CFA Level 2 – 22nd Feb

1.

Correct Answer: B

Investment in associate:

Purchase price $1,000,000,000

EI’s share of HD’s net income

$200,000,000(0.35) $70,000,000

Dividends received

$98,000,000 (0.35) ($34,300,000)

Amortization of excess purchase price

attributable to plant and equipment

($300 million (0.35) –$500,000)/10 ($10,450,000)

Investment balance $1,025,250,000

2.

Correct Answer: C

Equity Income:

Walter’s share of Wood’s reported income 30%(975,50 0) $292,650

Amortization of excess purchase price (65,000/8) ($8,125)

Unrealized profit ($7,140)*

Equity Income $277,385

*Walter’s profit on sale 250,000 – 165,000 = $85,00 0

Wood’s sells 180,000/250,000 = 72% of the goods purchased; total unrealized profit = 85,000 (0.28) =
$23,800, Walter’s share of unrealized profit = 0.30(23,800) = $7,140
3

Correct Answer: B

Sweeney is incorrect. There is a small difference between IFRS and U.S. GAAP in their inclusion of
contingent liabilities. IFRS include contingent liabilities if their fair values can be reliably measured. U.S.
GAAP includes only those contingent liabilities that are probable and can be reasonably estimated.

Anderson is correct. The difference between the acquisition price and the fair value of the acquired net
assets is recognized immediately as a gain in the profit and loss under both IFRS and the U.S. GAAP. Also,
both IFRS and U.S. GAAP now require minority interests to be reported on the consolidated balance
sheet as a separate component of stockholder’s equity.

4.Correct Answer: A

Under the full goodwill method, goodwill on the consolidated balance sheet would be the difference
between the total fair value of the subsidiary and the fair value of the subsidiary’s identifiable net
assets: 105,500,000 – (5,350,000+4 7,000,000+75,500,000-45,200,000) = $105,500,000- $82,650,000 =
$22,850,000.

The value of the noncontrolling interest will equal the noncontrolling interest’s proportionate share of
the subsidiary’s fair value: 105,500,000(0 .15) = $15,825,000

5.Correct Answer: B
Under the partial goodwill method, goodwill on the parent’s consolidated balance sheet would be the
difference between the purchase price and the parent’s proportionate share of the subsidiary’s
identifiable net assets: $85,500,000 – (0.85)(82,650,000) = $15,247,500.

The value of the non-controlling interest equals the noncontrolling interest’s proportionate share of the
fair value of the subsidiary’s identifiable net assets: 0.15(82,650,000) = $12,397,500.

6.Correct Answer: C

Statement 3 is incorrect. The amount reported in other comprehensive income is net of taxes.

Statement 4 is incorrect. IFRS require that held to maturity securities be recognized initially at fair value
plus transaction costs, whereas U.S. GAAP require held to maturity securities be initially recognized at
cost including transaction costs.

7.Correct Answer: C

The investment in Jador Inc. will be reported as £4,500,000 at the time of purchase.

IFRS requires that investments reported as held to maturity are initially recognized at fair value plus
transaction costs. Subsequent to initial recognition, IFRS requires that held-to-maturity investments are
reported at amortized cost using the effective interest rate method.

8.Correct Answer: C

Subsequent to initial measurement, the investment in Jador Inc. will be reported in the balance sheet at
amortized cost. The amortized cost is calculated as follows (£’000):

(1) (2) (3) (4)

Interest Interest Amortization= Carrying

Payment Income (1) – (2) Value

1/1/2010 4,500

31/12/2010 240 157.5 82.5 4,418

(1) 8% ×par value £3,000,000 = £240,000

(2) 3.5% × carrying value £4,500,000 = £157,500

(4) £4,500,000 – (£82,500) = £4,417500

9- B

Amounts recorded in the income statement (£’000) = changes in fair value + dividend payments

= (£3,240 – £2,875) + (0.025 × £2,875)

= £436.875 ≈ £437

For investments recorded at held for trading, any dividends/and or interests paid on the investment in
addition to fair value changes are recorded in the income statement.

