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2008 MOCK

CORE KNOWLEDGE EXAM


S olutions

PRJCEWATERHOUSECWPERS:

11

PASS MULTIPLE CHOICE EXAM

2008 Practice - Core Knowledge Examination 2 Solutions

1. Correct response is (D).

The Board of Directors have opened themselves up to personal liability, as non-payment of


withholdings to the Receiver General could result in Revenue Canada going after the Board
members personally, to pay the withholdings. This is the most serious risk. Paying salaries at the
end of the month will be unlikely to create human resource risk, as it is unlikely that employees
will leave the company in an economic downturn, because they are being paid once a month as
opposed to twice a month (answer A). Answer B is not correct, as paying their suppliers will not
impact their customers. Answer C is not correct, as they have not done anything that will affect
their reputation.

2. Correct response is (C).

The most serious risk facing BL is leadership risk, because of the President leaving. Currency
and financial instrument risk are less of a problem, as there is a hedge of the receivable with a
forward contract. Operations risk is not an issue, as there is no evidence that operations are
suffering, such as product/service failure, efficiency etc.

3. Correct response is (A).

Since enterprise risk management is a more formally structured approach and more top-down,
management buy-in is more difficult and it is sometimes harder to get management support and
acceptance for the program. Therefore, A is not one of the advantages.

4. Correct response is (C).

C is incorrect as at least some of the audit committee members should be independent. All of the
other choices are accurate in describing the audit committee responsibilities.

5. Correct response is (D).

The encryption and access controls are protective controls that prevent unauthorized access to
private information. C is a detective control that would only identify an access control violation,
and potential privacy breech after it occurred. Documented policies (A and B) do not always
mitigate the risk under consideration.

6. Correct response is (B).

The useful life of a piece of equipment is typically the shortest of its physical, technological, or
commercial life.

(Page 1)

7. Correct response is (B).

In goods delivered on a trial basis, significant risks of ownership are not generally transferred.
Accordingly, revenue is typically not recognized until the trial period ends.

(A) is incorrect because normally warranties for manufacturing defects do not cause the seller to
retain significant risks and rewards and the amounts payable can typically be estimated.
(C) is incorrect because delivery f.o.b. shipping point means title to the equipment has passed at
the shipping point at which time revenue would generally be recognized.
(D) is incorrect because the current financial status of the company would be considered in
determining whether collection is reasonably assured.

8. Correct response is (A).

CICA 1651.38 indicates that equity method investments financial statements are translated into
the functional currency of the reporting enterprise before the equity method is applied.

(B) is incorrect because the financial statements of the equity method investment are translated
into Canadian dollars before applying the equity method (1651.38).
(C) is incorrect because cumulative translation differences do arise on foreign equity method
investments as a result of translating their financial statements into the functional currency of the
reporting enterprise.
(D) is incorrect. Since an equity method investment is not controlled by the reporting enterprise,
it is unlikely to be an integrated foreign operation.

9. Correct response is (B).

Future income taxes are deemed to be monetary (CICA 1651.52). Preference shares redeemable
by the holders would be classified as a liability in the reporting enterprise's consolidated financial
statements. Accordingly they would be considered monetary items since they are a claim to
money (CICA 1651.03(b)).

(II) is incorrect because non-refundable prepayments for services are not claims to money, they
are claims for services.
(III) is incorrect because goodwill is not a claim to money.

10. Correct response is (D).

This report offers the manager timely results on his store's performance. A and B are incorrect
because the manager will require more timely feedback than an annual report provides. C is
incorrect because it does not provide as much information about the Toronto store as the report
described in D.

(Page 2)

11. Correct response is (C).

The rent is calculated as [($1,000*1.05 + $1,200*1.05)/2]. Per EIC 19:

... lease payments that depend on factors that are measurable at the inception of the lease, such as
the consumer price index or the prime interest rate, are not, in substance, contingent rentals in
their entirety and should be included in minimum lease payments based on the index or rate
existing at the inception of the lease.

(A) is incorrect because it excludes the interest factor which would be payable in year 1.
(B) is incorrect because it does not take into account straightlining of operating lease rentals
(CICA 3065.30).
(D) is incorrect because it includes the index change in year 2 as part of the straight line
calculation. However, straight line rental payments are calculated at the inception of the lease and
average LIBOR for the first year would not be known at that time.

12. Correct response is (B).

The lease rentals under an operating lease should be included in income over the lease term on a
straight-line basis, unless there is a more representative systematic and rational basis. (53065.30)
In this case, the correct answer is to sum up all 4 years and divide by 4 ($100,000 + $125,000 +
$150,000 + 0) / 4 = $93,750.

