic segments have the same size threshold and the segment must operate in a business environment that is different from that of the firm’s other segments.
For the year ended December 31, 2007, Gremlin Corporation reported the following transactions:
Issued 5,000 shares of preferred stock for land with a fair value of $4.8 million.
Purchased a patent for $3.3 million cash.
Acquired 40% of the common stock of an affiliate for $2.7 million cash which was borrowed from a bank.
Exchanged equipment with a book value of $1.7 million for equipment valued at $2.1 million. The exchange was an even trade.
Converted bonds payable with a book value of $5 million to 50,000 shares of common stock with a fair value of $6 million.
Calculate Gremlin’s cash flow from investing activities and cash flow from financing activities for the year ended December 31, 2007.
Cash flow from investing activities Cash flow from financing activities
A) $1.7 million inflow $1.3 million outflow
B) $6.0 million outflow $2.7 million inflow
C) $2.7 million outflow $6.0 million inflow
B
Only the acquisition of common stock of the affiliate for $2.7 million and the purchase of the patent for $3.3 million are included in cash flow from investing activities. Since the acquisition of the stock purchase was financed with a bank loan, $2.7 million will be reported as a financing inflow. Both remaining transactions are non-cash transactions and are disclosed in the notes to or in a supplementarty schedule to the cash flow statement.
Under U.S. GAAP, if a reliable estimate of total costs of a long-term contract does not exist, which of the following revenue recognition methods should be used?
A) Percentage-of-completion method.
B) Completed contract method.
C) Cost recovery method.
B
The percentage-of-completion method is used when ultimate payment is assured and revenue is earned as costs are incurred. Profit is recognized corresponding to the percentage of costs incurred to the total estimated.
If the total cost of a long-term contract cannot be estimated reliably, U.S. GAAP requires the completed contract method to be used for revenue recognition. The cost recovery method is used for installment sales when future cash collections are not assured.
For publicly traded firms in the United States, the Management Discussion and Analysis (MD&A) portion of the financial disclosure is least likely required to discuss:
A) results of operations.
B) unusual or infrequent items.
C) capital resources and liquidity.
*MD&A should include which parts (3)
B
For publicly traded U.S. firms, the MD&A portion of the financial disclosure is required to discuss results of operations, capital resources and liquidity and a general business overview based on known trends. A discussion of unusual or infrequent items may be included in the MD&A, but is not required.
Formula for quick ratio and current ratio?
quick = (cash + AR) / (current liabilities) current = current assets/current liabilities
According to the converged standards for revenue recognition issued in May 2014, a promise to transfer a distinct good or service is most accurately described as a:
A) performance obligation.
B) transaction.
C) contract.
A
Under IFRS, if a firm reports investment property using the fair value model, unrealized gains and losses on investment property are:
A) recognized in other comprehensive income.
B) recognized on the income statement.
C) disclosed in the financial statement notes.
B
The traditional DuPont equation shows ROE equal to:
A)
net income/assets × sales/equity × assets/sales.
B)
EBIT/sales × sales/assets × assets/equity × (1 - tax rate).
C)
net income/sales × sales/assets × assets/equity.
C
Profit margin × asset turnover × financial leverage. Although option A (net income/assets × sales/equity × assets/sales) also yields ROE, it is not the DuPont equation.
Over time, the reported amount of the annual interest expense on a long-term bond issued at a discount will:
A) remain constant.
B) increase.
C) decrease.
B
A portion of the discount must be amortized to the interest expense each year. The amortized amount is debited to interest expense and credited to debt. So debt goes up. The interest expense is debt times the effective interest rate. Thus, interest expense will increase over time.
Davis Inc. is a large manufacturing company operating in several European countries. Davis has long-lived assets that are valued on the balance sheet at $600 million. This includes previously recognized revaluation losses of $80 million. In the most recent accounting period, the fair value of these assets in an active market is $690 million. Which of the following entries will Davis record under the IFRS revaluation model?
A) Gain on income statement only.
B) Gain on income statement and a revaluation surplus.
C) Revaluation surplus only.