10.Correct Answer: C

The amount of goodwill recorded on Rigor’s balance sheet under the partial goodwill method is +
£1,292,000. This amount is calculated as follows:

Acquisition price* 2,825,000

Less: 70% of fair value of net assets** 1,533,000

Goodwill 1,292,000

*The fair value of Rigor’s shares exchanged for Vito’s shares is equal to the acquisition cost in Exhibit 1,
£2,825,000, which represents the acquisition price.

** Fair value of net assets = Total Assets – Total Liabilities

= £4,001,000 – £1,811,000

= £2,190,000

11.Correct Answer: A

A significant influence in a corporation is classified as an investment in an associate. Investment in

associates should be accounted for by the equity method.
12.Correct Answer: B

The closing value of Vito’s revalued machinery, which is recorded on the consolidated balance sheet as
at December 31, 2010 is £334,800.

Since Rigor has acquired a controlling interest in Vito, Vito’s assets will be recorded in Rigor’s balance
sheet at the fair value at the date of acquisition less any subsequent depreciation and revaluations.

· Given the machine has an original cost of £500,000 and

had a total useful life (at the time of purchase) of 8 years, annual depreciation
charge

is £62,500 (£500,000 ÷ 8 years).

· Thus the net book value prior to the valuation is

£312,500 [£500,000 – (62,500 × 3*)].

· *On the date of revaluation, January 1, 2010, the

remaining useful life is 5 years. Thus 3 years (8 – 5 years) of the useful life have

elapsed.

· Increase in PPE (net) using Exhibit 2 on revaluation date

is £106,000 (£1,546,000 – £1,440,000)

· Machinery’s revalued amount = £418,500 (£312,500 +

£106,000)

· Revaluation date onwards annual depreciation charge =

£83,700 (£418,500 ÷ 5 years)

· Machinery’s net book value at December 31, 2010 is

£334,800 [£418,500 – (£83,700 × 1 year)

 13.Correct Answer: A
Statement 1 is correct. Firms following IFRS would expense the entire cost immediately. Past service
costs are generated as a result of plan amendments. Under IFRS past service costs are recognized as
an expense in the P&L. In contrast, under U.S. GAAP, past service costs are reported in other
comprehensive income in the period in which the change giving rise to the cost occurs.

Statement 2 is incorrect. Under U.S. GAAP, unamortized past service costs are reported in
accumulated other comprehensive income and subsequently amortized over the average service lives
of the affected employees; the amortized amounts are included in the income statement.
14.

14.Correct Answer: C
Under U.S. GAAP, actuarial gains and losses that are recognized immediately are included as a
component of pension expense. However, under IFRS, actuarial gains and losses are recognized as
part of other comprehensive income and are not subsequently amortized to P&L. If they are treated
as other comprehensive income, this can reduce the volatility of pension expense (but increase the
volatility of equity).

U.S. GAAP only allows the deferred recognition of actuarial gains and losses using either the corridor
method or the faster recognition method to determine the minimum amount to be reported on the
income statement. Park has defined only the corridor method; under the faster recognition method the
actuarial gains and losses can be amortized more quickly.

15.Correct Answer: A
Estimated final year’s salary: $92,736
Estimated annual payment for each of the 20 years: (92,736×0.025)(10+5) = $34,776
Value at the end of Year 5, of the estimated future payments: $383,179.6
Annual unit credit: 383,179.6/15 = $25,545.30
Benefits attributed to prior years: Annual unit credit (10) = $255,453.
Opening obligation: 255,453/(1.065)5 = $186,450.25
Interest cost = 186.450.25(0.065) = $12,119.269

16.Correct Answer: A
Statement 3 is correct. An increase in the assumed discount rate can increase the interest cost.
However, the interest component of the pension obligation and pension expense may decrease if the
decrease in the opening obligation more than offsets the effect of the increase in the discount rate (this
is the typical effect).

Statement 4 is incorrect. An increase in life expectancy will have no effect on the promised
pension payments because the payments are to be paid over a fixed time period.
 17.Correct Answer: A
Total periodic pension costs = Ending funded status – contributions – beginning funded status

Total periodic pension costs = ($25,670 – $24,586) – ($19,615 – $18,956) – $65 = $360
18.
18.Correct Answer: B
If Care Medicines complied with IFRS, it would report remeasurement amounts as part of
net income:

Remeasurements = net return on plan assets* - actuarial gains and losses

*Net return on plan assets = Actual return – (Plan assets × Interest rate)

Remeasurements = [$980 – (12% × $19,615)] + $1,500 = $126.20 ≈ $126

19.Correct Answer: A
The amount of pension liability recognized under U.S. GAAP for the year 2009 is 466 million.

Under U.S. GAAP the amount recognized under a defined benefit plan is the pension plan’s funded
status. The funded status represents the difference between the fair value of the plan assets and the
projected benefit obligation (present value of the pension liabilities). If the projected benefit obligation
exceeds the fair value of the plan assets, this suggests that the plan is underfunded.

In the case of Hewer Corporation, the projected obligation as at December 31, 2009 exceeds the fair
value of the corporation’s plan assets on the same date ($589 million vs. $123 million).

20.Correct Answer: B
For both the 2008 and 2009 periods, total periodic pension costs exceeded employer/employee
contributions (in 2008 periodic pension costs exceeded contributions by $54 million and in 2009
pension costs exceeded contributions by $75 million). In the event that periodic pension costs exceed
contributions, the excess can be viewed from an economic perspective as a source of financing. In the
case of both 2008 and 2009, the appropriate adjustment would be to reclassify the excess as an inflow
related to financing activities rather than to operating activities, i.e. decrease operating cash flows
and increase financing cash flows.

Since the corporation has not made these cash flow adjustments, its operating cash flows are
21. overstated financing flows are understated for both the periods presented.
21.Correct Answer: B
The actuarial loss recognized by Hewer Corporation in its 2009 income statement is $7.0 million.

Under the corridor method, the net cumulative unrecognized actuarial gains and losses at the
beginning of the reporting period are compared with defined benefit obligation and the fair value of
the plan assets at the beginning of the period.
 If this cumulative unrecognized amount exceeds 10% of the greater of the PBO or the fair value
of plan assets, the excess is amortized over the expected average remaining working lives of the
employees participating in the plan and is included as a component of pension expense.

  PBO at the beginning of 2009 = $448 million

  Fair value of plan assets at the beginning of 2009 = $149 million

  Net cumulative unrecognized actuarial gains/losses at the beginning of 2009 = $150 million
 PBO balance ($448 million) > Fair value of plan assets ($149 million). Thus the PBO value is
used.
  10% of the PBO amount = $44.8 million ($448 million × 10%)
Unamortized portion of net actuarial loss = $105.2 million ($150 million – $44.8 million)

 Amortized portion of actuarial loss (recognized in 2009’s income statement) = $7.01
million ($105.2 million ÷ 15 years)

22.
22.Correct Answer: C
Amongst the actions listed, a(n):

increase in the discount rate to 12.2% in 2010 from 12.1% in 2009, will decrease the value of
the PBO being reported in 2010.

decrease in the actual return on plan assets to 8.5% will not affect the PBO amount as actual
return on plan assets are not used in the PBO computation.

increase in the rate of compensation increases to 3.8% in 2010 from 3.5% in 2009 will
increase the value of PBO being reported in 2010.

23.Correct Answer: C

Amongst the rate assumptions listed in Exhibit 2, the discount rate assumptions, expected return on
plan assets, and annual compensation rate increases are internally consistent. This is because these
rates are all increasing over the periods, 2008 and 2009 and thus correspond to the increase in the
expected inflation rate over the two periods. However, the actual return on plan assets is internally
inconsistent with these rates (including the expected inflation rate) as this rate of return remains
constant at 8% over the two years.

24.Correct Answer: B
On January 1, 2008, 2 years of the vesting period have elapsed and 1.5 years remain.

For the year 2008, the compensation expense recognized is $360 million ($540 million ÷ 1.5 years).