(C) is incorrect because it does not use the straight line basis to compute the lease rentals, as
recommended in the Handbook, but simply takes the actual amount paid in year 1.
(D) is incorrect as it computes the straight line calculation using 3 years, not 4 years.

13. Correct response is (C).

CICA 3461.087 indicates that the method for amortization of actuarial gains and losses should
apply consistently to gains and losses. The policy described defers recognition of gains, but not
losses.

(A) is incorrect because although it would be appropriate to use a lower threshold than 10%, it is
not appropriate to defer gains, but not losses.
(B) gives an incorrect reason for disallowing the policy (see A)
(D) is incorrect because it ignores the requirement in CICA 3461. 087 to treat gains and losses
consistently.

14. Correct response is (C).

In computing the compensation expense, the fair value of the options that are expected to vest
should be should be amortized over the vesting period. Of the 150,000 options, 98% are expected
to vest which amounts to 147,000. The total fair value of the options based upon a fair value per
option of $2.75 is $404,250. This amount should be amortized over the vesting period of 4 years
or 48 months in order to calculate the compensation expense.

$404,250/48 months X 9 months (options granted at beginning of 2nd qtr) = $727

(Page 3)

15. Correct response is (B).

The financial instruments standards permit an entity to choose an alternative of expensing


transaction costs as incurred. As long as this meets the condition of being more reliable and
relevant information, it would be a voluntary change in accounting policy. (CICA 1506.14)

(A) is incorrect because adoption of accounting policies for items previously immaterial is not a
voluntary change in accounting policy (CICA 1506.16(b))
(C) is incorrect as it is explicit in CICA 1506.20 that early adoption of a primary source of GAAP
is not a voluntary change in accounting policy
(D) is incorrect because accounting policies adopted for new circumstances are not voluntary
changes in accounting policy (CICA 1506.16(a))

16. Correct response is (A).

Per new inventory handbook section 3031, inventory must be measured at the lower of cost and
net realizable value. Net realizable value (NRV) refers to the net amount that an entity expects to
realize from the sale of inventory in the ordinary course of business (i.e. $963 per ounce) less the
estimated costs of completion and the estimated costs necessary to make the sale (in this case $8
per once). NRV is an entity-specific value, so if the company enters an agreement to sell the
inventory for a particular amount, that amount would constitute the NRV even if the normal
market value is some other amount (i.e. $958). Accordingly there would be a decrease in the
value of the inventory of per unit of $103 based upon cost of $1,058 less $955 ($963 - $8). Based
upon a 100 units this would amount to a decrease in the total value of the inventory of $10,300.

17. Correct response is (B).

The accounting policy decision to capitalize versus expense costs incurred to develop a prototype
impacts the way the expenditure is classified and thus presented on the cash flow statement. If
development costs are expensed, they are in included in net income and will be included in cash
flows from operations. If those same expenditures are capitalized, they will appear on the cash
flow statement as an investing activity. In subsequent years, amortization of capitalized costs is
deducted in determining net income, but is later added back to net income to arrive at cash flow
from operations. The result is that capitalized costs will never enter into cash flow from
operations but will appear as an investing activity.

Policy choices regarding revenue recognition & amortization (including salvage value) have no
impact on the cash flow statement as accruals are reversed and amortization expense added back.

18. Correct response is (C).

Revenue has been appropriately recognized in this case, as the sale has met all of the criteria
necessary to recognize revenue when delivery has not occurred ("bill and hold").
Criteria can be found in EIC-141, under Section 2(a).

(Page 4)

19. Correct response is (B).

In January 2006, the Accounting Standards Board announced its decision to require all Publicly
Accountable Enterprises to report under International Financial Reporting Standards for years
beginning on or after January 1, 2011.

The change from Canadian GAAP to International Financial Reporting Standards will apply to all
Publicly Accountable Enterprises, which include listed companies and any other organizations
that are responsible to large or diverse groups of stakeholders, including non-listed financial
institutions, securities dealers and many co-operative enterprises.

20. Correct response is (A).

The goodwill of the furniture reporting unit at the date of the acquisition is calculated as follows:

The value assigned to net assets excluding the customer list was $60 million. The fair value of
the customer list was $5 million. Hence the total value of the assets is $65 million. The value
assigned to the liabilities was $20 million. Therefore the value of the net assets was:

=$65- $20
= $45

The goodwill would be based upon the fair value of the reporting unit of $65 million less the
value of the net assets at the date of acquisition of $45 million which results in goodwill of $20
million.

As of the date of the impairment test, the fair value of the reporting unit was $40 million. The
value of the net assets is $30 million (i.e. $52 million less $22 million). Therefore the fair value
of the goodwill at year end (the date of the impairment test) is $10 million based upon $40
million less $30 million.

