Financial Reporting and Analysis

Total score: 0 out of 40, 0%

Question Feedback

Block 1: TOS
Question
1 of 1
By accessing this assessment, you agree to the following terms of use: The practice tests and mock
exams are provided to currently registered CFA candidates. Candidates may view and print the exams for
personal exam preparation only. The following activities are strictly prohibited and may result in
disciplinary and/or legal action: accessing or permitting access by anyone other than currently registered
CFA candidates and copying, posting to any website, e-mailing, distributing, and/or reprinting the practice
tests and mock exams for any purpose.
I agree.

Block 2: Question block created by wizard

Question
1 of 40

An analyst examining the statement of cash flows for possible manipulation is least likely to be concerned
about a(n):
cash flow from operations to net income ratio consistently higher than 1.

increase in cash from operations arising from a large change in accounts payable.

change in the classification of interest paid from an operating cash flow to a financing cash flow.

Question not answered

A cash flow from operations to net income ratio that is consistently higher than 1 indicates that operating
cash flow is consistently higher than net income and signals high earnings quality.

CFA Level I
“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling,
Section 4.2.2
Question
2 of 40

A company's most recent balance sheet shows the following values (NZ$ thousands):
Accounts payable 3,800
Long-term debt 5,590
Other long-term liabilities 800
Common stock 1,200
Retained earnings 1,810
The company’s debt-to-capital ratio is closest to:
0.77.
 1.86.

0.65.

Question not answered

The debt-to-capital ratio is

where Total Debt includes only interest-bearing debt.

CFA Level I
“Financial Analysis Techniques,” by Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Sections 4.4.1

Question
3 of 40

During a period of rising inventory costs, a company decides to change its inventory method from FIFO to
the weighted average cost method. Under the weighted average method which of the following financial
metrics will most likely be higher than under FIFO?
Number of days in inventory

Current ratio

Debt-to-equity ratio

Question not answered

If all else is held constant, in a period of rising costs the ending inventory will be lower under the weighted
average cost method and the cost of goods sold will be higher (compared to FIFO), resulting in lower net
income and retained earnings. There will be no impact on the debt level, current or long-term. Therefore,
the debt-to-equity ratio (Total debt/Total shareholder’s equity) will increase because of the decrease in
retained earnings (and lower shareholders’ equity).

CFA Level I
“Inventories,” Michael A Broihahn
Sections 3.7, 7.3
Question
4 of 40

An analyst would most likely conduct additional analysis when faced with which of the following financial
presentations?
Reporting a non-GAAP financial measure in an SEC filing

A change from LIFO inventory accounting to FIFO

A non-GAAP financial measure that excludes an expense that is likely to recur

Question not answered

The exclusion of recurring items from non-GAAP financial measures is strictly prohibited by the SEC and
should raise concerns that additional analysis is needed.
CFA Level I
“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling
Sections 4.1 and 4.2
Question
5 of 40

Which of the following is most likely to signal manipulation of financial reporting for a large, diversified
company?
A history of large expense items classified as unusual

Changes in accounting policies to reflect new accounting standards

Operating margins out of line with other diversified companies

Question not answered

A history of unusual expense items may indicate a pattern of management manipulating the way
investors perceive operating income performance. Repeated use of the "unusual" or "non-recurring"
category decreases the value of this classification and suggests that management may be trying to
manipulate users' perceptions of sustainable profitability levels.

CFA Level I

"Financial Reporting Quality," Jack T. Ciesielski, Jr., Elaine Henry, and Thomas I. Selling

Section 4.3

Question
6 of 40
Which of the following will be higher using the LIFO method compared with the FIFO method during
periods of rising inventory unit costs?
Ending inventory

Cost of sales

Gross profit

Question not answered

Under either a perpetual or periodic inventory system, using the LIFO method will result in higher cost of
sales than the FIFO method when inventory costs are increasing. This is because the cost allocated to
cost of sales under the LIFO method more closely reflects current replacement values of inventory, which
is higher than older inventory which was purchased at a lower cost.

