FRA3

2/2/23, 12:19 PM Kaplanlearn - Quiz
Question #1 of 106 Question ID: 1472664
If segmental cash flow data has not been reported, we can most appropriately approximate
cash flow as:
A) operating cash flow − cash interest − cash taxes.

B) EBIT + non-cash charges + increase in working capital.
C) EBIT + depreciation + amortization.
C. We are most likely to approximate segment cash flow as EBIT plus depreciation and
amortization. This calculation is necessary because segmental cash flow data is generally
not reported.
In order to compare companies using a common size statement, the various line items in a
company's income statement are most likely to be divided by the company's:
A) revenues.
B) total assets.
C) net earnings.
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High Plains Tubular Company is a leading manufacturer and distributor of quality steel
products used in energy, industrial, and automotive applications worldwide.
The U.S. steel industry has been challenged by competition from foreign producers located
primarily in Asia. All of the U.S. producers are experiencing declining margins as labor costs
continue to increase. In addition, the U.S. steel mills are technologically inferior to the
foreign competitors. Also, the U.S. producers have significant environmental issues that
remain unresolved.
High Plains is not immune from the problems of the industry and is currently in technical
default under its bond covenants. The default is a result of the failure to meet certain
coverage and turnover ratios. Earlier this year, High Plains and its bondholders entered into
an agreement that will allow High Plains time to become compliant with the covenants. If
High Plains is not in compliance by year end, the bondholders can immediately accelerate
the maturity date of the bonds. In this case, High Plains would have no choice but to file
bankruptcy.
High Plains follows U.S. GAAP. For the year ended 2008, High Plains received an unqualified
opinion from its independent auditor. However, the auditor's opinion included an
explanatory paragraph about High Plains' inability to continue as a going concern in the
event its bonds remain in technical default.
At the end of 2008, High Plains' Chief Executive Officer (CEO) and Chief Financial Officer
(CFO) filed the necessary certifications required by the Securities and Exchange Commission
(SEC).
To get a better understanding of High Plains' financial situation, it is helpful to review High
Plains' cash flow statement found in Exhibit 1 and selected financial footnotes found in
Exhibit 2.
Exhibit 1: Cash Flow Statement
High Plains Tubular Cash Flow Statement
Year ended December 31,
in thousands 2008 2007
Net income $158,177 $121,164
Depreciation expense 34,078 31,295
Deferred taxes 7,697 11,407
Receivables (144,087) (24,852)
Inventory (79,710) (72,777)
Payables 36,107 22,455
Cash flow from operations $12,262 $88,692
Cash flow from investing ($39,884) ($63,953)
Cash flow from financing $82,676 $6,056
Change in cash $55,054 $30,795
Exhibit 2: Selected Financial Footnotes
1. During 2008, High Plains' sales increased 27% over 2007. Its sales growth continues to
significantly exceed the industry average. Sales are recognized when a firm order is
received from the customer, the sales price is fixed and determinable, and
collectability is reasonably assured.
2. The cost of inventories is determined using the last-in, first-out (LIFO) method. Had
the first-in, first-out method been used, inventories would have been $152 million and
$143 million higher as of December 31, 2008 and 2007, respectively.
3. Effective January 1, 2008, High Plains changed its depreciation method from the
double-declining balance method to the straight-line method in order to be more
comparable with the accounting practices of other firms within its industry. The
change was not retroactively applied and only affects assets that were acquired on or
after January 1, 2008.
4. High Plains made the following discretionary expenditures for maintenance and
repair of plant and equipment and for advertising and marketing:
in millions 2008 2007 2006
Maintenance and repairs $180 $184 $218
Advertising and marketing 94 108 150
5. During the fiscal year ended December 31, 2008, High Plains sold $50 million of its
accounts receivable, with recourse, to an unrelated entity. All of the receivables were
still outstanding at year end.
6. High Plains conducts some of its operations in facilities leased under noncancelable
finance (capital) leases. Certain leases include renewal options with provisions for
increased lease payments during the renewal term.
7. High Plains' average net operating assets at the end of 2008 and 2007 was $977.89
million and $642.83 million, respectively.
What is the most likely effect of High Plains' revenue recognition policy on net income and
inventory turnover?
A) Only inventory turnover is overstated.

B) Only net income is overstated.
C) Net income and inventory turnover are overstated.
C. Revenue should be recognized when earned and payment is assured. High Plains is recognizing revenue as
orders are received. Since High Plains still has an obligation to deliver the goods, revenue is not yet earned. By
recognizing revenue too soon, net income is overstated and ending inventory is understated. Understated ending
inventory would result in an overstated inventory turnover ratio
In the context of the Beneish model to evaluate the probability of earnings manipulation, an
increase in Days Sales Receivable Index is least likely to signify:
A) a decrease in probability of earnings manipulation.

B) revenue inflation.
A
C) an increase in M-score.
Cash generated from operations (CGO) is least appropriately calculated as:
A) EBIT + non-cash charges − increase in working capital.

B) net income − cash flow from operations − cash flow from investing. ACCRUALS
C) operating cash flow + cash interest paid + cash taxes paid.
When comparing a large company with a much smaller company, which of the following
statements regarding economies of scale is most accurate?
A. Economies of scale are evidenced by larger companies displaying larger gross margins.
Having a larger revenue figure and a larger gross profit does not necessarily imply a larger
margin. An analyst will conclude that economies of scale are present in the industry if the
A)
larger company has higher revenues and a higher gross profit margin.
An analyst will conclude that economies of scale are present in the industry if the
B)
smaller company has a higher gross margin and lower revenues.
An analyst will conclude that economies of scale are present in the industry if the
C)
larger company has higher revenues and higher gross profit.
Wanda Brunner, CFA, is analyzing Straight Elements, Inc., (SE). SE is a discount manufacturer
of parts and supplies for the railroad industry. She has followed her firm's suggested
financial analysis framework, and has assembled output from processing data. When
applying the financial analysis framework, which of the following is the best example of
output from processing data?
A) Common-size financial statements.

B) Audited financial statements.
C) A written list of questions to be answered by the analysis.
A. Common-size financial statements are created in the data processing step of the
framework for financial analysis. Audited financial statements would be obtained during
the "collect input" phase of the financial analysis framework. Creating a written list of
questions to be answered by the analysis is part of the "define the purpose" phase of the
financial analysis framework.
Asma Pharma has made several strategic investments in other pharmaceutical companies.
In each instance, Asma has kept its stake just below 50% so it can account for the
investment using the equity method of consolidation.
Asma's balance sheet quality can be most accurately characterized as:
A) High-quality due to compliance with local GAAP.

B) Low-quality due to bias in measurement.
C) Low-quality due to lack of completeness.
C. One-line consolidation under the equity method obscures the components of balance sheet and artificially
boosts certain profitability ratios (e.g., return on assets or profit margin). This reduces the completeness and
quality of the firm's balance sheet. Compliance with GAAP is a necessary but not sufficient condition for
evaluating quality of financial statements. Equity method of accounting does not by itself lead to measurement
bias.
Garcia Mendoza is currently forecasting revenue for Remnicky Inc., a global provider of
sports statistics to broadcasters. Mendoza is forecasting that Remnicky's revenue growth
rate will be 100bps (1%) higher than global nominal GDP rate next year due to an increased
interest in tracking statistics worldwide. In consultation with his economic research
department, Mendoza has predicted that the real global GDP will grow at 1% next year,
before flattening out and showing zero growth for the next 4 years. Inflation is predicted to
remain steady at 1.5% for the next 5 years. Which of the following statements about
Mendoza's forecast for next year is most accurate?
A) Mendoza is forecasting growth of 3.5% using a hybrid approach.

B) Mendoza is forecasting growth of using a 3.5% top-down approach.
C) Mendoza is forecasting growth of using 2.5% a top-down approach.
B
William Jones, CFA, is analyzing the financial performance of two U.S. competitors in
connection with a potential investment recommendation of their common stocks. He is
particularly concerned about the quality of each company's financial results in 2007–2008
and in developing projections for 2009 and 2010 fiscal years.
Adams Company has been the largest company in the industry, but Jefferson Inc. has grown
more rapidly in recent years. Adams's net sales in 2004 were 33-1/3% higher than Jefferson's
but were only 18% above Jefferson's in 2008. During 2008, a slowing U.S. economy led to
lower domestic revenue growth for both companies. The 10-k reports showed overall sales
growth of 6% for Adams in 2008 compared to 7% for 2007 and 9% in 2006. Jefferson's gross
sales rose almost 12% in 2008 versus 8% in 2007 and 10% in 2006. In the past three years,
Jefferson has expanded its foreign business at a faster pace than Adams. In 2008, Jefferson's
growth in overseas business was particularly impressive. According to the company's 10-k
report, Jefferson offered a sales incentive to overseas customers. For those customers
accepting the special sales discount, Jefferson shipped products to specific warehouses in
foreign ports rather than directly to those customers' facilities.
In his initial review of Adams's and Jefferson's financial statements, Jones was concerned
about the quality of the growth in Jefferson's sales, considerably higher accounts
receivables, and the impact of overall accruals on earnings quality. He noted that Jefferson
had instituted an accounting change in 2008. The economic life for new plant and equipment
investments was determined to be five years longer than for previous investments. For
Adams, he noted that the higher level of inventories at the end of 2008 might be cause for
concern in light of a further slowdown expected in the U.S. economy in 2009.
The accompanying table shows financial data for both companies' Form 10-k reports for
2006–2008 used by Jones for his analysis. To evaluate sales quality, he focused on trends in
sales and related expenses for both companies as well as cash collections and receivables
comparisons. Inventory trends relative to sales and the number of days' sales outstanding in
inventory were determined for both companies. Expense trends were examined for Adams
and Jefferson relative to sales growth and accrual ratios on a balance sheet and cash flow
basis were developed as overall measures of earnings quality.
Adams Company Jefferson Inc.
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900
Sales discounts, returns,

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
Cost of goods sold 15,312 16,384 17,367 12,250 13,250 15,500
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Depreciation expense 625 669 709 500 515 516
Interest expense 400 428 454 360 366 396
Income before taxes 5,835 6,243 6,618 4,668 5,069 5,388
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880
Net addition to retained

501 566 664 208 281 353
earnings
Balance Sheet
Cash and equivalents 150 160 170 120 130 120
Short-term marketable
250 325 345 200 217 195
securities
Accounts receivable (net) 15,875 16,758 17,763 12,700 13,000 15,892
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Accounts payable 7,062 7,880 9,300 6,050 6,100 6,398
Other current liabilities 337 400 450 270 373 1,525
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000
Retained earnings 1,438 2,004 2,668 750 1,031 1,384
Total liabilities and