The impairment loss would be calculated as follows:

$20 million (carrying value of goodwill) less $10 million (fair value at the date of the impairment
test at year end) = $10 million.

21. Correct response is (A).

A loss must be accrued on a purchase contract when all of the following criteria are met:
1) The contract is not subject to change or cancellation - i.e unavoidable
2) The loss is likely and material - i.e. likely future sacrifice
3) The loss can be reasonably estimated - i.e. measureable

22. Correct response is (B).

The cost related to creation of the prototype meet the criteria for development under 3064.40.
However, the cost to search for the new plastic is considered research and therefore must be
expensed as incurred. In addition, market surveys as well as engineering focus groups would also
be considered research.

(Page 5)

23. Correct response is (C).

The CICA handbook permits differential reporting for qualifying enterprises. In general a
qualifying enterprise is one that:
1. Is a non publically accountable enterprise:
a. Does not have shares or securities that are publically traded
b. Is not otherwise publically accountable, (i.e. excludes co-operatives)
2. Its owners unanimously consent to the application of differential reporting options

There is no size test. Any company that meets the above criteria can use differential reporting.

24. Correct response is (D).

As a general rule, the sale of an HTM asset prior to its maturity would taint the category. As per
Section 3855.26:

An entity does not classify any financial assets as held to maturity when the entity has, during the
current financial year or during the two preceding financial years, sold or reclassified more than
an insignificant amount of held-to-maturity investments before maturity (more than insignificant
in relation to the total amount of held-to-maturity investments). One exception would be when
the investments are so close to maturity or the financial asset's call date (for example, less than
three months before maturity) that changes in the market rate of interest would not have a
significant effect on the financial asset's fair value.

In this case, given that the sale was 10 days before maturity this exception would likely apply.
Also, the sale took place following year end rather than during the current financial year or during
the two preceding financial years.

25. Correct response is (D).

To comply with S. 1535 "A" "B" and "C" must be disclosed.


There is no specific requirement to disclose the weighted average cost of capital.

(Page 6)

26. Correct Response is (C).

The total liability that needs to be accrued is $75,000 as this is the amount that will likely be paid
out. For balance sheet purposes it is not possible to offset the $75,000 and the $50,000 that the
company will recover from the insurance company as a financial asset and a financial liability can
only be offset and the net amount reported in the balance sheet when an entity:

(a) has a legally enforceable right to set off the recognized amounts; and
(b) intends either to settle on a net basis, or to realize the asset and settle the liability
simultaneously.

In this case the asset and liability will not be settled simultaneously. Rather the liability first has
to be paid out and 30 days later the receivable will be recovered. Therefore offsetting of the asset
and liability would not be allowed.

However on the income statement one would be allowed to offset the $50,000 recovery against
the expected cost of $75,000 and reflect a net expense of 25,000.

27. Correct response (A).

In order for PI to consolidate the other companies they must have control over them. Control is
presumed to exist with a majority ownership unless there are indications to the contrary.
Therefore with majority ownership consolidation is likely to be appropriate.

Currently PI owns 50 shares of BI (i.e. 25% of the 200 shares outstanding). In order for PI to
own a majority of the shares of BI it would have to acquire at least 51 more shares of BI. This
would give PI 101 out of 200 shares outstanding. If PI is able to control BI then they will also be
able to control Fl. The reason for this is that if PI controls BI it can control how BI votes all of its
shares of Fl. PI is therefore in the same position as if it directly held the 40% of the shares of Fl
that are held by BI. PI also already likely controls LI through owning 60% of its shares
outstanding. Accordingly it can control how LI votes all of its shares of FI. PI is therefore in the
same position as if it directly held the 45% of the shares of Fl that are held by LI.

Thus this situation is treated in the same manner as if PI directly owned 40% of FI plus 45% of Fl
which would give PI majority ownership of Fl (i.e. ownership of 85% of the shares of FI).
Therefore in addition to consolidating LI and BI, PI would also likely be able to consolidate Fl.

28. Correct response (A).

A not-for-profit organization would not have a statement of comprehensive income. Therefore an


increase in value in an investment which a not-for-profit organization classified as available for
sale would be recorded in the Statement of Changes in Net Assets.

(Page 7)

29. Correct response is (D).

The application of accounting policies that are consistent from period to period unless a change in
accounting policy is appropriate under GAAP relates to comparability rather than reliability. The
recording of events in a manner that conveys their substance rather than necessarily their legal
form relates to "representational faithfulness". The correct application of a basis of measurement
relates to "verifiability". The use of conservatism in making judgments under conditions of
uncertainty relates to "conservatism". Representational faithfulness, verifiability and
conservatism are all aspects of reliability.