CFA Level I
"Inventories" by Michael A. Broihahn
Section 3.5

Question
7 of 40
In accrual accounting, if an adjusting entry results in the reduction of an asset and the recording of an
expense, the originating entry recorded was most likely a(n):
deferred revenue.

prepaid expense.

accrued expense.

Question not answered

The adjusting entry to record the expiry of a prepaid expense is the reduction of an asset (the prepaid)
and the recognition of the expense.

CFA Level I
“Financial Reporting Mechanics,” Thomas R. Robinson, Jan Hendrik van Greuning, Karen O’Connor
Rubsam, Elaine Henry, and Michael A. Broihahn
Section 5.1
Question
8 of 40

A company uses the percentage-of-completion method to recognize revenue from its long-term
construction contracts and estimates percent completion based on expenditures incurred as a percentage
of total estimated expenditures. A three-year contract for €10 million was undertaken with a 30% gross
profit margin anticipated. The project is now at the end of its second year, and the following end-of-year
information is available:
Year 1 Year 2
Costs incurred during year €3,117,500 €2,582,500
Estimated total costs €7,250,000 €7,600,000
The gross profit recognized in Year 2 is closest to:
€880,000.

€960,000.

€617,500.

Question not answered

Percent (Costs incurred/Total costs anticipated) × 100
completed
Gross profit in Percent Complete × Future anticipated profit – Profit already recognized
the year
Year 1 Year 2

Costs incurred €3,117,500 €3,117,500 + €2,582,500 =

€5,700,000
Percent complete €3,117,500/€7,250,000 = 43.0% €5,700,000/€7,600,000 = 75.0%

Gross profit 43.0% × (€10,000,000 – €7,250,000) 75.0% × (€10,000,000 –

= €1,182,500 €7,600,000) – €1,182,500 =
€617,500

CFA Level I
"Understanding Income Statements,” Elaine Henry and Thomas R. Robinson
Section 3.2.1
Question
9 of 40
A company acquired a customer list for $300,000 and a trademark for $5,000,000. Management expects
the customer list to be useful for three years, and it expects to use the trademark for the foreseeable
future. The trademark must be renewed every 10 years with the Patent and Trademark office for a
nominal amount; otherwise it expires. If the company uses straight-line depreciation for all its intangible
assets, the annual amortization expense for these two assets will be closest to:
$0.

$600,000.

$100,000.

Question not answered

The trademark can be renewed at a minimal cost, therefore it is considered to have an indefinite life and
amortization expense is not required.
Annual amortization expense on the customer list = $300,000 ÷ 3 years = $100,000.

CFA Level I
“Long-Lived Assets,” Elaine Henry and Elizabeth A. Gordon
Section 3.2
Question
10 of 40
Which of the following is least consistent with the goals of accounting standards developed under the joint
conceptual framework project of the International Accounting Standards Board (IASB) and the U.S.
Financial Accounting Standards Board (FASB)? Accounting standards should be:
developed independently.

internally consistent.

principles based.

Question not answered

Under the joint conceptual framework project of the IASB and the FASB, accounting standards should be
principles based, internally consistent and converged. The goal of the joint framework is to move away
from the independent development of accounting standards.

CFA Level I
“Financial Reporting Standards,” by Elaine Henry, Jan Hendrik van Greuning, and Thomas R. Robinson
Section 2

Question
11 of 40

The following annual financial data are available for a company:

£ Millions
Beginning interest payable 90.4
Cash paid for interest 103.3
Ending interest payable 84.5
Interest expense (in millions) for the year is closest to:
£71.6.

£109.2.

£97.4.

