CPA Core 1 - Week 2

Question 1

Why is conducting an analysis of a company’s financial ratios beneficial?

a)

It is a central component of value-chain analysis.

b)

It identifies external opportunities for the company to pursue.

c)

It uncovers critical industry trends.

d)

It provides insights into a company’s financial state.

Answer 1

d) is correct because financial ratio analysis identifies how an organization is performing according to its balance sheet and income statement from a historical perspective to detect trends. This trend and comparative analysis serves as an indicator of the organization’s strengths and weaknesses.

Question 2

You, CPA, are concerned about one of your firm’s clients, Farm Acre Foods Inc. (Farm). Although very profitable, you suspect that Farm may be experiencing problems paying off short-term debt. Which one of the following analytical review calculations will highlight this concern?

a)

Gross profit percentage

b)

Inventory turnover ratio

c)

Quick ratio

d)

Times interest earned

Answer 2

c) is correct because the quick ratio provides information about Farm’s ability to meet its liabilities in the short term.

Question 3

Which of the following statements for financial statement analysis is true?

a)

A high debt-to-equity ratio is a negative qualitative factor.

b)

A high gross-margin-percentage ratio is a negative qualitative factor.

c)

A high dividend-payout ratio is positive qualitative factor.

d)

A high days-payable-outstanding ratio is a positive qualitative factor.

Answer 3

a) is correct. Debt service ratios provide an indication of a company’s long-term solvency. A higher ratio means that the organization has a more leveraged capital structure, which is considered higher risk.

Question 4

Which of the following scenarios best represents a possible increase in cash for the year?

a)

A redemption of term deposits

b)

A decrease in accounts payable

c)

A purchase of term deposits

d)

Advances to related parties

Answer 4

a) is correct. A redemption of term deposits is a cash inflow.

Question 5

During the year, LMN Inc. had:

sales of $2,500,000
gross profit of $1,000,000
net income of $125,000
Inventory was $275,000 at the beginning of the year and $300,000 at the end of the year. Assume the company used average balances when measuring its performance. What is the inventory turnover for the year?

a)

5 times

b)
5. 22 times
c)
5. 45 times
d)
8. 70 times

Answer 5

b) is correct because the inventory turnover of 5.22 times is correctly calculated as ($2,500,000 sales – $1,000,000 gross profit) / [($300,000 ending inventory balance + $275,000 beginning inventory balance) / 2]. Inventory turnover is calculated as cost of goods sold (sales less gross profit) divided by the average inventory balance.

Question 6

Which of the following would improve the quick ratio?

a)

Sell fixed assets to reduce accounts payable.

b)

Increase bank indebtedness to purchase equipment.

c)

Issue common stock to purchase inventory.

d)

Aggressively collect accounts receivable.

Answer 6

a) is correct. The quick ratio is defined as current assets less inventory, divided by current liabilities. A decrease in fixed assets would not affect the quick ratio, but a decrease in accounts payable would increase the quick ratio.

Question 7

Which of the following is included in the calculation of the current ratio?

a)

Property, plant, and equipment

b)

Goodwill

c)

Demand loan

d)

Bond payable, maturing in three years

Answer 7

c) is correct. The current ratio is defined as current assets divided by current liabilities. Demand loans are classified as current liabilities and are included as part of the current ratio calculation.

Question 8

You are a bank loan officer and you have been asked by your client to examine the financial leverage of her company. Which of the following analytical tools would yield the most useful insight about the ability of her company to obtain additional bank financing?

a)

Calculation of the working capital ratio

b)

Preparation of the income statement

c)

Calculation of the debt-to-equity ratio

d)

Gross profit analysis

Answer 8

c) is correct because the debt-to-equity ratio indicates what proportion of equity and debt the company is using to finance its assets. This is a measure of financial leverage.

Question 9

Kima Inc. had credit sales of $600,000 and cash collections of $450,000 last year. The ending balance in accounts receivable was $175,000. The allowance for doubtful accounts (AFDA) has a current credit balance of $2,600. Based on an aging analysis, Kima has estimated that the allowance for doubtful accounts is 4% of the gross amount of outstanding receivables. What is the bad debt expense for the year?

a)

$4,400

b)

$6,000

c)

$7,000

d)

$9,600

Answer 9

a) is correct. The allowance for doubtful accounts should be 4% × $175,000 = $7,000. Therefore, the journal entry required is Dr. Bad debts $4,400 ($7,000 – $2,600) and Cr. AFDA $4,400.

