FRA

The analytical tool that would be most appropriate for an analyst to use to identify the percentage of a company's assets that are liquid is the: common-size balance sheet. cash ratio. current ratio.

A common-size balance sheet expresses all balance sheet accounts as a percentage of total assets and would provide insight into what portion of a company's assets is liquid. On the other hand, cash and current ratios measure liquidity relative to current liabilities, not relative to total assets. Sections 7.1, 7.2 Section 3.2.1

Which of the following events is most likely to lead management to make biased accounting choices? * Changing the company's audit firm * Changing the company's fiscal year * Changing the company's CEO

A company might report lower earnings in the CEO's first year to create a positive trajectory for future periods. Alternatively, there could be motivation to report higher earnings under the new CEO. Either situation could lead to biased accounting choices. Sections 2.3 and 3.1

The following information applies to one of a company's investments currently classified as held to maturity: Prior Year End / Current Year End Market value $17,000 $16,000 Amortized cost $22,000 $20,000 The company reports its earnings using US GAAP. If the investment is reclassified as available for sale as of the end of the current year, the balance sheet carrying value of the company's investment portfolio would most likely: remain the same. decrease by $6,000. decrease by $4,000.

Available-for-sale securities are carried at market value, whereas held-to-maturity securities are carried at amortized cost. If the investment is reclassified as available for sale at the end of the current year, the carrying amount should be adjusted to its market value, which is $16,000. Compared with the amortized cost of $20,000, this is a decrease of $4,000. Section 4.5

Company A owns 60% of Company B. Company A's consolidated income statement most likely includes 100% of Company A's revenues and expenses and what portion of Company B's? 0% 100% 60%

Because Company A owns more than 50% of the shares in Company B it must present consolidated financial statements, which will include 100% of Company B's revenues and expenses. Section 2

Which of the following statements regarding inventory valuation is most accurate? * Both IFRS and U.S. GAAP allow the reversal of write-downs back to the original cost. * Both IFRS and U.S. GAAP allow agricultural inventories to be valued at net realizable value. * IFRS defines market value as net realizable value less a normal profit margin.

Both IFRS and U.S. GAAP allow agricultural to be valued at net realizable value. Section 4

An analyst is making the necessary adjustments to convert operating leases to capital leases for comparison with other companies. The most likely effect of the adjustments will be that the: current ratio will increase. debt-to-capital ratio will increase. interest coverage ratio will not be affected.

Converting an operating lease to a capital lease will increase the total debt by the present value of the lease payments. This change will increase both debt and the total capital, but because the debt/total capital must be less than 1, equal additions to the numerator and denominator increase the ratio.

The following tables present excerpts from financial statements for two merchandising companies following the format found in each of their annual reports. Company A Assets Noncurrent assets 9,640 Current assets 2,096 Total assets 11,736 Company B Assets Current assets 4,333 Noncurrent assets 19,923 Total assets 24,256 Which of the companies most likely prepares its financial statements in accordance with U.S. GAAP? Only Company B Both companies Only Company A

Company A prepares its financial statements under IFRS whereas company B uses U.S. GAAP. IFRS does not specify the order of presentation of current and noncurrent assets. Under U.S. GAAP, current assets are presented before long-term assets and current liabilities before long-term ones. Section 2.1

The following financial statement data are available for a company: Operating income 3,390 Net income 2,210 Operating assets 3,850 Change in cash and cash equivalents 1,010 Change in cash from operating activities 1,750 Free cash flow to the firm 2,240 The company's cash-to-income ratio is closest to: 0.79. 0.66. 0.52.

Cash to income = Cash flow from operating activities (CFO)/Operating income (1,750/3,390) 0.52 Section 4.4

An analyst is forecasting the gross profit of the following three companies. He uses the five-year average gross margins and forecasts sales based on an internal model. Company/Additional Information Company 1 Introduced new products last year for the first time in the past 10 years but with the most advanced technology Company 2 Has been offering the same products with the same technology throughout the period, and the demand and cost structures for their products have not experienced any significant changes Company 3 Renews its product offerings constantly as part of its corporate policy For which of the three companies will the forecast of gross profit be most reliable? Company 2 Company 3 Company 1

Company 2 will have the most reliable forecast because it has been offering the same products with the same technology, and their demand and cost structures have been stable too. Therefore, the relationship between sales and gross profit (i.e., gross margin) should be stable, and the use of average gross margins will be the most reliable. Section 3.1

Unused tax losses and credits that a company expects to use in future periods will most likely give rise to: deferred tax liabilities. valuation allowances. deferred tax assets.

