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Crash Course forFSA

CFA Level-I Exam

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Financial Reporting and Analysis


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Financial Statements Framework

FS Reporting Reporting Standards Reporting Quality International StandardsConvergence

The way companies depicttheir financial performance& health to investors

Income statement: financialperformance in terms ofoperational gains / losses over aperiod of time

Balance sheet:financial health of afirm in terms of assets & liabilities

as on date.Ownersequity = Assets - Liabilities

Cash flow statement: cash inflow& outflow for a period of timeCash flow = operating + investing +financing cash flow

Footnotes: disclosures to providedetailed information like accountingmethods, assumptions, legal

actions, contingencies, sales torelated parties

Management Discussion & Analysis:

assessment of financial performance discussion on industry trends, capitalresources, general business overviewdiscussion on accounting policiesrequiring significant judgments Auditors opinion: unqualified

opinion by auditor indicatesstatements are free from material

omissions & errors

www.edupristine.com Neev Knowledge ManagementPristine


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Principles for preparing FS:Fair representation: faithful representation of transactionsGoing concern: based on the assumption that firm will continue to existAccrual basis: transactions are recorded when they occur irrespective of cash flowConsistency: consistency in presentation of a/cs between periodsMateriality: free of misstatements or omissions

IFRS framework US GAAP framework

International Accounting Standard Board (IASB) goals:Global accounting standards with transparency, compatibility, & higherreporting qualityPromote the use of global accounting standardsConvergence between national GAAP standards and global a/cingstandardsNeeds of emerging nations & small firms in implementation of globala/cing standards

IFRS is a largely principle based approach with following characteristics:Understandability: easy to comprehend andComparability: comparable among firms and across time periodsRelevance: sufficiently detailed & relevant informationReliability: should reflect economic reality

Q. Which of the following characteristics least likely to contribute to therelevance?

A. Detailed footnotesB. Qualified opinion by auditorC. Annual report available on request

Ans. Annual report available on request act as a barrier in informationdissipation and hence does not contribute towards relevance

Q.Which of the following is least likely to be true in case of acompany which report its earnings according to IFRS?

CF Operations CF Financinga) Interest received Interest paidb) Dividends paid Interest receivedc) Dividend received Dividend paidAns. In case of IFRS interest received cannot be classified

under Cash flow from financing and hence answer is B





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Principles for preparing FS:Fair representation: faithful representation of transactionsGoing concern: based on the assumption that firm will continue to existAccrual basis: transactions are recorded when they occur irrespective of cash f lowConsistency: consistency in presentation of a/cs between periodsMateriality: free of misstatements or omissions

IFRS framework US GAAP framework

Financial Accounting Standards Board (FASB) has similarframework, but its rule based approach and differ in someaspects FASB defines assets as a future economic benefit, IASBdefines it as a resource for future economic benefitFASB does not allow upward revision of asset prices

Q.Which of the following is least likely to be true in case of acompany which report its earnings according to US GAAP?

CF Operations CF Financinga) Interest paid Dividends paidb) Dividends received Interest paidc) Interest received Dividend paidAns. In case of US GAAP interest paid cannot be classifiedunder Cash flow from financing and hence answer is B





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Fraud Triangle:Incentive to commit fraudOpportunity provided by weak internal controlAttitudes which justifies fraudulent behavior

Risk factors related to incentive to commitfraud: threat to financial profitability due to external

factorsexcessive third party pressure on mgmtthreat to personal net worth of management pressure to meet internal financial targets

Risk factors related to opportunities that exists:ineffective mgmt monitoringcomplex or unstable organizational structuredeficient internal controlsnature of the firmsindustry or operations

Risk factors related to attitudes:inappropriate ethical standardsknown history of violations of lawManagements obsession with increasingstock pricemaking commitment to third partiesregarding earning performance

Warning signs:

aggressive revenue recognitionabnormal growth rate compared toindustryabnormal inventory growth compared tosales growthdelaying expense recognitionLIFO liquidation

extending useful lives of long termassetsaggressive pension assumptionsoff balance sheet special purposeentitieshigher use of operating leases





