CFA LEVEL I

MOCK TEST PAPER

SOLUTIONS
Exam Date - 01.03.2020
Understanding Income Statements
1. A is correct.
When subtotals are presented, the income statement follows a multi-step format.
2. B is correct.
It is an element of the balance sheet.
3. A is correct.
IAS No. 1 states that expenses may be categorized by either nature or function.
4. B is correct.
Cost of goods sold is a classification by function. The other two expenses represent classifications by
nature.
5. A is correct.
“Operating profit reflects a company’s profits on its usual business activities before deducting taxes,
and for non- financial companies, before deducting interest expense.”
6. C is correct.
Operating profit = Revenue - Cost of goods sold - SG&A - Depreciation & Amortization
= 8,000,000 - 5,000,000 - 1,000,000 - 150,000
= 1,850,000
7. B is correct.
The appropriate time to recognize revenue would be in the month of August; the risks and rewards
have been transferred to the buyer (shipped and delivered), the revenue can be reliably measured, and
it is probable that the economic benefits will flow to the seller.
8. Removed.
9. Removed.
10. Removed.
11. Removed.
12. A is correct.
Revenue under percentage of completion method = Percentage of total cost incurred by the firm × Total
contract revenue

Profit = Revenue – Cost

= 1.1538 − 0.75
= 0.4038
13. B is correct.

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14. A is correct.

15. A is correct.
Under the converged accounting standards, the incremental costs of obtaining a contract and certain
costs incurred to fulfill a contract must be capitalized. If a company expensed these incremental costs in
the years prior to adopting the converged standards, all else being equal, its profitability will appear
higher underthe converged standards.
16. Removed.
17. Removed.
18. Removed.
19. C is correct.
Statement A is incorrect because the matching principle requires the company to estimate the
uncollectible accounts and not adopt the direct write off method. Statement B is incorrect because the
estimate is recorded as an expense. Statement C is correct.
20. B is correct.
The last in, first out (LIFO) method is not permitted under IFRS. The other two methods are permitted.
21. C is correct.
Retrospective application applies to the presentation of financial statements for previous fiscal years,
according to newly adopted principles.
22. C is correct.
A fire may be infrequent, but it would still be part of continuing operations and reported in the profit
and loss statement. Discontinued operations relate to a decision to dispose of an operating division.
23. C is correct.
Analyst #1’s statement is false: The LIFO method is not permitted under IFRS.
Analyst #2's statement is true: In the weighted average method, the cost per unit is calculated by
dividing cost of available goods by total units available. This results in cost of goods sold and ending
inventory values between those of LIFO and FIFO.
24. C is correct.
A change in accounting principle is retrospectively applied. The change in accounting principle affects
the financial statements for all periods i.e. the past, current and future periods. The change in
depreciation method is a change in accounting principle which will be applied on a retrospective basis.
25. Removed
26. Removed
27. A is correct.

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28. C is correct.
Basic and diluted EPS are equal for a company with a simple capital structure. A company that issues
only common stock, with no financial instruments that are potentially convertible into common stock
has a simple capital structure. Basic EPS is calculated using the weighted average number of shares
outstanding.
29. B is correct.
When a company has stock options outstanding, diluted EPS is calculated as if the financial instruments
had been exercised and the company had used the proceeds from the exercise to repurchase as many
shares possible at the weighted average market price of common stock during the period. As a result,
the conversion of stock options increases the number of common shares outstanding but has no effect
on net income available to common shareholders. The conversion of convertible debt increases the net
income available to common shareholders by the after-tax amount of interest expense saved. The
conversion of convertible preferred shares increases the net income available to common shareholders
by the amount of preferred dividends paid; the numerator becomes the net income.
30. A is correct.