For the year 2009, the compensation expense recognized is $180 million ($540 million –
$360 million).
25.Correct Answer: C

The funded status is equal to $17,236 ($87,200 – $6 9,964) which the difference between the ending
defined benefit obligation and fair value of plan assets,

26.Correct Answer: B
Net interest expense = Change in beginning of period funded status × discount rate

Net interest expense = $(54,500 – 60,000) × 12% = – $660

27.Correct Answer: C
Using the sponsor’s 2010 contributions of $15,425 and a $6,000 total pension costs, the sponsor’s
contributions exceed the pension expense by a pre-tax amount of $9,425 ($15,425 – $6,000). The
after-tax amount by which the sponsor company’s contributions exceed the pension costs is $7,068.75
or approximately $7,069 [$9,425 × (1 – 0.25)].

Since the sponsor’s contributions exceed the total pension costs, the excess is equivalent to a
repayment on a loan in excess of the scheduled payment (financing use of funds). This excess is
treated as an increase in cash inflow from operating activities and an increase in cash outflow from
financing activities by $7,069. Put another way, the $7,069 excess is treated as a decrease in cash
outflow from operating activities and a decrease in cash inflow from financing activities.

28.Correct Answer: A
Periodic pension costs are calculated as follows:

Total periodic pension costs (income) = Ending funded status – Employer

contributions – beginning funded status.

Total costs (income) = ($87,200 – $69,964) – $15,42 5 – ($60,000 – $54,500)

= ($3,689)
29.Correct Answer: B
Benefit 1: s
Stock options have payoffs, which can be characterized as asymmetric or one-sided. In other words,
the potential for profits (when the underlying stock price exceeds the option exercise price) is
unlimited on the upside and losses (when the stock price falls below the exercise price) are limited
to the option premium.

Thus the potential for risk aversion is limited and the potential for returns is unlimited on the
upside. This benefit accurately reflects a benefit of issuing stock to firm employees.

Benefit 2:
Although the issuance of stock option will dilute shareholder ownership in the future, as the options
are exercised and underlying shares are issued, the firm does not simultaneously issues shares with its
stock options issue. Regardless of whether the stock options dilute shareholdings immediately or in
the future, the firm’s existing shareholders will be affected by the issue once the options are
exercised (and associated shares issued). Thus benefit 2 does not accurately reflect a benefit of
issuing stock options to existing firm shareholders.

Benefit 3:
 When stock options are issued an annual compensation expense in recorded on the firm’s income
statement thereby reducing the firm’s profitability. Additionally, stock options can dilute the firm’s
earnings per share. Thus the issuance of stock options can reduce the firm’s overall profitability as well
an individual shareholder’s share in firm profitability. Benefit 3 misrepresents the benefit as well as effect
of issuing stock options on firm profitability.

30.Correct Answer: B
The fair value of an option tends to decrease with
a(n): increase in underlying exercise price;
increase in assumed dividend yields; and
decrease in stock price volatilities.

31.Correct Answer: B

Final salary= ($75,000) (1.0525)14 = $153,522

32
32.Correct Answer: C
Lump Sum Payment at Retirement = (0.025 × 161,581)1 5 = $60,593.

33.Correct Answer: A
Annual Unit Benefit = Value at Retirement/ Years of Service
= $56,553/15
= $3,770

34.Correct Answer: A
Benefits attributed to prior years in year 5 = Annual unit credit ($3,770) × 4

35. = $15,080
35.Correct Answer: C
Lump Sum Payment at Retirement = (0.025 × $161,581) 20

= $80,791.

36.Correct Answer: B
Annual Unit Benefit = Value at Retirement/ Years of Service

= $20,197/20
= $1,010
37.Correct Answer: A
In order to determine where foreign currency translation gains/losses are recorded, it is necessary to
determine the method to be used to translate El-Co Fiesta’s financial statements into U.S. $. This
method, in turn, is determined by the relationship of the functional currency of the subsidiary and the
presentation currency of the parent (Bernstake Ltd.).

The relevant functional currency is determined primarily by the currency in which the subsidiary
generates and expends cash; the currency which influences the sales price of goods and services; and
the currency of the country whose competitive forces and regulations mainly determine the sales price
of its goods and services.

In the case of the El-Co Fiesta, the relevant functional currency is the ARP. Since this currency
differs from the parent company’s presentation currency, the relevant translation method to use is
the current rate method. The current rate method records translation gains/losses as part of
comprehensive income, a component of stockholder’s equity.