B
Under IFRS, firms may choose to report long-lived assets at fair value. Upward revaluations are permitted and will result in a gain recognized on the income statement to the extent it reverses a previously recognized loss. Any excess is reported as a revaluation surplus, a direct adjustment to equity. In this case, the carrying value of the assets is $600 million and the fair value is $690 million. Of the $90 million excess of fair value over carrying value, $80 million is recognized as a gain on the income statement to reverse the $80 million loss that was previously recognized. The remaining $10 million is recorded as revaluation surplus in shareholders’ equity.
Question From: Session 8 > Reading 29 > LOS h
Which of the following situations will most likely require a company to record a valuation allowance on its balance sheet?
A)
A firm is unlikely to have future taxable income that would enable it to take advantage of deferred tax assets.
B)
A firm has differences between taxable and pretax income that are never expected to reverse.
C)
To report depreciation, a firm uses the double-declining balance method for tax purposes and the straight-line method for financial reporting purposes.
A
A valuation allowance is a contra account (offset) against deferred tax assets that reflects the likelihood that the deferred tax assets will never be realized. If a firm is unlikely to have future taxable income, it would be unlikely to ever use its deferred tax assets, and therefore must record a valuation allowance.
Session 8 > Reading 30 > LOS g
Under which financial reporting standards is the full amount of a deferred tax asset shown on the balance sheet, regardless of its probability of being realized fully?
A) IFRS, but not U.S. GAAP.
B) Neither IFRS nor U.S. GAAP.
C) U.S. GAAP, but not IFRS.
C
Under U.S. GAAP, the full amount of a DTA is shown on the balance sheet, with a contra account (valuation allowance) if it is likely that the full amount of the DTA will not be realized in the future. Under IFRS, the reported value of a DTA is reduced if there is a positive probability that the full amount of the DTA will not be realized in the future.
Which of the following is least likely one of the general requirements for financial statements under IFRS?
A)
Statements should be prepared under a going concern assumption.
B)
Statements should be prepared at least quarterly.
C)
No offsetting of income against expenses unless a standard permits or requires it.
B
IFRS require reporting at least annually. The other two choices are requirements included in IAS No. 1.
For impaired long-lived assets, a firm reporting under IFRS is least likely required to disclose the:
A)
estimated probabilities of reversing impairment losses.
B)
amounts of impairment losses and reversals by asset class.
C)
circumstances that caused the impairment losses or reversals.
A
Under IFRS, firms with impaired assets must disclose the amounts of impairment losses and reversals by asset class, the circumstances that caused the impairment losses or reversals, and where the losses or reversals are recognized on the income statement.
For a firm that uses the LIFO inventory cost method, a LIFO liquidation occurs if:
A) inventory quantity decreases during a reporting period.
B) the firm changes to a different inventory cost method.
C) sales decrease during a reporting period.
A
LIFO liquidation occurs when the quantity of inventory decreases during a reporting period. In an increasing price environment this results in older, lower costs being included in COGS for the period.
Which type of a capital structure contains no dilutive securities?
A) Complex.
B) Basic.
C) Simple.
C
A complex capital structure contains potentially dilutive securities such as options, warrants, or convertible securities. There is no basic capital structure but there are basic earnings per share which does NOT consider the effects of any dilutive securities in the computation of EPS.
If prices are decreasing, the best estimates of inventory and cost of goods sold from an analyst’s point of view are provided by:
A) FIFO inventory and FIFO cost of goods sold.
B) FIFO inventory and LIFO cost of goods sold.
C) LIFO inventory and FIFO cost of goods sold.
B
Whether prices are increasing or decreasing, LIFO cost of goods sold and FIFO inventory are preferred because they are the closest estimates of current costs.
At the beginning of the year, Alpha Corporation purchased 10,000 shares of Beta Corporation for $20 per share. During the year, Beta paid a $2,000 cash dividend to Alpha. At the end of the year, Beta’s stock was selling for $22 per share. What amount should Alpha recognize in its year-end income statement if the investment is treated as an available-for-sale security and what amount should be recognized in the income statement if the investment is treated as a trading security?
