Sold to Sophy Thwe (#YUTFIFX4)

Financial Statement Analysis: An Introduction

1. Which of the following would least likely be considered a role of financial
reporting? To provide information regarding:

a. Financial performance
b. Credit ratings
c. Changes in financial position

2. Financial statement analysis is the process of examining a company’s

performance in the context of its industry and economic environment in
order to arrive at a decision or recommendation. Which of the following
decisions is least likely to be supported by this process?

a. Arrive at a valuation to support a decision to invest

b. Assess a company’s liquidity and solvency in order to arrive at a credit
rating for the company and its debt
c. Assessing a company’s operating activities to assess compliance with
environmental, health, and safety regulations

3. Statements of Financial position can differ in presentation format between

GAAP and IFRS. Which is not a likely difference?

a. Order of liquidity of accounts

b. Order of years of data for multi-period statements (i.e. descending or
ascending years from right to left)
c. Order of categories (assets, liabilities, equity)

4. Which of the following Balance Sheet identity formulations is incorrect?

a. L = A – E
b. E = L - A
c. L/A + E/A = 1

5. Which of the following statements about Comprehensive Income (CI) is false?

a. CI includes all items that impact owner’s equity but are not the result
of transactions with shareowners
b. CI, when subtracted from Net Income gives Total Comprehensive
Income
c. CI components are reported either on the Income Statement or in
Other Comprehensive Income
Sold to Sophy Thwe (#YUTFIFX4)

6. The Balance Sheet equation is best represented by:

a. Resources controlled = obligations to lenders and creditors + residual
claims
b. Assets = debt + common stock + retained earnings
c. Total Assets – Debt = shareholder’s equity

7. In any given month, a company sells all it products on a cash basis (no
accounts receivable) but pays for its purchases the following month. From
month to month it’s sales and purchases have been flat. What is the
relationship between profit and cash flow?

a. Profit > cash flow
b. Cash flow > profit
c. Cash flow = profit

8. A company’s ability to pay returns to the providers of capital is best assessed
by the magnitude of its:

a. Net Income
b. Cash Flow from Operations
c. Total Comprehensive Income

9. With respect to consolidated income statements, which statement is
accurate?

a. Each line item of the consolidated income statement includes the
entire amount from the relevant line item on the subsidiary’s income
statement
b. Each line item of the consolidated income statement includes the
proportional amount from the relevant line item on the subsidiary’s
income statement
c. If the parent does not own 100% of the subsidiary, the minority
interest in Net Income must be added to the parent’s Net Income

10. Which of the following statements is FALSE?

a. Solvency refers to a company’s ability to meet long-term obligations
b. Liquidity refers to a company’s ability to meet short-term obligations
c. Financial flexibility refers to a company’s ability to lower solvency to
increase liquidity, and vice versa




Sold to Sophy Thwe (#YUTFIFX4)

11. Which of the following is accurate with respect to the reporting of dividend
and interest receipts and payments on the cash flow statement?

a. IFRS allows more flexibility than GAAP in determining which category
(operations, investing, financing) in which to report them
b. GAAP allows more flexibility than IFRS in determining which category
(operations, investing, financing) in which to report them
c. Both GAAP and IFRS are in agreement with respect to the treatment of
dividends and interest received and paid on the Cash Flow Statement

12. If an auditor is not able to issue an opinion with respect to a company’s
financial statements, they are most likely to issue a(n):

a. Adverse Opinion
b. Qualified Opinion
c. Disclaimer of Opinion

13. The main objective of an audit is to provide a(n) ________________________ that
statements are free from material misstatements:

a. Guarantee
b. Reasonable assurance
c. Unqualified opinion

14. Auditor’s typically do not express an opinion of which of the following:

a. A company’s internal controls
b. The Management Discussion and Analysis within the annual report
c. The soundness of accounting policies used in reporting the statements

15. Information regarding the effects of inflation on future results would least
likely be found in:
a. The Auditor’s Report
b. Notes to the financial statements
c. Management Discussion and Analysis

16. Which is unaudited?
a. Annual statement
b. Quarterly Statement
c. Notes to the Annual Financial Statement

17. An assessment of a company’s financial position at a point in time is best
evaluated using the:
a. Income Statement
b. Balance Sheet
c. Cash Flow Statement
Sold to Sophy Thwe (#YUTFIFX4)

Answers:
Financial Statement Analysis: An Introduction:

1. B is correct. Arriving at a credit rating is one of the roles of financial

statement analysis, not reporting.

2. C is correct. An assessment of compliance with relevant regulations does not

require an analysis of financial statements.

3. C is correct. IFRS specifies categories but not format. Therefore ordering by

liquidity may differ.

4. B is correct. E = A – L. A is correct since it is a correct reformulation of A = L

+ E. C is correct since dividing all components of the identity by A arrive at 1
= L/A + E/A.

5. B is correct. The proper formulation is TCI = NI + OCI. Some of the

components of CI are included in the calculation of NI, and others are
included in OCI.

6. A is correct. B is incorrect since liabilities include more than just debt.

Unearned revenue is an example of a liability that is not debt. C is incorrect
for the same reason.

7. C is correct. Sales and purchases are the same each month. All sales are cash,
and since this month’s COGS = this month’s payment to suppliers (sales and
purchases flat month over month), cash flow = profit.

8. B is correct. Since we are talking about payment s to the providers of capital

(interest and dividends), a company must have the cash to make such
payments. A is not correct since a company may have large depreciation
charges that result in negative Net Income, but may still have ample ability to
pay interest on debt. C is incorrect for the same reasons.

9. A is correct. B is not correct since the total amount of each related line item
must be included, not just the proportional amount. C is incorrect since the
minority interest in the Net Income must be subtracted to arrive at the
parent company’s Net Income, not added.
Sold to Sophy Thwe (#YUTFIFX4)

10. C is correct. Financial flexibility is accurately described as the ability of the

company to react and adapt to financial adversities and opportunities. A is a
true statement; solvency refers to a company’s ability to meet its long-term
obligations. B is a true statement; liquidity refers to the ability of a company
to meet its short-term obligations.

11. A is correct. IFRS allows more flexibility than GAAP across all standards.

12. 12. C is correct. Both A and B represent opinions.

13. B is correct. A is incorrect because audits are designed and conducted using
sampling techniques, and financial statement line items may be based on
estimates and assumptions, auditors cannot express an opinion that provides
absolute assurances or guarantees. C is incorrect since an unqualified
opinion is part of the Auditor’s report, which is part of the output of an audit
and not the purpose of the audit.

14. B is correct. Auditors express an opinion on both A and C.

15. A is correct. A discussion of the effects of inflation is most likely to be found
in the MD&A. The Notes may also contain information on the effects of future
inflation. The Auditor’s report is based solely on financial data presented, not
on likely future financial data.

16. B is correct. Both A and C are audited.

17. B is correct. Only the Balance Sheet is taken at a point in time. Both the
Income Statement and the Cash Flow Statement cover a period of time. The
Income Statement aides in evaluating the earnings potential of a business
while the Cash Flow Statement aides in evaluating a company’s ability to
generate cash flow.














Sold to Sophy Thwe (#YUTFIFX4)

Financial Reporting Mechanics

1. Business activities are typically classified into three groups for financial
reporting purposes. Which category would involve those activities
associated with obtaining and repaying capital?

a. Investing activities
b. Operating activities
c. Financing activities

2. Company A manufactures assembly equipment and sells some items to
Company B that arranges financing through Bank C. Classifying these
transactions for company A, B, and C respectively– the transaction will be
classified as:

a. Company A – Operating only, Company B – Investing only, Company C
- Financing
b. Company A – Investing only, Company B – Investing and Financing,
Company C – Financing only
c. Company A – Operating only, Company B – Investing and Financing,
Company C – Operating only

3. Interest income is least likely to be classified as a(n)

a. Investing activity
b. Financing activity
c. Operating activity

4. Contra accounts are least likely to be found with respect to which type of
financial statement element?

a. Assets
b. Expenses
c. Equity

5. A company ends an accounting period with the following account balance:
Current Assets $3,400, Total Liabilities of $12,600 and Equity of $4,000. If its
Inventory balance is only $700, what is the balance we should expect to find
for Non-Current Assets?

a. $12,500
b. $5,200
c. $13,200

Sold to Sophy Thwe (#YUTFIFX4)

6. A company records total assets of $15,000 and net assets of $4,200. Non-
residual claims on the company’s assets total:

a. $4,200
b. $10,800
c. $19,200

7. If we were interested in determining the earnings of a business from just
operating activities, we would use which of the following equations:

a. Revenue – Expenses
b. (Revenues + gains) – (Expenses + losses)
c. Gains – losses

8. A non-dividends paying company had the following balances in specific
accounts as of the end of a reporting period: Contributed Capital $2,000,
Beginning Retained Earnings = $5,000, Revenue = $10,000, Expenses =
$8,500, and Liabilities of $6,000. What is the total value of economic
resources owned by the company?

a. $14,500
b. $13,000
c. $8,000

9. On January 2, 20XX, a company receives cash for an annual membership fee
from a customer and decides to prepay its rent for the full year. On January
3, 20XX, what types of accrual accounts would we most likely see?

a. Accrued Expenses and Unearned Revenue
b. Prepaid Expenses and Deferred Revenue
c. Prepaid Expenses and Accrued Revenue

10. At the end of an accounting period a company has incurred legal expenses
but has yet to be billed for the work, the company, according to the standards
of accrual accounting, will most likely:

a. Record an asset account for prepaid expenses
b. Record an asset account for accrued expenses
c. Record a liability account for accrued expenses

11. During the month, a company recorded sales of $55,000 of which 50% was
on account and will be collected during the following month. Total Assets
increased by $100,000. Cash sales were most likely:

a. $72,500
b. $27.500
Sold to Sophy Thwe (#YUTFIFX4)

c. $82,500

12. A company with a March 31 quarter-end had the following events occur in
mid-February: The company received $50,000 for the delivery of equipment
to be made in 30 days. At quarter end, this will most likely result in:

a. A deferred revenue account on the balance sheet
b. The recording of $50,000 revenue in the quarter
c. A liability account for Unearned Revenue


13. As the owner of a small company you are hoping to record as little Net
Income as possible in order to reduce the amount of tax you must pay.
Which account are you most likely to use aggressive accounting tactics in an
effort to report a zero balance at year-end?

a. Unearned revenue
b. Accrued expenses
c. Prepaid Expenses

14. In terms of just the Balance Sheet, recognizing revenue before it is earned
would most likely:

a. Understate assets
b. Overstate liabilities
c. Overstate equity

15. You pay your employees every two weeks. Your year-end falls in the middle
of a pay period. The proper accounting treatment would be to:

a. Record an expense even though no payments were made
b. Record no transactions as this is a recurring expense with regular
payment dates
c. Record a prepaid expense for the 1 week and enter the appropriate
expense on the Income Statement for that 1 week

16. Which of the following will most likely result in an overstatement of
earnings?

a. Understate Prepaid Expense, understate Unearned Revenue,
understate Accrued Expenses
b. Overstate Prepaid Expense, understate Unearned Revenue, understate
Accrued Expenses
c. Overstate Prepaid Expense, overstate Unearned Revenue, understate
Accrued Expenses

Sold to Sophy Thwe (#YUTFIFX4)

17. A company can report a higher Net Asset balance by:

a. Understating Unearned Revenue, a liability account
b. Overstating Accrued Expenses, a liability account
c. Understating Prepaid Expenses, an asset account

18. Accountant typically wear their pants:

a. Below their bellybutton
b. At their bellybutton
c. Above their bellybutton
19. A company has shown a loss on its Income Statement for the most recent
period. As a result, the company’s net assets would have:

a. Decreased
b. Increased
c. There is no way to tell without more information from the Balance
Sheet

20. Which of the following is not a contra-asset account?

a. Depreciation
b. Allowance for Doubtful Accounts
c. Sales Returns and Allowances

21. A Cash Flow Statement can be prepared in two ways. Which is not one of
those ways?

a. The Imputed Method
b. The Direct Format Method
c. The Indirect Format Method
Answers

1. C is Correct. B is incorrect since Operating activities are those that are part of
the day-to-day operations of the company. A in incorrect since Investing
activities are those associated with the acquisition and disposal of long-term
assets.

2. C is correct. Company B is Investing in long-lived assets, that being the
assembly equipment, thus making it an Investing activity. They are also
doing this with a source of financing, thus making that a Financing activity.
Company A is in the business of selling the assembly equipment, thus making
it an Operating activity on their part. Company C is in the business of
providing financing, thus making it an operating activity on their part.

Sold to Sophy Thwe (#YUTFIFX4)

3. B is correct. Interest income is generated either in the ordinary course of

business (a bank that ends money receives interest income) or as a return on
investment (a company that invests excess cash in short-term money market
instruments). Financing activities involves the arranging of debt and the
repaying of debt. Interest in this category is exclusively an expense.

4. B is correct. A is incorrect since ‘Allowance for Doubtful Accounts ‘ and

‘Depreciation’ are two common contra-accounts. C is incorrect since
‘Treasury Stock’ is a common contra-account. There are no contra-expense
accounts.

5. C is correct. A = L + E, which can be expanded as follows: Current A + Non-

Current A = L + E. Thus, $3,400 + Non-Current Assets = $12,600 + $4,000.

Non-Current Assets = $12,600 + $4,000 - $3,400 = $13,200.

Note: The $700 of Inventory mentioned is part of the $3,400 of Current
assets.

6. B is correct. A = L + E. E is also called Net Assets. E is also referred to as a

residual claim on assets. Thus non-residual claims refer to Liabilities. So,
$15,000 = L + $4,200, making L = $10,800.

7. A is correct. Revenues are from operating activities as are expense. B is

incorrect since it includes both gains and losses, which are the result of non-
operating activities. C is incorrect since it only includes non-operating items.

8. A is correct. A = L + E = L + Contributed Capital +Beginning Retained

Earnings + Revenue – Expenses – Dividends = $6,000 + $2,000 + $5,000
+$10,000 - $8,500 - $0 = $14,500.

9. B is correct. The receipt of cash for an annual membership means that we

have received revenue before we have earned it, setting up a deferred
Revenue account. The use of the money to prepay rent sets up a Prepaid
expense account. Accruals are expenses or revenues incurred but not yet
billed. Deferrals/Prepaids: revenues/expenses paid but not yet incurred.

10. C is correct. Accruals are expenses or revenues incurred but not yet billed.
Since the company has incurred some legal expense, this will be a future
obligation; hence it must be a liability. A is not correct since this does not
represent cash paid for an as of yet un-incurred expense. B is incorrect since
an accrued expense is a liability, not an asset.

11. B is correct. If Sales = $55,000 with 50% on account, the cash portion of sales
must have been $27,500. The value for Total Assets is not needed in this
case.
Sold to Sophy Thwe (#YUTFIFX4)

12. B is correct. The sale was made in mid-February for delivery in 30 days.
That would mean that by March 31, the quarter-end, the sale was completed
with delivery (Delivery would have happened march 15th).

13. C is correct. Rather than having a balance in the Prepaid Expense account on
the balance sheet as an asset, claiming the prepaid expense as an expense in
the current period would reduce that balance to zero and increase the
amount of expenses charged against revenue in the current period. A is
incorrect since reducing Unearned Revenue to zero would entail claiming
higher revenue. That would increase taxes due, not reduce them. B is
incorrect since reducing Accrued Expenses to zero would also serve to
reduce the expense account that was increased as a result, thereby increasing
taxes due, not decreasing them.

14. C is correct. Assets would be unchanged since the company has already been
paid for the sale and reflected in the Cash Account. By not recording a
liability for Deferred or Unearned Revenue, we would be understating
Liabilities. Since A = L + E, if A is unchanged and L is lower, E must be higher
for the equation to remain in balance.

15. A is correct. This is an Accrued Expense, a liability account. B is incorrect
since it violates the matching principle. C is incorrect since we have not
prepaid for an expense, we have incurred and expense for which we have not
paid.

16. B is correct. It is the only option that has no conflicts. Overstating Prepaid
expenses reduces current period reported expenses, understating Unearned
revenue results in increasing current period revenue, and understating
Accrued Expenses reduces current period reported expense. So, overstating
current period revenues, and understating current period expenses twice
results in overstated earnings. A is incorrect since understating Prepaid
Expenses would increase current reported expenses, putting downward
pressure on reported earnings. C is incorrect since overstating Unearned
Revenue would lower current period reported revenue, putting downward
pressure on earnings.

17. A is correct. Understating Unearned Revenue results in higher reported
revenue in the current period and resulting higher Net Income (which goes
to Retained Earnings, an Equity account). It also results in an
understatement of liabilities. Since A = L + E, a lower L needs a higher E to
balance. B is incorrect since an overstatement of an Accrued Expense
increases current period reported expenses which results in a lower Net
Income (which goes to Retained Earnings) It also results in increase in a
liability account. Thus, for A = L + E, a higher L would need a lower E. C is
incorrect since an understatement of a prepaid expense would increase
current period reported expenses, which results in a lower Net Income
Sold to Sophy Thwe (#YUTFIFX4)

(which goes to Retained Earnings). It also results in a decrease in an asset

account. Since A = L + E, a lower A would need to be offset by either a lower
L or lower E. Since L would be unaffected, the result is a lower E.

18. C is correct. This just comes from experience and observation.

19. A is correct. Since Net Income/Loss goes to Retained earnings, the loss
would lower RE, which lowers Equity.

20. C is correct since we are looking for a contra-asset account, Sales Returns and
Allowances is a contra-revenue account.

