10/21/2018 CMA Exam Review - Part 1

Overview

Upon completion of this lesson, candidates should be able to:

Identify the users of these financial statements and their needs. (1.A.1.a.)

Demonstrate an understanding of the purposes and uses of each statement. (1.A.1.b.)

Identify the major components and classifications of each statement. (1.A.1.c.)

Identify the limitations of each financial statement. (1.A.1.d.)

Identify how various financial transactions affect the elements of each of the financial statements and determine the proper classification of the
transaction. (1.A.1.e.)

Identify the basic disclosures related to each of the statements (footnotes, supplementary schedules, etc.). (1.A.1.f.)

Demonstrate an understanding of the relationship among the financial statements. (1.A.1.g.)

Prepare a balance sheet, an income statement, a statement of changes in equity, and a statement of cash flows (indirect method). (1.A.1.h.)

Every lesson in CMAexcel lists which of the official Institute of Certified Management Accountant Learning Outcome Statements (LOS) are covered
in the lesson. Every LOS is appended by page numbers that refer to where the LOS is addressed in the CMA Learning System Study Guide. If you
ever feel you require additional information on a subject, we encourage you to use this cross reference to review the study guide.
Financial statements are how organizations communicate to the business community. This lesson provides an introduction to financial statements
and how organizations prepare and use them. You will learn the different users of financial statements, how financial statements are related, and
how to prepare financial statements, including the statement of cash flows' operating section using the indirect method.

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Study Guide

I. A variety of users depend on financial statements to determine the financial position and health of organizations.
A. Managers use financial statements to determine whether the organization is utilizing resources in the most cost-effective manner and
to make key investment and financing decisions.
B. Shareholders and prospective investors use financial statements to determine whether they can receive an appropriate return on
investment.
C. Financial institutions assess the ability of borrowers to repay loans and other debt through financial statement analysis.
D. Suppliers use financial statements to assess the ability of their customers to pay bills on time.
E. Customers use financial statements to assess whether their suppliers will remain in business to provide an ongoing supply of goods
and services.
F. Employees analyze financial statements for their own job security and to determine the impact of profit-based compensation.
G. Competitors compare their performance to others in their industry or area using financial statements.
II. There are four financial statements businesses use to communicate financial information to stakeholders.
A. The balance sheet shows the organization's classification of assets, liabilities, and owner's equity as of a particular date.
1. A balance sheet is a "snapshot in time" of an organization's financial position.
2. The balance sheet is not indicative of movement over a particular time period.
3. The balance sheet contains three specific types of accounts.
a. Assets are resources the organization owns to produce future economic benefit.
b. Liabilities are the obligations an organization has to transfer economic benefit (primarily money and other resources) to
third parties.
c. Equity consists of the funds owners contribute to the organization plus any profits retained instead of being distributed to
owners.
d. The classic accounting definition is assets = liabilities + equity.
i. This means that the organization's resources under ownership equal the amount of obligations to pay third parties
plus the amount of funds related to ownership in the business.
ii. More simply stated, the accounting equation is "Uses of cash (Assets) = Sources of cash (Liabilities + Equity)"
e. Contra accounts are accounts which reduce or offset a related account. Two examples illustrate contra accounts below.
i. Fixed assets generally have a related contra-asset account called "Accumulated depreciation" to reduce the amount
of fixed assets on the balance sheet.
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ii. Paid-in-capital (an equity account) may have a contra-equity account called "Treasury stock" to record the cost of
stock repurchased by the organization.
B. The income statement shows the organization's sources of revenue, causes of expenses, and net income of operations for a given
period of time.
1. The income statement can be shown in one of two methods.
a. The single-step method shows the organization's total revenues and gains compared to total expenses and losses. An
example of a single-step income statement is shown below.

b. i.

c. A multi-step income statement shows how an organization's revenue, gains, expenses, and losses are split into operating
and nonoperating activities. This type of income statement provides a more detailed look at how an organization's primary
business operations are performing compared to nonprimary activities.

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d. i.

C. The statement of cash flows shows the changes to the organization's cash position over the course of a period of time.
1. The income statement records revenues and expenses on an accrual basis, so the cash flow statement presents a clearer picture
of the organization's sources and uses of cash.
2. The cash flow statement also reconciles the organization's cash position from the beginning to the end of the year.
3. The statement of cash flows is separated into three sections.
a. Operating activities — Cash generated and spent as a part of an organization's regular and ongoing operations.
i. Example — McDonald's cash flow from operating activities will show how the company uses and receives cash from
preparing and selling food and beverages.

