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Final Exam Review With Answers
Final Exam Review With Answers
Final Exam Review With Answers
1. An analyst screening potential equity investments to identify value stocks is most likely to
exclude companies with:
A) high price-to-earnings ratios.
B) low earnings growth rates.
C) high dividend payout ratios.
The correct answer was A
Value stocks are considered to be those that have low prices relative to earnings (or relative to
sales, cash flow, or book value). Screens that exclude firms with low earnings growth rates or
high dividend payout ratios are more likely to be used to identify growth stocks.
2. Junior analyst Xander Marshall sends an e-mail to his boss, Janet Jacobs, CFA,
suggesting that Peterson Novelties is manipulating its results to artificially inflate profits.
He cites four reasons for his conclusion:
Earnings are much higher in the September quarter than in other quarters.
Much of Peterson’s earnings come from equity investments not reflected on the cash-
flow statement.
Jacobs is less concerned about Peterson’s earnings than Marshall is, though she does resolve to
check out one of his concerns. Which of Marshall’s observations best supports his conclusion?
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On its own, a declining LIFO reserve is not a sign of fraud. Peterson Novelties could have
simply moved a lot of inventory and disclosed the LIFO liquidation in its footnotes. When
unusual gains are recorded as revenue they will artificially boost sales growth. Each of the above
issues are potential danger signs, but can also be easily explained in a manner beyond reproach.
However, earnings from equity investments that do not generate cash flow are of very low
quality and warrant further examination.
3. Jacobs is less concerned about Peterson’s earnings than Marshall is, though she does
resolve to check out one of his concerns. Which of Marshall’s observations best supports
his conclusion?
On its own, a declining LIFO reserve is not a sign of fraud. Peterson Novelties could have
simply moved a lot of inventory and disclosed the LIFO liquidation in its footnotes. When
unusual gains are recorded as revenue they will artificially boost sales growth. Each of the above
issues are potential danger signs, but can also be easily explained in a manner beyond reproach.
However, earnings from equity investments that do not generate cash flow are of very low
quality and warrant further examination.
4. To adjust for operating leases before calculating financial statement ratios, what value
should an analyst add to a firm’s liabilities?
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stable or growing firm. Equity is greater because depreciation expense is less with straight-line
depreciation. Greater equity will result in greater book value per common share, the denominator
of the price-to-book ratio. Greater book value per share will result in a lower price-to-book ratio.
7. Frank Brill, CFA, is concerned that Moses Aviation is overstating its profits. The best
indicator of such action would be Moses Aviation’s:
While an unusually high sales-growth rate may indicate fraud, it could also indicate good
management. It’s a yellow flag, but not the best indicator of accounting shenanigans. Rising
inventory is also a dual signal. It could be meant to overstate profits, or it could simply reflect an
actual buildup of inventory in response to market forces or corporate operations. However,
companies should not recognize revenue from barter transactions. The additional revenue is
likely to improperly boost profits.
Statement
The cash effects of decreasing accounts payable turnover are unlimited.
#1:
Statement The tax benefits from employee stock options can result in a significant source of
#2: investing cash flow.
Statement #1 Statement #2
A) Correct Incorrect
B) Incorrect Incorrect
C) Incorrect Correct
The correct answer was B)
Incorrect Incorrect
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Statement #1 is an incorrect statement. The cash effects of decreasing accounts payable turnover
are limited. Suppliers will eventually stop extending credit because of delayed payments.
Statement #2 is an incorrect statement. The tax benefits from employee stock options can result
in a significant source of operating and financing cash flows. Tax benefits do not affect investing
cash flows
9. Patch Grove Nursery uses the LIFO inventory accounting method. Maria Huff, president,
wants to determine the financial statement impact of changing to the FIFO accounting
method. Selected company information follows:
Under FIFO, the nursery’s ending inventory and after-tax profit for the year would have been:
FIFO ending inventory = LIFO ending inventory + LIFO reserve = 22,000 + 4,000 = $26,000
FIFO after-tax profit = LIFO after-tax profit + (change in LIFO reserve)(1 − t) = $2,000 +
($1,000)(1 − 0.4) = $2,000 + $600 = $2,600
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10. Samson Therapeutics records all leases as operating leases. The company most likely
wanted to reduce:
A) leverage.
B) expenses.
C) inventory.