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Convergence of IFRS & US GAAP is ongoing process, but material differences in their accountingstandards are listed below:LIFO method is allowed under US GAAP but not allowed under IFRSIFRS allows upward revaluation of PP&E, but US GAAP does not allow upward revisionUS GAAP recommends equity method of a/cing for joint ventures, whereas IFRS uses proportionateconsolidationUS GAAP doesntpermit upward revaluation of intangible assets like goodwillUS GAAP allows capitalization of construction interest, IFRS allows capitalization of acquisition,

construction interestUS GAAPinterest received & paidCFO

IFRS flexible in terms of classification





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Financial Statement Analysis

Generally Accepted AccountingPrinciples (GAAP)

Critical RatiosBasic & diluted

EPSFinancial Statement

ImpactsInventory

AccountingDuPont

Analysis

Q.Contract to build a ship for$1,000 and a reliable estimateof the total cost is $800. FindNet Income using % ofcompletion method?Ans

RevenueRecognition

Unusual orInfrequent Items

Extraordinary Items(U.S. GAAP)

Similar to unusual/infrequentitems, extraordinary items areboth unusual & infrequent in

occurrence, and material innature (e.g., losses fromexpropriation of assets). IFRSdoes not allow extraordinaryitems to be separated fromoperating results.

DiscontinuedOperations

Two requirements:1. Completion of earnings-process2. Reasonable assurance of

payment.Revenue recognition methods: percentage of completionmethod. Completed contract method. Installment sales. Cost recovery method.

Gains/losses from disposal of abusiness segmentGains/losses from sale of assets

or investments in subsidiaries.Impairments, write-offs, write-downs, & restructuring costs.Integration expenses associatedwith businesses recently acquired.

Compute Cash FlowsFrom Operations (CFO)

Free CashFlow

Year 2010 2011 2012 Total

Cost $400 $300 $100 $800

Year 2010 2011 2012 Total

Rev 500 375 125 1,000

NI 100 75 25 200



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Operating Cash FlowDirect Method

Cash collections from Customers $429,980

Cash Paid to Suppliers (265,866)

Cash Paid for operating Expenses (124,784)

Cash paid for interest (4,326)

Cash Paid for taxes (14,956)

Operating Cash Flow $20,048

Net Income $18,788

Adjustment to net incomeDepreciation and amortization

Deferred income tax

Increase in accounts receivables

Increase in inventory

Decrease in prepaid expenses

Increase in accounts payables

Increase in accrued liabilities

7,996

416

(1,220)

(20,544)

496

13,406

712

Operating Cash flow $20,048

To be accounted for as a discontinuedoperation, a business assets, operations

have been decided to sell off by mgmt butnot yet disposed off. Income / losses arereported net of tax after net income fromcontinuing operations.

Direct Method- Start with cashcollections (cash equivalent ofsales); cash inputs (cashequivalent of COGS); cashoperating expenses; cashinterest expense; cash taxes.

Indirect Method- Start withnet income, subtracting

back gains & adding backlosses resulting fromfinancing or investmentcash flows, adding back allnoncash charges, andadding / subtracting asset &liability a/c that result fromoperations





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RevenueRecognition





Free CashFlow



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Free cash flow (FCF)measures cash available for

discretionary purposes. It isequal to operating cash flowless net capitalexpenditures.





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RevenueRecognition





Free CashFlow



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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

LiquidityRatios

Receivable, Inventory,Payables Turnover

Ratios

Total asset, Fixedasset, & WorkingCapital Turnover

Ratios

Gross, Operating& Net Profit

margin, Return onAssets

Debt Equity& Total Debt

Ratio

Interest &Fixed

ChargeCoverage





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Current ratio= current

asset / currentliabilities(CL)

Quick ratio = (currentasset - inventory) / CL

Cash ratio=(cash +mktable securities) / CL

Q. Assuming current assetsare $160,000 and currentliabilities are $40,000 thecurrent ratio isAns.4

Defensive interval= (cash+mkt. sec. + receivables)/ daily cash expenditures

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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All of which are used in thecash conversion cycle

Receivables turnover= net annual sales /avg. receivables

Inventory turnover =cost of goods sold /avg. Inventory

Payables turnoverratio = purchases /avg. trade payables

Days of sales outstanding= 365 / receivablesturnover

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, andaverage accounts receivable of $350,000, Neev'sreceivables turnover and average collection periodare closest to

