CC Fsa

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This files has expired at 30-Jun-13
Crash Course for FSA CFA Level-I Exam
Financial Reporting and Analysis
Financial Statements Framework
FS Reporting The way companies depict their financial performance & health to investors Income statement: financial performance in terms of operational gains / losses over a period of time Balance sheet: financial health of a firm in terms of assets & liabilities as on date. Owners equity = Assets - Liabilities Cash flow statement: cash inflow & outflow for a period of time Cash flow = operating + investing + financing cash flow
Reporting Standards
Reporting Quality
International Standards Convergence
Footnotes: disclosures to provide detailed information like accounting methods, assumptions, legal actions, contingencies, sales to related parties Management Discussion & Analysis: assessment of financial performance discussion on industry trends, capital resources, general business overview discussion on accounting policies requiring significant judgments
Auditors opinion: unqualified opinion by auditor indicates statements are free from material omissions & errors
Neev Knowledge Management Pristine
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FS Reporting
Reporting Standards
Reporting Quality
Principles for preparing FS: Fair representation: faithful representation of transactions Going concern: based on the assumption that firm will continue to exist Accrual basis: transactions are recorded when they occur irrespective of cash flow Consistency: consistency in presentation of a/cs between periods Materiality: free of misstatements or omissions
IFRS framework International Accounting Standard Board (IASB) goals: Global accounting standards with transparency, compatibility, & higher reporting quality Promote the use of global accounting standards Convergence between national GAAP standards and global a/cing standards Needs of emerging nations & small firms in implementation of global a/cing standards IFRS is a largely principle based approach with following characteristics: Understandability: easy to comprehend and Comparability: comparable among firms and across time periods Relevance: sufficiently detailed & relevant information Reliability: should reflect economic reality Q. Which of the following characteristics least likely to contribute to the relevance? A. Detailed footnotes B. Qualified opinion by auditor C. Annual report available on request Ans. Annual report available on request act as a barrier in information dissipation and hence does not contribute towards relevance
US GAAP framework
Q. Which of the following is least likely to be true in case of a company which report its earnings according to IFRS? CF Operations CF Financing a) Interest received Interest paid b) Dividends paid Interest received c) Dividend received Dividend paid Ans. In case of IFRS interest received cannot be classified under Cash flow from financing and hence answer is B
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FS Reporting
Reporting Standards
Reporting Quality
Principles for preparing FS: Fair representation: faithful representation of transactions Going concern: based on the assumption that firm will continue to exist Accrual basis: transactions are recorded when they occur irrespective of cash flow Consistency: consistency in presentation of a/cs between periods Materiality: free of misstatements or omissions
IFRS framework
US GAAP framework This files has expired at 30-Jun-13 Financial Accounting Standards Board (FASB) has similar framework, but its rule based approach and differ in some aspects FASB defines assets as a future economic benefit, IASB defines it as a resource for future economic benefit FASB does not allow upward revision of asset prices Q. Which of the following is least likely to be true in case of a company which report its earnings according to US GAAP? CF Operations CF Financing a) Interest paid Dividends paid b) Dividends received Interest paid c) Interest received Dividend paid Ans. In case of US GAAP interest paid cannot be classified under Cash flow from financing and hence answer is B
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FS Reporting
Reporting Standards
Reporting Quality
Fraud Triangle: Incentive to commit fraud Opportunity provided by weak internal control Attitudes which justifies fraudulent behavior
Risk factors related to incentive to commit fraud: threat to financial profitability due to external factors excessive third party pressure on mgmt threat to personal net worth of management pressure to meet internal financial targets

Risk factors related to opportunities that exists: ineffective mgmt monitoring complex or unstable organizational structure deficient internal controls nature of the firms industry or operations
Warning signs: aggressive revenue recognition abnormal growth rate compared to industry abnormal inventory growth compared to sales growth delaying expense recognition LIFO liquidation extending useful lives of long term assets aggressive pension assumptions off balance sheet special purpose entities higher use of operating leases
Risk factors related to attitudes: inappropriate ethical standards known history of violations of law Managements obsession with increasing stock price making commitment to third parties regarding earning performance
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FS Reporting
Reporting Standards
Reporting Quality
Convergence of IFRS & US GAAP is ongoing process, but material differences in their accounting standards are listed below: LIFO method is allowed under US GAAP but not allowed under IFRS IFRS allows upward revaluation of PP&E, but US GAAP does not allow upward revision US GAAP recommends equity method of a/cing for joint ventures, whereas IFRS uses proportionate consolidation US GAAP doesnt permit upward revaluation of intangible assets like goodwill US GAAP allows capitalization of construction interest, IFRS allows capitalization of acquisition, construction interest US GAAP interest received & paid CFO IFRS flexible in terms of classification
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Financial Statement Analysis
Generally Accepted Accounting Principles (GAAP)
Critical Ratios
Inventory Accounting
DuPont Analysis
Basic & diluted EPS
Financial Statement Impacts
Revenue Recognition
Unusual or Infrequent Items
Extraordinary Items (U.S. GAAP)
Discontinued Operations
Compute Cash Flows From Operations (CFO)
Free Cash Flow
Two requirements: 1. Completion of earningsprocess 2. Reasonable assurance of payment. Revenue recognition methods: percentage of completion method. Completed contract method. Installment sales. Cost recovery method.