31. B is correct.
Weighted average number of shares outstanding

32. B is correct.
Number of new shares that would have been issued at option exercise = 15,000

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 Diluted EPS

33. C is correct.
Common size income statements facilitate comparison across time periods (time-series analysis) and
across companies (cross-sectional analysis) by stating each line item of the income statement as a
percentage of revenue. The relative performance of different companies can be more easily assessed
because scaling the numbers removes the effect of size. A common size income statement states each
line item on the income statement as a percentage of revenue. The standardization of each line item
makes a common size income statement useful for identifying differences in companies’ strategies.
34. C is correct.
Total comprehensive income = Net income + other comprehensive income
Net income = Revenues – Expenses
Other comprehensive income includes gains or losses on available-for-sale securities and
translations adjustments on foreign subsidiaries.
(Revenues – Expenses) + Gain on AFS – Loss on FX translation
(8500 – 6900) + 630 – 870 = 1,360.
35. C is correct.
Other comprehensive income includes items that affect shareholders’ equity but are not reflected in the
company’s income statement. In consolidating the financial statements of foreign subsidiaries, the
effects of translating the subsidiaries’ balance sheet assets and liabilities at current exchange rates are
included as other comprehensive income.
36. C is correct.
Total comprehensive income = Net income available to common shareholders + Other comprehensive
income
Net income available to common shareholders = 23,600 - 12,980 - 800 = 9,820 million
Other comprehensive income = -460 + 3,150 = 2,690 million
Total comprehensive income = 9,820 + 2,690 = 12,510 million
37. C is correct.
38. C is correct.
Other comprehensive income = 1200 – (1000+100-20) = 120.
39. B is correct.
Other comprehensive income only reflects transactions that are not included in the net income. Thus,
foreign currency translation loss of CAD 75,000 and unrealized holding gains of CAD 39,000 on
available for sale securities will be included in the other comprehensive income.
40. B is correct.
Depreciation is included in the computation of operating expenses. Interest expense is a financing cost.
Thus, it is excluded from operating expenses.
41. A is correct.
Income taxes are expenses grouped together by their nature. Cost of goods sold includes a number of
expenses related to the same function, the production of inventory.
42. C is correct.
The matching principle requires that the expenses incurred to generate the revenue be recognized in the
same accounting period as the revenue.
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43. B is correct.
The five steps in revenue recognition are:
1. Identify the contract or contracts with the customer.
2. Identify the performance obligations in the contract(s).
3. Determine a transaction price.
4. Allocate the transaction price to the performance obligations.
5. Recognize revenue when/as the performance obligations have been satisfied.
44. Removed.
45. A is correct.
$24,000 / $60,000 = 40% of the project completed. 40% of $100,000 = $40,000 revenue. $40,000 revenue –
$24,000 cost = $16,000 profit for the period. No profit would be reported in the first year using the
completed contract method.
46. Removed.
47. A is correct.
LIFO and FIFO are both permitted under U.S. GAAP. LIFO is prohibited under IFRS.
48. B is correct.
Accelerated depreciation will result in higher depreciation in the early years and lower depreciation in
the later years compared to the straight-line method. Total depreciation expense will be the same under
both methods. The book value would be higher in the later years using straight-line depreciation, so the
loss from scrapping the equipment under an accelerated method is less compared to the straight-line
method.
49. Removed.
50. B is correct.
Year 1: (2 / 4) × 25,000 = $12,500. Year 2: (2 / 4) × (25,000 – 12,500) = $6,250.
51. A is correct.
A change in an accounting estimate is reported prospectively. No restatement of prior period
statements is necessary.
52. C is correct.
A physically and operationally distinct division that is currently for sale is treated as a discontinued
operation. The income from the division is reported net of tax below income from continuing
operations. Changing a depreciation method is a change of accounting principle, which is applied
retrospectively and will change operating income.
53. C is correct.
A change in accounting principle requires retrospective application; that is, all prior period financial
statements currently presented are restated to reflect the change.
54. C is correct.
Bad debt expense is an operating expense. The other choices are nonoperating items from the
perspective of a manufacturing firm.
55. B is correct.
Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common
shares outstanding.
Step 1: Calculate Adjusted EAC
adjusted EAC: net income - preferred dividends
+ after-tax interest on convertible debt
= adjusted earnings available for common shares
preferred dividends = (0.08)(90)(2,000) = 14,400
convertible debt interest = (60,000)(0.06)(1 - 0.40) = 2,160

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 adjusted EAC = (30,000 - 14,400 + 2,160) = $17,760
Step 2: Calculate Weighted average plus potential common shares outstanding.

