CFA2020L1QbanksAnswers financial reporting analysis

Study Session 6, Module 19.2, LOS 19.e Which of the following best describes nancial reporting and nancial statement analysis?. Study Session 6, Module 19.2, LOS 19.d Information about a

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Question #1 of 25 Question ID: 1204934Which of the following is an independent auditor least likely to do with respect to a company's nancial

statements?

A) Con rm assets and liabilities contained in them.

B) Prepare and accept responsibility for them.

C) Provide an opinion concerning their fairness and reliability.

Explanation

Auditors make an independent review of nancial statements, which are prepared by company

management and are management's responsibility It is the responsibility of auditors to con rm the

assets, liabilities, and other items included in the statements and then issue an opinion concerning their

fairness and reliability

(Study Session 6, Module 19.2, LOS 19.d)

Which of the following is an analyst least likely to rely on as objective information to include in a company

analysis?

A) Government agency statistical data on the economy and the company’s industry.

B) Corporate press releases.

C) Proxy statements.

Explanation

Corporate reports and press releases are written by management and are often viewed as public relations

or sales materials An analyst should review information on the economy and the company's industry and

compare the company to its competitors This information can be acquired from sources such as trade

journals, statistical reporting services, and government agencies Securities and Exchange Commission

(SEC) lings include Form 8-K, which a company must le to report events such as acquisitions and

disposals of major assets or changes in its management or corporate governance and proxy statements,

which are a good source of information about the election of (and quali cations of) board members,

compensation, management quali cations, and the issuance of stock options

(Study Session 6, Module 19.2, LOS 19.e)

An analyst who wants to examine a rm's nancing transactions during the most recent period is most likely

to evaluate the rm's statement of:

A) cash ows.

B) comprehensive income.

Reading 19: Introduction to Financial Statement Analysis

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C) nancial position.

Explanation

The statement of cash ows describes a rm's in ows and out ows of cash during a reporting period fromoperating, investing, and nancing activities Financing transactions such as issuance of debt or stock areshown on the statement of cash ows The statement of nancial position (balance sheet) presents therm's assets, liabilities, and equity at a point in time The statement of comprehensive income (incomestatement) does not directly re ect a rm's nancing transactions Cash raised is not included in a rm'srevenues and dividends paid and debt principal repaid are not included in its expenses

(Study Session 6, Module 19.1, LOS 19.b)

The step in the nancial statement analysis framework that includes making any appropriate adjustments tothe nancial statements and calculating ratios is best described as:

A) processing the data.

B) gathering the data.

C) analyzing and interpreting the data.

Explanation

The nancial statement analysis framework consists of six steps:

1 State the objective and context Determine what questions the analysis is meant to answer, the form

in which it needs to be presented, and what resources and how much time are available to performthe analysis

2 Gather data Acquire the company's nancial statements and other relevant data on its industry andthe economy Ask questions of the company's management, suppliers, and customers, and visitcompany sites

3 Process the data Make any appropriate adjustments to the nancial statements Calculate ratios.Prepare exhibits such as graphs and common-size balance sheets

4 Analyze and interpret the data Use the data to answer the questions stated in the rst step Decidewhat conclusions or recommendations the information supports

5 Report the conclusions or recommendations Prepare a report and communicate it to its intendedaudience Be sure the report and its dissemination comply with the Code and Standards that relate

to investment analysis and recommendations

6 Update the analysis Repeat these steps periodically and change the conclusions or

recommendations when necessary

(Study Session 6, Module 19.2, LOS 19.f)

Which of the following would NOT require an explanatory paragraph added to the auditors' report?

A) Doubt regarding the "going concern" assumption.

B) Uncertainty due to litigation.

C) Statements that the nancial information was prepared according to GAAP.

Explanation

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The statements that the nancial information was prepared according to GAAP should be included in theregular part of the auditors' report and not as an explanatory paragraph The other information would becontained in explanatory paragraphs added to the auditors' report.

The step in the nancial statement analysis framework of "processing the data" is least likely to includewhich activity?

A) Making appropriate adjustments to the nancial statements.

B) Preparing exhibits such as graphs.

C) Acquiring the company’s nancial statements.

Explanation

The nancial statement analysis framework consists of six steps Step 2: "Gather data" includes acquiringthe company's nancial statements and other relevant data on its industry and the economy Step 3

"Process the data" includes activities such as making any appropriate adjustments to the nancial

statements and preparing exhibits such as graphs and common-size balance sheets

A rm's internal controls are most accurately described as:

A) outside the scope of an audit report under IFRS and U.S GAAP.

B) a responsibility of the rm’s board of directors.

C) directly a ecting the rm’s nancial reporting quality.

Explanation

Weak internal controls provide an opportunity for low-quality or even fraudulent nancial reporting Arm's management, not its board of directors, is responsible for ensuring the e ectiveness of a rm'sinternal controls Under U.S GAAP, auditors are required to state an opinion on a rm's internal controls.(Study Session 6, Module 19.2, LOS 19.d)

Which of the following statements regarding footnotes to the nancial statements is least accurate? Financialstatement footnotes:

A) provide information about assumptions and estimates used by management.

B) may contain information regarding contingent losses.

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C) typically include a discussion of the rm’s past performance and future outlook.