Question not answered

Interest expense can be determined from the following relationship:
£ Millions
Beginning interest payable 90.4
Plus interest expense ?
Minus cash paid for interest – 103.3
Ending interest payable 84.5
Solving for interest expense = 97.4

CFA Level I
“Understanding Cash Flow Statements,” Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning,
and Michael A Broihahn
Section 3.2.1.5
Question
12 of 40

The following information about a company is provided:

Account $ Thousands
Contributed capital, beginning of the year 50
Retained earnings, beginning of the year 225
Sales revenues earned during the year 450
Investment income earned during the year 5
Total expenses paid during the year 402
Dividends paid during the year 10
Total assets, end of the year 800
Total liabilities (in $ thousands) at the end of the year are closest to:
472.

487.

482.

Question not answered

Given Assets = Liabilities + Equity. First calculate ending equity ($318, see calculation in the following
table).
$800 = Liabilities + $318, Total liabilities = $482.

$ Thousands
Contributed capital 50
Initial retained earnings 225
Sales revenues 450
Investment income 5
 Total expenses (402)
Net income for the year 53
Dividends paid (10)
Increase in retained earnings 43 43
Ending owners’ equity $318

CFA Level I
“Financial Reporting Mechanics,” Thomas R. Robinson, Jan Hendrik van Greuning, Karen O’Connor
Rubsam, Elaine Henry, and Michael A. Broihahn
Sections 3.2, 4.2
Question
13 of 40

Compared with using the FIFO (first in, first out) method to account for inventory, during a period of rising
prices, which of the following is most likely higher for a company using LIFO (last in, first out)?
Inventory turnover

Gross margin

Current ratio

Question not answered

During a period of rising prices, ending inventory under LIFO will be lower than that of FIFO and cost of
goods sold higher; therefore, inventory turnover (Cost of goods sold/Average inventory) will be higher.

CFA Level I
"Inventories,” Michael A. Broihahn
Sections 3.2, 3.4, 3.5, 3.7
Question
14 of 40
The following data are available on a company:
Metric $ thousands
Interest expense and payments 1,000
Income tax expense 1,100
Net income 3,400
Lease payments 500
The company’s fixed charge coverage ratio is closest to:
3.67.

2.27.

4.00.

Question not answered

First, earnings before interest and taxes (EBIT) must be calculated, then the fixed charge coverage ratio.

EBIT = Net income + Interest expense + Income tax expense 3,400 + 1,000 + 1,100 = 5,500

Fixed charge coverage ratio = EBIT + Lease payments 5,500 + 500 = 6,000
Interest payments + Lease payments 1,000 + 500 = 1,500
 Fixed charge coverage ratio 4.00

CFA Level I
“Financial Analysis Techniques,” Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Section 4.4.1

“Non-Current (Long-term) Liabilities,” Elizabeth A. Gordon and Elaine Henry

Section 5
Question
15 of 40
An entry made to record an accrual, such as bad debt expense, that is not yet reflected in the accounting
system is best described as a(n):
adjusting entry.

trial balance entry.

ledger entry.

Question not answered

Adjusting entries are a type of journal entries typically made at the end of the accounting period to record
such items as accruals that are not yet reflected in the accounting system.

CFA Level I
“Financial Reporting Mechanics,” by Thomas R. Robinson, Jan Hendrik van Greuning, Karen O'Connor
Rubsam, Elaine Henry, and Michael A. Broihahn
Section 5.1

Question
16 of 40

Private contracts, such as bank loan agreements, are most likely to provide an effective disciplinary
mechanism to insure high financial reporting quality because:
loan covenants may allow the lender to recover all or part of their investment if certain financial
conditions are triggered.
loan covenants require the firm to meet specific financial ratios in order to renew the loan.

lenders monitor managers and pay close attention to the firm's financial reports.

Question not answered

The monitoring role of lenders is most likely to insure high-quality financial reports because the lenders
inspect financial reports carefully to be sure they are not manipulated.