21. A is correct. Both the Direct and the Indirect Method are ways of preparing a
cash flow statement.





Sold to Sophy Thwe (#YUTFIFX4)

Financial Reporting Standards

1. According to the Conceptual Framework for Financial Reporting 2010, “The
objective of general purpose financial reporting is to provide financial
information about the reporting entity that is ________________ to existing and
potential investors, lenders and other creditors…”

a. consistent
b. useful
c. comparable

2. IASB and FASB are:

a. Regulatory authorities that enforce financial reporting requirements
b. Private sector Standard setting bodies
c. Government entity standard setting bodies

3. IOSCO is made up of:

a. The standard setting bodies within each country that are members of
this international organization
b. The accounting regulatory bodies of each country that are members of
this international organization
c. The securities commissions within each country that are members of
this international organization

4. The principles of securities regulation are based upon 3 core objectives

a. (1) Protecting investors (2) ensuring that markets are fair, efficient,
and transparent (3) reducing systemic risk
b. (1) protecting investors (2) ensuring operational independence of the
standard setting bodies within their jurisdiction (3) promoting
comparability of financial information across companies within their
jurisdiction
c. (1) protecting the integrity of capital markets (2)ensuring that
markets are fair, efficient, and transparent (3) reducing systemic risk

5. For an analyst, an understanding of the frameworks within which accounting
standards are arrived at help in assessing:

a. The relevance of financial information
b. The usefulness of financial information
c. The comparability of financial information

Sold to Sophy Thwe (#YUTFIFX4)

6. Converged standards are least likely to be:

a. Rules-based
b. Principles-based
c. Internally consistent

7. Which is least likely to be a barrier to the convergence of standards across
countries:

a. The multitude of separate standards required across different
industries such as Pharmaceuticals, Banking, Insurance, Energy, etc…
b. Differing opinions due to cultural issues
c. External political pressures

8. According to ‘The Conceptual Framework” guiding standards development
related to the preparation and presentation of financial reports, relevance
and faithful representation:

a. are underlying assumptions
b. are reporting elements
c. are qualitative characteristics

9. An asset listed on the balance sheet may have a net realizable value of $0 but
still be carried at some positive amount primarily because of:

a. the going concern assumption
b. the need to match debits and credits
c. cost/benefit considerations

10. Information that would potentially affect or make a difference in user’s
decision regarding the providing of resources to a company would most
likely be:

a. Verifiable
b. Relevant
c. Comparable

11. Information that is complete, neutral, and free from error can best be
described as having the qualitative characteristic of:

a. Timeliness
b. Faithful representation
c. Understandability



Sold to Sophy Thwe (#YUTFIFX4)

12. The clear and concise presentation of financial information enhances:

a. Understandability
b. Verifiability
c. Relevance

13. The income element of financial statements is best described as:

a. Increases in economic benefits in the form enhancements of assets or
decreases in liabilities
b. Decreases in economic benefits in the form of depletion of assets or
increases in liabilities
c. Resources controlled by the enterprise as a result of past events and
from which future economic benefits are expected to flow to the
enterprise

14. Which of the following statements is incorrect with respect to companies
that apply IFRS to their financial reporting?

a. The company must state explicitly in the notes to its financial
statements that it is in compliance with the standards
b. A company stating compliance with IFRS can only do so if it is in
compliance with all requirements of IFRS
c. A company electing to present financial information in accordance
with IFRS must provide reconciliations to their local GAAP standards
in the notes to the financial statements

15. The amount at which an asset could be exchanged, or a liability settled,
between knowledgeable and willing parties in an arm’s length transaction
would be captured by which valuation measure?

a. Present value
b. Fair Value
c. Historical cost

16. The characteristics of an effective financial reporting framework include:
a. Timeliness, verifiability, understandability

b. Going concern, accrual basis, faithful representation
c. Transparency, comprehensiveness, consistency




Sold to Sophy Thwe (#YUTFIFX4)

17. Similar transactions should be measured and presented in a similar manner

regardless of industry, company size, geography, or other characteristics is a
description of:

a. Transparency
b. Comprehensiveness
c. Consistency

18. ‘Users should be able to see the underlying economics of the business
reflected clearly in the company’s financial statements” is a description of:

a. Transparency
b. Comprehensiveness
c. Consistency

19. Financial reporting standards can be established taking an ‘asset/liability’
approach, which gives preference to proper valuation of the Balance Sheet, or
a ‘revenue/expense/ approach that focuses more on the Income Statement.
In recent years, standard setters have predominantly used:

a. Asset/liability approach
b. Revenue/expense approach
c. Both equally depending on context

20. With respect to company disclosures related to changes in accounting
policies, which statement offers the least amount of certainty?

a. The standard does not apply
b. Management is still evaluating the impact of the standard
c. The impact of adoption is discussed
















Sold to Sophy Thwe (#YUTFIFX4)

Answers

1. B is correct. The objective of financial reporting is to provide information
that is useful in making decisions. A and C are incorrect since they are
enhancing characteristics of financial reporting information, not objectives.

2. B is correct. Both IASB and FASB are private sector SROs. A is incorrect since
neither the IASB or the FASB are regulatory bodies. C is incorrect since
neither are government entities.

3. C is correct. IOSCO stands for International Organization of Securities
Commissions. Both A and B do not refer to securities commissions.

4. A is correct. Section 3.2.1

5. C is correct. A is incorrect since it is a fundamental qualitative characteristic
of financial reporting information and should be applied to all financial
reporting output regardless of the standard. B is incorrect since it is an
objective of financial reporting information, again regardless of the standard.

6. A is correct. Rules-based standards tend to be fitted to a particular standards
regime and lack universality. B and C are incorrect since they both represent
qualities of converged standards.

7. A is correct. Industry specific standards do not preclude a convergence of
standards. B and C are both specifically mentioned in the text in the third
paragraph under Section 4 as being barriers to convergence.

8. C is correct. A is incorrect since underlying assumptions include Accrual
basis and Going Concern. B is incorrect since reporting elements were
identified as Revenues, Expenses, Assets, Liabilities and Equity.

9. A is correct. The going concern assumption assumes that assets have value-
in-use, even if they would have no value in liquidation. B is incorrect since
matching debits and credits is about balancing the accounting equation, not
determining carrying values. C is incorrect since cost/benefit considerations
refer to the constraints on the benefits of providing more performance detail
versus the cost of doing so.

10. B is correct. Information that could potentially affect a decision is relevant. A
is incorrect since verifiable information does not have to be relevant. C is
incorrect since comparability refers to the ease with which one the
performance data from several companies can be compared, such as
inventory turnover ratios. Comparable data need not be relevant.

Sold to Sophy Thwe (#YUTFIFX4)

11. B is correct. A is incorrect since incomplete, non-neutral and error-prone

information can be timely. C is incorrect since non-neutral information can
be understandable.

12. A is correct. The focus is on presentation. Clear and concise are the very
definition of understandability.

13. A is correct. Income increase cash or accounts receivable, or the proceeds
can be used to pay suppliers or reduce debt. B is incorrect since it describes
expenses. C is incorrect since it describes assets.

14. C is correct. Companies that apply IFRS have no requirement that they must
reconcile to GAAP in the notes (we are looking for a false statement here). A
is incorrect since IFRS reporting companies must state their compliance to
the standard in the notes as per IAS No. 1. B is incorrect since that is a
general requirement of being in compliance, again as per IAS No. 1.

15. B is correct. The question is describing a market transaction, and a price
derived from a market transaction is considered a fair value. A is incorrect
since we are not discounting future cash flows. C is incorrect since an asset
bought 20 years ago would most likely not transact for the same value today,
either because of appreciation of depreciation.

16. C is correct. The question is with respect to the effectiveness of the
framework itself. A describes enhancing qualitative characteristics of
financial preparation and presentation. B describes one fundamental
characteristic (faithful representation) and two underlying assumptions of
financial preparation and presentation.

17. C is correct. Doing similar things in similar ways is the very definition of
consistency. Consistency is one of the general features of the presentation of
financial statements under IAS No. 1 and is a characteristic of effective
financial reporting. A is incorrect. Transparent reporting should reflect the
underlying economics of the business. Two businesses can use the same
asset in different ways, and as such, should not be consistent in the way they
report that use in their statements. Their reporting should reflect how they
use the asset in order to gain a better understanding of the nature of their
business. B is incorrect since comprehensiveness describes guidance for
recording all kinds of financial transactions, current and future.

18. A is correct. See the answer description from 17 above for more clarity.

19. A is correct.

Sold to Sophy Thwe (#YUTFIFX4)

20. B is correct. Management is offering no answer with respect to the

application of the standard. A and C are incorrect since users of the
statements are given certain and direct answers
Sold to Sophy Thwe (#YUTFIFX4)

Understanding Income Statements

1. The Income Statement can be presented as a separate statement followed by
a Statement of Comprehensive Income or as a section of a single Statement of
Comprehensive Income under which accounting standard?

a. IFRS
b. GAAP
c. Both IFRS and GAAP

2. The most comprehensive definition of Net Income is:

a. Revenue – expenses
b. (Revenue + gains) – (expenses + losses)
c. (Revenue + gains + Other Income) - (expense + losses + other
expenses)

3. An excerpt from MyCo’s Income Statement is as follows:

Revenue $XX
COGS $XX
Gross Profit $XX

MyCo is reporting using:

a. Single-step income statement
b. Multi-step income statement
c. grouping by nature

4. Under IFRS, revenue recognition for both goods and services differ along
which dimension with respect to U.S. GAAP:

a. The amount of revenue can be measured reliably
b. It is probable that the economic benefits associated with the
transaction will flow to the entity
c. The entity retains neither continuing managerial involvement to the
degree usually associated with ownership nor effective control

5. Which method would be appropriate for recognizing revenue before goods
are fully delivered or services completely rendered given that delivery has at
least begun?

a. Cost recovery
b. Percentage of completion
c. Instalment method
Sold to Sophy Thwe (#YUTFIFX4)

6. With reference to percentage-of-completion method of revenue recognition,
__________ uses the completed contract method as a way of recognizing
revenue under a long-term contract where the outcome cannot be measured
reliably while _________ will recognize revenue to the extent of contract costs
incurred. Which standards are these respectively?

a. GAAP and IFRS
b. IFRS and GAAP
c. Both allow each to be used

7. Under the percentage-of-completion recognition method, when a loss is
expected it is reported immediately under which standard?

a. IFRS
b. IFRS and GAAP
c. GAAP

TrumpCo has a contract to build a wall for the Mexican government for a total cost
of $17 billion and it will take an estimated 3 years to build. Total building costs are
estimated to be only $10 billion since TrumpCo rarely pays its subcontractors.
TrumpCo recognizes long-term contract revenue using the percentage-of-
completion method and estimates completion based on expenditures incurred as a
percentage of total estimated expenditures.

8. At the end of year 1, TrumpCo has spent $3.1 Billion. How much revenue will
TrumpCo recognize in Year 1?

a. $3.10 Billion
b. $5.27 Billion
c. $2.17 Billion

9. At the end of Year 2, TrumpCo had spent an additional $2.4 Billion for an
accumulated total of $5.5 Billion. Estimated total costs to complete have not
changed. How much revenue will TrumpCo recognize in year 2?

a. $4.08 Billion
b. $9.08 Billion
c. $1.68 Billion

10. How much will TrumpCo recognize in the 3rd and final year of the contract if
all costs come in as expected?

a. $17 Billion
b. $2.15 Billion
c. $7.65 Billion
Sold to Sophy Thwe (#YUTFIFX4)

MyCo has a contract to build a Mars lander for NASA for a total sales price of $50
million. It is estimated to take 5 years to complete but considerable uncertainty
exists surrounding costs since new technologies have to be developed. The outcome
cannot be reliably measured but it is probable that costs up to the agreed price will
be recovered. The final profit is highly uncertain but a loss is not expected. MyCo
has the following cost schedule: Year 1 - $7 million, Year 2 – $8 million, Year 3 – $12
million – Year 4 – $5 million and Year 5 - $9 million.

11. MyCo uses IFRS. How much revenue, expense, and profit, would be
recognized in year 2?

a. No revenue would be recognized until the contract is complete
b. Revenue = $8 million, Expenses = $8 million, Profit = $0
c. Revenue = $9.76 million, Expenses = $8 million, Profit = $1.76 million

12. MyCo uses IFRS. How much revenue, expense, and profit, would be
recognized in the final year?

a. Revenue = $18 million, Expenses = $9 million, Profit = $9 million
b. Revenue = 10.98 million, Expenses = $9 million, Profit = $1.98 million
c. Revenue = $50 million, Expenses = $41 million, Profit = $9 million

13. MyCo uses U.S. GAAP. How much revenue, expense, and profit, would be
recognized in year 3?

a. No revenue would be recognized until the contract is complete
b. Revenue = $12 million, Expenses = $12 million, Profit = $0
c. Revenue = $14.63 million, Expenses = $12 million, Profit = $2.63
million

14. MyCo uses GAAP. How much revenue, expense, and profit, would be
recognized in the final year?

a. Revenue = $18 million, Expenses = $9 million, Profit = $9 million
b. Revenue = 10.98 million, Expenses = $9 million, Profit = $1.98 million
c. Revenue = $50 million, Expenses = $41 million, Profit = $9 million

15. Under both IFRS and U.S. GAAP, companies must present _________ years of
comparative data for the Income Statement.

a. 2
b. 3
c. 5


Sold to Sophy Thwe (#YUTFIFX4)

16. Which accounting measure is affected by the company’s capital structure?

a. Net Income
b. Gross profit
c. EBIT

17. Which measure is unaffected by the asset intensity of the business.
a. EBITDA
b. EBIT
c. Net Income

18. Consider the following information

Parent Co owns 60% of each Child-1 Co and Child-2 Co. What is
Parent Co.’s Net Income after the adjustment for Minority
Interests?

a. $56 Million
b. $100 Million
c. $334 Million

19. A company that groups together all its depreciation, whether it be on
manufacturing equipment or office facilities, is grouping costs by:
a. Function
b. Nature
c. Method

20. You sell a property to Trump Enterprises for $5 million, which cost you $3
million. Trump Co. plans to build a ‘uge Clown Castle on the site. Trump Co.
will pay $500,000 on day 1 and the balance over the next 2 years (i.e. $2.25
million at the beginning of Year 2 and $2.25 million at the beginning of Year
3). There is significant doubt about the willingness of the buyer to complete
all payments. Which method of revenue recognition would not be used in
this case?

a. Cost Recovery Method
b. Completed Contract Method
c. Installment Method


Sold to Sophy Thwe (#YUTFIFX4)

21. Under the Cost Recovery Method, how much profit would you recognize on
your Income Statement at the end of the second year.

a. $2.75 Million
b. $1.10 Million
c. $0

22. With respect to the Revenue Recognition Accounting Standards Issued May
2014, the IASB and FASB issued a set of converged accounting standards
aimed at providing:

a. A more rules-based approach that can be applied to many types of
revenue-generating activities
b. A more contract-based approach that can be applied to many types of
revenue-generating activities
c. A more principles-based approach that can be applied to many types
of revenue-generating activities

23. Turkey Neck Contractors, a very old firm in the city, has been contracted to
build a Safe Space Dome for millennials. The dome will be constructed
without windows so that nothing offensive in the outside world can bee seen
from the inside. Turkey Neck has been offered a completion bonus of
$500,000 if the dome is completed within 2 years. Under the converged
revenue recognition standards of May 2014, the bonus would be considered
an example of:

a. Variable consideration
b. A performance obligation
c. Retrospective consideration

24. Trust Construction was contracted to build a fence along parts of the Ontario-
Quebec border. The original contract was for $4 million and a cost to build of
$2.4 million. After 1 year Trust Construction has incurred costs of $1.2
million. Trust Construction has recognized revenue of $2 million and
expenses of $1.2 million on their Year 1 financial statements. However,
shortly into Year 2 the Ontario Government ordered the original fence
modified to be 10 feet higher since rebels on the Quebec side have been
throwing left over poutine over the fence. The new contract price of the
fence is $5 million and will cost an extra $550,000. Roughly how much needs
to be recognized as a cumulative catch-up?

a. $500,000
b. $33,900
c. A cumulative catch-up does not apply to this situation


Sold to Sophy Thwe (#YUTFIFX4)

25. With respect to extraordinary gains/losses, which is a false statement?

a. To be classified as such, the event that caused the gain/loss must be
unusual and infrequent
b. The item is shown on the statement net of taxes
c. U.S. GAAP and IFRS require a separate line item on the statement for
all extraordinary gains/losses

26. Line items unusual and/or infrequent gain/losses appear where on the
statements?

a. After the calculation of Net Income on the Income Statement
b. They appear in Other Comprehensive income
c. They appear under Continuing Operations as a separate line item

27. Big Beaver Company reported EPS of $1.50 on its year-end statements. The
company reported Net Income of $3.6M and a weighted-average number of
shares outstanding of 2 million. What was the preferred dividend payment?

a. $2,000,000
b. $0
c. $600,000

28. Tiny Peter Company reported Net Income of $5M and paid dividends of
$1/share on 1,000,000 common shares. The company had a weighted-
average number of shares outstanding of 900,000 for the fiscal year. Tiny
Peter reported EPS of:

a. $5.56
b. $4.44
c. $4.00

29. Tiny Beaver Co. has a complex capital structure with a series of 1,000,000
convertible preferred shares outstanding convertible to common shares on a
1-for-1 basis. To calculate the Diluted EPS measure the company uses the if-
converted method. Each preferred share pays $1.50 in dividends. The
company reported $10M in Net Income and had a weighted-average number
of shares outstanding for the year of 10,000,000. What Diluted EPS did Tiny
Beaver Co. report?

a. $1.00
b. $0.91
c. $0.85


Sold to Sophy Thwe (#YUTFIFX4)

30. Holy Ship Batnam Cruise Lines reported the following at year end: Net
Income of $6M, weighted-average # of shares outstanding = 2M, a $1M
convertible debt issue carrying an interest rate of 7% and convertible into
250,000 shares, and a tax rate of 40%. Calculate Basic and Diluted EPS.

a. $3.00 and $2.83
b. $2.98 and $2.69
c. $3.00 and $2.69

31. Big Peter Cable Company reported Net Income of $7.2M for the year with a
weighted-average number of shares outstanding of 2,400,000. Big Peter had
stock options outstanding at the beginning of the year entitling key
employees to 80,000 shares at a strike price of $40. The average price of Big
Peter’s stock during the year was $62. Calculate both Basic and Diluted EPS.

a. $3.00 and $2.90
b. $3.00 and $2.96
c. $3.00 and $3.00

32. Assume the same information as in #31 above except that the options were
issued mid-year instead. Calculate Basic and Diluted EPS.

a. $3.00 and $2.96
b. $3.00 and $2.98
c. $3.00 and $3.00

33. In a common-sized income statement, taxes are expressed as a percentage of:

a. Sales
b. Earnings Before Tax
c. Net Income

34. In a multi-step, common size income statement, what is the correct order of
ratios calculated from the top to the bottom?
a. Operating margin, gross margin, net income margin
b. Operating margin, gross margin, pre-tax margin
c. Gross margin, operating margin, net income margin

35. The Twig and Berries Pub’s beginning shareholder’s equity is $150,000 and
its net income for the year was $50,000 with $10,000 being distributed as
dividends. If there was no issuance or repurchase of stock during the year,
what amount of Other Comprehensive Income was rerecorded if ending
shareholder equity was $181,000.
a. $($9,000)
b. $0
c. ($19,000)
Sold to Sophy Thwe (#YUTFIFX4)

36. Consider a company with the following events:

• January 1, shares outstanding = 6 million

• March 1, issued 500,000 shares
• June 1, 25% stock dividend
• October 1, repurchased 1,000,000 shares
• Dec 31, reverse 10 for 1 stock split

Calculate the weighted average number of shares outstanding at year-end.

a. 777,083
b. 712,500
c. 68,750

Answers

1. C is Correct. Both IFRS and GAAP allow either a single statement of CI or an

IS followed by a Statement of CI. GAAP also allows an IS and OCI to be
included in the Statement of Changes in Equity.