Explanation

Discussion of a rm's past performance and future outlook is most likely to be found in management'scommentary

(Study Session 6, Module 19.2, LOS 19.c)

A company's operating revenues for a reporting period are most likely to be shown on its:

revenues because revenue might be recognized in a di erent period than cash is collected The balancesheet displays a company's nancial position at a xed point in time

According to IFRS guidance for management's commentary, addressing the company's key relationships is:

A) neither recommended nor required.

Which of the following is least likely to be available on EDGAR (Electronic Data Gathering, Analysis, andRetrieval System)?

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In the nancial statement analysis framework, using the data to address the objectives of the analysis anddeciding what conclusions or recommendations the information supports is best described as:

A) processing the data.

B) analyzing and interpreting the data.

C) reporting the conclusions.

Explanation

1 State the objective and context Determine what questions the analysis is meant to answer, the form

in which it needs to be presented, and what resources and how much time are available to performthe analysis

2 Gather data Acquire the company's nancial statements and other relevant data on its industry andthe economy Ask questions of the company's management, suppliers, and customers, and visitcompany sites

3 Process the data Make any appropriate adjustments to the nancial statements Calculate ratios.Prepare exhibits such as graphs and common-size balance sheets

4 Analyze and interpret the data Use the data to answer the questions stated in the rst step Decidewhat conclusions or recommendations the information supports

5 Report the conclusions or recommendations Prepare a report and communicate it to its intendedaudience Be sure the report and its dissemination comply with the Code and Standards that relate

to investment analysis and recommendations

6 Update the analysis Repeat these steps periodically and change the conclusions or

recommendations when necessary

The role of nancial statement analysis is most accurately described as:

A) the reports and presentations a company uses to show its nancial performance to investors,

creditors, and other interested parties

B) the use of information from a company’s nancial statements along with other information to

make economic decisions regarding that company

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C) a common requirement for companies that are listed on public exchanges.

Explanation

Financial statement analysis refers to the use of information from a company's nancial statements alongwith other information to make economic decisions regarding that company Financial reporting refers tothe reports and presentations that a company uses to show its nancial performance to investors,

creditors, and other interested parties Financial reporting is a requirement for companies that are listed

on public exchanges

(Study Session 6, Module 19.1, LOS 19.a)

In addition to the audited nancial statements included in a rm's annual report, which of the followingsources of information is most likely to contain audited data?

A) Footnotes to the annual nancial statements.

B) Interim nancial statements led with the SEC.

C) Management’s commentary.

Explanation

The footnotes are an integral part of the audited nancial statements in a rm's annual report and areincluded in the audit opinion

Which of the following is least likely to be considered a role of nancial statement analysis?

A) Assessing the management skill of the company’s executives.

B) Determining whether to invest in the company’s securities.

C) To make economic decisions.

Explanation

The role of nancial statement analysis is to use the information in a company's nancial statements,along with other relevant information, to make economic decisions Examples of such decisions includewhether to invest in the company's securities or recommend them to other investors, or whether toextend trade or bank credit to the company Although the nancial statements might provide indirectevidence about the management skill of the company's executives, that is not generally considered therole of nancial statement analysis

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Which of the following statements about proxy statements is least accurate? Proxy statements are:

A) available on the EDGAR web site.

B) a good source of information about the quali cations of board members and management.

C) not led with the SEC.

Explanation

Proxy statements are issued to shareholders when there are matters that require a shareholder vote.These statements, which are also led with the SEC and available from EDGAR, are a good source ofinformation about the election of (and quali cations of) board members, compensation, managementquali cations, and the issuance of stock options

Which of the following best describes nancial reporting and nancial statement analysis?

A) The objective of nancial analysis is to provide information about the nancial position of an

entity that is useful to a wide range of users

B) Financial reports assess a company’s past performance in order to draw conclusions about the

company’s ability to generate cash and pro ts in the future

C) Financial reporting refers to how companies show their nancial performance and nancial

analysis refers to using the information to make economic decisions

Explanation

Financial reporting refers to the way companies show their nancial performance to investors, creditors,and other interested parties by preparing and presenting nancial statements The objective of nancialstatements, not analysis, is to provide information about the nancial position, performance and changes

in nancial position of an entity that is useful to a wide range of users in making economic decisions Therole of nancial statement analysis, not reporting, is to use the information in a company's nancialstatements, along with other relevant information, to assess a company's past performance in order todraw conclusions about the company's ability to generate cash and pro ts in the future

The standard auditor's report is most likely required to:

A) provide reasonable assurance that management is reliable.

B) provide an "unquali ed" opinion if material uncertainties exist.

C) provide reasonable assurance that the nancial statements contain no material errors.

Explanation

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The standard auditor's report contains three parts:

1 The nancial statements are prepared by management and are their responsibility and the auditorhas performed an independent review

2 The audit was conducted using generally accepted auditing standards, which provides reasonableassurance that there are no material errors in the nancial statements

3 The auditor is satis ed the statements were prepared in accordance with accepted accountingprinciples, 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 Theauditor may add this opinion as a fourth element of the auditor's report or provide it separately

Information about a company's nancial position at a point in time is most likely found in the:

Which of the following statements about nancial statement analysis and reporting is least accurate?