30. Correct response (D).

Reliability and relevance are the most likely to conflict. For example there may be a trade-off
between the timeliness of producing financial statements (which relates to relevance) and the
reliability of the information reported in the statements. Also, it may be more relevant to provide
certain information but there may be a problem with reliability. For example it may be more
relevant to provide the fair value for a certain type of asset but their may a problem with the
reliability of the fair value.

31. Correct response is (A).

A company that is highly dependent on its information system would require as little downtime as
possible in the event of a disaster. Unlike the other options, a hot site offers access to all of the
hardware and operational facilities required to continue operations.

32. Correct response is (B).

This set of duties is the only option that does not include tasks that provide the controller with the
capability to "change the accounting program." A, C and D include incompatible functions.

33. Correct response is (B).

The skill level of employees does not necessarily mitigate the risks faced by the company when
incompatible functions cannot easily be separated. A, C and D are all examples of appropriate
compensation controls.

34. Correct response is (C).

Piggybacking refers to the interception of communications between the system and an authorized
user. One common way to mitigate this risk is to program the system to automatically sever the
authorized communication line in periods of prolonged inactivity.

35. Correct response is (A).

Managers cannot attempt to mitigate all risks associated with an information system. It is
possible that managers may identify, but choose to accept, some IT risks.

(Page 8)

36. Correct response is (D).

An engagement letter does not require a description of the engagement team or partners. The
other responses are components required in establishing the terms of engagement.

37. Correct response is (D).

The audit is being conducted in accordance with the terms of the contract and therefore (D) is the
correct answer. (C) is incorrect as the contract required an "assurance" report.

38. Correct response is (B).

The auditor is required to report to the audit committee those misstatements identified during the
course of the audit that management has agreed are immaterial in aggregate to the financial
statements. The auditor is not required to provide specific audit procedures; but rather would
communicate the overall audit strategy. The auditor cannot state that fraud does not exist; rather,
they would be required to communicate if they found indications of fraud existing.

39. Correct response is (C).

The auditor is not required to review the working papers of a secondary auditor. If the primary
auditor in their judgment has not acquired the necessary audit assurance from other procedures
then they should review the working papers of the secondary auditor.

40. Correct response is (A).

The auditor is not required to review the working papers of the specialist or to assess the
calculations underlying their work. The auditor is expected to assess the reasonableness of the
source data used by the specialist in their work.

41. Correct response is (B).

The inherent risk is high due to the fact that Maple is a new client for Ziggy and the contracts for
Maple are complex (span multiple years). Control risk is assessed as low as management has
implemented strong controls over the financial reporting.

42. Correct response is (A).

The risk of the engagement has increased as Forty has planned to expand and the extension of the
credit facility is dependent upon the release of the current year's audited financial statements.
Materiality is unchanged as Fony's bank was a prior t sser of the financial statements and their use
is unchanged by extending the credit facility further.

(Page 9)

43. Correct response is (D).

Rayon Ltd. did violate the independence rule as management should have approved the journal
entries. There was not a problem with providing bookkeeping services for a non-public entity,
nor was there a problem providing staff at a reduced charge-out rate, as the work was still based
on hours provided at a chargeable rate.

44. Correct response is (B).

B is not correct, as the qualification paragraph comes before the negative assurance paragraph,
which is the last paragraph in the report.

45. Correct response is (B).

The future potential owners of Dello are unknown (i.e. it is not a publicly traded company) and
therefore no consideration would be made for unforeseeable direct users of the current financial
statements when establishing materiality.

46. Correct response is (A).

The issuance of management bonuses in itself is not a factor for materiality unless those bonuses
were subject to change based on the financial results. The other options are all quantitative or
qualitative factors to consider when establishing the level of materiality, i.e. in (b) covenants
impact the bank and in (c) regulations involve other users.

47. Correct response is (A).

The CAAT does not meet the assertion of completeness as it is only working with the current
existing revenue transactions and would not find other transactions not recorded within revenues.
The CAAT does not meet the assertion of existence as it is testing an income statement account
that is a total of the fiscal year's occurrences of revenue.

48. Correct response is (D).

Given the high reliance upon the system and vast geographic locations that hold the substantive
audit evidence; the best audit approach would be to use CAATs on the system and test the
controls of management review.

49. Correct response is (C).

The bank is concerned about the internal controls and due to the fact that the controller has left, a
special report on the internal controls over financial reporting would be the best report to give
them some assurance with respect to the internal controls.

(Page 10)

50. Correct response is (B).

The geographic distance of a location from the head office or audit location does not impact
whether a location should be visited during a course of an audit. The other factors are valid
considerations when planning for a multi-location audit.

51. Correct response is (A).

FWJ is not allowed to provide advocacy services while at the same time as providing assurance
services, regardless if different partners are involved.