2. C is correct. Revenues and Expenses are from operations, gains and losses
are non-operating components, and Other Income and Other Expenses cover
all other non-operating items that are neither gains/losses, such as income
earned on investments.

3. B is correct. Multi-Step Income Statements will have entries for Gross Profit,
Operating Profit, EBIT, EBT and finally Net Income.

4. B is correct. U.S. GAAP requires the seller to be reasonably sure of collecting

money whereas IFRS require that collection be probable.

5. B is correct. Both A and C are incorrect since they are methods of revenue
recognition after goods are delivered or services rendered.

6. A is correct. GAAP will use the completed contract method when outcomes
are uncertain by recognizing all revenue and related expenses upon contract
completion. IFRS will recognize revenue each period only to the extent of
costs incurred.

7. B is correct. Under both IFRS and US GAAP, id a loss is expected on the

contract, the loss is reported immediately, not upon completion of the
contract, regardless of the method used (e.g., percentage-of-completion or
completed contract)
Sold to Sophy Thwe (#YUTFIFX4)

8. B is correct. Costs to date are $3.1 Billion of an estimated $10 Billion. Thus,
under the percentage-of-completion method, the job is 31% complete
($3.1B/$10B). 30% of $17 Billion = $5.27 Billion.

9. A is correct. The job is now 55% complete ($5.5B/$10B). Thus, total
cumulative revenue recognized should be 55% of $17 Billion = $9.35 Billion.
Since $5.27 Billion was recognized in Year 1, that leaves $4.08 Billion this
year.

10. C is correct. Since 55% of the job has been completed by the end of Year 2,
that leaves 45% to be completed in the third and final year. 45% of $17
Billion = $7.65 Billion remaining to be recognized.

11. B is correct. Under IFRS, if the outcome of the contract cannot be measured
reliably, then revenue may be recognized to the extent of contract costs
incurred. Since expenses in Year 2 were $8 Million, both revenue and
Expenses will be $8 Million leaving a profit of $0. A is incorrect since this is
the method prescribed by the completed contract method under US GAAP. C
is incorrect since this uses the percentage-of-completion method which is
valid only if the outcome of the contract is certain.

12. A is correct. As of the end of Year 4, $32 million has been incurred in costs,
and thus $32 million has been recorded as revenue. Year 5 is the final year of
the contract, so the balance of the sales price must be recognized, which is
$18 million ($50 M - $32 M). Expenses in the final year are $9 million,
leaving a recognized profit of $9 million.

13. A is correct. Under U.S. GAAP, when the outcome cannot be measured
reliably, the completed contract method is used. Under the completed
contract method, the company does not report any income until the contract
is substantially finished.

14. C is correct. Since the contract is completed in the 5th year, all revenue and
expenses would be reported at that time. Thus, Revenue would be $50
million, Expenses would be $41 million and profit would be $9 million.

15. B is correct. A is incorrect but would be correct for Balance Sheet
comparative information. C is incorrect but would be correct for selected
data presented within the Notes to the Financial Statements.

16. A is correct. Net Income is a measure of performance after Interest Expense
is deducted. Both B and C are performance measure before the deduction of
Interest Expense.

Sold to Sophy Thwe (#YUTFIFX4)

17. A is correct. EBITDA measures the performance of a company before and

depreciation or amortization. Both B and C reflect depreciation and
amortization and thus would be affected by the asset intensity of the
business.

18. A is correct. Parent Co owns 60% of each subsidiary. Thus 40% of each
subsidiary’s loss belongs to the shareholders of that subsidiary. Parent Co
would have included 100% of each subsidiary’s loss in its Net Income. Thus
40% of -$170M = -$68 Million belongs to Child-1 Co.’s shareholders, and 40%
of -$220M = -$88 Million belongs to Child-2 Co.’s shareholders. Therefore,
Parent Co.’s net income would increase by $156 Million (or decrease by
negative $156 Million) by attributing the losses to the minority interests,
resulting in a Net Income for Parent Co of $56 Million.

19. B is correct. A is incorrect since grouping by function would be grouping
together expenses into a category such as cost of goods sold, which may
include labour and materials costs along with depreciation. C is incorrect
since there is no ‘Grouping by Format”

20. B is Correct. Both the Installment Method and the Cost Recovery Method are
used when collection is not assured or the final selling price cannot be
estimated.

21. C is correct. Under the cost recovery method of revenue recognition, you
would not recognize any profit attributable to neither the down payment nor
the first installment payment because the amounts received do not exceed
your cost of $3 million.

22. C is correct. The converged standard aims to provide a more principles-
based approach that can be applied to many types of revenue generating
activities.

23. A is Correct. B is incorrect since the dome itself is the performance
obligation. C is incorrect since there is no such reference.

24. B is Correct. Costs incurred to date have not changed but total costs will now
be $2.95 million. Thus, the project is $1.2/$2.95 = 40.6779661% complete.
The new contract price is $5 million, so $5M * 40.6779661% = $2,033,898.
Since $2 million has already been recognized, the cumulative catch up is
closest to $33,900.

25. C is correct. Only U.S. GAAP recognizes a category called extraordinary items.
IFRS does not. A and C are both true statements. Note that US GAAP no
longer recognizes this category.

Sold to Sophy Thwe (#YUTFIFX4)

26. C is correct. Unusual and infrequent items are now treated the same under
both IFRS and GAAP. They are reported as part of continuing operations but
on a separate line item.

27. C is Correct. EPS = (Net Income – Preferred Dividend)/wa# shares. Thus,
$1.50 = ($3.6M – X)/2,000,000. Solving for X gives $600,000

28. A is correct. Common share dividends do not affect the calculation of EPS.
Since there are no preferred shares, the calculation simplifies to NI/wa# sh.
Thus EPS = $5M/900,000 = $5.56.

29. C is correct. The company would have reported Basic EPS of ($10M -
$1.5M)/10M = $0.85. For the Diluted EPS calculation, nothing would be
subtracted from Net Income leaving $10 in the numerator. The number of
shares would increase by 1 million to a total of 11M shares in the
denominator. Thus Diluted EPS = $10M/11M = $0.91. However, this is an
antidilutive conversion. As such the conversion is not included in the
calculation of Diluted EPS, and both Diluted and Basic EPS are identical at
$0.85.

30. C is correct. Basic EPS = Net Income /wa# sh = $6M/2M = $3.00. For Diluted
EPS, the converted debt would no longer incur interest expense of $70,000.
The after-tax cost of that debt, $42,000, would be added to the numerator.
The number of shares would now increase to 2,250,000. Thus Diluted EPS =
6,042,000/2,250,000 = $2.69.

31. B is correct. Basic EPS = $7.2M/2.4M = $3.00. For Diluted EPS, we must first
calculate the number of new shares issued. 80,000 shares are required.
However, the company will generate (80,000 * $40/sh) $3.2M from the strike
price. Those funds can buy $3.2M/$[Link] = 51,613 shares. Thus the
company would have to issue 80,000 – 51,613 = 28,387 new shares. Thus
Diluted EPS = $7.2M/2,428,387 = $2.9649. Rounding to the nearest cent
leaves $2.96

32. B is correct. Basic EPS remain unchanged at $3.00. The new shares that
would be issued to cover the options are now weighted by 0.5 to represent
half a year. So new shares issued = 28,387*.5 = 14,193. Thus, Diluted EPS =
$7.2M/2,414,193 = $2.98.

33. B is correct. In the case of taxes, it is more meaningful to compare the
amount of taxes with the amount of pre-tax income.

34. C is correct. The complete order is gross margin, operating margin, pre-tax
margin, and net income margin.

Sold to Sophy Thwe (#YUTFIFX4)

35. A is correct. Ending shareholder equity should have been $150,00 + $50,000
- $10,000 = $190.000. Rather, it was $181,000 indicating that $9,000 is net
expenses bypassed the income statement. Therefore the amount of OCI is
($9,000).

36. A is correct. Step 1 is to adjust the January 1 and March 1 share counts for
the 25% stock dividend. Thus January 1 – 7.5 Million shares and March 1 –
625,000 shares. Now adjust all three share counts for the reverse stock split.
That results in the following:
• January 1, shares outstanding = 750,000
• March 1, issued 62,500 shares
• October 1, repurchased 100,000 shares

The final calculation is: (750,000 * 2/12) + (812,500 * 7/12) + (712,500 *
3/12) = 777,083



Sold to Sophy Thwe (#YUTFIFX4)

Sold to Sophy Thwe (#YUTFIFX4)

Questions 1 to 15 are in reference to Under Armour’s Balance Sheet shown above.

1. September 30, 2016 Working Capital =
a. $1,923,154
b. $1,169,311
c. 2.36:1

2. The balance sheets presented above for Under Armour are in what format?
a. Multi-Step
b. Classified
c. Liquidity-Based

3. Cash Equivalents are financial assets, which would not be reported at:
a. Historical cost
b. Amortized cost
c. Fair Value

4. Cash Equivalents include:
a. T-Bills, Notes, Bonds
b. T-Bills, Notes, equity
c. T-Bills, Commercial Paper

5. As of September 30, 2016, the Allowance for Doubtful Accounts was $33.6
million. Based on this value, what percentage of it total accounts receivable
does Under Armour estimate will be uncollectible?
a. .047%
b. 4.7%
c. 4.5%

6. Under Armour reports under U.S. GAAP. Which statement regarding their
inventories would apply?
a. If the net realizable value is less than the carrying amount, the
company must write down its inventory to the lower value
b. Inventories are carried at the lower of cost or market
c. Any inventory write-downs from previous periods can be reversed in
current periods

7. Calculate the Current ratio and the Quick ratio
a. 2.364 and 1.043
b. 2.364 and 1.232
c. 2.091 and 0.210

8. Under Armour most likely reports the value for Property and Equipment as:
a. Cost – accumulated depreciation
b. Fair value – subsequent accumulated depreciation
c. Cost – accumulated depreciation – impairments
Sold to Sophy Thwe (#YUTFIFX4)

9. Has Under Armour acquired any businesses in the past, and if so, how much
more than the fair value of net assets did it pay?
a. This cannot be determined form the balance sheet alone
b. No it did not since the equity section of the balance sheet shows no
adjustment for minority interests
c. Yes it did and the excess of the price paid over the fair value of the net
assets was $576.9 M

10. The value of $68.248 M for intangible was most likely arrived at by means of:
a. The revaluation model
b. The fair market value model
c. The cost model

11. Intangible assets are shown on the balance sheet as a net amount. What
would be the most likely reason for the decline in the value of intangible
assets from $79,692,000 as of September 30, 2015 to the $68,248,000 as of
September 30, 2016?
a. Amortization
b. Impairment
c. Decrease in fair value

12. Has Under Armour suffered any impairment to its Goodwill year-over-year?
If so, how much?
a. That cannot be determined by looking at the balance sheet in isolation
with the Income Statement
b. Yes it has as indicated by the amount of accumulated OCI year-over-
year. The increase of $10.973M year-over-year represents
impairment
c. Yes it has as indicated by the decrease in the Goodwill account year-
over-year. The amount of impairment was $23,969M

13. Under Armour’s total debt as of September 30, 2016 is:

a. $1,073,768,000
b. $1,762,183,000
c. $$823,768,000

14. Under Armour’s financial leverage ratio is:

a. 0.916
b. 0.558
c. 1.916

15. Under armour’s Long-term Debt to equity ratio is:

a. 0.414
b. 0.558
c. 0.471
Sold to Sophy Thwe (#YUTFIFX4)

16. Turkey Neck Contractors, an IFRS reporting company, has a $4M investment
in the equity of another company. This position represents less than 1%
ownership of the target company. The position is held purely for
investment purposes with an investment horizon of multiple years. During
the year the value of the equity increase to $4.34 million and dividends are
received in the amount of $400,000. Turkey Neck is most likely to hold in
asset in a category called ________________. It will record the increase in value of
the equity within ____________________. The $400,000 of dividends received will
be reported as ____________________.
a. Held-For-Trading, the Income Statement, Income on the Income
Statement
b. Available-for-Sale, the Income Statement, Income on the Income
Statement
c. Available-for-Sale, Other Comprehensive Income, Income on the
Income Statement

17. ‘Financial assets that are measured at fair value and any unrealized gains and
losses are recognized as profit or loss on the income statement’ describe
what category of financial asset?
a. Held-to-Maturity
b. Held-for-Trading
c. Available-for-Sale

18. Financial assets that are measured at amortized cost’ describe what category
of financial asset?
a. Held-to-Maturity
b. Held-for-Trading
c. Available-for-Sale
Sold to Sophy Thwe (#YUTFIFX4)

Questions 19 to 24 are in reference to Canadian Tire’s Balance Sheet shown above.

19. October 1, 2016 Working Capital =

a. $4,310.4
b. $5,590.4
c. 2.00:1
Sold to Sophy Thwe (#YUTFIFX4)

20. Canadian Tire’s Cash ratio for October 1, 2016 is:

a. 0.069
b. 0.108
c. 0.146

21. Canadian Tire’s is an IFRS reporting company. Which statements regarding

their inventory would not apply:
a. Any inventory write-down from a previous period can be reversed in
the current period
b. Inventory is reported on the balance sheet at the lower of cost or net
realizable value
c. Inventory would be valued using either LIFO, FIFO, or average cost

22. If you did not know what standard Canadian Tire reported under, what asset
listing would most likely hint that this was an IFRS reporting company?
a. Assets classified as held for sale
b. Long-term receivables and other assets
c. Investment Property

23. Are Canadian Tire’s Balance Sheets reported on a consolidated basis?

a. This cannot be determined without the accompanying Notes
b. No
c. Yes

24. What is Canadian Tire’s capital structure (i.e. how are their assets financed
expressed as the ration D:E)?
a. 63:37
b. 69:31
c. 60:40

25. Supid Auld Main LLC issued a 10-year quarterly bond with a 5% coupon and
total face value of $25 million. Market interest rates at the time of issuance
were 120 bps higher, thus net proceeds from the bond sale were
$23,718,676.48. If the bond discount is amortized on a straight-line basis,
what will be the reported amount under Bonds Payable on the balance sheet?
a. $25,000,000
b. $23,974,941.18
c. $23,846,808.83

26. A company repurchases $1M worth of its shares for cash. What is the likely
effect on the company’s net assets?
a. No effect
b. Net assets would decrease by $1M
c. Net assets would increase by $1M
Sold to Sophy Thwe (#YUTFIFX4)

27. A company repurchases $1M worth of its common shares by issuing $1M of
perpetual preferred shares to fund the repurchase. What is the likely effect
on the company’s net assets?
a. No effect
b. Net assets would decrease by $1M
c. Net assets would increase by $1M

28. A company repurchases $1M worth of its common shares by issuing

Preferred Shares will a 10-year redemption obligation. What is the likely
effect on the company’s net assets?
a. No effect
b. Net assets would decrease by $1M
c. Net assets would increase by $1M

Answer:

1. B is correct. Working capital is the excess of current assets over current

liabilities. Thus, WC = CA – CL = $2,026,561 - $857,250 = $1,269,311

2. B is Correct. A balance sheet with separately classified current and non-

current assets and liabilities is referred to as a classified balance sheet.

3. A is Correct. Financial assets are measured and reported at either amortized

cost or fair value.

4. C is correct. Cash equivalents are highly liquid investments with original

maturities of 3 months or less. A is incorrect since bonds and Notes have
maturities greater than 3 months. B is incorrect since equity holdings have
no maturity.

5. C is correct. Accounts Receivable are reported on a net basis. Thus to

determine the %’age uncollectible, we must first determine the gross amount
of accounts receivable. Thus we must first add back the allowance for
doubtful accounts before calculating the %’age uncollectible. Thus %’age
uncollectible = 33.6M /(713.731 + 33.60 = 4.5%

6. B is correct. Under US GAAP, inventory is carried at the lower of cost or

market. A is incorrect since that standard applies to IFRS. C is incorrect
since, once a write-down occurs, under US GAAP, there are no reversals.

7. A is correct. Current ratio = CA/CL = $2,026,561/$857,250 = 2.364. Quick

Ratio = (Cash + Marketable Securities + Account Receivable)/CL = ($179,954
+ $713,731)/$857,250 = 1.043
Sold to Sophy Thwe (#YUTFIFX4)

8. C is correct. Under the cost model, PPE is carried at historical cost less any
accumulated depreciation less and impairment losses. A is incorrect since it
ignores the impairment losses. B is incorrect since it describes the
revaluation model, which is not allowed under U.S. GAAP.

9. C is correct. Goodwill measures the excess a company pays over the fair
value of the net assets for the target companies it purchases. The value of
Goodwill on Under Armour’s balance sheet, listed as a non-current asset, is
$576,903,000.

10. C is correct. Since Under Armour is a U.S. GAAP reporting company, they are
only permitted the use of the cost model for intangible assets.

11. A is correct. Intangible assets with finite lives are amortized over the best
estimate of their useful lives. B is incorrect since, while impairment does
occur, it is not as likely as amortization, which is a predictable annual charge.
C is incorrect since it is not part of the cost model.

