JUN18L1FRA/C01 – R21-R27

Question 1

The following data (in thousands of dollars) are extracted from the financial statements of Hunter Company
for the year ended 20X6:

Interest Expense = 50

Cost of Goods Sold = 3,000

Sales Revenue = 5,000

Common Dividends Declared = 500

Salaries and Wages Expense = 670

Depreciation Expense = 80

Income before Taxes = 1,210

Total Expenses = 3,800

Income from Continuing Operations = 1,200

Gain on Sale of Land = 10

Income Tax Expense = 950

Net Income = 260

Cash, 20X6 = 1,800

Cash, 20X5 = 1,620

Accounts Receivable, 20X6 = 800

Accounts Receivable, 20X5 = 750

Inventory, 20X6 = 720

Inventory, 20X5 = 980

Accounts Payable, 20X6 = 820

Accounts Payable, 20X5 = 560

Salaries and Wages Payable, 20X6 = 290

Salaries and Wages Payable, 20X5 = 730

Interest Payable, 20X6 = 90

Interest Payable, 20X5 = 80

Income Tax Payable, 20X6 = 970

Income Tax Payable, 20X5 = 950

 Dividends Payable, 20X6 = 200

Dividends Payable, 20X5 = 160

Based on the information given above, how much should Hunter Company report as cash flow from
operations?

a) $230,000 inflow

b) $430,000 inflow

c) $430 inflow

The operating cash flow is computed as follows (indirect method)

Net Income $260,000

Adjustments for Noncash Items

Depreciation Expense 80,000

Gain on Sale of Land (10,000)

Changes in Working Capital

Increase in Accounts Receivable (50,000)

Decrease in Inventory 260,000

Increase in Accounts Payable 260,000

Decrease in Salaries and Wages Payable (440,000)

Increase in Interest Payable 10,000

Increase in Income Tax Payable 20,000

Increase in Dividends Payable 40,000

Operating Cash Inflow $430,000

Question 2

The following information relates to the installment sales of a property:

Total sales price $1,500,000

Total expenses $900,000

Down payment $200,000

The balance of the sales price is to be received over a five-year period. How much profit will the seller
recognize as attributable to the down payment under the installment method?
 a) $80,000.

b) $120,000.

c) $200,000.

Profit = $1,500,000 ‒ $900,000 = $600,000

Profit to sales ratio = $600,000 / $1,500,000 = 40%

Profit attributable to the down payment = $200,000 × 40% = $80,000

Question 3

A company has employed a new financial controller who has installed a new system to improve the
efficiency of inventory management, and who has written off a large amount of uncollectible receivables.
This is likely to:

Inventory Turnover Receivables Turnover

A. Increase Increase

B. Increase Decrease

C. Decrease Increase

a) Row A

b) Row B

c) Row C

More efficient management of inventory would be expected to increase the inventory turnover, by reducing
the number of days goods were held as inventory. Writing off receivables would reduce the denominator in
the receivables turnover, thereby increasing receivables turnover.

Question 4

When a company has incurred salary costs that have not been paid by the end of the accounting period, this
gives rise to:

Expense Asset/Liability

A. Accrued expense Liability

B. Deferred expense Asset

C. Deferred expense Liability

 a) Row A

b) Row B

c) Row C

This is an example of an expense that has been incurred but not yet paid. This is an accrued expense and a
liability since it must be paid in the future.

Question 5

If a firm issues convertible debt securities and these convertible debt securities are exercised, the growth
rate will most likely:

a) increase.

b) decrease.

c) remain the same.

Growth rate = Retention ratio × Return on equity = (1 – Dividend payout ratio) × (Net income / Equity) = (1 –
Dividend per share / Earnings per share) × Return on equity

If a firm issues convertible debt then it will dilute the EPS of the firm and reduce the retention ratio. Also, the
return on equity will decrease as the number of common shares in equity will increase. Hence, the growth
rate of the firm will decrease.

Question 6 Add Flag

TAC Party Inc. (TPI) made the following purchases during the year. TPI had no inventory on hand at the
beginning of the year. At the end of the year, TPI has 50 units still in inventory.