CFA Level I
“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling
Section 3.3.3
Question
17 of 40
Non-operating items reported on the income statement:
 include interest expense and interest revenue for non-financial service firms.

are shown as either financing or investing items on the cash flow statement.

are required to be reported as separate entries.

Question not answered

Non-financial service companies disclose interest received, dividends or profits from the sale of securities
held as investments as non-operating items. Interest expense is also disclosed as a non-operating item.

CFA Level I
"Understanding Income Statements," Elaine Henry, and Thomas R. Robinson
Section 5.5

Question
18 of 40

At the start of the year, a company's capital contributed by owners and retained earnings accounts had
balances of $10,000 and $6,000, respectively. During the year, the following events took place:
Net income earned $4,000
Interest paid on debt $500
Repayment of long-term debt $1,000
Proceeds from shares issued $1,000
Dividends paid $600
The end-of-year owners' equity is closest to:
$19,400.

$20,400.

$19,900.

Question not answered

Start-of-year capital contributed by owners $10,000

Additional shares issued 1,000

Initial retained earnings 6,000

Net income $4,000

Less dividends paid (600)

Increase in retained earnings 3,400 $3,400

Ending owners’ equity $20,400

CFA Level I
“Financial Reporting Mechanics,” Thomas R. Robinson, Jan Hendrik van Greuning, Karen O’Connor
Rubsam, Elaine Henry, and Michael A. Broihahn
Section 3.2
Question
19 of 40

The following financial information is available at the end of the year.

Share Information
Security Authorized Issued and Other Features
Outstanding
Common stock 500,000 250,000 Currently pays a dividend of
$1 per share.
Preferred stock, Series A 50,000 12,000 Nonconvertible, cumulative;
pays a dividend of $4 per
share.
Preferred stock, Series B 50,000 30,000 Convertible; pays a dividend
of $7.50 per share. Each
share is convertible into 2.5
common shares.
Additional information:
Reported income for the year $1,000,000

The diluted EPS (earnings per share) is closest to:

$2.93.

$3.08.

$2.91.

Question not answered

The convertible preferred shares are anti-dilutive, as shown in the following table. Therefore, the diluted
EPS is the same as the basic EPS, $2.91.

Basic EPS Diluted EPS

(using if-converted
method)
Net income $1,000,000 $1,000,000

Preferred stock, (48,000) (48,000) 12,000 shares × $4/share

Series A
Preferred stock, (225,000) 0 30,000 shares × $7.50/share
Series B
Earnings available $727,000 $952,000
to common
shareholders

Weighted Average Number of Common Shares (WACS)

Shares outstanding 250,000 250,000

If converted ______ 75,000 2.5 common/preferred ×

30,000 preferred
WACS 250,000 325,000

EPS = Earnings
available to common $2.91 $2.93*
shareholders/WACS
 * Exceeds Basic EPS; Series B is anti-dilutive and is thus not included.

CFA Level I
"Understanding Income Statements,” Elaine Henry and Thomas R. Robinson
Sections 6.2, 6.3
Question
20 of 40

A company operating in a highly fragmented and competitive industry reported an increase in return on
equity (ROE) over the prior year. Which of the following reasons for the increase in ROE is least likely to
be sustainable? The company:
implemented a new IT system, allowing it to reduce working capital levels as a percentage of
assets.
increased the prices of its product significantly.

decided to make greater use of long-term borrowing capacity.

Question not answered

An increase in price is not sustainable in a fragmented and competitive industry. Fragmented industries
tend to be highly price competitive because of the need to increase market share and undercut prices in
an attempt to steal share.
CFA Level I
“Financial Analysis Techniques,” Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Section 4.6.2

“Introduction to Industry and Company Analysis,” Patrick W. Dorsey, Anthony M. Fiore, and Ian Rossa
O’Reilly
Section 5.1.2
Question
21 of 40

Interest payable decreased during a company's fiscal year. Compared with the amount of cash interest
payments made, interest expense is most likely:
lower.

the same.

higher.