Ans: 2.85, 127.75

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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Total Asset Turnover =Revenue / Avg. total Netasset

Fixed Asset Turnover =Revenue / Avg. net FixedAsset

Working Capital Turnover =Revenue / avg. Working Capital

Q. Find the Total Asset Turnover Ratio given:

Net Sales = $32,500Net Assets (current year) = $11,400

Net Assets (previous year) = $9,800Ans.Average Net Assets = ($11,400 + $9,800) / 2 =$10,650Total Asset Turnover ratio = 32,500 / 10,650 = 3.05

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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Neev Corp. earned $10 million in revenuefrom producing widgets and incurred $5million in COGS-related expense. ABC'sgross profit margin would be 50%.

Gross, Operating & Netprofit margins

Return on Total Capital :(ROTC)

Return on Capital =EBIT/ Avg. Total Capital

Gross Profit Margin =Gross Profit / Revenue

Operating Profit Margin =Operating Profit/ Revenue= EBIT/ Revenue

Net Profit Margin = NetIncome / Revenue

Q.Neev Corp. earned $20 mn in revenue from producing widgetsand ABC's operating profit margin would be 30%. For the financial

year 2005 & 2006 total capital was $55 mn & $75 mn. Calculate thereturn on capital of Neev Corp for the FY2006?Ans. ROC = (20*30%) / [(55+75)/2] = 9.23%

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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Debt to Equity Ratio=Total debt / total equity

Total DebtRatio = Totaldebt/ total asset

If a company has $10 in debtand $20 in equity, it has a debtto equity ratio of 0.5($10M/$20M)

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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Year Company XYZ Company SPK

Net Income 30,000,000 80,000,000No. Of Stock Holders 3,000,000 5,000,000Net income per share $10.00 $16.00Dividend Declared $4.00 $6.00Dividend Yield 40.00% 37.5%RR 60% 62.5%ROE 25% 35%G 15.00% 21.88%

Fixed charge cov =(EBIT + leasepayments)/ (Interest

+ lease payments)

Interest & FixedCharge

Coverage

Growth Rateg = RR x ROE

Retention rate =1-Dividend Payout Ratio

InterestCoverage =

EBIT/ Interest

Q. Neev Inc.'s income statement showssales 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 approxAns: 3 times

LiquidityRatios


Ratios


Ratios




Ratio

Interest &Fixed

ChargeCoverage





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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

In periods of rising prices& stable or increasinginventory quantities





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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 * EBITmargin * asset turnover * leverage

DuPont equation: return onequity = (net income/sales)*(sales/assets)* (asset/Equity)You may also see ROE = (netProfit Margin) *(assetTurnover) *(Equity Multiplier)

Q. Firm has net profit margin of10%; asset turnover of 1.5; afinancial leverage of 1.2 timesAns. Return on equity =(10)(1.5)(1.2) = 18%

Q. Firm has o/p profit margin of 10%; asset turnoverof 1.5; a financial leverage of 1.2 times; tax rate of25%; and interest burden rate of 15%.Ans. Return on equity=(75/25)*15%*10%*1.5*1.2

= 8.1%





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Basic EPS calculation does notconsider effects of any dilutivesecurities:basic EPS= (net income - preferreddividends) / wtd. avg. no. of commonshares outstanding

Diluted EPS = available income for common shareholders /

(wtd. avg. common shares plus potential common sharesoutstanding)Therefore, diluted EPS =[(net Income - pfd div) + (Convertiblepreferred 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 tostock option]

Q.reported net income of $555,600 and 150,000 shares

of common stock outstanding for the entire year. 10,000shares of 6%, $100par, preferred stock outstandingduring 2006. During 2005, issued 1000, $1,000 par, 9%of bonds for $1,000,000 (issued at par), convertible to100 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 RatiosBasic & Diluted


ImpactsInventory

AccountingDuPont

Analysis

Capitalizingvs. Expensing

LeasesDeferredTaxes

Depreciation& Impairment

FinancingLiabilities

Marketable SecurityClassifications

Inter CorporateInvestments

Pension



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Capitalizing: lowers incomevariability & increases near-term profits. Increase total

assets & equityExpensing: opposite effect. Recognized when the carrying value of an asset ishigher than the sum of the future cash flows(undiscounted) from their use & disposal. This makesimpairments subject to mgmt manipulationLoss measured is the carrying value of the asset lessthe fair value of the asset.Financial Statement impact: Write-down willimmediately cause income, asset value, deferredtaxes, and equity to decline. It will cause futuredepreciation to decline, and as a result, future net

income will rise. Asset turnover ratios will increaseafter write down for impairment.

