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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 109 )

Updated On: 26-Jan-2026
Page 109 of 793
PDF with 3960 Questions

Bungling, Inc., is currently facing a lawsuit as a defendant. Its honest lawyers estimate that there is a 60-40 chance that Bungling will lose the lawsuit. The jury could award the plaintiff punitive damages ranging from $10,000 to $50,000. Bungling should

  1. not recognize any liability but disclose the details in footnotes.
  2. not do anything since the lawsuit is still not decided and considerable uncertainty exists.
  3. recognize a liability of $50,000 on its balance sheet as a conservative estimate.
  4. recognize a liability of $10,000 on its balance sheet.

Answer(s): A

Explanation:

If considerable uncertainty exists in measurement of an asset or a liability arising from events like a lawsuit, disclosure must occur in footnotes. The disclosure includes the nature of the contingency and an estimate or a range of estimates about the possible losses.



Firms A and B are identical. In one year, Firm A's statements have the beginning inventory understated and the ending inventory overstated. Then,

  1. A's tax payment is higher.
    II. B's tax payment is higher.
    III. B shows a higher income.
    IV. A shows a higher income.
  2. I & IV
  3. II & III
  4. I & III
  5. II & IV

Answer(s): A

Explanation:

COGS = Beginning inventory - Ending inventory + Purchases. Hence, if BI is understated and EI overstated, COGS is understated, implying income is overstated. Hence, Firm A will show higher income and pay higher taxes. It should be remembered that implicit in the use of the above inventory equation is the assumption that there have been no write-downs or write-ups in the inventory.



The main use of the balance sheet for creditors would be

  1. to forecast future cash flow needs.
  2. to review the short-term liquidity of the firm.
  3. to forecast cash collections.
  4. to forecast changes in fixed assets thereby assisting in the firm's profitability.
  5. to provide information about the nature of assets that the firm uses as debt collateral.

Answer(s): E

Explanation:

The balance sheet provides information about a firm's resources and obligations, including liquidity and solvency.



Which of the following describes a change in reporting entity?

  1. A company acquires a subsidiary that is to be accounted for as a purchase.
  2. None of these answers.
  3. A business combination is made using the pooling-of-interests method.
  4. A manufacturing company expands its market from regional to nationwide.
  5. A company acquires additional shares of an investee and changes from the equity method of accounting to consolidation of the subsidiary.

Answer(s): C

Explanation:

A change in reporting entity can occur in the following ways: initial publication of consolidated financial statements; change in consolidation policy regarding subsidiaries; and pooling of interests.



Free cash flow is not

  1. cash flow that includes discretionary uses such as debt reduction.
  2. the measure of cash available to the firm for discretionary uses after making all required cash outlays.
  3. better to have a large sum of.
  4. defined as cash flow from operations minus all capital expenditures.
  5. a cash flow with one definition because of its several discretionary uses.

Answer(s): E

Explanation:

The definition of free cash flow varies widely, depending on how one defines required and discretionary uses.



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