A) Financial statement analysis focuses on the way companies show their nancial performance to

investors by preparing and presenting nancial statements

B) Providing information about changes in a company’s nancial position is a role of nancial

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Question #21 of 25 Question ID: 1204928

Which of the following statements concerning the notes to the audited nancial statements of a company isleast accurate? Financial statement notes:

A) include management's assessment of the company's operating performance and nancial

Which of the following is the best description of the nancial statement analysis framework?

A) Gather data, analyze and interpret the data, determine the context, report the conclusions,

update the analysis

B) Gather data, analyze and interpret the data, process the conclusions, assess the context, report

the recommendations, update the analysis

C) State the objective and context, gather data, process the data, analyze and interpret the data,

report the conclusions or recommendations, update the analysis

Explanation

1 State the objective and context

2 Gather data

3 Process the data

4 Analyze and interpret the data

5 Report the conclusions or recommendations

6 Update the analysis

For publicly traded rms in the United States, the Management Discussion and Analysis (MD&A) portion ofthe nancial disclosure is least likely required to discuss:

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A) unusual or infrequent items.

B) capital resources and liquidity.

C) results of operations.

Explanation

For publicly traded U.S rms, the MD&A portion of the nancial disclosure is required to discuss results ofoperations, capital resources and liquidity and a general business overview based on known trends Adiscussion of unusual or infrequent items may be included in the MD&A, but is not required

Which of the following statements represents information at a speci c point in time?

A) The balance sheet.

B) The income statement and the balance sheet.

C) The income statement.

Explanation

The balance sheet represents information at a speci c point in time The income statement representsinformation over a period of time

According to the IASB, which of the following least accurately describes nancial reporting? Financial

reporting:

A) provides information about changes in nancial position of an entity.

B) is useful to a wide range of users.

C) uses the information in a company’s nancial statements to make economic decisions.

Explanation

The role of nancial reporting is described by the International Accounting Standards Board (IASB) in its

"Framework for the Preparation and Presentation of Financial Statements":

The objective of nancial statements is to provide information about the nancial position, performanceand changes in nancial position of an entity that is useful to a wide range of users in making economicdecisions

Using the information in a company's nancial statements to make economic decisions is nancial

analysis, not nancial reporting

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Question #1 of 11 Question ID: 1204945Professional organizations of accountants and auditors that establish nancial reporting standards arecalled:

A) International organizations of securities commissions.

Organization of Securities Commissions (IOSCO)

According to the IASB Conceptual Framework for Financial Reporting, one of the qualitative characteristics ofnancial statements is:

representation Going concern is an underlying assumption of nancial statements

Which of the following is a company least likely required to present according to International AccountingStandard (IAS) No 1?

A) Statement of changes in owners’ equity.

B) A summary of accounting policies.

C) Disclosures of material events.

Explanation

Reading 20: Financial Reporting Standards

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International Accounting Standard (IAS) No 1 de nes which nancial statements are required and howthey must be presented The required nancial statements are:

Balance sheet

Statement of comprehensive income

Cash ow statement

Statement of changes in equity

Explanatory notes, including a summary of accounting policies

Disclosures of material events that a ect the company are required by the Securities and ExchangeCommission (Form 8-K) for rms that are publicly traded in the United States

According to the IASB conceptual framework, characteristics that enhance relevance and faithful

representation include:

A) comparability and thoroughness.

B) timeliness and veri ability.

C) assurance and understandability.

Explanation

The four characteristics that enhance relevance and faithful representation are comparability, veri ability,timeliness, and understandability

According to the IFRS framework, timeliness is a characteristic that enhances:

A) only faithful representation.

B) both relevance and faithful representation.

C) only relevance.

Explanation

In the IFRS framework, timeliness, comparability, veri ability, and understandability are characteristicsthat enhance the two fundamental qualitative characteristics, relevance and faithful representation.Information that is not timely will not be relevant or faithfully represent the activities of a rm over thereporting period

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The objective of nancial reporting is most accurately described as providing information about a rm thatis:

A) useful to decision makers.

B) complete, neutral, and free from error.

C) compliant with accepted accounting principles.

Explanation

According to the Conceptual Framework for Financial Reporting, the objective of nancial reporting is toprovide information about the rm to current and potential investors and creditors that is useful formaking their decisions about investing in or lending to the rm

Required nancial statements, according to International Accounting Standard (IAS) No 1, include a(n):

A) cash ow statement and auditor’s report.

B) balance sheet and explanatory notes.

C) income statement and working capital summary.

Explanation

Financial statements that are required by IAS No 1 include a balance sheet, a statement of comprehensiveincome, a cash ow statement, a statement of changes in owners' equity, and explanatory notes thatinclude a summary of the company's accounting policies IAS No 1 does not require an auditor's report or

a working capital summary

Which of the following is least likely a qualitative characteristic accounting information must possess in order

to provide useful information to an analyst, according to the IASB Conceptual Framework?

characteristic, but is not one of the qualitative characteristics speci ed in the IASB Conceptual Framework.(Study Session 6, Module 20.2, LOS 20.c)

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A rm engages in a new type of nancial transaction that has a material e ect on its earnings An analystshould most likely be suspicious of the new transaction if:

A) the transaction is not governed by existing regulations.

B) management has not explained its business purpose.

C) no accounting standard exists that applies to the transaction.