Calculation: Straight line and SYD methodssubtract salvage value, the double-decliningbalance method does not. Assuming continuedinvestment in new assets. Relative to a firm thatuses accelerated depreciation. A company thatuses straight line depreciation will have:Lower: Depreciation expense, turnover ratios.Higher: Net income, assets, equity, ROA, ROESame: Cash flows.

Depreciation Impairment

Q.Company purchased machine at$6,000. Residual value = $1,000 after 5years.Ans. Double declining balance method is:Year 1: (2/5)($6,000)= $2,400Year 2: (2/5)($6,000 - $2,400)= $1,440Year 3: (2/5)($6,000-$3,840)= $864Year 4: $296,Year 5: Depreciation expense is $0





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LeasesDeferredTaxes





Pension



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Created when taxable income (on tax return) differsfrom pretax income (financial statement)Deferred tax liabilities (DTR) are created by the useof accelerated depreciation methods for tax purposes

(resulting in lower taxable income) & straight line forfinancial reporting (lower depreciation expense resultsin higher net income)If DTL are not expected to reverse, treat it as equityfor 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 thetime the bonds were issued.For premium bonds, CFF is overstated & CFO isunderstated relative to par bonds.

Q.3 year, 10% coupon, FV $100,000 trading at $105,221issued on 31 Dec 2002 when market rate = 6%Ans.Annual interest payment = $100,000*10% = $10,000interest expense in I/S = 105,221*6% = 6313.26Amortized value of bond = $105,221 (10,000 6313.26) =$101,534.3





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LeasesDeferredTaxes





Pension



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Balance Sheet Income

Statement

Held fortrading

Fair value Dividends,interest

realized G/L

Unrealized G/LAvailablefor sale

Fair value

Unrealized G/L part ofcomprehensive incomeunder shareholders equity

Realized G/L

Interest,Dividends

Held-to-maturity

Amortized cost Interest

Realized G/L

Capital /Finance leases result in:Higher: assets, liabilities, CFO, Debt /Equity.

Lower: Net income (early years), FCFF,current ratio, working capital, assetturnover, ROA, ROE.Same: Total cash flow.Compared to Operating Leases





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LeasesDeferredTaxes





Pension



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50% ownership: Control of the investor;use consolidation method.

Defined Contribution PlanCompany contributes on a definedamount into the planDefined amount = pension expenseDefined Benefit PlanCompany makes promises of futurebenefits to be paid to its employeesExample: 80% of final salary to be paideach year until death





ImpactsInventory

AccountingDuPont

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LeasesDeferredTaxes





Pension



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Question 1

The owners contribution in a company is $45000. The company pays dividends in the current year on itsnet 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 Retained earnings Total

Balance (prev year) $45000 $30000 $75000

Net income $37500 $37500

Distributions ($8500) ($8500)

Balance $45000 $59000 $104000


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Question 2

Strauss Corporation purchases a machine for $50000. The machine has a useful life of 5 years and noresidual 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 assetcompletely


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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 ascash 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 existing300000 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

standardsC. The company is likely to carry a higher financial risk than the industry standardsThis files has expired at 30-Jun-13

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Answer 4

B.

The company has taken on higher debt than the industry standards. However higher leverage adds to thefinancial 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 theacquisition

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 accountinggoodwill


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Question 6

Seal Corporation would like to change its reporting standards from US GAAP to IFRS. Which of thefollowing 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

C. $22.05 millionThis files has expired at 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 expenditureis $ 12 million. FCFF = 34.0512 =$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 canindicate

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 salesand 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 tolose 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 5years. 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 andaccounting?

