Wiley

CMAexcel Learning
System
Exam Review 2019
Part 2: Financial Decision Making
Session 3

Learning Outcome Statements (LOS) identifiers

appear on the slides as applicable to highlight
where we address each LOS within the material.

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 Session 2 Recap
• Section A, Topic 2: Financial Ratios
• Exercise: Financial Statement Analysis—
Financial Ratios

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 Session 3 Overview
• Section A, Topic 3: Profitability Analysis
• Section A, Topic 4: Special Issues
• Section A Practice Questions

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 Topic 3: Profitability
Analysis
• Profitability is the firm’s ability to generate
earnings
• Dividend related ratios analysis
• Integrates tightly with financial statement
analysis
• Encompasses a high-level analysis called
DuPont Analysis
• Involves qualitative aspects of revenue,
expense, and income measurement
Part 2, Section A, Topic 3: Profitability Analysis 4
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 LOS P2.A.3.a.

Question: Comparative ROA

An investor is deciding whether to invest in either of two
companies (Company A and Company B) within the same
industry. Both companies have a 15% profit margin and
total assets of $15,000,000. Which of the following is true
when measuring these companies based on their return
on assets (ROA)?
a. The company with the lower sales per year will be
more attractive.
b. The company with the higher sales per year will be
more attractive.
c. Each company is equally attractive as their assets
are equal.
d. Both are equally profitable, therefore they are
Answer:
b. 2,equally
Part
attractive.
Section A, Topic 3: Profitability Analysis 5
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 LOS P2.A.3.a.

Question: ROE Conceptual

For a given level of sales, and holding all other
financial statement items, including liabilities,
constant, a company's return on equity (ROE) will:
a. increase as their debt ratio decreases.
b. increase as their equity increases.
c. decrease as their total assets increase.
d. decrease as their cost of goods sold as a percent
of sales decrease.

Answer:
c.
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 LOS P2.A.3.a. and f.

Question: DuPont
In analyzing return on equity (ROE), which of the
following ways does the DuPont model enhance the
analysis of the ROE calculation?
a. It does not enhance the analysis of ROE
calculations.
b. It measures operational efficiency, asset use
efficiency, and financial leverage.
c. It measures operational leverage, asset use
efficiency, and financial efficiency.
d. It measures how well the organization manages
its assets at various levels of activity.
Answer:
b. 2, Section A, Topic 3: Profitability Analysis
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 LOS P2.A.3.h.

Question: Operating Profit Margin

Tech Manufacturing Company realized $15,000,000 in
sales, with a cost of goods sold of $6,000,000, and
operating expenses of $4,500,000. Their operating
profit margin would be:
a. 25%.
b. 35%.
c. 30%.
d. 40%.

Answer:
c.
Part 2, Section A, Topic 3: Profitability Analysis 8
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 LOS P2.A.3.h.

Question: Profit Margin and Asset

Turnover
Which of the following correctly defines the
relationship between profit margin and asset
turnover?
a. ROA using the DuPont model is calculated by
subtracting asset turnover from profit margin.
b. ROA using the DuPont model is calculated by
multiplying profit margin times asset turnover.
c. There is no relationship between profit margin
and asset turnover.
d. ROA using the DuPont model is calculated by
dividing profit margin by asset turnover.
Answer:
b. 2, Section A, Topic 3: Profitability Analysis
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 LOS P2.A.3.c.

Question: Earnings Power

Earnings power is:
a. the best possible estimate of the average
business earnings over a number of years.
b. a forecasting tool that anticipates probable
future conditions instead of making the
assumption of a continued trend.
c. a mathematical calculation based on past
earnings that can absolutely predict future
earnings.
d. the company’s ability to turn liabilities into
income-generating activities.
Answer:
a. 2, Section A, Topic 3: Profitability Analysis
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 LOS P2.A.3.g.

Question: Cost of Goods Sold

In the last fiscal year, LMO Company had net sales of
$7,000,000, a gross profit margin of 40%, and a net
profit margin of 10%. What is its cost of goods sold?
a. $2,800,000.
b. $6,300,000.
c. $700,000.
d. $4,200,000.

Answer:
d.
Part 2, Section A, Topic 3: Profitability Analysis 11
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 LOS P2.A.3.h.