The correct answer was A
Finance (capital) leases are recorded on the balance sheet, and by recording all leases as
operating leases, the company can reduce its leverage. Lease accounting has no effect on
inventory. "Expenses" is not the best answer as operating leases will result in higher expenses in
the later years relative to the finance (capital) lease.
11. At the end of 2007, Decatur Corporation reported last-in, first-out (LIFO) inventory of
$20 million, cost of goods sold (COGS) of $64 million, and inventory purchases of $58
million. If the LIFO reserve was $6 million at the end of 2006 and $16 million at the end
of 2007, compute first-in, first-out (FIFO) inventory at the end of 2007 and FIFO COGS
for the year ended 2007.
FIFO
FIFO COGS
Inventory
A) $36 million $54 million
B) $26 million $54 million
C) $36 million $74 million
The correct answer was A
2007 FIFO inventory was $36 million ($20 million LIFO inventory + $16 million reserve). 2007
FIFO COGS was $54 million ($64 million LIFO COGS – $10 million increase in LIFO reserve).
12. Earlier this year, Barracuda Company issued 5,000 employee stock options. Recently,
2,000 options were exercised at a price of $10 per share. To avoid dilution, Barracuda
purchased 2,000 shares at an average price of $12 per share. Barracuda reported both
transactions as financing activities in its cash flow statement. For analytical purposes,
what adjustment is necessary to better reflect the substance of the stock repurchase?
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Operating cash Financing cash
flow flow
A) Decrease $4,000 No adjustment
Increase
B) Decrease $4,000
$4,000
Increase
C) No adjustment
$4,000
The correct answer was B)
Increase
Decrease $4,000
$4,000
Barracuda reported a $4,000 net outflow from financing activities [2,000 options × ($12 average
market price – $10 exercise price)]. However, since the options are a form of compensation, the
$4,000 outflow should be reclassified as an operating activity for analytical purposes. This is
accomplished by increasing financing cash flow $4,000 and decreasing operating cash flow
$4,000.
13. Joan Zeller, CFA, suspects Cornwall Carpets is overstating its profits. Which of the
following is least likely to motivate Cornwall to overreport?
A) expense all costs of this project until technological feasibility has been established.
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B) expense all costs of this project in the periods incurred.
C) capitalize all costs of this project.
The correct answer was A
Under IFRS and U.S. GAAP, costs of developing software are expensed until technological
feasibility is established, and capitalized after technological feasibility has been established.
15. A firm acquires investment property for €3 million and chooses the fair value model for
financial reporting. In Year 1 the market value of the investment property decreases by
€150,000. In Year 2 the market value of the investment property increases by €200,000.
On its financial statements for Year 2, the firm will recognize a:
A) $1,600.
B) $4,800.
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C) $5,200.
The correct answer was B) $4,800.
An asset is impaired if its future cash flows (undiscounted) are less than its carrying value.
18. If a company has a net profit margin of 15%, an asset turnover ratio of 4.5 and a ROE of
18%, what is the equity multiplier?
A) 0.267.
B) 2.667.
C) 0.523.
The correct answer was A
There are many different ways to illustrate ROE one of which is:
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19. At the beginning of 20X7, Bryan’s Bakery Company purchased a secret cookie recipe for
$25,000. In addition, Bryan developed a new cake recipe at a cost of $5,000. Bryan
expects to use both recipes indefinitely; however, the useful (economic) life of similar
recipes has been 10 years. Assuming straight-line amortization, what amount of recipe
expense should Bryan report for the year ended 20X7 and what amount should Bryan
report as assets related to these recipes on its balance sheet at the end of 20X7?
When computing for earnings per share (EPS) computation purposes, what was Juniper’s weighted
average number of shares outstanding during 20X4?
A) 735,000.
B) 930,000.
C) 870,000.
The correct answer was A
The January 1 balance is adjusted retroactively for the stock dividend and (540,000 × 1.5) =
810,000 shares are treated as outstanding from January 1. The weighted average number of
shares is computed by multiplying the shares by the number of months held, as follows:
22. Determine the cash flow from operations given the following table.
Item Amount
Cash payment of dividends $30
Sale of equipment $25
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Net income $25
Purchase of land $15
Increase in accounts payable $20
Sale of preferred stock $25
Increase in deferred taxes $5
Profit on sale of equipment $15
A) $20.