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 inthe 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 doesaffect 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 companyscurrent 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 theyear 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 shouldbe 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 ofthe 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 interestrate 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, CPT PV= 71.5mn

Interest expense = 71.5*7% = 5.0mn


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Question 15

During 2009 R&M Corporation reported net income was $ 120.5 mn and had $ 85 mn weighted averagenumber 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 stockoptions outstanding at the end of the year, convertible into 100 normal equity shares per option at thestrike price of $ 25. Compute the diluted EPS, if average market price of the stock for the entire year 2009was $ 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= 120.5mn10000*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 costassociated with acquired goodwill reported on the balance sheet is least likely to be incorrect?

A. Company can capitalize the expenses associated with developing goodwillB. 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. Companyvalued 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 itsacquisition 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, ifcompany would have chosen percentage of completion method for revenue recognition instead ofcompleted contract method?

A. Selection of revenue recognition method will not have any effect on either book value or cash flowfrom 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 incase 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 theyear 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 incomestatement 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 inincome statement


Q ti 20

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Question 20

The financial statement is prepared according to IFRS. The carrying value of its inventory was $5.2 millionbefore 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


A 20

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Answer 20

C.


Q ti 21

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Question 21

A real estate firm capitalizes expenses as against expensing. Which of the following is most likely to becorrect for the firm?

A. Stockholders equity is lowerB. In later years interest coverage ratio is higher

C. Cash flow from investing activities is lower


A 21

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Answer 21

C.


Q ti 22

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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 bondis issued, what is the impact on the debt to equity ratio?

A. IncreasesB. Decreases

C. No change


A 22

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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 debtequity ratio


Question 23

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Question 23

IASB expresses the objective of financial statements in "Framework for preparation and presentation offinancial 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.


Answer 23

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Answer 23

B.


Question 24

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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.


Answer 24

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Answer 24

B.

Eg:

Cash - 100,000 Unearned Revenue100,000


Question 25

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Question 25

An internet company buys advertisement space from another internet company in exchange for ad spaceon 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.


Question 26

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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 itmanufactures 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 inflationA. 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.


Question 27

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Question 27

S & D Company has 20000 shares of common stock outstanding and 1000 shares of convertible preferredstock. 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, isconvertible 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 beginningof the year.

A. 1.5

B. 1.12

C. 1.14


Answer 27

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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 is1000*15=15000.

EPS = 40000/(20000+15000+2000-1389) = $ 1.12


Question 28

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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. $73000B. $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 outstandingNet income = 6*10000 = $ 60000


Question 29

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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 statementB. 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.


Question 30

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Question 30

The following information is available :

Net income $290

Decrease in accounts receivables $30Depreciation $12

Increase in inventory $16

Increase in deferred tax liability $10

Increase in accounts payable $12

Taxes paid $24

Find the cash flow from operating activities according to the US GAAP.

A. $450

B. $224

C. $338


Answer 30

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Answer 30

C.

NI + Depreciation + decrease in receivablesincrease in inventories + increase in accounts payables +

increase in deferred tax liability = 290+12+30-16+12+10=338


Question 31

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Question 31

Parity Inc reported the following from their financial statements:

Days of Receivables : 30 days

Stock turnover ratio 5Gross 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 periodafter the introduction of the new product.

A. increase by 6 days

B. decrease by 36 days

C. decrease by 5 days


Answer 31

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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


Question 32

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Q

The sales figure of Rutherford Inc stood at $ 10 million with a gross profit margin of 30%. The company isplanning 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 withits plan of launching the new product?

A. 30.83%

B. 69.17%

C. 43.24%


Answer 32

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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 ifthe financial leverage ratio (total assets/ total equity) is not increasing proportionately.


Question 33

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S &P Corporation has invested $ 30000 in an asset that depreciates over a period of 5 years by thestraight-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 is40%.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


Answer 33

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C.

The tax base is more likely to be higher than the expensed tax rate to reverse the deferred tax liability so

created


Question 34

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Simply Good Inc has a promoters stake of 87% in the organisation. It also operates in an industry which ishighly 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 followingconditions identified by SAS No 99?

A. Incentives and pressure

B. Opportunities for fraud

C. Attitudes and rationalisations


Answer 34

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B.


Question 35

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M&P Corporation leases out a crane for its own use for ten years with an annual payment of $ 10mn. Atthe 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 endof the first year, if appropriate interest rate is 8%?

A. $ 67.10mn

B. $ 62.47mn

C. $ 57.47mn


Answer 35

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B.