Question: Gross Profit Margin

An increase in the gross profit margin for a
merchandising firm indicates that the firm:
a. is increasing its revenues.
b. is decreasing its fixed costs.
c. has been managing its quality control better,
which results in fewer returns.
d. is doing a better job of managing cost of sales.

Answer:
d.
Part 2, Section A, Topic 3: Profitability Analysis 12
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 LOS P2.A.3.e.

Question: Matching Sales and Receivables

A business is showing an increase in receivables

without a matching increase in sales. This may
indicate that the company has:
a. an increased number of customers.
b. become more efficient at delivering its products.
c. decreased its terms of credit.
d. problems with collection of receivables.

Answer:
d.
Part 2, Section A, Topic 3: Profitability Analysis 13
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 LOS P2.A.3.j.

Sustainable Growth—The Importance

of ROE
• Sustainable growth is ROE  retention rate
• Is the rate at which a firm can grow
• Without changing its capital structure and
• Without issuing new common stock

Sustainable Growth Rate = ROE  (1 – Dividend Payout

Ratio)

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 LOS P2.A.3.j.

Question: Sustained Equity Growth

AEW Corporation’s net income is $5,000,000, and its
dividend payout is $1.20 per share, with 500,000
shares outstanding. Its average common
shareholders’ equity is $7,000,000. What is AEW’s
sustainable equity growth rate?
a. 0.078
b. 0.714
c. 0.629
d. 0.8

Answer:
c.
Part 2, Section A, Topic 3: Profitability Analysis 15
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 LOS P2.A.3.j.

Question: Sustainable Growth

Consider the following factors relating to Tech Manufacturing:
Sales $15,000,000
Cost of Goods Sold $ 6,000,000
Operating Expenses $ 4,500,000
Total Assets $ 6,500,000
Total Equity $ 2,000,000
Corporate Tax Rate 40%
Dividend Payout Ratio 30%
What is Tech Manufacturing's Sustainable Growth Rate if Tech has no
interest-bearing debt?
a. 0.995
b. 1.280
c. 0.954
d. 0.945

Answer: d.
Part 2, Section A, Topic 3: Profitability Analysis 16
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 LOS P2.A.3.c.

Income Measurement Analysis

The following must be considered in measuring income:
• Estimates
• Accounting methods
• Disclosure incentives
• Different needs of users

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 LOS P2.A.3.c.

Question: Measuring Income

Which of the following must be considered in measuring
income?
I. Estimates regarding future events
II. Accounting methods used by the company
III. The degree of informative disclosure about results of
operations
IV. Different needs of users

a. II and III only.

b. I, II, and IV only.
c. I and II only.
d. I, II, III, and IV.
Answer:
d.
Part 2, Section A, Topic 3: Profitability Analysis 18
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 LOS P2.A.3.f.

Revenue Analysis
Rules regarding the recognition of revenues:
• Activities for creation of revenue must be substantially
complete.
• The risk of ownership must have been effectively passed
on to the buyer.
• The revenue must be able to be measured or estimated
with substantial accuracy.
• The revenue recognized must normally result either in
an increase in cash, receivables or other asset, or a
decrease in a liability.
• Business transactions must be at arm’s length, with
independent parties.
Part 2, Section A, Topic 3: Profitability Analysis 19
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 LOS P2.A.3.f.

Question: Revenue Recognition Criteria

Which of the following rules have accountants adopted
regarding the
recognition of revenues?
I. Revenues must be realized by a cash transfer.
II. Risk of ownership must have been effectively passed to
the buyer.
III. Business transactions should be with independent
parties.
IV. Revenue can be measured or estimated with
substantial accuracy.

a. II, III, and IV.

b. I, II, and IV only.
Answer:
c. I2,and II only.
a.
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d. II and
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 LOS P2.A.3.d.

Revenue Trends and Stability

Considerations bearing on the quality and stability of the
sales and revenue trend include:
• Elasticity of demand for products.
• Ability of the business to anticipate demand trends
by the introduction of new products and services.
• Level of competition.
• Degree of customer concentration and
dependence on a single industry.
• Degree of dependence on relatively few leading
sales associates.
• Degree of geographical diversification of markets.