31,337 33,084 35,518 25,070 25,604 27,907
shareholders' equity
% change gross sales 7.0% 6.0% 8.0% 11.7%
% change sales discounts

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%
% change cost of goods

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
% change in depreciation
6.0% 6.0% 3.0% 0.2%
expense
% change in accounts
6.0% 6.0% 2.0% 22.3%
receivable
% change in inventories 5.0% 13.8% 0.0% (13.5%)
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding
Balance sheet accrual

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
Cash flow accrual ratio 3.4% 3.5% 3.8% 2.0% 2.0% 4.3%
Jones observed that comparisons of 2007–2008 trends in sales, accounts receivables, and
cash collections showed:
Jefferson’s higher increase in sales relative to Adams’s led to improvement in cash

A) collections indicated by the rise in the revenue/collections ratio. There was no
change in Adams’s cash collections in 2008.
Jefferson’s sales growth accelerated in 2008 compared to Adams’s, but cash
collections declined as indicated by the rise in receivables and the
B)
revenue/collections ratio; Adams’s sales, accounts receivables, and cash collections
rose at similar rates in 2008.
Jefferson’s decline in cash and equivalents in 2008 resulted in lower cash collections
C) despite strong sales growth; Adams’s showed similar growth in cash and equivalents
and accounts receivable relative to sales gains.
B. The increase in Jefferson's revenues relative to cash collections along with the large
increase in accounts receivable indicates declining cash collections in 2008 compared to
its experience in 2007 and relative to Adams's, which showed consistency in both years.
Pysha Heavy Metals Ltd. supplies specialized metals to the chip fabrication industry.
Selected financial data for Pysha, as well as industry comparables, are shown below:
Pysha selected financial data (£ '000s):
20x7 20x8 20x9
Sales 1,169 1,312 1,414
Accounts receivable 58.45 72.16 98.98
Industry average:
20x7 20x8 20x9
DSO 22.6 22.8 22.4
Receivables turnover 16.2 16.0 16.3
Based on the trend in revenues and receivables, it can be most accurately concluded that:
A) Pysha’s revenues are growing at a faster rate than its receivables.

B) Pysha’s revenues are growing at a slower rate than its receivables.
C) The revenue growth rate divided by receivables growth rate is increasing over time.
Jared Mush is preparing a report on the Everystate corporation. The information below
pertains to the year ending 31 December 2015 and 2016.
Dec. Dec.
31,2016 31,2015
Property-Liability 32,567 31,309
Everystate Financial 3,928 4,309
Corporate and Other 39 35
Consolidated revenues $ 36,534 $ 35,618
Mush believes that for 2017, the growth rate in property/liability is 3%, financial is 2% and
corporate and other is 0. The estimated revenues for 2017 is closest to:
A) $38,230
B) $36,678 C
C) $37,590
An analyst finds return-on-equity (ROE) (based on beginning of the year equity) a good
measure of management performance and wants to compare two firms: Firm A and Firm B.
Firm A reports net income of $3.2 million and has a ROE of 18. Firm B reports income of $16
million and has an ROE of 16.
A review of the notes to the financial statements for Firm A, shows that the earnings include
a loss from smelting operations of $400,000 and that the firm has exited this business. In
addition, the firm sold the smelting equipment and had a gain on the sale of $300,000.
A similar review of the notes for Firm B discloses that the $16 million in net income includes
$2.6 million gain on the sale of no longer needed office property. Assume that the tax rate
for both firms is 36%, and that the notes describe pre-tax amounts. Which of the following is
closest to the "normalized" ROE for Firm A and for Firm B, respectively?
A) 16.0 and 18.0.

C.
B) 17.1 and 16.9.
C) 18.4 and 14.3.
Kerry Winstone covers TVStream Inc., a U.S. based company offering streaming video. She
has carried out an analysis using Porter's five forces model. The table below summarizes her
main conclusions.
Force Factors
Threat of substitutes Broadcast TV and DVD media are cost-effective substitutes.
There are several companies in the industry and TVStream

Rivalry
has a 25% market share.
Bargaining power of The content must be purchased from the major networks
suppliers and movie studios.
Bargaining powers of Customers are fragmented and the base consists largely of
buyers individual subscribers.
Major TV networks are in position to launch their own

Threat of new entrants
streaming service using existing technologies.
Winstone should most appropriately conclude that:
TVStream is likely to have a large degree of pricing power and above average
A)
profitability due to favorable bargaining power of suppliers.
TVStream is likely to have a high degree of pricing power derived largely from high
B)
barriers to entry.
TVStream is unlikely to have a large degree of pricing power and below average
C)
profitability due to threat of new entrants.
C
Which of the following is least likely an indicator of high-quality cash flow?
A) OCF derived from sustainable sources.

B) Total cash flow that is positive and high.
C) OCF adequate to cover capital expenditures, dividends and debt repayments.
B. High-quality cash flow focuses on positive, adequate and sustainable operating cash flow.
Firms with high borrowings could have high total cash flow but such cash flows would not
be sustainable (nor considered high-quality).
Galaxy Company recognized a restructuring charge in its year-end income statement. Similar
restructuring charges have occurred in the past. In addition, Galaxy recognized an
extraordinary loss. Galaxy uses the term "operational earnings" when discussing its financial
results. According to Galaxy, "operational earnings" excludes special nonrecurring
transactions such as restructuring charges, discontinued operations, and extraordinary
items. Should the restructuring charge and extraordinary loss be included or excluded from
"operational earnings" for analytical purposes?
A) One is included. A. The restructuring charge does not appear to be nonrecurring;

thus, it should be included
B) Both are included. in "operational earnings." By definition, an extraordinary loss is
unusual in nature and
infrequent in occurrence. Therefore, the extraordinary loss should
C) Both are excluded. be excluded from
"operational earnings."
Complete the following sentence. An analyst would apply _________ to the cash component of
income compared to the accrual component when evaluating company performance.
A) a lower weighting.
B) a higher weighting.
C) the same weighting.
B. Since the cash component has more sustainability in the future than the accrual
component, an analyst would apply a higher weighting to the cash component of income
than the accrual component when evaluating company performance.
Which one of the following choices is least likely to be an indicator of poor-quality earnings?
A) An investigation by the market regulatory authority is initiated.

B) Restatement of previously issued financial statements.
C) Reported earnings handily beat analyst estimates.
C. Enforcement actions by regulatory authorities and restatements of previously issued
financial statements are two (external) indicators of poor-quality earnings. Earnings that
meet or narrowly beat analyst estimates are considered to be suspect for poor quality.
Handily beating analyst estimates is not considered to be an indicator of poor-quality
earnings.
PixOut Inc. is a U.S. based manufacturer of waterproof cameras. PixOut's products are
typically used by leisure customers wishing to use a camera for snorkeling and deep-sea
diving. The cameras come in at a reasonable price point and are aimed primarily at the
'point and shoot' market. Recently, a rival manufacturer has brought an extremely cheap
waterproof case for smart phones to the market, and this is having a definite impact on
PixOut's sales.
Torsten Gruber is forecasting the impact the phone cover may have on PixOut's revenue
next year. Gruber's predicted sales figures in units are shown below:
2014E
PixOut cameras sold (units) 42,505
Sales of smart phone covers (units) 11,044
Gruber is assuming that a percentage of the phone cover sales have cannibalized PixOut
camera sales. In predicting the sales for 2014, he is assuming a 25% cannibalization rate. In
addition, he forecasts the average selling price of a PixOut camera is $185 and the average
selling price of the smart phone cover is $80.
Which of the following is closest to Gruber's estimate of the revenue lost by PixOut due to
cannibalization in 2014?
A) $5,898,000. Number of phone covers sold = 11,044

Cannibalization rate = 25%
B) $510,785. Number of camera sales lost = 11,044 × 25% = 2,761
Revenue lost = 2,761 × $185 = $510,785
C) $265,056.
An analyst is developing a framework for financial statement analysis for his firm. The
primary goal of financial statement analysis is to:
A) facilitate an economic decision.

B) document portfolio changes for purposes of the Prudent Investor Rule.
C) justify trading decisions for purposes of the Statement of Code and Standards.
A. The primary goal of financial statement analysis is to facilitate an economic decision. For
example, the firm may use financial analysis to decide whether to recommend a stock to
its clients. Documentation and justification of trading decisions may be aided by financial
statement analysis, but these are not the primary purposes.
Janet Smith has gathered the following information for the Power Tools Manufacturer
market in the U.S. and this is part of the first phase of analyzing the businesses in the
industry. The following issues are relevant:
1. Raw material and component purchases consist mainly of plastics (for casing) and
motors (for power). Some hardened steel is required to make drills and bits.
2. Access to a reliable and efficient source of supply is critical, especially with regard to
the electric motor.
3. Two manufacturers in the U.S. produce over 90% of the electric motors for the U.S.
markets.
4. Workers in the industry have a strong and well-organized union. As a result, the rate
of compensation growth is a cause for concern, as is the associated health and
pension benefits accruing to the work force.
5. Industry revenues have tended to track the fluctuations of the wider economy.
6. Sales growth in the industry has been 5% compounded annually over the past eight
years.
7. Non-U.S. sales grew 10% compounded annually over the last eight years.
8. The rate of growth in home ownership and new home starts is directly related to the
future volumes of power tool sales.
9. The three largest global producers of power tools control 80% of the U.S. markets,
down from 85% five years ago.
10. Economies of scales are critical to efficient and cost effective use of manufacturing
resources.
11. High capital expenditure is required to maintain plant and equipment.
12. The major areas for competition for all the manufacturers are price and delivery
times, these are the critical areas of concern for the major retail outlets.
13. China has become the third largest global market for power tools, and significant
production facilities in this market have led to the potential for major export growth
to the U.S. In other industries, Chinese producers have been able to match and often
better local producers on price and delivery times.
14. 75% of sales in the U.S. market are made through 12 major retail chains. They are
always looking for ways to reduce the price they pay to manufacturers.
15. Sales of power tools is highly seasonal due to customer buying patterns often related
to the weather.
16. Consumers are looking for value for money but surveys indicate that they are not only
looking for the lowest price. They do value quality and surprisingly the look of the
product is more important than many thought.
17. Taking a broad view of the markets, it is difficult to envisage alternative products and
technologies playing a significant role in the development of the market for the
foreseeable future.
Question #21 - 24 of 106 Question ID: 1472690
Which of the following is the most accurate statement with regard to the bargaining power
of buyers?
A) This force is strong due to comment (14).