N=10 I/Y=8% PMT=-10mn FV=0 CPT PV= 67.1mn

Interest expense = 67.1*8% = 5.37mnprincipal repayment = 10 mn - 5.37mn= 4.63mn

Lease liability= 67.14.63= 62.47mn


Question 36

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An analyst gathered the financial information about a company, which has earned $235 mn during theyear 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 shareseach. 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


Answer 36

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B.

Basic EPS= 235/80= $2.94 saving in earnings= 100000*9%*1000*(1-35%) = $5.85mn

Increase in no of shares= 100000*10= 1mnper 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


Question 37

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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 recordedon 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


Answer 37

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B.

A valuation allowance serves to reduce the value of deferred tax assets which will not be realized


Question 38

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Farm Fresh Corporation has authorized share capital of $ 200mn of face value $ 10, out of which $ 175mnis 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 was16mn?

A. 4.0mn

B. 2.5mn

C. 1.5mn


Answer 38

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C.

Treasury shares =(175/10) -16 =1.5mn


Question 39

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The following information is available about a company

Which of the following is least likely true about the company?

A. The company is not able to manage its inventory efficientlyB. The company must increase its collection effortsC. The company may be facing a decline in demand for its product in the market

Ratio Industry Standards Actual for companyCurrent ratio 2.2 2.7Debtors turnover ratio 6 8


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B.

The correct answer is The company must increase its collection effortsThe company has a better debtors t/o ratio than the industry standards which means it is able to recoverits debt faster. Therefore, increasing the collection efforts is not required


Question 40

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Which of the following will be the effect on the debt to equity ratio and cash flow from operations of acompany, if company chooses to report lease as operating lease instead of financial lease in its books ofaccounts?

Debt/equity ratio Cash flow from operations

A. Higher Higher

B. Lower Lower

C. Higher Lower


Answer 40

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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 ascompany is not reporting its lease payment liabilities on balance sheet


Question 41

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Using the given information calculate the firms cash flow from operations?

Net Income: 135

Decrease in a/c receivables: 15Depreciation: 25

Increase in inventory: 25

Increase in a/c payables: 12

Decrease in wages payable: 8

Increase in deferred tax liability: 15

A. 179B. 189

C. 169


Answer 41

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C.

Cash flow from operation= 135+25+15-25+12-8+15= 169


Question 42

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An analyst gathered the following information about a company:

Deferred tax assets $158,000

Taxable income $30,000Pretax 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. $283,000B. $255,000

C. $280,000


Answer 42

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B.

Increase in DTA= (30000-25000)*25 =125,000

DTA at the end of year= 15800028000 + 125000= 255,000


Question 43

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Singtel Inc follows the accelerated method of depreciation. In the later years of an assets life, this methodis most likely to result in which of the following:

A. Lower net profitB. Lower tax expense

C. Higher net profit


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C.


Question 44

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Which of the following will be the most likely effect of treating a sale of receivables with recourse as aborrowing against receivables on the balance sheet of a company?

A. Increasing the debt/equity ratioB. Reducing the value of cash and cash equivalent

C. Increasing the receivables turnover ratio


Answer 44

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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.


Question 45

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Smith and Companys receivable turnover is five times, inventory turnover ratio is six times and thepayables turnover ratio is ten times. Which of the following is most likely period of the cash conversioncycle?

A. 48 days

B. 96 days

C. 24 days


Answer 45

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B.

Cash conversion cycle= 360/5 + 360/6360/10= 72+60-36= 96 days


Question 46

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The US GAAP framework and FASB, while establishing the hierarchy of qualitative characteristics, givesprimary importance to:

A. Reliablity and RelevanceB. Relevance and Reliability

C. Reliability and Comparability


Answer 46

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B.


Question 47

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A chemical company has to account $50000 today to remediate a property once production is complete in6 years. If the discount rate applied is 6%. Find the value of asset reconstruction obligation.

A. $44490B. $70925

C. $89450


Answer 47

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B.

Future value of 50000 for 6 years at 6%

50,000*[(1.06)^6]70,925


Question 48

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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.


Answer 48

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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 burdenincreases the ROE will begin to fall if the financial leverage ratio (total assets/ total equity) is not increasingproportionately.


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