1  There are two methods to prepare the operating method of the statement of cash flows.
a  Direct method — The specific sources and uses of cash are listed to show how an organization spends and
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generates cash flows.

b  Indirect method — This statement begins with net income and reconciles

b. Investing activities — Reports cash inflows and cash outflows that relate to "investment in" and disposal of noncash assets.
i. Examples.
1  Cash inflow examples include sale of long-term assets, collection of loan principal, disposal of debt and equity
securities, and sale of other productive assets such as patents — but not inventory.

2  Cash outflow examples include purchase of long-term assets, lending to others, investment in debt and equity
securities, and purchase of other productive assets such as patents — but not inventory.
ii. The net of above items constitutes Net Cash Flow from Investing Activities, and can be positive or negative.
iii. The items that make up the Cash Flow from Investing Activities are presented in the same manner, regardless of
whether the direct or indirect approach is used to present Cash Flow from Operating Activities.
c. Financing activities — Reports cash inflows and cash outflows that relate to how the entity is financed.
i. Examples.

1  Cash inflow examples include sale of own stock or proceeds from borrowings (bonds, etc.).

2  Cash outflow examples include repurchase of own stock (i.e. treasury stock), paying lenders back (principal
only), and payment of dividends.
ii. The net of above items constitutes Net Cash Flow from Financing Activities, and can be positive or negative.
iii. The items that make up the Cash Flow from Financing Activities are presented in the same manner, regardless of
whether the direct or indirect approach is used to present Cash Flow from Operating Activities.
D. The statement of changes in equity shows how the organization's equity position has changed over the course of the year, including
the following items.1
1. The amount of new share capital issued
2. Any contributions of individual owners into the business
3. Any withdrawals of capital by individual owners
4. The amount of dividend paid during the year to shareholders
5. The amount by which PPE is valued up or valued down
6. The amount of net income earned during the year

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7. The amount of net income retained during the year

8. Any movement in the unrealized loss or gain reserve and reserve for changes in foreign exchange gain or loss, etc.
9. The following example of a statement of shareholders' (owners') equity comes from Deere & Company's 2013 annual report.

III. A.

IV. Each financial statement has advantages and limitations to the information it provides, which is why the four statements work together to
show the organization's financial position.

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A. Balance sheet advantages

1. Shows the organization's assets, obligations to pay, and owner's equity at a particular point in time.
2. Shows the timing of sources and uses of resources (short-term compared to long-term).
B. Balance sheet disadvantages
1. Only shows a snapshot of the organization's position. Does not show activity over a period of time.
2. Accounting principles such as first in-first out vs. last in-first out can differ among organizations, making comparison difficult.
3. Different organizations can use different estimates for the same type of activity, making comparison among different companies
difficult.
C. Income statement advantages
1. Shows the results of an organization's ongoing operations.
2. Provides a picture of whether the organization is generating the resources to continue operating as a going-concern entity.
D. Income statement disadvantages
1. Many income statement items rely on management judgments and estimates. This can hinder the ability to compare income
statements of different organizations.
a. Example — One organization may use a straight-line depreciation method, while another organization may record
depreciation using an accelerated method.
b. Example — One organization may use First In, First Out (FIFO) to value inventory and record cost of sales, while another
organization uses Last In, First Out (LIFO). If prices are rising (i.e. inflation), the second organization will record higher cost
of sales on the same inventory.
2. The accrual method of accounting means an income statement is not necessarily a good representation of an organization's
cash flows.
E. Cash flow statement advantages
1. Provides an analysis of how organizations receive and use cash. This is important because suppliers, employees, and lending
sources are paid in cash, not profits.
2. Separates cash activity into operating, investing, and financing activities, allowing investors to identify how an organization is
obtaining and using cash.
F. Cash flow statement disadvantages
1. Cash flow statements only show historical information. Investors and other users must infer future cash flows based on historical
information.
2. Cash flow statements do not consider the accrual method of accounting.
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3. Noncash expenses are ignored when preparing the operating section of a cash flow statement.
V. All four financial statements relate to one another to present an integrated picture of the organization's financial health.
A. Double-entry bookkeeping requires that debits and credits match for any journal entry reflecting an event.
1. Debits and credits equaling means a particular transaction may impact different financial statements in a number of ways.
2. The following table illustrates how several common transactions will impact the balance sheet, income statement, and
statement of cash flows.