12. C is correct. Since Goodwill has an indefinite life, it is tested annually for
impairment rather than amortized. Thus the only reason for a decrease in
Goodwill is impairment. That is obvious on the face of the balance sheet. B is
incorrect since all impairment losses from Goodwill go right to the Income
Statement and not to OCI.

13. A is correct. Debt is any interest-bearing obligation. Under Current

Liabilities, both the Line of Credit and the current maturities of long-term
debt would be included. Under Non-Current Liabilities, long-term debt
would also be included. Note that it is made clear that the long-term debt is
net of current maturities. Thus, total debt = $250,000,000 + $27,000,000
+$796,768,000 = $1,073,768,000

14. C is Correct. Financial leverage = Total Assets/Total equity =

$3,685,337/$1,923,154 = 1.916

15. A is Correct. Long-Term Debt/Total equity = $796,768/$1,923,154 = 0.414

16. C is correct. Since the financial asset is equity, it cannot be listed as Held-to-
Maturity. Since the investment horizon spans several years, it will be listed
as Available-for-Sale. Available-for-Sale financial assets are reported at fair
value with unrealized gains/losses going directly to Other Comprehensive
Income.

17. B is correct. A is incorrect as held-to-maturity assets are listed at amortized

cost. C is incorrect since unrealized gains/losses on available-for-sale
financial assets go directly to other comprehensive income.
Sold to Sophy Thwe (#YUTFIFX4)

18. A is correct. See 13 above for the logic.

19. A is correct. Working capital is the excess of current assets over current
liabilities. Thus, WC = CA – CL = $8,626.8 - $4,316.4 = $4,310.40

20. B is Correct. The Cash ratio = (Cash + Marketable Securities) / Current

Liabilities = ($300.2 + $166.6)/$4,316.4 = 0.108. Note that Long-term
investments, while being liquid, are not included in the cash ratio.

21. C is Correct. Under IFRS, LIFO is not allowed as an inventory valuation

method.

22. C is correct. U.S. GAAP does not include a specific definition of Investment
Property as a separate category.

23. C is correct. As evidenced in the Shareholder’s Equity section, there is an

adjustment for Non-Controlling interests.

24. A is Correct. From a common-sized balance sheet, we obtain a company’s

capital structure by observing the percentage of total assets that are financed
by equity with the difference financed by creditors. So equity as a percentage
of Total Assets = $5,590.4/$15,254.1 = 0.366 or 0.37. Thus the capital
structure is 63:37.

25. C is correct. Net proceeds of the bond were $23,718,676.48. Thus the
discount totalled $1,281,323.52 to be amortized using a straight-line process
over 10 years. The amortization amounts to $128,132.35 per year. So the
carrying amount of Bond Payable after 1 year amounts to $23,846,808.83.

26. B is correct. Shareholder Equity is also known as net assets (A – L = E). If

shares are being repurchased, then equity will drop by the amount of the
repurchase. Thus, Net Assets will decrease by $1M.

27. A is correct. Perpetual Preferred shares are listed in the shareholder Equity
section of the balance sheet.

28. B is correct. Preferred Shares with an obligation to repurchase within a

specified time period are listed in the Non-Current Liability section of the
balance Sheet. The result is that Shareholder Equity would decrease by $1M,
which, as said above, is also known as Net Assets.
Sold to Sophy Thwe (#YUTFIFX4)

Understanding Cash Flow Statements

1. Which would not be considered a cash flow from Investing activity?

a. Purchase of equipment
b. Purchase of 90-day T-Bills held as Cash Equivalents
c. Purchase of T-Bills held as Marketable Securities

2. TrumpsCo holds shares of Clown Castle Inc. as Marketable Securities. Clown

Castle Co. pays a dividend of 1 cent per every 1 million shares held.
TrumpsCo is a US GAAP reporting company. How does that penny appear on
the cash flow statement?

a. Operating inflow
b. Investing inflow
c. Financing inflow

3. If TrumpCo were an IFRS company, how would that penny in the question
above appear on the cash flow statement?

a. Operating outflow
b. Investing inflow
c. Financing inflow

4. Trudeau Co. borrows massive, and I mean massive, amounts of money to

hand out to unsuccessful people. Trudeau Co prices it services to its
successful customers with much higher margins to cover the costs of the
interest on all that debt. How will Trudeau Co reflect the payment of interest
on its debt on its cash flow statement? (Trudeau is a Canadian IFRS
reporting company)

a. Investing outflow
b. Operating outflow
c. Financing inflow

5. Millennials Inc. issued a $2M, 180-day Note to buy drums for inventory.
These drums are then sold at social protests since it is widely known among
their customers that a drum circle solves everything. What effect will these
transactions have cash flows?

a. No effect
b. Cash outflow from financing of $2M
c. Cash outflow from operations of $2M
Sold to Sophy Thwe (#YUTFIFX4)

6. If Millennials Inc. were a US GAAP reporting company, how would the

repayment of the 180-day Notes be classified on the cash flow statement if
the YTM on issue was 4.6% (assume 180/360 day count convention).
a. Financing outflow for the full face value of $2M
b. Financing outflow of $1,955,034
c. Investing outflow of $2M

Question 7 – 14 refer to the following data:

Selected Information, year over year:

Accounts Receivable: increased $75,000
Inventory: increase $87,000
Prepaid Expenses: decreased $25,000
Accounts Payable: decreased $120,000
Salaries Payable: decreased $45,000
Preferred Dividends: $25,000
Depreciation: $200,000
Accrued Liabilities: increased by $25,000
Retained earnings: increased $120,000
Interest Income: $10,000

7. Company purchases were:

a. $1,200,000
b. $1,287,000
c. 1,113,000

8. Cash paid to suppliers was:

a. $1,407,000
b. $1,287,000
c. $1,320,000

9. Cash collected from customers was:

a. $2,075,000
b. $2,000,000
c. $1,925,000
Sold to Sophy Thwe (#YUTFIFX4)

10. What were the total common share Dividends that were issued?
a. $42,500
b. $17,500
c. $67,500

11. The change in the Salaries Payable account was classified as:
a. An operating outflow
b. An operating inflow
c. Without the corresponding Salaries Expense form the Income
Statement, this cannot be answered

12. Cash paid for Operating Expenses was:

a. $550,000
b. $500,000
c. $495,000

13. Interest expense was:

a. $50,000
b. $60,000
c. $40,000

14. Net cash flows provided by current asset accounts was:

a. $137,000 outflow
b. $162,000 inflow
c. $162,000 outflow

Questions 15 and 17 relate to the information below:

15. What was the original historical cost of the asset that was sold?
a. $5M
b. $7.5M
c. $4.5M
Sold to Sophy Thwe (#YUTFIFX4)

16. What was the gain/loss on the sale of the asset?

a. Loss of $500,000
b. Loss of $2,500,000
c. Gain of $500,000

17. How are the sale and the gain/loss handled on the cash flow statement?
a. $2.5M outflow from Investing Activities, $500,000 inflow from
operating activities
b. $4.5 million outflow from Investing activities, $500,000 adjustment
(addition) to Net Income in the operating section, and a non-cash
adjustment of $2M (addition) for the depreciation component to Net
Income in the operating section
c. $2M inflow from Investing activities

Sold to Sophy Thwe (#YUTFIFX4)

Questions 18 – 25 relate to Costco’s Cash Flow Statement above.

18. If Costco’s COGS was $23.162B, determine the amount that Costco’s paid to
its suppliers for the year ending August 28, 2016.
a. $24.719B
b. $23.187B
c. $24.694B

19. How much did PPE increase on the balance sheet, net of all accumulated
Depreciation?
a. $2,649M
b. $1,394M
c. $2,345M

20. Costco’s cash flow has been positive:
a. In 2014, 2015 and 2016
b. In 2014 only
c. In 2014 and 2015

21. How much cash did Costco return to shareholders as a percentage of CFO in
each of 2014, 2015, and 2016?
a. 14.65%, 66.86% and 22.66%
b. 8.38%, 11.23% and 14.76%
c. 23.04%, 78.09% and 37.42%

22. What is Costco’s 2016 FCFF?
a. -$1,472M
b. $3,292M
c. $643M

Extra information for Costco:
Average Total Assets $33,090M
Operating Income $858M
Total Debt $5,161M

23. What is Costco’s Cash Return on Assets?
a. 9.95%
b. -4.45%
c. 2.59%

24. What is Costco’s Cash to Income?
a. -1.72
b. 3.84
c. 1.39

Sold to Sophy Thwe (#YUTFIFX4)

25. What is Costco’s cash Debt Coverage ratio?

a. 0
b. -0.285
c. 0.638

Answer
1. B is correct. Cash Equivalents are considered as part of the cash account.
Changes in the Cash/Cash Equivalents accounts for the year are what the
cash flow statement is trying to explain. As such, it is not a cash outflow from
within any section.

2. A is correct. Under US GAAP all dividends received are classified under cash
flow from operations.

3. B is correct. IFRS allows dividend income to be classified as an operating

inflow or an investing inflow. A is incorrect since that refers to an outflow. C
is incorrect since dividends paid would be classified as a financing cash flow.

4. B is correct. First, interest paid is an outflow of cash, so C can be eliminated.

IFRS allows interest paid to be classified as either an operating or a financing
outflow. A is incorrect since interest paid on debt is not an investing outflow.

5. C is correct. The drums will result in an increase in inventory, and an

increase in an asset account is a use of cash. Hence, the cash flow statement
will show an operating cash outflow of $2M. As such, A is incorrect. B is
incorrect since the issuance of the Notes would be a financing inflow, not an
outflow.

6. B is correct. Under US GAAP, all interest paid is classified as an operating

outflow. Since this is a money-market security, it was originally issued at a
discount. The difference between the issue proceeds and the face value is
considered interest. Therefore, the repayment of the Note at face value
would include both principal and interest. Principal = PV = $2M/(1.023) =
$1,955,034

7. B is correct. Purchases = COGS + Ending Inventory – Beginning Inventory =

COGS + Δ(Inventory) = $1,200,000 + $87,000 = $1,287,000

8. A is correct. Beginning Account payable + Purchases – cash paid to suppliers

= Ending Accounts Payable. Rearranging and collecting terms gives: Cash
paid to suppliers = Purchases – Δ(Accounts Payable) = $1,287,000 – (-
$120,000) = $1,407,000
Sold to Sophy Thwe (#YUTFIFX4)

9. C is correct. Beginning AR + Revenue – Cash collected from customers =

Ending AR. Rearranging and collecting terms gives: Cash collected from
Customers = Revenue – Δ(AR) = $2,000,000 - $75,000 = $1,925,000

10. B is correct. Beginning Retained Earnings + Net Income – Dividends = Ending
Retained Earnings. Rearranging, collecting terms and expanding gives:
Common Share Dividends = Net Income – Preferred Dividends – Δ(Retained
Earnings) = $162,500 - $25,000 - $120,000 = $17,500

11. A is correct. A decrease in a liability account results in a cash outflow. C is
incorrect since, regardless of the balance, the liability account still decreased,
hence cash must have been paid to reduce it up and above whatever balance
the salaries expense account would show.

12. C is correct. Cash Paid for Operating Expenses = Operating expenses +
Δ(Prepaid Expenses) - Δ(Accrued Liabilities) = $500,000 + (-$25,000) + (-
$45,000 -$25,000) = $495,000

13. B is correct. Net Interest = Interest Expense – Interest Income. So $50,000 =
X - $10,000. Solving for x gives Interest Expense of $60,000.

14. A is correct. Δ(AR) + Δ(Inventory) + Δ(Prepaid Expenses) = ($75,000) +
($87,000) + $25,000 = ($137,000). The brackets denote a cash outflow.

15. C is correct. Beginning PPE + CAPEX – Ending PPE = Historical Cost of Asset
Sold = $15M + $6M - $16.5M - $4.5M

16. A is correct. We have already established that the historical cost of the asset
was $4.5M. To determine the gain or loss on the sale we must consider the
carrying amount of the asset. To do this, we need to know how much
depreciation has accumulated on that specific asset. Asset’s Accum. Dep. =
Beginning Accum. Dep. + Dep. Exp (20X2) – Ending Accum = $6M + $3M - $
$7M = $2M. The asset was sold for $2M and had a carrying value of ($4.5M -
$2M) $2.5 million leading to a loss on the sale of $500,000.

17. C is correct. The sale of the asset for $2M is reflected as a cash inflow in the
Investing section.

18. A is Correct. Cash paid to suppliers = Purchases - changes in AP. Purchases =
COGS + changes in Inventory. Therefore Purchases = 23,162M + 25M =
23,187M. From the cash flows statement, we see that inventories
contributed $25M as an outflow. This implies that inventories increased
during the year by $25M. Therefore cash paid to suppliers = 23,187M –
($1,532) = $24,719M. We see from the operations section of the cash flow
statement that accounts payable was a use of cash of $1,532. This implies
that Costco paid down its accounts payable balance year-over-year.
Sold to Sophy Thwe (#YUTFIFX4)

19. B is Correct. Additions to PPE were $2,649 from the investing section of the
cash flow statement. Depreciation was $1,255, as seen in the upper portion
of the operating section. Adding $2,649 to PPE and $1,255 to Accumulated
Depreciation results in a net increase of $1,394M.

20. B is Correct. Adding CFO + CFI + CFF for 2014, 2015 and 2016 respectively
results in $1,105M, ($519M), and ($1,472M)

21. C is correct. Cash returned to shareholders is the sum of both dividends and
share repurchases. These two total are found in the financing section. So,
2014 = ($334 + 584)/3,984 = 23.04%. 2015 and 2016 are calculated
likewise.

22. C is correct. FCFF = CFO – CAPEX = $3,292M - $2,649M = $643M

23. A is correct. Cash return on assets = CFO/Avg. Total Assets = 3,292/33,090 =

9.95%

24. B is correct. Cash to Income = CFO/Operating income = 3,292/858 = 3.84

25. C is correct. Cash Debt Coverage = CFO/Total Debt = 3,292/5,161 = 0.638

Sold to Sophy Thwe (#YUTFIFX4)

Financial Analysis Techniques

1. When should an average amount be used in a ratio (i.e. Average Assets)?

a. Whenever we are using a Balance Sheet account
b. When our numerator is a flow variable and our denominator is a stock
variable
c. Whenever we are mixing cash flow values with income statement
values

2. Smarty Pants Inc., a maker of fine pants for conservative men, recently
reported year-over-year revenue growth of 20% and net income growth of
32%. Which is likely not an explanation of that outcome:

a. Better expense management year-over-year
b. Non-recurring/non-operating revenue/gains were present for the
year
c. A higher effective tax rate on interest expense thereby making the
after-tax cost of debt lower

3. A ratio that measures ‘turnover is a(n):

a. Performance ratio
b. Activity ratio
c. Solvency ratio

4. During periods of rising prices, adjusting a company’s inventory account
balance to reflect FIFO instead of LIFO will most likely have what effect on
the Inventory Turnover Ratio?

a. Increase the turnover
b. Decrease the turnover
c. Remain unchanged

5. Accelerating the recognition of revenue will have what effect on the Total
Asset Turnover ratio?

a. Increase the turnover
b. Decrease the turnover
c. Remain unchanged




Sold to Sophy Thwe (#YUTFIFX4)

6. A 20% increase in revenue due entirely to cash sales would have what effect
on the Days of Sales Outstanding ratio?

a. Increase the ratio

b. Decrease the ratio
c. Remain unchanged

7. Inventory received on consignment would have what effect on the number of

days of payables ratio?

a. Increase the ratio

b. Decrease the ratio
c. Remain unchanged

8. A company’s sales growth for the past year was well below the industry
average but its inventory turnover ratio was well above the industry average.
This is most likely due to:

a. Inadequate inventory levels to meet demand

b. An increase in Deferred Revenue
c. Improved delivery time to customer from time of order

9. A company’s sales increase 20% but its Accounts Receivable increased only
4%. Which reason is least likely to be an explanation?

a. The company has very stringent credit policies

b. The company has become much more efficient in collecting its AR
c. The company’s estimates for Allowance for Bad Debts was lowered
significantly

10. A company with an extremely high payables turnover ratio is probably:

a. Making full use of all credit facilities and taking the requisite amount
of time to make payment
b. Taking advantage of early payment discounts
c. Stretching out payments to suppliers well past the due date

11. A company has very high liquidity ratios but the number of days of payable
outstanding is much higher than the industry average. This is most likely due
to:

a. An inability to meet-short term obligations as they come due

b. An acceleration of payments before the due date in an effort to build
better supplier relationships
c. Stretching the amount of time that payment s are made to suppliers
Sold to Sophy Thwe (#YUTFIFX4)

12. If Costco sells 100 memberships on the last day of the quarter, what effect
will this have on their working capital ratio at the end of that quarter?

a. Increase the ratio

b. Decrease the ratio
c. No effect on the ratio

13. A new, high tech, high-productivity factory opened in an industry dominated

by firms with older factories and equipment. In comparing their Fixed Asset
Turnover ratios, the new company will most likely have a ratio that is:

a. Higher than the industry average

b. Lower than the industry average
c. The same as the industry average

14. A company managed to collect a substantial amount of it accounts receivable

before the end of the quarter. What effect did this likely have on its cash
ratio?

a. No effect
b. Increased the ratio
c. Decreased the ratio

15. A company with a low defensive interval ratio will most likely also have:

a. A low number of days of sales outstanding

b. A high number of days of payables outstanding
c. Declining revenues

16. A negative cash conversion cycle would most likely indicate that:

a. A company has very poor AR collection practices

b. A company collects cash from its customers before providing the
goods or services
c. A company makes no sales on credit, makes all purchases on 30-day
terms, and has an inventory turnover ratio of 12

17. A company recently changed its estimates for depreciation of fixed assets to
incorporate longer useful lives and higher salvage values. What is the most
effect on its Debt-to-assets ratio going forward?

a. It will increase the ratio and make the company’s solvency look worse
b. It will decrease the ratio and make the company solvency look better
c. It will decrease the ratio and make the company’s solvency look worse
Sold to Sophy Thwe (#YUTFIFX4)

18. A company issued $2M is preferred stock with in order to retire $2M is debt.
What effect will this have on its Debt-to-Capital ratio?

a. An increase
b. A decrease
c. Remains unchanged

19. A gain on sale of assets would have what effect on Operating ROA?

a. An increase
b. A decrease
c. No effect

20. Consider a company with a Payout Ratio 0f 40%, ROA = 16% and a financial
leverage ratio of 1.5. What is the company’s sustainable growth rate?

a. 9.6%
b. 6.6%
c. 14.4%

21. The DPR of a company over the last 3 year is as follows – 2013 – 35%, 2014 –
78%, and 2015 – 33%. Which is the most likely explanation of those data
points.

a. The company has an erratic dividend policy

b. The company has volatile earnings
c. The company has a constant retention rate

22. Consider the following data:

Based on the data, which is a least likely explanation?

a. The use of debt has contributed to the improved ROE over the 2014-
2016 period
b. Sales are increasing at a faster rate than assets, leading to an improved
ROE over the period 2014-2016
c. Better cost management had led to an improved ROE over the period
2014-1016
Sold to Sophy Thwe (#YUTFIFX4)

Answers
1. B is correct. A flow variable is over a period of time, so amounts from the
Income Statement and the Cash Flow Statement are flow variables. A stock
variable is at a point in time, so Balance Sheet variables are stock variable.
Thus, when our numerator is from either the CFS or the IS, and the
denominator is from the BS, use an average amount for the BS item. A is
incorrect because if we use two BS items, one in the numerator and one in
the denominator, there is often no need to use averages (e.g. Current ratio –
CA/CL). C is incorrect since they are both flow variables.

2. C is correct. Higher taxes will reduce Net Income. It may lower the
company’s cost of debt and thereby lower its WACC, but in the end it is still a
higher tax rate. Both A and B will positively affect Net Income without
affecting Revenue.

3. B is correct. Activity ratios measure how efficiently a company performs

day-to-day tasks (e.g., Inventory turnover, Payables turnover, etc.)

4. B is correct. Under LIFO, inventory will reflect older, lower prices but COGS
will reflect the newer higher prices. Therefore the turnover ratio of
COGS/(Avg. Inv.) will be represented by high/low. Under FIFO, inventory
will reflect the newer, higher prices and COGS will reflect the older, lower
prices. Thus the turnover ratio will now be represented by low/high. In the
end, the numerator will drop and the denominator will increase. Both effects
lower the turnover ratio.

5. A is correct. Total Asset Turnover = Revenue/(Average Total Assets).

Increasing the numerator will increase the turnover ratio. If there is a tax
effect for tax reporting purposes, it will result in a decrease in cash. Thus,
even considering a tax implication, this would only lower the denominator,
which would raise the turnover ratio as well.

6. B is correct. To see this, consider an example where sales are $100 and AR =
$20. Receivables Turnover is 5. Now increase sales by 20% to $120. The
increase was all cash sales so AR remains at $20. The new Receivables
turnover is 120/20 = 6. Days of Sales Outstanding = 365/AR Turnover. A
higher AR turnover results in a lower number of days of sales outstanding.

7. C is correct. Inventory on consignment does not result in a Payable. Since

the numerator is 365, and the denominator is Average AP, the ratio remains
unchanged.

8. A is correct. Running low levels of inventory can make the Inventory

turnover ratio higher. However, this also leads to stock-outs and lost sales,
Sold to Sophy Thwe (#YUTFIFX4)

leading to lower revenue. B is incorrect since Deferred revenue is a liability

account, and will affect neither the numerator nor the denominator. C is
incorrect since revenue cannot be recognized until ownership of the goods
transfers. So improved delivery time affect will have the same affect as poor
delivery time on Inventory levels.

9. C is correct. Lowering the Allowance for doubtful Accounts will increase the
reported Accounts Receivable (AR are reported on a net basis). A is incorrect
since stringent credit policies will result in growth in AR trailing growth in
revenue. B is incorrect since improvements in AR collection can keep the
growth of AR lower then that of revenue.

10. B is correct. Shortening the time between purchase and payment increases
the payables turnover. Taking advantage of early payment discounts would
increase the payables turnover ratio. Both A and C lengthen the time
between purchase and payment, and as such would decrease the payables
turnover ratio.

11. C is correct. The longer the time between purchase and payment, the greater
the number of days of payables outstanding. A is incorrect since liquidity
ratios are high indicating that the company has sufficient cash to meet short-
term obligations. B is incorrect since that would shorten the time between
purchase and payment, which would decrease the number of days of
payables outstanding.

12. C is correct. Working Capital Ratio = CA – CL. All the memberships sold on
the last day of the quarter will be recorded as unearned revenue, thereby
increasing CL. However, Costco does receive all the cash on the last day of
the quarter thereby increasing cash by the same amount. Thus CA – CL
would remain unchanged.

13. B is correct. The new firm would not have any accumulated depreciation
associated with its assets, and thus a higher carrying value. The other firms
with older factories and older equipment would most likely have much lower
carrying values for fixed assets. Therefore, the newer firm would have a
lower Fixed Asset Turnover ratio.

14. A is correct. Collecting from customers transfers AR into cash. Since the cash
balance would increase, and the cash ratio does not include AR, the ratio
would increase (improve).

15. B is correct. The defensive interval ratio measures how long a company can
continue to pay its cash expenses from its existing liquid assets. If this ratio
is low, in order to meet its cash expense obligations, it will tend to stretch out
its payables. A is incorrect since a low number of days of sales outstanding
would imply very efficient collection of AR, which would be at odds with a
Sold to Sophy Thwe (#YUTFIFX4)

low defensive interval ratio. C is incorrect since a very fast growing company
can run out of money if it does not have a source of growth financing.

16. B is correct. Cash Conversion Cycle = DSO + DOH – days payables. If we are
collecting cash BEFORE the sale, then we don’t need to measure how long it
takes to convert inventory to cash, the cash happens before the inventory. A
is incorrect since poor AR collections would increase DSO. C is incorrect
since all terms would equal zero, as would the cash conversion cycle.

17. B is correct. The denominator is Total Assets. By increasing useful lives and
increasing salvage values, the amount of depreciation going forward will be
much lower, resulting in smaller amounts added to Accumulated
Depreciation, resulting in higher than normal Total Assets. Increasing the
denominator will decrease the ratio, implying a better solvency position.

18. B is correct. Issuing $2M in preferred stock to pay down $2M in debt leaves
total capital unchanged. However, Debt will be $2M lower. Thus, the
numerator will decrease on top of an unchanging denominator.

19. B is correct. Operating ROA = Operating Income/(Average Total Assets). The

gain on the sale of asset would be considered non-operating income and
would not be included in the numerator. The gain on the sale of assets does
imply that cash increased by more than non-current assets decreased, thus
increasing Total Assets. Therefore, a constant numerator and an increasing
denominator will result in a decrease in measured operating ROA.

20. C is correct. Sustainable growth rate = b * ROE = (1 – DPR) * ROA * Leverage

= (1 - .4) * 0.16 * 1.5 = .144 or 14.4%

21. B is correct. Companies usually have a constant dividend as opposed to a

constant DPR. Therefore, as Net Income fluctuates from year-to-year, the
DPR fluctuates. DPR = Dividend/Net Income. A constant numerator and a
volatile denominator will create a volatile DPR.

22. B is correct. ROE = NPM * Total Asset Turnover * Leverage. Total Asset
Turnover = Sales/(Average Total Assets). If sales are increasing at a faster
rate than assets, the numerator will get larger at a faster rate then the
denominator, leading to a higher Total Asset Turnover. The ratio has
declined steadily from 2014 to 2016. A is incorrect, since the trend in the
Leverage Ratio has been increasing, indicating more debt in the capital
structure. C is incorrect since better cost management will lead to higher Net
Income Margins.
Sold to Sophy Thwe (#YUTFIFX4)

Inventories
1. Under rising prices, which relationship among the inventory cost formulas
would hold regarding the reported ending inventory balance of a company:
a. FIFO > Average Cost > LIFO
b. LIFO > Average Cost > FIFO
c. LIFO > FIFO > Average Cost

2. Consider the following data.

If nothing is sold, what is the value attributed to Inventory?

a. $460,000
b. $450,000
c. $555,000

3. Under what inventory valuation method would the allocation of costs

between COGS and Ending Inventory most likely be different depending on
whether a periodic or a perpetual inventory system were used?

a. FIFO
b. LIFO
c. Specific Identification

4. Under what inventory valuation method would the allocation of costs

between COGS and Ending Inventory be the same using a perpetual
inventory system.

a. Both FIFO and Average Cost

b. Both LIFO and Average Cost
c. Average Cost only
Sold to Sophy Thwe (#YUTFIFX4)

5. Under declining unit cost and constant or increasing inventory quantities,

higher COGS, lower carrying amounts for inventory, lower gross profits,
lower operating income, lower net income, lower retained earnings and
higher CFO describe which inventory valuation method?

a. FIFO
b. LIFO
c. Average Cost

6. The carrying amount of inventory and the amount of COGS will closely reflect
current replacement costs under which inventory valuation methods?

a. FIFO and LIFO respectively

b. LIFO and FIFO respectively
c. LIFO for both

7. Which is not true of LIFO under rising costs?

a. Higher cash flows due to lower taxes

b. Lower occurrence of inventory write-downs
c. Less efficient inventory turnover ratio

8. Companies in a rapidly changing technology market are more likely to use:

a. LIFO
b. Specific Identification
c. FIFO

9. A German durable goods manufacturer is most likely to use:

a. LIFO
b. FIFO
c. Specific identification

10. LIFO Liquidation occurs when:

a. Sales of units > purchases of units

b. There is an increase in the number of LIFO layers
c. Prices are declining while inventory levels are stable
Sold to Sophy Thwe (#YUTFIFX4)

11. Consider a company in a seasonal business where inventory levels are higher
in Q1 and Q3. Further, prices rise during these 2 peak demand seasons and
settles back to normal in the off seasons. Below is a table of the company’s
beginning inventory, purchases by quarter, unit costs, and sales by quarter.
Assume a quarterly perpetual inventory system.

Units $/units Total Cost Sales

Beginning Inventory 12 $6.00 $72.00
Quarter 1 31 $6.50 $201.50 36
2 16 $6.00 $96.00 13
3 43 $6.75 $290.25 40
4 19 $6.00 $114.00 15

What is the ending value of inventory under LIFO versus FIFO?

a. LIFO > FIFO
b. FIFO > LIFO
c. LIFO = FIFO

12. A company had Sales and COGS of $150K and $100K respectively in 2016.
The same company had LR balances of $16,000 and $10,500 in 2016 and
2015 respectively. What gross margin would the company have reported
under FIFO?

a. 33.33%
b. 37%
c. 29.66%

13. A company reported LR balances of $16,000 and $10,500 for 2016 and 2015
respectively. If the company has a tax rate of 35%, and had been a FIFO
reporting company instead, what would the net difference be in their total
assets?

a. An decrease of $5,500
b. An increase of $10,400
c. A increase of $3,575

14. If a company’s LR balance is increasing each year, then:

a. FIFO gross profit > LIFO gross profit
b. COGSFIFO > COGSLIFO
c. EBITFIFO < EBITLIFO



Sold to Sophy Thwe (#YUTFIFX4)

15. Converting a Balance sheet from LIFO to FIFO, the LR is allocated as follows:

a. Assets ñ LR, Equity ñ LR

b. Assets ñ LR(1-t), Equityñ LR(1-t)
c. Assets ñ LR, Equity ñ LR(1-t), Liabilities ñ LR(t)

A company reported the following:

Sold to Sophy Thwe (#YUTFIFX4)

16. Calculate EIFIFO for 2014.

a. $2,420
b. $1,720
c. $1,470

17. Calculate COGSFIFO for 2015.

a. $14,010
b. $14,830
c. $15,170

18. Calculate NIFIFO for 2015.

a. $1,166
b. $1,214
c. $922
Sold to Sophy Thwe (#YUTFIFX4)

19. ΔCFO under FIFO for 2015 would be closest to:

a. ($170)
b. ($122)
c. ($48)

20. Calculate the cumulative tax savings under LIFO.

a. $327
b. $277
c. $122

21. Calculate Retained EarningsFIFO for 2015.

a. $4,043
b. $3,502
c. $4092

22. Inventory Turnover under FIFO for 2015 is closest to:

a. 6.37
b. 6.30
c. 6.13

23. A company in which sector is most likely to experience inventory write-

downs?

a. Consumer Staples
b. Industrials
c. Consumer Discretionary

24. Inventory with an original cost of $1 million currently has a net realizable
value of $930K and a replacement cost of $935K. Under US GAAP, what
would be the carrying value of the inventory considering the above facts?

a. $930K
b. $935K
c. $1M

25. An IFRS reporting company had the following on its balance sheet:

In what manner was the $300,000 write-down of inventory recognised?

Sold to Sophy Thwe (#YUTFIFX4)

a. On the IS in either COGS or as a separate item

b. In Other Comprehensive Income
c. On the Income Statement as a Non-Operating loss

26. What effect would an inventory write-down reversal have on the Inventory
Turnover ratio?

a. Increase
b. Decrease
c. Remain unchanged

Answers
1. A is Correct. As prices are rising, FIFO leaves the higher cost goods in
inventory while LIFO leaves the lower cost, earlier prices in ending
inventory. Average Cost will always arrive at a value for ending inventory
that is between FIFO and LIFO.

2. A is Correct. Inventory will only include Raw Materials, Direct Labour,

Manufacturing Overhead and the delivery costs of Raw Materials. ($150K +
$100K + $200K + $10K = $460K). Any costs associated with finished goods
cannot be absorbed as a product cost and are instead treated as period costs.
Abnormal wastage is also not absorbed as a product cost.

3. B is Correct. If a periodic or a perpetual inventory system were used, FIFO

would result in the same COGS and Ending Inventory. The same is true for
specific identification. However, LIFO would most likely be different under
both systems.

4. A is correct. Under a perpetual inventory system, inventory values and cost

of sales are continuously updated to reflect purchases and sales. As a result,
the amount of cost of goods available for sale allocated to COGS and EI is
similar under FIFO and average cost methods.

5. A is correct. As costs are declining, LIFO COGS will be lower than FIFO. Thus
it is FIFO with the higher GOGS, which will lead to lower profit measures and
ultimately to lower retained earnings. The lower profits also lead to lower
taxes payable and thus higher CFO.

6. A is correct. Regardless of whether prices are rising or falling, LIFO charges

the latest units to COGS while FIFO leaves the latest units in inventory. The
latest units represent replacement cost.
Sold to Sophy Thwe (#YUTFIFX4)

7. C is correct. Under LIFO and rising prices, inventory carrying amounts will
be lower, reflecting earlier units purchased at lower costs. COGS will be
higher than FIFO since the latest units purchased will be charged to COGS.
Since Inventory turnover = COGS/(Average Inventory), the ratio will have a
higher numerator and lower denominator, thus implying a more efficient
inventory turnover ratio.

8. C is correct. Industries characterized by rapid technological changes

typically face declining prices over time (i.e. TVs, Computers). Under falling
prices, FIFO has the higher COGS and the lower EBT, and as such has the
lower taxes payable.

9. B is correct. A German company will be an IFRS company, and LIFO is not

permitted. Since the output will typically be many units of the same type
(cars, washing machines, etc..), specific identification makes no sense.

10. A is correct. A LIFO liquidation specifically happens when the number of

units sold exceeds the number of units purchased. Sales must then come
from the beginning inventory units, thus liquidating that stock. B is incorrect
since an increase in the number of LIFO layers implies that sales < purchases.
C is incorrect, since it is the units and not the prices that we pay attention to
regarding a LIFO liquidation. Even if prices are falling, we may still be adding
to inventory.

11. A is correct. Beginning Inventory + purchases = inventory available for sale =

121 units. Sales = 104 units. The last 17 units will be left in inventory for a
total cost of (17 * $6) = $102. Under LIFO:
Q1: 36 units sold – all 31 purchased in Q1 are removed and 5 from
beginning inventory are removed leaving 7 units remaining from
beginning inventory at $6/unit
Q2: 13 units are sold – 13 are removed from Q2 purchases leaving 3
remaining from Q2 at $6/unit and 7 units remaining from beginning
inventory at $6/unit
Q3: 40 units sold – all 40 are removed from Q3 purchases leaving 3
remaining from Q3 at $6.75unit, 3 remaining from Q2 at $6/unit and 7
units remaining from beginning inventory at $6/unit
Q4: 15 units sold – all 15 are removed from Q4 purchases leaving 4
remaining from Q4 at $6/unit, 3 remaining from Q3 at $6.75unit, 3
remaining from Q2 at $6/unit and 7 units remaining from beginning
inventory at $6/unit

LIFO Ending Inventory = (7 * $6) + (3 * $6) + (3 * $6.75) + (4 * $6) =

$104.25
Sold to Sophy Thwe (#YUTFIFX4)

12. B is correct. Under FIFO, COGSFIFO = COGSLIFO – ΔLR = $100,000 - $5.500 =

$94,500. Gross Margin = (Sales – COGS)/Sales = ($150,000 –
$94,500)/$100,000 = 0.37.

13. B is correct. Inventory would have been $16,000 higher ( + LR) but cash
would have been $5,600 lower [ - LR(t)].

14. A is Correct. If the LR is increasing, then prices are rising as new LIFO layers
are added. COGS will be higher under LIFO than under FIFO in that case,
leading to gross profit under FIFO > gross profit under LIFO. (COGSLIFO >
COGSFIFO by ΔLR)

15. C is correct. Inventory will increase by the LR. Retained Earnings will
increase by LR(1-t). Since A = L + E, and since the tax must be paid but no
cash has changed hands, we must record a liability; Deferred Taxes = LR(t).
Thus LR = LR(t) + LR(1-t).

16. A is correct. EIFIFO – EILIFO + LR = $1,600 + $820 = $2,420. Note the question
asks for 2014!

17. B is correct. COGSFIFO = COGSLIFO – ΔLR = $15,000 – ($990 - $820) = $14,830.

18. A is correct. NIFIFO = NILIFO + ΔLR(1-t). The tax rate for 2016 = Tax/EBT =
$406/$1,450 = 0.28. So NIFIFO = $1,044 + $170(1 – 0.28) = $1,166.40

19. C is correct. CFO changes for 2016 only by ΔLR(t) = $170(.28) = $47.6, which
is the additional tax that would have to be paid making this a cash outflow.