Gains/losses from disposal of a business segment Gains/losses from sale of assets or investments in subsidiaries. Impairments, write-offs, writedowns, & restructuring costs. Integration expenses associated with businesses recently acquired.
Similar to unusual/infrequent items, extraordinary items are both unusual & infrequent in occurrence, and material in nature (e.g., losses from expropriation of assets). IFRS does not allow extraordinary items to be separated from operating results.
Q. Contract to build a ship for $1,000 and a reliable estimate of the total cost is $800. Find Net Income using % of completion method? Ans
Year Cost 2010 $400 2011 $300 2012 $100 Total $800
Year
Rev NI
2010
500 100
2011
375 75
2012
125 25
Total
1,000 200
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Revenue Recognition
Free Cash Flow
To be accounted for as a discontinued operation, a business assets, operations have been decided to sell off by mgmt but not yet disposed off. Income / losses are reported net of tax after net income from continuing operations.
Direct Method- Start with cash collections (cash equivalent of sales); cash inputs (cash equivalent of COGS); cash operating expenses; cash interest expense; cash taxes.
Indirect Method- Start with net income, subtracting back gains & adding back losses resulting from financing or investment cash flows, adding back all noncash charges, and adding / subtracting asset & liability a/c that result from operations
Operating Cash Flow Direct Method Cash collections from Customers Cash Paid to Suppliers Cash Paid for operating Expenses $429,980 (265,866) (124,784)
Cash paid for interest

Cash Paid for taxes Operating Cash Flow
(4,326)
(14,956) $20,048
Net Income Adjustment to net income Depreciation and amortization Deferred income tax Increase in accounts receivables Increase in inventory Decrease in prepaid expenses Increase in accounts payables Increase in accrued liabilities Operating Cash flow
$18,788 7,996 416 (1,220) (20,544) 496 13,406 712 $20,048
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Revenue Recognition
Free Cash Flow
Free cash flow (FCF) measures cash available for discretionary purposes. It is equal to operating cash flow less net capital expenditures.
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Common-size balance sheet expresses all balance sheet items as a percentage of total assets. Common-size income statement expresses all income statement items as percentage of sales. Common-size cash flow statement expresses each cash inflow/outflow as a percentage of total cash inflow/outflow, or as a percentage of revenue. Horizontal Common-size financial statement analysis: Expresses each line item relative to its value in a common base period
Liquidity Ratios
Receivable, Inventory, Payables Turnover Ratios
Total asset, Fixed asset, & Working Capital Turnover Ratios
Gross, Operating & Net Profit margin, Return on Assets
Debt Equity & Total Debt Ratio
Interest & Fixed Charge Coverage
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
Current ratio= current asset / current liabilities(CL) Quick ratio = (current asset - inventory) / CL Cash ratio=(cash + mktable securities) / CL Defensive interval= (cash +mkt. sec. + receivables) / daily cash expenditures
Q. Assuming current assets are $160,000 and current liabilities are $40,000 the current ratio is Ans. 4
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
All of which are used in the cash conversion cycle Receivables turnover = net annual sales / avg. receivables
turnover = This Inventory files has expired at 30-Jun-13 cost of goods sold /
avg. Inventory
Payables turnover ratio = purchases / avg. trade payables
Days of sales outstanding = 365 / receivables turnover
Days of inventory in hand = 365 / inventory turnover
No. of days of payables = 365 / payables turnover
Cash conversion cycle = days of inventory on hold + day of sales outstanding days of payables
Q. If Neev, Inc. has annual sales of $1,000,000, average accounts payable of $400,000, and average accounts receivable of $350,000, Neev's receivables turnover and average collection period are closest to Ans: 2.85, 127.75
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
Total Asset Turnover = Revenue / Avg. total Net asset
Fixed Asset Turnover = Revenue / Avg. net Fixed Asset
Working Capital Turnover = Revenue / avg. Working Capital
Q. Find the Total Asset Turnover Ratio given: Net Sales = $32,500 Net Assets (current year) = $11,400 Net Assets (previous year) = $9,800 Ans. Average Net Assets = ($11,400 + $9,800) / 2 = $10,650 Total Asset Turnover ratio = 32,500 / 10,650 = 3.05
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
Gross, Operating & Net profit margins Gross Profit Margin = Gross Profit / Revenue
on Total Capital : This files has expired atReturn 30-Jun-13 (ROTC) Return on Capital = EBIT/ Avg. Total Capital Q. Neev Corp. earned $20 mn in revenue from producing widgets and ABC's operating profit margin would be 30%. For the financial year 2005 & 2006 total capital was $55 mn & $75 mn. Calculate the return on capital of Neev Corp for the FY2006? Ans. ROC = (20*30%) / [(55+75)/2] = 9.23%
Operating Profit Margin = Operating Profit/ Revenue = EBIT/ Revenue

Net Profit Margin = Net Income / Revenue Neev Corp. earned $10 million in revenue from producing widgets and incurred $5 million in COGS-related expense. ABC's gross profit margin would be 50%.