B) This force is strong due to comment (16).
C) This force is weak due to comment (13).
A
Which of the following is the most accurate statement with regard to the bargaining power
of suppliers?
A) This force is weak due to (2), (3), and (4).

B) This force is strong due to comments (2), (3), and (4).
C) This force is average due to (2), (3), and (4).
B
Which of the following is the most accurate statement with regard to the threat of new
entrants?
A) This force is strong due to comments (10) and (11) .

B) This force is weak due to comments (10) and (11).
C) This force is average due to comments (10), (11), and (13).
Which of the following is the most accurate statement with regard to the availability of
substitute products?
A) This force is weak due to comment (16).
B) This force is strong due to comment (17).

C) This force is weak due to comment (17).
C
Joe Carter, CFA, believes Triangle Equipment, a maker of large, specialized industrial
equipment, has overstated the salvage value of its equipment. This would:
A) understate earnings.
B) overstate liabilities. C. Overstating the salvage value reduces depreciation
expense, which in turn increases
C) overstate earnings. earnings.
Express Delivery Inc. (EDI) reported the following year-end data:
Depreciation expense $30 million
Net income $30 million
Total assets $535 million
Shareholder's equity $150 million
Effective tax rate 35 percent
Last year EDI purchased a fleet of delivery vehicles for $140 million. For the first year,
straight-line depreciation was used assuming a depreciable life of 7 years with no salvage
value. However, at year-end EDI's management determined that assumptions of a useful life
of 5 years with a salvage value of 10 percent of the original value were more appropriate.
How would the return on assets (ROA) and return on equity (ROE) for last year change due to
the change in depreciation assumptions? ROA and ROE would be closest to:
A. Under the new depreciation assumptions, depreciation expense would
A) ROA 5.0% and ROE 18.2%. be (140-14)/5 = 25.2 million.
Under the original assumptions depreciation of the fleet was 20 million.
B) ROA 5.7% and ROE 19.5%. Therefore depreciation increases by 5.2 million.
C) ROA 5.3% and ROE 20.5%.

Note that assets would have been lower by $5.2 million due to the new depreciation assumptions and shareholder's equity
by $3.38 million (5.2 × (1 - 0.35)) due to lower retained earnings. Tax liabilities would have fallen by $1.82 million to
balance the $5.2 million reduction in assets. Therefore, ROA would have been 5.0% (26.62 / 529.80) and ROE would have
been 18.16% (26.62 / 146.62).
Samuel Maskin, CFA is evaluating the financial statements of Northern Energy Inc. The
following is an extract from Northern's cash flow statement for the past three years:
20x6 20x5 20x4
Net Income $1,023 $988 $744
Depreciation $187 $145 $128
Restructuring Charges $(108) $(104) $212
Accounts receivable $(172) $(145) $(33)
Inventories $(418) $(202) $(180)
Accounts Payable $38 $37 $33
OCF $550 $719 $904
Which of the following conclusions is least likely for Northern?
A) Northern may have accelerated revenue recognition.

B) Days sales outstanding is probably increasing.
C) Northern is stretching payables.
C. We are not provided with income statement data such as revenues and COGS and hence have to make inferences
from the information provided. Accounts payable seem to be stable and decreasing as a percentage of net income
making the conclusion of stretching payables least likely. Revenue acceleration can be concluded based on large
increase in inventory in 20x6 (possibly reflecting returns from customers) combined with increases in accounts receivable
over time. Increases in accounts receivable (relative to earnings) also would indicate that days sales outstanding would
most likely be increasing.
Which of the following choices is most likely a biased accounting choice to overstate
profitability?
A) Classifying non-operating expenses as operating.

B) Lessor use of sales-type finance lease classification.
C) Channeling gains through OCI and losses through income statement.
B. Lessor use of sales-type finance lease classification results in Lessor recognizing the gross
profit at inception of the lease and is a mechanism to overstate profitability. Classifying
non-operating expenses as operating and channeling gains through OCI and losses
through income statement would understate profitability.
Samuel Maskin, CFA is evaluating the financial statements of Northern Energy Inc. The
following is an extract from Northern's cash flow statement for the past three years:
20x6 20x5 20x4
Net Income $1,023 $988 $744
Depreciation $187 $145 $128
Restructuring Charges $(108) $(104) $212
Accounts receivable $(172) $(145) $(33)
Inventories $(418) $(202) $(180)
Accounts Payable $38 $37 $33
OCF $550 $719 $904
The restructuring charges for Northern has most likely:
Reduced reported earnings in 20x4 while increasing reported earnings in 20x5 and
A)
20x6.
Increased reported earnings in 20x6 while reducing reported earnings in 20x4 and
B)
20x5.
Increased reported earnings for 20x4 while reducing reported earnings in 20x5 and
C)
20x6.
A. Restructuring charges contribute positively to 20x4 cash flow indicating that it was a noncash charge against
that year's income. In the following two years, there is a reversal of
that charge leading to an artificial increase in reported earnings for 20x5 and 20x6.
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:
The LIFO reserve is declining.

Earnings are much higher in the September quarter than in other quarters.
Many nonoperating and nonrecurring gains are being recorded as revenue.
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?
A) Nonoperating and nonrecurring gains recorded as revenue.

B) Equity investment earnings not reflected on the cash-flow statement.
C) The declining LIFO reserve.
B. 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.
Coastal Drilling Corp (CDC) reported the following year-end data:
EBIT $23 million
EBT $20 million
CDC reported in the footnotes to its financial statements that it had increased the expected
return on pension plan assets assumption which resulted in an increase of EBIT of $2
million. Analyst Wanda Brunner, CFA, thinks this change in assumptions is unfounded and
removes the $2 million increase in EBIT. Which of the following is closest to the tax burden
ratio after adjustment?
A) 55.6%.
B. Tax burden = NI/EBT or 1 - the effective tax rate. The increase in the return on pension
B) 60.0%. plan assets assumption increased EBIT, EBT, Income Taxes, and Net Income from what it
would have been. Removing $2 million from the reported numbers will reduce EBIT, EBT,
C) 61.9%. Income Taxes, and Net Income. However, the tax burden ratio will still be 1 - the effective
tax rate.
An analyst is analyzing TRK Construction (TRK) for possible recommendation to his firm's
clients. He wants to use TRK's financial statements to answer such questions as "Is TRK
suitable for firm clients?", "Is TRK priced properly relative to peers?", "What is TRK's earnings
quality?" The analyst is most likely to begin with:
A) a DuPont analysis.
B) a review of his firm’s framework for analysis of financial statements.
C) analysts adjustments to the financial statements.
B. Analysis of financial statements should be performed in the context of an overall
framework for the analysis of financial statements. Specific adjustments or analysis of
specific ratios is a secondary concern.
Classification of non-operating income as operating would lead to stated earnings that are
likely to be:
A) compliant with GAAP and sustainable.

B) non-compliant with GAAP.
C) compliant with GAAP but not sustainable.
C
A manufacturing firm purchases equipment for use in its operations. With regard to
recording the purchase using the cash basis versus the accrual basis of accounting, which of
the following statements is most appropriate?
With the cash basis, revenues and expenses relating to the equipment are generally
A)
recognized in the same period.
With the cash basis, revenues and expenses relating to the equipment are generally
B)
recognized in different periods.
With the accrual basis, the cost of the equipment is allocated to the cash flow
C)
statements
B. With the cash basis over the
of accounting, asset’sare
revenues life.
recognized when cash is collected and expenses are recognized when
cash is paid. Therefore, the cash flows may occur in different periods than when the revenues are actually earned or when
the expenses are actually incurred. For example, the purchase of equipment used in a firm's manufacturing operation may
result in an immediate cash outflow but the equipment generates revenues over its useful life. In this case, the revenues and
expense are reported in different periods.
With the accrual basis of accounting, revenues are recognized when earned and expenses are recognized when incurred,
regardless of the timing of the cash flows. With the equipment purchase, the cost of the equipment will be allocated to the
Question #35 of 106
income statement (not cash flow statement) over the asset's life and at the same time, matched with the revenues generated.
Question ID: 1472641
remain unresolved.
bankruptcy.
(SEC).
Exhibit 2.
Net income $158,177 $121,164
Receivables (144,087) (24,852)
Inventory (79,710) (72,777)
Payables 36,107 22,455
in millions 2008 2007 2006
Does High Plains' accounting treatment of its finance (capital) leases and receivable sale
lower its earnings quality?
A) The treatment of finance (capital) leases lowers earnings quality.

B) The treatment of the receivables sale lowers earnings quality.
C) Both treatments lower earnings quality.
B. A finance (capital) lease is reported on the balance sheet as an asset and as a liability. In the income statement, the
leased asset is depreciated and interest expense is recognized on the liability. Thus, capitalizing a lease enhances earnings
quality. An operating lease lowers earnings quality.
The receivable sale, with recourse, lowers earnings quality. The sale is treated as a collection thereby increasing operating
cash flow. However, High Plains is still responsible to the buyer in the event the receivables are not ultimately collected.
Thus, the receivable sale is a collateralized borrowing arrangement that remains off-balance-sheet.
Pritesh Deshmukh, CFA is analyzing the financial statements of Baza Restaurants Inc.
Deshmukh wants to use the Beneish model to evaluate the probability of earnings
manipulation.
Deshmukh makes the following statements:
1. Depreciation index of less than 1 would indicate that the company is depreciating
assets at a lower rate than in prior years.
2. Sales growth index of more than 1 indicates revenue inflation.
Which of the statements by Deshmukh are most accurate?
A) None of the statements is accurate.

B) Statement 1 only.
C) Statement 2 only.
A. Statement 1 is incorrect. Depreciation index of less than 1 indicates that the company is
depreciating assets at a higher rate than in prior years. Statement 2 is incorrect. Sales
growth index of more than 1 simply implies that the growth in sales is positive. While not a
measure of manipulation by itself, growth companies tend to find themselves under
pressure to manipulate earnings to meet ongoing expectations.
Which of the following items is least likely to involve the use of subjective measurement
estimates by management?
A) Use of criteria to determine treatment as an extraordinary item.