Question 10

Which of the following is considered part of cash and cash equivalents?

a)

Publicly traded shares

b)

U.S. currency bank account

c)

A 180-day term deposit

d)

Cash in a bank account to meet minimum balance requirements

Answer 10

b) is correct. Foreign currency funds in accounts that are accessible on demand are considered cash and cash equivalents as long as there is a ready market to exchange the funds to the company’s operating currency.

Question 11

Which of the following is considered part of cash and cash equivalents?

a)

100 ounces of silver

b)

An investment in shares of a blue-chip company

c)

A term deposit maturing in one year

d)

A 30-day government T-bill

Answer 11

d) is correct. T-bills with a maturity less than or equal to three months are considered part of cash and cash equivalents, given their highly liquid nature and the absence of risk that their value will change.

Question 12

Which of the following statements is true?

a)

Under IFRS, publicly traded bonds with a maturity less than or equal to three months are considered cash and cash equivalents.

b)

There are no significant differences between IFRS and ASPE in the treatment of cash and cash equivalents.

c)

Under ASPE, publicly traded bonds with a maturity less than or equal to three months are considered cash and cash equivalents.

d)

Under ASPE, minimum balance requirements in bank accounts are considered cash and cash equivalents.

Answer 12

b) is correct. There are no significant differences between IFRS and ASPE in the treatment of cash and cash equivalents.

Question 13

Which of the following is considered restricted cash?

a)

Foreign currency where there is a limited market for exchange into the company’s operating currency

b)

Minimum balance requirements in bank accounts

c)

Donations provided for a specific purpose in a not-for-profit organization

d)

Both b) and c)

Answer 13

d) is correct. Both b) and c) are correct because minimum balance requirements in bank accounts and donations provided for a specific purpose in a not-for-profit are both examples of restricted cash.

Question 14

Your client, Jay, runs an autobody shop and follows ASPE for financial reporting purposes. In Jay’s business, he extends credit to some of his customers. When should he write off a customer’s accounts receivable (AR)?

a)

An account receivable should be written off as soon as it is known to be uncollectable.

b)

An account receivable should be written off only when a customer has become bankrupt or has entered into receivership.

c)

An account receivable should be written off once it is overdue by 91 days.

d)

An account receivable should be written off only when the client has determined it is beneficial for tax reasons.

Answer 14

a) is correct. As soon as a receivable balance is known to be uncollectable, it should be written off.

Question 15

On January 3, 20X4, Simon Inc. sold and delivered goods to a customer for $40,000. The terms of the sale required the customer to pay $15,000 on January 3, 20X4, and then $25,000 on January 3, 20X5. The appropriate interest rate for this customer’s credit risk is 6%. What is the amount of the accounts receivable recognized on January 3, 20X4, prior to the $15,000 cash payment?

a)

$37,736

b)

$38,585

c)

$40,000

d)

$41,500

Answer 15

b) is correct. The accounts receivable is $15,000 + ($25,000 ÷ 1.06) = $38,585.

Question 16

The following accounts were taken from Blue Monkey Inc.’s unadjusted trial balance at December 31, 20X6:

Accounts receivable $850,000
Opening allowance for doubtful accounts (AFDA) January 1, 20X6 ($11,000)
Net credit sales $2,950,000
Blue Monkey estimates that 1.5% of the gross accounts receivable will become uncollectable. At December 31, 20X6, AFDA should have a credit balance of what amount?

a)

$1,750

b)

$11,000

c)

$12,750

d)

$44,250

Answer 16

c) is correct. The balance of AFDA would be calculated as $850,000 × 1.5% = $12,750.