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
Total Debt Ratio = Total debt/ total asset
Debt to Equity Ratio= Total debt / total equity
If a company has $10 in debt and $20 in equity, it has a debt to equity ratio of 0.5 ($10M/$20M)
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Liquidity Ratios
Interest & Fixedexpired at 30-Jun-13 This files has Growth Rate Charge Coverage g = RR x ROE
Retention rate =1Dividend Payout Ratio
Interest Coverage = EBIT/ Interest
Fixed charge cov = (EBIT + lease payments)/ (Interest + lease payments)
Q. Neev Inc.'s income statement shows sales of $100,000, cost of goods sold of $40,000 pre-interest operating expense of $30,000, and interest expense of $10,000. Neev's interest coverage ratio is approx Ans: 3 times
Year Net Income No. Of Stock Holders Net income per share Dividend Declared Dividend Yield RR ROE G
Company XYZ Company SPK 30,000,000 80,000,000 3,000,000 5,000,000 $10.00 $16.00 $4.00 $6.00 40.00% 37.5% 60% 62.5% 25% 35% 15.00% 21.88%
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
In periods of rising prices & stable or increasing inventory quantities

LIFO results in: High COGS Lower taxes Lower net income (EBT & EAT) Lower inventory balances Lower working capital Higher inventory turnover FIFO results in: Lower COGS Higher taxes Higher net income (EBT & EAT) Higher inventory balances Higher working capital Lower inventory turnover
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
DuPont equation: return on equity = (net income/sales) *(sales/assets)* (asset/Equity) You may also see ROE = (net Profit Margin) *(asset Turnover) *(Equity Multiplier) Q. Firm has net profit margin of 10%; asset turnover of 1.5; a financial leverage of 1.2 times Ans. Return on equity = (10)(1.5)(1.2) = 18%
Extended DuPont eq. ROE= (Net Income/EBT)* (EBT/EBIT)* (EBIT/ revenue)* (Revenue/ avg. total asset)* (avg. total asset/ avg. equity) ROE = tax burden * interest burden * EBIT margin * asset turnover * leverage
Q. Firm has o/p profit margin of 10%; asset turnover of 1.5; a financial leverage of 1.2 times; tax rate of 25%; and interest burden rate of 15%. Ans. Return on equity=(75/25)*15%*10%*1.5*1.2 = 8.1%
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Critical Ratios
DuPont Analysis
Basic & diluted EPS
Basic EPS calculation does not consider effects of any dilutive securities: basic EPS= (net income - preferred dividends) / wtd. avg. no. of common shares outstanding Diluted EPS = available income for common shareholders / (wtd. avg. common shares plus potential common shares outstanding) Therefore, diluted EPS =[(net Income - pfd div) + (Convertible preferred Dividends) + (Convertible Debt Interest)*(1-t) ] / [wtd. avg. shs + shares from conversion of conv. pfd. shares + Shares from conversion of conv. debt + shares issuable due to stock option]
Q. reported net income of $555,600 and 150,000 shares of common stock outstanding for the entire year. 10,000 shares of 6%, $100par, preferred stock outstanding during 2006. During 2005, issued 1000, $1,000 par, 9% of bonds for $1,000,000 (issued at par), convertible to 100 shares of common stock. The tax rate is 40%. Compute the 2006 basic and diluted EPS. Ans. Basic EPS= (555,600-60,000)/150,000= $3.31 Diluted EPS=(555,60060,000+1000*1000*9%(1-0.4)) / (150,000+100,000) = $2.20
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Critical Ratios
DuPont Analysis
Basic & Diluted EPS
Capitalizing vs. Expensing
Depreciation & Impairment
Deferred Taxes
Financing Liabilities
Pension
Leases
Marketable Security Classifications
Inter Corporate Investments
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Critical Ratios
DuPont Analysis
Basic & Diluted EPS
Deferred Taxes
Pension
Leases
Capitalizing: lowers income variability & increases nearterm profits. Increase total assets & equity Expensing: opposite effect.
Depreciation
Impairment
This expired at higher 30-Jun-13 subtract files salvage value, has the double-declining than the sum of
balance method does not. Assuming continued investment in new assets. Relative to a firm that uses accelerated depreciation. A company that uses straight line depreciation will have: Lower: Depreciation expense, turnover ratios. Higher: Net income, assets, equity, ROA, ROE Same: Cash flows.
Calculation: Straight line and SYD methods
Q. Company purchased machine at $6,000. Residual value = $1,000 after 5 years. Ans. Double declining balance method is: Year 1: (2/5)($6,000)= $2,400 Year 2: (2/5)($6,000 - $2,400)= $1,440 Year 3: (2/5)($6,000-$3,840)= $864 Year 4: $296, Year 5: Depreciation expense is $0
Recognized when the carrying value of an asset is the future cash flows (undiscounted) from their use & disposal. This makes impairments subject to mgmt manipulation Loss measured is the carrying value of the asset less the fair value of the asset. Financial Statement impact: Write-down will immediately cause income, asset value, deferred taxes, and equity to decline. It will cause future depreciation to decline, and as a result, future net income will rise. Asset turnover ratios will increase after write down for impairment.