20. A is correct. To calculate the cumulative tax savings we will need the tax
rates from 2015 and 2016. We have already established that the tax rate in
2016 was 28%. For 2015, the tax rate was $300/$1,200 = 25%. So the tax
savings up to 2015 = LR(t) = $880 * .25 = $205. The incremental tax savings
for 2016 has already been established as $122.40. Thus the total tax savings
amounts to $327.40.

21. A is correct. REFIFO = RELIFO + LR – Tax Shield. We have just calculated the
total tax savings as $327.40. So, REFIFO = $3,380 + $990 - $327.40 =
$4,042.60.

22. B is correct. Inventory Turnover = COGS/(Average Inventory). We need
COGSFIFO for 2016, which we have previously calculated as $14,830. We also
need EIFIFO for both 2015 and 2016. We have previously calculated EIFIFO for
2015 as $$2,420. EIFIFO for 2016 = EILIFO + LR = $1,300 + $990 = $2,290.
Inventory Turnover = $14,830/[($2,290 + $2,430)/2] = 6.30

Sold to Sophy Thwe (#YUTFIFX4)

23. C is correct. Consumer Discretionary industries are more sensitive than the
other two sectors to changing consumer tastes, changing economic
conditions, and technological obsolescence.

24. A is correct. US GAAP carries inventory at the lower of cost or replacement

value but with upper and lower bounds. The upper bound is NRV and the
lower value is NRV – normal profit margin. Since NRV is $930K and
replacement is $935K, the inventory will be carried at the upper bound of
$930K.

25. A is correct. Any write-down of inventory typically is charged directly to

COGS or may be a reported separately as an operating expense.

26. B is correct. The inventory Turnover ratio = COGS/(Avg. Inventory). A

reversal would lower COGS and raise average inventory. A decreasing
numerator and an increasing denominator both work to lower the ratio.
Sold to Sophy Thwe (#YUTFIFX4)

Long-Lived Assets

1. Company A exchanged an asset with Company B. The FV of the asset

received was $2M. The BV of the asset given up was $200K but its FV was
approximately equal to $2M. This transaction will be accounted for by:

a. An increase in total assets of $1.8M and a gain on the IS of $1.8M

b. No change in total assets since they have equal FV
c. An increase in total assets of $1.8M and an increase in OCI of $1.8M

2. Consider the following events for the most recent reporting period:

What will be the recorded cost of the equipment?

a. $288,000
b. $285,000
c. $275,000

3. With reference to the data in Question 2, what will be the total capitalized
costs for the most recent period?

a. $285,000
b. $288,000
c. $308,000

4. Company A constructed a factory over a 2-year period for its own use at a
total cost of $15M. The company borrowed $12M for the project at 5.25%
interest. In each of the two years, interest earned on the borrowed funds was
$360K in year 1 and $120K in year 2. The capitalized cost of the factory
under US GAAP and IFRS respectively are:

a. $16,260,000 and $15,780,000

b. $15M under both cases
c. $16,575,000 and $16,095.000
Sold to Sophy Thwe (#YUTFIFX4)

5. Company A constructs factories to sell while Company B constructs a factory

for their own use. Both incur interest costs on borrowed funds to support
the construction process. Where on the IS would this interest expense show
up for A and B respectively?

a. Both as Interest Expense
b. Interest Expense and Depreciation
c. COGS and Depreciation

6. Company A (a US GAAP company) and Company B (and IFRS company) both
borrow funds to construct their own buildings. Each earns $200K in years 1
and 2 on the borrowed funds. Which company will experience a positive
impact on CFO in the first two years as a result?

a. Interest expense if capitalized and will affect CFI, so neither company
will experience a positive effect on CFO
b. Company A
c. Company B

7. Referring to the data in Q6 above, assuming the buildings both cost the same
to construct, both will have 10-year useful lives and that both companies use
straight-line depreciation with equal salvage values, which company will
have the higher depreciation expense in Year 5?

a. Both use straight-line with the same assumptions about s=salvage
value, so both will have equal depreciation expense in Year 5
b. Company A
c. Company B

8. Company A acquired a patent for $2M with a useful life of 15 years. Company
B developed a technology for which they received a patent, which also has a
useful life of 15 years and cost $2M to develop. Which company will show
higher CFO as a result?

a. Neither since both companies will reflect the $2M as an outflow under
CFI
b. Company A
c. Company B

9. Referring to the information is Q8 above, which company will show higher
CFO in the years after the transaction.

a. Neither company will be advantaged or disadvantaged in terms of
CFO subsequent to the initial recognition period
b. Company A
c. Company B
Sold to Sophy Thwe (#YUTFIFX4)

10. Company A develops all its intangible assets internally. Company B identifies
competitive alternatives and acquires them instead. Assuming they spend
the same amount annually, which company will have the higher Total Asset
Turnover as a result?

a. Neither since the transaction do not affect revenue
b. Company A
c. Company B

11. Referring to the information in Q10, which company will have the higher
CFO/EBITDA ratio in the years where the relative expenditures are the
same?

a. Neither company will be advantaged or disadvantaged in terms of
CFO/EBITDA
b. Company A
c. Company B

12. Company A has acquired Company B for $1B. The FV of the net assets =
$750M. Of that amount, $500M is attributable to tangible assets and $250M
to intangible assets of which $175M are for identifiable intangible assets.
Goodwill will be recognized as:

a. $250M
b. $325M
c. $175M

13. Company A is valued as a multiple of CFO. With respect to intangible assets,
the company is most likely to:

a. Internally develop for its needs
b. Acquire its needed assets
c. Expense the costs in the period incurred

14. Company A and Company B compete is a fast growing technology market.
Both companies spend more year after year on intangible assets. Company A
internally develops its needed assets while Company B acquires them. As
long as this spending pattern continues, which company will show the higher
growth in Shareholder equity?

a. Neither company will be advantaged or disadvantaged in terms of
Shareholder equity growth
b. Company A
c. Company B

Sold to Sophy Thwe (#YUTFIFX4)

15. Company A is a private company concerned with tax minimization. Company

B is a public company concerned with maximizing valuations. Both must
incur costs of $1M to develop a database. Which is least likely?

a. Company A is more likely to internally develop

b. Company B is more likely to acquire
c. Both will prefer to internally develop

16. Company has $100M in debt with a fully blended interest rate of 6.33%. On
the IS, Company A reported interest expense of $4M. $2.33M has been
capitalized. Which is a true statement with respect to Company A’s Interest
Coverage Ratio?

a. The denominator should be $4M

b. The denominator should be adjusted to $6.33M
c. If left unadjusted, the ratio would understate the company’s true
solvency

17. A component of PPE cost $10M, has a salvage value of $2M, and a useful life 8
years. Company A uses straight-line depreciation while Company B uses
double –declining depreciation. What will Company B report for
Depreciation expense related to this asset in Year 2?

a. $1.875M
b. $1.5M
c. $2.0 M

18. With reference to the information in Q17 above, which company will
recognize the full depreciable cost of the asset sooner?

a. Company A
b. Company B
c. Both will take the same period of time to recognize the full
depreciable cost of the asset

19. With reference to the information is Q17 above, which company will have the
more positive impact on total asset turnover in the first 2 years.

a. Company A
b. Company B
c. Neither company will have an advantage on this dimension of activity

20. A company hired a new CEO several years ago. Since then, the company has
been showing strong and positive CFO and Net Income. Its CFO/EBITDA
ratio and its Net Income margin are both well above industry averages. Its
Sold to Sophy Thwe (#YUTFIFX4)

assets turnover ratios are well below industry average however. What
would most likely produce this effect?
a. The company has reassessed its depreciation polices and has
lengthened its estimate of useful lives and increased its estimates of
salvage values for several asset classes
b. The company is now capitalizing certain costs that were previously
recognized as expenses
c. The company had adopted the revaluation method for certain classes
of assets and has been recognizing revaluation surpluses in the years
subsequent to the CEOs appointment

21. For IFRS reporting companies, which long-lived asset valuation model is
rarely used?
a. Impairment
b. Revaluation model
c. Cost model

22. The use of straight-line depreciation over accelerated depreciation will most
likely not result in:
a. Higher average net assets
b. Higher variability of net income
c. Lower EBIT margins in the front years followed by higher EBIT
margins in the back years

23. 85% of a company’s PPE is used in the production of goods. The net PPE
equals $2B, the average useful life of the asset class has 16 years remaining
and the company uses straight-line depreciation. The amount of
Depreciation Expense that would be recognized as a separate line item on the
Income Statement would be closest to:
a. $125M
b. $19M
c. $106M

24. Component depreciation is allowed under:

a. IFRS
b. US GAAP
c. Both IFRA and US GAAP

25. Which intangible asset would be subject to amortization?

a. A non-renewable license with a term of three years

b. An internally developed customer list with a useful life of 15 months
c. An acquired trademark that can be renewed for a nominal fee every 5
years
Sold to Sophy Thwe (#YUTFIFX4)

26. Under the revaluation model, assets are carried at:

a. Cost – subsequent Accumulated depreciation
b. FV – subsequent Accumulated Depreciation
c. FV

27. Assume a company has an asset class subject to the revaluation model.
Currently the asset class has a carrying value of $140M. The FV of this asset
class at the end of Year 1 is $120M and at the end of Year 2 is $160M. Which
represents the sequence of reporting under the revaluation model?

a. Year 1 – a loss of $20M on the IS, Year 2 - a gain of $30M on the IS
b. Year 1 – a loss of $20M on the IS, Year 2 – a gain of $20M on the IS and
an increase in the revaluation surplus account of $10M
c. Year 1 – a loss of $20M on the IS, Year 2 – an increase in the
revaluation surplus account of $30M

28. Upward revaluation has what effect on the leverage ratio?

a. Increase
b. Decrease
c. Indeterminate

29. A company is deciding whether an impairment charge is required. As asset
with a carrying value of $1.4M has been assessed as having the following
values – FV less costs to sell = $1.35M, Value-in-use = $1.42M, FV = $1.39M.
This asset is:

a. Impaired under both IFRS and US GAAP
b. Impaired under only 1 of the standards
c. Not impaired under either standard

30. An asset requires an impairment charge under both IFRS and US GAAP. The
carrying value is deemed to be recoverable. The asset is:

a. Impaired under both IFRS and US GAAP
b. Impaired under only 1 standard
c. Not impaired under either standard

31. A company reported its gross PPE at $2.4B and its Accumulated Depreciation
at $1.44B. Its depreciation expense in its most recent statements was
$120M. The average age of its asset is closest to:

a. 20 years
b. 12 years
c. 8 years
Sold to Sophy Thwe (#YUTFIFX4)

A new suburban development was built with 100 identical homes. Two
companies purchased the entire subdivision each owning 50 of the homes for
the purpose of generating rental income. Company Able uses the fair value
model in reporting its Investment Property assets while Company Baker uses
the historical cost method. Both companies financed the purchase of these
new assets with 20% and 80% debt using 30-year fully amortizing
mortgages with fixed rates of 4.25%. Both companies face the same cost
structure in terms of insurance and property tax, and in the competitive
rental market, both companies receive the same rent per unit. Economic and
demographic conditions in the region have been supportive of housing prices
over the last 10 years with an annual mean increase in the local HPI (Housing
Price Index) of 3% per year. It is expected that these conditions will continue
over the next 10-year period.

32. Over the next 10-year period, which company will appear more profitable?

a. Able
b. Baker
c. Neither Able nor Baker

33. Over that same period, which company will report the higher CFO?

a. Able
b. Baker
c. Neither Able nor Baker

34. Which company will also show the lower Debt/Equity measure by the end of
the 10-year period?

a. Able
b. Baker
c. Neither Able nor Baker

35. Both Company A and Company B lease some equipment to be used in their
production process. The leases span 4 years. Company A has structured a
finance lease (capital lease) while Company B has structured an operating
lease. Which company’s current ratio will decrease as a result?

a. Company A
b. Company B
c. Neither Company A nor Company B
Sold to Sophy Thwe (#YUTFIFX4)

Answers

1. A is correct. In an exchange, the FV of the asset acquired is recognized on the

BS. The BV of the asset given up is derecognized. The net result is that total
assets will increase by $1,8M. That increase in total assets is recognized as a
gain on the Income Statement.

2. A is Correct. The capitalized cost of the equipment will include all cost to
bring the equipment to the place of use and get it ready for its intended use.
Total Cost = Cost of Equipment + Delivery + Setup + Modifications + Testing =
$250K + $10K + $15K + $10K + $3K = $288K.

3. C is correct. We have already established that the equipment will have a

balance sheet carrying value of $288,000. The lighting has a useful life of 5
years so that would also be capitalized. That brings the total capitalized costs
for assets to $308,000.

4. A is correct. US GAAP: Interest income is recognized as income on the IS and

not offset against interest expense. Total interest expense during the first 2
years was ($12M * 0.0525) * 2 = $1,260,000. Added to the $15M = $16.26M.
IFRS: IFRS nets out the interest earned against the interest paid and only
capitalizes the net. Thus, only $1,260,000 – ($360K + $120K) = $780K would
be capitalized as interest resulting in a total capitalization of $15.78M.

5. C is correct. Since Company A is in the business of selling constructed

buildings, capitalised interest appears in inventory first then COGS once the
sale is recognized as revenue. Company B is building a long-lived asset
subject to depreciation. Thus, capitalized interest expense will find its way to
the IS in the form of Depreciation.

6. B is correct. The US GAAP reporting company will report the interest earned
as income and that will show up in CFO as a cash inflow. The IFRS company
nets out the interest income against the interest expense and reflects that
amount as an outflow in CFI.

7. B is correct. The US GAAP company capitalized the full cost of the building
while the IFRS company capitalized a lower amount by $400K (2 years of
interest income on borrowed funds). Given that both use the same
assumptions regarding depreciable cost, the company with the higher
carrying amount will show the higher depreciation expense in Year 5.
Company a is the US GAAP company is this scenario.

8. B is correct. Since the intangible asset was acquired by Company A rather

than internally developed, the purchase price will be reflected as a cash
outflow from inventing activities. Company B internally developed its
intangible asset, and under both IFRS and US GAAP, those costs are expensed.
Sold to Sophy Thwe (#YUTFIFX4)

Thus Company B will show lower CFO as a result. Since the question asks
which company will show higher CFO, the answer must be Company A.

9. B is correct. The company that capitalized the asset will amortize the cost
over its useful life. Amortization is a non-cash expense, but it is still a tax-
deductible expense. The company that internally developed the asset will
experience no further expense in the subsequent years. Hence company A
will have higher CFO by the amount of the tax savings associated with the
amortization.

10. B is correct. Since Company A expenses, it records no increase in assets as a
result. Company B capitalizes, so assets will increase each year given that
both companies spend the same each year. So Company B will have an
increasing denominator for the Total Asset Turnover ratio while Company a
will not. Company A will have the lower asset base, and thus the higher total
asset turnover ratio.

11. C is correct. Company A expenses its costs, leading to cash outflows in CFO.
Company B capitalizes its costs leading to cash outflows in CFI. Company B
will have higher CFO’s and thus a higher numerator. Since EBITDA is before
amortization, Company B’s amortization expense in later years will affect
neither the numerator nor denominator. Thus Company B will show a higher
CFO/EBITDA ratio.

12. B is correct. The FV of the net assets is $75M implying a $250 recognition for
Goodwill. However, of the $250M in intangible assets, only $175K is
identifiable and can thus be recognized as intangible assets. The remaining
unidentified assets must be recognized as part of Goodwill. Thus the
Goodwill will be $250K + $75K = $325K.

13. B is correct. Acquiring allows for capitalization and no effect on CFO. Both A
and C result in a decrease in CFO.

14. C is correct. Company B capitalizes its intangible assets. This increase in
assets over Company A must be met with an increase in either liabilities or
equity. Since liabilities are unaffected, equity must increase. Thus, Company
B will show higher growth in shareholder equity over Company A as long as
each continues to spend more and more each year.

15. C is correct. Company A will want to report as much in expenses as possible
and will therefore prefer to internally develop. Company b would like to
report as much Net Income or CF as possible and will therefore prefer to
acquire. Thus both preferring to internally develop is least likely.

16. B is correct. To determine the true solvency of the company, the interest
expense used should reflect all interest obligations. C is incorrect since using
Sold to Sophy Thwe (#YUTFIFX4)

$m, the unadjusted interest expense, would result in a coverage ratio that is
much higher, not lower. That would overstate the company’s solvency, bot
understate.

17. A is correct. The asset will be depreciated over 8 years. The double-
declining rate would be (1/8 * 2) = 25% on the declining balance.
Depreciation in Year 1 would be $2.5M. Note that the double-declining
depreciation method does not consider salvage value. The method simply
stops once the carrying value reaches salvage value. The depreciation in
Year 2 will be $7.5M * .25 = $1.875M

18. C is correct. Both methods will depreciate the $8M of the $10M in the same
amount of time, namely 8 years.

19. B is correct. Double-declining depreciation will lower asset value faster in
the first few years. A lower denominator will drive a higher total asset
turnover ratio.

20. B is correct. Capitalizing costs increase total assets and result in cash
outflows being classified as inventing outflows instead of operating outflows.
This activity also increases Net Income versus expensing, which previously
had been done. However, total assets will increase thereby lowering the total
asset turnover ratio. A is incorrect since depreciation is a non-cash expense.
Thus while lowering depreciation expense will have a positive impact on Net
Income, will inflate total assets, it will have no affect on CFO. C is incorrect
for the same reason – the revaluation is a non-cash gain and will have no
affect on CFO.

21. B is correct. The revaluation model for intangible assets is rarely used, and
for intangible assets it is extremely rare. C is incorrect since the cost model is
the most common method of asset valuation. A is incorrect since, while
impairments do not happen every year, impairments are a required
component of asset valuation if evidence of impairment is present.
Impairments, although not an annually consistent charge, is still more
common than the use of the revaluation method.