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 Topic 4: Special Issues
• Economic profit and accounting profit
• Earnings quality
• Earnings persistence
• Market-based measures
• Impact of foreign operations
• Fair value accounting
• Impact of foreign currency
• International Financial Reporting Standards
(IFRS)

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 LOS P2.A.4.e.

Accounting Profit versus Economic

Profit

Economic Profit =
Total Revenue – (Explicit Costs + Implicit
Costs)

Accounting Profit =
Total Revenue – Explicit Costs

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 LOS P2.A.4.e.

Economic Profit and Accounting

Profit
• Accounting profits are approximations of economic profit.
• Economic profits are viewed over the long term.
• The earning process is continuous and not discrete.

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 LOS P2.A.4.e.

Limitations of Accounting Profits

• Artificial cut-off date for financial reporting purposes
• Judgments used to classify and recognize events
• Extensive use of estimates:
1. Allowance for doubtful accounts and bad debt
expense
2. Accumulated depreciation (useful life; method) and
depreciation expense

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 LOS P2.A.4.e.

Question: Accounting Profit

The correct definition of accounting profit is:
a. The excess net assets available to shareholders.
b. The excess of equity over liabilities.
c. The excess of revenues over the costs of land,
labor, and capital.
d. The excess of revenues over expenses.

Answer:
d.

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 LOS P2.A.4.e.

Question: Economic Costs

“Economic costs” often differ from costs shown in a
firm's financial statements. For a corporation, a
major difference would arise due to:

a. salary and wage costs.

b. opportunity costs.
c. state and local tax costs.
d. interest costs.

Answer:
b.
Part 2, Section A, Topic 4: Special Issues 27
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 LOS P2.A.4.e.

Question: Accounting versus

Economic Profits
Which of the following statements is true?
a. Economic profits are accounting profits minus implicit
costs.
b. Economic profits are accounting profits minus explicit
costs.
c. Accounting profits are economic profits minus explicit
costs.
d. Accounting profits are economic profits minus implicit
costs.

Answer:
a.
Part 2, Section A, Topic 4: Special Issues 28
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 LOS P2.A.4.d.

Accounting Changes
FASB ASC Topic 250, Accounting Changes and Error
Corrections (formerly covered in FASB Statement No.
154), outlines three types of accounting changes:
• Change in accounting principle—requires retrospective
application of the change (adjustment of prior period
financial statements).
• Change in accounting estimate—requires prospective
treatment of the change (do not restate prior period
financial statements).
• Change in reporting entity—similar to a change in
accounting principle, requires adjustment of prior period
financial statements.
Part 2, Section A, Topic 4: Special Issues 29
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 LOS P2.A.4.d.

Error Corrections
• Occurs when a material error is made in a prior period’s
financial statements
• Corrected by adjusting the beginning balance of retained
earnings.
• When financial statements of prior periods are being
reported on a comparative basis, they are restated to
correct amounts. The effect of the error on earlier
periods is presented as an adjustment of beginning
retained earnings for the earliest period presented net of
income tax effects.
• Examples of errors that might require correction include
the failure to accrue a material expense or income
amount, or the failure to depreciate property, plant, and
Part 2, Section A, Topic 4: Special Issues 30
equipment.
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 LOS P2.A.4.d.

Error Corrections (cont.)

When closing its books and preparing the December 31,
Year 2 financial statements, Briar Company discovered
that it failed to accrue interest income on a large note
receivable in the current period (Year 2) and also in the
prior year (Year 1). Amounts omitted include $91,800 for
Year 1, and $100,200 for Year 2. The December 31, Year 2
entry to correct these errors, ignoring the effect of income
taxes, would include a:
a. Credit to interest receivable for $100,200.
b. Credit to retained earnings for $91,800.
c. Credit to retained earnings for $192,000.
d. Credit to interest revenue for $91,800.
Answer:
b. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.f.

Earnings Quality
Refers to the validity and veracity of the reported
information

Basic factors:
• Selection of accounting principles
• Provision for maintenance of assets and
future earnings power
• Off–balance-sheet financing
• Effect of economic forces on earnings

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 LOS P2.A.4.f.