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Critical Ratios
DuPont Analysis
Basic & Diluted EPS
Deferred Taxes
Pension
Leases
Created when taxable income (on tax return) differs from pretax income (financial statement) Deferred tax liabilities (DTR) are created by the use of accelerated depreciation methods for tax purposes (resulting in lower taxable income) & straight line for financial reporting (lower depreciation expense results in higher net income) If DTL are not expected to reverse, treat it as equity for analysis.
Premium bond: coupon rate > market rate at issuance. Discount bond: coupon rate < market rate at issuance. Interest expense equals book value at the beginning of the year multiplied by the market rate of interest at the time the bonds were issued. For premium bonds, CFF is overstated & CFO is understated relative to par bonds.
Q. 3 year, 10% coupon, FV $100,000 trading at $105,221 issued on 31 Dec 2002 when market rate = 6% Ans. Annual interest payment = $100,000*10% = $10,000 interest expense in I/S = 105,221*6% = 6313.26 Amortized value of bond = $105,221 (10,000 6313.26) = $101,534.3
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Critical Ratios
DuPont Analysis
Basic & Diluted EPS
Deferred Taxes
Pension
Leases
Capital /Finance leases result in: Higher: assets, liabilities, CFO, Debt / Equity. Lower: Net income (early years), FCFF, current ratio, working capital, asset turnover, ROA, ROE. Same: Total cash flow. Compared to Operating Leases
Balance Sheet
Income Statement Dividends, interest realized G/L Unrealized G/L Realized G/L Interest, Dividends Interest Realized G/L
Held for Fair value This files has expired at 30-Jun-13 trading
Available Fair value for sale Unrealized G/L part of comprehensive income under shareholders equity Held-to- Amortized cost maturity
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Critical Ratios
DuPont Analysis
Basic & Diluted EPS
Deferred Taxes
Pension
Leases
Defined Contribution Plan Company contributes on a defined amount into the plan Defined amount = pension expense Defined Benefit Plan Company makes promises of future benefits to be paid to its employees Example: 80% of final salary to be paid each year until death
<20% ownership: No significant influence; use accounting methods for passive investments. 20% to 50% ownership: Significant influence; use equity method. Joint control Proportionate consolidation permitted under IFRS only, equity method usually required under US GAAP. > 50% ownership: Control of the investor; use consolidation method.
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Question 1
The owners contribution in a company is $45000. The company pays dividends in the current year on its net income of $37500. The payout ratio being 22.67%. If the retained earnings in the previous year was $ 30000. Find the current balance of the owners equity. A. $59000 B. $104000 C. $75000
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Answer 1
B. Contributed capital Balance (prev year) $45000 Net income Distributions Balance $45000 Retained earnings $30000 $37500 ($8500) $59000 Total $75000 $37500 ($8500) $104000
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Question 2
Strauss Corporation purchases a machine for $50000. The machine has a useful life of 5 years and no residual value. If the double declining method is used which of the following is least likely correct about the depreciation expense? A. The depreciation expense in year 3 is $7200 B. The DDM will never fully depreciate the machine C. The straight line method should be used for year 4 and 5 for depreciating the asset completely
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Answer 2
C.
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Question 3
Goodman and Co has issued $2 million as cash dividend to its preferred share holders and $3.5 million as cash dividend to its common share holders. The net income of the company at the beginning of the year was $180 million. The company issued 120000 new shares in July in addition to the already existing 300000 outstanding shares in the beginning of the year. Find the basic EPS of the firm. A. $423 B. $ 494 C. $ 567
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Answer 3
B. Weighted average no of shares is (12*300000+6*120000)/12 = 360000. The EPS is (180-2)/0.36 = 494
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Question 4
The following information is available regarding a company Ratio Industry Standards Actual for company Net Profit ratio 5% 2.4% Total debt to total assets 7.5% 10% Which of the following is least likely true about the company? A. The company must increase its efforts to reduce the cost of production B. The return on equity is most likely to be lower for the company as compared to the industry standards This files has financial expired at 30-Jun-13 C. The company is likely to carry a higher risk than the industry standards
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Answer 4
B. The company has taken on higher debt than the industry standards. However higher leverage adds to the financial risk but also increase the ROE for the share holders if the ROA is good.
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Question 5
Which of the following statements about goodwill accounting is least likely true: A. Accounting goodwill arises from the expected future performance of the firms assets after the acquisition B. Goodwill is not amortized C. Goodwill, if impaired is reduced and a loss should be recognized in the income statement
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Answer 5
A. It is the economic goodwill that arises from the expected future performance of the firm not accounting goodwill
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Question 6
Seal Corporation would like to change its reporting standards from US GAAP to IFRS. Which of the following changes is most likely to occur with respect to reporting of the cash flow statement? A. The interest and dividends received would be classified as operating activities B. Interest paid on companys debt may be classified as either operating or financing activity C. The taxes paid would be reported as operating activities
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Answer 6
B.
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Question 7
Karl Inc reports the following in its year- end financial statements : Net income of $32 million Depreciation expense $3 million Increase in accounts receivables $ 0.95 million Increase in capital stock of $ 35 million Purchased equipment for $ 12 million Find Karls FCFF. A. $37 million B. $12.56 million This files has expired at C. $22.05 million
30-Jun-13
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Answer 7
C. CF due to operating activities is ($ 32 million + $ 3 million-$ 0.95 million)= $ 34.05. Net capital expenditure is $ 12 million. FCFF = 34.05 12 =$22.05 million
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Question 8
A high inventory turnover ratio to industry norms commensurate with low number of days of inventory can indicate A. Company can have adequate inventory sufficient to handle increased sale. B. Company can have low inventory sufficient to handle increased sale. C. Company may have inadequate inventory leading to shortages in inventory resulting in lost sales and lower revenue.
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Answer 8
B. Since the inventory turnover is high the company would always have low inventory levels to keep pace with the increase level of sales. The inventory management is efficient which indicates it is not likely to lose out on sales.
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Question 9
Which of the following is not a cause of deferred tax assets? A. Post employment benefits B. Warranty expenses C. Municipal bond interest
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Answer 9
C. Municipal bond interest is not taxable. No deferred taxes are recognized
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Question 10
James Company has purchased an asset worth $ 41000 and leased it to Thompson Inc for a period of 5 years. The annual lease payment is $ 10000 to be paid at the end of each year. If the implied interest rate in the lease is 7%, which of the following statements is most likely true about the transaction and accounting? A. It is a sale type lease B. The lessor is most likely to remove the asset from the balance sheet and create a lease receivable in the same amount C. In the cash flow statement the interest portion of the lease payment is reported as inflow from investing
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Answer 10
B. The carrying cost of the asset is same as the present value of the lease payments, therefore it is a direct financing lease.
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Question 11
Which of the following financial statement line items is least likely to affect shareholders equity but does affect income statement of the company? A. Foreign currency translation gains and losses B. Adjustments for pension liability C Realized gains and losses from available for sale securities
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Answer 11
C.
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Question 12
What will be the effect of using LIFO method of inventory accounting instead of FIFO on companys current ratio and debt to equity ratio, assuming there is no LIFO liquidation and prices are rising? Current ratio Debt to equity ratio A. Lower Lower B. Lower Higher C Higher No effect
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Answer 12
B. LIFO will result into lower inventory and lower shareholders equity and hence higher debt/equity ratio and lower current ratio
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Question 13
As on 10th July, 2010 Goodman Inc purchased 100 shares of BBA for $ 105 per share. At the end of the year BBAs share price was $ 95 and during the year BBA paid a dividend of $ 2 per share. What amount of investment income should be recognized by company in its income statement and what amount should be reported on the balance sheet, if the investment is considered an available for sale securities? Investment income Balance sheet value A. $ -800 $ 9,500 B. $ 200 $ 9,500 C. $ -800 $ 10,500
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Answer 13
B. In case of an available for sale securities, only realized gains or losses will be realized in income statement and security should be marked on the balance sheet at fair value. Hence investment income = Rs 2*100= 200
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Question 14
S&P Inc. leases out a crane for its own use for six years with an annual payment of $ 15mn. At the end of the lease period crane will have salvage value of zero and company has the option to purchase the crane from lessee at the discount price. Calculate the interest expense for the first year, if appropriate interest rate is 7%. A. $ 6.3mn B. $ 4.3mn C. $ 5.0 mn
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Answer 14
C. N=6, I/Y=7%, PMT=-15mn, FV=0, Interest expense = 71.5*7% = 5.0mn CPT PV= 71.5mn
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Question 15
During 2009 R&M Corporation reported net income was $ 120.5 mn and had $ 85 mn weighted average number of common shares outstanding for the entire year. R &M had 10,000 outstanding preference shares of face value $ 1000 and paying dividend of 8% end of the year 2009. R &M has 100,000 stock options outstanding at the end of the year, convertible into 100 normal equity shares per option at the strike price of $ 25. Compute the diluted EPS, if average market price of the stock for the entire year 2009 was $ 50? A. $ 1.41 B. $ 1.26 C. $ 1.33
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Answer 15
C. New equity shares= 100000*100= 10,000,000 Repurchase of shares= 10mn*25/50= 5 mn outstanding shares after dilution= 85+5= 90mn Diluted EPS= 120.5mn 10000*8%*1000= 119.7mn diluted EPS= 119.7/90= 1.33mn
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Question 16
Which of the following statements regarding costs incurred by company for developing goodwill and cost associated with acquired goodwill reported on the balance sheet is least likely to be incorrect? A. Company can capitalize the expenses associated with developing goodwill B. Company cannot capitalize the costs associated with research and development of new product or goodwill C. Company cannot capitalize the costs associated with the acquired goodwill
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Answer 16
B.
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Question 17
At the beginning of the year company purchased all 10mn shares of its competitor for $25. Company valued its competitors net assets $25 mn higher than $200 mn reported on its balance sheet just before the acquisition date. What amount of goodwill should company report on its balance sheet as a result of its acquisition of competitor? A. $ 25mn B. $ 50mn C. $ 75mn
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Answer 17
A. Goodwill= 10*$25 ($200+$25) = $25mn
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Question 18
An infrastructure company has launched a new residential cum commercial project. Project is worth of $ 5,000 mn, costs are estimated to be $ 3,000 mn and the time to completion is three years. What will be the effect on the companys second years book value per share and first years cash flow from operations, if company would have chosen percentage of completion method for revenue recognition instead of completed contract method? A. Selection of revenue recognition method will not have any effect on either book value or cash flow from operations B. Book value per share will increase but cash flow from operations will not change C. Both ratios will increase if company opts for percentage of completion method
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Answer 18
B. Percentage of completion method is aggressive in revenue recognition and hence recognizes profit much earlier than completed project method. Thus increases net profit and retained earnings for year two in case of Percentage of completion method.
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Question 19
At the beginning of the year, Thomson Inc. purchased 1mn shares of S&P for $25 per share. During the year S&P paid $5 in the form of final and interim dividend. At the end of financial year shares of S&P were trading at $30 per share. What amount of investment income should Thomson recognize in its income statement if S&P is considered as trading security and an available for sale security? Trading security Available for sale A. $ 5mn $ 10mn B. $ 10mn $ 5mn C. $ 5mn $ 5mn
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Answer 19
B. If shares are classified as trading Securities Company will report unrealized gain of $5 and dividend of $5 per share. If shares are classified as available for sale only dividend income of $5 mn will be reported in income statement
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Question 20
The financial statement is prepared according to IFRS. The carrying value of its inventory was $5.2 million before a $ .3 million write down was recorded in 2007 for Veritose Company. In 2008, the fair value of Veritose Company inventory was $0.5 greater than carrying value. The effect of recovery of Veritose financial statement for inventory is: A. $ 0.5 million B. $ 4.9 million C. $ 0.3 million
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Answer 20
C.
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Question 21
A real estate firm capitalizes expenses as against expensing. Which of the following is most likely to be correct for the firm? A. Stockholders equity is lower B. In later years interest coverage ratio is higher C. Cash flow from investing activities is lower
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Answer 21
C.
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Question 22
A company classifies a 8% bond as held to maturity. If the market rate of interest decreases after the bond is issued, what is the impact on the debt to equity ratio? A. Increases B. Decreases C. No change
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Answer 22
C. Held to maturity securities are reported on the balance sheet at its book value and hence market rate of interest will not have any effect on the reported bond value. Thus there will not be any change in debt equity ratio
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Question 23
IASB expresses the objective of financial statements in "Framework for preparation and presentation of financial statements" What is the objective? A. Financial implications, measurement and changes in assets and liabilities. B. Financial position, performance and changes in financial position of an entity. C. Changes in income and expenses, financial position and changes in assets and liabilities.
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Answer 23
B.
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Question 24
In recording accounting entries on accrual basis, for cash movement prior to accounting recognition, adjusting entry will consider for Unearned (Deferred) Revenue A. Reducing the liability while recording cash received. B. Increasing the liability while recording cash received. C. Eliminate the receivable on cash collection.
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Answer 24
B. Eg: Cash - 100,000 Unearned Revenue 100,000
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Question 25
An internet company buys advertisement space from another internet company in exchange for ad space on its own website for the same value. Which of the following is most likely true under US GAAP and IFRS? A. According to US GAAP the revenue is not recognized. B. According the IFRS the revenue is to be recognized at a discount to market value C. According to IFRS revenue is to be recognized by fair value
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Answer 25
C.
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Question 26
A company is faced with a threat of arrival of a new and improved version of the product that it manufactures in the market. Which of the following inventory accounting method should it follow to minimize its loss? Assume prices are rising at the normal rate of inflation A. LIFO B. FIFO C. Inventory accounting method will not mitigate the losses
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Answer 26
A. Since the company is faced with the threat of obsolescence, it should do away with the latest inventory first to be able to recover the higher costs of inventory.
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Question 27
S & D Company has 20000 shares of common stock outstanding and 1000 shares of convertible preferred stock. It has reported net income of $ 40000. It also has 2000 outstanding warrants all year, convertible to one share each of $25 per share. The convertible10%, $100 par value, outstanding for the entire year, is convertible to 15 shares of common stock. If the tax rate applicable is 35% and the average stock price is $36. Find the diluted EPS of the firm if the preferred stock is converted into common stock at the beginning of the year. A. 1.5 B. 1.12 C. 1.14
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Answer 27
B. The numerator will be $40000 - $10000+$10000 = $40000. The warrants would be exercised and the company would receive $50000 with which the company can repurchase 50000/36= 1389 no of shares. On converting the preferred stock to common stock the no of shares to be issued by the company is 1000*15=15000. EPS = 40000/(20000+15000+2000-1389) = $ 1.12
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Question 28
Frank & Cos equity shares are being traded in the market at $54 per share with a price-earning ratio of 9. It has 10000 equity shares of $10 each and no preference shares. Find the net income. A. $73000 B. $100000 C. $60000
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Answer 28
C. EPS = Market price/p/e ratio = 54/9 =$ 6 EPS = net income/no of shares outstanding Net income = 6*10000 = $ 60000
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Question 29
A pension fund has invested in a 6% bond, at par, for $240000. The yield of the bond has dropped by 2%. Which of the following is least likely true regarding the accounting of the investment? A. The interest income of the bond is reported in the income statement B. The interest income and the unrealised profit on the bond are both reported in the income statement C. The bond is reported in the balance sheet at the amortised cost
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Answer 29
B. Pension funds are long term investors. Hence it is more likely that the bond would be held to maturity. Therefore the unrealized profit is not recognized and reported in the income statement.