38.Correct Answer: A
The appropriate translation method is the current rate method (see the solution to part 1). Under this
method all monetary and non-monetary assets are translated at the current rate (at December 31,
2009). Thus total assets, in U.S. $ terms, amount to $603,478.26 (ARP 3,470,000 ÷ ARP 5.75/U.S.
$) or approximately $603,000.

39.Correct Answer: B
Under the temporal method, Bernstake Ltd. would incur a foreign currency translation loss if the
subsidiary’s monetary assets were less than its monetary liabilities (or vice-versa) and foreign
currency weakened (or strengthened). The parent company would incur a translation gain if the
subsidiary’s monetary assets were greater than its monetary liabilities (or vice-versa) and
foreign currency strengthened (or weakened).

Based on the exchange rate trend, the ARP has weakened (over the year 2009) from being worth 4.45
to 5.75 for every US$. Additionally, translating El-Co Fiesta’s financial statements would result in a
translation gain as it as has a net monetary liability exposure (the monetary assets, ARP 1,420,000,
are less than the monetary liabilities, ARP 1,730,000) and the ARP has depreciated.
 40.Correct Answer: A
The temporal method will produce an inventory turnover ratio that is identical to the pre-translation
ratio. Pre-translation ratio is 0.85 (ARP 850,000/ARP 1,000,000) and ratio under the temporal method
is 0.85 [(ARP 850,000 ÷ 4.85)/ (ARP 1,000,000 ÷ 4.8 5)].

The ratio produced under current rate method will be 0.96 [(ARP 850,000 ÷ 5.10)/(ARP 1,000,000 ÷
5.75)]. This ratio is higher to the one calculated from the temporal method. This is because the ARP
has depreciated relative to the dollar, resulting in a lower US$ value for the inventory figure (which is
converted at the current rate) under the current method, hence a lower denominator for the ratio. On
the other hand, inventory under the temporal method is translated by using the rate at which inventory
was acquired. As the rate at which inventory was acquired is historical, the inventory translated under
this method has a higher US$ value producing a higher denominator and decreasing the inventory
turnover ratio.

If El-Co Fiesta used the LIFO method for inventory valuation (instead of FIFO), all inventory units
on the balance sheet would have comprised of older items and thus valued at relatively older
exchange rates, resulting in higher translated inventory values. Thus LIFO method produces a higher
denominator and hence a lower inventory turnover ratio also decreasing the ratio is the lower
translated value of the cost of goods sold (translated at a newer, lower exchange rate). Current FIFO
inventory valuation method would have resulted in lower translated inventory values (relative to the
LIFO method), as the inventory would have relatively recent items with more recent rates being used.
This produces a smaller denominator and hence a higher inventory turnover ratio. Also increasing the
ratio is the higher translated value of the cost of goods sold (translated at a newer, lower exchange
rate).

41.Correct Answer: A
Since long-term bonds are monetary liabilities, these are translated using current exchange rates under
the temporal method. Thus the U.S. $ value of notes payable amounts to $222,608.70 (ARP
1,280,000 ÷ ARP5.75/U.S. $) or approximately $223,0 00.

42.Correct Answer: A
Under hyperinflationary periods, IFRS requires nonmonetary assets to be restated for the general
purchasing power unit of the monetary unit. These restated assets will then be translated under the
current rate method at the current exchange rate.

Inflation-adjusted inventory = ARP 1,000,000 × 130/ 100

= ARP 1,300,000

Translated Inventory = ARP 1,300,000 ÷ ARP 8.00/U.S . $

= $162,500
43.Correct Answer: C

Since France Co has a net monetary liability exposure and the Euro has appreciated relative to the
dollar (Exhibit 4), the best course of action for the subsidiary would be to finance the purchase of the
plant using equity rather than debt (long-term notes payable) since capital stock is not exposed to
foreign exchange risk under the temporal method.

The subsidiary has a net monetary liability exposure of €6,740 million as its monetary assets
(cash and accounts receivable), €3,825, are less than its monetary liabilities (total liabilities),
€10,565 million.

Eliminating capital stock is not a recommended course of action since the notes payable are exposed
to foreign exchange risk under the temporal method (which is used as the translation method since
the presentation and functional currencies are identical), whereas capital stock is not.