Question: Earnings Quality

Which statements describe indicators of earnings quality?
I. Consistency in reporting policies is an indication of earnings quality.
II. A company with stable earnings levels is an indication of earnings
quality.
III. More conservative accounting policies are an indicator of earnings
quality.
IV. A company with widely varying earnings levels from year to year is
an indication of earnings quality.

a. I and II, only.

b. I, III, and IV, only.
c. I, II and III, only.
d. II, III and IV, only.
Answer:
c.
Part 2, Section A, Topic 4: Special Issues 33
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 LOS P2.A.4.f.

Earnings Persistence
Measures how well current earnings predict future
earnings
• Earnings that display steady growth trends
are most desirable.
• Effect of transitory income or expenses can
be isolated using:
Recast income statement.
Adjusted income statement.

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 LOS P2.A.4.c.

Off-Balance-Sheet Financing
Why?
• Motivation: manage the perception of indebtedness.
How?
• Accomplished by hiding the obligation or future claims
from the balance sheet.
Benefit:
• Firm benefits by obtaining the use of the asset without
recording the obligation.

Part 2, Section A, Topic 4: Special Issues 35

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 LOS P2.A.4.c.

Off-Balance-Sheet Financing (cont.)

• Factoring of accounts receivable
• Special-purpose entities
• Operating leases
• Joint ventures

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 LOS P2.A.4.c.

Question: Reasons to Use

Off-Balance Sheet Financing
All of the following are popular reasons that
companies may use off-balance sheet financing
except:
a. To improve certain financial ratios.
b. To increase assets and debt on the balance sheet.
c. To mitigate or transfer risk.
d. To make use of an asset without showing the
corresponding liability on the balance sheet.

Answer:
b.
Part 2, Section A, Topic 4: Special Issues 37
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 LOS P2.A.4.c.

Question: Off-Balance Sheet Financing

All of the following are forms of off-balance sheet
financing except:
a. Completing a horizontal merger.
b. Creating a special purpose entity.
c. Factoring accounts receivable.
d. Forming a joint venture.

Answer:
a.
Part 2, Section A, Topic 4: Special Issues 38
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 LOS P2.A.4.f.

Earnings Power/Quality
Best possible estimate of the average business earnings
over a number of years, preferably over an entire business
cycle
Two major considerations are:
1. Earnings power and time
2. Adjustment of reported earnings

Part 2, Section A, Topic 4: Special Issues 39

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 LOS P2.A.4.e.

Book Value versus Market Value

Book Value: The number on the balance sheet
(assets minus liabilities)

Market Value: Actual or estimated fair value

in the marketplace

Part 2, Section A, Topic 4: Special Issues 40

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 LOS P2.A.4.r.

Market to Book Value Ratio

Current Stock Price
Market to Book Value Ratio =
Book Value per Share

Question: The current market price of ABC Company

stock is $43.50 per share. What is ABC Company’s
price-to-book-value ratio for Y2?

Answer: 6.42
Recall from the prior slide that Book Value per Share
= $677,704/100,000 Shares = $6.78 per Share
Market to Book Value Ratio = $43.50 per Share/$6.78 per
Share
Market to Book Value Ratio = 6.42
Part 2, Section A, Topic 4: Special Issues 41
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 LOS P2.A.4.e.

Book Value per Share

Total Stockholder’s Equity – Preferred Equ

Book Value per Share
=
Number of Common Shares Outstanding

Question: What is ABC Company’s book value per share

in Y2?

Answer: $6.78

$677,704 – $0/100,000 = $6.777

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Question: Market versus Book

Value
Morton Starley Investment Banking is working with the management
of Kell Inc. in order to take the company public in an initial public
offering. Selected information for the year just ended for Kell is as
follows.

If public companies in Kell's industry are trading at a market to book

ratio of 1.5, what is the estimated value per share of Kell?
a. $27.50
b. $21.50
c. $13.50
d. $16.50
Answer:
d. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.e.

Question: Why Book and Market Values Differ

Which of the following statements is true?
a. Book value is usually higher than market value and is
calculated by dividing net earnings by the number of
common shares outstanding.
b. Book value is usually lower than market value and is
calculated by dividing net earnings by the number of
common shares outstanding.
c. Book value is usually lower than market value and is
calculated by dividing the common shareholders' equity by
the number of common shares outstanding.
d. Book value is usually higher than market value and is
calculated by dividing the common shareholders' equity by
the number of common shares outstanding.
Answer:
c. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.e.