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Question 30
The following information is available : Net income Decrease in accounts receivables Depreciation Increase in inventory Increase in deferred tax liability Increase in accounts payable Taxes paid $290 $30 $12 $16 $10 $12 $24
Find the cash flow from operating activities according to the US GAAP. A. $450 B. $224 C. $338
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Answer 30
C. NI + Depreciation + decrease in receivables increase in inventories + increase in accounts payables + increase in deferred tax liability = 290+12+30-16+12+10=338
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Question 31
Parity Inc reported the following from their financial statements: Days of Receivables : 30 days Stock turnover ratio 5 Gross profit ratio 30% Sales of the year 1,000,000
If it plans to introduce a new product, it expects to generate additional annual sales of $200,000 with gross profit rate of 20%. Given that average receivables remain constant find the change in receivables period This files has expired at 30-Jun-13 after the introduction of the new product. A. increase by 6 days B. decrease by 36 days C. decrease by 5 days
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Answer 31
C. No. of days of Receivables = 365/( sales/avg. Receivables) 30 = 365/ (1,000,000/x) x = 82191.78 New days of Receivables = 365/ ( 1,200,000/82191.78) = 25
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Question 32
The sales figure of Rutherford Inc stood at $ 10 million with a gross profit margin of 30%. The company is planning to launch another product in the market with expected annual sales of $2 million. The cost of sales is expected to be $ 1.3 million in the initial year. What is the Gross Profit ratio, if it goes ahead with its plan of launching the new product? A. 30.83% B. 69.17% C. 43.24%
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Answer 32
A. Total sales = $10 million + $ 2 million = $12 million. Total cost of sales = 0.7*10 + 1.3 = $8.3 million. GPM = (12-8.3)/12 = 30.83% does not always lead to increase in the ROE. If the interest burden increases the ROE will begin to fall if the financial leverage ratio (total assets/ total equity) is not increasing proportionately.
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Question 33
S &P Corporation has invested $ 30000 in an asset that depreciates over a period of 5 years by the straight-line method of depreciation. However, for tax purposes the asset is depreciated using an accelerated method of depreciation for 5 years with $ 8000 paid in the first year. The tax rate is 40%.Which of the following statements is most likely true? A. There would be a deferred tax liability of $1000 in the first year created in the balance sheet B. The carrying value of the asset will be lower than the tax base C. The tax payable in the fifth year is most likely to be higher than the tax expensed in that year
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Answer 33
C. The tax base is more likely to be higher than the expensed tax rate to reverse the deferred tax liability so created
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Question 34
Simply Good Inc has a promoters stake of 87% in the organisation. It also operates in an industry which is highly concentrated which gives it the advantage to dictate terms to its suppliers. Under such circumstances the company is most likely to succumb to fraudulent practices under which of the following conditions identified by SAS No 99? A. Incentives and pressure B. Opportunities for fraud C. Attitudes and rationalisations
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Answer 34
B.
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Question 35
M&P Corporation leases out a crane for its own use for ten years with an annual payment of $ 10mn. At the end of the lease period crane will have salvage value of zero and company has the option to purchase the crane from lessee at the discount price. Calculate the lease liability reported on the balance sheet end of the first year, if appropriate interest rate is 8%? A. $ 67.10mn B. $ 62.47mn C. $ 57.47mn
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Answer 35
B. N=10 I/Y=8% PMT=-10mn FV=0 CPT Interest expense = 67.1*8% = 5.37mn principal repayment = 10 mn - 5.37mn= 4.63mn Lease liability= 67.1 4.63= 62.47mn PV= 67.1mn
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Question 36
An analyst gathered the financial information about a company, which has earned $235 mn during the year and which have 80mn common shares outstanding from the beginning of the year. Company has 100,000 outstanding bonds of 9% coupon rate of par value $1000 per bonds convertible into 10 shares each. Which of the following will be the closest value of diluted EPS, if effective tax rate is 35%? A. $5.85 B. $2.94 C. $4.36
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Answer 36
B. Basic EPS= 235/80= $2.94 saving in earnings= 100000*9%*1000*(1-35%) = $5.85mn Increase in no of shares= 100000*10= 1mn per share impact=5.85/1 = $5.85 Since per share impact is higher than basic EPS, securities are Antidilutive in nature Diluted EPS = basic EPS = $2.94
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Question 37
US Vineyard Inc is a loss making wine maker that has a deferred tax asset of $ 68mn on its balance sheet. As of 31st March, 2010 it is probable that $ 15mn of the deferred tax asset will never be realized because of the uncertainty about future profit. Which of the following will be the most likely change to be recorded on its balance sheet? A. It is likely to create deferred tax liability of $ 15mn to offset this transaction B. It is likely to create a valuation allowance of $ 15mn C. It is likely to reduce deferred tax assets by $ 15mn
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Answer 37
B. A valuation allowance serves to reduce the value of deferred tax assets which will not be realized
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Question 38
Farm Fresh Corporation has authorized share capital of $ 200mn of face value $ 10, out of which $ 175mn is paid up capital subscribed by its promoters, various financial institutions and retail public. How many shares of treasury stock does the company own, if average number of total outstanding shares was 16mn? A. 4.0mn B. 2.5mn C. 1.5mn