22. B is correct. The use of straight-line over accelerated depreciation will result
in lower income variability from year to year. A is incorrect since the use of
straight-line over accelerating depreciation will result in higher average
assets over the assets. C is incorrect since straight-line depreciation will
result in higher EBIT margins in the earlier years (front years) followed by
lower EBIT margins in the later years (back years).

23. B is correct. Since 85% of the PPE asset class is used in the production of
goods, those costs would be absorbed as inventory costs. Thus only 15% of
the $2B would have depreciation expense listed as a separate line item on the
Sold to Sophy Thwe (#YUTFIFX4)

Income Statement. $2B * 15% = $300M. $300M/16 years = $18.75M/year

using straight0-line depreciation.

24. C is correct. Component depreciation is allowed under both standards. It is
rarely used under US GAAP but it is required under IFRS.

25. A is correct. The license has a clear finite life of three years. B is incorrect
since internally developed intangible assets are expensed, not capitalized. C
is incorrect since the trademark can have a potentially unlimited life due to
the low cost of renewability.

26. B is correct. Assets will be carried at their FV less any subsequent
depreciation since the last FV assessment.

27. B is correct. In the first year, FV dropped, so there would be a $20M loss on
the IS. In year 2, FV has increased beyond the original $140M. Thus, the first
$20M would be reflected as a gain on the IS, and the next $10M would be
added to the revaluation surplus account in the Shareholder Equity section of
the BS.

28. B is correct. A = L + E. Thus, A > E. Leverage ratio = (Avg. A)/E.
Mathematically, when a ratio > 1, then (A + constant)/(E + constant) < A/E.
Thus the leverage ratio will decrease.

29. B is correct. Under IFRS, the recoverable amount is the higher of FC – selling
costs and Value-in-Use. Value-in-use is the higher of the two, and is higher
than the carrying value of $1.4M, so no impairment charge is required.
Under US GAAP, since the FV is less than the carrying amount, there will be a
requirement to recognize an impairment loss. Thus only 1 of the standards
requires an impairment loss.

30. B is correct. Since we are told that the asset requires an impairment charge,
under IFRS a charge must be taken. Even though the amount is deemed
recoverable, IFRS allows for subsequent reversals. Under US GAAP, an asset
is impaired only when the carrying amount is deemed to be unrecoverable.
Since this is the case, there is no impairment under US GAAP.

31. B is correct. Average age of assets = (Accumulated
Depreciation)/(Depreciation expense) = $1.44B/$120M = 12 years.

32. A is Correct. Able reports its Investment Property assets at FV. Baker uses
historical cost less accumulated depreciation. As the HPI increases by the
projected 3% per year, Able will have FV gains year-over-year and no
depreciation expense. Baker will report no gains but will report depreciation
expense. As such, Able will report much higher Net Income than Baker.
Sold to Sophy Thwe (#YUTFIFX4)

Hence Able’s NIM (net income margin) will be higher than Baker’s
considering they have the same revenue base.

33. C is correct. Both companies have the same revenue and cost structures and
the same capital structures. The two differ on the standards adopted with
respect to their Investment Property assets. However, from a tax reporting
perspective, both companies are clearly in the same tax jurisdiction facing
the same tax laws. Both companies will have identical income for tax
purposes even though they have different income for reporting purposes.
The differences in financial reporting, gains on FV reporting versus
depreciation, are non-cash in both cases and will not affect CFO.

34. A is correct. Able will have higher Net Income and thus higher Retained
Earnings while Baker will have lower Net Income and thus lower Retained
Earnings. Both will pay off their debt at the same rate. While both
companies will have the same numerator, Able will have a higher
denominator by the after-tax amount of both the depreciation not taken and
the gains year-over-year in FV.

35. A is correct. For Company A, the equipment has been leased under a finance
lease and thus will increase PPE, a long-lived asset. Further it will have to
report the obligation as a liability. The lease spans 4 years. So the current
portion of ‘Obligations Under Capital Leases’ will be listed in the current
liabilities section with the balance being reported as a non-current liability.

36.
Sold to Sophy Thwe (#YUTFIFX4)

Income Taxes

1. Deferred Tax Assets will not arise from:

a. Taxes recognized for tax purposes but not recognized for financial
reporting purposes
b. Carry forward of previous losses
c. Taxes recognized for financial reporting purposes but not yet
recognized for tax reporting purposes

2. Which statement is correct?

a. When tax payable > tax expense, this creates a DTA
b. When tax payable > tax expense, this creates a DTL
c. When tax payable < tax expense, this creates a DTA

3. Income Taxes Paid, an outflow in CFO, reduces:

a. Income Tax Payable
b. Income Tax Expense
c. Deferred Tax Liability

4. A company reports its PPE at $180K for financial reporting purposes but the
asset class has a tax base of $160K. Given a tax rate of 30%, this situation
results in a:

a. $6,000 DTA
b. $20,000 DTL
c. $6,000 DTL

5. Which statement is FALSE?

a. All DTA/DTL are noncurrent under IFRS
b. DTA/DTL may be either current or noncurrent under US GAAP
c. All DTA/DTL are current under IFRS

6. Research costs of $2M are expensed in the current year for financial
reporting purposes but for tax purposes, this amount must be claimed over 2
years. This will result in:

a. Tax base < carrying value
b. Tax base > carrying a value
c. The creation of a DTL account

Sold to Sophy Thwe (#YUTFIFX4)

7. Unearned revenue of $500,000 is reported as a liability for year-end. For tax

purposes, there is no unearned revenue and thus the amount must be
claimed as current period taxable income. With a 35% tax rate, this sets up a:

a. DTA of $350,000
b. DTL of $175,000
c. DTA of $175,000

8. Donations made of $1M in the current period to various charities are only
75% deductible for tax reporting purposes. This will set up a:

a. DTA
b. DTL
c. Neither a DTL nor a DTA

9. With respect to an increase in the statutory tax rates within a jurisdiction,
reporting companies would experience:

a. An increase in their DTL and a decrease in their DTA
b. A decrease in their DTL and an increase in their DTA
c. An increase in both their DTA and DTL

10. A company reports current DTA of $45K, non-current DTA of $100K, current
DTL of $32K, and noncurrent DTL of $55K. What is the effect on the net tax
position of a 7% decrease in tax rates?

a. An increase in tax benefits of $4,160
b. A decrease in tax benefits of $4,160
c. A decrease in tax benefits of $3,150

11. A company has reports gross DTA balances that equal their gross DTL
balances. With respect to changes in tax rates, which would the company
rather have occurred?

a. A decrease in tax rates
b. An increase in tax rates
c. Since net tax assets (or liabilities) = $0, the company would be
indifferent to a tax increase or decrease

12. Tax credits would have the following effect on deferred taxes.

a. A tax credit reduces the balance in the DTL
b. A tax credit increases the balance in the DTA
c. A tax credit has no effect on deferred taxes


Sold to Sophy Thwe (#YUTFIFX4)

13. A company with a LIFO Reserve of $600M and a tax rate of 28% will have:

a. A DTA in the amount of $$168M
b. A DTL in the amount of $168M
c. Neither. A LIFO Reserve does not give rise to deferred taxes

14. Company S, a retailer with a long history, has been reporting losses for more
quarters than anybody can count. Any DTA balances would most likely:

a. Be eliminated since it is unlikely that the company will earn a profit in
the future
b. Reflect only balances arising out of taxable temporary differences
c. Reflect both taxable temporary differences and any unused tax loss
carry-forwards that have not expired

15. Deferred taxes on a company’s balance sheet should reflect:

a. Current statutory tax rates that gave rise to the deferred tax balances
b. Current effective tax rates that resulted in the difference between tax
expense and tax payable
c. Future statutory tax rates that are expected to be in place when the
temporary differences reverse

16. A company had a tax payable amount of $400,000. The company paid
$425,000. The result of this transaction would be to:

a. Increase the balance in the DTA account
b. Reduce the balance in the DTL account
c. Create a new asset account for Prepaid Tax expense

17. Write-downs of DTA due to uncertainty of their future economic benefits
reduce the carrying amount of the DTA and reduce Net Income in the same
period. Reversal of previous write-downs are allowed under:

a. IFRS
b. US GAAP
c. Both IFRS and US GAAP









Sold to Sophy Thwe (#YUTFIFX4)

Answers

1. C is correct. Claiming to pay more tax (financial statements) than you
actually did (tax returns) results in a liability, not an asset.

2. A is correct. Paying more tax (tax returns) than you claim to (financial
reporting) will create a future asset.

3. A is correct. Much like paying a supplier reduces your Accounts Payable,
paying your taxes reduces Income Tax Payable.

4. C is correct. Since R > T (i.e. $180K > $160K), this results in a DTL.

5. C is correct. Under IFRS, all DTA/DTL accounts are listed under the
appropriate noncurrent section on the balance sheet.

6. B is correct. For financial reporting purposes, since the entire amount has
been expensed, there will be no balance that needs to be carried on the
balance sheet to the next reporting period. The carrying value will be $0.
However, for tax reporting purposes, $1M has to be carried to the next
period on the balance sheet, so the tax base will be $1M. C is incorrect since
taxes paid will be higher than tax expense, setting up a tax asset, not a tax
liability.

7. C is correct. For financial reporting purposes, the balance sheet will have a
carrying amount of $500K for the liability Unearned Revenue. For tax
purposes, that liability will not exist since it must be claimed as revenue.
Since R > T, that sets up a DTA. The amount of the difference, $500,000, at a
tax rate of 35% results in $175K.

8. C is correct. This situation will not result in a temporary difference but
rather a permanent difference. As a result, not DTA or DTL is created.

9. C is correct. Increasing statutory tax rates will increase both DTA and DTL
balances.

10. B is correct. DTA = $145K and DTL = $87K. The company has a net DTA of
$58K. Since tax rates are dropping 7%, the value of this benefit will also drop
by 7%. $58K * 0.07 = $4,060

11. A is correct. Even though they would not benefit from a balance sheet
perspective, lower tax rates are always preferred for future income.

Sold to Sophy Thwe (#YUTFIFX4)

12. C is correct. A tax credit directly reduces taxes payable and thus has no
effect on carrying amounts or tax bases. As such it is a permanent difference
and therefore will not affect any deferred tax accounts. Permanent
differences result in a difference between a company’s effective and statutory
tax rates.

13. C is correct. If a company uses LIFO for reporting purposes, it must use LIFO
for tax purposes. As such the carrying amount of inventory and the tax base
will be equal leading to no deferred taxes.

14. B is correct. If there is uncertainty as to the probability of future taxable
profits, a deferred tax asset as a result of unused tax losses or tax credits is
only recognized to the extent of the available taxable temporary differences.
Recall that an asset by definition must offer future economic benefits. The
tax loss carry forwards of a company that is unlikely to produce profits in the
future would not offer future economic benefits.

15. C is correct. Deferred taxes should be measured at the tax rate that is
expected to apply when the asset is realized or the liability is settled.

16. C is Correct. The income tax paid in excess or owed to tax authorities is
separate from deferred taxes on the company’s balance sheet.

17. B is correct. Both IFRS and GAAP allow reversals.
Sold to Sophy Thwe (#YUTFIFX4)

Non-Current Liabilities


1. An IFRS company issued at $1M bond at a 2% discount to par. Costs of
issuance amounted to .75% of par. What is the liability that would be
reported on the Balance Sheet?

a. $1,000,000
b. $972,500
c. $980,000

2. If the company in Q1 above were a US GAAP company, what would the
liability be listed at?

a. $1,000,000
b. $972,500
c. $980,000

3. A bond was issued at a premium. The bond had a coupon rate of 5% on a
face value of $10M. The semi-annual interest expense will be recorded as:

a. $25,000
b. Less than $25,000
c. Greater than $25,000

4. What effect does issuing a bond have on a company’s current ratio?

a. None
b. Decrease
c. Increase

5. A company issue a bond at a 3% premium and pays issuing costs of 1%.
Under which standards would the company report a lower non-current
liability associated with Bonds payable?

a. IFRS
b. US GAAP
c. Both would report the same amount for Bonds payable





Sold to Sophy Thwe (#YUTFIFX4)

Question 6 – 9: A company issued a 5%, semi-annual, 10-year bond with a face

value of $10M for gross proceeds of $9.12M, which implies a market interest rate of
6.194%. Issuing fees amount to .6% of the face value of the bond.

6. Under US GAAP and IFRS, what will be the carrying amount of the bond at
issuance?

a. $9.12M and $9.06M respectively
b. Both will carry the bond at $9.12M
c. $10M and $9.12M respectively

7. What amortization amount of the bond discount will be reflected in Interest
Expense after the first coupon payment using the effective interest rate
method under IFRS (rounded off)?

a. $47,000
b. $30,508
c. $34,484

8. Repeat Q7 for US GAAP.

a. $32.446
b. $35,446
c. $34,484

9. What is the total interest expense related to the bond in Year 1 reported on
the Income Statement under IFRS?

a. $568,968
b. $431,032
c. $570,051

10. Under the effective interest rate method, Interest expense for a fixed rate
bond issued at a premium will _______________ over the life of the bond.

a. Decrease
b. Increase
c. Remain constant

11. Carrying bonds at their amortized value will __________________ leverage levels
when market interest rates are dropping

a. Understate
b. Overstate
c. Have no effect on

Sold to Sophy Thwe (#YUTFIFX4)

12. A company was able to retire a $5M debt issue early for $5.1M. how will this
be reflected on the CFS?

a. Cash outflow of $5M in CFF
b. Cash outflow of $5.1M in CFF
c. Cash outflow of $100K in CFO, cash outflow of $5.0M in CFF

13. A company issued $5M of 5-year bonds 4 years ago. How will this affect the
current ratio calculated from the balance sheet with one year left to maturity
on the bonds?

a. No effect on the current ratio
b. Decrease the current ratio
c. Increase the current ratio

14. To determine the PV of pension obligation, the discount rate used is typically:

a. A long-term government bond yield
b. A high quality corporate bond yield
c. The company’s WACC

15. With respect to a defined benefit pension plan, which of the following is
False?

a. The pension plan is typically funded through a separate legal entity
b. If the FV of the plan assets > pension obligation, the company lists a
net pension asset on its balance sheet
c. The company assumes no investment performance risk

16. Which component of the costs of a defined benefit pension plan would not be
recorded in Pension Expense on the Income Statement?

a. Employee service costs
b. Net interest expense/income
c. Remeasurements

17. The PV of pension obligations is highly dependant on:

a. The expected life span of in retirement
b. The projected salary on with future benefits are based
c. The discount rate used to state future obligations in terms of today’s
liability



Sold to Sophy Thwe (#YUTFIFX4)

18. Consider your answer to 17 above in answering this question. Which

statement is most likely to be true?

a. During recessions, the PV of Pension Obligations is overstated while in
expansions it is understated.
b. During recessions, the PV of Pension Obligations is understated while
in expansions it is overstated
c. The PV of Pension Obligations has no discernable relationship with
the business cycle

19. Considering your answer to Q18 above, when would companies most likely
report pension assets?

a. In expansions
b. In recessions
c. Mid-cycle from trough to peak of the business cycle

20. Company A and Company B compete in the same industry, produce
competing products, face similar input costs and realize similar selling prices.
Company A does not offer a pension plan while Company B offers a defined-
benefit plan. Which company would be expected to have lower gross
margins?

a. Company A
b. Company B
c. Gross margins should be similar for A and B since pension expense is
an operating expense.


















Sold to Sophy Thwe (#YUTFIFX4)

Answers

1. B is Correct. Under IFRS, the initial recognition will reflect the net proceeds
from the bond issue (gross amount received less issuing fees). The bond was
issued at 98% of par with a further .75% for fees. Total net proceeds =
97.25% of par or $972,500.

2. C is Correct. The liability for Bonds Payable will reflect gross proceeds from
sale. Since the bond was issued at 98% of par, the liability would appear
under non-current liabilities as $980,000.

3. B is correct. The future value of the liability will only be $10M. Thus any
premium will be amortized over the life of the bond and will reduce the
interest expense in each period.

4. C is correct. Issuing a bond will have potentially two liability effects. The
bond, when first issued, is more than likely to be completely recorded in non-
current liabilities. However, we must allow for the possibility that there is a
current portion of the bond payable due within the next 12 months (highly
unlikely given that we are issuing a bond). Further, all the proceeds of the
bond are now in cash, which increases current assets. Therefore, the current
ratio will increase.

5. A is correct. Under US GAAP, issuing fees are capitalized and amortized over
the life of the bond and Bonds Payable reflect the gross amount received.
Under IFRS issuing fees are taken off the balance of Bonds Payable and are
reflected net of issuing fees.

6. A is correct. Under US GAAP, the bond will be carried at its gross proceeds of
$9.12 while under IFRS the bond will be carried at its net proceeds at
$9.06M.

7. C is correct. Under the effective interest rate method, the carrying amount of
the bond is multiplied by the market rate of interest prevailing when the
bond was first issued to arrive at total interest expense. Since this is an IFRS
company, the carrying amount of the bond is $9.06M and the market rate of
interest at issuance needs to be calculated to account for the issuing costs.
So, PV = -90.6, FV = 100, N = 20, PMT = 2.5 CPT I/Y = 3.14% or 6.28% on an
annual basis. This is also a semi-annual bond, so we are considering only the
first payment in 6 months. Thus, total interest expense will be $9,060,000 *
(0.0628/2) = $284,484. The coupon payment will make up $250,000 with
$34,484 attributable to the amortization of the discount and issuing fees.

8. B is correct. The amortization of the bond discount will come to $9,120,000 *
(.06194/2) - $250,000 = $32,446. The carrying amount of the bond is
Sold to Sophy Thwe (#YUTFIFX4)

multiplied by the market interest rate of 6.194% (divided by to for the semi-
annual period) less the regular coupon payment. However, issuing costs of
$60,000 were capitalized and these are amortized on a straight-line basis.
$60,000/20 = $3,000 [.6% of $10 = $60K, 20 semi-annual payments]. Thus
total amortization component of interest expense = $35,446.

9. C is correct. We have already established that the amortization of the bond
after the first payment amounted to $34,484. That will bring the carrying
value of the bond up to $9,094,484. The second amortization charge will be
($9,094,484 * .0314) - $250,000 = $35,567. Thus, total coupon payments of
$500,000 added to the two amortization charges of $34,484 and $35,567
total $570,051.

