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Free Test Prep CFA-Level-I Exam Questions (page: 88)

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Which of the following is/are FALSE?

  1. Interest expenses that are capitalized are charged against investing cash flows.
    II. Firms that expense interest costs incurred on debt must treat them as financing cash flows.
    III. Firms that expense costs show lower equity than comparable firms that capitalize the costs.
    IV. Capitalization of expenses leads to lower tax payments in the first year.
  2. I, II & IV
  3. II & IV
  4. II & III
  5. III & IV

Answer(s): B

Explanation:

Interest expenses are treated as operating cash flows under US GAAP. Capitalization leads to higher net income since the entire expenses are not charged against it. Due to this, the tax deductions are lower in the first year, leading to higher taxes. The higher income leads to the capitalizing firm having a higher equity. The difference in equity reduces over time to zero.



The deferred income tax account

  1. can be reported as an asset
  2. is reported as a liability if it has a credit balance
  3. is where the difference between income tax expense and income tax payable is reconciled
  4. all of these answers are correct

Answer(s): D

Explanation:

The difference between income tax expense (based on accounting income) and the actual income taxes payable (based on taxable income) is reconciled in an account called deferred income taxes. It can be reported as an asset or a liability, depending on its balance and the circumstances.



In periods of rising prices, which inventory costing method results in the smallest income tax expense?

  1. Average cost
  2. Perpetual
  3. FIFO
  4. LIFO

Answer(s): D

Explanation:

LIFO assigns the largest dollar value amounts to COGS when purchase prices are rising, thus resulting in lower net income and lower income taxes.



Patterson Company has the following information of one of its vehicles purchased on January 1, 1992:

Vehicle cost $50,000
Useful life, years, estimated 5
Useful life, miles, estimated 100,000
Salvage value, estimated $10,000

Actual miles driven:

1992 30,000
1993 10,000
1994 15,000
1995 25,000
1996 12,000

No estimates were changed during the life of the asset. The 1994 depreciation expense using the sum-of-

years'-digits (SYD) method was ________.

  1. $13,333
  2. $8,000
  3. $10,667
  4. $10,000
  5. $6,000

Answer(s): B

Explanation:

SYD depreciation is calculated on a constant depreciable base equal to $40,000 ($50,000 original cost -10,000 salvage value), multiplied by the SYD fraction. The denominator is the sum of the digits of the total years of the expected useful life (1+2+3+4+5=15). The SYD fraction's numerator equals the remaining years. For 1994, the fraction is 3/15, and depreciation expense is $8,000 ($40,000 X 3/15).



Under the accrual basis of accounting, which of the following statements is true?

  1. Reported net income provides a measure of operating performance.
    II. Revenue is recognized when cash is received, and expenses are recognized when payment is made.
    III. Cash inflows are recognized when they are received, and cash outflows are recognized when they are made.
  2. I only
  3. I, II and III
  4. III only
  5. I and III

Answer(s): D



Valuation of PP&E and natural resources emphasizes all of the following accounting objectives except ________.

  1. accounting for monies invested in assets
  2. historical cost
  3. conservatism principle
  4. reality

Answer(s): D

Explanation:

The financials portray historical information; they do not paint a picture of today.



A firm has a net profit margin of 25%. Its total asset turnover equals 1.3 and equity turnover equals 2.1. The firm's ROE and financial leverage equal ________.

  1. 28.6%, 1.47
  2. 43.2%, 1.33
  3. 52.5%, 1.62
  4. 39.8%, 0.62

Answer(s): C

Explanation:

ROE = net income/equity = (net income/sales)*(sales/equity) = net profit margin * equity turnover = 25%*2.1 = 52.5% Financial Leverage = Total assets/equity = (total assets/sales)*(sales/equity) = (1/asset turnover)*(equity turnover) = 2.1/1.3 = 1.62.



When compared to the percentage-of-completion method, the completed contract method

  1. reports larger total assets.
  2. reports higher net assets.
  3. reports higher cash flows.
  4. reports income earlier.
  5. uses higher estimates of selling prices.

Answer(s): A

Explanation:

The completed contract method reports larger total assets because it accumulates inventory.



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