Explanation

New types of transactions may emerge that are not covered by existing accounting standards or

regulations Analysts should obtain information from a rm's management about the economic substance

of such transactions to ensure that they serve a business purpose and have not been created primarily tomanipulate the rm's nancial statements

Two underlying assumptions of nancial statements, according to the IASB conceptual framework, are:

A) going concern and accrual accounting.

B) historical cost and going concern.

C) accrual accounting and historical cost.

Explanation

The two underlying assumptions of nancial statements according to the conceptual framework areaccrual accounting and the going concern assumption Historical cost is one of several measurementbases that may be used for nancial reporting

Which of the following is least likely one of the general requirements for nancial statements under IFRS?

A) Statements should be prepared at least quarterly.

B) Statements should be prepared under a going concern assumption.

C) No o setting of income against expenses unless a standard permits or requires it.

Explanation

IFRS require reporting at least annually The other two choices are requirements included in IAS No 1.(Study Session 6, Module 20.2, LOS 20.d)

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An analyst gathered the following information about a company:

01/01/06 - 20,000 shares issued and outstanding

to the split or dividend

Step 1) Apply the 04/01/06 dividend to the beginning of year shares:

Adjusted shares = 1.05 × 20,000 = 21,000

Step 2) Apply the 10/01/06 split to the adjusted beginning-of-year shares and the repurchase

Adjusted beginning-of-year shares = 42,000 (= 2 × 21,000)

Adjusted repurchase = 10,000 (= 2 × 5,000)

Step 3) Compute the weighted average number of shares

42,000(12/12) - 10,000(6/12) = 37,000 shares

(Study Session 7, Module 21.4, LOS 21.g)

Reading 21: Understanding Income Statements

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Advantage Corp.'s capital structure was as follows:

December 31, 2005 December 31, 2004 Outstanding shares of stock:

of common stock Net income for 2005 was $850,000 Assume the income tax rate is 30%.

Calculate Advantage's basic and diluted earnings per share (EPS) for 2005.

Basic EPS Diluted EPS

[(850,000 − (3 × 10,000)) + 30,000 + (80,000)(1 − 0.3)] / [(110,000) + (20,000) + (30,000)] = $5.66

(Study Session 7, Module 21.4, LOS 21.h)

At the beginning of this year Aristotle Co had 400,000 shares of common stock outstanding During the year,Aristotle paid a 10 percent stock dividend on May 31, issued 90,000 new common shares on June 30, andrepurchased 12,000 shares on December 1 The number of shares Aristotle should use in computing

earnings per share at the end of the year is:

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Retrospective presentation is least likely required for a change from:

A) percentage-of-completion to completed contract revenue recognition.

B) zero salvage value to positive salvage value.

C) LIFO to average cost inventory valuation.

Explanation

Changes in accounting principle require retrospective presentation A change in the salvage value of anasset is a change in accounting estimate, which does not apply retrospectively

Which expense recognition method is most appropriate for intangible assets with inde nite lives?

A) Use straight-line amortization.

B) Test for impairment but do not amortize.

C) Use accelerated amortization for tax reporting and straight-line amortization for nancial

reporting

Explanation

Under IFRS and U.S GAAP, intangible assets with inde nite lives (e.g., goodwill) are not amortized but aretested for impairment at least annually

Maine Company's stock transactions during the year are described below:

January 1

100,000 common shares outstanding March 1 2 for 1 stock split

August 1 10% stock dividend

The weighted average number of shares outstanding used to calculate earnings per share is:

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A company changes from an incorrect method of accounting to an acceptable one Which of the followingstatements about this change is most accurate?

A) It is an unusual or infrequent item and is reported in net income from continuing operations B) It requires restatement of any prior period results that are presented in the current nancial

statements

C) It is a change in accounting principle and is reported below the line net of taxes.

Explanation

This is the correct treatment of this change The company must disclose the nature of the error and its

e ect on net income and restate any prior period results that are presented in the current nancialstatements

To convert an income statement to a vertical common-size income statement, each line item should bestated as a percentage of:

A) net income.

B) revenue.

C) pretax income.

Explanation

A vertical common-size income statement states each item as a percentage of revenue

(Study Session 7, Module 21.5, LOS 21.i)

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Assume that the exercise price of an option is $9, and the average market price of the stock is $12 Assuming

992 options are outstanding during the entire year, what is the number of shares to be added to the

denominator of the Diluted EPS?

For a rm with a simple capital structure, all of the following are necessary to measure basic earnings pershare (EPS) EXCEPT:

A) the timing and number of shares issued or repurchased during the year.

B) dividends paid to preferred shareholders.

C) dividends paid to common shareholders.

Explanation

Basic EPS = earnings available to common shareholders divided by the weighted average number ofcommon shares outstanding Earnings available to common shareholders equals net income minuspreferred dividends

Oregon Corp.'s stock transactions during the year were as follows:

January 1: 320,000 shares outstanding

April 1: 1-for-2 reverse stock split occurred

July 1: Acquisition of Smith, Inc in exchange for issuance of 60,000 shares

October 1: 30,000 shares issued for cash

What is Oregon's weighted average number of shares outstanding?

A) 167,500.

B) 250,000.

C) 197,500.