Step 3: Calculate Diluted EPS

Diluted EPS = 17,760 / 11,600 = $1.53.
56. C is correct.
(210,000 − 110,000) / 20,000 = $5 share
57. B is correct.
EPS = earnings available to common shareholders divided by the weighted average number of common
shares outstanding. Earnings available to common shareholders is net income minus preferred
dividends, or $4,750,000 (= $5 million - 250,000) for LMN.
58. B is correct.
The equation for Basic EPS (net income - preferred dividends / weighted average number of common
shares outstanding) does not include the number of preferred shares outstanding, because the objective
is to determine the earnings available to the common shareholder.
59. Removed.
60. C is correct.
The weighted average number of common shares outstanding is the number of shares outstanding
during the year weighted by the portion of the year they were outstanding. Since no new common
shares were issued in 2005, and there were 25 million shares at the end of 2004, there are 25 million
shares at the end of 2005. Note that the preferred stock shares do not affect the common shares
outstanding.
61. Removed.
62. B is correct.
A complex capital structure is one that contains 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.
63. A is correct.
Use the Treasury stock method
Proceeds = 100,000 ($40) = $4,000,000
Shares assumed purchased with proceeds= $4,000,000/$50 = 80,000 shares
Potential dilution = 100,000 - 80,000 = 20,000 shares
Basic EPS = $1/share
Diluted EPS = $1,000,000 / 1,020,000 = $0.98/share
64. A is correct.
Interest earned on the CD is recognized as interest income. The gain on the sale of treasury stock is not
reported on the income statement but is relected on the statement of changes in stockholders' equity
and on the balance sheet. The sale proceeds simply increase equity and increase cash.
65. B is correct.
Not all preferred stock is dilutive. Only convertible preferred stock is potentially dilutive.
66. B is correct.
Changes in accounting principle require retrospective presentation. A change in the salvage value of an
asset is a change in accounting estimate, which does not apply retrospectively.

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67. C is correct.
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.
68. B is correct.
A simple capital structure contains no potentially dilutive securities such as stock options, warrants, or
convertible preferred stock.
69. C is correct.
A vertical common-size income statement states each item as a percentage of revenue.
70. A is correct.
Preferred stock and bonds are only considered to be potentially dilutive if they are convertible. Options
are always considered to be potentially dilutive.
71. A is correct.
Both items are included in comprehensive income. Comprehensive income includes all items that affect
owners' equity except transactions with the company's owners. Any items that are included in net
income are also included in comprehensive income. The gain on sale is reported in net income. The
foreign currency translation loss is taken directly to owners' equity (i.e., not reported in the income
statement).
72. C is correct.
Since the exercise price of the warrants is less than the average share price, the warrants are dilutive.
Using the treasury stock method to determine the denominator impact:

Thus, the denominator will increase by 9,091 shares to 309,091 shares. The question asks for the total,
not just the impact of the warrants.
73. B is correct.

Next, check if the convertible bonds are dilutive:

numerator impact = (1,000 × 1,000 × 0.07) × (1 – 0.4) = $42,000
denominator impact = (1,000 × 25) = 25,000 shares

Since $1.68 is greater than the basic EPS of $1.25, the bonds are antidilutive. Thus, diluted EPS = basic
EPS = $1.25.
74. B is correct.
The warrants in this case are antidilutive. The average price per share of $15 is less than the exercise
price of $20. The year-end price per share is not relevant. The denominator consists of only the common
stock for basic EPS.
75. C is correct.
Each category of the income statement is expressed as a percentage of revenue (sales).
76. B is correct.
A 5% decrease in per unit production cost will increase gross profit by lowering cost of goods sold.
Assuming no fixed costs, gross profit margin will remain the same if sale quantities increase.
Administrative expenses are not included in gross profit margin.

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77. A is correct.
A foreign currency translation gain is not included in net income but the gain increases owners’ equity.
Dividends received are reported in the income statement. The repayment of principal does not affect
owners’ equity.
78. C is correct.
Comprehensive income includes all changes in equity except transactions with shareholders. Therefore,
dividends paid to common shareholders are not included in comprehensive income.
79. Removed
80. A is correct.
Simple capital structures do not include any potentially dilutive securities (a security that could
decrease earnings per share if exercised). Convertible bonds are potentially dilutive.

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