(C) is not correct, as there is no problem accompanying Umami to the bank and explaining
factual information to them, as long as they are not providing advocacy services at the same time.
(D) is not correct, as a separate engagement letter is not necessary for FWJ to accompany Umami
to the bank.

52. Correct response is (C).

The procedure will obtain comfort that the equipment exists and comfort towards valuation by
seeing that the equipment is either in operational condition and not obsolete.

53. Correct response is (D).

GAAS requires the auditor at a minimum to obtain an understanding of the controls at a client.
Given the weak control environment (only one employee at each location and limited employees
at the head office) and operations of the client, a mainly substantive approach would be the most
efficient at obtaining audit comfort.

54. Correct response is (B).

The internal audit department of a client can be used in the direct execution of an audit with the
proper planning and supervision over the internal audit staff.

55. Correct response is (D).

Agreement of the securities to the trade ticket or broker statement will only provide assurance on
the existence of the securities. Obtaining pricing quotes at purchase date and at year-end provides
only valuation assurance. A combination of the procedures in (A or B) and (C) would be required
to obtain comfort over both existence and valuation.

56. Correct response is (C).

An effective audit committee reviews key judgements and estimates made by management, but is
not responsible for developing those estimates and judgements because this would impair their
objectivity with respect to the financial statements.

(A), (B) and (D) are all duties which would commonly be carried out by an audit committee.

(Page 11)

57. Correct response is (A).

(I) is correct because reconciling goods leaving a warehouse to sales would alert management to
goods that were shipped without being invoiced.
(II) is incorrect because this would ensure existence of revenues, not completeness.
(III) is incorrect because variances showing excess inventory would alert the company to
problems with the occurrence of revenues (only variances showing too little inventory would alert
the company to a problem with completeness).
(IV) is incorrect because having the receptionist open mail is a control over completeness of cash
receipts. Sales would be recognized as goods were shipped.

58. Correct response is (C).

Interest rate risk is concerned with what would happen if market interest rates change. Companies
respond to interest rate risk through managing fixed versus floating borrowing profiles,
optimizing financing between debt/equity, and entering into economic hedging arrangements with
interest rate derivatives.

(II) is incorrect because it is evidence of a control over liquidity risk rather than operating risk.

59. Correct response is (B).

Insurance is a risk management tool that some entities use to control risks of losses of key
operating assets.

(A) is incorrect because not having insurance does not generally lead to a going concern note in
the financial statements.
(C) is incorrect because a purchased insurance policy does not meet the definition of a financial
liability.
(D) is incorrect because a purchased insurance policy would be a contingent asset rather than a
contingent liability.

60. Correct response is (D).

Hiring a local CA to perform a notice-to-reader provides management with no assurance over the
financial results of the foreign operation.

(A) would provide some assurance to management that it was meeting key tax and regulatory
requirements.
(B) and (C) would both provide management insight over the financial statements and
performance of the foreign branch.

61. Correct response is (B).

A banker's acceptance is a money market instrument and since it was issued previously, it would
now trade in the secondary market.

(Page 12)

62. Correct response is (C).

In order for the investment to be profitable there must be a positive net present value (NPV).
NPV = PV of annuity equal to the annual cost savings after tax per year over 5 years at 7%, plus
tax shield less the cost of the investment.

Computation of Tax Shield

$1,180,000 x .25 (tax rate) x .3 (CCA rate) X (1 + .07*/2) = $231,365


(.07* + .3) (1 +.07*)

* represents discount rate

Annuity factor for 5 years @ rate of 7% = 4.1

In order for this investment to produce a positive NPV the present value of the savings over 5
years on after tax basis plus the tax shield must exceed the initial investment.

4.33 (X *(1- .25)) + $231,365= $ 1,180,000

X = $292,112

292,112/925,000 = 31.6%

63. Correct response is (C).

The stock price is based upon: expected dividend / (required rate of return - growth rate)

In this case the dividend 2008 was $2.00; however it is the expected dividend that is used to
determine stock price. The expected dividend for 2009 is $2.00 + the amount by which the
dividend will grow (i.e. the growth rate) in 2009.

So we can solve for the growth rate as follows (with X being the growth rate):

2.00+ 2.OOX/ (.08 - X) = 41.20

2.00 + 2.OOX =41.2 x (.08-X)

2.OOX+41.2X= 3.296-2.00

43.2X = 1.296

X = .1.296/43.2 = .03 = 3%

Therefore the constant growth rate that will result in a price of $41.20 is 3%.

The yield in 2009 will be $2.06 */$41.20 = 5%


(which is the same as it was before the growth in dividends)

* Based upon 2008 dividend of $2.00 X 1.03 in light of 3% growth rate.