Question not answered

If the interest payable decreases during the year, then the interest expense on an accrual basis will be
lower than the amount of cash interest payments. The cash paid would be the full amount of the expense
plus the amounts paid to reduce the interest payable. For example,

Interest expense 100

Plus decrease in interest payable +12
Cash paid for interest 112
CFA Level I
“Understanding Cash Flow Statements,” Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning,
and Michael A. Broihahn
Section 3.2.1.5
Question
22 of 40
During the process data phase of financial statement analysis, an analyst will most likely develop a:
statement of cash flows.

statement of purpose.

common-size balance sheet.

Question not answered

During the process data phase, an analyst will produce a variety of reports and documents based on the
information collected. These may include common-size statements, ratios and graphs, forecasts, adjusted
statements, and analytical results.

CFA Level I
“Financial Statement Analysis: An Introduction,” by Elaine Henry and Thomas R. Robinson
Section 4

Question
23 of 40

Which of the following statements about the direct method for presenting cash from operating activities
is most appropriate? The direct method:
provides information on the specific sources of operating cash receipts and payments.

shows the impact of accruals.

shows the reasons for differences between net income and operating cash flows.

Question not answered

The direct method provides information on the specific sources of operating cash receipts and payments.
This approach is in contrast to the indirect method, which reconciles net income to cash flow and shows
only the net result of these receipts and payments.

CFA Level I
"Understanding Cash Flow Statements,"Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning,
and Michael A. Broihahn
Section 2.3

Question
24 of 40

The following selected data are available for a firm:

$ millions
Net income 90.0
Non-cash charges 15.2
Interest expense 28.0
 Capital expenditures 34.3
Working capital expenditures 13.0
If the firm's tax rate is 40%, the free cash flow to the firm (FCFF) is closest to:
87.7.

57.9.

74.7.

Question not answered

FCFF = NI + NCC + Int(1 – t) – FCInv – WCInv
$ millions
Net income (NI) 90
+ Non-cash charges (NCC) 15.2
+ Interest expense × (1 – Tax rate) 28 × (1 – 0.4) = 16.8
– Capital expenditures (FCInv) –34.3
– Working capital expenditures –13.0
(WCInv)
FCFF 74.7

CFA Level I
“Understanding Cash Flow Statements,” Elaine Henry, Thomas R. Robinson, Jan Hendrik van Greuning,
and Michael A. Broihahn
Section 4.3
Question
25 of 40
A company pays its workers on the 1st and the 15th of each month. Employee wages earned from the
15th to the 30th of September are best described as a(n):
prepaid expense.

unearned expense.

accrued expense.

Question not answered

Wage expenses that have been incurred but not yet paid are an example of an accrued expense: a
liability that has not yet resulted in a cash payment.

CFA Level I
“Financial Reporting Mechanics,” by Thomas R. Robinson, Jan Hendrik van Greuning, Karen O'Connor
Rubsam, Elaine Henry, and Michael A. Broihahn
Section 5.1

Question
26 of 40

An analyst has calculated the following ratios for a company:

Operating profit margin 17.5%

Net profit margin 11.7%
 Total asset turnover 0.89 times
Return on assets (ROA) 10.4%
Financial leverage 1.46
Debt to equity 0.46
The company's return on equity (ROE) is closest to:
22.7%.

15.2%.

4.8%.

Question not answered

Using DuPont analysis, there are two ways to calculate ROE from the information provided:

ROE = Net profit margin × Asset turnover × Financial leverage 11.7 × 0.89 × 1.46 15.2%
ROE = ROA × Financial leverage 10.4 × 1.46 15.2%

CFA Level I
“Financial Analysis Techniques,” Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Section 4.6.2
Question
27 of 40
Which of the following is most likely a sign of inventory manipulation to improve reported financial results?
Selective sales of older layers of inventory.

Inventory markdowns for obsolescence.

Declining inventory turnover ratio.

Question not answered

A company can intentionally sell older, lower-cost layers of inventory to generate earnings without
supporting cash flow, in order to produce specific earnings benefits.

CFA Level I

“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling

Sections 4.2.3, 4.3

Question
28 of 40
An equity manager conducted a stock screen on 5,000 US stocks that comprise her investment universe.
The results of the screen are presented in the table below.

Criterion Percent of Stocks

Meeting Criterion
Price per share/Sales per share < 1.25 35.0
Total asset/Equity ≤ 2.5 48.2
Dividends > 0 58.6
Consensus forecast earnings per share > 75.0
0
 Meeting all four criteria simultaneously 10.8

If all the criteria are independent of each other, the number of stocks meeting all four criteria would
be closest to:
371.

540.

293.

Question not answered

If the criteria are independent of one another, the probability that all will occur is the product of the
individual probabilities (multiplication rule for independent events)—that is, 0.35 × 0.482 × 0.586 × 0.75 =
0.074, or 7.4%, which would produce 7.4% × 5,000 = 371 meeting the criteria.

CFA Level I
“Probability Concepts,” Richard A. DeFusco, Dennis W. McLeavey, Jerald E. Pinto, and David E. Runkle
Section 2

“Financial Statement Analysis: Applications,” Thomas R. Robinson, Jan Hendrik van Greuning, Elaine
Henry, and Michael A. Broihahn
Section 5
Question
29 of 40
The following data are available for a company’s first year of operations:
Metric £
thousands
Earnings before tax reported on the income statement 2,640
Depreciation expense included in earnings before tax 4,500
Accounting expenses that are not deductible for tax purposes 2,130
Depreciation expense deductible for tax purposes in first year of operations 6,340
Corporate tax rate 25%
The company’s end-of-year balance sheet will most likely include (in thousands) a deferred tax:
liability of £733.

asset of £73.

liability of £460.

Question not answered

Deferred tax balances result from temporary differences between a company’s income as reported for tax
purposes and income reported for financial statement purposes. The temporary difference in this case
arises from the difference between the depreciation for accounting purposes and the depreciation for tax
purposes. Because of this difference, the company would report more income tax expense than would
actually be paid in taxes. The difference is a deferred tax liability.
 Temporary difference balance (in thousands) = Depreciation £6,340 – £4,500 £1,840
expense for accounting purposes – Depreciation for tax
purposes
Deferred tax balance (in thousands) =
Temporary difference balance × Corporate tax rate £1,840 × 25% £460

CFA Level I
“Understanding Balance Sheets,” Elaine Henry and Thomas R. Robinson
Section 5.2

“Income Taxes,” Elbie Antonites and Michael A. Broihahn

Sections 2.2, 4
Question
30 of 40
A U.S. company that complies with U.S. GAAP would like to exclude some items in determining non-
GAAP financial measures, other than EBIT and EBITDA. Which of the following items may be excluded?
For performance measures, items tagged as infrequent that occurred within the past two years

Impairment charges for long-lived assets

For liquidity measures, litigation costs requiring cash settlement

Question not answered

To assist investors in evaluating operating performance, companies often report non-GAAP earnings by
excluding asset impairment charges either for long-lived assets, goodwill or other intangible assets.

CFA Level I

“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling

Section 4.1

Question
31 of 40
A company with a tax rate of 40% sold a capital asset with a net book value of $500,000 for $570,000
during the year. Which of the following amounts related to the asset sale will most likely be reported as a
line item on its income statement for the year?
$42,000

$570,000

$70,000

Question not answered

The disposition of a capital asset is reported as a net gain or loss ($570,000 – $500,000 = $70,000) on
the income statement before tax effects.