Inventory Purchases Units Price/Unit

1st Quarter 100 $48

2nd Quarter 200 $50

3rd Quarter 100 $54

4th Quarter 75 $58

Total 475

Which of the following methods would result in the highest cost of goods sold?

a) First in, first out (FIFO).

b) Last in, last out (LIFO).

 c) Weighted average method.

Of the three choices, LIFO would result in the highest cost of goods sold. Under LIFO, the most recent
purchases are the goods sold first, ending inventory is made up of the oldest purchases. So in an
environment of rising prices, LIFO results in the highest cost of goods sold. Whereas under FIFO, the oldest
goods are sold first, ending inventory is made up of the most recent purchases. So in an environment of
rising prices, LIFO results in the lowest cost of goods sold. In an environment of steadily rising prices the
weighted average cost method will result in an ending inventory value in between FIFO and LIFO and,
therefore, will not be the highest cost of goods sold.

FIFO LIFO Weighted Average

Goods available for sale $24,550 $24,550 $24,550

Ending Inventory 2,900 2,400 2,584

Cost of goods sold $21,650 $22,150 $21,966

Question 7

A company provides the following information:

Year 1 Year 2

Return on equity 8.9% 9.4%

Return on total assets 4.5% 4.2%

Total asset turnover 1.5 1.7

The numbers could be explained by:

Financial Leverage Net Profit Margin

A. Increased Increased

B. Increased Decreased

C. Decreased Increased

a)a) Row A

b)
b) Row B

c)c) Row C

Return on equity = return on assets × financial leverage. Return on equity has increased when return on
assets fell, so financial leverage must have increased.
Return on assets = net profit margin × total asset turnover. If return on assets fell and total asset turnover
increased, it must be because net profit margins fell.

Question 8

If payment is received in advance of transferring the goods, the seller will most likely report a:

a) Contract asset

b) Receivable

c) Contract liability

If payment is received in advance of transferring good(s) or service(s), the seller presents a contract liability.

Question 9

In the year 2009 (its first year of operations), Indigo Computers made the following purchases:

Units Purchased Cost per Unit ($) Total Cost ($)

First quarter 5,200 28 145,600

Second quarter 6,700 23 154,100

Third quarter 7,300 19 138,700

Fourth quarter 4,200 25 105,000

Total 23,400 543,400

It sold 15,100 units during the year at a price of $30 per unit.

Indigo’s cost of goods sold under the weighted average cost method for 2009 is closest to:

b)
a) $350,565

b)
b) $360,500

c)c) $350,656

Cost of goods sold = (543,400/23,400) × 15,100 = $350,655.56

Question 10

An analyst has gathered the following balance sheet data (in $ millions) for a company:

20X3 20X2 20X1

Cash and equivalents 10 7 5

 Receivables 15 17 12

Inventory 20 11 13

Total current assets 45 35 30

Fixed assets, net 425 405 340

Total current liabilities 34 32 30

Total short and long-term debt 320 300 240

Comparing 20X3 with 20X2, the most reasonable conclusion an analyst might make about the company's
liquidity is that it:

a) improved, as indicated by the cash ratio rising to 0.258 in 20X3 from 0.194 in 20X2.

b) improved, as indicated by the cash ratio rising to 0.294 in 20X3 from 0.219 in 20X2.

c) deteriorated, as indicated by the cash ratio falling to 0.735 in 20X3 from 0.750 in 20X2.

The cash ratio rose, which is an indication of improving liquidity. The calculations are as follows:

Cash ratio = (Cash + Short-term marketable investments) / Current liabilities

20X3cash ratio = 10 / 34 = 0.294

20X2cash ratio = 7 / 32 = 0.219

Question 11

Which of the following is least accurate about ratio analysis?

a) Ratios cannot be used in isolation.

b) Ratios are not affected by different accounting treatments used by companies.

c) Ratios are useful when comparable industry ratios are available.

Ratios are affected by different accounting treatments used by companies.

Question 12

The balance sheet helps the analyst to assess which of the following?

a) The operating performance of the company.

b) The tax burden the company bears.

c) The company's ability to make distributions to owners.