Question 17

You, CPA, are teaching your firm’s co-op student about passive investments. You decide to compare how ASPE and IFRS account for passive investments. Which of the following statements is true?

a)

IFRS reports all passive investments at fair value, and ASPE reports passive investments at any of cost, fair value, or amortized cost.

b)

Under both ASPE and IFRS, investments adjusted to fair value at each reporting date require the changes in fair value to be reported in net income.

c)

For amortized cost investments, IFRS requires the use of the effective interest method, and ASPE permits a choice between the straight-line and effective interest methods.

d)

Accounting is the same under IFRS and ASPE for passive investments.

Answer 17

c) is correct because, for amortized cost investments, IFRS requires the use of the effective interest method and ASPE permits a choice between the straight-line and effective interest methods.

Question 18

Brown Inc. (BI) reports an investment in bonds using the amortized cost method. The bonds have a face value of $1,000,000 and were purchased on January 1, 20X7. The market interest rate is 8% and the bonds pay interest at a rate of 6%. Interest payments are made every June 30 and December 31. The bonds mature 10 years from the date of purchase, on December 31.

What journal entry records the acquisition of the bonds on January 1, 20X7?

a)

Dr. Investment in bonds $864,100
Cr. Cash $864,100

b)

Dr. Cash $864,100
Cr. Bonds payable $864,100

c)

Dr. Investment in bonds $1,000,000
Cr. Cash $1,000,000

d)

Dr. Investment in bonds $664,496
Cr. Cash $664,496

Answer 18

a) is correct:
$1,000,000 × (P/F 4%†, 20) = $1,000,000 × 0.45639 = $456,390
$30,000 interest × (P/A 4%†, 20) = $30,000 × 13.59033 = $407,710
Issuance price (fair value) = $456,390 + $407,710 = $864,100
†4% = 8% / 2 to reflect 20 half-year periods

Question 19

You, a CPA, are assisting your firm’s co-op student in learning about related party transactions (RPTs). You decide to compare how ASPE and IFRS account for RPTs.
Which of the statements below is true?

a)

IFRS and ASPE standards are completely converged in terms of RPTs; there are no differences.

b)

IFRS requires RPTs to be reported at the exchange amount of the transaction while ASPE requires RPTs to be reported at the carrying amount.

c)

IFRS does not provide guidance on measurement of RPTs, but ASPE does.

d)

IFRS does not provide guidance on disclosure of RPTs but ASPE does.

Answer 19

c) is correct because the main difference between IFRS (IAS 24 Related Party Disclosures) and ASPE (Section 3840 Related Party Transactions) is that IFRS only provides disclosure requirements, avoiding guidance on measurement of RPTs. ASPE’s guidance includes measurement.

Question 20

Max, a CPA, works for Hydrostone Inc., a real-estate development firm that recently completed a downtown condo building. Of the four RPTs listed below, which one is in the normal course of operations?

a)

Hydrostone Inc. sold a condo to the daughter of its majority shareholder. Terms and conditions of the sale were consistent with those of sales to unrelated parties.

b)

Hydrostone Inc. sold furniture from its head office to a member of its Board of Directors. The furniture, which did not match the newly painted head office, was sold at market price to the director.

c)

Hydrostone Inc. repaid a shareholder loan that had been outstanding for two years.

d)

Hydrostone Inc. issued preferred shares to a related party to finance a large condo development.

Answer 20

a) is correct. This is a transaction in the normal course of operations since Hydrostone Inc. is a real-estate development firm that recently completed a condo building. Per paragraph 25 of Section 3840 Related Party Transactions: “Usually, a related party transaction that is in the normal course of operations occurs within a normal business relationship and on terms and conditions that are similar to those of transactions with unrelated parties.” As noted in paragraph 24, examples of transactions in the normal course of operations include “a sale or purchase of real estate by an enterprise that is in the business of selling real estate as part of its ongoing activities.”

Question 21

Genette Inc. (GI) reports under ASPE. The controller of GI is about to record a journal entry to account for a related party transaction. The transaction in question was not in the normal course of operations for GI and resulted in no substantive change in ownership interests. How should the controller account for this transaction?

a)

Measure the transaction at the carrying amount and record any gain or loss in income.

b)

Measure the transaction at the carrying amount and record any gain or loss in equity.

c)

Measure the transaction at the exchange amount and record any gain or loss in income.

d)

Measure the transaction at the exchange amount and record any gain or loss in equity.