CFA Level 1
"Understanding Income Statements," by Elaine Henry and Thomas R. Robinson
Section 5.3
"Understanding Cash Flow Statements," by Elaine Henry, Thomas R. Robinson, Jan Hendrik van
Greuning and Michael A. Broihahn
Section 3.2.2

"Long-Lived Assets," by Elaine Henry and Elizabeth Gordon

Section 6.1

Question
32 of 40

If a company wanted to reduce its net income by overstating expenses, it would most likely do so by:
creating an unnecessary provision for the expense.

understating the value of trade payables.

overstating the value of its land.

Question not answered

If a company wants to reduce net income, it could overstate expenses. It would most likely do so by
overestimating an expense, such as a warranty expense or bad debt expense. The creation of the
expense would require an accrual, such as warranty liability or allowance for doubtful accounts. Thus,
overstating the expense would result in the overstatement or creation of an unnecessary provision.
Overstating the value of land would normally decrease an expense (by capitalizing some amount that
should have been expensed). Understating trade payables would understate the related expense or
inventory amount.

CFA Level I

"Financial Reporting Mechanics," Thomas R. Robinson, Jan Hendrik van Greuning, Karen O'Connor
Rubsam, Elaine Henry, and Michael A. Broihahn

Section 7.1

Question
33 of 40
A company sells a product with a three-year warranty included in the price. According to IFRS, which of
the following is the most appropriate accounting treatment for the warranty?
Fully recognizing the revenue and estimated warranty expense at the time of the sale and updating
the expense as indicated by experience over the life of the warranty.
Deferring all of the revenue and recognizing it over the life of the warranty period.

Fully recognizing the revenue at the time of the sale but waiting until the actual warranty costs are
incurred to recognize the expense.

Question not answered

Under the matching principle, a company is required to estimate the amount of future expenses resulting
from its warranties, and to update the expense as indicated by experience over the life of the warranty.
Waiting until actual costs are incurred will not match the expense with the associated revenue.
CFA Level I
“Understanding Income Statements,” by Elaine Henry and Thomas R. Robinson
Section 4.2.2

Question
34 of 40

A credit analyst is most likely to place more focus on:

operating leverage than financial leverage.

upside potential than downside risk.

cash flows than accrual income.

Question not answered

Credit analysts are particularly focused on assessing debt-paying ability, which is generated from cash
flows and not from accrual-based measures, such as net income. The return to debtholders is limited by
contract, so upside potential is less important than concern for loss.

Financial leverage is a major concern for credit analysts because it is associated with a greater chance of
default. Operating leverage, which measures the volatility of operating income as a result of fixed costs, is
a lesser concern.

CFA Level I

"Financial Statement Analysis: Applications," Thomas R. Robinson, Jan Hendrik van Greuning, Elaine
Henry, and Michael A. Broihahn

Section 4

Question
35 of 40

A company entered into a three-year construction project with a total contract price of $10.6 million and
an expected total cost of $8.8 million. The following table provides cash flow information relating to the
contract:
($ millions) Year 1 Year 2 Year 3 Total
Costs incurred and paid $1.2 $6.0 $1.6 $8.8
Amounts billed and payments received $2.4 $5.6 $2.6 $10.6
If the company uses the percentage-of-completion method, the amount of revenue recognized (in
millions) in Year 2 is closest to:
$3.5.

$7.2.

$5.6.

Question not answered

The portion of revenue recognized in Year 2 is equal to the total portion of the costs completed by the end
of the year, minus any revenue recognized in Year 1.
 ($ millions)
Total costs to end of Year 2 $1.2 + $6.0 = $7.2
Total costs of the project $8.8
Percentage of revenue to be recognized by the end of Year 2 81.81%
Percentage of costs (and revenue) recognized in Year 1 $1.2/$8.8 = 13.63%
Portion of revenue to be recognized in Year 2 68.18%
Revenue recognized in Year 2 68.18% × $10.6 = $7.2

Alternatively:
The revenue reported is equal to the percentage of the contract that is completed in that
period, in which percentage completion is based on costs.
In Year 2: ($6.0/$8.8) × $10.6 = $7.2.

