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CFA CFA-Level-II Exam Questions
CFA Level II Chartered Financial Analyst (Page 15 )

Updated On: 24-Feb-2026
Page 15 of 145
PDF with 715 Questions

William Jones, CFA, is analyzing the financial performance of two U.S. competitors in connection with a potential investment recommendation of their common stocks. He is particularly concerned about the quality of each company's financial results in 2007-2008 and in developing projections for 2009 and 2010 fiscal years.

Adams Company has been the largest company in the industry but Jefferson Inc. has grown more rapidly in recent years. Adams's net sales in 2004 were 33-1/3% higher than Jefferson but were only 18% above Jefferson in 2008. During 2008, a slowing U.S. economy led to lower domestic revenue growth for both companies. The 10-k reports showed overall sales growth of 6% for Adams in 2008 compared to 7% for 2007 and 9% in 2006. Jefferson's gross sales rose almost 12% in 2008 versus 8% in 2007 and 10% in 2006. In the past three years, Jefferson has expanded its foreign business at a faster pace than Adams. In 2008, Jefferson's growth in overseas business was particularly impressive. According to the company's 10-k report, Jefferson offered a sales incentive to overseas customers. For those customers accepting the special sales discount, Jefferson shipped products to specific warehouses in foreign ports rather than directly to those customers' facilities.

In his initial review of Adams's and Jefferson's financial statements, Jones was concerned about the quality of the growth in Jefferson's sales, considerably higher accounts receivables, and the impact of overall accruals on earnings quality. He noted that Jefferson had instituted an accounting change in 2008. The economic life for new plant and equipment investments was determined to be five years longer than for previous investments. For Adams, he noted that the higher level of inventories at the end of 2008 might be cause for concern in light of a further slowdown expected in the U.S. economy in 2009.

The accompanying table shows financial data for both companies' Form 10-k reports for 2006- 2008 used by Jones for his analysis. To evaluate sales quality, he focused on trends in sales and related expenses for both companies as well as cash collections and receivables comparisons. Inventory trends relative to sales and the number of days' sales outstanding in inventory were determined for both companies. Expense trends were examined for Adams and Jefferson relative to sales growth and accrual ratios on a balance sheet and cash flow basis were developed as overall measures of earnings quality.



Based on the financial results of Adams and Jefferson in 2007 and 2008, the company demonstrating the lower earnings quality would be:

  1. Adams due to lower cash collection measures, possible inventory obsolescence related to higher 2008 inventories despite slowing customer demand, higher expense growth compared to Jefferson, and lower balance sheet and cash flow accrual ratios relative to Jefferson.
  2. Jefferson due to sharply higher accruals ratios and less conservative accounting methods indicated by the change in depreciation policies and the impact of changes in shipment terms on revenue recognition and inventories for the special overseas offer.
  3. Adams due to slower revenue growth, higher expense growth compared to Jefferson, possible inventory obsolescence related to higher 2008 inventories despite slowing customer demand, and lower balance sheet and cash flow based accrual ratios in 2008 compared to Jefferson.

Answer(s): B

Explanation:

According to the simple measures of earnings quality, balance sheer and cash flew accruals ratios, Jefferson's earnings quality in 2008 was lower than its 2007 levels and relative to Adams. The more aggressive accounting treatment for the overseas special offer lowered the quality of revenues and may have understated inventories if some oF these customers don't take deliver)' of the shipments. Jefferson also instituted a more liberal policy toward depreciable lives versus Adams, another indicator of lower earnings quality. (Study Session 7, LOS 25.d,f)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.
For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.
For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Assuming International Oilfield is a significantly integrated sales division and virtually all operating, investing, and financing decisions are made by Continental Supply, foreign currency gains and losses that arise from the consolidation of International Oilfield should be reported in:

  1. shareholders equity.
  2. operating cash flow.
  3. net income.

Answer(s): C

Explanation:

Assuming International Oilfield is an integrated sales division and Continental Supply makes virtually ail of the decisions, the functional currency is likely the presentation currency.
Thus, the temporal method is used. Under the temporal method, remeasurement gains and losses are reported in the income statement. (Study Session 6, LOS 23.c)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year-end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0


At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Assuming that International Oilfield's equipment is depreciated using the straight-line method over ten years with no salvage value, calculate the subsidiary's 2008 depreciation expense under the temporal method.

  1. $78-4 million.
  2. $95.7 million.
  3. $104.7 million.