B) $35.
C) $45.
The correct answer was B) $35.
Using the indirect method, CFO = Net income 25 + increase in accounts payable 20 + increase in
deferred taxes 5 − profit on sale of equipment 15 = $35.
Increases in accounts payable and deferred taxes are sources of operating cash that are not
included in net income and must be added. Profit on sale of equipment is a CFI item that must be
removed from net income.
No adjustment needs to be made for cash payment of dividends (CFF), sale of preferred stock
(CFF), or purchase of land (CFI) because they are not included in net income. Only the profit on
sale of equipment, not the full proceeds from sale, is included in net income.
1,000 shares of 10%, $100 par preferred stock each convertible into 8 shares of common
were outstanding the whole year.
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What is the company’s diluted earnings per share (EPS)?
A) $2.50.
B) $1.00.
C) $1.15.
The correct answer was B) $1.00.
1/1 5,500 shares issued (includes 10% stock dividend on 6/1) × 12 = 66,000
= 60,000
Number of shares from the conversion of the preferred shares = (1,000 preferred shares)(8 × 1.1
shares of common/share of preferred) = 8,800 common
This number needs to be compared to basic EPS to see if the preferred shares are antidilutive.
Since the EPS after the conversion of the preferred shares is greater than before the conversion
the preferred shares are antidilutive and they should not be treated as common in computing
diluted EPS. Therefore diluted EPS is the same as basic EPS or $1/share.
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24. A firm has a weighted average number of 25,000 common shares selling at an average of
$11 throughout the year and 10,000, 6%, $100 par value preferred shares. If the firm earns
$210,000 after taxes, what is its Basic EPS?
A) $7.50 / share.
B) $5.00 / share.
C) $6.00 / share.
The correct answer was C) $6.00 / share.
(210,000 − 60,000) / 25,000 = $6 share
25. Based on the following data, how many shares of common stock should be used to
calculate diluted earnings per share?
10,000, 6% convertible bonds with each bond convertible into 20 shares of common
stock were issued at par ($100) on June 30th of this year.
The firm has 100,000 warrants outstanding all year with an exercise price of $25 per
share.
The average stock price for the period is $20, and the ending stock price is $30.
A) 1,266,667.
B) 1,000,000.
C) 1,100,000.
The correct answer was C) 1,100,000.
Warrants: anti-dilutive since the average stock price is less than the exercise price
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Convertible bonds: numerator impact = (# bonds) × (par value) × (interest rate) × (tax retention
rate) × (0.5 for 1/2 year outstanding) = (10,000) × (100) × (0.06) × (0.6) × (0.5) = 18,000, so the
numerator = 1,518,000 Denominator impact: increase in average shares = [(# bonds) ×
(conversion factor) × (# months outstanding)] / 12 = (1,200,000 / 12 = 100,000) so, the
denominator = 1,100,000 and EPS with conversion = 1,518,000 / 1,100,000 = 1.38, which is less
than 1.50. The bonds are dilutive and the diluted EPS calculation should use 1,100,000 shares of
common stock in the denominator. The warrants are out of the money based on the average price
of $20.
26. Wichita Corporation reported the following balances as of December 31, 2007:
Cash $?
Accounts payable 16,000
Accounts receivable 56,000
Additional paid-in capital 42,000
Common stock 19,600
Inventory 12,000
Plant and equipment 26,800
Notes payable 20,000
Retained earnings 30,000
Calculate Wichita’s cash and total assets as of December 31, 2007 based only on these entries.
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Liabilities plus equity are equal to $127,600 ($16,000 accounts payable + $20,000 notes payable
+ $19,600 common stock + $42,000 additional paid-in capital + $30,000 retained earnings).
Since assets must equal liabilities plus equity, cash must equal $32,800 ($129,600 total assets –
$56,000 accounts receivable – $12,000 inventory – $26,800 plant and equipment).
A) provide reasonable assurance that the financial statements contain no material errors.
B) provide an "unqualified" opinion if material uncertainties exist.
C) provide reasonable assurance that management is reliable.
The correct answer was A
1. The financial statements are prepared by management and are their responsibility and the
auditor has performed an independent review.
2. The audit was conducted using generally accepted auditing standards, which provides
reasonable assurance that there are no material errors in the financial statements.
3. The auditor is satisfied the statements were prepared in accordance with accepted
accounting principles, and the principles chosen and estimates are reasonable.