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The January 1 balance is adjusted retroactively for the reverse stock split and 320,000 / 2 = 160,000 sharesare treated as outstanding from January 1 Issuance of stock is included from the date of issuance Theweighted average shares are computed by multiplying the share amounts by the number of months theshares were outstanding, then adding these amounts and dividing the sum by 12

January 1: initial shares 160,000 × 12 = 1,920,000

July 1: Smith acquisition 60,000 × 6 = 360,000

October 1: cash issuance 30,000 × 3 = 90,000

Oregon's weighted average shares = 2,370,000 / 12 = 197,500

Are dividends paid to common shareholders and foreign currency translation gains and losses included in arm's other comprehensive income?

Dividends paid Foreign currency translation gains and

(Study Session 7, Module 21.5, LOS 21.l)

The rst-in- rst-out (FIFO) expense recognition method for inventories best describes the physical ow ofgoods if customers typically purchase units:

A) selectively from among all units for sale.

B) from the top of a stack.

C) in the same order the units are produced.

Explanation

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The FIFO cost ow method best approximates the physical ow of goods if customers typically purchaseunits in the order the units are produced, such as goods with a limited shelf life Last-in- rst-out (LIFO)best approximates the ow of goods if customers purchase units from the top of a stack, as with rawmaterials such as coal or gravel If customers choose individual units selectively from among all the unitsfor sale, the ow of goods may be unclear and the average cost method may describe it best.

Lawson, Inc.'s net income for the year was $1,060,000 with 420,000 shares of common stock outstanding.Lawson has 2,000 shares of 8%, $1,000 par value convertible preferred stock that were outstanding theentire year Each share of preferred is convertible into 50 shares of common stock Lawson's diluted earningsper share are closest to:

numerator of the EPS equation, and the additional common shares are added to the denominator of theequation Lawson's diluted EPS is $1,060,000 / (420,000 + 100,000) = $2.04

Orange Company's net income for 2004 was $7,600,000 with 2,000,000 shares outstanding The averageshare price in 2004 was $55 Orange had 10,000 shares of eight percent $1,000 par value convertible

preferred stock outstanding since 2003 Each preferred share was convertible into 20 shares of commonstock Orange Company's diluted earnings per share (Diluted EPS) for 2004 is closest to:

of the year The preferred dividends paid are added back to the numerator of the Diluted EPS equation,and the additional common shares are added to the denominator of the equation Orange's if-convertedEPS is $7,600,000 / (2,000,000 + 200,000) = $3.45 Because if-converted EPS is higher than basic EPS, thepreferred stock is antidilutive and no adjustment is made to basic EPS

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A rm has a weighted average number of 20,000 common shares selling at an average of $10 throughout theyear and 11,000, 10%, $100 par value preferred shares If the rm earns $210,000 after taxes, what is itsBasic EPS?

The following information pertains the QRK Company:

One million shares of common stock outstanding at the beginning of 2005

200,000 shares issued on the last day of March

500,000 shares issued on the last day of June

800,000 shares issued on the last day of September

What is the number of shares that should be used to compute 2005 earnings per share for the QRK

Do gains and losses, as well as expenses appear on the income statement?

A) Both appear on the income statement.

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B) Only expenses appear on the income statement.

C) Only gains and losses appear on the income statement.

Explanation

Gains and losses result from, transactions that are not a part of the rm's normal business operations.Expenses are amounts that are incurred to generate revenue; thus, expenses result from the rm'songoing operations Both are included on the income statement

Which of the following statements regarding making changes in accounting principles is least accurate?

A) The general rule is retrospective application.

B) Changes in accounting estimates are now treated the same as changes in accounting principles C) A change in accounting principle is a change from one generally accepted accounting principle to

another generally accepted principle The rm making the change must justify the change

Explanation

Changes in accounting estimates are not treated the same as changes in principles Changes in principlesare treated retrospectively, whereas changes in accounting estimates are accounted for in the current andfuture periods Both remaining statements are accurate

Selected nancial ratios from Mulroy Company's common-size income statements are as follows:

Relative to sales, it is most likely that Mulroy's:

A) income tax expense is increasing.

B) operating expenses are increasing.

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C) nonoperating expenses are increasing.

Explanation

Nonoperating expenses are equal to the di erence between operating pro t and pretax pro t Based onthe given pro t margins, Mulroy's nonoperating expenses increased from 3% of sales in 20X1 to 9% ofsales in 20X3 Because gross pro t margin is increasing, cost of goods sold is decreasing as a percentage

of sales Other operating expenses and income tax expense, as a percentage of sales, were stable over theperiod shown

(Study Session 7, Module 21.5, LOS 21.j)

When considering the impact of warrants on earnings per share, the method to calculate the number ofshares added to the denominator is derived using which method?

A) Weighted average method.

B) Cost recovery method.

C) Treasury Stock method.

Explanation

The treasury stock method assumes the hypothetical funds received by the company from the exercise ofthe options are used to purchase shares of the company's common stock in the market at the averagemarket price

The standard equation for computing basic earnings per share (EPS) is:

A) [Sales − Cost of Goods Sold] / Number of Preferred Shares Outstanding.

B) [Net Income – Preferred Dividends] / Weighted Average Number of Common Shares

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Kendall Company's net income for 20X4 is $830,000 with 200,000 shares outstanding Kendall has 1,000 6%convertible bonds (each bond $1,000 face value and convertible into 20 common shares) outstanding for theentire year Kendall's tax rate is 40% What is Kendall Company's diluted earnings per share for 20X4?

A) $3.77.

B) $3.94.

C) $4.15.