B) Use of FIFO (first in-first out) to cost inventories.
C) Use of straight-line depreciation method to depreciate tangible assets.
A. The use of criteria to determine treatment as an extraordinary item (i.e. Is the item within management's discretion? Is
the event likely to recur in the foreseeable future?) does not involve numerical and subjective estimates per se. It is more a
test of qualitative factors to determine the proper classification. Contrast this to FIFO, which is clearly a numerical
estimate since an alternative of using LIFO (last in-first out) is possible and this will result in a different reported amount
than FIFO. The same argument can be made for the use of the straight-line method since an alternative of using the
declining-balance method is possible to depreciate tangible assets.
Deluxe Toys Inc. produces electronic toys for 2-12 year olds. The most recent income
statement for Deluxe is given below:
Revenues 1500
Cost of goods sold 630
Selling expenses 120
Administrative expense 330
Operating profit 420
Ben Sharpe, Analyst with AP Partners, is forecasting Deluxe's operating profit for the next
fiscal year. Sharpe believes that a new sales tax of 10% is going to be imposed on electronic
toys. Sharpe also believes that cost of goods sold will remain the same per unit sold. Selling
expenses are a fixed percentage of sales, while administrative expenses are fixed. Deluxe is
expected to pass on the entire cost of the sales tax to the consumer. The price elasticity of
demand for Deluxe's toys is 0.75 (e.g., volume will decrease by 7.5% when the effective price
increases by 10%.) Forecasted operating margin for the next year is closest to:
A) 21% C. New sales (including tax) = 1500 × (1 - 0.075) × (1 + 0.10) = 1526.25

Sales tax = (1526.25 / 1.10) × 10% = 138.75 (divide by 1.10 because need to find out net-tax
B) 26% taxable base)
Net sales = 1387.50
C) 23% Due to 7.5% reduction in units sold, COGS will decline to 630 × (1 - 0.075) = 582.75
Selling expenses currently are 8% of sales. New selling expense = 1526.25 × 0.08 = 122.10
Administrative expenses are fixed at 330.
Operating profit = 1387.50 - 582.75 - 122.10 - 330 = $352.65, which is 23.11% of $1526.25.
Aggressive revenue recognition practices are least likely to increase:
A) reported ending inventory

B) reported expenses
C) reported assets
A. Aggressive revenue recognition practices would increase accounts receivable, revenues, expenses, income and
stockholder's equity. Ending inventory would decline but by less than the increase in accounts receivable resulting in
increase in total assets. Early recognition of revenues also accelerates recognition of expenses (COGS).
ABC Tie Company reports income for the year 2009 as $450,000. The notes to its financial
statements state that the firm uses the last in, first out (LIFO) convention to value its
inventories, and that had it used first in, first out (FIFO) instead, inventories would have been
$62,000 greater for the year 2008 and $78,000 greater for the year 2009. If earnings were
restated using FIFO to determine the cost of goods sold (COGS), what would the net income
be for the year 2009? Assume a tax rate of 36%. Net income would have been:
A) $439,760.
B) $455,760. C. The reduction in COGS would result in an increase in net income (62,000 - 78,000)
× (1 - 0.36).
C) $460,240.
Recently, Galaxy Corporation lowered its allowance for doubtful accounts by reducing bad
debt expense from 2 percent of sales to 1 percent of sales. Ignoring taxes, what are the
immediate effects on Galaxy's operating income and operating cash flow?
Operating Operating cash

income flow
A) Higher No effect
B) No effect Higher
C) Lower Lower
A. Lower bad debt expense will result in higher operating income. Operating cash flow is not
affected until Galaxy actually collects the receivables.
A firm seeking to lower current tax liability may elect to use which method of inventory
valuation during an inflationary period?
A) FIFO.
B) Average cost.
C) LIFO.
c. During an inflationary period, using LIFO would increase COGS, since the most recent
(highest cost) inventory would be sold. Therefore, earnings and taxes would be lowest
under LIFO.
Which of the following statements about cash flow is (are) CORRECT?
Statement #1: The cash effects of decreasing accounts payable turnover are unlimited.
The tax benefits from employee stock options can result in a significant
Statement #2:
source of investing cash flow.
Statement #1 Statement #2
A) Incorrect Correct
B) Correct Incorrect
C) Incorrect Incorrect
C. 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.
Which of the following statements regarding pricing power is most accurate? A company is
most likely to have a high level of pricing power, if it is operating in an industry that:
A) is fragmented.
B) has low barriers to exit.
C) has high fixed costs.
B. Pricing power is most likely to be low in industries that are fragmented, have limited
growth potential, have high barriers to exit, have high fixed costs, and in industries where
the product offerings are essentially identical.
Which of the following statements about financial disclosures are correct or incorrect?
Transitory earnings are usually more important to investors than

Statement #1:
permanent earnings.
Pro-forma earnings are usually prepared in accordance with generally

Statement #2:
accepted accounting principles.
A) Only statement #2 is incorrect.
B) Only statement #1 is incorrect.

C) Both are incorrect.
c. Statement #1 is incorrect. Investors are usually more interested in permanent earnings.
Statement #2 is incorrect. Pro-forma earnings are not prepared in accordance with
generally accepted accounting principles because they may exclude certain transactions.
This is why it is important for an analyst to understand the disclosures.
Brent Jones, CFA is analyzing the financial statements of Imperial Resorts Inc. Jones wants to
use the Beneish model to evaluate the probability of earnings manipulation.
Jones makes the following statements:
1. Depreciation index of less than 1 would indicate that the company is depreciating
assets at a higher rate than its peers.
2. Increases in Asset quality index indicate that the revenue recognition policies are
conservative.
Regarding the statements by Jones:
A) None of the statements is correct.

B) Only statement 1 is correct.
C) Only statement 2 is correct.
a. Statement 1 is incorrect. Depreciation index less than 1 indicates that the company is
depreciating assets at a higher rate than in prior years (and not relative to its peers).
Statement 2 is incorrect. Asset quality index is used as an indicator of excessive
capitalization of expenses.
Classification shifting is least likely to result in a higher:
A) equity value derived when earnings forecasts are based on operating earnings.
B) reported net income.
C) firm value derived when cash flow forecasts are based on core earnings.
b. Classification shifting results in inflation of core or recurring earnings while keeping the
total reported income same. This is used to mislead analysts into using a higher number
as a basis for generating forecasts of future earnings and cash flows. Such erroneous
forecasts would then result in inflated equity and firm valuation.
Victor Mendoza is an equity analyst for LLT Partners, a private wealth management firm.
Mendoza is currently valuing Testo Inc, a seller of smart phones. While reviewing the
financials, Mendoza collects sales information of two of Testo's popular models as indicated
below (figures in $ millions):
Year 20x1 20X2 20X3
Alpinex 88.9 92.3 97.5
Bemax 0 54 433
The annual growth rate for both models combined from 20x1 to 20x3 is closest to:
A) 144%
A. Combined sales in 20X1 = 88.9. Combined sales in 20X3 = 97.5 + 433 = 530.5.
B) 44% Annual growth rate = ([530.5 / 88.9]^1/2) -1 = 1.44 or 144%
C) 496%
Dan Partrino is currently constructing pro-forma accounts for Rooling Inc., an engineering
company based in the U.S. He has put together the following forecast for the next 3 years:
2013 2014E 2015E 2016E
$millions $millions $millions $millions
Sales 935 954 973 993
PPE (NVB) 295
EBITDA 239 253 278
Net Income for

95 107 130
year
Partrino is now forecasting the balance sheet and intends to use the following assumptions:
Capital expenditure will remain constant at 2.5% of sales for the foreseeable future.
Depreciation will be 1.5% of sales in 2014, 1.7% of sales in 2015 and 1.9% of sales in
2016.
Partrino's forecast of the net book value of PPE at the end of 2016 is closest to:
A) $325 million.
B) $304 million.
C) $318 million.
c. use 2.5% of sales - depreciation. add the sum to ppe
Star Chemical Inc. (SCI) reported the following year-end data:
Depreciation expense $25 million
Net income $35 million
Dividends $10 million
Total assets $250 million
Shareholder's equity $195 million
SCI also reported that it changed from an accelerated depreciation method to straight line
depreciation. The change resulted in a decrease in depreciation expense of $5 million.
Management felt that the change "would not have a material effect on financial performance
measures." Ignoring deferred taxes, what are the return on assets (ROA) and return on
equity (ROE) measures under the old depreciation methods?
A) ROA is 13.50% and ROE is 17.51%.

B) ROA is 13.30% and ROE is 17.05%.
C) ROA is 12.96% and ROE is 16.56%.
c.
Rapid Tech Inc has mistakenly overestimated the useful lives of their PP&E: it has become
apparent that due to rapid changes in technology, a significant part of Rapid's PP&E will
need to be replaced sooner than anticipated. Rapid's CFO has indicated that the new
depreciation schedules will take into account the shortened lives of the PP&E that will be
acquired as replacement. The most likely impact on Rapid's future return on invested capital
(ROIC) is that ROIC will:
A) decrease.
B) increase.
C) remain the same.
a. Increases in PP&E will increase invested capital, while higher depreciation expense will
reduce earnings. Both factors will reduce the return on invested capital.
Which of the following statements about operating income and operating cash flow are
correct or incorrect?
If operating income is growing faster than operating cash flow over the
Statement #1: long-term, the firm may be recognizing revenue too soon or delaying the
recognition of expense.
Operating cash flow exceeding operating income is sustainable over the

Statement #2:
long-term.
A) Both are incorrect.