(Page 13)

64. Correct response (C).

A pre-emptive right is the right of existing stockholders to purchase new issues of the company
stock before it is offered to the public, so that existing stockholders can maintain proportionate
ownership of the company, if desired and avoid losing control. So if a corporation wants to raise
more money by issuing new common shares, if it offers pre-emptive rights to existing
shareholders, they can maintain their proportionate ownership of the company. The company will
provide existing stockholders with subscription rights (aka rights certificates), giving
stockholders the right, but not the obligation, to buy the new shares at a specified price-the
subscription price (which is usually lower than the market price).

If the company issues preferred shares there should also not be a loss of control, as preferred
shares are typically non voting.

However if convertible debt is issued, common shares would be issued upon conversion, should
the debt holders decide to convert their debt into common shares which could lead to loss of
control.

65. Correct response is (D).

Debt covenants will not always impact a company's dividend policy, as the company may not
have a debt covenant or even if it does it may not impact dividends.

66. Correct response is (C).

Payback period does reflect the risk of the investment as the quicker the payback the less risky
the investment. Also the quicker the payback, the more liquid the investment. It however does
not accurately measure the profitability of the investment, as it ignores any cash flows beyond the
payback period.

67. Correct response is (D).

Free cash flow is a measure of financial performance calculated as operating cash flow minus
capital expenditures and dividends. Free cash flow (FCF) represents the cash that a company is
able to generate after laying out the money required to maintain or expand its asset base. (Please
note that it is in the calculation of sustaining capital reinvestment that expenditures for expansion
would be excluded). Free cash flow is important because it allows a company to pursue
opportunities that enhance shareholder value. While money expended to inventory is included in
the calculation given that changes in working capital impact operating cash flow, amounts
expended to pay down long term debt are not included in calculating free cash flow. Rather free
cash flow can potentially be used to repay long term debt.

(Page 14)

68. Correct response is (A).

(B) is not correct as if a company reduces its variable costs as a proportion of total costs, that has
no impact on financial leverage; it only impacts business risk. Therefore the first part of the
statement in (B) is not correct. (C) is not correct as the financial leverage will not always have an
impact on the return on equity. For example if a company borrows at a rate of X% to invest and
earns exactly the same after tax rate of return on its investment, the return with and without
financial leverage will be the same. (D) is not correct, as regardless of the relative stability of a
company's demand, an increase in financial leverage will lead to an increase in financial risk,
(although the increase in risk may not be as much as for a company with very unstable demand
for its product).

69. Correct answer (A).

Valuation of PI Based upon Capitalized Earnings Approach

Calculation of maintainable earnings

2008 2007 2006

Earnings $1,450,000 $2,102,000 $1,395,000

Non Recuring items:


Lawsuit 130,000
Change in interest (note 1) 6,000 3,000
Start up costs 135,000
Discontinued operations (note 2) 8,100
1,456,000 2,235,000 1,538,100

Taxes @40% (note 3) 582,400 894,000 615,240

Maintainable earnings after tax 873 COQ 1,341,000 922.860

Notes

1. For 2008 the adjustment to interest is based upon .5% (i.e. 7% - 6.5%) X $1,200,000 of debt equals
$6,000. For 2007 the impact is only half of $6,000 as the debt was only outstanding for half of 2007.

2. Based upon a loss from discontinued operation calculated as follows: Sales of $48,000 less direct
costs $56,100.

3. The 40% rate is based upon the relationship between net income after tax vs. net income before tax
for each of the 3 years.

Average maintainable earnings: $1,045,820.

The value of the business based upon the capitalized earnings approach is based upon:

Maintainable earnings of $1,045,820 X Multiple of (1/12.5%) plus Redundant assets $397,000 =


58,763560.

(Page 15)

70. Correct answer is (A).

Capians Inc. will need to ration its capital given that it has available investments which in total
require funding of $230 million, but is only able to raise $115 million. In order to determine
which projects to invest in, the profitability index (PI) for each project should be computed, and
only those projects with the highest ranking indices should be undertaken. As the company has
$115 million of funding the following projects should be chosen, as they have the highest PI's:
Labrinth, Drexdale, Balsisus, Capior and Agrium. If these projects are chosen, the company will
utilize its $115 in the most efficient manner thus maximizing the NPV from all projects
combined.

Project Profitability Ranking


Investment NPV Index
Name
B(/A)

Agrium $ 45,000,000 $ 9,000,000 .20 5


Balsisus $ 15,000,000 $ 4,200,000 .28 3
Drexdale $ 60,000,000 $ 18,000,000 .30 2
Labrinth $ 35,000,000 $ 20,000,000 .57 1
Capior $ 10,000,000 $ 2,100,000 .21 4
Tel Al $ 25,000,000 $ 4,000,000 .16 6
Carcic $ 40,000,000 $ 6,400,000 .16 6

71. Correct response is (C).

Although in some cases, the senior management team's involvement in the implementation is
necessary, not all technology implementations require this level of management involvement. In
all new technology applications, the skill level of staff, implementation timeline, budget and
effect on the overall organizational strategy must be considered.

