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Free Test Prep CFA-Level-I Exam Questions (page: 85)

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Firm A uses Double Declining and Firm B uses Sum-of-digits method of depreciation. In the first year, which of the following is/are TRUE?

  1. A shows lower assets than B
    II. A shows higher retained earnings than B
    III. A shows a higher debt-to-equity ratio than B
    IV. A shows a lower debt-to-asset ratio
  2. II & IV
  3. I & III
  4. I, III & IV
  5. II, III & IV

Answer(s): B

Explanation:

Double Declining results in a higher depreciation in the first year. Therefore, Firm A shows lower assets, lower income and hence lower equity in the first year. Thus, its debt-to-equity and debt-to- asset ratios are higher than B's.



If the net cash inflow = $12,000, Investing cash flow = $(4,000) and operating cash flow = $7,000, the financing cash flow equals ________.

  1. $9,000
  2. $23,000
  3. $15,000
  4. $12,000

Answer(s): A

Explanation:

financing cash flow = 12,000 - (-4,000) - 7,000 = $9,000



An end-of-period adjustment for depreciation of fixed assets involves an entry to an expense and

  1. the increase of a contra account
  2. the decrease of a contra account
  3. the reduction of a liability
  4. the increase of a liability

Answer(s): A

Explanation:

An adjustment for depreciation expense matches expenses with revenues for the period. An expense is incurred and the asset is reduced by increasing the contra account.



Morgan Inc. was organized on January 2, 1997 with the following capital structure:

10% cumulative preferred stock, par value $100 and liquidation value $105; authorized, issued and outstanding 1,000 shares, $100,000

Common stock, par value $25; authorized 100,000 shares;
Issued and outstanding 10,000 shares, $250,000

Morgan had net income of $450,000 for its first year, but no dividends were declared. How much was Morgan's book value per common share at December 31, 1997?

  1. $68.50
  2. $70
  3. $25
  4. $45.00
  5. $69.50

Answer(s): A

Explanation:

The book value per share of cumulative preferred stock is its liquidation value plus any dividends in arrears.
Thus, the book value per preferred share is the $105 liquidation value plus $10 ($100 X 10%) of dividends in arrears, or $115. The total book value for preferred shares is $115,000 ($115 X 1000). The total book value of the company is $800,000 ($100,000 par value of preferred stock + $250,000 par value of common stock + retained earnings equal to $450,000 of net income). Hence, $685,000 ($800,000-115,000) is the book value of the common stock, and book value per common share is $68.50 ($685,000 / 10,000 shares).



When purchased, plant assets are recorded at ________.

  1. future value
  2. market value
  3. lower of cost or market
  4. cost

Answer(s): D

Explanation:

Fixed assets are recorded at cost, which includes all normal and reasonable expenditures necessary to get the asset in place and ready to use.



From tax perspective, which of the following depreciation methods is usually the best?

  1. Double declining
  2. Modified accelerated
  3. Straight line
  4. Sum-of-digits

Answer(s): A

Explanation:

Since Double Declining results in the biggest depreciation expense of the four in the initial years, it allows the biggest deferral of tax payments. These deferrals can sometimes be for an indefinite period, thus avoiding them almost altogether.



Gamma-Theta is a financial software firm with gross sales of 176,000 last year. Its cost of goods sold equaled 25,685. Gamma-Theta's corporate tax rate is 35%. If its net income after taxes was 70,279, its operating expenses were ________.

  1. 31,889
  2. 42,193
  3. 29,495
  4. 51,722

Answer(s): B

Explanation:

Gamma-Theta's pre-tax income equals 70,279/0.65 = 108,122. Now, pre-tax income = gross sales - cost of goods sold - operating expenses. Therefore, 108,122 = 176,000 - 25,685 - operating expenses. This gives operating expenses = 42,193.



Restricted cash balances are ________.

  1. non-current assets
  2. not considered assets
  3. none of these answers
  4. regarded as part of long-term equity

Answer(s): A

Explanation:

At times, firms earmark cash deposits and balances for meeting longer term obligations like sinking funds or plant expansions. Such restricted cash balances are reported as non-current assets even though they are in a liquid form, since they are not available to satisfy current liabilities.



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