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Free Test Prep CFA-Level-I Exam Questions (page: 84)

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Which combination leads to the lowest income tax paid in earlier years of a firm?

Inventory valuationDepreciation

  1. FIFOStraight-line
    II.LIFOStraight-line
    III.FIFODouble Declining
    IV.LIFODouble Declining
  2. IV.
  3. II.
  4. I.
  5. III.

Answer(s): A

Explanation:

In the earlier years, this combination results in the lowest income reported and hence, the lowest taxes.



A firm has a constant pre-depreciation income using assets that last 5 years. The straight-line method results in a rate of return that ________ over the life of the assets. The accelerated methods result in a rate of return that ________ over the life of the assets.

  1. increases, increases
  2. decreases, increases
  3. decreases, decreases
  4. increases, decreases

Answer(s): A

Explanation:

The straight line and all accelerated depreciation methods giving an increasing rate of return on assets over the asset life (the pre-depreciation income is held constant to isolate the effect). This is a mathematical fact which you can easily prove.



An asset with a 10-year life has an acquisition cost of 5,000. The firm, using double declining method of depreciation has an accumulated depreciation of 2,440 at the end of year 3 (verify this!). The depreciation expense in year 4 is equal to ________.

  1. 467
  2. 630
  3. 512
  4. 731

Answer(s): C

Explanation:

The book value at the beginning of year 4 = 5,000-2,440 = 2,560. Then, depreciation expense in year 4 = 2/10*book value = 512.



The weighted average method is based on the assumption that the cost of merchandise sold should be calculated using the :

  1. lower of cost or market (LCM)
  2. FIFO
  3. LIFO
  4. weighted average cost

Answer(s): D

Explanation:

Under the weighted average method, inventory is priced at the average cost of the goods available for sale (Beginning inventory plus purchases during the period). The cost for the ending inventory under this method is influenced by all the prices paid during the period.



If a company fails to record a material amount of depreciation in a previous year, this is considered

  1. an accounting error.
  2. a change in estimate.
  3. an unusual item.
  4. a change in accounting principle.

Answer(s): A

Explanation:

This is neither unusual or a change, but simply an error.



Which of the following is/are current liabilities?

  1. Accounts receivable
    II. Cash advances received
    III. Advance magazine subscription payments received
    IV. Revenues from credit card fees
  2. II, III & IV
  3. II & III
  4. III & IV
  5. I, II, III & IV

Answer(s): A

Explanation:

Accounts receivable represent current assets.



Which of the following marketable securities would provide the greatest liquidity and stability?

  1. None of these answers
  2. All of these answers
  3. AA corporate bonds that mature in 5 years
  4. Common stock of a publicly held firm
  5. U.S. treasury bills

Answer(s): E

Explanation:

F. S. treasury bills would be the most liquid because the maximum maturity is 182 days (although most treasury bills purchased by firm's have a shorter maturity). In addition, the value of treasury bills would fluctuate less than the value of the common stock of another firm or long-term corporate bonds.



In a given period, the firm's beginning gross investment is 6,000 and ending gross investment is 10,000. The accumulated depreciation at the beginning was 500 and the ending balance in this account was 1,500. The firm uses straight-line depreciation. Then, the average depreciable life of the firm's assets is ________.

  1. 6.67 years
  2. 6 years
  3. 10 years
  4. 12 years

Answer(s): C

Explanation:

Note that: Average depreciable life = Ending Gross Investment/Depreciation expense. Depreciation expense = 1,500-500 = 1,000. Hence, ADL = 10,000/1,000 = 10 years.



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