Under U.S. GAAP, the auditor is required to state an opinion on the company's internal controls.
The auditor may add this opinion as a fourth element of the auditor's report or provide it
separately.
28. The following amounts were drawn from the records of JME Company: total assets =
$1,800; total liabilities = $750; contributed capital = $600. Based on this information
alone, retained earnings must be equal to:
A) −$150.
B) $150.
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C) $450.
The correct answer was C
(1,800 − 750 − 600) = −150
29. Allowance for bad debts and investment in affiliates are most likely to be shown as what
types of accounts?
30. Which of the following is the least likely to be considered an accrual for accounting
purposes?
A) Wages payable.
B) Accumulated depreciation.
C) Unearned revenue.
The correct answer was B) Accumulated depreciation.
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Accumulated depreciation is considered a contra-asset account to property, plant and equipment,
not an accrual.
31. In January 2014, Finley Corporation, a newly formed company, issued 10,000 shares of
its $10 par common stock for $15 per share. On July 1, 2014, Finley Corporation
reacquired 1,000 shares of its outstanding stock for $12 per share. The acquisition of
these treasury shares
a. decreased total stockholders' equity.
b. increased total stockholders' equity.
c. did not change total stockholders' equity.
d. decreased the number of issued shares.
32. Kraft, Inc. sponsors a defined-benefit pension plan. The following data relates to the
operation of the plan for the year 2015.
The expected return on plan assets and the settlement rate were both 10%. The amount of
pension expense reported for 2015 is
a. $230,000.
b. $290,000.
c. $310,000.
d. $470,000.
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a. straight-line basis over the expected future years of service.
b. years-of-service method or on a straight-line basis over the average remaining
service life of active employees.
c. straight-line basis over 15 years.
d. straight-line basis over the average remaining service life of active employees or 15
years, whichever is longer.
34. A company that uses the LIFO inventory cost method records the following purchases and
sales for an accounting period:
The company’s cost of goods sold using a perpetual inventory system is:
A) $3,780.
B) $3,500.
C) $3,760.
Your answer: A was incorrect. The correct answer was C) $3,760.
With a perpetual inventory system, units purchased and sold are recorded in inventory in the
order that the purchases and sales occur. Cost of goods sold for the July 12 sale uses 4 of the
units purchased on July 8: 4 × ($2,600 / 5) = $2,080. Cost of goods sold for the July 21 sale uses
3 of the units purchased on July 15: 3 × ($2,800 / 5) = $1,680. COGS = $2,080 + $1,680 =
$3,760.
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35. The present value of benefits earned during the current period by participants in a defined
benefit pension plan is best described as the plan's:
A) service cost.
B) past service cost.
C) net pension liability.
Your answer: A was correct!
Service cost refers to the benefits earned in the current period by a defined benefit plan's
participants. Past service costs are benefits awarded retroactively when a plan is initiated or
changed. Net pension liability or net pension asset is the difference between the fair value of a
defined benefit plan's assets and the firm's estimated obligation to pay benefits.
36. Which of the following ratio levels would suggest that a company is holding obsolete
inventory?
37. Mammoth, Inc. reports under U.S. GAAP. Mammoth has begun a long-term project to
develop inventory control software. On its financial statements, Mammoth should:
What is the inventory value at the end of the period using LIFO?
A) $1,575.
B) $1,225.
C) $3,450.
Your answer: A was incorrect. The correct answer was B) $1,225.
39. A firm is most likely to lease an asset rather than purchasing it if the asset:
41. Which of the following statements regarding deferred taxes is NOT correct?
If deferred tax liabilities are not included in equity, debt-to-equity ratio will be
A)
reduced.
Only those components of deferred tax liabilities that are likely to reverse should be
B)
considered a liability.
If deferred taxes are not expected to reverse in the future then they should be classified
C)
as equity.
Your answer: A was correct!
When deferred tax liabilities are included in equity, it will reduce the debt-to-equity ratio (by
increasing the denominator), in some cases considerably.
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42. What is Oregon’s weighted average number of shares outstanding?
A) 167,500.
B) 197,500.
C) 250,000.
Your answer: A was incorrect. The correct answer was B) 197,500.
The January 1 balance is adjusted retroactively for the reverse stock split and 320,000 / 2 =
160,000 shares are treated as outstanding from January 1. Issuance of stock is included from the
date of issuance. The weighted average shares are computed by multiplying the share amounts
by the number of months the shares were outstanding, then adding these amounts and dividing
the sum by 12.
43. Summit Co. has provided the following information for its most recent reporting period:
Sales $ 5,000,000
EBIT $ 800,000
Taxes $ 256,000
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Equity $ 1,700,000 $ 2,000,000 $ 1,850,000
44. Lightfoot Shoe Company reported sales of $100 million for the year ended 20X7.
Lightfoot expects sales to increase 10% in 20X8. Cost of goods sold is expected to remain
constant at 40% of sales and Lightfoot would like to have an average of 73 days of
inventory on hand in 20X8. Forecast Lightfoot’s average inventory for 20X8 assuming a
365 day year.
A) $8.8 million.
B) $8.0 million.
C) $22.0 million.
Your answer: A was correct!
20X8 sales are expected to be $110 million [$100 million × 1.1] and COGS is expected to be $44
million [$110 million sales × 40%]. With 73 days of inventory on hand, average inventory is
$8.8 million [($44 million COGS / 365) × 73 days].
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45. Financial information for Jefferson Corp. for the year ended December 31st, was as
follows:
Sales $3,000,000
Purchases 1,800,000
Inventory at Beginning 500,000
Inventory at Ending 800,000
Accounts Receivable at Beginning 300,000
Accounts Receivable at Ending 200,000
Accounts Payable at Beginning 100,000
Accounts Payable at Ending 100,000
Other Operating Expenses Paid 400,000
Based upon this data and using the direct method, what was Jefferson Corp.’s cash flow
from operations (CFO) for the year ended December 31st?
A) $1,200,000.
B) $900,000.
C) $800,000.
Your answer: A was incorrect. The correct answer was B) $900,000.
Note that no adjustment for inventories is necessary because purchases are given. From the
inventory equation, P = COGS + EI - BI.
46. The Management Discussion and Analysis (MD&A) portion of the financial disclosure is
least likely required to discuss:
Assets Liabilities
A) Increase No effect
B) Increase Increase
C) No effect Increase
The correct answer was A
When a firm recognizes revenue before cash is collected, equity increases (retained earnings) and
assets increase (accounts receivable). Liabilities would not be affected.
48. A video rental store with a large inventory of newly released movies is attempting to
determine an appropriate method of depreciation for its movies for rental. As well, it is
trying to determine an appropriate method of determining the cost of its inventory of
movies for sale. Which of the following treatments is most appropriate for the movies for
rental and movies for sale?
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The correct answer was C)
Accelerated
First-in, first-out
depreciation
With the movies for rental, a greater portion of the decrease in the value of newly released
movies would reasonably be realized in the first year, given the rapid rate of obsolescence in
view of the large number of movies available. Therefore, depreciating this pool of assets by a
greater amount in the first year using an accelerated depreciation method better approximates
economic depreciation than depreciating it straight line.
With the movies for sale, there are two methods available for accounting as inventory. FIFO is
appropriate for inventory that has a limited shelf life and LIFO is appropriate for inventory that
does not deteriorate with age. Because the movies have a very limited shelf life and will greatly
deteriorate in value with age, especially after the first year, FIFO is the most appropriate method
of accounting for the movies for sale.
49. Barton, Inc. received the following information from its pension plan trustee concerning
the operation of the company's defined-benefit pension plan for the year ended December
31, 2015.
The service cost component of pension expense for 2015 is $450,000 and the
amortization of prior service cost due to an increase in benefits is $60,000. The settlement
rate is 10% and the expected rate of return is 9%. What is the amount of pension expense
for 2015?
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A) $450,000
B) $612,000
C) $621,000
50. Rathke, Inc. has a defined-benefit pension plan covering its 50 employees. Rathke agrees
to amend its pension benefits. As a result, the projected benefit obligation increased by
$2,400,000. Rathke determined that all its employees are expected to receive benefits
under the plan over the next 5 years. In addition, 20% are expected to retire or quit each
year. Assuming that Rathke uses the years-of-service method of amortization for prior
service cost, the amount reported as amortization of prior service cost in year one after the
amendment is
a. $480,000.
b. $800,000.
c. $240,000.
[(5*6)/2]*(0.2*50) = 150
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