Available-for-sale Trading security A) $2,000 $22,000 B) $0 $22,000 C) $2,000 $20,000
A
Unrealized gains and losses from trading securities are recognized in the income statement while unrealized gains and losses from available-for-sale securities bypass the income statement and are reported as other comprehensive income, a component of stockholders’ equity. Cash dividends are recognized in the income statement for both trading and available-for-sale securities. Thus, Alpha will recognize only the $2,000 dividend if the shares are considered available-for-sale and will recognize $22,000 ($2,000 dividend + $20,000 unrealized gain) if the shares are considered trading securities.
Under U.S. GAAP, which of the following statements regarding the disclosure of deferred taxes in a company’s balance sheet is most accurate?
A)
Current deferred tax liability, current deferred tax asset, noncurrent deferred tax liability and noncurrent deferred tax asset are each disclosed separately.
B)
Current deferred tax liability and noncurrent deferred tax asset are netted, resulting in the disclosure of a net noncurrent deferred tax liability or asset.
C)
There should be a combined disclosure of all deferred tax assets and liablities.
*what about IFRS?
A
Under U.S. GAAP, deferred tax assets and liabilities are classified as current or noncurrent, based on the underlying asset or liability. Under IFRS, deferred tax items are classified as noncurrent.
A firm determines that inventory of manufactured goods with a cost of 10 million has a net realizable value of 9 million and writes down its carrying value to this amount. One period later, the firm determines that the net realizable value of this inventory has increased to 11 million. Under IFRS, the carrying value of this inventory:
A) must remain valued at 9 million.
B) may be revalued up to 10 million.
C) may be revalued up to 11 million.
*how about GAAP?
B
Under IFRS, inventory is measured at the lower of cost or net realizable value. Inventory that has been written down can later be revalued upward if its net realizable value recovers, but only to the extent that reverses the writedown (i.e., no higher than cost). Under U.S. GAAP, inventory that has been written down may not be revalued upward.
An IFRS-reporting firm reclassifies a building it owns from “owner-occupied” to “investment property.” The fair value of the building is greater than its carrying value. Under the fair value model for investment property, the firm will recognize a gain:
A) only if it reverses a previously recognized loss
B) equal to the difference between fair value and carrying value.
C) in other comprehensive income but not on the income statement.
A
When reclassifying a property from owner-occupied to investment property and using the fair value model for valuation of investment property, IFRS specifies that the firm should treat the event as a revaluation, recognizing a gain only if it reverses a previously recognized loss.
Guidance from the U.S. Securities and Exchange Commission regarding the criteria for revenue recognition least likely specifies that there must be:
A) reasonable assurance that the product will be delivered or the service will be rendered.
B) a determined or determinable price.
C) evidence of an arrangement between the buyer and the seller.
*What are the criteria (4)
A
Criteria:
- The product has been delivered or the service has been rendered.
- The other criteria are evidence of an arrangement between the buyer and seller;
- The price has been determined or is determinable;
- and the seller is reasonably assured of collecting money.
The approach to revenue recognition in the converged accounting standards that were issued in May 2014 is best described as:
A) objectives-based.
B) principles-based.
C) rules-based.
B
Question From: Session 7 > Reading 24 > LOS d
Under a finance lease (versus an operating lease) which of the lessee’s financial ratios will be higher?
A) Asset turnover.
B) Debt/equity.
C) Return on equity.
B
The debt/equity ratio will be higher because the finance lease requires the creation of a long-term liability on the balance sheet.
gross profit margin = ?
Operating profit margin = ?
Gross profit margin = gross profit / net sales
Operating profit margin = EBIT / net sales
Christophe Inc. is an electronics manufacturing firm. It owns equipment with a tax basis of $800,000 and a carrying value of $600,000 as the result an impairment charge. It also has a tax loss carryforward of $300,000 that is expected to be utilized within the next year or two. The tax rate on these items is 40% but the tax rate will decrease to 35%. Which of the following is closest to the effect on the income statement of the change in tax rate?
A) Decrease income tax expense by $5,000.
B) Increase income tax expense by $25,000.
C) Increase income tax expense by $5,000.
B
The $200,000 difference between the tax base and the carrying value of the equipment gives rise to a deductible temporary difference that leads to a deferred tax asset (DTA) of $80,000 ($200,000 × 40%). The tax loss carryforward of $300,000 also leads to a DTA but for $120,000 ($300,000 × 40%).