CFA Level I
“Understanding Income Statements,” Elaine Henry and Thomas R. Robinson
Section 3.2.1

Question
36 of 40
The following financial statement data are available for a company:

Metric Current Year Prior Year (£

(£ thousands) thousands)
Total debt 1,600 1,600
Total assets 4,800 5,200
Total liabilities 2,700 3,200

The company’s financial leverage ratio for the current year is closest to:
3.12.

2.44.

0.32.

Question not answered

Financial leverage ratio = Average total assets/Average shareholders’ equity.

Metric Calculation
(£ thousands) £ thousands
Average total assets (4,800 + 5,200) × ½ 5,000
Shareholders’ equity (Total assets – Total liabilities)
 At start 5,200 – 3,200 2,000
 At end 4,800 – 2,700 2,100

Average shareholders’ equity (2,000 + 2,100) × ½ 2,050

Financial leverage ratio =
2.44
Average total assets/Average shareholders’ equity 5,000/2,050
CFA Level I
“Financial Analysis Techniques,” Elaine Henry, Thomas R. Robinson, and Jan Hendrik van Greuning
Section 4.4

“Non-current (Long-term) Liabilities,” Elizabeth A. Gordon and Elaine Henry

Section 5
Question
37 of 40

A portion of a company's balance sheet appears in the following table (euros in millions):
Cash 4,000
Marketable securities 17,000
Accounts receivable 225,000
Inventory 229,000
Total current assets 475,000
Current liabilities 339,000

The company’s quick ratio is closest to:

0.06.

1.40.

0.73.

Incorrect.
The quick ratio is

CFA Level I
“Understanding Balance Sheets,” by Elaine Henry and Thomas R. Robinson
Section 7.2

Question
38 of 40

Common-size financial statements are most likely a component of which step in the financial analysis
framework?
Collect data

Analyze/interpret data

Process data

Question not answered

Preparing common-size financial statements is part of the process data step.

CFA Level I
"Financial Statement Analysis: An Introduction," Elaine Henry and Thomas R. Robinson
Sections 4.2–4.4

Question
39 of 40
A company issued a $50,000 seven-year bond for $47,565. The bonds pay 9% per annum, and the yield
to maturity at issue was 10%. The company uses the effective interest rate method to amortize any
discounts or premiums on bonds. After the first year, the yield to maturity on bonds equivalent in risk and
maturity to these bonds is 9%. The amount of the bond discount amortization recorded in the first year
is closest to:
$257.

$0.

$348.

Question not answered

Interest paid = Coupon rate at issue × Issued amount of bonds = 9% × $50,000 = 4,500

Interest expense = Market rate at issue × Carrying (book value) of bonds

Amortization of discount = Interest expense – Interest paid

Interest Interest Amortization Carrying

Expense
Year Paid (9%) of Discount Value
(10%)
0 47,565
1 4,500 4,757 257 47,822
Amortization of the bond discount in the first year is $257.

CFA Level I
"Non-Current (Long-Term) Liabilities," by Elizabeth A. Gordon and Elaine Henry
Section 2.2

Question
40 of 40
Which of the following accounting actions would increase stockholders’ equity in the current period?
Using LIFO rather than FIFO accounting for inventory in an inflationary environment.

Capitalizing, rather than expensing, a payment.

Increasing the allowance for uncollectible accounts receivable.

Question not answered

The capitalization of payments is an example of how choices affect both the balance sheet and income
statement. Capitalizing a payment changes the benefit from only the current period—making it an
expense—to a benefit in future periods as an asset. The creation of an asset results in a comparable
increase in stockholder’s equity.

CFA Level I

“Financial Reporting Quality,” Jack Ciesielski, Elaine Henry, and Thomas I. Selling

Section 4.2.1