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Answer 38
C. Treasury shares =(175/10) -16 =1.5mn
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Question 39
The following information is available about a company
Ratio Current ratio Debtors turnover ratio Industry Standards 2.2 6 Actual for company 2.7 8
Which of the following is least likely true about the company? files has expired at 30-Jun-13 A. The company This is not able to manage its inventory efficiently B. The company must increase its collection efforts C. The company may be facing a decline in demand for its product in the market
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Answer 39
B. The correct answer is The company must increase its collection efforts The company has a better debtors t/o ratio than the industry standards which means it is able to recover its debt faster. Therefore, increasing the collection efforts is not required
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Question 40
Which of the following will be the effect on the debt to equity ratio and cash flow from operations of a company, if company chooses to report lease as operating lease instead of financial lease in its books of accounts? Debt/equity ratio Cash flow from operations A. Higher Higher B. Lower Lower C. Higher Lower
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Answer 40
B. If company chooses to report lease as operating lease, lease payment will be treated as operating expense and hence cash flow from operations will be lower. Similarly debt/ equity ratio will be lower as company is not reporting its lease payment liabilities on balance sheet
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Question 41
Using the given information calculate the firms cash flow from operations? Net Income: 135 Decrease in a/c receivables: 15 Depreciation: 25 Increase in inventory: 25 Increase in a/c payables: 12 Decrease in wages payable: 8 Increase in deferred tax liability: 15 A. 179 This files has expired at 30-Jun-13 B. 189 C. 169
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Answer 41
C. Cash flow from operation= 135+25+15-25+12-8+15= 169
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Question 42
An analyst gathered the following information about a company: Deferred tax assets $158,000 Taxable income $30,000 Pretax income $25,000 Effective tax rate 30% Future tax rate 25% Out of the deferred tax assets of $158,000 reported, assets worth of $28,000 are permanent Which of the following will be the closest value of deferred tax assets reported at the end of the year? A. $283,000 This files has expired at 30-Jun-13 B. $255,000 C. $280,000
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Answer 42
B. Increase in DTA= (30000-25000)*25 =125,000 DTA at the end of year= 158000 28000 + 125000= 255,000
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Question 43
Singtel Inc follows the accelerated method of depreciation. In the later years of an assets life, this method is most likely to result in which of the following: A. Lower net profit B. Lower tax expense C. Higher net profit
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Answer 43
C.
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Question 44
Which of the following will be the most likely effect of treating a sale of receivables with recourse as a borrowing against receivables on the balance sheet of a company? A. Increasing the debt/equity ratio B. Reducing the value of cash and cash equivalent C. Increasing the receivables turnover ratio
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Answer 44
A. Analyst should treat sale of receivables with recourse as loan backed by receivables and hence will increase the total debt equity ratio of the company.
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Question 45
Smith and Companys receivable turnover is five times, inventory turnover ratio is six times and the payables turnover ratio is ten times. Which of the following is most likely period of the cash conversion cycle? A. 48 days B. 96 days C. 24 days
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Answer 45
B. Cash conversion cycle= 360/5 + 360/6 360/10= 72+60-36= 96 days
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Question 46
The US GAAP framework and FASB, while establishing the hierarchy of qualitative characteristics, gives primary importance to: A. Reliablity and Relevance B. Relevance and Reliability C. Reliability and Comparability
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Answer 46
B.
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Question 47
A chemical company has to account $50000 today to remediate a property once production is complete in 6 years. If the discount rate applied is 6%. Find the value of asset reconstruction obligation. A. $44490 B. $70925 C. $89450
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Answer 47
B. Future value of 50000 for 6 years at 6% 50,000*[(1.06)^6] 70,925
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Question 48
Which of the following is least likely to be the effect on the Return on Equity? A. Increase in the interest burden would reduce the total taxable income, hence always lead to an increase in the return on equity according to the Dupont equation. B. Increase in interest expense would reduce the ROE C. An increase in the operating profit margin and the financial leverage leads to a lower ROE.
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Answer 48
A. The correct answer is Increase in the interest burden would reduce the total taxable income, hence always lead to an increase in the return on equity according to the Dupont equation. Increase in the interest burden does not always lead to increase in the ROE. If the interest burden increases the ROE will begin to fall if the financial leverage ratio (total assets/ total equity) is not increasing proportionately.
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Crash Course for FSA CFA Level-I Exam

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Compute Cash Flows From Operations (CFO)

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