72. Correct response is (A).

Although the restrictions on data processing (B), DPA's reputation (C) and reporting flexibility
(D) are important considerations in the outsourcing process, the most important consideration is
the level of controls of LeBleu's information. If adequate controls over LeBleu's information do
not exist, risks associated with the information system (e.g., privacy, integrity etc.) increase.
Increased risk associated with the outsourcing decision is likely to force LeBleu to select a
different third party service provider, or to continue processing the payroll in-house.

73. Correct response is (D).

When data is created to test a system, the user can test how the system handles a variety of
inaccuracies. Existing information (A) is less likely to contain inaccuracies. User involvement
(B) and module testing (C) would only determine how the system handles inaccuracies if
inaccurate, dummy transactions were used in testing.

(Page 16)

74. Correct response is (B).

The preference of the users would be the least important consideration. The level of
customization required (A), the skill level of the IS staff (C) and the time line for implementation
(D) are all factors that could limit the ability of the company to develop the product in house.

75. Correct response is (A).

The direct implementation method has the shortest conversion timeline. However, errors found
in the system would affect all departments using the new system (B). Unlike the parallel method
of conversion, this conversion method does not provide opportunities to test the accuracy of data
(C), or have access to a backup processing system (D).

76. Correct response is (A).

Because the company relies heavily on its client processing system to manage customer orders,
parallel conversion would be the most suitable. Parallel conversion provides the opportunity to
test out the new program, while maintaining the operations of the old program. In the event that
problems arise with the new program, the company could continuously service its client's with
the old program, without any interruption in service.

77. Correct answer is (B).

Due to the level of analysis and detail required, zero-based budgeting is not cost effective.

78. Correct answer is (A).

A common reason to introduce ideal standards is to communicate with employees what the ideal
performance standard could be. Employees may be motivated to work towards this high
performance standard, and in so doing may perform better than they might have otherwise.
However, the variances between standard and actual performance measures are almost always
going to be negative, providing little insight or opportunity for additional analysis (B). (C) is
incorrect because all standard setting requires managers to consider quantity and cost, not just the
ideal standard setting process. (D) is incorrect because ideal standards do not provide the
expected performance, making forecasting difficult.

79. Correct response is (B).

The correct calculation is as follows:

budgeted fixed overhead X actual total number of labour hours


(total expected number of labour hours)

= (11,200/ (5,000 machines x 1.25 hours) ) x 7,000 hours


= 12,544

(Page 17)

80. Correct response is (B).

As the Cash Register Division is evaluated as a profit center, they would not be willing to accept
a price below the amount necessary to at least recover their incremental costs associated with the
order, as well as any lost contribution margin on sales to external customer, forfeited as a result of
the internal sale.

By accepting the order the Cash Register Division will have to give up sales of 150 units as they
have demand for 1,600 units; the order from the other division is 350 units and full capacity is
only 1,800 units.

Therefore, the Division will not sell the registers at an amount below the incremental variable
costs per unit of $900 for the first 200 units (which can be sold without giving up sales) and for
the next 150 units they will need to recover not only the variable costs but also the lost
contribution margin on the sales. Therefore they will need to recover the full sales price of
$1,450. In addition they will need to recover the additional fixed costs of $19,250 which are only
being incurred due to the increased volume generated by the order from the Sporting Goods
Division.

Thus the Cash Register Division will have to recover an amount in excess of $416,750 based
upon the following calculation:

$900 (total variable costs) X 200 registers plus $1,450 X 150 registers plus $19,250 (incremental
fixed costs) = $416,750.

81. Correct response is (D).

The calculation is as follows:

(Standard Rate x Actual Hours) - (Standard Rate x Standard Hours)


= ($12.50 x 450 hours) - ($12.50 x (0.25 x 1300))
= $1,562.50 unfavourable

82. Correct response is (D).

The calculation is as follows:

(Actual Price x Actual Quantity) - (Standard Price x Actual Quantity)


= ($2.75 x 137,000 ml) - ($2.50 x 137,000 ml)
_ $34,250 unfavourable

83. Correct response is (C).

Decentralization often decreases the efficiency of business operations. Due to duplication of


efforts, and increased communication costs, decentralization is not more efficient for the overall
organization.

(Page 18)

84. Correct response (C).

Marginal cost only covers the variable costs associated with the good. Because your department
is a profit centre, already operating at full capacity, this transfer price will not allow you meet
your objective of profit maximization.