Deferred tax assets arise from carrying forward unused tax losses and credits but are only recognized if there is an expectation that the company will be able to use them in the future. Section 3.1.5 Section 2

Issuance of common stock is most accurately classified as a(n): investing activity. financing activity. operating activity.

Financing activities are those activities related to obtaining or repaying capital. Examples include issuing common shares, taking out a bank loan, and issuing bonds. Section 2

The following data are available on a company: 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. 4.00. 2.27.

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 Interest payments + Lease payments 5,500 + 500 = 6,000 1,000 + 500 = 1,500 Fixed charge coverage ratio 4.00 Section 4.4.1 Section 5

A firm incurred the following costs related to production during the past year: Fixed production overhead costs 3.0 Raw materials costs 6.0 Labor costs 4.0 Freight-in costs for raw materials 1.0 Warehousing costs for finished goods 2.0 The total capitalized inventory cost (in US$ millions) for the year is closest to: 14.0. 13.0. 16.0.

Fixed production costs 3.0 Raw materials 6.0 Labor costs 4.0 Freight-in 1.0 Total capitalized inventory cost 14.0 Section 2

On 1 January 2011, a company that prepares its financial statements according to International Financial Reporting Standards (IFRS) issued bonds with the following features: • Face value £20,000,000 • Term Five years • Coupon rate 6% paid annually on 31 December • Market rate at issue 4% The company carries all its bonds at cost. In December 2013, the market rate on similar bonds had increased to 5%, and the company decided to buy back (retire) the bonds after the coupon payment on 31 December. As a result, the gain on retirement reported on the 2013 income statement income is closest to: £371,882. £382,556. £340,410.

Gain = Book value of debt - Market value £20,754,438 - £20,371,882 = £382,556 The market value of debt at retirement can be determined by discounting the future cash flows at the current market rate (5%) by using a financial calculator: Face value (FV) = £20,000,000; i = 5%; PMT = £1,200,000; N = 2; Compute present value (PV) = £20,371,882. The book value after the third interest payment (two payments remaining) can be found by using either a financial calculator and the market rate at the time of issue (4%) or an amortization table (shown next). FV = £20,000,000; i = 4%; PMT = £1,200,000; N = 2; Compute PV = £20,754,438. Sections 2.1, 2.2, 2.4

The following information about a company is provided: 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: 487. 472. 482.

Given Assets = Liabilities + Equity. First calculate ending equity ($318, see calculation in the following table). $800 = Liabilities + $318, Total liabilities = $482. 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 Sections 3.2, 4.2

On 1 January 2014, the market rate of interest on a company's bonds is 5%, and it issues a bond with the following characteristics: Face value €50 million Coupon rate, paid annually 4% Time to maturity 10 years (31 December 2023) Issue price (per €100) €92.28 If the company uses International Financial Reporting Standards (IFRS), its interest expense (in millions) in 2014 is closest to: €1.846. €2.386. €2.307.

IFRS requires the effective interest method for the amortization of bond discounts/premiums. The bond is issued for 0.9228 × €50 million = €46.140. Interest expense = Liability value × Market rate at issuance = 0.05 × €46.140 = €2.307. Section 2.2

During a period of rising inventory costs, a company decides to change its inventory method from FIFO (first in, first out) to the weighted average cost method. Under the weighted average cost method, which of the following financial ratios will most likely be higher than under FIFO? Number of days in inventory Debt-to-equity ratio Current ratio

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). Sections 3.7, 6

During a period of declining prices, a company using the last-in, first-out (LIFO) inventory method instead of first-in, first-out (FIFO) method will most likely report a lower value for: cost of goods sold. gross profit. ending inventory.

If prices are declining, using LIFO would match the lower (most recent) costs with current sales. Cost of goods sold would be lower with LIFO and gross profit (income) would be higher compared with using FIFO. Lower cost of goods sold means inventory balances, consisting of older, higher-priced items, would be higher using LIFO, increasing current assets relative to FIFO. Section 3.5

A company using IFRS reports its interest payments on long-term debt as a financing activity. If the company reported under US GAAP, the most likely effect would be a: higher cash flow from financing activities. higher cash flow from operations. lower cash flow from investing activities.

Interest payments can be reported either as operating or financing cash flow under IFRS, but they can be reported only as operating cash flow under US GAAP. The interest payment was originally reported as financing activity under IFRS, but under US GAAP it would be an operating activity. Therefore, under US GAAP, cash flow from financing activities would be higher and operating cash flows lower by the same amount. Sections 2.1, 2.2

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

Preparing common-size financial statements is part of the process data step. Sections 4.2-4.4

The following information is available about a company ($ millions): Year ended 31 December 2012 2011 Sales 322.8 320.1 Net income 27.2 26.8 Cash flow from operations 15.3 38.1 During 2012, the company most likely experienced a significant decrease in: * the proportion of interest-bearing debt relative to trade accounts payable. * the proportion of sales made on a cash basis. * inventory, anticipating lower demand for its products in 2013.