Explanation

Kendall's basic EPS is $830,000 / 200,000 = $4.15 To compute diluted EPS, bond interest paid net of taxes

is added to net income, and the number of shares that would be issued in the conversion is added to thedenominator Kendall's diluted EPS = [$830,000 + (1,000 × $1,000 × 0.06) × (1 – 0.4)] / (200,000 + 20,000) =

$3.94 Since diluted EPS is less than basic EPS, we know that the bonds are dilutive and should be

considered in calculating diluted EPS

Washington, Inc.'s stock transactions during the year 20X4 were as follows:

January 1

720,000 shares issued and outstanding

May 1 2 for 1 stock split

Which of the following securities would least likely be found in a simple capital structure?

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A) 3%, $100 par value convertible preferred.

B) 7%, $100 par value non convertible preferred.

C) 6%, $5000 par value putable bond.

Explanation

A simple capital structure contains no potentially dilutive securities such as stock options, warrants, orconvertible preferred stock

At the beginning of 2004, Osami Corporation had 1.4 million shares of common stock outstanding and nopreferred stock At the end of August 2004, Osami issued 1.2 million new shares of common stock If Osamireported net income equal to $7.2 million, what were its earnings per share (EPS) for 2004?

Which of the following data are least likely to be read directly from a common-size income statement?

A) Net pro t margin.

B) Ratio of SG&A expense to sales.

C) E ective tax rate.

Explanation

The e ective tax rate is income tax expense as a percentage of pretax income Items on a common-sizeincome statement are stated as a percentage of revenue (sales) Net pro t margin is net income as apercentage of revenue

(Study Session 7, Module 21.5, LOS 21.i)

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The approach to revenue recognition in the converged accounting standards that were issued in May 2014 isbest described as:

A complex capital structure, for purposes of determining disclosure of diluted Earnings Per Share, is

distinguished from a simple capital structure by the:

A) company having issued warrants, convertible securities, or options.

B) company's use of debt to nance its operations.

C) company having preferred stock outstanding.

Explanation

A complex structure contains potentially dilutive securities such as options warrants or convertible

securities Where as simple capital structures contain no potentially dilutive securities and contains onlycommon stock and non-convertible securities

When calculating earnings per share (EPS) for rms with complex capital structures, stock options areordinarily considered to be:

A) potentially dilutive securities.

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An analyst has gathered the following information about Artcraft, Inc for the year:

Net income of $30,000

5,000 shares of common stock and 500 shares of 8%, $90 par convertible preferred stock outstandingduring the whole year

Each share of convertible preferred can be converted into 4 shares of common stock

Last year, Artcraft issued at par, $60,000 total face value of 6.0% convertible bonds, with each of the 60bonds convertible into 110 shares of the Artcraft common stock

If Artcraft's e ective tax rate is 40%, what will Artcraft report as diluted earnings per share (EPS)?

A) $3.37.

B) $3.12.

C) $2.36.

Explanation

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Diluted EPS = adjusted earnings after conversion (EAC) / weighted average plus potential common sharesoutstanding.

Step 1: Calculate Adjusted EAC

adjusted EAC: net income - preferred

dividends

+

dividends on

convertible preferred stock +

after-tax interest on convertible debt

=

adjusted earnings available for common shares

preferred dividends = convertible preferred dividends = (0.08)(90)(500) = 3,600

convertible debt interest = (60,000)(0.06)(1 – 0.40) = 2,160

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Step 3: Calculate Diluted EPS

Diluted EPS = 32,160 / 13,600 = $2.36.

(Study Session 7, Module 21.4, LOS 21.h)

Jersey, Inc.'s nancial information included the following for its year ended December 31:

160,000 shares of common stock were outstanding for the entire year

18,000 shares of 10%, $100 par value cumulative preferred stock were outstanding for the entire year.Common stock dividends paid during the current year were $240,000

All preferred stock dividends were paid for the current year

Net income was $720,000

Basic earnings per share for Jersey, Inc for the year ended December 31 are closest to:

Rushford Corp.'s net income is $16,500,000 with 300,000 shares outstanding The tax rate is 40% Theaverage share price for the year was $372 Rushford has 50,000, 9%, $1,000 par value convertible bondsoutstanding Each bond is convertible into two shares of common stock

Rushford Corp.'s basic and diluted earnings per share (EPS) are closest to:

Basic EPS Diluted EPS

A) $65.63 $48.00

B) $55.00 $48.00

C) $55.00 $51.56

Explanation

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Rushford's basic EPS (net income / weighted average common shares outstanding) is $16,500,000 /300,000 = $55.00 Diluted EPS is calculated under the assumption that the convertible bonds were

converted into common stock, the bond interest net of tax is restored to net income, and the additionalcommon shares are added to the denominator of the equation Rushford's diluted EPS is [$16,500,000 +(50,000 × $1,000 × 0.09)(1 - 40)] / (300,000 + (50,000 × 2) = $48.00

Matrix, Inc.'s common size income statement for the years ended December 31, 20X1 and 20X2 included thefollowing information (percent of net sales):

20X1 20X2

Cost of Goods Sold (55) (60)

45 40 Selling General & Administrative (5) (5)

Depreciation (7) (8)

33 27 Interest Expense (15) (6)

18 21 Income Tax Expense (6) (7)

12 14

Analysis of this data indicates that from 20X1 to 20X2:

A) the e ective tax rate increased.