B. 1.

C. The relationship between the various financial statements is reflected in the figure below.
1. Income becomes a part of retained earnings.
2. Additional capital raised appears in the statement of cash flows as a financing activity and in the balance sheet as an increase in
owner's equity.
3. Dividends paid are reflected in the statement of cash flows as a financing activity and reduce retained earnings and cash.
4. Fixed asset purchases appear as increases in the balance sheet's fixed assets and in the statement of cash flows as investing
activities.
5. The following table shows the relationship between the various financial statements

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D. 1.

VI. In addition to the four key financial statements, financial statements also include additional disclosures to help investors understand
statements.
A. Disclosures are key explanations helping investors understand key assumptions and methods of accounting to help compare prior
periods and assist with comparisons with other companies.
B. Key disclosures include the following items.
1. Significant accounting policies, including the following:
a. Method of depreciation
b. Inventory valuation method
c. Revenue recognition policies
d. Securities classified as cash equivalents
2. Related party transactions

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3. Whether the business is in the development stage of operations and may not have adequate current profitability
4. Amounts and nature of maturing debt for the financial statement period
5. Sinking fund provisions
C. Supplemental schedules allow an organization to provide additional numerical detail to support the figures in financial statements.
1. Supplemental schedules allow organizations to provide more detailed information to help users understand or interpret
financial statements in more detailed.
2. Organizations can use supplemental schedules for instances such as the following:
a. Additional detail of fixed assets, such as types of fixed assets or length of service.
b. Business unit or segment revenues and expenses.
c. Additional detail of debt maturity levels or debt subordination levels.
D. Management's Discussion and Analysis (MD&A), which provides management commentary on the financial condition of the
organization, including forward-looking information.
1. MD&A provides additional depth to the numbers provided in the financial statements.
2. MD&A also gives management the opportunity to communicate about events impacting the business, including but not limited
to the following.2
a. Strategy and growth opportunities
b. Risk management and opportunities
c. Business results and outlook
d. Investment and financing decisions
VII. Most organizations prepare the statement of cash flow's operating section using the indirect method.
A. When an organization uses the indirect method to prepare the operating section of a statement of cash flows, it does NOT directly
identify sources and uses of cash like in the direct method. The indirect method computes cash flow by reconciling net income to the
changes in noncash gains, losses, and expenses and by adjusting for the changes in current asset and current liability accounts.
B. Cash flow from operating activities (indirect method) — The following Excel file shows an example of a cash flow from operating
activities using the indirect method. This example is also part of a Deep Dive as part of this lesson.
C. Cash flow Statement - Company XYZ, Year 2
1.
Cash flow from Operating Activities

Net income 73,500

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Depreciation 20,000

(Gain)/Loss (20,000)

Marketable securities (2,500)

Accounts Receivable 2,000

Inventory (3,000)

Other Current Assets (1,000)

Accounts Payable 3,000

Accrued Expenses 500

Other Current Liabilities 500

   

Cash flow from Operating Activities 73,000

D. Cash flow from investing activities

E. Cash flow from financing activities
F. The indirect method of preparing a cash flow statement reconciles net income to cash flow from operations by the following method.
1. Net income, PLUS
2. Depreciation expense, PLUS/MINUS
3. Non-operating losses (PLUS) or Non-operating gains (MINUS)
4. MINUS increases in current assets or PLUS decreases in current assets.
5. PLUS increases in current liabilities or MINUS decreases in current liabilities.
6. The following table shows the relationship between cash flows and changes in current assets and current liabilities.

7. a.

Footnotes

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1http://accountingexplained.com/financial/statements/equity-statement

2http://www.corpgov.deloitte.com/site/caneng/financial-reporting/managements-discussion-and-analysis/

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Notes

You haven’t made any notes or highlights yet.

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Flashcards

1
FC0101

Name the three items an income statement measures.

1. Sources of revenue
2. Causes of expenses
3. Net income

2
FC0102

1. The amount of new share capital issued.

List the six items that the statement of owner's equity tracks.
2. The amount of dividend paid during the year to
shareholders.
3. The amount by which property, plant, and equipment
(PPE) is valued up or valued down.
4. The amount of net income earned during the year.
5. The amount of net income retained during the year.
6. Any movement in the unrealized loss or gain reserve and
reserve for changes in foreign exchange gain or loss, etc.

