CFA Financial Reporting and Analysis 2 — Questions and Answers
Question 1: Under the percentage-of-completion method for long-term contracts, revenue is recognized:
- Only when the project is fully completed
- Based on the proportion of costs incurred to total estimated costs (Correct answer)
- When cash payments are received from the client
- Equally over the duration of the contract
Correct answer: Based on the proportion of costs incurred to total estimated costs
The percentage-of-completion method recognizes revenue proportionally based on the stage of completion, often measured as costs incurred to date divided by total estimated costs.
Question 2: A firm's current ratio is 2.5 and its quick ratio is 1.0. This difference most likely indicates that the firm has a large amount of:
- Accounts receivable relative to current liabilities
- Cash and cash equivalents on hand
- Inventory relative to current liabilities (Correct answer)
- Short-term debt maturing within one year
Correct answer: Inventory relative to current liabilities
The quick ratio excludes inventory from the numerator; a large gap between the current ratio and quick ratio indicates significant inventory in current assets.
Question 3: Which of the following would cause a decrease in a company's days sales outstanding (DSO)?
- A lengthening of credit terms offered to customers
- An increase in accounts receivable relative to sales
- Faster collection of receivables from customers (Correct answer)
- A large uncollectible accounts write-off at year end
Correct answer: Faster collection of receivables from customers
DSO measures the average number of days to collect receivables; faster collection directly reduces DSO.
Question 4: Under IFRS, investment property is most likely carried at:
- Historical cost only
- Fair value only
- Either historical cost or fair value, at the company's election (Correct answer)
- The lower of cost or net realizable value
Correct answer: Either historical cost or fair value, at the company's election
IFRS permits companies to choose between the cost model and the fair value model for investment property (IAS 40), and must apply the chosen policy consistently.
Question 5: An analyst is comparing two companies: one uses operating leases and the other uses finance leases for identical assets. In the early years, the company using finance leases will report:
- Higher operating income and higher net income
- Lower operating income and lower net income
- Higher operating income and lower net income (Correct answer)
- Lower operating income and higher net income
Correct answer: Higher operating income and lower net income
Finance leases front-load interest expense (below operating income) but remove lease payments from operating expenses, so operating income is higher while total expense (and net income) is lower in early years.
Question 6: A deferred tax liability arises when:
- Taxable income exceeds pretax financial income due to temporary differences
- Pretax financial income exceeds taxable income due to temporary differences (Correct answer)
- Tax loss carryforwards are available to reduce future taxes
- A company overpays its estimated taxes during the year
Correct answer: Pretax financial income exceeds taxable income due to temporary differences
A deferred tax liability arises when financial reporting income exceeds taxable income due to temporary differences, meaning more taxes will be owed in the future.
Question 7: The direct method of presenting the statement of cash flows differs from the indirect method in that the direct method:
- Starts with net income and adjusts for non-cash items
- Reports cash flows from investing activities differently
- Shows individual cash receipts and payments from operating activities (Correct answer)
- Is required under IFRS but optional under U.S. GAAP
Correct answer: Shows individual cash receipts and payments from operating activities
The direct method explicitly lists major classes of gross cash receipts and payments from operations (e.g., cash received from customers, cash paid to suppliers), unlike the indirect method that reconciles from net income.
CFA Financial Reporting and Analysis 2
Under the percentage-of-completion method for long-term contracts, revenue is recognized: