CFA Level 1 - Financial Reporting and Analysis Session 8 - Reading 23

CFA Level 1 - Financial Reporting and Analysis Session 8 - Reading 23 (Notes, Practice Questions, Sample Questions) 1. A company’s chart of accounts is: A)used for entries that offset other accounts. B)the set of journal entries that makes up the components of owners’ equity. C)a detailed list of the accounts that make up the five financial statement elements. Explanation — C: A company’s chart of accounts is a detailed list of the accounts that make up the five financial statement elements and the line items presented in the financial statements. Contra accounts are used for entries that offset other accounts. The categories that make up owners’ equity are capital, additional paid-in capital, retained earnings and other comprehensive income 2. Accumulated depreciation and treasury stock are most likely to be shown as what types of accounts? Accumulated depreciation Treasury stock A) Contra-asset Equity B) Contra-asset Contra-equity C) Liability Equity Explanation — B: Accumulated depreciation is a contra-asset account to the asset account property, plant & equipment. Treasury stock is a contra-equity account to common stock or additional paid-in capital 3. Allowance for bad debts and investment in affiliates are most likely to be shown as what types of accounts? Allowance for bad debts Investment in affiliates A) Contra-asset Asset B) Contra-asset Liabilities C) Liabilities Asset Explanation — A: Allowance for bad debts is a contra-asset account to accounts receivable. Investments in affiliates are considered assets 4. The following amounts were drawn from the records of JME Company: total assets = $1,200; total liabilities = $750; contributed capital = $600. Based on this information alone, retained earnings must be equal to: A)$150. B)$450. C)−$150 Explanation — C: (1,200 − 750 − 600) = −150 5. What is the fundamental balance sheet equation? A)Assets = Liabilities + Stockholders' Equity (A = L + E). B)Assets = Stockholders' Equity - Liabilities (A = E - L). C)Liabilities = Assets + Stockholders' Equity (L = A + E) Explanation — A: The fundamental balance sheet equation is Assets = Liabilities + Stockholders’ Equity (A = L + E). This is the fundamental accounting relationship that sets the basis for recording all financial transactions 6. Which of the following least accurately describes a correct use of double-entry accounting? A)A decrease in a liability account may be balanced by a decrease in another liability account. B)A transaction may be recorded in more than two accounts. C)An increase in an asset account may be balanced by an increase in an owner’s equity account Explanation — A: Keeping the accounting equation in balance requires double-entry accounting, in which a transaction has to be recorded in at least two accounts. An increase in an asset account, for example, must be balanced by a decrease in another asset account or by an increase in a liability or owners’ equity account. A decrease in a liability account may be balanced by an increase in another liability account, not a decrease. If two liabilities decrease without a balancing entry, the balance sheet will be out of balance 7. Allen Parsons, a CFA candidate, suspects a colleague at his firm of engaging in an illegal activity. Which of the following statements about procedures for compliance involving Standard I(A), Knowledge of the law is NOT correct? Parsons: A)should urge his firm to attempt to persuade the perpetrator to cease such conduct. B)is required to report this legal violation to the appropriate governmental or regulatory organizations. C)should consult counsel to determine whether the conduct is, in fact, illegal. Explanation — B: Standard I(A), Knowledge of the law, does not require that Parsons report legal violations to the appropriate governmental or regulatory organizations, but such disclosures may be appropriate under certain circumstances 8. Mary Kim practices in the economically advanced country of Oldasia as well as in the emerging market country of Newasia. By regulation, Oldasia prohibits licensed investment advisors from trading in securities ahead of their clients. Newasia has no laws or regulations in this area. According to the CFA Institute Standards of Professional Conduct, Kim may: A)trade ahead of her clients in Newasia only. B)not trade ahead of her clients in either country. C)trade simultaneously with her clients in Newasia only, as long as she has made full disclosure to her clients that she reserves the right to do this. Explanation — B: Under Standard I(A) Knowledge of the Law must apply the CFA Institute Code and Standards or the controlling law, whichever is stricter. Because Standard VI(B) Priority of Transactions requires members to put client trades ahead of their own transactions, Kim must follow the standard in the absence of governing law or where the law is less strict than the Standard