85. Correct response is (A).

Financial measures do not drive the value of the firm; non-financial variables (e.g., customer and
employee satisfaction, innovation and quality) drive value. Financial data (e.g., total revenue
earned) cannot capture this intangible information.

86. Correct response is (A).

The normal reassessment period ended on June 30, 2007, three years after the June 30, 2004 date
of the original notice of assessment.

(B) is correct because the deadline for the notice of objection is 90 days after July 11, 2008.
(C) is correct because, since the normal reassessment period is exceeded, the CRA can only
reassess Gary is there is misrepresentation in the tax return.
(D) is correct: s. 60(o).

87. Correct response is (C).

Recapture = $800,000 - $600,000 = $200,000


Taxable capital gain = % x ($1.1 million - $800,000) = $150,000
$350,000

88. Correct response is (C).

X Ltd. is connected to Y Ltd. because it owns more than 10% of Y Ltd.'s common shares: s.
186(4)). X Ltd. is not connected to Z Ltd. because it does not own more than 10% of Z Ltd.'s
common shares.

Part IV tax on Y Ltd. dividends = 15% x $10,000 dividend refund $ 1,500


Part IV tax on Z Ltd. dividends = 1/3 x $150,000 dividend received 50,000
51,500

89. Correct response is (C).

18% x $100,000, his 2007 earned income, maximum $20,000 18,000


Less: pension adjustment (5,000)
Add: unused RRSP deduction room at the end of 2007 2,000
Maximum RRSP contribution limit $15,000
(and $16,000 of contributions made)

(Page 19)

90. Correct response is (A).

UCC at the beginning of year $4,600


Plus purchase 24,000
Minus lesser of cost or proceeds on trade-in (4,000) 20,000
Less net amount of $20,000
%2 10 000
UCC for CCA purposes 14,600
CCA at 20% (2,920)
Add 1/2 net amount of $20,000 10,000
UCC at end of year 21 6 Q

91. Correct response is (C).

Business loss per above $3,000


Equipment ($30,000 FMV - $36,000 UCC) 6,000
Short term investments n/a
($12,000 FMV - $20,000 cost = $8,000 capital loss)
Eli gible cap ital prop ert y CEC - X $12,000 FMV)
3/4 1,0 00
$10,000

92. Correct response is (C).

Net capital losses and allowable capital losses expire:


December 31, 2006 net capital losses $20,000
Short term investments: 1/2 ($12,000 FMV - $20,000 cost) 4,000
$24,000

$24,000 x 2 = $48,000

Since the cost of the land is $80,000, the elected amount should be $128,000

($80,000 + $48,000)

93. Correct response is (A).

Salary $65,000
Bonus of $20,000 not taxable in 2008 since received in 2009
RPP contributions (employer portion): tax-free
Group term life insurance premiums 600
Registered pension plan contributions (employee portion) (8,000)
Union dues (1,000)
Professional dues to Professional Engineers Ontario 1 000
155,600

(Page 20)

94. Correct response is (C).

Frank cannot claim child care expenses as he is not the lower income spouse. Barbara can claim
$4,000 for child care expenses (the least of the $4,000 eligible for child above 7, the $12,000 paid
and 2/3's of her $30,000 earned income.

95. Correct response is (A).

The capital gain is $45,000 ($50,000 - $5,000) but the taxable capital gain is zero because it is a
gift of public company stock to a charity. The donation receipt will be for $50,000.

96. Correct response is (B).

S. 13(5.2) reallocates proceeds to eliminate a terminal loss on a building when there is a capital
gain on the sale of the subjacent land. Since the terminal loss before adjustment is $300,000
($400,000 minus $700,000), the proceeds allocated to the land is $700,000 ($ 1,000,000 minus
$300,000) and the capital loss is $100,000 ($ 700,000 minus $800,000).

97. Correct response is (B).

Since Mary is financially dependant upon Sally, the amount is included in her income because it
qualifies as a refund of premiums. Since Mary is not infirm or under 18, Mary cannot transfer the
$625,000 to her RRSP or annuity.

If Mary had not been financially dependant upon Sally, the amount would have been included in
Sally's income.

98. Correct response is (A).

Spousal RRSP withdrawals are included in the income of the contributor spouse to the extent of
the contributions in the year of withdrawal and the previous two years. Hence the amount
included in David's income is $8,000 ($5,000 plus $3,000) and the amount included in Denise's
income is the remaining $2,500.

99. Correct response is (B).

17% of the least of


1. $164,000 ($152,000 + $12,000);
2. $187,000 and
3. $400,000

Therefore, 17% x $164,000 = $27,880.

100. Correct response is (A).

The costs of changing address on legal documents; the costs of selling a house, and reasonable
traveling costs in moving the family members to the new residence are deductible under s. 62.

(Page 21)