France Co’s existing cash balance of €175 million c an only partially reduce its liabilities of €10,565

million. If the parent were required to pay off France Co’s remaining liabilities of €10,390 million
(€10,565 million – €175 million), it would need to send US$ 6,754 million (€10,390 million × US$
0.65/€) on January 1, 2010. On December 31, 2010 Ar ioco-P would be required to send US$ 7,793
million (€10,390 million × US$ 0.75/€) to pay €10,3 90 million. This will result in a foreign exchange
loss of US$ 1,038 million (US$ 7793 million – US$ 6 ,754 million), thereby failing to
eliminate exposure.

44.Correct Answer: B

Given that the Euro has appreciated from 0.65 to 0.75 relative to the US dollar, France Co will
report a translation loss under the temporal method as its monetary liabilities are greater than its
monetary assets (see the previous solution) resulting in a reduction in net income and hence its total
equity balance.

On the other hand, since the current exchange rate used to translate total assets under the current
method is greater relative to the historical exchange rates used to translate assets under the temporal
method and since it has a net asset exposure of €4, 566 million (€15,131 million − €10,565 million),
there will be a positive translation adjustment. Since the positive translation adjustment will increase
the total equity balance, this will result in a higher total balance being reported for the subsidiary
under the current rate method.

45.Correct Answer: A

A higher gross profit margin will be reported under the temporal method.

Under both methods, sales will be translated at the average rate. The rate at which cost of goods sold
is to be translated will determine the method to produce the highest gross profit margin for the
subsidiary.
Under the current rate method, cost of goods sold is translated at the average rate, i.e. US$ 0.70 per
€. The rate at which cost of goods sold is translated under the historical method will be an older and
lower rate, given the increase in the value of Euro over the 2010 period. Thus, the cost of goods sold
will be higher and gross profit lower under the current rate method, which produces a lower gross
profit margin using this method.

46.Correct Answer: A
Given that France Co.’s functional currency is identical to Arioco-P’s presentation currency, US$,
the temporal method is used to determine its translated retained earnings as follows:

€ (millions) Exchange rate (US$ $ (millions)

per €)
Cash 175 0.75 131.25
Accounts Receivable 3,650 0.75 2,737.50
Inventory 4,530 0.67 3,035.10
Total current assets 8,355 5,903.85
Property, plant, and
equipment 15,136 0.65 9,838.40
Less: accumulated
depreciation (8,360) 0.65 (5,434.00)
Total assets 15,131 10,308.25
Total liabilities 10,565 0.75 7,923.75
Capital stock 2,000 0.65 1,300.00
Retained earnings 2,566 to balance 1,084.50
Total 15,131 10,308.25

Since France Co was established on January 1, 2010 it has no opening retained earnings.

47.Correct Answer: C
Implication 1 has been inaccurately identified. Implication 2 has been inaccurately identified.

In scenarios of hyperinflation, U.S. GAAP simply requires the foreign currency financial statements
of the concerned subsidiary to be translated using the temporal method. On the other hand, IAS 21
(IFRS) requires foreign currency financial statements to be restated for inflation and then translated
using the current rate.

Under the temporal method and U.S. GAAP, liabilities will be translated at an exchange rate of AD
125.53 per US$. Under IFRS, liabilities will not be restated for inflation as they are expressed in
terms of the monetary unit current at the balance sheet date. Thus under the current rate method and
IFRS, these liabilities will be translated at the same exchange rate as used under the temporal method,
i.e. AD 125.53 per US$. Thus the translated liabilities under the two standards are identical.

Inflation in Algeria increased by 300% or by 3 times over the 2010 period. At the same time, the AD
lost about 26% [(125.53 – 100)/100] of its value. S ince the decrease in currency value is not matched
by the change in local inflation, IFRS and U.S. GAAP will produce different results.

48.Correct Answer: A
Using the temporal method (see the solution to part 4), France Co’s closing inventory account
balance is approximately US$ 3,035 million (€4,530 million × US$ 0.67 per €).
49

50

51.

52.
53.

54.
55.

56.
57.

58.

59.
60.