Sales are nearly the same for the two years. A decrease in the proportion of cash sales implies an increase in the proportion of credit sales, which would increase accounts receivable and decrease cash flow from operations. Sections 2.3.1, 3.2.5

When a company issues common stock as part of the conversion of a convertible bond, the cash flow statement will most likely: *include the transaction because it materially affects the company's financial position. * omit the transaction without disclosure. * omit the transaction but disclose it in a separate note or supplementary statement.

Significant non-cash transactions, such as the Significant non-cash transactions, such as the exchange of non-monetary assets or issuance of stock as part of a stock dividend or conversion are not incorporated in the cash flow statement. They are required to be disclosed, however, in either a separate note or a supplementary schedule to the cash flow statement. Section 2.1

Which of the following statements is least accurate? *The IASB is monitored by a board that includes the U.S. SEC. * IFRS Foundation trustees oversee the policy decisions of the FASB. * IFRS Foundation trustees appoint members of the IASB.

The Financial Accounting Foundation, not the IFRS, oversees FASB. Sections 3.1.1-3.1.2

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): * prepaid expense. * deferred revenue. * accrued expense.

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. Section 5.1

The following financial data are available for a company (current year/prior year) Cost of goods sold 600 400 Inventory 500 600 Accounts payable 200 400 Accounts receivable 400 900 Cash paid to suppliers (in thousands) in the current year is closest to: €900. €700. €300.

The calculation is as follows: Cost of goods sold +600 Minus decrease in inventory (500 - 600) -100 Purchases from suppliers 500 Plus decrease in accounts payable (200 - 400) 200 Cash paid to suppliers 700 Section 3.2.1.2

Security/Authorized/Issued and 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: $2.91. $3.08. $2.93.

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 Net income $1,000,000 $1,000,000 Preferred stock, Series A (48,000) (48,000) 12,000 shares × $4/share Preferred stock, Series B (225,000) 0 30,000 shares × $7.50/share Earnings available to common shareholders $727,000 $952,000 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 shareholders/WACS $2.91 $2.93* * Exceeds Basic EPS; Series B is anti-dilutive and is thus not included. Sections 6.2, 6.3

Changing the estimates of the salvage value of capital assets is the least effective way to manage earnings during the life of an asset for companies whose method of depreciation is: units-of-production. straight-line. double-declining balance.

The double-declining balance depreciation method applies the rate to the gross cost of the equipment, so a change in the salvage assumption will have no effect on earnings until the net book value reaches the estimated salvage value, at which point the company ceases to take depreciation on the asset. Section 4.2.1

2013 2012 Sales 2,240,000 Cost of goods sold (COGS) 1,320,000 Cash and investments 210,700 191,600 Accounts receivable 212,800 201,900 Inventories 63,000 71,500 Accounts payable 129,600 157,200 Other current liabilities 130,700 182,700 The company operates in an industry in which suppliers offer terms of 2/10, net 30. The payables turnover for the average company in the industry is 8.5 times. Which of the following statements is most accurate? In 2013, the company, on average: * paid its accounts more promptly than the average firm in the industry. * took advantage of early payment discounts. * paid its accounts within the payment terms provided.

The firm's days in payables is 39.9 days (see following calculations), therefore, it appears that the firm does not normally take supplier provided discounts (paying in 10 days) nor pay its accounts within the 30 day terms provided. However, on average, the company is paying faster than the average firm in the industry (42.9 days). Payables turnover = Purchases/Average payables = 1,311,500/143,400 = 9.15 times Where: Purchases = COGS + End inventory - Beginning inventory = 1,320,000 + (63,000 - 71,500) = 1,311,500 Average payables = (129,600 + 157,200 )/2= 143,400 Days in payables = 365/Payables turnover ratio For firm: 365 days/9.15 = 39.9 days For industry: 365 days/8.5 times = 42.9 days Sections 4.2.1, 4.2.2 Section 2.2

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 require the firm to meet specific financial ratios in order to renew the loan. * loan covenants may allow the lender to recover all or part of their investment if certain financial conditions are triggered. * lenders monitor managers and pay close attention to the firm's financial reports.

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. Section 3.3.3

A company owns its own office building which it purchased in 2011 for $1,000,000. The real estate market has been volatile in the last few years. The company uses the revaluation model as allowed by IFRS and the following table shows the fair market values since 2011: 2011 1,000 2012 600 2013 800 2014 1,300 The impact (in $ thousands) on the income statement in 2014 will most likely be a gain of: 300. 500. 200.