The balance sheet can help the analyst to assess the company's ability to make distributions to owners since
equity is the residual once liabilities have been paid with assets (probable future economic benefits).

Question 13

Luxury Mansions Corporation reported net earnings of $3 million for the year ended June 30, 2013. The
company had 800,000 common shares and 10,000 shares convertible preferred, payable at $10 per share, at
the beginning of the year. Each preferred share is convertible into two common shares. There were no other
potentially dilutive securities, and the tax rate was 25%. The company's diluted EPS, using the if-converted
method under U.S. GAAP and IFRS, is closest to:

a) $3.63.

b) $3.66.

c) $3.75.

Basic EPS Diluted EPS

Net income $3,000,000 $3,000,000

Preferred dividend* –100,000 0

Numerator $2,900,000 $3,000,000

Weighted average number of shares outstanding 800,000 800,000

Incremental shares** 0 20,000

Denominator $800,000 $820,000

EPS $3.63 $3.66

*10,000 preferred shares × $10

**10,000 preferred shares × 2

The security is antidilutive, and the diluted EPS should reflect the maximum potential dilution from
conversion or exercise of potentially dilutive financial instruments. Here, you are asked to calculate the basic
and diluted EPS. Diluted EPS will always be less than or equal to basic EPS. Therefore, under both U.S. GAAP
and IFRS, the reported diluted EPS would be $3.63.

Use the information below to answer the questions 14 to 18:

Information regarding the Coffee Company is as follows:

Balance sheet:
 December 31 January 1

Accounts payable $ 450,000 $ 780,000

Inventory 210,000 560,000

Accounts receivable 756,000 999,000

Prepaid expenses 399,000 578,000

Income statement:

Depreciation expense $850,000

Gain from sale of land 276,000

Cash flows:

Cash collected from customers $10,500,000

Cash paid for inventory 5,650,000

Cash paid for other expenses 1,354,000

All purchases were made on account.

Question 14

If all sales were made on account, how much is revenue reported in the income statement?

a) $10,499,000

b) $10,257,000

c) $10,354,000

Accounts receivable, beginning $ 999,000

Sales 10,257,000

Collections (10,500,000)

Accounts receivable, ending $ 756,000

Question 15

How much are purchases of inventory?

a)a) $5,220,000
b) $5,320,000
b)
 c)c) $5,230,000

Accounts payable, beginning $ 780,000

Purchases 5,320,000

Payments (5,650,000)

Accounts payable, ending $ 450,000

Question 16

How much is the cost of goods sold?

a)a) $5,812,000
b) $5,670,000
b)

c)c) $5,430,000

Inventory, beginning 560,000

Purchases 5,320,000

Cost of goods sold (5,670,000)

Inventory, ending 210,000

Question 17

How much will be recorded as cash flow from operations under the direct method?

a)a) $3,241,000
b) $3,567,000
b)

c)c) $3,496,000

Cash collected from customers $10,500,000

Cash paid for inventory (5,650,000)

Cash paid for other expenses (1,354,000)

Cash flow from operations 3,496,000

Question 18

How much is the net income under the indirect method?

a)a) $2,584,000
b) $2,107,000
b)

c)c) $2,659,000

Sales 10,257,000

Less:

Cost of goods sold 5,670,000

Other operating expenses 1,354,000

Depreciation 850,000

Gain on sale of equipment 276,000

Net income 2,659,000

Question 19

Prepaid expenses arise when a company makes cash payment:

a)a) At the same time of recognizing an expense.

b)
b) After recognizing an expense.

c)c) Prior to recognizing an expense.

Prepaid expenses arise when a company makes a cash payment prior to recognizing an expense.

Question 20

Which of the following is least likely to be a condition for recognizing revenue for the sale of a good
according to the principles set out in the converged accounting standards issued by the International
Accounting Standards Board (IASB) and Financial Accounting Standards Board (FASB) in May 2014?

a) A performance obligation has been satisfied.

b) The buyer has paid for a performance obligation.

c) A transaction price has been agreed for the performance obligations.

