Financial Reporting and Analysis
June 2013 CFA Level 1 Group
Arif Irfanullah
haidriqbal
Frank Brill, CFA, is concerned that Moses Aviation is overstating its profits. The best indicator of such action would be Moses Aviation’s:
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Your answer: B was incorrect. The correct answer was A) recognition of revenue from barter transactions.
While an unusually high sales-growth rate may indicate fraud, it could also indicate good management. It’s a yellow flag, but not the best indicator of accounting shenanigans. Rising inventory is also a dual signal. It could be meant to overstate profits, or it could simply reflect an actual buildup of inventory in response to market forces or corporate operations. However, companies should not recognize revenue from barter transactions. The additional revenue is likely to improperly boost profits.
haidriqbal
Falcon Financial Group is considering the purchase of Company A or Company B based on a low price-to-book investment strategy that also considers differences in solvency. Selected financial data for both firms, as of December 31, 20X7, follows:
|
in millions, except per-share data |
Company A |
Company B |
|
Current assets |
$3,000 |
$5,500 |
|
Fixed assets |
$5,700 |
$5,500 |
|
Total debt |
$2,700 |
$3,500 |
|
Common equity |
$6,000 |
$7,500 |
|
Outstanding shares |
500 |
750 |
|
Market price per share |
$26.00 |
$22.50 |
The firms’ financial statement footnotes contain the following:
- Company A values its inventory using the first in, first out (FIFO) method.
- Company B’s inventory is based on the last in, first out (LIFO) method. Had Company B used FIFO, its inventory would have been $700 million higher.
- Company A leases its manufacturing plant. The remaining operating lease payments total $1,600 million. Discounted at 10%, the present value of the remaining payments is $1,000 million.
- Company B owns its manufacturing plant.
To make the firms financials ratios comparable, calculate the adjusted price-to-book ratios for Company A and Company B.
| Company A | Company B |
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Your answer: B was incorrect. The correct answer was C) $2.17 $2.06
Company A should be adjusted for the operating lease liability and the related assets; however, adding the present value of the lease payments to both assets and liabilities does not change equity (book value). Thus, Company A’s adjusted P/B ratio is 2.17 = [$26 price / ($6,000 million equity / $500 million shares)]. Company B’s inventory should be adjusted back to FIFO by adding the LIFO reserve to both assets and equity. Thus, Company B’s P/B ratio is 2.06 = $22.50 / [($7,500 million equity + $700 million LIFO reserve) / 750 million shares].
I understand how this question has to be attempted however I would like to know how we should tackle such a huge question to be able to easily attempt it in 1.5 mins.
On Tuesday, 12 February 2013 21:17:16 UTC+5, June 2013 CFA Level 1 Group wrote:
haidriqbal
Enduring Corp. operates in a country where net income from sales of goods are taxed at 40%, net gains from sales of investments are taxed at 20%, and net gains from sales of used equipment are exempt from tax. Installment sale revenues are taxed upon receipt.
For the year ended December 31, 2004, Enduring recorded the following before taxes were considered:
- Net income from the sale of goods was $2,000,000, half was received in 2004 and half will be received in 2005.
- Net gains from the sale of investments were $4,000,000, of which 25% was received in 2004 and the balance will be received in the 3 following years.
- Net gains from the sale of equipment were $1,000,000, of which 50% was received in 2004 and 50% in 2005.
On its financial statements for the year ended December 31, 2004, Enduring should apply an effective tax rate of:
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Your answer: B was correct!
Total taxes eventually due on 2004 activities were (($2,000,000 × 0.40) + ($4,000,000 × 0.20) =) $1,600,000. Permanent differences are adjusted in the effective tax rate, which is ($1,600,000 / $7,000,000 =) 22.86%. Of the $1,600,000 taxes due, (($2,000,000 × 0.50 × 0.40) + ($4,000,000 × 0.25 × 0.20) =) $600,000 were paid in 2004 and $1,000,000 ($1,600,000 − $600,000) is added to deferred tax liability.
Another question I would like to know how to attempt.
On Tuesday, 12 February 2013 21:17:16 UTC+5, June 2013 CFA Level 1 Group wrote:
shruti....@gmail.com
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