The decrease in the tax rate from 40% to 35% will reduce the DTA of the equipment by $10,000 ($200,000 × 5%). It will reduce the DTA of the tax loss carryforward by $15,000 ($300,000 × 5%). In total, the DTA will decrease by $25,000. The decrease in the value of the DTA will increase income tax expense by $25,000 in the period when the DTA is decreased.
To adjust for operating leases before calculating financial statement ratios, what value should an analyst add to a firm’s liabilities?
A) Sum of future operating lease obligations.
B) Present value of future operating lease payments.
C) Difference between present values of lease payments and the asset’s future earnings.
B
What would be the impact on a firm’s return on assets ratio (ROA) of the following independent transactions, assuming ROA is less than one?
Transaction #1 - A firm owned investment securities that were classified as available-for-sale and there was a recent decrease in the fair value of these securities.
Transaction #2 - A firm owned investment securities that were classified as trading securities and there was recent increase in the fair value of the securities.
Transaction #1 Transaction #2
A) Higher Lower
B) Lower Higher
C) Higher Higher
C
Available-for-sale securities are reported on the balance sheet at fair value and any unrealized gains and losses bypass the income statement and are reported as an adjustment to equity. Thus, a decrease in fair value will result in a higher ROA ratio (lower assets). Trading securities are also reported on the balance sheet at fair value; however, the unrealized gains and losses are recognized in the income statement. Therefore, an increase in fair value will result in higher ROA. In this case, both the numerator and denominator are higher; however, since the ratio is less than one, the percentage change of the numerator is greater than the percentage change of the denominator, so the ratio will increase.
Mechanisms that enforce discipline over financial reporting quality least likely include:
A) government securities regulators.
B) counterparties to private contracts.
C) accounting standard-setting bodies.
C
Accounting standard-setting bodies issue financial reporting standards but do not enforce compliance with them. Securities regulators and counterparties to private contracts are among the mechanisms that discipline financial reporting quality.
If management is manipulating financial reporting to avoid breaching an interest coverage ratio covenant on the firm’s debt, they are most likely to:
A) overstate earnings.
B) understate assets.
C) capitalize leases.
*what’s interest coverage ratio?
A
Interest Coverage Ratio = EBIT/interest exp
Debt covenants may require a firm to maintain a minimum interest coverage ratio (EBIT / interest expense). Manipulating the financial statements to increase the interest coverage ratio would most likely involve overstating earnings, or possibly understating liabilities (for example by using operating leases instead of capital leases) to decrease interest expense. Understating or overstating assets would not affect the interest coverage ratio.
At the end of 20X8, Martin Inc. estimates that $26,000 of warranty repairs will be required in the future on goods already sold. For tax purposes, warranty expense is not deductible until the work is actually performed. The firm believes that the warranty work will be required over the next two years. The tax base of the warranty liability at the end of 20X8 is:
A) $13,000.
B) $26,000.
C) zero.
C
The carrying value of the warranty liability is $26,000 (the same amount is recorded as a liability on the balance sheet and as an expense on the income statement). The tax base is equal to the carrying value less any amounts deductible in the future. Therefore, the tax base is $0 ($26,000 − $26,000) since the warranty expense will be deductible when the work is performed next year.
Question From: Session 8 > Reading 30 > LOS c
LIFO liquidation may result when:
A) purchases are more than goods sold.
B) purchases are less than goods sold.
C) cost of goods sold is less than the available inventory.
B
For LIFO companies, when more goods are sold than are purchased during a period, the goods held in opening inventory are in included in COGS. This will result in LIFO liquidation.
Which of the following statements about tax deferrals is NOT correct?
A) A deferred tax liability is expected to result in future cash outflow.
B) Taxes payable are determined by pretax income and the tax rate.
C) Income tax paid can include payments or refunds for other years.
B
Taxes payable are the taxes due to the government and are determined by taxable income and the tax rate. Note that pretax income is income before tax expense and is used for financial reporting. Taxable income is the income based upon IRS rules that determines taxes due and is used for tax reporting.
Which of the following financial reporting choices is permitted under IFRS but not under U.S. GAAP?