Answer 21

b) is correct because, per Section 3840 Related Party Transactions, paragraphs 8 and 9: “A related party transaction shall be measured at the carrying amount, except as specified in paragraphs 3840.18 and 3840.29. When a related party transaction is measured at the carrying amount, any difference between the carrying amounts of items exchanged, together with any tax amounts related to the items transferred, shall be included as a charge or credit to equity.” Refer to the decision tree in Section 3840.

Question 22

Which of the following is a required disclosure under IFRS, but not ASPE?

a)

Nature of transactions

b)

Amounts

c)

Key management compensation

d)

Obligations

Answer 22

c) is correct because, per IAS 24.13, key management compensation is a required disclosure.

Question 23

Whirlwind Inc. (WI) received a grant from the Canadian government in the current fiscal year. The grant of $200,000 was paid to WI before the December 31, 20X7 year end to offset salary costs to be incurred in fiscal 20X8. WI will be entitled to this grant if it employs a specified number of students during 20X8. WI management is certain that the required student employment threshold will be met. WI applies IFRS.

What is the appropriate journal entry for WI to record in fiscal 20X7 with respect to the government grant?

a)

Dr. Cash $200,000
Cr. Salary expense $200,000

b)

Dr. Cash $200,000
Cr. Grant revenue $200,000

c)

Dr. Cash $200,000
Cr. Deferred grant revenue $200,000

d)

No journal entry is to be recorded until 20X8.

Answer 23

c) is correct. Since the grant is intended for use against 20X8 salary expenses as long as the condition is met, the reduction in expense/increase in income should not be reported until 20X8. It must be shown as a liability in 20X7. The reduction in salary expenses must be recorded as a reduction in expenses in the following fiscal year. Per IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, paragraph 12: “Government grants shall be recognized in profit or loss on a systematic basis over the periods in which the entity recognises as expenses the related costs for which the grants are intended to compensate.”

Question 24

In 20X7, the federal government provided land to Bomb Inc. (BI) to use in its business operations into the foreseeable future. The land had a fair market value of $55,000 and BI paid $0 to the federal government for the land use. BI uses IFRS to prepare its financial statements.

Which of the following is the best description of how to account for this grant?

a)

The land was received for free by BI so a transaction is not recorded. However, note disclosure is required.

b)

BI has the option of recording the grant and related asset at fair value or assigning a nominal amount to the grant and related asset.

c)

BI records a deferred grant at fair value and recognizes the grant over the expected period of usage of the land.

d)

BI must obtain an appraisal for the land and record the grant and related asset at fair value.

Answer 24

b) is correct because a transaction is needed to record the grant and the related asset either at the fair market value of the land or at a nominal amount. Per IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, paragraph 23:
A government grant may take the form of a transfer of a non-monetary asset, such as land or other resources, for the use of the entity. In these circumstances, it is usual to assess the fair value of the non-monetary asset and to account for both grant and asset at that fair value. An alternative course that is sometimes followed is to record both asset and grant at a nominal amount.

Question 25

In 20X7, Seawalk Scoops Inc. (SSI) celebrated the fifth anniversary of its program that employs ex-convicts who are being reintegrated into society. At this time, to recognize SSI’s success with this program, the Prince Edward Island government provided a grant that covered 10% of SSI’s salary costs associated with the employees in the program from the prior five fiscal years. The P.E.I. government hopes that this will encourage other companies to employ ex-convicts.

Which of the following is the best description of how to account for this grant?

a)

The grant should be recognized in income evenly over the next five years.

b)

The entire grant should be recognized in 20X7 since it relates to costs incurred in prior periods.

c)

The grant should be recognized in the periods to which it relates. Financial statements would need to be restated for the prior five years if the grant is material.

d)

The grant relates to paid expenses so it must be netted against these costs. The grant must be netted against 20X7 payroll expenses; if the grant exceeds 20X7 payroll expenses, the remaining grant money should be deferred to 20X8 and netted against 20X8 payroll costs.

Answer 25

b) is correct because the entire grant should be recognized in 20X7 since it relates to costs incurred in prior periods. Per IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, paragraph 20:
A government grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognized in profit or loss of the period in which it becomes receivable.