B) cost of goods sold increased.

C) interest expense per dollar of sales declined.

Explanation

On a common size income statement, all amounts are stated as a percentage of sales Interest expenseper dollar of sales has declined from 0.15 to 0.06 The other interpretations listed are not necessarilycorrect COGS increased as a percentage of sales, but if sales decreased, COGS may have decreased aswell The company's e ective tax rate (income tax expense / pretax income) can be calculated from acommon-size income statement Here the e ective tax rate was 33% in both years

(Study Session 7, Module 21.5, LOS 21.j)

When considering convertible preferred stock which of the following components of the earnings per share(EPS) equation needs to be adjusted to calculate diluted earnings per share?

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Antidilutive securities should be assumed to have been converted to common shares when calculating:

A) basic EPS but not diluted EPS.

B) diluted EPS but not basic EPS.

C) neither basic nor diluted EPS.

Explanation

Antidilutive securities would increase EPS if exercised or converted to common stock Therefore we do notassume they are converted when we calculate diluted EPS Basic EPS is calculated before assuming anypotentially dilutive securities are converted

A simple capital structure is least likely to include:

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The SSP Company had 5 million shares outstanding on January 1 On February 15 the board of directorsapproved a 3:2 stock split, e ective April 1 What is the weighted average number of shares outstanding forthe SSP Company for year-end?

Assume that the exercise price of an option is $6, and the average market price of the stock is $10 Assuming

802 options are outstanding during the entire year, the number of shares to be added to the denominator ofdiluted earnings per share (EPS) is closest to:

The Ga e Company had net income of $1,500,000 Ga e paid preferred dividends of $5 on each of the100,000 preferred shares Each preferred share is convertible into 20 common shares There are 1 million

Ga e common shares outstanding In addition to the common and preferred stock, Ga e has $25 million of4% bonds outstanding If Ga e's tax rate is 40%, what is its diluted earnings per share?

A) $0.50.

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B) $1.00.

C) $0.33.

Explanation

The preferred shares are convertible into 100,000 × 20 = 2 million common shares They are dilutive since:

Under accrual accounting, revenues are recognized in the same period in which the associated:

A) cash is collected.

B) invoices are billed.

C) expenses are incurred.

Explanation

Accrual accounting is based on the matching principle, under which revenues are recognized in the sameperiod that the expenses are incurred to generate those revenues

At the beginning of 2004, the Alaska Corporation had 2 million shares of common stock outstanding and nopreferred stock At the end of August, 2004, Alaska issued 600,000 new shares of common stock If Alaskareported net income equal to $8.8 million, what was the rm's earnings per share for 2004?

Basic EPS = $1,000,000 = $1.00

1,000,000

Diluted EPS = $1,500,000 = $0.50 which is less.

3,000,000

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When a rm recognizes revenue in excess of expenses on a product before cash is collected, what is theimpact on the rm's assets and liabilities, ignoring taxes?

Roome Corp has 5,000,000 common shares outstanding There are 500,000 warrants outstanding to

purchase the stock at $20, and there are 200,000 options outstanding to buy the stock at $50 The averagemarket price for the stock over the year was $40, and the current stock price is $60 The number of sharesused to calculate diluted EPS is:

Ajax Company has a simple capital structure Which of the following will NOT be found on its balance sheet?

A) 6%, $50 par value callable bond.

B) 10%, secured mortgage bond denominated in Swiss francs.

C) 3%, $100 par value convertible bond.

Explanation

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If convertible bonds exist, the rm has a complex capital structure.

Which of the following statements regarding basic and diluted EPS is least accurate?

A) A simple capital structure contains no potentially dilutive securities.

B) Antidilutive securities decrease EPS if they are exercised or converted.

C) Dilutive securities decrease EPS if they are exercised or converted to common stock.

Explanation

Antidilutive securities increase EPS if exercised or converted to common stock

The following information is for Trotters Diversi ed as of year-end:

Average common shares outstanding of 5.0 million

Average market price for common stock of $35.00 per share

Net income of $9.0 million

Common stock dividends paid of $1.2 million

Tax rate of 40%

500,000 shares of cumulative convertible preferred stock with $30 par value and 10% dividend Eachpreferred share is convertible into 5 common shares Preferred dividends of $1.5 million were paid.10,000 convertible $1,000 par bonds with a 6.0% coupon, each convertible into 8 shares of commonstock

400,000 stock options with an exercise price of $32.00 per share

All of these securities were outstanding for the full year

Diluted EPS for Trotters Diversi ed is closest to:

A) $1.23.

B) $1.19.

C) $1.50.