3
FC0103

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Name the two key disadvantages of the income statement.

1. Many income statement items rely on management
judgments and estimates.
2. Income statements provide an estimate of cash
generation, but the accrual method of accounting
requires organizations also to prepare a statement of
cash flows to reconcile sources and uses of cash.

4
FC0104

List four key disclosures commonly found in financial Significant accounting policies including:
statements.
1. Related party transactions
2. Whether the business is in the development stage
3. Amounts and nature of maturing debt for the financial
statement period
4. Sinking fund provisions

5
FC0105

How will dividends paid to owners appear in financial Balance sheet: - Reduction in retained earnings
statements?
Cash flow statement: - Cash flow from financing activities

Statement of owners' equity: - Reduction in retained earnings

6
FC0106

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Who are direct users of financial statements?

Investors and owners
Management
Suppliers
Creditors
Employees
Customers

7
FC0107

Who are indirect users of financial statements?

Regulatory agencies
Markets
Financial analysts
Planners and advisors

8
FC0108

Who are internal users of financial statements?

Board of directors
Company management
Employees

9
FC0109

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Who are external users of financial statements?

Investors
Suppliers
Customers
Stock exchanges
Regulatory agencies

10
FC0110

What are the four key financial statements?

1. Balance sheet
2. Income statement
3. Cash flow statement
4. Statement of changes in owners' equity

11
FC0111

What are the three sources of cash flows?

1. Operations
2. Investing
3. Financing

12
FC0112

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How does U.S. generally accepted accounting principles
(GAAP) provide relevant financial valuation guidance?
GAAP provides guidance reflecting fair value, attributes of
value, and validity of a value estimate. This validity is based on
the quality of the assumptions and inputs used, the
appropriateness of the measurement techniques, and the
judgment of the estimator.

13
FC0113

Describe level 1 of the GAAP-based guidance for valuation.
Level 1 is the highest quality estimation level: It includes inputs
based on unadjusted quoted prices in active markets for assets
or liabilities identical to those being valued at the
measurement date. This level reflects the most reliable
evidence of fair value.

14
FC0114

Describe level 3 of the GAAP-based guidance for valuation. Level 3 is the lowest quality estimation level and includes
unobservable inputs that are reflective of the entity's
assumptions.

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Knowledge Checks

Question 1 (TF7054)

One advantage of the income statement is that all companies use the same accounting methods. (III. D. 1.)
True
False

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Question 2 (TF7051)

The balance sheet measures results over a period of time. (II. A. 1.)
True
False

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Question 3 (TF7053)

An advantage of the balance sheet is to show the timing of sources and uses of cash. (III.A.2.)
True
False

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Question 4 (TF7052)

The income statement shows revenues and expenses for a period of time. (II. B.)
True
False

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Question 5 (TF7055)

The three sections of a statement of cash flows are operating, investing, and financing. (III.C.)
True
False

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Answered Question 1 (TF7054)

One advantage of the income statement is that all companies use the same accounting methods. (III. D. 1.)
True
False

Correct

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Answered Question 2 (TF7051)

The balance sheet measures results over a period of time. (II. A. 1.)
True
False

Correct

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Answered Question 3 (TF7053)

An advantage of the balance sheet is to show the timing of sources and uses of cash. (III.A.2.)
True
False

Correct

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Answered Question 4 (TF7052)

The income statement shows revenues and expenses for a period of time. (II. B.)
True
False

Correct

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Answered Question 5 (TF7055)

The three sections of a statement of cash flows are operating, investing, and financing. (III.C.)
True
False

Correct

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Slides

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Test Bank Questions

Question 1 (1A1-W014)
1A1-W014
How does the balance sheet help users?
It depicts the true value of an entity.
It measures the nonfinancial performance of an entity.
It shows the financial performance of an entity over a specific accounting period.
It assesses an entity's liquidity, solvency, financial flexibility, and operating capability.

The balance sheet assesses an entity's liquidity, solvency, financial flexibility, and operating capability. These factors can be observed by
calculating an entity's financial ratios.