B) Only one is correct.
C) Both are correct.
b. Statement #1 is correct. If operating income and operating cash flow are growing at
different rates over the long-term, the firm may be engaging in earnings manipulation.
Statement #2 is incorrect. Over the long-term, operating cash flow will eventually decline
without the support of operating income.
Andre Bursh, is analyzing large retailers and has collected the following information on three
companies based on the most recent financial statements:
Allied Stores Beta Mart Cash-N-Carry
Total Earnings (per share) $2.80 $1.33 $0.75
Cash element $1.90 $0.78 $0.25
Accrual element $0.90 $0.55 $0.50
Bursh notes that all three companies have reported stellar earnings this past year. Bursh is
concerned about sustainability of such high earnings. Which company's earnings will revert
to its mean fastest? a. Cash-N-Carry's earnings is comprised of large proportion of accruals
(0.50/0.75 or 67%).
Allied's accruals comprise (0.90/2.80) 32% of earnings and Beta's accruals
A) Cash-N-Carry. comprise 41% of
earnings.
B) Allied Stores.
C) Beta Mart.
The failure to recognize inventory obsolescence is an example of ___________.
A) Misclassifying expenses.
B) Understating expenses.
C) Delaying expenses.
b. Inventory must be tested for obsolescence using the lower-of-cost-or-market method. Obsolete inventory must be
written down (expensed) in the income statement which results in lower earnings. Thus, failure to recognize obsolescence
understates expenses and overstates earnings. Delaying expenses involves deferring recognition to a future period.
Delaying expense is the result of capitalizing a cost instead of immediately recognizing the cost in the income statement.
This is not the same as failing to recognize inventory obsolescence. Investors typically focus more on operating income
than nonrecurring and non-operating income. Thus, firms may have an incentive to increase operating income by
misclassifying an operating expense as a nonrecurring or non-operating item. Therefore, failure to recognize
Question #55 of 106
obsolescence is not an example of misclassification. Question ID: 1472698
Yolanda Resham is currently developing a forecast horizon for several companies that she
covers in her role as an equity analyst. The equities under consideration are part of a
portfolio with an average annual turnover of 25%. Which of the following statements is least
accurate regarding the choice of time horizon?
A) The time horizon should be independent of the average holding period for a stock.
B) A time horizon of 4 years would be consistent with the portfolio turnover.
C) Cyclicality should be considered when developing the timeframe.
a. The holding period should be considered. An average annual turnover of 25% is consistent
with a holding period of 4 years (1/0.25).
Ben Lorson is analyzing the revenue growth of Symphonica Inc., a retailer of audio visual
equipment. Relevant data for the last two years is shown below:
2013 2012
$ millions $ millions
Revenue 1,408 1,375
Total market size 17,606 17,450
$ billions $ billions
Nominal GDP growth 16,451 16,400
He is looking at three methods of predicting revenue for 2014:
1. Assume that Symphonica retains its 2013 share of the market for 2014, and the total
market grows at the same rate as it did last year.
2. Assume that revenue growth rate is equal to previous year's nominal GDP growth
rate.
3. A bottom-up approach which assumes that the growth rate of Symphonica's revenue
will be the same as last year
Which of the following statements regarding Lorson's forecast is most accurate?
Lorson’s market growth and market share model predicts a higher 2014 revenue
A)
figure for Symphonica than his bottom-up approach.
Lorson’s growth relative to GDP growth model predicts a higher 2014 revenue figure
B)
for Symphonica than his market growth and market share model.
C) Lorson’s bottom-up approach predicts the highest revenue for 2014.
C
Complete the following sentence. The cash component of income is ___________ than the
accrual component.
A) the same persistence. b. The accrual component of income (accruals) is less persistent than the
cash component.
B) more persistent. By persistent we mean the income is sustainable; that is, a dollar of
earnings today implies
a dollar of earnings in future periods. Lower persistency is partially due to
C) less persistent. the estimates
involved with accrual accounting.
Alex Fisher, CFA, is examining the phenomenon of mean reversion on the earnings of several
firms. Which of the following statements regarding mean reversion is least accurate?
A) Normal earnings should not be expected to continue indefinitely.

B) High earnings should not be expected to continue indefinitely.
C) Low earnings should not be expected to continue indefinitely.
a
Deluxe Toys Inc. produces electronic toys for 2-12 year olds. Ben Sharpe, Analyst with AP
Partners, is forecasting Deluxe's operating profit for the next fiscal year. Sharpe notices that
Deluxe's selling expenses have increased from 5% of sales to 8% of sales over last few years.
This is most likely to be due to the force(s) of:
A) Intra-industry rivalry and threat of substitutes.

B) Threat of new entrants and bargaining power of buyers.
C) Intra-industry rivalry and threat of vertical integration.
a. Increased selling expenses are consistent with an investment in building brand loyalty,
which is an appropriate response to a threat of substitutes and intra-industry competition.
By spending more on advertising, Deluxe can build brand loyalty, thus improving its
competitive position versus rival toy makers and alternative products.
With regard to specific measures to analyze in detecting manipulation in the financial

reporting process, which of the following statements is the least accurate?
An increasing days’ inventory on hand (DOH) measure may be indicative of obsolete

A)
inventory.
Negative nonrecurring or non-operating items may be indicative of misclassifying an
B)
operating expense.
A decreasing days’ sales outstanding (DSO) measure may be an indication of lower
C)
quality revenue.
C. Days' sales outstanding (DSO) measures the number of days it takes to convert receivables into cash and is
calculated by dividing the number of days in the period by the accounts receivable turnover ratio. An increasing DSO
(decreasing receivables turnover) may be an indication of lower quality revenue; that is, the longer it takes to collect
from customers, the more likely the receivables will turn into bad debt. Days' inventory on hand (DOH) is equal to the
number of days in the period divided by inventory turnover ratio and it measures the number of days it takes to sell
inventory. An increasing DOH may be indicative of obsolete inventory. Analysts should compare changes in the core
operating margin over time and look for negative nonrecurring (e.g., restructuring charges, asset impairments, and
write-downs) or non-operating items that occurred when the ratio increased. This may be the result of misclassifying an
operating expense.
Sustainable earnings are most likely to be driven by:
A) Conservative revenue recognition practices.

B) Cash flow element of earnings.
C) Accruals element of earnings.
B. Sustainable and persistent earnings are driven by cash flow element of earnings. The
stability and accuracy of earnings forecasts can be reduced by estimation process that
generates the accruals component of earnings. Conservative and aggressive revenue
recognition practices both would result in reversion in earnings (and hence lowers the
sustainability of earnings).
To assess the quality of financial reports, which question is least necessary for an analyst to
answer?
A) Do earnings represent an adequate level of return?

B) Are reported earnings consistent with the firm’s budget?
C) Are the financial reports decision useful and GAAP compliant?
B. Quality of financial reports is assessed by answering two questions: Whether the financial
reports are decision useful and GAAP compliant and whether the results quality is high
(i.e., earnings provide adequate return on capital and are sustainable).
Jeremy Jennings is explaining the concept of earnings quality to his new colleagues. Which of
the following measures is most indicative of a higher quality of earnings when attempting to
forecast future earnings?
A) Higher level of earnings.

B) Higher degree of persistence of earnings.
C) Higher degree of conservatism of earnings.
Endrun Company reported net income of $4.7 million in 1999, and $4.3 million in 2000. In
reviewing the annual report an analyst notices that the Endrun took a charge of $2.4 million
in 1999 for the costs of relocating its main office, and in 2000 booked a gain of $900,000 on
the sale of its previous office building. What would "normalized earnings" be for 1999 and
2000 if we assume a tax rate of 36% for both years?
A) $7.1 million and $5.2 million. B. You will increase 1999 earnings by the tax-adjusted
value of the 2.4 million one-time
B) $6.236 million and $3.724 million. charge (2.4 × (1 - 0.36) = +1.536), and you would
decrease Y2000 earnings by the taxadjusted amount of
C) $3.99 million and $2.54 million. the $0.9 million one-time gain (0.9 × (1 - 0.36) = -0.576)
Everystate Corporation reports Long-term debt of $3,398 and $3,658 respectively for the
year ended Dec 31 2016 and 2015 respectively. Everystate reported an interest expense of
$295 and $292 for the years ended 2016 and 2015 respectively. Everystate's interest rate on
average gross debt is closest to:
A) 8.68%
B) 8.36% B. Average gross debt = (3,398 + 3,658)/2 = $3,528
Interest rate = 2016 interest / average debt = 295/3528 = 8.36%
C) 8.53%
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880

501 566 664 208 281 353
earnings
Balance Sheet
250 325 345 200 217 195
securities
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000

31,337 33,084 35,518 25,070 25,604 27,907
shareholders equity

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
6.0% 6.0% 3.0% 0.2%
expense
6.0% 6.0% 2.0% 22.3%
receivable
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
Comparisons of expense trends in 2007–2008 showed:
higher growth of Adams’s SG&A and depreciation expense versus Jefferson’s; the
small change in Jefferson’s depreciation may relate to the change in depreciation
A)
lives, while the slower SG&A growth may reflect expense controls imposed to offset
lower gross profit margins.
higher growth of Adams’s SG&A and depreciation expense versus Jefferson’s may
B)
indicate more effective expense control by Jefferson in a slowing domestic economy.
Jefferson’s management appeared to have managed SG&A and depreciation
expenses more effectively than Adams’s; there was a small increase in Jefferson’s
C)
depreciation expense and slower growth in SG&A relative to the company’s previous
year and compared to Adams’s trends.
A. The more favorable trends in Jefferson's expenses may reflect more aggressive
depreciation accounting and controls imposed on discretionary expenses to offset
declining gross profit margins.
remain unresolved.
bankruptcy.
(SEC).
Exhibit 2.
Net income $158,177 $121,164
Receivables (144,087) (24,852)
Inventory (79,710) (72,777)
Payables 36,107 22,455
in millions 2008 2007 2006
Which of the following statements about evaluating High Plains' financial reporting quality is
least accurate?
High Plains’ extreme revenue growth will likely revert back to normal levels over
A)
time.
Because of the estimates involved, a higher weighting should be assigned to the
B)
accrual component of High Plains’ earnings as compared to the cash component.
C) Higher Plains may have manipulated earnings due to the risk of default.
B. It appears that High Plains manipulated its earnings upward in 2008 to avoid default under
its bond covenants. However, the higher earnings are lower quality as measured by the
cash flow accrual ratio. Because of the estimates involved, a lower weighting should be
assigned to the accrual component of High Plains' earnings. Extreme earnings (including
revenues) tend to revert to normal levels over time (mean reversion).
Pysha Heavy Metals Ltd. supplies specialized metals to the chip fabrication industry.
Selected financial data for Pysha, as well as industry comparables, are shown below:
Pysha selected financial data (£ '000s):
20x7 20x8 20x9
Sales 1,169 1,312 1,414
Accounts receivable 58.45 72.16 98.98
Industry average:
20x7 20x8 20x9
DSO 22.6 22.8 22.4
Receivables turnover 16.2 16.0 16.3
Note: DSO and receivables turnover are based on year-end receivables.
Relative to industry average, for 20x9, Pysha's DSO and Receivables turnover are most likely:
Receivables
DSO
turnover
A) Lower higher
B
B) Higher lower
C) Higher higher
Davide Andreu is concerned about the possible impact of inflation on two German retailers
that he covers in his equity analyst role. Andreu has used last year's financials to produce
common size income statements for the two retailers as shown below.
Tooboola GmbH Portentona GmbH
Sales 100% 100%
Cost of Goods Sold 38% 48%
Gross Margin 62% 52%
Sales, General & Admin 40% 20%
Depreciation 5% 15%
Operating Margin 17% 17%
Andreu is forecasting inflation of 10% in cost of goods sold for both companies due to large
increases in commodity prices in the next period. Due to the fragile state of the economic
recovery does not expect either company to be able to pass these costs on to consumers.
Sales, general and admin costs are likely to rise by 5% and accounting depreciation will be
unaffected.
If Andreu's forecasts are correct, which of the following statements is least accurate?
A) Tooboola has a larger forecasted gross margin than Portentona.

B) Both companies will experience the same decrease in gross margin.
C) The forecasted operating margins will be equal for Tooboola and Portentona.
Complete the following sentence. When earnings are relatively free of accruals, mean
reversion will occur __________.
A) relatively faster than usual.

B) at the same rate as usual.
C) relatively slower than usual.
C. Earnings consist of cash flow and accruals and there is an inverse relationship between
accruals and cash flow. When earnings are relatively free of accruals, mean reversion will
occur at a slower rate. The opposite is true when earnings are largely comprised of
accruals
Roy Banstaza is forecasting 2014 SG&A expenses for Compuland Inc., a provider of online
and live basic computing classes in the U.S. Relevant figures for the last 3 years for
Compuland are given below:
2011 2012 2013
$ 000's $ 000's $ 000's
Revenue 20,050 20,062 20,155
SG&A 5,212 5,218 5,240
$ $ $
Revenue per customer 225 220 218
Banstaza is forecasting a 2% fall in SG&A per customer in 2014 compared to 2013 due to an
improved online ordering and invoicing system that Compuland has adopted. He also
anticipates that the number of customers will continue to grow at the cumulative average
growth rate that Compuland has experienced over the last two years.
Which of the following is closest to Banstaza's forecasted SG&A expense for 2014?
A) $5,328,000.00
B
B) $5,231,000.00
C) $5,337,000.00
An analyst is developing a framework for financial statement analysis for his firm. This
framework is most likely to include:
A) Define the purpose of the analysis, process input data, and follow up.
Determine the allocation of firm fees, interpret processed data, and communicate
B)
conclusions.
Maintain integrity of capital markets, perform duties to clients and employers, and
C) A. Proper analysis framework should include:
avoid conflicts of interest. 1. Define the purpose of the analysis.
2. Collect input data.
3. Process input data.
4. Interpret processed data.
5. Develop and communicate conclusions.
6. Follow up.
Duster Corporation's year-end income statement reported the following:
Operating income $187,000
Results from discontinued operations:
Loss from segment operations
(net of $1,440 tax effect) ($2,160)
Gain on segment disposal
(net of $8,640 tax effect) 12,960 10,800
Gain on sale of equipment 3,400
Interest expense 12,400
Extraordinary loss
(net of $2,200 tax benefit) 3,300
Income tax expense 71,200
Calculate Duster's income from continuing operations for the year.
A) $100,200.
B) $103,500. C. Income from continuing operations includes all revenues and expenses except
discontinued operations and extraordinary items: $187,000 operating income + $3,400
C) $106,800. gain on sale of equipment – $12,400 interest expense – $71,200 income tax expense =
$106,800
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880

501 566 664 208 281 353
earnings
Balance Sheet
250 325 345 200 217 195
securities
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000

31,337 33,084 35,518 25,070 25,604 27,907
shareholders equity

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
6.0% 6.0% 3.0% 0.2%
expense
6.0% 6.0% 2.0% 22.3%
receivable
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
Based on the financial results of Adams and Jefferson in 2007 and 2008, the company
demonstrating the lower earnings quality would be:
Adams due to lower cash collection measures, possible inventory obsolescence

related to higher 2008 inventories despite slowing customer demand, higher
A)
expense growth compared to Jefferson, and lower balance sheet and cash flow
accrual ratios relative to Jefferson.
Adams due to slower revenue growth, higher expense growth compared to
Jefferson, possible inventory obsolescence related to higher 2008 inventories
B)
despite slowing customer demand, and lower balance sheet and cash flow based
accrual ratios in 2008 compared to Jefferson.
Jefferson due to sharply higher accruals ratios and less conservative accounting
methods indicated by the change in depreciation policies and the impact of changes
C)
in shipment terms on revenue recognition and inventories for the special overseas
C. According to theoffer.simple measures of earnings quality, balance sheet, and cash flow accruals ratios, Jefferson's
earnings quality in 2008 was lower than its 2007 levels and relative to Adams's. The more aggressive accounting
treatment for the overseas special offer lowered the quality of revenues and may have understated inventories if some
of these customers did not take delivery of the shipments. Jefferson also instituted a more liberal policy toward
depreciable lives versus Adams, another indicator of lower earnings quality.
Which of the following statements about operating income and operating cash flow is most
accurate?
Operating income is confirmed by operating cash flow when the growth rates of the
A)
two measures are relatively stable over time.
Operating cash flow usually increases faster than operating income when the firm is
B)
growing.
Operating income is more reliable than operating cash flow because of the
C)
judgments and estimates involved with accrual accounting.
A. When the growth rates of operating income and operating cash flow are stable over time,
operating income is being confirmed by operating cash flow. Operating cash flow is more
reliable than operating income. During growth, operating cash flow is usually lower than
operating income as the firm uses cash to increase inventories and receivables.
Errors that affect multiple financial statement elements are most likely to arise from:
A) compound issues.
B) measurement and timing issues.
C) classification issues.
B. Measurement and timing issues typically affect multiple financial statement elements
while classification issues typically affects categorization of a specific element in a financial
statement
When an analyst is developing long term projections of earnings for a company, which of the
following statements is least accurate?
A perpetuity should only be used if the analyst does not anticipate any inflection
A)
points occurring in the industry or economic environment.
When forecasting long term earnings for a highly cyclical company, an expected
B)
mid-cycle level of earnings should be used.
Earnings projections should be based on the most recent earnings for growing
C)
companies as it reflects the current state of the economy.
C. The most recent earnings figure may not sustainable. Even growing companies may face a
downturn due to changes in the industry. The most recent data is not necessarily the most
appropriate
Which of the following statements is CORRECT when inventory prices are falling?
A) LIFO results in higher COGS, lower earnings, higher taxes, and higher cash flows.
B) LIFO results in lower COGS, higher earnings, higher taxes, and lower cash flows.
C) LIFO results in lower COGS, lower earnings, lower taxes, and higher cash flows.
B
particularly concerned about the quality of each company's financial results in 2007– 2008
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880

501 566 664 208 281 353
earnings
Balance Sheet
250 325 345 200 217 195
securities
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000

31,337 33,084 35,518 25,070 25,604 27,907
shareholders equity

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
6.0% 6.0% 3.0% 0.2%
expense
6.0% 6.0% 2.0% 22.3%
receivable
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
The quality of earnings as measured by balance-sheet-based accruals ratios showed:
strong improvement in Jefferson’s earnings quality relative to Adams’s due to the

A)
sharp jump in the ratio in 2008 compared to the much smaller increase for Adams.
both companies’ earnings quality improved due to the increase in the ratio with
B)
Jefferson showing the most improvement.
decrease in Jefferson’s earnings quality relative to Adams’s due to the sharp jump in
C)
the ratio in 2008 compared to a much smaller increase for Adams.
C
An investor relations spokesperson for the Square Door Corporation was quoted as saying
that Square Door shares were a bargain, selling at a price-to-earnings (P/E) ratio of 12,
relative to the S&P 500 average P/E of 15.3. The financial statements reported net earnings
of $126 million, or $4.00 per share. The notes to the financial statements included a
statement that income for the year included a $31.5 million (after-tax) gain from the
reclassification of certain assets from its investment portfolio to its trading portfolio. What
would be the normalized P/E?
A) 16. A
B) 15.
C) 13.
The least valuable source of information about a businesses' risk is:
A) Notes to financial statements.

B) Auditor’s report.
C) Management discussion and analysis section of the annual report.
B. Because an audit report provides only historical information, such a report's usefulness as
an information source is limited. Companies are required to make certain risk related
disclosures in the notes to financial statements. Both GAAP and IFRS require companies to
disclose risks related to pension benefits, contingent obligations and financial
instruments. Ideally, companies should include principal risks that are unique to the
business (as opposed to risks faced by most businesses) in their MD&A
Cynbo Industries Limited operates in two countries Mazat and Napat. The effective tax rates
of Cynbo's operations in Mazat and Napat are 15% and 22% respectively. For the most
recent fiscal year, Cynbo reported profit before tax of $350 and $200 for Mazat and Napat
respectively. For the next year, it is expected that Cynbo's profit will grow at 5% and 8% for
Mazat and Napat respectively. The effective tax rate for Cynbo for the next fiscal year is
closest to:
A) 19.4% C. Given the growth forecasts, Cynbo's forecasted profit before tax, taxes and profit
after tax are 583.50, 102.65, and 480.86 respectively. Effective tax rate =
B) 18.5% 102.65/583.50 = 17.60%
C) 17.6%
Charles Nicholls, chief investment officer of Gertmann Money Management, is reviewing the
year-end financial statements of Zartner Canneries. In those statements he sees a sharp
increase in inventories well above the sales-growth rate, and an increase in the discount rate
for its pension liabilities. To determine whether or not Zartner Canneries is cooking the
books, what should Nicholls do?
A) Check Zartner’s cash-flow statement and review its footnotes.