10. A is correct. The market rate is applied to a lower carrying value on a
premium bond as the premium is amortized downward towards par. Since
the coupon is fixed, the combination of a fixed coupon and a decreasing
amortization component will decrease interest expense over the life of the
bond.

11. A is correct. When market interest rates are dropping, bond prices increase.
By carrying a bond at the amortized value, regardless of whether it was
issued at a discount or at par, will understate the value of the bonds with
respect to fair market value. Thus if Fair Value reporting were adopted for
all financial liabilities, leverage ratio would be measured higher as market
interest rates drop.

12. B is correct. The full amount of the debt retirement of $5.1M is a CFF
outflow.

13. B is correct. The bonds have one-year left to maturity and would now be
reflected in the current liability section of the balance sheet under Current
Portion of Long term Debt. This would have a negative shock on the current
ratio.

14. B is correct. Companies that are calculating the PV of the pension obligation
will use s discount rate equal to what the market rates are on high quality
corporate bonds.

15. C is correct. With a defined benefit plan, the company is obligated to deliver
future benefits and, while the assets are typically held in a separate legal
entity, the company assumes the risk of all investment performance
shortfalls.

16. C is correct. Remeasurements, whether gains or losses, are reported in OCI.

Sold to Sophy Thwe (#YUTFIFX4)

17. C is correct. A and B are important drivers of the pension obligation.

However, the question asks about the PV of the pension obligation. PVs are
highly dependant on the discount rate used.

18. A is Correct. During recessions, the lowering of interest rates results in a
lowering of the level of the yield curve. Since the discount rate is tied to a
high-quality corporate bond, the discount rate would be lower in recessions
thereby making the PV of Pension Obligations higher. The opposite effect
occurs in expansions when there is an increase in the level of the yield curve.
The higher discount rate would result in a lower value for the PV of Pension
Obligations. Thus, when rates are set low, the PV of Pension Obligations will
overstate the true cost of the future benefits, and when rates are high, the PV
of Pension Obligations will understate the true cost of the future benefits.

19. A is correct. There are 2 effects that create this outcome. First, the discount
rate is increasing, lowering the PV of Pension Obligations. Secondly, equities
are increasing, thus giving a boost to the equity asset allocation within the
pension fund.

20. B is correct. Pension Expense for production employees become part of
inventory, which becomes part of COGS.


Sold to Sophy Thwe (#YUTFIFX4)

Financial Reporting Quality

1. Financial reporting quality refers to:

a. The earnings and cash generated by the company’s core economic
activities and the resulting financial condition
b. The usefulness of information contained in the report
c. Is difficult to assess is earnings quality is poor

2. Faithful representation refers to information that is:

a. Complete, neutral, and free from error
b. Complete, conservative, and free from error
c. Timely, understandable, and verifiable

3. Which is the lowest type of reporting in terms of quality?

a. GAAP, decision-useful, low quality earnings
b. Within GAAP but earnings management
c. Within GAP but biased choices

4. A company reports well within GAAP with neutral choices. The company
made a net profit of $10M on sales of $150M. Total Assets = $200M and their
WACC = 8.65%. The company uses accelerated depreciation. Their reporting
quality is best described as:

a. GAAP, decision useful, but low quality earnings
b. GAAP, decision useful, sustainable and adequate returns
c. Within GAAP but biased choices

5. Which type of bias in the current period would lead to improved reported
financial performance in later periods.
a. Aggressive accounting choices
b. Conservative accounting choices
c. Earnings smoothing

6. Which accounting choice leads to an understatement of earnings volatility?

a. Aggressive choices
b. Conservative choice
c. Earnings smoothing



Sold to Sophy Thwe (#YUTFIFX4)

7. A new CEO was hired to turn around a failing company. Among the many
problems the CEO found were underperforming inventory, accounts
receivable balances outstanding for more than 180 days still on the books
and obsolete equipment. The new CEO ordered the inventory to be written
down to FMV, the accounts receivable to take charges for bad debts, and
some equipment to take obsolescence charges. These choices could be seen
as:

a. Biased
b. Conservative
c. Aggressive

8. With respect to the conditions conducive to issuing low-quality reports, the
fraud triangle is encompasses:

a. Opportunity, motivation, incentive
b. Incentive, motivation, rationalization
c. Opportunity, motivation, rationalization

9. When using a non-GAAP measure, which of the following would not be
expected?

a. The company must display the most directly comparable GAAP
measure in a footnote at the bottom of the immediate page
b. The company must provide a reconciliation of the non-GAAP measure
and the equivalent GAAP measure
c. Management must explain why it believes that the non-GAAP measure
provides useful information

10. Trump Enterprises is most likely to issue:

a. Within GAAP, but poor earnings quality
b. Pro-Forma earnings that are huge
c. No report whatsoever but say they did and that the media is just lying
to you about it

11. EBITDAR is justified since it:

a. Adjusts EBITDA by removing operating leases to make it comparable
to a similar company that has financing leases
b. Adjusts EBITDA in order to remove any restructuring charges since
they are non-recurring
c. Adjusts EBITDA to include the total amount of backlog on the order
book (unearned Revenue as of the reporting date, but confirmed
orders for delivery)

Sold to Sophy Thwe (#YUTFIFX4)

12. Consider a company that has a significant amount of debt with covenants
that may be at risk of being violated, a recent poor quarter, and a significant
amount of top management compensation tied to performance. This
company has _____________________ to engage in low quality reporting.

a. The opportunity
b. The motivation
c. The rationalization

13. With respect to mechanisms that discipline financial reporting quality, which
is not true?

a. Better quality reporting can result in a lower cost of capital through
lower perceived company risk on the part of investors
b. Since debt covenants are a possible motive for manipulation, lenders
typically monitor borrowers more closely
c. Audits are integral to uncovering fraud and assessing fair
presentation

14. Which is not true of Pro-Forma accounting measures?

a. There are no universal guidelines, management uses its own
discretion in deciding how to calculate these measures
b. Pro-Forma measures are neither fraudulent nor dishonest
c. Pro-Forma measure are non-GAAP measures; there are no Pro-Forma
measures under IFRS since IFRS does not allow the presentation of
non-IFRS measures

15. A company purchased equipment for $250,000 with a 5-year life and $50,000
salvage value. Which would make net income appear to have the higher
growth rate?

a. Expensing in the current period
b. Capitalizing in the current period
c. Both result in the same charges to income over the assets useful life

16. After adjusting for the presence of operating leases, which measure would
most likely increase?

a. Debt/Equity but not Interest coverage
b. Interest Coverage but not Debt/Equity
c. Both Debt/Equity and Interest coverage



Sold to Sophy Thwe (#YUTFIFX4)

17. Year-over-year a company has shown dramatic increases in Net Income

while sales have basically been flat. In the MD&A, management discussed at
length the efforts in the past year aimed at improving product quality,
lowering the average amount of inventory required to support sales, and
increasing the speed at which it collects accounts receivable. What might we
expect to find associated with such a report that would lead us to believe that
management is lying?

a. A higher inventory turnover measure
b. A lower expense allocation to warranty reserves
c. A shorter cash conversion cycle





Answers.

1. B is correct. A refers to the quality of the reported results. C is backwards,
earnings quality would be difficult to assess without reporting quality.

2. A is Correct. B is incorrect since conservative choices do not always faithfully
represent the information. C refers to enhancing characteristics of reporting
and not to faithful representation.

3. B is correct. (See Exhibit 2)

4. A is correct. Return on assets = 5% but WACC = 8.65%. Thus while they
have positive accounting profit, they have negative economic profit. C is
incorrect since accelerated depreciation is an available choice of depreciation
and may match their use of the asset.

5. B is correct. Conservative choices include decreasing reported income and
increasing reported expenses in the current period. Future periods would
then have higher reported income and lower reported expenses. A is
incorrect since aggressive choices in the current period would increase
revenue and decrease expenses. That would lower reported revenue in
future periods and increase expenses. C is incorrect since earnings
smoothing will work to reduce high earnings and to boost low earnings.

6. C is correct. Taking down high earnings and bringing up low earnings
reduce the volatility of earnings. A company will use conservative
assumptions when the company is doing well and aggressive assumptions
when the company is doing poorly. A is incorrect since aggressive choices
Sold to Sophy Thwe (#YUTFIFX4)

seek to maximize reported earnings. B is incorrect since conservative

choices will minimize reported earnings.

7. A is correct. Actions like these from a new CEO are sometimes referred to as
Big Bath Behaviour. A new CEO will take charges in the current period and
write off much more than needs to be in order to realize gains and reversals
in the future.

8. C is Correct.

9. A is Correct. If a non-GAAP measure is presented, the equivalent GAAP
measure must be displayed with equal prominence. Placing it in a footnote,
even on the immediate page, doe not satisfy this condition.

10. C is correct. Trump Enterprises has done many wonderful, and I say this, you
know, I can’t think of any better company, so many wonderful things that are
never reported. Instead, the media, and many of them, I suppose, are
wonderful people, but many others, and I’m hearing a lot of this folks, they
make things up. They just make it up. That stops now. Gotta stop folks.
Were gonna clean it up. Big League.

11. A is Correct. The ‘R’ in EBITDAR represents rent expense. Companies that
own their buildings or assets would have higher EBITDA versus those that
rent. EBITDAR is an attempt to make the numbers more comparable.

12. B is correct. All three conditions listed in the question are motives to issue
low quality reports.

13. C is correct. Auditors express opinions with respect to the fairness of the
information presented. An audit is not typically intended to detect fraud; it is
intended to provide assurance that the financial reports are fairly presented.
This is sometimes referred to as an ‘expectations gap’ between the auditor’s
role and the public’s expectations of auditors.

14. C is correct. Pro-Forma measures can be non-GAAP and can be non-IFRS.
IFRS has many of the same disclosure requirements if a non-IFRS measure is
included in a financial report.

15. A is correct. Expensing in the current period results in no depreciation
charges in future periods, thus allowing Net Income to show growth due
entirely to the lack of the deprecation expense. C is a true statement but is
not an answer to the question.

16. A is correct. Removing the effect of operating leases means replacing them as
financing leases. Both assets and liabilities would increase, butt not equity.
Thus the Debt/Equity ratio would increase. The implied interest expense
Sold to Sophy Thwe (#YUTFIFX4)

would also increase but have no effect on reported EBIT. Thus Interest
Coverage would decrease.

17. B is correct. Since management claims that quality has been increased over
the past year, they have no history on which to base a reduced warranty
reserve allowance against. Since this is an estimate, justifying a lower
current period expense for warranty reserves by invoking higher quality may
be a way to support higher Net Income on flat revenues. Both A and C are
consistent with management statements. A reduced level of inventory for
the same level of sales will increase inventory turnover. High inventory
turnover combined with faster AR collection will also shorten the cash
conversion cycle.

Sold to Sophy Thwe (#YUTFIFX4)

Review

I have taken some questions from an MIT course on Financial Statement Analysis
and amended them for our use. Below are 17 that are in CFA form with some
modification from the original to match our required LOS. If you want the full set of
91 questions, of which you should be able to do them all by the way, e-mail me at
meldrum.b.m@[Link].

1. A firm has a higher quick (or acid test) ratio than the industry average, which
implies:
a. The firm has a higher P/E ratio than other firms in the industry
b. The firm may be less profitable than other firms in the industry
c. The firm is more likely to avoid insolvency in the short run than other
firms in the industry and the firm may be less profitable than other
firms in the industry

2. An example of a liquidity ratio is ______:
a. Fixed asset turnover
b. Fixed asset turnover and acid test or quick ratio
c. Current ratio and acid test or quick ratio

3. A firm has a higher asset turnover ratio than the industry average, which
implies:
a. The firm is more profitable than other firms in the industry
b. The firm is utilizing assets more efficiently than other firms in the
industry
c. The firm has higher spending on new fixed assets than other firms in
the industry

4. If you wish to compute economic earnings and are trying to decide how to
account for inventory, ____________:
a. FIFO is better than LIFO
b. LIFO is better than FIFO
c. FIFO and LIFO are equally good

5. If the interest rate on debt is higher than ROA, then a firm will ______________ by
increasing the use of debt in the capital structure.
a. Increase the ROE
b. Not change the ROE
c. Decrease the ROE

6. A firm has a market to book value ratio that is equivalent to the industry
average and an ROE that is less than the industry average, which implies
___________.
a. The firm has a higher P/E ratio than other firms in the industry
Sold to Sophy Thwe (#YUTFIFX4)

b. The firm is more profitable than other firms in the industry

c. The firm is utilizing its assets more efficiently than other firms in the
industry

7. In periods of inflation, accounting depreciation is ______________ relative to
replacement cost and economic income is _____________.
a. Overstated; overstated
b. Overstated; understated
c. Understated; overstated

8. If a firm has a positive tax rate, a positive ROA, and the interest rate on debt
is the same as ROA, then ROA will be ____________.
a. Greater than the ROE
b. Equal to the ROE
c. Less than the ROE

9. A firm has a P/E ratio of 12 and a ROE of 13% and a market to book value of
_________.
a. 0.92
b. 1.08
c. 1.56

10. A firm has a (net profit/pre-tax profit ratio) of 0.625, a leverage ratio of 1.2, a
(pre-tax profit/EBIT) of 0.9, an ROE of 17.82%, a current ratio of 8, and a
return on sales ratio of 8%. The firm's asset turnover is _____________.
a. 1.3
b. 2.3
c. 3.3

11. A firm has an ROA of 14%, a debt/equity ratio of 0.8, a tax rate of 35%, and
the interest rate on the debt is 10%. The firm's ROE is ____________.
a. 11.18%
b. 11.54%
c. 12.62%

12. A firm has an ROE of −2%, a debt/equity ratio of 1.0, a tax rate of 0%, and an
interest rate on debt of 10%. The firm's ROA is ____________.
a. 2%
b. 4%
c. 6%

13. A company has a ratio of (total debt/total assets) that is above the industry
average, and a ratio of (long term debt/equity) that is below the industry
average. These ratios suggest that the firm _______________.
a. Utilizes assets effectively
b. Has too much equity in the capital structure
Sold to Sophy Thwe (#YUTFIFX4)

c. Has relatively high current liabilities

14. A firm's current ratio is above the industry average; however, the firm's
quick ratio is below the industry average. These ratios suggest that the firm
_______________.
a. Has relatively more total current assets and even more inventory than
other firms in the industry
b. Is very efficient at managing inventories
c. Has liquidity that is superior to the average firm in the industry

15. Which of the following would best explain a situation where the ratio of (net
income/total equity) of a firm is higher than the industry average, while the
ratio of (net income/total assets) is lower than the industry average?
a. The firm's asset turnover is higher than the industry average
b. The firm's equity multiplier must be lower than the industry average
c. The firm's debt ratio is higher than the industry average.

16. _______________ best explains a ratio of (sales/average net fixed assets) that
exceeds the industry average.
a. The firm expanded plant and equipment in the past few years
b. The firm makes less efficient use of assets than competing firms
c. The firm has a substantial amount of old plant and equipment

17. Comparability problems arise because:
a. Firms may use different generally accepted accounting principles
b. Inflation may affect firms differently due to accounting conventions
used
c. Firms may use different generally accepted accounting principles and
inflation may affect firms differently due to accounting conventions
used


Answers

1. C is correct. Current assets earn less than fixed assets; thus, a firm with a
relatively high level of current assets may be less profitable than other firms.
However, its high level of current assets makes it more liquid.

2. C is correct. A and B either wholly or partly refer to fixed assets.

3. B is correct. The lower the asset turnover ratio the less efficiently the firm is
using assets. C is incorrect since higher spending than the industry would
lead to higher levels of fixed assets and a lower asset turnover ratio. A is
incorrect since asset turnover measures efficiency, not profitability.

Sold to Sophy Thwe (#YUTFIFX4)

4. B is correct. Economic earnings measure return over a company’s required

rate of return. As such, the Income Statement should reflect the most current
costs for each category since the required rate of return is a marginal cost of
capital.

5. C is correct. If ROA is less than the interest rate, then ROE will decline by an
amount that depends on the debt to equity ratio. Since A = L + E, ROA > ROE.
If the interest rate is > ROA, then increases in debt will reduce NI by an
amount proportional to the amount of debt, thereby pulling ROE downward.

6. A is correct. Divide both P and E by B and we get (P/B)/ROE. The numerator
is Market to Book, and the denominator – E/B – is ROE. So, a lower ROE and
an equal P/B with the industry would result in a higher P/E ratio.

7. C is correct. Fixed assets are depreciated based on historical costs and, as a
result, depreciation will be understated relative to replacement costs during
periods of inflation. As a result, economic income is overstated.

8. A is correct. If the interest rate = ROA; ROE = (1 − tax rate)ROA; ROA > ROE.

9. C is Correct. First lets invert the P/E ratio and divide the numerator and
denominator by B. We will get the equality E/P = ROE/(P/B). Now
substitute for PE and ROE, 1/12 = 0.13/(P/B) and solve for (P/B). P/B = 12 *
.13 = 1.56.

10. C is correct. Using the DuPont decomposition, we get 17.82% = 0.625 × 0.9 ×
8% × asset turnover × 1.2. Solving for asset turnover = 3.3.

11. A is Correct. ROE = (1 − 0.35)[14% + (14% − 10%)0.8] = 11.18%.

12. B is correct. −2% = (1) [ROA + (ROA − 10%) 1]. Solving for ROA = 4%.

13. C is correct. Total debt includes both current and long term debt. The above
relationships could occur only if the company has a higher than average level
of current liabilities.

14. A is correct. Total current assets are high, and inventory is a very large
portion of total current assets, relative to other firms in the industry.

15. C is Correct. Assets are financed either by debt or equity. The situation
described above could occur only if the firm is financing more assets with
debt than are industry competitors.

16. C is correct. If the firm has more old plant and equipment than competing
firms, the denominator is deflated thus producing a higher than average
ratio.
Sold to Sophy Thwe (#YUTFIFX4)

17. C is Correct. Firms often select specific generally accepted accounting
principles for the desired effect on the financial statements. The analyst must
make adjustments in order to compare firms using different account
techniques. Often firms adopt specific techniques to offset the negative
effects of inflation on the firm.