Answer(s): B

Explanation:

Temporal method; [(975 million - 108 million) / 10 years = LCU 86.7 million / 1.00 =
$86.7 million] t [(225 million / 10 years) x Vi year = LCU 11.25 million / 1.25 = $9 million] = $95.7 million. (Study Session 6, LOS 23.c)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.
For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year- end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.


At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.
For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4

Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

Compute the cumulative translation adjustment reported on Continental Supply's consolidated balance sheet at the end of 2008 assuming International Oilfield is a relatively self-contained and independent, operation of Continental Supply.

  1. -$227 million.
  2. -$200 million.
  3. $298 million.

Answer(s): A

Explanation:

Under the all-current method, gains and losses that occur as a result of the translation process do not show up on the income statement but are instead accumulated in a balance sheet account called the cumulative translation adjustment account (CTA). The translation gain or loss in each year is calculated and added to the account, acting like a running total of translation gains and losses. The CTA is simply an equity account on the balance sheet. To compute the CTA for Continental's balance sheet, force the accounting equation (A = L + E) to balance with the CTA; [(120 million cash and receivables + 631.3 million inventory + 820.7 million equipment - 600 million liabilities) / 1.50] - $350 million capital stock - $525 retained earnings = -$227 million. The LCU 350 capital stock was issued at the end of 2005 at an exchange rate of LCU 1 = $1. The
$525 retained earnings figure was given in the itxt. (Study Session 6, LOS 23.c)



In 2001, Continental Supply Company was formed to provide drilling equipment and supplies to contractors and oilfield production companies located throughout the United States. At the end of 2005, Continental Supply created a wholly owned foreign subsidiary, International Oilfield Incorporated, to begin servicing customers located in the North Sea. International Oilfield maintains its financial statements in a currency known as the local currency unit (LCU). Continental Supply follows U.S. GAAP and its presentation currency is the U.S. dollar.

For the years 2005 through 2008, the weighted-average and year-end exchange rates, stated in terms of local currency per U.S. dollar, were as follows:

LCU/SUS 2005 2006 2007 2008
Average 0.90 1.05 1.05 1.25
Year- end 1.00 1.10 1.00 1.50

International Oilfield accounts for its inventory using the lower-of-cost-or-rnarlcet valuation method in conjunction with the first-in, first-out, cost flow assumption. All of the inventory on hand at the beginning of the year was sold during 2008. Inventory remaining at the end of 2008 was acquired evenly throughout the year.

At the beginning of 2006, International Oilfield purchased equipment totaling LCU975 million when the exchange rate was LCU 1.00 to SI. During 2007, equipment with an original cost of LCU 108 million was totally destroyed in a fire. At the end of 2007, International Oilfield received a LCU 92 million insurance settlement for the loss. On June 30, 2008, International Oilfield purchased equipment totaling LCU 225 million when the exchange rate was LCU 1.25 to $1.

For the years 2007 and 2008, Continental Supply reported International Oilfield revenues in its consolidated income statement of S375 million and $450 million, respectively. There were no inter- company transactions. Following are International Oilfield's balance sheets at the end of 2007 and 2008:

LCU in millions 2008 2007
Cash and receivables 120.0 216.0
Inventory 631.3 650.4
Equipment 820.7 693.6
Liabilities (all monetary) 600.0 600.0
Capital stock 350.0 350.0
Retained earnings 622.0 610.0

At the end of 2008, International Oilfield's retained earnings account was equal to $525 million and, to date, no dividends have been paid. All of International Oilfield's capital stock was issued at the end of 2005.

As compared to the temporal method, which of the following best describes the impact of the all- current method on International Oilfield's gross profit margin percentage for 2008 when stated in U.S. dollars? The gross profit margin would be:

  1. lower.
  2. higher.
  3. the same.

Answer(s): B

Explanation:

As compared to the temporal method, the all-current method will result in a higher gross profit margin percentage (higher numerator) when the local currency is depreciating as is the case in this scenario (the exchange rate has risen from LCU 1 per $1 to LCU 1.25 per $1; thus, it costs more LCUs to buy $1 which is the result of a depreciating LCU). Under the temporal method, COGS is remeasured at the historic rate; thus, COGS is not impacted by the depreciating currency.

Under the all-current method, COGS is translated at the average rate; thus, COGS is lower because of the depreciating currency. Lower COGS results in a higher gross profit margin percentage. (Study Session 6, LOS 23.d)






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