Analyze trends in Zartner’s receivables and consider the changing characteristics of
B)
its work force.
C) Calculate Zartner’s turnover ratios and review the footnotes of its competitors.
C. To assess the meaning of the inventory increase, look for declines in inventory turnover.
And if Zartner changes its pension assumptions, Nicholls should see how those new
assumptions compare to those found in the footnotes of financial statements from other
companies in the same industry.
remain unresolved.
bankruptcy.
(SEC).
Exhibit 2.
Net income $158,177 $121,164
Receivables (144,087) (24,852)
Inventory (79,710) (72,777)
Payables 36,107 22,455
in millions 2008 2007 2006
As compared to the year ended 2007, High Plains' cash flow accrual ratio for the year ended
2008 is:
A) the same. NI-CFO-CFI / average net operating asset
B) higher.
C) lower.
b
Mean reversion in earnings means that:
A) Extreme low earnings will revert to the mean but extreme high earnings will not.
B) Extreme high as well as low levels of earnings will revert to the mean.
C) Extreme high earnings will revert to the mean but extreme low earnings will not.
Hartford Manufacturing Case Scenario
Sally Wellington, CFA, analyzes the financial statements of Hartford Manufacturing, a

company located in the United States that uses U.S. GAAP. Wellington determines that
Hartford's most significant assets are its inventory and long-term assets. Wellington is
interested in the financial statement and ratio impact of the accounting methods used by
Hartford to account for these assets, especially when compared to the methods used by
Hartford's competitors. She gathers the following information to aid in her analysis:
Exhibit 1
Selected Financial Information (US$ millions)
Year Ended December 31, 20X1
Select Balance Sheet Information
Inventory 16,253
Property, plant and equipment, gross 34,221
Accumulated depreciation (12,835)
Property, plant and equipment, net 21,836
Total assets 60,038
Total liabilities 40,736
Total equity 19,302
Income Statement Information
Revenues 32,396
Cost of goods sold 18,885
Lease expense 590
Other expense 5,911
Depreciation expense 2,336
EBIT 4,674
Interest expense 1,522
Income tax expense (30%) 946
Net income 2,206
Based on her knowledge of Hartford's competitors and her review of Hartford's financial
statement disclosures and Management's Discussion and Analysis (MD&A), Wellington notes
the following:
Hartford accounts for its inventory using the LIFO method. All of Hartford's
competitors use the FIFO method.
As a result of technological advancements, the cost to produce Hartford's inventory
has fallen each year for the last five years. Hartford's LIFO reserve was (–)$2,603 in
20X0 and (–)$3,183 in 20X1.
Hartford recorded a $520 fixed-asset impairment loss on its December 31, 20X0
income statement. Wellington concluded that this impairment loss increased
Hartford's fixed-asset turnover ratio in 20X0, and Hartford's return on assets and net
profit margin in 20X1.
In 20X1 Hartford changed its depreciation method from the straight-line method to
the double-declining balance method and increased the useful lives and salvage
values of its fixed assets.
The majority of Hartford's lease agreements are accounted for as operating leases.
Hartford's largest competitors account for the majority of their leases as capital
(finance) leases.
Wellington knows that the Financial Accounting Standards Board (FASB) and International
Accounting Standards Board (IASB) have proposed a change in lease accounting that would
require the capitalization of all leases, including leases currently classified as operating
leases. Using a discount rate of 8% and an average remaining lease term of five years,
Wellington determines that the present value of Hartford's operating leases was $2,630 on
December 31, 20X1.
Which of the following characteristics of Hartford's long-term asset accounting is least likely
to be considered a quality of financial reporting problem by Wellington?
A) The increase in the useful lives and salvage values of Hartford's fixed assets.
B) The classification of the majority of Hartford's leases as operating leases.
C) The change from straight-line to double-declining balance depreciation.
c. Double-declining balance (DDB) depreciation is a more conservative method of depreciation than straight-line because
more depreciation expense is reported in the early years under DDB. Therefore, Wellington is not likely to consider
Hartford's change from straight-line to double-declining balance depreciation to be a quality of financial reporting
problem. Operating leases are a form of off-balance sheet financing that result in an understatement of an entity's liabilities.
Wellington will likely consider Hartford's extensive use of operating leases to be a quality of financial reporting problem,
especially given that Hartford's largest competitors account for the majority of their leases as capital (finance) leases. The
increase in the Question #87salvage
useful lives and of 106values of Hartford's fixed assets is likely to be considered
Question ID:a 1472650
quality of financial
reporting problem by Wellington because longer useful lives and higher salvage values decrease (understate) depreciation
expense. An effort to reduce expense could be a sign that the firm is trying to hide other problems, such as deteriorating
Which of the following is least likely an indicator of biased measurement in assessing
core profitability.
balance sheet quality?
A) Overly high assumed discount rate for pension obligations.

Company’s investment in debt securities of other companies, carried on the books
B)
at market value.
C) Understatement of impairment charges for property, plant, and equipment.
b. Understatement of impairment
charges on PP&E overstates value of PP&E. High discount rate reduces the value of PBO
and hence improves the funded position reflected on the balance sheet
Holdall Corporation recently reclassified many of their assets such that the average useful
life of their depreciable assets was reduced. Which of the following is the most likely result
from this change on net income and inventory turnover? (Assume everything else remains
constant.) Net income will:
A) decrease and inventory turnover may or may not change.

B) increase and inventory turnover will not change.
C) decrease and inventory turnover will rise.
a. Depreciation expense increases as the depreciable life of an asset decreases. Thus, net
income will decline. Depreciation will only affect inventory turnover if depreciation has
been allocated to individual inventory items; when and why this happens is outside the
scope of the Level II curriculum.
Year 20x1 20X2 20X3
Alpinex 88.9 92.3 97.5
Bemax 0 54 433
Mendoza believes that in 20X4 the combined growth rate of Alpinex and Bemax will slow to
30%. Mendoza also believes that Bemax's share of revenue will grow to 90%. The estimated
level of sales for Bemax based on Mendoza's assumptions is closest to:
A) $563 million
b. Combined sales for 20X3 = (97.5 + 433) × (1.30) = $690
B) $621 million Bemax's share = 0.90 × 690 = $620.69
C) $507 million
High-quality cash flow is least likely to be characterized by:
Financing cash flows sufficient to cover capital expenditures, dividends and debt
A)
repayments.
B) No significant differences between operating cash flow and reported earnings.
C) Volatility of operating cash flow being lower than that of the firm’s peers.
a
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880

501 566 664 208 281 353
earnings
Balance Sheet
250 325 345 200 217 195
securities
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000

31,337 33,084 35,518 25,070 25,604 27,907
shareholders equity

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
6.0% 6.0% 3.0% 0.2%
expense
6.0% 6.0% 2.0% 22.3%
receivable
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
Jones also observed that inventory and cost of goods sold comparisons showed:
Jefferson’s inventory decline suggests possible problems in inventory management

to meet the stronger customer demand from the special offer; Adams’s large
A)
inventory increase suggests better inventory management to meet future sales
growth.
Jefferson’s inventory levels may be understated and sales overstated to the extent
B) of product shipments for the special offer; Adams’s inventory increase may reflect
slowing product demand and possible inventory obsolescence.
Jefferson’s inventory increase and large increase in cost of goods sold may be
C) related to the success of the special offer; Adams’s large increase in inventories
suggests possible inventory obsolescence.
b. Jefferson's revenue and inventory levels may be distorted by revenue recognition for new
business from the special offer. Although the customers agreed to delay delivery of the
products, recognition of these sales prior to customer delivery lowers the quality of these
sales and understates inventory. Inventory is understated if the sale is not totally
complete.
MKF Consolidated reports $500 million in goodwill on its balance sheet. The market
consensus indicates that the value of MKF's intangible assets is $300 million. How should an
analyst adjust MKF's balance sheet? Reduce goodwill and:
A) equity by $500 million while increasing liabilities by $300 million.

B) increase liabilities by $200 million.
C) equity by $200 million.
c, If goodwill has no economic value apart from the firm, it should be eliminated from the
balance sheet. If the value of the intangibles can be reliably estimated they can be
substituted for accounting goodwill.
An analyst is analyzing a discount manufacturer of parts and supplies. She has followed her
firm's suggested financial analysis framework and has communicated with company
suppliers, customers, and competitors. This is an input that occurs while:
A) processing data.
B) collecting data.
C) establishing the objective of the analysis.
b
Jared Mush is preparing a report on the Everystate corporation. The information below
pertains to the year ending 31 December 2015 and 2016.
Dec. 31, Dec. 31,

2016 2015
Property-Liability 32,567 31,309
Everystate Financial 3,928 4,309
Corporate and Other 39 35
Consolidated revenues $ 36,534 $ 35,618
Mush's growth forecast for 2017 is 3% for property/liability, 0% for financial and 2% for
corporate and other. Also, Mush estimates that EBIT margins for the three divisions are 17%,
18% and 23% respectively. Forecasted 2017 EBIT is closest to:
A) $6,200
c. Forecast revenue for Property-liability = 1.03 × 32,567 = $33,544
B) $5,700 Forecast EBIT for property-liability = 0.17 × 33,544 = 5,702.48
C) $6,400
Which of the following is least likely an indicator of biased measurement in assessing

balance sheet quality?
A) Presence of substantial goodwill on balance sheet.

B) Understatement of valuation allowance for deferred tax assets.
C) Understatement of inventory impairment charges.
a. Presence of substantial goodwill does not inherently make it biased measurement. Only if
the value of goodwill is unjustified (based on market values of the investments), would the
measurement be considered biased. Understatement of inventory impairment charges
overstates value of inventory. Similarly understatement of valuation allowance for
deferred tax assets overstates the value of deferred tax assets
A firm has reported net income of $136 million, but the notes to financial statements
includes a statement that the results "include a $27 million charge for non-insured
earthquake damage" and a "gain on the sale of certain assets during restructuring of $16
million." If we assume that both of these items are given on a pre-tax basis and the effective
tax rate is 36%, what would be the "normal income"?
A) $143.04 million.
a
B) $147.00 million.
C) $94.08 million.
Inventories are listed on the balance sheet at $600,000, retained earnings are $1.9 Million. In
the notes to financial statements, you find a LIFO reserve of $125,000. Also, the probability
of a LIFO liquidation is high. Assuming a tax rate of 36%, what will be the adjusted value of
retained earnings?
A) $1,980,000.00 a. The highly probably LIFO liquidation suggests net income, income tax expense,
and equity will rise. The analyst can make this adjustment now for forecasting
B) $1,855,000.00 purposes. The adjustment to retained earnings will be: $125,000 × (1 - 0.36) = 80000
C) $1,820,000.00 lifo liquidation means use up the reserve for sale purpose when not enough
inventory, which could increase earnings.
($ in thousands) 2006 2007 2008 2006 2007 2008
Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

781 836 886 625 675 900
and allowances
Net sales 31,250 33,438 35,444 25,000 27,000 30,000
SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200
Taxes (tax rate 40%) 2,334 2,497 2,647 2,000 2,028 2,155
Net income 3,501 3,746 3,971 2,668 3,041 3,233
Dividends 3,000 3,180 3,307 2,460 2,760 2,880

501 566 664 208 281 353
earnings
Balance Sheet
250 325 345 200 217 195
securities
Inventories 6,500 6,850 7,800 5,200 5,200 4,500
PP&E (net of
8,562 8,991 9,440 6,850 7,057 7,200
depreciation)
Total assets 31,337 33,084 35,518 25,070 25,604 27,907
Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600
Common stock 15,000 15,000 15,000 12,000 12,000 12,000

31,337 33,084 35,518 25,070 25,604 27,907
shareholders equity

6.0% 6.0% 8.0% 33.3%
and allowances
% change net sales 7.0% 6.0% 8.0% 11.1%

7.0% 6.0% 8.0% 17.0%
sold
% change in SG&A 6.0% 6.0% 8.0% 5.1%
6.0% 6.0% 3.0% 0.2%
expense
6.0% 6.0% 2.0% 22.3%
receivable
Revenues % cash
1.03 1.03 1.03 1.0 1.0 1.1
collections
Days inventory
155 153 164 144 143 106
outstanding

3.4% 3.5% 3.9% 2.0% 2.4% 10.1%
ratio
The quality of earnings as measured by cash-flow-based accruals ratios showed:
Jefferson’s 2008 accrual ratio exceeded Adams’s ratio for the first time in the 2006–
A) 2008 period, thus demonstrating significant improvement in earnings quality
relative to Adams’s.
Jefferson’s 2008 accrual ratio exceeded Adams’s ratio for the first time in the 2006–
B) 2008 period, indicating a decline in earnings quality compared to previous years and
lower earnings quality relative to Adams’s in 2008.
Jefferson’s higher accruals ratio in 2008 compared to 2007 and relative to Adams’s in
C)
2008 indicates Jefferson’s higher earnings quality.
Year 20x1 20X2 20X3
Alpinex 88.9 92.3 97.5
Bemax 0 54 433
What percentage of combined growth in 20X3 is due to Bemax?
A) 79% b. Combined sales for 20X2 = 92.3 + 54 = 146.3

Combined sales for 20X3 = 97.5 + 433 = 530.5
B) 99% Increase in sales for both products in 20X3 = 530.5 - 146.3 = $384.20
Increase in sales for Bemax = 433 - 54 = $ 379
Percentage of combined growth attributable to Bemax = 379/384.20 = 98.65%
C) 54%
Analyst Jane Kilgore is worried that some of Maxwell Research's accrual accounting practices
will lead to excessive operating earnings recognition in the near-term. Examples of Kilgore's
concerns include the following:
Accelerated revenue recognition of service agreements.

Classification of recurring revenue as nonrecurring revenue.
Understated inventory obsolescence.
Which of Kilgore's concerns is least likely to overstate current operating earnings?
A) Understated inventory obsolescence.

B) Accelerated revenue recognition of service agreements.
C) Classification of recurring revenue as nonrecurring revenue.
c. Classification of recurring revenue as nonrecurring revenue will understate current
operating earnings. The other two items act to overstate revenue and understate
expenses.
Consider the following statements:
Compared to the cash basis of accounting, the accrual basis of accounting

Statement 1:
provides more timely information about future cash flows.
Compared to the cash basis of accounting, the accrual basis requires

Statement 2:
more use of discretion than the cash basis.
Are these statements CORRECT?
No, because it is actually the cash basis of accounting that provides more timely and
A)
relevant information to users about future cash flows.
B) Yes.
No, because it is actually the cash basis of accounting that results in more difficulty
C)
in properly assigning revenues and expenses to the appropriate periods.
b. Users of financial information seek timely information about future cash flows. The accrual basis of accounting
provides this information at the earliest appearance of objective evidence. Thus, accrual accounting provides more
timely and relevant information to users. The cash basis is more concerned with recording cash flows for transactions
that have already occurred.
Accrual accounting (not cash-based accounting) necessitates the use of discretion because of the many estimates and
judgments involved with assigning revenue and expense to the appropriate periods.
For the purpose of forecasting proforma financial statements, which of the following
statements is most accurate?
Forecasted capital expenditure is usually based on historic information whereas

A)
forecasted depreciation rates are usually based on forecasted data.
Forecasted depreciation rates are usually based on historic information whereas
B)
forecasted capital expenditure is usually based on forecasted data.
Forecasted depreciation rates and capital expenditure are usually based on
C)
forecasted data.
b. Depreciation rates are usually taken from historic disclosures regarding rates used in prior
periods. Capital expenditure is usually forecast using analysts' judgment regarding future
needs for PPE.
Fero Inc. (Fero) is a successful computer consulting services firm that has an established
policy of investing its excess cash in short-term, virtually riskless, and highly liquid money
market securities. However, it has recently deviated from this policy by investing in
commercial paper and medium-cap domestic equities. As well, Fero entered into a $1.0
million lease with Pasquale Inc. (Pasquale) for some specialized computer equipment on
December 28, 2008 that will be shipped at the very start of its next fiscal period on January
1, 2009. In exchange for the lease, Fero agrees to provide consulting services to Pasquale.
Which of the following activities is one in which Fero is least likely involved?
A) Ignoring cash flow.

B) Managing cash flow.
C) Misclassifying cash flow.
b
Marcel Schulte is analyzing various retailing firms. Which of the following items is least
indicative of a potential problem with revenue recognition and earnings quality?
A) Disproportionate revenues in the last quarter of the calendar year.

B) Use of barter transactions.
a. Disproportionate revenues in the last quarter may be an indication of aggressive revenue recognition to meet analyst
forecasts but it isC)much
Implementing
more likelyaif“bill
the and
firm hold” arrangement.
is a nonseasonal one. A retailing firm presumably has a disproportionate
amount of sales during the busy Christmas season in the last quarter of the calendar year so this point alone
would not be indicative of a potential problem. In a barter transaction, two parties exchange goods or services. The main
issue is whether:
(a) a sale transaction has actually occurred in substance; (b) it is not a "sham" transaction;
and (c) the transaction amount is overstated.
Bill and hold occurs when the retailer (seller) invoices the customer but does not ship the goods until a later date.
Alternatively, the seller may ship the goods to a location other than the customer's. In either case, the seller may be
Question
recognizing revenue #105 of 106
prematurely. Question ID: 1472595
High results quality is most likely demonstrated by:
A) high level of earnings determined conservatively.

B) GAAP compliant financial reports that are decision useful.
C) an adequate level of return that is sustainable.
c. High results quality occurs if the level of earnings provides an adequate level of return and
that the earnings are sustainable.
De Freitas Inc. (De Freitas) is a conglomerate. Its computer division was very profitable in the
current year because it launched a successful new lightweight laptop computer. Prices in the
automobile division have been rising over the years but it is engaged in a LIFO liquidation in
the current year. Which of the following best describes the effect on the long-run earnings of
the computer division and the automobile division compared to the most recent year?
Computer Automobile
division division
earnings earnings
A) Decrease Decrease
B) Increase Decrease
C) Decrease Increase
a. When examining earnings, analysts should be aware that earnings at extreme levels tend
to revert back to normal levels over time. This phenomenon is known as mean reversion.
For example, capital is attracted to successful projects (i.e. the new laptop) thereby
increasing competition and decreasing earnings in the long-run.
A LIFO liquidation involves selling more goods than are replaced. Thus, the automobile
division penetrated the older, lower cost layers of inventory thereby increasing profit. This
higher profitability is not sustainable, however, because the firm will eventually run out of
lower priced inventory. In the long-run, the earnings will decrease (to normal levels).

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2/2/23, 12:19 PM Kaplanlearn - Quiz

Question #1 of 106 Question ID: 1472664

A) operating cash flow − cash interest − cash taxes.

Question #2 of 106 Question ID: 1472663

Question #3 of 106 Question ID: 1472615

Exhibit 1: Cash Flow Statement

High Plains Tubular Cash Flow Statement

Year ended December 31,

in thousands 2008 2007

Net income $158,177 $121,164

Depreciation expense 34,078 31,295

Deferred taxes 7,697 11,407

Receivables (144,087) (24,852)

Inventory (79,710) (72,777)

Payables 36,107 22,455

Cash flow from operations $12,262 $88,692

Cash flow from investing ($39,884) ($63,953)

Cash flow from financing $82,676 $6,056

Change in cash $55,054 $30,795

Exhibit 2: Selected Financial Footnotes

in millions 2008 2007 2006

Maintenance and repairs $180 $184 $218

Advertising and marketing 94 108 150

A) Only inventory turnover is overstated.

Question #4 of 106 Question ID: 1472620

A) a decrease in probability of earnings manipulation.

Question #5 of 106 Question ID: 1472665

Cash generated from operations (CGO) is least appropriately calculated as:

A) EBIT + non-cash charges − increase in working capital.

C) operating cash flow + cash interest paid + cash taxes paid.

Question #6 of 106 Question ID: 1472680

Question #7 of 106 Question ID: 1472654

A) Common-size financial statements.

Question #8 of 106 Question ID: 1472651

Asma's balance sheet quality can be most accurately characterized as:

A) High-quality due to compliance with local GAAP.

Question #9 of 106 Question ID: 1472675

A) Mendoza is forecasting growth of 3.5% using a hybrid approach.

Question #10 of 106 Question ID: 1472616

Adams Company Jefferson Inc.

($ in thousands) 2006 2007 2008 2006 2007 2008

Gross sales 32,031 34,273 36,330 25,625 27,675 30,900

Sales discounts, returns,

Net sales 31,250 33,438 35,444 25,000 27,000 30,000

Cost of goods sold 15,312 16,384 17,367 12,250 13,250 15,500

SG&A expenses 9,028 9,660 10,240 7,222 7,800 8,200

Depreciation expense 625 669 709 500 515 516

Interest expense 400 428 454 360 366 396

Income before taxes 5,835 6,243 6,618 4,668 5,069 5,388

Net income 3,501 3,746 3,971 2,668 3,041 3,233

Dividends 3,000 3,180 3,307 2,460 2,760 2,880

Net addition to retained

Cash and equivalents 150 160 170 120 130 120

Accounts receivable (net) 15,875 16,758 17,763 12,700 13,000 15,892

Inventories 6,500 6,850 7,800 5,200 5,200 4,500

Total assets 31,337 33,084 35,518 25,070 25,604 27,907

Accounts payable 7,062 7,880 9,300 6,050 6,100 6,398

Other current liabilities 337 400 450 270 373 1,525

Long-term debt 7,500 7,800 8,100 6,000 6,100 6,600

Common stock 15,000 15,000 15,000 12,000 12,000 12,000