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CFA-Level-I: CFA® Level I Chartered Financial Analyst
Free Practice Exam Questions (page: 69)
Updated On: 2-Jan-2026

Page 69 of 496
PDF with 3963 Questions

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.



The following data have been obtained from a firm's financial statements:

operating profit margin 34%
interest expenses 465
depreciation expenses 123
debt-to-equity ratio 0.60
total assets 2,375
total sales 4,109

tax rate 37%

The firm's ROE equals ________.

  1. 19.17%
  2. 22.88%
  3. 56.32%
  4. 34.44%

Answer(s): D

Explanation:

The answer to this requires you to know the extended duPont system. However, you should NOT rely on your memory for complex formulas. Rather, start from the primary quantity needed (ROE here) and use some basic definitions and common sense. This approach will ensure that you are not caught by surprise during the exam.
You need to calculate net income and total equity to obtain ROE, since ROE = net income/total equity.
Operating profits equal earnings before depreciation, interest and taxes (EBDIT). The operating profit margin expresses EBDIT as a fraction of total sales and indicates the level of profitability of the firm. In this case, EBDIT = 4109*34% = 1,397. Since interest expenses are taxdeductible, EBT = 1,397 - interest expense - depreciation = 1,397 - 465 - 123 = 809. Therefore, net income after taxes = 809*(1 - 37%) = 510. Also, debt + equity = total assets and debt = 0.6*equity (given). So total assets = 2,375 = 1.6*equity, giving equity = 2,375/1.6 = 1,484. Finally, ROE = 510/1484 = 34.34%.



A defined benefit pension plan:

  1. pays defined benefits for a certain period after retirement.
  2. disburses benefits based on the returns on the fund's investments.
  3. promises to pay retirees a specific income stream.
  4. none of these answers.

Answer(s): C

Explanation:

In a defined benefit pension plan, the retirement benefits are "predefined." The employer commits to providing the benefits regardless of the performance of the pension plan. Thus, in this plan, the risk of pension plan performance is borne by the employer and not the employee.



At the end of a fiscal period, any revenue that has been earned but the company has not received payment for should be debited to an appropriate

  1. asset account
  2. expense account
  3. liability account
  4. revenue account

Answer(s): A

Explanation:

Revenue should be recognized in the period in which it is earned and is credited to the appropriate revenue account. If payment has not been received, then a debit entry to Accounts Receivable must be booked.



Which of the following is/are FALSE about Basic EPS and Diluted EPS?

  1. Basic EPS excludes anti-dilutive securities but Diluted EPS must include these.
    II. Basic EPS ignores instruments like convertible bonds and warrants but Diluted EPS does not.
    III. The Treasury stock method, when applied to Basic EPS, compares the average stock price during the period to the strike price in determining conversion.
  2. III only
  3. I & III
  4. I, II & III
  5. II only

Answer(s): B

Explanation:

Note that the questions asks for false statements. (I) is false since both methods exclude anti-dilutive securities from computations. Further, since the Basic EPS ignores all potentially dilutive securities and takes into account only simple capital structure instruments (stocks, bonds, preferred equity), it has no need for the Treasury Stock method i.e. the Treasury stock method is never used in the computation of Basic EPS.



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