Question: Book Value per Common Share

XYZ Company has revenues of $5,000,000, with net
income of $750,000. Its total assets are $6,000,000
(with current assets of $1,500,000), and its total
liabilities are $2,500,000 (with current liabilities of
$500,000). This leaves equity of $3,500,000, of
which $500,000 is preferred shareholders' equity.
XYZ Company has 1,000,000 shares of common
stock outstanding. What is XYZ Company's book
value per common share?
a.$3.
b.$3.50.
c. $1.
d.$2.
Answer:
a. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.e.

Question: Why Market Value May

Be Higher Than Book Value
Which one of the following best describes why the
market value of a company may be significantly higher
than the book value?
a.The company may still be using machinery which
has been fully depreciated.
b.The current growth in revenue may be difficult to
maintain in coming years.
c. The company may have recorded goodwill for an
acquisition that has been unexpectedly difficult to
merge with existing operations.
d.The company may have recorded in the current
period revenues for sales which may be returned in
future periods.
Answer:
a. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.b.

Effects of Changing Prices and

Inflation
• The value of the monetary unit has become increasingly
distorted by inflation.
• Inflation reduces the relevance and comparability of
historical financial statements, having a significant
compounding effect over time.
• Inflation has been relatively low in the United States, so
it is not of significant importance in the country.
However, one must consider the impact of inflation when
dealing with other countries.

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 LOS P2.A.4.b.

Question: Historical Cost versus

Fair Value Ratios
Consider the statements below comparing financial ratios based on
historical cost to those based on fair value. Which statements are
correct?
I. Fair value disclosures can supplement historical cost ratio analysis.
II. If market prices decline, then ratios using fair value prices will show
better results than those using historical cost.
III. If market prices decline, then ratios using fair value prices will show
worse results than those using historical cost.
IV. If market prices increase, ratios using fair value prices will show
higher ratios than those using historical cost.

a. I, III, and IV, only.

b. I and III, only.
c. II, III, and IV, only.
d. I, II, and IV, only.
Answer:
a. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.b.

Question: Accounting for Changing

Price Levels
The Meade Corporation reports the following financial results.

Which of the following is correct?

a. Over the four-year period, reported sales increased by 12%, but 10% was caused by
inflation.
b. Over the four-year period, sales increased faster than cost of goods sold.
c. Inflation increased reported sales more than it increased reported cost of goods sold.
d. The rate of inflation exceeded the increase in reported sales between Year 2 and Year
3.

Answer:
a. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.a.

Conducting Business Internationally

Companies face multiple accounting challenges when
conducting business internationally:
• Accounting for sales made abroad and denominated in
FC
• Accounting for purchases made abroad and
denominated in FC
• Accounting for assets held abroad, the value of which is
denominated in FC
• Accounting for liabilities (debt) held abroad, the value of
which is denominated in FC
• Accounting for a foreign subsidiary that has to be
consolidated into a U.S.-domiciled corporation
• Accounting for intercompany transactions with a foreign
subsidiary
50
•Part 2, Section A, Topic 4: Special Issues
Hedging in foreign currency
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 LOS P2.A.4.a.

Foreign Currency Transactions

• Foreign currency transactions are those business
transactions denominated (i.e., to be settled) in a
foreign currency.
• Transactions must be converted into the currency of the
reporting entity (i.e., USD) at the transaction date, the
payment date, and the balance sheet date if such date
falls between the transaction and payment dates.
• Convert the foreign currency to USD using the exchange
rate (also known as the spot rate) in effect at the
transaction date, payment, date, and/or balance sheet
date as appropriate.
• The conversion process results in exchange gains or
losses. These gains or losses are reported in the current
Part 2, Section A, Topic 4: Special Issues 51
period income statement.
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 LOS P2.A.4.a.

Question: Functional Currency

The functional currency of an entity is defined as the
currency:

a. of the entity's parent company.

b. of the primary economic environment in which the entity
operates.
c. in which the books of record are maintained for all entity
operations.
d. of the primary country in which the entity is physically
located.

Answer:
b. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.a.