The five steps in recognizing revenue are:

 1. Contract with customer
2. Identify performance obligations (distinct good or service)
3. Price determined
4. Allocate price to performance obligations
5. Recognize revenue when satisfied a performance obligation

Question 21

Norway Company entered into a contract to build a residential house for $1,000,000. The total contract
costs were reliably estimated to be for $800,000. Costs incurred were as follows:

2007 $400,000

2008 300,000

2009 100,000

What is Norway's net income for this project in 2008 using the percentage of completion method and the
cost recovery method?

Percentage of completion Cost recovery

a. 75,000 —

b. 75,000 75,000

c. 200,000 —

a) Row A

b) Row B

c) Row C

Norway's revenue, expense, and net income over the term of the project under the percentage of
completion method:

2007 2008 2009 Total

Revenue $500,000 $375,000 $125,000 $1,000,000

Expense 400,000 300,000 100,000 800,000

Net income 100,000 75,000 25,000 200,000

In the percentage of completion method, which is used when the outcome of the project can be measured
reliably, revenue, expense, and profit are recognized as the work is performed. According to the IFRS, if the
firm cannot reliably measure the outcome of the project, revenue is recognized to the extent of contract
costs, costs are expensed when incurred, and profit is recognized only at completion.
Question 22

A company incurs the following costs on a particular project:

Year 2006 2007 2008 Total

Costs incurred ($ '000) 500 700 300 1,500

The total revenue from the project is expected to be $2,000,000. Under the percentage-of-completion
method, the project’s net income in 2008 is closest to:

a) $600,000

b) $100,000

c) $300,000

Profit recognized in 2008 = (300,000/1,500,000) × (2,000,000 – 1,500,000) = $100,000

Question 23

Howard Inc. (a manufacturing concern) uses U.S. GAAP to report its financial statements. Which of the
following is most likely to be classified as an investing activity by this firm?

a)a) Sale of securities classified as available for sale.

b)
b) Receipt of dividends on investments.

c)c) Payment of interest on a loan.

Sale of securities classified as available-for-sale is represented as an investing activity.

Dividends received and interest paid are both operating activities under U.S. GAAP.

Question 24

When an income statement explicitly shows gross profit as a subtotal, it most likely uses a:

a)a) Multi-step format.

b)
b) Common-size format.

c)c) Single-step format.

When the income statement shows a gross profit subtotal, it is said to use a multi-step format.

Question 25

Working capital is the excess of a company’s:

 a) Assets over its liabilities.

b) Noncurrent liabilities over its noncurrent assets.

c) Current assets over its current liabilities.

Working capital is calculated as current assets less current liabilities.

Question 26

The following information relates to Hawaiian Clothing Inc. for the year 2009:

Net Income = $95,000,000

Beginning retained earnings = $240,000,000

Dividends paid = $20,000,000

Dividends declared = $30,000,000

The company’s ending retained earnings for 2009 are closest to:

a)a) $315,000,000

b)
b) $115,000,000

c)c) $305,000,000

Ending retained earnings = Beginning retained earnings + Net income – Dividends declared

Ending retained earnings = 240,000,000 + 95,000,000 – 30,000,000 = $305,000,000

Question 27

 Net income = $1,120,000

 Depreciation expense for the year = $27,000
 Decrease in inventory = $13,800
 Increase in taxes payable = $1,500
 Issuance of common stock = $60,000
 Dividends paid = $32,300
 Purchase of land = $28,300
 Investment in associate = $58,000
 Purchase of held-for-trading securities = $7,200
 Sale of available-for-sale securities = $84,700

Assume the company uses U.S. GAAP to prepare its financial statements.

The company’s cash flow from operations is closest to:

a)a) $1,155,100
 b)
b) $1,162,300

c)c) $1,130,000

CFO = Net income + Depreciation + Decrease in inventory + Increase in taxes payable – Purchase of held-for-
trading securities

CFO = 1,120,000 + 27,000 + 13,800 + 1,500 – 7,200 = $1,155,100

Question 28

Which of the following is most likely a general requirement for the preparation of financial statements?

a)a) Verifiability

b)
b) Timeliness

c)c) Accrual basis

Verifiability and timeliness are qualitative characteristics that enhance the value of financial information.

Use the following information to answer the question 29 and 30

The following information pertains to Compass Inc. for the fiscal year 2004:

Proceeds from sale of equipment: 340,000

Proceeds from the sale of treasury shares (CA = 650,000): 750,000

Purchase of bond investment: 1,670,000

Gain on sale of equipment: 70,000

Dividends paid: 460,000

Dividends declared: 560,000

Amortization of bond discount (Face value = 2,000,000): 20,000

Question 29

How much is Compass's net cash provided by financing activities?

a)a) $290,000
b) $310,000
b)

c)c) $260,000
Dividends declared is a noncash financing activity.
 Dividends paid (460,000)

Proceeds from sale of Treasury shares 750,000

Net cash provided by financing activities 290,000

Question 30

How much is Compass's net cash provided by investing activities?

a)a) ($1,450,000)
b) ($1,330,000)
b)

c)c) ($1,560,000)

Proceeds from sale of equipment 340,000

Purchase of bond investment (1,670,000)

Net cash used in investing activities (1,330,000)

Question 31

A month has transpired since rent was paid in advance of that month, the adjusting entry is:

a) prepaid rent [A] increased, rent expense [X] decreased.

b) prepaid rent [A] decreased, rent expense [X] increased.

c) prepaid rent [A] increased, rent expense [X] increased.

The adjusting entry is prepaid rent [A] is decreased, rent expense [X] is increased for a month which has
transpired since rent was paid in advance of that month.

Question 32

For the year ended 31 December 2012 Skyline Products reported net income of €1,300,000. At the beginning
of that fiscal year, the company had 750,000 shares of common stock outstanding. On 1 April 2012, the
company repurchased 150,000 common shares. That year the company also paid its common shareholders
dividends in the amount of $325,000. What was the basic EPS Skyline reported on its income statement for
2012?

a) €1.53.

b) €2.04.

c) €2.17.
The formula and calculation of basic EPS is as follows:

Basic EPS = (Net income−Preferred−dividends) / Weighted average number of ordinary shares outstanding

Skyline's basic EPS = 1,300,000−0 / 637,500 (see calculation below) = 2.04

In this question, the candidate needs to be careful not to read too quickly and mistake common dividends
for preferred dividends. The $325,000 dividend payment is not deducted in the numerator. The
mathematical part of the problem is solving for the denominator.

January 1 2012—beginning balance 750,000 × (3 months / 12 months) = 187,500

April 1 2012—150,000 shares repurchased 600,000 × (9 months / 12 months) = 450,000

Weighted average number of shares outstanding 637,500

Question 33

A company reports under U.S. GAAP and must decide on how to measure the value of its inventory. Under
U.S. GAAP, inventory must be measured at:

a) the lower of cost or net realizable value (NRV).

b) the lower of cost or market value.

c) historical cost only.

Under U.S. GAAP, inventories are measured at the lower of cost or market value.

Question 34

An analyst has gathered the following three years of data (in ₤ millions) for a company:

20X3 20X2 20X1

Select Data from Balance Sheets

Total current assets 300 250 200

Fixed assets, net 600 570 560

Short-term debt 100 100 100

Total current liabilities 330 220 200

Long-term debt 120 100 105

Equity 450 400 355

 20X3 20X2 20X1

Total liabilities and equity 900 820 660

The 20X3 financial leverage ratio that should be used in a DuPont analysis is closest to:

a) 0.3

b) 1.9

c) 2.0

When completing a DuPont analysis, the financial leverage should use averages of the beginning and ending
balances for each input. The calculation is as follows:

20X3 financial leverage ratio = Average total assets / Average total equity

= [(900+820)/2] / [(450+400)/2] = 1.9

Question 35

The comprehensive income statement contains:

a)a) Details of income from subsidiaries.

b)
b) Information on changes in stockholders' equity.

c)c) A detailed breakdown of cost of goods sold and other expenses.

Comprehensive income is the change in stockholders' equity as a result of net income and other revenue
and expense items that have been excluded from the income statement. These items include foreign
currency translation adjustments, pension liability adjustments, and unrealized gains and losses on
derivatives contracts and investments.