The revaluation model per IFRS allows the asset to be carried at fair value. If the revaluation decreases the value, as it does here from 2011 to 2012, then later increases the value to the extent that the losses are reversed, it is recognized in profit and loss, so from $800 to $1,000 = $200. Any increase in excess of the reversal will be recorded directly in equity in a revaluation surplus account and not on the income statement: $1,300 - $1,000 = $300. Section 4

The financial statement that would be most useful to an analyst in understanding the changes that have occurred in a company's retained earnings over a year is the statement of: financial position. comprehensive income. changes in equity.

The statement of changes in equity reports the changes in the components of shareholders' equity over the year, which would include the retained earnings account. Section 3.1.3

A company has operated at full capacity throughout the year, and a review of its inventory records for that period indicate that the following costs were incurred: Fixed production overhead $500,000 Direct material and direct labor $300,000 Storage costs incurred during production $25,000 Abnormal waste costs $30,000 The total capitalized costs to inventory during the year are closest to: $825,000. $855,000. $800,000.

The total capitalized costs include fixed production costs, the direct conversion costs of material and labor, and storage costs required as part of production. They do not, however, include abnormal waste costs. $500,000 + $300,000 + $25,000 = $825,000. Section 2

A global equity investor makes investment decisions based on only the P/E. The average P/E of all global equities is 14. The screen of a large number of global equities based on P/E resulted in the following distribution: Earnings Growth P/E Lower third 5% 8 Middle third 10% 15 Top third 8% 25 If the investor selects only stocks from the lower third of the distribution, it would be most appropriate to classify the investor as a: market-oriented investor. value investor. growth investor.

This investor is interested in undervalued stocks (stocks with below-average P/E) and thus is a value investor.

For a company issuing securities in the United States to meet its obligations under the Sarbanes-Oxley Act, which of the following is management required to attest to? * The accuracy of estimates and assumptions used in preparing the financial statements * The adequacy of internal control over financial reporting * The suitability of management and director compensation agreements

To be in compliance with Sarbanes-Oxley, it is To be in compliance with Sarbanes-Oxley, it is mandatory that management's Report to Shareholders discuss internal financial controls and their effectiveness, as well as the company's auditor's opinion of these internal controls. Section 3.1.7

A Canadian printing company that prepares its financial statements according to IFRS has experienced a decline in the demand for its products. The following information (in Canadian dollars) relates to the company's printing equipment as of the current fiscal year end: Carrying value of equipment (net book value) 500,000 Undiscounted expected future cash flows 550,000 Present value of expected future cash flows 450,000 Fair value 480,000 Costs to sell 50,000 Value in use 440,000 The impairment loss (in C$) is closest to: 60,000. 70,000. 0.

Under IFRS, an asset is considered to be impaired when its carrying amount exceeds its recoverable amount (the higher of fair value less cost to sell or value in use). Fair value less costs to sell: 480,000 - 50,000 = 430,000 Value in use = 440,000 Recoverable amount (higher value of the above two amounts) = 440,000 Impairment loss under IFRS = Carrying value (net book value) - recoverable amount Impairment loss = 500,000 - 440,000 = C$60,000 Section 5.1

Under IFRS, the costs incurred in the issuance of bonds are most likely: * deferred as an asset and amortized on a straight-line basis. * included in the measurement of the bond liability. * expensed when incurred.

Under IFRS, debt issuance costs are included in the measurement of the bond liability. Section 2.1

An analyst has assembled the following information with respect to a production facility: Carrying amount 132 Undiscounted expected future cash flows 120 Present value of expected future cash flows 100 Fair value if sold 105 Costs to sell 1 Under IFRS, the impairment loss on this production facility (in £ thousands) will be closest to: 32. 27. 28.

Under IFRS, the carrying amount (£132 thousand) is compared with the higher of fair value minus costs to sell (£104 thousand = £105 - £1) and present value of expected future cash flows (£100 thousand). The higher of the two amounts, the recoverable amount, is £104 thousand; therefore, the asset is impaired and written down to that amount. The impairment loss is = £132 - £104 = £28 thousand. Section 3.2.1 Section 6.6 Section 5.1

Under the International Accounting Standards Board's (IASB's) Conceptual Framework, one of the qualitative characteristics of useful financial information is that different knowledgeable users would agree that the information is a faithful representation of the economic events that it is intended to represent. This characteristic is best described as: verifiability. understandability. comparability.

Under the IASB's Conceptual Framework, verifiability means that different knowledgeable and independent users would agree that the information presented faithfully represents the economic events that it is intended to represent. Section 5.2

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%. 4.8%. 15.2%.

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 Section 4.6.2

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.

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. Section 5.1