Sales Denominated in FC
• Sales and accounts receivable (if sale was made on
credit) are converted to USD on the transaction date
using the exchange rate (spot rate) in effect on that
date.
• Accounts receivable will be revalued again on the
balance sheet date (if the balance sheet date falls
between the transaction and payment dates) and again
on the payment date.
• An increase in the exchange rate between dates will
result in an exchange gain; a decrease in the exchange
rate will result in an exchange loss.

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 LOS P2.A.4.a.

Purchases Denominated in FC
• Purchases and accounts payable (if purchase was made
on credit) are converted to USD on the transaction date
using the exchange rate (spot rate) in effect on that
date.
• Accounts payable will be revalued again on the balance
sheet date (if the balance sheet date falls between the
transaction and payment dates) and again on the
payment date.
• An increase in the exchange rate between dates will
result in an exchange loss; a decrease in the exchange
rate will result in an exchange gain.

Part 2, Section A, Topic 4: Special Issues 54

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 LOS P2.A.4.a.

FC Transaction Conversion Example

Scenario: On December 1, Year 1, RU Tuff Truckers, Inc., a US-domiciled
corporation, sells (exports) 1,000 vehicles to a German customer for
€1,000,000, when the direct exchange (spot) rate between the USD and
euro was $1.5413 = €1. The transaction is to be settled on February 1,
Year 2. RU Tuff Truckers, Inc. year end is December 31, Year 1. The
exchange rate increased on December 31, Year 1 to $1.6235 = €1, and
then declined on February 1, Year 2, to $1.5932 = €1. What exchange
gain or loss should the company report on December 31, Year 1, and
×
February 1, Year 2?
Accounts receivable (in USD) at December 1, Year 1: €1,000,000
× 1.5413

= $1,541,300
Accounts receivable revalued at December 31, Year 1: €1,000,000
×
1.6235
= $1,623,500; This represents an increase from December 1, Year 1, or
an exchange gain of: $82,200
Accounts receivable revalued at February 1, Year 2: €1,000,000 1.5932
Part 2, Section A, Topic 4: Special Issues 55
= $1,593,200; This represents a decrease
Wiley CMAexcel Learning System, Part 2: Financial Decision Making
from December 31, Year 1 (the
last revaluation
Copyright date),
© 2019, Institute of or Accountants.
Management an exchange Published byloss of:
John Wiley $30,300
& Sons, Inc.
 LOS P2.A.4.a.

Translating Financial Statements of

Foreign Subsidiary
• A foreign subsidiary of a U.S. business generally maintains its accounting
records in the currency of the country in which the subsidiary is located
(i.e., the local currency). This currency is often deemed its functional
currency. FASB ASC Topic 830, Foreign Currency Matters (formerly
addressed in FASB Statement No. 52), defines functional currency as the
currency of the primary economic environment in which the subsidiary
operates.
• Before preparing consolidated financial statements, FASB ASC Topic 830
requires that a U.S. parent company convert or translate its subsidiary
financial statements from the subsidiary’s functional currency into the
reporting currency of the U.S. (parent) company (i.e., the USD).
• If, however, the subsidiary’s local currency differs from its functional
currency, the subsidiary’s financial statements must first be remeasured
from the local currency into the functional currency.
• The U.S. parent company then translates the foreign subsidiary functional
currency financial statements into the USD (or reporting currency).
• Remeasurements of local currency financial statements to functional
currency result in gains or losses that are reported in the income statement;
translations of functional currency financial statements (or local currency
financial
Part 2, Sectionstatements
A, Topic 4:ifSpecial
the same) Issuesto reporting currency (USD) are reported 56
inCMAexcel
Wiley stockholders’ equity
Learning System, as a component
Part 2: Financial Decision Making of other comprehensive income.
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 LOS P2.A.4.a.

Remeasurement/Translation
Approaches
FASB ASC Topic 830, Foreign Currency Matters,
prescribes two methods for remeasurement/translation:
• The historical rate/temporal approach—used for
remeasurements (i.e., converting from local currency
to functional currency)
• The current rate approach—used for translations (i.e.,
converting from functional currency to reporting
currency or from local currency to reporting currency if
the local currency and functional currency are the
same)

Part 2, Section A, Topic 4: Special Issues 57

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 LOS P2.A.4.a.