Explanation

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Only the options and convertible preferred stock are dilutive First, calculate basic EPS to use as a

benchmark to determine dilutive capital components

Basic EPS = (net income – preferred dividends) / weighted average common shares outstanding =(9.0 – 1.5) / 5.0 = $1.50

Next, check for dilution

The stock options are dilutive because the exercise price is less than the average stock price There

is no numerator impact from the options The denominator impact = # options – [(# options ×exercise price) / average stock price)] = 400,000 – [(400,000 × 32) / 35] = 34,286 or 0.034 million

To check whether the convertible preferred stock is dilutive we need to determine whether itdecreases EPS To the numerator, we add back the preferred dividend The denominator impact = (#preferred shares × conversion rate) = 500,000 × 5 = 2,500,000, or 2.5 million Then, EPS = (9.0 – 1.5 +1.5) / (5.0 + 2.5) = $1.20 Thus the convertible preferred stock is dilutive

To check whether the convertible bonds are dilutive we need to determine whether they decreaseEPS To the numerator, we add back the after-tax impact of the coupon, or (face value × coupon × (1– t)), or (10,000 bonds × 1,000 par × 0.06 coupon × 0.6 ) = 360,000, or $0.360 million The

denominator impact = (# convertible bonds × conversion rate) = 10,000 × 8 = 80,000, or 0.080million Then, EPS = (9.0 – 1.5 + 0.360) / (5.0 + 0.080) = $1.55 Thus the bonds are antidilutive.Finally, calculate diluted EPS:

Diluted EPS = (9.0 – 1.5 + 1.5) / (5.0 + 2.5 + 0.034) = $1.1946

Moulding Company's net income was $13,820,000 with 2,600,000 shares outstanding The average shareprice for the year was $58.00 Moulding had 10,000 options to purchase 10 shares each at $40 per shareoutstanding the entire year Moulding Company's diluted earnings per share are closest to:

Using the treasury stock method to compute diluted EPS, if the options were exercised, cash in ow would

be 10,000 × 10 × $40 = $4,000,000 Based on the average share price of $58.00, the number of Mouldingshares that can be purchased with the cash ow is $4,000,000 / $58 = 68,966 The number of shares thatwould have been created is 100,000 – 68,966 = 31,034 Diluted EPS was $13,820,000 / (2,600,000 + 31,034)

= $5.25

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During 2007, Topeka Corporation entered into the following transactions:

Transaction #1 – Interest on a certi cate of deposit owned by Topeka was credited to Topeka'sinvestment account

Transaction #2 – Topeka sold 10,000 shares of common stock at $30 that had been repurchased

by Topeka last year for $20

Should Topeka recognize the results of these transactions as income on the income statement for the yearended December 31, 2007?

A) Neither should be recognized.

B) Only one should be recognized.

C) Both should be recognized.

Explanation

Interest earned on the CD is recognized as interest income The gain on the sale of treasury stock is notreported on the income statement but is re ected on the statement of changes in stockholders' equity and

on the balance sheet The sale proceeds simply increase equity and increase cash

The Better Building Company has a contract to build a building for $100 million The estimate of the cost ofthe project is $75 million In the rst year of the project, BB had costs of $30 million The Better BuildingCompany's reported pro t for the rst year of the contract, using the percentage-of-completion method, is:

A) $0.

B) $20 million.

C) $10 million.

Explanation

Reported pro t (in millions) = ($30 / $75)($100 − 75) = $10

Zachary Company's warrants issued in 2000 are Zachary's only outstanding potentially dilutive security In

2005, EPS and Dilutive EPS di ered for the rst time A possible explanation for the change is the:

A) year-end market price of Zachary increased.

B) average market price of Zachary decreased.

C) average market price of Zachary increased.

Explanation

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An increase in average market price could cause Zachary's warrants to go from antidilutive to dilutive Ifthe average price of the stock increases during the year, the warrants are likely to be exercised at somepoint during the year Neither of the other choices would do this.

A company reports a gain of €100,000 on the sale of an asset and a loss of €100,000 due to foreign currencytranslation adjustment Which of these items will be included in the company's comprehensive income?

A) Both of these items are included in comprehensive income.

B) Neither of these items is included in comprehensive income.

C) Only one of these items is included in comprehensive income.

Explanation

Both items are included in comprehensive income Comprehensive income includes all items that a ectowners' equity except transactions with the company's owners Any items that are included in net incomeare also included in comprehensive income The gain on sale is reported in net income The foreigncurrency translation loss is taken directly to owners' equity (i.e., not reported in the income statement).(Study Session 7, Module 21.5, LOS 21.k)

Which of the following statements regarding the treasury stock method of computing diluted shares is leastaccurate? The treasury stock method:

A) assumes that the hypothetical funds received by the company from the exercise of the options

are used to sell shares of the company’s common stock in the market at the average market

i

B) is used when the exercise price of the option is less than the average market price.

C) increases the total number of shares by less than the number that the exercise of the options

would create

Explanation

The treasury stock method assumes any funds received by the company from the exercise of the optionsare used to purchase shares (not sell shares) of the company's common stock in the market at the averagemarket price

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Barracuda Corporation, a U.S corporation, owns a subsidiary located in Germany The German subsidiary'snancial statements are maintained in euros If the euro recently appreciated relative to the U.S dollar, howwould the unrealized translation gain a ect Barracuda's retained earnings and total stockholders' equity?

Retained earnings Total stockholders' equity

(Study Session 7, Module 21.5, LOS 21.k)

The JME Jumpers, a professional volleyball team, sells season tickets to all home games The cost of a seasonticket is $1,000 and the team plays 20 home games, which run from April through August For the year endedJune 30, 2005, JME sold 1,200 tickets, collected 80 percent of the amount owed, and played 12 home games.How much revenue should JME recognize?

A rm with a capital structure consisting of only common stock and non-convertible bonds is said to have a:

A) simple capital structure.

B) non-diluted capital structure.

C) straight capital structure.

Explanation

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