Question 2 (1A1-W013)
1A1-W013
Which of the following is true of an income statement presented as per U.S. GAAP?
It reconciles beginning and ending balances of stockholders' equity.
Bank overdrafts are always included as a component of operating activities on the cash flow statement.
Financial measures of contractual agreements such as pension obligations, lease contracts, and stock option plans are required to be
disclosed on the income statement as a separate line item.
When a company sells a component of its business, the income or loss associated with the component should be reported net of tax
separately from income from continuing operations.

When a company sells a component of its business, the income or loss associated with the component should be reported net of tax
separately from income from continuing operations in a separate line item on the income statement. Both the after-tax operating income or
loss the component generated during an accounting period prior to the sale and the after-tax gain or loss recognized from the sale should be
reported separately.

Question 3 (1A2-W018)
1A2-W018
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Which of the following is true of disclosure requirements of accounts receivable?

The material receivables must be kept separate by type on the balance sheet and reported net of any valuation accounts.
The monthly change in credit sales and accounts receivables should be reported as part of footnotes.
Accounts receivables should not be reported as a line item if it is factored.
Accounts receivables should be classified as liquid part—included in current assets and as illiquid part—included in noncurrent assets.

The material receivables must be kept separate by type on the balance sheet and reported net of any valuation accounts.

Question 4 (1A1-W003)
1A1-W003

The cash flows and net income from four business segments for Taylor Laboratories Inc. have been provided.

Segment 1 Segment 2 Segment 3 Segment 4

Cash flow from operations $3,000 $(250) $(3,000) $2,000
Cash flow from investing activities (4,000) 6,000 8,000 (3,000)
Cash flow from financing activities 1,080 (1,000) (1,000) 1,080
Net income 1,500 1,750 2,375 1,500

Based on the information, which segment should be discontinued by the company?

Segment 3, because cash used in operations is high and cash inflow is predominantly from investing activities.
Segment 1, because net income is lowest and requires high investments.
Segment 4, because net income and cash inflow from operations are low.
Segment 2, because cash used in operations is low and cash flow from investing activities is not properly utilized.

Segment 3 should be discontinued because the major portion of the segment's income could be from the sale of its assets.

Question 5 (1A1-W0015)
1A1-W0015

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The following information is extracted from the financial statements of Foster Machines.

Net income $15,000

Depreciation on equipment 2,500
Dividend income 2,500
Interest income 5,000
Increase in accounts receivable 8,000
Increase in current liabilities 6,500
Redemption of bonds 7,500

The cash flows from operations were calculated to be $23,500. Assuming that the company follows U.S. GAAP, which of the following is a potential
error in the calculation of cash flow from operations?

Dividend income and interest income were added back to net income to calculate cash flows from operations.
Redemption of bonds was included in cash flow from operations.
Increase in accounts receivable was added to net income whereas it should have been deducted.
Depreciation on equipment was not added back to net income for calculating cash flows from operations.

As per U.S. GAAP, dividend income and interest income are included in the calculation of net income. Hence, dividend income and interest
income, being operating activities, should not be added back to net income. Net income $15,000 + Depreciation on equipment $2,500 −
increase in accounts receivable $8,000 + increase in current liabilities $6,500 = cash flows from operations $16,000. The incorrect answer was
calculated as follows: cash flows from operations $16,000 + dividend income $2,500 + interest income $5,000 = incorrect cash flows from
operations $23,500.

Question 6 (1A1-W017)
1A1-W017
"Employing different accounting methods will yield different net incomes." How is this factor a limitation of financial statements?
Choice between cash-based accounting and accrual accounting for financial reporting allows companies to smooth earnings for a longer
period.
The flexibility of employing different methods for presentation of financial statements can lead to inaccurate disclosure of information.
Change in net income due to change in accounting methods affects the determination of future performance of a company.

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Difference in results due to change in accounting methods makes it difficult for users to compare the performance of different entities.

Employing different accounting methods will yield different net incomes. Each choice of two or more accounting methods will further change
the results reported, making the task of comparing different entities very difficult, even when these methods are disclosed.

Question 7 (1A1-W008)
1A1-W008
Which of the following is a reason why a company provides prior years' financial information along with the current year's information?
Doing this helps the users of financial statements in measuring the reliability of information provided in the financial statements.
Doing this allows management accountants to determine the trend in an increase in resource requirement for future periods.
Doing this allows analysts to easily compare past performance to present performance and determine its future success.
This form of presentation of financial statements helps in prioritizing one type of revenue or gain over another to avoid classification
problems.

Most entities provide prior years' financial statement information alongside the current year's information for comparison as this allows
analysts to easily compare past performance to present performance and make a determination of future success.

Question 8 (1A1-W010)
1A1-W010

Following is an extract from the statement of shareholders' equity of Joyce Gregory Inc. prepared by the finance manager.

Common stock shares Common stock amount Retained earnings Other Total equity
Balance from previous year 500,000 $5,000,000 $15,000,000 – $20,000,000
Net income – – 100,000 – 100,000
Issuance of common stock 1,000 10,000 – – 10,000
Other comprehensive income – – – 10,000 10,000
Balance at the end of current year 501,000 $5,010,000 $15,100,000 $10,000 $20,120,000

The company's CFO did not approve the financial statements. Which of the following, if true, will support the CEO's decision?

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Net income should not be classified under retained earnings.

Issuance of common stock should be part of retained earnings.
Other comprehensive income will not be included as part of shareholders' equity.
Cash flow from operations is not included in the calculation of shareholders' equity.

Firms have the option of presenting the calculation of comprehensive income either as part of an income statement or as a separate
statement of comprehensive income. Comprehensive income can no longer be presented as a part of the statement of shareholders' equity.

Question 9 (1A1-W016)
1A1-W016

The following information is extracted from the financial statements of BrentPage.

Net income $25,000

Depreciation on equipment 2,000
Dividend income 3,500
Interest income 3,000
Increase in current assets 5,400
Increase in current liabilities 500
Loans granted to subsidiaries 12,000

Assuming the company follows U.S. GAAP, calculate the cash flow from operating activities.

$40,600
$20,100
$28,600
$22,100

The correct answer is $22,100. CFO = Net income + Depreciation − Increase in current assets + Increase in current liabilities = $25,000 + $2,000
− $5,400 + $500 = $22,100

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Question 10 (1A1-W009)
1A1-W009
Suzanne Rogers, a financial analyst, is analyzing Capital One's stock. She is more interested in estimating the cash flows Capital One can generate.
From the financial analyst's perspective, which of the following balance sheet reporting is best suited to avoid adjustments?
Inventory reported at current market value; fixed assets reported at historical cost.
Inventory reported at replacement cost; fixed assets reported at market value.
Inventory reported at historical cost; fixed assets reported at historical cost.
Inventory reported at historical cost; fixed assets reported at fair value.

The current market value of inventory closely reflects the value at which it can be sold. Fixed assets reported at historical cost will help to
estimate depreciation expense, and in turn the tax shield from depreciation, correctly.

Question 11 (1A2-W010)
1A2-W010
Under which of the following circumstances will cash, set aside to fulfill terms of an agreement, be determined as a long-term asset?
When it is not material and is subject to a significant risk of change in value due to change in the value of the associated long-term asset.
When it is used to pay liabilities beyond the operating cycle or year, whichever is longer, or for the retirement of a specific long-term debt.
When the minimum balance requirements designed to offset part of the risk of lending is more than the estimated value of the liability.
When there is a debt instrument that is expected to mature after the operating cycle.

Restricted cash is a current asset if it will be used to pay liabilities within a year or the operating cycle, whichever is longer. Otherwise, it is
reported as a long-term asset.

Question 12 (1A1-W023)
1A1-W023
Rita Williams and Sasha Ortiz recently joined Flifund Financials, a fund management company. They are assigned to value the stock of Probe
Systems. Rita's estimate of assets and liabilities is higher than Sasha's estimate. Which of the following will most likely undermine Rita's
estimation?
The company has no off-balance sheet transaction.
The company has purchased a high amount inventory on credit.
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The company has goods on consignment with another company.

The company has no debt.

Some transactions, like off-balance sheet transactions, can be recorded in a way that avoids reporting liabilities and assets on the balance
sheet. Here, Rita might have discovered the use of an off-balance sheet transaction by Probe Systems and hence valued Probe's assets and
liabilities higher.

Question 13 (1A2-W005)
1A2-W005
AWS Inc. is engaged in the construction of rail tracks. The CEO suggests allocating all of the insurance, property taxes, and supervisory factory labor
to construction, but the management accountant disagrees. The management accountant will argue that the indirect costs should be allocated in
what way?
The indirect costs should be allocated to the extent of the difference between net realizable value and carrying value.
The indirect costs should be allocated to the extent of proportionate completion.
The indirect costs should be allocated proportionally based on the value of the asset.
The indirect costs should not be capitalized to the rail tracks.

A proportional amount of the indirect costs should be allocated to a self-constructed asset based on value. Any costs incurred in excess of the
asset's market value should not be capitalized but would be recorded as a loss.

Question 14 (1A1-W006)
1A1-W006

The financial accountant of Eva Wolfe Corp. has ascertained the cash flows from operations as follows.

Net income $15,000

Depreciation on equipment 2,500
Dividend income 2,500
Interest income 5,000
Increase in current assets 8,000

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Increase in current liabilities 6,500

Cash flow from operations $16,000

The management accountant of the company argues that the cash flow from operations should be $8,500. Which of the following statements, if
true, will undermine the management accountant's calculation?

The company operates in a tax-free environment.

Dividend income and interest income, already included in net income, are considered cash flow from operating activities.
Cash flow from operations is ascertained using the direct method.
Depreciation on equipment should not be added back to net income for calculating cash flow from operations.

Investing cash inflows result from sales of property, plant, and equipment; sales of investments in another entity's debt or equity securities;
or collections of the principal on loans to another entity. However, dividend income and interest income are included in cash flow from
operating activities. Hence, the management accountant might have incorrectly calculated the cash flow from operations as follows: $15,000
+ $2,500 − ($8,000 − $6,500) − ($2,500 + $5,000) = $8,500.

Question 15 (1A1-W021)
1A1-W021
Why is it important for a financial analyst to scrutinize the statement of cash flows’ footnotes?
Footnotes provide vital information about a company's liquidity position, trend in revenue from different demographic regions, and changes
in capital structure.
Footnotes provide significant information about noncash investing and financing activities, such as the issuing of stock for fixed assets.
Footnotes detail the executive compensation details and shareholders' voting procedures and information.
Footnotes provide significant information about mergers and acquisitions a company is targeting in the current year.

The statement of cash flows requires footnote disclosure of any significant noncash investing and financing activities, such as the issuing of
stock for fixed assets or the conversion of debt to equity.

Question 16 (1A1-W020)
1A1-W020

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Juan Baker Inc. filed a suit against Foster Desserts in the second quarter of the current year and claimed damages worth $15,000. There was also a
pending litigation against Juan Baker Inc. for $12,000 to its customers for supplying lower-quality goods. The company was expecting to win the
suit against Foster Desserts. For presenting the financial statements for the year, Juan Baker's accountant realized a net gain of $3,000 as other
comprehensive income. As per U.S. GAAP, how should this information be presented?
The accountant should recognize contingent liability of $12,000 and disclose contingent gains of $15,000 as footnotes.
This information should not be presented as part of financial statements but should be disclosed in footnotes to financial statements.
The accountant should realize net gain of $3,000 as part of gains from discontinued operations.
This information should not be presented in financial statements but should be disclosed in the directors' responsibility statement.

Accounting recognition is not given to gain contingencies to avoid the premature recognition of income before its realization. However, loss
contingencies must be recognized when it is both probable that a loss has been incurred and the amount of the loss is reasonably estimable.

Question 17 (1A1-W018)
1A1-W018
McCarthy Corp. is issuing its first financial statements. The CFO of the company is of the view that all assets shall be recorded at historical cost
throughout the life of the organization. Which of the following is the best critique of such a disclosure?
Historical value assumes that the value of an asset is the amount that would have to be paid to replace the asset on the balance sheet date.
Historical value takes into account the effects of inflation on the asset; therefore, the value fluctuates in each period.
Historical value does not take into account the effect of depreciation; therefore, the true value of the asset cannot be determined.
Historical value is less relevant for assessing a company's current financial position.

Most asset accounts of a nonfinancial nature are reported at historical cost. While historical cost measures are considered reliable because
the amounts can be verified, they are also considered less relevant than fair value or current market value measures would be for assessing a
firm's current financial position.

Question 18 (1A1-W011)
1A1-W011
According to US GAAP, which of the following statements is true of comprehensive income?
Firms should report comprehensive income as a separate line item after net income in the income statement.
Any realized or unrealized gain on an asset should be included as part of comprehensive income, whereas realized or unrealized losses should

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be excluded from comprehensive income.

Firms have the option of presenting the calculation of comprehensive income either as part of an income statement or as a separate
statement of comprehensive income.
Comprehensive income can be presented as a part of the statement of shareholders' equity.

Comprehensive income can no longer be presented as a part of the statement of shareholders' equity. Firms have the option of presenting
the calculation of comprehensive income either as part of an income statement or as a separate statement of comprehensive income.

Question 19 (1A2-W025)
1A2-W025
An extract of the footnotes of Chavez Inc., with 13 subsidiaries across 4 countries, reads as follows:

"The company uses the current rate method for translation of subsidiary accounts. Paid-in capital accounts have been translated using the historic
rate. All assets and liabilities have been translated using the current exchange rate on the balance sheet date, whereas income statement accounts
have been translated using the end-of-year rate."

The CEO of the company did not approve the financial statements, stating that the accounting policies followed are not in line with U.S. GAAP.
Which of the following statements support the CEO's decision?
Income statement accounts should be translated based on the current exchange rate on the balance sheet date.
Income statement accounts should be translated based on the average rate for the current year.
All assets and liabilities should be translated using the average rate for the current year.
Paid-in capital accounts should be translated using the end-of-year rate.

In the current rate method, all assets and liabilities are translated using the current exchange rate on the balance sheet date. Paid-in capital
accounts are translated using the historic rate. For simplicity, ASC 830 Foreign Currency Matters (formerly SFAS No. 52, Foreign Currency
Translation) requires translation of income statement accounts based on the average rate for the current year.

Question 20 (1A1-W022)
1A1-W022
The management accountant of Kathryn Software decided to alter the financial statements due to an event that occurred after the balance sheet
date. Which of the following is the most likely reason for her decision?
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The event provides evidence about a loss of expected income due to inefficient collection efforts.
The company has decided to shift the company's headquarters to a country that follows IFRS in the next year.
The event provides additional evidence about conditions that existed as of the balance sheet date and alters the estimates used.
There is a sharp decline in the stock price.

If a subsequent event provides additional evidence about conditions that existed as of the balance sheet date and alters the estimates used
in preparing the financial statements, then the financial statements should be adjusted.

Question 21 (1A1-W025)
1A1-W025
While approving the financial statements for the current year, the management accountant of Rachael Groups discovered that sales were
overstated. Which of the following is the most likely reason for the overstatement?
Sales returns recorded are more than actual returns.
Abnormal losses are not accounted for.
General sales tax collected from customers was not accounted for.
The last in, first out method is used for valuation of inventory.

Usually sales tax is included in the selling price of a product. The sales account should be adjusted for the amount of sales tax collected, and it
should be recorded as a liability.

Question 22 (1A1-W001)
1A1-W001

The multi-step income statement, with additional income statement items, for Harrington Technologies Inc. is given below.

Net sales $2,000,000

Less: Cost of goods sold 890,000
Gross profit 1,110,000
Less: Transportation and travel 45,000
Depreciation 68,000

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Pension contributions 21,000

Operating income 976,000
Less: Discontinued operations 76,000
Income before taxes 900,000
Less: Tax expense @ 30% 270,000
Net income $630,000

Glen Hamilton, a financial analyst, analyzed the company's financial statements and concluded that the real net income should be $683,200
instead of $630,000. Which of the following arguments is most likely to support his conclusion?

$53,200 due from a client was written off as irrecoverable after the finalization of accounts for the current period.
The company valued its inventory using the specific identification method, whereas the financial analyst used the last in, first out (LIFO)
method for the current period.
The company might have liquidated its LIFO reserve.
The company has included expenses in relation to discontinued operations as part of income from continued operations.

Revenue and expenses from discontinued operations do not form part of income from continued operations. In this case, the analyst has
excluded discontinued operations since it is a nonrecurring item.

Question 23 (1A1-W004)
1A1-W004
The cash flow from operations for Charlene Energy Inc. is $25,000 for the current year. If the amortization expense increases by $5,000 and other
factors remain same, under which of the following assumptions will the cash flow from operations remain unaffected?
Cash paid for intangibles also increased by $5,000 during the year.
The company has an infinite life.
The company is operating in a tax-free environment.
The company can change the amortization method during a financial year.

Cash inflow from amortization arises because of the tax shield. In a tax-free environment, a change in amortization will not affect the cash
flows from operations.

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