Question: FX Transaction Gain/Loss

On December 8, 20X1, Andrews Corporation
purchased component parts from an unaffiliated
foreign entity in Europe for $20,000 Euro when the
spot rate was 1.25. The spot rate was 1.15 on
December 31, 20X1. Andrews paid the invoice on
January 8, 20X2, when the spot rate was 1.10. What
amount should Andrews report as a foreign currency
transaction gain in its December 31, 20X1 income
statement?
a. $0
b. $2,000
c. $1,000
d. $3,000
Answer:
b. 2, Section A, Topic 4: Special Issues
Part
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 LOS P2.A.4.a.

Question: FX Gain/Loss
On December 8, 20X1, ATI Corporation, based in the
United States, sold inventory to BMZ, an unaffiliated
foreign entity, in Europe for 10,000 Euros when the spot
rate was 1.25 Dollars / Euro. The spot rate was 1.15
Dollars / Euro on December 31, 20X1. BMZ paid the
invoice on January 8, 20X2, when the spot rate was 1.10
Dollars / Euro. What amount should ATI report as a foreign
currency transaction gain or loss in its December 31, 20X1
income statement?
a. $1,000 loss
b. $1,500 loss
c. $1,000 gain
d. $1,500 gain
Answer:
a. 2, Section A, Topic 4: Special Issues
Part
Wiley CMAexcel Learning System, Part 2: Financial Decision Making
59

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 LOS P2.A.4.a.

Question: Translation Methods

SFAS 52 (ASC 830) permits two different methods for
converting the financial statements of foreign subsidiaries
into U.S. dollars. When the functional currency is the local
currency of the foreign entity, the foreign financials are
translated into U.S. dollars using the:
a. Temporal method.
b. Current rate method.
c. Historical cost method.
d. Functional currency method.

Answer:
b. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.a.

Question: Translation Adjustment

At the end of a fiscal year a parent company translates the
financial statements for their foreign subsidiary. A net
liability balance sheet position exists and the foreign
currency has depreciated over the past year. Which of the
following statements is true?
a. There is no translation adjustment.
b. There is no transaction gain or loss.
c. There is a negative translation adjustment.
d. There is a positive translation adjustment.

Answer:
d. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.a.

Question: FX Remeasurements
If the books of a foreign entity are maintained in a
currency other than the functional currency, foreign
currency amounts must be re-measured into the
functional currency. Which of the following items
should be re-measured at the historical rate?
a. Prepaid expenses.
b. Property, plant, and equipment.
c. Accounts receivable.
d. Cost of goods sold.

Answer:
b. 2, Section A, Topic 4: Special Issues
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 LOS P2.A.4.a.

Question: FX Remeasurement at
Current Rate
If the books of a foreign entity are maintained in a
currency other than the functional currency, foreign
currency amounts must be re-measured into the
functional currency. All of the following items should
be re-measured at the current rate except:
a. Prepaid expenses.
b. Accounts payable.
c. Inventory carried at market value.
d. Accounts receivable.

Answer:
a. 2, Section A, Topic 4: Special Issues
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Section A Conclusion
• Section A content represents 25% of the multiple-
choice questions on the Part 2 exam.
• This content may also be tested in essay question
format.
To reinforce your learning:

• Study all the LOS for the section.

• Study all material for Section A in the WCMALS self-
study book.
• Use the practice test questions in the WCMALS self-
study book.
• Take the Section A practice test in the Online Test
Bank for a wider range of questions on all topics in the 64
Part 2: Section A: Financial Statement Analysis
section.
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Section A Practice Questions
We will now review the Practice Questions from the WCMALS
self-study book, Section A.

• Questions identified by topic.

• More questions on each topic and a full section test are
included in the Online Test Bank.

Part 2: Section A: Financial Statement Analysis 65

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Session 3 Wrap-Up
Content covered in Session 3
• Section A, Topic 3: Profitability Analysis
• Section A, Topic 4: Special Issues
• Section A Practice Questions

Content to be covered in Session 4

• Section B, Topic 1: Risk and Return
• Exercise: Capital Asset Pricing Model
• Section B, Topic 2: Long-Term Financial Management

Part 2: Financial Decision Making 66

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