A) Excluding actuarial gains and losses from balance sheet pension items.
B) Netting deferred tax assets with deferred tax liabilities.
C) Revaluing plant and equipment upward.
C
Upward revaluation of long-lived assets is permitted under IFRS. Under U.S. GAAP, most assets (other than certain financial instruments) may not be revalued upward. Neither netting deferred tax assets with deferred tax liabilities nor excluding actuarial gains and losses from balance sheet pension items is permitted under IFRS or U.S. GAAP.
In calculating the numerator for diluted earnings per share, the dividends on convertible preferred stock are:
A) added to earnings available to common shareholders without an adjustment for taxes.
B) added to earnings available to common shareholders with an adjustment for taxes.
C) subtracted from earnings available to common shareholders without an adjustment for taxes.
A
Diluted EPS = [(Net income − Preferred dividends) + Convertible preferred dividends + (Convertible debt interest)(1 − t)] / [(Weighted average shares) + (Shares from conversion of conv. pfd shares) + (Shares from conversion of conv. debt) + (Shares issuable from stock options or warrants)]
Interest coverage ratio = ?
Net profit margin = ?
Interest coverage ratio = (EBIT / interest expense)
Net profit margin = (net income / net sales)
Which of the following ratios would least likely measure liquidity?
A) Current ratio.
B) Quick ratio.
C) Return on assets (ROA).
*Ratios that measure liquidity? (6)
C
ROA = (EBIT / average total assets) which measures management’s ability and efficiency in using the firm’s assets to generate operating profits.
Ratios that measure liquidity (if a company can pay its current bills):
- quick ratio = (cash + marketable securities + AR) / current liabilities
- cash ratio = cash and cash equivalents / current liabilities
- current ratio = current assets / current liabilities
- receivables turnover = sales / avg AR
- inventory turnover = COGS / avg inventory
- payables turnover = supplier purchase / avg AP
For a company uses the LIFO inventory valuation method, a financial analyst can adjust the current ratio to the FIFO method by:
A) adding the LIFO reserve to current assets.
B) subtracting the LIFO reserve from current assets.
C) adding the LIFO reserve to current liabilities.
A
FIFO inventory = LIFO inventory + LIFO reserve, and inventory is included in current assets, the numerator in the current ratio.
Compared to a firm that purchases a PP&E asset for cash and capitalizes the asset, a firm that leases the same asset with an operating lease will have lower:
A) current liabilities.
B) long-term liabilities.
C) long-lived assets.
C
With an operating lease, the lessee does not recognize a long-lived asset on its balance sheet. Neither an operating lease nor a capitalized purchase for cash involves a balance sheet liability.
An analyst gathers the following information about a firm:
Last in, first out (LIFO) inventory = $10,000 Beginning LIFO reserve = $2,500 Ending LIFO reserve = $4,000 LIFO cost of goods sold = $15,000 LIFO net income = $1,500 Tax rate is 40%
To convert the financial statements to a FIFO basis, the amount the analyst should add to the stockholders’ equity is closest to:
A) $2,800.
B) $4,000.
C) $2,400.
C
If the firm had used FIFO inventory cost, tax liability would be higher by (LIFO reserve × tax rate) and retained earnings would be higher by [LIFO reserve × (1 − tax rate)].
(LIFO reserve)(1 − t) = $4,000(1 − 0.4) = $2,400.
To convert a firm’s financial statements from LIFO to what they would have been under FIFO:
- Add the LIFO reserve to LIFO inventory.
- Subtract the change in the LIFO reserve for the period from COGS.
- Decrease cash by LIFO reserve × tax rate.
- Increase retained earnings (equity) by LIFO reserve × (1 - tax rate).
Jerry Krome, CFA, is an equity analyst. The head of research at Krome’s firm composes a memo that contains the following statements:
- To the extent that management has discretion over the firm’s revenue recognition, an analyst should consider policies that recognize revenue later to be more conservative than policies that recognize revenue sooner.
- When comparing the performance of companies, an analyst can always use the information in the financial statement disclosures to adjust the financial statements for differences in revenue recognition policies.
With regard to the implications of revenue recognition policies for financial analysis, Krome should agree with:
A) only one of these statements.
B) both of these statements.
C) neither of these statements.
A
(picked both the first time, can’t always adjust, can only use the info to better understand the difference)
**always = warning sign
Because revenue recognition often relies on judgment and estimates from management, it is not always possible to calculate the appropriate adjustments that would account for the differences between companies’ revenue recognition policies. An analyst should use the policies disclosed in companies’ financial statement footnotes to understand the degree to which their revenue recognition is conservative or aggressive. In general, recognizing revenue sooner is considered aggressive and recognizing revenue later is considered conservative.
Which of the following statements that classify a lease as a finance lease under U.S. GAAP is least accurate?
A) The present value of the lease payments is at least 80% of the fair market value of the asset.
B) A bargain purchase option exists.
C) Title is transferred at the end of the lease period.
Under IFRS, if substantially all the rights and risks of ownership are transferred to the lessee, the lease is treated as a finance lease by both the lessee and lessor. Otherwise, the lease is an operating lease.
Under U.S. GAAP, the lessee must treat a lease as a capital (finance) lease if any one of the following criteria is met:
- Title to the leased asset is transferred to the lessee at the end of the lease period.
- A bargain purchase option exists.
- The lease period is 75% or more of the asset’s economic life.
- The present value of the lease payments is 90% or more of the fair value of the leased asset.
Under U.S. GAAP, the lessor capitalizes the lease if any one of the finance lease criteria for lessees is met, collectability of lease payments is reasonably certain, and the lessor has substantially completed performance.
For further reference:
SchweserNotes: Book 3 p.282
If a lease is treated as a finance lease, as compared to being treated as an operating lease, the effect on the lessee’s current ratio and the debt/equity ratio will be an:
Current Ratio Debt/Equity Ratio A) Increase Increase B) Decrease Increase C) Increase Decrease
B - With finance leases the lessee’s assets, current liabilities, and long-term liabilities will be greater than if the lease was an operating lease
A finance lease is, in substance, a purchase of an asset that is financed with debt. At any point in time, the lease liability is equal to the present value of the remaining lease payments.
From the lessee’s perspective, finance lease expense consists of depreciation of the asset and interest on the loan. The finance lease payment consists of an operating outflow of cash (interest expense) and a financing outflow of cash (principal reduction).
An operating lease is simply a rental arrangement; no asset or liability is reported by the lessee. The rental payment is reported as an expense and as an operating outflow of cash.
From the lessor’s perspective, a finance lease is either a sales-type lease or a direct financing lease. In either case, a lease receivable is created at the inception of the lease, equal to the present value of the lease payments. The lease payments are treated as part interest income (CFO) and part principal reduction (CFI).
With a sales-type lease, the lessor recognizes gross profit at the inception of the lease and interest income over the life of the lease. With a direct financing lease, the lessor recognizes interest income only.
For further reference:
SchweserNotes: Book 3 p.283
An analyst has decided to identify value stocks for investment by screening for companies with high book-to-market ratios and high dividend yields. A potential drawback of using these screens to find value stocks is that the firms selected may:
A) be those that have significantly underperformed the market.
B) have unsustainable dividend payments.
C) be concentrated in specific industries.
C
A screen for firms with high dividend yields and high book-to-market ratios would likely result in an inordinate proportion of financial services companies and add a significant element of industry (sector) risk. Uncertainty about sustainability of dividend payments and recent market underperformance are typical characteristics of value stocks in general and not a drawback to using this screen to identify them.
Question From: Session 9 > Reading 33 > LOS d
An analyst gathered the following information about a company:
Taxable income = $100,000.
Pretax income = $120,000.
Tax rate = 20%.
Assuming the difference between taxable income and pretax income will reverse in the future, the effect these events on the company’s financial statements will be to report income tax expense of:
A)
$24,000 and a decrease in deferred tax assets of $4,000.
B)
$22,000 with no change in deferred tax items.
C)
$24,000 and an addition to deferred tax liabilities of $4,000.
*What’s the formula for tax expense?
C
Deferred tax liability = (120,000 − 100,000) × 0.2 = 4,000
!! Tax expense = current tax rate × taxable income + change in deferred tax liability
0.2 × 100,000 + 4,000 = 24,000
